Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving WIX.com Ltd. (Nasdaq: WIX or “the Company”), an Israeli website and content development company. With its share price up approximately 300% in the past year, we have conducted an extensive fundamental and forensic accounting review, and believe investors are overlooking significant downside risks and dilution. As a result, we have a “Strong Sell” opinion and a price target of approximately $36 – $42 per share, or approximately 50% to 60% downside.

Executive Summary

Quick Highlights Driving Our “Strong Sell” Opinion And 50% – 60% Downside Target:

WIX.com (Nasdaq: WIX or “the Company) is an Israeli based technology service provider offering a free website solution that depends on upselling customers on additional features. With WIX’s share price up approximately 300% in the last twelve months, we believe investors are overlooking many issues that could cause a substantial price correction:

  • While WIX was an early mover in the freemium website creation model, it is now becoming more competitive with new players and its “growth at all cost” strategy through expensive advertising is appearing to plateau. Its customer acquisition costs are rising rapidly as its size creates a barrier for additional growth. As a result, we believe its recent deal to acquire DeviantArt represents a potential strategy shift to grow through acquisitions, and introduces new risks to its business model that investors should carefully consider. We think WIX’s business is set to slow, and investors should look carefully to see that its revenue growth in 2017 will outpace cash collections growth
  • WIX’s “unicorn” model appears too good to be true and there are emerging cracks beginning to appear in its financial statements including subtle revenue and tax restatements, and anomalies in its cost structure. WIX portrays itself as a well oiled machine with world record gross margins at 85% and that it will have spent ~$30m on capex from 2010 – 2017 to accumulate >100m registered users, engineer a negative churn business that produces $400m of revenues, $1.4 billion of collections, and is worthy of a $4bn market cap. Based on our analysis, these results merit scrutiny (e.g. try finding another negative churn business or capex efficient model). The SEC recently issued comment letters to WIX questioning its aggressive Adj. EBITDA presentation and its pace of revenue recognition and expense deferral. After two EBITDA revisions already, investors should be suspicious, but we believe more revisions may come. WIX is dropping subtle hints in its 20-F that because it is no longer an “emerging growth company” under Section 404 of Sarbanes Oxley, it will face stricter financial control.
  • WIX insiders have incentives to heavily promote its shares and left clues to suggest it intends to dilute with 2-3 million new shares We estimate its two founders are sitting on $225m of option gains needing to be monetized. Options under the 2013 plan start becoming fully vested in 2017. Early venture backers (Benchmark, Insight, Bessemer) have exited and only one initial backer remains. None of WIX’s top shareholders are Israeli funds. WIX has lured in retail investors and US funds through repeated Cramer Mad Money episodes. Now that WIX Is claiming it has reached a cash flow positive inflection point, and has ample cash on the balance sheet, we find evidence of pending dilution
  • Investors should be highly concerned by WIX’s audit situation: Two of WIX’s audit committee members have already resigned since coming public (both were non-Israeli based members). The Company’s two local Israeli auditors have a spotty track record of early identification of accounting issues, and both have been cited by the PCAOB for audit deficiencies. WIX’s annual audit fees of just $500k are miniscule in relation to other SaaS and marketing service technology companies
  • Background of WIX’s CFO Littered With Associations To Questionable Companies: WIX’s CFO has worked at three US listed public companies: Alvarion, Veraz Networks and ECI Telecom. Alvarion and ECI Telecom faced fraud allegations, and Veraz was sanctioned by the SEC for FCPA violations. Alvarion and Veraz (later merged with Dialogic) drifted to insolvency and delisting
  • Valuation Concerns Becoming Evident: WIX’s valuation is stretched (avg. analyst price target is $72), and they don’t correctly account for its significant dilutive share count. At 9.5x and 178x 2017E Sales and Adj EBITDA, WIX is priced for perfection. Investors ascribe a value of $1,600 per paying sub. vs. $400-$500 for peers. With average annual revenue per sub at ~$137/year, the current valuation represents ~12yrs. of subscriber sales. WIX could lose 20% just on the share count correction, yet we see total downside risk to $36 – $42/sh (50% – 60%)

WIX’s Meteoric Stock Increase Deserves Significant Investor Scrutiny

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Capital Structure and Valuation

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Are Investors Prepared For Significant Dilution Coming….?

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  1. 2017E stock compensation expense estimated by WIX at $39-$40m, an increase of $11.5m over 2016. 2016 stock compensation expense of $28m was a $9.3m increase over 2015. We estimate the number of options and RSUs granted consistent with prior year practices
  2. Share price of $61.50 as of Feb 15, 2017 when guidance was offered in the Shareholder Update report
  3. Simplified analysis does not take into account tax consequences or assume repurchase of shares which would only decrease outstanding amounts
  4. WIX says “As of February 28, 2017, 2,669,134 shares remained available for future grant under our share incentive plans.” (source: 20F p.76). This figure puts a maximum on the amount of options and RSUs to be issued
  5. Per WIX Shareholder Update
  6. Free cash flow guidance post DeviantArt acquisition. Last guidance estimated just ~$2m of acquisition related costs (down from $3m in 2016), so we can rule out a large acquisition to explain the share count differential

Warning: WIX Not Targeting Free Cash Flow

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Easy To Justify A Quick 20% Downside In Price

Sells-side analysts such as Needham has a $73 price target (March 2, 2017)

Our price target of $73 is based on a 5.8x 2018E EV/Sales multiple, in-line with other top performing SaaS companies, which we believe is appropriate given its faster revenue growth rate.

  • WIX is currently trading at approximately 7.3x EV/2018E Sales based on the actual fully diluted share count of 57.5m for this year according to WIX
  • At $57/share and $135m of net cash and equivalents, WIX’s EV would currently be $3.1 billion
  • Needham estimates $535m of 2018 sales
  • This equates to a 5.8x 2018E EV/Sales multiple in-line with peers according to Needham
  • At $57/share, that’s approximately 20% downside from the current price
  • This analysis assumes nothing else other than diluted shares directly from management, and a fair multiple directly from its sell-side broker
  • Where are we wrong?

Article by Spruce Point Capital

See the full PDF below.

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