Author: Jeremy Chia

Having options is an often underappreciated but valuable competitive advantage. Nassim Taleb, the author of the book, Antifragile, wrote, “An option is what makes you antifragile”.

Antifragile companies can thrive in times of chaos. But what constitutes optionality?

Optionality can come in the form of having opportunities to easily open up new business ventures. Think Amazon.com (NASDAQ: AMZN).

In its early days, Amazon was a first-party online retailer. At that time, all of its revenue came from selling products it bought and resold. But once Amazon built a substantial-enough user base, it easily pivoted its business into a marketplace and started generating revenue by providing services to third-party sellers to run their e-commerce business on Amazon’s marketplace.

Having the initial large user base gave Amazon the option to easily pivot into a marketplace.  That’s optionality.

As an investor, I often think about the options that a company has. Here are some examples of companies that I believe have the luxury of optionality.

Netflix Inc (NASDAQ: NFLX)

The streaming giant has built up an enviable catalogue of well-loved original content such as Stranger Things, Black Mirror, and more.

I believe Netflix can leverage this valuable intellectual property to grow revenues through selling merchandise, creating games, and even theme parks. Although these ideas may seem farfetched now, I think the possible options are exciting. To unlock all of these possibilities, Netflix’s management will need good execution and careful planning.

Besides original content, Netflix also commands a wide audience. That’s a valuable asset to own. At the moment, Netflix is laser-focused on its core offering of providing a great streaming service to its loyal user base. However, Netflix can easily upsell feature upgrades to its userbase in the future. Netflix has already announced that games could be included in a Netflix subscription in the future. If the introduction of games is a success, Netflix can have tiered subscription plans based on whether a user is willing to pay a higher premium for more of Netflix’s gaming services.

Upstart Holdings Inc (NASDAQ: UPST)

This fintech provides AI-powered software tools to banks that can better predict default rates on loans. Currently, Upstart is focusing on its core product of unsecured personal loans. Although this itself is a multi-billion dollar market (around US$84 billion), the bigger prize is in auto loans and home mortgages. Upstart’s AI tool could be leveraged to help banks make smarter loan decisions for both these markets.

With its purchase of Prodigy, a cloud-based automotive retail software provider, Upstart is already looking to grow into the auto loans market. The auto loans market is seven times the size of the unsecured personal loans market while the home mortgage market is multiple times larger than auto loans.

It is still early days for Upstart, but its pie could potentially grow much bigger if it is able to enter these new markets successfully.

Square Inc (NYSE: SQ)

Square started off by providing aspiring shopkeepers (the company calls them sellers) with a simple device that they can use to accept credit card payments. These square-shaped devices were much cheaper and easier to install than traditional card readers. 

After winning over users, Square leveraged on its seller base to upsell other software tools and to even provide loans to these sellers. 

But Square truly hit the gold mine when it released Cash App. This is a consumer-focused app for people to store money, transfer money to friends, and even directly deposit their wages into.

With a growing user base, Square has so many options to further monetiseCash App. Besides what has already been mentioned, Cash App also currently offers services such as investing, bitcoin trading, and debit cards. In the future, Square could roll out other services such as insurance, and buy now, pay later (BNPL). On BNPL, Square recently announced that it would be acquiring the Australia-based BNPL provider, Afterpay. The ability to roll out new features in Cash App is a valuable option that Square can easily take advantage of.

Coupang Inc (NYSE: CPNG)

South Korea’s e-commerce giant has already taken advantage of its gigantic logistics footprint in the country. From a 1st-party e-commerce player, Coupang now also acts as a third-party marketplace and delivers food and groceries.

There are many ways to grow its business, simply by offering new services to its third-party sellers to increase take rates, or to roll out new product offerings to its loyal consumer base by leveraging its logistics network.

With Coupang’s sprawling logistics infrastructure in South Korea in place, the options are abounding. But, Coupang is also careful in its spending. CEO Bom Kim said during the company’s recent 2021 second-quarter earnings conference call:

“We start with small bets, then test rigorously and invest more capital over time, but only into the opportunities we feel strongest about… …There are many other early-stage initiatives in the portfolio and I expect that we will not continue all of them. Only the investments whose underlying metrics show strong potential for meaningful cash flows in the future will earn their way to more significant investment.”

The bottom line

Optionality is a great trait to have as a company. It means that the company can easily build new revenue streams, create a more diverse business, and become a more resilient company. Thinking about the options that a company has gives me a better idea of how a company can transform in the future and what possibilities lie ahead.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Amazon.com Inc, Netflix, Upstart, Square and Coupang. Holdings are subject to change at any time.

How much of our portfolio should we invest in a high conviction stock?

This is an age-old question for any investor. In this article, I touch on two concepts – the absorbing barrier and Kelly criterion – and see how we can use them to structure the way we think about position sizing in investing.

