Chit Chat Stocks - Squarespace (Ticker: SQSP) Not So Deep Dive

Episode Date: December 20, 2022

Squarespace operates a platform for businesses and independent creators to build an online presence. The company enables its users to manage projects and businesses through custom websites. At the end of the month, we will publish an Arch Capital episode that will cover the company: Wix. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Squarespace. Enjoy the show! ****************************** Interested in becoming a member of 7investing? Subscribe with code “MONEY” and get $100 off your annual subscription for life: https://7investing.com/checkout/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:33) Industry | (12:30) Management & Ownership | (16:11) Earnings | (19:33) Balance Sheet | (24:00) Valuation | (27:20) Our Analysis | (30:20) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chit Chat Money. Today, we're going to be discussing Squarespace. One second as I change to gallery. Yep,

we're in gallery view. Okay. We are talking Squarespace as the, what is this, the third stock in our website in e-commerce month. This is another website builder, similar to GoDaddy, but without the domain stuff. And it's going to be very similar to Wix. They're extremely similar businesses. And we'll be covering Wix as the last episode in this month. We're going to talk about them today, go through all the basics on our Not So Deep Dev episodes. We try to go for about 45 minutes, cover the basics of what a business does, their financials, their ownership structure, any sort of quirks, what we liked, disliked, and then come to any sort of conclusions if we're more interested in the company.

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what does Squarespace do and give a little history of the company yeah the history is actually pretty interesting so uh I know I've given some boring history on on some of the companies uh that we've done recently but uh Squarespace is had there was a lot of color a lot of context so I'm excited to talk about that but as for the business the first line on the 10k uh I always love looking at it because sometimes it's super vague, like just way too vague, you know, and just a really broad mission statement. But Squarespace is okay. It says Squarespace is an all-in-one platform with everything to sell anything. It's still fairly vague, but basically it's a platform that allows – I'm going to try to approach this as if someone's never heard of Squarespace or Wix or is not that well-versed in the CMS space. So if you are familiar, I'm sorry for more of the basic layout, but Squarespace is a platform that allows all kinds of users to establish a professional looking internet presence and operate their business online. So when you're thinking about the popular Squarespace customer groups, you're probably thinking, well, you're thinking, ah, well, selling online must compete with Shopify. but there's a lot more, not every business is trying to sell something or like not every

business is trying to ship items where Squarespace really finds a lot of customers in like the restaurant industry, the photography, wedding planning, bloggers, artists, it serves as a portfolio for a lot of fields. So if you think about like if you're an interior designer and you've got a portfolio that you want to showcase. Squarespace is kind of a really ideal place to do that. It really got its start in blogging too. So that's probably one of the more common use cases that people use Squarespace for. However, Substack has kind of gone after that market as well. But anyway, it applies to a lot of fields, pretty much anything. Some of it probably lends itself a little better too, like the use cases I talked about. But in terms of the customer journey,

when a user comes to Squarespace, it's basically you can immediately start assembling the website you want with this sort of drag and drop canvas. And then they have a hundred plus templates that allow you to kind of get off to get an easier start. And so let's say you are a photographer. They've had so many use cases with that, that they've built these templates that you can easily replicate and then adjust it or customize it for your own needs. So if you want different colors, or you want slightly different layout, different logo in the corner, you can adjust it to your own desires. But really, you're probably going to have something similar to a lot of other photographers. So the templates certainly help. And I think they really help in terms of converting

someone who's just exploring how to build a website to, okay, I might actually buy this because it kind of gets them over that hump. And then at the end, once you've kind of established the website you want. And it's an iterative process. So you can keep going in and keep refreshing and updating it. It's not like you set it and forget it. But at the end, you'll get hit with basically a subscription price that says, we will do your hosting services. And if you go listen to the GoDaddy episode, we talked about what the hosting services require. That's storing all your data on co-location servers somewhere, allowing your website to actually run and then offering you a domain that you want, as well as security, they'll offer you

that for... The pricing changes constantly. It's very dynamic, but it's a one-year, two-year, three-year contracts for, let's say, $100, $200. They're constantly running discounts, so it changes. Right now, their average revenue per unique subscription is right over $200. So they'll provide the hosting services to you for that kind of subscription cost. Beyond that, though, Squarespace also offers some tools or solutions that are meant to actually help businesses run. So you can get custom domain emails. A lot of businesses like to use that. They have a plugin or they distribute basically G Suite and Google custom domains. And then they have a variety of add-ons as well. So things like this isn't even necessarily an add-on, but it allows you to manage your social media accounts. It allows you to sell online. It doesn't have its own payment solution, but it has payment partners. So that's kind of a difference between them and Wix. um you can schedule and take appointments you can send out email campaigns there's there's tons more that you're able to do if you're a business on here one of the big ones is talk which is t-o-c-k

