CompoundingCed's Mar 2022 review

Areas of Improvement for 2022

After reviewing my 2021 portfolio return and decisions, the area where I didn’t do well was in portfolio allocation. My mistakes in 2021 were:

• Allocating too little capital to fundamentally stronger companies. (For e.g. I only had 2.4% in DDOG at one point)
• Adding to fundamentally weaker companies that had grown more attractive because their prices fell. (For e.g. I added to FUBO a few times as price fell)
• Initiating try-out positions with too high allocation. (I would typically start with 5% allocation, which on hindsight seems too high.)

YTD Returns

Jan 2022	-21.4%
Feb 2022	-24.6%
Mar 2022        -22.8%

Monthly Activity: In the month, I sold out of Sea Limited. I added to S, TaskUs, MDB and GLBE. I initiated new positions in Snowflake (large position) and Unity Software (small position).

These are my current holdings at the end of the month. They are grouped into high allocation (10-15%), medium allocation (5-10%) and low allocation (0.1-5%), broadly reflecting my conviction levels.

Company	      Feb 2022 Mar 2022
DDOG		18.9%   17.3%
Tesla		10.3%   12.5%

SNOW            0%      10.4%
Monday	        9.3%    9.0%
SentinelOne	8.1%    8.9%
MongoDB	        3.9%    7.7%
ZScaler		7.5%    7.4%

GLBE		2.0%    4.5%
TaskUs		2.8%    4.4%
Upstart		5.9%    4.0%
Cloudflare	3.8%    3.8%
Nextdoor	5.6%    2.3%
Unity           0%      1.5%

Sea Limited	11.7%   0%

Cash		10.3%   6.4%

Portfolio Commentary

I work on the basis of 10 to 20 stocks. While I see others on the board have a concentrated portfolio to great effect, I’m not comfortable with allocating too much capital to a handful of companies. @GauchoRico shared a truism with me that concentration in a portfolio is a function of one’s stock picking skills. I don’t think I’m there yet, hence a greater diversification is prudent. Moreover, I currently don’t have a handful of companies that are executing so perfectly that I feel comfortable allocating >15% to each (I wish I do, though), hence I will have to spread my allocation out.

It was not a great Q4 2021 earnings season overall. Other than DDOG and TSLA, the higher conviction companies in the portfolio guided for either slowing growth in 2022 (SNOW, SE) or worsening operating profit margins due to re-investment in the business (MNDY, ZS). Companies that reported good results and gave good guidance were MDB, GLBE, TaskUs and Unity.

In reviewing the first quarter of 2022 for the portfolio, it seems that the turnover of the portfolio has been rather high. I started 2022 with 12 names, of which 5 are no longer in the portfolio (Affirm, FuboTV, Kaspi, MELI and Sea Limited). At the end of the quarter, I now hold 13 names, with new positions in ZS, Cloudflare, MongoDB, GLBE, Unity Software and Snowflake. In spite of the turnover, I now feel I have a stronger set of companies with which to ride the recovery.

Accountability for last month: I said I was looking to increase my allocation to TASK, GLBE, Unity Software, Snowflake and maybe ZS and NET. I added to all except for ZS and NET. I decided I wasn’t that convinced by ZS and NET is still relatively expensive. My lowest conviction was Nextdoor (still is) and I reduced the position by half.

Looking ahead in the month: I’m looking to increase my allocation to S and TASK. I’m also looking to initiate a decent-sized position in a yet-unnamed company. Results for SNOW and MNDY are making me think twice about my allocation. My lowest conviction is Nextdoor, so it will be the first to go if I need to raise capital. I think the end of the decline should be near and I hope to deploy all my cash in anticipation of the recovery.

High Allocation Companies (10-15%)

Q4 21: DDOG had as close to perfect a quarter as one could have expected. Growth accelerated and margins improved again. Total customer growth has been steady at 30+% while customer (>$100k ARR) growth has been accelerating since Q4 2020. Customers that are using >2 products and >4 products accelerated again. In short, they are executing brilliantly.

