During earnings season, I like to post portfolio updates after groups of my portfolio companies have reported their results. The first group of companies reported in early August so I posted an update on 13Aug. The last of the second group reported on 2Sep so this portfolio update includes the remainder of the portfolio companies.
PRIOR PORTFOLIO UPDATES
PORTFOLIO PERFORMANCE
| DATE | GauchoRico Portfolio (YTD) | S&P500 Total Return (YTD) |
|---|---|---|
| Jan | 3.1% | -1.0% |
| Feb | -1.2% | 1.7% |
| Mar | -13.2% | 6.2% |
| Apr | -1.5% | 11.8% |
| May | 3.4% | 12.6% |
| Jun | 28.0% | 15.3% |
| Jul | 33.7% | 18.0% |
| Aug | 73.3% | 21.7% |
| 3Sep | 79.2% | 22.0% |
The GR portfolio closed August at an all-time high (ATH) of +73.3% YTD. It was the seventh consecutive ATH and the 11th ATH in August. This was the first month with more than ten ATHs since I started tracking ATHs in 2019. Since the sector rotation trough in Spring 2021, the GR portfolio has hit 24 ATHs (7 in June, 6 in July, and 11 in August). It’s been quite a run with the portfolio rising 127% since the 13May trough! Over the long-term, the portfolio has had an incredible run as well: since the start of 2017 through the end of August 2021, the portfolio is up 2040% or 21.4x. This rise has not always been a smooth one. Since I started tracking the peaks and troughs in 2018, the portfolio has seen four major drops of 35% or more. These drops happen periodically in a concentrated, growth portfolio. I wrote about these big drops in a blog post earlier in 2021. Whether the portfolio will continue its rally or is on the cusp of a major drop, I cannot know. The portfolio is currently positioned for either scenario. After subtracting unpaid but due taxes from the cash position, the portfolio has about 3.3% net cash. The GOLD position (a cash proxy) of 1.4% brings the “cash” position to 4.7%. Thus, the portfolio is about 95% invested in eight growth stocks. However, I’ve taken off most of the leverage that I aggressively added between early March and May. I had taken up my short put exposure (max loss from short puts not covered by cash) to 35% of the total portfolios value. I currently have no short put exposure that’s not covered by cash. I had also converted shares to LEAPS between March and May. In May, the LEAPS comprised as much as 37% of the total portfolio’s value. Today, LEAPS comprise less than half of that level (highly concentrated in CRWD). Thus, the portfolio is now positioned to benefit from a continued rise in the stock prices of the portfolio companies (i.e. with 95% invested). But should we see another big drop, the portfolio once again has the capacity for leveraging. It’s comforting to have the upside as well as the capacity to reengage leverage if the opportunity arises.
Since the end of August, we’ve had three additional trading days (1Sep – 3Sep). The portfolio continued to rally into early September hitting ATHs on 2Sep and 3Sep. The YTD return now stands at +79.2% compared to the S&P 500’s return of 22.0%. The difference between the GR portfolio and the S&P 500 benchmark now sits at its widest margin of the year: a difference of 57.3%.
The GR portfolio also got a boost from options trading. Options trading includes options trades that are closed within three months. I consider my LEAPS investments as part of my long-term investing and not part of options trading as I’ve defined it above. For 2021 through the end of August, options trading comprised 14% of the portfolio’s total gains (realized and unrealized) while investing comprised 86% of the returns. On a quarterly basis, I post detailed reports on my options trading; the next report will be posted after the end of September.
2021 Notable Days for the Portfolio
Below are some of the notable days in 2021.
