Time For A Cautious Bet On A Bottom For Semrush Holdings (NYSE:SEMR)

Semrush Holdings (NYSE:SEMR) delivered detailed guidance in its Q4 2022 earnings report. If the numbers play out, the lows of March should mark the lows of the year for SEMR. However, the company created its guidance assuming that a more “normal” economic environment will unfold this year. Thus, I am “hopeful but cautious” shares given the recent events in the banking system suggest that normality remains a distant dream for traders and investors. Fortunately, SEMR’s low valuation makes it easier to bet on a bottom for SEMR.

Guidance

Management sprinkled guidance and expectations throughout the short conference call. They summarized their relatively optimistic outlook in this statement: “we expect it will be a year of balanced growth and significant margin improvement starting in the third quarter, and we expect to return to a non-GAAP breakeven run rate in Q3 time through our growth and efficiency initiatives.” Note that expectations for normalization conflict with the Federal Reserve Bank of Cleveland’s current probability of a recession. These odds start soaring in July and go over 50% in December:

Despite these odds, it is worthwhile to take a look at the numbers to assess the potential opportunity to invest in the future at a discount.

This summary of Semrush’s guidance includes data from the annual report and the Q1 2022 earnings report as well as the Q4 2022 earnings report:

• Q1 revenue: $70.3M to $70.7M, ~23% year-over-year gain.
• Q1 non-GAAP net loss of $8M to $7M, worse than the $2.6M loss a year ago.
• 2023 revenue: $306M to $309M, ~21% year-over-year gain, much lower than the 35% 2022 growth rate.
• 2023 non-GAAP net income: $3M (includes a $1.3M cost for exiting Russia, mostly incurred in Q1), a substantial improvement over 2022’s $33.8M loss which was heavily impacted by the exit from Russia.
• Positive free cash flow.
• Declining marketing spend as a percentage of revenue.
• “Modest” growth in employee count, lower than the 38% growth in 2022.
• Net revenue retention of “mid-teens over the long term”.
• Gross margin above 80% (I find it hard to imagine Semrush will ever get higher than the current range).
• G&A expense “below the pace of revenue growth”.
• R&D growth “slightly above 20%.”
• Platform development: 1) new apps for the App Center, 2) increased capacity to onboard new apps with more automated onboarding, 3) bundles available beyond the main subscription plans.

The revenue growth rate is healthy. Yet, it also represents slowing growth that is disappointing given management’s bullish commentary on new customer additions. Semrush reported “a strong start to 2023 with record new customer additions in January and February.” One problem is the company’s churn rate: on average 30% of customers return to Semrush. The company promised initiatives this year to reduce churn and reported that they “are already seeing improvements thus far in the first quarter.” Still, the slower growth rate means that a price/sales ratio from 5 to 6 is around fair value for SEMR this year (the ratio hit an all-time low of 4.3 earlier this month.

The Promise of AI

Generative AI, especially ChatGPT has been a rage this year. Given Semrush’s business in search engine optimization, it makes sense that the company has already developed AI models for its portfolio. The company indicated that its writing systems and position tracking currently use GPT and the company’s own AI models. The company plans to optimize for Bing and gain market share by selling products for Bing optimization. However, management did not explain how this increased market share will translate into a net increase in demand. For example, Bing is not likely to bring new people into search who otherwise would not have used search at all. Bing will gain at the direct expense of Google’s dominance. When Google rolls out its own GPT-enabled search, Semrush anticipates the interface will work similarly to featured snippets. The company already helps digital marketers optimize for featured snippets, so it seems the business is well-positioned for Google’s GPT-enabled search.

I will be looking for more news on AI developments for Semrush in coming months. Search will undergo fundamental changes, and Semrush will need to spend R&D dollars to keep up. AI-related press releases could be catalysts for the stock.

Revenue and Balance Sheet

Semrush reported full-year revenue of $254.3M, up 35% year-over-year, driven by higher average revenue per customer and growth in paying customers. The company saw increased revenue from higher-priced core customers, replacing lower-paying customers. The company did not provide information on the share of customers in its different price tiers or the dynamics of distribution across these tiers. The annual report shows that “customer cohorts typically experience their lowest dollar-based net revenue retention rate during their second full year after becoming a customer”, so a push for new customers this year will show its biggest payoff starting in 2025. Semrush’s dollar-based net revenue retention rate was 118% in 2022, down from 126% in 2021.

Semrush’s cash flow from operations in the 2022 fiscal year was negative $9.6 million. The company disclosed in its annual report that “we have a history of incurring net losses and, although we have achieved profitability in certain periods, we expect to continue to incur net losses in the future. We incurred net losses of $7.0 million, $3.3 million, and $33.8 million for the years ended December 31, 2020, 2021, and 2022, respectively.”

Fortunately, Semrush maintains a healthy amount of liquidity given its IPO and a follow-on stock offering. Semrush bought $157.9M in “short-term investments” which marked a major shift in its cash. I went to the annual report to figure out this purchase represented U.S. treasury bonds. Semrush likely made a timely purchase, but given the impact of T-bill purchases on the current banking crisis, I will be watching closely the value of these bonds in the next earnings report. Getting to positive free cash flow later this year will make the T-bill management a little less critical.

The Trade

SEMR surged 9.1% in response to earnings. This move helps make the case that SEMR has finally carved out a bottom in its stock price. The confident full-year guidance likely motivated buyers; perhaps the references to AI added a turbo boost as well. The stock even followed through with a 9.8% gain the next day as latecomers jumped into post-earnings glow. However, as of the time of writing, profit-takers have already reversed those second day of gains. This trading action sets SEMR up for a time of volatile, range-bound trading. Fortunately, the low valuation could help the stock weather whatever is coming in the economy this year. I am looking to make a cautious bet on a bottom in shares with purchases between current levels and the pre-earnings low. New lows of course would invalidate my bottoming thesis.

Be careful out there!