Description

Wix caught our eye after noticing Pat Dorsey holding about 20% of his portfolio in the stock at double its current valuation. We have long respected Pat Dorsey; an up-and-coming fundamental value investor focused on companies with moats protecting their current earnings power and allowing for high ROI internal investments.

This is slightly different from the average VIC pitch, as we have not bought the stock just yet because of a couple of lingering questions (laid out at the end). So we would love some feedback.

Quick synopsis for those who would would rather not read the whole thing.

Wix is the cheapest, judging by EV relative to sales and GP than its competitors. We believe they are the best positioned both in the core business and in a couple of growth outlets. Scale matters a lot in single product/brand RD/SM intensive businesses, leading us to believe Wix will continue to be the leader and eventually have the best margins. Their growth outlets potentially have much better economics than their current business.

Much of their marketing dollars seemingly has a great ROI even while the business is valued relatively cheaply. In addition, there are multiple adjacent markets where their market position should allow them to redeploy capital at high ROI for some time besides core marketing.

Essentially we believe they are trading on its current core DIY segment at about 10-20 times ebit power (perhaps and depending on how you calculate it laid out below). In addition, Webflow, a competitor to Wix Editor X, was valued at over 2 billion a year ago even while that segment generates just losses now for Wix.

Now onto the core thesis.

Wix has fallen hard recently due to slowing growth from a pull-forward in demand from the pandemic in website building and increasing losses even as they slowed. In addition, investors are getting nervous that although everyone always assumed they had a covered over earnings power, it is not surfacing even as growth slowed. 

Three parts of the business must be explored as very different opportunity sets and risks- something I think many people misunderstand about the company.

First is the core business made out of the DIY web building market, in which Wix is the leader. Importantly Shopify and its cohorts do not compete here and are instead entirely focused on Eccommerce. Shopify is in a substantially more economical market than Wix and has a significant runway to grow and dominate there. We think it is implausible for them to try to move into Wix's core market.

This segment currently makes up about 70% of the business and is where the core slowdown has happened throughout 2021 and must be explored. Included here are some agencies/freelancers that will build for others on the core DIY site for those who do not want to develop themselves but still want a cheaper option. It is substantially the same market and does not compete with WordPress on most projects.

Second is the commerce segment in which they have been aggressively moving against in the past 2+ years. Here they compete against most substantially Shopify and, to a lesser extent, Square/Block. Finally, there are some more eccomerce platforms significantly more focused on enterprises, which again Shopify rules, Wix is not in that market for now. 

This segment makes up about the other 30% of the business and less on a gross profit basis. This seems to be slowing a bit but not close to the general DIY market. This is a significant investment area for Wix and its direct competitors and is growing strongly for them all. 

Then lastly is EditorX, and perhaps you can include Velo by Wix (though that enhances them all). Without getting into detail here, this is the effort of Wix to get into the professional design agency market on the higher end, which is a substantially more extensive market. Here they compete with the famed WordPress, which owns the market (60-70%). There are many issues with WordPress and open source CMS that will be explored later. There is a significant move towards Low code/No code developer products with all the big tech either building or acquiring their way into this market. It is expected to grow from $10 billion to about $200 billion by 2030 as IT teams are increasingly constrained by the lack of developers. Webflow, which is EditorXs most direct (and perhaps only) competitor, has raised $140mm from multiple investors, including Google's growth fund on a $2.1 billion valuation. This happened in January of 2021 and compares to its $400mm valuation a year and a half before that. Webflow was started a lot earlier than EditorX and already has a more significant base and is also the superior product for now.

To point out, Wix has a current EV of 4 billion, so less than double Weblows private market valuation.

This segment essentially contributes 0 to Wix, having come out of Beta in early February 2022.

Now to start on the first segment, the DIY market. There are roughly five main competitors in this pace that are still around and at scale: Wix, Squarespace (the two biggest), Godaddy, Weebly (Square), and Automatic (private). 