Absorbing barrier

Imagine playing a game of Texas Hold’em poker and being dealt the best starting hand of the game – a pair of aces. This hand has an approximately 80% chance of winning against any other starting-hand combination.

What would be the ideal bet to make here? In theory, the bigger your bet, the bigger your expected return is on the investment because the odds of winning are tilted heavily in your favour. But does this mean we should bet all our savings on this hand? Probably not.

This is where the idea of the absorbing barrier becomes relevant. Nassim Taleb, author of a number of books, including Fooled by Randomness, explains,

“[A]bsorbing barrier is a point that you reach beyond which you can’t continue. You stop. So, for example, if you die, that’s an absorbing barrier. So, most people don’t realise, as Warren Buffett keeps saying, he says in order to make money, you must first survive. It’s not an option. It’s a condition. So once, you hit that point, you are done. You are finished. And that applies in the financial world of course to what we call ruin, financial ruin.”

The idea is that even if you have a big edge in a game, bet sizing matters. If you keep betting 100% of your net worth on a game of poker, even if you start off as an 80% favourite to win, in the long run, it will eventually result in financial ruin. This applies to any financial decision, even if the probability of the tail risk is extremely low.

In his Fat Tails Statistical Project, Taleb wrote,

“Every risk-taker who survived understands this. Warren Buffett understands this. Goldman Sachs understands this. They do not want small risks, they want zero risk because that is the difference between the firm surviving and not surviving over twenty, thirty, one hundred years.”

Kelly criterion

This brings us to the next topic, the Kelly criterion. The Kelly criterion is named after researcher J. L. Kelly who described a gambling formula for bet sizing that leads to the highest possible wealth compared to any other strategy if you have a slight edge in the game.

According to the Kelly criterion, the optimal size of an even-money bet is calculated by multiplying the percentage chance of winning by two and subtracting 100%. For a game that you have an 80% chance of winning, the optimal bet sizing is 60% of your available funds (80% x 2 – 100% = 60%). So if you lose your first bet, your next bet should be smaller, and vice versa.

By making the bet sizing a percentage of your available funds, the chances of complete financial ruin drop to zero as you will never bet all your available funds on a single bet.

However, as you may have guessed, in casinos and in gambling in general, you will probably never find a situation where you are a consistent favourite to win in an even-money bet. This is because casinos only offer games where the house has an advantage over the players.

Investment risk management

This is not the case in investing. Great stock pickers, with a proven approach, have higher odds of making winning bets by picking the right stocks to invest in.

Warren Buffett, for example, has been one of the investment greats of the past seven decades by consistently finding stock market winners to invest in. But even great stock pickers may not have a 100% track record. Despite his investing prowess, Buffett has admitted numerous investing mistakes, some of which has caused him or his firm to lose money.

And yet, Buffett is far from financial ruin. This is because of the position sizing for each of his investments and the diversification of his portfolio across a range of “bets”.

Real-life practicality

Calculating the ideal bet sizing using Kelly’s criterion may not be practical in real life investing, due to our inability to accurately calculate win rates and the fact that no investment is completely identical.

However, understanding the fundamentals behind absorbing barriers and the Kelly criterion can, at the very least, give us a framework to think about how to size our investments to reduce the risk of financial ruin over the long run. 

Portfolio positioning is a complicated topic and absorbing barriers and Kelly’s criterion are just some of the topics to consider. For more thoughts on portfolio sizing, you can read some of our other articles here and here.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently do not have a vested interest in any shares mentioned. Holdings are subject to change at any time.

Data as of 25 June 2021

The SPAC (Special Purpose Acquisition Company) craze has well and truly hit the market. 

From making up just a fraction of all funds raised through IPOs in the USA in the past, SPACs have grown to become the bulk of IPOs in the first quarter of 2021. During the period, SPACs’ fundraising made up 69% of all IPO proceeds raised, up from around 20% in 2020.

The recent booming interest in SPACs raises a question: Do SPACs really make good investments? In this article, I run through some of the pros and cons of investing in SPACs, who are the winners and losers in this space, and why I’m avoiding any SPACs pre-merger.

Why are SPAC IPOs so popular?

SPACs are entities that are formed with the intention of merging with another existing company. SPAC investors will then become shareholders of the new combined entity.

When SPACs raise money at an IPO, investors are simply providing the “shell” company with the capital to acquire another business. Before acquiring a company, SPACs have no commercial operations and are therefore sometimes referred to as “blank check companies”. 

Part of the popularity of SPACs is their potential growth. If a SPAC is able to acquire a good company at a good valuation, investors could reap the long-term gains from the combined entity.

Some SPACs may be in a position to acquire great companies due to the SPAC sponsor. SPACs that are sponsored by big-name investors or expert investment managers have the connections and expertise to acquire an early-stage company that has the potential to grow much bigger.

SPACs also provide downside protection as SPAC shareholders have the right to redeem their shares and be repaid from the trust account should they not like the deal. If they choose to redeem their shares, SPAC shareholders can get back cash based on the IPO price per share plus interest.

