Category: Enterprise

Zoom Video: Unique Billing Cycle and WFH Trend

Posted on by io-fund

This report is a 2-for-1 deal with Beth and Bradley both providing an analysis. Please reference Bradley’s Deep Dive on Financials Below.

This one has been especially challenging in terms of price action. Below, I tell you why we continue to hold the stock and added to it after the earnings report. If the market wants to give me a 15 forward P/S on Zoom, I’ll take it.

Growth is “slowing” because we are lapping extraordinary quarters. Zoom’s situation is very different from a company that put up 60%, then 50%, then 40%. I would call that slowing growth while l would call Zoom’s situation “tough comps.” There is an important difference.

When analysts “downgrade” a company yet set the price target comfortably higher than where the stock is trading at, then it’s meaningless because the analyst will be right no matter what happens. If you’re an institutional analyst, finding a way to be right no matter what happens with Zoom is probably a smart idea. The reason is that Zoom is very complicated to predict as management is offering very limited visibility into next year and because Q4 and Q3 are seasonal low quarters due to a unique billing cycle. We discuss the unique billing cycle in detail below.

The 350% revenue growth is a very hard comp to clear because consumers piled into the app unexpectedly. This has placed immense pressure on Zoom’s enterprise segment to carry the growth. Zoom is an enterprise company and the management had no intentions of being popular with consumers. Even now, the company does nothing to grow this segment other than to offer a free and lower priced tier. Zoom’s competition is Teams — not FaceTime.

One of the main reasons we want to continue holding Zoom is that hybrid work-from-home is an important trend for our portfolio. Asana’s growth is participating in this trend and Monday.com is also participating in the productivity tools category with work-from-home tailwinds. When we were down 40% in Asana, the portfolio manager Knox asked about my conviction and I said “we need to have more than Zoom for work-from-home – productivity tools will be winners this year.” The chances this trend wouldn’t carry Asana was low. Now, I’m reiterating “we don’t want to give up on the leader in work-from-home because the trend is not done yet.” On a side note, we will likely revisit Asana OR we will look at Monday.com if these companies get into a buy zone.

According to Gartner, 51% of knowledge workers will be working remotely by the end of 2021 up from 27% of knowledge workers in 2019. Looking forward, Gartner expects that 31% of all workers in the global workforce will be a mix of remote and hybrid with the United States at 53% of its workforce – in other words, not only knowledge workers. The senior research director who worked on the report stated, “Through 2024, organizations will be forced to bring forward digital business transformation plans by at least five years. Those plans will have to adapt to a post-COVID-19 world that involves permanently higher adoption of remote work and digital touchpoints.”

There are 3.3. billion workers in the world, which works out to about 1 billion remote workers.

Here's what is important to consider. On one hand, you could say that Zoom has 50% of the TAM already at more than 500 million users. However, those were many free accounts in the online segment. Instead, it’s important to consider that Zoom has substantial brand awareness yet only has 20% of the Global Fortune 2000.

Regarding productivity tools, Gartner reports 80% of workers are using collaboration tools for work, up from roughly half in 2019. Here’s the main statistic we think adds to our bull case: “Specifically, the use of meeting solutions surged during the pandemic. While workers globally reported that they spent, on average, 63% of their meeting time in-person in 2019, that number dropped to 33% by 2021 as more meetings took place over audio and video-enabled meeting solutions. The shift away from in-person meetings is expected to continue. Gartner predicts that by 2024, in-person meetings will drop from 60% of enterprise meetings to 25%, driven by remote work and changing workforce demographics.”remote work and changing workforce demographics.”

The good news is that Zoom is an enterprise product and always will be so this statistic directly applies (“enterprise meetings”). The consumer or online segment has distracted the market from the company’s core enterprise focus. Even today, Zoom is not attempting to expand on the consumer side or capture any market share here yet Wall Street has deeply discounted based on the drop-off in this segment. I discussed why this reminds me of when the market was deeply discounting Nvidia for fall-off in crypto mining in 2018 when I openly and consistently said crypto mining is not Nvidia’s thesis – rather the story is AI acceleration in the data center segment. Nvidia struggled to keep up with tough comps in Q4 2018 after crypto mining unexpectedly drove record revenue.

Zoom must execute on the enterprise side but there’s no reason in the recent earnings report to think they won’t. Meanwhile, the market is concerned over the wrong part of the story. Let’s talk about Q3 and Q4 specifically.

Why Q4 is Lower

An important factor as to why Zoom has reported lower third quarter (35%) and also low fourth quarter revenue guidance (19%) is because enterprise revenue is billed in Q1 and deferred revenue and billings are lower as the year continues.

So, how did Zoom put up its biggest quarters during Covid in Q3 and Q4? Well, it’s because consumers were piling in and paying monthly. This places Zoom in a predicament because enterprise is where the growth is coming from (and should be coming from) but the billing cycle means enterprise revenue is very weak in the second half at the very point in time that Zoom has high comps to clear.

The analysts covering the stock point towards lower deferred revenue growth as a concern, yet this is also front half-weighted.

“Turning to the balance sheet. Deferred revenue at the end of the period was one point two billion dollars, up thirty nine percent year over year from eight fifty five million dollars, and slightly up quarter over quarter. Looking at Q4, we expect the year-over-year growth rate in deferred revenue to be in the mid twenty. This is driven by the cyclical decline in the average remaining term of our annual customer contracts, which are front-half weighted.”This is driven by the cyclical decline in the average remaining term of our annual customer contracts, which are front-half weighted.”

