Month: September 2021

MongoDB Update: Atlas Helps Accelerate Growth

Posted on by io-fund

MongoDB Update: Atlas Helps Accelerate Growth

by Beth Kindig

We discussed on the forum that we like the Elastic setup and we want to add that we also like MongoDB in terms of both fundamentals and technicals. Below, we revisit MongoDB, a company that we have owned in the past, and our coverage of Atlas, a product that we expanded on in July of 2019.

In addition to these two, we have been eyeing Confluent (CFLT) a recent IPO. We will cover this company soon yet want to caution our readers as to the likelihood of a company holding its IPO opening price after the lock-up expires. This is very rare even for quality companies. Therefore, if we enter a company prior to lock-up, we sometimes have to exit and re-enter again due to the nature of IPOs.

You can read our past analysis here on MongoDB

And my previous editorial coverage of Atlas here from 2019.

Atlas Update:

MongoDB is officially an Atlas company with 56% of revenue coming from this product. The CEO ended the call by saying that aren’t many businesses growing at 80% with a run rate of $0.5 billion. He is talking specifically about Atlas. In fact, Atlas is mentioned on the earnings call 90 times (!)

MongoDB is officially an Atlas company

Here’s a quote from the call:

And I think you’ll see us continue to invest aggressively in Atlas, because every customer that we know, even the customers who are predominantly on-premise, they know that the benefit of using MongoDB is that they can start on-prem, but they have a very seamless path to the cloud. There’s no forklift upgrade. There’s no rewrite of the application code. It’s just a very seamless migration path. And so there’s different customers based on the regulatory environment they’re in, compliance reasons, sometimes even cultural reasons. They may be moving more slowly. But every customer has a very clear migration path to the cloud and we believe the ultimate destination will be Atlas.you’ll see us continue to invest aggressively in Atlas, because every customer that we know, even the customers who are predominantly on-premise, they know that the benefit of using MongoDB is that they can start on-prem, but they have a very seamless path to the cloud. There’s no forklift upgrade. There’s no rewrite of the application code. It’s just a very seamless migration path. And so there’s different customers based on the regulatory environment they’re in, compliance reasons, sometimes even cultural reasons. They may be moving more slowly. But every customer has a very clear migration path to the cloud and we believe the ultimate destination will be Atlas.

Atlas is the MongoDB product that allows the flexibility and scale of a document database with the automation of the cloud. The company took the well-loved NoSQL database that put MongoDB on the map and allowed companies to leverage NoSQL in the cloud and connect pipes to companies like Snowflake for structured and semi-structured data analysis. MongoDB has done well because its platform is nearly universal in terms of training and software developer experience. The fact that MongoDB is a highly requested skill across software developers is not a moat, per se, but it’s helped the company remain defensible. You’ll see here that MongoDB is the top-ranking document store with a comfortable lead in terms of score and is also in the top 5 database systems worldwide. Of the top 5, it’s the top-ranking NoSQL database.

The global NoSQL market was worth $4.9 billion in 2020 and will be worth $29.6 billion In 2026. This is equal to the SQL database market. With Atlas, developers can leverage any cloud infrastructure company and also leverage best-of-breed data analytics, when needed, such as Snowflake. Essentially, MongoDB is integrated with every major player and this has helped the company do well in a multi-cloud environment. Elastic is also a NoSQL database yet is primarily a search engine, and therefore, superior in terms of search with better tokenizers and analyzers that result in a more advanced search.

Here is why the market is excited about MongoDB as we’ve seen Atlas re-accelerate two quarters in a row.

A few things that could drive the more growth in the future is the ease-of-use features the company launched recently. The first is Atlas Serverless which allows a company to add compute and storage during traffic spikes or scale back during low usage periods. MongoDB will charge for usage and will maintain the servers for scaling compared to SQL which tends to charge on an hourly basis. This can help Atlas’ growth because it now competes with serverless databases like Google’s Firestone and expands the customer base to include those who can’t or don’t want to pay for dedicated Atlas clusters. It also allows for more integrations with serverless app platforms. As MongoDB put it in the earnings call, “We expect Serverless to drive more customer demand, because getting started on and using Atlas just became even easier.”

The release of MongoDB 5.0 in July includes Live Resharding, which simplifies the process of splitting a database into smaller pieces for horizontal scale. MongoDB now handles the data redistribution and backend synchronization of moving the data to the appropriate shards. The company also allows for time series data to sequence data in order of time. Of the 5.0 updates, the Versioned API release was the most requested change, which allows developers to update or change an API without breaking the client integration.

The 5.0 release followed the 4.0 release which improved the Atomicity, Consistency, Isolation and Durability (ACID) which is a set of properties offered in SQL databases that helps to make accurate transactions. Previously, NoSQL databases prioritized speed by complying with ACID on a single-document level. With the 4.0 release, MongoDB can compete with SQL on multi-document ACID transactions, which puts the company in a stronger position for e-commerce companies and also enterprises. This was an important release because it combined the best of both worlds, which is the speed of NoSQL with the transactional accuracy of SQL.

The main takeaway from MongoDB’s fast iterations of 4.0 and 5.0 is that more enterprises can use MongoDB because it’s bridging the gap with the benefits of SQL and serves both on-prem and cloud by allowing for a seamless transition if/when the enterprise is ready. Here’s a quote as to how Atlas has evolved since its launch:

Atlas has clearly become a mission critical platform. In the early days, there were probably people were, obviously, being a new service and people didn’t know what to expect. You saw more dev and test workloads, perhaps, peripheral or Tier 3 workloads moving on to Atlas. But as people got more and more experience with Atlas, as we added more enterprise features to Atlas, people became increasingly more comfortable and now we’re seeing, very, very large and demanding applications move to Atlas, even from some of the more conservative mainstream organizations out there. So what we’re really seeing now is enterprise adoption of Atlas at scale.as we added more enterprise features to Atlas, people became increasingly more comfortable and now we’re seeing, very, very large and demanding applications move to Atlas, even from some of the more conservative mainstream organizations out there. So what we’re really seeing now is enterprise adoption of Atlas at scale.

Notably, the recent FedRAMP approval could also be a catalyst for MongoDB as the company is able to serve local and federal governments now.

Multi-cloud is another driver, which we will expand on with in a cloud report for next week so that our members can have a more holistic view of why this trend is critical to have exposure to. On a similar note as multi-cloud, our past Atlas coverage focused on MongoDB’s ability to stave off competitors who had cloned its product, such as Amazon’s Document DB. At the time, the market was concerned MongoDB would lose substantial share to AWS. We thought that was unlikely as during the OSCON conference Amazon had stated that Atlas was the segment winner and that Atlas growth had continued after the AWS DocumentDB release. During that time period, I was particularly fond of this comment by the CEO, which exudes confidence: “Imitation is the sincerest form of flattery, so it’s not surprising that Amazon would try to capitalize on the popularity and momentum of MongoDB. However, developers are savvy enough to distinguish between the real thing and a poor imitation.” Dev Ittycheria, MongoDB’s CEO

Notably, MongoDB is fully valued at 38 forward P/S and won’t rank on cash efficiency in terms of the cloud category. Similar to Snowflake, competing with tech giants costs money and we can see this reflected in the sales and marketing costs with both Snowflake and MongoDB in the upper range for this cost.

Financials:

By Bradley Cipriano

MongoDB reported strong Q2 FY2022 results on 9/2/21 which beat both on the top and bottom-line. The 20%+ move in the stock price coupled with a strong surge in volume following the results suggests that there was a shift in the narrative. If so, MongoDB could be nearing an inflection point, where sales will reaccelerate and grow faster than usual, therefore, attracting a premium multiple.

While sales growth recently accelerated (growing 44% YOY, the fastest pace of growth since Q1 FY2021), the company’s core product, MongoDB Atlas, grew much faster at 83% YoY. This also represented the second quarter in a row where MongoDB Atlas sales accelerated on a YoY basis. Specifically, MongoDB Atlas sales increased 83% YoY, which represented the fastest pace of growth in the last six quarters. As shown in the chart above, MongoDB’s Atlas revenue growth rate has been trending up in recent quarters, suggesting that MongoDB is nearing an inflection point in its growth rate. Atlas accounts for 56% of MongoDB’s total sales and the net sequential dollar increase doubled in the recent quarter from $8 million in revenue to $18 million. Seasonally, Q2 tends to be stronger than Q1, adding to this increase.

Another key indicator that MongoDB’s business is doing well is the increase in downloads of MongoDB’s free basic products. The company utilizes an open-source distribution model, where users can download the basic version of MongoDB’s products for free. Once these users become familiar with the products and integrate them into their work flow, then they often convert to paying customers.