| Date | YTD Return | Notes |
|---|---|---|
| 01/27/21 | -2.2% | local bottom |
| 02/05/21 | +12.6% | new ATH |
| 02/08/21 | +14.0% | new ATH |
| 02/09/21 | +16.6% | new ATH |
| 02/10/21 | +16.8% | new ATH |
| 02/11/21 | +17.8% | new ATH |
| 02/12/21 | +18.3% | new ATH |
| 02/25/21 | -3.4% | -6.3% on the day |
| 03/03/21 | -6.3% | -7% on the day |
| 03/04/21 | -13.6% | -9.2% on the day |
| 03/05/21 | -17.1% | -4.1% on the day |
| 03/08/21 | -22.8% | -6.9% on the day |
| 03/09/21 | -11.0% | +15.3% on the day |
| 03/11/21 | -4.3% | +9.6% on the day |
| 03/18/21 | -10.2% | -6.7% on the day |
| 03/24/21 | -15.6% | -8.6% on the day |
| 03/29/21 | -19.0% | close to 3/8/21 trough |
| 03/31/21 | -13.2% | +6.6% on the day |
| 04/13/21 | +4.0% | +8.0% on the day |
| 05/04/21 | -10.9% | -6.1% on the day |
| 05/06/21 | -21.1% | -9.6% on the day |
| 05/07/21 | -17.5% | +4.6% on the day |
| 05/13/21 | -23.5% | new YTD low |
| 05/14/21 | -16.3% | +10.9% on the day |
| 05/20/21 | -5.3% | +7.1% on the day |
| 05/24/21 | -0.1% | 7th consecutive up day |
| 06/10/21 | +11.3% | +5.4% on the day |
| 06/17/21 | +19.8% | new ATH (finally!) |
| 06/18/21 | +23.2% | new ATH; +5.1% on the day |
| 06/22/21 | +27.4% | new ATH; +6.2% on the day |
| 06/23/21 | +28.0% | new ATH |
| 06/24/21 | +28.5% | new ATH |
| 06/28/21 | +30.8% | new ATH |
| 06/29/21 | +31.2% | new ATH |
| 07/06/21 | +33.4% | new ATH |
| 07/09/21 | +33.9% | new ATH |
| 07/14/21 | +25.6% | -4.0% on the day |
| 07/22/21 | +34.2% | new ATH |
| 07/23/21 | +36.9% | new ATH |
| 07/26/21 | +37.0% | new ATH |
| 07/28/21 | +37.9% | new ATH |
| 08/04/21 | +41.2% | new ATH |
| 08/05/21 | +49.1% | new ATH |
| 08/12/21 | +51.2% | new ATH |
| 08/13/21 | +55.9% | new ATH |
| 08/23/21 | +56.0% | new ATH |
| 08/24/21 | +65.1% | new ATH; +5.8% on the day |
| 08/25/21 | +66.3% | new ATH |
| 08/26/21 | +68.1% | new ATH |
| 08/27/21 | +72.4% | new ATH |
| 08/30/21 | +73.3% | new ATH |
| 08/31/21 | +73.3% | new ATH; +0.05% to ATH |
| 09/02/21 | +74.8% | new ATH |
| 09/03/21* | +79.2% | new ATH |
Weekly Performance
| DATE | GauchoRico YTD | S&P500 TOTAL RETURN YTD | DELTA |
|---|---|---|---|
| 01/08/21 | 6.5% | 1.9% | 4.6% |
| 01/15/21 | 6.4% | 0.4% | 6.0% |
| 01/22/21 | 10.2% | 2.4% | 7.9% |
| 01/29/21 | 3.1% | -1.0% | 4.2% |
| 02/05/21 | 12.6% | 3.6% | 9.0% |
| 02/12/21 | 18.3% | 4.9% | 13.3% |
| 02/19/21 | 14.2% | 4.2% | 10.0% |
| 02/26/21 | -1.2% | 1.7% | -3.0% |
| 03/05/21 | -17.1% | 2.6% | -19.7% |
| 03/12/21 | -6.3% | 5.3% | -11.6% |
| 03/19/21 | -7.7% | 4.5% | -12.3% |
| 03/26/21 | -15.8% | 6.2% | -22.0% |
| 04/01/21 | -9.5% | 7.4% | -16.9% |
| 04/08/21 | -3.3% | 10.4% | -13.6% |
| 04/15/21 | 0.0% | 11.9% | -11.9% |
| 04/23/21 | 3.1% | 11.8% | -8.7% |
| 04/30/21 | -1.5% | 11.8% | -13.4% |
| 05/07/21 | -17.5% | 13.3% | -30.7% |
