Writing in early November, it feels like the market is about make another downward move. It doesn’t feel great, but with 40% cash, I won’t complain if I can deploy at great prices.
Over the last few months, the strengths/weaknesses of the various SaaS models have really come to the fore. Usage based subs like SNOW and DDOG are expected to get hit more while non-usage, non-seat based ones (like NET) will hopefully be hit less amidst the macro uncertainty.
During this downturn, more investors are talking about taking into account macro in their investing. Prior to this, I’ve always taken the view that predicting macro events are impossible and hence I would not take them into consideration.
Macro has not been a concern when we’ve had 10 years of tailwind.
This downturn has really hammered home the point that the macro situation plays a HUGE role in share prices. But I still don’t know if it’s possible to predict these events better or how I can position my portfolio to deal with these events.
If you do, please drop me a note.
In lieu of a better method, I’m sticking with great quality hypergrowth companies whose share prices have now been pummelled.
At the time of writing, my stronger positions are Tesla, S, GTLB and GLBE. Weaker ones are MNDY and NET. This could of course change when some of these report results.
Follow me @CompoundingCed in Twitter for more sharing. As private messaging is disabled on this platform, Twitter would be the best way to have a conversation.
Areas of Improvement for 2022
This section is a reminder to myself.
After reviewing my 2021 decisions, the area where I didn’t do well was in portfolio allocation.
My mistakes were:
Too small allocation to fundamentally stronger companies.
(For e.g. I only had 2.4% in DDOG at one point)
Adding to fundamentally weaker companies as 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. On hindsight, this seems too high.)
Jan 2022 -21.4% Feb 2022 -24.6% Mar 2022 -22.8% Apr 2022 -37.9% May 2022 -51.5% Jun 2022 -51.2% Jul 2022 -46.7% Aug 2022 -44.2% Sep 2022 -49.1% Oct 2022 -51.8%
Monthly Activity: I sold a 2.5% position in DDOG, halved my MNDY stake, and exited MDB.
Subsequent to the month: Following the slew of results on 3 Nov, I exited DDOG and added 1% to NET.
Reasons given in the company section below.
These are my 8 holdings at the end of the month.
Company Oct 2022 Sep 2022 Tesla** 12.5% 13.8% DDOG 11.6% 14.6% SentinelOne 9.3% 9.8% Gitlab 7.9% 7.9% ZScaler 6.6% 6.7% GLBE 5.3% 5.3% Monday 3.8% 7.7% Cloudflare 2.8% 2.6% MongoDB 0% 5.2% Cash 40.1% 26.3%
**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.
High Allocation Companies (10-15%)
**Discussion of this company is OT for the board. I am including this for completeness. Contact me off board if you wish to discuss.
After a weaker than expected Q2, Tesla did very little wrong in Q3.
- Revenue grew 56% YoY to $21.5b
- Non-GAAP operating profit improved to 18.9% (from 18.0% in Q3 2021)
- FCF margin improved to 15.4% (from 9.6% in Q3 2021)
- Model S/X deliveries up 101% YoY
- Model 3/Y deliveries up 40% YoY
- Global vehicle inventory: 8 days
It was a very bullish call:
“As our factories ramp, we’re looking forward to a record-breaking Q4. So it really, knock on wood, it looks like we’ll have an epic end of year. So Q4 is looking extremely good.”
“On the production ramp, Giga Berlin achieved another milestone of 2,000 cars made in a week with very good quality and is ramping rapidly. Giga Austin or Giga Texas should reach this milestone very soon. And in fact, just yesterday, we extrapolated yesterday’s hold rate, it would be 2,000.”
There was some commentary on supply chain issues:
As we look ahead, our plans show that we’re on track for the 50% annual growth in production this year, although we are tracking supply chain risks which are beyond our control. On the delivery side, we do expect to be just under 50% growth due to an increase in the cars in transit at the end of the year, as noted, just above.”
