Additional thoughts on fast growing tech firms

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A few weeks ago, I made an attempt to analyze and compare non-profitable, fast growing tech companies with the following attributes:

  1. Fast revenue growth
  2. Lack of positive EPS
  3. Lots of recurring revenue
  4. Light capital business model

Here’s my previous post:

http://discussion.fool.com/comparative-metrics-fast-growing-firm…

Now, it’s been almost 2 weeks and I’ve had some time to think and do some additional evaluation. We’ve also had some of these companies report earnings. My thinking on how I should make investment decisions with such companies has evolved. The main change for me has been that I now shy away from companies that I believe have trouble scaling. My thinking on this seems very aligned to Tinker’s thinking. With MULE, NEWR, BL, and TLND (all of which were companies in my portfolio or on my list to evaluate), I have concluded that the complexity of selling and implementing their offering to customers may well limit the rate of customer growth and therefore revenue scalability and stock price appreciation. I realize that there may be some exceptions but I am now focusing looking at companies that I believe are on their way to scaling. The companies on this list are SHOP, SQ, HUBS, WIX, and TWLO. I already own them all and the next step is to evaluate them further for evidence that scaling is well underway. Why? Because I believe that scaling is an indicator that accelerated growth can continue and target market domination can occur.

Last night, NEWR reported their results. I see some things that I don’t like and that point to the validation of the hypothesis that their ability to scale is limited. What did I see?

The first warning sign is that revenue growth continue to decelerate. The q/q growth rate for the past 6 quarters was the following:


               Q/Q Revenue Growth
Q1 17          54%
Q2 17          48%
Q3 17          44%
Q4 17          40%
Q1 17          37%
Q2 17 (E)      30%

Don’t like that deceleration.

Next, let’s look at customer acquisition for the past 5 quarters:


            Customers       Cust Added    Seq Growth   Y/Y Growth
Q4 2016	    13518			
Q1 2017	    14048	    530	          3.9%	
Q2 2017	    14538	    490	          3.5%	
Q3 2017	    14915	    377	          2.6%	
Q4 2017	    15216	    301	          2.0%	        12.6%
Q1 2018	    15400	    184	          1.2%	         9.6%

They should be adding more and more customers each quarter. That would be evidence that scaling is working. If you compare the sequential growth in customers to other companies in the peer group, it looks pretty terrible. For me this is the nail in the coffin. It caused me to sell my small position today.

Now let’s look at MULE. Here’s recurring revenue growth:


              Y/Y Recurring Rev Growth
Q1 2016	      90.9%
Q2 2016	      77.1%
Q3 2016	      70.4%
Q4 2016	      63.0%
Q1 2017	      61.7%
Q2 2017	      54.8%
Q3 2017 (E)   44.3%
Q4 2017 (E)   39.4%

While the 39% growth in recurring revenue is still very strong, the deceleration has been consistent. Now, there are some things that give some hope. The guidance may well be lowballed by management. Also, management said that there were deals that moved from Q2 to Q3 or Q4, and they said that none of the deals were lost. This tells me that high growth may continue. However, there were 2 things said on the conference call that give me great concern. First, sales take 6-12 months to close. Implementation of new customers can take a year. This is a severe limitation to scalability.

Now let’s like at customer additions:


          Cust.  # Added   Growth (seq)    Growth (y/y)
Q2 2015	   655			
Q3 2015	   716	  61	    9.3%	
Q4 2015	   758	  42	    5.9%	
Q1 2016	   839	  81	   10.7%	
Q2 2016	   946	 107	   12.8%	    44.4%
Q3 2016	   994	  48	    5.1%	    38.8%
Q4 2016	  1071	  77	    7.7%	    41.3%
Q1 2017	  1131	  60	    5.6%	    34.8%
Q2 2017	  1170	  39	    3.4%	    23.7%

While not as bad as NEWR, these numbers don’t inspire a lot of confidence that they can scale. In particular, I don’t like the customer acquisition over the past year. Revenue growth has been strong and it appears it has come mostly from the strong and steady increase in spend per customer and strong customer retention. These are great (see below).