There was a question from a financial analyst who covers Zoom and yet was not clear on this point. I’ve included the transcript below. I think it’s important to put into context what is contributing to the slower Q4 growth. Candidly, I find it strange that the analyst had to ask again as it’s pretty clear what management is saying. The last analysis I/O Fund published discussed this here when we said: “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.”

Here's the earnings call transcript:

Kyle Keirstead, UBS

“39:21 Okay, Great. Maybe Kelly, metrics like deferred revenues and RPO are certainly not the most important to watch with Zoom, but they can be indicative of changes in the business, so it's still important to keep an eye on them. And you made some color about DR and RPO next quarter that I'd love if you could elaborate. I think on DR you mentioned that it'll grow mid-twenties due to a cyclical decline in average remaining term of annual contracts. I'm not sure I totally understand what that means. So I'd love to ask for a clarification. And then likely as well on RPO, you mentioned that we would see a shift back to long term plans. I'm wondering if you could elaborate on that as well. Thanks so much.”

“40:05 Yes. So for deferred revenue, there's two things to remember, which is the seasonality trend of our renewal is that Q1 is the largest quarter for renewals and Q4 is the lowest. So, in terms of new deferred coming on to the books, Q4 is the lowest quarter because of that, as well as the fact that Q1 is the largest quarter when deferred gets out of the balance sheet, but they are annual contracts, by the time you get to Q4 most of that has already been amortized and recognized. There is only twenty five percent of it in theory about left when you come into the quarter. So the combination of the fact that anything added in Q1 is almost fully amortized and will get refilled and renewed back in Q1. And the fact that Q4 is the lowest renewal quarter, those two things are what's driving this trend of renewals. — Sorry, of deferred, which I know is probably counter intuitive to any other company that you see because of the seasonality that we have.”

Karl Keirstead

41:25 Yes. And so the fact that DR growth would slow to mid-twenties is due to what?

Kelly Steckelberg

41:30 It's due to the fact that Q4 is our lowest renewal period as well as all those annual renewals that came on in Q1, which is the biggest quarter are now almost fully amortized and recognized.

Kelly Steckelberg

41:49 And then this has a strong impact on billings and RPO as well, because the same thing like they are adding to the building of the collections are happening earlier in the quarter and the remaining term is being amortized throughout the year, so there is — it's the short amount of contract left during Q4.

The goal of my analysis is not to sugarcoat the slowing growth in the consumer or online segment that is billed monthly. That growth is slowing – no argument here. Rather it’s to help put into context that the 19% growth is not reflective of enterprise growth. Zoom is and always will be an enterprise story. In fact, the company is so ambitious at the enterprise-level that its goal is to disrupt traditional telecom with cloud communications.

Let’s Talk About the Enterprise Segment

Zoom is returning to an enterprise story with strong growth in customers that spend over $100K. The growth in this segment is higher than pre-pandemic levels at 94% year-over-year. This is on a high base, as well. The law of large numbers states it’s much harder to grow 94% YoY on a base of 1289 customers (2021) than to grow 86% on a base of about 350 customers (2019). The acceleration here is impressive if we remove 2020 as an anomaly and on top of the strong 2020 base.

When you separate the segment of under 10 employees, we can see the effects Covid had on the company with the current quarter being the highest hurdle to clear at 485% growth in the year-ago quarter although Q4 is not much easier to clear in terms of comps with 470% growth. To be honest, the fact the growth isn’t negative in this segment is a miracle. It seems preposterous that any consumer would be getting on Zoom for the first time 18 months into the pandemic – meaning negative growth would be logical. Of course, the growth is probably small teams creating accounts. Don’t forget that any churn in free accounts like K-12 don’t affect revenue growth.

Notably, we are going through a hard stretch for enterprise account growth in terms of comps with 156% growth and 160% growth to clear from the year-ago quarter of Q4 and Q1. The last two quarters Zoom has done an excellent job of maintaining and pacing growth here. I’m expecting Q4 to be lower in enterprise growth while hoping Q1 will resume strength again here.

What was Zoom’s valuation when it was fully understood to be an enterprise story? At its lowest point, it was at 30 P/S and at its highest point it was at 60 P/S in 2019. Once we lap the consumer growth and clear it out, which is weighing on Zoom’s enterprise story, then we should see these valuations again.

The I/O Fund thinks Zoom is oversold at these levels.

Bradley also pointed out on the forum that enterprise is showing strength in long-term deferred revenue, which grew 30% year-over-year compared to 26% growth in the year-ago period. This could be a return-to-normal after concessions were made during Covid (Datadog also moving in this direction), yet it shows strength to lengthen a contract period. He does a deep dive on the financials below.

The one thing that bothers me about the Zoom earnings report this quarter is the Zoom Phone Acceleration slide disappeared as did the numbers for account growth over $1 million. This could indicate the company is not disclosing the growth rates because they were weaker than expected. This is what we got last quarter that was missing from this quarter’s presentation:

Does Zoom Have a Catalyst on the Horizon?

The catalyst for Zoom remains the transition to hybrid and remote work. What makes a market is demand and Gartner predicts strong demand through 2024. Zoom Phone also remains a catalyst with one analyst on the call pointing towards the addressable market of 400 million business phones on legacy technology. AR/VR is a catalyst as Zoom will likely release an avatar and other augmented features. You likely saw that Facebook “Meta” is now integrated with Teams. There are technically integrations already with Zoom and Meta, as well, and Facebook worked with Zoom on Portal. As you know, I don’t think Facebook is actually leader in this space and Zoom could easily acquire a startup for avatars or AR/VR features. Hybrid events is another catalyst that we’ve covered in the past on our LTBH webinar.

