Freshworks: Ideal Software Option For 2025 GARP Investors

seekingalpha11-22

Freshworks (FRSH) has been significantly punished by the market in 2024 but is poised for a rebound in 2025 due to low valuation.Interest rate cuts and a stronger economic backdrop in 2025 will boost ...

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Khanchit Khirisutchalual Freshworks (NASDAQ:FRSH) has been punished significantly by the market in 2024, but may be poised for a 2025 rebound. Software stocks have been a stock pickers sector this year, but interest rate cuts will provide the space a boost going forward. FRSH is in the business of keeping employees happy through its user friendly CRM and IT services. The focus of FRSH has previously been on the lower end of the market, filling a niche that Salesforce or ServiceNow may miss. However, the small and mid sized business space has been challenged in 2024 and is seeing headwinds. Any spending seen as superfluous has been axed for more mission critical spending in the C suite of businesses. FRSH shares have been hit significantly by this but the valuation has gotten too inexpensive to ignore. Recently Q3 earnings helped alleviate fears and boost the shares back to a technical buy signal before 2025. The companies Freddy AI agent is a potential further lever for growth in the coming year, with productivity gains possible for customers.  Improvement Forthcoming in Fundamentals Q3 was a continued improvement for FRSH on metrics like revenue growth with $186.6 million leading to 22% growth year over year albeit with steady GAAP losses. A loss of $38.9 million isn't ideal, however it was mostly from the share dilution and restricted stock units. Those who can stomach the dilution will find much to like, with the company generating solid cash from its software solutions. Growth did also accelerate q/q from 20% to 22%, while also reducing that GAAP loss - a good sign the company is on the road to profitability. Keep in mind though this is due to the acquisition of Device42 adding $8.8 million in revenue. A free cash flow margin of 21.5% is impressive at this smaller scale with a large cash horde of $1.05 billion building as well. This stock is ripe for a sizable buyback, and management agreed by starting a $400 million repurchase authorization. How aggressive they are buying back at the current level remains to be seen but it helps put a floor on the shares around where they are now at $15. Forward growth is expected to continue moderating, with 14-15% organic billings growth for the 2024 fiscal year. That said, valuation is very supportive of the equity at a market cap of $4.76 billion and enterprise value of just $3.74 billion. At a valuation of 28x forward earnings its hard not to be interested with a large TAM and strong growth prospects for the coming years. Freshworks new tool Freddy AI has been a driver of late with 1,700 customers using it for the co-pilot feature. This is up from just 1,200 last quarter, showing fast adoption which should help drive annual recurring revenue over time. It has improved productivity on average 30%, giving corporations immediate time to value and encouraging a 40% attach rate on new deals. Freddy self service is used by 1,100 more customers, showing a growth rate of 100% over 2023 at this time. These features will be key to differentiating from other large platforms going forward, as the company tries to leverage AI for the long term. Freddy AI agent is to come which is an upgrade on traditional button click customer service chatbot. It will improve customer experience starting in the first quarter of 2025 and help move companies to the higher priced Enterprise plan, boosting ARR over time. While not a huge needle mover in the short term it is essential to longer term growth.  FRSH Customer Growth (FRSH IR)As you can see above small and medium sized businesses are significantly trailing larger enterprises in growth. Large enterprise spending has remained relatively solid over the past year, as called out by many application software firms. Growth at constant currency has been 14% or better the past five quarters when you include all small and medium businesses above $5,000 in annual revenue. However, once you include the large enterprises paying $50,000 growth is an impressive 33% y/y. These customers are larger and more sophisticated, seeing value in the platform Freshworks offers. This acceleration shows the software investing cycle is starting to turn, and the sector is starting to see green shoots after two years of digestion. FRSH has a large cohort of smaller customers, which should see benefit as interest rates start going down and purse strings get loosened. This has already begun to happen, but the benefits for software stocks are probably to begin in full during the second half of 2025. That said, it's likely the market will start to price that in prior to the second half, especially if employment and other economic metrics hold up.  Data by YChartsFRSH is trading at a low valuation for a stock with continued growth of 20%+ in the most recent quarter. Even as growth has bottomed out and started to improve slightly, valuation has continued to decrease. GAAP operating margin continues to improve but keep in mind the main reason for GAAP losses is stock based compensation. Compensation in stock is always the highest as a portion of revenue for smaller cap companies, but free cash flow shows a more normalized picture for software. For example in Q2, FRSH generated $32.8 million in free cash with the company at a 26x FCF valuation. For 2025 this goes down to 23 times 2025 cash flow based on today's price, a valuation even a software skeptic could find reasonable. Part of this improvement is due to share price declines, but also due to increased cash flow over 2023. The company has kept dilution similar to 2023 with just 2% increase in stock compensation y/y. Technically the shares look good with it bouncing off support at $11 on six occasions in the past three months, with a technical break below that level. The shares have begun to perk up recently as optimism around new products grows and analysts grow more bullish on positive partner data. Q3 earnings confirmed the bottoming pattern and led to the significant buy signal we see today. FRSH - Buy on solid GARP valuation  As it stands now the stock is incredibly beaten down and even after its recent earnings rally is a candidate for tax loss selling. However, it appears the bottom on the shares is in and it's positioned to have a much better 2025 on low valuation and stable growth prospects. Interest rate cuts by the Federal Reserve will provide a tailwind for software stocks which move significantly from rate changes. A stronger economic backdrop in 2025 globally will be a boon for Freshworks, as companies enter the year more confident and able to spend on productivity. At 26x 2024 FCF and 28x 2025 earnings the company is priced with lots of valuation protection for investors. The removal of uncertainty after the election will now allow businesses to invest more in technology benefitting the whole sector. At the current price of just $16.50 per share I rate FRSH a buy for patient long term investors making a call on valuation. The potential for an uptick on AI fundamental growth is a bonus with software stocks set for a potentially solid 2025 as usage improves on AI tools.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2485424404"}