Medallia: We Still Like It Under $30

Prepared by Chris, CEO Quad 7 Capital and Team Leader at BAD BEAT Investing

The market is very difficult to find opportunities with limited downside and significant upside. One stock that generated 25% returns back in the late summer was Medallia (MDLA). Make no mistake at nearly $30, missing this recent 20% is disappointing, but in the medium term, we think this is going higher. We think you should consider the play below. Medallia works with some of the top brands globally and is seeing a rebound from the COVID slowdown. Let us discuss.

Source: Medallia Q2 slides

The suggested play

Target entry $29-$31

Second leg: $27

Stop loss: $25

Target exit: $35-$37

Option play: December Calls $30 Strike for ~$3.00

Time frame: Winter 2020

Discussion

Medallia has been hit hard by the coronavirus, perhaps more than other software stocks that may even have benefited from the conversion to remote-work. Medallia specializes in customer-experience software, and companies have been aggressively taking down marketing and customer outreach expenses as a non-mandatory use of cash that needs to be conserved during the pandemic.

However, with things coming back up and running, Medallia is in demand again. Some of Medallia’s slowdown is because it has a lot of Retail & Automobile exposure, representing 20% revenues:

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Source: Q2 slides

Medallia’s steep decline since the beginning of the year has recovered, and we like the space it operates in going forward. If you do not have any software exposure, consider MDLA. The company is profitable on a pro forma basis and generating free cash flows and has a good amount of liquidity.

This is a an important point which makes MDLA impressive relative to many SaaS stocks, especially amid an uncertain macro environment, something we learned from management.

Most of Medallia’s customers are well established major corporations. These businesses have large budgets and spend a lot on software subscriptions. Now, we did mention autos and retail, and these customers are under pressure. So that is a risk. But things seem to be improving in those sectors as 2020 moves forward. Overall, a high churn is unlikely.

At current share prices near $30, Medallia trades at a market cap of $4.2 billion. There is about $350 million of cash on hand and no sizable debt. The balance sheet is healthy.

We think revenue grows this year double digits. Given the space as a whole, Medallia could get to 10X forward revenues, which would put its share price in the mid-$30s accounting for cash/debt.

Recent performance strong

MDLA’s Q2 results were pretty good with solid revenue

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Source: Q2 slides

With COVID kicking up, revenue growth decelerated. This was expected, but revenues grew 21% to $115.5 million. This was a beat of analyst consensus by $5.2 million.

Billings are a key metric and they were solid with billings growth in the quarter rising 20% from last year. As the economy begins to re-open, retail and travel names will benefit, which MDLA does a lot of business with. The company is also profitable on a pro forma basis.

3949741 16029526570881157 Source: Q2 slides

Despite the growth of revenues slowing thanks to COVID, its pro forma operating margins grew from -2% to positive 2%. One negative was that cash flow was down, but was better than the losses of last year’s Q2. Cash, cash equivalents and marketable securities were $347.5 million as of July 31, 2020. This was a decline of $60 million primarily related to the acquisition of Voci.

3949741 16029527278034978

Source: Q2 slides

Forward look

Management, although pulling guidance mostly, was pretty clear about Q2 positives and negatives. We still expect some challenges from MDLA’s customers and also challenges around new business acquisition as everyone becomes more accustomed to building and sustaining virtual relationships. We think the full-year picture is still hard to predict. Still, the company has seen record SaaS revenues up 25% year over year, record total revenue up 21% year-over-year, and it added 57 enterprise customers in Q2, ending the quarter with 839 enterprise customers. It also had a record 146 customer ‘go-lives’ versus 100 in Q1, all executed virtually.

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Source: Q2 slides

What we like is that new customer growth is strong. Medallia saw dollar based net retention rate of 117% over the past 12 months, very strong.

This metric has varied slightly quarter-to-quarter; however, it consistently remains in the mid to high teens. Subscription revenue gross margin was 82% compared to 82% in the year ago quarter, which, considering the new environment, is strong. MDLA’s SaaS margins are among the best in class for subscription software companies.

As we look ahead, we are projecting total revenue to be between $116 million and $117 million for Q3. We expect SaaS revenue to be between $95 million and $95.5 million, representing growth of 20% year over year. Operating income is the wildcard here. For Q3, we expect non-GAAP operating income to be around $0.5 million. That is not bad for a company pounded by COVID.

Take home

Sure, we wish we wrote this at $26-27 and captured more upside after the big fall from $40. But if this market knocks the stock back again, buy it. We think it is heading to the mid $30s, with downside limited. The biggest risk would be if new massive stay at home orders or shutdowns hit its customers with the fall resurgence of COVID. While COVID persists, and is growing in many hotspots, we have a much better handle on the virus at least in terms of mitigation and treatment.

As such, we like a lot of names linked to reopening longer term. This SaaS play has potential as it is exposed to both blue chips that are doing fine, and some names like autos and retails linked to reopening.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MDLA over the next 72 hours. 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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