if you're a restaurant it allows you to book reservations and and process online orders as well i'll talk about that in a little bit but basically this is just allowing you to easily set up and run your business online that that that's the goal of squarespace and it gets grouped into the Software as a Service Content Management System, so SAS CMS. And really, it's very similar to Wix, which we'll talk about in a little bit. But the history, like I said, it's kind of a remarkable founding story. So Squarespace was founded in 2003 by Anthony Casalina, I believe I'm saying that correctly, out of his dorm room at the University of Maryland. So at the time, and I went and listened to how I built this episode with him on it, and he gives a really

good story about how he built this. And he wanted to make his own blog and realized there wasn't really an intuitive solution to kind of get set up without writing your own code. And so I believe he originally, when people would ask him what he did or what Squarespace was, he called it a publishing software, which I guess it still is today, but he wanted to build his own sort of publishing software. And that's what he did. I believe this was his early years in college. um and some of his at one point one of his friends just said like i'll give you two hundred dollars for this and he said wow you know all right this could actually now that i think about it this could be a business um and so he ended up having to get some space in some server rooms in new york

he got a thirty thousand dollar loan from his dad to kind of try to turn this into a you know a real real company and then plow some money into marketing and for the first several years even after college. At one point, I believe this was doing, at the time, it was like $650,000 in revenue. And he was still the only person at the company. He would write all the code, answer all customer questions. He'd run marketing for Google AdWords. I mean, he was doing everything. And he talked about having to constantly... He wasn't making any progress on the platform was his big thing. He was doing all these sort of menial tasks. And so he ended up hiring this different CEO and quickly he realized that it wasn't going to work and that he wanted to run things his own

way. And there was a lot of disagreements around different decisions. And he was even asked in the interview, did it kind of work? He said, no, not at all. I wanted to run this thing myself. And around that time, this was 2010, Anthony went out and they actually got an acquisition offer from Getty Images to buy out Squarespace, but he wanted to keep running the company. And so someone else said, hey, we'll give you some money. Excel and Index Ventures said, how about we invest some money in you? And then it's still yours. And so that's what he did.

He raised $38.5 million funding round from those two companies and really began building the business the way he wanted. And since then, it's been kind of the typical VC route, I guess you could say. He obviously still retains a lot of ownership, which Brett will talk about in a second. But they kind of went the typical CMS path, which is you start with a good website building solution, and then you start to build business tools. And a lot of this was through acquisitions. So they've made, I want to say, five acquisitions in the last five years. It might be four, but they acquired Acuity Scheduling, Unfold, Hawk, which was the big one.

which I'll talk about at the end. It's basically gone from this evolution of trying to be a blogging site to applying to any sort of business vertical, to being mobile friendly, to now being a full-blown commerce solution that allows companies to really sell online. That's been the evolution. They didn't actually go public until March of last year. They did take on some debt before they joined the public markets, which I'll talk about in a sec. But yeah, they've now in public for a little over a year. All right. Yeah. Let me hit industry and competition. It'll be similar to GoDaddy, but slightly different. So if we look at the website builder market, it is quite small, excluding WordPress, which we hit on a little

bit more during the GoDaddy episode, a little bit more of the details there, but I'm sure we're going to discuss that today. So excluding WordPress, which has the majority market share, they're only a few billion dollars spent on building websites each year. Squarespace is one of these as a non-WordPress website builder like Shopify, GoDaddy, Wix, BigCommerce, a few others. There are also a lot of products that they offer to customers that are outside of the website building. Like Brian mentioned, there's e-commerce selling, there's payments, although they don't have a native solution. So slightly different than Shopify and Wix. There's email marketing, social media tools, and more. So adding all those together, the say,

quote unquote, total addressable market here is definitely larger than just the website building stuff. However, the website building, as we'll talk about, there is plenty of market share to gain from WordPress itself. WordPress has maintained 50% plus of the CMS market for the last decade. So again, I'll say that again, WordPress has 50% plus market share of the content management system space. And they've had that for the last decade. It's been pretty stable. However, there are signs that Shopify, Squarespace, and Wix, especially those three, are finally making meaningful market share gains. And we've actually seen WordPress slightly decline its market share in 2022. And if you look at the table, so again,

