Updated: Feb 12, 2021
Proverbs Chapter 21 verse 21 states, "Whoever pursues righteousness and love finds life, prosperity and honor."
When I think of what righteousness and love means, it reminds me to consider God's perfect will and love versus my true nature. While God is perfect in every way in both biblical principles and kindness and compassion, I see how I am so far from being capable of meeting these qualities and standards. However, Jesus Christ died for my sin (or inability to be truly righteous or full of love), so that through Him, I can continue pursuing these qualities. It is through this relationship with Jesus, that I will find life, prosperity and honor.
When I think of this verse and investing, the key words, pursue and honor come to mind. I must continually pursue information, strategy, and diligence in order to be prepared for investment opportunities. And I must honor my family, friends, and community with respect to the investment dialogue that I generate.
This brings me to today's focus, earnings season. Four times a year, every quarter, every public company provides its most recent earnings report and update. We are in the midst of this in early February for the fourth quarter calendar year-end. For many companies, this means year-end for 2020, for others with different fiscal years, it may be different. Regardless, I will be providing updates for every holding within the portfolio, with exceptions being Special Purpose Acquisition Companies, SPACs, that have yet to announce a target.
Atlassian Corporation (TEAM) powers cross-functional collaboration across developers, IT, and non-technical teams. Key products include Jira, Confluence, and Trello, as well as cloud platform capabilities. The company considers its addressable market currently at $24 billion, with sustainable growth potential.
Atlassian's key financial metrics as of their latest filing and on a Last Twelve-Month, LTM, period are as follows:
Net Debt Position: $370 million
Revenues: $1.8 billion
Gross Margin, GM: 84%
Operating Cash Flow, OCF / Margin: $560 million / 31%
Free Cash Flow, FCF / Margin: $455 million / 25%
Shares Outstanding 249 million
Subscription Rev: $1.1 billion
Maintenance Rev: $500 million
Perpetual License Rev: $86 million
Other Rev: $126 million
Atlassian's fiscal year ends every June 30th. With the December quarter serving as the fiscal year's midpoint, Atlassian witnessed Revenue growth just above 24% for the first six months of the year. GM modestly improved, however, both OCF and FCF margins declined as nominal performance dropped by 5% and 10% respectively.
The 24% Revenue growth is a decline from the prior four-year average at 37%. Analysts are looking for fiscal year 2021 Revenue growth at 20% and 2022 growth at around 17%. Atlassian considers its competitive market intense, with relatively low barriers to entry. Major listed competitors include Microsoft Corporation (including GitHub) (MSFT), IBM (IBM), Google (GOOG), ServiceNow (NOW), Salesforce (CRM), PagerDuty (PD), Gitlab, Zendesk (ZEN), Asana (ASAN), Monday.com and Smartsheet (SMAR). The teams collaboration working environment has shifted recently with Asana going public and Salesforce acquiring Slack, Inc. (WORK).
Atlassian has provided clarity of the reasons why Revenue performance is anticipated to slow over the next couple of years as follows:
Contracting server business and corresponding marketplace impacts: There is a transition from the company's server licensing for customers to the cloud, which also effects the marketplace Revenue within the Other Revenue category. The company expects to continue to see declines for the Perpetual License Revenue as server licenses will no longer be offered.
Enterprise loyalty discounts applied to migrating customers.
Pricing to drive growth rates for cloud Revenue.
COVID and churn.
Free editions taking longer to convert into paying customers.
While Atlassian has explained the slow down, there are risks as to how Revenues may accelerate and/or perform post-2022. ServiceNow's (NOW) details were very strong and will be reviewed below, other competitors peers have not displayed substantially stronger results, with most still remaining at smaller scale. Smartsheet witnessed 43% Revenue growth from its most recent earnings call, has modest net cash, but is still struggling at its scale to generate positive Cash Flow, CF. PagerDuty has seen 28% Revenue growth, with around $120 million in net cash, and a 4% OCF margin, scale still remains small. Zendesk has witnessed 28% Revenue growth with more scale, and has nearly $300 million in net cash, but with negative OCF performance.
Based on peer results, Atlassian still has a long runway of growth potential ahead, so the key is to assess valuation. Key updated valuation metrics include:
Enterprise Value, EV: $61 billion
EV/Revenues: 34 times
Net Debt/OCF: 1.1 times
Stock Price, SP/OCF per Share: 109 times
Five analysts, DA Davidson, BMO Capital, Canaccord, Cowen, and Mizuho all raised their PTs to an average of $264 per share reflecting an 8% premium from last Friday's close. I am in the same camp with my PT at $260 per share, but this is based on a 12-month time frame. As such, I don't see much upside for Atlassian until we get better clarity on expected Revenue acceleration from fiscal year 2022.
