Recession-Fearing Investors Continue Cutting Stocks in Fastest-Growing Cloud Companies

Nima Gamsari, co-founder and CEO of Blend, speaks at the “Earlier Than You Think” conference in New York on October 16, 2018.

Alex Flynn | Bloomberg | Getty Images

Tech investors finally felt some relief last week when the Nasdaq ended a seven-week losing streak, the worst streak since the 2001 dot-com crash.

With five months in the books, 2022 has been a bleak year for tech so far. No one knows this better than investors in cloud computing companies, which have been among the favorites of the past five years, especially during the lockdown days due to the pandemic.

Paradoxically, growth remains strong and companies are benefiting from the economic recovery, but investors continue to sell., Blend Labs, and SentinelOne continue to double their year-over-year revenue by 179%, 124%, and 120%, respectively. However, this trio costs about half what it was at the end of 2021. The market was hit hard across the basket.

Byron Dieter of Bessemer Ventureners, a cloud startup investor and one of the most vocal commentators on cloud stocks, noticed earlier this month that the company’s BVP Nasdaq Emerging Cloud Index earnings multiples are back to 2017 levels.

Profit Please

One of Dieter’s colleagues at Bessemer, Kent Bennett, doesn’t understand why the fastest growing companies don’t get passes to the cloud category. But he has an idea.

“You can imagine that at a time like this, revenue would go to ‘fuck me get me out of this market’ and then return to efficiency over time,” said Bennett, who sits on the food service software board. Toast, which itself posted a 90 percent growth in the first quarter. Shares are down 52% since the start of the year.

Toast identified a decline in revenue in 2020 as in-person restaurant visits declined, resulting in less heavy use of the company’s hardware and software at the point of sale. Then came online orders. Now, more and more people are dining out, and Toast is seeing higher demand for its Go point-of-sale mobile devices and QR codes that allow people to order and pay with their own phone, CEO Chris Comparato said in an interview with CNBC earlier. . this month. .

Now that the company has recovered from its stumbling block, investors are advising it to “find a better path to profitability,” he said.

Management is telling all teams to be very mindful of their unit economics, but Comparato said it was not ready to tell investors exactly when the company will break even.

Toast came up with new information about fields. During Toast’s Q1 earnings report earlier this month, CFO Elena Gomez said the forecast implied her earnings before interest, taxes, depreciation and amortization in the second half of 2022 to be 2 points higher than in the first half since the company is running. to strengthen margins in the future.

“A few investors have pushed and they definitely want a little more detail,” Comparato said. “But a lot of them are like, ‘OK, that was a different tone, Chris, thanks.’ Chris and Elena, please continue to realize this vision. ”

Other cloud companies understand this as well.

Data analytics software maker Snowflake, which just completed a two-year streak of triple-digit revenue growth, “is not a growth company at any cost,” CEO Frank Slutman said in a phone call with analysts on Wednesday.

Offering subscription management software, Zuora is “focused on building a successful long-term business that delivers sustainable and profitable growth for years to come,” CEO Tian Zuo said in a quarterly phone call with analysts at his company. The company posted a net loss of $23.2 million on revenue of $93.2 million compared to a loss of $17.7 million in the year-ago quarter.

Let’s go back to the “rule of 40”

Even in the software industry, there is an old-fashioned notion that software should make money. Splunk, whose software helps corporate security teams collect and analyze data, included a slide titled “Increasing Profit Through Scale” in its shareholder presentation. It shows the performance of Splunk over the past few years in accordance with the “rule of 40” – the concept that the company’s revenue growth rate and profitability should be 40%. Splunk named 35%, the closest it has been in three years, in the current fiscal year.

The focus on efficiency isn’t completely absent from, whose software helps small and medium-sized businesses manage bills and invoices, but it’s easier to overlook as revenues grow faster than most businesses. Even before software sales began in November, executives touted the company’s economic health.

Blend Labs, which provides software that banks can rely on for mortgage applications and other processes, has adapted more aggressively to new market realities, but in terms of market capitalization, it also accounts for a tenth to seventh of

Despite rapid growth, Blend cut its staff by 10% in April. Nima Gamsari, co-founder and director of the company, told analysts that the company is conducting a “comprehensive analysis to align our cash costs with short-term market realities, while charting a clear path to products and higher operating margins that will result in blends having long-term profitability. ”

SentinelOne, which sells cybersecurity software that detects and responds to threats, is working on its cost structure. Co-founder and CEO Tomer Weingarten brought the improvement in margins to analysts’ attention during a conference call in March and said the company is committed to making more progress next year.

The comments and higher-than-expected results were generally well received by analysts. But many have lowered their price targets for SentinelOne stock.

“As we increase our growth estimates for S, we are lowering our PT to $48 per share solely due to declining software multiples,” BTIG analysts wrote to clients. In other words, the category was squashed and SentinelOne was not released from it.

By then, cloud computing fund WisdomTree, an exchange-traded fund that tracks the Bessemer index, had fallen 47% from its November 9 peak. The fall did not stop as the Federal Reserve confirmed its plans to fight inflation with higher interest rates.

This leaves cloud watchers wondering when the downward pressure will ease.

“It will take us several months to get out of this situation,” said Jason Lemkin, founder of SaaStr, a company that organizes cloud conferences. He likens the crash to a hangover after investors got drunk on cloud stocks. We haven’t finished our Bloody Mary and our aspirin yet,” he said.

Two of the biggest divas in all of the cloud, Shopify and Zoom Video Communications, saw triple-digit growth disappear last year as stores began to reopen and in-person social interactions began to return. Rather, that’s when investors should have realized that the demand boom was largely a thing of the past, Lemkin said.

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

However, the reset may be uneven. Cloud companies that adhere to the Rule 40 have significantly higher revenues than those that don’t, says Mary D’Onofrio, another Bessemer investor. Companies with free cash flow margins above 10% also have higher multiples as investors fear a recession, she said.

“The market changed when cash became king,” D’Onofrio said.

— Ari Levy of CNBC contributed to this report.

WATCH: Tech will see marketing budgets cut, slower hiring and firing, says Dieter de Bessemer.

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