Category: Data Center

Cloudflare Q2: Significant Margin Expansion, Customer Acceleration

Posted on by io-fund

Cloudflare’s adjusted operating margin reported significant expansion and the company is nearing GAAP profitability. In addition, its free cash flow grew 92% YoY and there was noticeable customer acceleration in the key metrics.

Cloudflare is going through a transition in customer contracts, transitioning from annual recurring contracts to offering more platform deals that are on monthly, pay-as-you-go terms with 3+ year duration. This is causing DBNRR and RPO to look lumpy, yet the company’s beat/raise is helping to shrug off any concerns from this transition.

Ultimately, Cloudflare is well positioned for AI inference at the edge and it’s operating leverage is a near-term bonus. We look at this and more below!

Revenue and EPS:

Q2 revenue topped estimates by nearly 2%, with Cloudflare’s revenue growth rate decelerating 50 bp to 30% in the quarter. Management increased full year revenue guide. Most importantly, Cloudflare reported significant progress toward becoming GAAP profitable.

  • Revenue of $401 million beat estimates by $6.5 million, representing YoY growth of 30.0%.
  • For Q3, management guided revenue between $423 million and $424 million, slightly ahead of the analyst consensus for $423.34 million. This represents YoY growth of 26.2%, a 380 bp deceleration.
  • GAAP EPS of ($0.04) beat by $0.06, marking significant improvement from ($0.28) in the year ago quarter.
  • Adjusted EPS of $0.20 beat estimates by $0.06, for YoY growth of 100% from $0.10 adjusted EPS last year and QoQ growth of 25% from $0.16 EPS last quarter.
  • Management guided adjusted EPS of $0.18, ahead of estimates for $0.15. 

For FY24, Cloudflare now sees revenue between $1.657 billion and $1.659 billion, for YoY growth of 27.8%. This also represented an $8 million increase from the guidance given in Q1. Management also boosted the adjusted EPS outlook to $0.70-$0.71, up from the prior view for $0.60-$0.61.

Margins:

Cloudflare showed strong improvement in operating margin and net margin, and significantly boosted its full-year operating margin outlook.

Based on management’s guidance for adjusted operating income of $50-$51 million in Q3, adjusted operating margin is expected to be 12%. For the full year, management boosted its adjusted operating income guide to $196-198 million, a nearly 22% increase from the prior view for $160-164 million. This pulls full-year adjusted operating margin up to 11.9%, a 210 bp increase from Q1’s view for a 9.8% margin and is suggesting that Cloudflare expects to witness strong operating leverage in the back half of the year.

  • GAAP gross margin was 77.8%, up from 75.6% last year and 30 bp QoQ expansion. Adjusted gross margin was 79.0%, up from 77.7% last year but a 50 bp QoQ contraction.
  • GAAP operating margin was (8.7%), a significant improvement from (-18.2%) last year and up from (-14.4%) last quarter.
  • Adjusted operating margin was 14.2%, a significant improvement from 6.6% last year and up from 11.2% last quarter, reaching its highest quarterly level.
  • GAAP net margin was (3.8%), a significant improvement from (9.4%) last quarter. Adjusted net margin was 17.3%, up from 10.9% last year, and up 190 bp QoQ.

Cash and Debt:

Cash flow continued to expand as well, certainly a plus in this environment for a cloud stock. Free cash flow expanded significantly by 92% YoY.

  • Operating cash flow was $74.8 million, for a margin of 19%, flat QoQ but up 6 percentage points YoY. OCF increased 16% YoY.
  • Free cash flow was $38.3 million, for a 10% margin, up from 9% in Q1 and 6% last year. Free cash flow increased nearly 92% YoY.
  • Cash and available-for-sale securities totaled $1.76 billion.
  • Debt (convertible senior notes) totaled $1.28 billion.

Network capex was 6% of revenue compared to 8% in the previous quarter. Management reiterated to expect network capex in the range of 10% to 12% in the second half of the year.

Key Metrics:

DBNRR was 112% in Q2, a 3 percentage point deceleration from 115% in Q1. Per the CFO’s opening remarks: “The decline in [DBNRR] was driven by slower net expansion in our larger customer cohorts, increased platform deals in the form of pool of funds contracts, which reduced friction to adoption across our product portfolio but can impact the shape of revenue recognition as well as deferred revenue and current RPO, especially for existing customers that transition into this structure and anniversarying the price increase to our Pro and business pay-as-you-go plans last year. For the next several quarters, we expect new customers to contribute a higher percentage of our overall year-over-year revenue growth. similar to the second quarter.”

