Qualtrics: A Buyout Could Save Some Investors (NASDAQ:XM) (2024)

Introduction

Qualtrics International (XM), or as I may call, Qualtrics XM, is a company that pioneered the experience management industry. I believe that this company is a strong business model with improving chances of a buyout; however, the company is overvalued and outside of the prospect of its acquisition, it is best to wait for a major drop.

Company Profile

Qualtrics International is an intriguing company where they have a very unique niche to provide software to allow businesses to manage the experience of many stakeholders such as consumers, employees, the view of their brand and products.

According to their most recent 10-K filing, they pioneered the experience management (XM) industry. In a way, they have the first mover advantage, which allowed them to at least gain a head start helping companies improve the experience of all relevant stakeholders, including stockholders in an indirect manner. This is mainly because companies can increase returns by providing much needed quality-of-life changes for customers and employees alike.

There are various ways that Qualtrics can collect data other than surveys, which can include calls, social media posts, product reviews, generally what can be understood here is that it is able to integrate itself onto digital forms of measurement. Its AI modules will likely do its best interpretation of meaning, tone, and feelings as a few examples of metrics to understand how customers or employees feel about something.

What Their 5 Products Offer

While the company covers four dimensions of experiences, that being customers (CXM), employees (EXM), product (PXM) and brand (BXM), they have one additional aspect of their business listed in their product section that provides consulting solutions to help companies find out what consumers want next.

CXM's solutions aim to provide a better quality of experience to customers across every possible channel. It is characterized by a view of the whole customer experience and so ideally does not leave out a single channel where the product can't miss their feedback or what they're saying.

EXM is a product that seems to be more tailored to human resources (HR) managers. It is supposed to allow them to more easily perform initiatives meant to improve the quality of life of employees in an entire organization. The way the product gets feedback is somewhat similar to CXM but allows for greater anonymity and for HR managers to look for feedback in more specific areas.

PXM allows for a product to be fine tuned to meet the market's needs. It allows people responsible for bringing products to market to understand what are the requests of customers so they can shift priorities at greater speeds so features that are desired are launched first.

BXM allows for the improvement of the perception of the brand. Usually, brands carry a reputation and perception that tells the consumer what the brand is about. For example, I know Disney (NYSE: DIS) for making family-friendly movies. I know Pringles (NYSE: K) for being that iconic potato chip company that makes potato chips neatly stacked in a tube or container. Brand XM is meant to home in on the customer's perception to maintain and improve the brand identity that entities (individuals and businesses) have.

DesignXM feels like the culmination of Qualtrics XM's history, as it is a software product that utilizes the capabilities of all four dimensions of experiences to suggest new ideas to improve the brand and products that customers know, figure out how to improve the employee experience and ultimately predict what the market will want next. I would say it is the consulting side of their offerings, especially as the company implies it can replace outsourced consultants as it does exactly what they do.

It's rather confusing at times considering what the company describes isn't specific enough for me to grasp, but I think combining the 10-K along with product reviews (which I'll note are subjective and biased, but provide a more specific view as to what the products are called) helps a long way to understanding what Qualtrics XM does and how its product is perceived as.

The business, however, is enticing and can definitely have some pretty good use cases especially as companies tend to have the disadvantage of having a disconnect between departments in the organization, the company and their customers, and they end up losing sight of the brands and products that made them the legends that they become.

This is especially supported with the staggering growth the company has experienced in the last 5 years and is projected to have in the next two.

Going from around $400 million in revenues to $1.5 billion in revenues is certainly an impressive feat. This was further helped by the pandemic lockdowns experienced in 2020.

Additionally, as seen here, I believe investors are going to be very pleased with the clear path to non-GAAP profitability, which is definitely a great step that should allow the company to achieve full GAAP profitability.

SAP's Exit

To begin with this section and talk about how SAP's (NYSE: SAP) exit could affect the company and the stock price, it is important to talk about the exit itself. Right now, SAP seems to be exploring a sale of its current controlling stake of Qualtrics XM, while Qualtrics XM has received a few bids for the entire company.

As of the moment, Silver Lake plans to acquire the company for $18.15 per share, or an estimated valuation of $12.4 billion. Considering Canada Pension Investment Board (CPP) also has shown interest in acquiring the company, and Silver Lake and CPP are both separate companies that invest in other corporations, it is fair to assume that there might be a bidding war. Emphasis on might.

As the story develops, there isn't much certainty as the talks are not a guarantee yet and their exclusive talks are likely to end on March 15, absent of any extensions.

It seems logical that a controlled company like Qualtrics XM would then find bidders after the controlling shareholder decided to explore selling the company. For SAP and Qualtrics XM shareholders, it is in their best interest for a bidding war to ensue, especially as both entities wanting to purchase the company are private equity firms, so overspending on the company might not have as much of a widespread effect, in my opinion. However, to be fair, it is also equitable to want these firms to get a decent price, so while SAP's exit might as well ignited interest from large funds towards the company, it is important if there is reason for any upside for the company's stock and prospective shareholders.

Stock Compensation Issue

Before talking about valuations, there is one section that I feel changes the picture drastically:

(Columns represent 2022, 2021 and 2020 in that order, numbers displayed in thousands)

I feel like this is the mountain in the room that raises massive eyebrows here. How can they literally spend about twice of their gross profit on the operating side of the business and still be afloat?