There was a significant change in the web development market in the past 10+ years where in 2010, about 80%+ of websites (judging from top 10mm) were built with regular custom-made HTML, CSS, and Javascript, all coding languages. All this was both time-consuming, frustrating and required extensive coding knowledge. Then, without getting into all the technical detail here, a new technology called a content management system (CMS) came out with WordPress being the most famous that revolutionized the market. Here there was no NEED for coding knowledge, and instead, the system could format a website with all the content input without the user having to do any coding. 

Two different types came out of this: the first is the likes of WordPress, Joomla, and Drupal, all open-source code that can be modified in many ways one wants. However, WordPress dominates all the others by now due to the flywheel effect of its community built around it. This will be discussed later, but it generally takes a professional with both coding knowledge and a designer to take advantage of WP to the full extent, or one must put in a lot of time, making it uneconomical for a big group of users.

Then is the DIY editors, which is also CMS but has built many tools to make it in a straightforward beginners editor. This segment started growing by bringing website building to more potential users and not particularly directly taking share from HTML websites. Then, as it improved and became increasingly relevant for some biggish websites, it started taking share and growing that way. By now, DIY comprises about 10% of the top 10mm sites, with Shopify having the lead. Although always smaller than Wix, Squarespace ruled in the top 10mm for some years. However, in the past couple of years, Wix pulled ahead even while having only about half of Squarespace's share in the top 10mm as recently as 2018.

All the companies throw around big numbers about the size of businesses without a website; we will leave them be (I hate trying to calculate Tam almost always a futile exercise). But, more conceptually, The growth of the DIY market will by now come from two areas. First, from dragging new participants into the website market, they push all the freelancers/SMBs/and other Orgs to build out an online presence for the low price. Core growth of Worldwide businesses will continue to contribute but will not be a colossal force here. In addition, as these tools extend their use cases and abilities, they will increase and slowly take share from existing sites. However, this will likely slow as the web has essentially migrated about 70% to CMS, so there is less room to take share from HTML, and WordPress ruling the rest of CMSs will be a harder contender.

The Net amount of Website adds every year is well over 100mm, so worldwide, there should be an extensive pipeline of new business for the market, but again, this is extremely hard to quantify. The most significant point is that there are many secular Tailwinds that, for the foreseeable future, will push the market larger as time goes on.

Wix has been slowing its growth on core subs over the past ten years, from over 80% in 2013 to 35% in 2018. They took off their cheapest sub-option in late 2018 and therefore experienced slowing growth of only 22% in 2019. They say that their focus is now more on the more valuable users. In 2020 the numbers stabilized partially due to e-commerce picking up (the core performing well too). In the first quarter of 2021, the numbers were very decent on sequential growth but then consistently slowed throughout the year until the 4th quarter, where it grew only about 2% or 8% core annualized. This happened as the losses ramped up from previous years. 

With that backdrop, I would like to discuss the economics and competitive environment of the general business the way it stands now. 

Most importantly, here are the churn rates of the business, which dictates how much the ROI of their marketing matters to the stability of the current business's economics and its general future stability. 

The only company in the segment that roughly breaks out churn is Godaddy. They put their entire sub-base at about 85%+ annual retention, but this does little to help given that their comparable DIY business is a fraction of their total business. Instead, the majority is pure domain buying and email to a lesser degree. However, they do helpfully break out that a user with a website and a domain has churn of less than half of domain-only subs. In addition, one with a domain/website/email has a churn of about 1/3 of the domain-only customers. Although we cannot determine from this actual churn, given that domain only likely takes up well over half of their customers, Godaddy's comparable churn is probably something less than 10%.

Two other points are that as users are subscribed longer, their churn rates go down (many SMBs fail at the beginning and other reasons). This is significant because the churn is a lot less for a lot of the base, and would slow assuming no more user growth.

In addition, as discussed later, Godaddy is focused more on the micro-business market than Wix, which everyone agrees is by far the superior product, which again would lead us to believe that Wix churn is less.

Now more specific on Wix, their model is a fascinating one (and being adopted by Godaddy now) in which it is a freemium subscription. Essentially the company lets anyone sign up for an account for free by providing an email and allowing one to build their Website and even publish it ultimately. These sign-ups are referred to as users, and all users signed up in any specific quarter are referred to as that quarter's cohorts. They then work on converting these users into paying subscribers by limiting functionality on their free sites.