MongoDB reported that downloads in the LTM increased 50% YoY to 75 million, bringing the cumulative downloads of MongoDB to over 200 million. Moreover, the 75 million downloads over the last 12 months was greater than the cumulative downloads in the first 11 years of MongoDB’s existence. Since downloads often result in paying customers, the surge in downloads is a leading indicator of future sales. We can see that MongoDB is taking advantage of the surge in downloads, as the company has ramped its expenditures on sales and marketing expense to convert these new users into customers. 

 

Customer metrics have also accelerated, as customers with ARR over $100k grew to 1,126, up 37% YoY and above the 36% and 30% YoY growth rates in Q1 FY2022 and Q4 FY2021, respectively. Total customer count grew 44% YoY to 29,000+ customers, while Atlas customer increased 46% YoY to 27,500+ customers. It is great to see that customers are driving growth (+44%), rather than an increase in price. Since raising prices is ultimately an unsustainable trend, we prefer to see growth driven by volume (customer count) rather than price.

Another key trend to monitor going forward is international growth, especially growth in Asia. In February 2021, MongoDB announced a global partnership with Tencent Cloud. The company also has a partnership with Alibaba Cloud. These partnerships have benefitted MongoDB, as sales to Asia increased 84% YoY to $20 million. Asia accounted for just 10% of sales in the most recent quarter, which means that there is plenty of runway left to capture share in the Asian market.

In summary, MongoDB appears to be nearing an inflection point as the company’s core product, MongoDB Atlas, has accelerated for two consecutive quarters. This acceleration may continue, as downloads have also greatly increased and downloads are a leading indicator of future sales since free users usually convert into paying customers. There were more downloads in the last twelve months than in the prior 11 years, suggesting that growth will remain robust going forward. MongoDB has also ramped its investments in sales and marketing to convert free users into paying customers, which should help support a further acceleration in sales going forward. Lastly, the company has started ramping in Asia with key cloud partnerships, with a long runway of sales available in the APAC key market.

 

 

 

 

The Key To Unlocking The Metaverse Is Nvidia’s Omniverse

Posted on by io-fund

This article was originally published on Forbes on Sep 2, 2021, 06:43 pm EDT.Forbes on Sep 2, 2021, 06:43 pm EDT.

Last week, I wrote that Nvidia could surpass Apple in five years as the artificial intelligence economy will be nearly four times larger than the mobile economy that drove Apple. To get an understanding of how big the AI economy will be, we pointed towards estimates of AI adding $15 trillion in GDP once it reaches maturation in 2030 compared to mobile adding $4.4 trillion to GDP in the current year.

The analysis discussed some of the underlying product strength Nvidia has with its GPUs and its new software suite that allows accelerated AI computing on virtual machines rather than bare metal servers. We also revisited my original thesis around the GPU-powered cloud and developer adoption of CUDA, both of which are still intact three years later.

There are numerous forward-looking catalysts for Nvidia as enterprises will seek to lower costs and increase production with AI. In fact, while I wrote the AI economy would be four times larger, Jensen Huang predicts that “Omniverse or the Metaverse is going to be a new economy this is larger than our current economy.”

Well then, so much for correlating the AI economy to the mobile economy as Huang predicts an entirely separate revenue segment will surpass our current GDP of $84.7 trillion.

Let’s Start with Metaverse Basics:

The dry definition of the Metaverse is a shared virtual 3D world that is interactive, immersive, and collaborative. The word “Metaphrase” was first coined by American writer Neal Stephenson in his science fiction Snow Crash in the year 1992. However, the word meta dates back to the Greek era, which means “after” or “beyond.”

There are many other articles online that describe the Metaverse in detail, like this one in Forbes by Cathy Hackl. She points out that the Metaverse is described as “digital realities where people work, play and socialize.” In some ways, social media and gaming are the stepping stones to these virtual realities. How many of us have friends and acquaintances on social media that we have never met, such as on Twitter or on Fortnite, or people we haven’t seen in decade yet feel close to, such as on Facebook or LinkedIn?

If you experience moments where your virtual life online feels as real as your physical life, then you’ve dipped your toe into the idea of a Metaverse.

The idea of a virtual economy already exists in many games where you can trade virtual goods and where players are paid for creating content. The idea of crypto mining is also an example of where real-world work is exchanged for virtual currency (and value). Now that Bitcoin at $1 trillion and rivaling the market cap of FAAMG stocks, we have already seen some evidence of a virtual world translating to the real world.

This new economy will be a combined effort of many companies and users. As mentioned, the term Metaverse is not new and has been used by tech companies over the past few years. Microsoft Xbox head, Phil Spencer made this point four years ago that he is a believer in the Metaverse. In addition to the various gaming and AR/VR tools that the company offers, it also purchased Minecraft maker Mojang Studios. Minecraft could be one of the pioneers of Metaverse in the future due to the digital world games and its large user base.

Roblox is another company that was early to this concept. On average more than 36 million young people come to Roblox to play, learn, and interact in a 3D virtual space. Neil Rimer, co-founder of Index Ventures which is an early investor in Roblox, rightly said in an interview with CNBC that “No single company can build a metaverse. It has to be a community.”

It’s important to point out that there are false starts and early spinouts in technology. I had written at length about why autonomous vehicles were an impossibility by 2020 when the financial news had generated a hornet’s nest worth of buzz. Three years later, and we do not have robotaxis or anything of the sort driving commercially on roads. Similarly, The Metaverse will take time to build.

Where Will the Metaverse Be Built?

Nvidia’s Omniverse is the simulation and collaboration platform that will be partly used to build the Metaverse. More than 50,000 individual creators have downloaded Omniverse since it opened Beta in December 2020 compared to 2 million that have registered with the CUDA platform. The number of creators is now opened up due to integrations with Blender and Adobe, where it can potentially reach millions of additional users.

In the words of CEO Jensen Huang, “We are thrilled to have launched NVIDIA Omniverse, a simulation platform nearly five years in the making that runs physically realistic virtual worlds and connects to other digital platforms. We imagine engineers, designers and even autonomous machines connecting to Omniverse to create digital twins and industrial metaverses.”

It makes sense that Nvidia is early to this market as the company has worked ten years on the ray tracing technology used in the RTX Turing GPUs. The RTX platform was invented by Nvidia to “physically simulate light behavior in the world” and combines RT cores for ray tracing with Tensor Cores for AI. This drives Nvidia’s professional visualization revenue segment, which was up 156% year-over-year and up 40% sequentially.

The company also invented the ability to simulate physics and create architectures in the cloud to build “connectors.” This led to the development of USD, or Universal Scene Description, which allows for a portal into virtual worlds. These virtual worlds are then used to train robots or to create concerts and theme parks.

This year’s Nvidia’s GPU Technology Conference event slides were made from the company’s own Omniverse platform to make the presentation more interactive. The main highlight of GTC 2021 was a perfect virtual replica of Jensen Huang’s kitchen and with a digital clone of the CEO himself. The details given in the video of The Making of the GTC Keynote shows the combined work of NVIDIA’s deep learning and graphics research teams with several engineering teams and the company’s in-house creative team.

To create the virtual keynote, the teams had to take several photos of the kitchen and Jensen to create the 3D model that could mimic his gestures. The keynote raised debates as to which parts were rendered and which parts were real. A TechRadar article had said that the entire presentation was not real. However, Nvidia reached out to the company to note that while “Jensen's corporeal form may have been rendered during portions of the keynote, it was Jensen Huang himself who was speaking at the presentation.”

The company’s post on the making of GTC made sure it was clarified. To be sure, you can’t have a keynote without a flesh and blood person at the center. Through all but 14 seconds of the hour and 48 minute presentation — from 1:02:41 to 1:02:55 — Huang himself spoke in the keynote.

Omniverse Use Cases

NVIDIA Omniverse Enterprise has made it possible for 3D production teams to work seamlessly together on complex projects. Rather than requiring in-person meetings or exchanging and iterating on massive files, design teams can work simultaneously in a virtual world from anywhere.

NVIDIA is working with various industry leaders using the company’s Omniverse platform in real-time situations. Omniverse enterprise software is in the early access stage and might be available later this year from NVIDIA’s partners, including Dell, HP, and others. Over 500 companies are evaluating Omniverse Enterprise, including BMW, Volvo, Lockheed Martin, Ericsson, and Bentley Systems.

Nvidia pointed out on the earnings call that there is a “Factory of the Future” that was developed on the Omniverse platform and that companies like BMW are using RTX and USD to simulate factories: “We've got a shared GTC Factory of the Future that is designed completely in Omniverse, robots trading Omniverse with goods and materials that are its original CAD data put into the battery. The logistics plan, like an ERP system, except this an ERP system of physical grids and physical simulation simulated through this Omniverse world, and you could plan the entire factory in Omniverse.