we'll have a source for this in the newsletter for tracks over the years, the market share. And it's some third-party estimate. So again, it might not be exact, but it's directionally correct. So from 2011 to now, so about 10 years, Shopify went from 0% to 6% market share. Wix went from 0% to 3.5% market share and Squarespace went from 0% to 2.9%. So basically 3% market share. Ryan, you have something to add? Yeah. And you mentioned WordPress has maintained 50% plus of the CMS market and it makes it sound kind of steady, but it's worth noting that CMS market or websites built using CMS is also growing as a percentage of active websites. So WordPress itself is actually growing active websites. It's just potentially here,

we think it's going to decline in market share among that growing industry. Yeah. And if, again, I said that 0% to 6%, 0% to 3.5%, and 0% to 3%, you add that together, So that's the 12.5% of market share gains from these companies that had zero. So they went from zero to 12.5%. If they can, say, double that over the next five years and go to 25%, the only place they're going to be able to take that is WordPress. So again, if the trends over the last decade continue, someone like Squarespace is going to gain more share. And we'll talk about maybe any reasons why that won't continue towards the end of the episode. If we look at competitors, we already discussed them.

There's Wix, GoDaddy, WordPress, Shopify, BigCommerce. You also have GoDaddy in domains. There's MailChimp in marketing, Sprout Social for social media management, OpenTable for, say, that restaurant management stuff, and various other products. But the key competitors that they're going to be looking at are WordPress, Wix, GoDaddy, Shopify. All right, let's move into management and ownership. As Ryan mentioned, the founder, CEO, and chairperson of the board is Anthony Casalina. Is that how you say it? Casalina.

He's only 39 years old, so pretty young for someone that's run this business for a long time. He has 75% voting power. So again, combine that with 75% of voting power. He is the CEO and chairperson of the board. He has, I think, the trifecta of total control of this entity. There's not really any holes in that. It seems like he would have to just want to give it up to leave. The board of directors has a very standard makeup.

There's nothing crazy there. They're executives from the technology industry of Wayfair, Getty Images. Getty Images actually has some sort of partnership with them. and I, as Ryan mentioned, they have a long standing relationship. And then there's a lot of VC partners on the board. So those ones that Ryan mentioned, like XL Ventures, a few others, but in total, there are only six members of the board. Total board compensation was 0.2% of 2021 gross profits. So no complications there. If we look at the ownership table, though, there are a lot of VC funds still associated with the stock, but that is really not too

relevant. I guess maybe from the stock could go down if there's a lot of selling pressure, if they want to get rid of their stake, but it's not too relevant again, because Casalena still has full control of this thing from a voting power perspective. Lastly, on management and ownership, let's go through executive compensation. I would say they have a fairly simple scheme. They do base salaries and then they give out executive stock options. If we look at total executive compensation in 2021, it was $88 million or 13.4% of 2021 gross profit. However, at first glance, you think, okay, that's way, way too high and something's wrong. They're kind of paying themselves too much. However, this was due to the company starting a long-term

stock award for Casalena based on stock price tranches that all had to be realized at the time of the compensation plan. So it wasn't actually true expenses in this regard. Most of the time, the SBC, they might try to... There's no adjusted EBITDA nonsense here, but basically they gave them kind of like a Tesla-based one where they have these stock price targets. And then if you hit the stock price target for, say, I think it was a 30-day or 90-day moving average, you get this certain tranche of stock options that'll vest for you, these performance stock units. And if we look at the stock price today, it's about $20 a share. And the first hurdle is $105 a share, with the last hurdle being $420 a share. I pasted the table

in to the newsletter for anyone to look at. So on the one hand, I get a little bit mad that he's paying himself so much, even though he owns, what is it, 35% of the economic interest of this thing. So he's already incentivized to get the stock price up. But on the other hand, it's not really that bad because he's only going to get paid if the stock does really well for shareholders. So that does somewhat align him. But again, he already was aligned. But if you're looking at, say, the 2021 numbers, that's why the expenses look so bad. Let's see.

Besides that, we got nothing. So let's move on to earnings, Ryan. What do the financials of this company look like? Well, the financials look pretty good. especially, well, I guess it's similar to GoDaddy, but at least on a profitability basis, it looks better than Wix, which we'll talk about at the end of this month. So over the last 12 months, they've done just under a billion dollars in revenue. So 846 million, that was up 13% versus the 12 months prior. 83% gross margins. So they generate, as a percentage