Now from each quarter's cohort, they will get some early amount that converts to premium subscribers. Even as time passes, some from that cohort will churn off on their premium subscriptions; there will be others in that cohort that will sign on. This requires MINIMAL ADDITIONAL marketing dollars because they have signed on already and are easily accessed through email and their account engagement. A bit more granular in the first year, there is generally higher general churn but also many increases in sign-ups. After a year or two, it seems that some number less than 10% of the cohort churn off every year but is mainly added back in by an additional 10%  of subs from that same cohort leading to practically no-churn for the business!

Now some real-world examples the 2010 first quarter cohort after 33 quarters was at 96% member retention (and higher on revenue retention). The q1 2011 after 29 quarters was at 90%, and q1 2012 after 25 quarters was at 102%. It is even more interesting that comparable churn on new cohorts is going down as they improve their products, besides slight variations in 2018 because they ended their cheapest sub offering. 

Two more fascinating numbers telling of their economics is that from 2013 their ARPU per sub has gone up at a cagr of 6% and with relative consistency. This leads to net revenue retention of over 100%.

 In addition, the converting number of subs from each cohort has been going up relatively consistently. It went from 1.5% in 2013 up to 3.73% in 2017. It then dropped off to 3.25% due to the nixing of their lowest sub-option. This should continue to improve as they improve their products over the long term.

Before discussing the marketing efficiency of the industry and Wix, I would like to discuss the competitive environment, which has a significant effect on this.

As noted, there are five of the biggest DIY companies worldwide Wix, Squarespace, Godaddy, Weebly (Square), and Automatic (private). 

The two most significant are Wix and Squarespace, with Wix leading the space both in the top line and in the website subs. On the top line, Wix is about 60% larger than Squarespace, and on GP only about 20% higher though this is due to Wix GP being pressured short-term.

 There are two critical differences in the product approach (without getting into an entire product review). The first is that Squarespace focuses on accommodating both the higher end (some agencies) and the lower end customer all at once by focusing hard on design but trying to keep control of it. Of course, this makes it harder to be effortless, but they do decent there too. 

On the other hand, Wix focuses on different types of customers through various products. They Built out their ADI for the customer who wants to put in no work and essentially builds the site for you. In addition, they have their standard editor for more advanced users. Still, even on this, they focus on giving as much intuition and control as possible by allowing the user to drag and place through the editor instead of Squarespace's more controlled environment. This results in an easier boarding of customers and a more effortless first experience but does have limitations. The ease and control on Wix do give room for users to mess up and get frustrated and also cause that the site is not as quickly transferred into a mobile site given its less structured than Squarespace. 

In addition, the other difference is that Wix is way more focused on giving the most comprehensive ranges of tools that Squarespace does not focus on. They have an App store with close to 300 apps that can add functionality and their Velo function, allowing one to program into the site and add abilities. In commerce, this will be key.

All in all, Wix is the more wide-ranged competitor and is focused on capturing the broadest range of customers-typical of the leader of any space.

Godaddy is the next biggest competitor and has been slightly gaining ground, especially in the US. No one will argue that their product is probably the worst of the bunch though they are improving it. Godaddy's general philosophy for the past many years was that they built a great brand around what most would think was a commoditized business-domain registrars. They managed to capture that market and keep a substantial amount of pricing power (50% GP-seems crazy)  even with barriers relatively low for the business. The idea was then to go out and acquire any decent company (or product) that they can then use to upsell to their customer base of micro-businesses. This included upselling Microsoft 365 for a 50% premium and other products like email, Website, etc. They did not historically have an excellent RD line but had proper management with a remarkable ability to keep cash flow generation and make smart accretive product acquisitions. 

The current management seems to have changed this and is definitely more focused on improving their products. Yet they will be unlikely to catch up really to the biggest guys. They have a significant advantage in that they have this big brand with high recognition but also a downside: they aren't known as a website builder.