Investors who are lucky enough to invest at the IPO can also reap some returns once the SPAC starts trading as the share prices of SPACs tend to trade at a premium to their cash value due to the hope that the SPAC can put the money to good use. 

SPACs often throw in an additional incentive for investors to invest at its IPO, known as a “warrant”. Warrants give holders the right to buy more shares from the company at a specific price on a specified future date. These warrants can be traded separately and can be worth more if the SPAC shares rise. These free warrants are an additional kickback to being an IPO SPAC investor.

Fees, dilution, and misaligned incentives

Although SPACs may seem enticing on the surface, there are associated costs that may make them a poor investment for latecomers.

One of the big costs to investing in SPACs is the “sponsor promote,” which are free shares that are issued to a SPAC’s sponsors once a merger is finalised.

For example, in a US$500 million SPAC, IPO investors may fork out US$500 million and receive 50 million in shares with a net cash value of US$10 each. But once a merger is secured, the SPAC sponsor gets free shares that typically make up 20% of the number of shares sold in the SPAC’s IPO.

As such, in my example, the number of SPAC shares increases from 50 million to 60 million and the net cash of each share drops to US$8.33.  So essentially, shareholders paid US$10 (or more if they bought in after the IPO when the price has risen) for a share that now only holds US$8.33 in cash.

In addition, redemptions may reduce the cash per share of the SPAC. Remember I mentioned that SPAC shareholders have the right to redeem shares at the IPO price plus interest. But redemptions are not good for the remaining shareholders of the SPAC.

Redemptions reduce the amount of cash left in the SPAC disproportionately more than reducing the share count. For example, a SPAC that raises US$500 million in cash may end up with around US$490 million in cash after accounting for IPO underwriting fees. However, to fulfil redemption requests, the SPAC still needs to pay back $10 per share for each share redeemed when the cash per share was actually only US$9.80 per share. 

Research by Stanford law found that while the SPACs they studied issued shares for roughly $10 and value their shares at $10 when they merge, at the time of a merger, the median SPAC holds cash of only $6.67. This is due to dilution, underwriting fees, and share redemptions.

Throw in the warrants that IPO investors are given, and the potential total dilution could be far worse. Investors who didn’t buy in at the IPO and didn’t receive warrants are fighting an uphill task to make a profit.

I haven’t even mentioned another cohort of investors who get special treatment- the PIPE investors. PIPE stands for private investment in public equity and these PIPE investors are offered shares just before a SPAC-merger deal closes to make up for any cash shortfall for the deal. PIPE investors are usually offered shares at IPO prices, which are lower than what the shares usually trade at.  Although not exactly dilutive, PIPE investors get much better deals than retail investors who bought in at market prices after the IPO.

Another risk is that SPAC deals may not always turn out so well. The study by Standford Law found that SPAC shares tend to drop by one-third of their value or more within a year following a merger. 

Some of the reasons why SPAC acquisitions may turn out poorly is due to misaligned incentives and the time scale involved. SPACs usually have a two-year time period to make an acquisition. This puts pressure on the sponsor to find a deal. To avoid closing the SPAC without finalising a merger, the sponsor may rush to complete a deal even if it may not be best for shareholders. These poor business acquisitions and heavy dilution may result in poor long-term stock performance for SPACs.

Winners and losers in SPACs

The odds of long-term success for SPAC shareholders are clearly stacked against them. The heavy dilution from “promote” shares given to the sponsor, the high fees involved, and the dilution from redemptions, put long-term shareholders on the back foot.

But not everyone is a loser.

The biggest winners in the deal are usually the sponsors. The sponsors are given promote shares even when they put up relatively little capital. Even if the share price falls, sponsors are able to make healthy profits as they received their shares at a very low cost.

Investors who invest during the IPO and sell before the merger may also reap substantial gains. As mentioned earlier. SPACs tend to trade at a premium to their net cash value before a merger is done due to the hope that a good deal can be struck.

IPO investors who bought in at cash value and sell in the stock market before a deal closes can make a healthy profit. They can also sell the warrants for extra profit on the side.

The losers are investors who invest after the IPO when the stock prices have risen to a large premium over the diluted net cash value. Unless the SPAC acquires an exceptional company at a really good price, latecomers to a SPAC are left with an uphill task to even make a profit.

Although there have been a few positive outcomes, the odds of long-term success, post-merger, are stacked against SPAC shareholders.

Conclusion

I get why the SPAC market is booming. Raising money at an IPO for SPACs is easy as investors believe they can make a quick buck even before a merger is confirmed. The warrants and redemption promise make it an even sweeter deal for IPO investors.  Sponsors are also enticed by the potential huge gains once they receive their promote shares which could be worth hundreds of millions of dollars.

However, for investors who are buying SPACs in the secondary market, the odds of success are much lower. Misaligned incentives and heavy dilution put long-term shareholders at a disadvantage.

