2023-10-06 05:50:29 ET
Summary
- Weave Communications offers valuable software solutions for healthcare SMBs, but I have reservations about its valuation.
- While the company's product portfolio and near-term prospects seem promising, concerns arise regarding its financial performance.
- Weave's stock multiple has expanded, yet its valuation, particularly in relation to forward free cash flows, appears relatively high at 50x forward free cash flows.
Investment Thesis
Weave Communications (WEAV) provides tailored software solutions for small and medium-sized healthcare businesses, enhancing patient engagement and streamlining operations.
Next, the business isn't growing all that fast. And even though Weave is making tremendous strides towards improving its free cash flow profile, I believe that paying more than 50x forward free cash flows is too rich a price tag. Consequently, I remain neutral on this name.
Weave Communications' Near-Term Prospects
Weave is an all-in-one customer communications and engagement software platform designed for small and medium-sized businesses ("SMBs"). It offers a comprehensive suite of tools and features that enable SMBs to streamline their daily operations, enhance customer interactions, and grow their businesses.
Weave's platform consolidates various communication and engagement workflows into a single, user-friendly interface. It includes functions such as answering phones, scheduling appointments, sending text reminders, requesting client reviews, collecting payments, managing email marketing campaigns, and verifying insurance. Weave's goal is to empower SMB entrepreneurs by providing them with enterprise-level communication and engagement capabilities in an accessible and intuitive manner, allowing them to focus on serving their customers, improving customer retention, and realizing their business dreams.
The business is a bit of a mixture of HubSpot ( HUBS ) meets Zendesk ( ZEN ).
In the near term, Weave's prospects are promising as they diligently work on enhancing their product offerings tailored for SMBs. Weave's commitment to addressing the unique needs of healthcare SMBs is evident through their expansion of integrations to support specialized medical practices and the introduction of innovative features like an AI-powered e-mail assistant and Softphones. These product developments aim to streamline communication and operational flexibility for businesses, ultimately improving their efficiency and patient engagement. Here's a quote from Weave's earnings call that echoes this argument,
SMB Healthcare businesses are well capitalized, well managed, and have proven able to withstand the economic uncertainty of the last few years. For example, dental practices are our largest and most tenured vertical and have among the lowest business failure rates of SMB.
Furthermore, Weave's focus on improving multi-location capabilities is contributing to their near-term growth.
Overall, Weave's near-term prospects revolve around its dedication to product innovation and customization, with a clear objective of empowering healthcare practitioners to better serve their patients and manage their businesses effectively.
Moving on, let's discuss its financials.
Revenue Growth Rates Remain Attractive
Weave's revenue growth rates are not the fastest, but they are perfectly acceptable. What stands out here is that with each passing quarter of 2023, Weave has slightly increased its revenue guidance for the full year.
What's perhaps surprising is that Weave has sought to be quite conservative with its H2 2023 results. Given the easier comparisons with the prior year, I would have assumed that the low revenue growth rate hurdles would have allowed Weave to point towards accelerating growth rates as Weave looks to exit 2023.
Given that this is not the case, I believe we have to come to terms with the idea that Weave is growing at less than 20% CAGR for the foreseeable future.
Given that this is still a young business, that annualizes less than $200 million of revenues, the likelihood that Weave gets a high growth multiple on its stock appears to be rather unlikely.
This takes us to discuss its valuation.
WEAV Stock Valuation -- Difficult to Value
Weave's multiple has expanded significantly throughout 2023 from around 2x forward sales to about 3x. Yes, it did reach more than 4x for a short while, but overall, paying 3x seems quite reasonable.
The issue that I have with Weave is that the business is barely breaking even on its free cash flow line.
As you can see above, the business' free cash flows are clearly improving. But annualizing close to $4 or $5 million of free cash flow is hardly going to get anyone notably excited. Particularly when we consider how much stock-based compensation management is taking per quarter.
For example, for Weave to deliver $1 million of free cash flow in Q2 2023, it took close to $6 million as stock-based compensation. Yes, this stock-based compensation should in time become a smaller part of its overall free cash flows.
But as it stands in Q2, stock-based compensation increased by nearly 30% y/y, meaningfully outpacing its revenue growth rates of 19%.
If we extrapolate Weave's Q2 2023 free cash flow forward over the next twelve months, it appears possible that Weave would be able to make around $7 to $9 million of free cash flow. This would leave its stock priced at more than 50x forward free cash flows. For a business that's growing at less than 20% CAGR? This is simply too high a price tag for what's on offer.
The Bottom Line
I'm somewhat uncertain about Weave Communications' near-term prospects, primarily due to concerns about its valuation. While the company offers a comprehensive suite of communication and engagement tools for small and medium-sized healthcare businesses, which is promising, its financial performance raises some questions.
The company's revenue growth rates, while acceptable, are not particularly robust, and it appears that Weave may be growing at less than a 20% CAGR for the foreseeable future. This has implications for its valuation, as Weave's stock multiple has expanded but may not be justified given its current fundamental performance.
One key detractor is Weave's free cash flow profile. While there has been improvement, the business is still barely breaking even on its free cash flow line. Stock-based compensation is a significant factor in this equation, and its growth outpaces revenue growth rates. If Weave continues on its current trajectory, it may generate around $7 to $9 million of free cash flow over the next twelve months, leading to a valuation of more than 50x forward free cash flows.
This high valuation might be challenging to justify for a company with growth rates that appear to be more moderate. Consequently, I remain neutral on Weave Communications at this time, primarily due to concerns about its valuation relative to its growth prospects.
For further details see:
Weave Communications: Balancing Prospects And Valuation With A 50x FCF