Sleep Cycle (SLEEP.ST)
Featuring notes from my conversation with Jessica Grunewald at Redeye
Sleep Cycle AB (ST: SLEEP), referred to as “Sleep Cycle” for the remainder of this writeup, is a high return on capital business that offers sleep solutions through its self-named app. Revenues and net income for 2023 were mSEK 236.15 and mSEK 46.14 which were year-over-year (YoY) increases of 11.4% and 35.9%, respectively. Through the first three quarters of 2024, revenues and net income were mSEK 194.77 and mSEK 45.12 which were increases of 11.4% and 26.4% versus the same period in 2023. The business is headquartered in the mean streets of Gothenburg, Sweden.
History
Per its homesite, linked here, Sleep Cycle launched in 2009 essentially as a smart alarm clock. It used the accelerometer in the iPhone which at the time was “extremely sensitive, able to pick up on the smallest of movements” that allowed the app to wake people up during their lightest sleep stage. It now has a vast database on sleep and offers more than its basic “smart alarm function”. These will be described in more detail in the “What Does Sleep Cycle Do?” section of this writeup. The business was founded by Maciej Drejak who sits on the Board of Directors and owns more than 43% of the business. Sleep Cycle went public in June of 2021.
CEO
Erik Jivmark is the CEO of Sleep Cycle and has acted in this capacity since November of 2023. Per the 2023 Annual Report, he previously worked at Volvo where he was responsible for Volvo’s Stockholm Tech Hub and as Director of Digital for Volvo Cars AB in Sweden and the United States. Before that he worked at Accenture.
Executive Compensation
Mr. Jivmark’s compensation is comprised of three elements: fixed salary, variable remuneration, and pension and other benefits. I will not mention the pension and other benefits as they are capped at 30% of the CEO’s fixed salary and don’t seem material to overall expenses.
Fixed salary
Per p. 40 of the 2023 Annual Report, “The senior executives' fixed salary is revised each year and shall be competitive and based on the individual's competence, responsibility and performance.” Classic corporate speak there, and no fixed salary amount was given for the new CEO. I don’t want to speculate on what it will be versus the previous CEO as the remuneration agreements are most likely different. I’ll just have to wait for next year’s summary compensation table.
Variable remuneration
The Remuneration Committee gives itself a lot of leeway in granting variable remuneration. Per pp. 40 – 41 of the 2023 Annual Report, “Variable cash remuneration covered by these Guidelines shall aim at promoting the Company’s business strategy and long-term interests, including its sustainability. Variable cash remuneration shall be based on predetermined and measurable criteria, which can be financial or non-financial, shall directly or indirectly be linked to the achievement of Sleep Cycle’s business strategy and shall be measured over a period of one or several years. They may also be individualized, quantitative or qualitative objectives.
Further variable cash remuneration may be awarded in extraordinary circumstances, either for the purpose of recruiting or retaining senior executives or as remuneration for extraordinary performance beyond the individual’s ordinary tasks, provided that such extraordinary circumstances are limited in time and only made on an individual basis. The total variable cash remuneration may amount to not more than 100 per cent of the senior executive’s fixed annual cash salary.”
The CEO’s variable remuneration is comprised of share-based payments through the issuance of warrants and a cash-based bonus performance program. Per Sleep Cycle’s 2023 Remuneration Report, Mr. Jivmark was granted 100,000 warrants which give him the right to subscribe to 100,000 shares during the period from and including 1 December 2026 up to and including 2 January 2027. The exercise price is SEK 52.60 per share.
The performance measures for the cash-based bonus performance program are the number of paying subscribers and EBIT, weighted 60% and 40%, respectively. The measurement period for this bonus was 10/1/2023 – 10/1/2024.
Summary Compensation Table
I am not posting one for this writeup due to the installation of a new CEO about a year ago. Also, as stated above, I’m not sure how his fixed salary and variable remuneration compare to the previous CEO and don’t want to speculate on that matter.
One thing I can say is that the CEO owns 6,000 shares of the business in addition to his warrants.
Executive Officers and Board of Directors
I usually don’t comment on this but came across a few interesting tidbits while researching Sleep Cycle.
In addition to appointing a new CEO in Q4 of 2023, Elisabeth Hedman was hired as the new CFO in June of this year. She previously worked at TimeEdit, a software company focused on scheduling in the academia sector, and at Norin Bank which, per its website, describes itself as “… a business-oriented Nordic financing bank.” In addition to serving as CFO, she also serves as the head of Investor Relations. She owns 2,000 shares of Sleep Cycle and has been issued 100,000 warrants.