There were questions about the pool of funds contracts in the Q&A, detailed below.

Billings increased 23% YoY and 9% QoQ to $421.7 million. This represents a 9% QoQ growth from $387.6 million last quarter. With that said, Billings growth has been decelerating for a few quarters and is down 9 points from 32% growth YoY in the year ago quarter. 

Deferred revenue totaled $394.5 million, a 5.5% QoQ increase.

RPO of $1.421 billion represented an increase of 6% QoQ and 37% YoY. This is lower growth than last quarter, when RPO grew 8% QoQ and 40% YoY. See below discussions around Pool of Funds accounts.

Paying Customers & Workers Platform Accelerated

Cloudflare Worker Applications grew from 2M developers to 2.4M developers in four months, per the CEO’s opening remarks. The Workers AI Platform developer accounts grew 67% QoQ and inference requests grew 700% QoQ. Of course, this is large growth on small numbers, but take notice that Cloudflare is one of the only best-of-breed software companies able to quantify their AI impact right now.

Paying customers totaled 210,166 in Q2, a 21% YoY increase. This represented a 400 bp acceleration from 17% YoY growth reported in each of the last three quarters. On a QoQ basis, Cloudflare added more than 13,000 customers, compared to sequential additions of less than 10,000 in each quarter in the last two years.

For customers with ARR of >$100K, Cloudflare reported 30% YoY growth to 3,046. This customer cohort contributed 67% of revenue, flat with Q1 yet up from 64% in the year ago quarter.

Earnings Call:

Pool of Funds Accounts

The CFO explained that Cloudflare is seeing a transition in their billing from annual contracts to pool of funds accounts that are on a monthly basis for three or more years. The pool of funds accounts are unique to the largest customers (for example, 4 of the top 10 customers are this account type) that use many products across the entire Cloudflare platform. These are considered larger platform deals that are paid on a monthly basis in a multi-year contract  rather than an annual contract on one product. This is shifting how DBNRR and RPO are reported since revenue is recognized as the customer consumes the service.

This is how the CFO explained it: “So as it relates to revenue, the revenue is now recognized as the customer consumes the service, and as a result, the record revenue recognition might be nonlinear and might ramp over time with respect to deferred revenue because those deals have monthly billing terms, we do not report upfront deferred revenue, and this can result then in lower deferred revenue growth. And then current RPO is also impacted because the contract duration is longer. So you recognize upfront less in current RPO. So while there the deals are very beneficial and healthy to the business. They generate some noise in this transition in our DNR and in the other metrics.”

There was a question about this from an analyst where the CFO pointed toward this creating lumpy, yet “significantly higher total contract values.”

Question
Fatima Boolani (Analysts)

Matthew and Thomas, this is for you both. I had a bare picture question around the pricing strategy across the portfolio. So at a tactical level, you had some meaningful price increases that you're first ones ever. Thomas wondering if you could just opine on how far deep those have pervaded the installed base. And if you can kind of talk to where we are in terms of the innings in terms of how that inferred in the base? 

And then Matthew, the bigger picture question for you is, if I piece together a lot of what you shared in the prepared remarks as it relates pool of fund deals, more pay as you go, more consumption, payment modalities especially as the Workers' portfolio scales, how should we generally think about the business impact and sort of revenue elasticity, if you will.

Answer
Thomas Seifert (Executives)

There's not much to add to what Matthew just said. Some of the impacts of this transition, you have seen, we talked about how pool of funds deal impact the lumpiness or make our numbers a little bit more lumpy. We will also have an increasingly higher share of variable revenue in our numbers, while this number is still small today, and it will grow meaningful over time. 

But this is less driven by price increases, as Matthew said, but it's more driven by the structural changes that this transition implies. And with all the overall benefits of more stickiness, longer-duration deals, platform fills with better expansion capability and significantly higher total contract values.

Cloudflare’s View on the Inference Market

We’ve discussed in the past how Cloudflare is uniquely positioned to capture inference at the edge. Per the opening remarks, Cloudflare signed a $500,000 contract for Workers AI for inference tasks across their edge network. The key metrics around 2.4M developers on the Workers platform and 67% QoQ growth on Workers AI are also important to pay attention to as we go along.

The CEO explained that his view on inference is that half of it will be run on devices and the other half will be run on networks like Cloudflare: “That also has the benefit of making it as performant as possible. And it also means that you can have the AI that's responding have regional differences more easily so that if you're responding in the U.K., the — an AI can spell color with a U, whereas if it's in the U.S., it can spell it with no U. I think all of those things then drive a lot of the other 50% of inference tasks to be running at a network like Cloudflare.