This will help BMW to increase the speed in decision-making and improve efficiency. The new approach will help to view their entire factory in simulation mode with photorealistic detail. Another advantage is that data is available immediately and any changes can be made in the planning stage itself, which saves time and money.

Bentley Software is an infrastructure engineering software company that builds complex infrastructure projects. The Bentley iTwin platform allows engineering firms to create and analyze digital twins of infrastructure assets. The result is millimeter-accurate digital content that even allows users to explore and even walk through infrastructure in real time. The digital twins are explored across multiple devices including AR/VR headsets. Foster + Partners, the architectural design and engineering firm that built Apple’s headquarters, is also testing Omniverse to help them render virtual sets in real-time.

Beyond the Omniverse:

As stated in the introduction, Jensen Huang said in the earnings call, “I'm fairly sure at this point that Omniverse or the Metaverse is going to be a new economy that is larger than our current economy.” If that’s true, then many companies will be winners in the space. Facebook is certainly trying as CEO Mark Zuckerberg said, “I expect people will transition from seeing us primarily as a social media company to seeing us as a metaverse company”.

My personal opinion is that Facebook has too many privacy issues and (frankly) a poor reputation to find much uptake in new markets. We’ve seen the company fail many times at attempts to move into stable coins, dating, Facebook gifts, Parse, among others. Not to mention the Cambridge Analytica data scandal, with its only success outside of the social network being accomplished through acquisitions. Regardless, the company is likely to get the kind of headlines that investors tend to rely on.

Unity, Epic Games and Roblox have arguably the best audience as they’ll target gamers for the Metaverse. The trick will be recruiting non-gaming audiences to produce a bigger market than what is currently being monetized through gaming.

For a list of investable Metaverse companies, check out the Roundhill Ball Metaverse ETF META provides exposure to companies that are involved in Metaverse. NVIDIA is currently its largest holding followed by Microsoft, Roblox, Tencent, Unity and Autodesk.

Conclusion:

If the Metaverse economy surpasses the real-world economy, as Huang predicts, then one day we may look back at Jensen Huang’s keynote in a fully rendered kitchen and memorialize this moment similar to Steve Jobs keynote in 2007.

However, the beauty of a company like Nvidia is that I don’t have to time the Metaverse in order to see real gains. If the Metaverse thesis takes longer than expected to materialize, I am still bullish on the company due to its AI and GPU-cloud capabilities that is driving many industries. In fact, I am so bullish on Nvidia for AI that I believe the company can outpace even Apple, which I covered here.

Here’s Why Nvidia Will Surpass Apple’s Valuation In 5 Years

Posted on by io-fund

This article was originally published on Forbes on Aug 27, 2021,12:24am EDTForbes on Aug 27, 2021,12:24am EDT

Nvidia has a market cap of roughly $550 billion compared to Apple’s nearly $2.5 trillion. We believe Nvidia can surpass Apple by capitalizing on the artificial intelligence economy, which will add an estimated $15 trillion to GDP. This is compared to the mobile economy that brought us the majority of the gains in Apple, Google and Facebook, and contributes $4.4 trillion to GDP. For comparison purposes, AI contributes $2 trillion to GDP as of 2018.

While mobile was primarily consumer, and some enterprise with bring-your-own-device, artificial intelligence will touch every aspect of both industry and commerce, including consumer, enterprise, and small-to-medium sized businesses, and will do so by disrupting every vertical similar to cloud. To be more specific, AI will be similar to cloud by blazing a path that is defined by lowering costs and increasing productivity.

I have an impeccable record on Nvidia including when I stated the sell-off in 2018 was overblown and missing the bigger picture as Nvidia has two impenetrable moats: developer adoption and the GPU-powered cloud. This was when headlines were focused exclusively on Nvidia’s gaming segment and GPU sales for crypto mining.

Although Nvidia’s stock is doing very well this year, this has been a fairly contrarian stance in the past. Not only was Nvidia wearing the dunce hat in 2018, but in August of 2019, the GPU data center revenue was flat to declining sequentially for three quarters, and in fiscal Q3 2020, also declined YoY (calendar Q4 2019). We established and defended our thesis on the data center as Nvidia clawed its way back in price through China tensions, supply shortages, threats of custom silicon from Big Tech, cyclical capex spending, and on whether the Arm acquisition will be approved.

Suffice to say, three years later and Nvidia is no longer a contrarian stock as it once was during the crypto bust. Yet, the long-term durability is still being debated —- it’s a semiconductor company after all —- best to stick with software, right? Right? Not to mention, some institutions are still holding out for Intel. Imagine being the tech analyst at those funds (if they’re still employed!).

Before we review what will drive Nvidia’s revenue in the near-term, it bears repeating the thesis we published in November of 2018:

Nvidia is already the universal platform for development, but this won’t become obvious until innovation in artificial intelligence matures. Developers are programming the future of artificial intelligence applications on Nvidia because GPUs are easier and more flexible than customized TPU chips from Google or FGPA chips used by Microsoft [from Xilinx]. Meanwhile, Intel’s CPU chips will struggle to compete as artificial intelligence applications and machine learning inferencing move to the cloud. Intel is trying to catch-up but Nvidia continues to release more powerful GPUs – and cloud providers such as Amazon, Microsoft and Google cannot risk losing the competitive advantage that comes with Nvidia’s technology.from Xilinx]. Meanwhile, Intel’s CPU chips will struggle to compete as artificial intelligence applications and machine learning inferencing move to the cloud. Intel is trying to catch-up but Nvidia continues to release more powerful GPUs – and cloud providers such as Amazon, Microsoft and Google cannot risk losing the competitive advantage that comes with Nvidia’s technology.

The Turing T4 GPU from Nvidia should start to show up in earnings soon, and the real-time ray-tracing RTX chips will keep gaming revenue strong when there is more adoption in 6-12 months. Nvidia is a company that has reported big earnings beats, with average upside potential of 33.35 percent to estimates in the last four quarters. Data center revenue stands at 24% and is rapidly growing. When artificial intelligence matures, you can expect data center revenue to be Nvidia’s top revenue segment. Despite the corrections we’ve seen in the technology sector, and with Nvidia stock specifically, investors who remain patient will have a sizeable return in the future.”When artificial intelligence matures, you can expect data center revenue to be Nvidia’s top revenue segment. Despite the corrections we’ve seen in the technology sector, and with Nvidia stock specifically, investors who remain patient will have a sizeable return in the future.”

Notably, the stock is up 335% since my thesis was first published – a notable amount for a mega cap stock and nearly 2-3X more returns than any FAAMG in the same period. This is important because I expect this to trend to continue until Nvidia has surpassed all FAAMG valuations.

Nvidia Chart Surpass Apple's Valuation

I/O Fund

Below, we discuss the Ampere architecture and A100 GPUs, the Enterprise AI Suite and an update on the Arm acquisition. These are some of the near-term stepping stones that will help sustain Nvidia’s price in the coming year. We are also bullish on the Metaverse with Nvidia specifically but will leave that for a separate analysis in the coming month.

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Nvidia Not Standing Still with Ampere Architecture and A100 GPU

“Nvidia’s acceleration may happen one or two years earlier as they are the core piece in the stack that is required for the computing power for the front-runners referenced in the graph above. There is a chance Nvidia reflects data center growth as soon as 2020-2021.” -published August 2019, Premium I/O Fund

Last year, Nvidia released the Ampere architecture and A100 GPU as an upgrade from the Volta architecture. The A100 GPUs are able to unify training and inference on a single chip, whereas in the past Nvidia’s GPUs were mainly used for training. This allows Nvidia a competitive advantage by offering both training and inferencing. The result is a 20x performance boost from a multi-instance GPU that allows many GPUs to look like one GPU. The A100 offers the largest leap in performance to date over the past 8 generations.

At the onset, the A100 was deployed by the world’s leading cloud service providers and system builders, including Alibaba cloud, Amazon Web Services, Baidu Cloud, Dell Technologies, Google Cloud platform, HPE and Microsoft Azure, among others. It is also getting adopted by several supercomputing centers, including the National Energy Research Scientific Computing Center and the Jülich Supercomputing Centre in Germany and Argonne National Laboratory. 

One year later and the Ampere architecture is becoming one of the best-selling GPU architectures in the company’s history. This quarter, Microsoft Azure recently announced the availability of Azure ND A100 v4 Cloud GPU which is powered by NVIDIA A100 Tensor Core GPUs. The company claims it to be the fastest public cloud supercomputer. The news follows the launch by Amazon Web Services and Google Cloud general availability in prior quarters. The company has been extending its leadership in supercomputing. The latest top 500 list shows that Nvidia power 342 of the world’s top 500 supercomputers, including 70 percent of all new systems and eight of the top 10. This is a remarkable update from the company.