Bringing video to the contact center as the video engagement center is not something I would shrug off although it does require more time to build a solid solution. Zoom is also spending its cash to encourage developers to build on its platform, which is a tried-and-true approach to innovation.

Where this Leaves Zoom Investors

There is certainly some suspense here as there is no visibility into Q1 at this time. Q4 tells us essentially nothing about how Q1 will perform. Again, this is partly due to the unique billing cycle and partly due to unusually high comps this year. Management is not willing to discuss guidance more than a quarter out. The combination of tough comps and seasonally low Q3 and low Q4 has beat up the price quite a bit. I/O Fund is willing to wait another quarter as the guidance for Q1 will start to show us what post-Covid Zoom truly looks like.

Deep Dive into Financials

By Bradley Cipriano

Zoom’s Q3 sales increased 35% YoY to $1.050 billion, which came in ahead of the Street’s estimate by $31 million (3%). Q3 also marked the 14th consecutive quarter that sales increased on a sequential basis. It is impressive that Zoom has been able to continue to grow sales every quarter even after its blockbuster 2020 results. Looking forward, management raised their guidance and now expects that total FY2022 sales will increase by ~54% YoY to $4.080 billion at the mid-point, which also implies another quarter of sequential growth.

Management also provided guidance for bookings, which is a key metric used by investors to gauge the sustainability of future topline growth. On the call, CFO Kelly Steckelberg stated that the company expects deferred revenue to increase around “mid-twenty” percent YoY in Q4. This implies a bookings growth rate of just 7%, which seems low, but is due to tough comps as bookings had increased 320% YoY in Q2 FY2021. Furthermore, the company’s bookings have become more seasonal and are now front-loaded to the beginning of the year. As a result, Q4 bookings will be relatively depressed while Q1 FY2023 bookings will be more robust. Nonetheless, the relatively low bookings guide may have spooked investors.

The soft bookings guide was offset with strong trends in RPO and net deferred revenue. RPO represents contracted sales that have yet to be fulfilled and can be used as a proxy for forward growth. RPO increased 51% YoY to $2.5 billion, while RPO to be completed in the NTM increased 39% YoY to $1.6 billion. Stated differently, long-term RPO increased 80% YoY to $821 million, which highlights Zoom’s strength with enterprise customers. Enterprise customers signing long-term deals is a favorable trend as it showcases their commitment to Zoom’s products. We can also see this in deferred revenue trends, as long-term deferred revenue increased 30% YoY, the fastest pace of growth since Q2 2020.

However, despite the strength in enterprise, small customer accounts do represent a headwind to growth in the near term. CFO Steckelberg explained on the Q3 call that small/online accounts represent a headwind that has been incorporated into the Q4 guide. She added that online churn in Q3 performed better than they had initially expected at the beginning of the year, but that online/small accounts are more impacted by the holidays than enterprise customers, leading to temporary increases in churn. This churn should reverse in FY2023, leading to stronger growth in future quarters. Furthermore, small accounts fell YoY from 38% of total sales to 34% of total sales in Q3, highlighting that this customer cohort is not as significant as enterprise customer strength.

Even with these temporary churn headwinds, forward looking metrics remain strong. For example, the growth in NTM RPO was also strong and grew 39% YoY and NTM RPO represented 38% of next twelve-month sales, up 751 bps YoY. The increase in NTM RPO as a percentage of forward sales signals that Zoom has more contractual support for future sales, which improves the quality of forward growth (Zoom is more likely to meet or exceed its sales targets).

Trends in deferred revenue also highlight the quality of recently reported sales. Net deferred revenue (which is total deferred revenue less accounts receivables) increased 41% YoY to $808 million, which was faster than the 35% YoY increase in sales. Looking forward, net deferred revenue represents 27% of NTM sales, which is up 309 bps YoY. The increase in net deferred revenue provides balance sheet support for future sales, which improves the quality of forward sales growth. So, while bookings may be slowing, the quality of the company’s forward sales is improving. In our opinion, analysts are likely being conservative with their forward sales estimates.

Continuing down the income statement, gross margin increased 750 bps YoY to 74%, while non-GAAP gross margin increased 774 bps YoY to 76%. Non-GAAP R&D and S&M expense margin increased 320 bps and 444 bps YoY to 6.4% and 22.6%, respectively, while non-GAAP G&A expense declined 163 bps YoY to 7.8%. It is great to see that management has kept G&A under control despite the surge in sales during the last two years. Following these trends, non-GAAP operating margin increased 173 bps YoY to 39.1%, and non-GAAP EPS also increased 12% YoY to $1.11, which beat by $0.02.

Finally, cashflows also remained robust during the year. In the LTM, free cashflow increased 60% YoY to $1.7 billion, which followed a 1,019% YoY increase in the prior year quarter. Relative to TTM sales, TTM FCF margin fell 1,063 bps YoY to 42%, but this remained well above the pre-covid levels of 17% (in Q3 FY20). Zoom’s valuation also does not appear to correctly reflect the company’s strong cashflows. As shown below, Zoom’s EV/FCF metric is well below other SaaS peers, yet Zoom is growing nearly 2x as fast as the peer median.

In all, Zoom beat top and bottom -line estimates and raised its sales guide for FY2022. However, trends in bookings may have spooked investors as they are expected to grow just 7% YoY next quarter, which could signal that sales may slow down in FY2023. However, this is offset with a rise in both contractual and balance sheet support for future sales as NTM RPO and net deferred revenue increased YoY relative to forward sales estimates. This increase in support for future sales improves the quality of forward estimates and suggests that sales estimates are conservative. Furthermore, gross and operating margins improved YoY while cashflows remained robust and increased YoY despite tough comps. Zoom remains a high-quality company with strong growth and cashflows and also appears to be undervalued relative to other SaaS companies.