The fact that SPAC shareholders rely on the sponsor to make a good acquisition creates even more uncertainty. Investors who want to buy SPACs on the open market should consider these factors when making any investment decision.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently do not have a vested interest in any shares mentioned. Holdings are subject to change at any time.

There are some exciting developments in the biotech space. This is not surprising, given the rising interest to invest in biotech. More money leads to more talent working on these projects and ultimately increases the odds of scientific breakthroughs.

With that said, here are some exciting biotech trends that could be game-changers in their respective fields.

Liquid biopsies

A biopsy is a procedure that involves the extraction of sample cells or tissue from a tumour to determine the extent of a disease. It is useful to determine the characteristics of the tumour, which helps doctors determine the next step of treatment.

Traditional biopsies are invasive procedures that may result in complications. Imagine taking a sample of a tumour in your liver. The process involves inserting a needle into your liver to extract the tumour sample. The risks to this procedure include bleeding, infection, accidental injury to nearby organs etc.

Enter liquid biopsies. A non-invasive procedure, liquid biopsies are simple blood tests that are able to detect characteristics of a tumour without needing to take a direct tissue sample. 

Tumours release a variety of biomolecules into the bloodstream that can be detected via a blood sample study. These biomolecules help doctors figure out what sort of treatment a patient needs without requiring an invasive traditional biopsy.

In addition, liquid biopsies could potentially become the first line of cancer-screening for healthy individuals. 

At the moment, the lack of good cancer screening has resulted in numerous cancer patients only being diagnosed late. As you may have heard, the earlier you detect cancer, the better your prognosis and the better the outcome of treatment. Due to the non-invasive nature of liquid biopsies, it could become an important first line of detection.

Companies such as Guardant Health (NASDAQ: GH) and the Illumina (NASDAQ: ILMN)-owned, GRAIL, are leading the way.

Guardant Health already has an FDA approved test called Guardant360 which can be used for tumour mutation profiling across all solid cancers. The test is gaining wider acceptance from oncologists, with more than 150,000 tests performed to date. Guardant Health is also actively testing liquid biopsies as a screening tool with a major study in place since 2019. If the trial is successful, the company will submit its test for FDA approval which could become a game-changer in cancer screening.

CRISPR gene editing

For some time now, scientists have realised that specific genes in our body may predispose us to diseases or may cause inherited diseases to pass from generation to generation.

Although they may have identified genes that are causing these diseases, scientists have not been able to alter the gene sequences in question to reverse or prevent the diseases from occurring. CRISPR gene editing may change this.

CRISPR, which is short for Clustered Regularly Interspaced Short Palindromic Repeats, is a gene-editing method that scientists have identified to efficiently and precisely modify, delete, or replace parts of the human DNA.

Scientists aim to develop gene-based medicines based on CRISPR technology to remove disease-causing genes. This could potentially solve the problem of genetic diseases such as sickle cell anaemia, cystic fibrosis, haemophilia, and many more.

CRISPR Therapeutics AG (NASDAQ: CRSP) and Editas Medicine Inc (NASDAQ: EDIT) are two companies that are focused on the transformative potential of CRISPR gene-editing technology. 

CRISPR Therapeutics currently has two programs that are at the clinical trial stages. The first is a therapeutic program to treat inherited hemoglobinopathies, β-thalassemia and sickle cell disease. Both these diseases are significant global burdens with around 300,000 and 60,000 babies born with sickle cell disease and β-thalassemia, respectively, each year.

The second is CRISPR Therapeutics’ Immuno-Oncology program. Immuno-Oncology is the use of immune cells to seek and destroy cancer cells. CRISPR Therapeutics aims to use CRISP technology to generate off-the-shelf immune cells that can be more easily administered and produced than the current CAR-T therapies that require the patient’s own genes. 

Similarly, Editas Medicine has two programs that are in early-stage clinical trials. The first is for the treatment of Leber Congenital Amaurosis 10 (LCA10), which is a group of inherited retinal degenerative disorders that are the most common cause of inherited childhood blindness affecting 3 of every 100,000 children globally.

The other program in early-stage clinical trials is for the treatment of sickle cell disease. 

Both companies are also developing other solutions for numerous other diseases which are in much earlier stages of development.

Although CRISPR gene-editing technology is still in its infancy, the potential of the technology seems very promising.

Tumour treating fields

Another interesting development in oncology is the use of tumour treating fields. This involves the application of alternating electric fields to disorientate the positions of tumour cell proteins which in turn disrupt the cell division of tumour cells. 

Novocure Ltd (NASDAQ: NVCR) is a key player in this arena. I first wrote about Novocure a year ago. Since then, the stock price has climbed by more than 200%, perhaps due to good news regarding some of its ongoing clinical trials. 

Currently, Novocure’s tumour treating field solution is FDA-approved for recurrent and newly diagnosed glioblastoma and mesothelioma. 

