semrush is a high-growth software company that came public in 2021. semrush scored very well
on both brian and i's investing checklist and we both became shareholders right away.
This company continues to execute well today but its stock has basically gone nowhere over
the past year. Given its small size and huge potential we think that semrush could deliver
10x returns for investors over the next decade here's why we'll be buying shares
in our public portfolio today my name is Brian Feroldi and my name is Brian Stoffel
thanks to commonstock for sponsoring today's video if you're into this series each saturday
brian and i post a video about a stock that we are buying and our rationale for why. Brian
like you mentioned one of the reasons that we think this has the potential to 10x over the
next decade is because of its small size today semrush trades for just $1.6 billion dollars
making it a small cap stock Semrush's mission is to make online competition fair and transparent
with equal opportunities for everyone this is simple inspirational and optional. I love it me
too brian but how does the company do that well it has a software-as-a-service platform where
companies can handle everything that they need to view their online marketing activities like
search engine optimization digital advertising and pr advertisers face a huge challenge today the
average consumer spends 6.5 hours per day online but they are overwhelmed with information because
of that it can be really difficult for a new company to get its product in front of the right
eyes at the right time semrush solves this problem by creating a suite of tools that can help with
all phases of a company's digital growth company has tools that can help with paid advertising to
get eyeballs quickly you can then pivot to social media and pr campaigns to get eyeballs over the
medium term and the company also has tools that help with content and search engine optimization
to help grow organic reach over time so how does the company do that well it is able to collect
data from a number of different sources to create an online visibility profile and that includes
both third party and importantly first party data that other companies don't have so how does some
rush make money the company uses a software as a service business model to attract and
retain customers as of the most recent quarter the company's dollar based net retention rate
retention includes churn was 127% which showcases just how much its customers like using its
platform now those customers are expensive to acquire but that should come down as a percent
of revenue over time demand is robust and the vast majority of revenue is recurring but does semrush
have a moat we think the answer is yes one moat comes from the network effect the more users that
join its platform the more it gets access to good high quality data the company can use that to make
its tools better however we think that this is a weak mode at best the key mode really comes from
switching costs which we believe are pretty high nowhere is this more obvious than when you look
at the expansion within the cohort semrush has the important thing to note is that each one of
those lines gets thicker over time which means that they not only hold on to their customers
but get them to spend more every year you could also make the argument that the name semrush has
become the market share leader in its category and it does have some brand value we don't assign it
much credit there but you could make the argument that we should we also think it's worth mentioning
that it does have a counter positioning advantage over much larger rivals namely alphabets google
and meta's facebook both of those companies obviously have more data than semrush but they
also have walled gardens which means that they're just focused on their properties by using semrush
customers can focus on the entire internet instead of those unique properties and when you consider
the number of customers that are on this platform is growing and the number of tools on this
platform are growing we think that the company's moat is expanding but how about the numbers well
over the last 12 months revenue has continued to grow at a torrid pace of just about 50%. Gross
margin on a gaap basis is rapidly approaching 80$ and while net income is negative if you look at
those numbers they're very small on an absolute basis meanwhile the company is producing positive
free cash flow for several years its balance sheet is absolutely pristine with $260 million in cash
and $0 debt and while its returns on capital are currently negative we think it's only a matter of
time before they become positive but what about leadership well oleg and dimitri got together a
number of years ago and co-founded semrush they are both still on board with oleg as the ceo
employees give this company very good reviews overall and insiders of this company own a
whopping 62% of shares which is worth more than $1 billion dollars at current prices but what about
optionality well if you look at the company's history you see that they have a track record
for rolling out new tools and services that are adopted by its customers as for operating leverage
the company is currently focused on growing the top line and not the bottom line so we think
there's a lot of operating leverage ahead of this business while the addressable market is just $16
billion dollars that's somewhat small you've got to remember this is a small company that
has only captured 1% of that so far and while the company has made a handful of acquisitions
recently this company's history is growing organically so how is semrush fared as an
investment well surprisingly well it's about break even since it went public over a year ago which is