of their own revenue. They generate a larger, they generate more from their core subscription business than Wix, which is generally a higher margin than the commerce solutions, not to mention the commerce solutions are a little different than Wix. But ultimately, it's a slightly higher margin business on a gross basis. And then a lot of that trickles through to free cash flow. So $127 million in free cash flow. That's 15% free cash flow margins. That's over the last 12 months and it's been improving or it's expected to improve this year. So most recent quarter, when we're talking about what's kind of happening now, they have $218 million in total revenue. That was growing at 8% a year due to two things. So unique subscriptions reached 4.2 million,

which grew 4%, although it was flat sequentially. So it's not growing quite as quickly on a quarter over quarter basis as it used to. And that's been kind of across the entire CMS space. Website growth has stalled out a little bit. And then the average revenue per unique subscription is also up 4%. And there's also some foreign currency headwinds as well, although not quite as much. So only about 30% of their business is done outside of the US. Total bookings increased 10% would have been 14% constant currency. Commerce revenue was growing year over year, but primarily because of the talk acquisition. So they paid $400 million for this online ordering and reservation system called talk. But if you exclude that GMV for

their commerce segment, actually, I'm pretty sure it actually declined year over year. So a lot of that is kind of just macro, but also likely some sort of reversion from COVID trends where maybe some businesses that were conducting more sales online, I'm thinking particularly with the restaurants, some of those transactions have migrated back to in-person. There wasn't a whole lot of color on it, but that would be my guess. um and then this quarter specifically for just over 41 million in operating cash flow so that's 19 operating cash flow margin that was actually down last year due to and they said timing of payments and this is asked about that's by definition so yes it was asked about on the conference call uh and they it was kind of a number of things but uh basically i believe a A lot of it had to do with this tax receivables not coming in, and then they also front-loaded some marketing costs that weren't going to actually occur until later on.

So, lumpy, but ultimately, you're looking at about historically 15% to 20% cash flow margin business. There isn't a whole lot of CapEx here. It's pretty light. So, free cash flow is generally pretty close to their operating cash flow figure. They do, however, issue a lot of stock-based compensation, but they have been buying back as well. So I'll talk about that in a sec. But $75 million in stock-based compensation year-to-date. If you just annualize that, we're looking at about $100 million given out in stock each – this year.

But in the second quarter, they authorized a $200 million buyback, and so far Q2 – or so far repurchases have outpaced SBC. in total they're guiding for 100 i guess the two numbers you probably didn't know just under a billion dollars in revenue and 840 million and they're guiding for 140 million dollars in free cash flow this year roughly so right around 15 to 20 percent free cash flow margins and those have been slightly expanding over time yeah but but a lot of it is spc at the moment as they continue to invest for growth so something to watch yeah and that might become a little bit more of a material cost here as we talk about the balance sheet. So $230 million in cash and liquid securities on the balance sheet, it's a pretty healthy amount, but $520 million in total

debt. However, it's a variable rate and 30 million of it is current. So most of this is all due in 2025, but it's LIBOR. So the London Interchange Bank overnight rate, banking overnight rate, something like that uh basically that the the the london the the equivalent of the london tenure is maybe the way to say it right uh no no no that is slightly lower uh it's just it's close on the rate is it not oh yeah sure sure it might it might track it close but it's not it has nothing to do with it but yeah it's just banking what what um the banks are able to lend at kind of they just average it out it's a weird system we don't need to go into it um on this podcast but yeah it'll it'll uh libor will go up as interest rates rise so yeah all

right naive take on my part but essentially it's going to rise if the federal funds rate yeah that's the most important thing yeah um anyway they they entered into this term loan in 2019 for 350 million dollars then they upsized it in 2020 to 550 million um The effective rate at the end of the last quarter was 4.63%. If rates continue to rise, as we mentioned there, you should expect that effective rate to also rise. I didn't see any hedges in place or interest rate swaps or anything like that. It's your typical floating rate debt where you took on the risk that if general rates

rise, your payments or interest payments will as well. So, on top of that, the debt has some conditions that Squarespace can't have a total debt. And they say total debt to EBITDA ratio greater than four and a half times. And then it kind of steps down over time to three and three quarters. But total debt, you could probably just look at it on a net debt to EBITDA basis because they could theoretically pay the debt down early if they wanted to with that cash. So the way I would look at it is that net debt to adjusted EBITDA or they report an unlevered free cash flow, which I imagine is close to however the banks are assessing that EBITDA figure. Net debt to adjusted EBITDA right now is about 2.4 times. So not too crazy, but my concern here is that it's going to be harder to buy back stock the closer you get to 2025 if rates rise because then you're spending more money towards interest payments and there's just less flexibility to use that cash, less cash available to be repurchasing. So that's why I say you may want to pay attention to at least where that SBC is trending. Yes. Yeah, that was a big. We're going to compare ish Wix versus Squarespace later. And I think the balance sheet works has a big advantage there, although neither of them are perfect.