It is also in late-stage clinical trials for brain metastasis, non-small cell lung cancer, pancreatic cancer, ovarian cancer, and phase II clinical trials for liver and gastric cancer.

There has also been higher adoption of its commercialised products over the year with the company reporting a 12% increase in active patients and a 32% increase in net revenues in the first quarter of 2021.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Ser Jing and I currently have a vested interest in the shares of Illumina Inc. Holdings are subject to change at any time.

Ser Jing and I manage an investment fund that invests in a number of software-as-a-service (SaaS) companies.

Over the past few weeks, a handful of them reported their quarterly earnings results. Here’s a quick summary of how they performed and highlights from their respective analyst briefings.

DocuSign Inc (NASDAQ: DOCU)

The leader in e-signatures posted a solid set of results for the quarter ended 30 April 2021. Revenue was up 58% year-on-year to US$469.1 million, billings grew 54% to US$527.4 million, the gross margin improved to 78%, and free cash flow more than tripled to US$123.0 million. DocuSign’s free cash flow margin (free cash flow as a percentage of revenue) is also now a healthy 26%.
To me, the most impressive part was that the company’s revenue grew 9% sequentially. This is a solid achievement considering that DocuSign’s last three quarters prior to the latest reporting quarter have been positively impacted by COVID-19. 

In the quarter ended 30 April 2021, DocuSign added 96,000 and 11,000 net new total customers and enterprise and commercial customers, respectively. These translate to respective sequential growth of 10.7% and 8.8%, and should set DocuSign up well for the rest of the year.

DocuSign’s CEO Dan Springer said the following in the company’s latest earnings conference call: 

“Since the start of the pandemic, DocuSign has helped accelerate access to healthcare, government, education, small business lending and many other services around the world. What began as an urgent need has now transformed into a strategic priority. And as a result, DocuSign has become an indispensable part of many organization’s business processes.

Put another way, once businesses usually transform their agreement processes, they simply don’t go back. We believe this trend will only accelerate as that anywhere economy continues to emerge.”

MongoDB Inc (NASDAQ: MDB)

The leading NoSQL database provider started its fiscal year 2022 with a bang.

For the first quarter of fiscal year 2022, revenue climbed 39% year-on-year to US$181.6 million and the company turned free cash flow positive this quarter (US$9.6 million) from a negative figure (-US$7.4 million) a year ago.

MongoDB also recorded sequential revenue growth of 5.8%, which should set it up nicely for the coming quarters as the company laps last year’s strong results. 

During MongoDB’s earnings conference call for the first quarter of fiscal year 2022, CEO Dev Ittycheria said, 

“As we look to the future, there are a number of reasons why we are bullish about our long-term prospects. 

First, we are seeing increased adoption, enterprise adoption of Atlas. In the first quarter, approximately two-thirds of new business won by our field sales team was Atlas, more than double the percentage from 2 years ago. Not only are our customers choosing more of Atlas, they’re building or moving mission-critical workloads onto Atlas, which is the biggest driver of growth of our more than 1000 six-figure customers.

Second, cloud partners are recognizing the value that MongoDB and Atlas bring to their own businesses. Using Q1 as an example, we had a record co-sell quarter with AWS, GCP and Alibaba. We are seeing increasing opportunities to expand ways we partner with cloud providers through both technical integrations as well as go-to-market initiatives to enable more customers around the world to derive the benefits of using MongoDB.

Finally, our C level customer conversations indicate that our application data platform strategy is clearly resonating in the marketplace. Customers increasingly tell us that they prefer to standardize on a general-purpose platform, rather than use a myriad of single function databases that add more cost and increase the complexity of running workloads in the cloud.”

Veeva Systems Inc (NYSE: VEEV)

Continuing the winning theme, Veeva, which provides a suite of cloud software solutions for the global life sciences industry, announced a good set of results for the quarter ended 30 April 2021. 

Revenue grew 29% from a year ago to US$433.6 million, operating income rose 47% to US$128.4 million and the company added 59 new customers to bring its customer account above 1,000. On a sequential basis, Veeva’s revenue grew 9.2%.

Veeva’s CEO Peter Gassner shared the following comments during the company’s latest earnings conference call: 

“Our level of partnership with the industry is noticeably increasing, and there are multiple reasons for this. With every quarter of customer success and reliable delivery, Veeva becomes a more trusted partner. Our expanding product footprint, with products such as CDMS, Safety, MyVeeva, and Data Cloud, also makes Veeva a more strategic partner. The move to a digital-first way of working is also making technology and data more strategic overall to our customers. And finally, our move to operating as a public benefit corporation is encouraging to our customers as they look to us for long-term partnership.”

Okta Inc (NASDAQ: OKTA)

Okta, the leading identity and account management company, reported a 37% year-on-year rise in revenue to US$251.0 million for the quarter ended 30 April 2021. The company’s current remaining performance obligation rose 45% year-on-year to US$899 million, setting it up nicely for the next 12 months. Okta’s free cash flow margin also improved to 21% from 16% in the same quarter a year ago.

