CompoundingCed's May 2022 review

This month’s update is later than usual as I wanted to wait for all my companies to report before gathering my thoughts for the portfolio.

Just when I thought we had seen the bottom in March, my portfolio continued to get blind-sided with lower lows in April and May. From chatter in Twitter and on this board, there’s evidently plenty of pain. My portfolio has NEVER declined this much from its all-time high. While I no longer feel pain from the huge drop, talk of a recession and the uncertainty surrounding further price declines mess with my mind. In times like these, it helps to remind myself of a few things: volatility is a fee and not a fine in this stock market game (, with good stock picking we will do well in the long run, and the stock market (as defined by the indices) always recovers to make new highs.

Areas of Improvement for 2022
I keep this section to serve as a reminder to myself. 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 prices 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%
Apr 2022        -37.9%
May 2022        -51.5%

Monthly Activity: I closed 4 positions in TaskUs, Nextdoor, Upstart and Unity Software for various reasons (see write-up for each). Other than that, there was not much movement in the portfolio as I sat pat watching prices decline further. Following Q1 results, I decided I would look for opportunities to add to SentinelOne and Gitlab. I will be looking to reduce my position in SNOW.

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

Company	      Apr 2022 May 2022
DDOG		17.3%   17.4%
Tesla**		12.4%   13.8%

SentinelOne	10.5%   9.6%
Monday	         7.9%   8.9%
SNOW             8.7%   8.2%
MongoDB	         7.6%   6.5%
ZScaler		 6.8%   6.5%
Gitlab	         2.9%   6.7%

GLBE		 3.7%   4.0%
Cloudflare	 3.4%   2.8%

TaskUs		 5.1%     0%
Upstart		 3.4%     0%
Nextdoor	 2.2%     0%
Unity            1.2%     0%

Cash		 7.0%  15.4%

__**Discussion of this company is OT for the board. I am including it for completeness. Please contact me off board if you wish to discuss this company.__

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. Chris 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.

High Allocation Companies (10-15%)

DDOG had another great quarter in Q1. Revenue growth was 83% YoY and non-GAAP operating margin improved from 9.8% to 23.1% (!!!). FCF margin improved from 22% a year ago to 36%. Total customer growth was steady at 30% while customer (>$100k ARR) growth was even stronger at 57%. Customers that are using >2 products and >4 products accelerated again. In short, they are executing brilliantly.

In the quarter, there were a few notable product enhancements. They announced the general availability of the Application Security Monitoring, which was the 14th product in the DDOG platform and 4th product within their cloud security platform. They also announced two new capabilities for Watchdog, their AI engine: Log Anomaly Detection (It understands and baselines normal patterns in logs, and proactively discovers abnormalities such as new text patterns, meaningful changes in data volumes of existing patterns and error outliers.) and Root Cause Analysis (It identifies causal relationships between symptoms of an issue across an organization’s services. By doing so, it pinpoints the precise service where an issue originated.) In May, DDOG announced the acquisition of Hdiv Security, a security-testing software provider which detects vulnerabilities at runtime.

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 and I am happy with a >15% allocation.

**Discussion of this company is OT for the board. I am including the write-up for completeness. Please contact me off board if you wish to discuss this company.

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. The company reported another blowout quarter in Q1. Revenue grew 81% YoY, non-GAAP operating profit improved to 21.4% (from 11.6% in Q1 2021) and FCF margin improved to 11.8% (from 2.7% in Q1 2021). Gigafactories Texas and Berlin were officially launched while Shanghai faced production issues due to COVID-related shutdowns. The ramp in Texas and Berlin will adversely impact gross margins in Q2 but higher ASPs (Average Selling Price) would offset some of those headwinds.

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 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%)

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. In the latest MITRE evaluation, S1 outperformed the competition again. Out of the 30 vendors evaluated, S1 achieved 100% prevention, 100% detection, the highest analytic coverage (108/109) with zero detection delays, demonstrating the platform’s ability to autonomously combat the most sophisticated threat actors.

Q1 results were more-of-the-same (read: very good). Revenue grew 109% YoY and 19% QoQ, while operating margin improved from -127% a year ago to -73%. Including contribution from Attivo (a recent acquisition), revenue growth for 2022 is expected to be in the triple digits and improvement in operating margins is expected. Customer growth is also strong, with large customers (>$100k ARR) growing 113% YoY and 14% QoQ.

This is a high conviction company. This is a company where I’d be happy to increase my allocation.

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.”.

