Medallia, Inc. | MDLA

Medallia, Inc. (MDLA), another unprofitable “unicorn,” has pitched investors a wildly unrealistic and overstated TAM.  In addition, MDLA only provided two years of historical financials in its IPO documents despite a 20-year operating history in order to curate a narrative about accelerating growth with profitability that is egregiously misleading.

Prescience Point Research Opinions:

• The purported TAM is unrealistic and overstated by at least 2x: MDLA claims its TAM is $68.0B, which assumes every company globally with over $150M in annual revenue will purchase MDLA’s customer experience platform at the same levels as current customers. These assumptions are not only overly optimistic but completely unrealistic.  We estimate the actual market opportunity is less than $10.0 billion.
• Accelerating growth narrative is dubious when put into proper historical context; FY 21 guidance implies organic growth will slow to lowest rate in at least a decade: Revenue growth peaked in the 18M ended FY 15 at ~200.0% and has meaningfully decelerated ever since. The JOBS Act allowed MDLA to disclose only two years of financials in its IPO prospectus filings despite having a nearly two-decade operating history.  Moreover, during its IPO Roadshow, MDLA buried an unusual revision to one of its Risk Factors that warned revenue growth may slow, a complete contradiction from what it told prospective investors.
• Q3 20/FY 20 guidance sandbagged, and FY 21 guidance unnecessarily provided a quarter early to prop stock price before IPO lock-up expiry: Consistent with a dramatically overstated TAM and carefully curated growth narrative, MDLA pumped as much positive news as possible in its last quarterly results before the lock-up expired. On 01/15/20, the lock-up of >108.0 million shares (>6x float) expired and while some have volume and/or blackout restrictions, we estimate at least 2x to 4x of the float are available for immediate                   
• Revenue is inflated by tuck-in acquisitions: Over the last year, MDLA claimed revenue contribution from its acquisitions was “negligible.” However, we estimate recent M&A could collectively add at least $7.5 million to FY 20 revenue (~9.0% of expected revenue growth).  In addition, we estimate FY 21 organic revenue growth will be below 20.0% for the first time in over a decade.
• Revenue is inflated by tuck-in acquisitions: Over the last year, MDLA claimed revenue contribution from its acquisitions was “negligible.” However, we estimate recent M&A could collectively add at least $7.5 million to FY 20 revenue (~9.0% of expected revenue growth).  In addition, we estimate FY 21 organic revenue growth will be below 20.0% for the first time in over a decade.
• Profitability was window dressed prior to IPO to create the illusion margin was turning positive: While MDLA has historically been unprofitable, guidance calls for long-term non-GAAP EBIT margin to be +20.0%. In the quarters immediately preceding the IPO, MDLA reported significant sequential improvement in profitability and even two quarters of positive margin.  However, the results were driven by one major accounting gimmick: higher cost capitalization.  If capitalized costs were normalized, MDLA would have been unprofitable in every quarter it disclosed.          
• Sell-side (i.e. MDLA’s IPO underwriters) has perpetuated the narrative and understated MDLA’s current valuation for better optics: Nine of the eleven major sell-side firms covering MDLA participated as an underwriter in its IPO. Nearly all of them have “buy” ratings with flattering price targets.  These underwriters have zero incentive to produce objectively independent research, it’s purely a regurgitation of management’s overly optimistic targets.  In addition, many sell-side analysts are understating MDLA’s current valuation by using the wrong diluted share count by not accounting for certain stock options and RSUs.
• Public investors are getting the short end of the stick and paying a premium for it as insiders cash out: We believe MDLA’s backers were initially pushing for a sale but after no takers surfaced, they opted for an IPO instead to cash out. Insiders have unloaded massive stakes: the founders sold ~20.0% in two tranches (Fall 2018 & Summer 2019) and the current CTO sold ~10% in Dec. 2019.
• Shares are trading at 13.1x EV/Sales, reflecting an impossible reality: We value Medallia’s shares at $14.12, a downside of ~55.0%.  In fact, less than a year ago MDLA’s board, with help from management and an independent valuation firm, valued its common stock at only ~$6.50/share.