I was recently surprised to see that Oracle’s Cloud Infrastructure offering is accelerating its revenue growth at a fairly large scale (approaching $4B annual run rate). For the past several years, we have neatly defined the hyperscalers as the Big Three of AWS, Azure and GCP. This has been convenient for investors and analysts alike, as we have only had to track activities within these three. Analysis of independent software infrastructure and security providers could limit consideration of each company’s products in relation to similar offerings from the Big Three hyperscalers.
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These posts represent in-depth analysis of a particular company or general theme.
Zscaler delivered an impressive earnings report to cap off their fiscal year, demonstrating their ability to capitalize on strong demand for their leading Zero Trust solution. Coming into the report, investors were concerned about decelerating billings, worsening operating leverage and the need to provide an out of cycle fiscal year guide. Additionally, competitors like Palo Alto and Cloudflare had been increasingly vocal about customer wins. None of these factors appeared to impact the Q4 report, however, with Zscaler re-accelerating billings growth and highlighting several enormous enterprise and federal customer lands.
I had shared similar concerns and gradually reduced my allocation to Zscaler stock over the course of this year. Based on the Q4 results, this move appears to have been premature. While I still wonder about the longer term play for Zscaler, in the immediate term, they are feasting on the heightened demand environment for Zero Trust, as large enterprises and government agencies scramble to upgrade their network security. In this post, I’ll dig into the details from Zscaler’s quarter, revisit their product strategy and consider the path forward.
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After fairly positive earnings in Q1, MongoDB’s Q2 report reflected increased pressure from the macro environment. Product-market fit, competitive position and GTM motion with large customers all remain consistent. What appears to have changed is a marked slowdown of utilization expansion for specific customer segments, compressing revenue growth as a consequence of MongoDB’s consumption model. This impact is being compounded by the mix shift of EA license revenue to Atlas.
In spite of this, management is continuing to invest heavily to drive large customer growth. Sales and Marketing spend increased significantly in Q2, highlighted by a surge in sales headcount and the resumption of in-person events, particularly the MongoDB World conference. These are resulting in growth of Direct Sales customers, which hit record net additions in Q2 and now account for 86% of total revenue. As new salespeople ramp up, more customers should push over the $100k ARR spending threshold.
In this post, I review the results, unpack how these are related to customer behavior and provide some signals that investors can monitor to track MongoDB’s progress going into 2023. For the next couple of quarters, I think that MDB stock will be under pressure. However, when headwinds to customer expansion abate, the reversal could be swift, reflecting a similar pattern that we observed in 2021, magnified by the greater mix of Atlas revenue. This could provide a favorable set-up for second half of 2023, as the company laps this year’s results. However, that means investors would need to stay invested and have faith in MongoDB’s product vision.
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After two quarters of mixed results, Snowflake reignited investor sentiment with their Q2 earnings report. Revenue beat prior estimates for the quarter by a large margin, with management upping forward projections as well. Customer activity was the highlight of the quarter with record additions of $1M customers and surprising linearity in DBNRR. As we are two quarters past platform optimizations, Snowflake may be starting to benefit from additional workload migrations by large customers. Looking forward, their product strategy to expand the reach of the Data Cloud and bring application development directly onto customer data should provide additional drivers of platform utilization.
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Continuing my series of looping back on a few companies that I had held previously, I thought it would be instructive to revisit Fastly (FSLY). I had owned Fastly stock during its heyday in 2020, entering in early 2020 and ramping up my position after their strong Q1 2020 results and initial guide for Q2. By May 2020, FSLY was one of my largest positions with a cost basis of $32. The stock took off over the summer, jumping from the low $20 range in May to break $100 by August.
It eventually reached a peak of $128, before pre-announcing weak Q3 results, stunning the market. Yet, FSLY still managed to break $100 again in early 2021, as investors assumed it might recapture its prior momentum. Unfortunately, it didn’t, delivering one poor quarterly report after another. Following the disappointing Q3 2020 earnings, I began reducing my allocation in the $80-$90 price range and still managed to capture a favorable upside. I finally closed my position in early 2021.
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I like to keep tabs on stocks that I have owned previously, in the event that their execution catches back up with the potential I had identified previously. When I invest in a company, it is because I see an opportunity in which a strong product strategy could drive durable revenue growth and operating leverage over the long term. However, that thesis may not always play out as expected, or may take longer to align with execution. Companies can also experience different product adoption curves, cycling through rapid and slowing growth, as each product category achieves market fit.
