Category: Stock Analysis PDFs

Telehealth: Premium Analysis

Posted on by io-fund

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Telehealth: Premium Analysis

Overview

Telehealth is the trend that shows the most evidence of overnight, digital transformation ushered forth from covid-19. According to a new report from S&P Global, telehealth patient volume has increased 3,000 to 4,000 percent during the early months of the Covid-19 outbreak. 

In times of indiscriminate buying and indiscriminate selling, things can get noisy. As we continue to focus our efforts on breakouts that become buy and holds, we believe this is a trend that will outperform and are eying an entry despite a run-up in some names.

According to the report from S&P Global, providers that rarely employ remote care options have switched over to telehealth services. Facilities such as NYU Langone Health saw 7,000 video visits per day or about 100,000 video visits in April compared to 300 visits per month pre-pandemic. 

According to American Telemed, three-quarters of U.S. hospitals are using digital technology to reach their patients via video, audio, chat, or email. Patient use of telehealth is up from 11% in 2019 to 46% this year, with 76% of consumers saying they are interested in using telehealth in the future. 

These reports allow for enough evidence to track this trend but predictions may prove to be too low by year-end. You can read a rather optimistic write-up of various accounts as to this explosive trend here. 

These two comments piqued my interest as we see that volume continued into May:

“In just the last three months, our healthcare providers completed over 605,000 virtual visits, including nearly 247,000 in just the month of May. What’s equally impressive is our projections for telehealth usage post-pandemic.

Mass General Brigham providers will go from approximately 1,500 virtual visits per month to 250,000.”

“In established virtual care leader, PSJH’s telehealth network was able to scale services from 70,000 telehealth visits in a year to 70,000 in one week to support the COVID-19 surge. Their clinicians leveraged telehealth technologies in many ways, including helping diagnose appendicitis in a young patient, working with a firsttrimester pregnant patient to guide her using a fetal heart rate monitor, providing a more calming experience for behavioral health patients, and staying engaged with frail and elderly patients.”  

We see similar evidence of this in Veeva’s earnings call where management stated telemedicine is increasing rapidly from less than 1% of visits in February to 30% of visits in April. Teladoc and Livongo are guiding for over 70% growth during a year when companies like Google are expected to report a dip in revenue for the first time. 

On July 25th, the current telehealth regulations are set to expire. Examples of this include increasing the services used by Medicare, paying for virtual care, and letting doctors treat patients across state lines. Also, recently on June 15th, thirty senators signed a June 15 letter asking for temporary telehealth provisions to be made permanent. 

According to an analysis on Medicaid and CHIP Payment and Access Commission, 44 states and territories expanded telehealth services by changing Medicaid policies in response to the pandemic. Additional state-based policies now allow a patient’s home to qualify as an originating site. 

In early June, a new bill was sent to Congress called the “Evaluating Disparities and Outcomes of Telehealth During the COVID-19 Emergency Act of 2020” that proposes a study of telehealth use for children’s health and mental health. The goal is to establish new policies for telehealth coverage including for Medicare and Medicaid Services. 

As Livongo points out in their most recent earnings call, in-patient appointments are important and by no means will be permanently replaced. Yet, remote monitoring and virtual appointments are here to stay and the trajectory here will change if regulatory barriers are lowered permanently. If this is the case, then there’s nothing quite like having the right product when a new microtrend is ignited. 

Essentially, we do not think these trends are in the rear-view mirror or a temporary pull forward situation, rather we believe we are in the beginning stages of a green field for cloud software in the sluggish and expensive health care industry. Driving down costs and increasing effectiveness can literally save lives. 

We think one of the most bullish points is that the tech giants have eagerly wanted to move into this space and select companies with market caps with $7 billion to $15 billion market caps have instead taken the lead (LVGO and TDOC). We’ve included Veeva in this analysis as a more conservative choice as the company has shown consistent revenue growth and profit margins. Should we see a rotation to profitability, Veeva will be a top choice. As of now, I am asking Knox to prioritize Teladoc and Livongo as we think these momentum plays can become solid buy and hold companies.

Veeva

Veeva Systems is an industry-specific competitor to Salesforce but with more data management and regulatory compliance features than typical customer relationship management software (CRM). Biotech and pharmaceutical stocks can be volatile yet Veeva has navigated this well and has proven to be a stable way of investing in these industries. In Veeva’s S1 filing, there were 23,000 life sciences companies with revenues of $1.6 trillion. The market is now at $2 trillion and growing at 5%.

One major benefit to Veeva over the other two companies covered in this report is that Veeva is mature and has shown verifiable gains for many years and increasing cash flow to upwards of $400 million.

Subscription revenue retention rates are 120%. Revenue increased 38% year-over-year in the most recent quarter to $337 million with non-GAAP operating income increasing 39% year-over-year to $130 million. Non-GAAP net income increased 34% year-over-year to $105 million. The company’s forward growth for the upcoming quarter is at 27% to 28% with EPS between $0.63 and $0.64. The company has over $1 billion in cash and no debt as of April 30th, 2020.

Full-year FY 2021 revenue guidance is between $1.38 billion and $1.395 billion with EPS of $2.50 to $2.55. This forward guidance was reduced by $10 million on the top end and operating income was increased by $10 million due to reduced travel expenses. 

The company has a goal of tripling this revenue to $3 billion by 2025.  

Financials Takeaway: Veeva is a financially fit company with nearly 30% revenue growth and decent profit margins of 20%. Although in the current hypergrowth climate, this may be overlooked right now, there may come a time when profitability is more desirable than sheer top-line growth. When this time comes, Veeva is a solid company. 

Product Overview:

Veeva spans three products: Veeva CRM, Veeva Vault and the Commercial Cloud, which includes event management on the Physicians World platform and patient analytics Crossix. Last year’s revenue primarily came from higher-margin subscription services at around 80% compared to lower-margin segments at 20%.

Veeva CRM is fairly straight-forward customer relationship management software that allows sales reps to collaborate across teams and engage more customers to drive business growth. The Commerical Cloud combines CRM with other offerings, such as data applications and warehouses for data management and new AI products to identify next-best actions. 

Commercial cloud is expected to contribute about $580 million in revenue with total subscription revenue being $1.14 billion. Of the $580 million, Crossix adds $76 to $78 million. The headwinds to the Crossix business will be offset by the strength in CRM add-ons. Crossix was an acquisition recently made for $430 million in cash to strengthen Veeva.

Vault:

Veeva Vault is a CRM platform and applications suite built for life sciences. The value proposition Vault offers is to combine content applications and the associated data onto one platform for efficiency and compliance. 

The name Vault is a nod towards security and regulatory oversight while allowing for horizontal application access. Vault revenue is expected to top $550 million for FY2021 and is growing in the 40% range and also now accounts for half of revenue. Veeva is looking to expand into cosmetics, consumer goods and chemical businesses. Management thinks the market could be at least $1 billion annually for Vault.

Veeva’s narrow industry-specific focus allows the company to move quickly, such as when the company accelerated the launch of SiteVaultFree for remote monitoring. AstraZeneca implemented Veeva’s remote monitoring to manage clinical trials for covid-19. 

The clinical suite project is a unified platform for clinical trial management system (CTMS), electronic trial master file (eTMF) and studies. AstraZeneca is preparing to supply upwards of 1 billion doses of a covid-19 vaccine. Veeva stands to benefit from ongoing Covid-19 lockdowns due to the need for virtual monitoring of clinical data and the need for virtualized sales channels. 

Veeva has had the luxury of being a first mover with a lack of direct competitors. Microsoft has a new health care and data solution that is more geared towards sharing health care data to find cures and improve patient health. This may not overlap as much with Veeva’s CRM which is more concerned with improving the sales process but there may be some overlap here with Veeva’s Vault product.

Conclusion:

Veeva stands out as a company with consistent growth and strong profitability. According to some analysts, Veeva should see more upside on profits than Salesforce. Although it’s reasonable to say that some of Veeva’s growth this year may not sustain after a vaccine, there is likely going to be some permanent effects of digitization across health care and life sciences. 

Teladoc

Teladoc’s revenue grew 41% year-over-year to $180 million in Q1 2020. The global subscription access fee revenue increased 29% YoY to $137 million with the United States increasing 33% and global increasing 17%.

Net losses and EPS year-over-year were marginally the same with about $30 million in net losses or ($0.40) to ($0.43). Adjusted EBITDA was positive $10.7 million compared to $1.2 million in the year-ago quarter. 

This was a miss on EPS as analysts expected ($0.36).

Visit fee only revenue saw phenomenal growth of 93% year-over-year to $43.7 million with the United States increasing 205% for visit fee only and 69% growth for paid visits. This is an area where Teladoc has a growth opportunity globally as the International visit fees grew only 5% YoY. Total United States Paid Membership saw growth of 60.8% and Visit Fee Only growth of 88.7%.

The company is guiding for revenue growth of $215 million to $225 million next quarter representing growth of 65% to 73%. Adjusted EBITDA in the range of $20 million to $24 million with EPS of $(0.28) to $(0.23).

Total revenue guidance for the year is between $800 million and $825 million with adjusted EBITDA in the range of positive $70 million-$80 million. Net loss per share in the range of $(1.27) and $(1.13). 

The company has $508 million in cash and long-term debt of $447 million. In May, the company raised $850 million in convertible debt with proceeds partly used to exchange $228 million in existing 2022 notes for a combination of cash and shares of Teladoc health common stock.

Financials Takeaway: 

Teladoc is guiding for accelerating revenue growth from 41% to 65%-73%. If Teladoc can deliver this (and maybe more) it will continue to be a top stock this year. What we see is a divergence between subscriber growth and reported revenue, which is a good thing as subscriber growth will drive ongoing revenue growth this year. Additionally, if Teladoc reports another strong quarter, I believe it will be differentiated from cloud software peers that may see 20% or so revenue growth this year (and have yet to report this due to Q1 having minimal exposure to the shutdowns).

Product Overview:

Teladoc Everyday Care offers nonemergency video calls with physicians for $59 with insurance or $75 without insurance. There are 43 million members using Teladoc’s service with 4 million appointments hosted last year.   

Teladoc also offers products such as Advance Medical, which is a medical opinion program that gives expert medical opinions from 800 dedicated health care professionals and 450 medical doctors. As of now, 35 million people access the service. Bestdoctors is a second opinion service that Teladoc acquired for $440 million in June of 2017. Betterhelp is a direct to consumer mental health product. Healthiestyou makes health care as easy as possible with prescriptions and access to doctors with an emphasis on ease for people on-the-go.

Current Growth/Flywheel Dynamic:

Teladoc is a coronavirus growth story with impressive numbers. 

The company may be going through some serious flywheel effects. It took the company until 2019 to cross 1 million visits per quarter and this doubled to 2 million in Q1 2020. New registrations increased 125%. 

The company expects to add 6 to 7 million paid members in the second quarter to end the quarter with 49 million to 50 million U.S. paid members. Management guided for 8 to 9 million total visits, or growth of 90% to 115%. The company expects adjusted EBITDA of $70 to $80 million, up 130% at the midpoint.

As Piper Sandler analyst Sean Wieland put it, the growth with Teladoc is “unprecedented across membership, utilization and scope of services.” Stephanie David Demko of SVB Leerink stated Teladoc is a sleep-easy name in highly uncertain times. 

A few risks/competitors … 

Teladoc’s moat comes from being first-to-market and working across many disciplines in health care, such as behavioral health, dermatology and second opinion ancillary services. The “right place, right time” may be hard for competitors to catch up to. 

Allen Lutz of Merrill Lynch pointed out that the pandemic “is driving substantial engagement and interest from payers.” He is referring to payers moving into the space with United Health’s potential acquisition of AbleTo for $470 million that could pose a threat to Teladoc. 

In the private markets, Zocdoc is a competitor and has an all-star line-up of investors. The company pivoted in April from being an appointment booking startup to including virtual doctor visits. Therefore, this competitor is only two-months old. Zocdoc has a different pricing model with medical providers paying a $299 annual fee and then is charged for each initial visit.

One could argue that Microsoft Teams is also a competitor here although the singular focus Teladoc demonstrates will be hard to beat, as evidenced by the acquisition of InTouch Health.  

Livongo

Livongo is a hypergrowth company with many triple-digit growth numbers. Notably, this was the case before covid-19 as the core product for diabetes has been growing rapidly. The pandemic may be delivering new opportunities for Livongo to expand into behavioral health and other new areas. 

This quarter, Livongo reported outstanding revenue growth of 115% year-over-year in the Q1 2020 results to $68.8 million. Gross margins are at 73% with non-GAAP earnings of $0.03 per share and adjusted EBTIDA of $3.8 million.

Livongo for Diabetes members increased by 100% year-over-year to 328,000 with clients up 44% quarter-overquarter. Estimated Value of Agreements nearly doubled from last quarter to $89 million up from $48 million.

To put this growth in perspective, Livongo had 114,000 members for its diabetes program in March of 2018 and 164,000 members by March of 2019. By December, the number was 220,000 (pre-covid) – so doubled in 18 months. The company then grew to 328,000 in March of 2020. These are numbers to pay attention to. 

Revenue guidance remains strong for next quarter at $73 million to $75 million. The annual revenue is expected in the range of $290 million to $303 million, representing growth of 70% to 78%. This is an upward revision from $280 million to $290 million. 

Adjusted EBITDA for the year is expected to be between ($14) million to ($10) million. The company had cash and cash equivalents of $368 million with no debt. 

Livongo has demonstrated strong revenue growth year-over-year from $30 million in annual revenue in FY 2017 to $68 million in FY 2018 and $170 million in FY 2019. 

Financial summary:

Similar to Teladoc, Livongo is guiding for some serious growth of 70%+. This is during a time when budgets may be cut in other areas of tech as Q1 did not provide enough exposure for internal budget planning to shift. 

I do believe that TDOC and LVGO have the ability to deliver these growth estimates this year and can continue being winners.  

Product Overview:

Livongo helps people manage chronic diseases. The diabetes-management technology platform helps patients with diabetes check their blood sugar levels. This is done with a cell-connected blood glucose meter to check blood glucose and receive personalized feedback and recommended lifestyle changes. 

At the time of the IPO, Livongo’s prospectus cited case studies that the diabetes program lowered HbA1c, a clinical metric that reflects blood glucose over the last three months. The company’s platform also reduces cost with savings of 21.9% for diabetic patients. Livongo began with diabetes as the condition is chronic, costly and requires close monitoring. 

By year-end, 35% of Livongo’s customers used solutions other than Livongo for Diabetes. To address heightened behavioral health needs, Livongo for behavioral health powered by myStrength is now offering specific COVID-19 and social isolation modules to manage stress and anxiety to all people. These also include Livongo for Hypertension and Livongo for Prediabetes and Weight Management.

Areas for growth:

Livongo can expand existing partnerships with companies such as Amazon Alexa, Apple Health, Fitbit and more. These companies are in need of a more vertically integrated monitoring solution for their hardware as they’re more experienced in hardware and more broad applications for consumer tech. 

As management stated in the call, “Remote monitoring is here to stay, and we expect it to become the standard of care for the most vulnerable and expensive populations” – I agree that any solutions that can lower health care costs for providers and improve the health of expensive/vulnerable populations should be in high demand even after a vaccine. The main issue with remote monitoring is user adoption and this may be on a new trajectory with covid-19. Insurance companies may also help to drive this trend of monitoring. 

