Recession-fearing investors continue to scrap fastest-growing cloud stocks

Nima Ghamsari, co-founder and chief executive officer of Blend, speaks at 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, when the Nasdaq broke a seven-week loss streak, the worst since the dotcom crisis of 2001.

With five months on the books, 2022 has been a dark year for tech so far. Nobody knows more than investors in cloud computing companies, which have been among the darlings of the past five years, especially during the stay-at-home days of the pandemic.

Paradoxically, growth remains robust and companies are benefiting from the reopening of the economy, but investors are selling anyway.

bill.comBlend Labs and SentinelOne are all still doubling their sales year over year, at 179%, 124% and 120% respectively. Still, the trio is worth about half of what they were at the end of 2021. The market has taken a sledgehammer to the whole basket.

Byron Deeter of Bessemer Venture Partners, an investor in cloud start-ups and one of the most outspoken cloud stock commentators, noted earlier this month that revenue multiples for the company’s BVP Nasdaq Emerging Cloud Index had fallen back to where they were in 2017.

win please

One of Deeter’s colleagues at Bessemer, Kent Bennett, isn’t sure why the fastest growers don’t make it through the cut in the cloud category. But he has an idea.

“You can absolutely imagine that at a time like this it would go from revenue to ‘Holy crap, get me out of this market,’ and then back to efficiency over time,” said Bennett, who serves on the restaurant software board. sit. company Toastwho showed himself 90% growth in the first quarter. The stock is now down 52% so far.

Toast revealed declining turnover in 2020 as in-person restaurant visits became lighter, resulting in less intensive use of the company’s hardware and software at the point of sale. Then the online ordering started. Now, more and more people are eating in again, and Toast is seeing increased demand for its Go mobile outlets and QR codes that allow people to order and pay on their own phones, CEO Chris Comparato said in an interview with CNBC earlier this month.

Now that the company has recovered from its Covid stumble, investors are telling the company to “outline a better path to profitability,” he said.

Management tells all teams to be very diligent about their unit economy, but Comparato said it isn’t ready to tell investors when exactly the company will break even.

What Toast did offer is new information about margins. During Toast’s first-quarter earnings call earlier this month, chief financial officer Elena Gomez said the forecast implies profit margin before interest, taxes, depreciation and amortization will be 2 points higher in the second half of 2022 compared to the first half. as the company works to increase margins in the future.

“A few investors have pushed, and they definitely want some more details,” Comparato said. “But a lot of them say, ‘Okay, this was a different tone, Chris, thank you. Chris and Elena, please keep doing this with this vision.'”

Other cloud companies are also getting the message.

Creator of data analysis software Snowflakewhich just ended a two-and-a-half-year streak of triple-digit revenue growth, is “not a company that grows at all costs,” CEO Frank Slootman explained Wednesday in talks with analysts.

Zuora, which offers subscription management software, is “focused on building a long-term successful business, delivering sustainable and profitable growth for years to come,” CEO Tien Tzuo said during his company’s quarterly analyst call. 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 prior year quarter.

Return to the ‘rule of 40’

Even in the wider software industry, there is a renewed recognition of the old-fashioned notion that software should make money. splunkwhose software helps enterprise security teams collect and analyze data, including a slide in his shareholder presentation called “Growing Profitable With Scale.” It charted Splunk’s performance in recent years with the “Rule of 40“, a concept that dictates that a company’s revenue growth and profit margin should reach 40%. Splunk called for 35%, the closest to three years, in the current fiscal year.

The emphasis on efficiency isn’t entirely absent from Bill.com, whose software helps small and medium-sized businesses manage billing and billing, but that’s easier to miss as revenue grows so much faster than most businesses. Even before the software sale kicked off in November, executives praised the company’s healthy unit economy.

Blend Labs, which gives banks software to draw on for mortgage applications and other processes, has been more active in repositioning itself for the new market reality, but it’s also one-seventeenth the size of Bill.com by market cap.

Despite its rapid growth, Blend reduced its workforce by 10% in April. Nima Ghamsari, co-founder and head of the company, told analysts the company was conducting a “comprehensive assessment to align our cash consumption and short-term market realities as we chart a clear course towards stronger product – and operating margins that will lead Blend to 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 turned analysts’ attention to improving margins during a conference call in March, saying the company aims to make more progress in the coming year.

The comments, and the better-than-expected results in general, were well received by analysts. But many lowered their price targets on SentinelOne shares anyway.

“As we raise our growth estimates for S, we are lowering our PT to $48/share, fully reflecting a reduction in software multiples,” analysts at BTIG wrote to clients. In other words, the category was crushed and SentinelOne was not exempt.

At that time the WisdomTree Cloud Computing Fund, an exchange-traded fund that tracks Bessemer’s index, was down 47% from its November 9 high. The decline has not stopped as the Federal Reserve has reiterated its plans to fight inflation with higher interest rates.

That leaves cloud observers wondering when the downward pressure will ease.

“It’s going to take us a few months to get through this,” said Jason Lemkin, founder of SaaStr, a company that conducts cloud-centric conferences. He likens the decline to a hangover after Covid got investors drunk on cloud stocks. “We didn’t survive our Bloody Marys and aspirins,” he said.

Two of the biggest divas in the Covid cloud set, Shopify and Zoom Video Communications, saw triple-digit growth fade last year as stores reopened and face-to-face social contacts began to return. If anything, investors should have understood that the boom in demand was largely a thing of the past, Lemkin said.

“We’re going back to the average,” he said.

The reset may not be uniform. Cloud companies that adhere to the 40 rule show significantly healthier revenue multiples than those that don’t, says Mary D’Onofrio, another investor at Bessemer. Companies with a free cash flow margin of more than 10% are also enjoying higher multiples better these days, she said, as investors fear a recession.

“The market has turned to where cash is king,” D’Onofrio said.

— CNBC’s Ari Levy contributed to this report.

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