On the Q4 2021 call, there was strong bullishness

”But to your second question, we also see, right now, a lot of the demand, a lot of the growth is coming from mid-market and large enterprises and also the higher end of the market. And we feel good about that part of the market, like we see it successfully standardizing Datadog. We see it successfully land and expand with us. I think we’re growing faster. Well, I would say we’re an equivalent size and growing faster than anybody else in the market for that specific part of the market. So I think we feel good about it. That’s a big part of what we’re doing.”

On improving margins from lower S&M spending as % of rev: ”That’s because of the usage and the cross-sell and the efficiency of it in our frictionless adoption. So it’s an indication of both the robustness of the end market as well as the ability for clients to adopt more of the platform.”

On winning the competition: ”The reason why we’re winning those situations is we offer an integrated platforms where others don’t. We’re cloud-native where others aren’t. And most importantly, we have a lot more usage and adoption from the teams on the ground around our product. So that’s the deployed everywhere, used by everyone saying that I repeat at every call, that really is what makes us win in the end with customers. And that applies upmarket, that applies downmarket, it applies everywhere.”

This is my highest conviction position. It has now exceeded 15% by virtue of declining less than my other holdings. I am comfortable with a 17% allocation.

**When I first joined the board, I remember coming across an earlier post that said any discussion of Tesla was OT because the company was all hype. I can’t seem to find the post now. Moreover, I believe the company has proven itself in the past decade. I’m including a write-up of the company for completeness but I’ll remove it from future posts if it becomes an issue.

Capital intensive. Highly competitive. Eccentric founder-CEO. There are many reasons to justify why an investment in Tesla would be silly. Yet, the company’s stock was up over 300 times at the end 2021 from its IPO price. It must be doing something right.

There are signs that the EV industry is at the beginning of technology S-curve adoption where growth can accelerate exponentially. Over the next few years, Gigafactories in Shanghai (Q1 2022: it has applied for at least a doubling of already-built capacity), Berlin and Texas are expected to come online and meet the demand.

Tesla’s products enjoy a fanatical cult-like following, similar to Apple’s iPhones (another company in a capital intensive, highly competitive industry, and with an eccentric founder). Growth optionalities include subscription from Full Self Driving and its future autonomous ride-hailing network.

The company grew at hyper growth rates in 2021 and is guiding for 50% CAGR over the next few years. In Q4 2021, revenue grew 65% YoY and 29% QoQ. Margins improved across the board. Currently, the company is supply constrained with only 4 days’ worth of inventory at the end of Q4 2021. Even with the current shortage in chip supply, the company expects 2022 growth to be in excess of 50%.

My initial allocation was about 5% and it grew organically to a >10% allocation. As long as the company continues executing as it has, I’m happy to keep a reasonably high-conviction allocation. There are a couple of reasons why I find it hard to make TSLA an outsized high-conviction position. First, selling a physical product at scale means more complications than selling software. (Yet, successfully doing so means higher barriers to entry for the competition.) Second, at $1T market cap, it could be harder for the company to double or triple compared to other SaaS companies (but I don’t rule it out).

My write-up for the company is here…

Medium Allocation Companies (5-10%)

I have held back from a meaningful allocation to SNOW for a long time because declining growth in total customers worries me. Q4 results were good but not great (101% YoY growth and a mere 15% QoQ growth, with vastly improved operating margins.) as the company saw a “slower-than-expected return to normal consumption in January.” Customer growth continued their steady decline at 44% YoY and 10% QoQ growth rates.

The company guided for slower product revenue growth in 2022 (Q1: 81% YoY growth and FY: 67% YoY growth) and announced cloud deployment improvements that are expected to have ~$97m revenue headwind for full year revenues.

I started buying after Q4 results, where sub-$200/share for the company was too tempting. As I’m writing this review, it seems like my current 10.4% allocation is rather high, given the outlook for the company. I’ll be looking to trim.

