Kinesic Capital Proposes Value Creation Plan to ON24 Board of Directors

SAN FRANCISCO--(BUSINESS WIRE)--The letter below was sent by Kinesic Capital LLC (“Kinesic Capital” or “We”), a current shareholder of ON24, Inc. (“ON24” or “Company”), to the ON24 Board of Directors (“Board” or “Directors”) and management team on March 7, 2023.

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Dear ON24 Board of Directors,

Most software companies strive to be a “Rule of 40” business. This could be 20% operating margins plus 20% revenue growth, or 40% operating margins plus 0% revenue growth. This metric is relevant because it highlights the tradeoffs between growth and profitability, as well as the high profit margin potential embedded in most software business models.

Here is the issue and why we are writing this letter. ON24 is currently a “Rule of -18%” business¹, and that needs to improve immediately. Several ON24 Directors are currently employed by software companies with attractive “Rule of 40” metrics (Snowflake Inc.: 48%, Five9, Inc.: 34%)². However, ON24 has not been held to a similar standard.

It is evident to Kinesic Capital that ON24’s current management team has had limited regard for shareholders since going public, and that the current operating plan will not create shareholder value going forward. Significant changes are needed, so we propose a three-step plan (“Value Creation Plan”) that we believe is in the best long-term interest of all ON24 shareholders:

1. Management needs to further reduce operating expenses immediately in order to achieve a 20% non-GAAP operating income margin by Q4 2023, and commit to maintaining that level of profitability going forward. We estimate this will require a ~25% reduction in ON24’s non-GAAP operating expenses in addition to the cost saving measures already announced during the Company’s Q4 2022 earnings³. We acknowledge this is a challenging exercise, but we believe it is necessary to correct ON24 management’s misjudgment of the durability of 2020 & 2021 revenue growth and the associated doubling of run-rate operating expenses that occurred from the end of 2019 through early 2022. This will ultimately position ON24 for long-term success with a leaner and more focused cost structure. If management does not cut expenses aggressively themselves, it is likely a private equity buyer will take the Company private at some point and do it for them. In that scenario, current management will be at risk of losing their jobs, and the Company’s Directors will also likely be replaced.
   
   
2. Management needs to be opportunistic regarding its share repurchases, acting aggressively and expeditiously when the stock offers an attractive return. Since valuing any business is more an art than a science, we offer a guidepost. We believe ON24 shares are highly attractive at an EV / 2023 consensus revenue multiple of below 1x, or below $9.25 per share. Given the stock’s recent drop to $7.87⁴, we urge ON24 to start buying shares immediately from all willing sellers below $9.00 per share. If there are $75 million worth of shares available to be purchased below $9.00, then we encourage ON24 to utilize its entire $75 million share repurchase authorization promptly. In order to achieve this, we believe ON24 should repurchase shares in the open market, and also commence a tender offer at $9.00. If there are more than $75 million worth of shares available to be purchased below $9.00, then we encourage the Board to authorize an additional $75 million in share repurchases and continue retiring shares. Repurchasing significant amounts of ON24 stock under $9.00 per share will act as a return accelerant for remaining shareholders and help reduce future return drag from ON24’s overcapitalized balance sheet ($328 million in net cash as of Q4 2022).
   
   
3. Management needs to cut its annual stock-based compensation expense in half as quickly as possible and commit to no material acquisitions until ON24 shares are more appropriately valued. ON24 equity offers too attractive of a future return (and accordingly too high of dilution to current shareholders) to be distributing it so generously. Similarly, given ON24’s current valuation of 0.5x 2023 consensus revenue, significant acquisitions (in cash or equity) will most certainly destroy shareholder value and should be off limits until shares are more appropriately valued. As a guidepost, we propose ON24 should trade at 2x+ revenue before any material acquisitions are considered. We believe step #1 in this plan should be enough to increase ON24’s valuation to that level.