“This means that, again, you should expect a gap between production and deliveries in Q4, and those cars in transit will be delivered shortly to their customers upon arrival to their destination in Q1.”
This was the reason cited why share price dropped after results were announced. I don’t see how a difference in delivery timing is a huge issue.
There had been growing calls for share buyback on Twitter and Musk took the opportunity to address this:
“Even in the downside scenario next year, even if next year is – was a very difficult year, we still have the ability to do a $5 billion to $10 billion buyback. This is obviously pending Board review and approval. So it’s likely that we’ll do some meaningful buyback.”
I don’t think Tesla needs to do a buyback at this stage in its growth and shared my thoughts here: https://twitter.com/CompoundingCed/status/1581974389259898880?s=20&t=cHfviQeEcaekN5CfW5lFCA
There was some chatter about Tesla’s valuation (Musk: “I see a potential path with Tesla worth more than Apple and Saudi Aramco combined.”) but that’s noise as far as I’m concerned.
Tesla is my highest conviction company right now because of the visibility of its runway and its ability to execute in what is a notoriously difficult industry. I’d be happy to add if the market continues to throw up silly prices.
My thoughts on Musk are here: https://bit.ly/3M05B5U
My write-up for the company is here Tesla Inc | An Investment Pilgrim's Journal
**Discussion of this company is OT for the board. I am including this for completeness. Contact me off board if you wish to discuss.
DDOG had a pretty good Q3 but its forward guidance and outlook was worrying.
Revenue growth 61% YoY to $437b
Non-GAAP operating margin improved to 17.1% (from 16.3% in the same period a year ago)
FCF margin declined to 15.4% (from 21.1% in the same period a year ago)
Total customer growth 27% YoY, customer (>$100k ARR) growth at 44%.
Customers that are using >2, >4 and >6 products increased again.
Guidance 38% growth for Q4. This was the weakest guide since IPO.
In the last quarter, the company had warned: “our larger spending customers continue to grow but at a rate that was lower than historical levels.”
“This effect was more pronounced in certain industries, particularly in consumer discretionary, which includes e-commerce and food and delivery customers and affected more specifically our products with a strong volume-based component such as log management and APM suite.”
This continued in Q3: “we saw relatively more deceleration in the consumer discretionary vertical, particularly in e-commerce and food and delivery.”
“At a high level, Q3 was overall very similar to Q2 with strong performance in new logos and new product attach activities tempered by growth of usage from existing customers that, although healthy, was below our long-term historical averages.”
I didn’t like what I read from the call.
DDOG has a rather large component of volume-based revenue (log management and APM suite) that is starting to hurt the company as its largest customers start consuming less.
Looking ahead a year, my view is that consumer discretionary will continue to remain weak as the world grapples with inflation worries and a potential recession.
Assuming the company grows 11% sequentially over the next 3 quarters, growth will slow to high 40% by 2H 2023.
I trimmed my position by 2.5% before results. With the combination of its weak Q4 guidance and tough compare in 1H next year, I decided to exit my position completely following Q3 results.
Medium Allocation Companies (5-10%)
SentinelOne’s AI-powered Singularity platform seems sufficiently differentiated and superior (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)
- zero detection delays
This demonstrates the platform’s ability to autonomously combat the most sophisticated threat actors.
Q2 results were a very strong beat.
- Revenue grew 124% YoY (110% guidance) and 31% QoQ (including Attivo numbers)
- Operating margin improved from -98% a year ago to -57%.
- 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 also strong: large customers (>$100k ARR) growing 117% YoY and 28% QoQ.
This is a high conviction company. The significant beat in Q2 was “driven from the organic business”, according to management.
I’d be happy to increase my allocation.
In Q2, Gitlab achieved
- 74% revenue growth YoY
- 89% gross profit margin and improving non-GAAP operating profit margin of -27% (vs -42% in the same period a year ago)
- Customer (>$5k ARR) growth was 61% YoY and Customer (>$100k ARR) growth was 55% YoY.