           Avg Recurring Rev pre Cust ($000)      Dollar-based Retention Rate
Q2 2015	    $89	                                  1.12%
Q3 2015	    $99	                                  1.16%
Q4 2015	   $105	                                  1.21%
Q1 2016	   $115	                                  1.25%
Q2 2016	   $125	                                  1.22%
Q3 2016	   $136	                                  1.20%
Q4 2016	   $143	                                  1.17%
Q1 2017	   $152	                                  1.16%
Q2 2017	   $164	                                  1.16%

These numbers are impressive and will probably allow (assuming they continue) MULE to continue to grow revenue rapidly for a while. I still own a substantial position in MULE and after the post-earnings release selloff, I am inclined to believe that the shares will recover and even continue the growth. However, I see a company that’s more likely to achieve scalability as a better place for my investment dollars for the long run. So I’ve held on for now but I will look to sell these share should I see an opportunity and I need cash.

Next, let’s look at TLND. Here’s the recurring revenue growth:


           Rec Rev GR (y/y)    Rec Rev GR (1YR)
Q1 2016	   39.9%	
Q2 2016	   39.5%	
Q3 2016	   41.4%	
Q4 2016	   43.2%	       41.1%
Q1 2017	   42.5%	       41.7%
Q2 2017	   42.9%	       42.5%
Q3 2017(E) 37.6%	       41.4%
Q4 2017(E) 36.7%               39.7%

Growth is strong and not decelerating or accelerating, assuming TLND beats their guidance. For Q2 2017, the CEO noted on the earnings call that y/y recurring revenue growth would have been 46% (instead of 43%) if not for currency headwinds. Thus, in looking at revenue, there is no evidence yet that scalability is limited. We will need to watch this going forward as the company grows larger.

Now let’s look at customer number growth. TLND has more than 1500 customers, but they find it more relevant to report the number of customers who spend more than $100K per year. Here are those figures for the past several years:


          Cust  Added     Seq Growth   Y/Y Growth
Q1 2015	  100			
Q2 2015	  110	10	  10.0%	
Q3 2015	  122	12	  10.9%	
Q4 2015	  138	16	  13.1%	
Q1 2016	  162	24	  17.4%	       62.0%
Q2 2016	  186	24	  14.8%	       69.1%
Q3 2016	  221	35	  18.8%	       81.1%
Q4 2016	  224	 3	   1.4%	       62.3%
Q1 2017	  259	35	  15.6%	       59.9%
Q2 2017	  291	32	  12.4%	       56.5%

Aside from one bad quarter, the growth figures look very strong. I don’t see any red flags yet to suggest that TLND has trouble selling their offering even to organizations with large big data budgets. Perhaps, I’ve misclassified TLND as a company that’s not scalable. We need to continue to monitor for going pains.

Other business metrics look solid as well so I’ve decided to keep my position in TLND.

I never bought any BL due to concerns about high customers acquisition costs, high on-boarding costs, and scalability challenges.

Next I will spend some time looking at SHOP, SQ, TWLO, and HUBS which are all companies that I think have shown that they can be scalable.

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I have concluded that the complexity of selling and implementing their offering to customers may well limit the rate of customer growth and therefore revenue scalability and stock price appreciation.

Not really. The complexity, especially the installation, is pretty much part of technology and most companies have some way of mitigating that for their customers, often or their partners or specialized vendors just do it for their customers. Ex: Product complexity, AWS, never limited their growth, any ERP implementation has enormous implementation complexity, takes 6 to 18 months and multi-million dollar budgets, that never stopped Oracle, SAP or the companies they have acquired from growth. On the other hand, operational complexity is a limiting factor. Any successful vendor has to simply that. If you ever handled any software licensing deals of any major software vendor you would know how complex selling is. Even most mundane sales take months of courtship.

I reject this. The true limiting factor is not complexity but TAM, total addressable market and the value proposition of the product you sell. If there is a compelling value, the complexity is not a concern.

the next step is to evaluate them further for evidence that scaling is well underway. Why? Because I believe that scaling is an indicator that accelerated growth can continue and target market domination can occur.
…
They should be adding more and more customers each quarter. That would be evidence that scaling is working.