New LTBH Position: Stars are Aligning for Palantir

Posted on by io-fund

A few notes before we look at Palantir:

  • We are looking to close Atomera and will look to get back in when the timing is better. We feel the message in the earnings call is that during supply shortages, things are moving slowly for Atomera. Meanwhile, small caps are looking like they could break out (follow Knox on the forum and on webinars) and we prefer to put our money elsewhere for now. Atomera could still move but we have to make these decisions to keep the portfolio at a reasonable size.
  • There’s a chance we re-enter Vuzix as small caps are starting to break out. Knox might be seeing a setup he wants to take and the company had some good quarters in the past. Note: this is likely good news for many small caps, not only the ones we own.
  • Confluent is a strong company. We stepped aside until the lockup expires as a matter of discipline. Look for us to put MongoDB in the LTBH portfolio and Confluent at some point, as well. We are encouraged by cloud results so far this earnings season (so far, so good).

Palantir Analysis:

We break down Palantir’s product below and we believe the Apollo layer is especially interesting, competitively speaking. We also point out that government contracts will likely boost the company’s revenue in the near term. The Obama Administration used Palantir for many government projects and we believe the Biden Administration is a tailwind for the company in the near-term. With a company that is two-thirds deal value from the government, this piece cannot be ignored.

The company has as many risks as opportunities. We go through those risks below, mainly the price of the product, the unusually high stock based compensation, widespread ethical concerns (for 10+ years), and more agile AI/ML competitors sprouting up to compete for commercialized accounts. Due to these risks, we may not hold for the 3-5 year time frame that we typically target, rather are entering as a LTBH for the 6-month to 1-year tailwinds that we are expecting from increased government spending. This is distinguished from momentum positions that are often higher beta and/or moving in price. In this case, we think Palantir being off 50% from its all-time high of 39.00 does not reflect the current tailwinds from the government segment. We are encouraged by the commercial growth, as well, but it’s the government spending in the near-term that could cause a material change to the story. The upcoming earnings report will tell us more.

Palantir has two platforms: Gotham and Foundry. There is a layer between the two platforms and applications called Apollo. The Apollo layer is where innovation has been rapidly occurring and helps contribute to Palantir’s competitive edge (more on this below).

Gotham and Foundry create a unified data set for actionable insights across industries such as manufacturing, product development, and customer experience. The data that Palantir gets is from the customer database although the company may use other data sets for government customers, such as scraping social media or other publicly available information on the web. The traditional deployment includes hosting Palantir’s servers in a customer’s data center.

The difference between Palantir and competitors, such as Tableau, Alteryx or Cloudera is that Palantir is able to answer questions a model cannot answer. Traditional business intelligence companies require a complete data set whereas Palantir is able to tackle situations where there is not a complete data set.

Palantir Gotham was the company’s first platform, built for government operatives in defense and intelligence sectors. The platform enables users to identify patterns hidden deep within datasets using semantic, temporal, geospatial and full-text analysis.

The Graph product allows data to be seen as nodes and edges to visualize and plot characteristics in a logical manner.

Map brings geospatial capabilities to track geo-located objects and events and to create heatmaps for the density of the objects.

Object Explorer is powered by the Horizon in-memory database, which competes with Apache Spark for letting users query billions of objects. The data provides further analysis for Map and Graph data.

Browser: This enables search queries for investigations and surfaces information, runs relevant searches, displays key data points and answers analytical questions.

Palantir Foundry is the commercial offering and has four layers of tooling: Foundry Core, Data Foundation, Ontology and Workflows. 

This four-step process does the following:

  1. brings volumes of data into one place,
  2. transforms the data into a format that analysts can work with and enables validation in a number of programming languages
  3. the “ontology layer” allows datasets to be turned into real-world concepts
  4. workflows is where it all comes together in an integrated environment for object exploration, point-and-click top down analysis, code authoring, time series analysis, data science and application development. When a user has a question, it answers it using all layers and tools available.

Palantir describes Gotham and Foundry as the “ability to construct a model of the real world from countless data points.” Unlike a SQL database, natural language is used to query data and return results in real-time rather than through strings.

Apollo is the Linchpin:

The company has a third platform or layer called Apollo and also Apollo for Edge AI. This product provides continuous delivery and an automated configuration layer that allows Foundry and Gotham to work across all cloud environments and also in places where there is little to no connectivity. On top of Palantir being able to form conclusions from incomplete data sets, the company can also deploy its platform and applications anywhere.

Palantir’s marketing team says Apollo “goes where no SaaS has gone before” because it allows what is done on-premise to also run on multi-cloud SaaS with code that is deployed across all environments rather than written for a specific environment. The orchestration allows for on-hardware AI models to consume real-time data from sensors, radio, geo-data and time series data. Where bandwidth is not an issue, the company transmits all raw inputs and enriched metadata from models. Where there are constraints, the platform transmits meta-data only which can reduce bitrate by 20X. At times, a simulated environment can be created with Palantir’s Edge AI from historical data to help train AI models. The simulated environment is then deployed at the edge. With Apollo, Palantir’s centralized operations team is capable of 41,000 updates per week at no additional cost.

