Hot on the heels of Snowflake Summit, Databricks held their annual Data + AI user conference from June 27 – 30 in San Francisco. The event was packed with announcements and informative sessions for 5,000 in person attendees and 60,000 virtually. Having these two user conferences in close proximity provides us with an opportunity to compare product direction and strategy. On the surface, the two companies appear to be rapidly converging towards a common vision of becoming the single platform needed for analytics, data engineering and machine learning. At the same time, the two companies currently cater to rather distinct audiences, use cases and implementation tolerances.
In this post, I will review Databricks’ product strategy, what was announced at Data + AI and how it all relates to Snowflake.
Cloudflare held another innovation week from June 20 – 24, this time focused on Zero Trust solutions. They introduced a number of new capabilities and aligned their marketing message around what is expected for a full-featured Zero Trust SASE platform. Included in this were comparisons to offerings from other vendors. While Cloudflare is not considered the leading SASE provider by industry analysts at this point, these latest developments bring them a step closer to feature parity. At minimum, they check all the boxes for a marketable SASE platform and have a growing stable of customers. The question for investors will be whether they can continue to move upmarket, win larger deals and displace leading providers for enterprise spend in this growing category of the security market.
In this post, I will review Cloudflare’s Zero Trust offering, the product announcements made this past week and the opportunities for Cloudflare to increase their share of the market.
Industry analyst Gartner just released their 2022 Magic Quadrant for Application Performance Monitoring and Observability. These reports are important because they are consumed by enterprise IT decision makers as an input to technology purchase decisions. They provide a directionally useful measure of a provider’s position in a product market and how its offering relates to competitors.
As I am parsing the many product announcements coming out of Snowflake Summit, the new Cybersecurity Workload is worth calling out independently. It was first introduced a little over a week ago. This workload’s purpose is to help customer organizations detect and respond to threats by leveraging the Data Cloud for their security analytics. During Summit, the Snowflake team hosted a separate Cybersecurity track which included 15 sessions and presentations from a number of customers. This level of engagement likely explains why Snowflake pre-announced the availability of Cybersecurity workloads, versus bundling it with the other product announcements this week. As an aside, I am planning to publish coverage of the rest of Summit shortly.
Photo Credit: HAP/Quirky China News / Rex Features
The dynamic between the public cloud vendors and independent software providers is evolving quickly. Just a few years ago, the hyperscalers (AWS, Azure, GCP) were rapidly rolling out their own infrastructure services targeted at various layers of the application stack. These included solutions for data processing, security, communications, identity and even observability. The premise was that as enterprises migrated application workloads to the cloud, the hyperscalers might as well try to capture as much spend as possible. These services went far beyond the basic storage and compute offerings of their foundation.
Snowflake reported Q4 FY2022 earnings on March 2nd. The results for the quarter were strong across all operational measures. However, planned platform performance optimizations are driving a near term decline in revenue recognition for the next couple of quarters. These were taken into account in setting Q1 and FY2023 revenue projections. The market’s knee jerk reaction was to view this as an indication of revenue deceleration and future execution risk. The stock subsequently dropped by 15% the next day. After a brief dip to a 52 week low on March 14th, the stock has recovered to about a 16% post-earnings dip currently. Notably, SNOW is down 34% since the beginning of 2022 and 45% from its peak in November 2021.
In spite of the market’s reaction, I think Snowflake’s trajectory is well on track. I view the platform optimization less as a revenue headwind and more as a solidification of market share. While Snowflake’s FY2023 (this calendar year) revenue growth may well decelerate into the 80% range, I think this report and several other factors build confidence in durability of revenue growth above 50% for several more years. That compounding growth is supported by an enormous addressable market, which is expanding at an incredible rate. Add to this Snowflake’s increasing product offerings and adoption of data sharing, which serve to drive more consumption of the core compute and storage engine.
I recently had the honor to deliver a guest lecture to the London Business School for their Master’s in Finance program (ranked #1 in the world). As part of their coursework, students are examining the emergence of digitally-driven companies and how to assess their value in the public markets. I provided perspective on trends in the data infrastructure space and what signals are important to watch beyond analysis of financial statements. The talk focused on a case study of Snowflake and why I think they are well-positioned to maintain their leadership in this large category. I will incorporate some of that content into this post.
MongoDB delivered a banner quarterly report in early December, beating expectations on all fronts. The highlight was their continued revenue growth acceleration over the past four quarters. As investors will recall, MongoDB was impacted by a COVID-driven slowdown in IT spend that pushed revenue growth into the high 30% range in 2020. In calendar year 2021, though, MongoDB has reversed that trend and logged increasing growth rates each quarter. Yet, the stock is down almost 30% from its peak in November, with much of that occurring in 2022. This aligns with the same sell-off we have seen for all high multiple software stocks.