All right. I'll hit valuation quick. Pretty simple with this one. Let me pull up my metrics. Let me make sure that's the right one because we're doing this kind of at the same time as GoDaddy. Okay. Yes. Squarespace charts and metrics. All right. I have two here. Well, first off, market caps for anyone that's referencing about 2.8 billion, 2.78 billion. Add back the net debt, we get an enterprise value of right around 3.1 billion. So just $3 billion EV. If we get EV to gross profit on a trailing 12-month basis, we're at 4.4. Pretty not cheap in that regard, but pretty darn close to the market average, I would say. And then if we look at EV to free cashflow, it's 24.2. But remember, majority of that is SBC. So again, it's not cheap, I would

say. They're going to grow free cashflow per share, right? Because that share count is coming down. But we did talk about those concerns around how much money they're going to have to be able to deploy into the buyback. And then second, they are still investing a lot for growth. So I think my most important metric, at least in the near term, would be EV to gross profit, most likely, because with the long-term tailwind that they've theorized, someone agree with, or at least part of the thesis with the website builders is that there will be this long-term opportunity to steal market share from WordPress. They're going to have to spend on marketing in sales, they're going to have to continue on R&D to stay up to speed with Wix and Shopify

for the stuff that they compete with. I guess they're not going for the crazy e-commerce stuff that they want to compete with in there. But again, EV to gross profit is probably my preferred metric there. But let's move on to, or Ryan, you have something to add for valuation. Yeah, and I was scrolling through some of the history on the business before the show. And, uh, the, they used to have a private market valuation, I believe at $10 billion. So really, wow. Well, the VC market, the VCs, yeah, it's not, well, is it surprising?

It's maybe not, but the, it's, it's kind of cool to look at how much, uh, how, how rationalized some of these valuations have come in. So, or how far they've come in. I mean, 80% drawdown versus the private, well, 70% drawdown versus private valuation, which I don't think, let me see. You want to see what year that was? Yeah, and they used to be trading at 12,

13 times sales in that regard. And now they're down to an EV of about 3 billion, which gives them, we're probably going to get down to about three, four times gross profit here very shortly with this current multiple. But let's move on to anecdotal evidence. I can just do mine if you're looking that up, Ryan. So with these, we built some websites ourselves. So we knew that Squarespace was a good option. We chose Wix. It's kind of a toss up. They both have fairly similar numbers as we'll go over with Wix. Squarespace is just slightly smaller. But when you visit its product website, so say you go to squarespace.com and are checking out all the stuff they have, you understand right away what Squarespace offers. When you look up Squarespace on Google, the first pop up on Google is, you know, the things you read first are website builder, create a website in minutes with a link to its homepage at Squarespace. um i think that's good because uh you know with a competitor like godaddy or maybe those jumbled

wordpress things if you're a do-it-yourselfer you're going to get confused and with squarespace or wix um which are essentially very similar in this regard you're not i think it's much easier to understand what you're getting into and it says okay create a website in minutes boom they'll have these templates for me i can create this thing in a day which is kind of what we did with one of ours um and then i also like to look at the google search stuff for advertising uh because that's super important for these because that's basically what people are doing uh you know i searched build a website which i think millions and millions of people do that's specifically what casalina said they would buy google adwords on when they first started exactly uh so that's pretty

competitive and they're still doing that because squarespace was the first ad for me that pops up Um, so it's, it, it's interesting in that regard where on the one hand, it's kind of a commodity where you have all these listings on Google search or wherever you're searching and it's going to be Wix, Squarespace, uh, GoDaddy, but WordPress is not going to advertise there because they're open source. So I think that's where part of the advantage is where these companies are competing for customers, but since there's such a large tailwind, it can be kind of rational and And since WordPress is open source, they can have a much more tailored approach to what kind of the SEO strategy in that regard.

