Why I prefer ZS to ZM and CRWD

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#3

If Splunk is an example of the “end state” for our hypergrowth companies, than isn’t their market cap instructive perhaps? Splunk has same P/S as CRM, but CRM is over a $100b mkt cap. It appears that once you have growth slow to a certain point and/or your business model is thrown into question (Splunk’s pricing model compared to open source options) then the P/S deflates.

Dreamer,

What’s important to figure out is when this “end state” of ~20% revenue growth will be hit. Splunk has run into it at a run rate of about $2 billion. Salesforce was at a run rate of over $10 billion before their growth slowed to mid-20’s. Square is at $2 billion now and still growing at well over 40%. The question is how long will growth continue, and for that we must answer situation by situation, company by company. Market cap is one piece of the puzzle.

at some point the stocks we own may need to appreciate based on growth and not via multiple expansion, and history seems to teach us that the multiples will eventually contract. Shouldn’t we be factoring in future contraction?

To that I reply yes, but easier said than done. That’s sort of what I attempted to do here: https://discussion.fool.com/great-post-ethan-i-think-you-are-far…

Any thoughts?

Bear

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#4

Dreamer wrote:
at some point the stocks we own may need to appreciate based on growth and not via multiple expansion, and history seems to teach us that the multiples will eventually contract. Shouldn’t we be factoring in future contraction?

Bear wrote:
To that I reply yes, but easier said than done. That’s sort of what I attempted to do here: https://discussion.fool.com/great-post-ethan-i-think-you-are-far…

Any thoughts?

Trying to forecast these hypergrowth companies out several years can be challenging and end up being inaccurate. Then trying to use these forecasts to try to predict future EV/Sales ratios (i.e. future stock prices) could be even more inaccurate. I tried this once a few years ago (in August of 2015) when my stocks (unbeknownst to me) hit a peak. The analysis and my spreadsheets made be overconfident and I acted on it. Then my stocks (almost all of them) dropped 40-60% from the peak. The result was catastrophic:

https://discussion.fool.com/conviction-can-be-dangerous-32756562…

Chris

28 Likes
#5

What’s important to figure out is when this “end state” of ~20% revenue growth will be hit.

Any thoughts?

Same thought as before, the top of the “S” forms somewhere around 85% market penetration (by the industry, not by any one company). The logic is simple, no more market to conquer, no more fast growth. If it’s a well run business it will morph from fast growth to cash cow, dividend payer.

There are several ways to keep growing, invent/invade new markets (iPod, iPad, iPhone, iWatch, iSomethingElse). M&A which can be good or bad.

One though to keep in mind is the type of market the industry is serving, if you are serving people (video conferencing, advertising) your market grows slowly, if you are serving data your market can grow fast for a very long time.

Denny Schlesinger

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#6

What’s important to figure out is when this “end state” of ~20% revenue growth will be hit. Splunk has run into it at a run rate of about $2 billion.

Bear - I am definitely not suggesting this sort of analysis is simple or clear-cut. SPLK has had outstanding growth the past 4 years: 668m, 934m, 1.3b, 1.8b…well above 20% and more like 40-50% at a larger scale than MDB/ZS/ESTC/TTD and others are today.

Yet you kind of would have been better off selling out in Feb 2014, over 4 years ago…before they even had that nice run! If you came across SPLK in mid-2017, you did ok and can exit with a smile, even though the past 15 months have essentially been a wash. They may simply be too complicated an example to explain, but the fact that they continued strong growth and the stock price did not cooperate for a good chunk of the past 5 years is puzzling.

3 years ago, Saul wasn’t even investing in these SaaS names for the most part. 4 years ago this board would have been focused on P/E, I believe. This is all new territory…as such, even looking for past predictors on the present and future may be a (lowercase) fool’s errand.

I am trying to find predecessors or models for my stocks to follow.
TTD is without peer, as programmatic at scale is new, and you can’t compare them to Google or Facebook obviously.
MDB? Easy to think “Oracle” but they are really something different and more aligned with data/opensource in an agile/cloud world. ESTC is similar, although morphing a bit into APM and security. So SPLK seems like an interesting comparison for both of them.

NOW and CRM seem to be more purebreds in the Enterprise productivity software realm, and the WORK, PLAN, PAYC, ZEN, and others seem to be from same family tree.

There may be nothing to glean here. Ultimately I agree on the ZS call only because there are too many examples of multiple contraction and incredible stories turning on a dime, that it is hard to justify P/S of 50-60-70 when you have mkt caps already over 15b…commonsense seems to say the upside is limited.