The challenge will be getting ahead with modeling a revised growth rate for fiscal years 2023 and 2024. Regardless, I think that Atlassian is trading at a pretty steep premium so I am inclined to be more patient as things play out.
ServiceNow, Inc. (NOW) considers itself the platform of platforms, targeting workflows and efficiency whether for IT, employees, customers, or creators. IT workflows include management products for service, operations, business, and assets. Other products include DevOps, security operations, governance-risk-compliance, and telecommunications network performance management.
ServiceNow's key financial metrics as of their latest filing and on a Last Twelve-Month, LTM, period are as follows:
Net Cash Position: $2.9 billion
Revenues: $4.5 billion
Gross Margin, GM: 78%
Operating Cash Flow, OCF / Margin: $1.8 billion / 40%
Free Cash Flow, FCF / Margin: $990 million / 22%
Shares Outstanding 202 million
Customers with Annualized Contract Value (ACV) > $1 Million: 1,093
Subscription Rev: $4.3 billion
Professional Services & Other Rev: $234 million
ServiceNow's fiscal year ends every December 31st of each calendar year. For the full 2020 year, ServiceNow witnessed Revenue growth just above 31%. GM improved by 120 basis points, and OCF/FCF margins also increased by around 400 basis points, while nominal values increased by 44% and 66% respectively.
The 31% Revenue growth is a decline from the prior four-year average at 36%. Analysts are looking for fiscal year 2021 Revenue growth at 27% and 2022 growth at around 25%. Clearly, ServiceNow's performance has been much stronger than Atlassian's with much larger scale, despite both companies seeing a similar competitive market. ServiceNow is expected to generate over $7 billion in Revenue for 2022 versus $2.4 billion for Atlassian (six-month lag in fiscal years), with Bill McDermott stating that the company is well on its way to becoming a $10 billion Revenue company.
While Atlassian is in the midst of a transition, with slowing growth the next two fiscal years, ServiceNow is displaying strong maturity and stability with its continued growth trajectory. A key growth driver is customers with an ACV greater than $1 million that has averaged nearly 30% growth the past three years. Many software service companies offer products that are very inexpensive that generate thousands upon thousands of customers. Getting to a level where accounts enter seven figure levels is key to continue to scale the business.
Key updated valuation metrics for ServiceNow include:
Enterprise Value, EV: $116 billion
EV/Revenues: 26 times
Net Debt/OCF: N/A
Stock Price, SP/OCF per Share: 67 times
Eleven analysts, Argus, Cowen, RBC Capital, Credit Suisse, Needham, Macquerie, Oppenheimer, BMO Capital, Canaccord, Barclays, and Mizuho all raised their PTs to an average of just below $620 per share reflecting an 5% premium from last Friday's close. I disagree and feel this is much too low as ServiceNow is separating itself substantially from its peers and is on track towards $10 billion in Revenue. My PT is set at just below $750 per share over the next 18-month period.
Both companies have lower FCF per share metrics, with ServiceNow being slightly lower historically. I do expect ServiceNow to see both its OCF/FCF margins contract from 2020 being a unique year and a likely peak. However, I believe that ServiceNow's current valuation is much more reasonable today, and that it will maintain this premium over time, and analysts will begin raising PTs further over the coming months.
Spotify Technology (SPOT) is a leading global audio streaming subscription service. With a presence in 93 countries and territories and growing, the company's platform includes 345 million Monthly Active Users, MAUs, and 155 million Premium Subscribers as of December 31, 2020.
Spotify's key financial metrics as of their latest filing and on a Last Twelve-Month, LTM, period are as follows:
Net Cash Position: $4.9 billion
Revenues: $9.6 billion
Gross Margin, GM: 25.5%
Operating Cash Flow, OCF / Margin: $317 million / 3.3%
Free Cash Flow, FCF / Margin: $570 million / 6%
Shares Outstanding 190 million
Premium Segment Rev: $8.7 billion
Add-Supported Segment Rev: $912 million
Monthly Active Users (MAUs): 345 million
Premium Subscribers: 155 million
Add-Supported MAUs: 199 million
Premium Average Revenue per User (ARPU): $5.27
Like ServiceNow, Spotify's fiscal year ends every December 31st of each calendar year. For the full 2020 year, Spotify witnessed Revenue growth just above 27%. GM was stable, and OCF/FCF margins decline by 500 and 400 basis points respectively, while nominal values dropped by 50% and 22% respectively.
