CompoundingCed's Sep 2022 Review

CompoundingCed · October 3, 2022, 5:07pm

What was supposed to be a quick post turned out to be a long edit for the new format!

It was an uneventful September.

Last month I said that it feels like the market is finally responding positively to good earnings.

Now it feels like there’s more panic to come. Who can say for sure?

My strategy hasn’t changed. I am now in 26% cash. I’m happy with my allocation and will look to add opportunistically.

Shameless plug: What I learned from Saul was inspirational for my first sharing on Twitter: https://bit.ly/3UQvn0J. I hope to share more learnings there that are OT for this board.

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. This 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%
Jun 2022    -51.2%
Jul 2022    -46.7%
Aug 2022    -44.2%
Sep 2022    -49.1%

Monthly Activity: There was no activity in the portfolio this month.

These are my current 9 holdings at the end of the month.

Company	      Aug 2022   Sep 2022
DDOG           15.8%      14.6%
Tesla**		   13.1%      13.8%

SentinelOne	    9.6%       9.8%
Gitlab	        9.0%       7.9%
Monday	        7.1%       7.7%
ZScaler		    5.9%       6.7%
GLBE	        5.7%       5.3%
MongoDB         7.7%       5.2%

Cloudflare	    2.7%       2.6%

Cash		   23.4%      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%)

Datadog
DDOG continued to perform in Q2.

Revenue growth 74% YoY
Non-GAAP operating margin improved from 13.2% in the same period a year ago to 20.8%
FCF margin declined from 18% in the same period a year ago to 15%
Total customer growth steady at 29% growth, customer (>$100k ARR) growth was stronger at 50%.
Customers that are using >4 products and >6 products accelerated again.
Customers using >2 products declined from 81% the previous quarter to 79% in Q2.
This was due to more customers landing with >2 products from the get go. I’m not too bothered.

Call notes:

Warning: “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.”

Guidance for Q3:

Revenue growth lowered, 53% YoY growth.

Margins to be adversely impacted 100bps in Q3 due to increased spending and 400bps in Q4 due to the Dash user conference.

Tesla
**Discussion of this company is OT for the board. I am including this for completeness. Contact me off board if you wish to discuss.

Capital intensive. Highly competitive. Eccentric founder-CEO.

There are many reasons why an investment in Tesla would be silly. Yet, the company’s stock was up over 300x 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, Berlin and Texas are expected to expand production.

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, Optimus 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.

Q2 results were weaker than expected due to shutdowns in Shanghai:

Revenue grew 42% YoY and -10% QoQ
Non-GAAP operating profit improved to 16.7% (from 14.9% in Q1 2021)
FCF margin declined to 3.7% (from 5.1% in Q1 2021).

In spite of the weaker Q2, the company painted a strong picture for 2H.

“We are positioned for a record-breaking second half of the year. We’re quite excited about this. Shanghai is back to full production and Tesla recently completed an upgrade in production capacity in the factory."

“Texas and Berlin continue to ramp up nicely.”

There was also a good example of how great companies can emerge stronger from crises in innovative ways:

“And so one of the ways that we’ve been able to address supply chain issues on the chip front is by rewriting of software to be able to use different chips or, in some cases, achieve dual use of a single chip, which is even better. The chip shortage has served as a forcing function for us to reduce the number of chips in the car.”

As long as the company continues executing as it has, I’m happy to keep a reasonably high-conviction allocation.

My thoughts on Musk are here on Twitter: https://bit.ly/3M05B5U

My write-up for the company is here Tesla Inc | An Investment Pilgrim's Journal

Medium Allocation Companies (5-10%)

SentinelOne
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.

Gitlab
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
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: in-house point solutions developed by individual companies for internal use.

Gitlab estimates that itself and its largest competitors have less than 5% of the market.

Gitlab achieved

74% revenue growth YoY in Q2
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.

Call notes:

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.

MongoDB
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 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.

Call notes:

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.

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

Monday
As the work-from-home trend seems here to stay, Monday 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.

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%. I took the opportunity to sell into strength.

ZScaler
Compared to CRWD, ZS seems to 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, “In Q4 (they have a June year end), 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.

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
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.

Call notes:

“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%)

Cloudflare
Cloudflare continues to confound me.

It posted another consistent set of results in Q2. Consistent, but not spectacular. Yet the share price jumped about 20% after-hours.

I’m not complaining, but I don’t understand it.

Results:

Revenue growth was 54% YoY
Non-GAAP operating profit margin improved from -2.6% in the same period a year back to -0.4%.
Paying customer growth was 20% YoY.

The company is aiming to increase their $NRR to above 130% and it planned to do so by bundling products together.

In Q1, their pipeline generation slowed, sales cycle extended and customers took longer to pay their bills.

In Q2, those metrics stabilized but “they’re not where we throw up hooray yet.”

The CEO cautioned that “while our business remains strong, I believe this is a time for prudence and caution.”

The CEO then shared about their strength in Zero Trust services.

“Because in a lot of cases, the kind of previous Zero Trust solution either suffered from a lack of ability to scale, real performance bottlenecks, not having the total global coverage that global companies need, and Cloudflare addresses all of those things extremely well. So I think that, that’s an opportunity for us.”

It was heartwarming to hear how he could use high gross margins to help their customers with pricing during tougher periods:

“We try to be strategic and accommodating where we think it makes sense to build business relationship and business. But we’re using our margin to accommodate for that without any doubt.”

NET has gotten more expensive after the pop, I’m happy to keep my position, but I think other companies will probably give me better value at their prices.

Then again, this company’s price moves continues to confound me…