Notably, Okta’s revenue grew by 7.3% sequentially, which shows that the company can still grow from its high base in the last fiscal year. Okta also added 650 net new customers in the quarter bringing its total to 10,650.

Okta’s CEO, Todd McKinnon, is bullish on the company’s prospects of becoming a primary cloud provider as it expands its capabilities and integrates with its recent acquisition of Auth0. He said the following in the company’s latest earnings conference call:

“Okta is well-positioned to become the standard for digital identity. The Okta and Auth0 platforms are made up of core technologies that are flexible, extensible, and incredibly customizable to make that spectrum possible. By building a platform that connects with everything and meets every identity use case, over time, we’ll push the technology ecosystem to be safer and create more value for everyone. Together, Okta and Auth0 create a powerful combination.

We’ve strengthened our position as the world’s leading independent identity cloud. We’ll create even more powerful network effects that will drive platform innovation, allowing us to better serve our customers with a broader range of use cases and audiences. And as a result, we’ll capture more of the massive and growing $80 billion identity market opportunity even faster. The world is still in the early stages of modernizing its identity infrastructure.

The secular trends I mentioned earlier that have been driving our business will continue to drive our business for years to come. With that as a backdrop, we’re establishing a new long-term financial target, which is a significant step-up from our prior FY ’24 framework. Given our market-leading position, unmatched technology portfolio, and the massive market opportunity, we’re confident that we can grow our revenue base to achieve $4 billion in FY ’26. With growth of at least 35% each year, along the way, we will continue to invest in driving product innovation and our go-to-market initiatives while targeting a free cash flow margin of 20% in FY ’26.”

Salesforce (NYSE: CRM)

One of the pioneers of SaaS business model, Salesforce had a strong start to fiscal 2022. Revenue was up 23% year-on-year to US$5.96 billion, current remaining performance obligation grew 23% to US$17.8 billion, while the weighted average diluted share count only increased 2.9%.

On a sequential basis, Salesforce’s revenue rose 2.4% which is decent as Salesforce has a seasonal sales cycle. The compant’s CEO Marc Benioff is as bullish as ever. During Salesforce’s latest earnings call, he commented: 

“Now, for fiscal 2022. I’m thrilled we are raising our revenue, our guide by $250 million to $26 billion. This is one of the largest raises we’ve really ever had. It represents 22% projected growth year-over-year. And we’re not just raising revenue. And again, thanks to Amy, we’re raising our operating margin to 18%. So that is incredible. And in a few years, we’re going to be doing $50 billion ($21.25 billion in 2020) and by the fiscal year 2026. So that is an incredible thing.”

He also touched on why he believes Slack will make a good addition to Salesforce. He said, 

“And this pending acquisition of Slack also. We’ve never been better positioned for the future. This is an all-digital, it’s an all work from anywhere world. It’s made our companies, Salesforce and Slack, more important to customers than ever. So bringing them together is so exciting. And once this merger is approved, we’re going to be able to build Slack and all of our products will all become Slack-first. It’s going to make our customers more productive.

We’re going to work with software companies on building incredible new capabilities like we’ve seen these amazing examples of what Slack can do. I’ll tell you we’re really excited about creating this number one enterprise applications company.”

Zoom Video Communications Inc (NASDAQ: ZM)

One of the biggest winners of the COVID-19 pandemic, Zoom continues to post excellent results.

It reported a 191% year-over-year increase in revenue to US$956.2 million in the quarter ended 30 April 2021. GAAP net income increased more than eight-fold to US$227.4 million and free cash flow increased by 80% to US$454.2 million. The free cash flow margin for the quarter was an industry-leading 48%.

On a sequential basis, Zoom’s revenue grew by 8.4%, allaying fears that customer-churn from the reopening of economies around the world would impact Zoom’s revenue growth.

Although Zoom’s growth is expected to slow from the incredible numbers seen in FY2021 (326% revenue growth), Zoom still expects total revenue in 2022 to be between US$3.975 billion and US$3.99 billion, compared to US$2.6 billion in FY2021. This translates to growth of 50% at the low end.

Zoom’s CEO, Eric Yuan, said in the company’s latest earnings call: 

“In a recent survey we conducted, 80% of U.S. respondents agreed that all interactions will continue to have a virtual element post-pandemic, and that figure was even higher in many of the other markets we surveyed. The hybrid model is here to stay, and Zoom Events will be an excellent solution for our customers who are looking to create and host company events with a versatile and powerful solution.”

Yuan also highlighted some big customer wins during the quarter, which demonstrates Zoom’s strong value proposition in the midst of heavy competition from the other tech giants that are trying to shoulder their way into the videoconferencing space.

Summary

It has, without doubt, been a great start of the year for the SaaS companies in our portfolio.

