Vimeo (NASDAQ: VMEO) hasn’t had a good time lately. Markets have punished high stock multiples and for good reason. Rates are rising and the potential for earnings growth has also diminished, so hard multiples become doubly less justifiable. The problem for Vimeo is that they could really have an earnings growth problem, which is devastating them at this seemingly quite reasonable multiple in the old rate paradigm. The Q3 forecast should keep investors on the sidelines as signs of a recession are already emerging.
Our comment Q2
Revenue growth was 16% and gross margin growth was 20%, so there was a nice expansion in gross margin and the move towards breakeven is progressing. Here is the key point, however, the ARPU growth was 10%, which comes from sales driven growth. That’s a big chunk of revenue growth now, and apparently that’s going to have to account for more revenue growth in the third quarter on the forecast.
The tips are where things start to look a little dark. They say they expect revenue growth of around 5%, which isn’t much at all. This indicates that subscriber growth will only slow, and what’s worse is that sales-driven growth may not be able to offset declines in self-service, or that customer-driven growth sales could slow down, possibly due to lower conversion rates and slower business. Remember that sales enablement revenue, which now accounts for around 35% of revenue, is higher ARPU and generates positive price and mix effects as it comes from converting customer profiles. self-service business in sales-assisted customers per seat.
Another thing to consider is that Vimeo has a large international exposure, apparently around 30% of their business. The dollar has come into a completely privileged position as the world’s reserve. The impact of rising rates on entrenching the exorbitant privilege of the USD is one of the major mitigators of US woes in the face of fairly aggressive rate hikes. However, 50% exposure is not ideal, as these currency headwinds impact earnings. A mitigating factor here is that sales-assisted revenue is denominated in USD, so in addition to the upsell that occurs in the sales-assisted shift, there is the benefit of reduced currency exposure. However, apparently conversions in international markets are lagging behind.
Finally, we note that moves to increase marketing efforts have continued. Apparently they are still only 75% complete as of now and will further increase marketing spend. There’s no doubt that upselling customers is a good strategy and a source of untapped value, but these aggressive marketing spends will need to be backed by good retention for marketing ROIs to not plummet. This might get tricky in a tougher macro environment. Conversions are particularly difficult to achieve in a difficult economic scenario, and they will also have to maintain them. Initially, there is the effect that the losses are getting worse and the effects of reflexivity make their appearance.
The price has fallen by a third since our last coverage, and that’s partly due to reflexivity factors that play into all unprofitable businesses. But in general, markets are adjusting to higher risk-free rates and what that means for required returns in the stock market. The VMEO multiple is not so bad, it is at 0.8x price/sales. With companies like this able to produce between 20% and 30% EBITDA margin, this implies a fairly low multiple on forward EBITDA of less than 3x.
However, in the meantime, there are years of not producing profits and burning cash in a hostile stock market environment where funding has completely dried up in the public markets. The ECM is dead for now, and this creates reflexivity effects, and long periods of risk-free rates, potentially worsening returns up to 6% per year given the clip of the rate hike cycle and the long-term inflation risks. Earnings growth, and indeed any earnings, must happen soon and quickly for VMEO, otherwise this current multiple will not improve and cash will be burned to directly reach the value in the vaults.
Speaking of cash burn, it cancels out at around $100 million a year. According to marketing commentary, that will be around $125 million, unless the 6% headcount reduction is followed by further reductions. From the second quarter, there are approximately 2 years of cash left to cover this rate of consumption. If, as forecasts suggest, revenue growth may become more constrained with rising headwinds, this rate may not decline quickly and therefore 2 years is the maximum period before a capital raise occurs, and she will probably come before as a precaution. The bear market may not be rising at this time when it begins in effect. Dilution could occur, and even with eventual earnings in Vimeo’s future, multiples might not improve much. In other words, there are few levers of return. The only thing Vimeo can do is keep selling. The untapped potential remains, and if there isn’t too much of a drop in leads and conversion rates, and we don’t get a lot of churn, all of those concerns about dilution and cash destruction dissipate. Still, long-term rates are an issue for multiple floors.