| 05/14/21 | -16.3% | 11.7% | -28.0% |
| 05/21/21 | -2.4% | 11.3% | -13.7% |
| 05/28/21 | 3.4% | 12.6% | -9.2% |
| 06/04/21 | 2.3% | 13.3% | -11.1% |
| 06/11/21 | 12.6% | 13.8% | -1.3% |
| 06/18/21 | 23.2% | 11.7% | 11.5% |
| 06/25/21 | 28.0% | 14.8% | 13.2% |
| 07/02/21 | 28.9% | 16.7% | 12.1% |
| 07/09/21 | 33.9% | 17.2% | 16.6% |
| 07/16/21 | 23.8% | 16.1% | 7.6% |
| 07/23/21 | 36.9% | 18.4% | 18.5% |
| 07/30/21 | 33.7% | 18.0% | 15.7% |
| 08/06/21 | 46.7% | 19.1% | 27.6% |
| 08/13/21 | 55.9% | 20.0% | 35.9% |
| 08/20/21 | 50.2% | 19.4% | 30.9% |
| 08/27/21 | 72.4% | 21.2% | 51.2% |
| 09/03/21 | 79.2% | 22.0% | 57.3% |
ALLOCATIONS
| TICKER | 9/3/21 | 8/31/21 | 8/13/21 | 7/31/21 | 6/30/21 | 5/31/21 | 4/30/21 | 3/31/21 | 1/31/21 | 12/31/20 |
|---|---|---|---|---|---|---|---|---|---|---|
| UPST | 23.3% | 22.3% | 21.4% | 13.0% | 7.8% | 6.3% | 4.4% | 5.7% | — | — |
| CRWD | 15.8%* | 18.7%* | 14.9%* | 19.1%* | 19.9%* | 20.0%* | 30.2%* | 27.7%* | 31.2%* | 31.5%* |
| DDOG | 14.0%* | 14.4%* | 15.8%* | 16.4%* | 15.7%* | 16.7%* | 12.0%* | 12.9%* | 10.7% | 10.4% |
| DOCU | 12.6% | 12.5% | 11.3% | 13.2% | 12.6%* | 6.6%* | 5.7%* | 5.6%* | 16.2%* | 16.4%* |
| LSPD | 10.0%^ | 9.5%^ | 8.8%^ | 11.1%^ | 11.3%^ | 12.1%^ | 13.1%^ | 13.2%^ | 4.8%^ | 3.3% |
| NET | 7.2% | 6.9% | 7.7% | 13.4% | 15.9% | 15.2% | 16.6% | 15.2% | 17.9%* | 17.8%* |
| SNOW | 5.3% | 5.3% | 5.7% | 6.0% | 5.6% | 6.8% | 6.9% | 3.0% | 0.5% | — |
| ROKU | 2.5% | 2.7% | 3.0% | — | — | — | — | — | — | — |
| GOLD | 1.4% | 1.5% | 1.6% | 2.0% | 2.0% | 2.9% | 1.6% | 1.7% | 1.4% | 3.0% |
| ZM | — | 2.5% | 4.4% | 5.5% | 5.8% | 10.8%* | 11.0%* | 12.3%* | 11.5% | 11.0% |
| NEM | — | — | — | — | — | — | 1.0% | 1.1% | 1.0% | 1.0% |
| PATH | — | — | — | — | — | — | 0.1% | — | — | — |
| PTON | — | — | — | — | — | — | — | 4.0% | 4.0% | 4.2% |
| BPRMF | — | — | — | — | — | — | — | 1.2% | 1.3% | 1.4% |
| Cash | 8.0% | 3.9% | 5.8% | 1.4% | 6.5% | 3.0% | -0.2% | 1.2% | 0.8% | 0.7% |
Two positions in the portfolio remain leveraged with call options. I have zero CRWD shares; the entire position is comprised of Jan 2023 call options ($170 and $175 strike prices) that were purchased between 5Mar and 3May 2021. I sold the Jan 2023 $200 calls this past week. The CRWD allocation changes are amplified when CRWD stock moves up or down. The DDOG allocation is comprised of a 13.2% allocation in shares plus a 0.8% allocation in Jan 2023 call options ($65 strike price). The portfolio contains 16.6% of its value in the form of calls options and 75.5% in stock. The remainder is cash. The cash position increased because not all of the proceeds from the ZM shares sale were reinvested. Of the cash, 4.7% of the portfolio’s value is owed in accrued but unpaid capital gains taxes leaving 3.3% of net available cash.
