Please reference the forum for Knox’s updates and charts to supplement the spreadsheet and also the blog we wrote yesterday to supplement the spreadsheet.
We increased the rank for cloud infrastructure and data center companies while also raising cloud infrastructure monitoring. For now, we adtech is ranked lower as there are too many unknowns as to when demand will return. These are great companies so we will continually monitor as we go along.
Please note: April Spreadsheet coming tomorrow! Please note: April Spreadsheet coming tomorrow!
Nobody knows how the pandemic will play out. Many of our readers have said on the forum that “finding the bottom” is not the goal, and we couldn’t agree more.
If you were to press me for an answer, my belief is that a recovery in Q3 is being very optimistic. I know that some banks and institutions have forecast this. In my perspective, the demand in tech is unknown – will buyers resume at previous levels? The employment situation in tech is certainly not immune either. A few more cracks appeared this week with a report of 4,000 layoffs in the startup sector. Startups are big consumers of cloud software, so it has a domino effect.
Our approach is to make educated decisions based on product knowledge/competitive positioning (my analysis) and probabilities (Knox’s technical analysis). We do not have strong bear or bull opinions. I personally get fatigued with the “buy buy buy my portfolio” analysts and the “world is ending” analysts. That’s part of why Knox is so instrumental. He presents the index numbers and the stock movements, uses a methodology to manage risk and remove emotions, and we go from there.
When looking at the month ahead, our company’s portfolio has this general plan:
Buy at the high end of the targets for data center stocks: cloud at the infrastructure level and cloud at the platform level should do well. One of the reasons I focused on cloud for the premium site during the sell-off is that it’s insulated from trade wars and recessions. My article at the time said, “My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Lastly, cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech — such as mobile, e-commerce and advertising — which are reaching saturation, are finding themselves in the crosshairs of anti-trust and are susceptible to consumer spending changes.”
On that note, I think a solid cloud coronavirus portfolio would include: Nvidia, AMD, Microsoft, Alibaba, Datadog, and Dynatrace. I plan to add Okta this month. I’m not a fan of Intel myself as their innovation lags, but I would listen to an argument here. You could make an argument for Amazon too, as the e-commerce, grocery and data center are all strong segments right now.
We covered LAM recently, which is more on the memory side. I’m looking for cash-cow havens that position well for a renewed trend and can also weather the year ahead. LAM has impressive levels of cash. There is some crossover with the data center but mainly powers mobile and electronics. That last part could be stalled but I’d like to get into the stock during this year’s respite from the semiconductor rally.
Buy at the mid-low end of the targets for ad-tech: This may take through next quarter (Q2) to see the full effects. I’ll be listening closely on the earnings calls. This is Pinterest, Roku, The Trade Desk, Snap, Twitter, Google, Facebook, Rubicon/Telaria. Here is some follow up information in addition the premium blog post I wrote recently:
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To recap, ad-tech companies could have a positive earnings surprise but it’s not probable they will get through the three long months of Q2 unscathed. Patience here is going to pay off. Usage going up well over double digits and revenue being flat to down is not something to get hasty with.
Disney is a great example of a big brand having to furlough workers. You can imagine what this did to Disney’s ad spend, and we know Roku was a favored ad platform for Disney. Basically, whatever we see for Q1, we can expect this impact to double or triple in Q2.
You’ll see some conviction downgrades across ad-tech for April.
Buy at the mid-low end of the targets for consumer related stocks. Apple, of course, falls into the consumer category. On another note, Inseego was on CNBC this past week on seeing an increase in demand for hotspots. This boost could be a one-time event.
Buy at the high end of the target for enterprise stocks with excellent cost-benefit ratios: Alteryx is very expensive, so it’ll be interesting to see if they can maintain the $4500 product cost as we (potentially) face more layoffs in tech.As stated, I plan to look closer at Okta as identity access management is likely doing well in the current environment. They’ve got the special sauce with the product, and in times of stress, companies will go with the brand name that works well rather than undercut with cheaper competitors. Identity management could go under the data center category, as well.
Cloud work-from-home: As you know, I like Slack. The market will likely question Slack bc the company is bottom heavy with it’s freemium model; meaning paid accounts aren’t offsetting the free accounts. “Will the product monetize?” — this is what financial institutions are unsure of. I am not as worried about this. It’s common to gain as much traction as possible and give up gains in the beginning stages. Monetizing is easier than building a product that works well and can scale.
