Ben’s Portfolio update end of August 2023

SlowAndFast · September 3, 2023, 5:44pm

Ben’s Portfolio update end of August 2023

Returns and portfolio holdings:

	Portfolio	Notes
2020	63.6%	Since May 12, 2020, where I started this portfolio with over 40 companies, mostly holding large cap tech & FAANG, but also some high-growth SaaS.
2021	13.1%	Discovered Saul’s board in February 2021 and started concentrating to 16 companies through December 2021.
2022	-60.7%	Concentrated a bit more through July 2022 from which point I started posting my monthly updates on Saul’s board, holding about 12 or fewer positions.

2023	YTD	Month
Jan	8.3%	8.3%
Feb	16.3%	7.3%
Mar	17.9%	1.4%
Apr	5.2%	-10.8%
May	40.5%	33.5%
Jun	38.6%	-1.3%
Jul	50.7%	8.7%
Aug	41.2%	-6.3%

Timestamp: 08/31/23 after marked close.

These are my current positions:

	Aug 2023	Jul 2023	First buy*
Datadog	17.1%	19.4%	5/13/2020
Snowflake	16.7%	17.7%	2/8/2021
Nvidia	15.5%	13.7%	5/13/2020
Cloudflare	14.7%	14.5%	11/2/2020
Crowdstrike	13.1%	12.2%	5/13/2020
Zscaler	12.4%	12.0%	3/4/2021

Monday	7.1%	6.7%	9/13/2021

TradeDesk	2.4%	2.5%	5/13/2020
Enphase	1.1%	1.3%	5/15/2020

Timestamp: 08/31/23 after marked close.

*held through today

Company comments:

Cloudflare:

Cloudflare reported fiscal Q2 2023 on 8/3/23. Their revenue was $308.5M (6.3% QoQ, 31.5% YoY), exceeding my expected $307M (6% QoQ, 31% YoY). Even better, for Q3 I had expected a guide of $325M (6% QoQ, 28% YoY) and they guided for $330.5M (7.1% QoQ, 30% YoY). With a new FY guide of $1285M at the midpoint (slightly increased from $1282M in Q1), QoQ revenue growth is implied to accelerate not only from Q2 to Q3, but also from Q3 to Q4. So QoQ revenue growth went from 5.6% in Q1 to 6.3% in Q2 and is guided to 7.1% in Q3 and 7.7% in Q4 - an awesome outlook of accelerating revenue growth. And even though revenue beats have been at 1.1% or below since 3Q22, I think there is a good chance they can beat the Q3 guide and implied Q4 guide, which would be fantastic. But even if they don’t, and just meet their midpoint they would continue to re-accelerate revenue growth in the next two quarters. So while Cloudflare has been stuck with QoQ net new revenue of around $19M to $22M since 3Q21 they are likely to break out of that by Q4 with an implied midpoint guide of $25M.

Coming to secondary metrics, the only negative was that DBNRR continued to drop to 115%, down from 117% last Q and 126% a year ago. But “Based on our visibility, we believe the deceleration in DNR is nearing a bottom” and we should also keep in mind that this is a lagging metric. Customer growth and RPO trends are much more important at this point as they are forward-looking: While their total customer count continued to grow 3.6% QoQ, large customers (making up more than 60% of total revenue) grew an impressive 9.1% QoQ, up from 5.6% last Q and 7.0% the Q before. With that they managed to add 196 large customers spending more than $100K in annualized revenue, the second largest number in their history. RPO growth also accelerated QoQ and grew 8%, up from 5.7% in Q1, to just over $1B; 75% of which will make it to the top line in the next 12 months.

So what do these numbers tell us about future revenue growth and growth durability in particular? Taking their current quarter’s revenue of $308.5M, assuming that they will continue growing their customers around 3.5% per quarter in the next 4 quarters (or 1.035^4 = 1.1475, 14.75%) and that their DBNRR will stay at 115%, Cloudflare would generate $1.472B in revenue in the next four quarters; 31% more than they generated in the last four quarters. So the question is: can they continue to grow customers at 3.5% per quarter and keep a DBNRR of 115%? Will NRR go up again? Or not? I believe NRR will eventually go up again, as might customer growth. But even if it stays constant, it shows Cloudflare’s potential to deliver growth durability at 30% YoY, which, given their continued bottom-line improvements, would already be an awesome combination.

Speaking about profitability, Cloudflare delivered excellent numbers: They achieved record operating income of just over $21M, a 6% margin, up from -0.4% a year ago and beating their guide by a solid 40%. Better yet, their new guide implies continued progress here: They guided for $20.5M in Q3 and implied $23M in Q4. Assuming similar quarterly beats of over 30% their operating income could come close to $60M in the second half of the FY.