Google, Facebook, Amazon, and Apple are all consumer-facing (mostly). Seems silly to take 4 of the largest public companies in the history of mankind and use their mkt caps to justify Zoom or something. Kind of like assuming every NBA draft pick will be Michael Jordan. (hint: scouts don’t do that)

CRM reached escape velocity. NOW appears to have done so, too. Splunk was close and then the engines stalled. Perhaps it has more to do with the stickiness of the products. The former are critical to entire enterprises in many cases. Splunk may be relevant to just the data/scientists, and if reddit threads on open source are to be believed, these devops guys are constantly trying out other things. Maybe SPLK, ESTC, MDB, and other open source models are weaker as a result of the ability for their end users to opt out and try new/disruptive solutions.

You can’t just swap out CRM or NOW quickly…no more than you could SAP or ORCL.

2017 was great, 2018 was great, 2019 has been great…just trying to get in front of 2020, as the same tricks don’t work forever.

Chris - instead of next 5 years, I worry more about next 12-18-24 months.

Denny - S curve solves everything, I guess. But Splunk didn’t stop appreciating due to 85% saturation…I think you have to account for disruption, which effectively makes the TAM questionable.

Dreamer

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#7

What’s important to figure out is when this “end state” of ~20% revenue growth will be hit. Splunk has run into it at a run rate of about $2 billion. Salesforce was at a run rate of over $10 billion before their growth slowed to mid-20’s. Square is at $2 billion now and still growing at well over 40%. The question is how long will growth continue, and for that we must answer situation by situation, company by company. Market cap is one piece of the puzzle.

I absolutely agree. Hyper growth at a lower revenue Tun rate is much less impressive than the same growth at a higher run rate. I think there is something special about companies that can grow revenue over 50% when they are already at a billion dollar run rate. Also, don’t forget that once companies reach maturity, operating profit margins become part of the question.

#8

Why I prefer ZS to ZM and CRWD. CRWD has a PS around 60. ZM’s is around 70. ZS has a PS in the mid 30’s.

Drew and Dreamer,
I have about four and a half times as large a position in Zscaler as I have in ZM and Crowd, so I clearly agree with you in principle.

CRWD has an interesting bus model and was built-for-cloud, but when you started investing in AYX/TTD/MDB/ZS in early 2018, they were all about $3b or less mkt cap. If at that time I told you they would get to $17b mkt cap, you would jump for joy and consider it a job well done.

Dreamer, You are indeed “dreaming” of the good old days when we were the only people aware of these SaaS companies and taking them seriously. As I wrote in my discussion of valuation, this is the year that the awareness has become mainstream. Much as we might want to find a new AYX, TWLO or ZS at a cheap bargain price, it just is not going to happen any more. Those days are gone for good and we just have to live with it.

But there are other companies I like equally (like Elastic - ESTC, which is also growing at ~60%) that have a much, much less expensive valuation (ESTC’s PS is about 21!) Hence, ESTC is an 11% position for me, and ZS, although I’ve added this month, is only about a 4% position.

Drew, we can no longer imagine that Elastic is undiscovered. There has to be a reason that its stock price is below where it was six months ago when I just looked it up, and up just from $70 to $80 over the past year (compare that with any of our stocks). I would think of their continued large losses, their modus operandi of acquisition after acquisition, and their open source model. Not even touching on competition.

Finally, there is a big difference between growing at 60% and growing at 100%. If you grow at 60% for three years you are up 300%. If you grow at 100% for three years you are up 700% (eight times where you started). Not that I think either is going to happen, but just as an example why Crowdstrike might be at a higher multiple.

Here’s a little summary of Crowd’s business from my end of the month summary. It’s really quite remarkable:

“What you have just seen is a company with a revenue run rate of about $400 million, which will have revenue this year of roughly a half a billion dollars, with a rate of revenue growth last quarter of 103%, with subscription revenue making up 90% of the total and growing at 116%, with annual recurring revenue growing at 114%, with subscription gross margin of 73% which is up 11 points from 62% a year ago, with operating cash flow margin of +1%, improved from -7% in the quarter a year ago, with free cash flow margin of -17%, which improved 19 points from -36% the year ago quarter, with adjusted net profit margin of -23%, which improved 44 points from -67% the year ago quarter, with a dollar based retention rate between 120% and 147% (and some reason to think it’s about 140%), and over 3000 customers, with the mumber of customers growing by 21.6% SEQUENTIALLY last quarter, which compounds out to growing at 119% over four quarters (growth was “only” 103% last year, but over 170% the two previous years). My guestimate for revenue growth next quarter is 104%, but that is just a common sense guess, based on the cadence of yoy dollar growth of revenue in recent quarters. What you’ve just seen is a true powerhouse of a company. I added a little this month.

While it has been stated on the board that end point security is a commodity, companies selling commodities just don’t grow revenue 100% per year, year after year, and especially not with RISING MARGINS, both gross and net. Sorry, but that just doesn’t happen to commodity sellers.”

