Category: Stock Updates (Blogs)

Earnings Update: TWLO, SNAP and SHOP Q2 2021

Posted on by io-fund

Below, we review Twilio, Snap and Shopify. This quarter, Snap separated itself from other ad-tech companies in the ad rebound cycle. On the surface, this was accomplished through user growth and strong guidance. From a product perspective, our readers knew going into this quarter (and last quarter) that augmented reality has quietly begun its trajectory.

Twilio is a company that recently acquired Segment. This is not your typical acquisition, rather it is a hard pivot into first party data. Twilio’s future very much depends on management nailing this transition. We had presented this in granular detail in our Twilio LTBH (long-term buy and hold) webinar. We see no issues with Twilio’s report, in fact, with Segment Journeys Twilio is ahead of schedule on cross-selling, which began July 1st.

Shopify is a steady winner that we had stated in a Motley Fool podcast was a favorite pick of ours going into 2021 and during our two LTBH Top 10 portfolio review found here and our 2021 portfolio review here. Some of these LTBH positions are like hitting singles and doubles while others we swing for the fences. Shopify has the most potential to become a FAANG stock as the company has solidified its place at the e-commerce infrastructure layer. We discuss why Shopify shows evidence of taking market share from Amazon, and one area in particular where Shopify is stronger. Rarely, do we see such a strong product open the flood gates for distribution at this stage in its maturity; the flood gates for distribution are social media.

Summary:

In May, we disclosed that we were looking to increase our Snap position (and Shopify) and we closed our Pinterest position after reviewing our LTBH portfolio. We could not have been clearer in terms of our conviction on this augmented reality (AR) stock. We also broke down the company in great detail in June, which is worth a refresh if you’d like more product analysis and backstory on the company’s AR strategy and how it relates to Apple’s iOS updates.

There are a few key takeaways from Snap’s earnings. The first is that the product is going through rapid iteration to be a first mover in augmented reality. At the consumer level, you could say Snap is an only mover as there isn’t another company reaching early adopters with this much consistency. The second takeaway is that we’ve seen an ad rebound in many earnings results this quarter yet Snap stands out for its user growth in the face of tougher comps – both this quarter and next quarter’s guidance.

Here is a laundry list of AR product features that Snap discussed in the earnings call:

  • Cartoon 3D Lenses turn people into 3D-animated cartoons. The Cartoon 3D Style Lens shows the potential for AR features to go “viral” with 2.8 billion impressions in the first week.
  • Connected Lenses which enables real-time shared experiences, like building LEGO models together
  • Scan which allows users to scan outfits and find recommendations or the right size/look
  • A Unity plugin for personalized Bitmojis to be used in games
  • Lens creators can use Lens Studio 4.0 for features like virtual classification, multi-person 3D body mesh and cloth simulation
  • Spectacles with 3D reality display
  • Content products like Snap Original Shows including 177 international channels
  • Spotlight, where Snaps are showcased, grew a whopping 49% quarter-over-quarter

The keywords from this earnings report are “inside and outside of Snapchat.” Many of the AR features above will reach non-Snapchat audiences. Disney is using the Camera Kit at their theme parks. Bumble is using Lenses to create backgrounds and effects. Viber is a calling and messaging app that uses Snap’s lenses. Restaurant recommendations can be overlaid onto Maps and Poshmark is using Snap’s minis platform for daily shopping events. Although “minis” are technically on the Snapchat platform, they’re coming from developers outside the platform, such as Ticketmaster which uses minis to discover shows and buy tickets.

As far as App Tracking Transparency (ATT) is concerned, and the IDFA which we reviewed in a webinar, Snap believes the effects will be seen later down the line. “Apple’s rollout of the most recent iOS update came later in Q2 than initially anticipated, and the pace of updates by iPhone users has also been slower than we anticipated. This has given us more time with advertisers to navigate the transition but also means the effects of these changes will come later than we initially expected.”

Also, the company stated they are seeing higher opt-in rates than what is being reported “across the industry.” The obligatory disclosure that management dropped was this, “It is too early to determine how long it will take until these changes are fully adopted, the scale of the potential interruptions to demand, or the ultimate impact on the longer-term growth of our business.”

Per my previous coverage on IDFA, we aren’t trying to be heroes by making big calls here. With that said, the I/O Fund did strategically think through what companies will be comparatively stronger than others. Our portfolio reflects this, which you can find here. Despite the obligatory disclosure on the ultimate impact of IDFA, Snap is guiding very strong for the next quarter.

Financial Report:

Snap’s Q2 results beat expectations with sales accelerating by 116% YOY to $982.1 million, which beat analyst estimates by 16% ($135.7 million). The topline beat was driven by an acceleration in both DAU and ARPU during the quarter.

Daily active users (DAU) increased 23% YOY to 293 million, an increase of 55 million and an acceleration from the 22% growth reported in the prior quarter, and also surpassed the 17% growth rate posted in the year-ago quarter.

The rise in DAU was also accompanied by an acceleration in average revenue per user (ARPU), which increased 76% YOY to $3.35, and represented the fastest rate of growth in the last four years. SNAP also guided for Q3 sales to increase 59% YOY to $1.08 billion at the midpoint, which came in ahead of the consensus estimate by 8%.

Revenue growth was driven by the North American market, as sales increased 129% YOY to $701.7 million. The strong topline growth in North America was driven by a surge in ARPU, which increased 116% YOY to $7.37, and was well above the $1.95 and $1.07 ARPUs in Europe and the “Rest of World”, respectively. SNAP’s CBO, Jeremi Gorman, explained during the Earnings Call that “we are continuing to accelerate our investments in sales and sales support beyond North America in order to capture our global ARPU opportunity faster in the years ahead”. An acceleration in global ARPU’s will materially benefit SNAP’s topline going forward. To be complete, we note that Europe’s sales grew 94% YOY to $152.3 million while the Rest of the World grew 86% YOY to $128.1 million.

Continuing down the income statement, adjusted gross margin improved 800 bps YOY to 55% during Q2. Furthermore, SNAP reported that adjusted EBITDA grew by $213 million YOY to $117 million. We note that absent a small loss in Q1, SNAP has reported a positive (and rapidly growing) adjusted EBITDA metric in 3 out of the last 4 quarters. We believe that if SNAP can continue to demonstrate the leverage in its business model by reporting strong topline growth and positive cashflows, the company can sustain a high multiple. Finally, the firm’s adjusted EPS of $0.10 beat the consensus estimate of -$0.01 by $0.11.

Notably, Snap’s earnings included numerous one-time benefits which in aggregate accounted for 60% of the firm’s adjusted earnings during the quarter. For example, SNAP reported $79.9 million in gains from non-marketable securities during the quarter, up from $0 in the prior year quarter. SNAP also early adopted a new accounting standard which cosmetically improved its interest expense by $20.1 million during the quarter. In aggregate, these one-time items provided a $0.06/share benefit to SNAP’s Q2 adjusted EPS and accounted for ~55% of the firm’s $0.11 beat during the quarter. Nevertheless, the firm’s results were still robust after excluding these one-time items.

As we’ve seen, social media is putting up triple-digits after the Covid dip from last year. In this case, Snap reported 116% and Pinterest reported 125% growth. Where Snap separated itself was not on revenue growth, rather on user growth with a 23% increase in daily active users to 293 million. This was primarily driven by DAUs in the Rest of World, which was up 55% YoY. The fact Snap is profitable now for three quarters doesn’t hurt either with impressive gains in ARPU.

Snap’s guidance on user growth is also strong at a rate of 21% year-over-year for an estimated 301 million users. The company expects to see between 58% to 60% in Q3.

Snap was not completely unscathed from the tougher comps that covid created in terms of usage. The company noted that there was a decrease in daily time spent watching Stories and a decline in volume of Story posting activity although the number of daily users grew year-over-year.

Twilio Quarterly Earnings

Summary:

Despite Twilio coming in better than expected on revenue, EPS and dollar-based net expansion rate, it was Segment’s sequential growth that concerned analysts. As stated in the April webinar, Twilio’s acquisition of Segment is an important pivot and the true story we want to analyze and track closely.

Before we review the ER in-depth, let’s look at Segment’s growth:

Segment Sales:

Q2 = $46.6m

Q1 = $44.6m

QOQ growth = 4.5%

Here is a note from our new financial analyst, Bradley Cipriano: “Segment was acquired on November 2nd 2020 and Q2 2020 Segment sales were $23m. It’s not apples to apples to do QoQ calculations since Q4 only included 2 months of Segment sales. By dividing quarterly sales into months, Q4 Segment monthly revenue was $11.5m while Q1 was $14.87m and Q2 was $15.5m, so monthly sales growth did decelerate from 29% QoQ to 4.5% QoQ.”

We are not too concerned with the sequential growth as an immediate impact is unpractical and management stated they began to cross-sell on July 1. In fact, the July 1 date is six months early from management’s previous expectations of when they will be ready to cross-sell. Here is what the CFO said in the prepared remarks: “For go-to-market, we began co-selling Twilio and Segment on July 1, accelerating our timeline by approximately six months, due to the excitement from businesses wanting to leverage the technologies from our combined offering. Lastly, the integration of the back office and G&A functions is mostly complete. We expect to finish this portion of the integration by the end of the year. We are very much on track and excited about what we can do together. “we began co-selling Twilio and Segment on July 1, accelerating our timeline by approximately six months, due to the excitement from businesses wanting to leverage the technologies from our combined offering. Lastly, the integration of the back office and G&A functions is mostly complete. We expect to finish this portion of the integration by the end of the year. We are very much on track and excited about what we can do together. “

The product that Twilio is using to cross-sell is called Segment Journeys. Segment Journeys is a product that unifies the customer experience with some retailers stating they’ve seen 400% revenue growth, such as Rugs.com. The platform allows marketers to know if a customer has seen specific messaging – whether its ads or emails, how the customer has engaged and what step the customer is ready for next on a granular basis with over 300 tools.

Twilio stated the following in terms of forward growth and Segment’s contribution: “Michael, this is Khozema. In terms of the guide, I mean, I guess what I would say is I think you're maybe you're reading a little too much into it. I think in terms of what we see for the third quarter guidance, it's a really strong growth rate of 50% to 52%. And I think on top of which we remain really optimistic about our performance in the near term as well. And we provided guidance previously, for example, of 30% plus growth over the next 4 years and feel really, really good about that over the medium term …. It won't show up in our financials for some period of time. And we haven't even started, right? I mean we basically just started a few weeks ago, and it will just take some time for it to bleed into our financials.I think in terms of what we see for the third quarter guidance, it's a really strong growth rate of 50% to 52%. And I think on top of which we remain really optimistic about our performance in the near term as well. And we provided guidance previously, for example, of 30% plus growth over the next 4 years and feel really, really good about that over the medium term …. It won't show up in our financials for some period of time. And we haven't even started, right? I mean we basically just started a few weeks ago, and it will just take some time for it to bleed into our financials.

While Segment’s sequential growth led to flat price action for Twilio following the ER, one positive point was the slight increase in DBNER from 133% to 135% (more below). This is the pulse or vital sign for a cloud company and it’s nice to see it remain steady while the company ramps up for post-acquisition cross-selling. Analysts also pointed out that Twilio has doubled its headcount in the most recent year. Here was a nice way that management put this: “We just have this sort of really good problem, is how I would characterize it, in that our core business is growing at such a fast rate. You're just — it's going to take some time for the other pieces to start showing up in our financial statements.”

