ON24: Shift to Neutral (NYSE:ONTF) considering guidance and capital allocation

elevator pitch

I have a Hold investment rating on: On24 Co., Ltd. (New York Stock Exchange:ONTF) stock.

Previously, in my previous article written on October 12, 2023, I highlighted that ON24’s valuation based on price-to-earnings metrics is not tricky. The present writing is a review of ONTF’s recently released results for the last quarter of the previous year.

I believe ON24 no longer warrants a Buy rating given its lackluster fiscal 2024 guidance and the risks associated with low returns on shareholder equity in the near term. However, ON24’s latest reveal also has some positives. Q4 2023 results suggest that ONTF has done a good job of making the company lighter in terms of its cost structure, and its new AI engine could be a key growth driver. We have decided to downgrade. Taking these various factors into consideration, we are switching ON24 from Buy/Bullish to Hold/Neutral.

ON24 delivered a huge EPS beat in the fourth quarter.

ONTF disclosed the company’s fourth quarter 2023 financial results in a press release issued on February 22 after the market closed.

A key highlight of ON24’s recent quarterly results was significant revenue improvement. The company recorded regular EPS of $0.06 in the fourth quarter of 2023, which represents a significant turnaround from the non-GAAP adjusted net loss per share of -$0.04 in the fourth quarter of 2022. Prior to ONTF’s earnings release, sell-side analysts had expected much more modest Q4 2023 net income for ON24, at $0.02. S&P Capital IQ Consensus data. Additionally, ONTF’s actual Q4 top line was $39.3 million, +5% higher than Wall Street’s consensus revenue estimate of $37.3 million (Source: S&P Capital IQ).

I previously noted in my October 2023 update to ONTF that there was a “significantly high proportion of customers with multi-year contracts (49% of annual recurring revenue as of end-2023)” and a “meaningful number (more than one-third)” . )’s customers’ utilize ‘one or more of the Company’s products.’ This explains why ON24’s revenue was stable on a QoQ basis in Q4 2023 (+0.3% topline expansion QoQ to be exact). In its Q4 2023 earnings press release, ONTF also shared its most recent quarterly “Total Retention Rate” and “New Retention Rate.” The ‘Business Acquisitions’ indicator was at its highest level in the last three years and six quarters respectively.

Separately, ON24 said in its latest quarterly earnings call that the company’s “annual total cost structure was approximately $61 million lower in the fourth quarter of last year compared to the second quarter of 2022.” Additionally, ONTF’s sales and marketing expenses (the company’s largest operating expense item) as a percentage of revenue decreased from 45% in the fourth quarter of 2022 to 42% in the fourth quarter of 2023. It is worth noting that ON24 has already noted the ‘progress’ it has made in cost optimization. “Along with the previous post on October 12, 2023.

unfavorable financial outlook and capital return prospects;

I’m not very impressed with ON24’s financial outlook and the company’s shareholder return prospects, despite the company’s respectable fourth quarter performance outperformance.

ONTF said in the company’s fourth-quarter earnings call that it will introduce “ON24 AI-powered ACE,” or its “next-generation AI-powered analytics and content engine,” to customers this year. As an indicator of the future growth potential of its “AI-powered ACE” products, ON24 has already received pre-orders from a variety of customers following its Q4 2023 earnings announcement. On the other hand, this latest move could potentially impact ON24’s near-term profitability and its stance on share buybacks.

According to ONTF’s FY 2024 management guidance, the company expects revenue and regular EPS to decline -11% and -61%, respectively, to $145 million and $0.035 for the current year.

ON24 acknowledged in the company’s Q4 2023 results briefing that it faces “a choppy environment in which many of our customers continue to face limited marketing budgets.” Apart from this, higher-than-expected investments related to ‘ON24 AI-powered ACE’ could be another reason for significantly lowering the company’s FY 2024 revenue outlook. ONTF noted in its most recent quarterly earnings call that it is “focusing on selective investments in specific categories,” including new “AI-based analytics and content engines.”

On the other hand, ONTF’s expected returns on shareholders’ equity in 2024 may not meet expectations.

Over the past two years, ON24 has allocated approximately $166 million to share buybacks and special dividends, equivalent to more than half of its current market capitalization. ONTF does not pay regular dividends and may opt out of share buybacks in the future.

In response to questions about capital allocation and share repurchases in its Q4 2023 earnings briefing, ONTF emphasized that “our balance sheet remains strong, which will allow us to invest in our strategic priorities.” From ON24’s management comments, it would be reasonable to infer that the company is focused on capital investments rather than capital returns for the foreseeable future. For example, ONTF may consider allocating more capital to AI-related investments to increase future growth prospects.

In summary, the new AI engine is expected to have a positive impact on ON24’s mid- to long-term growth prospects. However, increased AI-related investments are also likely to have a negative impact on the company’s profitability and return on capital in the short term.

final thoughts

A Hold rating for ONTF is fair. ON24’s latest quarterly results release offers both favorable and unfavorable readings. On the positive side, the company’s cost structure has improved, as evidenced by its fourth quarter EPS performance, and its new AI engine is receiving good interest from customers. On the negative side, ON24 is expected to report lower revenue and net income for the current fiscal year, and the company may allocate more capital to investments and return less capital to shareholders.