First of it is not clear to me what exactly you mean by scaling. The revenue growth, or customer growth (except where network effect is in play) that you used as an example, how that relates to scaling?

I can understand and see how scaling means profits because you can leverage an existing SGA infrastructure on higher revenue, thus increased profits. You can also argue to a limited extent that as you scale your investments on selling & marketing is leveraged over a bigger base, but even for companies which have achieved an inflection point, whereby they can leverage or scale very easily, cannot grow if their addressable market is saturated.

A continued sales growth is just that continued sales growth. Why are you calling it as “scaling”?

I think basically what you are looking for is companies that have a big TAM, and have a small market share where they can continue to grow and take share or where the TAM can continue to grow, even if their market share remains constant.

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<<<Why are you calling it as “scaling”?>>>

It is very simple. The one product that you make (like a Model T, that you can get in any color as long as it is black, or the stupid idea of a restaurant based upon the “Speedee” kitchen processing model that only sells a hamburger with 2 pickles, french fries, and soft drink that can be created one time and reproduced brainlessly thousands of times, or a DOS or Windows operating system that you make once and can ship on tens of millions of PCs AS IS, or the enabling technology to create your own online SHOP in hours, with front end, back end, and everything you need for less than $100 a month, and all SHOP has to do is create ONE product, that product distributes to millions of vendors, that they can modify to their needs WITH NO additional input or expense incurred by SHOP) that is scaling.

The ERP vendors operated in a time of computer technology and what they replaced was so cumbersome that even the enormously expensive and custom implementation of ERP software was better than what was.

Oracle got big on its database, which scaled. It then expanded into applications that required far more cost in implementation than the underlying software cost.

I want a product that scales. McDonalds will pull in far more profit than trying to produce a series of incredible high and and complex restaurants that cannot be easily reproduced. It is by scaling these businesses and efficiently expanding these products to the world, that the world’s fortunes have almost exclusively been made on. There will always be exceptions, but those exceptions do not change the rule.

We have discussed MULE a lot, so I will use that. I actually do not understand their scalability issues that well. I do know they are producing a product that is more scalable than what came before it. They are creating a better way to integrate disparate software. That makes them more SCALEABLE than Tibco and the rest of the “integrators” that have an extremely hard time scaling because you cannot just take an out of the box product and move on.

MULE has a chance, not because it is an inherently scaleable business model, but because it is more scaleable than the other solutions that exist to try to address the problem.

Still, you don’t need (and never did need) a year of sales cycle, customization, a score of engineers, etc. to introduce DOS based PCs into your organization.

You didn’t need these sort of things to put Intel based PCs and servers into your organizations.

You don’t need these sort of things to standardize your business on Shopify.

You don’t have to think much to open up a McDonald’s franchise. It is the same thing, everywhere, every time.

The Model T…

And so on.

You don’t see DEC in business anymore.

I guess I keep going on. But as in life, everything is relative, and even a not real scaleable product can be competitive if it is a more scaleable solution than the solutions to the problem.

But that does not make this not very scaleable, but more scaleable than the alternatives, necessarily a better investment than more scaleable products that are also disruptive.

There are too many investments to analyze. You can buy them all, or use heuristics to buy the one’s most likely to be the best. Heuristics are decision making tools that enable better decision making when there is not enough time or resources to consider everything.

Do you think venture capitalists sit through each and every proposal given them? No. They eliminate most of them on little things like, “can this business scale?” No, sorry. Yes. They will look further.

At present SHOP (that clearly scales) is trouncing the market, whereas MULE (that may scale better than alternative solutions, but is not truly scaleable in the scheme of things) is losing big time to a secular bull market.

You make the choice. Markets are not always right, but as a decision making criteria, stocks that have done well in the stock market (and you can identify why) are much more likely to continue doing better in the market longer term than those that have not done very well.

The market identifying lack of scaleability is one of those things. 0% margin for 20% of their revenues, and that is the fastest growing aspect of their revenues? Lets think through that one in regard to scaleability of the business model.