As the work-from-home trend seems here to stay, will be a beneficiary. The space seems to be quite competitive with players like Asana, Smartsheet, Atlassian, etc. Having said that, it is worth noting that, according to the company, their largest competitor is still “email, and spreadsheet, and PowerPoint.” and “On 70% of the deals we see literally no competition.”.

Prior to Q4 earnings, I thought it was likely they would turn Non-GAAP Operating Margin profitable in 2022. I’ve since had to reset those expectations based on the company’s 2022 guide. The company expects to be investing more heavily in 2022 to keep up hyper growth. With the resumption of conferences, travel and accelerated hiring, operating margin is expected to worsen.

The more I think about them spending $8m on the Superbowl ad, the more uncomfortable I get. “Brand awareness” advertising like billboards, TV commercials and print ads provide companies very little information about how well the advertising does because companies cannot measure how their audience respond to the advertisements, and hence cannot measure their ROI. For a company like Monday, with a relatively small Sales & Marketing budget ($57m in 2020 and $77m in 2021), to spend that much on an ad campaign with no measureable results, just seems like a poor capital allocation decision to me.

Monday was a high conviction position prior to Q4 earnings but I don’t think I can say the same now. It fell to a medium allocation in my portfolio by virtue of price decline and I’m probably going to trim the position.

SentinelOne’s AI-powered Singularity platform seems sufficiently differentiated and superior (as per Gartner Peer Insights and MITRE ATT&CK assessments) compared with other cybersecurity offerings. Like many others here, I’ve monitored the company since IPO but never pulled the trigger because of its ridiculously high negative margins. In Q3 2021, it finally showed vastly improved margins. At triple-digit revenue and customer (>$100k ARR) growth rates, it was tempting to build it up to a medium conviction position after Q3 results.

Q4 results were more-of-the-same. Revenue grew 120% YoY and 17% QoQ, while operating margins improved from -104% a year ago to -66%. Revenue growth for 2022 is expected to be in the 90% region and improvement in operating margins is expected. Customer growth is also strong, with large customers (>$100k ARR) growing 137% YoY and 25% QoQ.

As I’m writing this, I may bring this company up to a high allocation position.

This is a SaaS company that has been listed for a while and used to be a board mainstay IIRC. MongoDB’s NoSQL database architecture puts it in a strong leadership position with little real competition from legacy relational databases.

Growth started declining in Q2 2020 and that’s probably when investors here lost interest. However, growth was given a shot in the arm when Atlas, its cloud-based database-as-a-service offering started reaccelerating revenue growth in Q1 2022 (i.e. in Year 2021). Atlas revenues are now large enough to meaningfully move the needle for the company. Total revenue growth has accelerated in the past 3 quarters and the company should do well as long as Atlas growth holds up.

Looking at margin improvement trends, it is likely that the company will turn profitable and FCF positive in FY 2022….unless they do a MNDY/ZS and decide to go big on reinvesting in the business for the coming year. I first initiated a position in January 2022. Its declining Enterprise business will be a drag on overall revenue growth and is keeping me from allocating too much. I took the recent opportunity during the March decline to add.

This is a recent addition in Jan 2022. ZS’s growth had reaccelerated for a number of quarters prior but I had always been hesitant because it had been investing heavily and sacrificing operating profit margins to achieve that growth.

Revenue growth started accelerating in Q3 2020 (ZS has a 31 Jul year-end. I included the latest quarterly results for completeness but my decision to enter was prior to its release.)

Year       Q1     Q2     Q3       Q4     FY
2020      48%    36%    40%      46%    42%
2021      52%    55%    60%      57%    56% 
2022      62%    63%

In that time frame, operating margin (non-GAAP) did not show a consistent improvement.

