Category: In-Depth Analysis (Page 2 of 7)

These posts represent in-depth analysis of a particular company or general theme.

Looping Back on Confluent (CFLT)

April 12, 2023 / poffringa

Following disappointing results from the hyperscalers, Confluent was one of the first independent software infrastructure providers to report Q4 earnings on January 30th. Further complicating the picture, they preceded that report with an announcement of an 8% staff reduction on January 26th. That filing included top-level Q4 results. This flurry of news overshadowed two key points from the reports that subsequently became clear.

First, Confluent largely maintained their revenue growth target for full year 2023 that had been previously set in Q3. Initially, the market seemed to be anticipating the standard q/q raise. However, subsequent earnings reports from other software infrastructure providers made it clear that just maintaining guidance represented a positive signal, as several companies made fairly significant downward revisions to their full year revenue target from either what analysts had modeled or the company’s own guidance from the prior quarter. Among peers, Confluent was one of few companies that kept the target about the same.

Second, the driver of the layoff was a desire to pull in profitability targets by a year. Because force reductions can be organizationally disruptive and sometimes a signal of worsening demand, the layoff was initially interpreted negatively. The full Q4 report provided sufficient evidence that demand was softening, but not falling off a cliff, as new customer activity was strong.

The upside to the staff reduction is a significant decrease in expenses. Confluent’s revised operating margin target for end of year 2023 is now Non-GAAP break-even. If achieved, Confluent will have improved their operating margin by 2000 bps (20%) for two years in a row. They have telegraphed that FCF margins will follow a similar path.

These two factors, along with other positive signals in the report and earnings call, make Confluent’s results look more favorable relative to peers. When compared to subsequent reports from most other software providers, Confluent is forecasting less revenue growth deceleration and a marked improvement in operating margin.

This momentum may well provide investors with a favorable set-up going into 2024. Looking to next year, we could have a situation in which Confluent is growing at 30%+ revenue with positive operating margin. The stock appears fairly valued now, implying that further price appreciation could increase proportionally to revenue growth.

MongoDB (MDB) Q4 FY2023 Earnings Review

April 2, 2023 / poffringa

With MongoDB’s Q4 earnings report following most peers in the software infrastructure space, investors were bracing for decelerating revenue growth and a conservative guide for the upcoming year. MongoDB delivered just that. While Q4 notched a nice beat on revenue with growth of 36% annually, the preliminary guide for FY2024 came in at just 16% growth, almost 10% below analyst estimates.

That level of deceleration would normally torpedo a stock, but MDB closed the following day lower by about 8%. In subsequent weeks, the stock recovered that drop and recently closed above its pre-earnings price. Granted, most software stocks benefited from a favorable boost over the last week. This price action implies that the market is anticipating a recovery for the software sector and that preliminary revenue guidance may be conservative.

While sales growth is struggling, MongoDB is demonstrating a rapid improvement in profitability. Q4 was their highest level of Non-GAAP operating margin to date, passing 10% for the first time. This coincided with a 400 bps improvement in gross margin and record free cash flow. Looking forward, preliminary estimates for EPS surpassed analyst targets. The full year FY2024 operating margin target is starting at 5%, slightly higher than what was delivered in all of FY2023. I expect this to increase as the year progresses, just as it did in 2022.

Similar to peers, MongoDB’s explanation for subdued revenue growth is slower spend expansion by existing customers. In times of economic stress, MongoDB is hit by a double whammy. As a consumption business, if their customers experience a slowdown in digital activity, then Atlas usage decreases. Additionally, customers will delay workload migration projects, as they try to manage costs. These factors combined to force MongoDB leadership to set a low revenue growth target for FY2024, expecting that these headwinds will continue.

Snowflake (SNOW) Q4 FY2023 Earnings Review

March 24, 2023 / poffringa

Leading up to Snowflake’s Q4 FY2023 earnings report, investors felt insulated from the risk of a low revenue guide for the full year. This concern had been abated in the Q3 report, as management blunted a reduced Q4 revenue guide with a preliminary estimate that FY2024 would deliver product revenue growth of 47%. During the Q3 earnings call, this had the immediate effect of propping up the lagging after-hours stock price.

When management lowered their actual guidance in the Q4 report on March 1st to reflect product revenue growth of 40% y/y, investors were disappointed. Expectations for higher growth had already been set. Stepping back though, without the pre-announcement, a 40% guide may have been fine. Combined with an adjusted FCF margin target for the year of 25% puts Snowflake in the rare position of maintaining performance above the Rule of 60 in a tough spending environment. That target would deliver about $700M in free cash flow for this year.