2 years from now, I will gladly eat crow if MULE becomes a market killing stock. What I want to know is can MULE scale? or does the market have it really wrong based upon some FUD event.

Tinker

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It is very simple.

My question is why would you consider sales growth as scaling. I could have a software, that solves a problem, and I can keep selling it infinitely but what if TAM (total addressable market) is just a small bunch of 100 thousand users?

For me, scaling is the ability to replicate the concept easily, or something that can be extended easily to adjacent markets or allows you to reap higher profits as the sales increase. I could be wrong, I didn’t get that from the original post.

They eliminate most of them on little things like, “can this business scale?”

What you are referring here scale as what is the Total Addressable Market (TAM).

So here is my understanding, basically, you are saying by scaling, do I have a big enough addressable market, do I have an ability to easily grow share in that market, and as I grow my share, can I increase my margins, thus profits?

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Kingran,

I think we are talking past each other.

Of course any investment needs a sufficient TAM.

I think I was very clear. You can fill your whole organization up with Windows and Intel PCs and all you have to do is go to Best Buy and buy them and plug them in. And viola you have functional PCs standardized in your organization.

That is the ultimate in scaling. One piece of software, built one time, in one manner, and a copy of it goes on 100s of millions of PCs that are easily acquired and used and customized by each individual, all without costing Microsoft an added dime.

I don’t think I can be clearer over what I mean. TAM is only the total addressable market. Scaling is the ability to efficiently and profitably exploit the TAM.

You cannot efficiently and profitably exploit a large TAM if 20% of your revenues are at 0% margins, and that is also the fastest growing function of your business, and if it takes a year to negotiate the contract, a year to implement the contract, and to make matters worse, you have to do that with EVERY SINGLE CUSTOMER!

What does SHOP have to do to retain a new customer? Nothing, they go to the website, put in their credit card, and build the product themselves.

What does Microsoft do to retain a new Windows customer? Nothing. The customer goes to Best Buy or Dell or whatever, puts in their credit card, and the PC is delivered to them. This happens by the tens and hundreds of millions of times over and over and over again, all with Microsoft having to do nothing.

If you cannot see the difference in the ability to scale your product, I am at a loss.

Remember that next time when you try to figure out how McDonalds has served hundreds of billions of hamburgers, and all profitably if you want to consider how an idea scales vs. simply trying to fill demand.

The whole key to getting rich is figuring out how to efficiently and rapidly fix a problem and meet demand.

Funny how Henry Ford had to change the entire production line and limit options in order to, yes, SCALE, the production and distribution of automobiles ot the masses.

Tell me when a customer can simply download MULE software, plug and play it, and the software talks to each other.

A company like Nutanix (whose stock is not doing very well at present) can scale. It is not the entirety of what makes for a great business, but it is one critical aspect towards creating a world dominating business.

Tinker

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What you are referring here scale as what is the Total Addressable Market (TAM).

So here is my understanding, basically, you are saying by scaling, do I have a big enough addressable market, do I have an ability to easily grow share in that market, and as I grow my share, can I increase my margins, thus profits?

Kingran,

Tinker answered the question about scaling very well.

I did not mean TAM at all. Scaling to me means the ease with which a company can fill in the TAM. Are there bottlenecks to their growth into the TAM? If there are bottlenecks then can they somehow be overcome so that the company can expand marketshare and revenues rapidly such they can generate profits for shareholders. You are, of course, correct that TAM is important; specifically what is important is that the company’s marketshare is very small in relation to the TAM. If I want to make 10x on my investment, then I want there to be lots of room for the company to expand. There’s an extra bonus if the TAM is also growing and if there are adjacent markets or additional dimensions of expansion available (e.g. Shopify Capital and Square Capital are examples of additional sources of revenue and profits that a) act synergistically with the core business, and b) help their customers grow and be successful). I think that all of the companies on the original list of fast growing tech companies that I looked at have a very small marketshare in relation to the TAM.

The growth rate of customer additions and revenue growth are good indicators that a company can expand its marketshare toward the TAM. The indicators can be verified by other information.