Net margin and FCF margin numbers tell a similar story of success: Net income grew to a record $34M, a 11% margin and free cash flow grew to $20M, a 6.5% margin; both up from being negative a year ago.

These are all very exciting developments, showing that Cloudflare not only has overcome their sales/GTM issues but are thriving again with a bright outlook for what is still to come.

Datadog:

Datadog, oh Datadog, you are not making it easy for us investors! Datadog reported fiscal Q2, 2023 on 8/8/23 before the market open and I was initially divided on how this quarter went. As always it is never good to see FY guide being reduced. While their previous guide had indicated significant revenue growth acceleration in the second half of the FY, this outlook has become much more foggy with the reduced guide (now guiding for $2.055B at the midpoint, instead of $2.090B, a 1.7% reduction).

Before diving in further, we have to remember and keep in mind that we are still in the midst of macroeconomic headwinds and companies cost optimizations, which Datadog, as a consumption based company, is feeling much more directly than SaaS subscription based companies.

For Q2 I had expected revenues of $516M (7% QoQ, 27% YoY) and we got $509M (5.8% QoQ, 25.4% YoY). And to keep their QoQ growth rate constant next Q, they will have to beat their guide by 3%; consider that this quarter’s beat was the lowest at 1.9% since my recording started in 2019. So can they beat Q3 by 3% or more? It is certainly possible looking at their historical beats that were way above 5% from 3Q20 through 3Q22. But with this Q’s lower beat and the reduced FY outlook there is much more uncertainty than there was about the future. On top of that, Datadog’s Q3 is typically a tad slower than Q2: Q3 QoQ growth dropped in 4 out of the previous 5 years in comparison to Q2, with 2020 being the exception. So it would be prudent to assume that they will grow about 4.7% QoQ in Q3. On the other hand, that means it would be very good news if they can actually hold on to their 5.8% QoQ growth rate in Q3, considering the seasonal headwind.

Ok, well, but how did they do this quarter - taking the outlook aside? Just skimming over the numbers it looked like a mixed bag, but after having a closer look I would say there was much more good than bad. Actually the only apparently bad was customer growth kept slowing to below 3% for both reported cohorts. Here, the main reason might have been seasonality: QoQ large customer growth dropped from Q1 to Q2 from 12% to 8% in 2022 and from 14% to 12% in 2021. So the large customer growth drop from 5% to 3% could just be that: seasonality. And looking to previous Q3s, large customer growth rates have been pretty constant from Q2. So any large customer growth QoQ re-acceleration in Q3 would be very good news. On the good news side of this quarter, Datadog didn’t experience increased churn and customers’ multi-product expansion trends kept going in the right direction: The percentage of customers using 2+, 4+ and 6+ products grew by 1, 2 and 2 percentage points, respectively.

Coming back to revenue growth, they added $28M net new revenue. And while I wanted to see a number of $30M or more, consider that this is a 2.25x increase in net new revenue compared to last quarter. Taken in isolation, quite a feat and strong reversal from last quarter. Yes, there was again seasonality at play, but this was the first time in Datadog’s history that they managed to sequentially more than double net new revenue. With that, I believe Datadog has definitely bottomed with net new revenue in Q1. The question is how will the saga continue? Looking towards the rest of the FY, I think it would be fantastic if they can manage to generate $60M in net new revenue in Q3 and Q4 combined. Because of seasonality, I believe it will drop below $30M in Q3, but pick up again in Q4, giving me below updated forecast:

DDOG_net_new_revenue

Again, I think if they can manage this it would be very good news for the company that shows that they are out of the macro weeds and are picking up their growth story again. Note that the above plot implies QoQ revenue growth of 4.7% in Q3 and 7.5% in Q4.

What also bodes well, looking at the second half of the FY, are RPO and billings growth rates, which accelerated significantly this quarter: RPO growth jumped to 9.6% QoQ, up from 7.5% last Q and 2.7% last Q2. Billings growth jumped to 1.8% QoQ, up from -4.7% last Q and -10.8% last Q2. So the growth acceleration in RPO and billings versus the growth deceleration in customers tells me that NRR is probably close to its bottom and might turn again soon. I wanted to see NRR again stay above 130% but it dropped to above 120%. This is less concerning to me since it is a lagging metric and we have been repeatedly told that this will happen sooner or later during the last couple calls. Also as I said before, it might be nearing a bottom already. And accelerating RPO and billings growth while customer growth is decelerating tells me that they are focussing more on large and very large customers to drive future revenue growth, which seems natural for where Datadog currently is in its evolution (also check out Bert Hochfeld’s article on this topic, here, “A misunderstood earnings release and conference call: A positive set-up for investors” Datadog: No, Its High Growth Era Isn't Over, It's Just Starting (NASDAQ:DDOG) | Seeking Alpha).