And so we are trying to build that network out ahead, make sure that we can answer any inference tasks that can't get determined on your own device as close as possible to that device and then make it very easy to get that inference task from us are from the device to us in a standard-based API-driven way, so that it's seamless to that end user […] But I really think that inference is going to be between the end devices themselves and a network that is like Cloudflare that spans the globe and is incredibly close and in every jurisdiction where end users might be.”

Conclusion:

The operating leverage is helping Cloudflare’s stock price today while its AI inference positioning is more of a medium-term story. We are encouraged by the initial ramp of the Workers platform and believe key AI winners are being decided today, evidenced by this early traction. Cloudflare is physically positioned at the edge to where there is no way around Cloudflare when it comes to inference (literally) as hyperscalers are positioned too far away from devices for the low latency that AI inference will require. Management being able to improve margins and cash flow help make it an easy choice to keep Cloudflare in the portfolio as we wait for the medium-term story to solidify.

Damien Robbins, I/O Fund Equity Analyst, contributed to this analysis.

Recommended Reading:

Cloudflare Q2 Earnings Preview: With Bated Breath for FY Outlook

Posted on by io-fund

Cloudflare will report its results on August 1st. Management guided revenue in the range of $393.5 million to $394.5 million, representing YoY growth of 27.7% at the midpoint. Despite the Q1 revenue beat of 1.4%, management did not raise the FY guidance due to the mixed macroeconomic environment and geopolitical uncertainty. They remained cautious and said that the short term is uncertain, and the long term is bright.

Cloudflare is at an advantage as the company has visibility into many industries and had rightly given early warning of the slowdown in 2022. They reassured investors in the last earnings call during the Q&A that the level of concern is not the same as in Q1 2022 but remains prudent.

We see pockets of weakness (Tesla, for example, continues to face the effects of high interest rates), yet we will need to look to more commentary from Cloudflare to understand if the situation has grown worse or better as it’s not clear from our vantage point what spooked the CEO last quarter.

Revenue

The analysts expect Q2 revenue to grow 27.9% YoY to $394.5 million. Revenue growth will decelerate from 30.5% YoY to $378.6 million in Q1. It will further decelerate to 26.1% YoY growth in Q3 and 25.9% in Q4 and then accelerate to 26.2% growth in Q1 FY 2025. This is actually quite strong for best-of-breed cloud as many >40% revenue growth cloud companies have dipped <20% in recent years.

Margins

The Q1 gross margin improved 180 bps YoY and 50 bps sequentially to 77.5%. The adjusted gross margin improved 170 bps YoY and 60 bps sequentially to 79.5%. This was higher than the management’s long-term target of 75% to 77%.

The operating margin was (-14.4%) compared to (-16.3%) in the same period last year and (-11.8%) in the previous quarter.  The adjusted operating margin improved 450 bps YoY and 20 bps sequentially to 11.2%. The operating expenses as a percentage of revenue were reduced by 300 bps YoY due to the focus on higher productivity and greater efficiency in the operations. Sales and marketing expenses as a percentage of revenue reduced by 100 bps, R&D expenses reduced by 200 bps and general & administrative expenses reduced by 100 bps YoY. The adjusted operating margin guide for the next quarter is 9%, up 240 bps YoY and down 220 bps sequentially.

The net loss was (-$35.5) million or (-$0.10) per share compared to (-$38.1) million or (-$0.12) per share in the same period last year. The adjusted net income was $58.2 million or $0.16 per share compared to $27.2 million or $0.08 per share in the same period last year and beat estimates by 22.6%. The guide for the next quarter is $0.14.

The analysts expect adjusted EPS to grow 40.7% YoY to $0.14 in Q2 and decline by (-6.3%) YoY to $0.15 in Q3.

Cash Flow and Balance Sheet

  • Q1 operating cash flow was $73.6 million or 19% of revenue compared to $36.41 million or 13% of revenue in the same period last year.
  • Free cash flow was $35.6 million or 9% of revenue compared to $13.9 million or 5% of revenue in the same period last year as it benefited from an uptick in collections on accounts receivable. Network capex was 8% in the recent quarter. Management expects network capex to be 10% to 12% of revenue in 2024, including the rollout of GPU capacity to every location.
  • The company has cash and available-for-sale securities of $1.72 billion and debt of $1.28 billion compared to $1.67 billion and $1.28 billion in the December quarter.