Docusign should have some staying power too this year. Really great product for legal, real estate, and finance industries who are now working from home. These industries don’t typically work from home so a true growth opportunity and perhaps a change or reinforcement around documents for digital management. We will be covering Docusign soon and officially adding this company to our coverage and portfolio.
Regarding Zoom Video, don’t get confused about this company as the press starts to lump it into a Coronavirus fad. The company has a rare combination of strong financials and perfect product-market fit. I also covered the security issues on the forum – not concerned with this and actually quite common (and easily fixable).
Please subscribe to any chat rooms on the forum where you’d like more information. forum where you’d like more information.
Regarding Knox’s targets, he is holding fast on the ranges, and will update if he sees a need to raise them. Also, if the market is signaling a potential turn, and our stocks have not hit the respective targets, we will update you in a blog post.
Our goal is utilize this opportunity to setup great long-term positions. However, due to the uncertainty in the global economy, we will lean towards being cautious. What this translates to, is that we feel the 2300-2750 region in the S&P 500 carries too much risk. If a vaccine hits the market tomorrow, we will get back in with more confirmation of an upward trend. Please keep in mind, if we do re-enter a bull market, our projections of where that will take us will make up for being a little late. If we continue to see the ripple effects of closed businesses and (mind-blowing) unemployment, then we will look below 2300.
I recently discussed Zoom Video and its continued phenomenal rise. In the face of a global pandemic, the company has become the top performing stock on the NASDAQ this year with over 130% gains, or nearly a 160% spread with the 30% market decline.
From there, the stock has continually commanded the highest price-to-sales in the cloud software category and was able to hold its opening IPO price of $62 as support even when the market dumped cloud software last September with 30-40% drawdowns across the board.
So what’s Zoom’s secret?
Zoom’s easy access and URLs is the foundation of Zoom’s success. This is what we call product-market fit and why analysis on tech stocks should start with the product to maximize returns.
Product-market fit is what led me to call Zoom Video the best IPO of the year in 2019, why I encouraged investors to know their winners during the cloud selloff, and why we reiterated a buy signal on my research site when Zoom Video was at $65.
Zoom Video is a company where valuation defies logic. Zoom’s enterprise value/sales of 66 is the highest EV/Sales of any U.S. tech company valued at more than $500 million. The forward PE ratio is 260, although some of this reflects a company newly profitable.
Prior to going public, Zoom Video (ZM) had been doubling its revenue for the past three years and did this again for the fourth year. The company posted 100%+ revenue growth, climbing from $60M in revenue for fiscal 2017 to $330M in revenue for fiscal 2019. This is with gross profit margins in the high 70% to low 80% range.
Additionally, quarterly revenue also grew 78% same-quarter year ago to $188.3 million. Adjusted EPS was $0.15 compared to $0.04 EPS in the year-ago quarter. Q4 GAAP income grew 92% YoY to $10.6 million with adjusted non-GAAP income growing 292% YoY to $38.4 million. And total revenue grew 88% year-over-year to $622.7 million and revenue grew at a CAGR of 117% from FY 2017 to FY 2020.
Meanwhile, Zoom Video’s forward guidance shows a more tempered growth rate as the company approaches the $1 billion annual run rate. The median revenue estimate for Zoom Video is 48% growth in fiscal 2021 to $921.8 million and 39% growth in fiscal 2022. Management guidance for revenue is slightly lower than the consensus at $910 million in the mid-range for fiscal 2021. The median EPS guidance for FY 2021 is $0.45 and for FY 2022 is $0.58.
Finally, it’s worth mentioning that Zoom is outperforming both Google Hangouts and Microsoft Skype. The app is currently the second most downloaded mobile app, behind TikTok, according to app-analytics firm Sensor Tower. Citing data from tracking company Apptopia, The New York Times reported that close to 600,000 people had downloaded the iOS app in a single day earlier this month.
Last week, I wrote about how algorithms led to the fastest bear market in history. I explained that what’s driving the speed and severity of the bear market is the escalation of algorithmic trading, which is more prevalent than it was during the Great Recession in 2008.