One risk facing Twilio is the increase in fees from AT&T that will now be passed on to customers. Twilio had been absorbing those costs and there could be some falloff as these costs will negatively impact customers moving forward. Total impact is about $4.5 million per month (to the company). The acquisition of Zipwhip may help offset this into the future as the company provides lower cost toll-free messaging. This is more important than you may imagine as telephony costs in a world of readily available web apps (and push notifications) competing with Twilio was making the SMS product cost prohibitive.

In addition to IoT for future growth potential not reflected in current earnings, there is also a product called Frontline that is in public beta and will help workforces that are not located at desks (i.e. mobile workforces). According to the earnings call, this market exceeds the call center market. For instance, many sales people take calls while on the road or between appointments.

Financials:

Twilio’s Q2 sales grew 67% YOY to $668.9 million, which represented the fastest pace of YOY growth since Q3 2019 and beat the consensus estimate by $69.8 million (12%). Twilio’s Segment business, acquired in November of 2020 and central to our thesis, grew its sales 4.5% QOQ to $46.6 million, while active customers increased 2% QOQ. It will be important to monitor these two metrics going forward as Twilio builds its customer data platform and pivots the company around the Segment business.

DBNER remained stable at 135%, highlighting how Twilio has been able to sell new services to its existing customer base. Management also guided for Q3 sales to increase 51% YOY to $675 million at the midpoint, which was 6% ahead of the Street’s estimate (management’s guidance does not include any sales from its recent $850 million acquisition of Zipwhip, which occurred after the close of 2Q21).

The company’s adjusted operating profit declined YOY from $9.5 million down to $4.2 million during the latest quarter. This cost pressure flowed down the income statement as TWLO’s non-GAAP EPS declined YOY from a $0.09 profit in 2Q20 down to a -$0.11 loss during the most recent quarter. The cost pressure is expected to continue into 3Q21, as management guided for a non-GAAP loss of -$0.16/share at the mid-point, which was below the Street’s estimate of a -$0.07/share loss.

Gross margin for Twilio were 54%, a 200 bps YOY decline from 56% and a 100bps QOQ decline from 55%. This is down from 59% gross margins two years ago in Q2 2019. This is the lowest gross margin for Twilio at least two years back. However, during Q2 2021 call, management stated no change to the long-term gross margin guide of 60-65%: "I wouldn't say there's any real change in our long-term framework around gross margins. I mean we're still targeting 60% to 65%."

As discussed previously, TWLO is making investments in enterprise sales, Flex and new growth products coupled with infrastructure investments. While these investments will generate near term losses, they will support the company’s growth in the long run.

Possibly a sign that TWLO’s recent investments are benefitting the firm, we note that deferred revenue has surged in recent quarters, most recently growing by 239% YOY to $98.7 million. As the name implies, deferred revenue will convert into sales in the near term, which provides support for future sales. Furthermore, receiving cash upfront is a favorable trend for TWLO, as it allows the firm to immediately deploy the funds into investments that support future growth.

Shopify Quarterly Earnings

I like to come up with taglines for the stocks I cover, like “dark horse” for AMD and “royal flush” for Roku. I would say Shopify would be “ML-FAANG” or “most likely to become a FAANG.” There are others that we cover that have potential for massive global scale – Nvidia, and even Zoom. In fact, I think Nvidia will become one of the world’s most valuable companies, but the path won’t look or feel like a FAANG.

Regarding Shopify’s potential, it’s not as easy as saying “because they are building a fulfillment center, they will rival Amazon.” Amazon has the store front so these two are not apples-to-apples. However, due to various distribution methods, Shopify could be even bigger than Amazon on e-commerce (notably Amazon’s AWS is roughly half of its EBIT) because Shopify is building the e-commerce infrastructure that will extend well beyond a single storefront. I can’t help but wonder if some of Amazon’s miss is because of Shopify’s new dominance. It’s a natural thought to have when one competitor is thriving and the other guides lower than expected.

Please reference this forum post from our new team member Bradley Cipriano on Amazon’s miss.reference this forum post from our new team member Bradley Cipriano on Amazon’s miss.

You are likely familiar with Shopify’s online products as these are the core products for the company. However, offline was quite strong this quarter as merchants adopted Shopify’s point-of-sale (POS) products. This, in particular, helped Shopify during the re-opening while Amazon struggled to capture growth during the transition of the economy re-opening.

This quote is especially potent from management as to how Shopify plans to dominate online, offline and social combined: “In terms of the legacy point of sale market, we are also starting to see more legacy merchants that are starting to offline begin to use Shopify point of sale as well. They're using it because the product is really good but also because every business today, and frankly, for the next, the next 100 years is going to be omnichannel. Talking about omnichannel going forward will be like talking about color television. Every business by default will be omni-channel and Shopify is the platform that enables that.”because every business today, and frankly, for the next, the next 100 years is going to be omnichannel. Talking about omnichannel going forward will be like talking about color television. Every business by default will be omni-channel and Shopify is the platform that enables that.”

We talk about Gross Merchandise Volume (GMV) below under financials, which was a blowout and the highest in company history, yet on a more granular level we see that GMV in the United Kingdom outpaced the overall GMV despite being one of the first economies to re-open. Here’s a quote from management: “And so we use the UK as an example of one of the economies that reopened first and our UK GMV grew faster than our average suggesting that when we equip merchants with multi-channel, they do better in a very fluid commerce environment.”

This is a key point as Shopify is (perhaps) exploiting Amazon’s biggest weakness: which is too many irons in the fire. We see Andy Jassy, who comes from AWS, taking the helm. If we read between the lines, this means Amazon is prioritizing cloud infrastructure and AI/ML. This isn’t a bad decision, as we are ultra-bullish on AI, but it does leave an opening for strong competitor with a fresh angle and laser focus on e-commerce.

This is seen in Shopify’s ongoing strategy to become the infrastructure – this means Shopify will perform the checkout process, process the payment and other e-commerce services on the backend regardless of: your store front, what country you’re in, if you’re on a website or social media or a mobile app, or regardless of if their fulfillment center processes the order or a global merchant fills the order. Shopify aims to be omnichannel and omnipresent with a full stack offering. Speaking of “[regardless] of what country you’re in,” we will focus on international the next time we write on Shopify. The main takeaway here is that Shopify can quickly move across borders by being more of an infrastructure play than a store front.

We also can’t forget the distribution firehose that is social commerce. This impact will come in future quarters and I imagine it will eventually take over offline POS. Here is what management said: “The rank order of our GMV mix continues to be the online store, offline POS as second, and then all social channels and marketplaces third, and the social channels and marketplaces today represent a small percentage of the mix, but growing very rapidly.”

Pictured Above: Simulation of the open flood gates of social commerce 😉

Financial Overview:

Shopify grew sales 57% YOY to $1.12 billion in the most recent quarter, exceeding estimates of $1.05 billion, while gross merchandise volume (GMV) increased 40% YOY to $42.2 billion. This is impressive considering Q2 2020 GMV grew a stunning 119% YOY last year. The firm’s ability to post strong YOY growth after a blockbuster year raises our conviction that SHOP will be able to continue to compete with Amazon and take share, as discussed above and in our prior coverage of SHOP here and our 2019 coverage here.

Merchant sales increased 52% YOY to $785 million, aided by the expansion of Shop Pay, which took market share during the quarter. Shop Pay increased its GMV penetration rate YOY from 44.6% of GMV in Q2 2020 to 48.0% of GMV for the most recent quarter, perhaps taking share from other payment options such as PayPal.

At the same time, subscription sales increased 70% YOY to $334.2 million, while monthly recurring revenue rose 67% YOY to $95.1 million.  Adjusted operating margins increased to 21%, up YOY from 16%.

Notably, SHOP excluded $778 million in gains from equity investments during the quarter and $2.0 billion of gains YTD following a couple of well-timed investments in FinTech companies. Specifically, in April 2021, SHOP received shares of Global-E (GLBE) in lieu of cash payments for its services helping the company build an international payment network.

The GLBE shares had an initial fair value of $192.3 million. GLBE went public one month later in May 2021, and SHOP’s stake in GLBE was worth $1.0 billion as of June 2021, nearly a 10x return in one month. SHOP also received $24.7 million investment in Affirm ($AFRM) last year (July 2020) for non-cash consideration due to its strategic partnership with AFRM. When AFRM went public in January 2021, SHOP’s stake was worth $1.4 billion, resulting in a 55x return in one year.

Despite excluding these large gains from earnings, Q2 2021 non-GAAP EPS still more than doubled YOY from $1.05 to $2.24 and came in well above consensus of $0.96. Likewise, YTD free cashflows nearly tripled YOY from $64.9 million to $188.7 million. The firm’s cash balance of $7.8 billion remains at all-time highs, suggesting that SHOP has ample liquidity to finance growth going forward.

While SHOP does not provide quantitative guidance, management expects 2021 sales to continue to “grow rapidly”, albeit at a slower rate than 2020. However, management expects adjusted operating profit to be above the level in 2020, this is despite the investments SHOP is making in its fulfillment center, which we explored in greater detail in our prior research coverage.

Bradley Cipriano contributed to this analysis.

Zoom’s Acquisition of Five9 = 360 Degree Cloud-Native Communications

Posted on by io-fund

On the forum, I stated that Zoom had 90 degrees of the cloud-native communications market with web conferencing and moved to 180 degrees with Zoom Phone. This “half-circle” represents employee communications. When the sales department has a meeting with the marketing department, they’ve been using Zoom for up to 10 years. Prior to this, these departments used Cisco Webex, where Eric Yuan cut his teeth. Ten years ago, when Zoom came on the market, employee communications software and apps were too cumbersome to deliver the speed required for communications. Mobile was especially an issue for legacy products. The beauty of Zoom’s product is it reduced friction entirely from where it used to take minutes to join a call to mere seconds.

Five9 is on the opposite 180-degree side of the enterprise communications circle, which is customer communications. Customer communications is when you go to call your credit card company 1-800 number or health insurance company as a customer. These contact centers are very good in siloed situations yet there is a lot of friction when it comes to aggregating omnichannel touchpoints. Have you ever called your credit card company and discussed an issue for 5-10 minutes only to be transferred to another department where you must repeat the exact same issue for 5-10 minutes? Or, have you ever engaged with a chatbot or live chat and 10 minutes later ended up calling in for help because it was ineffective? 

Many of these customer contact centers are quite advanced yet they are not able to connect the pieces in the customer journey to be effective. Wait times have improved yet getting the customer what they need to increase loyalty has not improved.

Here is how Zoom depicts the 360-degree circle:

Here is how Gartner shows the circle – which is actually two circles overlapping:

More on Five9 …

I’ve published volumes on Zoom Video so it makes sense to focus on Five9 for this analysis.

Five9 was not a hypergrowth story like Twilio or Zoom during Covid. In fact, the stock price being up 187% is pretty generous of the market as the company has remained range bound in the 28-40% revenue growth range even during the ideal conditions for a contact center company, which was the work-from-home environment we saw last year.

By my estimation, Five9 has a “bells and whistles” issue and lacks focus. There are too many features and the company tries to do too much. That’s an opinion of mine, although if you visit the website, you’ll probably see what I mean as it’s a bit overwhelming. Essentially, Five9 doesn’t have its cornerstone selling point.

