Description

With the collapse in US software valuations and towards the end of 2Q22, Freshworks (FRSH) has become super interesting. Although FRSH is listed in the US, it is a leading B2B SaaS company from India. We have followed FRSH since its IPO in September 2021 and have always liked the business, but there was no margin of safety, until now. FRSH was founded in India and currently has over 85% of its workforce based there; a portion of the sales and marketing team and senior management have relocated or transitioned to the US and EU. The company has catapulted from being an India-based product-led growth software provider in customer support and IT service management to a leading B2B SMB and mid-market SaaS company offering globally competitive solutions. The model resonates with what we expect from Indian tech companies – operate locally and sell globally. Over a span of 10 years, the company has reached USD400m+ in revenue through a combination of two mature and two new products, a) customer support management (USD220m+ revenue), b) IT service management (USD110m+ revenue), c) customer relationship management (USD50m+ revenue), and d) HR management (USD20m+ revenue). FRSH has reached the top of the league tables as a stalwart challenger evidenced by over 10k verified customer reviews for its products and enjoys a competitive advantage that larger US peers do not have – a low cost of operations in India. As a testament, it is rare to find vertical software companies having two or more successful products in separate verticals. Through our primary diligence, FRSH has already reached the product maturity of seven to eight on a ten-point scale when compared to the incumbents, ServiceNow, Atlassian, HubSpot, and Zendesk (and at some level Salesforce). FRSH’s product offering is 20-40% cheaper vs. peers (R&D and customer support based in India at lower costs), which makes it very appealing to SMBs and mid-market firms looking to switch over from legacy on-premise software to SaaS.

We like founder-run businesses and FRSH is no exception. Girish comes from a product management background and has over two decades of experience with software and SaaS businesses. Instead of siloed product development and/or large bolt-on acquisitions, Girish focused on building FRSH’s four core products with a single underlying infrastructure in mind. As such, the different vertical products all “speak” to each other enabling a single “true source” of data. From the very beginning and by design, FRSH aimed to build an ecosystem instead of being a single product company. So far there is clear evidence of success in its two mature products (customer support management and IT service management) which make up the bulk of its revenue. With its ecosystem of products, FRSH has only just started its cross-selling journey with 22% of customers buying more than one product. We expect cross-sell penetration to accelerate in the years to come.

There is significant opportunity in FRSH’s end-markets as the majority of SMB and mid-market customers are greenfield acquisitions since they are either on legacy on-premise solutions or using homebrewed products. FRSH has already cemented its value-add with SMBs and has been steadily moving upmarket to the mid-market segment alongside the growth of its customers. As FRSH’s customer mix shifts to mid-market, its LTV/CAC ratio will also expand resulting in an overall increase in ROIC.  Based on our analysis we see mid-market customers having close to double the LTV/CAC ratio vs. SMB customers. We are relieved that Girish does not plan to target top of the pyramid enterprise customers, which would have required a complete overhaul of FRSH’s go-to-market model. This would have meant significant investments without a clear ROI and resulted in FRSH directly clashing with mature competitors who have been entrenched with their customer for decades, leaving FRSH with little to differentiate on. Knowing where to reinvest capital is an important attribute we look for in our management teams and Girish exemplifies this.

FRSH has been growing revenue over 40%+ annually while being EBITDA breakeven. In contrast, certain competitors are focused on (unsustainable) growth at all costs while burning cash. This is made possible due to FRSH’s low-cost India operations. These operations provide FRSH the ability to be price competitive while offering 24x7 customer support to all customers (including freemium customers) at a fraction of the cost that global leaders can provide. Following its IPO, FRSH has roughly USD1bn of cash (along with breakeven cash flows) thereby providing resilience to weather long durations of macro weakness. In addition, with its product-led growth model (FRSH has free versions for all its product offerings), it can help solve pain points for its SMB customers during periods when these customers are feeling the cash crunch, potentially elevating FRSH to antifragile status. As long-term cash flow focused investors, we were not interested in paying bloated software valuations for high growth businesses with limited visibility into future cash flows. We understand that FRSH’s product quality and cost structure will only get better with time and as of today, we see FRSH trading at a sustainable and durable normalized cash flow multiple.

Catalyst

Continued revenue growth