All right, I'm going too long on that. Ryan, any anecdotal evidence to add or do you kind of have similar stuff? Yeah, the only thing I'd add is I would say this is sort of the top website builder when it comes to design. I think it just maybe looks a little nicer, which is probably why it lends itself well to kind of the photography, the wedding planners, the portfolio style people. If that's like your top priority, I don't think it is quite as good in terms of business functionality as some of the other website builders, especially Shopify and Wix. um but uh if if design sort of your your your big thing then this is probably a really good uh this is probably the go-to platform for those kind of people i would say also i mentioned the private market valuation that was 2021 so right before they went public yeah

they raised at that round or that valuation gotcha gotcha yeah and that also makes sense that they're investing if it's kind of the design stuff they're investing in the social media tools as well, which I think is quite smart. All right, let's move to future growth opportunities. Ryan, you have the TOC acquisition. Yeah, and I'm not even sure this would be where I think they'll generate some of their growth moving forward,

but they spent a lot of money on it, so it almost makes me feel like I have to have this here because $400 million in a mix of cash and stock, they made this sort of right at the heart of maybe a little delayed post COVID, but it was at a time when restaurants really needed this solution. And so, um, basically talk competes sort of with open tables. So, um, restaurants pay $199 a month and they use talk as their reservation system. They can also process online orders. They got really popular when they launched talk to go, um, which was their, uh,

online ordering the pickup uh what do they call it um curbside pickup kind of offering for restaurants that's really when they saw a lot of growth and then obviously covid was a big tailwind for them because restaurants needed this kind of solution um but to me it it feels like they kind of just bought this at like just the peak of in online restaurant orders and maybe that's a trend that will continue over time and it's like a slowdown now but could they have acquired it for 100 million dollars right now yeah that that to me it's both a concern and then also i mean i know restaurants is kind of a big market or customer market for them so it's good that they have a little bit of a better service offering for them but uh it's concerning that maybe they

do this again at an opportune time, I should say. Yeah. And I think it'll work out if customers and ARPU continue to climb because this should be something for the restaurant tier that can really, really help ARPU. But we will see. All right. Mine is going to be the classic one that everyone is focused on, and that is growth in commerce. So as with Wix and GoDaddy, I think Squarespace likely saw how much Shopify had grown with its Arm of the Rebels, the software behind the e-commerce to compete with Amazon approach

with e-commerce and payments for online businesses. I think Squarespace is definitely trying to replicate that. I don't think we don't need to think about that. They say that. And they now offer a ton of e-commerce tools for its website builders. Last quarter, they did $1.4 billion in GMB

through the platform of 3% year over year. Again, though, like Ryan mentioned, some of that was inorganic because of talk right is that what you were saying earlier uh so yeah the not a lot of it but yeah some of it yeah could be um you're gonna really it's really important what that number looks like i think a year from now um but for reference so squarespace did 1.4 billion dollars in gmb shopify did 46 billion over that same time period so i think you can either read that as bullish or bearish.

One, there's a giant opportunity within these arm the rebels stuff. There's not just going to be Amazon that rules everything. But two, Shopify is such a lead in this space that I wonder if they're just going to

become a winner takes all. It's tough. I kind of feel like they're different. The GMV mix is very different. That's true. Yep. Yep. Like a little more reservations, like different types of business than people that are shipping merchandise. Yeah. Or like a trainer. So an exercise trainer of any sort of type that uses Squarespace for their website, they can take

payments for a class of say they travel around or their personal trainer or whatever it is. And that's entirely different than Shopify. You don't do that on Shopify. Shopify by definition of the name is for shopping online. But here's the thing though, why is the commerce so valuable is because if you get a subscriber that not only pays for the website, but uses Squarespace to facilitate transactions, and again, they aren't going to be as valuable because they don't have Squarespace payments like Shopify payments or Wix payments or GoDaddy payments, but they're going to have much, much higher lifetime values if someone is using them for their commerce. And Squarespace becomes much more valuable to that customer

and you're likely not going to churn because it could be easy to switch over, say, your website from a Squarespace to somewhere else if it only is the design part and you're like a blog or you have nothing else except for people, some things to read and then contact for whatever type of business you are. But if you're doing your actual business

through Squarespace or a good percentage of it, it is a giant risk to leave them because you don't know what's going to go wrong. So I think that's very bullish for them and the website builders in general. But let's move to highlights and lowlights. I think we're going to have similar ones here, Ryan. So why don't you go

and then I'll hit any that you don't have. Yeah, highlights for me. Squarespace has always kind of had a focus on profitable growth. We've seen some companies in the CMS space that are less fixated on that, but that's really been their focus even since the early days.

So, and management has made it clear that that's going to continue. That's sort of a, they explicitly state that in their conference calls. Second one for me, and I already kind of mentioned this, I do think they've carved out a pretty strong niche among end markets that are focused on design first, especially the non-merchant types. So, you know, the photographers, wedding planners, those kind of customers. And then the last one is just the industry tailwinds. We've talked about this time and time again, but more and more people, especially the non-technical people, are building websites themselves. And Squarespace has a well-known brand within the do-it-yourself space. So I think there is going to be plenty of top-of-the-funnel customers coming to them over time. And lowlights for me, though, I think the talk acquisition kind of scares me. It bolsters their offering, I'm sure, for restaurants, but it seems poorly timed.