Key Metrics

RPO

RPO increased 8% QoQ and 40% YoY to $1.343 billion. This is an acceleration from growth of 37% YoY in the previous quarter.

Billings

The company’s primary focus is on RPO as a more comprehensive measure of its business. We track billings since they are reported for other cybersecurity stocks. Billings grew by 24% YoY and declined by (-7%) sequentially to $387.6 million and a deceleration from 28% YoY growth and 15% sequentially in the previous quarter.

DBNRR

The dollar-based net retention rate was 115% in Q1, flat QoQ but down from 117% in the year-ago quarter. Management expects the decelerating trend to stabilize around the current levels.

Customers

Customers with greater than $100,000 annualized revenue grew by 33% YoY to 2,878. The number of customers has been trending higher sequentially even though the growth decelerated from 35% in the previous quarter.

Matthew Prince, CEO and co-founder, said in the earnings call, “We added 122 new large customers, those that pay us more than $100,000 per year, and now have 2,878 large customers, up 33% year-over-year. Revenue contribution from our large customers during the quarter increased to 67%, up from 62% in the first quarter last year. Digging into our largest customers, we added a record number of net new customers year-over-year spending more than $100,000, $500,000 and $1 million on an annualized basis. We are successfully moving upmarket and becoming a larger and more strategic vendor to more and more of our customers.”

Paying customers grew by 17% YoY to 197,138 and have been growing at a similar rate in the last three quarters.

Cloudflare is reporting 2 million developers on their Workers platform. This is up from “more than a million” in a press release in November of 2023 and is up from 450K developers in May of 2022 per a corporate blog. Per the opening remarks: “The last few months were incredible for the entire workers' ecosystem. First, we crossed over 2 million active developers building applications on Cloudflare Workers. Second, in April, we GA-ed a number of key products like DY, our serverless SQL database; hyperdrive, which makes any traditional database perform like it's globally distributed; and Workers AI, which allows developers to run and tune AI models across our global network.”

Other key points to watch

FY Outlook

Cloudflare has good visibility in various industries since the company is a leading CDN player. Management has been cautious due to macroeconomic uncertainty and geopolitical tension, maintaining the FY 2024 guide of $1.648 billion to $1.652 billion, representing a YoY growth of 27.3% at the midpoint. However, the market expected a rise in the FY 2024 guide, particularly after the strong Q1.

Matthew Prince said in the earnings call, “I feel extremely confident and clear in the long-term opportunity that Cloudflare has in front of us. In the short-term, however, my crystal ball is less clear. We see a lot of signals based on our privileged position running a good chunk of the Internet. Even without that visibility, if you've been watching the news at all, it's clear that the near-term outlook for the world is uncertain, increasing tensions in the Middle East, no end in sight from the Russia-Ukraine war and potential signs of instability in Asia. It's not at all certain on anything we see that things will get worse, but we do know from even recent history that macro factors can impact short-term sales trends.”

During the Q&A, Matthew Prince clarified that they didn’t see a clear signal of a slowdown that they saw in 2022. He described the crystal ball as cloudy. “We see things that worry us, but we also see things that give us some level of optimism. And so, I think describing the crystal ball as cloudy is the right thing.”

Customer wins

The management highlighted strong customer wins during the Q1 earnings. Some of the notable include:

“The National Cyber Security Centre, the UK's technical authority for cyber threats, signed a three-year contract with Cloudflare to deliver its protective domain name service. PDNS protects over 1,400 UK organizations in central government, local government, healthcare and emergency services from malware and cyber threats.”

“A leading technology company expanded their relationship with Cloudflare, signing a three-year, $40 million pool of funds contract, $8.5 million of which are expansion.”

“A large international energy company signed a five-year, $4.5 million contract. This new customer is going all-in with Cloudflare's SASE platform with 6,000 Zero Trust seats along with CASB, DLP, browser isolation, Magic WAN and Magic Firewall.”

Network capex

The company has been efficiently managing capex despite the GPU rollout and benefitting from the uniqueness of its platform to onboard new workloads. Management mentioned that they don’t need capex like the hyperscalers. Matthew Prince highlighted in the earnings call that they sell more high-margin products like Zero Trust and SASE that require lesser capex. They also made the right decision to reserve space, sensing the AI opportunity. The company now only needs to plug the GPU cards into the servers, freeing up the capex to invest in other areas. Also, they note that the inference tasks do not require cutting-edge GPUs that are in short demand, so the company has more flexibility in choosing between different GPU vendors.

Network capex was 8% of the total revenue in Q1 and has been at the same level in the last three quarters. Management expects network capex to be 10% to 12% of revenue in 2024, including the rollout of GPU capacity to every location.