On that note, I am not one to make acquisition calls as it’s impossible to predict what goes on in private negotiations but the synergy between what Livongo offers and what Apple needs for the wearables segment is uncanny. Bezos with Amazon is more visionary than Tim Cook, so if Apple does not look at the company, then Amazon could see Livongo as a way to leap forward very quickly with remote monitoring solutions. 

In March, Livongo made inroads with a CVS partnership as detailed here.  

Livongo has a product that aggregates data across devices for personalized insights (although this is challenging in health care with HIPAA laws around prescriptions). These personalized insights turn into nudges for specific actions and behavior support that are continually improved through recommendation engines. The company has signed deals with Dexcom and Prognos Health to accelerate the Health Signals platform and AI engine. 

What Livongo Health does that separates itself from a long line of healthcare solutions providers is aggregate copious amounts of patient data and use artificial intelligence to provide helpful tips for people with chronic illnesses in order to incite behavioral changes so they live longer, healthier lives.

Similar to Teladoc, the surge in demand has partly come from an easing of regulations and lower barriers from the coronavirus. For instance, with Livongo’s Behavior Health product, covid-19 modules make-up 3% of content but are driving 25% of member views. 

Livongo is continually gaining more credibility with the Government Employee Health Association choosing them as a covered benefit for diabetes prevention for more than 2 million federal employees. The company is also on a new curated marketplace Health Transformation Alliance, or HTA and Welltok, for the consumer engagement platform that serves 7 million employees. 

Kaiser Premanente has selected Livongo for Behavioral Health for their entire population. This is the largest behavioral health contract in the company’s history and will be roll out over the next five years.  

The company states 147 million Americans are living with a chronic condition and 40% live with more than one chronic condition. The majority of health care spending goes towards chronic conditions with Livongo reporting this to be 90% or $3.7 trillion. With that said, Livongo believes their addressable market is $46 billion.

From what I can tell, Livongo’s retention rate is 94% as stated in the Q4 earnings report. Some cloud software investors draw a hard line at 100% with the pickiest drawing a line at 120%. My analysis tends to be more forgiving if the company meets other qualifications – such as guiding for forward revenue that is likely 200% higher than many cloud software companies this year (who have much higher retention rates).  

Piper Sandler analysts estimate that the new contract (GEHA) could provide Livongo with 10,000 more customers this year, and said the company is positioned to pick up business from Medicare recipients. 

Goldman Sachs analyst is positive of the quarter results. However, he cautions “Livongo does still primarily sell into the employer space, and the impacts of high unemployment/recessionary environment on its growth is a concern”.

KeyBanc analyst Donald Hooker raised his price target on the stock to $85 from $52. Hooker wrote to clients that

KeyBanc sees Livongo "as a potential 'beat-and-raise' story through 2020 and 2021." 

I am also impressed with the company for the revenue growth prior to covid-19 between 2017 and 2019, plus the drive management had in bringing the company public when digital health companies were out of favor last July. 

This was the first time in three years a digital health company went public. This decision shows Livongo is more of a leader than a follower, albeit a bit anecdotal, it doesn’t hurt to observe the behaviors of the management in these smaller companies and the risks they’re willing to take before there are tailwinds.

Atomera: Premium Analysis

Posted on by io-fund

5def19a5-a8b7-456d-99e3-99ff81d19571_Atomera-Premium-Analysis-v.2.pdf

Atomera: Premium Analysis

Atomera

Please note that small cap stocks can be extremely volatile and high risk. Atomera has a market cap of $160 million with a current price-to-sales of 254. The forward price-to-sales is 29. This illustrates that a small cap needs very little revenue growth to move from an outsized valuation to one that is more aligned with the market. This also represents a fair amount of speculation as the forward price-to-sales is determined from a consensus of two analysts who are counting on deals moving through the pipeline. There is no guarantee this will happen.

Atomera’s extreme volatility was on display last week. The stock climbed 24% before erasing those gains by market close. Last month, Atomera offered 1.76 million shares for $5.00 per share to raise $8.8 million. This led to a 13% drop. Additionally, Atomera is expecting no revenue in Q2 due to the effects of the coronavirus. This could add to volatility. 

I am covering Atomera because I feel like there are some gains to be had in the breakup between Huawei and Western countries. There is a major restructuring going on. I also like how the market is attempting to price this company right now. We may wait until after the first Phase 4 deal (see below), as there will be plenty of runway left.  

Technical analysis can often be less important when a trend is in play and the story is well known. However, for stocks like Atomera, technical analysis is crucial. Knox will be updating our readers this weekend and as we go along on this company.

Please note, as one reader pointed out on the forum, there are bearish comments online about design challenges around MST. These comments are likely correct to some extent and the question is if the company can overcome them. I’ve included more information under the subheading “Design Challenges” below.   

I am still initiating coverage and asking Knox to track this stock for an entry because I am comfortable with the iteration process for technologies that solve big problems. The semiconductor market is old fashioned and moves very slowly at times around new processes. However, I am especially keen to find worthy stocks that help strengthen the domestic semiconductor market as China tensions heat up. 

Financials

Atomera’s revenue in Q1 2020 was $62,000 compared to $71,000 in the year-ago quarter. For Q4, the revenue was $138,000 compared to $150,000 in the year-ago quarter. 

The company’s net loss is $3.6 million per share, or negative ($0.22) EPS. Adjusted EBITDA was a loss of $2.9 million.  

The company has cash and cash equivalents of $11.4 million as of March 31, 2020. As mentioned, ATOM recently issued shares at $5.00, for gross proceeds of $8.8 million. 

For the full year 2019, revenue was $533,000 compared to $246,000 in fiscal 2018. Net loss was ($0.84) EPS in FY 2019 compared to ($1.02) EPS in FY 2018. TTM revenue is slightly down from FY 2019 at $520,000 and ($0.83) EPS.

The median forward revenue estimate from two analysts is $786,000 for 2020 with one analyst projecting $5.45 million in 2021. It’s the second estimate that makes Atomera exciting although the road may be bumpy between now and 2021. 

Roth Capital is the bullish analyst: “We regard ATOM as a highly differentiated silicon enhancement IP vendor that is gaining traction with large semiconductor supply chain companies. We believe the company continues to make solid progress across its significant base of engagements. We expect ATOM to continue to convert additional engagements to licensing revenue over the next few quarters. We maintain our Buy rating.”

Forward EPS estimates for 2020 is ($0.71) and ($0.61).

Integrated License Agreements

Revenue is generated from integrated license agreements. Customers pay a licensing fee to use MST technology in the manufacturing of silicon wafers. Royalties are paid for each silicon wafer or device that incorporates the MST technology (see below for more on MST). The company also generates revenue through engineering services revenue. 

According to the 2019 Investors Presentation, the company has an addressable market of $6-$7 billion in royalty fees primarily driven by FinFET and Advanced Nodes ($6 billion), RF SOI ($50 million) and 5V Analog ($660 million). 

Please note: I’ve reached out to Investor Relations to confirm these numbers have not changed from any design challenges and will update as we go along. 

Total addressable market as of 2018 was $7 billion at 2-3% licensing fees, or $140 million. The 5V analog market adds another $660 million to the addressable market figured on a market size of $33 billion. 

Valuation

The gamble that Phase 4 deals will go through is best understood when looking at the spread between forward PS ratio of 200 with the PS ratio in 2021 at 29. Due to Atomera’s tiny revenue of roughly $520,000-$530,000 per year, Phase 4 deals are imperative to reach the 1-year forward price-to-sales (i.e. this is an all or nothing stock).

Customer Pipeline

As of now, there are 19 customers with 26 engagements with 16 in Phase 3 (integration). The more bullish moves around this stock are due to the Phase 3 deals the company has in the pipeline. It would be easy to presume the Phase 3 deals are with larger semiconductor companies as Atomera has a very specific use for its product. TMSC is used often as an example in their Investor Presentations. 

According to the March 2020 Investors Presentation, the company is engaged with 50% of the world’s top semiconductor markets. The company states Asahi Kasei Microdevices and STMicroelectronics have licensed the technology plus “a large fabless semiconductor company” for mobile 5G markets. 

The coronavirus is a challenge for Atomera as the customers in Phase 3 are cautious with budgest. There is also a slight delay in R&D engineering for new programs. As the company explained on the earnings call, the production personnel are in the fab, but development engineers continue to work from home, which can limit the ability to start new R&D lots. 

Per the management, “where some customers would normally be starting wafers, they may be holding back until their engineers get back into the office to start pulling the levers on new lots.”

Here is what the company said about the coronavirus: “Due to the delays created by the coronavirus travel restrictions and the impact on our customer’s business, we are now expecting to have no revenue in Q2 2020. But as Scott indicated in his remarks, none of our customers have ceased work on MST and progress on the JDA contracts has been delayed but not canceled.”

Therefore, any investment in Atomera is a gamble on the company moving one or more customers to Phase 4 (installation). If/when the company moves to Phase 4 through Phase 6 (production), revenue levels become much more attractive. 

Notably, it can be viewed as concerning that the company held a secondary offering at $5.00 a share before securing a Phase 4 deal. On the other hand, this may be to buy time and create a necessary financial cushion as covid-19 delays budgets and capex/R&D spending. 

Product

Mears Silicon Technology (MST) is a performance enhancing technology that the company believes helps integrated circuits overcome a number of key engineering challenges.

Primarily, MST enhances transistor capabilities and reduces chip size. According to Atomera and a third-party study by PMIC published on their website, MST can result in a 16-21% reduced chip size. 

MST allows DRAM designers to reduce chip size without moving to a new technology node. According to Atomera, the IDM process/development is $10 million and the foundry equipment upgrade is $30 to $50 million. Meanwhile, a foundry for a new node can cost billions. 

MST is also beneficial in stopping dopant diffusion in high temperature manufacturing, which makes it helpful in chip designs. According to Tailwinds research, MST could become an essential element in FinFET production processes, as dopant diffusion is a major issue. The three major companies who have explored FinFET are Intel, Samsung and TSMC. 

According to Atomera, Mixed-Signal/RF devices can also achieve a 10-11% die size reduction. This is achieved with a lattice design that increases horizontal current flow and reduces vertical leakage. 

The CEO grew a $1 billion-plus division at Broadcom and also worked as an SVP and GM at Altera.  The CTO has been inventing and working on patents for broadband networks for 30 years. I don’t see any flags with the management (a common issue with small caps). 

Design Challenges

Atomera is as high-tech as a company and concept can be. Obviously, there are design challenges to overcome or the company would be generating more sales and would no longer be a tiny cap company. What I look for here is whether there will be enough demand to overcome the design challenges and to support the iteration process. I believe there is with the recent pressure on more domestic semiconductor manufacturing. 

There is an ongoing debate sparked on a thread by an anonymous commenter on Seeking Alpha. The comment asserts: “High temperatures of older nodes won’t let their concept survive. Finer nodes with finfets/nanowires don't need it.” The comments state that Atomera’s advantage lies in “surface inversion devices whereas finfet/nanowires are volume inverted.”

I try to stay as neutral as possible and weigh both sides of a debate like this. The truth is this company could go either way – boom or bust — but probably not much in-between. 

One thing I like about passionate bulls/investors and passionate bears/short sellers is they always bring to the surface the major catalysts or risks. 

Here is what Atomera’s Investor Relations team said when I inquired about these issues: “MST1 and MST2 have different properties for handling thermal budgets, depending on the application.  There is a lot of variability in customer processes and thermal budgets, and Atomera has worked with enough to have a good sense of how to navigate these types of engineering challenges.”

Below is what one of Atomera’s investors said (who also writes analysis). I’m pasting sections from his blog on the topic below. You can read the full blog here: “Are All the Atoms Aligned for Atomera?”  

“The first potential issue to be addressed relates to diffusion of oxygen in high-temperature processes. Which translates roughly into the question of can MST be applied to chips that have high heat during manufacturing? The concern here is that many production lines have stages in which chips are subject to annealing at very high temperatures. If the thin layer of oxygen that Atomera applies were to be diffused in these processes, this would greatly diminish if not alleviate all the benefits of MST. Taking it one step further, if MST is not going to be used in high-heat process manufacturing, the applicable market for MST would be greatly diminished making this truly only a niche product.

From my digging, it appears that this concern is very overblown but not completely without merit.

Atomera has developed a work-around solution whereby they can apply MST at later stages in the  process, thereby missing out on the high temperature steps that could diffuse the oxygen. This actually was discussed on ATOM’s Q2 2018 earnings call. Here’s what they said about this issue…

“I’m very pleased to tell you that during the last quarter, Atomera has started testing an optimized version of our film that shows remarkable potential by attacking the problem in a new way. Our approach has been to find a new material construction method that’s better at oxygen retention so it’s able to withstand a wider spectrum of processes surrounding MST…This should make it easier for customers to see better results earlier in their integration process and gain higher confidence in MST’s ability to withstand manufacturing variances during mass production which is a critical factor in their decision of whether to adopt our technology.”“I’m very pleased to tell you that during the last quarter, Atomera has started testing an optimized version of our film that shows remarkable potential by attacking the problem in a new way. Our approach has been to find a new material construction method that’s better at oxygen retention so it’s able to withstand a wider spectrum of processes surrounding MST…This should make it easier for customers to see better results earlier in their integration process and gain higher confidence in MST’s ability to withstand manufacturing variances during mass production which is a critical factor in their decision of whether to adopt our technology.”

I can also confirm that during conversations with management, they have specifically noted that oxygen diffusion is a potential issue, but they are very confident in their ability to deal with this. However, applying MST after annealing will certainly place constraints on the process. Some potential customers will need annealing too late, in the process, for MST to help them. Dopant implantation messes with the crystals, annealing heals them. Is it possible for doping to be accomplished without high energy, destructive implants? Maybe. But if not, how many customers are impacted by this?

At this time, I’m sure Atomera knows how big this potential issue is through their customer interactions, but it’s impossible for outsiders to have this knowledge. Having listened to the Company and learned what I can about semiconductor manufacturing processes, it seems likely that the truth lies somewhere between MST being a niche product and it working on any and all processes. I lean in favor of the market being much larger than some concerns have expressed.

Another issue mentioned by investors related to the stage of the product. Namely, all the white papers reporting the great gains of MST were based on simulations. Which implies that the process has yet to be replicated in the real world. Once again, here’s CEO Scott Bibaud, this time on last quarter’s conference call…

“These papers are based on simulation models and only limited experimental results since the advanced process nodes are not widely accessible and are extremely expensive, but they all show impressive performance improvements with MST. Over the last few months, we’ve had multiple test results from actual silicon runs, which have validated those fundamental mechanisms.”“These papers are based on simulation models and only limited experimental results since the advanced process nodes are not widely accessible and are extremely expensive, but they all show impressive performance improvements with MST. Over the last few months, we’ve had multiple test results from actual silicon runs, which have validated those fundamental mechanisms.”

So, yeah, it’s true that the papers were based on simulations, but Atomera has run their process on customer silicon many times. The theoretical gains were seen in these runs. However, “customer silicon” is, by definition, not Atomera’s. The data obtained from these trials is not Atomera’s to share with the world, and I don’t think a semiconductor company would be sharing their test results  

from a new process with their competitors. So, we’ve not seen the actual numbers from silicon runs and will need to base confidence here on management’s statements that those numbers are consistent with simulations.”

Conclusion:

This is a true Hail Mary small cap idea. The stock’s potential hinges on Phase 4 deals coming through (already a gamble) meanwhile the coronavirus may have delayed orders.  