PORTFOLIO CHANGES
Changes since 13Aug2021
I’ve made relatively few changes to the portfolio since my last portfolio update on 13Aug.
- Sold LSPD 17Dec $65 calls: With LSPD shares at around $104.50, I decided to further deleverage the portfolio by selling the remainder of the LSPD 17Dec $65 call and using all of the proceeds to buy LSPD shares.
- Bought LSPD shares: Used the proceeds of the LSPD options sale to buy LSPD shares.
- Sold all ZM shares: Sold ZM the day after the 13Jul quarter’s results were released.
- Bought UPST: Added ~0.6% allocation to position (proceeds came from ZM share sale).
- Bought DOCU: Added ~2.3% allocation to position before DOCU earnings (proceeds came from ZM share sale).
- Sold CRWD Jan2023 $200C calls: Sold these calls after the 31Jul quarterly result. The action was solely a portfolio management and allocation decision. The CRWD position remains a 100% LEAPS position with Jan2023 $170Cs and $175Cs.
EARNINGS RESULTS
SNOW, ZM, CRWD, and DOCU reported quarterly results since my last portfolio update. Below are my thoughts on these results.
SNOW (5.3% allocation; Q2FY22 25Aug earnings date)
There is anxiety and uncertainty among some of the investors whose opinions I respect. Some have held their shares, some have sold their entire position, and none added to their positions. What in the recent quarter’s results led to these reactions?
Let’s start with the bear case. I don’t think it’s really a bear case but more of a case of possible greener pastures elsewhere. The leading indicators for the strength of SNOW’s business and revenue are added customers and RPO (remaining performance obligations which is all committed revenue that’s not been recognized). Revenue from new customers typically lags meaningful contribution for 9-12 months after the contracts are signed. The case that those who sold their SNOW positions are making is that the past two quarters were weak in added RPO and new customers so revenue growth in 2022 is going to slow significantly. Some have said that they think revenue growth will slow from its current ~100% y/y growth rate to 80%. I do see a case for selling SNOW so don’t think that selling SNOW is the “wrong” move. However, I’ve decided to hang on to my position. My rationale for doing so is explained below.
- Revenue growth in Q2 was 103% y/y: SNOW continues to be one of the fastest growing companies available.
- Issued very strong guidance: Revenue growth guidance for Q3 came in a 92%. We can expect them to beat this (as usual) so they’ll likely come in around 100% y/y growth for Q3.
- Strong DBNR continues: SNOW’s dollar-based net expansion rate was 169% for Q2. This backward-looking metric is going to stay above 160% for the remainder of FY2022 (according to management per the Q2 earnings call). Also, management expects DBNR to remain very high (130-140%) for a long time after FY2022.
- RPO is only the minimum commitment by customers: Some investors have called out RPO being too low. However, customers often consume more from SNOW than is specified in the contract. As customers keep finding new use cases, I expect consumption to exceed customers’ commitments.
I bought the very highly valued SNOW shares because I strongly suspect that SNOW is building an essential business that’s also a flywheel (the more customers that use the SNOW platform, the more essential it becomes for existing customers and prospective customers, leading to an increased competitive advantage and an acceleration is adoption). For customers, it’s all about extracting value from their data. But now with data sharing that can be monetized and selectively shared on SNOW, data that belongs to others can also add value. Specifically, that value add is realized through cost saving and/or by the incremental addition of revenue. If computers can detect this value creation, then decision making of SNOW consumption can be handed over to computers bypassing the friction inherent in human decision making processes. Yes, I think that computers will be allowed to increase spending provided that that spending is net positive for the business. If and when that happens and people are removed from spending decisions, then I see a lot of friction to growth being eliminated. This is the high level reason why I’m invested in SNOW. Data sharing/data cloud is progressing nicely as was highlighted during the Q2 earnings call:
“…we have tremendous growth in the data listings that are coming onto the marketplace. And by the way, the reason that they’re coming is because they’re viewing Snowflake increasingly as a place where they can sell data. And the network effect starts to be induced, and more data begets more data, right, because it becomes a very rich environment after a while. So, we’re very positive with this quarter with the growth in listings, the growth in data, and so on. And that’s really how we track our progress in terms of the data cloud and the data networking relationships that make up that data cloud.”
