Back when the bitcoin protocol rolled out, a team of developers had plans to revolutionise a different industry.
They weren’t looking at payments, like Satoshi Nakamoto.
Developers at the start-up, Tiny Speck, had their eyes set on games.
The MMORPG genre to be specific.
The acronym stands for Massively Multiplayer Online Role-Playing Game.
Think of it like a virtual world. Players can interact with each other in real time.
Battle. Level up. Journey on quests. All that good stuff.
It’s the social aspect that makes MMORPGs one of the largest and most addictive forms of gaming. Those qualities also make it one of the most profitable.
At the time, the most popular MMORPG was World of Warcraft (WoW).
Owned by the billion-dollar company, Activision Blizzard [NYSE:ATVI], WoW was generating more than a billion dollars in subscription sales, with little investment into software.
The idea for Tiny Speck was to create something similar. A MMORPG that was highly addictive, social and profitable.
But it would be vastly different from the standard games of the time.
Their big project was Glitch, a 2D world which existed in the minds of 11 giants.
It was like ‘Monty Python crossed with Dr Seuss on acid,’ Stewart Butterfield later said, one of Tiny Speck’s co-founders.
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The start-up attracted about $15.7 million from outside investors. But it proved almost impossible to spread Glitch beyond a loyal few.
Butterfield and team saw the inevitable, Glitch was never going to be a big hit. Maybe it was because they tried to introduce too much change to a genre that players already liked…
Yet in failing to change the MMORPG world, Tiny Speck created something far more special.
Something that could upend a 48 year old invention we all use every day!
Email isn’t always the best way to communicate.
But for a wide variety of purposes, its pretty good.
Receiving articles, like one you’re reading now, scheduling meetings at work, sending documents, briefs and zip files.
Email can do all that.
But does it do it effectively?
The guys at Tiny Speck didn’t think so. Its why they created their own message system, which suited their needs to send code and design specs amongst each other.
Serial tech entrepreneur, Hiten Shah explains:
‘At least initially, Butterfield had no plans to develop Tiny Speck’s internal chat tool as a commercial product. Instead, the team kept tweaking and improving its nascent communications tool as they worked on their game.
‘New functionality was added on an ad-hoc basis. If a dev needed to share a design spec with a colleague, they built a function that could handle it. When it became clear that the team needed to be able to find old messages, they built an archive search tool.’
When Glitch got cancelled in 2012, Butterfield and the team didn’t immediately think to commercialise their messaging app.
But soon enough, they realised they’d built something worth spreading. It was like email, only better.
‘Butterfield and his team used Internet Relay Chat (better known as IRC), an online chat tool that was enormously popular in the late 1980s and early 1990s.
‘…Aside from introducing new features as they found a need for them, Butterfield and his team had two advantages when they began building their internal chat tool.
‘First, although IRC was popular, it was still relatively difficult to use. To join an IRC channel, you had to first connect to a specific server, a process that didn’t always work.
‘Second, IRC offered users an amazing degree of granularity when it came to adjusting settings.’
What they created was a user friendly, collaborative messaging, file sharing and data storage tool. And it was created out of necessity.
When that light bulb moment came, Butterfield and the gang knew they had something big. Something that could infiltrate the corporate world. Something that could take over email, or at least become email 2.0.
That collaborative tool is now an $18 billion public company. And everyone wants in…
Software is eating the world
The messaging tool Butterfield and team created is Slack.
Source: Slack Prospectus
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It’s one of the newest tech market debutants. And from the looks of things, investors seem to like the ‘email 2.0’ story.
On its first day of trading Slack rose 48% above its $26 reference price (set by the exchange).
While it’s the first of recent tech listings to go up on the first day of trading, I can’t help but think we’ve seen this all before.
The disruptive up and comer, promising to destroy an established market, industry or technology.
There’s already been a whole bunch of journos foretelling Slack’s inevitable rise and email’s inevitable demise.
This kind of thinking has seeped into many investor’s psyche.
Most don’t look at Slack as a business, potentially earning cash into the foreseeable future. What they see is a lottery ticket.
They missed out on Amazon. But Slack is their next chance. A chance to ride the ‘next big thing’ all the way to the top, then talk about how smart they were for buying it in the first place.
So, price is of no object. For the moment, sales growth is the be all and end all.
If you forget about the numbers for a second and just look at Slack’s model, its hard not to buy into the ‘future of workplace communication story’.