Twilio (TWLO) is one such stock that I rotated in and out of, first entering in mid-2018 and exiting in 2021. During that time period, I watched the stock ascend from about $60 to an all-time-high of $443 in February 2021. Since its 2021 highs, the stock has descended back into the $80’s, putting it well below the price range going back to 2019 (pre-Covid). It’s Price/Sales ratio is now below 5, an all-time low over the prior 5 years. This ratio was above 10 for most of 2018-2019, reaching as high as 20 in mid-2019 and even peaked at 37 in 2021.
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Cloudflare (NET) announced Q2 FY2022 earnings on August 4th, demonstrating better than expected resilience to the macro backdrop, in contrast to many software infrastructure peers struggling with more acute softening of demand. Cloudflare beat revenue projections for Q2 and raised estimates for the remainder of the year. More significantly, they demonstrated a renewed commitment to deliver positive free cash flow, reversing the backsliding in Q1’s report. Growth in large customer additions hit a new record, illustrating Cloudflare’s ability to cross-sell their product suite to enterprises across multiple categories. While DBNRR ticked down a point, leadership is committed to crossing the rarefied threshold of 130%. The market favored the results as the stock popped 27% the following day.
I will share a summary of my reactions to the report, structured around financial performance, product activity and Cloudflare’s broader strategy. I won’t rehash all of the metrics, as those are readily available online in the earnings report and Investor Presentation. Additionally, investors new to the Cloudflare story can catch up on the narrative through my prior coverage.
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Datadog (DDOG) announced Q2 FY2022 earnings on August 4th. In contrast to their strong report from Q1, this quarter’s results were mixed. The impact of the macro environment on enterprise spend was pronounced, resulting in a slowdown in commitments from large customers. This weighed on next quarter and full year revenue estimates as well as profitability measures. With that said, we observed a similar pattern in 2020, which provided a nice set-up for outperformance in 2021. Datadog is rapidly expanding their product footprint and demand for software infrastructure overall remains high. I don’t see any other factors contributing to Datadog’s deceleration. This implies that as the macro environment normalizes, Datadog should be in a favorable growth position looking forward to 2023.
I will share a summary of my reactions to the report, structured around financial performance, product announcements and the competitive landscape. I won’t rehash all of the metrics, as those are readily available online in the earnings report and Investor Presentation. Additionally, investors new to Datadog can catch up on the narrative through my prior coverage.
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As quarterly earnings season kicks off for independent software infrastructure companies, I like to review the performance and announcements from the larger technology providers for signals about the demand environment and trends that may impact the smaller software companies that I cover. The hyperscalers (AWS, GCP, Azure) provide the most obvious corollary. Commentary from adjacent providers can also be useful, whether in consulting, hardware or enterprise software vendors. Thus far, the reports have been instructive.
In this post, I will go through the take-aways of interest from Microsoft Azure, Google Cloud Platform, Amazon Web Services and IBM. In future posts, I will try to batch up earnings reports from other software infrastructure providers taking the same approach of picking out the signals that might be interesting for general trends in the industry. For these posts, I won’t rehash the full performance for a particular company, as the hyperscalers in particular address a lot of unrelated industry segments. Rather, I will try to summarize and cherry-pick the items that are relevant for independent software infrastructure and security providers.
Continue readingAs we approach the next set of earnings for software infrastructure companies, we are receiving some signals that overall IT spending is lagging, primarily as a consequence of recession fears and consumer demand slowdown. There is a likelihood of spending pullback, similar but perhaps less acute than what we saw in early 2020. Some software companies have already telegraphed this, with examples like ServiceNow and Microsoft recently commenting on the tough demand environment.
Going forward, as this trend manifests, it will likely impact the valuations of software infrastructure companies. Analyst targets for revenue growth and profitability will be adjusted downward, or will remain static absent the typical beat and raise cadence. I can’t offer any additional insight into macro drivers and how those will play out over the next 12 months. However, I think it is worth considering some characteristics in software infrastructure spend that could help counterbalance overall adjustments to IT budgets. These factors may help some companies limit the impact more than others. Further, as macro headwinds subside, these factors will ensure that well-positioned software companies can return growth to previous levels.
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