CEO Slootman during the Q&A session of the Q2FY22 earnings call
Now that sounds like continued great progress. As an investor, this is exactly what I want to see. One of the analysts on the earnings call asked about data sharing. Here is that exchange:
Mark Murphy (analyst): “Frank, how many of your Fortune-500-type customers are in discussions with you today with some kind of a plan to build their own data cloud, for instance, an energy cloud, or an insurance cloud, or a retail cloud that uses Snowflake’s data-sharing model?”
Frank Slootman (CEO): “I can tell you that I’m involved in those conversations on a daily basis. You know, we lead with a value proposition literally in every conversation. We’re batting 1,000, you know, when we go down the data cloud path. So, we’re super excited by the way this is resonating with our future customers. Now, that said, the way our market has historically worked, you know, people have had a workload attitude and mentality to the world in terms of moving to the cloud. So, sometimes the data cloud is viewed as something that is sort of phase 2 or phase 3. People are first preoccupied with moving data to the cloud, then moving workloads to the cloud, and then having sort of pulling up, and having a look at what’s next. We’re working very hard to make sure that we look at the data cloud right from the beginning.“
Batting 1.000!!! That’s a 100% customer conversion rate when they go down the data cloud path. This was the top reason I have SNOW in the portfolio, and there’s no way I’m selling out when there’s strong evidence of super strong traction with their data sharing/data cloud. SNOW is still in the process of building up the best data analytics solution in the world. They are working on maximizing the utility that data can have for customers while minimizing the friction in the process of turning data into actionable and profitable knowledge. Furthermore, SNOW is engineering their sales and marketing (and product customization) around about a dozen verticals. Each vertical has unique requirements so the customization around the product and the selling and marketing process will increase adoption within each vertical. This customization doesn’t happen overnight and is still in process, so I expect increasing success as SNOW rolls out more vertical-specific product features, marketing, and sales channel specialization.
ZM (0% allocation; Q2FY22 30Aug earnings date)
ZM’s 31Jul quarter’s results were released on 30Aug. I sold my entire position after the result. Below is the explanation for my decision.
Some other investors who I know and respect sold their ZM position either late last year or early this year. I decided to hang on because I wanted to give ZM a chance to leverage their strong market presence to gain fast traction on some new products: Zoom Phone, Zoom Room, and OnZoom. I made the assumption that ZM’s video conferencing business would continue to grow at about 50% y/y while these faster growing new businesses become large enough to reignite overall revenue growth.
ZM’s revenue growth was ok, but the guidance for Q3 and the implied guidance for Q4 show much more slowing than I (and apparently the market) expected. Customer growth numbers were also somewhat anemic compared to prior quarters. Management’s reason for the projected deceleration was that the video conference business customers (non-enterprise only) slowed faster and more steeply than they expected. The enterprise business was very strong particularly with the Zoom Phone adoption: +241% y/y growth in the number of $100K+ ARR customers and +320% y/y growth in the number of $1M+ ARR customers. Also, Zoom Phone doubled the number of seats to 2M from mid-January to August.
So Zoom Phone is doing great as I hoped it would, and it appears that Zoom Phone is on the way to strong success. However, compared to the size of the overall business the Zoom Phone contribution is still too small to make a difference. Adding up the ARR of the $100K+ and $1M+ Zoom Phone customers, I estimate that Zoom Phone currently contributes about $65M in annual revenue. Unfortunately, this is less than 2% of the Company’s overall revenue. Thus, even if Zoom Phone doubles again in a year, it won’t contribute to growth in a meaningful way. Zoom Room and OnZoom are even smaller and even farther behind on the customer adoption curve.
In summary, ZM’s core business is slowing sooner than I expected coupled with a lack of visibility in any meaningful revenue from ZM’s second act products was the reason for my exit from ZM. Others foresaw this sooner than I did, but better late than never; regardless, the ZM ride has been a fun and profitable one. Now was the time to let it go and pay the taxman for all those capital gains.
