AGB 2021.2 - Wix.com (WIX)
Returns Driven Marketing Spend
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Wix.com
Wix is a leading provider of tools and technology that individuals and SMBs can utilize to build a web presence on the Internet. The company operates a freemium model, allowing registered users access to free tools to build their websites. A free site, however, doesn’t get its own custom domain name, has Wix ads across its pages and lacks access to additional features such as payments or analytics. As of the third quarter of FY20, Wix has more than 189M registered users, most of which are driven to the site via paid online marketing and/or directly due to awareness of Wix’s brand.
Registered users convert to premium subscribers at a predictable rate, allowing Wix to accurately forecast the future revenue and billings (called collections) growth of each cohort by year. As of the third quarter of FY20, the company had 5.3M premium subscribers or 2.8% of its registered users. The subscription segment is categorized under Creative Subscriptions, which includes access to all of Wix editing software, including Corvid and Editor X. There are different tiers of Creative Subscriptions depending on whether the product is just a content website or one that has business and eCommerce capabilities enabled. There are specific vertical applications for business purposes such as Wix Stores, Wix Bookings, Wix Hotels, Wix Restaurants, Wix Photography and Wix Events to name a few.
On top of the subscription segment, Wix also charges for additional Business Solutions. These include Wix Payments (accepting payments directly on the website), Wix Ascend (essentially an operating system to run a small online business), Wix Answers (customer support infrastructure) and third party applications such as Google’s G-Suite. Business Solutions revenue is not as predictable as Creative Subscriptions, but have the added benefit of Wix participating in the growth of its customers. For example, with Wix Payments, the company gets paid a small percentage of the GMV that flows through a premium subscriber’s website.
According to Wix, the market for building websites is roughly 10% DIY (do-it-yourself) and 90% DIFM (do-it-for-me). When the company was first founded, it specifically catered to the DIY segment of the market. With many iterations of its editing software and specifically its AI based website design software called Corvid, the DIFM professionals have the tools to effectively leverage Wix for their business. The growth in the DIFM segment of the market has resulted in an increase of the average revenue per user for Wix because these customers have more than one premium subscription. Corvid based sites now make up 10% of the traffic that comes to all Wix sites.
Wix competes against many other domain name registry/website creation software players such as GoDaddy, Squarespace and Drupal and eCommerce specific website builders such as Shopify and Magento. Wix and Shopify have been market share gainers over the past 5 years. Wix differentiates itself from other website creation software players with its superior software based offerings and from eCommerce specific players by targeting customers that don’t just want to build an eCommerce platform. It is a very competitive market, where price and quality of product offering both matter. Wix estimates that 95% of all websites are not commerce based and for Wix approximately 15% of its customers have enabled eCommerce capabilities (though much more so since Wix Payments was introduced).
Wix is constantly optimizing its operating model to get the best returns for its marketing and R&D dollars, while carefully considering margin and growth implications. An example of this is when the company decided to stop offering its lowest premium subscription tier called Connect Domain. It was a $4-$5 monthly subscription that still had Wix advertisements on the customers’ pages. This plan attracted lower return customers due to the low price point and higher churn, which the company felt diluted the Wix brand. After removing this offering, the company saw better churn and many subscribers that stayed opted for the higher tier subscriptions.
The Creative Subscriptions segment is very steady and has ~80% gross margins. The Business Solutions segment currently has almost 30% gross margins but is expected to reach 35%-40% margins long-term as Wix Payments normalizes with the growth of its other solutions.
Why is it a good business?
Wix’s business model is similar to that of a SMB SaaS company. A software package is provided to the customer with the payment depending on the tier of services used, and the customer is billed monthly. Because there are obvious cash flow benefits (payment upfront vs. services provided later), customers are encouraged to take the annual pricing option, which helps with the company’s cash conversion cycle. As of FY19, 84% of its customers opt for the annual option. This results in revenues understating growth (as long as the company is growing) and so the company uses Collections as a non-GAAP metric to track growth. This similar to the Billings metric that many SaaS companies use.
One thing that’s dissimilar to enterprise SaaS companies is that Wix’s customers tend to be single users or SMBs looking to put their business online. And due to the lower implementation costs, time and effort vs. an enterprise wide integration, the churn tends to be higher for Wix users. However, Wix’s churn rate (while they don’t release gross churn) tends to be good (negative on a net basis) because registered users that don’t become premium subscribers immediately can become subscribers later on. Furthermore, the successful SMBs that make it get bigger and opt for higher tier Subscriptions or additional Business Solutions.
