Rising AI Pressure Will Squeeze SaaS Margins But Yield Respite

Key Takeaways

• Accelerating AI and automation trends risk commoditizing Freshworks' core offerings, leading to pricing pressure and limited differentiation in a competitive SaaS market.
  
• Heavy exposure to small and midsize clients makes Freshworks vulnerable to economic downturns and uneven growth, despite success in partner ecosystem expansion and cross-sell efforts.
  
• Heavy reliance on SMBs, weak brand differentiation, and intensifying AI-driven competition threaten revenue growth, profitability, and expansion into the enterprise segment.

Catalysts

A software development company, provides software-as-a-service products in North America, Europe, the Middle East, Africa, Asia Pacific, and internationally.

• While Freshworks continues to benefit from the global shift to cloud-based SaaS and digital transformation, the rapid acceleration of AI and automation in IT and business processes could commoditize core offerings, making differentiation more difficult and putting pressure on pricing, which could ultimately limit growth in average revenue per user and constrain margins.
  
• Despite strong revenue growth in AI-related products and increasing customer adoption of AI Copilot and Agent agents, the company's current monetization represents only a small fraction of its overall customer base and remains early stage, making future revenue expansion from AI uncertain as customers may be slow to broadly trust or pay for autonomous AI functionality at higher price points.
  
• While multi-product adoption, cross-sell opportunities, and strong integration with acquired solutions like Device42 support net retention rate stability and ARPU improvement, Freshworks' historically heavy exposure to SMB clients makes it vulnerable to recession risk and tighter IT budgets, raising the risk of elevated churn and uneven top-line growth in a downturn.
  
• Although the growing ecosystem of partners, third-party integrations, and expanded vertical focus should improve market reach and customer lock-in, ongoing consolidation in the SaaS space could pressure Freshworks to increase investments in R&D and go-to-market initiatives, stretching operating leverage and threatening long-term operating margin gains.
  
• While management's disciplined cost control has resulted in industry-leading gross and free cash flow margins, sustaining the balance between investing in innovation, scaling into the enterprise segment, and containing costs will be difficult if slower cross-sell progression or intensifying price competition drags on earnings and margin expansion in future years.

Freshworks Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Freshworks compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Freshworks's revenue will grow by 11.8% annually over the next 3 years.
• The bearish analysts are not forecasting that Freshworks will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Freshworks's profit margin will increase from -7.0% to the average US Software industry of 13.1% in 3 years.
• If Freshworks's profit margin were to converge on the industry average, you could expect earnings to reach $143.2 million (and earnings per share of $0.55) by about September 2028, up from $-54.9 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 41.5x on those 2028 earnings, up from -69.5x today. This future PE is greater than the current PE for the US Software industry at 35.7x.
• Analysts expect the number of shares outstanding to decline by 3.77% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.43%, as per the Simply Wall St company report.

Freshworks Future Earnings Per Share Growth

Risks

• The company remains heavily exposed to SMBs and lower mid-market customers, which could increase vulnerability to economic downturns, tech budget tightening, and higher customer churn, thus putting sustained pressure on revenue growth and net margins.
  
• The rapid advancement of AI and automation across the SaaS sector risks commoditizing core offerings, potentially intensifying competitive pressures and forcing Freshworks to reduce software prices, hindering the company's ability to grow average revenue per user and expand earnings.
  
• Ongoing sector consolidation may require Freshworks to spend aggressively on product innovation, integrations, and partnerships just to maintain relevance, resulting in elevated R&D and sales expenses that may dilute long-term profitability.
  
• The slow ramp and early days nature of new AI revenue streams, combined with the remaining uncertainty around customer adoption rates of advanced AI agents, may limit the near-to-medium-term impact on ARR growth and delay expected improvements in net dollar retention rates.
  
• Weak brand differentiation and a still-limited foothold in the enterprise segment expose Freshworks to powerful, better-capitalized competitors, which may result in longer sales cycles, higher customer acquisition costs, and growing pressure on revenue and operating margins over time.

Valuation

• The assumed bearish price target for Freshworks is $18.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Freshworks's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $27.0, and the most bearish reporting a price target of just $18.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $1.1 billion, earnings will come to $143.2 million, and it would be trading on a PE ratio of 41.5x, assuming you use a discount rate of 8.4%.
• Given the current share price of $13.09, the bearish analyst price target of $18.0 is 27.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.