Ampere architecture-powered laptop demand has also been solid as OEM’s adopted Ampere Architecture GPUs in a record number of designs. It also features the third-generation Max-Q power optimization technology enabling ultrathin designs. The Ampere architecture product cycle for gaming has also been robust, driven by RTX’s real-time ray tracing.

In the area of GPU acceleration, Nvidia is working with Apache Spark to release Spark 3.0 run on Databricks. Apache Spark is the industry’s largest open source data analytics platform. The results are a 7x performance improvement and 90 percent cost savings in an initial test. Databricks and Google Cloud Dataproc are the first to offer Spark with GPU acceleration, which also opens up Nvidia for data analytics.  

The demand has been strong for the company’s products which have exceeded supply. In the earnings call, Jensen Huang mentioned “And so I would expect that we will see a supply-constrained environment for the vast majority of next year is my guess at the moment.” However, he assured that they have secured enough supplies to meet the growth plans for the second half of this year when he said, “We expect to be able to achieve our Company's growth plans for next year.”

Virtual Machines for AI Workloads

Virtualization allows companies to use software to expand the capabilities of physical servers onto a virtual system. VMWare is popular with IT departments as the platform allows companies to run many virtual machines on one server and networks can be virtualized to allow applications to function independently from hardware or to share data between computers. The storage, network and compute offered through full-scale virtual machines and Kubernetes instances for cloud-hosted applications comes with third-party support, making VMWare an unbeatable solution for enterprises.

Therefore, it makes sense Nvidia would choose VMWare’s VSphere as a partner on the Enterprise AI Suite, which is a cloud native suite that plugs into VMWare’s existing footprint to help scale AI applications and workloads. As pointed out by the write-up by IDC, many IT organizations struggle to support AI workloads as they do not scale as deep learning training and AI inferencing is very data hungry and requires more memory bandwidth than what standard infrastructures are capable of. CPUs are also not as efficient as GPUs, which have parallel processing. Although developers and data scientists can leverage the public cloud for the more performance demanding instances, there are latency issues with where the data repositories are stored (typically on-premise).

The result is that IT organizations and developers can deploy virtual machines with accelerated AI computing where previously this was only done with bare metal servers. This allows for departments to scale and pay only for workloads that are accelerated with Nvidia capitalizing on licensing and support costs. Nvidia’s AI Enterprise targets customers who are starting out with new enterprise applications or deploying more enterprise applications and require a GPU. As enterprise customers of the Enterprise AI Suite mature and require larger training workloads, it’s likely they will upgrade to the GPU-powered cloud.

Subscription licenses start at $2,000 per CPU socket for one year and it includes standard business support five days a week. The software will also be supported with a perpetual license of $3,595, but support is extra. You also have the option to have get 24×7 support with additional charges. According to IDC, companies are on track to spend a combined nearly $342 billion on AI software, hardware, and services like AI Enterprise in 2021. So, the market is huge and Nvidia is expecting a significant business.

Nvidia also announced Base Command, which is a development hub to move AI projects from prototype to production. Fleet Command is a managed edge AI software SaaS offering that allows companies to deploy AI applications from a central location with real-time processing at the edge. Companies like Everseen use these products to help retailers manage inventory and for supply chain automation.

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Fiscal Q2 Earnings and More on the Arm Acquisition:

Over the past year, there have been some quarters where data center revenue exceeded gaming, while in the most recent quarter, the two segments are inching closer with gaming revenue at $3.06 billion, up 85 percent year-over-year, and data center revenue at $2.37 billion, up 35 percent year-over-year.

It was good timing for Jensen Huang to appear in a fully rendered kitchen for the GTC keynote as professional visualization segment was up 156% year-over-year and 40% quarter-over-quarter. Not surprisingly, automotive was down 1% sequentially although up 37% year-over-year.

Gross margins were 64.8% when compared to 58.8% for the same period last year, which per management “reflected the absence of certain Mellanox acquisition-related costs.” Adjusted gross margins were 66.7%, up 70 basis points, and net income increased 282% YoY to $2.4 billion or $0.94 per share compared to $0.25 for the same period last year.

Adjusted net income increased by 92% YoY to $2.6 billion or $1.04 per share compared to $0.55 for the same period last year.

The company had a record cash flow from operation of $2.7 billion and ended the quarter with cash and marketable securities of $19.7 billion and $12 billion in debt. It returned $100 million to the shareholders in the form of dividends. It also completed the announced four-for-one split of its common stock.

The company is guiding for third quarter fiscal revenue of $6.8 billion with adjusted margins of 67%. This represents growth of 44% and with the “lion’s share” of sequential growth driven by the data center.

We’ve covered the Arm acquisition extensively with in a full-length analysis you can find here on Why the Nvidia-Arm acquisition Should Be Approved. In the analysis, we point towards why we are positive on the deal, as despite Arm’s extremely valuable IP, the company makes very little revenue for powering 90% of the world’s mobile processors/smartphones (therefore, it needs to be a strategic target). We also argue that the idea of Arm being neutral in a competitive industry is idealistic, and to block innovation at its most crucial point would be counterproductive for the governments reviewing the deal. We also discuss how the Arm acquisition will help facilitate Nvidia’s move towards edge devices.

In the recent earnings call, CFO Colette Kress reiterated that the Arm deal is a positive for both the companies and its customers as Nvidia can help expand Arm’s IP into new markets like the Data Center and IoT. Specifically, the CFO stated, “We are confident in the deal and that regulators should recognize the benefits of the acquisition to Arm, its licensees, and the industry.”

Conclusion:

The conclusion to my analysis is the same as the introduction, which is that I believe Nvidia is capable of out-performing all five FAAMG stocks and will surpass even Apple’s valuation in the next five years.

Here’s Why Nvidia Will Surpass Apple’s Valuation In 5 Years

Posted on by io-fund

Aug 27, 2021, 12:24am EDT (Originally published on Forbes)

Nvidia has a market cap of roughly $550 billion compared to Apple’s nearly $2.5 trillion. We believe Nvidia can surpass Apple by capitalizing on the artificial intelligence economy, which will add an estimated $15 trillion to GDP. This is compared to the mobile economy that brought us the majority of the gains in Apple, Google and Facebook, and contributes $4.4 trillion to GDP. For comparison purposes, AI contributes $2 trillion to GDP as of 2018.

While mobile was primarily consumer, and some enterprise with bring-your-own-device, artificial intelligence will touch every aspect of both industry and commerce, including consumer, enterprise, and small-to-medium sized businesses, and will do so by disrupting every vertical similar to cloud. To be more specific, AI will be similar to cloud by blazing a path that is defined by lowering costs and increasing productivity.

I have an impeccable record on Nvidia including when I stated the sell-off in 2018 was overblown and missing the bigger picture as Nvidia has two impenetrable moats: developer adoption and the GPU-powered cloud. This was when headlines were focused exclusively on Nvidia’s gaming segment and GPU sales for crypto mining.

Although Nvidia’s stock is doing very well this year, this has been a fairly contrarian stance in the past. Not only was Nvidia wearing the dunce hat in 2018, but in August of 2019, the GPU data center revenue was flat to declining sequentially for three quarters, and in fiscal Q3 2020, also declined YoY (calendar Q4 2019). We established and defended our thesis on the data center as Nvidia clawed its way back in price through China tensions, supply shortages, threats of custom silicon from Big Tech, cyclical capex spending, and on whether the Arm acquisition will be approved.

Suffice to say, three years later and Nvidia is no longer a contrarian stock as it once was during the crypto bust. Yet, the long-term durability is still being debated —- it’s a semiconductor company after all —- best to stick with software, right? Right? Not to mention, some institutions are still holding out for Intel. Imagine being the tech analyst at those funds (if they’re still employed!).

Before we review what will drive Nvidia’s revenue in the near-term, it bears repeating the thesis we published in November of 2018:

Nvidia is already the universal platform for development, but this won’t become obvious until innovation in artificial intelligence matures. Developers are programming the future of artificial intelligence applications on Nvidia because GPUs are easier and more flexible than customized TPU chips from Google or FGPA chips used by Microsoft [from Xilinx]. Meanwhile, Intel’s CPU chips will struggle to compete as artificial intelligence applications and machine learning inferencing move to the cloud. Intel is trying to catch-up but Nvidia continues to release more powerful GPUs – and cloud providers such as Amazon, Microsoft and Google cannot risk losing the competitive advantage that comes with Nvidia’s technology.from Xilinx]. Meanwhile, Intel’s CPU chips will struggle to compete as artificial intelligence applications and machine learning inferencing move to the cloud. Intel is trying to catch-up but Nvidia continues to release more powerful GPUs – and cloud providers such as Amazon, Microsoft and Google cannot risk losing the competitive advantage that comes with Nvidia’s technology.