In terms of competitive advantages, similar to SaaS companies there are almost no network effects or scale advantages but Wix’ customers have high switching costs. The longer a customer is on the Wix platform, the more likely the customer is likely to stay, due to the complexities of moving the website and data to another platform. The company has mentioned that customers that try to move their site from Wix to GoDaddy would find it almost impossible and would have to recreate the website from scratch. Customers that take on added services tend to be even stickier as well. Wix Payments is a key example of this. When customers start collecting payment through their site, price of subscription becomes less important and reliability, scalability and ease of use becomes much more relevant.
The Creative Subscriptions business is so predictable that the company can forecast collections by the quarter for any cohort of new registered users. On average, Wix collects 60% of its in initial marketing investment in the quarter that the marketing dollars were spent. Then 80% is collected in the subsequent quarter and 100% by the third quarter. Because almost all of the marketing spend is online advertising (almost 95% of marketing expenses), these ad campaigns can be carefully measured for ROI and the company can flex up/down the marketing spend depending on the immediate returns that the company is seeing.
Returns on capital?
Wix’s capital spend is predominantly R&D (89% of spend over the past 10 years) with a little bit of capex and very few acquisitions. R&D expenses are related to improvement of existing products as well as creating new ones. With high gross margins on the Creative Subscriptions segment and a very effective market spend strategy, the return on R&D expenses are quite high.
Wix, similar to other Internet companies, does most of the company’s marketing spend online. The company effectively backs into the desired payback period or TROI (Time to Return on Marketing Investment) to arrive at the level of marketing spend and desired growth rates. This was evident during the second quarter of FY20 when the company saw the payback period shorten and thus increased marketing spend by 90% to achieve higher growth rates.
The current average payback period is 7-9 months for marketing dollars and this number used to be lower prior to the company’s IPO at 5-7 months. With a 7-9 month payback period on marketing dollars, the implied returns are very high if you assume that the collections for a certain cohort remain stable going forward, which they are. After 3 quarters, the marketing dollars are almost all recouped in the form of collections. After that, it’s mostly profits going forward. After 19 quarters or 4.75 years, the 1Q16 cohort has paid almost 5.5x the original marketing investment.
What’s interesting to see is that the company has seen a slowdown in the number of new registered users since FY15 (except for the first three quarters of FY20) but these newer cohorts have higher cumulative collections. The main reason for this is that the Business Solutions segment, while not as predictable as Creative Subscriptions, is growing much faster and this is mostly due to Wix Payments. Since this product was introduced in 2018, Wix has been able to grow with the growth of its customers.
The recent acquisition of Deviant Art in FY17 for $36M is one of the largest in the company’s recent history. There isn’t much to say about the deal other than it’s difficult to see how an online community for art and design actually fits with the core Wix business. It may have decent returns on capital if they can grow the platform or rightsize costs, but as of the current state of the financials, it has likely been dilutive to returns.
We estimate that Wix generates between 55%-70% returns on its capital spend. The returns for this business are very steady (evidenced by the low variance of the yearly returns) and that’s because the growth of the business is achieved in a very systematic way. The deliberate use of R&D dollars and the company’s TROI metric driving marketing dollars leads to consistent returns at one of the highest rates we’ve analyzed on AGB.
Reinvestment potential?
What’s great about Wix is that it’s really a global business. There isn’t much added infrastructure required to sell its products and services in the U.S. vs. Europe or Asia. There are some investments needed to be made for the different languages and to account for cultural preference when it comes to website design, but these investments are minimal.
The addressable market for Wix is the global SMB market that wants to establish a presence on the Internet. This includes companies that just need a website for information purposes or ones that need a fully transacting eCommerce platform. Goldman estimates that the TAM is $24B assuming the 175M SMBs globally, but that’s likely before considering the Business Solutions revenues on top of the Creative Subscriptions.
Statistics from the World Bank suggest that over half of SMBs already have a dedicated webpage in the U.S. and that number skews higher in Asian countries where Internet penetration is much higher. The average percentage outside of the U.S. and Europe is over 40%.
