Investors scared of recession keep cutting fastest-growing cloud stocks
Nima Gumsari, co-founder and CEO of Blend, speaks during the Sooner Than You Think Conference in New York on October 16, 2018.
Alex Flynn | Bloomberg | Getty Images
Tech investors finally got some relief last week, as the Nasdaq broke a seven-week losing streak, its worst stretch since the 2001 dotcom crash.
With five months on the books, 2022 has been a dark year for technology so far. Nobody knows this better than investors in cloud computing companies, which have been among the darlings of the past five years, particularly during the stay-at-home days of the pandemic.
Ironically, growth remains strong and businesses are benefiting as economies reopen, but investors are selling anyway.
Bill.com, Blend Labs, and SentinelOne still doubled their returns year over year at 179%, 124%, and 120%, respectively. However, the trio is worth about half of what it was at the end of 2021. The market has taken a sledgehammer on the entire basket.
Byron Dieter of Bessemer Venture Partners, an investor in cloud startups and one of the most vocal commentators on cloud stocks, noted earlier this month that revenue multiples for the BVP Nasdaq Emerging Cloud Index have fallen back to where they were in 2017.
One of Deeter’s colleagues at Bessemer, Kent Bennett, isn’t sure why the fastest farmers didn’t get a pass through the cloud class. But he has an idea.
Bennett, a board member of the restaurant program, said Toast, which showed 90% growth in the first quarter. Inventory is now down 52% since the start of the year.
Toast revealed lower revenue in 2020 as in-person visits to the restaurant eased, resulting in less intense use of the company’s point-of-sale hardware and software. Then take off the online application. Now that people are increasingly eating again, CEO Chris Comparato said in an interview with CNBC earlier this month, Toast is seeing stronger demand for Go mobile point of sale devices and QR codes that allow people to order and pay using their own phones. .
Now that the company has recovered from its Covid stumble, investors are telling the company to “chart a better path toward profitability,” he said.
Management is asking all teams to be very diligent about their unit economics, but Compiato said he’s not ready to tell investors exactly when the company will break even.
What Toast provided is new information about the margins. On Toast’s first-quarter earnings call earlier this month, Chief Financial Officer Elena Gomez said guidance indicates that the EBITDA margin in the second half of 2022 will be two points higher than in the company’s first half. It serves to enhance margins in the future.
“A few investors have paid, and they want more details, sure,” Comparatu said. “But a lot of them are like, ‘Okay, that was a different tune, Chris, thank you. Chris and Elena, please continue to implement this on this vision. “
Other cloud companies are getting the message as well.
CEO Frank Slotman, CEO of Snowflake, announced in a call with analysts on Wednesday.
Zuora, which offers subscription management software, is “focused on building a successful long-term company, and achieving sustainable, profitable growth for years to come,” CEO Tien Tzuo said on his company’s quarterly analyst call. The company reported a net loss of $23.2 million on revenue of $93.2 million, compared to a loss of $17.7 million in the first quarter of last year.
Back to the “Rule of Forty”
Even across the broader software industry, there is a re-acknowledgment of the old view that software should make money. Splunk, whose software helps corporate security teams collect and analyze data, included a slide in its shareholder presentation called “Increasing Profitability with Scope.” He charted the past few years’ performance for Splunk against the “Rule of 40,” a concept that states that a company’s revenue growth rate and profit margin should be as high as 40%. Splunk called for 35%, the closest it has been in three years, in the current fiscal year.
The focus on efficiency isn’t entirely absent at Bill.com, whose software helps small and medium-sized businesses manage billing and invoicing, but it’s easy to miss, because revenue is growing much faster than it is in most businesses. Even before software sales began in November, executives were touting the economics of the company’s health unit.
Blend Labs, which gives banks software they can rely on for mortgage applications and other operations, has been more active in reinventing itself for the new market realities, but it’s also one-seventeenth the size of Bill.com by market capitalization.
Despite enjoying overgrowth, Blend reduced its staff by 10% in April. Nima Ghamsari, co-founder and president of the company, told analysts that the company is conducting a “thorough review to align our cash consumption with near-term market realities, while charting a clear path toward stronger product and operating margins that will lead to Blend owning long-term profitability.”
SentinelOne, which sells cybersecurity software that detects and responds to threats, has been busy working on its cost structure. Co-founder and CEO Tomer Weingarten directed analysts’ attention to margin improvement during a March conference call, and said the company aims to make further progress over the next year.
Analysts received better-than-expected comments and results overall. But many of them are still lowering their price targets on SentinelOne stock anyway.
“As we increase our growth estimates on S, we have reduced PT to $48/share due to a drop in software multiples,” BTIG analysts wrote to clients. In other words, the class was crushed, and the SentinelOne was not exempt.
By then, the WisdomTree Cloud Computing Fund, an exchange-traded fund that tracks the Bessemer index, is down 47% from its high on November 9. The decline did not stop as the Federal Reserve reiterated plans to fight inflation by raising interest rates.
This leaves cloud watchers wondering when the downward pressure will drop.
It’s going to take us a few months to get through this. It’s like falling back into a hangover, after Covid has teased investors on cloud stocks,” said Jason Lemkin, founder of SaaStr, a conferencing company focused on the cloud. It didn’t go through Bloody Marys and Aspirins,” he said.
Two of the biggest divas in the Covid cloud group, Shopify and Zoom Video Communications, saw their triple-digit growth disappear last year as stores started reopening and in-person social shares started making a comeback. If anything, Lemkin said, investors should have realized that the demand boom was largely in the past.
“We’re going back to the middle,” he said.
Reset may not be uniform, though. Mary Donofrio, another investor in Bessemer, said cloud companies that adhere to the rule of 40 show healthier revenue multiples than those that don’t. She said companies that show free cash flow margins above 10% also have higher multipliers better these days, as investors fear a recession.
“The market has shifted to where liquidity is king,” said D’Onofrio.
CNBC’s Ari Levy contributed to this report.
Watch: Bessemer Dieter says technology will see cuts in marketing budgets, slower recruitment and layoffs.