Although the amazing growth in 2020 is not expected to repeat, the above-mentioned companies continue to see strong secular tailwinds and are executing well.

Sequential growth from the last quarter also shows that these companies are continuing to grow and are experiencing minimal customer-churn despite the reopening of the economy.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Ser Jing and I currently have a vested interest in the shares of Veeva, Zoom, Salesforce, MongoDB, Okta and Docusign. Holdings are subject to change at any time.

With most major e-commerce companies having reported their earnings updates for the first quarter of 2021, here are some of the key themes I picked up and the companies that are winning in this space.

South Korea e-commerce growing fast – Coupang riding the wave

Korea may have one of the most mature e-commerce markets globally, but there is still plenty of room for growth.

During Coupang Inc‘s (NYSE: CPNG) earnings conference call for the first quarter of 2021, CEO Bom Suk Kim said: 

“Korea is a massive e-commerce opportunity. It’s the fifth-largest globally and grew at a 20% CAGR over the last five years, second only to China. And it’s the largest e-commerce opportunity not won by Amazon or Alibaba, but there is a broader play here.

Similar to China, Korea is leapfrogging the offline retail revolution. The US has more than 10 times the offline retail footprint per capita of Korea.

We believe we are at the centre of two revolutions, not just the transition from offline to online, but also a retail revolution that happened first offline in the US, but is now starting online in Korea. The market also boasts a highly connected tech-savvy consumer base with high mobile usage. We believe these structural characteristics create strong tailwinds for e-commerce that will lead to higher online penetration than other markets.”

In the first quarter of 2021, Coupang delivered total revenue growth of 74%, approximately three times faster than the overall Korean e-commerce segment. 

This growth is even more impressive when considering that the company lapped a COVID-induced spike in e-commerce demand in the first quarter of 2020, which started in Korea in late January 2020.

Personalised e-commerce on the rise – Etsy well-positioned

E-commerce activity for products that are customisable, handmade, or unique has grown faster than the e-commerce market in general.

Etsy Inc (NASDAQ: ETSY), which is a global marketplace for unique handcrafted products, saw its gross merchandise sales in the first quarter of 2021 grow by a staggering 132% from a year ago. For perspective, this was more than double Amazon’s 64% growth in third-party seller services revenue for the quarter. 

Etsy’s team has done an excellent job in driving traffic to its marketplace and building a two-sided network. Etsy CEO Josh Silverman commented in the 2021 first-quarter earnings conference call that Etsy is focused on building brand awareness, creating more buyer triggers, and creating in-app personalisations to help improve the buyer experience. 

Although Etsy’s management warned of slower growth in the latter part of 2021 due to difficult year-on-year comparisons, CFO Rachel Glaser remains bullish on the long-term prospects. She said the following in Etsy’s 2021 first-quarter earnings call:  

“We remain very excited about the opportunity ahead and believe that now is the right time for us to invest for growth. These investments primarily are in the form of people and marketing dollars. Our growth has vastly outpaced our hiring and we are leaving far too many great ideas on the cutting room floor. We’ve already added 100 employees in Q1 and intend to keep hiring throughout the year. So we have ample resources in time to impact the holiday season and beyond.”

Arming the rebels- Shopify 

Shopify Inc (NYSE: SHOP), which provides the tools for merchants to start an online shop, saw revenue growth of 110% in the first-quarter of 2021. Shopify’s revenue for the quarter was also sequentially higher than 2020’s fourth quarter, which is usually a seasonally stronger quarter.

Shopify’s merchants are growing fast. The company’s gross merchandise value soared 114% from the same period last year. Like Etsy, Shopify’s growth outpaced the revenue growth recorded in Amazon’s third-party marketplace services.

Shopify’s partnerships with Facebook and TikTok are also going smoothly. Harley Finkelstein shared the following comments during Shopify’s 2021 first-quarter earnings conference call:

“We are ushering in a new era of social commerce and helping more brands and consumers engage in the Digital Main Street. The number of shops actively selling on Facebook shops has more than quadrupled since Q1 a year ago, as well as the GMV through Facebook. While still small, the launch of Facebook shops in May of last year is clearly starting to make a difference here.

In Q1, we expanded our marketing partnership with TikTok internationally to an additional 14 countries in North America, EMEA, and APAC. So far, we’ve seen good traction in the adoption of TikTok in the U.S. since we launched the integration last October. And we recently expanded our Pinterest channel into 27 additional markets, opening discoverability and sales opportunities worldwide.”

Latin America e-commerce – Mercado Libre triple-digit Growth in GMV

Latin America continues to see higher e-commerce adoption. MercadoLibre Inc (NASDAQ: MELI), the e-commerce front runner in Latin America, reported a 114% increase in gross merchandise value (GMV) on a currency-neutral basis. 