Chris

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One last example ISRG vs. STXS. You probably never heard of STXS. Both companies have miracle surgical robots, but in different fields. ISRG is now worth $30 billion. I am not sure if STXS is still in business despite having a product that remarkably improves certain heart surgeries and makes the lives of cardiologists much easier.

The problem with STXS is the magnetics used in their robot required a specially sealed room. Unfortunately, to create this room, you normally had to add on a new room, or retrofit (in a not real easy manner) the new room.

So what happened? In practice STXS equipment would only be installed in new construction. The business could not SCALE, because sales were mostly limited to cardiac facilities that were undergoing new construction.

Whereas ISRG daVinci surgical robots could be installed in any operating room, and has been by the thousands. daVinci scales, STXS’s robot - cannot even remember the name anymore, and the data for it was overwhelming, did not scale.

Is what it is. So if the business does not scale well, don’t invest in the business no matter what the TAM is. That is my rule. But invest as you choose.

Tinker

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Thank you for your insight Tinker! I happen to agree with you wholly!

My takeaway is this: can the company fill in their TAM efficiently enough.

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What is scale…here’s a good definition:

Scale is about adding revenue at a rapid rate while adding resources at an incremental rate. Google, Salesforce.com, or Citirx are prime examples for successfully scaling their businesses. They have mastered the formula of quickly adding customers while adding fewer additional resources; thus, driving consistent growth and increasing their margin over time.

I think Tinker has appropriately pointed out that for a company to be sustainably fast growing, it likely needs to scale and he has given us the example of software or chips in millions of computers.

Scaling is IMPORTANT…let’s go back to MULE for moment because this seems to be the area of concern/dispute. In their recent earnings call they seemed to mention “scale” a lot:

We provide a disruptive platform to help companies create an application network, in which they can quickly discover, reuse and compose application components to deliver new and enhanced services. To build an application network, customers require key capabilities, which we provide in our Anypoint Platform.

A platform is scale…by definition.

We continue to execute our land and expand strategy, growing to 1,170 customers at the end of the second quarter, and maintaining our strong dollar based net retention rate of 116%

Land and grab is a form up scaling…it just is. The additional revenue is not associated with other additional incremental costs such as sales cycles, etc.

Remember MULE is more akin to an enterprise software company like Oracle, SAP, SAGE, CRM etc…did they scale?

This is a combination of growth at scale, that few software companies have achieved.

Uh oh…there’s that word again…right out of the CEO’s mouth.

We are generating significant growth at scale, and as we look ahead, our pipeline of opportunities are strong.

There he goes again…keeps telling us growth at scale…must be important as Tinker has alluded.

While we expect to realize leverage in sales and marketing, as we scale the business, our primary near term focus remains driving growth and market adoption. We are at the beginning of addressing a very large market opportunity and have a leadership position that we believe will help us to create a category defining trend.

Scaling yet again!!

We are delivering outsized growth in an efficient manner, and making important investments that we believe will cement and extend our leadership in this enormous market for a long time to come.

Sounds like the definition of “scaling” to me (see above definition).

we run the business to be a long term subscription revenue growth model

Sounds like scaling to me…they just keep taking in annual subscription fees…BTW, they get around $175,000 per customer as I recall so these customers are not ma and pa type.

We believe that we are fundamentally powered by them and we can scale much faster, if they are in our corner.

Referencing the fact that 25% of their new business as been sourced by prior customers, they again speak to scaling.

It has been just over the past couple of years that we have been at a scale, where we are starting to really see them pick up and run with us and start to build businesses around us, and that’s the part.

Scale scale scale…they seem to be very focused on this issue!

We are not at that scale yet. I think there will still certainly be some Q4 effect, but frankly I think it will be a balance of factors,

They seem very focused on scale indeed.