The Turing T4 GPU from Nvidia should start to show up in earnings soon, and the real-time ray-tracing RTX chips will keep gaming revenue strong when there is more adoption in 6-12 months. Nvidia is a company that has reported big earnings beats, with average upside potential of 33.35 percent to estimates in the last four quarters. Data center revenue stands at 24% and is rapidly growing. When artificial intelligence matures, you can expect data center revenue to be Nvidia’s top revenue segment. Despite the corrections we’ve seen in the technology sector, and with Nvidia stock specifically, investors who remain patient will have a sizeable return in the future.”When artificial intelligence matures, you can expect data center revenue to be Nvidia’s top revenue segment. Despite the corrections we’ve seen in the technology sector, and with Nvidia stock specifically, investors who remain patient will have a sizeable return in the future.”

Notably, the stock is up 335% since my thesis was first published – a notable amount for a mega cap stock and nearly 2-3X more returns than any FAAMG in the same period. This is important because I expect this to trend to continue until Nvidia has surpassed all FAAMG valuations.

Below, we discuss the Ampere architecture and A100 GPUs, the Enterprise AI Suite and an update on the Arm acquisition. These are some of the near-term stepping stones that will help sustain Nvidia’s price in the coming year. We are also bullish on the Metaverse with Nvidia specifically but will leave that for a separate analysis in the coming month.

Nvidia Not Standing Still with Ampere Architecture and A100 GPU

“Nvidia’s acceleration may happen one or two years earlier as they are the core piece in the stack that is required for the computing power for the front-runners referenced in the graph above. There is a chance Nvidia reflects data center growth as soon as 2020-2021.” -published August 2019, Premium I/O Fund

Last year, Nvidia released the Ampere architecture and A100 GPU as an upgrade from the Volta architecture. The A100 GPUs are able to unify training and inference on a single chip, whereas in the past Nvidia’s GPUs were mainly used for training. This allows Nvidia a competitive advantage by offering both training and inferencing. The result is a 20x performance boost from a multi-instance GPU that allows many GPUs to look like one GPU. The A100 offers the largest leap in performance to date over the past 8 generations.

At the onset, the A100 was deployed by the world’s leading cloud service providers and system builders, including Alibaba cloud, Amazon Web Services, Baidu Cloud, Dell Technologies, Google Cloud platform, HPE and Microsoft Azure, among others. It is also getting adopted by several supercomputing centers, including the National Energy Research Scientific Computing Center and the Jülich Supercomputing Centre in Germany and Argonne National Laboratory. 

One year later and the Ampere architecture is becoming one of the best-selling GPU architectures in the company’s history. This quarter, Microsoft Azure recently announced the availability of Azure ND A100 v4 Cloud GPU which is powered by NVIDIA A100 Tensor Core GPUs. The company claims it to be the fastest public cloud supercomputer. The news follows the launch by Amazon Web Services and Google Cloud general availability in prior quarters. The company has been extending its leadership in supercomputing. The latest top 500 list shows that Nvidia power 342 of the world’s top 500 supercomputers, including 70 percent of all new systems and eight of the top 10. This is a remarkable update from the company.

Ampere architecture-powered laptop demand has also been solid as OEM’s adopted Ampere Architecture GPUs in a record number of designs. It also features the third-generation Max-Q power optimization technology enabling ultrathin designs. The Ampere architecture product cycle for gaming has also been robust, driven by RTX’s real-time ray tracing.

In the area of GPU acceleration, Nvidia is working with Apache Spark to release Spark 3.0 run on Databricks. Apache Spark is the industry’s largest open source data analytics platform. The results are a 7x performance improvement and 90 percent cost savings in an initial test. Databricks and Google Cloud Dataproc are the first to offer Spark with GPU acceleration, which also opens up Nvidia for data analytics.  

The demand has been strong for the company’s products which have exceeded supply. In the earnings call, Jensen Huang mentioned, “And so I would expect that we will see a supply-constrained environment for the vast majority of next year is my guess at the moment.”  However, he assured that they have secured enough supplies to meet the growth plans for the second half of this year when he said, “We expect to be able to achieve our Company's growth plans for next year.”

Virtual Machines for AI Workloads

Virtualization allows companies to use software to expand the capabilities of physical servers onto a virtual system. VMWare is popular with IT departments as the platform allows companies to run many virtual machines on one server and networks can be virtualized to allow applications to function independently from hardware or to share data between computers. The storage, network and compute offered through full-scale virtual machines and Kubernetes instances for cloud-hosted applications comes with third-party support, making VMWare an unbeatable solution for enterprises.

Therefore, it makes sense Nvidia would choose VMWare’s VSphere as a partner on the Enterprise AI Suite, which is a cloud native suite that plugs into VMWare’s existing footprint to help scale AI applications and workloads. As pointed out by the write-up by IDC, many IT organizations struggle to support AI workloads as they do not scale as deep learning training and AI inferencing is very data hungry and requires more memory bandwidth than what standard infrastructures are capable of. CPUs are also not as efficient as GPUs, which have parallel processing. Although developers and data scientists can leverage the public cloud for the more performance demanding instances, there are latency issues with where the data repositories are stored (typically on-premise).

The result is that IT organizations and developers can deploy virtual machines with accelerated AI computing where previously this was only done with bare metal servers. This allows for departments to scale and pay only for workloads that are accelerated with Nvidia capitalizing on licensing and support costs. Nvidia’s AI Enterprise targets customers who are starting out with new enterprise applications or deploying more enterprise applications and require a GPU. As enterprise customers of the Enterprise AI Suite mature and require larger training workloads, it’s likely they will upgrade to the GPU-powered cloud.

Subscription licenses start at $2,000 per CPU socket for one year and it includes standard business support five days a week. The software will also be supported with a perpetual license of $3,595, but support is extra. You also have the option to have get 24×7 support with additional charges. According to IDC, companies are on track to spend a combined nearly $342 billion on AI software, hardware, and services like AI Enterprise in 2021. So, the market is huge and Nvidia is expecting a significant business.

Nvidia also announced Base Command, which is a development hub to move AI projects from prototype to production. Fleet Command is a managed edge AI software SaaS offering that allows companies to deploy AI applications from a central location with real-time processing at the edge. Companies like Everseen use these products to help retailers manage inventory and for supply chain automation.

Fiscal Q2 Earnings and More on the Arm Acquisition:

Over the past year, there have been some quarters where data center revenue exceeded gaming, while in the most recent quarter, the two segments are inching closer with gaming revenue at $3.06 billion, up 85 percent year-over-year, and data center revenue at $2.37 billion, up 35 percent year-over-year.

It was good timing for Jensen Huang to appear in a fully rendered kitchen for the GTC keynote as professional visualization segment was up 156% year-over-year and 40% quarter-over-quarter. Not surprisingly, automotive was down 1% sequentially although up 37% year-over-year.

Gross margins were 64.8% when compared to 58.8% for the same period last year, which per management “reflected the absence of certain Mellanox acquisition-related costs.” Adjusted gross margins were 66.7%, up 70 basis points, and net income increased 282% YoY to $2.4 billion or $0.94 per share compared to $0.25 for the same period last year.

Adjusted net income increased by 92% YoY to $2.6 billion or $1.04 per share compared to $0.55 for the same period last year.

The company had a record cash flow from operation of $2.7 billion and ended the quarter with cash and marketable securities of $19.7 billion and $12 billion in debt. It returned $100 million to the shareholders in the form of dividends. It also completed the announced four-for-one split of its common stock.

The company is guiding for third quarter fiscal revenue of $6.8 billion with adjusted margins of 67%. This represents growth of 44% and with the “lion’s share” of sequential growth driven by the data center.

We’ve covered the Arm acquisition extensively with in a full-length analysis you can find here on Why the Nvidia-Arm acquisition Should Be Approved. In the analysis, we point towards why we are positive on the deal, as despite Arm’s extremely valuable IP, the company makes very little revenue for powering 90% of the world’s mobile processors/smartphones (therefore, it needs to be a strategic target). We also argue that the idea of Arm being neutral in a competitive industry is idealistic, and to block innovation at its most crucial point would be counterproductive for the governments reviewing the deal. We also discuss how the Arm acquisition will help facilitate Nvidia’s move towards edge devices.

In the recent earnings call, CFO Colette Kress reiterated that the Arm deal is a positive for both the companies and its customers as Nvidia can help expand Arm’s IP into new markets like the Data Center and IoT. Specifically, the CFO stated, “We are confident in the deal and that regulators should recognize the benefits of the acquisition to Arm, its licensees, and the industry.”