Compared to other software infrastructure peers, Snowflake enjoys one of the highest valuations. Its market cap is about $44B with a trailing P/S ratio of 21. With optimistic revenue estimates, this ratio comes down quickly. At analysts’ revised revenue target for FY2024 (current calendar year), the forward P/S ratio is 15.5. Looking out two years with the FY2025 revenue estimate for $4.024B in revenue, the forward P/S approaches 11. Currently, analysts are projecting a revenue growth rate of 38.9% for FY2025, which is just a tick below the revised projection for FY2024 (this year) for 40.2% revenue growth.

That linearity forms the crux of the Snowflake investment thesis. If the company can continue expanding into their seemingly uncapped TAM at a durable revenue growth rate around 40%, then the opportunity for upside is reasonable. Combined with an adjusted FCF margin of 25% (or more), a premium valuation multiple appears fair. The price to FCF multiple for FY2024 lands at about 63 – not outlandish considering that Snowflake more than doubled FCF over the past year.

Datadog (DDOG) Q4 2022 Earnings Review

March 4, 2023 / poffringa

After enjoying several years of hypergrowth, Datadog’s revenue outlook for this year reflects a substantial slowdown. The challenge for investors is to discern whether annual growth in the mid-20% range is the new norm for Datadog or reflective of headwinds from the broader pullback in IT spend. Similar to the discussion around hyperscaler growth trajectories, enterprise IT teams are using this period of macro pressure to optimize their software infrastructure spend.

This optimization is a natural outcome of the rush to push through cloud migrations and feature releases during Covid with little oversight to spending levels. With IT budgets contracting, the opposite motion is taking hold, magnified by a concentrated effort to address accumulated optimization debt. After ignoring bloat for two years, enterprise IT teams are scrambling to lower costs. For the hyperscalers, this is a straightforward exercise. A plethora of options and flexibility make it very easy to reduce server instance sizing, commit to longer usage terms and even turn off services that are underutilized. The same advantages of cloud elasticity that drove rapid growth during boom times can apply a similarly acute impact on spend if reduction is the goal.

Opportunities to optimize spend on Datadog exist as well – not the same mechanics as with the hyperscalers, but familiar patterns. Customers can remove Datadog licenses from some hosts (APM, Infrastructure), shorten log retention periods (Log Management) or even limit the number of test runs (RUM, Synthetics, Continuous Testing). Further, as customers introduce new cloud workloads, they might forgo monitoring or apply limited observability coverage to their tiers. If customers delay a digital transformation project, that would impact Datadog spending growth as well.

As with the hyperscalers, these optimization efforts are creating a headwind to Datadog’s normal spend expansion. While customers are adopting multiple Datadog products at the same rate, they are ramping up utilization more slowly, or even optimizing down, on existing workloads. By not expanding spend as infrastructure tiers go through this one-time capacity adjustment, Datadog’s sequential revenue growth is being compressed.

Q4 2022 Hyperscaler Earnings Review

February 7, 2023 / poffringa

Over the last two weeks, we received earnings results from the three hyperscalers – AWS, Google Cloud Platform and Microsoft Azure. Additionally, several software companies reported, providing another view of trends in software infrastructure and developer tooling. If that wasn’t enough, various economic reports and a Fed meeting were mixed in. I won’t cover the macro developments, beyond commenting on how they influenced market performance during the period and exacerbated the market’s reaction.

Overall, we received mixed signals. On one hand, the hyperscalers exhibited a deceleration in revenue growth, as customers used this period to “optimize” cloud usage and stretch out projects. On the other hand, several software companies reported revenue with less deceleration and surprisingly linear growth projections looking forward. A couple of explanations might be drawn from this.

First, while software infrastructure company sales are correlated to usage of cloud resources, certain companies may be more insulated from the effects of resource optimization. In some cases, pricing models by host or service have less elasticity than options available for hyperscaler optimization, like server downsizing, reserved instances and cold storage. Additionally, a few software infrastructure companies have been experiencing ongoing optimization over a longer period, going back to early 2022.

Second, the hyperscalers issue limited forward projections. They generally report revenue performance for just the prior quarter and sprinkle in a little verbal commentary about the current quarter. None of them project growth for the full year, which is particularly important now as most software companies are providing their preliminary full year 2023 guidance.