And it worries me that maybe they're going to... I'm all for them building out solutions to help their customers and maybe even buying small solutions and then upselling it to their big customer base. But $400 million is a big deal. That's four years worth of cash flow at the current rate, roughly three years, whatever. I don't know. That's kind of concerning. I don't think talk was worth that, at least not from what we've seen so far in terms of

how they've improved the financials. Other lowlights for me, floating rate debt, big chunk of that's due mostly in 2025. So if they see a rise in rates, it's going to inhibit their ability to invest in other things. So it's just – I wish they would have raised on fixed-rate debt. I honestly don't see why they didn't try to do that. I know that's hindsight, but you're not taking advantage of low-rate environments by buying variable-rate debt. so that and it seems like they were taking on debt to because it was sort of an opportunistic time maybe it was to finance that talk acquisition maybe that's why they upsized it but um i don't

know it just it feels like it was a poor decision obviously i have the benefit of seeing that rates have risen so uh maybe not fair for me to say last one i'm not 100 sold on casalena um he does control the ship i just didn't kind of it's hard to describe why but i just kind of got that gut feel um listening to that interview where it felt uh i it's like it's impossible feeling to describe i didn't feel like he was necessarily the perfect capital allocation partner which is what you're looking for with management yeah it's hard to kind of judge management It's hard to do that. You just kind of listen and say, do I trust them if you don't meet them or if they haven't been in the public markets that long? On the flip side, I do like that he has tried to go at it with a lean approach.

Those first couple of years where he's like, we can do this without having to hire. It's nice in terms of it shows that there's a focus on profitability. But at the same time, they gave up. There are companies that started much later than them, Shopify and Wix. have eaten their lunch, maybe because they didn't invest enough. Yeah. They've stalled out a bit on the market share. If you look at those over the last couple of years, Wix has done a little bit better. It's interesting. Yeah. I don't know what to think about that. I think it's something investors need to consider a lot though. All right. My highlights

have the same as you, the profitable growth, CMS stuff. There should be that tailwind. But just generally, the business model, I think, is attractive to me, where you have a combination of one, fantastic unit of economics, two, recurring revenue, and three, pricing power due to the high switching costs and the fact that the value the website builders are providing versus the cost of a website builder each year is low. Right now, the difference is huge. I think generally they're about $200 a year across the industry. So I think that could raise to $400 over the next decade

and no one would bat an eye. So that combination of one, fantastic unit economics, recurring revenue, and then the pricing power make website builders like Squarespace just extremely attractive to me. I'm not sure why there's this narrative that content management systems are bad businesses. That's fine. You should be happy. I know, I guess. Yeah. I mean, it's competitive,

but I feel like the lifetime value is really high when you attract a user. The downside is the commodity-ish stuff. But again, there is a little bit of scale if you can offer so many more features to someone, which there are a ton that a small business needs when building an online business. And they can't do any of it in-house. my low lights though uh besides the ones you had yeah i had talk and i had the castle casalena um basically dictatorship here as a bit of a low light uh the other one i had though is that they relate to the game at e-commerce and online payments and they don't even have their

internal payment solution which as it's expensive to build out and the margins are going to be low with the start so i don't know if they're ever going to do that um but i worry that similar to Wix and GoDaddy, Squarespace will lose a lot of customers to Shopify that are e-commerce focused and a lot of them

are e-commerce focused. I don't think it's a failure like we discussed before given the size of the market opportunity. There can be winners in either space.

Shopify will be a winner and then, you know, Squarespace can also be a winner. But annual GMV might be lower than investors expected

a few years from now. Maybe that lower than investors expected back when they raised at a $10 billion valuation. Um... Maybe not now at a $3 billion valuation, but we'll see. All right, bull case, let's wrap things up.

Ryan, what do you see here, valuation versus what you need to go right if you're thinking of buying this thing? Yeah, I think the good thing about these businesses is it's pretty easy to understand the drivers. Commerce complicates things a little bit, but ultimately, it's pretty easy to understand the drivers. So I think they have to grow unique subscriptions at 10% plus over the next several years. It's come down a little bit post-COVID, but their three-year CAGR has been 16%, so I do think they can do that. I also think that they need to increase their average revenue per subscription.

That's going to come through a combination of both price increases, and they've been a little more reluctant to do price increases compared to some of the other companies. So price increases, and then probably more commerce revenue per subscriber as well. And then they're able to maintain 20% free cash flow margins. I know that's kind of a big one. I think it's doable. Oh, easy. And with their SPC levels, it should be able to go higher. Yeah.