However, one or two Phase 4 deals can really move the stock price for this company. The June 2019 investors report provided two scenarios showing $6.7 million in revenue up to $29 million in revenue as a result of signing one large customer. 

From a high-level overview, I like this company right now (given the ample risks) because I am keen to invest in the increasing pressure on semiconductor companies to reduce dependency on China and to make up for Huawei’s dominance. As one Seeking Alpha comment had also pointed out, the semiconductor industry can be slow to adopt new technologies. This is very true, however, the geopolitical tensions will put pressure on the manufacturing process.  

It’s important to emphasize that if Atomera signs a Phase 4 deal, there will still be time to invest. To reduce risk, we may explore waiting until the first Phase 4 deal is signed OR we will wait for a very clear technical breakout. We are not front-running this stock based on fundamentals. 

Knox is essential to navigate this and he will write a blog update on the technicals (and what he’s looking for) this weekend.

F5 Networks: Premium Analysis

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F5 Networks: Premium Analysis

F5 Networks

Overview:

Like many traditional hardware companies, F5 Networks is shifting from a hardware model to a software-driven business to accommodate an increasingly cloud-driven world. The effects of the shift to cloud services are not fully reflected yet in the company’s revenue growth, which was at 7% YoY in the most recent quarter. The company has been basically range bound with revenue growth around 5% since 2016.

F5’s cloud services are distinguished from running apps on virtual machines in a single cloud from being able to run distributed, container-based microservices across multiple clouds. The services have the added benefit of security, such as advanced web application firewalls. This is important because up to 40% of internet traffic comes from botnets with 20% being bad bots. 

The three main products which work to consolidate networking tasks and deploy apps faster., are BIG-IP, the NGINX Controller and a new SaaS offering called Beacon. These three products tie together traffic management, API management, app security and end-to-end app visibility and analytics.

There are a few trends that help to support F5’s future revenue growth. Primarily, the shift away from monolithic architectures and towards microservices architectures (and the popularity of containers orchestrated by Kubernetes). Also, the complexity of multi-cloud and hybrid cloud environments. 

However, it is the 5G catalyst that I am most interested in and the reason I am covering the company. 

F5 Product Summary:

F5 Networks is well known for its hardware-based Application Delivery Controller (ADC) product offerings. The company recognized a need to move to cloud based workloads due to the decline in ADC hardware and the shift to software-based solutions.

As the number of applications grow, the complexity increases. Companies must deploy, manage and secure applications across private data centers, private clouds, public cloud, microservices environments and multi-cloud environments. This complexity is how F5 hopes to gain and defend its market share. 

The customer base for F5 are companies that need to scale and deploy applications very quickly. Essentially, developers write the code for the applications (i.e. the business logic, backend components, and user interfaces). F5 helps to deliver the application to the device, machine and browser. 

The company acquired NGINX for $670 million in May 2019. This helped the company to expand to new addressable market opportunities including web servers, application servers, and API gateways. The company is seeing promising early wins for NGINX Controller 3.0. It is also seeing real traction with the F5 and NGINX combination. 

Another major recent acquisition was Shape security for $1 billion which helped the company to target the application security market. Shape is a leader in anti-fraud and abuse protection. The company’s existing Canadian banking customer is a BIG-IP customer and experienced an account takeover attack on their web application. With Shape in full mitigation mode, it was able to block a major attack.

Load Balancing

F5’s two products are the F5 BIG-IP Local Traffic Manager and the F5 BIG-IP DNS. The local traffic manager balances loads across servers in a single data center. The DNS uses topology-based load balancing to determine the closest data center. 

Load balancing refers to distributing requests across web servers to avoid overloading any one server. Load balancing distributes the requests based on the actual load at each server to ensure availability and helps with denial of service attacks.

Microservices

Microservices is a newer architectural framework designed so that changes won’t break the entire app. The core functions of a microservices framework can be deployed independently, meaning individual services can function without affecting the others. This is opposed to a monolithic approach where the source code is built into a single deployment. With a monolithic/single deployment, there is a lot of downtime as any update requires the entire app to be taken offline. 

Microservices closely resembles service-oriented architecture (SOA). In this architecture, individual services communicate through the enterprise service bus (ESB). This allows for iteration and deployment without monolithic development cycles but it also creates a single point of failure (the ESB).

Containerized microservices allow applications to be run independently on the same hardware with much greater control. This is the foundation for cloud-native applications. 

NGINX:

The main benefits to NGINX is the software approach to application delivery and API management, as well as the brand name in open source and DevOps. The acquisition creates end-to-end application infrastructure and allows F5 to transform into a more software and multi-cloud approach. The acquisition also helps to combine security technologies with web servers and load balancers. 

The goal of F5 and NGINX is to combine the application teams, developer teams and operations under one umbrella to include AppDev, DevOps, NetOps and SecOps. 

NGINX’s main competitor is Apache. F5 Networks is popular with the Fortune 500 and NGINX is popular with developers/open source community. More than 400 million sites use NGINX and NGINX Plus, including Netflix, Dropbox and Zynga. In 2019, it was reported that NGINX was closing the gap with Apache and Microsoft in webfacing computer market share to about 30% of the market.

This also provides F5 with inroads into servicing Kubernetes nodes. Kubernetes is a leading container platform that was designed by Google and is now used everywhere. Kubernetes has exploded in popularity with 78% of developers using it for cloud native projects. This is a tailwind for F5 (although not a major catalyst as NGINX is free, open source software).

The most recent product announced from the acquisition is the NGINX Controller 3.0 which helps development teams deploy applications in multi-cloud and hybrid cloud environments. In the recent quarter, F5 secured a leading oil and gas company in the Middle East from the new acquisition. The oil and gas company had both security and API management challenges, it opted to deploy NGINX for API management and F5’s advanced web application firewall for API security. 

Shape Security:

Shape Security protects against automated attacks, botnets and targeted fraud. The company mitigates more than 1 billion attacks daily and is deployed on more than 200 million mobile devices worldwide. The company is used by eight of the top twelve U.S. banks. The company separates good traffic from bad traffic. Shape Security will augment F5’s application infrastructures.  

According to F5, the acquisition will boost its software revenue growth from 35-to-40 percent to 60-to-70 percent next year. It expects to achieve breakeven non-GAAP EPS within 24 months of closing the acquisition.

5G: Network Slicing, Gi-LAN Consolidation and Edge Computing:

F5 Networks is positioned to help 5G infrastructure scale. The new 5G architecture will have the ability to “slice” the network into different segments from the radio network (RAN) to the core in order to help allocate resources according to various use cases and traffic spikes. The existing 4G core networks do not have networking slicing built into the system. F5 Networks can provide the existing 4G systems with GTP session directors and DNS session directors. 

In addition to network slicing on existing 4G systems, F5 Networks can also improve the monolithic architecture of the Gi-LAN Networks, which are independent network functions on dedicated devices from a wide range of vendors. Latency increases with each hop in the chain the data packet has to traverse. The monolithic architectures — with individual service functions on different hardware — can have a major impact on latency. The monitoring of the system is challenging and security is also an issue. 

The solution is to consolidate Gi-LAN into one instance/appliance to reduce the latency and simplify the network design. F5 Networks offers a Gi-LAN consolidation solution that includes TCP/IP optimization, firewalls, traffic steering, deep packet inspection, URL filtering and DNS security. Most importantly, F5’s solutions are available in both physical and network function virtualization (NFV) environments. The company’s in-house load balancing is also important to scale and eliminate redundancy. 

F5 also facilitates edge computing with virtual edition software for load balancing, web application firewalls, service discovery and monitoring. The company is also well positioned for providing application delivery control and security services for microservices architectures within containerized infrastructures (i.e. Kubernetes). 

5G Case Study: Rakuten Mobile

The case study with Rakuten Mobile is especially interesting as a model for how important F5 Networks could become in the near future as telcos can reduce capex and physical infrastructure needs with cloud networks and network functions virtualization capabilities (NFV). 

Rakuten is Japan’s biggest mobile virtual network operator (MVNO). In early 2019, the company announced plans to build a network in 12 months without significant capex. The reduced capex is made possible through a cloudnative network. The goal is to shift towards Network Functions Virtualization (NFV) technology, which uses the principles of cloud computing to create service delivery platforms “with greater agility and customization.”

The end result is a Radio Access that is virtualized and running as a virtual network function on a private cloud. You can read more here and the press release regarding Rakuten’s partnership with F5 here.   

Financials

F5 Networks reported fiscal Q2 2020 earnings at the end of April. Revenue increased 7% year-over-year to $583 million with EPS of $2.23. This beat analyst estimates by $20 million on revenue and $0.24 on EPS. 

In the previous quarter, revenue increased 5% to $543 million.

On a non-GAAP basis, product revenue comprised approximately 45% of total revenue and it grew 10% year-overyear to $262 million. Of this, software represented 35% of product revenue and it grew 96% year-over-year. Excluding the partial contribution from Shape, software grew 65% year-over-year. Services revenue grew 5% to $324 million.

Full year revenue grew 4% to $2.2 billion with non-GAAP income of $626 million, or $10.36 per share, up from $612 million in fiscal year 2018.

The company has cash and cash equivalents and short-term investments of $820 million and $182 million in cash flow from operations. Long-term debt at the end of March 31, 2020 was at $380 million. The company repurchased $50 million worth of shares in the most recent quarter.  

For the fiscal Q3, the company expects both GAAP and non-GAAP revenue in the range of $555 million to $585 million and non-GAAP diluted earnings per share in the range of $1.91 to $2.13. 

The company withdrew the FY 2020 outlook provided in December 2019 when they announced the Shape acquisition. F5’s gross margins are forecast to be around 85% and operating margins to be 30-32% for full year 2020.

Following the Q2 report, F5 attracted some bullish analysts from Piper Sandler and Nomura who believe there is upside due to strong forward guidance and the current results coming from an acceleration of existing trends rather than a pull forward.

Despite these newly bullish analysts, the overall rating is neutral on F5. Notably, Goldman Sachs has a neutral rating due to the earnings stability being offset by the “less certain spending environment.”

F5 is holding up well with the current shift towards work from home. In the most recent earnings report, the company saw an acceleration in purchases of F5 solutions while some purchases were pushed out to future quarters. 

Here are some examples from the earnings call on how F5 Networks has been used during the coronavirus:

•       F5 enabled one of the largest banking and investment institutions in the United States to scale its VPN access from 400,000 to 500,000 remote users.

•       The company helped a multinational mass media conglomerate to increase network capacity within one day, so that 100,000 additional employees could work from home in the U.S. and London.

•       A fortune 10 Retail Healthcare Corporation added 160,000 remote workers to its network in under 24 hours. 

Addressable Market & Valuation

F5’s biggest risk is the number of competitors relative to addressable market. Often this level of competition leads to pricing wars. 

The total addressable market in the application security market has doubled to $8 billion from $4 billion with the Shape Security acquisition, according to F5’s Investor Presentation. Competitors include A10, Akamai, Cisco, Citrix, Imperva, Juniper, Radware, and Symantec.

The ADC market was valued at $2.9 billion in 2016 and will reach $4.2 billion by 2023, which is modest growth of 5%. According to MarketsandMarkets, the Application Security market size is expected to grow from $2.8 billion in 2017 to $9.0 billion by 2022. Competitors here include Citrix Systems, Radware, A10 Networks, AWS, Array Networks, Barracuda, HAPRoxy, Kemp, VMWare and Microsoft Azure. 

Application delivery controller revenue declined 4% to 7% in 2018 with F5 owning 47 percent of ADC market share at that time. This prompted the shift towards software. 

According to IDC, there were more than 700 million application instances in 2018 and this will grow to 3.7 billion by 2023 for growth of 500%. There were 314 million enterprise applications in 2018 and this is forecast to reach

1.8 billion by 2023. 

The company trades at a forward PE ratio of 15 and forward PS ratio of 3.5. This is at the low range for comparable companies. 

Conclusion:

There are reasons that F5 has a low valuation comparatively speaking. The company has been hit hard by the transition away from hardware and on-premise. The NGINX acquisition does little for F5’s top line, which has struggled to break out from 5% year-over-year growth. F5 Networks is also a company that has many competitors with a smaller addressable market than what I typically cover. 

However, as companies seek to scale application deployment, there are infrastructure-level issues that cloud software companies will struggle to solve. F5’s experience with hardware and a pivot towards software could be a winning combination. This goes beyond end-to-end application infrastructure, where the company already has a solid reputation (i.e. Datadog and IBM’s RedHat both favor F5 as a partner here). F5 is also doing a good job of staying in front of the trends of microservices and the Kubernetes platform. 

The more interesting catalyst for is whether F5 can solve major infrastructure and capex issues for telcos. F5’s network functions virtualization (NFV) capabilities can enable a higher throughput, low-latency network and ensure application availability for wireless networks. I believe F5 could be uniquely positioned to solve these issues which should be in high demand as global competition increases for scalable 5G deployment.

Micron: Premium Research

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Micron: Premium Research

Micron Overview:

Our goal is to catch Micron for the 2021 rebound which is likely delayed a year from the anticipated 2020 rebound. This rebound should occur when high-end smartphones are released again and the automotive market comes back to help drive demand in embedded DRAM. Mobile and automotive are the hardest hit segments in 2020. Data center segment remains strong.

Due to the cyclical nature of memory and storage, Micron is likely to become a 1-2 year holding rather than a permanent buy-and-hold.

Product:

Micron is the only company in the world with a portfolio of DRAM, NAND, and 3D XPoint technologies. X100 is the fastest storage device in the world. The company has also entered into a new 3D XPoint wafer sale agreement with Intel that replaces the previous agreements.

In the most recent fiscal year, DRAM comprised two-thirds of Micron’s revenue and NAND one-third of revenue.

NAND memory saves data even when the power is removed, such as when a cell phone is turned off. DRAM only saves memory when a device has power but is much faster than NAND and lasts longer. Beyond mobile devices, NAND is found in traffic lights, digital advertising panels/displays, and anything with artificial intelligence that needs to store data.

As covered in the Lam Research report, NAND has been around since the 1980s but got a much-needed boost from 3D NAND, which stacks vertical chips. Historically, Micron focused on DRAM for PCs and servers an expanded into NAND over the past ten years.

One risk to Micron is the thin moat as competitors Samsung and SK Hynix outpace Micron in total memory/storage shipments. With little differentiation, these companies have pricing wars with Samsung generally considered the industry leader. Toshiba and Western Digital (SanDisk) are also competitors.

This is one reason Micron continues to invest in R&D in products such as 128-layer 3D NAND, 3D XPoint and also 1Z-nanometer DRAM.

“The Memory Guy” Jim Handy has a great write-up describing how Micron has improved its profitability in the DRAM market. His analysis points towards Micron holding a leadership position in 1Znm production over Samsung and Hynix. The new DRAM was introduced at CES and is geared towards the server and hyperscale markets.

One of the bull cases for Micron right now is DRAM and NAND pricing, which is high due to low inventory and previous capex cuts. There is low supply right now regardless of contracting demand. Prior to Covid-19, the market believed pricing had bottomed in 2019.

Micron is one of the most volatile semiconductor stocks with lows around $10 in 2016 and highs around $60 in 2018. Regarding valuation, the stock is trading at double its current PE ratio as 2019 and similar forward PE ratio as 2019. The issue here is any data center strength may not be able to offset the weakness in the mobile and automotive segment.