Year       Q1      Q2       Q3        Q4       FY
2019      1.9%    13.4%    7.7%      9.2%    8.3%
2020      4.0%    12.2%    7.5%      6.2%    7.5%
2021      13.8%   9.4%    13.0%     10.5%    11.6% 
2022      10.4%   8.7%

In my mind, there was little difference between CRWD, whose growth had been slowing but had been showing decent margin improvement, and ZS, whose growth had been accelerating because it had been investing heavily in OpEx. In the words of management, “…we’re going to prioritize growth over operating profitability.” (Q1 2022)

In December, I reviewed the company again and realized that over the past three years, their guidance for Operating Profit Margin had increased gradually and that they were likely planning for minimal margin improvement. During the Q4 2021 call, management said, “If we continue to have high growth and strong unit economics, we’ll prioritize investing in the business, which would lead to lower than 300 basis points of margin expansion per year. To that point, our fiscal 2022 guidance of 40% to 41% revenue growth and 9% to 9.5% operating margins reflects approximately 150 to 200 basis points of margin expansion after adjusting for the increased T&E and M&A expenses.

I finally decided that accelerating growth with slight margin improvement (ZS) was preferred over slowing growth and decent margin improvement (CRWD). I established a medium allocation. I was half looking forward to increasing my position after the latest earnings release.

In the latest quarter, ZS posted decent-but-not-great revenue numbers (63% YoY and only 11% QoQ) and declining operating margins (8.7% vs. 9.4% a year ago and 10.4% a quarter ago). It also guided for declining margins next quarter. I see a parallel with MNDY where conferences, travel and increased hiring will provide pressure on operating margins for the rest of the year. For this reason, I find it hard to increase this to a high allocation. I’m happy with my medium allocation for now.

Low Allocation Companies (0.1-5%)

Global-e Online
GLBE facilitates cross-border e-commerce. It aims to make international transactions as seamless as domestic ones. Services include interaction with shoppers in their native languages, market-adjusted pricing, localized payment options, compliance with local consumer regulations and requirements such as customs duties and taxes, shipping services, after-sales support and returns management.

The company solves a pain point for merchants as huge upfront costs and efforts are needed to offer cross-border sales. According to Forrester, brands typically see around 30% of e-commerce traffic being international but in terms of actual sales figures, no more than 5-10% come from international shoppers.

In April 2021, the company announced a partnership with Shopify where GLBE would be the exclusive 3rd-party provider of cross-border services integrated into Shopify’s checkout. I’m unsure if this will be a needle-mover as Shopify has its own native white-label cross border service (Shopify Markets).

Q4 results were decent (54% YoY and 40% QoQ revenue growth, operating margin improved from 10.1% a year ago to 13.5%, Net Dollar Retention Rate 152%, Gross Dollar Retention Rate >98%). It posted very strong 2022 guide of 66% revenue growth in Q1 2022 and 72% growth for the year.

“Basically, we have seen with our clients, giving priority into investment in direct-to-consumer cross-border. And we’ve seen it with multiple of our clients, opening more lanes and investing more in penetration into new geographies, which expected to continue going into 2023.

In parallel, 2021 was a record year for us in finding new business and new logos in, and a lot of this effect would come into play only in 2022 and would contribute to this accelerated growth. We do see, as we spoke about in previous calls, a lot of the effects of COVID that are here to stay. So the need for brands and the desire to go direct to consumer was accelerated through the pandemic, and this state does not change. There might be certain relief with shops being open. However, the trend of brands, especially larger brands, moving into a direct-to-consumer on a global basis is not stopping, and we see it in our pipeline. And this gives us, I would say, quite a lot of confidence building our planning into 2022 and onwards.”

Given the more volatile nature of e-commerce revenues compared to SaaS companies, I’m happy to maintain this position with a low allocation.

TaskUs operates in an un-sexy but critical sector: Business Process Outsourcing. It focuses on serving high growth tech companies. Services offered include Digital Customer Experience (largely non-voice channels), Content Security (content monitoring and moderation) and AI operations (data labelling and annotation for purpose of training AI algorithms).