In May, the company launched Work OS with 4 new products: Monday projects, Monday dev, Monday marketer and Monday sales CRM. This will see it further differentiate itself with other work software companies.

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.

I don’t know if I’m overthinking this, 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. Q1 results were good, with revenue growth at 84% YoY and operating margin flattish at -40.4% (compared to -39.5% a year back). Enterprise customers (>$50k ARR) grew 187% YoY and 21% QoQ.

It fell to a medium allocation in my portfolio after some trimming in April and by virtue of price decline. I’m happy to leave it as it is for now or trim a little if I need to raise capital for other positions.

I don’t think it was a great set of Q1 results from SNOW. While YoY revenue growth looks pretty good at 85%, the drop from triple digit growth rates just a quarter back is too large for my liking. The sequential QoQ numbers show more alarming information. In Q4, QoQ growth declined to 15% (or 75% annualized) while Q1 QoQ growth declined to 10% (or 46% annualized). For context, in the 12 quarters prior to Q4, QoQ growth had largely been above 20% (or 107% annualized). Customer growth has also declined precipitously to 39% YoY from 67% YoY a year ago. Remaining Performance Obligation declined sequentially in Q1, which is the first time it has happened since publicly publishing results.

Looking forward in the year, the company expects consumption to decrease, especially from consumer-facing cloud companies. It also announced cloud deployment improvements that are expected to have ~$97m revenue headwind for full year revenues. In short, I think the revenue decline going forward will be drastic.

As I am writing this review, I believe I should reduce my position in the company.

MongoDB’s NoSQL database architecture puts it in a strong leadership position with little real competition from legacy relational databases. 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 5 quarters and the company should do well as long as Atlas growth holds up.

The company posted a great set of results but warned of macro headwinds (more on that later). Revenue growth came in at 57% YoY and the company turned operating profit profitable, with OPM improving from -4.6% a year ago to 6.1%. Customer growth continued to be strong at 31% YoY. Atlas revenue came in at 82% YoY growth and is now 60% of total revenue.

The company shared that it was experiencing slower growth in the self-serve and mid-market channels in Europe and in May, started to see the same trend in North America. The root cause was slower growth in usage of its underlying applications. It expects a negative $4 million to $5 million impact to Q2 revenue and a negative $30 million to $35 million impact to fiscal '23 revenue guide. In spite of the headwinds, the company still raised its fiscal ’23 guide by $11m.

I am happy to keep this a mid-size position.

Compared to CRWD, ZS seems to have prioritised revenue growth over operating margin in the past few years. In their Q1 2022 earnings call, they said, “we’re going to prioritize growth over operating profitability.” This probably makes sense since they are already non-GAAP and FCF profitable.

In the latest quarter, ZS posted good-but-not-great revenue numbers (63% YoY and only 12% QoQ) and declining operating margins (9.5% vs. 13.0% a year ago). 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.

This is the latest addition to the portfolio. Gitlab’s platform is built on Git, an open-source VCS (Version Control System) application. A VCS is a collaborative tool that records the changes made to source codes over time and stores the information in a repository. This allows team members to see who has made what changes, when. If something goes wrong, they can easily revert the project back to an earlier state.

Git is critical for teams because without it, teams have to store different versions of the source code in different folders. This is a huge problem, especially if different people have to work on the same project. They would have to send different versions around via email and then manually merge the projects. Git reduces costs by enhancing productivity, consolidating different tools and eliminating integrations. It also enhances operational efficiency through reducing security and compliance risk.

Gitlab (and Github – owned by MSFT) provides Git services such as command-line interfaces (CLI) for advanced developers, web-based interface for new programmers, web-based repositories, wiki support, bug tracking, feature requests and task management. Revenues are subscription based, on annual or multi-year contracts.

While Github has a larger marketshare than Gitlab, their largest competitor is DIY DevOps, which are in-house point solutions developed by individual companies for their own internal use. Gitlab estimates that itself and its largest competitors still have less than 5% of the market overall.

Gitlab achieved 75% revenue growth YoY in Q1, with 90% gross profit margin and improving non-GAAP operating profit margin or -28% (vs -45% in the same period a year ago). Customer (>$5k ARR) growth was 64% YoY and Customer (>$100k ARR) growth was 68% YoY.

I am looking to increase my allocation to the company.

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).

Q1 results were decent (65% YoY revenue growth, operating margin improved from 10.1% in the same period a year ago to 13.5%, Net Dollar Retention Rate >130%). It lowered revenue guide for the full year from 72% to 64%, which is still very strong. The uncertainty, with fears of a macro slowdown, is that revenue for the year will get revised lower.