Peter Alsterberg joined the business in April of 2024 to serve as its newly created Chief Commercial Officer where, per Sleep Cycle’s press release announcing his appointment, he will focus on partnerships, revenue management, and new revenue streams by leveraging Sleep Cycle’s data and platform. He owns 10,000 shares of the business and has been issued 100,000 warrants.
The last addition I am aware of was Petter Höglander as Chief Product Officer in April of 2024. Per the press release announcing his appointment which is linked above, “Petter Höglander brings a wealth of experience in driving growth in the B2C subscription space, having played pivotal roles at renowned companies such as Teemyco, Epidemic Sound, Record Union, Viaplay, and MTG. His proven track record in achieving product success and his expertise in subscription-based models make him an invaluable addition to Sleep Cycle's senior leadership team.” Petter owns 4,800 shares of the business and has been issued 100,000 warrants.
The Board of Directors has four members. Only one member, Anne Broeng, has more than two years of experience. She’s been a board member since 2020, chairman of the audit committee since 2020, and one of the two members of the remuneration committee since 2024. She owns 10,000 shares of the business.
Two of the other three members, Mathias Høyer and Maciej Drejak, have been on the Board since 2023, with Mr. Høyer becoming the second member of the remuneration committee earlier this year. He owns 14,107 shares of the business.
I mentioned Mr. Drejak and his substantial ownership of the business earlier and found it eyebrow raising that he’s listed as “independent in relation to the company and management”. How can someone who owns more than 43% of the shares (8,707,984 shares for those of you counting at home) be labeled as independent? Not really a red flag in my book, but just something I noticed.
Hans Skruvfors got on the Board earlier this year. Per the IR website, he does not own any shares and has not been issued any warrants.
I don’t recall seeing this much turnover on the Board of Directors since I started researching businesses. I don’t have an opinion either way on whether it’s good or bad, but it is something to be noted.
What Does Sleep Cycle Do?
Sleep Cycle, you guessed it, aims to help improve your sleep, specifically your sleep quality. What is sleep quality? Sleeping through the night and waking up feeling refreshed is a telltale sign of it. Lack of drowsiness and having energy throughout the day is another sign that you’re getting quality sleep. Per the CDC, signs of poor sleep quality include trouble falling asleep, waking up repeatedly throughout the night, and feeling sleepy or tired even after getting enough sleep.
Why focus on sleep? It is one of the three building blocks for a healthy person. The other two are regular exercise and a nutritious diet. To borrow a bit from Charlie Munger, not getting enough sleep is one of those things that will make you go through life like a one-legged man in an ass kicking contest. The day to day is made so much harder by not getting enough of it.
The benefits of getting enough sleep throughout the night are numerous. Per the CDC again, benefits include getting sick less often, staying at a healthy weight, a reduction in stress, improvement in mood, improved heart health, improved metabolism, lower risk of chronic conditions like Type 2 diabetes, heart disease, high blood pressure, and stroke. Getting a good night’s sleep also improves your attention and memory.
Posted below are a series of links to articles and videos about the benefits of better sleep:
https://health.gov/myhealthfinder/healthy-living/mental-health-and-relationships/get-enough-sleep
Alright, back to Sleep Cycle.
Per its homesite, “The Sleep Cycle app is a comprehensive sleep service that helps you fall asleep, wake up refreshed and improve your sleep.” I mentioned earlier that the first iteration of its product was essentially a smart alarm clock. That remains at the core of the business. The other products Sleep Cycle offers are Sleep Aid, Journal & Statistics, sleep tracking and recording, and individualized Sleep Programs. Let’s see what each product does for the user.
Smart Alarm
The Smart Alarm allows you to use the app in three different ways. The most popular option is the Smart Alarm Clock and Sleep Tracking. The user sets a wake-up window, and the app will analyze their sleep through their phone via a microphone or accelerometer. After tracking your sleep, the app wakes up the user during a lighter sleep stage which allows them to wake up easier than if they were in deep sleep. The other two functions of the Smart Alarm are just a regular old alarm, which still gives you access to your data if you’d like, and for those of you who don’t like alarms, you can choose only to track your sleep data. An “Intelligent Snooze” feature is offered which lets the user snooze until the end of their wake-up phase and gently wake you up.
