Description

Nextdoor is the dominant social network for local neighborhoods. With cash comprising nearly 70% of its market cap and enterprise value at 1.2x revenue, Nextdoor is being priced as if growth will never accelerate and the company will never be profitable. We think Wall Street’s perception is too pessimistic. First, in our opinion, Nextdoor has no direct competition due to the platform’s strong network effect and unique verified address-specific focus. Second, Nextdoor has an all-star cast of board directors and shareholders who have presided over early growth phases at leading Internet companies such as Uber, Zillow, Facebook, LinkedIn, Pinterest, and Airbnb. Third, Nextdoor has the potential to produce significant operating leverage with 80%+ gross margin. We believe the Board will act rationally and steer Nextdoor towards profitable growth sooner than Wall Street’s expectations. As the company builds out its advertising platform and moderates expenses, we see an upside potential scenario of $3.70-4.25 per share based on $350 million in revenue, 20% EBITDA margin, and a 12-15x EBITDA multiple in 3-4 years.

Company background

Nextdoor is a hyperlocal social networking platform for neighborhoods. Individuals join Nextdoor to connect to their local neighborhoods, discover what’s happening nearby, and find local resources. Organizations, such as public agencies, join Nextdoor to find out what’s important to their constituents and to communicate with them directly. Unlike other social networks, Nextdoor requires its users to submit their real names and addresses. Nextdoor generates revenue from businesses’ advertising on its platform. While it has no direct competitor of similar scale, Nextdoor competes for advertising dollars with other ad platforms such as Google, Facebook, Yelp, and Angi. The company was founded in 2008 and operates in 11 countries. Today, the platform has over 38 million average weekly active users (“WAU”), with the vast majority of users and revenue coming from the U.S. Nextdoor became a publicly traded company in November 2021 through a SPAC transaction with Khosla Venture Acquisition Co. II.

Why this opportunity exists

Like most companies that came public via SPAC mergers, Nextdoor has seen its share price decline significantly since the merger consummation, down 85% from an all-time high of $13.50 in November 2021. There are several reasons for this drop:

Disappointing revenue growth: Nextdoor lowered guidance in each of the past three quarters, citing deterioration in the macro-environment throughout 2022. While user engagement has remained solid, the revenue shortfalls have been exacerbated by Nextdoor’s immature AdTech tools and lower mindshare among advertisers as compared to Google, Facebook, Snap, Pinterest, and Tik Tok.

Cash burn: To capitalize on a large advertising market opportunity, management believed it needed to invest in its nascent ad platform and grow its advertiser base. As a result, the company planned for near-term operating losses when it came public. Even as Wall Street has turned against negative earnings stories, Nextdoor has yet to disclose when it expects to achieve profitability.

Exposure to digital advertising: Wall Street has already soured on the entire digital advertising sector given disappointing earnings from Google, Facebook, and Snap. As a relatively small player in an out-of-favor sector, Nextdoor is less likely to garner interest among institutional investors.

SPAC stigma: The track record of companies that came public via SPAC merger has been poor. Nextdoor’s earnings results thus far have confirmed that negative perception.

Why we think Nextdoor has attractive upside

Nextdoor was substantially overvalued when it came public at 15x revenue. However, we think Nextdoor’s current risk/reward profile is favorable with cash comprising nearly 70% of its market cap and enterprise value trading at 1.2x revenue. We think Wall Street is materially underestimating Nextdoor’s value proposition and profitable growth potential.

Dominant local community engagement platform: Nextdoor has over 75 million verified users in 11 markets and over 38 million average WAU. Over 90% of users arrived at the platform organically. Currently, it has no direct competitor of similar scale. This is because of the platform’s strong network effect. Facebook tried to compete against Nextdoor by launching Facebook Neighborhoods in May 2021, but quickly shut it down in September 2022 after failing to gain traction.

Unique value proposition to advertisers: Nextdoor has verified users and addresses, which enable deeper level of ad targeting based on demographic and geographic information. For example, a high-end consumer electronics brand can target certain ZIP codes that better match the income level of customers it desires. Importantly, Nextdoor is less affected by Apple and Google’s privacy policy changes due to its ownership of verified first-party data.