Historically, buying Micron at a price-to-book value of 1 has done well. The stock is currently trading at a price-tobook of 1.439.

Micron Financials:

In the most recent quarter ending in February, Micron’s revenue beat estimates yet fell 18% year-over-year to $4.80 billion. Revenue was down 7% from $5.14 billion quarter-over-quarter. TTM revenue was $19.6 billion with non-GAAP net income of $2.9 billion, or $2.54 EPS.

DRAM sales were down 11% sequentially and NAND sales were up 6% sequentially. DRAM was impacted by flat sales prices and lower bit shipments.

Earnings were also down YoY with Micron reporting GAAP net income of $405 million, or $0.36 EPS, compared to $1.62 billion, or $1.42 EPS in the year-ago quarter and $0.45 EPS last quarter. Non-GAAP income of $517 million or $0.45 per share beat estimates by $0.08 compared to $1.71 EPS.

Capital expenditures were $1.94 billion in Q2 2020. Management expects FY 2020 capex to be $7 to $8 billion. For fiscal Q2 ending in February, the company had cash and investments of $8.12 billion with a net cash position of $2.7 billion. The company has about $5 billion in long term debt. Recently, Micron drew on a $2.5 billion revolver to have cash on hand.

Margins are decreasing with gross margins of 28% in Q2 2020 compared to 49% in Q2 2019. Operating margins were at 9.2% in the most recent quarter compared to 33.5% in the year-ago quarter.

The median forecast for FY 2020 ending in August is $20.11 billion, down 14.7% year-over-year.

The median forecast for FY 2021 is $24.49 billion, up 21.74% year-over-year. Forward estimates for EPS of $4.90 for FY 2021 will represent an increase of 124% YoY.

QLC SSD bit shipments rose 60% sequentially in the 2Q FY2020. The company expects QLC SSD to grow in the 2H 2020.

The company began to deliver LP5 mobile DRAM products to customers including Xiaomi, which is using LP5 in its 5G-capable Mi smartphones in 8GB and 12GM configurations.

In the graphics market, GDDR6 bit shipments increased more than 40% q-o-q. In the new gaming consoles the company will deploy SSD’s in place of hard drives for the first time.

Effects of Covid-19:

Micron is more exposed than other semiconductors to consumer spending.

About 15% of Micron’s revenue comes from China, where there was weaker sell-through of consumer electronics and factory shutdowns in the fiscal second quarter ending in February. According to the most recent earnings call, some of this was offset by stronger data center demand due to increased gaming, e-commerce, and remote-work. Management expects this trend to continue globally.

Due to Covid-19, Micron expects to see lower demand for smartphones, consumer electronics, and automobiles than prior expectations. Anticipating changes to customer demand, Micron is moving supply from smartphones to service the strength in the data center markets for both DRAM and SSDs.

Some equipment companies have also indicated delays in equipment deliveries due to the impact of various government actions to combat COVID-19.

The Malaysian government issued lockdown orders on March 16 and Micron closed the manufacturing plants in Muar and Penang. Later, the Malaysian government declared semiconductor production as essential and after a few days the production resumed on a limited basis. In the earnings call, the company stated it’s using its global supply chain to mitigate production impact.

For the most part, analysts are cutting their forecasts for Micron, primarily due to Covid-19. Goldman Sachs, Piper Sandler, KeyBanc and Morgan Stanley have all lowered price targets.

Revenue Segments & Addressable Market:

Micron’s business composition is 64% DRAM, 32% NAND and 4% 3D XPoint memory.

Micron has four business units, which are reportable segments:

• Compute and Networking Business Unit (CNBU) — 41%

• Mobile Business Unit (MBU) — 26%,

• Storage Business Unit (SBU) — 18%

• Embedded Business Unit (EBU) — 15%

Micron has the following revenue segments. According to recent earnings reports from various semiconductor companies, mobile and automotive are exposed.

• Mobile — 25%

• Client and Graphics — 20%

• Enterprise and Cloud Server — 20%

• SSDs and other storage — 15%

• Automotive, Industrial and Consumer — 15%

Country 2019 Revenue in US$ Mil %

  • United States 12,451 53
  • Mainland China excl Hong Kong 3595 15
  • Taiwan 2,703 12
  • Hong Kong 1,614 7
  • Other Asia Pacific 1,032 4
  • Japan 958 4
  • Other 1,053 4
  • 23,406 100

One of Micron’s strongest selling points is the addressable market of $83 billion for DRAM and $99 billion for 3D NAND by 2025. This is a combined addressable market of $182 billion.

Source: Micron Presentation

Future catalysts for NAND and DRAM include artificial intelligence and autonomous vehicles requiring data storage and memory capacities. In the long-term, the management believes it will benefit from secular growth in the industrial IoT market as 5G rolls out. Current markets include the data center and internet of things in addition to PCs and mobile smartphones

According to TrendForce, YMTC, a new competitor located in Wuhan, China, is set to compete with 128L products by the end of the year.

Technical Analysis

The above chart is a look at the weekly price pattern of Micron (MU). The larger the trend, the more important it is to the direction of the price. Since 2009, Micron has been trading within a leading diagonal pattern. This is a 5wave pattern that tracks along a trend channel (in gray). Each of the larger degree 5 waves (in red) are comprised of 3-waves (in blue).

According to this pattern, we are in the larger degree 4th wave (in red). Within this wave, we have completed the A and B wave. Therefore, we are in the middle of the final C-wave down. I will target the lower end of the trend channel, which we have not touched. There are a cluster of Fibonacci price levels around the trend channel between $34-$22.

The weekly RSI is also confirming that we are not yet in a renewed uptrend for MU. Until the RSI can break above the downward sloping trend line as well as break above 60, the momentum suggests the current uptrend off the March lows is a corrective move in a larger degree trend, which is pointing down.

It would be rare to see this larger degree pattern not follow the current trend. However, if price can break above the $61 level, which is confirmed by the weekly RSI, I will look at that level as a bullish move and a targeted entry to ride the new bull market in MU.

The daily chart shows this trend unfolding in real time. The uptrend’s structure off the March lows is overlapping and symmetrical. It further suggests weakness. This is also confirmed by the internals.

The volume is slowing down at current levels, suggesting that the participation at current prices is weakening. The Accumulation/Distribution line suggests that the smart money has not been buying into this uptrend, and in fact using it to unload shares. The MACD histogram and the MFI are showing notable weakness below the price as well.

All of this together further supports a topping pattern that is unfolding. If price can break below $41, this will confirm the target entries below.

Okta: Premium Research

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Okta Premium Research

IAM Overview

Identity and access management (IAM) helps to make sure the appropriate people access the appropriate networks and applications. Features include authentication, authorization, trust and security auditing for both onpremise and cloud-based systems. 

Defining and managing roles is needed for both customers and employees. The goal is to have one digital identity per user, and to maintain, modify and monitor this digital identity to allow access to the appropriate assets and in the right context. This may include onboarding or offboarding the user. IAM systems allow for the administration of user access across an enterprise and ensures compliance.

IAM became more complicated once employee’s began to use their own devices and as companies transitioned to the cloud. This is because there was no longer a perimeter. Today there are on-site employees, off-site contractors, hybrid cloud environments, software-as-a-service applications, bring-your-own-device users, UNIX, Windows, Mac, iOS, Android – and soon there will be billions of machine to machine connections (internet of things) communicating through APIs. 

IAM is important because these devices, user credentials and access points are where the majority of security breaches occur. According to IBM, 60% of data breaches are caused by an organization’s own employees.  

According to Forrester, IAM is broken down into six technologies that have high business value. 

•       API Security: Allows for easy, single sign-on (SSO) access for B2B ecommerce and API integrations. This is especially useful for IoT, or the internet of things, device authorization as many devices must communicate seamlessly. This is important for machine-to-machine communication.  

•       Customer identity and access management (CIAM) enables organizations to capture and manage customer identity and profile data. Features include customer registration, self-service account management, access management, and directory services. Customer retention is much higher when there is less sign-on friction and fewer required steps. This is also important for omnichannel sign-in, such as switching from mobile to laptop.  

•       Identity Analytics (IA): Identity analytics evolved from the use of cloud and allows behavior analytics to identify usage and access patterns in data collected from the IAM. This creates risk profiles for the user behaviors and helps manage risk profiles based on application usage.

•       Identity-as-a-Service (IDaaS): This provides single-sign on and identity management as a software service. The benefit is to remove servers, purchase/upgrade/install software, data backups and hosting fees from the provisioning process.  

•       Identity Management and Governance (IMG): IMG helps to minimize the risk of data breaches and improve end user productivity. Offers control and visibility into inappropriate access or policy violations. Helps to achieve compliance.

•       Risk-based authentication (RBA): Allows for a variation of single-sign on and two-factor authentication.  

Overview of Okta:

Okta is the preferred name brand in identity access management (IAM). When speaking to security professionals, the company is highly regarded. Okta’s Identity Cloud is an independent and neutral cloud-based identity platform that allows its customers to integrate with any application or scalable platform. One obvious benefit is that Okta does not lock customers into an ecosystem, like Microsoft or Salesforce, hence the word “independent” is frequently used in their marketing materials. 

Workforce Identity simplifies the way an organization’s employees, contractors and partners connect to its applications and data from any device. This is the majority of the business. 

Customer Identity Cloud enables organizations to transform their own customer’s experience making use of API- level access and seamless customer experiences. There is a large product range including Universal Directory, Single Sign-On, Adaptive Multi-Factor Authentication, Lifecycle Management and API Access Management.

The company recently launched new products, such as Access Gateway or advanced server access Dynamic Scale. This helps enterprises handle traffic bursts with up to 500,000 authentications per minute. 

This month, the company announced end-to-end passwordless access with Okta FastPass. This will allow for a passwordless login experience across iOS, iPadOS, macOS, Android and Windows. The goal is to reduce friction while increasing security. The company believes that early access to FastPass will be available in Q4 2020.

There are a few reasons companies are more likely to go with a proven brand like Okta for identity access management. For one, IAM allows access to the company’s most critical systems and assets. Also, in order for IAM to work effectively, Chief Information Security Officers (CISOs) must put all of their eggs into one basket, as One Identity points out. Therefore, they will lean towards the independent solution that is also best in breed. 

There are additional concerns and costs to integrating IAM with both on-premise and the cloud, and whether internal admins can properly work with IAM. Once IAM is implemented, CISOs and security teams want a solution that works effectively and does not duplicate workloads. In other words, this isn’t the place where a company cuts corners or goes with discounted solutions. 

On the larger corporate-level, Microsoft is one of Okta’s main competitors. However, Microsoft’s goal of locking businesses into Azure, Skype and Office 365 is not ideal for all companies. Many prefer the freedom of multi-cloud and multiple vendors/cloud software solutions. Ping Identity is a competitor on the SMB level, yet does not have near the revenue growth or suite of products/solutions. Salesforce also has their hat in the ring but similar to Microsoft requires vendor lock-in with their software suite.

Addressable Market & Customer Use Cases

When Okta went public in 2017, the Workforce Identity addressable market was at $18 billion. According to Okta’s

Investor Day Presentation, Workforce Identity has now grown to $30 billion and Customer Identity has grown to $25 billion. Over the past three years, Okta’s revenue has grown at a CAGR of 54% from FY 2017 to FY 2020.  

Okta derived 84% of its total annual revenue from the United States. The company believes that global demand will be a long-term opportunity.

Use cases for Okta:

•       New Corp put 75% of its computer power into the public cloud and extended their workforce operations with applications like Google Apps and Dropbox. There are a total of 150 apps across all of News Corp’s digital sites and work flows. News Corp uses Okta’s single-sign on (SSO) access for easy access to applications, secure access with multi-factor authentication, and automates provisioning for new employees to onboard quickly.

•       In the third quarter, the company won a workforce identity contract for Berry global, a Fortune 500 manufacturing and packaging company with tens of thousands of employees. The company wanted to protect itself from modern security threats. The company will improve the sign on experience for employees, reduce helpdesk request by enabling self-service password requests and enhanced security with multi-factor authentication.

•       A Fortune 50 telecommunications company for its business customers to securely access key business services. Okta was selected over Microsoft to lower maintenance and infrastructure costs and provide faster time to value.

•       Recently, Autodesk selected Okta Identity Cloud to centralize identity and access management for its customers. AutoDesk is the global leader in design and engineering software (Source: 4Q FY 2020 Earnings call transcript).

•       Fortune 500 financial services company upgraded to Okta’s Access Gateway to UniFi access to both cloud and on-premise applications and enhanced security for its over 10,000 employees.

•       For customer identity, a European film and television studio and distributor with over 8 million subscribers was recently onboarded. 

•       NTT data, a global top 10 global business and IT services provider, was a notable upsell in the quarter. 

Coronavirus Effects

Although Okta has stated that billings will face headwinds this year, the company is not revising Q1 revenue guidance of $171 to $173 million. As of now, revenue guidance for fiscal 2021 ending  January remains at $770 million to $780 million. The FY 2021 loss per share is slightly improved from $0.37-$0.42 to $0.31-$0.36.

The company expects slightly improved earnings per share of negative $0.16 to $0.17 compared to $0.23-$0.24 due to the reduced costs in Sales and Marketing from Okta’s employees working from home.  

Despite the strength in Okta’s product during the work from home trend, a few analysts have placed a hold on the stock due to valuation concerns. Canaccord Genuity states they are on the sidelines due to valuation and Needham analyst Alex Henderson recently downgraded Okta due to little room for improvement in valuation. 

Financials:

On March 5th, Okta reported Q4 and fiscal year 2020 results. Total revenue in the recent quarter grew 45% yearover-year to $167.3 million. In the previous quarter, revenue grew 45% YoY to $153 million. 

Subscription revenue grew 46% to $158.5 million. Remaining Performance Obligations (or subscription revenue backlog) grew 66% YoY to $1.21 billion and calculated billings grew 42% YoY to $225 million.

Subscription revenue makes 94% of FY 2020 revenue while professional services and others make up 6%.

Okta is not profitable yet with non-GAAP loss per share of negative $0.01 EPS in the recent quarter compared to negative $0.04 EPS in the year-ago quarter.  

Full year revenue grew 47% YoY to $586.1 million. Subscription revenue grew 49% YoY to $552 million and calculated billings grew 44% YoY to $703 million. Non-GAAP EPS was negative $0.31 EPS compared to negative $0.32 EPS in the previous year. 

Revenue guidance for fiscal 2021 ending January remains at $770 million to $780 million. The FY 2021 loss per share is slightly improved from $0.37-$0.42 to $0.31-$0.36. This will represent a growth rate of 31% to 33%.

Consensus estimates for Okta is $771.65 million in FY 2021 and $1.0 billion in FY 2022.  

In the earnings call, CEO and Co-Founder Todd McKinnon stated the company is investing in growing its base of large enterprise customers. The company added 142 customers with annual contract value greater than $100,000 bringing the total number figure to 1,467 – or an increase of 41% y-o-y. Total customer base is 7,950. 

Operating cash improved 266% from $15.2 million to $55.6 million. Free cash flow also saw a big improvement from negative -$6.8 million to $36.3 million for fiscal year 2020. The company ended the year with $1.4 billion in cash, cash equivalents and short-term investments. Okta carries current liabilities of $546 million and long term debt of $837 million.