Sleep Aid
This feature grants the user access to a variety of bedtime stories for adults, sleep music, sleep meditation guides, sleep coaching, bedtime rhymes, and white noise.
Journal & Statistics
The “Journal” part of the app is the sleep analysis from the previous night along with a quick overview of it. The “Statistics” are all the sleep statistics since the user started utilizing the app.
The user’s sleep quality statistics are analyzed and assessed through an algorithm. To quote from its product site, “As you continue to use Sleep Cycle, the algorithm adjusts to your personal sleep patterns and habits. A high sleep quality score is nice to aim for, but more important is to keep an eye out for dips (or peaks) in your sleep quality and see the correlation between this and external factors, which you add in your sleep notes before each sleep session.” One sleep factor that is measured is sleep regularity which is a user’s bedtimes and wake up times over a sustained period. You would obviously want these to be as consistent as possible. Other factors that are measured are time-in-bed, “asleep after” which measures how long it takes a user to go to sleep, their actual sleep time, time spent snoring, heart rate, and steps taken throughout the day.
Sleep tracking and recording
These measurements are closely linked to the Journal and Statistics and explain how and what Sleep Cycle measures during your sleep. Some of them overlap, so I will only mention those that I haven’t yet. Sleep Cycle claims this is the best way to track your sleep because a user’s sleep data is automatically logged, allows for objective sleep analysis, sleep quality and patterns are measured, it’s affordable, and can serve as a motivational tool for users to make “appropriate lifestyle changes”.
The other measurements not mentioned above include sleep phases which show you when and how long you were at each stage of sleep. Another is sleep notes which allow the user to enter information about their lifestyle choices and how those are affecting their sleep. These and the other factors mentioned in this section lead to an overall sleep quality assessment which shows the factors that are impacting their sleep.
Sleep Programs
Per its product site, Sleep Cycle claims these programs have “created a buzz amongst early adopters and test groups with its original collection of science-based sleep-training programs. ‘Sleep Programs’ is created by Sleep Cycle’s sleep experts and is a unique approach to improving sleep and educating on sleep-related topics, as it provides personalized, interactive and guided training.” Included in these programs are a focus on four sleep topics which include relaxing from stress, daytime hacks, relaxing the mind, and bedroom hacks.
What’s Unique About Sleep Cycle?
There is a tab labeled “Sleep Cycle as an investment” on its IR site and I’ve copied and pasted the four reasons the business gives on why one may choose to invest in it. I think these point to its unique factors or at least as close as I can get to them.
Being the market leader and most downloaded sleep app is rightfully listed as a #1 reason to consider investing in the business. This more than other factors is what seems to differentiate Sleep Cycle from the competition. Per the Q3 2024 Report, it now claims to have analyzed more than 3 billion nights, up from the >2-billion-night figure listed in 2023 Annual Report.
Number three on the list, its winning business model, caught my attention. I’m a big believer that the best businesses are those in “win-win” scenarios with their customers. The business makes money while the customer enjoys the product, and we have that at Sleep Cycle. Per p. 29 of its 2023 Annual Report, the business cites data which claims that more than 70% of its customers sleep better with the help of the Sleep Cycle app. It follows naturally that the business will continue to make money as its customers re-up on their subscription month after month.
There was an intriguing phrase that kept coming up in its quarterly reports. While not a core differentiating feature of the business, it did catch my eye. The phrase in question was a “focus on increased profitable growth.” It’s just kind of assumed that every business targets this, and yet it rarely happens. You don’t often hear businesses, especially small/micro/nanocaps, say this outright. I think it’s a feather in management’s cap to make this intention public because it shows potential investors that they’re dialed in to running a profitable enterprise.
Notes from discussion with Jessica Grunewald from Redeye.
Jessica is an equity research analyst at Redeye and covers Sleep Cycle. I reached out to talk with her about the business and luckily, she agreed to do so. My notes from the conversation are listed in the bullet points below. I’m posting all my notes in one section because I think it’s easier for readers to see her thoughts/comments/concerns in one section of this writeup versus them being interspersed throughout. For the record, I ran my notes by Jessica, she edited/clarified and sent them back to me. That updated version appears below.
From 2022 until late 2023, growth was FX-driven. The focus now is on ARPU and subscriber growth.
Issues/concerns with the business:
One trick pony
She doesn’t see the business broadening their offering outside of the sleep-related segment
Her response to this risk is that most tech/CSS companies are a one-trick pony and have managed to build huge businesses out of them. I agree with her on this.