Conclusion:

The conclusion to my analysis is the same as the introduction, which is that I believe Nvidia is capable of out-performing all five FAAMG stocks and will surpass even Apple’s valuation in the next five years.

Zoom’s Q2 Earnings Update: What Happened?

Posted on by io-fund

Zoom’s Q2 Earnings Update: What Happened?

by Beth Kindig

If you own Zoom, why are you invested in the company? That’ll be a key thing to answer as the market is clearly doubting the company. I know exactly why we are in the stock. Before I review our thesis and why the earnings report was stronger than the market is pricing in (again, for our purposes), I want to begin with the bad news.

The bad news is that the online business is declining and management is being very conservative in regards to their guidance because they’re unsure of how to forecast the churn and lower signups in the individual and small account category. Zoom uses the words online business to refer to the small accounts that sign up online. They use the words channel and direct to refer to the enterprise sales that require their sales team.

The annual forecast of 51% revenue growth places Zoom in the top tier of cloud stocks this year in terms of growth – and that’s especially impressive considering their 300%+ quarters last year. Some are referring to this as a pull forward but that’s not accurate. A pull forward refers to business you would have secured at one point yet it comes earlier or consolidates into a single quarter or time period. What Zoom experienced was a leap from enterprise to consumer during Covid with consumer not being its core business. This is not a pull forward because consumer was a bonus or unexpected use case for the product. It reminds me of Nvidia’s use case with crypto mining, which the market had a severe reaction to, even though crypto mining was not in Nvidia’s product road map.

There are some reports that point towards a deceleration across accounts as the issue. Well, yeah … it has to decelerate from 300%+ but what’s the deceleration referring to exactly? The write-ups will say something like “User growth exploded for Zoom throughout the pandemic, with the number of customers with 10 or more employees skyrocketing 458% from 66,300 in fiscal Q2 2020 to 370,200 during the company’s fiscal Q2 2021. That growth, however, slowed in Q2 2022 to 36%, with the company reporting 504,900 such customers.”

That looks scary yet the revenue growth in Q2 2022 of 51% is not a problem as it was carried by the critical enterprise segment. I review those numbers below. Believe it or not, some enterprise segments actually accelerated from last year. You wouldn’t know that from the earnings reaction.

However, let me be really clear that the reason the market is spooked is the fiscal year guide, and subsequently what it means for Q4’s growth and beyond. The confusion around the current quarter is mainly journalists trying to figure out what’s causing the sell-off and thinking it was something in the current quarter’s ER so you’ll see those quotes like what I pasted above.

Here's the question on the earnings call that caused the sell-off Tuesday:

So, I look at your implied guide for Q4. It seems like you're guiding it to decel to around 12% or so, plus or minus from 30% or so in Q3 with a similar compare I would argue. Now, it seems like it'll actually be down potentially sequentially from Q3. So, can you elaborate on why that might be the case? You talked about online issues. How long do they last, for example? And if we go to like 10% to 12% growth in Q4, should we accelerate afterward if we — the compares get easier, how should we think about next year? –. It seems like you're guiding it to decel to around 12% or so, plus or minus from 30% or so in Q3 with a similar compare I would argue. Now, it seems like it'll actually be down potentially sequentially from Q3. So, can you elaborate on why that might be the case? You talked about online issues. How long do they last, for example? And if we go to like 10% to 12% growth in Q4, should we accelerate afterward if we — the compares get easier, how should we think about next year? – Shebly Seyrafi, FBN Securities

Here was the answer from management. Notably, Zoom calls the individual accounts the “online segment.”

“Yes. So, in terms of what you're seeing in Q4, it is continued uncertainty around headwinds in the online segment, absolutely, it’s driving that. And we're — in terms of what that implies for next year, we're not ready to give FY'23 guidance today, unfortunately. So we will be prepared to do that when we get on the Q4 earnings call and, of course, we'll have a lot more earnings at that point to share with you, but that is what – exactly what continues to drive that in Q4.” – Kelly Steckelberg, CFO Zoom it is continued uncertainty around headwinds in the online segment, absolutely, it’s driving that. And we're — in terms of what that implies for next year, we're not ready to give FY'23 guidance today, unfortunately. So we will be prepared to do that when we get on the Q4 earnings call and, of course, we'll have a lot more earnings at that point to share with you, but that is what – exactly what continues to drive that in Q4.” – Kelly Steckelberg, CFO Zoom

My read on the situation is that management doesn’t know what to expect right now. It was an unexpected situation last year and unwinding from that is hard to model. Please also note, that Zoom has what’s called “front-weighted seasonality” which means contracts renew more in the first half of the year than the second half of the year. This is technically a headwind to Q3 and Q4 although that was already taken into account with the guide.

So, where does that leave us considering Zoom is a LTBH position but nearly 5% allocation? As annoying as this may be, I don’t see any change to the thesis we set out for Zoom. There is confusion about the company’s revenue segments and how they’ll unwind but this earnings report saw accelerating growth in enterprise. Therefore, at most, I see us taking the allocation down to 3% and then back to 5% on a breakout. The reason is we will keep the 3% minimum is that this company is rare and special, I’ve already made that case many times.

Cash is the great equalizer in terms of product-market fit; if you knew nothing else about product, that’ll quickly communicate to you the relationship a tech company has with its customers in any given market. Cloud isn’t ad-tech, where it’s this cash efficient either, which makes Zoom’s cash even more rare. Why is Zoom able to keep costs so low while growing this rapidly? I expand on this below.

I want to point out that Knox has done an excellent job with this position as the highest entry he’s guided was in the mid-$300s with the high-$200s in May. He was extremely clear when Zoom became overextended into the $400s and even $500s, that we were not buyers. Therefore, we are about a 10%-15% drawdown from our last entry. It’s not only our wins that make a portfolio but it’s also avoiding the losses. We take both very seriously.

Enterprise > Consumer

Consumers turned to Zoom during Covid because the product is easy to use and has a viral mechanic, which is the easy-to-share URLs that allow a frictionless video call without logging into accounts or downloading software. 

Zoom is clear on who and what they are. The Five9 acquisition that we covered in-depth here expands their enterprise footprint from employee communications to customer communications for call centers.

Channel and Direct Business drove the revenue results this quarter and the company clearly stated they expect this growth to be “robust” into the future. The company grew revenue by 54% year-over-year to $1.02 billion, exceeding guidance of $990 million.

Enterprise customers that spend more than $1 million dollars in ARR grew by 77% year-over-year. Zoom also reported 131% year-over-year growth in accounts with greater than $100,000 in trailing twelve months of revenue. This was an acceleration from 112% growth in the year-ago quarter.

The Net Dollar Expansion rate for customers with more than 10 employees was above 130% for customers. This is contributed to an increase in spend and upsells on Zoom Phone and Zoom Rooms.

Zoom Phone grew customers by 241% year-over-year and the company “set a record for the largest Zoom Phone deal to date twice in the same day.” There are now 26 customers with more than 10,000 seats. The incremental revenue was driven primarily by new customers. The company is growing Zoom Phone seats at a rate of 1 million per 8 months.

Here's an important excerpt from the call: “In addition to these great customer wins, we also closed another strategic channel partnership with Telkomsel, the largest cellular operator in Indonesia, which is the world’s fourth largest country by population. Telkomsel understands and wants to support their 170 million subscribers’ need for seamless and reliable virtual meetings to thrive in the digital workplace era. They will be leveraging the power of Zoom’s Developer Platform and ISV Partner Program to deliver a fully integrated solution via their CloudX offering for the Enterprise segment and Zoom native apps for the Consumer segment.”

Signing one cellular operator can make up for a lot of online accounts. Telkomsel’s CloudX is unified communications and a contact center solution. As noted in past analysis, Zoom also has partnerships with British Telecom, Lumen Technologies, and Orange Business Services. Zoom’s Distributor Partner Program includes Carahsoft Technology Group in the U.S., Nuvias Unified Communications in Europe, eLink Distribution AG in DACH, and West Telco in LATAM and EMEA, Avant Communications and Intelisys.

 

Zoom’s Cash

There’s no doubt that Zoom’s bottom line is exceptional with operating income of $1.5 billion expected in fiscal year 2022 and adjusted EPS of $4.75 to $4.79.

We can also see that Zoom’s earnings turn into cash, highlighting the high quality of its results. For instance, YTD FCF increased 45% YOY to $909 million, which is impressive considering YTD earnings were $544 million. Zoom’s cashflows are higher than its earnings, which improves the quality of recently reported results.