Valuation

The company trades at a P/S ratio of 18.9 and a forward P/S ratio of 16. The average P/S ratio since the company’s listing in September 2019 is 33. We continue to monitor the 20x forward P/S level that ‘best-of-breed’ cloud stocks struggle to maintain, particularly when the macroeconomic conditions worsen.

Conclusion

The company sits in an enviable position for AI inference at the Edge. The developer growth of Workers to 2 million was the highlight in the last earnings report. We continue to monitor the key metrics and the outlook for the year. We liked the management’s response on network capex as it shows they have a strategy. It’s showing up today with cash flows remaining at an acceptable percentage of revenue – although, notably, we want to stay neutral here regarding what the network capex reports in the future and continue to scrutinize cash flow margins.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Recommended Reading:

I/O Fund’s Cloud Q4 2021 Earnings Overview

Posted on by io-fund

Cloud reports in two waves, with the first wave of Q4 earnings ramping this week. Microsoft was the first to report on January 25th, and strength in cloud sales helped the company beat expectations. Specifically, Azure and other cloud services revenue increased 46% YoY in the quarter, which drove consolidated sales growth of 20% YoY, beating topline estimates by 2%. In the analysis that follows, I give a brief overview of the cloud industry and discuss key metrics that investors should be aware of heading into Q4 earnings.

Cloud: Top 10 EV/FWD Revenue Multiples

Below we ranked cloud stocks based on their EV/NTM sales multiples. Snowflake (SNOW) has the highest multiple in the cloud sector, as the cloud platform provider most recently reported accelerating topline growth coupled with improving retention and other key metrics. Snowflake is benefitting from increasing rates of data ingestion in the cloud environment, a secular tailwind that will likely continue to be strong in the near term.

SentinelOne (S), Zscaler (ZS) and Cloudflare (NET) follow Snowflake’s valuation and have been rewarded a relative premium in the cloud category. Each of these companies provides cybersecurity solutions, which is a market that will likely continue to see strong demand as companies increasingly digitize and migrate online. As companies move online, their attack surfaces increase, driving demand for cyber security solutions.

It is noteworthy that cloud valuations have normalized in 2022 following the heightened volatility in financial markets. Nonetheless, these leading cloud companies highlighted below will likely continue to report robust growth in the near term as cloud adoption remains a strong secular tailwind for the foreseeable future.

Cloud: Top 10 Three-month Forward YoY Growth Rates

Below is a chart of forward sales growth expectations for cloud stocks expected to grow the fastest in the upcoming quarter. Bill.com (BILL) is expected to report the fastest growth rate in our cloud universe heading into Q4 earnings at nearly 140% YoY. However, Bill.com recently completed its acquisition of Invoice2go, which impacts the company’s as-presented topline growth rate.

Absent M&A, Bill.com’s sales are still strong and recently grew 78% YoY on an organic basis, up from the 73% YoY organic growth rate in the prior quarter.  Also noteworthy are the differing growth rates between Monday.com and Asana, two work productivity platforms that are both rapidly growing.

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Monday.com is expected to grow sales 75% YoY to $88 million while Asana is expected to grow sales slower at 54% YoY to $105 million in quarterly sales. The next few quarters will likely shed light on which platform is the leading work productivity solution going forward. Strength in enterprise will be a key metric to monitor to gain insight into which company  is the leading work productivity platform.

Top 10 Weekly Share Price Movements

Below is a table of the weekly change in share price for our universe of cloud stocks (week ended 01/21). Markets have been volatile and every cloud stock in our universe was down last week as the Nasdaq declined by 7%. However, there were some relative outperformers, such as Workday (WDAY) and Zuora (ZUO), both of which support back-office operations, and the market may be expecting these companies to perform well given the labor shortage. Furthermore, Anaplan (PLAN), Box (BOX) and Dropbox (DBX) have also outperformed well on a YTD basis, and were up 4%, 2% and 3% relative to the Nasdaq’s 7% YTD decline. Lengthening the timeframe to 1-year and Box has performed the strongest of the three and is up 38% YoY. Likely contributing to its outperformance, Box has reported three consecutive quarters of acceleration topline growth, with sales rising 14% and billings increasing 25% YoY in Q3. The outperformance in billings suggests sales may continue to accelerate, and management guided for Q4 sales to accelerate to 15% YoY.