CRWD (15.8% allocation; Q2FY22 31Aug earnings date)
CRWD stock has moved around a fair amount going into earnings. It first dropped and then rallied after the PANW results. The cyber security sector has received a lot of attention recently with several high-profile ransomware attacks earlier in 2021. In addition, Russian and Chinese hackers successfully conducted some massive breaches. The full attention of the U.S. government is now on better protecting both public and private computer systems. It seems that the tailwinds for cyber security vendors could not be stronger. With this backdrop, I’ve been expecting a strong acceleration in results for best-in-class cloud cyber security company CRWD. Well, I’ve been expecting a strong acceleration in growth for CRWD for a least three quarters now. It didn’t materialize in Q4 FY2021. Not in Q1 FY2022. And now in Q2 FY2022, it didn’t come either. So I ask myself, as I have been doing after each of the past several quarters, whether a reacceleration is still coming or whether the recent quarters’ results are as strong as they’re going to be going forward. Was a steeper deceleration in the cards without the pandemic and cyber security industry tailwinds? After the latest results, let’s reevaluate.
- Room to grow: If one listens to management and believes what they’ve been saying, then CRWD still has a lot of room to run. Specifically, they’ve been pointing out that with about 13,000 customers CRWD still has the vast majority of the market to capture; some of the legacy cyber security companies have well over 100,000 customers. Furthermore, when looking at CRWD’s investor presentation (updated in August 2021), we can see that CRWD claims that companies are vastly underspending on IT security (see slides 22-23) and should in aggregate spend 5-10x of their current spend. According to third party market research and the Company’s analysis, CRWD’s TAM (total addressable market), including both market growth and new products, is set to increase by about 200% in the next four years as shown in the following slide:
CRWD appears to have a lot of room to grow.
| Q2 2021 | Q3 2021 | Q4 2021 | Q1 2022 | Q2 2022 | |
|---|---|---|---|---|---|
| Sequential Cust Growth | 15.5% | 16.4% | 17.6% | 15.4% | 14.5% |
| % Using 4+ Modules | 57% | 61% | 63% | 64% | 66% |
| % Using 5+ Modules | 39% | 44% | 47% | 50% | 53% |
| % Using 6+ Modules | N/A | 22% | 24% | 27% | 29% |
- Customers continue to expand their spend with CRWD: CRWD’s dollar-based net retention has exceeded 120% in each quarter for the past 14 consecutive quarters. CRWD continues to add new modules and customers are eating up what CRWD is selling. CRWD reports the percentage of their customers that have purchased 4+, 5+, and 6+ modules, and these metrics are getting better and better each quarter. All three increased again. Looking over the past five quarters (table on the right), we can see that customers are increasingly adopting more modules all while CRWD continues to grow its customer base at a blistering rate (in excess of 80% y/y). This is an incredible feat especially considering that CRWD is now quite large: achieved $1B+ ARR three quarters ago. In addition, CRWD continues to grow the number of modules so perhaps we can soon expect the Company to report customers using 7+ modules, then 8+, and so on. These metrics also point to CRWD’s ability to develop products that are highly valued by customers.
- Revenue and ARR growth stagnation: CRWD’s subscription revenue grew 71% y/y continuing a deceleration that began four quarters ago. Likewise, ARR y/y growth continued to decelerate dipping to 70% growth from 74% in the prior quarter and 87% a year ago. Admittedly, these metrics were just a little disappointing to me when considering that the cyber security industry supposedly has the strongest tailwinds and sentiment ever. I and other investors were certainly hoping for a re-acceleration of revenue growth and ARR growth. But complaining about 70%+ growth seems silly as CRWD is still among the best of the best growth companies out there. So, as an investor, I’m satisfied and am content to wait three months to see what Q3 brings.
- Management enthusiasm: In comparison to recent quarters, CRWD’s management sounded relatively subdued on the earnings call. My perception of the change in tone could mean nothing at all or perhaps it had something to do with the relative success of CRWD’s competitors, notably PANW which had a very enthusiastic earnings call. In any case, this is just speculation and doesn’t factor at all into my allocation decision.
