Ben’s Portfolio update end of May 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%
These are my current positions:
May 2023 Apr 2023 First buy* Snowflake 16.8% 20.1% 2/8/2021 Datadog 16.0% 15.1% 5/13/2020 Cloudflare 14.7% 13.3% 11/2/2020 Nvidia 12.0% 11.7% 5/13/2020 Crowdstrike 12.0% 12.1% 5/13/2020 Zscaler 10.0% 8.9% 3/4/2021 SentinelOne 8.7% 8.7% 12/10/2021 Monday 6.3% 5.7% 9/13/2021 TradeDesk 2.1% 2.6% 5/13/2020 Enphase 1.6% 2.0% 5/15/2020
*held through today
So far I have not made any trades in 2023.
Company comments:
A brief follow-up on Cloudflare’s earnings results and my conviction in the company:
For reference, here is a direct link to my longer write-up on Cloudflare’s 1Q23 earnings: Ben’s Portfolio update end of April 2023
It appears Cloudflare’s sales/GTM was always not great, we (and management) just didn’t notice it as long as their products sold themselves in a different macro economy. That speaks for their products. How many companies do we know that can grow revenue at 50% for years while their products sell themselves? Anyways, now we know that their sales/GTM was never as great as it could be. Should that reduce conviction? By itself, yes for sure. However they also told us that their under-performers contributed only 4% of annualized new business last year. So that can be interpreted as if any change in this part of staff will only give upside to the top-line going forward. The next question then is do I believe that management can significantly improve their sales/GTM? Only time will tell, but I still believe they can. On top of that, a turning macro (whenever it will come) gives additional upside. Ok, that’s the narrative part, but what about the numbers? Having to reduce FY guide certainly isn’t good. Again, by itself that should lower conviction. But context and reasons matter as always: their sudden lengthening of sales cycles by 27% and 49% for expansion deals came as a result of the bank runs which resulted in all their potentially new and existing customers to freeze. The timing of that and how the situation developed until their earnings date forced them to lower their FY guide as they had to assume the sales cycles will stay as elongated through Q2. But wait a minute, how could Zscaler not have been impacted that much when they just pre-announced great numbers? (by the way, probably pre announced just to stick it to NET after they declared all-out war with their Descaler 
program). First, I am not so sure what fraction of their products actually overlap as a percentage of revenue, but probably much less than 100%. Second, Zscaler had more time after the bank runs and before their quarter closed. So if their customers froze as well, it could have had less impact on the quarter as some deals which closed a couple weeks later than originally planned still fell into their Q while dropping off Cloudflare’s Q1. In any case, even with all of that, Cloudflare was in Q1 a worse company than I thought it was in Q4. So yes, that should reduce conviction, even though many issues can be explained. But my other companies have also been struggling (relatively speaking) as evident from their numbers. That, at least for me moved Cloudflare from place 2 to place 3 of my conviction ranking and there was no need to manually adjust my position size as the market did that for me already. Finally, I really recommend Peter Offringa’s take on NET’s earnings results, here: Cloudflare (NET) Q1 2023 Earnings Review - Software Stack Investing
Datadog:
Datadog reported fiscal Q1 2023 on 5/4/23. While they had guided for flat QoQ revenue growth, they reported $482M (2.6% QoQ, 33% YoY), a 2.9% revenue beat. After last Q’s 5% beat, which was on the low side historically, I had hoped for a bit more which would indicate consumption based businesses already had the worst behind them. Now it looks like we just got into it (similar story with Snowflake’s consumption business by the way; see below) as Datadog’s consumption didn’t slow down as much even after the COVID drop. The good news however is they put out a relatively strong Q2 guide, which, if they beat by again (only) 3% will result in 7% QoQ growth. Since FY23 comps are very hard I will focus on QoQ numbers in judging DDOG’s FY23 revenue performance. Datadog also re-iterated their FY guide, increasing expected revenue by $10M at the midpoint to $2.09B. That, to me, implies significant revenue growth re-acceleration in the remaining three quarters. Datadog has a history of significantly beating their initial FY guide. For example they beat FY22 revenue which the guided in 4Q21 by 10%. So it is not crazy to assume they will manage a 5% beat of their initial $2.08B guide, which would result in $2.183B this FY. To achieve this they would have to re-accelerate significantly and looking at a raw sequential revenue add projection consistent with such a 5% beat is quite encouraging:
