Description

Happy Thanksgiving, VIC! Let me ask you, do you like founder-led companies? Do you like companies that have proven to be excellent allocators of capital? Do you like companies with recurring revenue models? Companies that have high free cash flow margins? How about situations when there are identifiable, near-term ephemeral structural headwinds to the stock? If the answer to these questions is “yes”, we have the stock for you. We believe SEMR will be worth $40/share over the next 12-18 months vs today's price of $20.50.

SEMrush (NYSE: SEMR), founded is 2008, is a cloud-based muti-tenant online visibility management tool. Search engine optimization (SEO) is the primary use case, but the product is evolving into a wholistic online marketing/brand management platform. The platform now includes tools such as social Media marketing, content marketing, digital public relations, and competitive research intelligence. In total the platform has more than 50 different tools, up from just 4 in 2012. SEMrush is founder-led, has high nominal (77%) and incremental (79%) gross margins, and generates 12% free cash flow margins. Neither the founders nor the private equity holders sold into the IPO. Since then Oleg, the CEO, has sold ~2% of his 57mm shares (~40% total current ownership), and the private equity firm (Greycroft) has still yet to sell any shares. Capital allocation is one of the primary reasons we like SEMR. The company generated $168mm of ARR (annualized recurring revenue) and $124mm of run-rate revenue at the time of IPO, despite having only raised $37mm of outside capital in 2016. The chart below show how this 3.4x multiple compares to its peers.

SEMrush is implicity a bet on the continued growth of online advertising. While online advertising has grown at a healthy rate over the past few years, SEMR has consistently outperformed its market.

Morgan Stanley has twice increased its estimates for 2021 US online advertising spend three times this year. The firm took its estimates from 20% to 27%, and currently estimates 34% growth. Next year MS is projecting 17% growth, up from the initial 16% estimate.

US online advertising growth has also shifted more towards search in the post-IDFA world. We think this tailwind will be more acute in 2022 as advertisers implement new budgets for the upcoming calendar year.

US online advertising growth should continue to grow double-digits for the foreseeable future as e-commerce continues to take share within retail expenditures. This growth is a tailwind for SEMrush organic growth. Net dollar based retention (NDBR), which measures how much “same-store” SEMrush customers spend on a y/y basis, has accelerated from 114% a year ago to 124% in the most recent quarter.

SEMrush is seeing an acceleration in the number of active free customers on its platform. At the end of F2020 the company had 404,000 active free users, up 21% from the 334,000 in F2019. As of 3Q21 the company had 549,000 active free customers, up 42% from 3Q20 and 28% sequentially from 2Q21. These active free customers represent conversion targets for paying customers, and an accelerating active free customer base should result in an accelerating growth rate of paying customers over the next twelve months.

Market structure is also improving for SEMR. One of its two primary competitors, Moz, was acquired by J2 Global in June of 2021. Founder/Former-CEO Sarah Bird announced she was leaving the company on November 1st. We have heard morale has soured at the company post-acquisition (not a surprise), and employees have begun to leave (corroborated by LinkedIn Insights):

SEMR has internally developed many tools that should allow it to grow beyond its core SEO product. Its social media marketing product has over 20,000 free users, compared to Sprout Social’s 28,000+ customers and $5.7B enterprise value. SEMrush has yet to monetize the social product though, favoring user and engagement growth over near-term monetization. Sellerly, SEMrush’s Amazon marketplace search optimization tool, and Marketplace, an Upwork-like platform that connects ghost-writers with small businesses, both represent compelling long-term opportunities.

SEMrush has also displayed competency in M&A. In late 2020 it acquired Prowly, a media relations/PR bolt-on product, for $3mm. At the time of acquisition Prowly was generating $1mm of run-rate revenue growth at 100%+ y/y (3x EV multiple). We believe Prowly will grow to produce $1mm of run-rate revenue per quarter within the next 6-12 months, lower the purchase multipole to less than 1x. Social media marketing, sellerly, marketplace and prowly all represent potentially needle-moving opportunities in the near-to-medium term.