We do not believe they are a significant threat to Wix or Squarespace and will likely keep their market position and perhaps take some from Weebly. However, if they focus entirely on this product (which makes up a fraction of revenue), then there is a risk of building out that part of their brand but nothing too bad.

There are also two headwinds to Godaddy's core business. One in Verisign's price increases who Godaddy said they may and may not raise prices, perhaps eroding their 50% margins that we are unsure how they have in the first place. Second, on Hosting, they essentially outsource it to AWS, which provides the same service. So again, the company is not guiding any downturn, but we are skeptical. But that's a conversation for another time.

Weebly was a decent competitor and focused on taking on the bigger competitors by focusing on absolute simplicity. They keep products to a minimum and make everything as easy as possible. Their size is a fraction of Wix and Squarespace at about 15-20% of their size. However, they have slipped more since Square bought them in 2018. The reason is that Square is not focused on this product as it is not their business and is instead focused on commerce which is why they bought them. They use it to enhance Square online and take on Shopify by coming in through their POS micro-market domination.

Auttomatic, the founder of WordPress, has built a DIY tool around WordPress but simplified and limited it. They can leverage WP tools and be a very economical company, but they are limited as a competitor twisting and focusing entirely on their target base. They will likely dominate blogs as they were built on that but not much else (though WooCommerce is good too). The company is not publicly traded, so its info is generally more limited.

At the end of all the differences in products, a significant aspect is brand power and advertising reach. All the products are usable for many users, and an important deciding factor is marketing economies of scale. Wix is the biggest here but is not followed far by Squarespace, with Wix's ad budget perhaps about 25% higher. These two will likely continue leading the space and concentrating their lead over time. Again, Godaddy has the advantage of wide brand recall, and Automatic, built on WordPress, will also stay put with their brand leaning.

Judging by search (and different tools will say other things but all directionally the same),  Wix search is anywhere from double to 4 times Squarespace with about 5+mm monthly searches and even more than Godaddy. In addition, about 50% of their new users come from direct traffic, which is highly economical.

To understand the business, it must be understood that there are two questions: first is competition on current users. This is very limited due to the switching costs of switching over one's entire site. It will switch over their whole look, and the controls one is used to on one platform may make it harder to switch. There are very few options to import your site from one company to the next. Churn in this industry comes primarily from the site being non-relevant anymore. 

In addition, the high switching costs de-incentivizes the big player from lowering long-term prices and actually has the opposite effect. It makes more sense to grow revenue by raising prices over time because of the base rather than competing on the margin for new customers and losing revenue. This point is core to the thesis.

So the competition is more relevant to the prospects of user growth and marketing economics. Wix reports TROI in marketing which is the direct acquisition costs and the revenue gained. It is running at payback in the revenue term in about 12 months which is getting less efficient but is still insanely good economics. The question is that judging from a non-Wix number, there is a different perspective. Total ad spending divided by Sub gains is less economical and getting worse. For 2019 it was $311 per net sub add against a gross of 125, and for 2022, we estimate it at $660 against a gross of $130. This number is very telling if, as we laid out, they do not need to spend much on their current cohort base. If that is the case, the slowdown in ad economics is less steep, but the general business is not as good as we have made it out.

One last point is that they do some brand marketing now, which does not directly contribute.

The critical fear here is that as the DIY market stops its share growth and starts growing more slowly, the industry may not slow down its marketing spend and instead compete with their bigger scale, not allowing profits to come. As long as the marketing comes at a good ROI, it is acceptable and excellent; the question is what happens when it does not, and will the industry compete rationally?

This is one of the most significant bear cases for this but will likely not cause a deterioration in the business and is instead a management capital allocation question.

One last dynamic at play here is Wix, with its push towards agencies, which has now started pushing for companies who have their own demand from their customer base to use Wix. They do this either through co-branding or by themselves. It began in 2019 with a company in Japan called NTT, a marketing company for SMBs. In late 2021 the company announced a partnership with Vodaphone, the UK company though it is unclear what demand will come from there. More significantly, the company signed on Vistaprint, an SMB marketing company with about 20mm customers. The company said it will now use Wix for all of its website creation. They will transfer all the current websites onto Wix throughout 2022 in what Wix says will be hundreds of thousands of customers. Management believes that hundreds of thousands more customers will come due to this partnership. The exact terms were not disclosed but given minimal incremental costs, it will likely be significantly accretive. 