This leaves investors with a confounding dilemma. They could project the hyperscaler Q1 growth commentary reflecting further deceleration downward through all of 2023. Or, they could follow the lead of the software company full year estimates and factor in some re-acceleration going into the second half of the year. A deeper look into the mechanics of workload optimization may provide insight into this apparent divergence.

ServiceNow (NOW) – The Platform for Digital Business

January 30, 2023 / poffringa

ServiceNow has evolved over the last ten years from a specialized ITSM provider to a full-featured low code platform with ready-made solutions for a number of common enterprise business functions. If you were to believe the often hyperbolic CEO, ServiceNow will become the only software platform needed by enterprises to address digital transformation. While their product expansion has been impressive, I think their scope will land somewhere in between.

ServiceNow (NOW) is a company that I have followed for years and have owned in the past. While we tend to see large software services vendors slow down revenue growth as they pass $1B in sales, ServiceNow is exhibiting staying power by executing product expansion across multiple, adjacent service categories and then cross-selling them into the largest enterprises. This motion drives enormous spend elasticity, with nearly 100 customers exceeding $10M in ACV.

The company started in 2004 with IT Service Management, basically delivering a better software solution for the enterprise IT Helpdesk. This naturally expanded into other IT services, like asset management, operations management, portfolio management, governance and compliance and more recently security operations. At their core, all of these business processes are organized around “workflows”, which represent a series of steps taken by the user, a specific data model to store the state of their interactions and logic to control the flow and enforce business rules. The original model mirrored a “ticketing” system. Since then, workflows have evolved into full-fledged applications.

Okta’s Latest (OKTA)

January 23, 2023 / poffringa

Okta has undergone a lot of change over the last two years. In 2020, the company was considered the leading independent provider of IAM (Identity and Access Management) services, enjoying great brand recognition and rapid growth. They had achieved strong penetration in the workforce identity space and were tracking to extend their reach into customer identity. Okta had labelled their product category as the Identity Cloud and attributed an estimated TAM of $55B (which they have further increased to $80B). They were well positioned to consolidate this new market segment around solutions to manage identity for both enterprise organizations and application developers.

In March 2021, Okta announced the acquisition of competitor Auth0. I found this a bit surprising, as I had assumed Okta could expand into the application identity space organically, as an extension of the Identity Cloud. Rather than building the customer identity capability internally, Okta leadership decided to acquire it for $6.5B in OKTA stock. To be fair, Okta’s product opportunity in customer identity was nascent and needed to establish appeal with developers. Acquiring Auth0 provided immediate access to a superior product offering and a community of developers. More importantly, the acquisition potentially short-circuited a competitive threat. Other larger platforms (like Salesforce and Oracle) were rumored to be looking at acquiring an identity solution as well. Okta was simply preempting their move.

Auth0 will operate as an independent business unit inside of Okta, and both platforms will be supported, invested in, and integrated over time — becoming more compelling together. As a result, organizations will have greater choice in selecting the identity solution for their unique needs. Okta and Auth0’s comprehensive, complementary identity platforms are robust enough to serve the world’s largest organizations and flexible enough to address every identity use case, regardless of the audience or user.
Okta Press release, march 2021

Following the acquisition, the Okta leadership team decided to keep the two platforms separate, with the intention to integrate them over time. This translated into separate organizations, which operated independently for more than a year. Combining the sales teams began in 2022, but experienced challenges, culminating in the announcement of Q2 FY2023 results in August 2022. As it became clear that the whole acquisition and integration process had been poorly managed, the market began losing confidence in Okta leadership. This blame has increasingly fallen on Okta CEO and co-founder Todd McKinnon.

Confluent (CFLT) – A Big Data Play

January 15, 2023 / poffringa

Confluent stock recently bounced off its 52 week low, yet still trades under the closing price from 2022. This is in spite of posting strong results in their Q3 report in early November, which drove an 11% after-hours pop. More broadly, Confluent is part of a basket of companies that provide enterprises with software infrastructure and services to power their digital experiences. Entering 2023, we see pressure on this basket, associated with concerns around the durability of growth. This effect, along with lingering headwinds from the path of interest rates and macro volatility, has ratcheted down expectations for the software infrastructure basket.