To contrast here is how streamlined Zoom and Twilio are:

  • Zoom delivers web conferencing and audio for employees. It’s also now a consumer favorite
  • Twilio simplifies SMS for developers. It’s also becoming an omnichannel marketing solution using first-party data

Despite the fact Five9 lost its way by trying to do too much (evidenced by its lackluster sub-40% growth for many years including during the hypergrowth window of 2020), the product has some chops and ranks competitively across cloud contact centers in the North American region. The company is third for high-volume customer use cases, second for customer engagement use cases, and first place for agile contact center use cases. Agile means it’s quick to deploy for specific use cases (like health care, for instance, needs a customized deployment) and can scale quickly if needed.

The ongoing argument in terms of the shift towards cloud communications is that omnichannel approaches have not resulted in a unified customer experience. The pain point –for both the consumer and the SMB/enterprise – is the sheer number of touchpoints we have today. This includes chat, phone, email, SMS and social media.

Here’s a visual of what Zoom and Five9 will set out to accomplish with multiexperience between employee communications and customer communications. Cisco is one company that has combined Webex with a contact center. As you already know, this is an easy competitor for Zoom to take on. Otherwise, Zoom is primarily taking on competitors in either UCaaS or CCaaS but not both.

Source: Gartner

In a previous Forbes article, I had stated “Zoom’s ongoing goal will be to disrupt all legacy systems with cloud-native communications – and this means every possible method of communication that is not currently done on the cloud and/or is currently on the cloud but is too cumbersome of a process due to walled gardens.”

Vendor lock-in usually means Microsoft or Google. There is serious vendor lock-in across enterprise companies with 115 million users on Microsoft Teams due to the cross-sell from Office. Google’s walled garden likely destroyed its potential for doing more in communications, as well.

Quick note: I’ve seen some questions about the difference between UCaaS and CCaaS. We can simplify this by calling UCaaS “employee communications” and CCaaS “customer communications.” We know these are cloud-native and we know employee communications is unified. While I’m on the topic, it’s important to note that Zoom made the UCaaS Gartner quadrant for the first-time last year with the addition of Zoom and was immediately named a leader.

Artificial Intelligence

The reason that combining employee communications with customer communications is important is for data integration. One of the most advanced areas for AI is speech and voice recognition. This lends itself well to customer contact centers who speak with customers all day, every day. The AI for enterprise communications will become more effective when CX and EX is combined.

In November of 2019, Google released its Contact Cloud Center AI (CCAI) solution and Five9 was an integration partner for the release. The integration allows Five9’s contact center to send the voice conversation and contextual data to Google’s Cloud CCAI via APIs for real-time transcription and the triggering of knowledge base responses. Salesforce was also a launch partner for the use of CRM to help with custom integrations across a customer base and customer service agents.

The stack in this case (moving forward) would be Zoom for voice/audio/chat for customer contact centers, Salesforce for millions of agent desktops, and Google’s AI voice recognition for accuracy. This is also a great illustration as to why a walled garden like Microsoft isn’t a good reason to discount Zoom. In many ways, you can do more outside of walled gardens and reduce vendor lock-in (or dependency). This is why best-of-breed is becoming popular (reference my Snowflake analysis). In this case, Google likely has the better AI for voice recognition and a company with high customer service volume isn’t stuck with Microsoft for a contact center just because it uses Microsoft for other software products.

If I were to guess the motivating factor behind Zoom’s choice in Five9, it is probably because the company has been working on AI for customer communications. This will save Zoom not only the build for a contact center, but can immediately center Zoom in the trend of AI voice recognition where it’s being rapidly adopted and needed for communications.

Key Points from Investors Call and Investors Presentation:

You can access the investors call here and the presentation here.

Five9 stockholders will receive 0.5533 shares of Class A common stock of Zoom Video Communications. This represents a 13% premium at the time of announcement to Five9 for a stock price of $200.28. The transaction value is $14.7 billion and is an all-stock deal. The transaction is expected to close in the first half of 2022. This equates to a 25.3 price-to-sales, which the Five9 CEO pointed out, is the highest M&A P/S paid in the cloud category. On a side note, even though this was stated, I’m not sure this is correct as I believe Slack was bought at a 29 price-to-sales.

According to the Investors Presentation, Zoom will increase the addressable market from $62 billion to $86 billion, for an increase of $24 billion by adding the customer communications. The company points to the cross-sell opportunity, which means not only will Zoom increase its TAM but should capture a higher percentage of the TAM.

Last twelve months revenue for Zoom Video was $3.3 billion compared to Five9’s $478 million. The growth from Zoom was nearly 10X higher at 296% compared to Five9’s 37%. If we look to growth rates prior to Covid, Zoom was growing at higher growth rates of about 3X compared to Five9. My main concern with this acquisition is if we will see slower rates of growth for Zoom. I’ll look to management to make sure the cross-selling re-accelerates the customer communications portion for the growth opportunity that was emphasized in the call.

Management teams have to balance giving away their entire strategy to competitors while also keeping investors happy with enough transparency. According to Zoom’s CEO, they chose Five9 because the two companies had synergy and have landed significant deals in education and retail. He also said that building the solution would take many years and that customers don’t want to wait. As stated, I think it’s because Five9 has been working on the AI-driven automation. At one point, when pressed to state why Five9 specifically, the answer was “look at our video assets and look at their AI.”

According to the Investors Call, Zoom will partner with Five9 competitors, and vice versa, with Five9 continuing to partner with Cisco and Microsoft, for example.

Key Points from Previous Zoom Analysis:

In the August 2020 and April 2021 analysis, I emphasized that the story for Zoom Video was changing and the company was doubling TAM with Zoom Phone. Although I’ve discussed Zoom Phone many times – here is one example:

Last August, I pointed out that Zoom’s hardware-as-a-service products allowed companies to replace legacy systems by consolidating software and hardware for one consistent experience. ServiceNow made headlines last year when they chose Zoom Phone to replace their business phone lines by stating, “Going forward, with the addition of Zoom Phone, we're getting a head start on an even more robust experience with Zoom— one-touch communication and collaboration features, plus Zoom-connected conference rooms.”ServiceNow made headlines last year when they chose Zoom Phone to replace their business phone lines by stating, “Going forward, with the addition of Zoom Phone, we're getting a head start on an even more robust experience with Zoom— one-touch communication and collaboration features, plus Zoom-connected conference rooms.”

This is key because as the CEO of Five9 pointed out, Zoom has the very best technology available today with Zoom Phone. The CEO of Five9 also pointed out that “the opportunity here is the millions, tens of millions, even hundreds of millions of phones, that have to be replaced. When you replace the phone system, you replace the contact center.”

Another key point from our ongoing analysis with entries into Zoom from $62 onward is the international opportunity. The United States is a large land mass with very few telephone providers (we call it a duopoly between AT&T and Verizon). There’s Charter, etcetera, but you get the idea. Many other countries don’t have the reliability that the United States has and/or many countries have close borders and require new country codes when they dial a number 1,000 miles or even 500 miles away. Zoom is all about global and that’s key for investors to understand. This isn’t about the United States.

A Note on Twilio:

There will be customers who overlap between Twilio/Flex and Zoom/Five9 and will evaluate both to ultimately choose one. However, Segment is the main pivot we are interested in for Twilio and the post-IDFA world. It’s the omnichannel marketing path that is most interesting for Twilio as it can eat into advertising budgets rather than IT budgets for a call center (like Five9).

I covered our thesis on Twilio here in a 1-hour LTBH webinar and also here in a Q1 post-earnings write-up.

Additional Resources:

Zoom Discusses Two Important Catalysts In Q1 Earnings

Zoom Video Stock: Will History Repeat?

Zoom Video: Stock Speeds Ahead But Can It Sustain? Deep Dive Analysis

Top Cloud Stocks for H2 2020

Zoom Video: 2019 Analysis

H1 2021 Cloud Software Update

 

 

 

 

H2 2021 Cloud Report: Winners Keep Winning, Plus Okta & Auth0

Posted on by io-fund

We are seeing nearly the exact same names in the Top 10 list for forward growth after the Q1 earnings reports. The good news is we picked strong companies and we didn’t abandon them when they were called Covid stocks. This is what you want although you won’t get the drama that comes with SPACs or small caps. 

We continue to like Zoom, Shopify and Datadog. Of those Zoom has the most room in terms of 1-year and 2-year forward estimates as it’s ranked quite low due to the uncertainty following its banner year last year. If we can get some revisions on those estimates with another quarter of strong reporting, then we could see the company return to all-time highs.

Right now, Zoom is ranked number #6 on current year growth at 51% and is ranked #34 for 1-year forward growth at 20% and then ranked #39 on 2-year forward growth at 17%. That’s quite the gap between current year and 1-year forward on a company that’s reported strong for many years. If the company clears Q2, the uncertainty should start to clear up. You know where we stand – winners keep winning and this product has exceptional product-market fit. We’ve covered this very in-depth on the site across many reports.

Regarding Shopify, I had said that the immense distribution that comes from reaching roughly 4.4 billion social media users across many sites, including TikTok, should not be overlooked in the noise. The combination of a strong product cracking open the pinata on this kind of distribution is what we want in our portfolio for the LTBH positions. Here’s an excerpt from the May update:

“The reason we want to increase our position in Shopify throughout the year is fairly straight forward – Shopify is now reaching billions of consumers through social media. The distribution potential of these partnerships reminds me of an avalanche trigger as Shopify will reach billions with Facebook and Tik Tok and hundreds of millions with Pinterest. Now, they only need to build out the Fulfillment Center and focus on improving their own app; although borrowing these mega size audiences is probably the fastest path to growth for our purposes.”

Datadog is a position that lets us participate in the cloud IaaS growth of Azure and AWS and Google Cloud but through a pureplay. We reviewed this company post-Covid here and also on the 1-Hour LTBH Webinar Update last month.

Twilio’s story hasn’t fully come together yet but we like the Signal acquisition very much. In an effort to get in front of the market, we held a 1- hour LTBH webinar on this company as we like to highlight stocks where the story is not fully known yet our conviction is high.

We’ve also covered Crowdstrike and entered/exited this stock. There is plenty of coverage on Cloudflare on our forum although we have not officially covered this stock. We’ve passed on Palantir due to low commercial account growth. We front run many stocks (technically, we are front running Twilio on the pivot), however, transitioning from government contracts to commercial accounts is tricky in the tech industry. This is because the product was developed and the team built with guaranteed sales and moving into a more “only the strong survive” environment, is a different skillset. We continue to monitor this company.

Notably, we are also pleased that Asana is doing well. It’s the top performing cloud stock this year, up 127% year-to-date with our position up about 100%. I can’t claim credit for this as all of the credit goes to Knox’s technical chops. Atlassian guided for negative growth sequentially and this is being revised upward quite a bit right now with some 60-day revisions up as much as 35%. However, at the roughly 21% growth that management guided for, we like Asana better for now.

Spotlight on Okta and the Auth0 Acquisition

One name that is starting to pop up in my Q1 post-earnings scans is Okta. Okta is a stock we’ve covered in the past yet shied away from during budget constraints in Covid. You can access our prior research here.