More recently, the company announced a partnership with Yellow Pages Limited, a $300mm Canadian SMB marketing company that has a customer base of roughly 125,000 SMBs, so also a significant win. Again, these will be long-term compounding revenue streams that come at little incremental costs besides some golf games with management.

Now on Eccomerce:

There is the absolute ruler here, which is Shopify. They started in the SMB market, which they rule and focused on improving the product; they now have the largest enterprise platform with almost 15,000 subs there, adding more every year than some competitors have in total. They had historically little competition in SMBs, with the like of Bigcommerce (short them) completely kicked out of the market by now, having under 50mm of ARR from real SMBs. 

They had an absolute laser focus on this market and are increasingly coming to rule it. The only threats currently are in the Enterprise segment from Salesforce/Oracle/Adobe if they try to pursue it, but it is doubtful that they will have a significant impact. As of now, they seem to rule, and the only question is that if Shopify becomes too powerful and is successful in its strategy to give its own  ERP and CRM software and go through the leaders. If that is the case, they may make a real renewed effort to penetrate. 

Just a point: although Shopify really does dominate, WP/WooCommerce is a competitor that they will unlikely takedown. It is open source and will always exist, similar to how DIY will never take WP down. However, there is a slight chance that if Shopify builds out a powerful enough backend, especially SFN as laid out below, AND it allows headless capabilities they may penetrate.

However, our view is that a couple of competitors have their foot in the door here and will start competing. This is #1 Square and then the DIY site builders, most importantly Wix.

First conceptually, multiple businesses started in various verticals: POS, commerce engines/CMS,  software providers, and payment providers. Then, beginning from Shopify, the online providers started using their customer relations to move into every adjacent business, including payments, POS offerings, software solutions, and ERP-type solutions and CRMs. This was possible like many businesses because they could upsell and integrate seamlessly with the customer they owned. This caused POS providers who also had a customer relation, most importantly Square, to move into the online solution and again software, using all of their touchpoints. Square is still behind in their offering by a long shot but will catch up to some degree. 

 The software providers will have a more challenging time moving in and perhaps do not need it. They are broader-based, and getting a small market share in Enterprise, although they are trying, will not help them much. Paypal and other payment providers are in the same camp here as the software provides but will doubtfully move as they have a less optimal opening into the market. 

The last one is the DIY website providers, most importantly Wix and Squarespace.

They have a foot in this exact SMB market given that they build sites and can upsell the eCommerce solution given their scale and brand recognition here. 

They are starting not directly competing with Shopify and instead focused on building a general site and upselling those who ALSO want to sell (i.e., a salon). In addition, they are focused on services and have 50% of their GPV coming from that and not products like online trainers (a vertical they are strong in). This is not precisely in Shopify's line of fire.

Wix is still a fraction of Shopify at about 5% of their GPV. Still, they are growing faster especially considering that they do not yet have a foot in Enterprise, which makes up the majority of Shopify GPV. If you strip out the 10% of Shopify Merchants that do not use their payment solutions which makes up about 50% of GPV and is mostly Enterprise, Wix is at more than 10% of their GPV and is growing faster.

They have also launched a POS in early 2020. They are following Shopify's lead by penetrating every adjacent market through their eCommerce platform. The success of this will likely be an outgrowth of their eCommerce success.

Wix's increasing focus on Partners and agencies also gives them a big foot in the door in commerce as 90% of agency projects are not commerce. As a result, they may use Wix/Editor X for their commerce solutions. As a proof point, Wix Partner revenue is growing 75%, and we expect it to grow even faster in the future with Editor X addressed soon.

If they manage to break into that market, the economics are outstanding, especially with their base DIY structure supported already by their other base. Shopify sub revenue per non Enterprise is currently about $450  or triple Wix. So although Wix is pricing more competitively, they will still generate substantially higher Sub revenue per sub. The costs are higher but are still significantly cheaper than Wix Ad costs though this may change as competition heats up. Godaddy estimates the total revenue per sub at $1,000 on average inclusive of Payments.

