Here we are, crippled and battered. A lot has happened in the last two weeks and I thought a little overview would be helpful. Let’s start with a quote:
“Bear markets make you feel dumber than you are in the same way that bull markets make you feel smarter than you are”.
I definitely don’t feel like a genius right now, I’ve made some mistakes and lost money. But I’m still swimming and breathing, so it could be worse.
In general, the earnings season was better than many expected. Banks and especially energy companies reported very good figures. Consumer spending also held up better than feared. The reporting season in our universe started with the Hyperscalers and ServiceNow. So far so good. When ZoomInfo presented the results, it quickly became clear what to expect. The narrative of the recession-proof SaaS business cracked a bit. But let’s take a closer look at the individual companies, I won’t juggle a lot with numbers but will give my general assessment.
DDOG
A mixed quarter. While it´s very positive that NRR >130% and new customer adds (≈1000) are healthy, it is clear that customers are trying to optimize their spend and make shorter commitments. Margins were good, with operating margin (17%) and fcf (15%). The outlook shows the disadvantages of a consumption-based model, I expect a little less than 45% yoy in Q4.
→ The results were a bit below my hopes. I have therefore reduced my position by about 35%. Despite this, DDOG remains a great company with great management, many new products introduced at DASH and constant innovation. A clear leader with little competition. The near future will be difficult, but the thesis remains intact for me.
NET
A disappointing quarter for me. NET reported 47% yoy growth and Fcf was negative at -2%. NRR ticked down from 126% last quarter to 124%. The operating profit of around 15M was positive. Next quarter growth should be around 45% yoy.
→ Here’s the thing about Cloudflare - they are an innovation machine, have a charismatic CEO and are in an interesting position because of their unique network. But it has always been the case that numbers and narrative/valuation have been far apart (not so much after the selloff). So far, their unique feature has been extreme consistency, which has not been the case this quarter. Because they have never shown the desire to be profitable, there is no foundation to help investors confidence with a “miss” at the top line. What I want to see is positive cash flow in Q4 as announced at the beginning of the year. My expectations were high as Matthew Prince sounded very upbeat during the last few months. I just expected better results, I have to say. It’s also that I’m having trouble understanding exactly where it’s going - first R2 was the next big thing, now the focus has been heavily on zero trust. I’m just not so sure anymore, and therefore I halved my position in the first few minutes after earnings were released - it was my largest before, together with SNOW. I want to see the many products and opportunities bear fruit before increasing my allocation again. As others have already noticed, I also lacked information about FedRAMP, unfortunately there was nothing new to report.
I still like the huge addressable market ahead of Cloudflare, the vision of the team and their creativity - however personally I would like to have a little more focus on sharpening their profile and executing on existing products now. There could be a big chance now that the hyperscalers are slowing down a bit at the moment and are proving to be quite expensive.
BILL
I think this was a good quarter - market disagrees, it seems. Core revenue growth came in 83% yoy and total revenue increased 94% yoy. Record in new customers, record gross margin (≈86%), net income of 16.9M and free cash flow positive. Float revenue is a nice feature of the business that could offset some softness in transaction revenue as long as interest rates stay high.
→ Already had a big position but added a bit into the weakness the last days.
To conclude: for me it looks like everything is getting sold in the last days, regardless of good or bad earnings. The early weakness we are seeing in Software, while some consumer facing companies still see no impact, seems to have changed the narrative to the other extreme. I think the reason for this is, that most SaaS companies are dealing with huge enterprises which anticipate a downturn much earlier then most other market participants. Therefore the cost cutting and optimizing starts long before a real recession begins. And of course, our SaaS companies are still far too expensive, they are shouting! But are they really?
Unfortunately, there is no key metric that can give absolute truth about this. But with EV/GP/Fwd Growth I think we’re getting as close as we can. This means enterprise value/gross profit/estimated next FY growth. This is what it looks like after todays close:
Score
Snowflake 20.7
Crowdstrike 13.1
Cloudflare 12.7
Zscaler 12.6
Datadog 12.1
ServiceNow 10.7
Bill 9.9
Palo Alto 9.8
GitLab 9.0
Sentinel 8.1
Monday 4.7
Nvidia 22.8
Tesla 18.4
Apple 12.1
Microsoft 11.5
Costco 7.4
Alphabet 6.8
For me that doesn´t look expensive at all! Apple and Microsoft are estimated to grow <5% next year and since these are very mature businesses it´s unlikely they will reaccelerate meaningfully. That means if I you calculate with two years into the future, a probably still rapidly growing SaaS company like CRWD or DDOG is much cheaper than a mature slow growing business like MSFT.
This is how my portfolio looks right now:
Snowflake 12.3%
Bill 11.5%
Crowdstrike 11.0%
Datadog 7.7%
Cloudflare 6.7%
Zscaler 6.7%
___________________________
BTC 3.0%
ETH 1.5%
Cash 40%
As of today after the close:
2022 – down 45,8 % year-to-date (max. drawdown from peak Nov 16th 2021: 54,3%)
Now you could ask why do I have such a large cash position when the companies are that cheap. This part of my portfolio is a tradable position - I will jump in and out of a specific QQQ ETF with this part. So I’m fully allocated in single companies right now. Since this is off topic for this board, I will not go further into detail.
How will it go from here? I have no idea. IF this cycle follows historic patterns, it is very likely that our companies bottom a long time before the indexes do. Long yields will fall and provide us with a floor. This could be tomorrow or in several month - or maybe Im completely wrong. What I know is, these companies have strong balance sheets, many of them generate positive cash-flow and appear to be valued extremely reasonable. We will ride it out until better days come.
All the best, Hannes
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