Okta

Okta gets an honorable mention for moving back into the top 10 list for both the 1-year and the 2-year forward revenue estimates. In fact, right now it’s estimated to be a percentage point higher than Crowdstrike on the forward estimates. This isn’t organic as it’s due to the Auth0 acquisition, which we discuss in detail below.

Okta: Product Summary

As mentioned, we’ve covered Okta with an in-depth analysis published last year. I’d like to review a few key points from that analysis before we talk about Auth0.

In the previous analysis, we discussed the importance of IAM systems as it allows for the administration of user access across an enterprise and also ensures compliance. This is critical because 60% of data breaches are caused by an organization’s own employees. By having one digital identity for employees and customers, a company can easily modify and monitor a digital identity to allow access to the appropriate assets and in the right context.

IAM became more complicated once employees 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. 

Okta is an independent IAM provider that allows customers to integrate with any application or scalable platform. Because Okta is best-in-breed, the company can win over Chief Security Officers (CISOs) that want flexibility and who want to avoid vendor lock-in (i.e., Microsoft). IAM allows access to critical assets, ad not only are switching costs high but CISOs will want a vendor that lets them sleep well at night.

The solution Workforce Identity comprises the majority of the business and simplifies the way an organization’s employees, contractors and partners connect to applications and data from any device (as discussed above). You can think of these as internal employee uses. New Products from Okta include FastPass, which allows for password-less login across multiple devices.

The Customer Identity Cloud enables organizations to transform their own customer’s experience making use of API-level access and seamless customer experiences. This is more external. Dynamic Scale helps enterprises handle traffic bursts up to 500,000 authentications per minute.

Here are the six technologies that IAM comprehensively covers:

  • API security: Allows for single sign-on (SSO) access for B2B ecommerce and API integrations.
  • Customer identity and access management (CIAM) enables organizations to capture and manage customer identity and profile data
  • Identity Analytics (IA) creates risk profiles for user behaviors and manages risk profiles.
  • Identity-as-a-Service (IDaaS) provides single-sign on and identity management as a software service
  • Identity Management Governance (IMG): Helps to minimize risk of data breaches and improves end user productivity
  • Risk-based authentication (RBA): Allow for variation of single-sign on and two-factor authentication

The Auth0 Acquisition

Okta closed on the Auth0 acquisition in May for $6.5 billion.

Auth0 is in the Identity-as-a-Service space (IDaaS) and offers an identity platform suite that supports single sign-on (SSO) through a centralized authentication server. To illustrate, you use single sign-on when you use the same username and password for the I/O Fund website as the I/O Fund forum. It allows you to be authenticated securely through an API.

The company is able to detect password compromises in real-time by checking against a database of hundreds of millions of breached credentials. The compromised user is then notified by email or text and Auth0 can restrict access until the password is reset. The API authentications are integrated with Microsoft Azure, Facebook, Twitter, WordPress, GitHub and Paypal.

Although there are many competitors in the startup scene, Auth0 can claim it’s prevented millions of malicious attempts with up to 1 billion transactions every day and 4 billion logins per month.

The dashboard for administrators offers control over user account provisioning and deletion, and offers full visibility into history and logs. Auth0 also offers personalized user targeting that enables control over features like social logins and multi-factor authentication. There is also automation through rule builders.

Auth0 and Okta are competitors in the customer identity space and are typically both evaluated by customers. The result will be better pricing power and a stronger product when going up against Microsoft on IAM. Okta’s primary source of revenue has been Workforce Identity. Auth0 acquisition will help strengthen the Customer Identity segment and will diversify Okta across both markets for IAM.

Here's how the two work together. What’s being illustrated is that the Workplace Identity often leads to a cross-sell on Customer Identity with lifetime spend of $17 million.

 Source: Investor Presentation

The last private valuation for Auth0 was $1.9 billion when the company raised a $120 million round. The round was led by Salesforce Ventures likely for the Customer 360 product that Salesforce has, which enables a universal identity and first-party data collection through the sign-on process. From there, audiences can be segmented and personalized experiences can be created (similar to our Twilio discussion on Segment). It would make sense that Okta acquired Auth0 to prevent Salesforce from competing with Okta.

Auth0 is a developer-centric company, similar to Twilio. The company has won over developers with its easy-to-use drop-in identity management solution for authentication APIs. The issue with Okta not being developer-centric and competing more at the Microsoft level is that developers prefer to work with companies that offer more support for the SMB-level. The Auth0 acquisition helps with this quite a bit. Okta is more of a sales-driven culture for the enterprise than a developer-centric focus.

Okta has stated they’d like to court developers for advanced use cases, such as the use of biometrics for authentication. Not only is the use of biometrics very complex but it needs to be properly implemented by developers. The top-down approach Okta uses is not well suited for this, yet the bottoms-up approach from Auth0 is well suited.

Financials

Okta is a $1 billion run rate company with the most recent quarter posting $251 million in revenue. This represents an increase of 37% year-over-year. The remaining performance obligations (RPO) was $1.89 billion, for an increase of 52%, with current RPO expected to be recognized this year up 45% compared to the year-ago quarter. Most bullish analysis will focus on RPO growth.

The adjusted earnings the company reported was EPS of ($0.10) compared to ($0.06) in the year-ago quarter. The bearish side to Okta is the ongoing lack of profitability. The company’s losses are increasing in terms of percentage of revenue on a GAAP basis from 36% to 29% of total revenue. On an adjusted basis, the operating losses were 6% of total revenue, a slight improvement from 7% last year.

This is a graph from Okta’s Investor Presentation helps demonstrate the regress:

These losses steepen with the Auth0 acquisition with adjusted EPS for next quarter of ($0.36) to ($0.35) and for fiscal year 2022 of ($1.16) to ($1.13). Forward guidance includes the Auth0 acquisition with total revenue of $295 million to $297 million, or 47% to 48% year-over-year. Last fiscal year, the adjusted EPS was $0.11

To be fair, the free cash flow margin is at 21% and this has improved. The company has $2.5 billion in cash and cash equivalents. This helps the company to satisfy the Rule of 40, which helps to sift through the many key metrics in the cloud and SaaS vertical to establish what companies have a healthy top line combined with a healthy bottom line. There is a great write-up here from Scale Ventures who has specialized in cloud startups for twenty years. They discuss why this is an important rule for public companies. Here’s an excerpt:

The Rule of 40 states that, at scale, a company's revenue growth rate plus profitability margin should be equal to or greater than 40%. SaaS management teams are often driving towards either rapid growth or increased profitability, and the Rule of 40 has become a construct for framing the balance of these two phenomena. Given that increased investment (whether from external or internal sources) is usually required to drive growth, rapid expansion and strong profitability are usually at odds with each other, and finding the right mix between the two can be tricky. a company's revenue growth rate plus profitability margin should be equal to or greater than 40%. SaaS management teams are often driving towards either rapid growth or increased profitability, and the Rule of 40 has become a construct for framing the balance of these two phenomena. Given that increased investment (whether from external or internal sources) is usually required to drive growth, rapid expansion and strong profitability are usually at odds with each other, and finding the right mix between the two can be tricky. 

One of the more interesting slides from Okta’s Auth0 Investor Presentation is the chart showing the 2018 Cohort’s Contribution Margin:

My only concern with the above chart is that Okta has been in business for about twelve years, and therefore, there should be at least ten cohorts with high contribution margins yet the company is still unprofitable.

The company is forecasting a minimum of 35% growth each year through 2026 for revenue of $4 billion. The key drivers will be Customer Identity segment with Auth0, growth in the enterprise customer base, expanding partnerships and international expansion.

We will be keeping Okta on our radar for any re-acceleration in revenue or increased forward guidance as the 35% minimum growth is a solid baseline.

With Auth0, the company is now guiding for fiscal year growth of 45% to 47% year-over-year. There was some criticism from an analyst on the earnings call because Okta did not break up the organic growth in the guidance. The losses are expected to be in the range of adjusted EPS ($1.16) to ($1.13).

Addressable Markets and Valuations

Auth0 was valued at $1.9 billion last July and Okta is paying $6.5 billion, or a 350% increase. The all-stock deal dilutes shareholders by 20%. Notably, Auth0 will be issued shares at $276.21

Okta is known for being downgraded due to valuation concerns. Despite the company having average performance during the 2020 due to Covid, it’s still in the top 10 on forward P/S. By average performance, the 40% range was overshadowed by many other cloud stocks seeing outsized performance. The digital transformation did not show up for Okta in a big way.

Sometimes you can squeeze out a 40 forward P/S but that doesn’t leave too much room in Okta’s current valuation. We will need to see more post-acquisition as we don’t want to front run this right now. If it was in the 20s, we likely would bite.

In the most recent earnings report, Okta stated the identity’s market addressable market was at $80 billion. If we break this down, we find the identity access management (IAM) market was at $12.3 billion in 2020 and will reach $24.1 billion by 2025 for a CAGR of 14.5% during the forecast period of 2021 to 2025. There is another forecast of 13.2% CAGR for IAM between 2018 and 2026 from $9.5 billion to $24.76 billion.

According to Okta in the most recent earnings call, customer identity TAM is $30 billion.

Of the key markets, health care is expected to be the fastest growing market driven by the need to prevent unauthorized users from accessing patient information. Healthcare organizations experience 5 times more attacks than financial institutions.

Asia Pacific is the region expected to drive the most growth with North America holding the largest share.

Conclusion:

Okta is firmly back on radar. What we want to see from this company is increased guidance following the Auth0 acquisition. The baseline of 35% forward growth is an excellent baseline to work from as any increase from here will help the stock quite a bit. There is strategic value to diversification and cross-selling in your customer base. For Okta, the acquisition adds developers plus strengthens their fastest growing segment (customer identity).

For now, the company get honorable mention, and if we see the right set-up, we will take it, but only if we see the right setup. Taking the number two position on 1-year and 2-year forward is a key reason as to why Okta is back on our radar. To be candid, the bottom line is a bit ugly for a company this age and at these growth levels (i.e., not hyper growth), so let’s see if the cross-selling improves this.

2021 Renewables Analysis: Overview of Stocks We Are Targeting

Posted on by io-fund

Over the past fifteen years, there has been a marked shift in the world’s most valuable industry. Oil dominated the top 10 in the prior decade and technology dominates in the current decade. However, what will happen when these two dominant industries merge into renewables and combine the addressable market of fossil fuels with the disruptive nature of technology?

It’s a big question to ask as many renewables companies look like moonshots, or they’ve operated for some time and have cyclical financials. There are many highs and lows in their financials due to the level of infrastructure required for renewables and the dependency on cyclical supply chains. To put it plainly, the financials in the renewables sector are what most growth investors try to avoid. First Solar is a great example as the company rotates between 100% growth in some quarters and negative growth in others. Cyclical issues are the norm and not the exception. We discuss this more towards the end of the report as we identify a handful of companies we are keeping a close eye on.

You can reference our previous renewables report here.

The Bull Thesis:

Our first report on renewables highlighted a study from the College of UC Berkeley claiming that by 2035 the U.S. could see up to 90% of U.S. energy consumption come from renewable energy sources. This report assumes favorable subsidies and legislation that should facilitate this transition and acknowledges that government assistance is not a guarantee. Without government support, the report claims the U.S. could see up to 55% of its energy consumption come from renewable sources by 2035.

