Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on Samsara Inc. (NYSE: IOT)
NOTE TO EDITORS: The Following is an Investment Opinion Issued by Spruce Point Capital Management
Reveals That Samsara’s Aggressive Accounting Policies Defer Expenses into Future Periods and Have Resulted in Material Overstatement of Gross and EBITDA Margins by an Estimated 664bps and 1,176bps, Respectively
Expresses Concerns Over Samsara’s Opaque and Subjective Financial Reporting Given its Chief Accounting Officer’s Prior Leadership Role at VMware When the SEC Charged it With Misleading Investors by Obscuring Performance and Shifting Results Between Periods
Highlights Serious Risks to Revenue Growth, Including the Potential for Hardware Disruptions as the FCC Considers Blacklisting a Key Chinese Wireless Module Supplier
Provides Detailed Evidence That Samsara has a Vulnerable Competitive Position and Demonstrated a Poor Track Record of Winning Large Deals, as Evidenced by its Recent Failure to Win the Massive U.S. Postal Service Contract
Questions the Company’s Upside Potential Related to Artificial Intelligence (AI) Given its Historical Practices of Providing Free Upgrades for These Features
Argues That Samsara Suffers from Poor Governance, Including a Failure to Adopt a Clawback Policy for Fraud or Misstatement, Misguided Compensation Schemes, and an Audit Chair Spread Thin Among 10 Different Boards
Sees 45% to 75% Long-Term Downside Risk to Samsara’s Share Price and Urges Investors to Visit www.SprucePointCap.com and Follow @SprucePointCap on Twitter for the Latest on $IOT
September 21, 2023 09:00 AM Eastern Daylight Time
NEW YORK--(BUSINESS WIRE)--Spruce Point Capital Management, LLC (“Spruce Point” or “we” or “us”), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled “The Accounting For Things” that outlines why we believe shares of Samsara Inc. (NYSE: IOT) ("Samsara" or the "Company") face up to 45% to 75% long-term downside risk, or $6.30 – $13.90 per share. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and exclusive updates.
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Spruce Point Report Overview
Samsara provides vehicle telematics, video safety, and asset tracking solutions that target fleet applications. The Company sells a bundled offering whereby its hardware is given away for free, and its software (which includes a license to its hardware) is billed as a subscription. Founded in 2015, Samsara underwent several strategic pivots before opportunistically capitalizing on the 2019 U.S. Department of Transportation mandate for trucking companies to implement electronic logging devices (ELDs) that track driver duty cycles. Samsara is one of the most richly valued software companies in the public markets.
The concerns we outline in our report include:
- Unlike most SaaS companies, Samsara has a material hardware business that gives the Company a uniquely poor business model subject to numerous serious risks. Based on our analysis of customer quotes and agreements, we believe hardware represents approximately 25% of the value of Samsara contracts. Moreover, our review of product datasheets finds that Samsara devices generally employ very mature technologies (little more than what is found in today’s cellphones) and that suppliers of comparable products typically garner gross margins in the low thirties. Not only does Samsara hold more physical inventory than most pure SaaS companies, but the Company’s hardware giveaway and sizeable related engineering effort weigh on Company gross and operating margins, which have historically ranked among the worst relative to peers. However, Samsara management largely avoids discussing its hardware products (sometimes even suggesting that the cash flow implications should be ignored) and represents that its reliance on hardware will decline. In contrast, we highlight that, by any reasonable metric, Samsara’s reliance on hardware has only increased over the past several years and that new product initiatives are only more hardware intensive. For example, capitalized device costs as a percent of new ARR added has risen from 44% to 62% since FY2021.
- We believe Samsara’s improving profitability is a mirage, as the Company’s accounting policies (in part related to its hardware business) have resulted in the massive overstatement of gross and EBITDA margins. Samsara capitalizes both hardware product costs and sales commissions and amortizes them over a five-year period. However, our analysis of customer contracts shows that nearly 80% have terms of three years or less. While the Company supports this policy by referencing hardware warranty periods, we find that its standard licensed device warranty periods have been changed to reference contract terms and that warranty periods for hardware accessories (which, by our analysis, comprises an average of 17% of hardware value delivered) are subject to just a one-year warranty. In fact, our research found that Samsara has a history of hardware reliability issues and frequent replacement cycles. We also note that Quartix, a telematics peer company, recently moved from expensing these costs to amortizing them over a two-year period. When we adjust hardware cost amortization to a three-year schedule, we find that Samsara’s gross margins have been overstated by approximately 664 basis points (or bps). More alarming, we suspect that other gross margin detractors are not being captured, namely that hardware replacements and returned hardware from churned customers are not resulting in the requisite write-offs. Making similar adjustments to capitalized sales commissions shows that the Company’s Adjusted EBITDA margins were likely overstated by nearly 1,176bps in FY2023. Therefore, we find that recent analyst accolades for approaching breakeven profitability are completely unwarranted. Our findings of accounting distortions are troubling given that Samsara’s Chief Accounting Officer was VP and Controller at VMware during a period when the SEC charged it with misleading investors by obscuring financial performance and shifting revenue into future quarters.
- New concerns about ELD security vulnerabilities and the potential blacklisting of a component supplier signal unknown risks to Samsara products that may result in new revenue headwinds and additional gross margin pressures. At the urging of Congress, FCC Chairwoman Rosenworcel recently asked U.S. agencies to consider declaring Chinese wireless module company Quectel a national security threat and to add the Company to the Covered List of banned suppliers.1 Our review of FCC teardown photos reveals Samsara uses Quectel modules in numerous key products, and we believe the risks presented are real, as the FBI previously warned industry participants of the potential for ELDs to be compromised. We believe the blacklisting of Quectel could lead to revenue headwinds, particularly in the government sector where Samsara has noted recent strength and necessitate hardware replacements, which should result in capitalized hardware cost write-offs and thus lower gross margins.