Take a look at what one of the most successful venture capitalists, Marc Andreessen wrote back in 2011:
‘Today, the world’s largest bookseller, Amazon, is a software company — its core capability is its amazing software engine for selling virtually everything online, no retail stores necessary. On top of that, while Borders was thrashing in the throes of impending bankruptcy, Amazon rearranged its web site to promote its Kindle digital books over physical books for the first time. Now even the books themselves are software.
‘Today’s largest video service by number of subscribers is a software company: Netflix. How Netflix eviscerated Blockbuster is an old story, but now other traditional entertainment providers are facing the same threat. Comcast, Time Warner and others are responding by transforming themselves into software companies with efforts such as TV Everywhere, which liberates content from the physical cable and connects it to smartphones and tablets.
‘Today’s dominant music companies are software companies, too: Apple’s iTunes, Spotify and Pandora. Traditional record labels increasingly exist only to provide those software companies with content. Industry revenue from digital channels totalled $4.6 billion in 2010, growing to 29% of total revenue from 2% in 2004.
‘Today’s fastest growing entertainment companies are videogame makers — again, software — with the industry growing to $60 billion from $30 billion five years ago. And the fastest growing major videogame company is Zynga (maker of games including FarmVille), which delivers its games entirely online. Zynga’s first-quarter revenues grew to $235 million this year, more than double revenues from a year earlier. Rovio, maker of Angry Birds, is expected to clear $100 million in revenue this year (the company was nearly bankrupt when it debuted the popular game on the iPhone in late 2009). Meanwhile, traditional videogame powerhouses like Electronic Arts and Nintendo have seen revenues stagnate and fall.
‘The best new movie production company in many decades, Pixar, was a software company. Disney — Disney! — had to buy Pixar, a software company, to remain relevant in animated movies.’
And who could have foreseen the rise of the two software titans Microsoft or Oracle?
Ignoring stock split and dividends, both stocks are up around 136,000% and 80,000% since IPO.
Had you seen any excel model or back of the envelope calculation forecasts such growth you’d likely throw it out, thinking it was absolute drivel.
Clearly people, even today, underestimate what software can do. How much it can change business models and industries.
So maybe Slack will upend email all together. Investors who’ve bought into the stock certainly feel that way.
Is it too late to buy Slack?
Slack does look more like ‘the next big thing’ than anything else I’ve seen in the recent past.
I could be completely wrong on that.
But what makes me say that is Slack’s business model. And that’s how you have to look at the company.
Looking at financial figures, forecasting them out…that’s a waste of time in this situation.
The most optimistic growth assumptions will either look too silly, or they just won’t validate you buying Slack at its current stock price, today.
Here’s a quick, dirty and rather silly looking valuation I put together earlier…
Source: Money Morning
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Revenue growth of 50% for five years, then 25% for another five…
Operating margins grew to 25% so quickly…
Capex needs (what Slack would have to invest to grow) little to nothing compared to earnings…
These assumptions look ridiculous. I mean, the revenue growth we’ve used turns $1 into almost $24 within 10 years!
And yet we still don’t get close to Slack’s market value per share of $36.25.
To be fair, it’s probably better to value Slack on a per user basis, then add some future potential addons to that.
If you do plan to jump into Slack (or some other rich software company), you’d be better off focusing on the business model. Then you could consider what new markets Slack could branch off into through their core business.
Amazon doesn’t just sell books anymore, you know…
If you focus on that (the business model and new potential markets to branch into), then Slack looks pretty wonderful.
Take a look at this…
Source: Slack Prospectus
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The chart above shows the annual reoccurring sales from each user cohort. If you became a Slack user in 2015, then you’re in the 2015 cohort, and so on.
As you can see, annual reoccurring revenue is increasing for each cohort.
That means not only are customers sticking with Slack when they sign up, they are also spending more (for upgrades) over time.
This is how Slack has a net dollar retention rate of 138%!
It’s probably one of those star dazzling figures that got investors to pay up for the stock in the first place.
But is it worth it?
Well, if Slack can build up a loyal following…
And if they become the workplace communication tool around the globe…
And if they can find more markets to spin into…
Then maybe it’s worth paying up for.
There are a lot of ifs there, mind you. And not all are easy to do.
Rather than buy or not buy Slack, think about the broader theme we’re looking at here.
These are the two constants for almost all industries.
Only few Buffett-like stocks can stand the tests of time, subduing competitors and generating incrementally higher returns on the money they invest.
The rest are subject to change. Whether they adapt or not.
Editor, Money Morning