The company has been expanding internationally over the past two years, namely, Stockholm, Munich, Amsterdam, Paris, and Toronto. 

Prior to the Coronavirus, the company’s operating expenses were expected to rise due to an increase in headcount. The company’s headcount rose 40% in the first half of FY 2020 and 44% in the second half of the year.  

Valuation:

As stated, a few analysts pointed out that Okta is reaching maximum valuation. I believe most tech growth stocks will go through a valuation adjustment this year. Okta will not be an exception, although the company should fare better than most. 

By my estimation, Okta will fare better than most because its core business of IAM for the cloud is a stable market (comparatively to others right now). We know Okta is not reducing guidance as of yet and I imagine this will be an anomaly come May/June when the majority of companies will have revised guidance or will decline to offer guidance. 

When considering Okta’s valuation, it’s important to note that Okta spends more than 50% of its revenue on sales and marketing. I’ve been critical of this in the past and continue to question the runway of a few cybersecurity companies. Some companies spend heavily to stave off competition (this is my thesis for cybersecurity). Others move very quickly and spend heavily to gain market share while the opportunity is nascent. This is essentially what Amazon did and Netflix has been doing. I am initiating coverage on Okta because of the company’s name brand status in the B2B/enterprise world and because I believe it will be the de facto IAM company. 

Okta has a current price to sales of 26 and a forward price to sales of 20.7. During the Q4 2018 selloff, Okta was at a current price to sales of 14-15 and its lowest forward price to sales has been 17. This would place Okta at a market cap of $12 to $13 billion with an addressable market around $50 billion (combining both workplace and customer identity markets).

Keep in mind, a $12-$13 billion market cap places Okta where the stock traded during the momentum rotation in Sep/Oct 2019; which was a 1-year low for many cloud stocks. Therefore, this is not a drastic discount given the current economic uncertainty. 

However, you have to balance the fact that Okta’s customer base and market is more likely to stay intact this year compared to other tech companies. Assuming forward revenue will remain in the $770M range in the current fiscal year (as the company has stated it will) and $1 billion in the next fiscal year, then Okta will stand apart from companies that are lowering guidance.

Catalysts and Competitors:

Ping Identity carries a much cheaper valuation yet the low growth reveals a company that struggles to compete. Ping is forecasting full year revenue growth of 9%-11% from $242 million to $263 million. This growth is too low for me to personally consider, especially considering total addressable market in IAM has been growing rapidly.

It’s important to note that Gartner and Forrester place Okta above the competition. This matches the overall reputation of Okta in the tech industry. When I speak to companies about products, Okta is well received and spoken of very highly.  

Regarding Salesforce, Microsoft, IBM and Oracle, many of these companies require vendor lock-in and are not able to innovate as quickly. Okta’s FastPass is a good example of how Okta is innovating.  

On the topic of catalysts, Okta is a Coronavirus shopping list stock. Millions of employees will work from home this year and this will present operational challenges. Products like Okta will ensure only authorized users access their cloud applications. The CEO, Todd McKinnon, stated in a recent interview that the company is seeing an 80% increase in the amount of strong authentications. 

We are covering Okta as a buy-and-hold due to hybrid cloud migrations, the popularity of multi-cloud (which prevents vendor lock-in) and the company’s future potential in blockchain. These are the more important catalysts, in my opinion, as valuing companies based on the Coronavirus is beyond my scope. 

I feel fairly confident that blockchain will take off in the financial markets within a reasonable time span of 1-3 years and that Okta will be very well positioned when this occurs. Gartner and a few others place 2023 as the year when blockchain will be mainstream. The market will reach $3 trillion by 2030 (not all of this will be IAM, of course). Basically, I like Okta now for hybrid and multi-cloud and the $50 billion TAM …. but I really like Okta for the much bigger TAM that includes blockchain down the line.

Technical Analysis by Knox Ridley to follow this week.

Lam Research: Premium Analysis

Posted on by io-fund

6b4ae414-df00-4cd5-9374-8f23dd501538_Lam-Research-Premium-Analysis.pdf

Lam Research: Premium Analysis

Lam Research

Introduction:

Lam Research is cash efficient with forward guidance that shows earnings will grow at a rate that is rare to see in the semiconductor space. There is a 1.5% dividend, an exceptional buyback schedule and adjusted forward earnings per share of $20.34 for FY 2021, up from $16.05 for FY 2020. The $4 EPS increase in adjusted forward earnings in 2021 alone is more than Nvidia, Qualcomm, Taiwan Semiconductor, AMD or Qorvo’s respective EPS. 

Lam Research’s forward EPS is nearly double Broadcom, in second place.

Lam Research has best-of-class etch processing equipment. The majority of its revenue comes from supplying NAND and DRAM memory manufacturing. The company provides micro-processors, memory devices, various processing solutions and fabrication equipment for semiconductor companies. 

Front-end wafer processing solutions from Lam Research help to create chips and applications for edge devices. Wafer processing create transistors, capacitors and wiring for semiconductors. 

Lam Research’s customers span across Micron, Samsung and Intel. Analysts covering Lam Research like to point out that the company is protected from supply and demand as memory manufacturers will continue to buy from Lam Research even during a low point in the cycle. This was proven during 2015 when Lam Research did not feel the effects of the memory trough.

With that said, Lam Research is not entirely immune to supply chain issues as fiscal 2018 to fiscal 2019 reported a 13% decline.

Financials:

The company released its Q2 fiscal year 2020 results on January 29, 2020. Revenues grew 2.41% to $2.58 billion with trailing twelve-month revenue at $9.55 billion. This is slightly lower than FY 2019 revenue reported in the quarter ending in June with Lam Research’s fiscal year beginning July 1st. 

Net income fell 11% year-over-year to $514.5 million in Q2. Earnings per share were $3.43 compared to $3.09 for the previous quarter and $3.51 for the same period last year. Adjusted earnings per share came in at $4.01 compared to $3.18 in the previous quarter. 

Historically, revenue grew 18% from fiscal 2016 to fiscal 2019 although declined in 2018 due to trade war issues.  

Gross margins are at 45.7% compared to 45.3% in the 1Q FY 2020, which is average for a semiconductor company. The company has cash and cash equivalents of $3.03 billion at the end of the Q2 compared to $4.6 billion at the end of the Q1. The company reported cash and cash equivalents and investments of $4.9 billion compared to $5.8 billion at the end of Q1. 

This was due due to $1.0 billion of share repurchases, dividend payment of $166.7 million and capital expenditure of $62.1 million. These outflows were partially offset by $307.9 million of cash generated from operating activities. 

The company has long-term debt of $4.4 billion with current debt of $667 million. The operating cash flows were $307.9 million in fiscal Q2 2020 compared to $464 million in Q1 2020 and $642.4 million in Q4 2019.

Forward Guidance

The median revenue forecast for fiscal 2020 was $10.23 billion for an increase of 5.7% and $11.87 billion for fiscal 2021 beginning in July. However, the company recently withdrew financial guidance for Q3 2020 due to the company being located in California where non-essential companies have “shelter in place” restrictions.  

According to the recent investors day presentation, the company expects revenue to reach $14.5 billion to $15.5 billion for 2023/2024. This assumes a water fab equipment market assumption of $60 billion up from a market of $46 to $47 billion in the current year. If the market is more bullish by this time frame, the addressable market estimate for WFE is $70 billion with Lam Research’s revenue at $17 billion and EPS of $36.

The company also announced that it will return 75% to 100% of Lam Research’s free cash to investors, up from a previous target of 50%, and will also boost its dividend each year. Please note, this was stated at the start of the coronavirus disruption and prior to California’s closure of nonessential businesses. 

According to the earnings call, NAND demand is expected to be strong in calendar year 2020. The company expects to see growth in water fab equipment of $8 billion to $10 billion this year due to strong spending in foundry/logic (over memory). The company stated early signs of improvement in NAND spending with DRAM more in the longterm.

Services growth will be important to watch in the next quarter and into the future. According to management on the earnings call, services grew 30% year-over-year with multi-year contracts that provide recurring revenue to the company. The expectation is that services will outgrow the installed base with growth of 10-11% year-overyear. 

The company’s decision to buy Novellus Systems for $3.3 billion in 2011 helped the company to gain a leading position in the deposition segment. More recently in the earnings call it’s mentioned that the atomic layer deposition (ALD) is another area of growth. The company is gaining market share because of best-in-class film properties along with hyperactivity and low defects.

Valuation:

Lam Research has a more attractive valuation a month ago as the price is down 25% from the Febuary peak. However, it’s important to note this was more of a reversion to the mean rather than a deep discount as Lam Research is now trading at its 5-year average across nearly all valuation metrics.

Click here to view spreadsheet.

What I like about Lam Research is its cash flow and also the company’s cash on hand relative to annual revenue.  

Applied Materials reported $14.6 billion in revenue last year yet similar cash reserves of $3 billion as Lam Research with $9.6 billion revenue. The 5-year free cash flow growth rate for Lam Research is 38.12% compared to Applied Materials at 12.47%. 

The 5-year free cash flow growth rate for KLA is 7.52%. This is a significant spread on free cash flow and the comparables. 

Notably, Lam Research has higher forward revenue estimates of 17% compared to AMAT at 13.45% and KLA at 10.59%. When averaged over the next two years, Lam Research has similar revenue to both comparables. 

Earnings are similar across Lam Research and Applied Materials, although when you add in shares outstanding, Lam Research is set apart with 160 million shares compared to Applied Material at 945 million shares, which results in a much higher EPS for Lam Research. 

This, in turn, will allow Lam Research to do more buybacks and pay a dividend, which will attract a wide range of investors (value investors for the free cash flow, dividend investors for income, and growth investors for the memory market, stability from equipment sales and few competitors on etch).

It’s anyone’s guess as to what exactly the market has priced in with the Coronavirus as the company has not issued a revised guidance at this time other than to withdraw its current guidance (see below). 

Due to global economic conditions, the headquarters being shut down, and uncertainty in demand for NAND, some discount from the five-year average would be ideal. 

During the trade war, Lam Research traded at a PE ratio of around 10 and during the Q4 2018 selloff, the stock traded around PE ratio of 9. We have yet to see Lam Research trade at these levels during the Coronavirus/March bear market as it’s remained at a PE ratio of 13 or above. With that said, a forward PE ratio at 9 would be reasonable when comparing the last two sell-offs in tech and semiconductors. 

When looking at EV/EBIT, Lam has also remained above its Q4 2018 selloff and China trade war valuations. 

Some of the hardiness we are seeing in semiconductors during the March lows reflects the fact that a pricing surge was expected this year, yet as noted below, analysts and manufacturers are mixed on whether this will occur now due to a lack in demand (not supply).  

The majority believe the pricing surge will be much softer than previously estimated to flat while Gartner is calling for 10-15% increases in pricing (see below).

COVID-19 Impact

Multiple San Francisco bay area counties issued shelter-in-place order. The company needs to temporarily stop on-site work at its Fremont and Livermore locations for three weeks effective March 17, 2020. As a result of these implications the company’s manufacturing activities in the two California facilities will be disrupted and parts from key suppliers will be impacted. The company has withdrawn the March quarter 2020 financial guidance.

The company also has supply chain activities in Malaysia, and on March 16, 2020, the Malaysian government issued orders to close certain business activities from March 18 to March 31, 2020. 

Lam Research saw a 43% drawdown from its February peak and is currently trading down 24%. Meanwhile, analysts are mixed on the semiconductor market recovery following COVID-19 shutdowns. 

On March 20th, Mizuho analyst Vijay Rakesh upgraded the stock from neutral to buy. Rakesh expects a rebound in the second half of 2020 and into 2021 based on the expectation for growth in NAND, DRAM, and etchequipment spending. The analyst mentions valuation is cheap compared to the historical average. 

Regarding COVID-19 Rakesh states, “While (first half of 2020) wafer-equipment spending will likely be impacted from COVID-19, we see a better (second half 2020) by the need to add capacity to tight memory supply, and foundry/logic WFE spending given strong seasonal 5G handset demand, a strong data center outlook and 7nanometer/5-nanometer ramps.”

Evercore names Nvidia, Lam Research, and ASML as top ideas for long-term investors amid the “incredibly uncertain” demand picture. Meanwhile, B.Riley analyst Craig Ellis downgraded the 10 chips companies, writing that he “underestimated potential for a risk” from outbreak of COVID-19.

Morgan Stanley analyst says that the company’s analyst day featured “several incremental positives,” including a strong earnings target and a higher FCF return plan. The firm sees Lam Research as a core holding, but “can see more upside elsewhere around the theme of memory improvement.” (Note: is likely this analyst is referring to Micron as Morgan Stanley is bullish on Micron).

Addressable Market and Valuation

According to Gartner the worldwide wafer fab equipment market is expected to reach $53.6 billion in 2020, down 1% from 2019. According to the March Investors presentation, Lam Research has outperformed water fab equipment (WFE) growth 2:1. Lam Research’s revenue grew at a CAGR of 16% from 2013 to 2019 and WFE grew at a CAGR of 8% in the same period.

Lam Research’s customer list includes Micron Technology, Samsung Electronics, SK Hynix, Toshiba, TSMC, among others. In 2019, Lam Research was also named a preferred supplier for Intel. 

Geographically, Lam Research is weighted towards China at 29% and Taiwan at 26%. The United States makes up 9% of Lam Research’s revenue.  

NAND is primarily driven by smartphones, including SSD and memory cards. The global 3D NAND flash memory drive market size was $9 billion in 2017 and is projected to reach $99 billion by 2025, growing at a CAGR of 35.3%. Asia-Pacific will be a strong contributor to global share at nearly half of the market at $48 billion. Key players for

NAND include Samsung Electronics Co., Ltd., Toshiba Corporation, SK Hynix Semiconductor, Inc., Micron Technology, Inc., Intel Corporation, Apple Inc., Lenovo Group Ltd., Advanced Micro Devices, STMicroelectronics, and SanDisk Corporation.

Statista places the size of the dynamic random-access memory market worldwide at $63.5 billion in the current year, growing to $83.4 billion by 2024. DRAM memory is used in smartphones and tablets and the increasing demand for online operability and internet connectivity. 

Low-power consumption and high-density memory technologies, such as DRAM, are also used in data center infrastructure due to cloud services requiring cooling, high speed data transmission and back-up facilities. 

According to IC Insights, NAND Flash sales declined 27% in 2019 and will rebound at 19% in 2020. DRAM sales declined 37% in 2019 and will rebound 12% in 2020. 

Source: IC Insights

However, COVID-19 shutdowns may soften the pricing surge that was beginning to form due to demand. The weakened forecast comes from an uncertainty in consumer spending on mobile phones and devices that use chips. If major hyperscalers curb their spending in the second half, as discussed by TechTarget, then flash and SSDs will be impacted. Others agree that there’s unlikely to be shortage this year in memory and that NAND flash, SSDs and DRAM should remain at a reasonable price. In contrast, Gartner continues to believe NAND flash will see a 10-15% increase in pricing with SSD prices likely higher. 

Product Overview

Lam Research manufactures equipment for semiconductor companies. The company serves the etch, deposition and clean markets with a specialty in 3D NAND flash and advanced DRAM. 

As the market leader in etch, Lam Research supplies a critical process in chipmaking where excess material is removed. Lam Research also produces deposition equipment, which applies thin-film layers to surfaces. 

