ZScaler's Optics

This is how I see it right now. It looks like an optics problem, similar to Twilio.

The CFO said the first half of the year’s billings would be 43% of the year’s.

$510 million is the high end of billings guidance. 43% of that is $219 million.

This quarter’s billings were $88. So that implies Q2 will be $131 million.

$131 vs. last year’s Q2 implies 14% billings growth, down from 74% last year. Wall Street doesn’t like that sort of optics.

But let’s say this is very conservative guidance and the company does $530 million in billings. That implies $140 million for Q2, which is 22% growth. Sure, the beat could get even bigger but I can’t see the company possibly doing better than 30% billings growth next quarter which will ooze into Q3’s revenue guidance.

Don’t get me wrong, I still think this is a valuable company and I really think the product is discontinuous and special, but I think next quarter might be dangerous when it still trades at 14x forward sales. Anyway, that’s my 2 cents.

Q2 will be very interesting…

  • Fish
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Thanks for your insight above, Fish. Though you have gills, you still aiitte in Monkey’s book.

Allow me to reframe the conversation. You’re explicitly talking in terms of 90 days or “next quarter.” That’s fine. Perhaps the high valuation and lower growth rate in the next 90 days will cause another buying opportunity. One way of investing is, in fact, short-term, however relatively you want to define it. Or momentum investing based with fancy graphs and bars and all kinds of reverse-inside-out candlesticks.

But another way is to think is in terms of the business and where it will be in years and perhaps, if we get lucky, even decades. Now go on and read the transcript from yesterday’s earnings call:

https://www.fool.com/earnings/call-transcripts/2019/12/03/zs…

Nothing in there suggests this company is thinking in terms of 90 days. They’re thinking in terms of the future of network security. The entire future, like infinity! Here’s a direct quote:

The next question is, why can’t they build a platform like Zscaler, well the answer lies in the architecture. Architecture is like the foundation of a building you can’t change the foundation unless you start all over which is hard and takes a long time. We know that start-ups like Salesforce and Workday competed and won against much larger on premise incumbent vendors, because of their cloud native architecture. We believe we are doing the same in the network security space.

So reasons to sell now is because next quarter might continue to be a transition phase in a much bigger cycle of continuing growth. Maybe the multiples continue to come down. You sell now, invest in something else, hopefully that goes up, you sell that, buy back in to ZS later at just as good or an even better banana bargain. But what if all those things don’t go that way?

Reasons to hold or buy more now: everything about the business suggests they have no competition in an ever expanding essential non-frivolous market with a sales team just starting to scale its ducks in a row––or whatever that weird animal metaphor is. Cost is the opportunity in other stocks while we wait. But also what if ZS is now as low as it will go and will start climbing instead? It is already off by 50% from its peak, right? Forgive the price anchoring.

To Monkey, option one feels closer to short term risk taking while option two sounds closer to what we mean by “investing” with investing implying “for the long term.” And everything about Zscaler suggests a successful vision in the years ahead.

Monkey’s not arguing that one is necessarily better––what’s ultimately better is whatever shakes the bananas from the tree. But we should know the philosophy we’re employing.

At the moment, everything about Zscaler suggets a powerful business only getting better and more essential with no competition in sight. Sales are lumpy? Fine. What will the price of ZS be 5 years from now. If it’s 100% higher, Monkey will take his 20% yearly gains without the agitation of guess work. His AYX position is already insanely high and that, too, might have some unforeseen rotten bananas in the bunch.

Not all excellent investing gains happen every quarter, each and every quarter. Sometimes there are pauses for integration.

TL;DR: sometimes excellent companies grow in non-linear ways and doing nothing is more efficient than doing something. Is patience not even a thing in investing anymore? Why or why not? (Note: patience is not the same as “hope” in this case; there seems nothing “hopeful” about Zscaler––just execution and the time needed to execute.)

But enough from the animals: What do the humanoids among us think?

Monkey (long ZS and still considering selling puts to gain extra shares at an even lower cost should it continue to drift lower)

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I have a small ZS position (<1%), opened after the last quarterly hit punished them more than I thought was warranted. Believe it or not, it’s still above water, but not by a lot.

I was hoping this Q would provide some clarity and a little boost and I would add to the position, but I still find myself not fully confident to expand the position, knowing that end of year selling will abound for the next few weeks.

Definitely like what the company is doing and believe they have great potential, but that is tempered by my realistic brain observing the slowing growth and what those growth numbers trigger others to be doing (Saul, for example, trimmed through October, November and yesterday/today, but did add some back). In other words, I think there may yet be a better opportunity to buy shares in December – or, sell puts on future bananas, as Monkey is doing.

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…Nothing in there suggests this company is thinking in terms of 90 days. They’re thinking in terms of the future of network security. The entire future, like infinity! …So reasons to sell now are because next quarter might continue to be a transition phase in a much bigger cycle of continuing growth. Maybe the multiples continue to come down… Reasons to hold or buy more now: everything about the business suggests they have no competition in an ever expanding essential non-frivolous market with a sales team just starting to get its ducks in a row… At the moment, everything about Zscaler suggests a powerful business only getting better and more essential with no competition in sight. Sales are lumpy? Fine. What will the price of ZS be 5 years from now?..

Monkey, I thought your entire post was a beautiful piece of writing. I often wish that I could write so clearly. I agree entirely. I’m just not as sure as you are so I’m willing to sit with a reduced but still very meaningful position of about 6.7% of my portfolio.

Best,

Saul

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Pretend you did not listen to the call or read the transcript from the company leaders opining on the business.

What line item in the financials leads you to believe “everything about the business suggests they have no competition in an ever expanding essential non-frivolous market”?

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Pretend you did not listen to the call or read the transcript from the company leaders opining on the business.

What line item in the financials leads you to believe “everything about the business suggests they have no competition in an ever expanding essential non-frivolous market”?

Torque, that is exactly it. Narrative “they are coming to us” and “no competition in ever growing market”. Alteryx can say that, Datadog can say that, Zoom can say that, but I do challenge anyone to go through the trend of the last two earnings (not just this earning) and find numbers that support that narrative. I dare say you cannot.

The narrative states ever growing, mission critical, market, and we are it. Microsoft supports this position without question.

Thus the duality. Yes, the narrative and the numbers no longer are even close to being in sync and yet there is still truth to the long term narrative. I won’t deny that. So holding in Monkey’s terms makes sense as the narrative still makes sense because Microsoft makes sense.

And not holding because the investing process/methodology is broken also makes sense. For me, however, I’m sticking with process. Been burned too many times by “vision” of narratives. When Arista’s numbers broke from the narrative - boom - out at the top despite Arista still being a fine company with fine management. Better investments out there where narrative and numbers coincide.

Tinker

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