Hortonworks (HDP) - A Discussion

Investment Analysis Clubs Saul’s Investing Discussions
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Chris and I recently had a discussion on Hortonworks on a thread which had no mention of Hortonworks in the name of the thread, and I thought that other people interested in the stock could have missed it. So a gathered it all together here and am reposting it, somewhat edited and abbreviated. I had exited HDP after the recent management turmoil.

Chris asked:
Regarding your exit from HDP, how much was that decision related to…

  1. the recent management changes and losing confidence in the company?

  2. the slowing in revenue growth?
    2015 revenue growth was 165%,
    2016 revenue growth was 51%,
    2017 revenue growth will be 29% based on guidanc,

  3. having better places for your money?

I responded:
I would say it was 1, compounded by 2. I figured they have been having decreasing growth and this is part of why the head of sales was summarily fired. I imagine that future bookings were down even more and guidance will reflect that. They’ve had a huge run-up this year, even after yesterday’s fall, and I sold as close to the opening as I could today.

AJ put in some nice words for me:
This seems to be sturdy reasoning for the head of sales being fired. This assumes it is essentially performance related. Other things COULD have happened. There could have been major differences of opinion in the future direction of the business, major personality conflicts, Verma saw something he didn’t like, the CEO saw something in Verma he didn’t like, etc… Who knows for certain, but Saul’s reasoning certainly makes a lot of sense.

Chris continued:
I’ve been taking a closer look at all these tech companies that are growing fast, are not EPS positive, and have lots of recurring revenue. I’m doing the comparisons because the EPS, EPS growth, and P/E metrics are not relevant for these companies. Some things about HDP that stood out and were a positive:

  1. $198 million of deferred revenue on the balance sheet. This is quite enormous given that their reported revenue for the TTM was $199 million. Deferred revenue was up $12.8 million sequentially and $79.1 million y/y.

  2. A comparatively low EV/TTM sales of 3.5. This compares to what I call peers (SHOP, MULE, HUBS, NEWR, TLND, TWLO) that had ratios of 17.3, 14.3, 9.1, 8.7, 8.7, and 8.1. The average difference is about 3x!

Chris then made tentative conclusions as follows:
My conclusion here is that even if the growth were to slow from the current 53% (recurring revenue growth) to half that, the stock price is valued attractively compared to the peer group. A second conclusion is that with the recognition of the cash already collected makes it unlikely that the reported growth rate will slow in the next few quarters; yes, if bookings do drop as you (Saul) suggested then they might see growth dropping…but a temporary slowing is ok due to the low valuation. My feeling is that HDP will continue to do quite well, so while I agree with Bear on HDP, I do realize that when my past opinions have differed from you (Saul), you were correct most of the time. We will get more information on HDP’s next earnings call on August 3rd…

However, Chris then looked a little further and discovered that:
HDP is still burning A LOT of cash compared to the peer group companies that I’ve selected. Last quarter, cash flow from operations was negative $9 million, and for the TTM it was negative $54.8 million. While the burn is slowing, it is still MUCH higher than the other companies in the peer group, most of which are either CFFO positive or near neutral.

Another BIG negative of HDP is the level of stock based compensation that they gave out. In FY2016, they gave out $98.8M. Then in Q1 2017, they gave out another $23.4M. In the last 4 quarters they gave out a total of $92.8M. They are the smallest company in the peer group with a market cap of $776M so their stock-based comp is quite a massive dilution.

To put this in perspective, SHOP has been criticized by some on this board as having high stock based comp. Now SHOP has a market cap of $8.1B which is more than 10 times that of HDP yet SHOP’s stock based comp in the past 12 months was $24.9M compared to HDP’s $92.9M. So adjusted for size HDP is handing out about 40 times more stock than SHOP!!!

I responded that I had been looking at the same thing from a different angle, adjusted earnings per share, and adjusted net losses.
For the past 12 months HDP has lost 50 to 70 cents a quarter and $2.38 cents (adjusted) for the twelve months. That’s enormous.

To put it in perspective, for the past 12 months Shopify has been losing 0 to 4 cents a quarter and 10 cents for the twelve months.
That’s $0.10 compared to $2.38 !

For a little more perspective:
Shopify had adjusted net losses of 2.6% of revenue for 2016. Pretty much irrelevant.

Hortonworks had adjusted losses of 80.4% (!) of revenue for 2016. That’s pretty hard to get to a profit. It means they spent almost twice as much as they took in as revenue.

If you follow GAAP, Hortonworks had GAAP losses of 137% of revenue. That’s hard to grasp! That means that HDP spent (GAAP) almost two-and-a-half times as much money as what they took in as revenue.

When you put together the enormous cash flow losses, the huge adjusted earnings losses, the huge stock-based comp, and now the management turmoil, maybe there are safer places for our money. That doesn’t mean the company won’t do well eventually. I don’t know. But I can’t be in all the companies in the market and I want to choose ones that I have more confidence in.

We’ve been lucky and made a good profit on this stock so far this year, up until the management turmoil. I don’t feel the need to stretch my luck.

Saul

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Fantastic recap and fantastic discussion. Thanks Chris and Saul for putting so much work into this!

Matt

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Really great discussion and I’d like to contribute.

