Motley Fool Hidden Gems Investing - Squarespace’s $6.9B Takeover, First of Many?

Episode Date: May 13, 2024

Private equity has $2.6 trillion in dry powder to put to work, is Squarespace at the top of a long shopping list? (00:21) Jason Moser and Dylan Lewis discuss: - Permira private equity’s plans to take website-builder Squarespace private at $6.9B. - The Biden administration’s reported plans to raise tariffs on EVs, solar equipment, and medical supplies, and why automakers in China aren’t too concerned. (14:54) The internet economy is all about eyeballs. Fool analyst Asit Sharma and Ricky Mulvey take a look at Pubmatic, an advertising company creating trillions of impressions per quarter and facing off against some trillion dollar companies. Companies discussed: SQSP, SCHW, PUBM, TTD, MSFT, NFLX Monarch Money free trial offer: www.monarchmoney.com/fool Host: Dylan Lewis Guests: Jason Moser, Asit Sharma, Ricky Mulvey, Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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This episode of Motley Fool Money is brought to you by Squarespace, which will be brought to you soon by Premier of Private Equity. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Jason Moser. Jason, thanks for joining me. Hey, Dylan. Glad to be here. How's everything? Things are good. We've got some dealmaking going on in private equity. We've got the global EV race heating up, and we've got a look at a lesser-known player in online advertising today.

Jason, I love it when we check the news on a Monday morning and we've got a fun deal to unpack. Certainly the case today. Website building suite Squarespace will be going private thanks to an all-cash deal from private equity firm Premiera, valuing the company at around $6.9 billion. Seems like a nice time for us to reflect on Squarespace as a publicly traded company. It has not exactly been a world-beater. It went public at a tough time during the peak of the pandemic. What do you think Premier sees in Squarespace's business? It's not been the greatest time for Squarespace. Obviously, a very competitive industry in website building and what comes with that. I think that Premier likely sees

A couple of things. First and foremost, they see this massive market opportunity. When you look at Squarespace's S-1, for example, back when they went public in 2021, when they filed that S-1, based on data from Intuit, they were estimating around 800 million small to medium-sized businesses in a medium-term addressable market of $150 billion, at least. And so, I mean, those are big numbers, of course, and that's not something that is all Squarespace's opportunity. But this is where the puck is headed, right? When it comes to retail, when it comes to commerce, it's headed online. And if you own a small to medium-sized business and you don't have a web presence, you're leaving something out there, right? You need

to get on that. And so, Squarespace, obviously, is one tool that can help get that done. Yes, it's been a difficult time for the company as a publicly traded company, but I would imagine that Premiera sees this attractive market opportunity, maybe has some ideas in regard to strategy and ways that they could perhaps improve the business. And when you're chasing a market opportunity of $150 billion, as quoted, it's understandable to want a little slice of that. To be clear, Squarespace is not alone in being a company that has struggled in this zone. I think the nearest competitor for them is a company like Wix. Both of those businesses are kind of, it depends on your basis type stocks.

If you've owned it really over the last two years or so, you're probably feeling pretty good. If your basis is tied to some of the pandemic highs, probably not feeling quite as good. But if you expand that out and you get out just beyond the site builders and you start thinking more about companies that specialize in e-commerce, bring BigCommerce, bring Shopify in the mix. Similar story there, too. How do you look at these companies that are really good at one specific thing in the zone vs. the more built-for-shopping, more e-commerce, more breath-oriented offerings? On its own, if you look at the website building opportunity, that on its own probably isn't the most attractive out there. We saw,

For example, Block, formerly Square, they acquired Weebly sometime back, which was essentially the same thing. Heck, I even remember building a website on Weebly back in the day, and I was impressed with how easy it was and how robust you could make it. They had the freemium version, and then you could upgrade and pay subscription fees to get more features. I think that's really the key to it all. On its own, maybe it's not the most attractive, But when you consider the opportunity to build additional value-add features and additional revenue streams, thinking about things like ads or payments or what have you, then it starts to become a little bit more palatable because, again, those are large market opportunities

on their own and obviously can tend to be more recurring in nature, given the nature of the actual business in that online space. If you're looking for details, shares up 13% to just over $43. The deal price was $44. Jason, it seems like there's a high level of confidence that this one is going to be happening. There's not a lot of uncertainty being priced into the stock right now. No, I don't think so. This is a situation where you've got Squarespace obviously competing against very tough incumbents out there, Shopify, among others. When you look at the fundamentals of the business, it's not a bad business, but it's a young business and still trying to establish its own market position there.

