Transcript

Over the last couple of weeks, The Freshworks IPO has made headlines across India. Interestingly, the company has also been the number one popular stock on Vested as Indian investors rushed to invest in the stock. What is it that makes Freshworks such an interesting investment opportunity? We are going to be answering that in today’s video.

What is a SaaS company

Before we get to Freshworks, it’s important to understand first what a Software as a business or a SaaS business is and what makes SaaS businesses good investments.

A SaaS company is basically one that helps create software for businesses. Investing in SaaS companies might be less challenging than investing in companies across other domains because there are some common characteristics in all SaaS businesses that help you judge the performance of the company in an easier manner.

What makes SaaS a good investment

The first is that most SaaS businesses have a predictable, recurring revenue stream.

This is because these businesses function on the subscription model. This means that customers often make yearly recurring payments making the revenue quite predictable.

The next common trait is that these businesses have high gross margins. You probably know what gross margin is, but as a refresher gross margin is the total difference between the total revenue and the cost of goods sold of a company. The cost of goods sold is basically a total of all the costs involved in generating revenue. Customer support, software services, customer success, and development operations are all part of the cost of goods sold for a SaaS company.

The third common factor for these kinds of businesses is that they have to expand revenues with more usage. This happens in two ways:

One, when the existing customers tend to upgrade to premium plans as their business processes become more and more dependent on the software, thus increasing revenues for the SaaS company. The other scenario where this happens is when the SaaS businesses offer add-on services to the existing customers for an additional fee. This again in turn increases the SaaS business revenue as usage increases.

Alright! Now, it’s time to focus on Freshworks.

Origin of Freshworks

Don’t forget about what we spoke for SaaS businesses, because we’ll be coming back to that soon. But first, let’s dive right into the origins of Freshworks. The story behind it.

The tale of how Girish Mathrubootham founded Freshworks when his television set broke during a relocation from the US to Chennai is quite iconic in India’s startup circle. After 6 months and 28 email threads, he realised how the customer service process was completely broken and launched a service called Freshdesk!

Yes, Freshworks was actually originally called Freshdesk.

Launched in 2010 in a seven hundred square foot warehouse in Chennai in India, Freshworks only sold help desk software in the initial days. As commerce became more and more omnichannel, so did customer service.

Inbound inquiries came through email, chat, phone calls, and even text messages! Keeping track of those queries became difficult. To solve this problem, businesses of all sizes required a unified help desk software solution. And Freshworks tapped into this need and created a solution for the same.

Over the years, Freshworks has added a ton of other software products to its offering and has amassed customers all over the world.

Freshworks is now a global company with offices in 6 countries, and over 52,000 customers across the world!

Freshworks’ listing on the NASDAQ stock exchange has now become a monumental source of inspiration for Indian SaaS startups that want to build large global businesses.

Freshworks Offerings

Now that you know the company’s journey, let’s focus on its offerings.

Freshworks offers three core software products namely Customer Experience, IT Service Management, and Sales and Marketing. These offerings help businesses optimise internal communications along with task management.

Now, let’s focus on the metrics that will determine if you should invest in Freshworks or not. Freshworks’ main competitors include the likes of ZenDesk, Salesforce, HubSpot, Monday.com, Atlassian and Service Now.

Revenue Growth

The first metric we’ll look at is Revenue Growth.

The quarterly revenue for Freshworks grew by 126% in the second quarter of 2021, which is the second-highest amongst competitors. This growth, though, could possibly be attributed to Freshworks’ small size compared to other companies in the space.

Let’s take a look at how competitors stack up. We start with HubSpot, which grew by 90% with a quarterly revenue that is 3.5 times higher than that of Freshworks. Zendesk, the closest competitor of Freshworks, grew by over 64% but boasts a 3.6x higher revenue.

On top of the list is Monday.com which grew 315% over the past 8 quarters, even though it has about the same quarterly revenue as Freshworks. Freshworks’ Q2 2021 revenue was $88.3 million, while Monday.com’s was $70.6 million.

So, we can conclude that Freshworks’ revenue growth is still small but it’s quite fast-growing!

Next, let’s look at the Operating Margin.

Operating margin refers to how much profit a company makes on every dollar that it has earned after paying for variable costs.

Typically, small to medium size SaaS companies do not have a positive operating margins, as the upfront cost of software development and customer acquisition is actually larger than the revenue generated.

Freshworks has a -4% operating margin as of today, which leaves it in the middle of the pack compared to its competitors! That’s excellent when we look at its size. The reason probably for this can be attributed to its workforce which is mainly situated in India when it started. The majority of the revenue though on the other hand comes from North America.

This gives Freshworks both advantages: One, is that of relatively cheaper cost of labour and second, a relatively higher revenue. In contrast, Zendesk has a much larger revenue but at -13% operating margin, whereas Monday.com with comparable revenue has a margin of -75%!

CAC Payback Period

Next, let’s move ahead to the CAC Payback Period.

CAC in simple terms is the measure of sales efficiency. CAC Payback Period is a time it takes for a company to earn back their customer acquisition costs. The shorter this time period, the more efficient the business is, and the less likely the company will experience a cash crunch.

Freshworks is in the middle of the pack compared to the other companies with a CAC payback period between 1.5 to 2 years.

One of the critical factors that helps Freshworks to be one of a kind company is its diverse consumer base.

As of June 30, 2021, the company has about 52,000 paying customers, up by 8% compared to December 2021.

Another notable fact is that there is low customer concentration risk since no customers individually contribute more than 10% of the company’s revenue.

Next, it is true that the company started with and continues to focus on Small and Medium sized businesses. However, over time the consumer mix has shifted towards larger organizations. As of June 2021, the company has 13,325 customers contributing more than 84% of total Annual Recurring Revenues, which is 36% higher than the same period last year.

Valuation

Finally, let’s talk of the valuation that the newly listed company has:

As of September 30, Freshworks is valued at $12 billion. We can look at the company’s price to sales ratio to try to ascertain how pricy the valuation actually is. Freshworks’ price to sales ratio stands at 39 times which is higher than the likes of Zendesk and Salesforce but it’s actually much cheaper than its closest comparable in terms of revenue size Monday.com.

Alright! So, to conclude we loved the Freshworks story. The company started in India and successfully created a global product. Recognizing the cost advantage that it has, it entered the market by actually underpricing its competitors. The combination of lower prices and easy setup allowed the company to acquire small and medium sized businesses as its primary segment.

As the product expanded, Freshworks started to move upmarket to larger companies, and compared to its peers, its growth rate is still rapid and continues to be rapid. And, thanks to its labour cost advantage, it is achieving this growth with an operating margin that is actually better than its peers of similar size.

Alright! So, that’s it for today. Let us know if you are going to invest in Freshworks in the comments below.

Happy investing and stay tuned for more.

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Our team members at Vested may own investments in some of the aforementioned companies/assets. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for an investor’s portfolio. Note that past performance is not indicative of future returns. Investing in the stock market carries risk; the value of your investment can go up, or down, returning less than your original investment. Tax laws are subject to change and may vary depending on your circumstances.

This article is meant to be informative and not to be taken as an investment advice, and may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.

This video is meant to be informative and not to be taken as an investment advice and may contain certain “forward-looking statements” which may be identified by the use of such words as “believe”, “expect”, “anticipate”, “should”, “planned”, “estimated”, “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success of or lack of success of particular investments (and may include such words as “crash” or “collapse”.) All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.