On marketing returns, their costs per sub add are about 2-3 times Wix historically, and gross is 5++ against Wix and grows faster. Shopify margins have been growing very fast even as they continued to have extremely high growth.

Given that DIYers are the upstarts without the built-in sub-base, they are coming in cheaper than Shopify, which Shopify cannot copy (and perhaps doesn't have to). This should allow them to penetrate the market, unlike Bigcommerce, giving up.

On the Payments side of the business, Godaddy came in with insanely cheap pricing, about 20% cheaper than everyone. It is doubtful that will allow them to dominate or that competitors in this market must copy them, given we do not believe that is the design factor for most SMBs.

(We do hear that many on the street believe that the payments business is becoming commoditized (not the visa/Mastercard part), leading to Paypals drop and somewhat to Shop.)

Suppose they successfully build out their Eccommerce SMB segment and a competitive app store relative to Shopify. In that case, Wix will have the same opening that Shopify had in entering the Enterprise market, which is more profitable. This will be enforced with their new focus on Agencies that build most of these sites. We believe this part of the business is even more economical and opens up more market opportunities.

Godaddy is doubtful to do this, but Wix and even Squarespace (and perhaps one day Square) will be able to do this.

The big question against this whole competitive landscape outlook is Shopify's new initiative, Shopify fulfillment Network, the reason for the significant drop in Shopify stock. The fact that investors are dropping a stock valued at over 100 billion over 2 billion in spending is ridiculous. We believe that Shopify is still likely overvalued at this point, but if successful on SFN, it is a different story (i.e., investors got it all wrong here).

Shopify is trying to build out their fulfillment network similar to Amazon by leveraging third-party Distribution networks that they control and managing inventory and SKU placement across the US. They are now starting to spend a projected billion a year building out this network. 

If successful, they will do something huge and will likely kill a significant advantage Amazon had over all of eCommerce. They will allow the entire internet to have economical 1-2 day shipping and continuously push Amazon on this and will essentially come down to if 1-2 day shipping is that much worse than the same day (probably not that much). This will cause every merchant to be forced to use Shopify as the most economical eCommerce platform, and everything else fades away.

If they manage to do this, then another Shopify product, the Shopify marketplace app, launched 1+ years ago that we believe is likely overlooked, may be even more so soon. Shopify's Marketplace app is growing fast, with 2mm downloads in January. If they control shipping, they will enhance overall customer satisfaction and build out a good marketplace where they own the demand. In addition, they perhaps can eventually offer a prime product type. Again, this will allow anyone to buy from Shopify merchants across the internet and have free shipping. Analysts have been asking about this, but they did not comment. 

The critical question is that this is a tough execution feat and is even more challenging given that they do not control most of the inventory like Amazon. In addition, they will not want to have strict controls unfriendly towards merchants like Amazon will make this challenging. This is primarily why we do not own the stock (some others too).

Even if they fail, Amazon reportedly coming into the market will likely kill a lot of the marketplace. Their distribution will be a killer relative to the rest, and no one will compete economically. We would not own Shopify just based on this.

Wix is not prone to losing its current market share because of all that due to its focus on services and smaller merchants, which would not find it more economical because of distribution. However, their prospects for breaking into this market big time, especially Enterprise, become less certain down the line if either Amazon comes in big or SFN is successful.

As an aside, Wix is also trying to build out a marketplace that is growing nicely but will be an outgrowth of how successful they are in commerce.

Next is the Wix's Editor X, Webflows (private) competition. These two services are part of a new wave in the tech sector of Low/No code building. This essentially means building programs that let one build out applications that were once only possible through custom coding from scratch and now can be done through an easy interface without coding knowledge.

 The thesis is that IT depts are backlogged, and programmers are increasingly getting more expensive. All the Cloud providers, including Amazon (Honeycode), Google (Appsheet), and Microsft (power apps), are getting into this space. They are not direct Editor X competition as they are used for building business applications, not websites that Webflow and Editor X are for, but it is the same movement. A recent Research And Markets report expects Low/No code to grow from $10 billion to $190 billion in 2030. Google's investment in Webflow shows that they directionally believe the same.