March 2020 holds the record for how quickly stock prices dropped into a bear market — only 16 days after the S&P 500 Index hit its last closing high Feb. 19. The second-fastest bear market was the notorious 1929 crash that set off the Great Depression, followed by the elevator drop of 1987’s Black Monday.
Americans invested in stocks through 401(k)s and other retirement accounts may be unaware that they are part of a small minority of investors who are in it for the long run. Guy De Blonay, a fund manager at Jupiter Asset Management, said 80% of the stock market was controlled by machines during the selloff in 2018’s fourth quarter. In 2017, analysts at J.P. Morgan said “fundamental discretionary traders” accounted for only 10% of stock trading volume.
The “flash crash” on May 6, 2010, caused the Dow Jones Industrial Average DJIA, -4.44% to drop 998.5 points (about 9%) within minutes, only to recover a large part of the decline later in the day.
According to the Commodity Futures Trading Commission (CFTC), high-frequency trading “did not cause the Flash Crash, but contributed to it by demanding immediacy ahead of other market participants.”
Flash moves of nearly 1,000 points in either direction are now the new normal, with 14 occurring in the past 30 days. Four of those intraday moves were more than 9%. Trading curbs, known as circuit breakers, were hit four times this month.
Furthermore, according to Wells Fargo, robots will replace 200,000 banking jobs over the next 10 years. And Citigroup C, has formed a lab to cross-train traders and developers for machine learning and artificial intelligence.
Perhaps we will get a coronavirus vaccine or antiviral tomorrow, and business will go on as usual. Or, the opposite could happen, and things will get worse. One thing is certain: Until there is regulation, the machines will profit either way.
This article was originally published on Forbes on Mar 25, 2020,10:18am EDT
Cybersecurity stocks were on a roller coaster ride in 2019 months before the coronavirus took hold. Last year saw exhilarating highs and sudden drops in stocks such as Crowdstrike and Zscaler with both losing nearly fifty percent of their market cap from August to October.
These companies post solid revenue growth yet their bottom lines reveal evidence of stiff competition in the very crowded cybersecurity sector.
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Crowded Cybersecurity Space
In 2004, the global cybersecurity market was worth a mere $3.5 billion and grew nearly 35-fold to $120 billion by 2017. As of 2018, there were up to 200 vendors competing in each layer of cybersecurity. Primary stakeholders, such as chief information security officers (CISOs), use as many as 80 security vendors across their teams.
According to Cybersecurity Ventures, global spending on cybersecurity will exceed $1 trillion cumulatively over the five-year period of 2017 to 2021. (The 80-plus vendor per CISO certainly doesn’t hurt).
Where there is 35-fold growth, startups are sure to follow. This growth helps companies out of the IPO gate while sustaining long-term can become challenging in crowded markets.
The recent RSA conference in San Francisco, one of the last to be held before the coronavirus took hold, was a reminder of cybersecurity being a peak saturation with over thirty-six thousand attendees and hundreds of exhibitors – all for a market that is roughly equal to 1/8thof Apple’s market cap (or Google, Amazon and Microsoft’s).
Solid Top Line Growth, High SG&A Costs
In Crowdstrike’s recent earnings report last week, the company reported a fourth-quarter loss of $28.4 million, or 14 cents a share, with an adjusted loss of 2 cents a share when considering stock-based compensation and amortization of acquired assets. Revenue was up an impressive 90% in the fourth quarter at $152.1 million compared to $80.5 million in the year ago quarter. This was well above the forecast of $135.9 million to $138.6 million.
There is no question that Crowdstrike’s top line is investable. Meanwhile, the bottom line may face headwinds. SG&A expenses eat at the company’s operating expenses. Sales and Marketing last year required fifty-five percent of revenue, or $266.6 million of the $481.41 in revenue. Total SG&A expenses were at $355 million, or 73% of total revenue.
Historically, Crowdstrike spent 91% SG&A to revenue in the quarter ending October 2018 and 72% in the quarter ending October 2019.
Fierce competition in a rather small addressable market was one reason I cautioned against buying Crowdstrike at the IPO. The market size for endpoint security was at $6.4 billion in 2018 and will grow to $13.2 billion by 2022, according to Statista.