In my last update on MongoDB, I discussed MongoDB’s exciting new product positioning. At their annual user conference in July, the leadership team highlighted their product rebranding as the first “Application Data Platform”. Their vision is to address all data storage workloads that developers typically need to build a modern, scalable software application. This scope goes far beyond a document-oriented database, to span caches, search indices, mobile app interfaces and even basic analytics for data visualizations. The premise is that developers prefer to focus on building features, versus worrying about data storage infrastructure. Additionally, engineering teams can reduce cognitive overhead with fewer database solutions to learn. MongoDB’s goal is to increase developer productivity by eliminating the “tax on innovation”.
The combination of strong execution and product expansion is driving a favorable set-up for MongoDB stock as we transition into 2022. Compared to other high growth peers, MDB’s valuation appears to be reasonable. Given the momentum in large customer expansion, the uptake of Atlas, use case consolidation and the tailwinds of digital transformation, I think their revenue growth rate of 50% is sustainable in 2022. With a $850M revenue target for the current fiscal year, MongoDB has plenty of headroom to expand into the nearly $100B TAM for database spend. Accordingly, I have re-entered MDB in my personal portfolio and currently have a 8% allocation. As MongoDB keeps posting solid results, I will likely increase this further.
As the intended outcome of this blog is to drive investment decisions, I think it is important to step back periodically and track portfolio returns. All of my blustering about software infrastructure companies, secular trends and durability of growth would be meaningless if they didn’t translate into tangible portfolio growth. For transparency, I publish the holdings in my personal portfolio and update allocations weekly. These holdings incorporate the individual company research and commentary provided on this blog. I also track the portfolio’s YTD return and include that metric as the primary measure of performance.
The portfolio is where the rubber meets the road, so to speak. While I don’t run a fund, the detailed analysis I share on this blog allows me to make investment decisions. All of my personal income is drawn from this portfolio. Performance over time is critical and I manage the portfolio actively. The holdings shared as part of the Software Stack Investing portfolio represent the vast majority of my real-world investments.
This blog and service are free – some readers have asked why. There is no hidden agenda. I share my analysis and the portfolio allocations with the public to force my own research process and to solicit valuable feedback. My investment decisions are influenced by the positive or negative feedback I receive from readers. If I put forth an investment thesis for a stock and and other investors push back, that can change my perspective. Positive reinforcement is helpful as well. With that in mind, let’s take a look at how 2021 played out and what learnings investors can apply going forward.
In my prior post on Cloudflare in October, I highlighted several themes that are changing how compute, data storage and network connectivity are being consumed by developers and leveraged by the digital enterprises supporting them. This included a summary of product deliverables coming out of Birthday Week in September. Since then, Cloudflare has continued their trajectory of rapid product development, by completing two more Innovation Weeks packed with new announcements. They also reported Q3 earnings in early November, delivering the same consistent high revenue and customer growth to which investors have become accustomed.
In the last month, we have also seen a significant change in valuations for high growth software infrastructure companies. Cloudflare stock is down 38% from its peak price following earnings. As the macro environment shifts, we may see more volatility. The market will try to reconcile what is a “fair” valuation for high growth companies, incorporating the removal of substantial government stimulus. On one hand, multiples are still above historic norms. On the other, software infrastructure in particular is demonstrating durable revenue growth rates over a longer period than other sectors. The hyperscalers provide an easy reference point, growing at 40% y/y and higher with annual run rates between $20B – $60B.
As I have discussed about software infrastructure leaders, the combination of customer additions, broadening product reach and consistent annual spend expansion are allowing these companies to extend the “law of large numbers” to a point further in the future. Compounding of high revenue growth rates over many years eventually pulls down even excessive valuation multiples. This may explain why the market has assigned a premium to Cloudflare, at least for the time being. The prospect of becoming a fourth cloud provider and the connective fabric of the Internet certainly lend some rationalization to the perceived opportunity.
In this post, I review Cloudflare’s latest product announcements, analyze their Q3 quarterly results and draw conclusions about the durability of their growth going forward. I also discuss why I think Cloudflare is uniquely positioned to execute on this broader opportunity. Their network-first mindset has created architectural advantages to address challenges in application performance, data distribution, security and compliance. The Internet, after all, is nothing without a network.
Datadog (DDOG) delivered another impressive earnings report on November 4th. After a strong Q2, Datadog is showing no signs of slowing down as we finish out the year. They beat expectations for Q3 on the top and bottom line, further accelerating revenue growth from Q2 to a staggering 75% year/year increase. Further, they raised projections for Q4 and the full year, with the initial revenue target for the current quarter implying higher revenue growth than Q3. The stock surged 12% the day after earnings, bringing DDOG’s 2021 performance to nearly a double from its $98 price at the close of 2020. DDOG is well past the $150 target for 2021 that I set at the beginning of the year. It now occupies the second largest allocation in my personal portfolio.