 Websites will probably lead here because adoption is easier. This is because it now works that designers go onto Adobe XD or Figma and build out a design. They then send it to a developer who completes the project by coding it into existence either from scratch or WordPress. Webflow and Editor X cut out most of the coding, so the designers do what they always did, and the platform builds out the code itself. The need for coding after that is minimal, if any. Essentially they do not need to build a new user base like business applications but rather upsell agencies and designers. 

The economics, if successful here, are enormous. This includes sticky agencies who get used to these tools. In addition, its cost is less as it must sell once to an agency, and they keep making sites which becomes a constant source of growth given that each site is annual revenue. The churn here will likely be way lower, given the money spent on the site and the market position.

The market here is insanely bigger than the DIY, or about ten times bigger. The current solution of custom-coded websites has declined and now has perhaps a 33% market share (judging on top 10mm) and is continuously declining fast (from 76% ten years ago).

 The other solution is WordPress which owns the market. WordPress is an open-source code, and is what makes it so popular is that you can make it do whatever one wants. In addition, an entire ecosystem is built around this given its popularity, where third parties create themes and plugins, etc., that one can use for it. WooCommerce, the biggest Commerce platform (no, not Shopify), is an open-source code built again on top of WordPress. 

There are issues with the open-source system that lead us to believe that Webflow and EditorX do not have to take down the entire WP but instead can penetrate, unlike other open-source CMS. For another open-source product to take on WP is impossible at this point. This is seen with the decline of every single other one besides WP. The ecosystem is too robust for that, and one can easily replicate any advantage that another one can have.

However, there are issues in open source more generally; the most glaring is that WP sites are the most hacked into sites globally. The open-source nature gives hackers an open book to be able to Hack. In addition, the amount of hackable plugins is vast, and one must be on top of the entire site, updating every month or day that there are updates because of vulnerabilities. If they do not and any Plugin or the general WP system becomes vulnerable, they will get hacked. 

For agencies and companies, this forces them to monitor sites and update continuously—some updates cause-specific plugins not to work together well and cause a need to switch. Sometimes it may not be openly apparent what is causing the issues after the updates. Then is the Hosting headache, where one must find a compatible hosting company and all the other parts of the system.

Designing on WP is also challenging, where one must either go through a design tool and then have a programmer use it. The other option is using a tool built again on WP called Elementor, a design tool that solves some of the issues with WP but not all.

Editor X came out of Beta last month, but we have a case study with Webflow. From the top 10mm sites Webflow market share of CMS went up from 0.2% in January 2020 to 0.7% currently. Even more interesting, they have almost a 3% market share in the top ten thousand. In the past year, there was no CMS that grew market share besides the DIY, WP, AND Webflow. So again, there is a reason they just got a private market valuation of $2.1 billion.

From the feedback we heard, Editor X is trying to build out the system around designers, making it feel like an AdobeXD or Figma that does everything. This creates some challenges on the cleanliness of the code and some other code geeky things. The idea is to upsell not only to those familiar with coding and sophisticated products but to try to serve a broader range of designers. So, all in all, Webflow seems like the superior product for now. However, Wix is focusing on this as their growth outlet, and they have a lot more access to capital than Webflow does. So, as a user of both put it, ''it really will depend on how much TLC Wix decides to give Editor X''.

Managements comments that they believe Editor X can be more significant than their DIY segment was not some crazy CEO promotion but is reality.

At the end of the day, the question is how much we are paying for the current business and how much we need their growth adjacent market outlets (commerce and Editor X) to work out for valuation. We will make some assumptions and comment on the premises. This will be a tricky exercise to come to a concrete conclusion, which is why we did not buy the stock just yet. After that, you can make your adjustments.