Top 10 Changes in sales growth estimates – last 90 days

The table below ranks cloud stocks by their topline revisions over the last 90 days. An increase in topline revisions signals that the Street believes that the company will grow faster than initially believed, which can result in outperformance. Confluent (CFLT) has had a 16% topline revisions over the last three-months, which leads cloud stocks. Confluent raised its FY2022 sales guide in November by 8% at the mid-point and also announced a partnership with Alibaba in December, both of which likely contributed to the higher topline estimates. Another standout is New Relic (NEWR), which saw a 9% rise in estimates over the last 90 days, driven by a strong earnings report as the company reported an acceleration in sales and guided for a further acceleration in Q2. New Relic’s shares are up 27% over the last three-months as the company recently revamped its product offering and migrated to a consumption billing model. Time will tell if the recent changes resulted in sustainable growth or if the recent changes provided only a short-term boost to growth.

Update on EV/Fwd revenue multiples:

Overall stats:     

  • Overall cloud forward median:   8x
  • Top 5 cloud forward median:      24x
  • Overall cloud forward average:  10x

EV/FWD SALES:

As shown below, the median and average cloud EV/NTM sales multiple was trending up throughout 2021 but has since corrected in 2022 to levels last seen in early 2020. For instance, the median cloud EV/NTM revenue multiple was 8x in the most recent week, which is below the 9x median cloud multiple in May 2020. Furthermore, the delta between the average and median multiple has narrowed recently as the top valued cloud stocks have had their valuations compress, reducing the distortion on the average calculation. If Q4 growth comes in strong for the cloud category, expectations for forward growth will likely be revised higher, leading to a recovery in valuations.

Top 5 EV/FWD SALES:

In the chart below, we can more clearly see the large dispersion in cloud valuations, as the top 5 premium valued cloud stocks have had their EV/Fwd sales multiples expand since 2020. However, the top 5 valued cloud stocks have had their valuations halved since November. The median cloud stock has also experienced a multiple compression in recent weeks.

EV TO FWD Sales Growth Buckets:

We can further dissect the change in cloud valuations by breaking up the group into high growth (>30%), mid growth (>15% and <30%) and low growth (<15%). The below chart shows the historical valuations for stocks in various growth buckets. Each growth bucket has had their valuations compress since November, with the high growth bucket experiencing the steepest decline. The market may be expecting a deacceleration in growth in the near term, which would explain the correction in high growth valuations. If growth in cloud remains robust in Q4 and estimates come in strong, then valuations may rebound in the next few months. Microsoft’s strong cloud results discussed above suggest that cloud will continue to grow strongly in the near term.

Top EV TO FWD SALES:

The below chart provides a more holistic view of the cloud landscape heading into Q4 earnings, sorted by EV to Fwd revenue multiples. As mentioned above, Snowflake (SNOW) sports a premium multiple, driven in part by its accelerating topline, followed by three cyber security firms: SentinelOne (S), Zscaler (ZS) and Cloudflare (NET). Snowflake’s premium multiple is 380% above the cloud median of 8x, which may be warranted given its triple-digit accelerating topline growth rate.

Growth adjusted EV/Fwd Revenue (EV/Fwd Rev/Fwd Growth)

The last chart is based on EV to FWD sales but also takes into account forward growth expectations. By scaling valuation relative to forward growth, we can more clearly see which companies are cheapest relative to forward growth. A low value in the below chart means that a company is cheap relative to growth. Note that some names may be skewed due to acquisitions. It is interesting to note that Snowflake drops from having a 380% premium valuation relative to the median to a 33% premium after taking into account its strong growth rate. Alteryx and Splunk move to being some of the most expensive cloud stocks once we factor in their forward growth.

Finally, the last table we will be discussing includes aggregate cloud operating metrics. The below table illustrates the median topline growth, margins and FCF generation for the cloud industry. The median growth rate was 36%, and the market expects the median cloud stock to grow sales by 28% YoY in Q4. Gross margins remain robust at over 73% and cashflows are slightly positive at 3% of three-month sales for the median cloud company.  Cloud remains a category exhibiting rapid growth, with strong margins but relatively low cashflows. As the category matures, cashflows will likely materially improve, rewarding investors in the long run.

While cloud valuations have been volatile in recent weeks, the category remains one of the fastest growing areas in the market. The I/O Fund believes in the long-run success of the cloud category, and we remain invested  Find out what the Street is saying about cloud stocks headed into Q4 earnings in our I/O Fund’s Preview of 7 Cloud Stocks for Q4 Earnings.

The I/O Fund is a team of analysts that share their research publicly as they build a portfolio of 30 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here.by clicking here or sign up for our free newsletter here.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.