In summary, CRWD appears to be on track and my confidence in the Company remains high. However, UPST has now surpassed CRWD as the company with the best risk-reward profile (IMO). DDOG has also caught up to CRWD, and I’d rank DDOG to be about equal to CRWD on the risk-reward scale. I did sell about 12% of my 2023 call options so my allocation is now 15.8%, but the position behaves like a 37% allocation position.
DOCU (12.6% allocation; Q2FY22 2Sep earnings date)
DOCU was the last portfolio company to report its quarterly results. My thoughts about their 30Apr quarter were summarized in my 4Jun Portfolio Update. DOCU now has another quarter under its belt, but my overall sentiment on the Company is largely unchanged. I like my growth companies to have four characteristics which I described in a recent blog post. Let’s go through them again for DOCU.
Dominant company within its markets: DOCU is far and away the dominant company in its market with >50% market share in its eSignature business. It’s not even a contest.
Profitable: Many hyper growth firms aspire to one day become profitable. DOCU is already there. Free cash flow (FCF) hit a record $162M in the quarter; FCF margin also hit a record 32%. DOCU continues to throw off increasing amounts of cash all while investing substantial amounts into R&D and other expansions efforts.
Durable competitive advantage: DOCU is leveraging its market leadership position in eSignature to expand into adjacent markets such as CLM and Notary. Notary has now been rolled out into 18 U.S. states with more on the way. Furthermore, DOCU continues to utilize its financial strength to expand on its lead by pushing into new geographies and introducing new product features and enhancements. Thus, by building on its considerable lead, DOCU is erecting a larger and larger barrier to entry which further increases its competitive advantage.
Continued future growth: DOCU’s subscription revenue grew at 52% y/y. While this is higher growth than the year ago quarter, growth was higher during the pandemic (three quarters prior to the most recent quarter). Management expected growth to dip lower after the pandemic, and we are seeing this now. It’s likely that DOCU’s growth will settle in the high 40%s in the coming quarters. So why is it acceptable to keep DOCU in the portfolio when there are higher growth opportunities available? Sticking with growth for a moment, DOCU has only penetrated a small fraction of its addressable market (see slides 10-11 in the latest investor presentation). DOCU has years of growth ahead in eSignature and its newer products. In addition, DOCU has room to grow internationally; international revenue comprises only 22% but it is growing faster (71%) than overall revenue (50%). Thus, the growth boost from the international business should continue for a while.
So let’s go back to the question of the relatively low growth of DOCU. Why is it ok for the portfolio to hold a position that’s expected to grow less than 50%. First, growth will likely remain high for a very long time. Second, the other three characteristics are incredibly strong which means that the certainty of DOCU being the top company in its markets is virtually assured; the possibility that DOCU will be disrupted is pretty much off the table, maybe more so than any of the other companies in the portfolio. Last, DOCU has and continues to lay the groundwork for its new and upcoming products to succeed. eSignature is the prerequisite for the next products in the Agreement Cloud. In short, DOCU’s strategy and product roadmap is extremely powerful and and continues to be brilliantly executed.
FINAL THOUGHTS
Earnings season is now over for the portfolio companies so we get a long break before it all starts again in early November.
The GR portfolio is at an ATH. It’s hit 26 ATHs since the 13May trough including on 9 of the last 10 trading days. It’s true that 2021 is a highly unusual year with a) 2020’s massive fiscal stimulus yet to fully work its way through the economy, and b) large numbers of workers poised to return to jobs (and I’m sure they’ll be spending a lot to make up for a year of being cooped up). There are reasons to be optimistic about the future, and perhaps stocks will continue to push higher. On the other hand, we’ve had quite a run for the past 3 1/2 months with the portfolio up 134% since 13May. We know that stocks don’t continuously go up in a straight line; they periodically pull back, and highly concentrated growth portfolios occasionally have big drops. As usual, I really don’t know what’s going to happen in the near term. But as the portfolio gets higher and higher, I can’t shake the feeling that a big drop is getting more and more likely. As I mentioned previously, the GR portfolio is ready for either possibility.
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