Finally, amazing things happened on the profitability front this quarter:

Their gross margin improved by 1% to 81% and unchanged from last Q2. Their operating income margin jumped to 21% from 18% last Q and unchanged from last Q2. And now to the great numbers: net margin jumped to a record 25%, up from 20% last Q and 21% last Q2. And FCF margin, which I had expected to drop significantly from last Q because of seasonality, jumped to 28%, up from 24% last Q and 15% last Q2. And all of that while keeping their operating expenses as a percentage of revenue in-line with the last Q2 - amazing.

So, to summarize, viewing this quarter’s numbers and how they developed from Q1 in isolation paints a much worse picture than when factoring in seasonality and trends from previous years. With that, I believe Datadog performed pretty much in-line with previous year’s trends with some promising developments in RPO and billings and with the only real negative being the reduced FY guide and the resulting increased uncertainty for the second half. As you can see from my FY23 projections, the reduction in the FY guide might not have been necessary, which, if I am right, gives significant upside. If, on the other hand, I am wrong, I’ll definitely lower my conviction in the company going forward - especially if other consumption based companies (like Snowflake) start taking off again. EDIT after Snowflake reported: SNOW indeed seems to take off again! More on that below.

Monday:

Monday reported fiscal Q2 2023 on 8/14/23 before the market open. They delivered revenue of $175.7M (8.3% QoQ, 42% YoY), only slightly below my expected $177M (9.1% QoQ, 43% YoY). For Q3 I had hoped they would guide for $186M (5% QoQ, 36% YoY), and they guided for $182M (3.6% QoQ, 33% YoY). They increased their FY guide by 1.6% to $715M at the midpoint. While those are certainly not bad numbers, I don’t see them meaningfully breaking out of their quarterly net revenue adds, which has been hovering around $13M.

Just like with other companies we follow, NRR has come down in all customer cohorts. And just like with other companies, I am less concerned about this metric since it is lagging and because gross retention remains stable. “we continue to expect moderate pressure on NDR throughout the remainder of the year. And by the way, we took it into account in our guidance, and we assume full NDR to be slightly below 110%. To your question, when we are expected to stabilize, so already going into July, we see signs of stabilization and we expect it to level off by the end of the year. Just as a reminder, because it’s a weighted four-quarter average, then there is a lagging effect.”

Large customer growth, a leading indicator for revenue growth was strong again in Q2: In Q1 they added a record 209 customers spending more than $50k per year and in Q2 they did it again - adding another 209 large customers.

On the profitability side they continued their amazing margin expansion: Operating income was $17M, up from negative $15M a year ago and zero in Q1. With that they achieved an operating income margin of 9%, a net margin of 12% and a free cash flow margin of 26%.

Snowflake:

Snowflake reported fiscal Q2 2024 on 8/23/23. Product revenue was $640M (8.5% QoQ, 37.3% YoY) versus my expected $634M (7.4% QoQ, 36% YoY). This is awesome news as it shows a strong reversal from the weak last two quarters where they grew 6.3% QoQ. Better, their Q3 guide of $672.5M (5% QoQ, 28.6% YoY) versus my expected $666M (5% QoQ, 27% YoY) points to further QoQ revenue acceleration in Q3, if they can again beat this guide by 4.2% (they beat Q2 guide by 4.5%). So a 4.2% beat would imply QoQ revenue growth of 9.5%, which, going forward would compound to 44% YoY growth (1.095^4 = 1.438), so a sharp re-acceleration from their guided 28.6% YoY growth for the upcoming Q3. Aligned with that, and speaking about visibility going forward, “We are seeing encouraging signs of stabilization but not recovery. Our forecast calls for these customers to more closely align their consumption with their annual contract value” and "the sentiment really seemed to change in July with customers really reengaging with us”. I believe this all bodes very well for future revenue growth.

Coming to secondary metrics, the total customer growth held steady at 4.3% QoQ, compared to 4.2% QoQ in Q1. The more important cohort of customers spending >$1M TTM grew 7.5% QoQ, adding 28 new large customers this quarter. This figure is down significantly from the last four quarters where they added in-between 40 and 45 large customers each quarter. I take it as a yellow flag, keeping in mind that those are still small numbers which can be noisy. So while I would like to see QoQ re-acceleration in this cohort next quarter, a 7.5% QoQ growth rate, compounding to 33.5% YoY is above the YoY revenue growth figure Snowflake guided for in Q3 at 28.6%. That is just to say that, while down significantly from a year ago, a 7.5% QoQ large customer growth rate is still a major driver of future revenue growth (rather than a drag on revenue growth). I was happy to see strategic customer growth (Forbes 2000) up again, growing 3.6% QoQ, up from 1.5% QoQ in Q1. This means they added 22 new strategic customers, up from only 9 in Q1.

