Asana: This Dog Is Headed Downward

Introduction

Asana: A physical posture assumed and held during a yoga session.

Downward Dog: A yoga asana where the body forms an inverted V.

My experience with yoga lasted all of a few minutes. My body was not flexible enough to contort itself, or strong enough to fight the laws of gravity. While I had no problem breathing in and out, I wasn't sure it actually made me more peaceful or took my mind off the problems in the real world.

Like how hard investing is. Companies exposed to trends do well for a while, and then falter. They blow their profits on overpriced acquisitions or make strategic errors. If they do well, the employees are handsomely rewarded. If they don't, senior executives still make out okay.

One can make a fortune on compounders over long periods of time. However, I find that disinvesting is an easier proposition. There are always fads and unfounded optimists. People who raise public money with a dream and no idea how to run a business. Negative compounders that keep generating losses until they slowly go out of business. There's nothing like a period of higher interest rates and tighter money to excise such excesses from the market.

For the past two years, Asana (NYSE:ASAN) has had operating losses amounting to almost three-quarters of its revenue. For the coming year, it has promised to clamp down on expenses and limit its losses to half its revenue. Or as one could say: It will lose a Curtis Jackson for every George Washington it brings in! Its stock chart looks like a downward dog, but I believe the downward part still has a long way to go. It is being propped up by the CEO committing to buying the stock. It's unclear how he is funding this, and it's possible it's through margin loans. Meanwhile, employees are paid in copious amounts of stock, which ensures that the shares available to be sold constantly increase.

Company background

Asana is an enterprise software company that sells a work management platform, which helps companies manage work tasks across the organization. I find an online calendar and Excel works pretty well for me, but I guess different strokes for different folks. The company was formed in 2008 as Smiley Abstractions, before changing its name in 2009. Asana is headquartered in the mecca of money-losing software companies, San Francisco.

The company was founded by Justin Rosenstein and Dustin Moskovitz, one of the many people considered co-founders of the company Meta Platforms (META), when it was known as Facebook. He likes to think of himself as a "cosmopolitan consequentialist" who is "openly mischievous, but secretly good." With his wife, he founded a non-profit whose mission is to "help humanity thrive."

It's reasonable to think that someone who finds success and fortune in their first endeavor would go on to repeat the feat. But sometimes, people who are rich aren't visionaries or good managers. They just happened to be in the right place at the right time. Like being Mark Zuckerberg's roommate.

Asana annual financial overview

For the year ending January 31, 2023, Asana reported $547 million in revenue, up 45% YoY. Operating income was a loss of $408 million (-75% operating margin, dismal even by growth software company standards). The company spent $435 million on sales and marketing, or 80% of revenue. This product sure looks hard to sell! It declared a non-GAAP operating loss of $207 million after excluding about $200 million in share-based compensation and restructuring expenses. The average share count for the year, at 200 million, was up 13% YoY.

The company has a market capitalization of $4.6 billion at the current share count of 214 million. It has a healthy cash balance of $0.5 billion and a minor amount of debt. It thus has an enterprise value of $4.1 billion, amounting to 6x its forward annual revenue.

The balance sheet looked pretty normal. The deferred revenue balance amounts to about 4 months of forward revenue. The company has an accumulated deficit of $1.2 billion from past operating losses. The cash flow statement was dreary, with net cash from operations for the year being an outflow of $160 million, even after $190 million of stock compensation was added back. The company raised a net $347 million (after expenses) in stock from a private offering subscribed by the CEO.

The company guided to $643 million in revenue for the coming year (up 17.5% YoY), with a non-GAAP operating loss of $125 million. This would amount to a -50% operating margin on a GAAP basis, even with a rapid slowdown in growth.

A true believer or propping up the stock?

As Asana's stock went on a roller-coaster ride after publicly listing during the Covid boom, the CEO was a regular purchaser of its stock.

In September 2022, as cash at the company was running low, Asana's CEO bought $350 million of stock sold by the company at the then-market price of $18.16. It sure was a vote of confidence. He announced that the market opportunity was enormous, and the company was fully funded to get to free cash flow positive by the end of 2024. Alas, with continuing losses, the stock continued to go nowhere.

Then, in the company's earnings call in March 2023, the CEO announced that he would buy a further 30 million shares of the company in the open market through a pre-arranged trading plan that would take effect from June to December 2023. Curiously, the company did not put this information in its earnings release. It was, however, good for the stock to pop up even as the initial post-market price action indicated investors were not too happy with the results or guidance.