- A re-examination of Samsara’s revenue growth raises concerns, especially as new market penetration has been modest. While impressive on the surface, Samsara’s historical revenue ramp was the result of the fortuitous, one-time government mandate for ELDs, an accounting sleight of hand, the beneficial impact to revenue recognition of customer financing, and the aggressive practice of buying out existing customer contracts (a costly technique for buying business that we believe is not appropriately captured in the Company’s financial disclosures). Today, despite management’s hand-waving, the Company derives nearly all its revenue from fleet applications. Moreover, past new product development efforts to expand into a variety of industrial applications have simply failed.
- Samsara faces formidable competitors as its differentiation wanes and commoditization takes hold, with clear evidence showing the Company’s failure to win large contracts. We believe Samsara’s competitors have largely gone unnoticed due to their private company status. However, we highlight that many have impressive customer counts, achieved credible revenue scale (if not greater in select applications), developed industry-leading technology, or won marquee customers after competing head-to-head with Samsara. In fact, with the list including several unicorns, we anticipate the next IPO wave will include several of these companies, which may create troubling comps for Samsara. And if Samsara is the clear leader as it promotes to investors, why has it lost so many large customer opportunities? We highlight and analyze Samsara’s failure to win the massive U.S. Postal Service contract, as well as the fact that private company competitors have won fleet leaders such as Amazon, Pepsi, UPS, and Walmart. We also show how the largest municipal fleet contracts have been won by its competitor Geotab, a Canadian private company. We suspect Samsara’s large enterprise failures stem from its early market focus on the thousands of very small trucking customers responding to the ELD mandate. Furthermore, the fleet telematics market is rapidly commoditizing, and Samsara’s primary competitive differentiation – long considered its ease of implementation – fails to position the Company for larger, more sophisticated customers and applications. In contrast to management’s positioning, we believe the migration to OEM-supplied hardware will hurt Samsara, as price compression seems inevitable. Finally, we note a new potential growth headwind: the recent Teamsters contract with UPS prohibited the use of cab-facing cameras, which generate 40% more ARR than forward-only cameras.
- Signs of growth pressures are beginning to emerge. The second derivative on nearly all key Samsara growth metrics is negative. Moreover, Samsara has historically spent extravagantly on sales and marketing, and we note that the Company’s Magic Number (a vital SaaS metric for sales efficiency) has signaled trouble for the past six quarters. We also highlight that Samsara recently removed past disclosures in SEC filings referencing an LTV:CAC ratio above 8x, which suggests its underlying customer economics may be deteriorating. Samsara does not disclose customer counts or churn, but by our calculation, we believe ARR churn has been increasing to unattractive levels. We see numerous reasons for churn to continue to worsen, including telematics commoditization, the emergence of strong competitors, and Samsara’s SMB-heavy customer base, which is both economically sensitive and rolling off their initial contracts in a markedly different telematics landscape. While Samsara has received analyst kudos for its recent turn to positive free cash flow after years of massive losses, we note that results have been driven largely by the sharp rise in interest and other income. In addition, they are highly dependent on the Company’s use of stock compensation instead of cash to attract, retain, and motivate employees. Therefore, we believe that Samsara’s cash flow is extremely low quality.
- Samsara suffers from governance failures more commonly associated with low-quality stock promotions than credible multi-billion-dollar companies. To begin, we take issue with Samsara’s highly exaggerated assessment of its Board of Directors’ skills. How can investors take a company seriously if it cannot provide a credible self-assessment? We also highlight that Samsara, unlike its peers, has not implemented a compensation clawback policy in the event of fraud or financial misstatement, which is troubling given the accounting issues we have identified, the over $100 million of unrecoverable compensation paid to management over the past three years, and the disclosure that the Company’s audit committee held a special meeting in FY2023. Samsara also has seemingly selected proxy peer companies designed to maximize compensation, as the list suspiciously excludes multi-billion-dollar IoT industry leaders in favor of larger technology companies. Samsara has further eased its compensation criteria by reducing vesting periods and removing performance conditions. Finally, we are troubled that Audit Chairman Chadwick has been allowed to serve on ten boards, including several private companies rumored to be embarking on the time-intensive IPO process.
- Samsara’s industry-leading valuation defies all logic; we see 45%-75% downside. Samsara has always been richly valued, but the Company’s shares particularly benefited from the recent AI-induced rally, even though we find that it has historically given away its AI capabilities for free. In fact, Samsara is not even a top ten holding in the sole IOT-focused ETF despite its pure-play focus and $14 billion enterprise value. Today, Samsara shares trade at an astronomical 16x 2023E revenue, making it one of the most richly valued companies among the entire IoT and SaaS universes. We find its valuation unsupportable and unsustainable. Samsara’s IoT peers trade at an average of just 4x 2023E revenue. Moreover, Samsara embodies all the attributes that have historically resulted in lower SaaS multiples - SMB focus, hardware business, and communications focus – as those issues are known to drive lower margins and worse customer economics. Samsara’s valuation dramatically eclipses even precedent IoT M&A transactions, where multiples have ranged from 4x-8x revenue. Finally, we highlight that current and future Advanced Driver Assistance Systems (ADAS) and self-driving systems could completely displace Samsara solutions, which threatens to impair any terminal value investors are modeling to support their Samsara price targets. In our opinion, Samsara’s coming multiple compression will likely be severe, and we see 45%-75% downside risk.
The research note can be found at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
