2023-05-18 15:26:56 ET
Summary
- I expect the soon-to-be-launched payment business to enable significant growth reacceleration for Squarespace starting FY 2024/25 onwards.
- Price increase and considerable debt level are a concern. But cash flow generation is steady, while operating margin is expected to expand.
- Shares are down 12% since April. Target price indicates a 10% undervaluation, I rate Squarespace a buy.
Squarespace (SQSP) is a popular all-in-one website building and hosting platform with a user-friendly interface and a wide range of customizable templates that allow individuals, businesses, and creatives to create professional-looking websites.
Overall, Squarespace is a good business with a decent balance between growth and profitability that will continue to benefit from the growing global e-commerce trend. Since its IPO in 2021, growth has declined from ~28% to just over +10% today. Yet, operating and free cash flow / OCF and FCF generations have been consistent and on a slight upward trend in recent times.
Given the recent selloff that has resulted in the 12% decline in shares price since April, I believe the stock is now trading at an attractive price level. As such, I think that Squarespace merits further exploration as a buying opportunity. In the near term, I identify two catalysts on the stock:
- The introduction of Squarespace Payment will enable the company to unlock higher revenue growth and expand its GMV / Gross Merchandise Volume transaction fee, which currently stands at just 3% for customers on the basic commerce plan.
- Operating margins can increase further as Squarespace leverages more effective and efficient marketing strategies. In Q1, I observed a surprisingly strong execution ability from Squarespace in implementing an onboarding strategy to convert users cost-efficiently.
In this first coverage, I assign a buy rating for the stock and wish to discuss further the two key catalysts, as well as the risk factors affecting Squarespace, before arriving at the price target for the stock.
Catalyst
I believe that launching Squarespace Payment is a step in the right direction. As an e-commerce platform, it is ideal for companies like Squarespace to have a business model that generates revenue as a function of GMV or GPV / Gross Payment Volume of its customers to balance out the more steady - yet predictable - fixed-fee subscription revenues.
This allows Squarespace to realize a potential upside from the customers’ success, and capture more value from the growing e-commerce market. Squarespace currently charges a 3% transaction fee, but only in its basic plan . With integrated payment services across its plans, I expect Squarespace to start adding competitive payment processing fees on top of the existing fees, effectively not only taking some shares from the existing payment services in its platform, such as PayPal (PYPL), but also unlocking significant growth potential.
The leading player in the space, Shopify (SHOP), also achieved success with its payment services business. Having launched its own payment services in 2013, it makes up ~70% of its revenue today, surpassing the revenue generated from the e-commerce platform subscription fees alone. It is noteworthy that Shopify doubled its revenue in only a year after launching its payment platform. During that period, Shopify also saw an almost 4x growth in payment processing revenue.
Given that Squarespace is launching the payment platform sometime in Q4, I expect that the business will only begin seeing the impact of the higher revenue growth from payment processing activities sometime in Q3 2024.
In addition, I must admit that I was impressed by Squarespace's 2.5% subscriber growth despite the reduced marketing spend. While the management credited this performance to the well-run attribution strategy, it is relatively challenging to rely on that process alone to generate predictable growth for a business at Squarespace’s scale. Given the success in maintaining revenue growth while reducing marketing spend from 54% to ~43% of revenue, Squarespace demonstrates that it may have a formula that it can replicate into the next quarters.
It is also possible that Squarespace may reduce marketing spend further and stay at a more sustainable level of 38% - 40% of revenue. With Shopify spending just between 20% - 25% of its revenue for sales and marketing in recent times, there is significant room for improvements for Squarespace in that area. Another lever to reduce paid marketing would be organic traffic generation, which Squarespace has a solid foundation for.
Squarespace has a strong domain rating of 94 and an even stronger “dofollow” of +99%. In terms of SEO / Search Engine Optimization, “dofollow” links are valuable because they pass link equity from one website to another, improving the receiving website's authority and search ranks based on the reputation/authority of the linking site.
Its peers Shopify and Wix (WIX), on the other hand, possess a slightly higher domain rating of 95 but a bit lower-quality organic traffic, given their 77% - 88% dofollows. This implies that Squarespace is benefitting from organic traffic coming from higher-quality sites much more than its peers are, which effectively should positively impact its sign-up and trial conversions.