But even a more conservative scenario resulting only in a 3% beat of the initial FY guide would demonstrate good recovery and set them up well for FY24:
What gives further confidence in Datadog’s revenue trajectory is their RPO which grew 7.5% QoQ, above 2020’s 5%, 2021’s 6.9% and 2022’s 5.3% Q1 growth numbers. Additionally, their NRR was still above 130% this quarter. And while customer growth was a mixed bag with 4.7% QoQ growth of large customers (down from 6.9% last Q) and 9.9% QoQ growth of their total customers (up from 4.5% last Q) it is noteworthy that their multi-product adoption still has a lot of traction: Customers using two or more products grew 9.9% QoQ (up from 5.8% last Q), customers using 4 or more products grew 12.5% QoQ (up from 9.7% last Q) and while QoQ customer growth dropped to 16% from 17.6% last Q for 6+ product users, this cohort now makes up for 19% of all customers (up from 18% last Q). So nice to see continued progress with multi-product adoption.
There were no surprises on the profitability front: While operating income margin stayed constant at 18%, net margin improved by a percentage point to 19% while total operating expenses stayed in-line with last Q at 63% of revenue. One nuance that is interesting is that Datadog slightly prioritized R&D over S&M as the former went from 30.3% of revenue to 31.2% in Q1 vs. Q4 while the latter dropped from 26.7% to 25.1% of revenue. FCF did a nice showing with a 24% margin.
Monday:
Monday reported fiscal Q1 2023 on 5/15/23. They delivered revenue growth of $162M (8.2% QoQ, 50% YoY) versus my expected $163M (8.6% QoQ, 51% YoY). So they pretty much nailed that and beat their guide by 4.7%. I was also hoping for a new guide of $170M for Q2 and we got $169M (4.2% QoQ, 36.6% YoY) at the midpoint. They also increased their FY guide from $690.5M to $704M at the midpoint, a 2% raise. With that, for the rest of the FY, I would really like to see them break meaningfully out of their $12M-$13M raw sequential revenue add range, in which they have been stuck now for the last 7 out of 8 quarters. And while their net retention rates continued to drop across all cohorts, their very strong large customer growth this Q gives additional confidence here as it grew 14.2%, up from 11.4% last Q.
Coming to profitability, we should keep in mind that their first half of the FY and the first Q in particular is always front loaded with expenses. As a result, Monday displays strong seasonality with profitability margins. Taking this into account, they made great progress, delivering 0% operating income margin and 4% net income margin, up from -40% on both margins in the last Q1. So while they spent $7M more in operating activities this Q than last Q1, they managed to reduce their operating loss by $44M to break even (spent just as much for operating activities as they made in revenue). This is the power of operational leverage where revenue growth quickly caught up with their expenses and with that I expect Monday’s FY23 to be their first FY being both positive in operating income margin as well as net income margin. Combining their continued operating margin improvement with another record FCF quarter, delivering $39M or a 24% margin cements Monday’s successful path towards profitability.
Snowflake:
Snowflake reported fiscal Q1 FY24 numbers on 5/24/23. They delivered product revenue of $590M (6.3% QoQ, 50% YoY), only slightly below my expected $594M (7% QoQ, 51% YoY) and beating their guide by 3.4%. Speaking about guide: This quarter they basically flat out told us that they have zero visibility into consumption for the rest of their FY: “we are flowing these patterns through to the full year due to our lack of predictability and visibility of our customer behavior”. So in order to better understand the company performance, there is really no use for the updated guide they gave. As I see this, they just threw a dart while being blindfolded. The first question that emerges though is how comfortable am I with them having no visibility into their very near term future consumption? Let’s try to get to the core of that question.
