Thursday, July 25, 2024

Freshworks takes a calculated risk. Will it work?

On 1 May, founder-CEO Girish Mathrubootham moved on to become the executive chairman while Dennis Woodside, who was serving as the president, was named the new chief executive. The stock fell on the news, from $18.25 to $14.67, and has subsequently traded below the $14 mark.

As explained by Mathrubootham in a note to the “Freshworks kudumba” (Tamil for family), he will focus “on our long-term product vision and AI, spending more time with our teams in India”, while Woodside has said he will “drive the execution of the business we have now” and look after short-term targets.

This seems like a calculated gamble by a company that has run up against poor macro-economic conditions and also faces a shift in the technology, with artificial intelligence coming into the picture. 

Freshworks, which started as Freshdesk in Chennai some 14 years ago, is one of India’s leading SaaS (software-as-a-service) outfits. It offers cloud-based customer service software.

The San Mateo-headquartered firm listed on Nasdaq in September 2021, raising $1.03 bn in its IPO. Prior to that, it already had marque investors like Tiger Global, Accel, CapitalG and Sequoia Capital India backing it. The stock was offered at $36 per share, and hit a peak valuation of $50.25 in October 2021 before gradually sliding down.

Freshworks’s current market capitalisation is about $4.26 billion. It reported a revenue of $596 million for 2023 with a net loss of $137 million (the company follows a January-December financial year). This was an improvement on 2022, when Freshworks had a net loss of $232 million on revenue of $498 million. The company has about 4,900 employees, and caters to more than 60,000 companies of all sizes.

Also read: Investors may find Dennis Woodside a better chief for Freshworks

Freshworks’ March-quarter results show a 3% sequential rise in revenue, while it narrowed its loss to $23 million from a loss of $28 million in the December quarter. The company has projected that its revenue in 2024 will hit the band between $695 million and $705 million, with year-on-year growth of 17-18%, slightly lower than the 18-19% revenue growth the company had projected in February. 

Non-GAAP operating profit jumped to $21.8 million in the March quarter from $3.9 million in the corresponding year-ago period. Non-GAAP operating profits exclude expenses such as stock-based compensation, payroll taxes on employee stock transactions, and amortization of intangibles. The ESOP compensations would be the major item among these for a company like Freshworks.

Freshworks targets hitting the $1 billion revenue mark by 2026, which might be achievable. Apart from the transition in the C-suite, Freshworks also announced the acquisition of Device42, an American IT-management firm, for $230  million. This could help accelerate its growth curve.

However, in March, the Freshworks board cancelled an award of 6 million shares to Mathrubootham, which was scheduled to be given in tranches until 2029, on the basis of specific share price targets being hit. It said the company had hit hurdles due to macro-economic conditions “entirely outside the control of the company’s leadership”. Mathrubootham continues to hold a stake of 4.3% in the company.

Apart from normal cyclical slowdowns, all SaaS businesses now have to reckon with the new threat of AI-based tools. While Freshworks is already offering some of these, the competition in this space is intense.

One key factor to consider may be the composition of Freshworks’ customer-base. More than 51,000 clients are small and medium-sized businesses (SMBs), defined as companies with no more than 250 employees. This segment is the biggest target audience for a transition to off-the-shelf AI-based tools. Big companies with specific needs may look for customised solutions, whereas SMBs will be happy with generic AI-based products.

Mathrubootham is seen in SaaS circles as a visionary, and an inspirational leader with a nose for developing and marketing great products. He needs to do this and it would be natural for him to return to his roots in Chennai and seek the AI talent that could help do this. It would be difficult for him to focus on this while fronting a Nasdaq-listed company with the demands of day-to-day running. 

According to company insiders, including both the men at the top, Woodside was brought in 18 months ago to play precisely that role of day-to-day management, and the transition may not have been a surprise within the “kudumba”.

It is, of course, a risk because both men have to hit the ground running in their new roles, and investors and customers have to be comfortable as well. However, it appears to be a calculated risk. Freshworks needs to develop an AI-based product portfolio, and Girish Mathrubootham is the obvious person to do this. If he has to step sideways in order to do this, well so be it.

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