As we consider the possibility of these macro headwinds starting to abate in 2023, growth investors have the opportunity to shift into stock picking mode. The goal is to identify companies that have the potential to outperform muted growth projections for 2023, stemming from an expectation for lower IT investment after a surge of cloud spending over the last two years. While some areas of enterprise IT investment will likely moderate, I think other functions could see a re-acceleration of demand as we exit this year.

Harnessing data to drive efficiencies in enterprise operations, supply chain management and curated customer experiences is one that I see as ripe for further investment. While every consumer-facing business has an app at this point (long couched as “digital transformation”), I am looking forward to the next wave of growth where businesses must instrument every corner of their operations and leverage the data collected to improve efficiency, lower cost and drive competitive advantage. Let’s call this data transformation. New capabilities in IoT, real-time streaming, parallel processing and data mining are converging. Advanced AI models are facilitating algorithms that can automate decision making and produce better work products. Labor shortages will reward businesses that can streamline more of their daily operations and lower cost.

Occupying a critical step in this emerging data-enabled business paradigm is Confluent. With the leading platform for data streaming, Confluent is well positioned to capitalize on the shift from uni-directional consumer and business interactions to multi-directional coordination between all participants (humans and devices) in an industry ecosystem. As the majority of data creation shifts from human activity to device activity, data volumes will explode, requiring better systems to distribute it from many producers to many consumers.

In this post, I will examine some of the emerging trends in harnessing a data-driven economy, how Confluent fits into that and the business opportunities available. I will then review how Confluent has executed against this backdrop and whether it represents the best way for investors to capitalize on this second wave of data (not digital) transformation.

Elastic’s Ambitious Growth Plan

January 3, 2023 / poffringa

I haven’t written about Elastic since late 2020. I held a position in 2020, but shifted my allocation to Datadog in 2021. At that point, it was becoming clear that Datadog was emerging as a leader in the observability space. While I still maintain a large portfolio allocation to Datadog, Elastic may provide a favorable return over the next two years, if they can execute on their aggressive growth plan and FY2025 financial targets.

At their Analyst Day in September, the leadership team set an ambitious growth target for $2B in revenue by FY2025. As we are halfway through Elastic’s FY2023, this represents roughly a 2x increase in revenue within 2.5 years. When the leadership team presented the model for this target, they projected a revenue CAGR of 36% to reach it. That would be an acceleration from the current growth rate in the low 30% range.

Additionally, this target comes with profitability improvements, anticipating a couple percentage points of growth each year for adjusted operating and FCF margins, over their roughly break-even state at the time. As ESTC stock appears reasonably valued with a P/S ratio just below 5, these targets might allow for a positive return over the next 2-3 years.

Of course, the macro environment and softer IT spend could hamstring these plans. Elastic’s most recent quarterly report for Q2 FY2023 issued a month after the Analyst Day made these targets appear more challenging. Yet, the leadership team didn’t reset them. Given their exceptionally high net expansion rates for large customers and particularly among new Elastic Cloud users, they might just get close.

MongoDB (MDB) Q3 FY2023 Earnings Review

December 26, 2022 / poffringa

In Q3, MongoDB reversed a number of the trends that hampered their Q2 earnings report. They delivered a strong beat on revenue growth, a return to positive operating margin and a nice bump in customer activity. The market reacted as positively to the Q3 report as it did negatively for Q2, pushing the stock up 23% the following day. Since then, MDB stock has appreciated further and now hovers around $200 a share. This is still below the $241 close the day after the Q2 report, but is well above the 52 week low of $135 touched before Q3 earnings.

While the trends turned back in a positive direction in Q3, the broader macro environment may still pressure growth for the next couple of quarters. Atlas sequential and annual revenue growth were the lowest in the last two years. Much of the revenue outperformance for Q3 was attributed to strong growth in EA license revenue. Nonetheless, these results were much better than expected coming out of Q2. Adding to the upside momentum, MongoDB resumed its path to profitability, with positive operating income and improved gross margin.

For the long term, I still think MongoDB is well-positioned to participate meaningfully in the secular trends of data growth and platform consolidation. Going into the second half of 2023, year over year comparisons become easier and the current investment in S&M will drive further growth. The inflection to sustained positive operating margin should provide support for the valuation multiple. MongoDB’s competitive position is defensible, as industry analysts rank it above comparable alternate solutions in features and capabilities. While the hyperscalers offer competitive products, the depth of MongoDB’s collaboration and partnership agreements with each is actually increasing, providing an additional tailwind to growth.

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