To start, I think it is important to remind myself that unlike SaaS businesses, which should have very predictable revenue, consumption businesses like Datadog or Snowflake just can’t have this predictability as customers can theoretically decide to stop consuming at will, or as we have seen slow down their growth of consumption. I just point that last part out to make it clear that neither Datadog, nor Snowflake actually see their revenue reduced, just the growth thereof. Customers being able to adjust their consumption to match their current needs is not necessarily a bad thing for consumption businesses. First, it shows the true value that companies like Datadog and Snowflake bring to the table, pretty much in real-time while the numbers of classical subscription SaaS businesses will be more washed out over longer time frames. Second, it is easier to attract and attach new customers if they don’t immediately have to sign up their dollars for a long period. Third, while revenue will slow quicker in tough economic times it’ll likely bounce back much stronger when the tide turns. Of course there are many more pros and cons and without getting into a deeper discussion about subscription vs. consumption these are just some things to keep in mind.
So, while revenue growth and other supporting metrics like customer growth, data marketplace listings, RPO and NRR kept deteriorating this quarter, my sense is that this is still more a reflection of the current macro economy rather than an underlying problem with Snowflake’s business. After all, their NRR is still world-class at 151%. I do expect it to fall further though, just because of the inertia that is built into this metric and looking at the linearity of its recent drop can give us some idea if the trend is starting to reverse when they report next Q - or not:
Zoom-in:
So it would be a good indicator if they report a NRR number north of 145% next Q. In any case a NRR of 151% doesn’t sound to me like a failing company. It tells me that they are still expanding very well within their existing customers. And what about landing new customers? Well, they just grew their $1M+ customers by another 13% QoQ or 80% YoY. Does that sound like they are having trouble getting new large customers that meaningfully contribute to revenue? I think not. I am also not cherry picking this customer cohort either as it is much closer correlated to revenue than any of the other customer cohorts. And how about their ability to bring all those top-line dollars to the bottom line? Well, they just turned out an incredible FCF margin of 46% … 46%! Wow!
So with that, I am inclined to stick to the longer term narrative for Snowflake (which I won’t reiterate here as we have discussed it in great detail) and give Snowflake’s current lack of visibility and my thesis of a temporary slow-down some more time before hitting the break.
Wrapping it up
And there you have it. Another round of earnings results showing us that we are not out of the macro weeds yet. Living through this economic down-turn I cannot help but notice that there is quite some noise in the timing of how and when different companies are impacted by macro and customer optimizations in particular. I believe the solution is to zoom out a little bit more than just the usual quarterly earnings cadence and let macro and customer optimizations take its course.
Another general thought I had is that maybe it is time to adjust our revenue growth expectations for our companies in general. I think we have been very much spoiled in 2020 and 2021, with growth rates north of 50% YoY. This might have largely been a result of the sudden increased demand in those new products after large populations were sent to work from home after COVID hit. I just keep thinking about what Saul wrote back then when he said that before COVID we were in awe of companies growing revenue consistently 30% YoY. Maybe that is all we should and can expect from the best companies in the world going forward…
Next up in June are the cyber security companies Crowdstrike, Zscaler and Sentinel which will conclude this earnings season for our portfolio. I am looking forward to seeing what they can deliver.
Thanks for reading and I wish everyone a great June!
Past recaps
July 2022: Ben’s Portfolio end of July 2022 - Saul’s Investing Discussions - Motley Fool Community
August 2022: Ben’s Portfolio end of August 2022 - Saul’s Investing Discussions - Motley Fool Community
September 2022: Ben’s Portfolio update end of September 2022
October 2022: Ben’s Portfolio update end of October 2022
November 2022: Ben’s Portfolio update end of November 2022
December 2022: Ben’s Portfolio update end of December 2022
January 2023: Ben’s Portfolio update end of January 2023
February 2023: Ben’s Portfolio update end of February 2023
March 2023: Ben’s Portfolio update end of March 2023
April 2023: Ben’s Portfolio update end of April 2023