The “thing” about Hortonworks is that it’s simply run a bit oddly (and complicated-ly), financially speaking. Like its competitor, Cloudera, they burn a ton of “cash,” but a lot of that “cash” is actually stock options. This is actually really genius: they show a huge loss on the books, but they actually pay out no money for these – in fact money comes IN when the options are exercised. The huge glaring problem of course is that shareholders get diluted. With the market cap as low as 500M in 2016, the 99M they gave away in SBC diluted shareholders an incredible 20%. But again, this means they pay 99M of their “expenses” without spending a dime – they actually make money doing it.

This “free” 99M basically paid entirely for their R&D in 2016. They were still non-GAAP unprofitable, though, because they spent 264M in SG&A. Their revenue was only 184M and gross profit was only 112M, so that 264M is a HUUUUUUUUUUUUUUUUUGE number. But then you have to figure in all the deferred revenue! They generated 80M of that in 2016, so you could add that to the 184M top line revenue and get…magically…264M! Did they plan that?

So yeah, it’s complicated. It’s ridiculous. But somehow, that’s what companies in this space do. Hortonworks may have taken it to an extreme, but it’s called land and expand, and it’s why they’ve been growing at a torrid pace. Here’s where doubt is creeping in for me: 35% is not a torrid pace. Even 52% subscription revenue, while incredible for most companies, may not be enough when you consider this crazy model. And then there’s the uncertainty from the recent resignation (that we all know could easily be more like a firing, but who knows?)

And then there’s the fact that, as Chris pointed out, PS ratio is 1/3 or 1/4 of some of the other companies we look at, which is to say Hortonworks sells as little as 25 cents on the dollar compared to something like Shopify. (For the brevity fans: It’s cheap.)

All this to say, this ain’t your grandpa’s startup. Probably the best thing to do is just exercise some caution. After adding twice to my position in July alone, it was over 11%. That’s simply too much for something that complicated. I’ve cut that back to 8% already, and I continue to consider moving to 7%, 6%, or maybe 5%. Obviously if it goes up more I might trim, if not, we’ll see. But there is a lot of uncertainty with this baby…especially going into Aug 3. If they can’t produce the growth, they’ll have some 'splaining to do.

Hope that somehow manages not to just confuse everybody more!

Bear

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And then there’s the fact that, as Chris pointed out, PS ratio is 1/3 or 1/4 of some of the other companies we look at, which is to say Hortonworks sells as little as 25 cents on the dollar compared to something like Shopify. (For the brevity fans: It’s cheap.)

Not exactly as cheap as it seems. Here’s why (at least compared to SHOP):

  1. SHOP is growing much faster. SHOP’s revenue growth has been 85% (total revenue) and 65% for the recurring subscription revenue. SHOP’s deceleration has been very slow so far. By comparison, HDP’s revenue growth is lower and its revenue growth deceleration has been higher. Part of the value discrepancy is justified by the growth rate differential and growth rate deceleration differential.

  2. The PS ratio does not factor in dilution and HDP is diluting at 40x the rate of SHOP!

  3. SHOP is cash flow positive. Their TTM CFFO was $17.4M; SBC was $24.9M so without SBC SHOP would have been cashflow negative but not by nearly as much as HDP. SHOP has guided $55M in SBC for FY17. In contrast, HDP is funding the company’s operations by giving away equity. The PS ratio should be lower due to the dilution. And HDP should get additionally dinged for being at the mercy of the public equity market which adds a substation amount of financial risk.

Overall consider #1-3 above, HDP might be 40-50% cheaper than SHOP but certainly not 67-75% cheaper. Again, I consider this discount to be warranted and not a gift by the market as the dilution and additional risk should result in a lower valuation.

Chris

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Overall consider #1-3 above, HDP might be 40-50% cheaper than SHOP but certainly not 67-75% cheaper. Again, I consider this discount to be warranted and not a gift by the market as the dilution and additional risk should result in a lower valuation.

I have not had good luck trying to compare apples and oranges. I think you can say, yes based on the PS ratio HDP is 25% the price of SHOP. But then you have to consider X, Y, and Z.

Trying to come up with a way to really compare them like to like, or boil everything down to a score for each company has (to me) proved a lowercase fool’s errand. I make it a point to look at all the numbers you mentioned, but to hold the pluses and minuses in their separate columns.

JMO.

Bear

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This is actually really genius: they show a huge loss on the books, but they actually pay out no money for these – in fact money comes IN when the options are exercised… they actually make money doing it.

I am not sure you are reading this correctly. Imagine if the company does a secondary to its employees at say, for example, $2.5 per share would you be celebrating it as a genius move? I am not so sure. The stock compensation is still a compensation and there is a cost, instead of paying cash, the company is paying through equity in the enterprise. When you raise cash by selling the stock is not making (like revenue) money.

so you could add that to the 184M top line revenue and get…magically…264M

I am not sure your math is correct here either. The only cost incurred up front for the deferred revenue is “Sales” cost, there are still other costs to provide the service, i.e., there are expenses associated with this revenue that will not be incurred now, hence it is deferred revenue. Counting future revenue to the current period is not magic but bad math.

PS: You can explain the story simply with your P/S, TAM, and growth rate rather than this incorrect math.

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