GDDY - Wix.com: GAAP Losses Make It A Sell

2023-04-05 18:51:06 ET

Summary

• Wix has cut marketing, but remains unprofitable.
• The share count is up after more than $200 million in buybacks, showcasing how stock compensation is a real expense.
• Expect the stock to come down as insiders sell.

Introduction

Whenever I talk about a stock that is generating GAAP losses due to high stock compensation, I always get the same pushback: but the cash flow is positive! This is due to stock compensation being added back in a company's operating cash flow statement. I believe the FASB has made a mistake in this definition. The stock compensation amount is more accurately "cash flow from financing", as the company is effectively selling this amount of stock to fund its employee compensation. Given the way financial statements are currently presented, I would calculate free cash flow as operating cash flow less the stock comp add-back less capex, putting it in line with GAAP net income if there is no net working capital change. There are some other adjustments one can make, but those are minor in comparison. A company has to buy back stock equal to its stock compensation just to keep its share count flat. I will illustrate this concept with Wix.com ( WIX ).

Company background

Wix.com sells a service that enables small-businesses to create a website using drag and drop tools, along with some ancillary services like payments. The company got a boost from COVID, as small-businesses rushed to establish an online presence. It competes with Squarespace ( SQSP ), Weebly and GoDaddy ( GDDY ).

Wix was incorporated in 2016 and is headquartered in Tel Aviv, Israel. The company has been unprofitable for the last ten years , with modest losses growing larger over the last few years. The 20%+ revenue growth of yesteryears has given way to single digit % revenue growth in the last year.

Wix annual financial overview

For the fiscal year ending December 31, 2022, the company reported $1,388 million in revenue, up 9% YoY. Operating income was a loss of $285 million (-20% operating margin). The company did a creditable job of cutting expenses (particularly marketing) towards the end of the year, resulting in Q4 operating margin being -9%. It declared a non-GAAP profit in Q4 by excluding $60 million in share based compensation, amortization and acquisition- related expenses (although there is no evidence the company has made any acquisitions in the last year).

The company had 58.2 million shares in Q4 (up from 57.1 million a year ago, even after $232 million in buybacks) and a market capitalization of $5.8 billion. It reported $928 million of debt and $1,258 million of cash. It thus has an enterprise value of $5.5 billion, amounting to 4x its annual revenue. There are an additional 7 million shares from stock options and restricted share units that would be in the diluted share count if the company were to be profitable.

The balance sheet looked good, except for property and equipment jumping from $50.4 million last year to $108.7 million this year. The company is building a $150 million headquarters, and capitalizing the expense. You can see this in the cash flow statement as well, with capex of $70 million against depreciation of $17 million for the year. Higher depreciation is in the cards when the company starts using its swanky, new headquarters!

The company guided to $367 million to $371 million in revenue for the next quarter (up 7-9% YoY), and I believe this is achievable. For the full year, it expects revenue to be $1,510 million to $1,535 million or 9-11% growth. The higher end of this range looks aggressive to me, as it is more than the company is currently doing. Wix expects to be unprofitable on a GAAP basis, with stock compensation coming in at 15% of revenue. The company believes it will be on the path to achieve the "Rule of 40" in 2025.

And what is the "Rule of 40"?

Over the last few years, there's been a rule formulated that says a company is doing well if its free cash flow margin plus its growth rate is more than 40%. Except that the free cash flow calculation includes stock compensation, so a company that gears its employee compensation more towards stock has a better chance of meeting the threshold. I would define the metric as GAAP operating margin plus YoY revenue growth rate. On this measure, few companies pass (although some impressively do). Wix falls woefully short at -2% in its latest quarter. I see almost no chance that it will get anywhere near 40%, even after adding back a substantial amount of stock compensation.

The corroding effect of stock compensation

As I referenced before, Wix spent $232 million buying back stock in the last year, depleting its cash balance. However, its share count for the fourth quarter was still up a million shares from the prior year! How is this possible? The answer lies in the $237 million of stock compensation for the year. If properly valued, the company would need to spend this amount of money buying back stock to keep the share count flat. The share count for the fourth quarter is an average for the quarter, so on an ending basis, it is probably close to what it was a year ago. Assuming stock compensation is operating cash flow ignores the constant increase in shares coming on to the market, which have to find buyers. This expense is not "already in the share count" as people claim. It is a real expense for shareholders. Investors would be better off valuing companies on GAAP operating income, with an add-back for amortization of acquisition-related intangibles, if necessary. This amortization is usually a phantom expense for technology firms.

WIX stock valuation and recommendation

Wix doesn't believe its substantial stock compensation is a valid expense, but I do. However, I will be generous in valuing the company by assuming that its operating margin will increase over time to 8% from -9% in its latest quarter.

An 8% margin on forward revenues of $1.5 billion would result in normalized annual operating profit of $120 million. Due to the company's substantial net operating losses (accumulated deficit of $1.1 billion), I will assume that the company will never pay taxes. Thus, it would generate $120 million in after-tax operating income or $2 per share. I will apply a 25x multiple befitting a company growing close to 10%, to come to a per share value of $50 for the business. Then I will add back the approximately $5 per share of excess net cash on the balance sheet to arrive at fair value for the shares of $55, or 45% downside from the current share price of $100. The stock was close to this level in the middle of last year.

In a bull case, the company will get to a 12% operating margin. This would result in normalized annual operating profit of $180 million or $3 per share. I will apply a 35x multiple to get to a value per share of $105 for the business. Adding back $5 per share of net cash would result in fair value for the shares of $110 or 10% upside from the current price. You can see that the assumptions needed for upside are fairly aggressive - an improvement of more than 20% in the operating margin accompanied by a healthy multiple.

In a bear case, the company will get to only a 6% operating margin. This would result in operating profit of $90 million and operating earnings of $1.50 per share. A 25x multiple would result in the business being worth $38 per share. Adding back $5 of cash would result in fair value for the shares of $43, for 57% downside from the current share price.

Based on the above analysis, I recommend that investors sell any positions in WIX stock, as employees continue to sell the copious amount of stock they are awarded each year. For the intrepid, I recommend shorting the stock. The short interest is not high at 6% of float . If your broker pays you a short rebate on the sale proceeds, you can make more than 4% a year for holding the short position at current interest rates. The company does not pay a dividend.

External ratings

Seeking Alpha's quantitative system gives Wix a composite rating of 4.8, equating to a strong buy, with a D for valuation and D+ for profitability, offset by an A+ for growth, A- for momentum and A+ for revisions. Wall Street analysts are almost equally positive , with a rating of 4.05, translating to a buy.

Risks are moderate

Shorting a stock is not for the faint-hearted who cannot bear short-term losses. I recommend keeping each position small and manageable. The main risk I see is acquisition risk. At a $6 billion valuation, it is certainly in the deal range for a larger company or private equity firm.

Fundamentally, the company could grow rapidly and increase its margins a lot. I don't see this as very likely.

The Fed could pivot, money could become looser, and giddy investors could drive up the share price far higher than the fundamentals suggest.

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