The issue with having SMBs as your core customer is that the failure rates are pretty high, meaning gross churn rates are inherently higher. Almost 40% of SMBs fail within the first three years and that number goes as high as the mid 60%s if you look forward 10 years. That’s why Wix doesn’t give out gross churn numbers but net churn by cohort, which remains steady. This is important because the increased collections from the surviving businesses in a cohort and the registered users that later become premium subscribers outweigh the customers that fail to renew or just go out of business altogether.
The company stopped presenting their cohort analysis this way after the fourth quarter of FY19, but it’s interesting to see that for each cohort of active premium subscriptions, there is a bump in the collections for the first year and then fades lower over time. This shows that many businesses on Wix fail within the first year. The good thing is that the collections settle above the first quarter’s collection for each cohort, implying that the net churn rate is actually negative.
Wix is moving up market somewhat with its newer products like Corvid and Editor X. The DIFM market tends to be sticker because they are businesses that help other businesses get their online presence off the ground. As of the company’s December FY20 Analyst Day, Wix has 270k customers that develop websites for others on the Wix platform.
We estimate that Wix reinvests between 35%-50% of its capital back into the business every year, resulting in 20%-25% growth in intrinsic value. With the increased adoption of Business Solutions on top of the Creative Subscription segment, Wix could see a sustained growth in the upcoming years.
What else is important?
Covid impact
Similar to other online platforms, Wix benefited from the effects of Covid-19. The company saw increased conversion of its marketing spend, allowing Wix to increase advertising dollars by 90% y/y in the second quarter of FY20. Growth in the number of registered users accelerated in the first three quarters of FY20 to +18.4% y/y and premium subscriber growth jumped to +20.7% y/y. This was coming off of a FY19 growth rate that experienced deceleration is user and subscriber growth.
Conversion of incremental registered users also increased from 2.3% in FY19 to 3.1% for the first three quarters of FY20. This is indicative of what the company was seeing with the returns on its marketing spend. The increased conversion to premium subscribers meant that there was stronger intent from the FY20 cohort to remain paying subscribers over time. This makes sense as more customers were moving their businesses online due to the lock-down related measures around the world.
eCommerce, understandably, became a much larger portion of the net new premium subscribers in FY20. eCommerce growth on the Wix platform more than doubled the growth rate of the non-eCommerce customers for the first three quarters. The company has also stated that over 80% of eligible new premium subscribers have elected to adopt Wix payments, indicating that that most of the new subscribers are conducting some form of commerce.
Wix vs. Shopify
Anyone who has done research in this space has to compare Wix to Shopify. While there are many differences there are also many similarities. Wix addresses a larger number of potential customers as website creation for content is much larger than just ecommerce. However, the basic content websites fall under the slower growing Creative Subscriptions segment for Wix. Shopify on the other hand is singularly focused on addressing the needs of ecommerce businesses and services much larger customers.
But if you analyze the financials of Shopify and Wix, the two companies has very similar segment margin profiles. Shopify’s subscription margins are 80% and its Merchant Solutions segment margins are 38%. Shopify is a larger business with a much higher level of GMV flowing through its platform, and thus its Merchant Solutions margins are higher than the Business Solutions margins for Wix.
HQ is in Israel
Wix is based in Israel and benefits form a few tax advantages. First, there is an R&D tax deduction credit for certain industries as long as the company gets approval from the relevant Israeli government ministry. The company believes that most of its R&D expenses qualify for this deduction.
Second there is a benefit related to stock option grants for Israeli companies. This benefit is called a cashless net exercise of options. Typically when in-the-money options are exercised, some cash is infused into the company (the strike price) and the shares are issued. However, because the company doesn’t have a need for a cash infusion Wix can elect to issue fewer shares based on the difference between the strike and the current share price, which reduces dilution. This mechanism is as if shares are issued and repurchased in one action.
Optionality
Wix has a Marketplace where first party and third party applications are sold to premium subscribers of Wix. These applications can range from Google Ad Sense to enabling a rewards program on your site to aps that can help with drop shipping. Wix typically takes 30% of the revenues generated on the platform. While there isn’t much financial information that’s been disclosed, this could be a meaningful revenue opportunity if third party developers find it lucrative to develop their applications on top of the Wix platform.
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Wonderful
Great writeup! Any thoughts on WIX vs GoDaddy as a product and investment?