A Forrester study commissioned by Gitlab: “our customers saw a 407% return on investment within 3 years of deployment of our DevOps platform.”
“Despite the volatility in the macroeconomic environment in the second quarter, we have not seen any impact to our business.
"The current environment is not slowing down customer decisions, nor elongating our sales cycles. Buying cycles have actually sped up across the business, and we continue to see strong win rates.”
I am looking to increase my allocation to the company.
Compared to CRWD, ZS’s results seem to show they have prioritized revenue growth over margin in the past couple 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 numbers (61% YoY and 11% QoQ) and improving operating margins (12.0% vs. 10.5% in the same period a year ago).
For their FY23, they guided for operating margin expansion of 150 bps.
On the current operating environment, management said, “As we saw more deals getting scrutinized, we delivered more of these business value assessments, which helped us close many large multiyear, multiproduct pillar deals.”
This sounds like their clients really like ZS’s value proposition.
I’m happy with my medium allocation for now and wouldn’t mind increasing allocation if the opportunity arises. Having said that, perhaps an allocation to CRWD would make sense too.
GLBE facilitates cross-border e-commerce.
It aims to make international transactions as seamless as domestic ones.
- 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
- 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.
Q1 results were decent
- 52% YoY revenue growth
- operating margin was flattish at 12% compared to 13% in the same period a year ago
- Net Dollar Retention Rate >130%.
- Revenue guide for Q3 (73%) and the full year (74%) was very strong.
“On the merchant activity front, demand for our services continues to remain strong as more and more brands around the world put direct-to-consumer and cross-border sales,”
“What differentiates us is the fact that the direct-to-consumer channel is in the focus of the merchants and is gaining share over other channels. So this channel is definitely growing and growing in a nice pace."
“We believe that this is a secular trend that will stay for us for a long time as merchants prioritize this channel for a reason.”
"They want the close relationship with the consumer, they want to have the data, and they want to enjoy the margins at the end of the day. I think this is what differentiates direct-to-consumer cross-border from the sort of general e-commerce market.”
Given the more volatile nature of e-commerce revenues compared to SaaS companies, I’m happy to maintain a low-ish allocation.
Low Allocation Companies (0.1-5%)
Q1 and Q2 showed some rather rapid deceleration in revenue growth while the guide for Q3 is for even slower growth.
From 91% revenue growth in Q4, Q1 saw 84% growth and Q2 saw 75% revenue growth. The guide for Q3 is 58% revenue growth, which is the slowest guide they’ve issued since IPO.
Q2 operating margin improved to -12% (compared to -14% in the same period a year back).
Enterprise customers (>$50k ARR) grew 147% YoY and 21% QoQ.
I trimmed about 1% allocation after Q2 results because I didn’t think the results were fantastic and yet the share price popped about 20%. In October, I decided to halve my position.
Cloudflare started to show weakness in Q3 but I somehow didn’t feel that disappointed after reading the call notes.
- Revenue growth was 47% YoY to $254m
- Non-GAAP operating profit margin improved to 5.8% (from 1.3% in the same period a year back)
- FCF margin improved to -1.8% (from -23.1% a year ago)
- Paying customer growth was 18% YoY.
- $NRR was 124%
On their NRR: “We will continue to be dissatisfied until it’s over 130%, and we believe that it’s still very achievable as we add seats and storage-based products like Zero Trust and R2.”
Some weakness was starting to show in the results: “We saw a higher level of churn in our pay-as-you-go customer base, primarily due to more customers shifting down to our free customer tier. We think this is a function of a more challenging macro environment.”
“In the quarter, we observed an increase in our sales cycle and expect similar sales dynamics to continue, leading to longer lead time deal closures. We are cognizant of the increasingly cautious environment and have factored this into our outlook.”