Apple or Google might create their own product
For now, Apple is going more towards diagnostics which require FDA approval and not competing directly with Sleep Cycle.
Sleep Cycle and Apple seem to have a good relationship
Apple promoted Sleep Cycle as one of the top 10 apps after the newest software update
Sleep Cycle owns its own platform. Most of the competitors are building on SDKs from Apple or Google while Sleep Cycle has its proprietary technology.
This seems like a real differentiator which I was entirely unaware of.
Brand is another differentiator. Their customers trust them.
They can use their data advantage to develop new products.
Potential additional revenue stream – Monetizing its platform and data, but management hasn’t spelled out any concrete projects/initiatives yet
On C-Suite and Board turnover over the last year or so:
She speculated, but her answer was that the buyout didn’t go through, the business wasn’t growing outside of FX gains, and costs needed to be reined in.
Dividend payment isn’t an issue with her. She’s not worried about it.
Majority shareholder is not involved in the day-to-day
Buybacks are an opportunity in terms of capital allocation per management, but a board decision
You must be on a certain list to do buybacks in Sweden and Sleep Cycle is on them
She thinks management’s capital allocation decisions are good and that it is high on management’s agenda
CEO wants to 4 or 5x the business if you look at strike price for his LTIP warrant programs
Capital allocation and respect for the shareholders is prominent when she speaks to management
She thinks management is very professional, especially for a business of this size
CEO is balanced with this communication between the business and growth
Management has a lot to prove, but it’s still early days
Risks that stand out more than others:
Management could leave, but she thinks this is low
Bigger players would do their own thing, but we discussed this previously. Apple seems to be moving in a slightly different direction.
Execution risk on the new growth strategy. The Financial targets are sound but ambitious, especially the growth target. Can they get there? There is good traction in subscriber growth in Q3 2024, but there is still a lot to prove.
Competitors:
Market share is ~50%
Sleep Cycle has a good brand, reputation, and history
There could be an irrational actor that raises a ton of money, but she doesn’t think we’re in that environment
She thinks Sleep Cycle could run at +30% margins, but that would indicate that the business has essentially reached the limits of its growth and has transitioned to being a cash cow.
This would mean they aren’t investing in new opportunities
She’s interested in the new partnerships with myfitnesspal (and more to come, according to management) and how they will drive subscriber growth
Refer to her updates via Redeye’s website
Overall, she thinks it’s a high-quality company
I highly recommend checking out Jessica’s work on Sleep Cycle. Its profile on the Redeye website can be found here which features her pitch on the business, its valuation, updates, financials, ownership, disclosures, and plenty of other information. Thank you again Jessica if you end up reading this.
Valuation
*** All financial data were taken from TIKR or Sleep Cycle’s publicly available documents, presentations, media, etc. ***
Revenue
Sleep Cycle’s revenue growth since 2018 is shown in the screencap below.
Revenues CAGR’d at 16.74% between 2018 and 2023. Since going public in 2021, revenues have CAGR’d at only 8.88%.
Revenues through the first three quarters of 2024 were mSEK 194.77 which was an increase of 11.4% over the same period in 2023.
Sleep Cycle had 893,000 paying customers at the end of 2023. Per the Q3 2023 Report, paying subscribers increased to 915,000. Average revenues per user (ARPU) for 2021 – 2023 were SEK 212, SEK 234, and SEK 262. ARPU for the first three quarters of 2024 were SEK 278.
Management does not break out revenues by geography, but the CEO did state that the United States accounts for ~40% of sales during a recent presentation. You can find a link to the presentation here.
Sleep Cycle trades at ~3.6x 2023 revenues given its current market capitalization of mSEK ~860.
Free Cash Flow
Sleep Cycle’s real free cash flow (RFCF), defined as operating cash flow minus stock-based compensation and CapEx, is shown in the screencap below.
RFCF has increased at a robust rate of 38.55% per year since 2021. Do realize that net income was significantly impacted in 2021 because of increases in expenses related to Sleep Cycle’s IPO. RFCF was mSEK 49.42 through the first three quarters of 2024 which was an increase of ~35% over the same period in 2023.
Sleep Cycle trades at ~17x 2023 RFCF given its current market capitalization of mSEK 860.
Capital Structure
The asset side of Sleep Cycle’s balance sheet is shown in the screen cap below.
This side of the balance sheet looks great. You’ll notice that the cash balance reduced substantially from 2022 to 2023, but that was due mostly to the dividend payments which started during 2023.