When we talk about the application network and we think about bringing together all these endpoints and making it all work together in providing the single platform that everything is connected within an enterprise, as we talked about before, then the next logical step is, if you can provide analytics on top of that and see what’s happening in real-time across all those nodes in the network, and then from a security standpoint, if you can manage all of those nodes, because you can’t really control with the firewall anymore, that’s a tremendous opporUnity for us

So they intend to add functionality to their platform that offers more value to customers and generates more revenue…sounds like scaling to me.

the nature of what we are selling, the nature of who we are selling it to and how this platform is being used and contemplated today, is changing, and that’s having a – our sales cycle have lengthened, not dramatically, but they have lengthened the average sales cycle for a new business is running five to six months, that’s up incrementally from what it was a year and two years ago

5-6 month sales cycle is what concerns Tinker…just doesn’t roll out like a computer sale from Best Buy. Despite that, they get average $164,000 annually in subscription fees per customer (up 31%) …ongoing…is that scaling?

The point is that Tinker is spot on regarding the enormous value of scaling in any company. Perhaps the debate here is whether an enterprise software company (Oracle, CRM, etc.) like MULE can scale and if so to what degree?

We could compare to SHOP of course in terms of customer growth, moat, revenue growth, etc…but I would suggest that these are very difficult comparisons not the least of which is the value that a SINGLE customer brings to MULE or a lifetime of subscription fees.

It might be an interesting excercise to consider Oracle’s or CRM’s history and growth and scaling to look for parallels rather than against SHOP. Obviously these companies at $200 Billion and $60 Billion market caps pale the little MULE at $3 Billion…but…can MULE “scale” up to that level of greatness???

Sorry to interject…now back got the NPI.

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Land and grab is a form up scaling…it just is. The additional revenue is not associated with other additional incremental costs such as sales cycles, etc.

Duma,

YEs they talk about their strategy a lot and they talk about scaling a lot. But they aren’t doing that great on the land part. Again, here is the sequential growth in customer number for the past 2 years:

9.3%
5.9%
10.7%
12.8%
5.1%
7.7%
5.6%
3.4%

Last year is not looking so great. For a comparison here’s TLND which also sells into enterprise customers:

10.9%
13.1%
17.4%
14.8%
18.8%
1.4%
15.6%
12.4%

Management can talk all they want about scale but in the end they need to deliver. Can MULE get the customer acquisition back up? We will see but I think achieving that will be essential for them to create the value needed to make this investment worthwhile. I prefer to in vest in companies where the results reflect the words of management.

Chris

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Management can talk all they want about scale but in the end they need to deliver. Can MULE get the customer acquisition back up? We will see but I think achieving that will be essential for them to create the value needed to make this investment worthwhile. I prefer to in vest in companies where the results reflect the words of management

Thanks Chris.

I see what you are saying and the “scaling” issue is an important one for sure…it is acknowledged by all in this discussion I believe.

But…I think there are caveats to what you are saying…for example, based on your chart of “sequential” customer growth rates with TLND blowing away MULE…if we rely on that, we should have bought TLND 2 years ago and bypassed MULE.

Yet here MULE has nearly 2 1/2 times the revenue as TLND and twice its market cap with better revenue YoY growth rate at least this past quarter.

The stock charts are shorter term due to the recent IPO’s, but certainly since Jan 2017, the stock chart agrees with your customer acquisition modeling…and supports where you would want your money.

Now do the same thing for customer acquisitions for TWLO vs TLND…what do you see?

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Now do the same thing for customer acquisitions for TWLO vs TLND…what do you see?

TLND reports their $100K+/yr revenue customers. TWLO reports all their customers. But here are the sequential customer growth numbers.

TWLO TLND
9.8% 10.9%
12.2% 13.1%
6.4% 17.4%
13.0% 14.8%
7.4% 18.8%
11.9% 1.4%
6.2% 15.6%
11.2% 12.4%

So the above is the land portion of the land and expand.

Below is a comparison of the dollar-based net expansion rate for the past 2 years (the expand part):

TWLO TLND MULE
149% 123% 116%
156% 124% 121%
172% 123% 125%
170% 124% 122%
164% 121% 120%
155% 125% 117%
155% 125% 116%
141% 125% 116%

Chris

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TLND reports their $100K+/yr revenue customers. TWLO reports all their customers. But here are the sequential customer growth numbers.

Thanks Chris.

So really the customer acquisition growth rates are closely approximated between TLND and TWLO…yet the stock price action was quite divergent.

Then we look at the revenue growth rates and clearly TWLO appears moor promising than TLND from that perspective.