Since year-end 2020, we’ve seen even higher growth reported than previously estimated with worldwide capacity growing by 45%. This is the largest annual growth rate since 1999. The growth was driven by a 90% rise in wind power and a 23% expansion in new solar power installations. Most importantly, the IEA is predicting that large capacity gains in renewable energy becomes the “new normal” in 2021 and 2022 with gains in capacity similar to 2020.

The key point to renewables is that the levelized cost of energy (LCOE) for utility-scale solar photovoltaic (PV) has plummeted 400% in the past five years. I covered this for MarketWatch with the image below to depict how competitive solar has become compared to other energy sources. This is important because the industry has seen a change in the story and (generally speaking) is why the renewables’ financials were deep in the red over the last couple of years.

This has led to hockey stick growth. According to the report, wind is growing the fastest (50%) within the renewables category yet solar (26%) is expected to overtake wind power.

The reason for this growth is that the technology is being developed for and marketed to individual consumers whereas wind is designed primarily for a region’s electricity grid. As the efficiency and storage continue to increase, and the cost continues to go down, more people will likely migrate to having a home that is independent of the grid predominantly due to a reduction in personal expenditures, which will also align with the desire to become greener.

More importantly, the cost to produce 1 kilowatt of solar electricity is now competitive with wind, and is the cheapest form of electricity available when taking into account utility-scale systems installed in locations that receive full sun.

If we use the metric of levelized cost of energy (LCOE), solar is more expensive to build upfront, but much cheaper to maintain, compared to a natural gas power plant that is less costly to build but has significant and on-going costs to maintain. As stated, the LCOE for solar has plummeted as much as 400% in the past five years, making the economic incentive a real driver for municipalities and business to develop on a large scale.

Global Addressable Market

Renewable energy companies have global addressable markets, which makes it an attractive industry for investment. In any given region – China, the United States or Europe, energy accounts for 15-18% of the country’s GDP. According to Brookfield Renewable Partners, one of the world’s largest investors in renewable energy, $5 to $10 trillion will be invested in renewable energy worldwide by 2030.

We’ve covered why we are keen on China for electric vehicles specifically. In a similar vein to the country having a need for electric vehicles due to a lack of oil, China is also the biggest manufacturer of solar photovoltaics and the largest producer of solar-generated electricity. According to Wood Mackenzie, China will exceed the United States on solar power through 2024.

Last year, China accounted for 50% of the world’s growth in renewable energy capacity. In Q4 of 2020, China added 3X gigawatts in capacity compared to Q4 2019.

The country’s global share is at 22.9% with a 10-year annual growth rate of 33.4%. Compare that to the United States with a similar global share of 20.1% yet with a 10-year annual growth rate of 10.1%.

India is forecast to become a growth market, as well, with ambitions to reach 225 gigawatts of power by 2022 compared to 10 gigawatts of power in 2019.

India and the United Kingdom are tied for the second highest 10-year annual growth rate in the 17% range after China’s 33%.

With that said, the United States is a key market with 5% of the world’s population yet accounts for 17% of the world’s energy. The daily per capita energy consumption in the United States is 2.6 gallons of oil, 9.7 pounds of coal, and 255 cubic feet of natural gas. Residential consumption is 11.8 kilowatts (KWh) per person.

Even though the growth rate is much lower in the United States, on a per capita basis, the country is in a wide lead for both fossil fuels and renewables. In Q4 of 2020, the United States added 19 gigawatts compared to 13.7 in the year-ago quarter compared to the 3X growth China reported.

Constraints to Renewables:

Renewable energy’s capacity factor is more fixed due to the elements. Solar has a capacity factor of 25%, while wind has a capacity factor of 35%. These numbers are based on the rotation of the sun and other weather patterns. Advancements within this field must come from an acceleration of efficiency during the restricted time that it can produce energy.

The average size of natural gas power plants in the U.S. is 820 megawatts.  The average current capacity factor for natural gas in the U.S. is 58%. This means that the average natural gas power plant produces 4,166,256 MWh/year.

Compare this with one of the more advanced on-shore wind turbines, which is about 810 ft high with a blade diameter with a 518 ft diameter. One turbine has a 5 MW size, with a capacity factor of 35%. Therefore, one turbine equals 15,330 MWh/year. In order to have the equivalent energy output of the average natural gas power plant, you would need 272 of these turbines.

There are now off shore wind farms where the capacity factor is an impressive 63%. Furthermore, General Electric has developed an off shore turbine called the Haliade-X that can produce 12 MW.  So, one of these turbines produces 66,225 MWh/year. Even with such improvements, you would still need 63 of these turbines, which seems more plausible.

The scalability issue becomes even more exacerbated with solar. For example, the United States is in the process of beginning to build one of the more advanced solar farms in the world, called the Gemini Solar Project in Nevada. When completed, the generation facility will have a size of 690 MWs, and the total land mass it will take to build this array is roughly 7100 acres. For perspective, Central Park in NYC is about 840 acres. So, the size of the Gemini Solar Project is the size of about 8.5 Central Parks.

With a capacity factor of 25%, the total MWh/year comes out to 1,511,100 MWh/year. Thus, you would need nearly three Gemini Solar Projects to equal the average energy output of the average natural gas power plant.

We have seen huge improvements in renewable energy tech; however, total scalability of the U.S. energy grid is not feasible (yet).

Impact from Covid

Due to COVID-19, the energy sector as a whole saw the largest drop in investments in history. The sector as a whole experienced a roughly 20% decline in investments, which includes renewable energy projects. Many believe this is a temporary setback, and preliminary earnings reports seem to agree in some cases while other companies are still reporting negative revenue growth.

Stocks We are Watching

Renewable energy companies that generate free cash flow and have strong balance sheets have a competitive advantage over financially weaker rivals, since they have greater access to the capital needed to finance growth. That's why investors should focus their attention on financially strong clean energy companies.

Although this is not an extensive list, we spell out our thoughts on why a couple of names make our watchlist and why others don’t. We are providing this in case it’s helpful as renewables often have quarters with negative revenue growth, etcetera, so more depth into why we ignore this in some cases and not others may be helpful.

Plug Power:

Plug Power is a high growth company within renewables, and thus has attracted a very high valuation. As we covered before, management is expecting high growth over the next several years, believing that in 2024 it will earn $200 million in operating profit and record gross billings of $1.2 billion (gross billings will be $325M-$330M in FY’20). 

Per our previous coverage, HC Wainwright projected Plug's revenues in 2024 will be about $1.1 billion — more than four times the company's trailing revenues currently. Current consensus is projecting Plug to grow revenue 40% next year in FY 2021.   

In Plug’s most recent earnings report, the company “reaffirm(ed) the recently raised gross billings targets for 2021 and 2024.”  Plug Power’s accounting issues have also been cleared up with minimal impact on the overall financial outlook of the company. The company reported 76% growth in revenue year-over-year for $72 million in revenue which was less than analyst expectations at $77 million. There was also a EPS miss at ($0.12) compared to ($0.08) expected.

Why has the stock done well despite a weaker-than-expected earnings report? My guess is because Plug Power is the fastest growing company within the renewables sector and the underlying key metrics are stronger than the surface-level ER reveals. Although profitability is an issue, Plug Power’s fuel cell systems segment is growing rapidly and this is the company’s most profitable segment.

Gross billings are also very healthy. Here is what the CEO said in the last earnings call:

“Investors should expect $115 million to $120 million of gross billings for the quarter. This is approximately 40% of our target revenue of $475 million for the year. Usually, at this point in the second quarter, […] 33% of our annual revenue will have been achieved. We are at a run rate that is higher from both a revenue and growth rate level than we have experienced in the past.”

Plug Power is at the top of our list right now for renewables.

Enphase:

Enphase has done well because it’s a safer choice than many other renewables as the company has been consistently profitable for many quarters (9 out of the last 10). The company has an adjusted gross margin of 41% with adjusted EPS in the most recent quarter of $0.56.

Not only is Enphase consistently profitable yet the company has maintained industry-leading growth. The most recent quarter reported 46% growth year-over-year and 14% sequentially. In 2019, Enphase was in the 75%-100% growth range. This is important because the company is very consistent where other solar stocks are not.

During Covid, there was a brief pause in revenue growth in Q3 and Q2 of 2020. The company reported flat growth in Q3 2020 and -6% growth in Q2 2020. For this industry, that is not bad at all and is actually a sign of strength that Enphase bounced back faster than it’s peers.

The company has a cash balance of $1.48 billion. In March, the company issued convertible notes due 2024 and 2025 for net proceeds of $1.19 billion.

For the second quarter, Enphase management guided for $300 million to $320 million, or 140% growth. Again, this is due to the weaker quarters the company had last year during Covid, which were flat to negative. It’s better to look at the growth on an annual basis, which is expected to be 70% growth for FY 2021 with analysts expecting $1.32 billion this year, up from $774.4 million.

Enphase is at the top of our list for renewables.

SolarEdge:

SolarEdge competes with Enphase yet does not have the same consistency as the company has reported flat to negative growth for four quarters. The company reported revenue of $405.5 million, or (6%) year-over-year yet up 13% sequentially.

Adjusted gross margins are at 36.5%. The company has $515 million in cash.

Looking forward, SolarEdge is expecting $445 million to $465 million in revenue, or an increase of 37% for the upcoming quarter. The annual growth for FY2021 is expected to be around 29% with the year after at 25.3%.

We will keep an eye on SolarEdge for improving financials.

Blink and ChargePoint:

ChargePoint operates the largest online network of independently owned EV charging stations operating in 14 countries. The adjusted gross margins are in the 20-25% range.

We like this company for its strong cash position and steady forward growth. Revenue increased 24% year-over-year to $40.5 million with management guiding for $46 to $51 million in revenue next quarter. The company also confirmed its revenue outlook of $195 to $205 million for FY 2022 ending in January. This represents 37% growth year-over-year. The company has cash and cash equivalents of $610 million after exercising warrants worth $73.8 million.

Blink is a fast-growing company with revenue growing 72% year-over-year and charging stations growing 370% year-over-year. However, the company has very little revenue to speak of with $2.2 million in the first quarter. It’s easier to put up triple digit numbers with a low revenue base. The company also losses of $7.4 million that have gotten steeper as the company grows, up from losses of $3 million in the previous year.

We wanted to highlight these two to show why we prefer Stem as our high beta play. Not only is Stem growing faster but plans to be profitable this year. Notably, we also have exposure to EVs through Xpeng and Nio. We’ve owned Tesla and Lucid Motors in the past.

Stem:

Stem has over 900 systems operating on its Athena AI software in over 200 cities worldwide. Athena AI optimizes time-of-use and demand charges, resulting in 10% – 30% monthly electricity bill reductions.

The company is still in its infancy with $33M in net revenue for the FY 2020. Revenue is projected to grow 348% YoY in 2021 to $147M. With the way the company recognizes its sales, 88% of its forecasted 2021 revenues are from contracts that have already been executed. This means there is minimal risk that the company will fall short of its 2021 revenue target of $147M. Notably, the company has a pipeline of $1.43 billion.

The company reaffirmed its 2021 financial guidance for $147 million in the latest earnings report on May 17th. The company also outlined they expect nearly half of the annual revenue to come in Q4.

Revenue came in at $15.4 million in revenue compared to $4 million in the year, up nearly 275%. Adjusted gross margins were at 19% compared to 1% a year ago.