Risk
Considering that Squarespace has not yet experienced any material effect from the price increase, I would continue to be cautious. As a side note, Squarespace recorded a 2.6% decline in GMV processed by the platform despite the revenue growth in Q1. This may suggest that some of its paid customers, a lot of them being SMBs, were probably seeing a slowdown in sales.
Despite the management’s suggestion that 75% of existing customers have already transitioned to the new pricing on an annual basis as of Q1, some of the renewed customers facing pressure from the price increase will be evaluating their options to move their stores to a better-priced solution next year. It is worth noting that with the recent price increase, Squarespace’s $23 per-month basic business plan is notably more expensive than what its competitors offer for the relatively same features. Shopify and Wix’s basic plans are priced at $19 and $17 per month respectively.
On the other hand, I would also like to highlight the relatively high Squarespace’s debt level, which is ~$583 million today. A lot of this comes from the +$500 million of term loan, which has a quarterly principal and interest payment, which is based on a LIBOR or ABR floating rate .
Given the size of the term loan, the credit agreement indicates that for a 100 bps increase in LIBOR or ABR, Squarespace will incur an additional $5.6 million in debt servicing. Interest expense already increased by almost 4x in Q1 2023, and given the macro uncertainty and high-interest rate environment, Squarespace is practically exposed to a greater interest rate risk which could pose a challenge to its bottom-line profitability outlook.
Valuation/Pricing
My target price for Squarespace is driven by the following bull vs bear scenarios of the 5-year revenue forecast:
- Bull scenario (70% probability) - I expect Squarespace to reaccelerate its revenue growth to 15% in FY 2024, driven by the increase in the adoption of Squarespace Payment. Furthermore, I expect Squarespace to maintain a steady 20% growth all the way into FY 2027 as it continues to integrate the payment services into its POS / Point of Sale devices, capturing further growth opportunities through the adoption of the payment-integrated POS by the merchants within Acuity and Tock’s network. Profitability and cash flow outlook to significantly improve as a result, with Squarespace driving more efficiency into its marketing strategy and also lifting operating margins by at least +10%.
- Bear scenario (30% probability) - I assume here that Squarespace becomes a 10% grower. Squarespace to see some elevated churns in FY 2024 due to the delayed effect of price increase on its user base, though the challenged growth outlook there will be counterbalanced by the relative success in the Squarespace Payment business. Profitability and cash flow outlook to improve, though margin expansion will remain modest.
I assign a P/S of 8x to Squarespace under the bull scenario, considering that the payment business will be the key growth driver and potentially become a more dominant business than the e-commerce platform subscription, building a similar outlook to the market leader Shopify.
Shopify has a P/S of 13x, the highest among all the stocks in the e-commerce platform comparable universe. Since the median P/S of the peer group is 4.6x, I would expect that the improving growth and profitability and the success of the payment business will enable Squarespace to trade closer to the midpoint of 4.6x - 13x in the bull scenario.
Meanwhile, I expect Squarespace to have a P/S of 4x under the bear scenario, which is the level where the stock is currently trading at.
Consolidating all the information above into my model, I arrived at an FY 2027 weighted target price of +$78 per share in FY 2027. Discounting that target price with a 20% discount rate, I reached a Present Value/PV weighted target price of +$31 per share. The 20% discount rate represents the expected annual return for holding Squarespace.
In summary, +$31 per share is the highest price point at which investors can purchase the stock to realize a projected 20% annual return should my FY 2027 target price of +$78 be achieved. At ~$28 per share today, the stock trades at a ~10% discount to my target price, indicating that it is undervalued.
Conclusion
Squarespace is overall an interesting business positioned to benefit from the growing e-commerce trend. While its growth rate has declined from previous levels, the company has maintained consistent and slightly improving operating and free cash flow generation. The recent selloff has made the price attractive, creating a potential buying opportunity. With a target price of +$31 per share, Squarespace is currently trading at a 10% discount. I rate Squarespace a buy.
Two key catalysts are expected to drive further growth for Squarespace, the most important one being the launch of the payment services. On the other hand, I continue to be cautious of the impact of the company’s decision to raise prices as well as the relatively high debt level, especially in today's high-interest rate environment.
For further details see:
Squarespace: Payment Business Will Be A Game Changer