I wonder if what is missing in your early theory regarding scaling is the “cost growth” rate.

If your and Tinker’s theory is that we can assess the investment grade of the high growth/no earnings companies but “scalability”, then by definition we should expect these companies to grow revenue faster than they grow costs (inclusive of SBC).

How else will you attempt to explain the divergence in stock price for TWLO vs TLND in a prospective fashion?

It would be very important to avoid confirmation bias and instead look for exceptions to your rule and why they are exceptions.

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How else will you attempt to explain the divergence in stock price for TWLO vs TLND in a prospective fashion?

My guess is Uber. I think the sell off is due to Uber deciding to multi source and take some business in-house. I think it makes no difference to TWLO in the long run.

Chris

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My guess is Uber. I think the sell off is due to Uber deciding to multi source and take some business in-house. I think it makes no difference to TWLO in the long run.

Maybe…but here is their last 3 quarters operating expenses:

MULE 38, 44, 56, 70
TLND 27, 29, 32, 34
TWLO 47, 52, 61, 65

Obviously, MULE’s is increasing, TWLO has gone up 50% in past year but TLND Haas had a minimal bump.

That little addendum to your “scalability” theory seems prudent to consider IMO.

Haven’t looked at SBC but it should probably be considered as well since some of these companies can be abusive.

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<<<If your and Tinker’s theory is that we can assess the investment grade of the high growth/no earnings companies but “scalability”, then by definition we should expect these companies to grow revenue faster than they grow costs (inclusive of SBC).>>>

What I said was that it is a critical element in choosing investments. I did not say it was the only one. As for example I pointed to NTNX, a business that clearly is very scaleable, but yet has been disappointing so far stock wise. It is just one element.

But in the end, it is a critical element. What you want is superior economic returns. Profit is not what counts, it is the ability to build economic value and a cash creating machine. You cannot do that without scaling - period.

Look at MULE. As I said, I really don’t understand it. But what disturbed me is that MULE HAS TO talk so much about it to analysts. Why? Because analysts see that it is not so obvious that its business is scaling. Of course the CEO is going to say otherwise, but I look for clues elsewhere.

Now if MULE’s business can scale beyond market expectations then you will have a HUGE winner.

I just don’t see it in the numbers, I don’t see it in the business model, I don’t see it qualitatively. What I see is a company whose fastest growing segment is at 0% margin! And this is 20% and outgrowing the rest of the revenue.

That is the OPPOSITE of scaling. Scaling, as you defined very well DUMA, and I am paraphrasing, is rapidly making more revenue while the cost of this revenue remains fixed or at least grows much slower than the revenue.

Here, MULE’s cost of acquiring revenue is going to just get worse as this 20% of 0% margin revenue continues to grow as a percentage of the companies revenues!

That is an incredible thing to see!

That is unless MULE can turn this off at some point and turn on the spigot…

Which perhaps they can do. But my point is that there are a lot of investment opportunities out there. We have limited time. As a heuristic method it cannot be denied that businesses that scale the best also are the ones that have historically changed the world.

So I am moving on from MULE if I have a long term perspective, until they can show that their product scales. At that point, they might change the world and be an awesome long term business I want to own.

Tinker

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As for TWLO, TWLO is a business with incredible ability to scale. The problem is, does TWLO have a sufficient CAP to make this ability to rapidly grow revenue a wealth creating center.

That is a big issue as much of what it does can become more commoditized by competition overtime. Thereby removing pricing power, and thereby removing the ability to monetize.

The problem of scaling is not the same for each company. I saw the movie the Founder, with Ray Kroc and McDonalds. McDonalds problem of scaling was not the business model or the business, but the two original inventors of McDonalds who stuck Ray Kroc with 1.9% royalties on the businesses that he was rolling out. It nearly bankrupted Ray Kroc and brought to a steaming halt the role out of McDonalds.

Kroc got around it by a brilliant scheme of becoming a real estate company. Instead of each franchisee picking and buying their own real estate for the restaurant, Kroc built his own company (outside of the original contract) to buy the land, and lease it back to the new franchisees.