ON24 achieving a 20% non-GAAP operating margin by Q4 2023 should translate to $33.5 million in run-rate non-GAAP operating income⁵, which we believe investors would value at a 10-15x multiple. This would translate to a share price between $12.25 and $15.50, offering current shareholders a ~55% to ~95% return (assuming no shares are repurchased). If management is highly opportunistic in its share repurchase program and retires $150 million worth of stock at $9.00 per share, then a share price between ~$14.00 and ~$18.50 is achievable, offering current shareholders a ~75% to ~130% return⁶.

Importantly, this plan outlines just the first steps in ON24 becoming a high-quality software business. This plan should enable ON24 to be a “Rule of 20” business in 2024 (20% non-GAAP operating income margins plus 0% revenue growth), but then it will be up to the management team to accelerate growth in an efficient manner in order to build a “Rule of 30” or “Rule of 40” business over time.

We are seeking a win-win outcome for all ON24 stakeholders. If the current ON24 management team will not execute this Value Creation Plan, then we believe the Board has a fiduciary duty to replace them with executives who will.

We do not see a need for the ON24 Board to respond publicly to this letter or use further Company resources engaging shareholder activism advisors. The path forward is clear (see the Value Creation Plan above), and ON24’s focus should be on execution. Investors will evaluate how seriously the ON24 Board takes its fiduciary duties based on the Company’s actions in the coming months. The opportunity is present to create substantial value for ON24’s shareholders and turn the Company’s poor public track record into a reputable one going forward; we urge the Board to capitalize on it.

Respectfully,

Spencer Walsh
Managing Member, Kinesic Capital LLC

About Kinesic Capital

Founded in 2020 by Spencer Walsh, Kinesic Capital LLC is a boutique investment advisor managing a single, concentrated, public equity strategy. Kinesic searches globally for the best risk-adjusted return opportunities within the technology and consumer sectors.

Important Disclosure Information

This communication may contain Kinesic Capital’s current views on the value of ON24’s securities and certain actions that ON24’s Board of Directors and management team may take to enhance the value of its securities. Kinesic Capital’s views are based on analysis of publicly available information and assumptions believed to be reasonable. There can be no assurance that the information Kinesic Capital considered and analyzed is accurate or complete. Similarly, there can be no assurance that Kinesic Capital’s assumptions are correct. ON24’s performance and results may differ materially from Kinesic Capital’s assumptions and analysis. Views expressed in this communication constitute the current opinion of Kinesic Capital and are subject to change without notice.

Kinesic Capital has not sought, nor received, permission from any third-party to include their information in this communication. Any such information should not be viewed as indicating the support of such third party for the views expressed herein. Nothing herein is or should be construed as investment, legal, or tax advice, or an offer to sell or a solicitation of an offer to buy any securities.

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^1	Based on the midpoints of ON24’s 2023 guidance (-12% 2023 revenue growth plus -6% 2023 non-GAAP operating income margin = -18% “Rule of 40”).
^2	Based on consensus estimates for 2023.
^3	ON24 management guided to $38-40 million in run-rate operating expenses savings by the end of Q2 2023 vs. Q2 2022. This implies reducing operating expenses to ~$31 million per quarter by Q3 2022. We suggest a further ~25% reduction to ~$23 million in quarterly operating expenses in order to generate 20% non-GAAP operating income margins by Q4 2023 (assuming $42 million in Q4 2023 revenue and 74% non-GAAP gross margins). If management is able to generate higher revenue or gross margins, then a lower reduction in operating expenses would be required to reach 20% non-GAAP operating income margins.
^4	ON24 common stock market close price on March 6, 2023.
^5	Assumes $42 million in Q4 2023 revenue, in line with ON24’s 2023 guidance.
^6	Hypothetical return calculations are based on a current share price of $7.87, a net cash balance of $328 million, and a fully diluted share count of ~53 million. $14.00 and $18.50 share prices assume $150 million in stock is repurchased at $9.00 per share and that shares are valued in the future at 10x and 15x ON24’s potential non-GAAP operating income of $33.5 million.