Weave Stock: Bargain SaaS Expanding Into New Verticals (NYSE:WEAV)

I last provided commentary on Weave Communications (NYSE:WEAV) in June of 2023. Since then, WEAV’s stock has shown notable fluctuations in its value. It started at around $11 per share, then experienced a sizable decrease, reaching as low as mid-$6 per share in October. Recently, the stock has recovered and even seen a period of growth as it currently trades at around $13 per share.

In my previous analysis, I recommended a buy rating for the stock based on two key factors: the company’s notable progress towards profitability and its relatively modest valuation at the time.

This article aims to provide an updated analysis of Weave, taking into consideration recent events and developments that I believe are relevant to the company’s valuation and its prospects for the future.

Thesis

I reaffirm my ‘buy’ rating for Weave, primarily driven by its encouraging free cash flow generation and an aggressive expansion strategy into new verticals and industries. This expansion will not only diversify Weave’s revenue streams, but it will also significantly enlarge its addressable market, laying the groundwork for substantial growth.

Company Overview

As a quick refresher or for those who aren’t familiar, Weave is a software company that specializes in providing communication and practice management solutions for small and medium-sized businesses primarily in the healthcare industry, however, as of late, they have begun branching out to adjacent areas as well. Founded in 2008, Weave aims to offer solutions for the way business owners interact with their customers, while simultaneously helping to streamline the business’ operations.

Weave’s platform integrates various functionalities like payments, texting, scheduling, reminders, and reviews into a single, efficient platform. This integration aims to transform how business owners attract, engage, and retain customers to grow their businesses. The company’s range of products and services includes cloud-based communication systems, VoIP solutions, messaging platforms, and more. These solutions are designed to maximize the value of customer interactions while minimizing the time and effort spent on manual or mundane tasks.

The company released their Q3 2023 earnings back in November, and their latest investor presentation can be found in the slides below.

Financials

Since its IPO in 2021, Weave’s stock price has experienced significant fluctuations. But despite this volatility, the company’s revenue has consistently shown an upward trajectory. Over the past four quarters, Weave reported total revenues of $162.46 million, marking a 19.2% increase year over year. In the most recent quarter alone, the company generated $43.5 million in revenue, up from $36.2 million in the same quarter of the previous year, reflecting a 20.1% year-over-year growth.

At this stage in the company’s life cycle, Weave’s primary focus should be centered on increasing raw revenue and maintaining growth momentum. However, it’s worth noting that Weave’s growth rate, while relatively steady, has not matched the rapid expansion often seen in similar-sized software companies. This moderate growth rate may partly explain the company’s strategy to explore new market verticals, aiming to tap into additional revenue streams, a topic explored further in the subsequent sections of this article.

On a GAAP-basis, Weave is marginally cash flow negative, but continues to trend in the right direction. This gradual improvement reinforces my confidence that cash flow generation will not pose a long-term issue for Weave, barring anything extraordinary, nor will they be troubled with having to raise more financing.

Historically, Weave’s gross margins have been lower compared to its public counterparts, partly due to the inclusion of physical products in their software service. However, the positive trend of margin improvement continues. The company’s Q3 gross margin stands at 67.4%, which is considerably healthy for Weave, especially considering where they were at just a year or two ago.

Valuation

In my last analysis of Weave, I compared it to EngageSmart (ESMT) for a valuation comparison. However, in October, EngageSmart agreed to be acquired by Vista Equity Partners for $4 billion.

This deal, which closed just a couple of weeks ago, can serve as a benchmark for Weave’s potential value in a similar scenario. EngageSmart, with $365.4 million in TTM revenues, was valued at approximately 11 times revenue in the take-private transaction. Applying this multiple to Weave, whose revenue is about half of EngageSmart’s, suggests a possible valuation near $1.8 billion for Weave, approximately double its current market value. While this comparison isn’t perfect due to EngageSmart’s GAAP profitability in contrast to Weave’s non-profitability, it offers a perspective on the potential value of a profitable Weave.

Although EngageSmart likely has a higher-value customer base, I don’t think it would be unreasonable for Weave to be priced at 6-7x EV to Revenues. Such a valuation would imply that Weave is 20-30% undervalued today.

Catalysts

In my previous analysis, I highlighted the importance of Weave’s free cash flow values in the short-term as a key indicator of its potential to unlock greater value. While this remains a valid point, other emerging factors are also poised to significantly influence the company’s valuation, particularly its expansion into new verticals. Historically, Weave has predominantly served health care professionals like doctors and veterinarians. However, the company’s recent pivot towards capturing market share from other service-based industries such as HVAC, plumbing, and electrical services have the potential to substantially grow Weave’s value. This move could transition Weave from being a niche, vertical software provider to a more comprehensive, horizontal software company.

Weave has long used this same slide to discuss the size of their market. It pegs the size of their total addressable market at $12.5 billion. Yet, for the longest time, Weave has played exclusively in the SAM and SOM circles (dental, optometry, veterinarian, medical). However, Weave has begun its expansion to other service providers that this slide has long hinted at.

It’s important to note that Weave’s expansion strategy seems focused on verticals with similar characteristics to healthcare practices—namely, sectors with low client churn. Despite operating in the SMB sector, which typically sees high churn rates, Weave has successfully maintained relatively low churn rates. This success can be attributed to their historical client base of sophisticated business owners who operate stable, recession-resistant businesses. Industries such as dental, optometry, and pediatrics, which are essential and in constant demand, exemplify this trend. These businesses rarely face closures, underpinning the demand for their services.

This strategic focus is a savvy move. By targeting recession-resistant, brick-and-mortar service businesses, Weave aligns itself with sectors that not only have a long-standing presence and low failure rates but also have an urgent need for software solutions to modernize their operations.

If Weave can simultaneously maintain encouraging short-term free cash flow and successfully penetrate these new markets, the company’s stock could see significant growth. This dual strategy positions Weave not just for steady growth but for a potentially transformative leap in its market standing.”

Risks

A major risk that I foresee for Weave, intricately linked to its primary growth catalyst, lies in its expansion into new verticals. This strategic move, while potentially lucrative, carries the inherent danger of alienating Weave’s existing customer base. The core customers, primarily from the healthcare sector, have been instrumental in Weave’s growth to date. There’s a risk that these longstanding customers might perceive the platform as less tailored to their specific needs if Weave no longer markets itself as a dedicated healthcare solution. This perceived shift in focus could potentially lead to increased customer churn.

However, this risk is counterbalanced by an opportunity. If Weave can effectively manage its expansion while continuing to cater to the needs of its current customers, it could establish a strong foundation of stable revenue. This stability would be vital as the company navigates more opportunistic and potentially volatile new market segments.

Therefore, monitoring churn rates will be crucial in the coming periods. These figures will likely serve as a critical indicator of Weave’s ability to balance growth with customer retention, thus dictating the company’s future trajectory.

Conclusion

Overall, Weave continues to stand out to me as an attractive investment opportunity. The company continues to trend in the right direction for its fundamentals (growth and profitability), while also beginning to expand into new verticals. From a growth and valuation standpoint, the addition of these new verticals have the potential to serve as an unlock for Weave’s stock. Investors should pay close attention to their Q4 2023 earnings release on February 21st, 2024.