The firm’s cashflows are largely driven by pre-payments from enterprise customers, which are stored in deferred revenue. Deferred revenue was a healthy $1.15 billion as of Q2, up 62% YOY, and signaling that enterprise customer growth remains strong. As discussed above, a lot of the uncertainty in management’s guide comes from smaller accounts (online accounts), so it is good to see that Enterprise has amble cash support for future sales.

We can gain further confidence that Enterprise is performing strong by scaling deferred revenue to expected H2 enterprise sales. Zoom disclosed on the Q2 call that 40% of its sales are from monthly payers (online accounts), which do not prepay revenues and as a result, do not drive deferred revenue. Last year, around ~40% of Zoom’s H2 sales were from monthly payers.

By stripping out the 40% monthly payers from the H2 guide, we can see that enterprise sales are expected to increase to ~$1.2 billion in H2. Considering Zoom’s $1.15 billion deferred revenue balance, the company’s H2 enterprise sales are 94% supported by pre-payments of cash (deferred revenue), up YOY from 72% support in the prior-year quarter. Viewed differently, Zoom’s enterprise sales are performing stronger than they were last year. If you believe that Zoom’s story is driven by Enterprise (we do), then this is a great trend to see. 

However, it also means that any raises or beats for Q4 will require online payments to come in stronger than expected since enterprise is accounted for in the deferred revenue balance.

 

Hybrid Work-from-Home

As stated above, Zoom Phone is the most prominent product that can drive future revenue growth as the telecom and cellular operators embrace cloud-native. Quite a bit of this will be driven by the developer platform that Zoom has launched and Zoom Apps.

However, hybrid work-from-home is not to be overlooked. Zoom Rooms and Zoom Events are the two products that fall into hybrid WFH.

According to Gartner, by the end of 2021, 32% of workers worldwide will be remote while 51% will be working in a hybrid environment. As you can see from the chart below, Gartner sees this increasing from 50% to 60% in the United States with more percentage increases in India and Western Europe. Zoom Rooms facilitates this by allowing office conference rooms to connect with the remote employees.

Zoom Events capitalizes on the event industry which is one of the last to resume after Covid. It’s not hard to imagine that events will end up being hybrid too, moving forward, to help reduce travel and maximize the number of attendees. Right now, 73% of event planners believe hybrid will be more common in the future.

Conclusion

I’ve been here many times where the wrong revenue segment is driving a market reaction. Zoom is not a consumer story and the current earnings results are showing robust enterprise sales.  Regardless, I won’t sugar coat anything with my readers and Q4 is a gamble right now. That’s the issue and why we saw a 16% decline the day after earnings.

I’ve laid out why we will remain in our position so you can make an educated decision for yourself. We also offer backup with Knox’s entries and so you’ll know when the company is rev’ving up again. We won’t blink an eye when the charts say the timing is right to increase allocation. In my opinion, the chances are incredibly high that Zoom becomes the leading cloud-native communications company globally. Notice I’m not saying the leading web conferencing app and notice I’m not saying “one of the leading.” It’s a big TAM, it’s a sharp team, it’s an incredible product, and they’ve got a pile of cash – that’s all I got for ya.

 

 

 

 

 

Elastic 2021 Analysis

Posted on by io-fund

Beth had previously written a premium analysis on Elastic back in early 2020 that focused on Elastic’s core products. Please read that analysis here if you haven’t yet.

In this article, I will instead discuss why we are now bullish on Elastic and why we think its stock will do well going forward. This analysis focuses on Elastic’s feud with Amazon AWS, its transition from open-source to open-core licensing and the uncertainty that currently surrounds the stock. Importantly, we believe that this uncertainty could provide an opportunity given the stock’s valuation. We conclude our discussion with an overview of Elastic’s recent results and the company’s financial future.

Why we like Elastic:

Elastic recently reported an acceleration in both sales and user growth. We believe that Elastic is well positioned to continue to report strong growth going forward. Elastic’s rapidly expanding total addressable market (TAM, pictured below) supports our belief that there is plenty of runway ahead for Elastic.  
Elastic’s Total Addressable Market (TAM)

Elastic is a search company. As data consumption grows exponentially, search will become increasingly more critical for organizations. Being able to quickly scale and search structured and unstructured data is what Elastic is built for.  Search is also necessary for both preventing and detecting security threats. CEO Shay Banon summarized Elastic’s position during the Q1 Earnings Call when he said that “as data volumes grow, the best and most natural way to explore data is by searching it… We see usage of Elastic just as a general search platform that is very useful to do many, many different things”. In short, growth in data consumption will benefit Elastic’s topline going forward. This is also true for companies like MongoDB and Snowflake as well, yet Elastic has a much more attractive valuation.

Volume of Data consumed worldwide 2010 to 2025

Furthermore, having a founder CEO in a complex space such as enterprise search can be a game changer since success is driven by product. Since no one will understand the product more than the founder, a founder-CEO can provide an edge for a company since product is often paramount, especially in tech.

Despite these traits, Elastic trades at a discount to its peers (discussed below), which we believe is due to the uncertainty surrounding Elastic’s transition to open core and the feud with Amazon’s AWS. We believe that these concerns may subside, and that Elastic will emerge from this uncertainty a stronger company. We discuss these concerns in greater detail next.

From open-source to open-core and the feud with Amazon AWS

Elastic has its roots in open source, which facilitated the rapid adoption of its software and has been a cheap and efficient form of distribution. Elastic makes money by offering certain features of its software available through paid subscriptions. Clearly, Elastic has been able to capitalize on its open-source distribution model, as it reported $608 million in sales in FY2021.

While being open source provides many benefits, the caveat is that its free, and that anyone can make changes to the code and redistribute (sell) it. In 2015, AWS started reselling Elasticsearch as “Amazon Elasticsearch”, which Elastic has contended is an obvious trademark violation. CEO Banon has explained that “this trademark issue [with AWS] drives confusion with users thinking Amazon Elasticsearch Service is actually a service provided jointly with Elastic, with our blessing and collaboration. This is just not true”. Essentially, Amazon has been implying a partnership with Elastic and has effectively taken some of Elastic’s revenue for the last 6+ years.

AWS went even further and in 2019, AWS announced that it will maintain an Open Distro of Elasticsearch, which was similar to a fork of Elastic’s code. ESTC stock sold off 5% that day. Elastic’s founder-CEO responded to the AWS news by highlighting how Elastic has been “forked, redistributed and rebundled so many times I lost count. It is a sign of success and the reach our products have. From various vendors, to large Chinese entities, to now, Amazon. There was always a "reason", at times masked with fake altruism or benevolence. None of these have lasted. They were built to serve their own needs, drive confusion, and splinter the community”. Elastic has so far been able to counter AWS’s fork, evident in its rapid user growth (discussed below). The stock is also up 87% since AWS announced the Open Distro of Elasticsearch.

The feud with AWS and Elastic escalated further in early 2021. On January 14th, Elastic announced a licensing change to its Elasticsearch and Kibana products. The change was aimed at preventing cloud providers (i.e., AWS) from selling its free software without contributing back to the open-source project. On January 21st, AWS responded to Elastic’s license change by announcing that “AWS will step up to create and maintain a ALv2-licensed fork of open source Elasticsearch and Kibana”. AWS has since forked the last ALv2 version of Elasticsearch and Kibana and has called it OpenSearch.

As shown below, the AWS announcement on 01/21/21 marked the top in ESTC’s stock. This feud with Amazon AWS has resulted in uncertainty, as the market is concerned that Elastic will not be able to overcome the AWS threat. We note that since January 2021, Elastic’s financials have improved, yet the stock is still below its ATH. We believe that we are presented an opportunity to buy a high performing company at a discounted price due to this temporary uncertainty caused by the AWS fork. We explain why we believe that Elastic will be able to overcome the AWS threat in more detail next.

Elastic’s stock returns since its IPO

Why we believe that Elastic will be able to overcome the AWS threat

It will take time for Elastic’s licensing change to take effect, since only new releases of Elasticsearch software will be impacted. So, we will have to wait a few quarters to know for sure if Elastic is benefitting or not from the licensing change. This uncertainty can be our opportunity.

By taking a step back and observing the situation from a developer’s perspective, we can better gauge the situation. AWS is forking the Elasticsearch software to maintain its use for AWS, not for other uses. If you want to use it for AWS, great. But if you want to use it in a multi-cloud environment, then the software will likely require further modifications. These modifications will accentuate the differences between AWS’s fork and Elastic’s official releases. The two products will likely operate very differently and portability/migration between services will become harder over time. Do you pick AWS’s fork, or Elastic’s core software?