Well, I'll show the entire operating cash flow segment and let you take a guess what likely is the main driver of operating expenses.

If you guessed stock-based compensation, you got it right. Very likely it is the main driver of half the company's operating expenses. Here's a couple more figures to get this analysis going further:

So, here's what seems to be going on. The company has been compensating its C-Suite with a very beautiful (for them) payment package. The CEO alone got about half of that stock-based compensation and I really cannot just understand what could be going on here, especially as this seems to be normal now that the company is fully public.

The pay package incurred in 2021 (not yet seeing 2022 online) is confirmed by the CEO pay package displayed in salary.com, which drew its source from the 2021 Proxy Statement.

The 2022 Proxy Statement will likely come out in a month from now, based on the release of the prior Proxy Statement, which explains why stock-based compensation is rather outdated in most websites. However, if there's anything to go by in the 10-K, I believe this level of stock-based compensation should be an insult to shareholders and customers of the company. The company performed somewhat well during the year, but I don't think it's going to align the executives' interests with shareholders if their pay package is high regardless if the stock price goes down 99% or up 99%. For context, the stock price went down 70% in 2022, and was never positive for the entire year.

I'd speculate shareholders will not approve the CEO's pay package if it's the same as it was in 2021, considering it's just excessive. It severely affects the GAAP profitability and doesn't show responsible spending on their CEOs. I don't believe this aligns the CEO's interests with shareholders due to the apparent discrepancy between the stock price and the CEO's pay package, even if the company held well against a year like 2022.

Valuation

How does this come into play for the valuation? Well, I'd say the company is doing somewhat well for itself. Here's a few metrics that will be useful for determining the company's valuation:

Before proceeding, I drew their EBITDA from their Income Statement displayed on Seeking Alpha, Revenue, Equity, Operating Cash Flow and Shares Outstanding (Class A and Class B) from their 2022 10-K, their non-GAAP EPS from the quote page's annual EPS chart, and their free cash flow was calculated using the operating profit in the 10-K after taxes and subtracting it by the cash used or provided by investing activities.

Now, I will be honest, these numbers don't look good to me, but it can be worse. Qualtrics XM's growth profile could be completely hammered, but it is at least both growing and trying to improve profitability. As such, I believe I can use my normal pre-determined valuation metrics for the metrics I want to use. For revenues, this would be 5x, equity is one-to-one (even at negative equity), EPS and cash flows are 20x while EBITDA would normally be 5x.

However, due to various negative numbers and various insignificant numbers leading to unrealistic valuations, Qualtrics XM can only be valued based on revenue and equity as the following metrics would lead to these valuations:

I don't see Qualtrics reaching these numbers, especially if the projected non-GAAP EPS by analysts of $0.22 materializes. This would then mean a share price of $4.40 by using a 20x valuation metric, which is my standard for EPS-based valuation.

EBITDA is negative, so I don't need to say that a negative valuation is possible here. It's already implied in the stock market that free cash isn't handed out for just buying stocks; this only happens with dividends on profitable companies for record-date shareholders.

This leaves us with the above mentioned valuation metrics. Revenues would have a 5x multiple as standard and is applicable here, and so it would provide a market cap of $7.293 billion dollars, or a price target of $12.48. Equity would be one-to-one and allow for a price target of $3.26. This is still a major disparity.

However, valuation is in the eye of the beholder, and I honestly believe that there's always a reason why some companies catch a bid. As the saying says: "one man's trash is another man's treasure," and so it is fair to look at multiple viewpoints to valuation.

For one, you can add the two price targets together and get a valuation much closer to what we have right now: $16.74.

Alternatively, I can give revenues a weight of 80% and equity a weight of 20% and then add them together with their respective weightings. I'll illustrate what it looks like: (Revenue Val*0.8)+(Equity Val*0.2).

This gives us a valuation of approximately $10.64 per share, or a market cap of around $6.2 billion.

Regardless of how it's looked in this valuation analysis, Qualtrics XM is a bit overvalued and potential buyers may be overpaying for the company, similar to how investors have done back when the company IPO'd. I believe the odds for a bidding war would significantly decrease as the bidding price per share approaches $20 per share. However, should bidders actually agree on a price this high in the future, this would be a boon for current investors that bought recently. However, this would leave early investors with something to be desired, leading to another good example as to why dollar-cost averaging is a good strategy, as well as not piling in on low-value stocks (meme stocks, growth story stocks, turnaround story stocks).

Based on the analysis provided here, though, I'd say the company's valuation is a little too spicy for my taste, considering how irresponsible stock compensation spending has been in the last two years. I'll give this $11 per share.

Conclusion

To recap, Qualtrics XM is a very enticing business with great potential to appreciate in the long-term. However, there is a good reason to try to avoid potentially overvalued companies like these, especially if their executives are taking a massive paycheck in the form of stock-based compensation that affects the overall net profitability of the company in such a drastic way.

However, I believe there simply are problems with profitability that from the looks of it, management is trying to fix. As such, the company should be valued at least more modestly while management sorts this out.

The prospect of a buyout is likely the main reason that saves this company from being rated a Sell. Simply put, the odds are honestly decent for a buyout considering SAP wants to sell their 71% stake and there are a couple of bidders for the company. So, at least in my book, it would make sense to wait and see what happens with the talks and then after a conclusion is made, take action accordingly.

I rate Qualtrics XM stock a Hold with a price target of $11 per share.

The Dragon of Wall Street