Apollo Edge AI links together satellites to lower latency for the AI-enabled decision chain by orchestrating up to 237 satellites in what the company is calling a “meta-constellation.” This meta-constellation optimizes hundreds of orbital sensors and AI models to power Palantir’s models. One example they provide is tracking submarines that pose a threat to the U.S. and its allies. In this case, submarines are being tracked on a granular level in areas where there is no bandwidth available. These are the kinds of obstacles that Palantir overcomes while being independent of one cloud environment, such as AWS or Azure.

Financials:

Palantir is growing its annual revenue of roughly $1 billion by 50% for estimates of $1.5 billion in 2021. This looks like it will be accomplished with the last two quarters at revenue growth of 49% year-over-year growth. Current estimates for Palantir in the upcoming quarter are at $386.53 million, or growth of 33.5%. To me, these estimates seem low considering the commercial growth the company has been posting. On top of revenue > $1 billion and growth > 40%, Palantir is free cash flow positive with a 13% adjusted free cash flow margin and adjusted EPS of $0.04.

The main metric for Palantir is commercial revenue, which has accelerated nicely over the past few quarters. In the last quarter, commercial revenue grew 90% year-over-year. The company is also adding commercial customers faster than overall customers at 32% compared to 13% for total customers. In the quarter ending in March, the company reported revenue growth of 72% year-over-year. This was slightly lower than government revenue growth of 83% YoY.

The company also grew total contract value booked from $337 million to $925 million, although this is a mix of both government and commercial contracts. According to the fine print, the maximum potential revenue from commercial contracts is $348 million and an additional $195 million in commercial contracts that are subject to negotiation and approval.

The deal value also increased 63% to $3.4 billion, however, of this $428 million comes from commercial contracts and $195 million comes from commercial contracts currently under negotiation. Therefore, the majority of the deal value increase came from the government.

For FY 2021, the company plans to double its adjusted free cash flow in the upcoming quarter from $150 million to $300 million.

Stock Based Compensation:

Palantir has some of the highest rates of SBC in the cloud universe. Over the last twelve months, SBC was 114% of sales, which is well above the peer median of ~18%. The issuance of SBC is dilutive to shareholders and can weigh on the share price in the near term. However, Palantir recently completed its IPO, which is typically a period of outsized stock-based compensation.

Looking forward, Palantir’s rate of SBC will likely normalize to a more sustainable rate, which will lessen the impact of dilution and should benefit shareholders going forward.

A key benefit of high SBC is that employees become owners in the company and have a vested interest in the company’s success, which can even help reduce turnover and improve productivity. The biggest concern Bradley sees with high rates of SBC is if the SBC is repurchased via stock buybacks but is still excluded from adjusted EBITDA and earnings. This accounting trick can cosmetically improve the presentation of profitability by excluding payroll expense from non-GAAP metrics. However, Palantir does not appear to be playing these games, as it has not repurchased any stock during the year.

Catalysts:

Some real-world uses for Palantir include Hershey’s using the software for global food distribution and to correlate weather patterns with snack consumption. Chase Bank and other financial firms have used Palantir’s data analysis to identify troubled properties and ensure employees are not committing fraud (and in turn, the management team was actually spied on instead).

Pharmaceutical companies use Palantir to expedite the development of new drugs – this being a substantial use case during Covid and partly why Palantir’s revenue has accelerated. In the last earnings report, Palantir discussed companies leveraging Palantir’s software for R&D and manufacturing to accelerate development. The software helps health care data be shared to share trial data.

Utility companies use Palantir to monitor equipment, such as to monitor equipment in mining shafts or for grid management and safety. The powerlines from PG&E in California created wildfires and experience ongoing power outages during heavy winds. PG&E partnered with Palantir in early 2021 to help assess where the most danger is for power shutoffs and for wildfire risk assessments.

Climate change initiatives coming from the government will also be a tailwind for Palantir as the company’s software is used to help companies de-carbonize and achieve low carbon footprints. The more spent here, the more Palantir will see additional tailwinds.

DataRobot is a popular company used for unifying data for AI and they are partnered with Palantir to help forecast demand.

As stated, Palantir was first hired by Obama for border patrol with the New York Times reporting “Palantir’s technology was used extensively by the Obama Administration.” It is not clear as to whether the Trump Administration used Palantir or if the agencies, such as the FBI and CIA did during the years the Trump Administration was in Office. In other words, I am not sure if Palantir is bipartisan or not but my understanding is the company saw more government contracts during Obama and now Biden. We also saw Biden place a former Palantir advisor as the director of national intelligence. The DNC is headquartered in Denver and the company recently moved to this city. Alex Karp attempted to state sensational reasons for this move, which I called out as simply creating headlines. I believe the move was strategic for Palantir to be closer to the money.

Risks:

The closest competitor for Palantir is Semantic AI, which supplies graph-based analytical platforms to the DoD and other government agencies. There will likely be more competitors in the near future as the AI/ML market is built out. For instance, there is energy-specific software such as Stem that uses AI software to optimize energy resources and battery usage by using algorithms to issue forecasts that then work across the grid, batteries and solar for optimal output. Stem claims to have taken over 100 energy storage systems that were previously managed by competitors and is also used across Big Tech, such as Facebook, Amazon, Apple and Home Depot. In this case, one could argue Stem serves the commercial market whereas Palantir is more suited for larger utility companies due to its government-sized solution. Essentially, the risk is that Palantir could be “too much product” for commercialized companies that prefer a simple solution. You can read our analysis regarding Stem here.

Tiberius is a database used for administering the Covid vaccine. USA Today reported complaints from a few healthcare agencies that Tiberius was often wrong and did not improve results compared to their own in-house databases.