Compare this to Crowdstrike’s market cap of $11 billion today with a peak market cap of $21 billion in August of 2019. In the S-1 filing, Crowdstrike states the addressable market is $24.6 billion and will reach $29.2 billion, yet this includes modules for categories that cannot stand alone.
Zscaler Inc (NASDAQ: ZS) released its second-quarter fiscal year 2020 results on February 20, 2020. Revenue grew 36% year-over-year, which is slower than the CAGR of 56% from the fiscal year 2016 to the fiscal year 2019. The company’s full-year revenue guidance of $414-417 million, which suggests a year-over-year growth of 37% at the mid-point. This was slightly better than the median analyst estimate of $410.85 million.
Zscaler’s report also shows evidence of a crowded sector that requires outsized sales and marketing expenses of $61 million per quarter, or 61% of revenue, and total SG&A at 90% of revenue.
Cybersecurity Consolidation on the Way
Crowded markets typically evolve into consolidation as startups with more advanced R&D are acquired by larger companies who need to move quickly to protect their moat. Consolidation in the cybersecurity space will make it more challenging for nimble security vendors to compete, especially because large-cap companies with moats can offer a more intrinsic approach to problems.
VMWare’s acquisition of Carbon Black in October of 2019 for $2.1 billion is an example of consolidation. Financial analysts were cautious of the acquisition, stating, “What remains to be seen is whether VMware backed the right horse in this race.” The comment refers to the very crowded space of endpoint security, where Crowdstrike, Cylance, Symantec, McAfee, Sophos, Palo Alto Networks, and FireEye all offer endpoint protection and compete.
VMware’s moat lies in its access to 70 million virtual machines and over half a million customers, which can help Carbon Black scale very quickly. After acquiring endpoint security company Carbon Black, the combined entity is now able to offer a more complete service rather than requiring CISOs to pile up on separate tools for various endpoints.
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Following the acquisition, VMware reports a new revenue line item in its earnings reports titled “subscription and SaaS revenue” in which Carbon Black’s revenues will partly contribute. This segment reported revenues of $556 million, an increase of 52% year-over-year and faster than the group’s revenue of $3.07 billion, which grew 11% year-over-year for the 4Q of fiscal year 2020.
Akamai is similar to VMWare in that they are expanding from their core products to compete in cybersecurity. Akamai is traditionally a content-delivery network and website-acceleration company. With this level of access to the edge, where most security hacks occur, Akamai has found itself in a serendipitous position to offer competitive security products, such as protection from distributed denial of service (DDoS) and website-application security.
One of the main value propositions Akamai offers is to simply reduce vendor bloat, as the company consolidates content delivery network (CDN) needs with the adjoining website security. Notably, Akamai’s SG&A expenses are 33% of total revenue with sales and marketing at 18% of revenue.
Coronavirus Selloff Will Require Conviction
Splunk and CyberArk had reclaimed 52-week highs in February prior the coronavirus selloff. Despite having a healthy competitive lead in their respective domain, both companies could not stave off the indiscriminate selling.
Founded in 2003 with a public listing in 2012, Splunk is one of the original big data platform companies that came of age at time when big data software had a long runway. The company has since expanded to security to leverage their data software as a way to troubleshoot and scan for breaches.
Splunk Inc announced its 4Q fiscal year 2020 results on March 4, 2020 with total revenues growth of 27% year-over-year to $791 million. Software revenues grew 33% y-o-y to $617 million with average recurring revenue (ARR) up 54% year-over-year.
According to Gartner’s magic quadrant, CyberArk is the leader in privileged access management. The company listed on the public markets over five years ago, posted 90% revenue growth in 2015, and has since stabilized to a consistent 20% revenue growth. CyberArk released its 4Q and full-year 2019 results on February 12, 2020. Revenue for the 4Q rose 19% year-over-year to $129.7 million with the full-year revenue growth of 26% year-over-year to $433.9 million.
Conclusion:
The coronavirus selloff will level the playing field for cybersecurity stocks. Investors will need to evaluate if their investments can overcome the risk that too much supply inherently brings to a marketplace. Expect to see smaller vendors repeatedly challenged by large players who have millions of customers. The word “moat” is popular in the financial industry, but it’s never been more important than in a crowded field such as cybersecurity.