This month, the company announced the Sense.i platform, which has a space-saving architecture and will help customers meet wafer output targets “by producing more than 50% improvement in etch output density.” The company describes the platform as self-aware due to autonomous calibration that helps reduce downtime and labor costs while the tool self-adapts to maximize wafer output. The platform also has a small footprint, which helps as manufacturers increase the complexity of their processes. 

The majority of its revenue comes from supplying NAND and DRAM memory manufacturing. The company provides micro-processors, memory devices, various processing solutions and fabrication equipment for semiconductor companies. 

NAND memory saves data even when the power is removed, like when a cell phone is turned off. DRAM only saves memory when a device has power but is much faster than NAND and lasts longer. Beyond mobile devices, NAND is found in traffic lights, digital advertising panels/displays, and anything with artificial intelligence that needs to store data. NAND has been around since the 1980s but got a much-needed boost from 3D NAND, which stacks vertical memory chips. I’ll cover 3D NAND in more detail in the upcoming Micron research report.

Catalysts for Lam Research include FinFET and planar for 3D NAND with multiple patterning and vertical layers. 3D NAND spans single-level cell (SLC), multi-level cell (MLC) and triple-level cell (TLC). As chipmakers must battle each other for more power per chip while often in pricing wars, equipment providers like Lam Research can provide an advantage through superior tools. There are more layer-counts in 3D NAND and foundry/logic transitions to the process node that require greater multiple patterning steps. Upgrades from the planar to 3D NAND have been strong drivers for Lam Research’s double-digit revenue growth although these upgrades may level off in the future. 

For Lam Research’s customers, Moore’s Law states that the number of transistors on a microchip doubles every two years although the cost of computers is halved. Superior equipment providers (like Lam Research) can help stave off the effects of Moore’s Law for their customers by helping to deliver high-volume manufacturing. 

The competitive advantage for Lam Research is the lead it has from service contracts and customer collaboration for high-volume manufacturing. It would be challenging for new competitors to compete with the scale and resources that Lam Research has. Lam Research has an installed base of 61,000 chambers as of the end of December 2019, up from 40,000 units in 2015. The company is also driving more revenue per chamber. New technologies like “Sense.i” deliver significant productivity and throughput improvements. The tool will be delivered to all major customers to increase manufacturing rates. 

Lam Research merged with Novellus in a $3.3 billion stock deal in 2012 to become a market leader in deposition materials. In 2016, an attempt to merge with KLA-Tencor was shot down.  

Lam Research is also releasing an advanced atomic layer deposition (ALD) tool as well as a plan to introduce dry photoresists for EUV patterning in lieu of the current wet photoresists. The ALD-tool will target companies such as ADM International and Applied Materials for physical/chemical vapor deposition. 

TSMC has mentioned that the 5G and HPC are the growth drivers in the long-term. This should also help the company to diversify from any slowdown in memory chip clients. 

Technical Analysis

By Knox Ridley 

Elliott Wave/Fibonacci Price Zones (Weekly Chart)

The above chart is my Elliott Wave count for LRCV going looking back to 2009. All Elliott Wave charts are meant to be analyzed on the logarithmic charts, which is why the trend looks more balanced. It’s measuring the percentage change in a stock. 

I have LRCV ending a large degree third wave, in blue, and currently in the 4th wave down. Fourth waves typically retrace to the 23.6% to 38.6% retracement level of the entire 3rd wave. On rare occasions we see it retrace to the 50% retracement level. These levels are outlined in black to the right of the green target box.

The red, blue and black prices on the right of the chart correlate to the larger degree counts. What we want to see are confluences of price clusters. When we see this intersection, it usually marks an important region for support/resistance. These typically act as magnets to the price above and can usually be counted as great areas to either layer in or look for a bottom.

Basic Technical Analysis (Hourly Chart)

If we zoom into the hourly chart we can get a better idea of where this correction may bottom. Corrections typically unfold in 3 legs that are symmetrical (in Elliott Wave it’s marked as A,B,C). In other words, more times than not, the length of the first leg is usually the length of the last leg down.

In the chart above, this symmetrical leg down is shown by the 100% extension in black, which is to the left of the target box. This area also coincides with a number of Fibonacci price clusters, which is shown on the right of the target box. 

The areas where we will focus is the yellow and green bands.  The yellow band consists of the $174 – $161 region, which coincides with two Fibonacci price clusters as well as the 1/2 Gann Fan. The green band consists of $135 region which is the 100% extension of the first leg down as well as some major price clusters

Also, the B wave that we are in shows many divergences, which suggests this rally is running on fumes. We have multiple negative reversal patterns, where the RSI and MACD are making higher highs while the price is making a lower low. This is saying that a larger amount of buying pressure is needed to push the stock up to a lower price than before. The volume is also suggesting that this rally isn’t widely being bought either.  

Putting it Together

The above chart combines the Fibonacci price clusters in black, on the right of the chart, and the Gann Fan angles. One thing becomes evident, the $174 region is an intersection between the Gann Angle 1/2, and the Fibonacci price cluster. 

I’d look for the $174 area to act as support in the coming days/weeks. It would also be a good level to start layering in, for anyone with a long-term time frame in mind. 

If the price can close above $288 and sustain above that level, then I consider that a cautious bullish scenario. I’ll consider entering with very tight stops. 

I will update you when we approach one of these two scenarios.

5G: List of Stocks and Overview

Posted on by io-fund

Here is a direct link to the 5G list of stocks spreadsheet: 5G List of Stocks 2020

300c2b14-9353-4a4a-bc1a-7309e2824cee_5G-List-of-Stocks-v1.pdf

5G: List of Stocks

For this analysis, please reference the 5G spreadsheet that includes a comprehensive list of the companies we are tracking across various metrics. We have also written an overview of 5G infrastructure and where we believe the most growth will occur in the 5G tech stack.

Access 5G spreadsheet here. Access 5G spreadsheet here.

As stated in our first 5G analysis, the goal is to balance optimism with a more conservative outlook. Nokia is a great example of where the 5G “hypercycle” can go wrong. The company chose a chipset that ended up being too expensive and this hurt Nokia’s profit margins. The stock is down 30% over the past year. 

The following from NXP’s earnings report was sent to me by a reader: “And clearly, there is a churn going on in China right now, not only with the suppliers but also with the different standards and the different combination of carriers and their technology…it looks like it’ll still be a couple of quarters out before we’ll see strong growth in 5G deployment. We clearly see that it’s coming, just don’t see it in the near term."

NXP Semiconductors provided guidance around base stations in their recent earnings report, with the serviceable market for power stations growing only 13% CAGR over the next five years to $2.5 billion by 2024. Meanwhile, NXP issued more optimistic guidance for macro base stations and last mile solutions with a broad-based roll-out in late 2020 to early 2021 at 30-35% CAGR. 

Cisco also reported declining revenue this week for fiscal Q2 2020 and stated revenue will continue to decline slightly 1.5% – 3.5% year-over-year in Q3. The CEO called 5G a “multi-year transformation” on the earnings call.  

With this in mind, we are evaluating companies that solve problems unique to 5G that did not exist in the fourth generation of wireless. We are looking for companies that supply the expensive 5G chips (like Nokia referenced) and last mile connectivity (like NXP referenced). Ideally, for long term gains, the companies we evaluate will serve both consumers and business/enterprises.

I was not surprised to see the Sprint and T-Mobile merger approved. I discussed this in the prior PDF. You can expect to see the government to subsidize 5G and also become lenient with regulations in order to push 5G ahead.

The United States is behind China on 5G and this is more important than any single argument around the merger. 

Top Stocks to Watch:

As of today, one of the more important takeaways from the spreadsheet is that Micron may be undervalued in regards to its impact on 5G. We will cover this stock in a full-length report as there are few competitors in data storage/DRAM. 

Qualcomm ranked high across a few important metrics and that is reassuring as we also like its competitive positioning across multiple manufacturers with the Snapdragon X55 solutions.  An example was found in our coverage of Inseego on hotspots and fixed wireless access, where we noted there are 33 OEMs that Qualcomm is working with on hotspots and FWAs (Inseego being only 1 of the 33). This level of diversification helps provide a safety net if one OEM stumbles or a 5G roll-out is delayed. 

Skyworks and Qorvo are market favorites with well-known stories due to being Apple suppliers. These companies provide radio frequency front end (RFFE) components with an increasing bill of materials (BoM) from 3.5% during the 3G era, to 14.6% in premium 5G mmWave smartphones. Some bullish analysts expect the BoM for RFFE components to increase by as much as 30%, including Gary Mobley of Wells Fargo. Keep in mind, average sales price (ASP) of smartphones will be tested – even for 5G. 

Regarding Qorvo and Skyworks, keep in mind, the bigger opportunity will be at the enterprise-level. Here’s a writeup on that with an overview of the 5G breakdown. 

Large Cap Stocks:

Micron:

•        Micron has nearly 150% forward projected EPS growth from $2.27 to $5.52. 

•        In addition, Micron ranks high across 5G stocks with forward revenue growth of 25% with healthy margins of 20%. 

•        Micron is guiding for weak sales and earnings over the next two quarters which has provided a lower valuation than most. However, the company is one of the only DRAM and NAND suppliers capable of serving the 5G market. 

•        Micron may be undervalued with a forward price to sales of 2.5 and forward EV/EBITDA of 8, which is half that of its 5G semiconductor peers. 

•        The company is developing a new memory chip, the 3D Xpoint, to provide both DRAM and flash. 

•        Micron extends beyond the consumer use case to include industrial IoT and other data and storage needs for 5G.

Here’s a snapshot of data consumption over the next few years:

 Source: Cisco and Telecoms.com

Qualcomm:

•        Qualcomm ranks high on forward EPS growth of 45% from $4.21 to $6.10. 

•        Excluding small cap stocks, the company is second to Micron in the 5G category for forward revenue growth of 23%.

•        Operating margins are slightly better than Micron at 31%. 

•        Qualcomm has an EV/EBITDA of 14 which is double Micron’s.

•        Qualcomm’s Snapdragon X55 and platform will power the majority of 5G devices across many manufacturers.

•        We like Qualcomm as a diversified play across consumer and enterprise. The company works with many smartphone manufacturers and is in hotspots and fixed wireless access devices. 

•        Qualcomm has been trading at an important resistance zone.

•        Qualcomm was covered in the 5G semis overview. Please reference this for more information.

Skyworks and Qorvo:

•        Skyworks and Qorvo have EPS growth in the 20% range and revenue growth in the 10-15% range.

•        The only drawback to Skyworks is that it’s mainly a consumer smartphone play with 73% of sales coming from smartphone wireless chips. 

•        RFFE components are expected to have a 3x higher bill of materials for premium smartphones.

•        The market favors Skyworks and Qorvo as the story of being Apple suppliers is well known and easily understood. 

•        Qorvo was covered in the 5G semis overview. For more information, please reference this PDF.

Lam Research:

•        Lam Research provides wafer fabrication equipment with the majority of its revenue coming from NAND and DRAM memory manufacturing (like what Micron does).

•        Lam had a big rally in 2019 due to its strong financials.

•        We covered Lam Research in the 5G semis overview.

Taiwan Semiconductor:

•       TSMC is a fabrication plant for semiconductors that supplies integrated circuits to fabless semiconductor companies. 

•       Taiwan Semiconductor manufactures over 10,000 products for nearly 500 customers.  TSMC owns

50.5% of the foundry market and is a supplier to Apple and Huawei. 

•       The company is currently making a lot of lists for top stocks of 2020 and is a well-known story to the market. 

Small Cap 5G Stocks – Watch list:

We will be covering 5G small cap stocks throughout the next two quarters. As of today, our watch list is:

•       Boingo Wireless: 

We covered this early-on and have seen nearly 30% gains in the last 2-3 months. Please reference the PDF and Knox’s TA updates as the stock recently broke resistance. 

•       Inseego: 

This stock ranks high on revenue growth and has won over many analysts following the Huawei security concerns. Please be aware, the lead investor is H2C Holdings, which is ran by Phil Falcone. For disclosure purposes, he had a high-profile bankruptcy with LightSquared and an SEC investigation for using clients' funds to pay taxes. It's important to report all information on a stock and we will be issuing an update on our TA that comes out tomorrow. The stock has climbed 13% over the past week since we covered the company in a PDF.

•       Tower Semiconductor and Atomera: 

These small caps compete on 5G mobile-transmit receive chips that have the ability to deliver up to ten times the data rate as 4G LTE, as well as RF SOI technology that helps to increase battery life and boost data rates. These companies are having less-than-spectacular earnings reports with flat to declining revenue but look for a breakout in 2020. Tower works with Cavendish Kinetics, which Qorvo acquired. 

•       F5 Networks:

F5 Networks is a company I like a lot and plan to cover with a PDF as they specialize in network functions virtualization (NFV). NFV enables network slicing and software virtualization, which we covered in our 5G tech stack report. Network slicing will allow a physical network to be separated into multiple virtual networks that can support different radio access networks. F5 Networks recently acquired Security Shape, an AI-driven cyber security company. I am especially interested in F5’s recent acquisition of NGINX, which has an open source developer following, and will help F5 provide flexibility for software developers. 

•       Generac Holdings:

This company had an earnings beat last week and the stock responded with a 15% increase since the report. The company provides power generators and energy products with most of the gains reflecting the power outage issues in California. The company is also well positioned to provide backup power for 5G networks. 

•       By my estimation, Microvision and Appian Corporation will be slower to breakout because they require successful 5G roll-outs before the products or technologies can fully mature. We will keep them on our radar for now. 

o   Microvision could be an acquisition target for AI-powered assistants. 

o   Appian is an enterprise-level low-code programming platform for automation. 5G will drive a need for enterprises to release new applications very quickly, similar to Sprint.

Dynatrace Premium Research

Posted on by io-fund

6ca1bcfb-1977-41c8-a084-07f790a54db0_Dynatrace-Premium-Research.pdf

Dynatrace Premium Research

Dynatrace

Dynatrace is a premium application management software company that ranks high on product evaluations by Gartner and Forrester. The company claimed 8.8% of the APM market in 2018, placing the company in third place behind New Relic at 10.3% and Cisco’s AppDynamics at 11.2%. The company is ahead of IBM at 8% and Broadcom at 7.6% of the APM market.

The all-in-one cloud platform is priced higher than other APM products and is sold as a package rather than as separate modules. The offerings include real-time topology and AI algorithms to monitor applications, infrastructure and business operations. 

In 2016, Dynatrace launched a full-stack cloud monitoring platform. The platform is now the main driver of growth at 80% of annual recurring revenue, up from 75% of total annual recurring revenue last quarter, and up from 39% a year ago. Subscriptions and services combined make up 98% of revenue compared to licensing at 2%.

Dynatrace is seeing the positive effects of transitioning to the subscription-based model in its operating margin. The non-GAAP operating margin grew from 13% in fiscal Q1 2019 to 22% in fiscal Q1 2020, ending in August. The most current non-GAAP operating margin in fiscal Q2 2020 was 23%. 

Dynatrace is focused on large, enterprise accounts with greater than $750 million in annual revenue. This is reflected in the company’s average account totaling over $200,000 ARR per customer. 

Product

Please refer to the Datadog Premium Research report for more information on the APM market including information on competitors New Relic and AppDynamics. t for more information on the APM market including information on competitors New Relic and AppDynamics.

Dynatrace’s product road map is geared towards exceeding Cisco’s AppDynamics and New Relic in AI-powered analytics, such as self-learning AI, real-time discovery, automated problem remediation and the use of AI chatbots. 