Best,

Saul

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#9

Drew, we can no longer imagine that Elastic is undiscovered. There has to be a reason that its stock price is below where it was six months ago when I just looked it up, and up just from $70 to $80 over the past year (compare that with any of our stocks). I would think of their continued large losses, their modus operandi of acquisition after acquisition, and their open source model. Not even touching on competition.

Saul,

ZS’s stock price is currently right where it was 5 months ago…why do you use this as a mark against ESTC and yet make ZS one of your top two positions?

Personally, I don’t believe in price anchoring. You may be right about some things holding ESTC back currently, but if growth ticks back up to 70%+, I think the stock would skyrocket.

Bear / Drew

17 Likes
#10

Saul,

ZS’s stock price is currently right where it was 5 months ago…why do you use this as a mark against ESTC and yet make ZS one of your top two positions?

MDB, despite a big up day, also where it was 5 months ago.

And let’s not even bother mentioning SQ.

ESTC earnings are tomorrow, and should serve as a catalyst…up or down.

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#11

Yes, we know why ZS is where it was 5 months ago. A research company called OTR did a “channel check” that said there is weakness at 10 of 14 resellers, driving the stock down. So we know exactly what FUD is going on there.

With ESTC there was the lockup expiration that was holding the stock down supposedly. That was resolved in July. Then the stock went up. Only to do an about face and turn around and go down again for some unknown reason and leave everyone to talk about how ESTC has the lowest P/S ratio relative to their high growth rates of any of these enterprise software stocks. But no explanation why that may be.

Now one could make the same case for MDB. It has been stagnant lately. But it had such a huge run earlier. ESTC never quite had that kind of run.

So maybe the question is why is ESTC trading at such a low price multiple compared to ZS even though they’re growing at roughly the same rate right now.

I have no interest in ESTC but I could be wrong and it doesn’t mean others share my belief bringing the stock down.

4 Likes
#12

ZS’s stock price is currently right where it was 5 months ago…why do you use this as a mark against ESTC and yet make ZS one of your top two positions?

ZS is up 70% give or take a bit in the past year, and is only “down” to UP 70% because of a hit article. ESTC is up from about $70 to about $80 in the past year. No comparison.

MDB, despite a big up day, also where it was 5 months ago.

Sorry Dreamer, that’s a specious argument. The month before five months ago Mongo rose 50%, that’s 50% in one month, and you chose to measure from the top of that rise. And Mongo is up over 100% in the past 12 months, so you can think of it as resting a bit. That’s nothing to do with ESTC that is up 14% or so in the past year, and has no reason to take a rest, and is still at a lower EV/S.

And let’s not even bother mentioning SQ.

No, let’s mention it. Its total lack of movement over 12 months when everything else was booming is one of the main reasons I gave for exiting it.

Saul

20 Likes
#13

Saul, What are your thoughts about McAfee going public as a spinoff. Since they are in the security space could this affect ZS and CRWD? Thanks.

#14

Hi Bronzeone, instead of asking a one-liner question, why don’t you tell us about McAfee, and after doing that tell us what you think the effect, if any, will be on Zscaler and Crowdstrike, and will it compete at all in any serious way?.
Thanks,
Saul

15 Likes
#15

Why is Splunk getting cheap despite year’s of hyper growth? Because it’s business model is being disrupted.

That became crystal clear this earnings call, although we speculated about it for a few quarters.

Don’t look backwards.

Tinker

9 Likes
#16

Don’t look backwards.

Tinker

Huh? So we should think our companies today couldnt suffer same fate?

The very point is that stellar ER results from 2014-2018 werent informing you that you should exit.

From a CAGR perspective, you would have been better off selling SPLK in Feb 2014 and never looking back and investing your funds elsewhere. Was only obvious in retrospect. Point is sometimes you can benefit from declaring victory vs justifying 50-60 p/s or expecting every company to get to $50b mkt cap overnight.

Hope the slack board is going well.

Dreamer

7 Likes
#17

Splunk has been chugging along for years now. In all honesty it was a pretty typical quarter for Splunk. And as it crosses the $2 billion mark, it’s growth is slowing slightly, just as it has been for the past few years. I held Splunk from July 2017 to July 2018, which, at that point, I compared Splunk to Alteryx and asked myself why am I holding Splunk when that money could have been in Alteryx. So I sold SPLK and bought AYX, which turned out to be the right call. Splunk has had slowing growth for years now, but I attribute that to law of large numbers.

But let’s take a look at Splunk. Its License revenues were up 36% YOY to 200,668 million in Q2 2018. Up from $147,231 million 2017. Total revenue was $388 million versus $280 million.