Palantir greatly centralizes datasets and AI/ML — which is a risk. You’ve likely read my analysis on the Blockchain is Going to Eat the Internet and why decentralization is important. Using Palantir for defense is one thing, but now that Palantir is beginning to move into other industries, the blurring of the lines as to where the government ends and the free market begins is problematic with a company like Palantir. Palantir’s greater loyalty will be with the government (it’s biggest customer) yet their software is now inside company databases. The United States tends to prefer a separation across government bodies whether it’s church/state or state/federal or judicial/executive/legislative, when possible. What Palantir is proposing is that a heavily government-funded company be the middleman.

What affect could this have? Already, Palantir has been used to hunt down illegal immigrants and to enter their homes for arrests. This article is worth a read for more information. Uber has been in a string of never-ending lawsuits over the independent contractor/employee debates – another human rights issue that a tech company faced. These lawsuits threaten Uber’s business model, and even after getting the measure on a ballot which passed in California, the class action lawsuits are still ongoing after the State of California decided to sue the company. We predicted this would be troublesome long-term for Uber as part of our bear thesis at the time of IPO. As Palantir moves outside the government, I expect we could see some States and non-profits fight the company on the use of its software. There is a history of non-profits, such as Amnesty International, calling out Palantir on how the software is used in terms of targeting specific individuals. The bigger Palantir gets, the more the public and critics will see how powerful (and invasive) the software can be. As of now, Palantir has chosen to target illegal immigrants who can’t bring a class action lawsuit – hence non-profits stepping in. If the company were to target United States citizens, I would fully expect lawsuits to pop up.

To help illustrate, the week Palantir went public, Hootsuite stated the company would terminate its ICE contract due to disagreements within the company. The CEO of Hootsuite tweeted: “We typically do not make public facing statements about specific customers or contracts. However, due to the attention around this particular case we can confirm that Hootsuite has decided not to do business with the U.S. Immigration and Customs Enforcement.” Tech companies often see employees engage in protests when a company contracts with the government on AI-driven war missions and privacy issues.

In the past, Google ended a contract with the Pentagon when employees protested using AI for lethal purposes. Karp became controversial and challenged Google on this decision, saying it was a “loser” position. Palantir could become subject to competing for talent with companies that are more privacy-compliant or viewed as being more ethical. Here’s an example about how they describe their hiring process: “We spend time thinking about exactly what gamma radiation your incoming Bruce Banner needs to turn into the Incredible Hulk. And then we irradiate them.” The hyperbolic description of using “gamma radiation” is likely just the stock-based compensation.

Conclusion:

The stars (and satellites) are aligning for Palantir, and with government spending, it has the ingredients to become a stock market darling if the revenue accelerates. The product is often framed as captivating and the company will likely sell Wall Street on commercial growth. Regardless, the ethical issues can mire the company long-term, and at its core, Palantir is still a government contractor. We are more likely to be 3-10 year bulls for decentralized blockchain companies that handle data in privacy compliant ways over a heavily centralized company. However, for the sake of the current tailwinds, we have entered the stock and added it to our LTBH portfolio.

I/O Fund’s Cloud Q3 2021 Earnings Overview

Posted on by io-fund

In the analysis below, we give a brief overview of our universe of cloud stocks and discuss key metrics that investors should be aware of heading into Q3 earnings.

Cloud Stocks: Top 10 EV/FWD Revenue Multiples

Below is a table of cloud stocks ranked by their EV/FWD sales multiples, along with their most recent YoY growth rate, gross and free cashflow (FCF) margins. Cloud has been a strong category for growth recently, which has rewarded the top performers with premium multiples

Cloudflare (NET) has the highest EV/FWD sales multiple in our universe of cloud stocks. The company has made some announcements around object storage costs recently, which could be impactful for the company going forward.

Snowflake is right behind Cloudflare at a 91x EV/FWD Revenue multiple. Snowflake grew sales over 100% in Q2, and its net revenue retention rate was 169% during the quarter, highlighting the company’s success in capturing market share. Management attributed the strong results to increased customer data consumption, a trend that will likely continue into the future.

Cloud Stocks: Top 10 Three-month Forward YoY Growth Rates

Looking forward, Bill.com (BILL) and Snowflake are expected to be the fastest growing cloud stocks in our universe. BILL’s expected growth rate is skewed by its recent acquisition of Divvy, and excluding the acquisition, organic growth is expected to be ~60% next quarter. Snowflake is expected to continue to report strong growth of 92%, similar to the 104% growth it reported in the most recent quarter. As mentioned above, Snowflake is benefitting from a secular tailwinds as enterprises increase their data consumption.

Top 10 Weekly Share Price Movements

In the table below, we ranked the cloud stocks that saw the largest one week increase in their share price. Shopify (SHOP) has been a top performer this past week, as the stock rebounded after a slight sell-off following its Q3 results. Microsoft (MSFT) also reported last week and the market reacted by increasing its market cap to $2.5T, surpassing Apple as the most valuable company in the world.

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The I/O Fund has covered Microsoft in detail since 2018 when Beth explained Microsoft’s hybrid strategy when she boldly stated that Azure could overtake AWS on cloud IaaS. Microsoft’s hybrid cloud approach has allowed the company to outperform its peers and positions Microsoft well to continue to take share in the hyper-growth cloud market.