The company expects to reach adjusted EBITDA profitability in 2022 and turn FCF positive in 2023. Gross margins are expected to improve to 38% by 2025. The gross margin improvement will be driven by Stem’s increasing software revenue, which is the highest margin portion of their business (~80%)

Stem is a newer company that must prove itself. On that note, we are very bullish on this company for the exposure to software within the renewables sector that this particular investment provides. Notably, Stem is the one renewables stock and the only SPAC we remained with during the sell-off. Please reference our Stem position on the portfolio and our past research here.

iSun:

iSun offers solar, energy and data solutions. The company is a “deSPAC” or basically SPAC post-merger that has very low gross margins. In the most recent quarter, the company reported $7.26 million in revenue yet had only $119,000 in gross profit. This nearly $0 in gross profit is a pattern in previous quarters, as well. We see this company as too high risk for an entry at this time. The margins would need to improve substantially for consideration.

Bloom Energy:

Bloom Energy has revenue of $194 million per quarter, an increase of 23.8% year-over-year. The adjusted gross margins are at 29% with adjusted EPS of ($0.07). The company has negative operating margins of (7.4%) in the first quarter of 2021 which is an improvement from the (29.6%) operating margin in the first quarter of 2020.

The company has cash of $365.7 million and debt of $522.2 million.

Management guided for forward revenue of $950 million to $1 billion for FY 2021, or 25.7% growth. The company was flat last year and saw very low growth the year prior.

Overall, this company is not high growth enough for our portfolio.

Conclusion:

One reason why the renewables sector is at a starting point (and we are not seeing the full picture yet in terms of financials) is that Moore’s Law applies to renewable tech. For example, the cost per watt in solar has gone from $22 in the 1980s, to $3 in 2011, and is now about $2.90 per watt. In fact, MIT released a report explaining how close we are to $0.20 per watt, which will make the economic benefit of transitioning to solar a real driver for both individuals, businesses and municipalities.

Right now, we rate Plug Power slightly higher than Enphase in terms of positions we want to build. We are also reiterating our conviction on Stem compared to other high beta plays in this sector. We believe these are the top three choices – Plug Power for growth, Enphase as a market leader and Stem for its position with the Athena AI software and strong revenue growth out the gate.

Kingsoft Cloud Update

Posted on by io-fund

The growth of cloud IaaS in China is why we are invested in Kingsoft Cloud. Below, we review this company in light of a missed earnings report and weaker price action than some of our other positions.

Background on KC:

Kingsoft Cloud specializes in internet streaming, yet has incredibly strong parent companies for an opportunity this size. The two parent companies are Xiaomi, the number three mobile device globally second to Apple and Samsung, and Kingsoft Corporation, which is a software company from the 1990s that is the equivalent of Microsoft Office in China.

Xiaomi gives its traffic to Kingsoft Cloud, and therefore, mobile streaming and internet traffic is a specialty. This is seen in the client list of ByteDance (Tiktok), iQIYI, Bilibili and NetEase. Notably, Xiaomi is on the blacklist but this isn’t too surprising as a mobile company.

What is interesting to me is the internet-of-thing (IoT) footprint that Xiaomi has, which is the largest in China. According to Harvard Business Review, Xiaomi has surpassed $37 billion in IoT revenue from more than 210 IoT devices excluding smartphones and laptops. The article is a good read as HBR did a “multi-year” review on how Xiaomi grew its market by targeting price conscious and tech savvy consumers. The company then strategically set up retail locations to attract IoT purchases.

Kingsoft Cloud is also moving quickly into the enterprise cloud, which should help the company diversify from public cloud (i.e. the mobile/internet streaming). You’ll see below in the Financials section that this is where the majority of the growth is coming from. The company noted verticals such as Finance and Health Care as their major focus. This entry shouldn’t be terribly difficult given the parent company Kingsoft Corporation holds a spot similar to Microsoft Office in China with enterprise customers using the WPS Office software.

The reason Kingsoft Cloud can be considered a bit safer than other Chinese stocks, in my opinion, is that the company is on a $1 billion annual run rate. In addition, China has made it clear that becoming a leader in 5G and AI is a primary focus and this is impossible without a larger cloud IaaS footprint. There is a serious gap here in the country’s ambitions compared to the country’s capabilities. We first covered this with our Alibaba premium research report where we said the following:

“China’s enterprise IT market is five to seven years behind the United States and Western European markets. Once fully mature, China’s need for cloud infrastructure will rival the United States with 3x the population and a bottomless appetite for smart cities, artificial intelligence and machine learning plus manufacturing IoT automation.

The reversal of where China is today with cloud IaaS, and where China will be in five years, could be a bigger story than the B2B marketplace as the growth is closely tied to China’s position as a global leader.

In 2017, China published a roadmap on how it seeks to become a global powerhouse in AI. According to the report entitled “Next Generation Artificial Intelligence Development Plan,” the domestic AI market will be worth a total of $150 billion. Today, China’s AI market is worth $6.2 billion.

Artificial intelligence and machine learning require private cloud and public cloud infrastructure-as-a-service (or a hybrid mix with on-premise servers) as storing data in separate silos weakens AI and ML capabilities, reduces training performance and lowers accuracy. Artificial intelligence and machine learning require speed with most AI solutions split between 40/60 with private/public cloud or 60/40 if you’re a regulated industry.”

Although we closed our position in Alibaba, a similar thesis applies to Kingsoft Cloud.

Overview of Cloud IaaS

In the Top 10 LTBH webinar when I covered Datadog, I had stated that if the tech giants all believe cloud IaaS is the most critical layer into the foreseeable future, who am I to argue with this?

The chess game has been set with AWS’s Andy Jassy now CEO of Amazon and Azure’s Satya Nadella as CEO of Microsoft. I’ve also made the case that Google better hurry up and find its focus because these two heavyweights have chosen their primary focus and direction for the next decade.

Basically, I want exposure to this strong positioning. Although SaaS shows the most revenue overall globally, it’s being clearly communicated from Big Tech that IaaS is the most important layer. I could write a whole report on why that is (and will when I cover Datadog soon). Primarily it’s not only the infrastructure for software but is also the infrastructure for AI, ML and 5G.

Regarding Kingsoft Cloud, it’s centered in this trend and in the region where the most growth will occur. In fact, China is unique from the United States because cloud IaaS is China’s largest category in terms of revenue whereas software is the largest globally.

 Here are estimates from Statista:

Source: Statista

The interesting part is that China grew much, much faster than these estimates predicted. In fact, due to Covid, Alibaba reported 60.1 billion Yuan in fiscal year 2021, or about $10 billion USD.

According to IDC, the Q4 cloud IaaS market in China was at $3.49 billion, or annual run rate of $14 billion. If we look at the size of the global IaaS market, which Gartner states was $82 billion in 2021, then we see China is equal to about 17% of the market if we calculate with the 2021 average of $14 billion.

The market in China is expected to grow at 28.3% CAGR compared to United States growth of 20.3% CAGR from 2019 to 2024. Notably, these estimates were given prior to Covid.

If we take only the public cloud market, Frost & Sullivan predicts the market will grow from 81 billion RMB to 368 billion RMB in 2024 – or nearly 5X. Right now, China has about 6.5% of the global public cloud market and this is forecast to grow to 10.5% by 2024.

As outlined in the S-1 filing, the same firm predicts that China’s internet cloud market will grow 4X from roughly $50 billion RMB to $215 billion RMB and the enterprise market will grow 3X from $108 billion RMB to $345 billion RMB.

Of the 17% that China has, Kingsoft Cloud stated in the S-1 filing from 2019 that they have 5.4% in terms of revenue from IaaS and PaaS.

The estimates indicate that China will take increasing market share in cloud IaaS as the country catches up to other developed regions. With many segments expected to double in percentages, we can comfortably assume China will own 20% of the cloud IaaS market.

If Kingsoft Cloud grows to own 10% of the market, and we figure $23 billion for the Chinese market in two years ($14 billion at 28% CAGR), then the company should hit around $2.3 billion in annual revenue.

$2.3 billion happens to be what the analyst estimates are, as well, for FY 2022

This implies growth of about 50% this year from annual revenue of $947 million to $1.5 billion and also 49% growth the following year.

Financials

This quarter, Kingsoft Cloud reported growth of 30% for $1.81 billion RMB in total revenues, equal to $277 million USD. This means Kingsoft is a $1 billion USD annual run rate, which is rare for China. Public cloud makes 77% of revenue with enterprise cloud 23% of revenue. The enterprise cloud grew 131.3% in the most recent quarter.

The revenue missed consensus of $1.88 billion RMB.

Despite tougher comps following Covid, Kingsoft is guiding for second quarter revenue growth of 39% to 45%, which represents a reacceleration from Q1. However, the company’s guidance of 2.13 billion RMB to 2.23 billion RMB is also under Q2 analyst consensus for 2.41 billion RMB.

Last year, the company reported 58% growth in Q2 2020. As with all Covid beneficiaries, analysts are timid as to KC’s growth in the back-half of the year as the company reported 75% and 72% in revenue, respectively. This means the hurdle is higher for KC in Q3 and Q4. Perhaps the stronger guide for Q2 is a good sign. The company repeated many times that the backlog is healthy with RMB 2.8 billion, or $432 million (a little over a quarter’s worth of revenue). This does not include new bids from Q1, which management alluded to included “some big internet companies.”

The adjusted gross margin increased from 4.9% last quarter to 6.7% this quarter. In the earnings call, management noted the improvement was attributed to the financial and health care verticals, and the contribution of public cloud’s revenue and margin.

The company has a cash position of RMB 5.46 billion, or about $840 million USD. The company’s loss per share improved from RMB 0.39 to RMB 0.11 or ($0.02) per share.

Valuation:

It takes about two seconds to see the massive discount Chinese that stocks are trading at compared to stocks in the United States. Kingsoft is not immune to the China discount as it has more revenue than cloud stocks Okta and Datadog yet trades at 1/6 the forward P/S.

When the chart below is adjusted for a 3-5 year time frame, we see it has been since March of 2018 that Chinese stocks and United States stocks traded in the same range of 15 P/S. There was a strong decoupling after early 2018.

Kingsoft held the 15 P/S range in February of 2021 so it’s not out of the question the company could return to this valuation. It would need to meet/exceed guidance on Q2 and to guide strong for Q3-Q4 to resume these levels. Cloud IaaS is fully capable of this because it tends to be a steady performer.

Management:

Jun Lei, the CEO of of Xiaomi, serves as the Chairman of the Board of Directors. He has been with Kingsoft since 1992 and was also previously the chairman of Cheetah Mobile. The CEO of Kingsoft comes from Phoenix New Media, an internet, mobile and television company in China. The Board also has members who previously held roles at Google/IBM and IDG Capital/McKinsey. Management has members with experience from Goldman Sachs Asia (CFO), enterprise cloud company Qiniu, gaming company Zynga and Baidu.

The most critical member is Jun Lei as he accomplished the unusual feat of rising to the top of China’s most treasured industry – mobile. He overcame Apple for the number one spot in China in 2014 and is now in the number three spot. To be frank, he did this by ripping off Apple, but nonetheless it was an accomplishment as United States companies dominated China prior to this breakthrough.

In 2013, he was appointed a delegate of the National People’s Congress.