The most recent Q2, their most recent quarter, license revenues were up 44% YOY to $279 million. That’s a $79 million increase in license revenues. Compared to a $53 million increase in revenues last year’s Q2. Are you telling me that a company that basically grows revenue in a quarter in License revenues what ESTC almost does total is being disrupted by said ESTC? Let’s leave the anecdotal “case studies” that ESTC loves to talk about aside. The numbers just do not show it… or if they do, it’s a very slow, gradual disruption. A silent disruption if you will. ESTC grew revenues $33 million this quarter over last year’s quarter. They grew revenue $25 million in Q1 last year. So if anything, the share of new revenue is even more in Splunks favor. Splunk got 70% of new revenue this quarter versus 68% last year’s comparable quarter. That’s including only Splunk’s license revenue to all of Elastic’s revenue, service revenue included. Splunk grew overall revenue by $128 million. Which is more than what ESTC did total this quarter.

Do I think Splunk is getting disrupted by ESTC? They may be hurting a little, I’m sure, but their growth is just fine. You wouldn’t be able to tell looking at the numbers. Do I think there are better places for your money than Splunk? Yes, it’s why in June of 2018 I sold my SPLK and bought AYX with the proceeds.

I just don’t see this fascination with Elastic disrupting Splunk. Especially when Elastic’s revenue growth rates are falling at a faster percentage rate than Splunks! Splunk got to where they were for a reason. Unfortunately I cannot get excited about “new opportunities in SIEM” or endpoint security. It’s why I can not truly get excited about ESTC. I cannot get excited about when a CEO talks about one conversion from Splunk to Elastic. I don’t believe anecdotal stories indicate overall trends. Such is what makes a market.

One of the life’s lessons in the market is the new company often has it’s work cut out for it to displace the incumbent leader. Generally that, and I’d rather buy stocks in less competitive industries. I suppose those are the reasons I cannot fully get interested in ESTC. So if it does well without me, so be it.

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#18

Slack board is doing very great, thank you. It is the reason I don’t participate as much here as I use to. And no it is not just in retrospect. In 2014 there was no Elastic. We started talking about this last year about Splunk. Just as we said about Symantec that they got disrupted by Zscaler (when everyone else said we were crazy). Sold out of NVDA at the top, sold out of Arista at the top. Why? It was becoming pretty clear the thesis was reaching its peak fo rnow.

With Arista for sure that was obvious. Sold SHOP too at the same time. Over thinkgin I suppose, I just did not trust SHOP’s business model. But then boom, comes the marijuana business!

Out at the top of the 3D bubble…and so on.

In fact the primary mistake I made, and won’t again, is buying these fallen angels as turn arounds. Particularly around earnings. Appears Saul simply never even tried to make that mistake.

No company is disrupted until there is a clear disruptor on the scene. There was not in 2014. There was in 2018. 2019, and the last earnings call…BINGO.

But if you wish to continue investing from the past (and yes, past price appreciation is a very good proxy for future over performance - but only one data point) - or state we only analyze things in retrospect, more power to you then is all I can say.

I see NPI has not lost any of its sparkle. Have a good day.

Tinker

4 Likes
#19

12x,

I appreciate your interpretation. I don’t deny Splunk put up good numbers, as they typically do. What I think you probably saw and may have already discussed, but just in case you did not, was management’s painful discussion of customers hate their pricing model, hate it. And the difficulty they are having making a transition that may be less hated.

It was a very unusual conversation to have when the quarter itself had decent numbers, but management was still explaining the problems it was seeing. It was clear and classic signs of disruption and Splunk trying to react to it without destroying its business model.

But I will leave it to others to discuss if they want. That is why Splunk share price is under performing. It is a real business challenge they have. We shall see how they deal with it. They have a good product no doubt.

Tinker

1 Like
#20

You continue to either not read clearly or purposely attribute thoughta to me that arent mine.

I am not advocating buyins splunk. I am saying they are an example of a stock that many could have held too long.

I also never base my investment on ESTC to be tied to Splunk. Logs are just one part of elastic biz.

Amazing your investments are all perfectly timed. I guess you werent pro-nvda inNov 2018 when we all thought they were the best stock out there…and then mgmt proved inept.

You have an entire saul board full of posts to reply to. Maybe ignore mine then.

Enjoy your slack board.

Dreamer

7 Likes
#21

Dreamer and Tinker, please keep the personal jabs to yourselves via off-board email, or whatever.

Let’s focus on the points being discussed, not the person discussing them.

Thanks for your cooperation.

34 Likes
#22

Dreamer,
One issue with SPLK was even in the 2014-17 period when revenue was growing nicely its margins started going south. Ideally you want margins to stay flat or rise. Maybe that had something to do with the stock’s under performance in 2014-17. But since 1/2018 SPLK has done better and the margins are better too. The pricing issue is holding it back now or else we would have seen a much higher P/S.

https://www.macrotrends.net/stocks/charts/SPLK/splunk/profit…

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