Its cloud-based technology allows clients to set up operations quickly and allows clients to outsource their customer experience processes at earlier stages of their company lifecycle. I believe it offers a strong value for young tech companies where customer experience is crucial but perhaps not a core capability to develop internally yet. As services and companies become more digitized, the demand for client engagement services is going to be more non-core and yet grow in demand.

It should be noted that there’s some degree of customer concentration, but this reliance on top customers is decreasing. FB represented 32% of 2020 revenue and 27% of Q2 2021 revenue. Doordash represented 12% of Q2 2021 revenue. Other clients include Zoom, Netflix, Coinbase and Oscar.

It was hit by a short seller report in January (same guys that issued a short report on Lightspeed). The report focused mainly on the Facebook business, the highly competitive nature of the industry, historical discrepancies prior to listing and how overvalued the company was. There were no claims of outright fraud. IMO, the concerns raised by the short seller were not issues of grave concern and my thesis for the company is still intact. However, the spectre of a short report can have short term pressures on the stock price.

Q4 results were good (63% YoY and 13% QoQ revenue growth, operating margin improved from 14.3% a year ago to 18.3%, 57% growth in clients with >$1m revenue and 100% growth in clients with >$10m revenue). The stock price jumped by >20% following results.

It looks like it will do well for Q1 2022. ”2021 was one of our strongest – actually our strongest sales year ever. And I previously shared that Q1 of 2021 was the best quarter that we’ve ever had in terms of sales in our company’s history. Q1 of 2022 is off to a very fast start, and it feels reminiscent of Q1 of last year. So I’m excited to tell you more about the specifics of the wins we’ve had so far when we report our Q1 results.

As far as the 30% growth forecast that we provided at the midpoint, 2022 is off to a very, very strong start. We’ve got visibility to around 95% of the forecast that we provided today, and we’re continuing to see robust demand across our broadening portfolio of clients.

The company announced the launch of new business lines in financial crime and risk and an upcoming launch of learning experience service for training the employees of clients.

The company is not expensive at about 34x TTM earnings. I’m looking to make this a medium size position.

Like many here, I was caught swimming naked with a large position when Q3 earnings came out.

As a layman, I have two concerns with their AI models. First, there’s really no way to truly tell if their models are superior to existing credit evaluation methods until we get some sort of macro-economic pressure. Second, I can’t say for sure having years of head start in data collection will definitely result in a better AI model over the competition. In my mind, it is possible that someone with better algorithms can eventually build a better mousetrap.

Q4 results did not disappoint (33% revenue growth QoQ and improvement in margins from 17.1% a year ago to 29.0%). The position grew organically from 3.9% to 5.9%. The potential for sustained hyper growth and improving operating margins are keeping me in this position. However, the greater uncertainty around revenue growth means I’m happy to keep this a relatively small position.

I owned and sold this company in 2021. Then I recently bought it again this January when prices cratered. Cloudflare’s consistent/pedestrian 50% performance and relatively high valuation made me look for shinier stocks in 2021. I couldn’t quite understand the run-up in 2H 2021.

The company posted another consistent set of results in Q4. Customer growth accelerated in 2021, giving me confidence that revenue growth can at least stay consistent, if not accelerate in 2022. It’s still not as cheap as the other SaaS companies. I’d be happy to add more to this position if the market gives me an opportunity to do so. With its relatively lower growth rates, this will be a low-to-medium allocation at best.

Nextdoor offers a very different kind of social network platform: the hyper local network. Users are real people with real addresses. It aims to be a social network based on trust (no avatars, bots and multiple accounts allowed) and kindness (local moderation and toxic content censorship).

Businesses and brands like to advertise on Nextdoor because it offers them a reach that other social networks cannot. As an example, if a baker were on another platform, say Instagram, she would have to build followership. She might build it up to 5-20 people, but she’d have to be a good marketer to make it really happen. In Nextdoor’s case, when a bakery posts to a neighbourhood, and to nearby neighbourhoods, it is getting to tens of thousands of people, all of whom live locally and could actually come into the store.

