Semrush (SEMR): Company Basics & Recasting Intangibles (1/3)

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Here’s another live example of intangible recasting: Semrush SEMR 16.10 +0.36 +2.29%.

Why this company? Well for starters I own the stock, so I’ve already put together the numbers.  But I also think recasting is particularly relevant and worthwhile here because: (1) SEMR does a lot of investment in customer acquisition via its income statement (the invested capital part of the ROIC ratio), and (2) it’s a SAAS company, which means there is a pretty direct relationship between customer acquisition costs and revenue, which means we have fewer questions about whether or not investment today has a reliable relationship with tomorrow’s revenue and income, which is the case for say a pharma company.

To be clear, I am not going to get into a stock pitch for SEMR here. But I think a basic understanding of the business is necessary as context for understanding the intangible recasting and thinking about SEMR’s ROIC generally. So I will provide this background and then get into the capital productivity numbers. As I have mentioned elsewhere on this blog, a peeve of mine is what a poor job many analysts do of effectively communicating how a business actually makes money, so I’ll do my best at that in the installment of a series of posts on SEMR. 

How Does SEMR Make Money?

Semrush was founded in 2008 and IPO’d in 2021, not a great time for a tech IPO, and in fact, I came across the company by screening for recent IPOs that weren’t fairing particularly well. Sometimes an IPO falls into a void where the initial buyers are flippers (and therefore gone in short order) and there has not been enough time or interest among fundamental investors for the stock to get a solid holder base yet. Or at least that was my thinking.

Here’s how the company describes itself in the S-1: “Semrush is a leading online visibility management SaaS platform that enables businesses globally to identify and reach the right audience for their content in the right context and through the right channels.”  Here is how it categorizes those channels:

Semrush's five channels for successfully reaching the right audience: SEO, advertising, content marketing, social media, market research.

But if you are familiar with internet marketing, you probably know that really, Semrush is an SEO product – that is how it got its start. And if you are familiar with internet marketing you probably also know that there is an entire world devoted to SEO optimization, and SEMR is considered the best if not one of the better ways to do it.  SEO optimization is important because it’s a way to get traffic without paying for keywords (AKA Organic Traffic), which means potentially very low customer acquisition cost (CAC). This traffic tends to grow over time by itself, which is kind of magical.  Basically, anyone selling anything on the internet is or should be investing in SEO for these reasons. Some might say they question the future of SEO because of things like ChatGPT, which is fair, but that’s well beyond the scope of what we are discussing here. 

SMR’s has a subscription model, which makes its revenue highly recurring.  Here is a link to its pricing a screen grab:

The Semrush SEO pricing plan model, which factors in customer acquisition costs and customer lifetime value.

SEMR acquires customers mostly through a web funnel, whereby it offers free products to users and then tries to convert them to paid as these users seek incrementally more products (e.g., “upgrade to premium”), AKA moving down the customer acquisition funnel.  There is a whole culture of creating and optimizing these funnels in Startup World. Per SEMR’s November 2022 investor presentation, the company says it has 94,000 paying customers and a 122% dollar-based net retention ratio.  Its future sales will be driven by the rate at which it keeps existing customers (with revenue growth from price increases and selling them additional products) and (profitably) acquiring new customers, per below.

What does a typical customer look like?  

SEMR has a range of customers, from a one-off blog (like this one) using some free tools or the Pro subscription to optimize for SEO, to larger SMBs that use the Business subscription and pay for multiple users for example, several individuals in the marketing department getting access on a per-seat cost basis. This is a business aimed squarely at SMBs, it’s not large enterprises driving the revenue. 

Customer Lifetime Value & Customer Acquisition Cost

Like many subscription businesses, SEMR is highly focused on its LTV/CAC ratio.  LTV is customer lifetime value (numerator). We want this number to be a lot higher than what it costs to acquire a customer (denominator). I think this ratio is kind of a microcosm or operating version of ROIC, with the latter being financial statement-driven and more company-global in nature. But they are getting at the same thing: how much does the company invest today, to get X in revenue and income in the future? What rate of return does that imply? What has this looked like historically for this business? Is it improving or fading? How sustainable is it? This is also a big chunk of what ROIIC is. For example, a LTV/CAC of 2x would imply that the customer generates $200 of lifetime income for the company over the life of the customer for every $100 invested in getting that customer, approximately.  The rest of the money the business invests is to service that new customer and other existing ones (think of this as the investment in the ball-bearing plant for an industrial company).  ROIIC captures both parts of this investment, while LTV/CAC just captures the first (and very important) part.  Forecasting of how all of this plays out into the future (in addition to the discount rate and terminal value assumptions) drives the present value of the business from its future operations, which is incremental to the value of the net assets the business has in place today.  Or put another way: Intrinsic Value of Semrush = The PV of future income net of investment + value of assets in place.

SEMR Financials & Valuation Basics

As of 1Q23, SEMR had a market cap in the low $1Bs.  Against this, the company has about $240mm in net cash, and it doesn’t burn much – only $9mm in 2022.  One thing that drives me (and many others) crazy is excessive SBC for tech companies – one of the maddening aspects of it is the add-back to get to CFFO. If one thinks of it (as I do) as a true cash expense, then a lot of companies burn a lot more cash than their GAAP or “adjusted” financials show. But here SBC was only $7mm on a $250mm revenue base – so saying SEMR doesn’t burn much cash is accurate even considering SBC as a cash expense. 

Here are two additional screengrabs from the November 2022 Investor Presentation that capture a lot of the key financial info aside from what I mentioned above:

Semrush historical financial numbers denoting revenue and growth from customer acquisition, overhead, etc. across five years.
Semrush Investor Presentation 1/2
A snapshot of Semrush's historical financials.
Semrush Investor Presentation 2/2

Some of what I think are the key points here include:

I think that’s enough of the basic financials to frame the ROIC analysis here, and in fact, the last bullet above brings us to the point of looking at SEMR in the first place: recasting intangible investment from the income statement to the balance sheet so that we can treat investment in a way that reflects the economic reality of the business when calculating ROIC.  That’s next!

Please email me with questions/comments/errors related to this post!