The liabilities and equity side of Sleep Cycle’s balance sheet is shown below.
Current liabilities have increased steadily over the years, but that’s mainly because of its unearned revenues which are prepayments of its monthly or yearly plans. It tracks that they should increase as revenues do the same.
Additional paid in capital (APIC) decreased substantially due to the payment of dividends. I looked this up online because it should’ve come out of retained earnings, not additional paid in capital. I’m not sure if this was an error in TIKR’s data or if I’m missing something here. The corresponding account in Sleep Cycle’s 2023 Annual Report confirms this difference, so my hunch is that it is above board and I’m just unaware as to why it is allowed to pay dividends out of its APIC account.
Returns on Invested Capital (ROIC)
Sleep Cycle’s ROIC from 2018 – 2023 is shown in the screencap below.
Sleep Cycle’s ROIC since going public has been exceptional. These results indicate that it is very efficient with its capital. Net Income ROIC was significantly different than NOPAT ROIC in 2021 because of increased personnel, marketing, and auditor expenses related to its IPO.
Returns on Incremental Invested Capital (ROIIC)
Sleep Cycle’s ROIIC and value compounding rates are shown in the screencap below.
Sleep Cycle compounded its value somewhere between 12% and 43% from 2021 – 2023. The negative results for both reinvestments rates and ROIIC produce a positive result. I drove myself crazy trying to think of a way that this wasn’t true. It wasn’t intuitive and I needed an engineer friend of mine to explain it. I forgot simple multiplication of fractions. The compounding rate equation is equal to the reinvestment rate multiplied by ROIIC. Incremental invested capital is the numerator in the reinvestment rate calculation and the denominator in the ROIIC calculation. Therefore, it cancels out leaving you with NOPAT (or Net Income) Change divided by Cumulative NOPAT (or Net Income) which produces a positive result. It still doesn’t make sense to me intuitively, but it’s right. We’re going back to our regularly scheduled programming.
My hunch is that Sleep Cycle has been compounding its value closer to 12% than 43% because the Net Income Value Compounding rate started from a very low base due to increased expenses related to the IPO. This positive value contradicts what’s happened with its stock price which is shown in the screencap below.
Its stock price is down ~45% since going public which indicates a huge spread between what the market thinks of this business versus its actual results. Applying a 12% CAGR to its IPO price of SEK 70/share means that this business should be trading close to SEK 100/share, which is more than double its current price.
Risks
Product development – I had this concern before speaking with Jessica Grunewald, but it relates to her “one trick pony” risk that she mentioned during my conversation with her.
The business highlights the screencap below on its IR website.
The concerns here are the feasibility of the “Improvement”, “Diagnostics”, and “Treatment” products and how they will impact profitability down the road. Will these products move the needle?
Take rates – Sleep Cycle is at the mercy of Apple’s, Samsung’s, and Huawei’s take rates.
Growth target – Management aims to double revenues in the next three to four years. That’s an aggressive increase, so I’ll need to monitor and compare the actual results to this growth target as time goes on.
New management – Executive management is mostly new. Time will tell if they have the chops to not only run this business but keep compounding its value at a healthy clip year-in and year-out.
Tailwinds
TAM is massive – The estimates of what percentage of people don’t sleep well in the United States varies. I saw some results in the mid-teens and others approaching 50%. The base line of the lowest number I came across translates to tens of millions of people who don’t sleep well. That number obviously increases once other countries are factored in meaning that there is a very large potential growth runway available to Sleep Cycle. That’s not to say that they’ll capture a certain amount of it, but it gives them the opportunity to.
Structural trends affecting sleep-apps – The four trends listed in Sleep Cycle’s Q2 2024 Presentation were an intensified consumer emphasis on health, acknowledgment of sleep's role in overall wellness, consumer empowerment within the health space, and the rise of recurring revenue models through subscriptions.
Outlook
Is Sleep Cycle a great business? I think so. Is there value here? The numbers point towards “Yes”. In fact, they indicate that Sleep Cycle is currently trading at less than half of what its price should be assuming you apply a compounding rate of 12% over a three-year period from its IPO price to now. Applying that valuation more than double the multiples it trades for, but that’s what happens with quality enterprises.
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*** Remember that this isn’t investing advice. Consult a trusted financial or investment advisor before making any kind of investment decision. ***
Disclosure: I do not own shares in Sleep Cycle.