I/O Fund’s Preview of 7 Cloud Stocks for Q4 Earnings

Posted on by io-fund

IBM released upbeat results recently as the company beat consensus analysts’ revenue estimates by $740 million and adjusted EPS by $0.06. Even though IBM is not a pure-play cloud company, it has increased its focus in the cloud segment to stay in the race. IBM’s cloud revenues increased 16% YoY in Q4 and the results brought some relief to the investors after the recent volatility in the stock market.

On the other hand, Microsoft beat analysts’ revenue estimates by 1.9% and adjusted EPS by 6.9%. Microsoft Cloud revenue grew 32% to $22.1 billion. This is a positive sign for the broader cloud market. The company’s capex has also been strong, suggesting that management believes demand is structural.

Our Cloud companies’ earnings preview includes Dynatrace, Unity Software, JFrog, DigitalOcean, UiPath, Palantir, and BigCommerce. To understand valuations across the cloud companies and how the sector is positioned moving into earnings, please reference our analysis, “I/O Fund’s Cloud Q4 2021 Earnings Overview.”

Dynatrace Inc – Earnings on February 02nd

ARR: Annualized Recurring Revenue

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

The company’s revenue in Q2 FY22 grew 34% YoY to $226.35 million. According to the analysts’ consensus estimates, revenue is expected to grow 28% YoY to $234.6 million in the next quarter. The management has been positive on the long-term growth prospects due to the digital transformation across industries. In the last earnings call, they mentioned that the near-term market expansion opportunities include the U.S. government's investments in cloud platforms.

Barclays analyst Raimo Lenschow has lowered the price target to $65 from $85. He has an Overweight rating. According to the analyst, the main question for software investors in 2022 is not around end demand, as there are "no issues there," but the correct valuation level for the space. "Are we going back to the long-term average, or should software bounce back to the more recent highs given the exciting structural growth profile? We are in the former camp,” says the analyst as he gets a bit cautious on the sector.

Jefferies analyst Brent Thill also lowered the price target to $60 from $75 and has kept the hold rating. He adjusted his targets across the app, infrastructure and security software spaces. “Software underperformed the S&P 500 by 15% in 2021 as overall valuations contracted 10%,” according to Thill, who thinks multiples in the space will continue to compress in 2022 as 80% of software names are expected to decelerate with "digital digestion" happening coming out of the pandemic.

Please note that the I/O Fund may or may not agree with the above financial analysts, yet we objectively report what the Street is saying. You may view our previous analysis of the company below:

3 Different Ways Companies Can Game Their Topline Growth Rates

Podcast with Motley Fool: I’m Bullish on These Trends for 2021

Unity Software Inc – Earnings on February 03rd

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

Unity’s revenue grew by 43% YoY in Q3 and is expected to grow 34% to $295.29M in the next quarter. The company recently completed the acquisition of Weta Digital. Weta is a digital visual effects company known for its work in Lord of the Rings, Avatar, and Wonder Woman. The management believes that the company’s addressable market will increase by about $10 billion from the acquisition.

Piper Sandler analyst Brent Bracelin made an interesting point that the company is an indirect beneficiary of Activision and the Microsoft deal due to its unique position as the leading 3D creator platform for gaming, movies, AR/VR, and metaverse applications. The analyst also believes that Unity can expand its footprint as a 3D creator platform in the coming year.

Stifel analyst J. Parker Lane has initiated coverage of the company with a buy rating and a price target of $190. According to the analyst, “Unity's broad set of solutions has made the company a market leader in the gaming industry and positioned its platform to address emerging use cases in other industry verticals.” Lane further adds, “Additionally, the company's continued investment in research and development, tuck-in acquisitions, and presence in gaming has helped it withstand the headwinds of IDFA and gain market share in a competitive advertising market.”

Read our previous article on the company below:

IPO Round Up

JFrog Ltd – Earnings on February 10th

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

The company’s revenue grew by 38% YoY in Q3 and the consensus analysts’ estimates suggest revenue to grow 36% to $58.1 million in the next quarter. The management expects revenue in the range of $57.5 million to $58.5 million and adjusted earnings per share of break-even to $0.01. For the full year, management expects revenue in the range of $205 million to $206 million, representing a growth of 36% YoY at the mid-point.

Stifel analyst Brad Reback has a buy rating and a $45 price target. He sees the company is well positioned to sustain 30%-plus revenue growth as it leverages its "unique position within the DevSecOps workflow.” He further believes that JFrog has a growing suite of solutions to help customers build, manage, distribute, and secure their respective applications more effectively and efficiently.