Nextdoor is a relatively new company on the public markets (it merged with a SPAC) so it will have to prove itself. Revenue growth has been consistently above 40% YoY in the last 5 quarters and was 66% YoY each in the last 2 quarters. Gross Margin is over 80% and Operating Profit Margins have been improving consistently.

Growth potential is great because while it is in 11 countries (US, UK, Canada, Australia, Netherlands, France, Italy, Spain, Germany, Sweden and Denmark at the time of the IPO), it is only monetizing the US and the UK. The company is targeting 40% YoY growth over the “next several years”.

Other immediate levers of growth include increasing penetration in neighbourhoods (it is currently in 45m households with potential for about 160 households) and increasing Average Revenue per User (about $1.80 in the US vs. $8.20 for SNAP and $5.10 for Pinterest).

This is not the most important detail, but the board has an impressive board, comprising Mary Meeker, David Sze from Greylock Partners and Bill Gurley from Benchmark Capital.

I thought it had a more-than-decent Q4. Revenue growth was 48% YoY and 13% QoQ. Revenue guidance for Q1 is 40% YoY. Operating margins improved from -22.4 a year ago to -14.7%. Weekly Active Users grew 35% YoY and 9% QoQ. The one ding was ARPU grew only 11% YoY and 2% QoQ. The market didn’t move a beep in response to this set of results, which surprised me. One reason could be a general aversion to SPAC-merger companies. I’m going to keep this position small because either my analysis is wrong or there’s just very little market interest in this company. If I have to raise capital for other positions, this will probably be first to go.

Unity Software
Unity is one of two global leading platforms (the other being Epic Games) for creating interactive real-time 3D and 2D content. Traditionally, in order to build real-time 3D applications, large teams with many engineers would need to invest significant time and resources in the development of tools and technology. Unity is multi-platform, meaning it allows content creators to create content once and deploy to multiple platforms like Windows, Mac, iOS, Android, PlayStation, Nintendo Switch, etc. seamlessly.

Unity has been consistently achieving 40+% growth and improving margins over the last 3 years. I held back earlier because growth rates were rather low compared to other hypergrowth companies and I wasn’t sure if they were sustainable post-Covid. In the Q4 2021 earnings release, there were signs that revenue might accelerate in 2022, hence I thought it was worth a small allocation. I’ll probably maintain the small allocation till there’s more information from Q1 results.

Recently Closed Positions

Sea Limited
Sea was the first company I brought to the board.…

It’s a gaming and e-commerce giant based in Singapore. It has a brilliant business model where the cash-generating gaming business (Garena) provides the cashflow to build the initially capital intensive e-commerce business (Shopee). In any new market it enters, it leads with gaming, followed by e-commerce 18-24 months later.

In the past 12 months, it has brought the fight to MercadoLibre in Latin America, and entered India, France, Spain and Poland.

It has grown at triple-digit YoY growth rates for the past 13 quarters and margins have been improving.

From the Q3 2021 report, there were concerns over slowing growth in the gaming business, particularly in quarterly average users and quarterly paying users. Looking back at my notes, the first signs of slowing growth in Garena came in Q2 2021. On hindsight, I should have trimmed to a medium conviction position after the Q3 report.

In January, India announced a ban on Garena, likely due to the company’s association with Chinese Internet company Tencent. India comprises an estimated low- to mid-single digit share of Garena’s revenues.

I was disappointed with the Q4 report and guide for 2022. The company posted declines in QAU (-10% QoQ) and Quarterly Paying Users (-17% QoQ) for Garena. For 2022, bookings for the gaming business is expected to decline while the e-commerce business is still expected to grow at hyper rates. I expect the company to grow at 50-60% tops in 2022, which is a sharp decline from its triple-digit growth rates over the past 4 years.

In the first week of March, I exited the position pre-market after results were announced. I may re-enter the position at some point because e-commerce in South-East Asia is still at a nascent stage but it’s no longer a high conviction company for me.

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