The company has executed well since the IPO, beating and raising estimates all three quarters. Revenue growth in 2021 well likely be ~51% ($189mm) vs original sell-side estimates of 33% ($166mmE vs $125mm F20A). We view the forward estimates as equally conservative. Sell-side is currently looking for 27% revenue growth in 2022 and 24% in 2023. With NDBR at 124%, paid customers growing at 24% y/y, and active free customers up 42% y/y, we think it is likely SEMrush grow revenue 40%+ in 2022 and 35%+ in 2023. This puts the company near the top for SMID cap growth. Compared to its marketing tech peers HUBS & SPT it trades at a 50% discount, despite growing faster than both.

So why does SEMrush trade at such a deep discount in spite of better fundamentals? The primary reason is its founders, CEO and top management are from Russia, and the CEO especially does not speak English well. They are not promotional in any way, shape or form, in spite of excellent results. The second reason is this was a low-float IPO. Only 10mm shares were initially offered out of ~150mm total diluted shares outstanding. Volume has been thin since the IPO, an impediment for large funds who would otherwise want to own the stock. In an attempt to alleviate this issue, the company attempted a secondary offering last week. I wouldn’t call this the ideal environment for a high-growth SMID cap, and the deal did not go off well. After trading north of $30 after-hours following its 3Q report, the stock settled-in around $26 at the time of the offering announcement. When it looked like the deal was going to price sub $21, Greycroft decided to pull its shares, forcing the company to shift its offering to mostly primary shares (or pull the offering entirely). The offering ended-up pricing at $20.50. While the stock has been more liquid since the offering, the process itself has been a clear overhang in addition to the beating high-growth SMID cap names have taken over the past two to three weeks.

SEMrush has been growing revenue 44%, 58% and 53% in the most recent three quarters. Second quarter growth was aided by a ~700bps tailwind due to easy compares in  2Q20. The acceleration is revenue growth (backing out the easy compare) has been driven by an acceleration in NDBR from 114% to 124%. Paid users have been growth in the mid-20% range, and there’s been a ~200bps tailwind from the Prowly acquisition. On a rule of 40 basis, SEMR is doing ~65% (53% revenue growth + 12% free cash flow yield). In spite of growing 50%+ and generating healthy FCF, the stock trades at a huge discount to is peers of similar growth/quality.

(h/t Jamin Ball Cloud Judgement 11.19.21 for the above charts)

Given the acceleration in NDBR to 124% (revenue growth of legacy customers), and the acceleration of active free users (42% y/y, 28% q/q), it’s highly likely SEMrush significantly exceeds estimates for 2022 and 2023 growth of 27% and 23%. We think the stock will begin to trade more in-line with high-quality, high-growth peers as the structural overhang from the deal dissipates, liquidity (ADV) increases, and the market becomes more comfortable with management (execution, capital allocation). We think the stock will be worth $40 a year from now.

The Bet:

-          SEMrush benefits in a post-IDFA online advertising world as ad dollars are shifted away from targeting and back to search

-          Online advertising, specifically in the US, continues to grow 15%+ due primarily to the growth of e-commerce

-          SEMrush’s competitive positive strengthens vs its primary competitors Moz and Ahrefs

-          SEMrush management continues to execute on its strategic plan of becoming a more wholistic marketing, brand management platform by adding functionality and tools to the platform

-          Near-term structural overhangs due to the lack of liquidity and subsequent poorly executed secondary offering dissipate

-          SEMrush management efficiently reallocates the recently raised capital and free cash flow into business which drives down churn, increases NDBR. Could also see small, tuck-in M&A (e.g. Prowly)

-          SEMrush stock trades more in-line with high-growth, high-margin recurring revenue peers.

Catalyst

- Structural headwind from recent secondary goes away

- Continued execution from management builds confidence (March 2021 IPO)

- 2022/2023 budgets in a post-IDFA world directly benefit SEMR

- Competitors are losing focus, employees, benefitting SEMR's competitive position in the market

- Potential take-out for someone like HUBS (both companies HQ'd in Boston)