To his credit, Moskovitz works for a salary of $1 per year with no stock grants. As per the company's proxy statement filed in April 2023, he has beneficial ownership of 112.4 million shares of the company out of a total of 218.3 million as of that date (page 62 of proxy statement). From my reading of the footnotes, 3.1 million shares belong to entities where he is a trustee or director but not a beneficiary. Thus, he owns about 50% of outstanding shares, which would go to about 60% once he completes the anticipated open market purchases.

The company has cash to fund itself for four more years at the current rate of cash burn and it is possible it will reduce its losses to prolong this time frame. The bigger issue for Asana is the huge amount of stock compensation, which will ensure an ever-increasing share count. I do not believe the company will ever get to GAAP profitability as it doesn't recognize stock compensation to be a real expense. It may target becoming non-GAAP profitable, but that will still mean large operating losses on a GAAP level. The company is issuing about 10 million shares to its employees per year (page 102 of the 10-K filing). So effectively, the CEO will be buying shares equivalent to three years of stock compensation. This could lead to a short-term increase in the price of shares, but I believe the longer-term trend is downwards.

ASAN stock valuation and recommendation

The lazy way of valuing a loss-making software company is to slap on a multiple of revenues. I believe doing so is a mistake as companies can have very different margin profiles. To value the company, I will assume that it can ultimately reach a GAAP operating margin of 5%.

A 5% margin on 2023 revenue of $643 million would result in normalized annual operating profit of $32 million. In recognition of the company's enormous net operating loss carry-forwards, I will assume that it will never pay taxes. Thus, it would have $32 million in after-tax operating income or $0.15 per share. I will apply a generous 50x multiple to arrive at a per share value of $7.50 for the business. By comparison, Microsoft (MSFT) trades at 35x earnings, and Oracle (ORCL) at 25x, though they have slower growth rates. I will add back the $2.25 per share of net cash on the balance sheet and round up to arrive at fair value for the shares of $10, or more than 50% downside from the current share price of $21.

In a bull case, the company might get to a 10% operating margin. This would result in normalized annual operating profit of $64 million or $0.30 per share. I will apply a 70x multiple to get to a value per share of $21 for the business. Adding back $2.25 per share of net cash would result in fair value for the shares of $23, offering less than 10% upside from the current price. Thus, the company has to improve its operating margin from -50% to +10% and garner a high multiple for the current share price to be justified.

In a bear case, the company will never become profitable. In this case, I would value it at its net cash of $2, for 90% downside from the current share price.

I recommend that investors sell any positions in ASAN stock. The opportunity to sell into the CEO's purchases will last six months, after which the selling deluge from employees will continue with no ready buyers. For those with courage, I recommend shorting the stock. I would caution that the short interest is moderately high at 14% of float. A lower-risk option would be to buy puts, perhaps at the $20 strike.

External ratings

Seeking Alpha's quantitative rating system gives ASAN a composite rating of 3.4, equating to a hold, with an F for valuation, D for profitability, B+ for growth, and A- for momentum and revisions. Wall Street analysts are similarly lukewarm, with a rating of 3.5, translating to a hold. Their price targets have followed the stock up and down in a similar downward dog pattern!

Risks are moderate

The main risk for any small or mid-cap company is acquisition risk. I believe that the losses here would be too much for a private equity firm to stomach, even the ones that have been doing head-scratching deals, where they've ignored the large amount of stock compensation. I don't believe any other enterprise software company, even with the most ardent investment bankers, will touch this with a barge-pole. So that leaves how frustrated the CEO gets and whether he will put more good money after bad to acquire the whole company. Getting financing could be tough, and the philanthropy and cosmopolitanism will have to take a back-seat! It will also leave the open question of how to replace $200 million a year of stock compensation for employees.

On a fundamental basis, the company could rapidly increase its revenue, cut costs and become profitable.

I'm sure the company is working on some kind of AI angle, so who knows how investors will react to it. It certainly doesn't take much to get people excited!

Conclusion

Even in the landscape of unprofitable tech companies with high stock compensation, Asana stands out with losses amounting to half its revenue. With no fundamental support for the valuation and regular stock sales from employees, the only thing investors can hang their hat on is the CEO committing to buy shares. This offers a good opportunity for investors to offload their holdings or short the stock.