Top 10 Changes in sales growth estimates – last 90 days

The table below ranks the cloud companies that have had the largest revisions to their forward topline growth expectations over the last 90 days. As mentioned above, Bill.com (BILL) recently completed a series of acquisitions which contributed to an outsized increase in its sales expectations. Similarly, Qualtrics (XM) recently completed its acquisition of Clarabridge, which has led to an upward adjustment in its growth rate. Datadog’s (DDOG) estimates have increased 9% over the last 90 days and its stock price has also increased nearly 50% over the same time period. The market is likely pricing in strong growth for the company as Datadog continues to lead in the cloud observability category.

Update on EV/Fwd revenue multiples:Update on EV/Fwd revenue multiples:

Overall stats:

  • Overall Cloud forward median:  16x
  • Top 5 Cloud forward median:  65x
  • Overall Cloud forward average:  22x

EV/FWD SALES:

As shown below, the median and average cloud EV/Fwd revenue multiple has trended up throughout the year. The average multiple has started to increase faster than the median, as the top valued cloud companies have experienced a sharp rise in their multiples in recent months.

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 rapidly expand since May 2021 and are now at new highs. The cloud category is often considered to a be a “winner gets most” market, where the market leader captures the majority of the addressable market. This dynamic helps explain why the top 5 valued cloud stocks have grown their multiples much faster than the median.

EV TO FWD SALES Growth Buckets:

We can further dissect the changes in cloud valuations by breaking up the group into high growth (>30% growth), mid growth (>15% and <30%) and low growth (<15%). The below chart shows that higher growth cloud stocks receive a higher multiple from the Street. Furthermore, high growth stocks used to be valued more richly back in Q4 2020 but have since seen their valuations normalize to a lower multiple. If Q3 cloud earnings come in strong, then the market may push valuations back up to their historic highs.

Top 30 EV TO FWD SALES:

The below chart provides a more holistic view of the top 30 valued cloud stocks based on EV to Fwd revenue estimates. Cloudflare (NET) and Snowflake (SNOW) have the highest valuations of the group and are valued more than 500% higher than the cloud median of 15x. As mentioned above, NET and SNOW are benefitting from trends that are expected to continue to result in robust growth going forward, such as cloud storage costs and data consumption. 

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 chart below means that a company is cheap relative to growth. For example, SNOW dropped from being one of the most expensive stocks to being valued closer to the median once we take into account its strong growth expected next quarter.

Finally, the last table we will be discussing includes aggregate cloud operating metrics. The below table shows that cloud is performing strongly as the median forward growth rate is above 20%, while gross margins are high at over 70%. The median cloud company is also FCF positive with a 6% FCF margin.

Strong growth and positive cashflows signal that the cloud category is healthy and performing well. The I/O Fund expects this strength to continue going forward. Find out which the Street has been saying about cloud stocks heading into earnings. “Overview of 6 Cloud Stocks for Q3 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.premium service 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 Overview 6 Cloud Stocks for Q3 Earnings

Posted on by io-fund

Cloud stocks continue to do well in the market as these companies are growing very fast. This quarter we chose Cloudflare, Datadog, Dropbox, Bill.com, Five9, and RingCentral with some already reporting today and some reporting soon.

To understand valuations across cloud stocks and how the sector is positioned, please refer to our analysis “I/O Fund’s Cloud Q3 2021 Earnings Overview”

Cloudflare Inc – Earnings on November 04

Cloudflare’s Q3 sales grew 51% YoY to $172 million, which beat the consensus estimate of $166 million by 4%. The company also expects Q4 sales to grow 47% YoY to $185 million, which is 5% higher than the Street’s initial forecast of $176 million.

Source: Earnings report and YCharts

Cloudflare’s revenue grew from $85M in 2016 to $431M in the year 2020, a compounded annual growth rate of 50% during the period. In the second quarter revenue grew 53% YoY to $152M, it was primarily helped by the strong growth in paying customers. At the end of the second quarter, it had 126,735 paying customers (+32% YoY) and it also witnessed a significant addition of large customers. This growth continued into Q3 as Cloudflare beat topline estimates by 4% after reporting strong YoY sales growth of 51% during the quarter.

Going into earning, Jefferies analyst Brent Thill had downgraded the company to a hold rating from a buy with a price target of $195. The analyst is concerned of the valuation after the strong share gains. However, he continues to view Cloudflare as the "most disruptive cyber vendor with strong fundamentals," he is of the view that “the company has the richest multiple in his coverage universe at 56 times enterprise value to consensus 2023 revenue estimates” and he "would look to get more constructive at a more reasonable valuation."

Needham analyst Alex Henderson has said that the company’s move into email security as a positive. He says “just one more example of why Cloudflare will become a major company.”

Please note, the I/O Fund is objectively reporting what the Street is saying. We covered Cloudflare previously here: Pinterest and Snap Show V-Shaped Recovery; Cloudflare Guns for Zero-Trust

Datadog Inc reports on November 04th

Datadog reported that Q3 sales grew 75% YoY to $270 million, which bested the consensus estimate of $248 million by 9%. The company expects Q4 sales to grow 64% YoY to $291 million, which is 10% higher than initial expectations.

Source: Earnings report and YCharts

In the prior quarter of Q2, Datadog reported strong second quarter results. It beat the analyst’s revenue estimates by $21M and the adjusted earnings by $0.06. The company had also raised the full-year revenue guidance to $938M-$944M, up from the previous guidance of $880M-$890M. Datadog continued this momentum and reported a 9% top line beat during Q3 and guided Q4 sales 10% higher than initially expected.

It also witnessed strong growth of large customers (annual recurring revenue of over $100,000) as they grew to 1,610 from 1,015 from the same period last year in Q2. This quarter, large customers grew to 1,800, up 66% from 1,082 in the prior year quarter.