Full-stack observability is another area where Dynatrace stands out. Rather than offer infrastructure monitoring or application monitoring separately, the company has developed a more comprehensive approach to business observability. In a recent earnings call, Dynatrace stated the company was four years ahead of the competition in full-stack observability, which helps return business value to its customers. 

In a sponsored case study, Dynatrace returns up to 311% ROI over three years to its customers with the investment paid back in six months.

Hybrid cloud

Dynatrace’s product roadmap includes expanding into multi-cloud and hybrid cloud and using purpose-built AI to perform root cause analysis faster.

Hybrid cloud is a technology that enables companies to store some of their data on their own servers while simultaneously sending other data to the private and public cloud. Companies prefer hybrid cloud because it is cost-efficient, transparent, and safe. Hybrid essentially helps to push many companies off the fence in deciding between cloud and on-premise. 

According to a recent study, 76% of companies are committed to hybrid cloud. This is the main catalyst for why Microsoft Azure has gained in popularity against the heavyweight Amazon’s AWS as Microsoft set out to specialize in hybrid cloud in 2016. (I’ve hammered this point home a few times on Microsoft). It’s important to pay close attention to this trend as hybrid will be a driver for the remaining growth in cloud. 

Fundamentals

As stated, Dynatrace is reporting 23% non-GAAP operating margins since moving to an all-in-one cloud monitoring platform. The company is profitable on a non-GAAP basis at $0.06 in the most recent quarter, yet has reported negative GAAP EPS of -$1.58. 

Total revenue increased 27% year-over-year in the most recent quarter with subscriptions and services growth exceeding this at 37% YoY and annual recurring revenue increasing 44%.

The question that is worthy of speculation, is if the subscription growth of 37-47% is going to pick up the overall revenue growth in the forward year as the Dynatrace platform eclipses the classic products at 80% versus 20%. Subscription and services also far exceed licensing at 98% versus 2%.

The company is projecting full year fiscal 2020 revenue to be between $533 million and $535 million. This is up from $431 million in fiscal 2019, or 24% growth. 

As of now, the company is not projecting the kind of rampant growth that the more popular cloud software stock report although revenue growth has been steadily increasing since the 2016 product pivot. Revenue growth was negative from 2017-2018 as the company absorbed the transition and was at 8% year-over-year growth from 2018-2019.

The CEO believes the company is in the sixth quarter of a 10-12 quarter transition from the licensing model to the subscription model. The dollar-based net expansion rate of 140% is well above the cloud software benchmark, which is a very good sign for future revenue growth. This is higher than any cloud software subscription company that reported net retention in 2018 with the previous leaders being Smartsheet at 130% and Alteryx at 131%. Netdollar expansion rates measure whether the growth from the existing customer base offsets any losses. Typically, these numbers will decline over time. With Dynatrace, the number has increased due to the pivot to cloud platform. 

Non-GAAP operating income is expected to be in the range of $119 million to $121 million. This will put non-GAAP EPS at $0.23 to $0.24 for the fiscal year ending in March.

There was nearly $1 billion in debt on the balance sheet, but this has steadily improved over the last year with the help of the IPO. Following the public offering, which produced $590 million in net proceeds, the current debt balance is $540 million. Cash flow for fiscal Q2 was $27.2 million, and $174 million on trailing 12-month basis.

According to Dynatrace’s S-1 Filing, the addressable market is $18 billion. Gartner places the addressable market for global IT operations software at $29 billion with compound annual growth rate of 6.7% to $37.5 million in 2023. 

Notable Price Volatility & Upcoming Lockup

Expiration

Dynatrace launched in 2006 and raised $22 million before Compuware bought the company in 2011. The private equity firm, Thoma Bravo, bought Compuware for $2.5 billion in 2014 and spun Dynatrace off as a private company after merging Dynatrace with Keynote, another APM company in Thoma Bravo’s portfolio.  

After the company went public in August, Thoma Bravo reduced its stake from 71% at the IPO to 61% over the course of a week in December. The stock price fell 12% during this time with the offering from Thoma Bravo of

27.5 million shares. 

Most importantly, the company’s lock-up period will expire on January 28th. The company reports quarterly earnings the following day on January 29th. One of the current trends in this IPO market is for lock-up expirations to result in a short-term drawdown in stock price.

Technical Analysis

By Knox Ridley

Just under 6 months ago, Dynatrace (DT) listed on the NYSE at $16. Following the recent, hot IPO trends, DT closed on the first day of trading 49% above its IPO price at $23.85. Notably, shares opened at $25.50. 

However, unlike the broad market that continued to rally in the back half of 2019, DT then began a 36% drawdown that bottomed just above its IPO listing price at $17.13.

Basic Technical Analysis

Using basic Technical Analysis, we can follow the initial downtrend with the price and MACD using the downward sloping, blue-dashed lines in the chart above. The MACD signaled long before the bottom that the momentum was fading.  

Notice the green arrow sloping up on the chart. As the MACD was making higher lows, price was making lower lows. This is the type of positive divergence that we see before a bottom. The trend reversed when both price and the MACD broke through the blue downward sloping lines shown on the chart, as DT began to make higher highs and higher lows for the first time since going public.

Since then, Dynatrace has been in a standard uptrend. It’s worth noting that DT broke above the all-time high at $26.90 this year. This is a sign of strength that we want to see prior to initiating a long position.

Just like on the way down, we can use the same trendline tools to gauge the health of the current uptrend. The MACD signaled weakness prior to the actual recent top. As the price was making new highs, the MACD was making lower highs, which is a sign of fading momentum. The RSI, MACD and price all followed their own internal trendlines in unison, highlighted in blue. Recently, all three have broken these trends, which is a sign that a possible reversal is underway.

Elliott Wave Analysis

Using Elliott Wave, we can get a clearer idea of what the structure of Dynatrace is telling us. The initial downtrend followed a standard 3-wave structure, where the C wave unfolded in a final 5-wave impulse before bottoming. Since a reversal at $17.13, the uptrend broke out to new highs, which takes a larger degree downtrend off the table for now. 

We have a clear 5-waves up off the bottom, which is highlighted by the green roman numerals. These waves coincided with the standard Fibonacci levels that make up a 5-wave uptrend – e.g., 3rd waves typically break at the 161.8%extension of waves 1 and 2, and the 5th wave terminates around the 200% extension. 

This would now put us in a larger degree 2nd wave, which will be confirmed if Dynatrace breaks through $26.50 level. Above this region, and DT could press higher, extending for its final 5th wave towards the $30 region before we see a larger degree pullback. 

If Dynatrace breaks support to confirm the 2nd wave scenario, I’ll look between the 38.2% retrace level, around $25, and the 61.8% retrace level, around $22, to initiate a position. 

If this is the structure we are dealing with, expect the 3rd wave up to take us to new highs and beyond. However, if DT closes below $19.25, I will consider this a failed impulse and stop out of any long position. 

Datadog Premium Research

Posted on by io-fund

509d3f81-5ab0-47d8-b044-88c293b4f7b5_Datadog-Premium-Research.pdf

Datadog Premium Research

Fundamentals

Following its IPO in September, Datadog reported revenue that was up 87.8% year-over-year at $95.9 million compared to analyst expectations of $87.73 million. The revenue growth was higher than the 79.5% reported earlier in the year. 

Company guidance for Q4 revenue is between $101 million and $103 million. Full year revenue is expected to be between $350 million and $352 million. Forward 1-year revenue is expected to be around the $500 million mark.

This places Datadog second to Crowdstrike for estimated forward revenue growth in the cloud software category. 

However, it bears mentioning, Datadog is closer to profitability than any other cloud software company (among those currently reporting negative EPS). Datadog hovers near profitability with non-GAAP operating margin of 0.7% and non-GAAP EBIT of $0.6 million. GAAP operating margin is negative -4.4%. Free cash flow is negative $3.7 million. 

Full year non-GAAP EPS is estimated at negative -$0.12 to -$0.11. 

Datadog went public in September and is trading at 34 times the midpoint on its full-year guidance of $351 million. If other IPOs in 2019 are any indication, the expiration of the lock-up period on March 17th will likely see some level of adjustment in valuation. 

Addressable Market

The broad infrastructure monitoring market is quite nuanced with many players specializing in various aspects of cloud and IT. The broad addressable market will be worth $34 billion by 2024. It requires further effort, however, to break this down into the areas that Datadog directly serves. 

According to IDC, the global APM market reached $4.3 billion in 2018, posting 13.4% growth from 2017. The fastest growing companies during 2018 was AppDynamics at 42% market share and New Relic at 35% market share. The market is expected to grow annually by 11.84% over the next several years. 

Datadog is expanding into network performance monitoring with a current addressable market of $2 billion. The log management market (as a standalone) is worth $1 billion. 

Conservatively, Datadog’s addressable market is around $8 billion to $10 billion. For optimists, (such as the Jefferies’ analyst who stated Elastic’s market was around $40 billion), you could look at the $34 billion IT infrastructure monitoring market especially since Datadog does help monitor on-premise.

The $8-$10 billion market is sufficient enough for Datadog to continue its 65% growth with current revenue of $350 million. The company would only have to claim 5-10% of the market to be a breakout stock.

Product Overview

Datadog is a cloud-based monitoring and analytics company that offers infrastructure monitoring and has expanded into application performance monitoring (APM). The company aggregates metrics and events across the full infrastructure and application stack for a single point of view.

Datadog began as an infrastructure monitoring tool in 2010 and expanded into APM in 2016 with the public release in February of 2017 for full stack observability. 

Application performance monitoring assures applications and websites run as expected with optimal speeds across mobile platforms, cloud-native infrastructures, virtualized and containerized servers, etcetera. APM also assures that the application is performing as it should, backend processes are executing as they should, including transaction processing, and detects bug or errors in the application code, in the application server, website front end, a slow query, or a slow network.

Distributed application environments can cause numerous bottlenecks and it can be challenging to figure where the bottleneck is coming from. Meanwhile, slow speeds can cause customer drop-off. 

APM performs the following functions:

•       Digital user experience monitoring: determines if there is slowness, errors or downtime that could lead to a loss of revenue

•       Transaction profiling: analyzes the transaction flow to isolate the cause

•       Code-level diagnostics: According to DZone, 43% of application performance issues come from code. Diagnostics help to identify the line of code or query causing the issue.

•       Deep-dive analysis: Looks beyond code at the server and application infrastructure for problems such as insufficient memory or long wait times

•       Infrastructure monitoring: similar to deep drive analysis, ideally infrastructure monitoring is part of the APM package to monitor slow network connections or virtualization bottlenecks.

Competitors

There are a few 800-lb gorillas in the space, such as New Relic, AppDynamics (Cisco) and CA Technologies owned by Broadcom. Dynatrace is also considered a leader in APM and is a private company. 

Datadog lists New Relic, AppDynamics and Dynatrace as their main competitors.  

Source: IDC APM Market

New Relic

New Relic was founded in 2008 and entered the market with a SaaS-only APM solution. The products have expanded since then to include Infrastructure, Synthetics, Browser, Mobile and Insights for analytics. 

The company has expanded into monitoring Kubernetes containers and microservices monitoring (important for automation and machine learning) and now has a presence in Europe although global geographic coverage is a weakness for New Relic. Another weakness is the lack of on-premise.

New Relic’s most recent acquisition was SignifiAI for incident management, which occurred in February 2019. The company is also focused on root cause analysis including predictive anamoly detection, topology-enhanced operational event correlation, and automatic deployment tracking. 

Annual revenue of $479 million is expected to grow to $591 million revenue in the current fiscal year ending in March. Forward 1-year revenue is estimated at $693 million. New Relic is distinguished by its profitability, with EPS of $0.24 in the last quarter and current fiscal EPS of $0.64. 

App Dynamics

AppDynamics offers both on-premise and SaaS-based APM. Cisco bought AppDynamics for $3.7 billion. According to Gartner, App Dynamics revenue is in the $500 million range+ from sales of APM suites in 2018 (this matches IDC’s data). In an effort to improve its machine learning capabilities, Cisco acquired Perspica in 2017 for a purchase price of $3.7 billion. Perspica helps to surface issues by applying machine learning to large amounts of operations data. Instead of analyzing data after it’s in the database, this helps to analyze the data real-time as it’s being ingested. 

AppDynamics weakness is also its strength: Cisco. The revenue is likely reflective of Cisco’s market dominance in networking, yet many APM-specific customers are more apt to go with a smaller, specialized company that is solely focused on APM.

Dynatrace

Dynatrace’s analytics are sold as a package rather than as separate modules with analytics offering real-time topology and AI algorithms to detect anomalies, business impact and root cause across users, applications and infrastructure. The product roadmap includes expanding into multi-cloud and hybrid cloud and using purposebuilt AI to perform root cause analysis faster.

Dynatrace is a premium solution and is priced higher than other APM products.

Catalysts

Hybrid Cloud

I’ve covered the strengths of hybrid cloud in-depth with my Microsoft coverage over the past 1-2 years. Essentially, hybrid cloud allows companies to keep their most sensitive data on-premise while sending less sensitive workloads to the cloud for real-time data processing. Microsoft’s lead in hybrid cloud is what caused me to predict the Pentagon would choose Microsoft over Amazon, as well as Azure’s ongoing growth despite AWSdominance, as Amazon has been focused on cloud-only while ignoring the needs of Fortune 500 companies and others who are more cautious with intellectual property and first-party data.

Read my analysis on Microsoft being a hybrid clod leader here and why this is an important cloud market.

Datadog serves hybrid cloud customers and allows for monitoring of both environments. New Relic, on other hand, is SaaS-only (or cloud only). From my perspective, the most growth will come from hybrid over the next few years as the majority of companies today have resisted sending data to another company’s servers and must eventually choose a solution to remain competitive on AI and ML. 

In my opinion, the future growth of hybrid is an important catalyst and market opportunity for Datadog. You can read more about Datadog’s hybrid offering here.  

Network Performance Monitoring

Network performance monitoring is a potential catalyst for Datadog in 2020. Although the addressable market is quite small at around $2.1 billion, the cross-selling with customers could strengthen Datadog’s revenue growth.  

The company launched network performance monitoring in November of 2019 to expand on infrastructure monitoring and application monitoring. By monitoring virtualized networks, the product helps to increase performance optimization and reduce costs by looking for more optimized network patterns and to quickly find the source for network issues.  

For instance, if a cluster is saturating the network capacity, this monitoring tool helps to pinpoint the root cause. There are also topology and traffic flow tools to visualize network connections. 

Competitors in network performance monitoring include Netscout, Riverbed, Viavi and Extra Hop. Again, it’s about the cross-selling with the other products that Datadog provides rather than competing in network performance monitoring as a standalone product.

Technical Analysis

By Knox Ridley

Like many new IPOs, Datadog (DDOG), with just 4 months of price action to analyze, is showing a series of overlapping, corrective patterns, signaling uncertainty by the market. 

In November of 2019, Datadog hit an all-time high of $44, just before a near 25% drawdown took it down to $33.15. Since bottoming, it’s been in an overlapping uptrend, attempting to repair the damage done.   

Using basic Technical Analysis, we have a clear picture of where DDOG is, and what hurdles it needs to clear to regain higher prices. Starting with the upward trend lines that are highlighted in the blue, we can see a clear trend in price that is supported by a rising MACD and RSI. In other words, the momentum is building with price, which indicates a healthy trend. If we see a break of these trend lines in unison, expect Datadog’s price to test the recent low around $33. 