All-star board of directors and shareholders: Nextdoor’s current top holders include Benchmark, Greylock, and BOND. They are venture investors that invested in Nextdoor with some priced at $2.57 per share or above when the company was private. None of these investors have sold shares. In fact, Greylock and BOND have acquired additional shares in the open market during the Summer of 2022 at $3-$3.50 per share. In addition, these three holders have board representatives with impressive track records of investing in and presiding over leading Internet companies with similar models:

• Bill Gurley: partner at Benchmark, early investor in Uber, GrubHub, OpenTable, Zillow
• Mary Meeker: partner at BOND, former partner at Kleiner Perkins and investor in Facebook, Snap, Airbnb, Block/Square, Canva, Pinterest
• David Sze: partner at Greylock, early investor in LinkedIn and Facebook

We believe these board directors will act rationally and steer Nextdoor towards profitable growth sooner than Wall Street’s expectation. As one supporting piece of evidence, Stitch Fix (SFIX) recently committed to significantly reducing expenses in a push towards profitability. Bill Gurley sits on the board of Stitch Fix.

Sarah Friar, Nextdoor’s CEO and board director, has a strong operating background. As the CFO of Square from 2012 to 2018, she was instrumental in reversing the company’s operating losses to mid-teens EBITDA margin by the time she left. She was essentially Square’s chief operating executive during the time that Jack Dorsey was holding dual CEO roles at Square and Twitter. Mary Meeker has been a board director at Block/Square since 2011 and oversaw Friar achieving profitable growth at Square.

Profitability outlook

We believe Nextdoor can achieve profitable growth given the inherent leverage in its business model. Management has targeted 40% long-term EBITDA margin. We do not think this lofty margin goal is achievable until Nextdoor has reached a much greater scale, probably over $1 billion in revenue. However, we believe 20% EBITDA margin is attainable in the medium term as we expect the company to cut operating costs in light of a macro-environment that has forced many tech companies to reduce expenses. On its last earnings call, management guided to a decrease in Q4 2022 operating expenses both sequentially and year-over-year. Management has not provided 2023 guidance but has stated that it will focus on controlling the cost side of the P&L where it sees leverage in 2023. The CFO further affirmed on the call that the company “feels strongly about the need to show financial discipline and demonstrate leverage in the model.” Nextdoor expects leverage in marketing given 90% of new users came to the platform organically. In addition, recent investments in ad-tech, mid-market customers, and self-service capabilities should, in our opinion, also drive leverage in 2023 and beyond.

We think Nextdoor can achieve revenue of $350 million in 3-4 years, or 14-18% CAGR. To reach $350 million in revenue, we believe our assumptions on average WAU and average revenue per active users (“ARPU”) are conservative. We assume WAU continues to grow at 9-12% CAGR, down from 17% in Q3 2022. We assume ARPU grows at 4-5% CAGR. We note that Nextdoor’s current ARPU is around half of SNAP’s and one-fifth of Pinterest’s. Therefore, Nextdoor has ample room to close the ARPU gap with its admittedly higher profile peers.

At $350 million in revenue, we believe Nextdoor can achieve 20% EBITDA margin by holding expenses at the same level as 2022 and gain operating leverage as revenue scales from $210 million in 2022. Nextdoor expects to incur $290 million in non-GAAP operating expenses in 2022, up 21% year-over-year. We think the company will reduce expenses over the next 1-2 years as revenue growth slows due to macro uncertainty. As the economic environment improves in 2024-2026 and revenue re-accelerates, we believe expenses will rise on an absolute basis but decline as a percent of revenue. For reference, Yelp attained 20% EBITDA margin at a similar revenue level.

Valuation

Based on our assumptions of $350 million in revenue and 20% EBITDA margin in 3-4 years, we see an upside scenario of $3.70-4.25 per share based on 12-15x EBITDA, or an IRR of 15-25% from the current price of $2.20 per share. We think there’s further upside should management get more aggressive on expense reduction or digital advertising experience a faster recovery. We believe the downside should be protected by cash on the balance sheet ($1.55 per share as of Q3 2022). While we expect cash burn to continue in the near-term, we think the rate of burn should decline as management executes on cost reduction initiatives.

Risks

Inability to execute on monetization opportunity: Nextdoor’s investments have focused on helping advertisers optimize their ad placement, developing different ad formats, improving self-serve capabilities, and enhancing ad measurement/conversion data. If the company were unable to make progress on these initiatives as it cuts expenses, Nextdoor would take longer to reach desired profit levels.

Further deterioration in ad spending: Nextdoor’s reliance of advertising revenue makes it susceptible to macro-economic weakness since digital advertising budgets are easier to cut. Our assumption of $350 million in revenue and 20% EBITDA margin may take longer to realize should the macro weakness persist.

Decline or stagnation in user engagement: Nextdoor has enjoyed solid user engagement on its platform, but it must continue to enhance features to sustain usage. Recent initiatives include location-based recommendations for local events/places and connections to help users connect/follow people they know.

Catalyst

Decline in cash burn

Guidance on profitability

ARPU growth via increased advertiser engagement and improvement in ad platform

Rebound in digital advertising