They've grown revenue at about 17% annualized over the last three years. Not bad, but probably not something necessarily to write home about. Still working towards profitability. But worth noting, it is cash flow positive, even after you account for stock-based compensation. I think that when you look at this acquisition, it's not the craziest valuation for a business like this, somewhere between six and seven times sales. So, to me, it does make sense to go ahead and take a chance on this now when the valuation is looking a little bit more attractive, given that Squarespace has had such a difficult time as a publicly traded company. It's a nice opportunity for us to check in a little bit on the private equity space.

In researching the show, I saw a piece from S&P Market Intelligence that at year-end 2023, private equity firms were sitting on nearly $2.6 trillion in dry powder. A lot of cash on the sidelines. Basically double what they had in 2016, and I think an all-time high for the category. This is not the first time we have seen a tech company get taken private, especially one that had come out to some fanfare on the public markets. Qualtrics was out as a public company for about two years before it got scooped up in 2023. I think Toshiba also taken private in 2023. Do you expect that we'll see some more announcements like this with how much money is sitting on the sidelines right now, Jason?

Yeah, that's a lot of cabbage. I think just by virtue of that alone, yes, we are likely to see more deals here in the future. They don't want that money just sitting there. That money has to go to work doing something. I think now we will likely see more deals materialize. We've got a lot of companies out there with very interesting prospects, but just very young business models. I think Squarespace fits into this category. Some interesting prospects. It's still a young business finding its way. Now, we're in a bit more of a risk-off environment. It's not like we've seen over the last few years, where investors just had this unquenchable thirst for risk. It's a little bit of a different situation now. What that means, what comes

along with that, valuations start to look a little bit more enticing. It makes a lot the sense that private equity is taking a very close look at a lot of these businesses. I would imagine we'll start to see slowly here through the rest of 2024 and into 2025. I'd imagine we'll be talking about some more deals here on the show in the coming months and quarters. Over to a space where business might be a little bit tougher going forward. EVs. Reports out this week that President Biden will announce a new set of tariffs on EVs, solar equipment, and medical supplies coming from China, in part to protect American industry and also in the interest of national security.

Jason, EVs are getting the headline and are really showing up in a lot of the reporting on this. But I think we do need to put it relatively plainly, there are not a lot of EVs coming into the United States from China right now. No, not at all. I think it's somewhere in the neighborhood of a couple of thousand. It's really not even material. That rings true for most of the markets where these tariffs will occur. This is a recurring theme we've seen over the last several years. A lot of companies are looking to reduce their dependence on China through supply chains,

figuring out ways to diversify their businesses away from depending necessarily on that Chinese economy. We've seen Apple obviously making big inroads with India, for example, not only for consumers, in regard to production as well. You mentioned the word headline. I think this is a headline, but there's not a whole heck of a lot more to it. On its own, this stuff isn't terribly impactful. Like you said, we're not bringing a lot of EVs in from China. The solar cell market, not a big deal there. It's not something where this is going to impact one side terribly. But But it seems to me, at least, they're trying to hit this before it really becomes a problem. We're talking about things like solar and EVs and whatnot.

We're talking about markets that are still developing and represent really attractive growth opportunities. So, just trying to get ahead of this before it actually does become a problem and we become too dependent on an economy outside of our own. I think the concern here is just the sheer market dynamics of, the U.S. is generally at a higher price point for most of the EVs that we're seeing. You know, a lot of the cars that are coming out of China are a bit cheaper. While it does not have an immediate impact, I do know when we look at things like tariffs

and trade negotiations, Jason, there tends to be a little bit, you do this, I do that. And so, I can't help but wonder what type of response we may see related to these tariffs, because I think at present, the tariff is about 25%. That could escalate up to about 100% under this new plan. I have to imagine that China will respond to that. and there will be some effect for companies in the United States. I suspect you're right. Sort of a tit-for-tat kind of a deal there.