The reason for the downward revision is the company saw significant reduction in sales in several Central and Eastern European markets. The company expects sales in that region to remain weak but for the other geographical markets to maintain their strength.

Given the more volatile nature of e-commerce revenues compared to SaaS companies, I’m happy to maintain a low allocation and possibly trim it if capital requirements arise.

The company posted another consistent set of results in Q1. Revenue growth was 54% YoY and operating profit margin improved from -5.4% a year back to 2.3%. Paying customer growth remained consistent at 29% YoY. Customer growth accelerated in 2021, giving me confidence that revenue growth can at least stay consistent, if not accelerate in 2022. The one thing to note was that they are planning to maintain operating margins at breakeven and continue maximizing growth. 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.

Closed Positions

TaskUs warned of revenue slowdown going forward as several of their clients shifted their focus to reducing cost. Across all verticals, the operating environment has led to an acceleration in their clients’ demand for growth in offshore work and a decrease in demand for onshore work. The greater reliance on offshore work will lead to lower revenue for the company. In Q2, the company expects to incur severance costs due to employee layoffs in the US.

The company is trading at 18x TTM earnings and is not expensive if it can maintain >20% growth (which is likely). However, with the company expecting slower growth, I believe there will be better use of my capital elsewhere than in TaskUs.

Q1 results were so-so but what really spooked investors were developments that were revealed during the call.

First, the likely worsening macro environment with both rising interest rates and rising consumer delinquencies has started to affect the business. The loan default rates rose quite abruptly towards the end of 2021 and are now back to pre-pandemic levels.

Second, the company had to use its balance sheet to provide loans temporarily. Upstart’s platform allows loan investors to provide capital to finance those loans in a fairly automated manner. When there are sharp rises in interest rates (like what we saw in the quarter), the prices on Upstart’s platform does not react fast enough to provide the return requirements that investors now require. There was a period where there was insufficient investor capital and the company had to step in to provide liquidity. This is not ideal for a company that is supposed to be asset-light and merely provides the AI algorithm for underwriting loans.

Upstart still has quite a few revenue drivers going for it. The auto retail lending business is expected to contribute meaningfully to Upstart’s monthly transaction volumes by the end of the year, “setting up for a significant ramp in 2023”. It also started testing its Small Dollar loan product a few weeks before the quarterly call. Finally, the small business lending team expects to have their product in the market in 2H 2022.

In all, I felt there was too much uncertainty and risk around the business. I decided I could put my capital to better use elsewhere.

Nextdoor was a low conviction position to begin with. While it marketed itself as a very different kind of social network, I never got the impression it was taking off as well as other social networks had done in their early days. With growth guidance for Q2 weak at 29% YoY, I decided to exit.

Unity Software
Unity experienced two issues, not due to external factors but mainly due to their own doing. The first was a fault in their platform that reduced the accuracy of their Audience Pinpointer tool, which affected revenue because the tool experienced significant growth post Apple’s IDFA changes. The second was that they lost a portion of their training data due to them ingesting bad data from a large customer. This was estimated to have an impact of $110m in 2022. The company does not expect these issues to last beyond 2022.

I believe that the company can get over these temporary issues and there is no permanent impairment of value. However, growth (circa. 40% YoY) was not high to begin with compared to my other companies, hence I exited. If the price for Unity gets more attractive, I may consider re-establishing a position.

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Hey CCed,

The Good
I wanted to let you (and others!) know that I love your report format. It’s informative, complete, yet fairly concise.

The Great
But the thing I like the most, is your final paragraph for each company, where you explain your bottom-line thoughts regarding the company’s performance, and your plans for keeping, increasing or decreasing your current allocation. In the end, I think this is the part missing in so many discussions.

The Bad
Any suggestions I could offer are so small, that I choose to decline; I don’t see need for change.

The Goal
Technical and financial info are so valuable and they steer our investments to a significant degree. I think most of us understand the how and why of them because of the great examples from Saul and other gurus here. But for me, the bottom-line opinions are just as valuable and I wish others would consider a similar wrap-up of their thoughts on allocation for a company, not just in port reports, but also at the end of detailed discussions which might change one’s opinion on a company’s future success or lack thereof. (And if comments can’t affect our view of a company, and industry or a process, why post them?)

I strive to learn something at every opportunity. Today you made the task easy.

Well done and many thanks,