Risks:

The risk to Kingsoft Cloud is not the addressable market, the growth/demand and timing, or even number of competitors. The risk is the size of its competitors. Cloud SaaS in the United States is a great example of a category where competitors tend to be similar sized, and therefore, the playing field is level. This isn’t the case with cloud IaaS where BAT (Baidu, Alibaba, Tencent) rules China like MAG (Microsoft, AWS and GCP) rules the United States. Now we have to add H to the acronym for China as Huawei is growing rapidly.  

Kingsoft Cloud is the largest independent cloud provider, which means there is no conflict of interest for internet companies to work with KC as they don’t directly compete. Tencent and Baidu, for example, compete with smaller internet companies.

Another prominent risk is the costs associated with building out infrastructure. The adjusted gross margins are drastically lower than the SaaS category in the 70%+ range. You can also see the costs associated with IaaS reflected in the IDC costs, which cover bandwidth and racks. These costs range between 68% of revenue in 2020 to 77% of revenue in 2017.

 We’ve covered the fact that Kingsoft Cloud is not audited in this write-up here.

Conclusion:

We try to have a diversified portfolio across tech and China is a region we want exposure to. With that said, China is not for everyone. For the I/O Fund, it’s easier to invest in a stock in China long-term that has solid parent companies and is participating in a predictable trend.

We will need to see one of two things happen for Kingsoft Cloud to resume its previous valuation of 15 P/S. The company needs to come in strong in the second half of the year or we need to see China come back in favor. The first one is where we have focused our efforts in this analysis.

We think a cloud IaaS company with $1 billion in revenue and 50% growth is investable. It has a rock bottom valuation coupled with the recent history of trading at a much higher valuation.

Additional Reading:

Alibaba Premium Analysis 2019
August 14th: Alibaba Quick Glance
Alibaba and Ant Group Premium Research Report
Kingsoft Cloud (KC)

New Forum Instructions

Posted on by io-fund

Thanks for everyone’s patience.

We have decided to launch a very basic version of the forum and then add features every 1-2 days to avoid any crashes or bugs.

You can check out the new forum here: https://wire.io-fund.com

We’d like one more day to import the data from the old forum. We plan to start posting on Thursday, June 24th so please use Tribe for one more day.

As you’ll see, we are calling this a Wire rather than a Forum as we have begun to rely on the transmission of information on the community site. I find myself not wanting to miss out on the information posted on the forum and we think the word Wire best represents the critical and professional nature of the community.

Some bullet points:

  • Downvote and Upvote is enabled. Similar to Reddit or HackerNews, the forum will be organized by which posts are the most popular.
  • We are launching with “Trending” but plan to add “Most Recent” and “Most Popular” for sorting the posts. You will be able to quickly click through these three ways to sort the posts.
  • Bookmarks are enabled right now so if you like a post and want to save it for later, you can hit the upper right tab and it will save to your bookmarks.
  • You’ll be gaining points as you post. We will call this “equity” rather than “karma.” The benefit of this is that those who are down voted will see the effects of posting against our Forum Guidelines. On that note, the Forum Guidelines were written with the group in mind and after getting quality feedback from our members.
  • Formal moderation is coming soon. If the flag button is hit enough times by enough members, then the post will be removed until it can be moderated by our team.
  • I/O Fund Activity and Stock Setups in the menu will allow you to reference I/O Fund posts quickly. Knox’s trade setups will be going in the right hand where it says RECENT TRADE NOTIFICATIONS. These will automatically post when you get the SMS/email notification and will remain on the right side as you scroll through other posts.
  • You’ll see a placeholder for Crypto. The plan is to allow subscribers to either opt-in or opt-out of crypto posts so you have a choice as to whether you see those or not. This will go live in the next 1-2 weeks.
  • Slack and Mailchimp APIs are coming in the next 1-2 weeks to help you set alerts. For instance, you can get a weekly email of the top-ranking posts.
  • The New Members tab will be a separate space for New Members to voice questions. This will hopefully alleviate the influx of posts we get on the main feed.
  • You will have the ability to DM each other in the next couple of weeks.

Thanks again for your unwavering patience on this!

Nasdaq100 Levels to Watch for the Next Leg Higher

Posted on by io-fund

Being a contrarian in tech investing has been a rewarding strategy over the last 5 years. Believe it or not, as far back as 2016, the contrarian position in tech was to remain a bull. Each year since, floods of articles presented the popular thesis that the “tech bubble” was about to burst (2016, 2017, 2018, 2019, 2020, 2021).

For those that remained a contrarian, the cumulative returns of the NASDAQ100 since 2016 has been ~ 207% returns. Meanwhile, the average drawdown per year since 2016 was an eye popping 17%, while the average annual return for the year was about 21%.

Only those who ignored the talk of a bubble participated in the epic run that has resulted in the Nasdaq100 driving forward some of the world’s most valuable companies. Which leads to another point: analysts continually and consistently misunderstand tech in the early days of a company’s rise. Using value metrics to build the case for a bubble, these same analysts have gone silent when that bubble refuses to cooperate with soothsayer predictions.

Once again, this year is witnessing a rotation out of tech growth, as more articles claim that this is the actual popping of the tech bubble – for real, this time. Although I do believe the market will experience a true secular bear market at some point in the future, more importantly, I believe the market is setting up first for what appears to be the next leg higher.

I also believe that tech, as well as growth, will resume its lead in the next leg higher. I outline my reasons below.

1) Understanding Tech and What it is Telling us Now

From September of 2019 through January of 2020, the market narrative was that cloud computing was over stretched, resulting in a severe value rotation. At that time, we were hearing that the stocks in this sector had price/sales ratios greater than many of the tech stocks during the dot.com bubble.

A fair representation of these companies can be found in the ETF with the ticker symbol CLOU. This is a pure play on the cloud microtrend and was overweight many of the richly valued tech darlings of the time, such as Zoom, Shopify, Crowdstrike – just to name a few.

Despite cloud being “overstretched” with “dot-com like valuations,” from the February peak to the March low, CLOU saw a 32.94% drawdown, compared with the S&P500 that saw a 35.63%. Also, worth noting, CLOU finished the year up 77.9% while the S&P500 finished the year up 18.4%.

In other words, stocks with little to no earnings, and a price/sales ratio ranging between 20 – 40, provided more protection to investors during the March ’20 bear market than the value oriented broad markets. The reason behind this phenomenon is either ignored or shrugged off as an anomaly; however, understanding why this occurred is the type of information that would help one to identify companies like Amazon and Google in early stages, despite their rich valuations.

Beneath the negative earnings, and price/sales ratios well into the double digits, are powerful microtrends that can scale globally. Beth Kindig of the I/O Fund presciently wrote an article in 2019 stating that Cloud Computing would be a good safe haven in an economic contraction, even with bubble-like valuations.

“My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession.”

Her thesis was simply that the cloud microtrend was still in the middle of its expansion, and the very nature of migrating to the cloud makes enterprises more efficient as well as reduces costly IT overhead, which can help them survive slowing GDP.

Furthermore, we are seeing companies within cloud grow YoY revenues at rates that are historical records. For example, in recent reports: Shopify grew YoY revenue by 110.4%, Zoom by 191.4% (this is after 3 consecutive quarters of greater than 350% growth), Snowflake grew by 110% and Crowdstrike grew by 70%.

All of these companies came in above consensus in the most recent quarter while most raised forward guidance. We are now lapping the most critical quarter for tougher comps from Covid and we think in the next couple of months, the words “tougher comps” will fade from memory as the better term will be “sustained growth.”

2) Technical Signals

Where is the money from growth flowing?

Since the February top in 2021, we have seen a large rotation from growth names into value. Some have posited that the growth trend is over, and the era of value is set to lead. To get a clue as to whether this thesis is correct, I think analyzing the flow of money from tech is key.

On a simple 3-month relative return, which takes us back to the start of the correction, we can see money flowing from high growth sectors and into value sectors.

However, if we dig down a little deeper, the money seems to be flowing into early-mid cycle sectors, such transportation, financials, industrials, materials. The standard late-cycle sectors, such as utilities and consumers staples, appear to be lagging, which suggests that the market is more likely positioning for a move higher than preparing for a protracted drawdown.

I further believe that the market put in an important bottom on May 12th. Below is a chart showing that since the May 12th bottom, quietly, we’re starting to see a rotation back to high growth names, and the selling of value as well as commodities. 

It appears that underneath the moderate price movements in the broad market, we’re beginning to see a rotation back into growth names. We will need to see this trend continue, but so far, if the bottom is in, the up days in the market are suggesting a continuation of growth outperformance.

Breakouts Around the World

Just like in late 2016, we are seeing an abundance of analysts suggesting that the major top is in or we are close. This would be followed by a major and protracted bear market. Also, just like in late 2016, this thesis is not being supported by the price action in major markets around the world.

The above chart illustrates the breakouts we are seeing across the board: Global Blue Chips, Emerging Markets, Europe, India, even Small Caps are showing strength, as is China. These are typically not the intermarket signals we see just prior to a major bear market.

Strong Market Breadth

Market breadth is a technical measurement that measures the number of companies participating in a trend. In other words, if the number of companies that are participating in a broad market uptrend is growing with the market, then this is a healthy uptrend.

On the other hand, leading into most corrections, we see market breadth decreasing while the broad market continues higher. If fewer stocks are holding the markets up, this is typically a bad sign for an uptrend.

We use many methods to measure market breadth, but the simplest and oldest way is the advance decline line. Simply put, this indicator plots the difference between the number of stocks in the market that are increasing in price vs. the ones that are decreasing.

If we compare this indicator to the S&P 500, we can see an instance leading up to the September selloff in 2020 where the advance/decline line was signaling weakness, while the market continued higher. Today, we are not seeing this. In fact, the advance/decline line is breaking out to new highs before the market. This is indicating that more stocks in the market are moving up vs. down, and when we see this indicator breaking out ahead of price, more time than not, price follows.

The NASDAQ100

Most importantly, the NASDAQ100 (NDX) appears to be setting up for a large breakout move.

NDX is approaching a major resistance zone in blue on the chart (between 3800-4080). The upward-trending, zig-zag pattern into this resistance is typically a bullish pattern. Also, note how the price has respected the upward sloping trendline, which is highlighted with the dashed green line. This is also a promising sign, and gives us a clear level to work with regarding any coming weakness.

The Counter Argument

With as many bullish signals as we are getting, the NASDAQ100 must confirm the next leg higher with a breakout above 14080. Tech is simply too important of a sector both in the economy as well as being a large percentage of the broad market. If NDX fails to break out, and instead breaks below major support at 13200, we could see another correction before we can get another shot at a breakout setup.

Also, the transportation index is flashing a potential warning that this breakout could be premature.

 Historically, the transportation index tends to lead the market. Because global commerce relies on transportation, a slowing down in this sector tends to signal a slow-down in the economy. Also, because equities are usually looking ~6 months out, the price of the transportation index can be a strong leading indicator.

As of today, the Dow Jones Transportation Index (DJT) is trending down while the rest of the major indexes are trending up. Because of the tight consolidation, this trend could change in an instant; however, I would not get too concerned unless supports break across the board in the U.S markets.