Kroc thereby created enough revenue for himself to allow him to massively rollout the franchises and to innovate at the restaurants against the wishes of the two investors.

So this is not necessarily just a numbers game, but a qualitative element. The problem with scaling can be something different in each business.

MULE - too labor intensive.
TWLO - too little CAP to maintain pricing.
McDonalds - idiot inventors who tried to starve the innovator.

Watch to see if MULE or TWLO can get around their impediments to scaling. And by scaling it is not just growth, but creating wealth with the growth.

Too much good stuff today on the boards. But I thought I would way in here on this.

It is about building wealth. Not growing revenues. And you only do this by scaling your business. If the business cannot do this, then you don’t want to own that business unless there is a way to get around whatever impediment to scale exists.

Tinker

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Tinker:

As regards MULE, I think they are facing another hurdle as I understand it in that they must also “create the need” in the minds of the customer. They are essentially in a truly unique situation with zero competitors but also in a developing “need” to network the cloud, mobile, data, etc…many (perhaps most) of their potential customers may not even realize that they can do better, be better, change faster, adapt quicker all at less cost… and all through the Anypoint platform.

So in that sense, and I think they referred to this in the last earnings call, they need to get out and not just make the sale, but also “educate” potential customers about what is possible…why the customer needs MULE…that explain some of that longer sales cycle.

You could look at this as a negative (perhaps their customers to date have been just the early adopters) or you could look at that as the “wow factor”…should pragmatists join the party. But in the near term…I could see this being an early barrier to adoption…but word is getting out with 25% of their new business sourced from established customers.

Regarding your comment about the “professional services” revenue growing at a fast clip with 0 margins…I dont think that is a major concern…this would be the support, manpower type costs of supporting their customer base and represents the cost of keeping customers happy. I believe their main strategy is to build a recurring revenue model in the form of subscription fees annually and in perpituity…that grew by 36% and has 91% margins!!

Here was the discussion of professional services growth:

Hey, thanks for taking my question. Quick question on professional services. If you look like, you talked about the higher utilization earlier, but – and the growth was really high at 70%. How are you thinking about that, and we talked earlier about the partner channel, and obviously, they kind of should do [ph] more and hopefully will do more, whereas you are building your own capacity. Can you just talk to that subject a little bit? Is that kind of the growth rate that continues to stay higher, is the end amount really high, or how are you thinking about that? Thank yOu.

Matt Langdon

Sure Raimo, good question. All the indicators are positive. Frankly, with regards to our services business, there is a lot of demand. There is just some gating items, quite frankly. We have actually had good traction on hiring in our services personnel, but we got to get those resources and get them ramped. We have got to get more and more partner resources, subcontract resources trained and ramped. And there just can be some variability from quarter-to-quarter and our visibility into that available capacity, frankly is something we are still – we have good immediate visibility, but we are working to extend that even in the longer term.

There are some – I don’t want to use the word conservative, but again, based on the facts before use, given what is typical Q3 behavior, those kinds of dynamics that are implicit in the number for Q3.

I’d say in general over the course, at or around breakeven is generally what we are aiming for. But quite frankly, we are more focused on how and how successfully we are attaching our services to new customer lands. We view it as a very important and strategic ingredient in landing effectively and getting a customer on a path to success. And we think we can do that relatively efficiently, but we are not running it in the near term to be a significant margin – positive margin generator

I really dont think this is a huge issue. As you recall, their services revenue is only 20% of their total and may vary from quarter to quarter. They seem to be leveraging this to get to more and more subscription revenue which is the lion’s share of total revenue that has 91% margins!

Also as an aside…talk about a moat…who would ever leave riding this MULE…ever.

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https://www.google.com/amp/s/www.forbes.com/sites/alfresco/2…

Here is an interview that provides more depth into what mulesoft does, what it is trying to do, why it is so compelling, and the real challenges of getting customers to jump into this sort of change.

Tinker

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MULE Cisco 13F filing

I noted in this 13f that CSCO has a position in MULE, but I am unclear if this is new
or not. Any ideas what CSCOs interest might be?

https://www.sec.gov/Archives/edgar/data/858877/0000950123170…