The 27% Revenue growth is a decline from the prior three-year average at 34%. Analysts are looking for fiscal year 2021 and 2022 Revenue growth at approximately 20% per year. Competition for Spotify is strong with listed competitors including Amazon Music (AMZN), Apple Music and Apple Podcasts (AAPL), Deezer, Joox, Pandora (SIRI), SoundCloud, TikTok, YouTube Music (GOOG), and others with competing services. Competition is expected to weigh on near-term growth potential, but Spotify has continued to retain a top position globally.
Spotify's financials are reported in Euros so there is currency risk involved in Revenue and other financial estimates. The key focus has been on GM impacts for both Premium and Add-Supported Revenue, with the latter experiencing substantial declines. Premium performance has improved offsetting this with GM remaining stable. The key impact on Cash Flows has been increasing expenses for podcast deals and focus. Other important line items impacting performance have included deferred taxes as losses have mounted, and accounts receivable.
Key updated valuation metrics for Spotify include:
Enterprise Value, EV: $54 billion
EV/Revenues: 5.6 times
Net Debt/OCF: N/A
Stock Price, SP/OCF per Share: 186 times
Three analysts, Loop Capital, UBS, and Barclays all raised and lowered their PTs to an average of $325 and $235 per share reflecting a 5% premium and 25% discount from last Friday's close. I am much more optimistic with a PT near $433 per share which is based upon a higher Revenue expectation near or above $14 billion, and an improvement for both OCF/FCF margins.
As Spotify continues to pursue a podcast focus and expenses have increased, I see an opportunity for a low point and recovery pattern to occur. I also believe that competitors such as Amazon, Apple, and Google will face increasing challenges based on the environment that is painting them as Big Tech colluders with government to thwart competition. Spotify will remain laser focused on audio streaming and will need to continue to innovate and execute to differentiate its service. With nearly $5 billion in cash and no debt, Spotify is prepared to invest for the future.
Peloton Interactive, Inc. (PTON) is the largest interactive fitness platform in the world with a community of over 3.1 million Members as of June 30, 2020. The company states that it has pioneered connected, technology-enabled fitness, and the streaming of immersive, instructor-led boutique classes to its Members anytime, anywhere. Peloton feels that it makes fitness entertaining, approachable, effective, and convenient, while fostering social connections that encourage Members to be the best versions of themselves.
Peloton's key financial metrics as of their latest filing and on a Last Twelve-Month, LTM, period are as follows:
Net Cash Position: $2.1 billion
Revenues: $3 billion
Gross Margin, GM: 44%
Operating Cash Flow, OCF / Margin: $854 million / 29%
Free Cash Flow, FCF / Margin: $708 million / 24%
Shares Outstanding 295 million
Connected Fitness Products Rev: $2.4 billion
Subscription Rev: $571 million
Ending Connected Fitness Subscriptions: 1.7 million
Average Net Monthly Connected Fitness Churn: 0.5%
Total Workouts: 297 million
Average Monthly Workouts per Connected Fitness Subscription: 26.7
Like Atlassian, Peloton's fiscal year ends every June 30th. With the December quarter serving as the fiscal year's midpoint, Peloton witnessed Revenue growth of 163% for the first six months of the year. GM declined by 200 basis points, however, both OCF and FCF margins and nominal values increase exponentially, with the latter increasing by nearly 1,500%.
The 163% Revenue growth is an increase from the prior two-year average at just over 100%, largely driven by the pandemic impacts. Analysts are looking for fiscal year 2021 Revenue growth of just below 120% as a result, and growth for 2022 at nearly 35%. There are a variety of competitors, however, Peloton feels that the company's first-mover advantage, leading market position, brand recognition, and vertically integrated platform set them apart in the rapidly growing market for connected, technology-enabled fitness. Peloton argues that it provide a superior value proposition and benefit from the endorsement of its Connected Fitness Subscriptions, giving the company a competitive advantage versus traditional fitness and wellness products and services, and future potential entrants.
Peloton has gained tremendous endorsement success from many celebrities, however, many investors have shied away from the company thinking that the COVID pandemic has exacerbated a so-called fad. Analysts have keyed in on the subscription service as it generates a GM closer to 60% versus the 40% from connected fitness products, and has diversified a more recurring form of Revenue. I think a company like Peloton is a prime example of investor generational bias. Many in older generations don't see how a company like Peloton can simply maintain its advantage, but Peloton is looking to shift how work out enthusiasts exercise, namely, a gym isn't altogether necessary, and the individual and/or social user experience can be uniquely tailored through the platform subscription service.
