Will Slack Be a Buy When It Comes Public?

Slack is on the verge of coming public, and the numbers that we've seen so far look very impressive. However, it's also possible that the company's valuation may not be justified by its business fundamentals.

In this week's episode of Industry Focus: Technology, host Dylan Lewis and Fool.com contributor Brian Feroldi talk about Slack's management team and corporate culture, the risks facing the business, and whether they plan to buy the stock on day one.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

10 stocks we like better than WalmartWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, the Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Walmart wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of June 1, 2019The author(s) may have a position in any stocks mentioned.

This video was recorded on June 14, 2019.

Brian, I know one of your favorite things to look at when we're talking companies is management and the company culture. You always dig into Glassdoor. What did you find there?

Feroldi: This company has two co-founders. One of them is Stewart Butterfield, who is currently the CEO. Very glowing reviews for him on Glassdoor: I see a 97% approval rating. The company itself gets 4.7 stars out of 5. Clearly, this is a culture that has a beloved leader. Butterfield owns slightly more than 8% of total shares outstanding before the direct listing. The other co-founder is a guy named Cal Henderson. He is the CTO at the organization. He owns about 3% of the business. Combined insiders in general own 46% of total shares outstanding. Given the high approval ratings [and] the high inside ownership, I think this is a thriving company culture with a great management team.

Lewis: Are there any big red flags that you see with this business? I mean, we are so glowing so far in our review of this company. I think it's good for us to take a step back and figure out what could go wrong here.

Feroldi: Sure. I always like to check about a number of things. Is it a penny stock? In this case, no; it is a multibillion-dollar organization. Is there any excessive customer concentration? No -- 88,000 paying customers, so that's not an issue at all. The industry itself, I think, does not face any long-term headwinds. I think that there are clear tailwinds behind this business, given increased remote work, and working with teams from various parts of the world. This business, from what I can tell, does not rely on any outside forces for its success.

Another factor we haven't touched upon is stock-based compensation. In fiscal 2019, stock-based compensation was $23 million. That is before the company direct-lists, and it's very common for that number to rise substantially after a company has come public. But that is a number that is very low in the grand scheme of things.

Overall, if I was to come up with any sort of knock against this business, I would just say that they are not yet profitable. They are not yet producing free cash flow. But in total, I think there's a lot to like here.

Lewis: As an investor, I think the biggest risk may be the valuation. You know, it is going to be tough for them to live up to the numbers that I am seeing right now. We talked about how they've got just over [$400 million] in trailing 12-month-revenue. The number I have seen for their direct listing is $17 billion as a valuation, which would put them at roughly 37 times trailing sales [Editor's note: Numbers are rounded]. There's a lot of different philosophies about IPOs, Brian. At a valuation like that, there are bound to be some hiccups here and there. It may make sense to hang out on the sidelines a little bit.

Feroldi: Yeah. If investors were interested in this, I mean, the numbers that we've seen out of some IPOs recently are just insane. We talked about Zoom, what a high-quality business we both thought that was, on our last show. That's been a sensational IPO that currently trades hovering around 70 times trailing sales, which is just such a nosebleed number. By comparison, Slack at 37 times sales could be viewed as a bargain, even though it's completely ridiculous when viewed through a normal valuation lens.

If listeners are interested in this, one technique that we always expound on is to buy positions in thirds: Buy a small sliver upfront, and then just wait and see. See how the company acts as a public company when they have a number over their head. Does the management change? Does the dilution get crazy? There's no rush in buying IPOs, is the advice I would give listeners.

Lewis: Yeah. This is a great-looking business. The problem here is that everybody knows it. It is no secret. It's a well-known company, and it's getting a ton of press with all of the normal outlets that are covering the market, so you're going to be paying a hefty premium for this business. If it isn't prohibitively expensive for you to do so, and you really like the company, just buy a couple of shares. Then you can track it over time, build that position, as you get a better sense of what management wants to do, how the numbers look quarter after quarter. I'm going to be putting it immediately on my watch list, but probably not buying shares in the first month or so that it's publicly traded.

Feroldi: That's exactly the same thing that I'm going to do. I think this is a great business. There's many reasons to be optimistic about the long-term potential here. But I am personally not going to be in a rush to pull the trigger on this stock right when it comes public.

Lewis: The company is planning to list its shares on June 20, and it will be under the ticker symbol WORK. We're choosing our words carefully throughout this show, Brian, because this is not an IPO; this is a direct listing. The TL;DR -- the quick takeaway on that -- is Slack is not going to be raising money by taking the shares public, they're really just allowing for shares to be traded. There's a lot more nuance to it, but I think it's fair to leave it at that.

Feroldi: Yeah. And kudos to them for getting such a great ticker symbol, right? WORK -- gotta love that.

Lewis: Yeah, I had to double-check that. I thought it was taken. Like, you're telling me Workday doesn't have that one locked down? Come on! But, yeah, I guess they managed to finagle it.

Feroldi: Well-done to them!

Brian Feroldi has no position in any of the stocks mentioned. Dylan Lewis has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends WDAY and ZM. The Motley Fool has a disclosure policy.