A lot of politics, and even more so, a lot of diplomacy that comes with things like this. We see two different aspects of this, from the economy side of things, but then also the political side of things. And speaking of headlines, these are headlines that I suspect we're going to see more and more of this type of back and forth here over the next several months. If I remember correctly, there's, I think, an election in November that has some relatively modest consequences. I'm not sure. But yeah, I think this is one of those things. We'll continue to see the back and forth nature of it. I think the key for things like this, really, it all boils down to diplomacy.

You don't want to look at this as, we just want to go it on our own. But by the same token, I mean, there is sort of a protectionist nature here when it comes to these developing markets. And we want to make sure that we are not overly reliant on any one in particular. And obviously, the history with China and the government there is, how do I put this diplomatically? It's volatile. Let's just say it's volatile. I'd imagine we'll continue to see this back and forth, but hopefully it's nothing that's too terribly debilitating for either side. Fair to say that businesses that have a fair exposure to China, that volatility will continue. I suspect, and I think we're going

to continue to see language riddled throughout these earnings calls over the next several quarters. Companies, again, they're trying to diversify away from that reliance on that China supply chain. That makes perfect sense, particularly when we've seen the impacts. We've seen the impacts when those supply chains were so dependent on one particular entity, one particular economy in regard to supply chains, and then those supply chains break, it can have really long-reaching impacts. That's something worth avoiding if we can. Alright, a final story for the news roundup. For some retail investors, the times and the portfolio dashboards are changing.

Schwab's TD Ameritrade migration nearly complete over the weekend. I think just shy of 2 million TD customers moved over to Schwab. Jason, it marks the end of an era for some folks in their investing journey. I saw a lot of people on X lamenting that they were so used to checking in on TD and are now being switched over to Schwab. Now that we finally have all these customers over, we know it was part of Schwab's grander strategy. How should we be looking at this? Well, I, for one, hope that this is it. I was a Scottrade user. Scottrade got acquired by TD Ameritrade. Then I had to get used to TD Ameritrade. I was like, OK, TD Ameritrade

is not so bad. This is working. Oh, wait, now it's getting acquired by Schwab. Fortunately, I guess I was piped over to Schwab much earlier, so I've had a chance to get familiar with that user interface. I will say, whether it's web-based or app-based, I think Schwab has a terrific interface. I'm able to get everything done I want to get done. But this is really, I think, a story of the strong getting stronger. Schwab is one of the biggest financial entities out there in the world. When I talk about big, we're talking about 35 million active brokerage accounts. You're talking more than 5 million workplace participant plans. You're talking about 2 million banking accounts and close to $9 trillion in client assets. This is a

massive company. I think bringing TD Ameritrade into the fold, it's understandable. Consolidation in this space is something we've been talking about for a while. Clearly, Schwab saw a lot of value there in TD Ameritrade. I guess, to your point there in seeing the reactions on Twitter or wherever else, about people disappointed that they have to leave that TD Ameritrade interface. Well, maybe that just goes to show TD Ameritrade was doing something right. Maybe Schwab made a wise choice in bringing TD Ameritrade into the fold. But this absolutely is something that makes one of the biggest banks out there even bigger, even stronger. I think folks who've been moved over to Schwab, there's a little bit of a

learning curve, but you get used to it quickly, I'm sure. If there's anything that's true over time, it's that people hate change, right? We all do. We all do until we figure out, oh, well, maybe it wasn't so bad, right? Jason Moser, thanks for joining me today. Thank you. You just found out that your sales team is at risk of missing quota. Don't panic.

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Sign up for exclusive access today. rippling.ai slash fool. Coming up, the internet economy is all about eyeballs. Up next, pool analyst Asit Sharma joins Ricky Mulvey for a look at Pubmatic, an advertising company creating trillions of impressions per quarter and facing off against some trillion-dollar companies. Asit, before we get into Pubmatic, a lot of this ad platform stuff is a little confusing. Can you explain what a sell-side ad platform does? Who are the customers? Absolutely. A sell-side platform, Ricky, is a platform that represents publishers.

