Analyzing the Short Report on Samsara (IOT)

Samsara (IOT) shows strong growth in the face of turmoil. That’s what we concluded a few weeks ago during our annual check-in with a stock we not only hold, but think others should consider holding. The company has sported some of the most solid software-as-a–service (SaaS) metrics we’ve seen, though the recent disappearance of net retention rate seems puzzling. Attention is now directed towards the Rule of 40 which the company has managed to meet or exceed over the past four quarters. Overall, we saw no major causes for concern during our recent checkup which is why we were surprised to see Spruce Point Capital issue a short report on IOT last week.

Investors can only hope the stocks they find most compelling are scrutinized by some of the most critical critics around – short sellers. These firms make their living identifying possible discrepancies between the intrinsic value of a company and the value the market is willing to assign. We generally see short reports target companies that are overvalued and have some perceived systemic problems that aren’t overly apparent. Since we already know Samsara is overvalued, we’re only interested in exploring the latter.

While the simple valuation ratio (SVR) has since dropped to 14, Spruce Capital thinks it ought to be in the range of 3.5 to 7.5 representing a share price range of $6.30 to $13.90 a share. Our catalog average is 6.5, so that means if Samsara is an average company, then it should trade at around $12 a share. According to Spruce, it’s definitely not your average SaaS company.

Dissecting the Samsara Short Report

“Spruce Point believes that IoT is an old technology that has suffered from adoption headwinds and poor profitability.”

Spruce Point

When analyzing short reports, it’s important to separate opinion from fact. We can all agree that generative AI has loads of potential in creating business efficiencies, but these algorithms are only as good as the data you feed them. Our piece on investing in the Singularity elaborates upon the value of IoT sensors in the bigger picture, so we’ll go back to what we always say. The ground truth for technology adoption is always revenue growth. Spruce thinks that’s slowing down, and the trend doesn’t lie.

Revenue Growth Slows

Spruce believes “signs of growth pressures are beginning to appear,” and that’s an intriguing comment given Samsara raised guidance last quarter and expects 37% revenue growth this year.

Spruce’s comment on slowing growth is consistent with companies that are scaling. The larger you become, the more difficult it is to grow, but Spruce thinks much of the gloom is yet to come. The report points to “increasing churn rates ahead, including commoditization, low switching costs, increasing competition, SMB-heavy customer base, macroeconomic pressures, and Samsara’s historical focus on customer acquisition over retention.” It’s that last comment that rings a bell as it reinforces our concern about Samsara no longer providing net retention rates. Why, we don’t know. In their last earnings call an analyst probed this, and they need to keep probing until these key metrics reappear.

SaaS companies aren’t supposed to remove key metrics, and they also aren’t supposed to be over-reliant on hardware. The SaaS label implies that software is being sold which allows for rich gross margins that expand when you scale. Hardware sales are just that – hardware sales.

Hardware vs. Software

Quality of revenues is another concern for Spruce as they point to cheap commodity hardware constituting upwards of 25% of Samsara’s total revenues. Key hardware concerns raised in the report surround 19 Samsara quotes and/or contracts which Spruce obtained through FOIA requests and municipal websites representing a total of $8.4 million in total contract value. If we divide that out by each contract term, we get about $2.2 million in run rate. Should an isolated sample of a single customer type that represents just 0.24% of run rate be considered significant? There’s only one way to know, and that’s for Samsara to start breaking out their revenues by hardware vs. software instead of bundling them all together and calling it ARR. But this isn’t the only accounting change the report calls for.

Some Accounting Concerns

Make fun of bean counters all you want, but their decisions directly affect how investors perceive a company. We’ve praised Samsara’s gross margins and – as Spruce says – “found comfort in improving margins.” The short report points out that because the hardware amortization period is three years instead of five years, that gross margin has been overstated over the past two years by 600 basis points. In other words, last quarter’s gross margin should have been 69% instead of 75%. You can do the math for the rest of these numbers:

You could probably argue this accounting decision either way, and we’re more interested in the bigger picture concern raised – that Samsara may not be successfully diversifying into other areas aside from vehicle telematics for fleets.

The Bigger Picture

Someone recently quipped on Twitter that autonomous driving will wreak havoc on the organ transplant community because deaths from motor vehicle crashes and fatal injuries are the biggest source of organs for transplant, accounting for 33% of donations, according to the United Network for Organ Sharing. Some of autonomy’s impacts won’t even be apparent until it’s too late, and businesses like Samsara need to think about how the various levels of autonomy slowly coming online will affect their solutions. Expanding into adjacent offerings such as “site visibility” could help alleviate these concerns, but Spruce suspects that these sales might be just fleet management under a different color (the report provides one example).

Spruce questions whether Samsara has truly differentiated themselves from other telematics providers, albeit ones that don’t command such a high valuation. Is Samsara selling more story than substance? Passing yourself off as a SaaS company means you get to enjoy higher premiums, otherwise you’ll enjoy the sort of valuations Trimble (TRMB) does – an SVR of 3 – which probably reflects the old conglomerate discount. Spruce believes that if Samsara was benchmarked against public pure-play vehicle telematics companies, that would suggest an appropriate SVR of 5 to 10. In a future piece, we’ll dig into the broader telematics niche and look at some of the publicly traded companies Samsara competes with.

Our Thoughts on the Short Report

Our concerns about retention rate are mimicked in the short report, and we’re grateful to have seen these other potential issues raised so they’re on our radar now. Analysts from Wolfe Research were quick to issue a research note to subscribers – When They Go Short, We Go Long – which is what it says on the tin. Take that with a grain of salt. What we’re waiting for – and expect to see – is an official response from Samsara that addresses some of the concerns raised. A delay in responding is acceptable given the need to consult with legal before responding, and it’s likely management is dealing with inquiries from concerned shareholders.

Private equity firm General Catalyst is Samsara’s largest shareholder with a Managing Director sitting on Samsara’s Board of Directors. It’s likely he’s asking some questions right now, and so is Baillie Gifford, the second-largest shareholder and – based on what we’ve seen – a competent investment manager. Investors will rightfully hone in on their biggest concerns which management will be responding to all week. If we see institutional owners start bailing, that will be a big concern, and so will a failure to respond by Samsara.

Conclusion

Tech companies are new and shiny things that the outside world tries to make sense of. How much hardware should a SaaS company have before they’re obligated to start reporting on hardware vs. software sales? What amortization rate should be used for that hardware? What’s an acceptable pace for growth as a company scales? How long is a piece of rope? All these questions can have various acceptable answers, but we’re more interested in what comes out of the horse’s mouth. We’ll be eagerly waiting to hear what Samsara has to say.