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Hyperscalers – Friend or Foe?

April 10, 2022 / poffringa

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 Updates – Q4 FY2022

March 19, 2022 / poffringa

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 Q3 FY2022 – A Broadening Data Platform Is Driving Growth

February 9, 2022 / poffringa

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.

2021 Year End Review

January 5, 2022 / poffringa

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.

Cloudflare Q3 2021 – Helping Build a Better Internet

December 18, 2021 / poffringa

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 Q3 2021 – Land and Expand (Squared)

November 24, 2021 / poffringa

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.

The Invisible Hand of Product Agility and TAM Expansion

October 20, 2021 / poffringa

The agile software development process is based on four time-honored, yet simple, tenets codified in the Agile Manifesto. They emphasize responding to change, actively soliciting customer feedback and most importantly, shipping software as early as possible. The expected outcome is to speed up software development cycles and get relevant product into the hands of customers. Then, the cycle repeats. Test, observe, iterate and release again, always striving to increase the output of each subsequent “sprint”. Leading software infrastructure companies have taken this approach to heart, exhibiting a strong bias towards rapid product release cycles. This allows them to continuously expand their product footprint, enter new markets and stay far ahead of competitors. Agility is the beating heart of their product cycle.

The concept of a total addressable market (TAM) is well-understood by investors. It provides an estimate of the revenue opportunity available for a product or service. Companies often include this estimate in their S-1 filing, investor decks and quarterly reports. As investors, we will usually take a summary view, sometimes skeptical, of management’s sizing of the market and how they calculate that. As long as the TAM is big, we usually check the box and move on to historical financial indicators like revenue growth and profitability to evaluate our potential holdings.

Yet, product agility and addressable market expansion can have an impact on stock valuation, primarily for the forward view. These influences can manifest when the market perceives that a company’s TAM has expanded. This may be the result of a product announcement or strategic partnership. Even if the underlying stock’s financial metrics haven’t changed in the interim, the perceived potential associated with an expanded market opportunity can drive up valuation.

Similarly, when a company is rapidly launching new products and extending the functionality of existing ones, investors gain confidence that the company will successfully fill the addressable market. Agile companies always seem to have a new product announcement (or clusters of them), with beta customers lined up to use them. Even if the initial version isn’t complete, agile companies work with users to quickly flesh out the features that are important and discard those that aren’t. The team repeats the process, incorporating learnings and software components from the prior cycle into the next build. Because of this re-use, more customer value can be crammed into each cycle.

While some software companies embrace product agility, Cloudflare provides a textbook example. They are delivering the fastest product release cadence in software infrastructure, dazzling investors with each subsequent “Week” of releases. Not only are they rapidly iterating on existing platform capabilities, but they are entering new billion dollar markets with alarming frequency. Birthday Week delivered several major releases, which in aggregate likely doubled their TAM. And leadership claims the product development pace is accelerating from here.

In this post, I will explore the signals that investors can watch that indicate a bias towards shipping product and TAM expansion. I will conduct this investigation using Cloudflare as the example, providing updates on their recent product announcements and what this implies for future growth. In the abstract, these principles can be applied to any software infrastructure company, generating insight into why some maintain hypergrowth for years and others just seem to be plodding along.

A Warehouse for Warehouses

October 3, 2021 / poffringa

Conventional paradigms for data management are being disrupted. Collecting data in silos for single purpose analysis captures only a portion of its value. Increasingly, large data sets will be combined across companies and industry ecosystems to generate a higher dimension of insight. These data sets will span enterprises, their suppliers, partners and customers. New businesses will emerge to provide third-party data sets to supplement and enhance data aggregations by industry. These will power the next generation of AI-driven data applications and services.

At the core of multi-party data sets will be a system for controlled, performant data sharing. Such a system must have governance and access control at its core, and utilize materialized views to prevent copying of data. It must be easy to configure and manage, without requiring extensive coding or provisioning new infrastructure. It should also incentivize independent data set creators with a means to market, distribute and monetize their data.

Snowflake is building such a system with their Data Cloud, enhanced by Data Sharing and the recently launched Data Marketplace. While the features and capabilities of their core data management platform are important to consider relative to other providers, the curation and management of industry specific data sharing ecosystems could represent an end-run around competitors. As the number of participants in data sharing and distribution webs increases, network effects will kick in that create stickiness for their core Cloud Data Platform. Participation in the sharing ecosystem could become the primary driver of platform usage over time.

In this post, I will dive into these trends and how Snowflake is well-positioned to capitalize on them. I won’t spend much time detailing Snowflake’s core data platform and how it relates to competitive offerings. Other analysts, particularly Muji at Hhhypergrowth, have covered that extensively (see additional reading at the end). I will focus on the next big wave of growth for Snowflake, centering on their data sharing capabilities and the rapidly developing ecosystem of participants by industry. This opportunity encompasses an enormous addressable market and will drive future expansion of SNOW’s already large market cap.

Twilio (TWLO) Q2 2021 Update

September 12, 2021 / poffringa

Twilio released their Q2 2021 earnings report on July 29th. The results were mixed. Twilio outperformed significantly on the top-line, but gross margin and operating margin were lower than investors had hoped. TWLO stock dropped 5% the day after earnings and has sunk almost 13% from the pre-earnings price to date. Looking forward to Q3, Twilio’s total and organic growth should accelerate slightly, but additional headcount and acquisition absorption will keep operating margins under pressure.

At a high level, Twilio is continuing their rapid expansion trajectory, marked by organic growth over 50% and significant uptick in international activity. These are being driven by the broad enterprise migration of offline customer experiences into new digital channels. This digital transformation often takes the form of building custom applications, for which Twilio’s programmable communications APIs provide key building blocks. I expect these secular tailwinds to continue and provide ongoing demand to drive Twilio’s future expansion.

Datadog (DDOG) Q2 2021 Update

August 28, 2021 / poffringa

Datadog released Q2 2021 results on August 5th. The report was exceptional, demonstrating a return to the high revenue growth trajectory investors became accustomed to before COVID. Datadog beat expectations for Q2 on the top and bottom line by a significant margin, and raised projections for Q3 and the remainder of the year. The stock surged 15% following the results, after generally flatlining for the past 12 months. DDOG is now up over 35% in 2021 and I project it will end the year even higher. With this performance, DDOG is now the largest position in my personal portfolio.

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