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Needham analyst Jack Andrews has a buy rating and a $71 price target. The analyst is positive on its leverage to strong macro demand trends for DevOps tools and practices, expects its key financial metrics to inflect higher. He further believes that the company is trading at a discount to the broader software companies creating a favorable risk/reward. At the time of the writing, the company was trading at 6.0x EV/Fwd revenue multiple.

Read our previous article on the company below:

Tech Growth Earnings Review for Q3 2020 – Part 2

DigitalOcean Inc – Tentative Earnings date is February 15th

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

The company’s shares got listed in March 2021. The stock rose about 30% since its IPO. The consensus analysts’ estimates suggest revenue to grow 36% YoY to $119.02 million. The company’s net dollar retention rate (NDR) has shown improvement from 105% in Q4 20 to 116% in the last quarter. On the other hand, the growth rate has also shown acceleration for three consecutive quarters.

Source: Investor PresentationInvestor Presentation

Source: Investor PresentationInvestor Presentation

William Blair analyst James Breen has initiated coverage of the company with an Outperform rating. He notes, “DigitalOcean is a comprehensive cloud platform designed to simplify cloud infrastructure for developers, start-ups, and small to midsize businesses.” He is also positive on the large and growing addressable market, which is expected to reach $116 billion by 2024.

UiPath Inc – Tentative Earnings date is February 15th

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

UiPath had a successful listing in April 2021. The company’s revenue grew 50% YoY in Q3 and the consensus analysts’ estimates suggest revenue to grow 36% to $283.25M. The company is betting on the robotic process automation market (RPA). According to Precedence Research, the Robotic Process Automation market is expected to reach $23.9 billion by 2030, growing at a compound annual growth rate of 28% from 2021 to 2030.

Oppenheimer analyst Brian Schwartz has upgraded the company to Outperform with a $56 price target. In his opinion, “UiPath as the RPA market leader should benefit from a strong top-line driver with good business efficiency tools demand this year. At the same time, valuation risk has lessened considerably.”  

Wells Fargo analyst Michael Turrin upgraded the company to Overweight with a price target of $60. The analyst sees a "potential tailwind emerging" for the company from a tightening labor market, which he thinks could benefit automation-centric vendors.

Palantir Inc – Tentative Earnings date is February 15th

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

Palantir's revenue grew 36% YoY in Q3 and the consensus analysts estimate revenue to grow 30% to $418.07 million. The company's initial focus was on the government sector. The company's first platform Gotham was mainly built for government operatives in the defense and intelligence sector. The company continues to win deals from the public sector. On the other hand, the commercial revenue segment has also shown strong growth in the past few quarters.

Source: Investor PresentationInvestor Presentation

Jefferies analyst Brent Thill lowered the company’s price target to $24 from $31. He kept a Buy rating on the shares and adjusted his targets across the app, infrastructure, and security software spaces.

Deutsche Bank analyst Brad Zelnick lowered the firm's price target to $18 from $25 and kept a Hold rating on the shares. The analyst is bullish on software industry fundamentals but recommends a balanced approach with greater valuation sensitivity than in recent years.

Read our previous article on the company below:

Q1 Earnings Analysis for Etsy, Square, and Palantir

BigCommerce Inc – Tentative Earnings date is February 18th

ARR: Annual revenue run-rate

Source: YCharts, Earnings Reports, and I/O FundYCharts, Earnings Reports, and I/O Fund

The company’s revenue grew 49% YoY to $59.3 million in Q3. It included $5.9 million from the recently acquired Feedonomics, a data feed optimization platform. The consensus analysts estimate revenue to grow 43% to $61.82 million in the next quarter. Management expects revenue in the range of $61.3 million to $61.7 million, representing a growth of 42% to 43%. The guidance includes expected Feedonomics revenue of $7.1 million to $7.3 million. For the full year, the management expects revenue in the range of $216.2 million to $216.6 million, representing a growth of about 42%.

Needham analyst Scott Berg has been positive on the recent acquisition and also has a bullish stance on the company. In his words, "We came away incrementally more confident in BIGC’s positioning in the market entering 2022 and its growth opportunity upmarket as large organizations look to re-platform from legacy on-prem solutions to a flexible, multi-tenant SaaS platform." He has a buy rating and a price target of $85.

On the other hand, a few other Wall Street analysts have lowered the price target on the company due to overall weak market sentiment. KeyBanc analyst Josh Beck lowered the price target to $40 from $75. Barclays analyst Raimo Lenschow lowered the price target to $36 from $67.

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