If you operate strictly on AWS, then the AWS fork may be appealing. If you operate in a multi-cloud environment, then the official Elastic releases will likely be a better choice since it was developed for all different cloud environments. Moreover, certain capabilities are absent from the AWS fork, such as machine learning, which is “built into Elasticsearch and readily available to all customers, without dependencies on any specific proprietary external services. [Elastic does] not believe this to be the case with the new forks, which are primarily built for and governed by AWS”. Machine learning is often a key reason why corporations migrate to the cloud, so we should expect users to want this functionality and hence prefer Elasticsearch over OpenSearch.

At the I/O Fund, we believe that multi-cloud environments will dominate going forward, which should drive traffic to neutral and best-of-breed Elasticsearch over AWS supported OpenSearch. Multiple surveys also signal that most companies are already using multi-cloud providers (shown below). Since Elastic collaborates with all major cloud providers, its software will be optimized for multi-cloud environments. The AWS fork of Elasticsearch will likely be biased towards AWS, meaning that AWS operability will be prioritized over other cloud platforms.

We also note that Elasticsearch also observes and monitors a cloud providers performance. We believe that cloud users want an independent party monitoring their cloud environments. For the last six years, AWS has been able to sell its “Amazon Elasticsearch” product by implying a partnership with Elastic using its trademark. This feigned partnership has likely led users to believe that Elasticsearch was developing the software, not Amazon. By changing the licensing agreement, Amazon has been forced to change the name of Amazon Elasticsearch to OpenSearch. This should help resolve the misunderstanding that Amazon Elasticsearch was not independent of AWS. Furthermore, this should also redistribute the revenues that went to Amazon Elasticsearch back to Elastic, benefiting Elastic’s topline. 

We believe that Elastic will benefit from the licensing change as users will prefer the agnostic Elasticsearch versions to search and observe their cloud environments. This should also lead to a redistribution of revenue that Amazon has taken by reselling Elasticsearch as its own product, benefitting Elastic’s topline. The prevalence of multi-cloud environments will also favor Elasticsearch over AWS’s fork. In the next section, we go beyond the licensing change and provide a brief overview of Elastic’s growing presence in cybersecurity and what this could mean for the company going forward.

Security and SIEM

On top of the licensing changes, Elastic recently released a new version of its code which included a new product called Limitless Extended Detection and Response (XDR), which builds on Elastic’s security offerings. Elastic XDR can be used to unify security information and event management (SIEM) capabilities across all endpoints onto a single platform. Elastic explained further that XDR allows users to “ingest and retain large volumes of data from diverse sources, store and search data for longer, and augment threat hunting with detections and machine learning”.

A question we need to answer is if Elastic is expanding into the highly competitive security vertical because it is running out of runway in its core search market or if this is a natural progression for the firm. The latter appears to be the case, as searching data is a great way to detect and prevent threats. CEO Banon explained during the Q1 Earnings Call that “as companies go online, their surface areas become bigger and they generate more data that needs to be used to detect” threats that can remain hidden out of view. Searching that data is a natural way to detect threats and prevent future threats.

CEO Banon also clarified how Elastic will be able to compete with the numerous security vendors on the market during the Q1 call. He explained that a user first needs to be able to observe threats in order to detect them, and searching the data is the best way to observe threats. He stated further that Elastic’s search engine has been built to identify, among other things, threats.

During the Q1 call, CEO Banon painted a clear picture of what the XDR product is trying to solve: which is to provide a unified place where “you can store all data possible and threat hunt extremely fast, either manually or through AI and machine learning algorithms, and then extend to the peripherals so you can detect and prevent”. Elastic’s platform is already built to scale and quickly processes large amounts of data, so it’s a natural progression to use it for threat detection and prevention.

Finally, what really sets Elastic’s XDR product apart is its ability to scale. Elastic is built to scale: you can change the timeframe of your data search from 2 weeks to 2 years and still receive results within minutes (some competing products can take days or fail to ever finish a query if the dataset is too large). Elastic’s 10+ year history and large developer community has contributed to its ability to quickly scale and process large amounts of data. As observability and security continue to merge going forward, Elastic’s platform is well positioned to benefit from these converging trends. We also note that Elastic’s financial performance has improved in recent quarters, which we discuss in greater detail next.

Financials

Elastic reported Q1 FY2022 results on 08/25/21. The results came in strong as sales accelerated 50% YOY to $193 million and beat estimates by $20 million (12%). The beat flowed into guidance, as Elastic raised its topline guide for FY2022 to $811 million at the mid-point, implying a 34% YOY growth rate which was 3% ahead of the Street’s initial estimate. Since the licensing change went into effect in February 2021, Elastic’s sales have accelerated: from 39% YOY growth in the January quarter (Q3 FY21) to 44% YOY growth in Q4 FY21 and then to a 50% YOY growth rate as of the latest quarter. The acceleration in sales implies that Elastic’s licensing change has not dissuaded customers from signing up and/or increasing their usage of Elastic’s platform.

Elastic’s Q1 gross margin improved 131 bps YOY to 74%, which was above the three-year average of 72%. Operating margins declined 174 bps YOY to -16%, as CEO Banon explained on the Q1 Earnings Call that Elastic has front loaded expenses by hiring software engineers to support its growth initiatives. Cashflows on a 12M basis were an ­inflow of $15 million, an improvement from an outflow of -$7 million in the prior year quarter. Non-GAAP EPS was $0.04, which beat estimates by $0.16.

Customer metrics also showed an acceleration in Elastic’s business. For example, after the licensing change took effect in Q4 FY21, customer count growth accelerated. Specifically, Q1 FY22 (Q4 FY21) customer count grew 32% (33%) YOY to 16,000 (15,000), faster than the 31% YOY growth rate in Q3 FY21. Furthermore, Q1 customers with contract values greater than $100k increased 24% YOY to 780, an acceleration from the 20% and 18% growth rates reported in Q4 and Q3 FY21, respectively. The acceleration in customer growth suggests that the licensing changes have been beneficial.

However, despite reporting an acceleration in sales, a top and bottom-line beat, a raise in guidance and improving customer metrics, Elastic’s stock slightly sold off after the strong Q1 print. We believe this was because billings came in low. However, we do not think this is a concern since growth in cloud sales does not increase billings.

Cloud sales, which are 100% subscription based with no free option, increased 89% YOY to $62 million, an acceleration from the 70% and 79% YOY rates reported in Q4 and Q3 FY21, respectively. Elastic cloud is mostly billed monthly, meaning there is no deferred revenue and hence, no billings associated with the sales. However, as cloud customers grow in usage, their contracts will get larger in which point they will likely convert to annual billing. This will then lead to a rise in deferred revenue and a rebound in calculated billings growth. In short, we believe that billings are temporarily subdued due to the growth in cloud sales, which is a good problem to have.

Viewed holistically, we believe that Elastic is a high performing company reporting strong growth, positive cashflows and improving customer metrics. While there are concerns, such as the AWS threat and subdued billings, we believe that these concerns are just temporary issues. In the next section, we briefly discuss Elastic’s discounted valuation.

Valuation

Elastic trades at an 18x Fwd P/S multiple, well below its peer group median of 32x Fwd P/S (peers: DDOG, CRWD, DT, SPLK, MDB). Elastic’s EV/Sales multiple of 21x was nearly half its peer group’s 40x EV/sales multiple. However, Elastic is growing just as fast as its peer group. As shown in the below charts, ESTC’s most recent growth rate is above the peer median, yet its valuation is nearly half the peer median. We don’t believe that Elastic deserves such a large discount relative to its peers. As discussed, the AWS threat and subdued billings growth are temporary concerns which will ultimately make Elastic stronger. For its strong growth and healthy margins, we expect that Elastic will start to trade closer to the peer median.

Elastic’s Sales Multiple Relative to the Peer Median

Elastics Three-month Growth Rate vs Its Peers

Conclusion :

The I/O Fund believes that Elastic is a high-quality company with strong growth and a relatively cheap valuation. We discussed the uncertainty that surrounds the stock which helps explain the discount in Elastic’s share price. We also explained why we think that the AWS threat and subdued billing concerns are just temporary issues. Looking forward, we expect Elastic to continue to grow its topline as its TAM continues to balloon. We also expect that the firm’s valuation will converge towards its peer group once the licensing uncertainty is fully behind the firm, which may take a few quarters. 

Additional Resources:

2020 Elastic Analysis

Overview of Elastic's Q4 2021 Results

Disclosure: Bradley Cipriano and the I/O Fund may own shares in Elastic and have no plans to change their respective positions within the next 72 hours. You can access the I/O Fund’s positions here. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies.Disclosure: Bradley Cipriano and the I/O Fund may own shares in Elastic and have no plans to change their respective positions within the next 72 hours. You can access the I/O Fund’s positions herehere. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies.