investing in the time of COVID-

Dear All,
https://en.wikipedia.org/wiki/Love_in_the_Time_of_Cholera
The market has been impressive in the speed, scope and magnitude of the market crash. The world has had an unprecedented response to COVID-19 which will undoubtedly have a major impact economically as well as on the social fabric of our lives. You will find all sorts of opinions to the, “world is ending” and, “this will have a short and limited impact.” Major questions remain, will the US go the way of Italy, Iran and Wuhan where the virus overloaded health care systems and had a greater than 3% mortality rate or will the social distancing/travel restriction policies be enough that the US follows the rest of China, Hong Kong, Japan, South Korea with good mitigation, slow virus spread and a health care system that can keep up. Mortality rates in those countries have been closer to 0.7%. No matter the answer, We are at a time of much fear and uncertainty. I am a physician and I worry that the US has acted too late. Time will tell. There is much uncertainty, how long the outbreak will last and how long and deep the economic outbreak will be. We are in a very different investing environment than a short 2 months ago and everything can change again in the course of 2 or 3 weeks. Italy went from a few cases to 60 million people being quarantined in 3 weeks.

Here is my thinking and what I have been doing. Near the beginning of the outbreak I reduced my positions that were burning cash. These included ESTC, MDB and SMAR. I was lucky that I was able to do that near many of their highs (ESTC I just sold the rest of, so not all good). I had also sold ZS because of their poor business results and Coupa because business spend is going to be ugly for a while. Those moves increased my cash position to a bit under 30% when my portfolio was much higher. Now the cash has grown closer to 40%, because the rest of my portfolio has shrunk! I’ve been sitting on that cash except for some minor almost net neutral moves. Below is my watch list.

My thinking that now is the time for strongly cash flow positive businesses that have plenty of cash doing mission critical things. I’ve identified TEAM, PAYC, OKTA, AYX, DDOG.

TEAM - Attlassian has a large range of tools that allow for mostly software product management, tracking and support as well as collaboration tools, coding tools and some security tools. Basically close to a one stop shop for software development firms. Remote work doesn’t hurt TEAM and might actually benefit them as companies have to be more deliberate about tracking projects. Revenue growth has been a steady 36-38% despite moving to a mostly SAAS revenue stream. Operating Income has been a pretty incredible 17-31% and last quarter FCF was 49%!! This will fluctuate but it is always pretty good. Rule of 40 is 86%, puts it right up there with ZM but at a much cheaper price. They have almost 2 billion of cash in the bank with 870ish million of senior notes and 672 derivative liabilities. This is a company that will be able to acquire other companies and talent through whatever we go through. Obviously others think similarly as I do as TEAM has only fallen a little over 20%. Its ev/s is around 20 which is the lowest I have seen it since tracking the company.

PAYC - Paycom is a SAAS based HR and Payroll company. They have been one of my favorites because of their strong focus on making their customers successful. Hard to switch out especially as by all accounts their customers love them. They don’t like to oversell, they want customers to only buy what they need and then grow with their customers. Revenue growth has been in the 28-30% range but they have been steadily increasing their EBITDA (i’ll use that since this is what they report). THeir EBITDA margin is an incredible 43%. 133 million of cash on hand and 32 million in debt. They will have no problem servicing their debt. EV/S is down to 17.5. This used to be lower years ago, but PAYC wasn’t a cash generating machine years ago.

OKTA - sits at the heart of a company’s identity management, single sign on, and zero trust security plan. Rev growth has been around 48% and pretty stable, Consistently improving operational leverage. Last quarter 21.5% FCF margin, expect this to bounce around but overall is going in a positive direction. 1.4 billion cash, 937 of debt at very low rates. EV/S is down to 21.5. They dropped to 16 ev/s back when their growth was slowing and there was some question about their operational leverage. 21.5 is the lowest we have seen for quite a while.

AYX - has been discussed plenty here. EV/S is down to 14. Lowest I have ever seen it was at 12 way back when I first bought it but it is a much much stronger company now. 9.6% FCF margin, 974 million cash, 697 million convertible bond at something like 0.5% interest rate.

DDOG - Single pane, cloud based analytics and monitoring. Rev growth has been above 80%, very efficient early stage business that has a lot of room to grow and expand their product portfolio. FCF margin about 10% and improving. 777 million of cash and no debt . EV/S is down to 25 which is the lowest I’ve seen. I think they had a flash crash to a similar EV/s but i didn’t calculate it at the time.

