Medallia: Right Approach, Wrong Company (NYSE:MDLA)


Source: Medallia Q2 FY2021 Earnings – September 2020

Investment Thesis

Medallia’s (MDLA) data-centric, AI driven approach to customer experience is a rather new iteration of the business to consumer paradigm. And not only is it the latest iteration of such a relationship, but it’s also the future of B2C. Companies without a robust consumer data analytics platform, such as the one Medallia offers, will struggle in a world of AI/ML ultimately driving business decisions.

To that end, you might think Medallia is my next great idea. Unfortunately, such is not the case, as I believe its product is being replicated by companies, such as Zendesk (ZEN). In the case of Zendesk, however, and likely other more comprehensive customer engagement platforms, Zendesk has a bevy of other products to offer its customers, each of which integrates seamlessly into the overarching platform, such as Zendesk’s Sunshine Platform.

In short, I am very lukewarm on Medallia, though I believe the company is worth exploring so as to understand this rapidly growing industry which will be at the center of all client relationship management platforms in the future.

Understanding Medallia

Medallia is a market leader in the experience management market and employs AI and machine learning to drive efficiencies for its customers and their interactions with their customers. Medallia’s service appeals to a wide-realm of industries and has a strong customer base to build on.

Medallia is a young company that IPO’d in September of 2019 and is still in its early growth stages. The company is expecting strong revenue growth as the experience management market is expected to grow steadily to $23.6 billion by 2027. In this note, I illustrate Medallia’s innovative solutions and provide a valuation. Ultimately, however, I will not be buying Medallia any time soon.

Solutions That Create Value

The image below simplifies the process by which Medallia collects information and feedback from a variety of sources in each company’s operations. The image shows how the data collected is analyzed through AI and machine learning to drive efficiencies.

Source: Medallia Q2 FY2021 Earnings – September 2020

Medallia’s platform integrates with some of the most popular other platforms, as can be seen below. This is extremely beneficial for Medallia’s service because it allows the platform to comprehend data and make improvements using comprehensive data from all of a company’s external and internal components.

Source: Medallia Q2 FY2021 Earnings – September 2020

As can be seen above, Medallia integrates with some of the popular SaaS and customer relationship management systems today. As companies use more and more systems to manage their businesses, Medallia breaks down data silos by gathering data from multiple points so that these platforms can be used more efficiently and synchronized in real-time.

In April of 2018, Forrester released a report in which it analyzed data gathered from the Medallia customer interviews to reflect the total economic impact that the Medallia Experience Cloud could have on an organization. Below, I include their findings, which highlight the average ROI of six of Medallia’s customers over a three year period.

Source: Medallia Q2 FY2021 Earnings – September 2020

Clearly, Medallia is making a substantial difference for its customers by cutting costs and improving the overall customer experience. To show Medallia’s continued success, Medallia was named a leader in the experience management market by Forrester again in 2020.

Source: Forrester Wave CFM Report 2020 | InMoment

Customer Approval

Medallia is clearly offering a strong service and this is supported by a large customer base and the company’s 117% net retention rate.

Source: Medallia Q2 FY2021 Earnings – September 2020

Companies across eight industries employ Medallia’s, which highlights that Medallia’s platform for data analysis has a wide-realm of compatibilities. I expect that Medallia will translate to strong future returns as it has made a strong impact on its current customers.

Source: Medallia Q2 FY2021 Earnings – September 2020

By virtue of Medallia’s offering being so perfectly attuned to our present B2C reality, the company has become mission-critical for many mega-enterprises. I don’t expect this to stop being the case; however, I do foresee competition becoming very, very serious about entering this arena. Former customers may become competitors because they see that Medallia’s customer experience-centric, data analytics-driven approach is in fact the right approach for supporting businesses’ ongoing relationship with customers.

Now that we’ve explored the business a bit, let’s delve into the company’s financials, which are curiously rather anemic, given the rapidly growing, mission-critical industry in which the company operates.

Revenue & Balance Sheet Analysis

As we see below, Medallia has grown its revenues steadily, and we should expect further growth through 2023 (18.6% annually through 2023).

Source: Ycharts.com

Medallia has spent aggressively on SG&A, while spending on research and development has remained steady since its IPO. Medallia’s decrease in spending on research and development is allowing Medallia to pursue more aggressive growth. This has resulted in strong enterprise customer growth, which is illustrated below.

Source: Medallia Q2 FY2021 Earnings – September 2020

Medallia’s increase in customer base is a good indicator that spending on SG&A will result in revenue growth. Between Medallia’s superior solutions and its spending to acquire additional customers, I believe this will fuel strong revenue growth over the next few years. Medallia is also expecting strong revenue growth and is projecting strong operating margins, as the company will not spend on SG&A so aggressively as a percentage of its revenue.

Source: Medallia Q2 FY2021 Earnings – September 2020

Medallia is anticipating subscription revenue growth between 25% and 30% while it will generate strong free cash flow growth as SG&A expenses should slowly decrease as a percentage of revenue while research and development has already decreased.

With all of this being said, it appears the company is attempting to execute a land and expand model, which is very common for SaaS companies today. This is really Medallia’s only option at this point, as competitors race to capture the wallets of businesses who will, almost universally, need some form of Medallia’s software. This is a risky decision, however, as other larger companies will create a competing product, and if their competing product is equivalent in terms of technology, larger companies will be able to “expand” (as they’ve already landed) and shut the door on Medallia.

Alright, next let’s determine what an investment in Medallia should yield today.

L.A. Stevens Valuation Model

To determine a fair value for MDLA, we will employ our proprietary valuation model. Here’s what it entails:

  1. Traditional discounted cash flow Model using free cash flow to equity discounted by our (as shareholders) cost of capital.
  2. Discounted cash flow model including the effects of change in shares outstanding.
  3. Normalizing valuation for future growth prospects at the end of the 10 years. Then, using today’s share price and the projected share price at the end of 10 years, we arrive at a CAGR. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.

Notable Assumptions

Assumption Value
Long-term free cash flow margin 30%
Shares outstanding 143M

As can be seen above, Medallia’s valuation presently does not offer much in the way of compelling returns, and for that reason, among others I mentioned in this note, I will not be committing capital to Medallia.

Of note, I used a conservative growth rate of 15%. The company projects about 18% annualized growth over the next few years, and to be sure, the company could acquire to further accelerate this growth; however, as with all investments I make, I am conservative in my assumptions so as to ensure I only buy the most compelling risk/reward scenarios.

Concluding Thoughts

While I am certainly bullish on Medallia long term, I believe that very innovative, smaller industry participants, such as Zendesk, have already begun aggressively encroaching on a market in which Medallia has been a pioneer and trailblazer.

In short, I’m bullish on Medallia, mostly because I am a perennial optimist and could see management executing a robust land and expand model.

With that being said, I won’t be committing capital to Medallia.

As always, thanks for reading; remember to follow for more, and happy investing!

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Disclosure: I am/we are long ZEN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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