Yext: After Rebound, Moving To The Sidelines (NYSE:YEXT)

Recessions and tough economic times sometimes help to separate wheat from chaff. Although it can be tempting to believe that this year’s massive rebound in tech stocks will lift the tide for all names proportionally, I’d caution investors to exercise extreme discipline in stock-picking this year – especially with stocks that have seen huge “phantom rallies” since the start of the year.

Yext (NYSE:YEXT), in particular, is a name worth re-investigating. The AI-driven search company, at one point a growth luminary in the software sector, has struggled for years especially as the pandemic directly impacted its core clientele (retail and restaurants). Up ~15% year to date and more than 60% from lows reached last fall, I think Yext has likely reached the end of its recovery rope, at least in the short term.

After the recent recovery rally, Yext’s bull and bear case are now more balanced

I was bullish on Yext last summer as the stock cratered below $5. Now, however, with the stock significantly higher than it was before, I am switching my take to neutral.

Yes, Yext is still cheap. At current share prices near $7, Yext trades at a market cap of $879.1 million. After we net off the $162.3 million of cash on Yext’s most recent balance sheet, the company’s resulting enterprise value is $716.8 million.

For the fiscal year FY24 (the year for Yext ending in January 2024), Wall Street analysts have a consensus revenue target of $414.9 million, representing just 4% y/y growth (data from Yahoo Finance). This puts Yext’s valuation at just 1.7x EV/FY24 revenue.

But to me, Yext is more of a value trap. I now view the stock as a relatively balanced bag of positives and negatives.

On the bright side for Yext:

• Differentiated technology base. Yext isn’t another CRM or HCM platform with dozens of competitors, (in particular mega-cap competitors) in the market. Its Search product helps drive in-website search functions based on natural language processing; its Listings product (Yext’s core original offering) helps companies manage how their location data is stored across the web, and Knowledge Graph helps companies process and manage mentions of a company’s brand online.
• Recurring revenue. All of Yext’s products are subscription-based and the majority of its revenue is recurring.
• Easy to swallow for potential buyers. Yext’s relatively diminutive ~$400 million enterprise value makes the company quite an easy acquisition target, especially for a larger “portfolio” software company looking to add an extra ~$400 million in recurring revenue. In particular, I think Alphabet (GOOG) is quite a synergistic buyer, especially given Yext’s original focus on location-based data and Google Maps.

But on the flip side:

• Growth has stalled. Yext is barely managing to eke out growth anymore, and in the tech space, lack of growth creates a vicious cycle where customers start to lose faith and churn (software requires support, ongoing maintenance, and feature updates – none of which companies want to invest in if they think the vendor is in trouble of sinking).
• Cost cuts can only go so far. We appreciate Yext’s ferocity at cutting costs, but on a stagnant revenue base this can only go so far – especially when cuts are being made to the company’s revenue-producing sales teams.
• Founder exit. Howard Lerman’s resignation as CEO in 2022, as well as the concurrent exit of longtime CFO Steve Cakebread (a former Salesforce executive and well-known in the tech community), indicate a lack of faith in the direction of the business.

All in all, I think the recent upswing in Yext stock is an excellent time to lock in gains (or cut losses) and move to the sidelines. Yext has been a routine disappointer in earnings announcements, and when the company next announces earnings in March, I think we’ll see the stock take another leg downward. We’ll have a chance to dive back into Yext at better prices, but for now it’s best to exercise caution.

All signals point to an ailing company

The first and foremost thing we should discuss is our top concern: Yext’s inability to grow.

Yext achieved flat revenue growth (actually, a reduction of -30bps y/y) in Q3, to $99.3 million. Consensus is continuing to expect a slight decline heading into Q4. And in my view, consensus expectations for a return to single-digit growth in FY24 are quite optimistic given where the business is currently landing.

The issue here, to me, is that Yext is focusing on cutting costs from a position of weakness. The current recession has given many stronger companies an opportunity, if not even an excuse, to trim fat and bulk up operating margins. Yext announced a layoff of 100 employees in January, representing about 8% of its workforce.

Commitment to profitability is a positive thing. Yext showed a return to positive operating margins on a pro forma basis in Q3, up to a 3% margin from a -5% loss in the year-ago quarter. But here’s the issue: the cuts seem to be happening in the pieces of the company that are the most apt to drive growth.

In Q3, as a percentage of revenue from a pro forma basis:

• Sales and marketing expense fell -4 points to 49% of revenue,
• R&D expense fell -2 points to 14% of revenue, and
• General and administrative costs fell only -1 point to 15% of revenue

I’d have preferred to see more cost-cutting on the overhead side. Marc Ferrentino, the company’s COO, noted on the Q3 earnings call that he believes a smaller, leaner sales team can do better:

We’re making good progress in driving efficiency across our sales organization. And as Mike mentioned, we’re successfully doing more with less. This shows in our ARR growth, which we achieved with a leaner, stronger and hungrier sales team, not surprisingly doing more with less is also what our customers strive for, particularly in this economic environment. So our objectives are closely aligned with our customers. What resonates with our customers is being able to show how quickly we can solve their answers problems across one area of their organization, and then demonstrate how our platform can be adapted to manage additional pain points. I’m encouraged by the momentum we’re beginning to see here and most importantly, the results are resonating with our customers. It’s becoming even more clear that we are well positioned to drive long term growth as our new and existing customers are taking greater advantage of multiple products across our Answers platform. What resonates with them is the value add and cost savings that our products enable to help our customers with digital adoption and becoming mission critical, particularly with the growing number of disconnected digital tools that are implemented across organizations.”

I think, however, these reductions will take a toll on both sales employee morale and ultimately Yext’s chances of returning to growth.

And from a product sphere, Yext’s reductions to its engineering and software development teams don’t bode well for the company’s product roadmap. Its biannual software release in the Fall seemed, at least to me, light on new features outside of a new “Listings Verifier” product that fact-checks a company’s web appearances.

I don’t see any major product development efforts or new monetization streams in the works here, which is a major concern.

Key takeaways

Yext can slice expenses all it wants, but if the company shrinks, these efforts won’t avail too much. It’s worth noting that Yext isn’t quite as mission-critical as other software platforms might be that are directly intertwined in a company’s operations – and so especially in the current macro environment, Yext may see elevated churn alongside slowing deal cycles.

I’ll continue to watch and wait here, but I do think Yext’s prospects of rallying significantly beyond $7 are more limited now.