I don’t doubt our companies will be impacted, especially depending on how deep this thing goes, but those are my picks for companies that have the right product, right financials and right market positioning. I don’t think this is the time to go all in, we have many weeks ahead of us of the COVID-19 getting worse. The economic impacts are just starting. I am however begining to invest a small portion of my cash. Companies that come through this are going to be in an amazing position to pick up business and talent. They will be lean mean business machines. I think the above companies will be part of that group.

Finally, stay away from Margin, be careful of options, don’t invest the cash you need to live . Don’t put yourself in a position to go to zero. This too shall pass. Maybe not today, tomorrow or six months from now, but it will.

Best,
Ethan

93 Likes

Hey Ethan,

Thank you for this kick-ass and deeply wise reflection. Monkey is most curious, however, why CRWD didn’t make the list: isn’t the security of your online company’s website/database one of those “I wish I didn’t have to, but I can’t take the risk not to” expenditures? And it has a subscription model? And its numbers have been accelerating in the cash positive direction? And it’s now 63% off it’s highs? And it’s only an 8B marketcap?

What suits are going to cut the budget on the security of their business, or say “no, we’ll risk it; we already have one virus, what are the odds we’ll get a digital one as well?”

Does Monkey fundamentally misunderstand online security and how important an offering it is, especially with a product as sticky and easy to implement as Crowd’s (as opposed to Zscalers, which is great to have philosophically and for the long term, but not exactly essential)?

Wouldn’t security come first, say, before Payment software stuff, which in theory could be done in alternate ways, but if a security breach happens, you’d truly be in a world of rotten bananas?

Put another way: of all the massive long-term opportunities right now, Monkey has begun to signal CRWD as one of the biggest, looking two years down. But there doesn’t seem to be the same kind excitement, so maybe it’s his flimsy understanding?

But on the other paw, it is (or was?) Saul’s #3, which is saying a lot in terms of his (and many others) confidence. Who here is frothing at the long-term opportunity here?

Why no love?

Pondering,

Monkey (long CRWD)

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Having last year left FireEye after 7 years, I am not a fan of CRWD. Its not that I don’t love their execution and growth. It is just because the security competition is so tough with too many players needing consolidation. They all have endpoint firewall protection, forensics collection, and malware detection. Each vendor tries to get their detection tricks of the week advantage. Customers tend to stay with the vendor that "is good enough’ and they can afford…especially in tough times which may be near. Most customers really cannot ascertain the detection fidelity of one vendor or another unless they are a bank, health care, financial, or the military.

-zane

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Monkey, I thought about CRWD. Let me preface this with, I like CRWD. I think crwd might end up being a good investment. Now some numbers. CRWDs grew revenue 88% and seems likely that barring coronavirus it would continue in the >80% range at least for next quarter. FCF was 7 million or a FCF margin of 6%. They have 833 million in cash and 204 million in debt. Their EV/S is down to 16.9 . This is the cheapest from a valuation standpoint that they have ever been and pretty ridiculously cheap for a company posting those types of numbers. I have concerns that endpoints protection is pretty easy to switch out, concerns about competition, but at the same time this is a company that had one of the best earnings reports I’d seen until AYX’s came out. Anyways, just random musings. Maybe CRWD should be part of the list. Their cash flow isn’t as good, but they have tons of cash.

thanks monkey.

-e

7 Likes

Major questions remain, will the US go the way of Italy, Iran and Wuhan where the virus overloaded health care systems and had a greater than 3% mortality rate or will the social distancing/travel restriction policies be enough that the US follows the rest of China, Hong Kong, Japan, South Korea with good mitigation, slow virus spread and a health care system that can keep up. Mortality rates in those countries have been closer to 0.7%. No matter the answer…

I’m sorry, what? Why do “major questions” remain? I can almost certainly tell you the answer: the USA will follow the Italian model, although probably much worse. The reason is quite simple: the USA has done very little to slow the spread of the virus. What we have done has been too little too late.

I would point to the criminal lack of testing, made freely (read: for free, at no cost) available to all who need it. The lack of a national health care system with almost 30 million people without any form of insurance (and most with expensive co-pays), ensuring millions will avoid doctors and hospitals due to prohibitive costs. And lack of a social safety net, ensuring normal people can maintain income while under quarantine (they need to work to feed their kids, ergo, they will work, even while sick).

Add to that the criminal messaging for our leaders, basically downplaying this as just another flu that will magically take care of itself with minimal impact, and you have all the makings of a national disaster, unfolding daily in front of our eyes. Because of exponential growth rates, however, it will still take some time for this virus to overwhelm our hospitals. That should happen in about 2 weeks or so, depending on where you live.

