2023-12-14 07:47:36 ET
Summary
- Squarespace is recommended as a buy due to its potential for capturing market share and growth in the online presence industry.
- The company is well-positioned to take advantage of the shift towards online interactions for small and medium-sized businesses.
- The acquisition of Google Domains and product innovation are expected to drive growth and increase revenue for Squarespace.
Investment overview
I give a buy rating for Squarespace (SQSP), as I believe SQSP to continue capture share and grow. As SQSP continues to roll out more product enhancements, it should increase their capabilities in up-selling, which I think is a key source of growth. Unlike what the macro headlines suggest, business remains stable, and I expect valuation to inflect upward once SQSP starts showing growth acceleration.
Business description
SQSP is a platform that helps companies develop their brands, websites, and other online presences. In essence, SQSP gives companies a simple way to establish an online presence, streamlines business-to-consumer [D2C] relationships, and supports commerce transactions. SQSP features (like websites, domains, and e-commerce tools) are usually very simple to use and navigate, and as such, businesses can perform them without any aid. Because SQSP mainly works with SMBs, which lack the in-house IT departments often required to write their own codes, this is crucial. The demand for SQSP is well shown in the historical growth rate of the business. Revenue has grown by more than 2.5x since FY18 to LTM3Q23. A better metric to show the underlying demand could be GMV, which has grown by more than 4.5x since FY18 (~$6.1 billion over the last 12 months.
Large addressable market
I believe SQSP is benefiting from a fundamental shift in the way that SMBs interact with their customers. In my opinion, COVID has been a major accelerator in this shift and has forced SMBs to be more open-minded in how they interact with end-consumers. The two easiest ways for SMBs to gain an online presence are: 1) Creating a website and 2) Create social media accounts. As such, I believe SQSP is definitely well positioned to take advantage of this shift.
Given that SQSP is targeting SMBs, this also means that there are a ton of opportunities out there for SQSP to capture. Based on the data from Globalnaps , there are roughly 400 million SMEs in the world, and they account for more than 90% of the firms out there. With 400 million SMEs, this implies a $90 billion-dollar global addressable market for SQSP (400 million multiplied by SQSP 3Q23 ARPU). Now, obviously, SQSP will not be able to address all of them due to geographical reasons and language (for instance, China). Assuming SQSP core markets are the developed markets, I believe the addressable market is closer to ~55% of the $90 billion, or $40.5 billion. Either way, SQSP is still very thinly penetrated in this large market. As of 3Q23, SQSP has 4,404 unique subscriptions; assuming 1 subscription is for 1 SMEs, this means that SQSP is only ~1% penetrated.
Some might worry that growth is going to see structural impairments due to the macro headwinds, but I think the structural shift in behavior is going to outweigh the macro headwinds in the long term. In the recent earnings call, management called out that the demand trends remain stable, and that its growth strategies continue to drive growth.
Google Domains and product innovation to drive growth
I see the acquisition of Google Domains on 7th September as a major growth driver that should accelerate SQSP bookings and revenue growth. Generally, domains are annual plans, as it is unlikely for a business to buy 1-month-long domains. As such, upon the acquisition of Google Domains, SQSP would immediately see an increase in bookings that would be translated into revenue over the coming months and quarters. The negative aspect of this is that it is going to depress gross margin in the near term due to higher operations costs and an upfront payment related to domain registry fees associated with Google Domains acquisition. However, I expect gross margins to normalize over time as up-front registry costs start to be in line with subscription revenue.
On the other hand, organically, as SQSP has built out its portfolio, it will have a lot more opportunity to better bundle its products in order to drive higher customer lifetime value [CLTV]. In fact, I believe the opportunity set by up-selling could significantly expand the addressable market. As of 3Q23, ARPU is $226, which translates to $19/month. The current highest price plan for SQSP is $49/month, which is 2.6x more than the current average pricing. Assuming SQSP is able to fully upsell all of its users, the $90 billion addressable could 2.6x to more than $200 billion. Logically, it is unlikely that SQSP will be able to drive successful up-sells across all its users, but the sheer size of the market points to huge growth potential. From a qualitative perspective, management has also hinted that they are still in the very early stages of upselling. Specifically, in the FY21 earnings call, management mentioned that they are still in the very nascent stages of upsell, cross-sell, and bundling. Some of the recent product launches and updates that make me feel positive that SQSP can continue this upselling momentum are the launch of Squarespace Payments, Squarespace Domains, and Squarespace AI for advanced website content generation capabilities.
to continue to grow through the existing customer base that we have, which is pretty large, and we are still at very nascent stages of doing upselling, cross selling, bundling like if you look at the growth that we have had in ARPUs on a total basis. Company 3Q23 earnings
Payments has huge potential
I see a lot of potential in the SQSP Payments module, as I expect digital payments to grow accordingly as more SMBs shift their businesses online. It is tough for these SMBs to accept cash-only payments if consumers buy from their website. Naturally, the one that is offering the platform is the one that is best positioned to up-sell payment functions to these businesses. So far, SQSP has begun rolling out its payments solution to new customers in the US, and the product is currently available to <10% of customers in the US. While management does not expect material revenue contributions in 4Q, I believe payments are a key addition to the portfolio, and I am hopeful for this to gain accelerating traction over the coming quarters.
Valuation
Based on my research and analysis, my expected target price for SQSP is $45. Following are my model assumptions:
Revenue should accelerate from FY23 onwards as SQSP continues to gain share, up-sell its products, and the macro environment gradually turns for the better (or stabilizes). On the latter, I note that inflation has gone down a lot, which means the Fed is unlikely to drive an increase in rates at the same pace in CY23.
For valuation, I believe SQSP should trade at a 4x forward revenue multiple when SQSP shows signs of growth acceleration. At the start of the year, SQSP was trading at 4.7x revenue, and because of the weak macro headwinds, stock de-rated downwards to the current 3.7x. Given that SQSP fundamentals remain strong, I don't see a reason for it to trade down that much. However, I do recognize the risk of SQSP exposure to SMBs, and as such, I am assuming SQSP to trade at 4x forward revenue (a modest increase from 3.7x to reflect the growth acceleration).
Risk
Squarespace has outsized exposure to SMBs, which in turn have outsized exposure to consumer spending. This introduces a greater degree of cyclicality. Key drivers for Squarespace's business include broader commerce trends and new business formation. In a weak macro environment, both variables will see very weak growth.
Conclusion
In conclusion, my recommendation is a buy rating for SQSP. As SQSP consistently enhances its offerings, focusing on effective up-selling strategies, it should have no issues sustaining its growth momentum. With a global addressable market of $40.5 billion, representing a small fraction of the larger potential, SQSP's penetration remains at approximately 1%, signifying ample room for growth. The recent acquisition of Google Domains and organic product innovations pave the way for SQSP's growth. While this acquisition might initially impact gross margins, the potential for revenue growth is significant. Additionally, SQSP's Payments module showcases promise in the growing digital payments sphere.
For further details see:
Squarespace: Large TAM With Fundamentals Remaining Strong