Think about a company like Yahoo, which is a company that Pubmatic has had a long relationship with. That's a publisher. They have inventory on their webpages, and they want to sell that inventory. So, you can see that's differentiated from what we call the demand side. Those are advertisers who want to advertise and reach end users. So, it's a pretty simple demarcation between the two. Publishers on one side, that's sell side. Buyers or advertisers on the other side, that's the demand side. So, this is one of those companies I've probably experienced, but maybe I don't know where. So, where might I have seen a Pubmatic ad? Well, let's see. If, again, you've been on any of Yahoo's sites, you'll likely have seen one of

these ads, maybe News Corp, any number of publishers with acronyms that really we don't come into contact with in the wild. So, let me go to some other examples where you probably have seen some of the inventory that's represented on this platform. If you've played games on Zynga or Electronic Arts. You've seen those. Coming soon, Klarna. If you use Klarna, you'll see ads that are generated through Pubmatic's platform. Same with Roblox, which also just announced a partnership with this company. If you've ever ventured onto over-the-top streaming sites, there are several which Pubmatic represents. AMC Networks, Barstool Sports, Major League Baseball, the Cox Media Group. Their reach is really pretty wide. I'm going to just say that if you spent more

than a few hours on the internet or a connected device of some sort, you've probably seen an ad that came through a Pubmatic server. That's a lot of the internet, but this company claims they're doing 58 trillion impressions in a quarter, which sounds like a lot. How is that possible? I know you've listed their customers, but how is that even possible? Well, think about, Ricky, not just the internet, but connected TV. So, we mentioned streaming. The number of hours that we as a society spend on the internet, on TV shows that aren't through traditional linear TV, through gaming, all of this amounts to an amazing, just sort of incomprehensible amount of inventory, if you think of each click as representing a destination or

each minute that you might spend on a streaming platform as a potential to see an ad, multiply that out by maybe hundreds of millions of people or billions of people, since we've got 8 billion people on the planet, and the math starts to work out, crazily enough. I don't want to go back to the old days of seeing how much time I spent on my phone. I used to do this and install the minimalist app after that. But when we start extrapolating the math, it actually is like, that's not a big number at all. Full favorite, the trade desk, which is on the other side of ad buying. Do these companies have a relationship? Is Pubmatic selling ads to the buyers on the trade desk? Yes, it is. In fact, Pubmatic integrates with

many platforms that are on the demand side, but the trade desk is one of the biggest integrations that it has. So think of it as being able to link both sides of that sell side and demand side equation that I talked about. You sort of have to play nice with the business model on the other side. And that's something that Pubmatic has done a great job of. They actually cooperated with the trade desk a few years ago when the trade desk was trying to promote its solution to cookies. We had all the signals that Google Chrome was going to dispense with cookies. They wouldn't follow you around the internet anymore. But some new technologies would have to come into place that would protect user privacy

and also let advertisers get to us. Pubmatic really worked with the Trade Desk and several other major players in the industry to have technology. It's called UID 2.0. It's just one of many that Pubmatic works with. But having this kind of positive frenemy relationship with the other side, I think is one of the things that's enabled them to succeed. A lot of the internet economy is winner take all, or there's one or two big winners and then all of the other companies seem to be left

to the side. It's difficult to be the second most popular bookseller on the web or the third most popular ride hailing app in the United States. On this sell side, which is a space I've seen, but I'm less familiar with. Is Pubmatic the big winner, or are there other competitors for investors to watch? I think they're the big winner so far. I mean, there is Magnite, which was formed from the merger of two different companies several years ago. There's a company called Croteo. And these are decent business models. But Pubmatic, I think, has differentiated itself through really astute investments in technology, which we can get into in a moment here. By doing that, I think they've won more creds with publishers. One example is,

they now have something that blurs the line between demand side and sell side. When they offer a new product up to publishers, they get a pretty rapid uptake. I think you can consider them in terms of potential and profitability. Probably, too, now share of the market is on this smaller or sell side. I could think of them as a talk dog. Yeah. Speaking of technology investments, this is a rare tech company that's actually adding to its headcount this year, growing their employee base by 11%. I know they're making moves on where those folks are going with generative AI. What do you make of this move in the investments Pubmatic's making? I think it's solid. On one hand, you can say, gee, maybe the company is having to spend more

to make more money. But Pubmatic has a history of investing during various cycles. This last cycle, when interest rates spiked, inflation spiked, and advertisers pulled back, all these stocks got pummeled. Pubmatic was working on its platform during that time. They were actually a very early adopter of generative AI. They've got a team of engineers out in Pune, which is close to Mumbai in India. They were really into using this technology to become more efficient. It's a very cost-efficient company. It's always been profitable. It generates a lot of free cash flow per revenue dollar. I see this as really coming to the end of the cycle of investment in capital expenditure. I've had a chance to speak to the CEO, Rajiv Goel, a few times.