Side note: Wuhan’s response was slow in the beginning, and yes they were overwhelmed. In their defense, they were first. They quickly mobilized in a way that was admirable. Something the US is just not capable of repeating. Not because “we love freedom” or some other BS. But because China has a national health care system and a belief that government can mobilize to save lives, and that top down, national action is required. That citizens should take priority over markets. They put in place a rigorous, multi-faceted testing pipeline to ensure sick people were identified and quickly isolated, especially from their families, when testing positive. They built 10 temporary hospitals in a couple of weeks! This system was fast and effective. We have a very fractured and in many ways broken health care system that will not function under this stress test. Certainly not without top down mobilization, which did not happen, and likely won’t happen.

So you can stop asking the question of whether it will be bad, and just start preparing for the worst. I’m not primarily talking about revisiting your portfolios, I’m talking about making sure you isolate yourself and your loved ones as much as possible. Avoid all non-essential travel. Take care of your families, especially anyone over 65. If you have a loved one in a senior care facility, you had better do a quick analysis of whether they are prepared for what is coming. If not, you should get your family members out of that facility asap. Make sure you have cash on hand should the economy really go south, which I expect will happen, in the coming months.

I’m reminded of the satirical headline (was it The Onion? Can’t recall): “How will your death impact markets?” I think it nicely highlighted our misguided priorities in a real crisis like this, as least what we see in the media. America can’t BS its way out of this with cutesy marketing and flowery lies. This is the real deal. This virus just doesn’t care what you say about having “the best health care system in the world,” or whatever.

But sure, by all means, reorganize your portfolios. But on the basis of reality. If you are assuming this is just going to magically go away, that we are going to get lucky and do little but not be significantly impacted, then I am quite sure you will be in for a very rude awakening in about 10 days, if not sooner. There are specific steps we should have taken to follow South Korea and not Italy. We did not follow those specific steps.

Americans have no special immunity from this virus. We were shown how to mitigate it over 6 weeks ago. We did almost nothing to prepare. And now - to be brutally honest - it’s too late. Brace for impact.

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Joe,

I’m sure you’re trying to be helpful by…let’s just say not sugar coating things! I won’t respond to your thoughts, however, because your post was not about investing. I realize in extreme times like this we all have a lot on our minds, and it’s ok to tell each other to stay safe, but let’s get our news elsewhere, and let’s certainly not stray into discussing the successes or failings of political leaders. This is an investing board.

Ethan’s original post was investing focused (and awesome) so let’s continue to discuss it, but please, no responses to Joe’s rant.

Thanks,
Bear
Assistant Board Manager

45 Likes

“Americans have no special immunity from this virus. We were shown how to mitigate it over 6 weeks ago. We did almost nothing to prepare. And now - to be brutally honest - it’s too late. Brace for impact.”

The other concern we have here in the US is that we are incredibly unhealthy. Heart decease, obesity, diabetes, these are problems a country like South Korea doesn’t really deal with. We are a fat society and they are not.
So If this does spread as it’s spread in other countries, and there is simply no reason that it won’t, the death rate is most likely going to be much higher here, not lower.

The virus is here, not border control, or shutting down of travel is going to stop it now. It’s now how to live with it is the only thing we as a society and nation can focus on.

TMB

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Sorry about above post. I saw the one above mine and didn’t realize I was on Sauls board until I hit send. My bad.

TMB

1 Like

re:comment by evan1234

“I have concerns that endpoints protection is pretty easy to switch out, concerns about competition, but at the same time this is a company that had one of the best earnings reports I’d seen”

I am long CRWD and have recently added a bit. Can you clarify what you mean by 'switch out",and “endpoints protection” and which competition is concerning you? The full extent of the meaning behind those phrases is not obvious.

I noticed others have shown a bit of reticence regarding CRWD. Any clarification would be appreciated.

COVID-19 implications for business by McKinsey :

https://www.mckinsey.com/business-functions/risk/our-insight…

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While the rant was off target, to say it has no merit in terms of investing is the equivalent of burying your head in the sand. Be assured, we are at the beginning, and things will get really bad. That’s apparent with any rational analysis of the facts. I am not at all sure markets have priced in just how bad it is going to get. Just off the news, Spain which is a few weeks ahead of us is using ice rings to store corpses because the hospital morgues can’t handle the numbers. if you think that scenario will not impact market sentiment, you are more of an optimist than I am.