much more than most ipo stocks can say and it has a history of beating wall street expectations
meanwhile the company is not at all focused on returning capital the shareholders at this point
it is focused on top line growth so what are the risks well by far the most important risk
is competition there are a number of different players that offer tools similar to semrush's
like Hubspot Yext and Hootsuite and that is where you need to keep your eyes another key
risk is geopolitical risk this company has ties to Russia and while that is changing in the near
term this is definitely something for investors to watch beyond that it's worth mentioning that
the valuation on this while not absurd is still quite high we'll get to that in a minute so how
do the company's numbers look recently well in the most recent quarter the company's revenue grew 43%
to $57 million dollars that exceeded wall street's estimate and management's own guidance on the
bottom line the company lost about a penny on a non-gaap basis that was lower than last year
but it did come in ahead of wall street's estimates gross margin came in very strong
almost touching 80% and while operating a net margin weren't negative that was mostly due
to non-cash charges and as you can see while free cash flow was down it was still positive and that
net income swing was very small those numbers are both at about zero the bottom line this company
has a solid balance sheet with $260 million dollars in no debt the big news from the quarter
was that the company has chosen to exit russia completely the company is going to be relocating
its employees that live there outside of the country and that's going to cost about 25 million
dollars we think that this is a cost that is well worth it in the long run despite that turmoil
the company still added about 5,000 customers during the first quarter bringing its total to
87,000 which was 19% growth year over year the company also recently closed on two acquisitions
that open up new revenue opportunities for itself the first was an acquisition of a company called
the backlinko which gives the company access to valuable content and opens up courses as
a new revenue stream for the company the second acquisition was in telecom that goes by the name
compite and compite offers sales enablement and competitive intelligence software semrush
believes that it can take that software and upsell it to its existing customer base of 87,000 users
according to guidance for the upcoming quarter management expects that revenue grow about $33
to $60 million dollars that figure exceeded wall street's target looking at the full year
the company actually raised its outlook from previously up to $250 million dollars which
would represent 33% growth that was ahead of wall street's expectation if we look at the bottom line
wall street has already factored in the costs for relocating those employees so it now expects the
company to lose about $0.34 cents per share so what are we gonna be watching to tell if
our thesis is on track first we're going to keep an eye on the dollar based net revenue retention
rate we want to see this figure remain high which indicates that customers are sticking around and
spending more second keep an eye on their ability to attract new customers the growth rate is about
19 now it might come down slightly but we want it to remain solidly positive third keep an eye on
employee relocation we want to see this company follow through on its plans to
cut ties with russia forever and last keep an eye on free cash flows they might go negative
because of those relocation plans but one of the things that excited us about this company
was that it was so small growing so fast and yet still free cash flow positive we want to
see that trend continue overall we can't help but think that this company's moat continues to
expand as it continues to grab customers upsell them and add new products and as we said we are
both already shareholders of the company and we believe that the thesis for investing is still
on track we recently re-ran some rush to our investing checklist and it scored very well on
my framework it got a 77 that score will increase mightily into the 80s if the stock starts to beat
the market and it got an 11 on my framework which is just knocking on the door of that anti-fragile
territory now how about valuation well it's important to remember that semrush is in the
launch slash hyper growth phase of its growth cycle for that reason it's important to remember
that management is focused on growing revenue and gross profit at this point it's not focused on the
bottom line or optimizing for expenses for that reason the best metric that investors can look
at is likely to be the price to sales ratio and the price to gross profit ratio as the price to
free cash flow ratio and price to earnings ratio aren't yet relevant if we look at the price to
sales ratio we see that it trades at about seven times sales that's still expensive on an absolute
basis but it's cheaper than the company has ever been in the past if you look at the price to gross
profit ratio this figure is currently hovering at about 10 again not screaming cheap but not
all that expensive given this company's potential as usual we'll be posting all of these slides over
on our common stock portfolios and we encourage you to push back on anything that we've said and
help us to fill out our thesis each week we look for the most insightful comment about our purchase
once we select it commonstock pays that person $250 dollars we want to give a shout
out to beaver capital who won that award for the comments regarding our recent purchase of Roku
common stock sent beaver capital $250 dollars and this week we'll also be choosing the top comment
to win $250 dollars so follow us over on common stock and let us know your thoughts. Brian's out.