And they're basically at that right now. uh sometimes it floats under but generally around that level and then if those things if those three things happen um they'd be generating if we assume so five percent growth and average revenue per sub ten percent plus at a minimum you've got 15 percent revenue growth then 20 percent free cash flow margins you're looking at more than 250 million dollars in free cash flow within three years at 15 times free cash flow, which I think... It's a haircut from here. It's reasonable, certainly reasonable in a bull case. You've got just under a $4 billion market cap, which is within three years, that's upside from here. That's more than a 10% return annually.

Yeah. Unless that SBC comes in so aggressively, although I don't think it would. It wouldn't all be SPC for that market cap expansion. Mine's similar. I think it's very simple. They continue to gain market share versus WordPress, driving a steady growth of new customers to their business, which is a continuation of what they've done over the last decade. And then ARPU steadily grows through the adoption of Karma's tools and price increases. It's very, very simple. Revenue grows at 10% plus a year. And then you have consistent operating leverage due to the strong gross margins. Again, you need the capital discipline though, because we're going to talk about Wix. The big downside with Wix is they

haven't had the capital discipline over the last couple of years. Well, we looked at someone like GoDaddy with the capital discipline, or excuse me, not even the capital, just the spending discipline as they've grown. You've seen they've been able to grow like that. If Squarespace can put up something similar, they can probably have even better margins. And yeah, at the current EV to gross profit multiple of 4.4, if they end up converting a lot of that to cash, eventually, I think the stock would be very, very cheap. So yeah. Bear case though, Ryan, what do you think? So, well, for one, I think the debt's put them in a precarious spot. So short term- Well, not a bankruptcy one, but just more of a flexibility, right?

Yeah. So I guess here's the problem. So short term, I could see some elevated churn. You look at the gmv numbers that means unless it's more just everything moving to in-person transactions there could be there there was an unreal amount of small business uh starts and website making going on during covid which you can if you look at the charts it accelerated during covid and has since tapered off if you start to see some lagging churn so companies that are like they subscribed during COVID, but they haven't had the chance to renew and now they're not going to renew or whatever the businesses have failed, that kind of thing. Maybe net subscription ads slows or even declines for a little bit. I mean, we're seeing sequentially flat. So if you see that,

there's a chance that they're going to see some compression on the top line. on top of that if rates rise at the same time you've got increased interest expenses with kind of compressing top line and then you're going to have to roll that debt double whammy double whammy too on how rising is the economy would be hurt and that could impact their net ads yeah yeah and the and the uh i mean if you're rolling that debt they're probably going to have to do it at more expensive rates too. So I don't know. It's just, I think there's a possibility that free cash, and then you've got, then SBC is more dilutive when they're not using that excess cash to buy back. So maybe free cashflow per share grows at a pretty slow rate in

that scenario. Yep. All right. My Bear Case is just inverting the big thesis around non-WordPress website builders gaining share in WordPress. I said die last episode, but again, it's going to take many, many years for that to happen, given their dominance in the marketplace. But that's the big thesis, is that they continue to take customers from them and as the website builder industry just grows in general. If that doesn't happen, because there's still some growth reflected in the stock price, right? There are expectations for growth. If that doesn't happen, and for some reason, that trend stops, and Squarespace only grows customers by, say, low single digits each year, along with the overall website builder

market, I don't think the stock would do well. And the floor seems fairly high unless they make some terrible missteps as an executive team. But I just worry that the stock could be stuck at these levels if they don't grow enough and there is some competition out there. So, you, I think, have to be pretty darn confident that the WordPress is going to lose market share over the next decade if Squarespace is going to do well. All right. More or less interested. Ryan, let's close things out. More interested.

It would. I do think they'll get market share. I worry a little bit about the valuation here and just some of the decisions they've made. I was kind of bummed out to see the balance sheet, but I am more interested. If there's some sort of steep sell-off, this is something that will be on my – it is on my watch list already, so it'll kind of move up, I guess. Yeah, I'm interested as well. The business model seems sound to me. I don't think management is bad.

I didn't see any big red flags or anything like that. They're not too tested in the public markets. It's only been about a year or so. So I think that's something that I will want to see. But yeah, the business model is very sound. And I think there's a long-term talent. So what more could you ask for? All right, that's going to do it for this episode.

Next week, we're doing BigCommerce, which is a Shopify competitor, I believe, although we'll have to figure it out ourselves. And then after that, we'll be covering Wix to close out the year. That's going to do it for this episode. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time.