First, some background: both Wix and Squarespace significantly deleveraged in 2021, with margins getting squeezed relative to past years. As a result, they both had operating margins declining about ten percentage points (relative to revenue). This, together with slowing revenue, was the key reason for the big selloff. In the words of a prominent Israeli tech investor,'' the whole thesis was that the company had fixed costs and was in investment mode. Now their growth is slowing, and losses are mounting, somethings off.''

The way these digital-based RD/S''M heavy businesses work is that their cost structure is not directly correlated with operating scale but is different structurally. The CFO generally tries to keep them relatively inline depending on management competence and growth (ROI) prospects. In 2021 the growth slowed significantly from 2020 to the first quarter of 2021, which caused a mismatch. This is even more so with both companies pushing and investing hard into commerce verticals and solutions. Their investments into RD and S''M will not generate short-term returns if the segment has a pullback as it just had from covid pull-forward demand. As laid out above, the company's DIY segment should, over time, at least see low double-digit growth coming from a mix of higher ARPU and general development of the internet. Many Buy-side analysts expected (pre-2021) 15-20% longer-term growth; by now, those expectations have been squashed.

Now for a fun exercise.

In 2018-2020, Squarespace generated a 12-13% net margin inclusive of SBC. On Cash flow, while accounting FOR CAPEX and SBC, they had 20% margins. Wix puts out every quarter how much the current sub-base is expected to generate over the next ten years (possible because of cohort similarities). It currently stands at about $15.7 billion or $1.57 billion a year. If you assume that $1.1 billion is from their subs and not business solutions that come at a lower margin, and they can generate the same 20% margin, they should have $200mm of FCF. If the other segment can have a 7% margin, they should have about a total of $235mm in FCF against an enterprise value of 4 billion or less than 20 times earnings. In addition, there is another 350mm of ad spend that is primarily for growth, as laid out earlier; if you layer that in, they can earn almost $600mm. In addition, Wix has a bigger scale than Squarespace and should therefore show higher margins given it is such a fixed-cost business. One last point is that Even Squarespaces RD and GA are in growth mode, trying to expand internationally and grow their platform's capabilities. 

So obviously, the question looms why is Wix generating losses in the face of Squarespace's profitability? This is really why we do not own the stock yet, and we are trying to get a meeting with CFO/CEO to get our confidence level up. 

I will explain why I believe they are not as profitable and then lay out some pushback nagging us. 

In 2017 and on, its gross started dropping both on their main subs and business solutions. The reason was increased focus on scaling site speed (and SEO) and customer support on subs. Both should leverage well with Customer service seen scaling well by Godaddy. Business solutions started scaling in payments but are not yet at scale, but the management believes that margins there should get from 30-40%, similar and even a bit worse than with Shopify. In addition, the management historically just scaled costs with revenue growth and went faster than even that in 2021. This is even as Business solutions made up a more significant chunk and come at a lower gross, leading to growing losses. So they have called out a stop to that.

We believe that they are investing significantly in both growing partner revenue which is growing 75%, and commerce which is growing big time. They seem to be investing in these areas more aggressively than Squarespace, which of course, is not a bad thing. 

In addition, they have been investing aggressively for the past few years in building out their Editor X business which they are building out as a whole separate brand. Unfortunately, this currently has practically no revenue and is just incurring losses.

They base marketing on revenue and not on ROI as they claim this also causes margins to lag. Still, it should be noted that each extra sub is very incrementally profitable since structurally, this business is a very fixed cost.

Just another point management does claim that on their core business, they are at over 20% FCF.

Now the pushback here is a couple of points. First is just plain and straightforward management. Perhaps Squarespace has better control over the org and is leaner on cost structure because of CFO competence. In addition, Squarespace's CEO owns about 30+% of the company against 1-2% for Wix insiders, so perhaps they just run it more efficiently because of incentives. 

In addition, the next most significant question is that perhaps we are wrong on the company not needing to market to their inherent customer base to keep churn low, as we explained in regards to the freemium model. If that is the case, it would partially explain their inability to scale margins as they grew. In addition, perhaps we overestimate how much they are a fixed-cost business. 

Disclaimer: we may take a position at any time.

Catalyst

Moving towards GaaP profitability.

The growth of EditorX and Ecommerce.