Thanks for the question, Bear. It is a thought provoking one. While you used DDOG as an example, I took your question as relating to the environment as a whole so my answer focuses on that. To answer your question, I believe you will do just fine sticking with some of the Board heroes if you’re willing to wait 6 months to a year. I do not think the fundamental understanding of how these companies should be valued will change.
I want to start by saying that no one knows what the future holds, including me. Famous investor Stanley Drunkenmiller has said this is the hardest environment to predict in his 45 years of investing. See https://twitter.com/greatquarter/status/1570578003926855681?s=20
But here is how I see things. It all boils down to one issue:
Were the concepts of cloud computing, data analytics (aka “AI”), cybersecurity, ctv ads, and work-flow management a “one time” need created by the pandemic or are these the building blocks of the future?
I believe these are the concepts of the future and that they will encompass every aspect of our lives. As a business, you’ll either embrace them or be left for dead. I can tell you firsthand that the pandemic opened the legal field up to a whole new world. We are still having federal and state hearings, conducting depositions, and having client meetings on Zoom or Teams. Not because we need to. But because it is so much more convenient. Our server closet is now a freezing cold storage closet. We pay a cloud company to host our “work stations” so we can log in from home, or any device anywhere, and feel like we are sitting at our desks at work.
If these are such important trends, then why is the growth of the pick-axe companies for these trends slowing? I believe it is due to a cyclical downturn in most all stocks, created by the fastest interest rate hike in over 40 years. I do not think it relates to company execution or odds of future success. The good news is that “cyclical” is another way of saying temporary. This downturn is temporary. It will end like all others have, and the potential upside on the other side is enormous.
One example of what I’m talking about can be gleaned from MSFT’s earnings call yesterday. Optimizations have sucked for cloud companies, but they are part of the long game. The hyperscalers want their customers to fall in love with the cloud by falling in love with how easily it can scale down just as fast as it scaled up. This is how you build a long-term customer that is going to consume a heck of a lot more over time than you might make in a few months of charging for un-used compute before an unhappy customer leaves the cloud. Here is the quote from the MSFT earnings call:
Mark Moerdler [Analyst]
Congratulations on the quarter and the guidance and thanks for taking my question. I’d like to drill into Azure and more specifically, Azure IaaS/PaaS consumption. IaaS/PaaS consumption has really stepped down recently, and it’s important to understand the macro versus macro and optimization that will rebound, whether it’s going to rebound quickly or is there a more fundamental issue? In other words, is it simply purely macro and everyone is stepping back a little bit and they’re going to hit the pedal as soon as this comes back or is there something more fundamental that is driving corporate maybe to step back and that, that slowdown could sustain even when the IT spending rebounds. Thank you.
Satya Nadella [MSFT CEO]
Thanks, Mark for the question. Maybe I’ll make three comments. And it’s also important, I think to distinguish between what I’d say, macro or absolute performance and relative performance because I think that’s perhaps a good way to think about how we manage our business.
First is optimizations do continue. In fact, we are focused on it. We incent our people to help our customers with optimization because we believe in the long run that the best way to secure the loyalty and long-term contracts with customers when they know that they can count on a cloud provider like us to help them continuously optimize their workload. That’s sort of the fundamental benefit of public cloud, and we are taking every opportunity to prove that out with customers in real time.
The second thing I’d say is, we do have new workloads started because if you think about it, during the pandemic, it was all about new workloads and scaling workloads. But pre pandemic, there was a balance between optimizations and new workloads. So what we’re seeing now is the new workloads start in addition to highly intense optimization driven that we have.
The third is perhaps more of a relative statement because of some of the work we’ve done in AI even in the last couple of quarters, we are now seeing conversations we never had, whether it’s coming through you and just OpenAI’s API, right? If you think about the consumer tech companies that are all spinning essentially Azure meters, because they have gone to open AI and are using their API. These were not customers of Azure at all.
Second, even Azure OpenAI API customers are all new, and the workload conversations, whether it’s B2C conversations in financial services or drug discovery on another side, these are all new workloads that we really were not in the game in the past, whereas we now are. So those are the three comments that I’d make, both in terms of absolute macro, but more importantly, I think, what is our relative market position and how it’s being changed.
Amy Hood [MSFT CFO]
Mark, maybe the one thing I would add to those comments is, we’ve been through almost a year where that pivot that Satya talked about from we’re starting tons of new workloads, and we’ll call that the pandemic time, to this transition post, and we’re coming to really the anniversary of that starting. And so to talk to your point, we’re continuing to set optimization. But at some point, workloads just can’t be optimized much further. And when you start to anniversary that, you do see that it gets a little bit easier in terms of the comps year-over-year. And so you even see that in a little bit of our guidance, some of that impact from a year-over-year basis.
Here is what I hear from this quote: (1) optimizations are good because they equate into long term customers wanting to stay in the cloud, (2) AI usage is bringing in a whole new swath of customers and cloud compute needs, and (3) we’re about to circle around to where we have easier prior year comparable numbers. Those are some powerful statements to me.
This downturn has been brutal–both emotionally and financially. But I believe that the pandemic gave us a peek into the window of the future and who the long-term winners are going to be. While valuations may have ticked up a little fast back then, I think the long-term winners will catch up to those valuations again once it appears we are nearing the end of this cyclical downturn. Here’s to hoping that is sooner rather than later.
Rant over, thanks for listening.
Hang in there.
BTL
@laneylawyer on Twitter
Long DDOG, SNOW, CRWD, ZS, NET, TTD, MNDY, and DT
No investment advice, just musings.