Key updated valuation metrics for Peloton include:
Enterprise Value, EV: $42 billion
EV/Revenues: 14 times
Net Debt/OCF: N/A
Stock Price, SP/OCF per Share: 51 times
Most analysts were positive on Peloton including with ten analysts, Gordon Haskett, Barclays, Stifel, Goldman Sachs, Cowen, Roth Capital, Canaccord, Needham, Truist, and JPMorgan all raising their PTs to an average of $177 per share reflecting a 20% premium from last Friday's close. There were three though, MKM Partners, BMO Capital, and Raymond James all with mixed reviews including PTs at $130, $45, and no PT. Key concerns of these three relate to declining hardware margins, competition, and future comparables being tough to beat. I am on the bull side with a PT near $204 per share which is based upon a slightly higher Revenue expectation at $5.5 billion in fiscal year 2022, and an OCF margin declining towards 25%.
I really feel like Peloton will make or break the long-term investment story over the next 18-months. It's nothing new as any company that pushes the limit faces more pressure from competitors as they scale. Companies that will win over the long-term always welcome competition and beat it. Right now, I'm in the camp expecting that Peloton will continue to deliver. But I also recognize the sensitivity to competition, especially the "Amazon effect", so I will remain prudent in managing the position.
Pinterest, Inc. (PINS) provides a visual discovery engine in the United States and internationally. The company's engine allows people to find inspiration for their lives, including recipes, style and home inspiration, Do-it-Yourself DIY, and others. It shows them visual recommendations based on people personal taste and interests. The name of the game for Pinterest, is advertising monetization.
Pinterest's key financial metrics as of their latest filing and on a Last Twelve-Month, LTM, period are as follows:
Net Cash Position: $1.8 billion
Revenues: $1.7 billion
Gross Margin, GM: 73.5%
Operating Cash Flow, OCF / Margin: $29 million / 1.7%
Free Cash Flow, FCF / Margin: $31 million / 1.8%
Shares Outstanding 629 million
United States Rev: $1.4 billion
International Rev: $288 million
Quarterly Monthly Active Users (MAUs): 459 million
United States MAUs: 98 million
International MAUs: 361 million
Quarterly Average Revenue per User (ARPU): $1.02
United States ARU: $3.74
International ARU: $0.21
Pinterest's fiscal year ends every December 31st of each calendar year. For the full 2020 year, Pinterest witnessed Revenue growth just above 48%. GM increased by nearly 500 basis points, and OCF/FCF margins and nominal value (while still very modest) increased exponentially as Pinterest witnessed initial Cash Flow inflection.
The 48% Revenue growth is a decline from the prior two-year average at 55%. Analysts are looking for fiscal year 2021 Revenue growth at 38% and 2022 growth at approximately 33%. Pinterest breaks down their competition in a couple ways. First larger peers including Amazon, Facebook (including Instagram) (FB), Google (including YouTube), Snap (SNAP), TikTok and Twitter (TWTR). Smaller competitors include Allrecipes, Houzz and Tastemade, that offer users engaging content and commerce opportunities through similar technology or products.
The key distinguishing factor for Pinterest is the difference between the U.S. and international business. For the U.S. key metrics including MAUs and ARU have increased by an average 9% and 36% respectively the past four years. For international, these same metrics have increased by an average 42% and 80% respectively. As Pinterest's MAUs within the U.S. continue to grow around 10% per year, the company will continue to need to scale the international business towards $1 billion in Revenue, while at the same time, continuing to drive U.S. and international ARU.
Key updated valuation metrics for Pinterest include:
Enterprise Value, EV: $50 billion
EV/Revenues: 29.5 times
Net Debt/OCF: N/A
Stock Price, SP/OCF per Share: 1,787 times
Nine analysts, Loop KeyBanc, Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, Wedbush, Susquehanna, Bernstein, and Piper Sandler all raised their PTs to an average of $91 per share reflecting an 11% premium from last Friday's close. I am much more optimistic with a PT near $117 per share which is based upon a higher Revenue expectation near $3.3 billion, and a further Cash Flow inflection breakout towards a 10% OCF margin.
I am looking to put two and two together through combined increased U.S. ARU and sustained robust international MAU and ARU growth. The U.S. scale is strong and only needs to see MAU growth continue just below or close to 10% per year over the next few years. The unit economics should continue to drive Cash Flow performance towards my estimated margin.
In the future, I will attempt to focus on one company at a time, but as earnings tend to come out with more than one holding on the same day, some blog updates may follow this similar pattern. 2020 was a year where I was able to get in to many holdings with solid entry levels, including position increases. For these five companies, no moves have been made as I do not see any compelling opportunities to increase positions further, despite my increased PTs.
The 60% rule is in full effect as none are really close to triggering a potential 60% return over the next 18-month period. At the same time, I don't see anything alarming to contest continuing to hold any within the portfolio. Sometimes, the review simply is just that, a review, with no immediate actionable follow-up.