If we see these trendlines broken, the red retrace levels offer likely targets, based on basic rules of symmetry and Fibonacci levels. My main target will be around the $31 region if this scenario unfolds, which coincides with the

78.6% retrace level and the 100% extension of the initial move down. However, we could see it bottom at the 61.6% retrace level around $33, or to hit the 127.2% extension around $29-$28. This is my justification of the yellow target box, which I will watch closely if DDOG fails to breakout. 

Just above Datadog’s current price is a heavy clusters of Fibonacci prices that coincide with the $40-$42 region. With momentum fading, shown in the declining RSI and MACD, as well as negative divergence between price and the RSI, the probability of Datadog breaking this region is low. 

However, if this resistance is broken on heavy volume, expect an acceleration in price due to the high level of short interest in the current float, sitting around 25%. As price moves against shorts, especially breaking a region as significant as the $42 price level, they will cover their positions, creating a rush of buying pressure, which in turn, pushes the price higher at a rapid pace.

Elliott Wave – Scenario 1

The above chart offers my primary Elliott Wave count, which suggests another leg down. This would put us in the early stages of the final (C) wave down. The evidence I use to support leaning towards this count is as follows:

 –          The (B) wave up is slightly overlapping, which is what we see in corrective moves.

–          The declining internals in RSI and the MACD recently discussed are fading, and showing divergences as well. 

–          The heavy concentration of Fibonacci levels around $40-$42. 

–          The general fact that the market is heavily stretched and due for a correction. 

Expect the (C) wave to retest the last low around $33. If this scenario unfolds, my likely target will be around the $31 region, which is a concentration of significant Fibonacci levels and basic symmetry. I will likely be a buyer around the levels outlined in the yellow target box between $33-$28. 

Elliott Wave – Scenario 2

This is my alternative game plan, if DDOG can break through the $42 region with heavy volume. If this happens, we will have a clear 5-waves up, which would tilt the probability that we are in a 3rd wave higher. If that is the case, I would likely go long, with tight stops, which I will update if this scenario unfolds.

Please note, Datadog’s lock-up expires March 17th, 2020. We expect to see some price volatility following this date.

Elastic Premium Analysis

Posted on by io-fund

c95f5842-95ad-4186-ba97-be2e10dcc7ab_Elastic-Premium-Analysis.pdf

Elastic Premium Analysis

SECTION 1: Product Overview    

The Elastic stack includes Elasticsearch, Logstash, Beats and Kibana.

Elastic has partnered with cloud infrastructure companies, such as Microsoft Azure, Amazon AWS, Google Cloud and Alibaba Cloud. The Elastic Stack works well with Kubernetes, which is the machine learning powerhouse for containerized applications. 

Elasticsearch:        

Elasticsearch is the core product and search engine that allows for storing, searching and analyzing data. 

Google search is built for users to query hundreds of thousands of terabytes of HTML data (or about 20 petabytes per day). In contrast, Elasticsearch is built for developers who need to design more complex application searches. For instance, Elasticsearch can forecast data center storage capacity with queries or can search customer sentiment that is determined by natural language processing.

To further illustrate, here are some examples of how Elasticsearch is used today:

Business-to-consumer:

•       Pairing a passenger with an Uber driver with search

•       Recommending grocery items on Instacart

•       Matching online dating profiles for Tinder dates

•       Processing billions of log events for Sprint to monitor outages

•       Processing billions of log events for Fitbit, which has a rate of 250,000 logs per second, to enhance data discovery and validate failures

Business-to-business:

•       E-trade uses Elasticsearch to identify trading anomalies across 115 terabytes of data

•       Adobe uses Elasticsearch to search across both textual and non-textual formats, such as images, videos, 3D templates. This helps assist computer vision, which trains computers with ML to have a high-level understanding of non-textual items. This is done at a rate of 600 queries per second and an ingestion rate of 25,000 per second. 

•       Blizzard uses Elasticsearch to make sure their games are running at peak performance

•       Cox Communications and TV2 use Elasticsearch to analyze billions of content delivery logs

•       John Deere uses Elasticsearch to handle 18 billion documents and 11 terabytes of data storage, running 20,000 events every second. This helps to support remote management, variable rate application and field and water management.

Products such as Elastic Cloud Enterprise allows companies to run the entire stack in the cloud with a SaaS offering. The Elastic Stack is also available on-premise, or a hybrid of both. Elastic Cloud Kubernetes extends the Elastic Stack for use on cloud native technologies and containerized architectures. 

Logstash and Beats:           

Logstash and Beats are ingestion tools that can be put on thousands of applications to query external systems. From the examples above, John Deere is ingesting data from thousands of external sensors in the field, for instance. This helps complete the stack for the optimal use of Elasticsearch. 

Ingestion can become quite technical. For instance, eBay uses Beats to break down the silos from containerized machine learning platforms, such as Docker and Kubernetes. This helps to automate application deployment and keep up with fast-evolving application lifecycles. The Beat product also has an auto-discovery feature to ingest newly discovered workloads, to collect and enrich data, and to send to the internal monitoring system. 

In eBay’s case, the company built a way to tag the metadata from Beats auto-discovery so that users could access the information with familiar labels. A real-life example of this might be analyzing data from website logs, call centers and competitor website scans with the end result being a system that can the difference between skis named SALOMON QST 92 17/18, Salomon QST 92 2017-18 and Salomon QST 92 Skis 2018 – and also measure rising popularity perhaps with social media.

Kibana:        

Kibana is a free, open source tool that integrates tightly with Elasticsearch.

The visualization and exploration tools include interactive charts, mapping support, pre-built aggregations and filters, plus easily accessible dashboards. Elastic allows enterprises to pull more data in for visualization purposes with products such as Elastic Cloud Enterprise or Elastic Cloud on Kubernetes.                   

SECTION 2: Elastic Fundamentals        

A major fundamental risk for Elastic is that revenue growth may not be rewarded in 2020 as we’ve seen plenty of evidence that investors’ appetites are turning more towards profitability, which Elastic is far from reaching. 

The market was not kind to Elastic in 2019. Tech growth companies with negative earnings that did not have a perfect earnings report were penalized last year. Elastic was no exception. 

Analysts are projecting EPS estimate of negative -$1.35 in fiscal year 2021 compared to negative -$1.22 in fiscal year 2020 ending in April. Revenue in fiscal year 2020 ending in April is estimated at $416 million and fiscal year 2021 at $567 million. The company has $307 million in cash and $42 million in debt. 

The stock has a 52-week high of $104 in July and hit a new 52-week low of $61 a month ago on December 5th. The most recent earnings report revealed a slowdown in annual billings from 53% in the year-ago quarter to 45% in the most recent quarter. The company beat on all other estimates, including revenue, EPS and net expansion rate – which is phenomenal at 130. Despite this, the billing slowdown was enough to cause a 20% drawdown on stock price following the earnings report, from $78 to $61. 

The recent drawdown has resulted in Elastic trading at one of its lowest valuations yet as a public company. The stock is currently trading at 12 Forward EV/Revenue with an enterprise value of $5.03 billion. When considering revenue growth, this is an attractive valuation as Elastic is reporting 59% YoY revenue growth. Notably, revenue has decelerated from 79% YoY in early 2018 — yet has remained stable at 59% for the past three quarters. 

So, the question that remains, will Elastic have an earnings surprise, which is the purpose of this report. There is an important catalyst to consider, which I’ve outlined below. I believe it’s highly probable that Elastic’s fundamentals improve in the coming year due to its entry into endpoint security.    

Market Size & Competitors  

Determining the market size for Elastic is challenging for a few reasons. The first is that the company does not neatly fit into a specific category. In fact, the company is absent from Gartner’s magic quadrant for Insight Engines, although Elastic is mentioned as the brains behind two products on the quadrant: Intrafind and Lucidworks. Here is what Gartner says about Elastic:

“Of the vendors most often shortlisted by the reference customers we surveyed, Elastic (Elasticsearch) appears in the top five, and Apache (Solr) in the top 10. Neither Elasticsearch nor Solr are considered insight engines — extensive development is required for them to meet the market definition. However, they do provide highly effective search engines for those seeking only search capability or wishing to undertake development. Consequently, they form a foundational layer in the stacks of a number of commercial insight engines, including two in this Magic Quadrant: Lucidworks and IntraFind.” Of the vendors most often shortlisted by the reference customers we surveyed, Elastic (Elasticsearch) appears in the top five, and Apache (Solr) in the top 10. Neither Elasticsearch nor Solr are considered insight engines — extensive development is required for them to meet the market definition. However, they do provide highly effective search engines for those seeking only search capability or wishing to undertake development. Consequently, they form a foundational layer in the stacks of a number of commercial insight engines, including two in this Magic Quadrant: Lucidworks and IntraFind.”

According to Jefferies’ analyst John DiFucci, Elastic’s addressable market is around $40 billion and could double to $71 billion by 2022. He cites the technology is only limited by the “creativity of the customers.”        I agree that the limitations for Elastic’s growth will eventually lift as we are in the early stages of machine learning (ML), computer vision and natural language processing (NLP). 

ML and NLP are two markets that will grow rapidly over the next decade, with Elastic a recipient. NLP will grow from $3 billion in 2017 to $43 billion in 2025 (source: Statista). Research on Global Markets estimates ML will reach $19.4 billion by 2023, at a CAGR of 48.3%. Big data analytics is quite large at $168 billion in 2018 and forecast to grow at a CAGR of 13.2% to $274 billion by 2022. Elastic sits somewhere between these three markets.

The companies listed on the Insight Engines magic quadrant are not direct competitors. Rather, I would consider Splunk the biggest competitor as their customer value proposition of providing log analytics most closely overlaps. Elastic Stack and Splunk frequently compete for customers. According to developers who work with the products, Splunk is more mature while Elastic is more flexible due to its roots in open source. Other competitors include Sumo Logic on the enterprise side and Greylog on the open source side. The Elasticsearch open source tools are also available through Amazon without the need for enterprises to upgrade through Elastic (although the more optimal experience is with Elastic Stack).  

SECTION 3: Endpoint Security         

The log management and analytics dashboard offered by both Splunk and Elastic has evolved into an important secondary offering for Security Information and Events Management (SIEM).  In other words, because these companies monitor so many endpoints for data ingestion, the platforms are also useful for security monitoring. 

By using Search Processing Language (SPL), log management systems are able to perform high-order security analysis and assessments regarding the collective state of these systems from a single interface. For instance, Elastic has been used for threat protection by organizations such as the University of Indiana to monitor hundreds of thousands of devices across students, faculty, and staff. 

In October of 2019, Elastic closed the acquisition for Endgame, a leader in endpoint security for $234 million. This followed Elastic launching a Security Information and Events Management (SIEM) product in June. Endgame has enough credibility to be used by the U.S. Navy and the U.S. Air Force.

To raise the stakes, Elastic will be the first to charge for endpoint security by the amount of the data stored rather than by machine. This will allow companies to scale endpoint security more efficiently and will help Elastic compete with Splunk.

Splunk was ranked number one in SIEM by market share in 2018. The SEIM market was worth $5.3 billion in 2018 and is expected to grow at a 19.7% annual rate to reach $12.9 billion by 2023.  Elastic should be able to compete very closely with Splunk due to Elastic Stack having similar capabilities of ingesting data from endpoints. Even claiming a small portion of this market should help boost Elastic’s $500 million in annual revenue. 

We believe Elastic’s market entry into endpoint security along with competitive pricing will be an important catalyst for the company in the near future. 

SECTION 4: Basic Technical Analysis and Closing the Gap    

By Knox Ridley

Elastic (ESTC) is in a clear downtrend. After testing the all-time lows at $60.10, Elastic is bouncing back towards an important resistance price region at $67.50, highlighted with a red dotted line in the chart. If Elastic can close above this price, we will likely see a closing of the gap around $77.50, which is highlighted in yellow. This move would be about a 14% move from current prices (and about 24% from its recent bottom). 

Furthermore, it’s worth noting that Elastic has taken back its 10-day Exponential Moving Average (EMA) and closed just below the 21-day EMA. The volume of this bounce is on very light volume, which is descending as the price is ascending. This means that the market is not buying this beyond just a bear market bounce, and should be factored into any buying plan.

Internals (MACD, RSI, MFI)    

Looking at the internal strength of Elastic (ESTC), the MACD, Relative Strength Index (RSI), and Money Flow Index (MFI) are all telling an interesting story. First off, they are all in well-defined downtrends, which is highlighted by the dashed red lines. 

The RSI and MACD are also bouncing against support while trending down, and doing so at lower levels, which looks to be coiling for a move up. We will want to see these indicators break this downtrend in unison with the price of ESTC breaking out as well to indicate a possible change in trend.

The MFI, which is basically the RSI with volume factored in, is showing a positive divergence. In other words, as the price is making lower lows, the MFI is making higher lows. This is always a great indication of fading selling, and usually indicates a shift in sentiment. 

Closing above the start of this gap with high volume, and internals that are breaking out would be a key pivot that would further identify that Elastic is in a new uptrend, and not just a bear market correction.        

Price Symmetry       

Symmetry is a very powerful force in technical analysis. When a move in a certain direction reaches the length of prior moves, we usually see this resistance zone terminate the short-term, corrective move, and signal the continuation of the bigger trend. On the other hand, if the price can break through, it’s a strong indication that the larger trend has possibly changed. 

The above chart shows the length of the last correction in the current downtrend. The price increased by about 24% before continuing the larger trend to new lows. After bottoming recently, a 24% move up from the low would coincide with closing the gap just discussed. There is a lot of overhead resistance above Elastic, and until we see ESTC break above this region with heavy volume, we can only assume that this move is a correction in a larger downtrend trend.

Elliott Wave Count 

Elastic’s price structure, since its IPO, has been a series of overlapping structures. An overlapping structure, where the price retreats most of the previous move, indicates the uncertainty in the market. 

The above count shows Elastic is completing a corrective, 3-wave move up, which is highlighted by the red (A), (B), (C), and then began a new, corrective 3-wave move back down. In both 3-wave trends, the C wave unfolded in a 5-wave move, which is highlighted in blue and also common in 3-wave corrections. My best count has us in the final 4th wave of the C wave, which would suggest newer lows ahead. 

The alternative count has us as completing the 5th wave down, which would suggest we are in the very early stages of a renewed uptrend. I have a problem with this count due to Elliott Wave rules; however, if Elastic  can close the above gap on heavy volume and close above the 100% extension, I will take that as evidence that this alternative count is in play.           

How to Trade 

Elastic is a high conviction idea, that may take some time to play out. The market obviously hasn’t seen the value in Elastic over the past month, hence the current trend. We do not think this will last, but how early we are is the real question. Depending on your investment style, we have 3 suggestions:

Buy now and Forget: If you want to buy your position today and hold it, a good stop would be just under $53. Below here and we are entering uncharted territory with all-time lows.

Layering in: If you prefer to layer in, the same stop above would hold. Then, if Elastic hits lower, you can layer in more in the green target region on the chart, between $58.50-$53.50. if ESTC decides to continue higher from current prices, if it closes above $74.50 on heavy volume, with the internals breaking the current downtrend, then you can put the remainder of your position in with a 25% trailing stop.

We plan to trade with the layering in approach. 

Wait and See: If you prefer to wait and see, I’d target the green box in the chart between $58.50-$53.50