The last time I spoke to him was last year. He told me, look, we are in an investment cycle, and that's going to have its end as well. We'll have to start reinvesting in CapEx, capital expenditure. But for now, we've made those investments. Now we have to optimize them. And part of that, logically, is hiring more engineers to reduce the cost of impressions for advertisers, which helps their bottom line, too, because they sell more of these clicks. So, yeah, I think, given their history, it's a move you can have confidence in, But you have to watch it, too. They have to get a yield on that investment. Because if you look at the income statement, as this company has dramatically grown revenue,

it hasn't necessarily grown its operating income, even though it's profitable. It still may be experiencing growth pains, or do they have a spending problem? I don't think it's a spending problem. Historically, they actually have generated decent operating income. But we're, I think, a couple of years into that cycle now that I mentioned before, it's really the dip in advertising demand that hit their income statement. You see them slowly coming out of that. The forerunner of that is cash flow. Free cash flow hit a trough. It tripled in the last quarter. I think the margin on a book basis, a gap basis, is going to follow as now we see more advertisers spending. As that spend

goes up, you'll see them capture the incremental profit. I think that's more of a cyclical thing when you look back at their entire history, even before they were a public company. We got a glimpse into that when they had their S-1 a few years ago. But I think the point behind your question is correct, though. If you're growing in a competitive environment, investors are going to want to see, if this is your narrative and that is their narrative, when this advertising spend keeps growing, it's got to show up in the bottom line, right? We're going to need to see that bottom line profit. And then as we wrap up, any other flags, good or bad? Green flags, orange flags, yellow flags, red flags, you're keeping an eye on with this company.

Yeah. So I'm very fond of this company, Ricky. I've been following it for a number of years, ever since it went public. I've recommended it in services I work in. But you have to be clear-eyed about this. The biggest threat to a business like Pubmatic may not be what looks obvious. The obvious thing is, the trade desk can step over into the supply side. In fact, as I mentioned, Pubmatic has a product that steps into the demand side. Trade desk has its product to try to play with publishers themselves. But really, the threat is more the big giant. We have Google, which is a force in the digital advertising field. And you have companies like Microsoft. Microsoft was chosen to act as a sell-side and demand-side platform for Netflix.

That's a big chunk of business that rightfully maybe should have gone to Pubmatic and the Trade Desk. Whenever big tech throws its weight around, the little fish feel what it is to be a minnow. I think that to succeed, the Trade Desk, Pubmatic more so, is going to have to be able to navigate some waters where Microsoft can take what it's done with Netflix and lift and shift that to another big entity. I know we're almost out of time, but I want to put in one pathway that Pubmatic can actually do this, and that's through retail media advertising. They've been very quick to work with a growing number of retailers who want to advertise or let their vendors advertise to customers. I think that's a wave that they will be able to ride.

The second is something that Rajiv Goel has been very intent on, which is called supply path optimization. That's cutting out all the middlemen in the buying process on the supply side. He's been pushing the company to do this, which is a higher-margin business. So, each quarter, you see more and more revenue is a function of supply path optimization. And there's your margin, Ricky, in the long run. That's where a lot of the profit is going to come from. But there is a significant problem with the connected TV story, though, if you have Microsoft throwing its weight around with Netflix, because that's the story Pubmatic's telling investors is, hey, more ad impressions

on TV. This is where people are spending time, and this is where we're selling. The part we're not hearing as much about is those trillion-dollar companies who are also looking at that market. Totally. I mean, this is really such an opportunistic market, meaning that there's opportunity there for the tech players, but there's also opportunistic revenue from big tech giants. The one thing I think Pubmatic would answer back to that is, it's a very fast-growing market. There's room for a smaller player to keep growing, even as giants take a bigger chunk of the business. But I think it's a risk. I think you're right to call that out as a risk. We'll keep following it. I think it's got a bright future, but it's not like a slam-dunk future. I think the

company is really capable, management is capable, the product is good, the tech is good. But you have to put all those pieces together and get out there and fight against these big whales every day. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening! We'll be back tomorrow. We'll be right back.