RBC Capital analyst Matthew Hedberg has raised the company’s price target to $176 from $154 and has kept the Sector Perform rating on the shares. The analyst expects the company to report "strong" Q3 results with upside, building off last quarter's acceleration. The analyst adds that he expects Datadog to continue to benefit from continued traction in multi-module sales, strong new customer adds, and favorable cloud adoption trends.

Our previous analysis on the company:

Podcast with Motley Fool: Big Tech Plus the 1 Stock I’d Buy Right Now

Tech Growth Earnings Review for Q3 2020 – Part 2

Video: Our Stock Picking Strategy

Dropbox Inc reports on November 04th

Dropbox reported Q3 sales of $550 million, which grew 13% YoY and came in 1% higher than the consensus estimate of $545 million. The company’s outlook for Q4 forecasted sales to grow 12% YoY to $563 million, 2% higher than the Street’s initial estimate of $553 million.

Source: Earnings report and YCharts

The company’s revenue growth is not very strong when compared to other cloud stocks. However, the company has got good free cash flow and it’s profitable. In the last quarter, the management has raised the full-year revenue guidance to $2.136B-$2.142B from $2.118B-$2.130B. It aims to generate annual free cash flow of $1B by the year 2024. The management revenue guidance for the third quarter is $543M-$546M, which represents a growth of 12% YoY at the mid-point.

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Jefferies analyst Brent Thill has a price target of $40 and a buy rating on the stock. He believes that the company’s increased full year guidance is still conservative.

Bill.com Holdings Inc reports on November 04th

Bill’s Q1 FY22 sales were $116 million, which beat the consensus estimate by 11% and represented a 166% YoY growth rate (organic growth was 78% YoY). Bill.com guided for Q2 sales to grow 141% YoY to $131 million, which was 12% higher than initial estimates.

Source: Earnings report and YCharts

The consensus analyst’s revenue estimates are strong for the next quarter. However, we cannot compare to the previous periods as the results will include Divvy. It completed the acquisition of the spend management solutions provider Divvy, on June 01, 2021, and the 4Q results included Divvy results. The stock has been one of the best performers in the sector. However, it would be interesting to watch how the company faces competition from other players and justifies its valuation. Bill.com reported Q1 FY2022 sales that beat top line estimates by 11% and guided next quarter sales well above consensus estimates.

Jefferies analyst Samad Samana had a buy rating going into earnings and a price target of $350. The analyst anticipates organic core revenue growth to "decelerate modestly" against a tougher comp, but his 60% growth outlook is still "very healthy". Bill.com should be a "core" long-term growth holding, with the stock offering "solid upside" based on his potentially "conservative" assumptions.

Deutsche Bank analyst Bryan Keane initiated coverage of Bill.com with a Buy rating and $360 price target. He believes that “BILL is uniquely positioned in the market due to its end-to-end offering, including accounts payables (AP) and accounts receivables (AR) automation as well as electronic payment offerings like virtual cards, instant transfers and cross-border FX. He further states “We see potential for ~70% Y/Y core organic growth in 1Q22 and ~57% Y/Y for FY22 compared to guidance of ~60% Y/Y and ~45% Y/Y driven by new customers, higher engagement, and increasing take rates from mix shift with reported growth reaching as high as +124% Y/Y in FY22 including Divvy and Invoice2go.”

Five9 Inc reports on November 08th

Source: Earnings report and YCharts

The consensus analyst’s revenue growth is slower than the second quarter and also from the previous year. The company did not have an earnings call in the last quarter due to the pending merger transaction and the next call would have more details about growth prospects as a standalone company.

Analysts have been positive after the Zoom-Five9 deal failed to materialize. Barclays upgraded FIVN to Overweight, saying the deal's breakdown refocuses the investment case back on fundamentals. And “We don’t think lack of a deal hurts Five9’s positioning with enterprise customers."

Evercore has an overweight rating on the stock and in the words of analyst Peter Levine, "firing on all cylinders, the pending acquisition was not a distraction, partner contributions remain strong, and the numbers released in the proxy are a fair representation of the current trends in the business."

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Jefferies analyst has a $180 price target and a hold rating. His checks throughout Q3 suggested demand remains solid across both UCaaS and CCaaS, he thinks Five9 "has a tough setup" given that management not providing guidance last quarter has resulted in "a wider than normal estimate dispersion." Management's 10-year financial plan in their merger proxy raised buyside expectations, but he does not expect the company to guide to the proxy levels, which may disappoint some investors.

We have covered Five9 stock in our premium site in the past.

Please find our semiconductor earnings preview here.

RingCentral Inc reports on November 09th

Source: Earnings report and YCharts

RingCentral has been showing steady growth. The management had raised the full-year revenue guidance to $1.539B to $1.545B, which represents a growth of 30% to 31%, which is up from the prior guidance of $1.5B to $1.51B. The third quarter revenue guidance is in the range of $390.5M to $393.5M.

Source: Earnings Slides  

Jefferies analyst Samad Samana has a buy rating on the stock with a price target of $360. His checks throughout Q3 suggested demand remains solid across both UCaaS and CCaaS, which he thinks should translate into solid Q3 results.

Barclays analyst Ryan MacWilliams initiated coverage of RingCentral (RNG) with an Overweight rating and $350 price target. “RingCentral shares are attractive and RingCentral Office remains the most applicable as well as marketable solution for mid-market enterprise customers, even though Zoom Phone (ZM) and Microsoft (MSFT) Teams adoption has unfairly changed investor perception of the stock, leading to a disconnect in valuation to the company's recent quarterly performance.” 

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.