So total customer growth stayed stable, large customer growth decelerated and G2000 customer growth accelerated. Overall, I think the “land” part of “land and expand” was just OK. On the “expand” side, NRR was 142% close to my predicted range of 143-145%. I expect it to continue to drop though, but expect it to be above 135% in Q3, given the inertia in this metric. But it should then start to show some signs of leveling out as “over time, it is going to continue to converge closer to our growth rate. I do think it will stabilize, but I do expect it’s going to come down slightly from where it’s at right now just in what we’re seeing today.”

We can do a similar exercise as we did with Cloudflare above, but given that Snowflake’s consumption based revenue is less predictable than Cloudflare’s subscription revenue, I would take the following with a grain of salt: Let’s assume Snowflake’s NRR drops to about 131% and stays there and customer growth drops from 4.3% to 3.5% QoQ growth. That would mean Snowflake would reach a revenue growth rate of (1.035*1.07)^4 = 1.107^4 = 1.504, or 50.4% YoY revenue growth (10.7% QoQ), which is, again, a sharp re-acceleration from their Q3 guide of 28.6% YoY. I think that would be absolutely fantastic. I’ll leave it up to your imagination if they can maintain customer QoQ growth at 3.5% (implying deceleration) and expanding their customer’s revenue at a lower than current 131% going forward. I think though it is entirely possible and they might even do better than that. Please let me know if you see any flaws in this thinking! (The implied 50% YoY growth rate sounds almost too good to be true.)

Another metric that supports this hypothesis is their RPO growth, which, after dipping last Q re-accelerated again and grew 3.8% QoQ, up from negative 6.9% in Q1. It is now at over $3.5b with over $2b to make it to the top-line in the next 12 months. So while customer growth numbers were just OK, this shows that they are adding more quality customers that are going to spend more going forward, which should eventually support their NRR and lead to revenue growth acceleration.

We also saw great progress on the data sharing side: Customers that have at least one stable edge grew 8.7%. With that, a record 26% of all customers have at least one continuous data-sharing connection between Snowflake accounts. This is indicative of Snowflake’s flywheel gaining more momentum and thus a positive trend. Snowflake also managed to break out of their trend of decelerating marketplace listings, which jumped to 13.5% QoQ growth, up from only 3% in Q1, 8% in Q4 and 11% in Q3. Just to emphasize this again: they added 5 times more new market place listings in Q2 than they added in Q1. Or in other words, in Q2 they added 33% more marketplace listings than in the previous 3 quarters combined, showing a sharp shift in engagement. I am curious where this metric will go form here!

Finally, Snowflake continued to make great progress on the profitability side: product gross margin increased by a percentage point to 78%, operating income margin jumped to 8%, up from 4% last Q2 and net margin jumped to a record 12%, up from 1% last Q2. FCF margin was close to my expectation at 13% - well done!

Wrapping it up

I am really happy with the performance of Cloudflare and Snowflake this quarter! I think they both reported excellent numbers and provided an awesome near-term outlook. I also think Datadog did well and has a very good outlook with surprise upside potential, but there is more uncertainty going forward than there was just a quarter ago. So, while I haven’t done so yet, I might trim Datadog a bit, but just because it is currently our largest position and I now have a slightly higher conviction in Snowflake and Cloudflare.

To summarize the reports from Snowflake, Cloudflare and Datadog: We saw a strong reversal of the decelerating revenue growth trends that started a year ago (and held approximately through the previous quarter), supported by re-accelerating, forward looking, secondary metrics like RPO. In addition all three companies have made great strides in profitability and are likely to continue to do so - a great combination. So I am confident that these three companies will do very well going forward in the mid-term and my long-term view of them hasn’t changed at all, if not improved due to developments in the AI space.

I thought Monday’s numbers were good, and they demonstrated that they are on track. I also like the numbers reported by The Trade Desk, which makes me think I should take a closer look at this company and potentially increase our stake here. Finally, Nvidia had an absolute blow-out quarter (guided for 53% QoQ revenue growth and managed 88% QoQ!!!) and I am really happy to have held on to this company over the last 3 years, where it grew into our third largest position at 15.5% of the portfolio. Holding on, despite not only revenue growth declines, but actual revenue declines at times, really required a focus on the long-term perspective, which is something I also try to keep in mind with our other holdings as I continue to follow their numbers each quarter.

Next month, I’ll share my thoughts on Crowdstrike (spoiler: I thought they had a great quarter) and Zscaler, the latter of which is still due to report as the last company of our portfolio this earnings season. Until then,

thanks for reading and I wish you all a great September!

Ben