There was also some good news: “Our win rates against Zscaler and Palo Alto Networks continue to be very strong. Our product in that space competes extremely well with them. I think that Zero Trust is very much going to be the story of the next few years to come.”
Putting things in context: “We are talking about a subscription-based model. So a lot of the things we see in the third quarter and we’ll see in the fourth quarter are the impact of when we started to talk about the macro climate going to change. So when we give guidance for the fourth quarter, it’s less the in-quarter impact of the business. It’s just a flow-through of what already has happened.”
“We, of course, for sure not assumed an improving of the macroeconomic environment. And with an outlook in Q4 and Q1, there’s nothing that signals that it’s going to get better anytime soon.”
The CEO took the opportunity to stress the strength of their subscription business in times like these:
“I think that if you are a usage-based, a purely usage-based model, it is a place where people are looking for areas to save money. Similarly, if you are a seat-based model, as you’re seeing some companies do layoffs or, at a minimum, not expand their seats, that is something that is challenging in the current environment.”
“I think we are fortunate that today, most of our revenue is not usage-based and not seat-based. And so while we are adding products that are in both of those categories, and we think that over time that, that will be an expansion driver for us, that today, we’re not seeing that downward pressure from people trying to rationalize or consolidate their bills.”
The CEO received a question on customers moving to the free tier and why NET wouldn’t “raise the floor on that so you can hold on to the paying customers?”
CEO: “I think that what we see as the value from that pay-as-you-go business is that those customers, whether they pay us something or not, end up being our biggest advocates and our biggest champions inside whatever large organization that they operate at.”
“So if you look at who are our largest customers and you go down the top 10 customers, almost all of them came to us originally because some technical leader inside that organization used Cloudflare’s pay-as-you-go services, fell in love with us, understood us and was able to adopt us as part of that. And so I think that, that benefit is so substantial to us that we always want to make sure that we’re treating those customers well.”
“They may go from paying us $20 a month to not paying us something because gas prices went up, that isn’t something that we’re trying to optimize for. What we’re trying to optimize for is that those customers love us, they understand us and they take us to work. And so as they do, that’s how we’ve been able to close so much of the Fortune 500. Behind almost every 1 of those Fortune 500 wins is a pay-as-you-go customer who advocated for us internally, and that is our secret sales force.”
I thought that was a fantastic example of long term thinking by the company’s leadership.
There is no doubt the company is facing some headwinds in the current environment. However, I didn’t come away from the call feeling like the decline would be drastic, compared to say SNOW or DDOG. My expectations are for low 40% growth in this challenging period, which is not a drastic decline from the 50+% it was posting before.
Following the 20% decline in share price after results was announced, I added a small 1% allocation.
I hung around with MDB longer than I should have.
The company posted a decent Q2.
- Revenue growth came in at 53% YoY
- Operating profit margin improved from -6% in the same period a year ago to -4%.
- Customer growth continued to be strong at 28% YoY
- Atlas revenue came in at 73% YoY growth and is now 64% of total revenue.
The company was experiencing slower growth in the self-serve segment (US and Europe), mid-market segment (US and Europe) and enterprise segment (Europe).
The root cause was slower growth in usage of its underlying applications. Q3 and Q4 would also be tougher quarters to lap due to strong performance last year.
With most segments of its business facing headwinds, I should have exited following Q2 results. I finally pulled the trigger in October.
Jan 22: CompoundingCed's Jan 2022 review
Feb 22: CompoundingCed's Feb 2022 Review
Mar 22: CompoundingCed's Mar 2022 review
Apr 22: CompoundingCed's Apr 2022 review
May 22: CompoundingCed's May 2022 review
Jun 22: CompoundingCed's Jun 2022 review
Jul 22: CompoundingCed's Jul 2022 review
Aug 22: CompoundingCed's Aug 2022 review
Sep 22: CompoundingCed's Sep 2022 Review