1 Recent IPO Stock to Put on Your Watchlist

Since going public in September, Freshworks (FRSH -0.46%) has failed to impress Wall Street, and the stock currently trades 13% below its IPO price. But investors shouldn't write off this software company just yet. More than 50,000 businesses worldwide rely on Freshworks to improve customer and employee experiences, and the International Data Corporation (IDC) puts its market opportunity at a whopping $120 billion.

In this Motley Fool Backstage Pass video, recorded and broadcast on Oct. 4, 2021, Motley Fool senior analyst Asit Sharma explains why Freshworks is worth adding to your watchlist.

Asit Sharma: This actually went public I think I'm going to say just a couple of weeks ago. Is that screen look OK guys. FreshWorks is interesting to me because it reminds me of a company which has had a similar journey in the customer-facing world called HubSpot. HubSpot has been a very successful stock recommendation that the Motley Fool has made for and through many services for several years. We've recommended and rerecommend it in various services.

Freshworks is basically a customer service organization. This is software-as-a-service company that offers help desk's that face small and medium-sized businesses customer bases. Their primary product is this product called Freshdesk, and I'm going to just scroll through here and show you some of their products. But this is basically like a tech support desk, which makes it easy to provide customer service if you're a very small business. Let's say you start that YouTube channel that Jose and I were joking about and then you start to scale up a little bit. You've got a few employees, you're deciding now I'm going to sell a service that since we've got all this recognition from YouTube channel, I'm going to use that as a marketing segue into selling products. But you don't have the hands around the table for customer support because you're selling globally, maybe you're also using Global-E services. [laughs] I don't know if they hit companies that small, but you get the picture.

When you start to scale as a business in the current economy, the upside is that there's so many tools to help you grow quickly. Platforms are very level now between businesses that start overnight and Fortune-500 businesses. Favorite example of mine is Halo ice cream. Now, the tools that you can use to develop a product are available to everyone. You can take a small product or service out of your house and it can go global overnight. But let's suppose that happens and you want to have the infrastructure around your company to be able to scale up to service your customers needs. They are aimed at small businesses which need these services.

You will see here that they are also branching into sales. Modules to help you grow your sales if your small or medium-sized business, sales and marketing. Also right-size your IT service management. As your company begins to grow, this helps you allocate the IT across your organization in a really efficient manner. Want to show you too what the bigger applications looked like for this. They've got a couple of growing companies in their portfolio while they are focused on that small and medium-sized business market; they also now are serving enterprise customers. I think the three of us are probably familiar with a number of buy now pay later companies that are both public and private.

Klarna is a very well-known company that specializes in buy now pay later. This little right up here, it's from the perspective of Freshworks and it explains how their messaging software helps Klarna service in multiple languages and also automate customer service to figure out who need the most help, how to match that up to someone who has the relevant expertise. Their software is really good at that. It is facing a global customers, it's always on in that sense the various suites can be used, again for mom-and-pop instances on up to the enterprise. This gives you a little bit of a view of how their product map is starting to flush out. These are the big buckets I was talking about, customer experience, IT service management, sales and marketing. They're also getting into HR, human resources. It's a very modular type of company which is turning itself into a platform.

I mentioned HubSpot, it looks and acts very much like HubSpot. HubSpot started as a company which provided inbound content marketing for small businesses. In other words, instead of me trying to go out and throw darts at a dartboard and try to market my services over the Internet. HubSpot enables small entrepreneurs to pull people into their websites using great content. But HubSpot overtime has evolved to building other types of modules. They call them hubs. They also have IT modules, they have a hub now which is devoted to operations. In the same manner, they are able to land with customers and expand even in very small businesses. I see Freshworks is following this very useful and very effective template because they are grabbing the customers and gradually adding these different modules of service.

Just a few other things I wanted to walk through here, some statistics at a glance from their S-1 based on their prospective, you here back these terms around for all practical purposes an S-1 registration statement is the same as a prospectus. Actually, the S-1 is a container document for the prospectus, but they mean the same thing. Basically the offering documents that a company shows investors before it goes public.

This is from that document, you can see that they are a growing company. This is last 12 month's revenue of $308 million last 12 month's revenue growth, nearly 50% year-over-year. They have 52,000 customers across the globe and 13,000. If we do some quick math here, 13,000 is roughly a quarter of 52,500. This customer base has one-quarter of its business in annualized recurring revenue over $5,000. There is a very solid recurring revenue component to this company. Great Glassdoor ratings for the CEO. A very big, addressable market. Gross margins now, I don't think it's on the slide, are hovering around 79% to 80%. I like that component as well.

Now, I'm going to take just another couple of minutes here to show you a few things that are of interest to me. Again, this is a stock that I'm currently researching, so just to open a dialogue, I'm highlighting the things that I'm looking at and love to have questions in the Q&A, and I'll chat with my colleagues in just a second here to see which questions they have. But I always like to see graphs like this.

This is a cohort graph. It's a visual way to represent the net expansion rate of customers, how the spend is increasing with each cohort. You can see here that when they were first starting, this is in 2012, they were able to grow those first cohorts of business very slowly and gradually. As time is going on, they're selling more and at faster rates to newer cohorts of customers. The most recent cohorts, you see, not only are the bands bigger but they're sloping upward into the right, which is of interest to me. It means that they're getting better at retaining customers. They are getting better at selling them additional services each year. As they've added on to those modules I was referring to, for example, a human resource module, they've got more to sell satisfied customers, so these bands are getting bigger. I like to see that in a software-as-a-service company. This caught my eye both visually but also cut my investing eye.

Quickly to take a look at the balance sheet for this company. This is pre-IPO. Here you see how the balance sheet changed from 2019-2020. We're going to look at this last column here which is the most recent expression of the balance sheet. You can see they've got about $324 million in total current assets against $173 million in current liabilities. They've got basically net working capital that's very solid with no long-term debt, and I like to see that on the books. Just two more things here. As we can see, revenue is growing at a very nice clip. These are the year-end looks, so revenue jumped from $172 million to about $250 million between 2019 and 2020. It's about a 45% growth rate. But if you look at what's happening this year versus the first six months of 2020. Because this is a business that is all online and it's helping companies grow, they didn't slowdown during COVID, they accelerated, but they're accelerating post-COVID. This growth rate for the first six months of this year equates to about a 55% growth rate, so growth is accelerating into 2021. Last thing I promise.

On the financials here, this is the cash flow statement. They are getting into a state of positive cash flow and positive free cash flow. Not generating a ton of cash just now from operations, but they are reinvesting in the business. But I just wanted to make sure everyone was aware they're not burning cash either. They were in that state where operating cash was negative and they were also purchasing property and equipment, so you had in the red expression of free cash flow. But here you see as we go on in the first six months of this year, cash flow is positive and even after purchases of property equipment, they're still positive.

Lastly, just to sum up here. What's the edge? I always look for an edge with companies that I'm researching. For me, they've got multiple service points in that small and medium-sized business market. They can keep adding on more modules. They're attacking lots of basic functions, including IT, sales and marketing, now HR, the customer service experience. But there are many more that they could do. They could be like HubSpot and even get into operations modules. They've got that growing recurring revenue component. As I mentioned, 25% of their customer base is giving them on average, $5,000 each in annualized recurring revenue, and those increasing cohort spends that I talked about. Really early stage in the research but I like what I see so far.