Supports to watch

Dow Jones Transportation Index – 15250

Dow Jones Industrial Index – 34300

NASDAQ100 – 13200

Regardless of the bullish signals and global breakouts we identified, if the above supports breakdown, we will likely look to hedge our portfolio over the short to intermediate-term time frame. We believe the outlook, as of now, is signaling a higher probability of another leg higher. However, until price agrees with our thesis, the I/O Fund remains cautiously bullish.

AR/VR Pureplay: Vuzix

Posted on by io-fund

I want to give you a heads-up on one stock we are circling right now. I’ll write up a full-length report on Vuzix soon.

Recommended Reading:

Unity: Premium Analysis
Mobile Augmented Reality: Snap and Unity (and Apple)

Vuzix: AR/VR Pureplay

Founded in 1997 (yes, 24 years ago), Vuzix was the first company to release a AR/VR headset for the military and also the first to release a headset for consumer purposes. When we talk about being too early to a trend, we don’t typically mean 24 years too early, yet this is the case with Vuzix. Between now and then, the company has worked with Raytheon on digital night vision for weapons and has also contracted with DARPA to develop heads up display for military ground personnel.

Intel bought 30% ownership of the company in 2015 and the company partnered with BlackBerry in 2017 to deliver smart glasses for enterprise companies.

Fast forward, and Vuzix is becoming the smart glasses of choice for industries that are early adopters of the technology – primarily the medical field. This past month has been busy for the company. John Deere announced the company is using the Vuzix M400 smart glasses to provide remote support. The M400 and M4000 received clearance for medical training this past week and the company also received over $1.2 million in new orders from Rods and Cones for virtual surgical collaboration. There are many press releases in the medical industry that I will discuss in the full-length report, these are only the most recent.

The company is small in terms of revenue and market cap. Last quarter’s revenue was $3.9 million compared to $1.5 million in the year-ago quarter, or an increase of 156%. Smart glasses sales rose by 177% year-over-year to $2.4 million. The company was break even in terms of gross profit in the past yet posted $1 million in profit in the most recent quarter.

Regardless, gross margins are slim at 28% with product gross margins at 45%. As with many small cap companies, the bottom line is a bit ugly as the company has a net loss of $6.6 million. If the company continues to grow the top line, then some of this should resolve on its own as R&D is around $2 million per quarter and sales and marketing is $1.2 million.  

The company closed a public offering of 4,768,293 shares on April 1st for $97.75 million. The shares were priced at $20.50 while the stock was trading at $24.85. The companies proforma cash is $145 million as of April 1st.

Here is how the company’s growth has looked over the past few quarters:

We began writing about this trend in Q3 2020 to discuss the start of this trend and that timing looks aligned with the graph above. Point being, I can’t imagine growth would be very impressive coming from any company in the AR/VR business until around Q3 2020 and so it seems like Vuzix’s growth is right on time.

The earnings call discussed there being “increased inbound interest in order flows related to the reopening of the economy” as industries such as logistics, warehousing, retail picking, e-commerce and third-party logistics are looking for “many 1000s of units.” The company explains that their technology increases worker productivity and can contribute to healthier margins. I find it interesting that AR/VR could be a covid rebound play. This is a bonus as the trend was set to take off around this time with or without covid.

The company also has a partnership with Verizon although this is not meaningfully adding to revenue at this point.

I’ll expand more on Vuzix soon as we are clearly focused on AR/VR as a fund. We were early to Unity and have discussed in detail our views on Snap – most recently in the LTBH webinar.

Knox likes the chart so he will probably enter soon.

Sea Limited Q1 Earnings Update

Posted on by io-fund

Sea Limited showed tremendous performance in each of their three business segments in their Q1 earnings report.  The dominant position Sea Limited has in three separate and growing businesses is what makes the company so strong.  The biggest risk is that one or more of their three businesses will fall off its current pace and lag growing competition.  In the company’s Q1 report, Sea Limited demonstrated that they are a company executing better than ever in each of their three business segments. 

Shopee

In Q1, Sea Limited announced e-commerce revenue of $922.3M, representing 250% YoY GAAP revenue growth.  Gross orders totaled 1.1 billion, a 153% increase YoY.  Gross Merchandise Value (GMV) was $12.6B in the quarter, representing 103% YoY growth.  Adjusted EBITDA declined to -$413M from -$264M in Q1 ’20 due to increased investments in S&M and R&D.  However, Adjusted EBITDA loss per order decreased by 38% YoY to $0.38 compared to $0.61 in Q1 ’20.  This indicates that Sea Limited continues to outgrow its costs in terms of gross order volume. 

In Southeast Asia, Taiwan, and Indonesia, Shopee ranked #1 in the Shopping category by average MAUs and total time spent in app on Android for Q1, according to App Annie.  These rankings are further indication that the strategy management has taken is to prioritize growth in favor of short-term profits – and this is paying off as the company continues to extend its leadership position in various regions. 

Sea Limited has expanded its platform into parts of Latin America, but management did not separate out financials in the region.  With that said, the company has previously discussed its plans to invest aggressively to building out the infrastructure necessary to compete with MercadoLibre. 

Garena 

Sea Limited announced digital entertainment (Garena) revenue of $781M, representing 111% YoY GAAP revenue growth.  Bookings of $1.1B grew 117% YoY, while Quarterly Active Users increased 61% YoY to 649M.  Quarterly paying users grew by 124% YoY to 80M and represented 12% of QAUs for the Q1 compared to 9% for Q1 2020. 

The company’s blockbuster game, Free Fire, was the highest grossing mobile game in Latin America, Southeast Asia, and India for Q1.  Moreover, Free Fire overtook PUBG Mobile and Call of Duty Mobile as the top grossing battle royale style game in the United States.  App data from Sensor Tower shows that Free Fire has continued its momentum into Q2, as it was the 3rd most downloaded mobile app game in the world in April. 

Source: Sensor Tower

SeaMoney

Sea Limited’s digital financial services segment saw $51.3M of revenue in Q1, representing 396% YoY growth.  This segment is still just 3% of the company’s total revenue as we are in the very early innings of the shift to FinTech in Southeast Asia.  Nevertheless, we are seeing promising growth metrics from SeaMoney, showing that they are primed to be a top FinTech player in the region. 

Mobile wallet services recorded a total payment volume of $3.4B, which more than tripled compared to the $1.1B a year ago.  Quarterly paying users surpassed 26.1M in the quarter.

In December 2020, Sea Limited was awarded a digital banking license in Singapore.  A report by Financial Times shows that almost 50% of Southeast Asian adults are unbanked an additional 25% are underbanked.

This underscores the tremendous long-term opportunity Sea Limited is trying to capture in FinTech.  There is a long runway for growth in digital banking as well as digital payments in Southeast Asia, and we are seeing Sea Limited begin to position themselves for future growth.  Over the long-term, SeaMoney has the potential to be a legitimate source of revenue and capture a bigger piece of the revenue pie in addition to Shopee and Garena.      

Q1 Earnings Results

Sea Limited announced Q1 results last month, growing GAAP revenue 147% YoY to $1.8B (US $).  Total gross profit increased 212% YoY to $645M, while total adjusted EBITDA advanced to positive $88.1M compared to -$70M in the Q1 2020. 

The Q1 adjusted EBITDA number missed the consensus estimate of $173M, but the company has been very transparent about its strategy to aggressively reinvest profits back into the business to focus on top line growth.  In total, sales & marketing expenses increased 120% in the quarter while research & development expenses increased 118%.  Management appears to be taking the right approach to stimulating growth and engagement in each segment of the business, as evidenced by some of the growth metrics discussed below.

Sea Limited has three distinct business segments in e-commerce, digital entertainment, and digital financial services.  All three business segments executed tremendously in Q1, with each segment exceeding a triple digit growth rate.  Below is the revenue breakdown in Q1 2021 versus the breakdown in Q1 2020.

Valuation

Sea Limited currently trades at a 12.4x EV/NTM revenue multiple, down from its peak valuation of around 27x last February.  Below, we compare this valuation to other international e-commerce stocks MercadoLibre and Jumia. Notably, Sea Limited has higher forward growth projections for 2021 than MercadoLibre or Jumia.  The table below shows a more detailed comparison of Sea Limited to MercadoLibre and Jumia.  We also included Ozon Group and Coupang, two less expensive e-commerce leaders, for comparison. 

Conclusion

Sea Limited did not give guidance for Q2 or FY21, but consensus estimates are calling for 89% YoY revenue growth for the full year.  All three of Sea Limited’s business segments are performing better than ever, and the company has a long runway for growth as Southeast Asia continues to become more digitalized.  Sea Limited has positioned itself as the dominant e-commerce company in the region with the success of Shopee, the top shopping platform in SE Asia.  With Garena, Sea Limited has the most dominant gaming company in the region with no signs of slowing growth.  SeaMoney, the company’s third segment, is ideally positioned to be one of the leading FinTech players in the region and will continue to benefit from increased digitalization.

UiPath: LTBH Position – Report Coming Soon

Posted on by io-fund

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UiPath: Robotics Process Automation (RPA)

When I think of artificial intelligence, one of the first things that comes to mind is robotics process automation (RPA). To be clear, these two are not the same – but together, advanced AI skills can be integrated into robots to understand documents including structured and semi-structured data, visualizing screens, and comprehending speech. You can think of RPA as the last-mile delivery for artificial intelligence. In other words, what do you do with AI, ML and NLP – what’s the outcome? A popular choice will be to automate processes with robotics.

I’ll go into greater detail in the upcoming PDF report but the main takeaways from the S-1 Filing are:

· Revenue growth of 81% to $608 million

· Dollar-based net retention rate of 145%, ranking it in the top 5 among public SaaS stocks who disclose this metric

· Gross margins of 89% which are among the highest in the software industry

As the top line increases, the bottom line is improving.

Over its last 12 months, UiPath has a free cash flow margin of 4% to go along with a -18% operating margin.  The -18% operating margin is a significant improvement from the -154% operating margin the company recorded in 2019. 

UiPath logged a $92M net loss in its last fiscal year, an improvement from the $520M net loss the company announced the year prior.

At the time of its S-1, UiPath had a total of 7,968 customers, exceeding a 70% CAGR in customer growth over the last 2 years.  Customers with over $100K+ ARR totaled 1,002.  UiPath automates millions of repetitive tasks for an impressive list of customers that includes 63% of the Fortune 500 and 8 of the Fortune 10. 

UiPath has an EV/NTM Revenue valuation of 35.9x using its 81% YoY growth run rate.  Below is a comparison of UiPath to some other high growth software stocks.  PATH currently ranks 3rd among the highest valuations in the software industry. 

 

Caution: IPO lockup periods usually see a decline in price

We’ve stated many times in the past that IPOs are tricky and we tend to not participate. We patiently waited for Snowflake, for example. We did the same on Zoom as we were prepared to find our lowest entry post-IPO.

The reason a lock-up period is followed by a lower stock price, even when the company is fundamentally strong and will go on to make bigger gains, is because some investors need to exit and go find their next big win. These are seed round and Series A investors who made plenty in the public offering and prefer to go find new portfolio companies.

Therefore, if we enter UiPath, we could exit again prior to the lock-up period expiring. This isn’t because we don’t want a position in the company, rather it’s that we need to compete on performance, and to also be transparent so our subscribers are fully aware of how we navigate volatile tech growth. 

Maybe UiPath will be the first to hold its opening price after lock-up. In the meantime, I want to give you a heads up in case the I/O Fund initiates before we release the deep dive research.