MercadoLibre’s GMV grew 183%, 92%, and 114%, respectively, in its three core markets of Argentina, Brazil, and Mexico. The company’s logistics network is also steadily spreading its influence with more than half of MercadoLibre’s Brazil consumer packed goods being shipped from its own fulfilment centre.

The company’s product mix continues to shift towards big brands as MercadoLibre has put an emphasis on attracting global and local household name-brands. MercadoLibre’s Chief Financial Officer, Pedro Arnt, explained during the company’s 2021 first-quarter earnings call:

“In consumer electronics, for example, we have added partnerships with Panasonic, Asus and Intelbras, while our CPG portfolio now includes stores by JMacedo and Mondelez.

As a result, approximately 20% of our marketplace sales are already from Official Stores, an increase of 7 percentage points over the same quarter last year.

Overall product depth continues to improve, as live listings have reached almost 300 million listings this quarter, increasing versus Q4 in all major geographies. Part of this increase was driven by the growth of unique sellers in our marketplace, with almost 1 million total sellers with successful sales during the quarter.

We will continue to grow our already ample seller base, adding almost 200k new sellers to our marketplace this quarter.”

Southeast Asian E-commerce booming- Shopee and Lazada both reporting triple-digit growth

Its boom town for e-commerce in Southeast Asia. Alibaba (NYSE: BABA) reported that Lazada recorded another quarter of triple-digit growth in the gross number of orders. But while Lazada continues to grow, all eyes seem to be on Sea Ltd‘s (NYSE: SEA) Shopee, which since its launch in 2015 has quickly overtaken Lazada to become the number one e-commerce player in the region.

The number of orders on Shopee surged 153% year-on-year and even exceeded the orders seen in the fourth quarter of 2020, which is a seasonally busier period for commerce. Shopee’s gross merchandise value also increased by 103% year-on-year and 6% sequentially.

According to App Annie, Shopee ranked first across its core markets in Southeast Asia and Taiwan by  monthly active users and total time spent in-app on Android in the Shopping Category.

Shopee also recorded a gross profit in the first quarter of 2021, a welcome turnaround from its negative gross profit a year ago. Sea’s CEO, Forrest Li, commented in the company’s 2021 first-quarter earnings call:  

“To conclude, we believe that e-commerce penetration remains low across all our markets, in spite of the step change in digitalization since the onset of the pandemic. Against this backdrop, we remain committed to investing with efficiency to capture the attractive potential over the long run.

We believe our hyperlocal and highly targeted approach, alongside our commitment to focus and invest with efficiency for the long term, will allow us to build a healthy and sustainable ecosystem that can offer the best long term value for buyers and sellers and in turn our other stakeholders.”

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Mercado Libre, Etsy Inc, Shopify Inc, Coupang, Amazon Inc, Sea Ltd, and Facebook Inc. Holdings are subject to change at any time.

As an investor, I am constantly on the hunt for what my blogging partner Ser Jing and I call “compounders.” These are companies that are able to grow their cash flows at an exponential rate by reinvesting their cash.

This is where the truly great companies stand out. They have great capital allocators at the helm who are able to reinvest their cash at high rates of return. The biggest companies in the world all seem to share this common trait.

Let’s take a look at the three largest companies in the US stock market in terms of their market capitalisation.

Growing beyond computers

Take Apple Inc (NASDAQ: AAPL) for example. It feels like a long time ago that Apple was merely a computer company. 

The company which used to sell only computers pivoted to sell smartphones. This revolutionised the company and set the stage for it to become the most valuable company in the world.

The late Steve Jobs was a visionary leader who made important investments to make Apple’s iPhone one of the most popular smartphones in the world. 

His early investments into smartphones have clearly paid off as Apple continues to rake in the cash from its iPhone sales. In its last reported quarter, Apple sold US$47.9 billion worth of iPhones.

Today, Apple’s management team has made other excellent capital allocation decisions, such as placing a focus on services and new products – such as Apple Watch and AirPods – which have become billion-dollar businesses themselves. 

The company also seems to be making the right decision by purchasing its relatively low-priced shares in the market, returning shareholder’s capital at this opportune time, which should further increase shareholder value.

From Windows to the cloud

Microsoft Corporation (NASDAQ: MSFT) made its first big break when it sold its “Windows” graphical operating system for computers. This was a huge breakthrough and a highly profitable business.

It was an easily scalable, asset-light, and high margin business. But as with any product, growth eventually slowed as personal computers made their way to nearly every household in the developed world. 

To keep growing, Microsoft made some extremely intelligent but difficult capital allocation decisions. It built Azure, its cloud computing infrastructure-as-a-service platform. This was capital intensive and a lower margin business than software. But as seen today, Azure has become an important part of Microsoft’s business and is growing quickly.

Microsoft also built other cloud software products such as Office 365 and Dynamics 365 and has even ventured into gaming through Xbox. These investments have paid off and Microsoft is now in a much better position for growth.

Pivoting from first-party selling

Amazon.com Inc (NASDAQ: AMZN) has grown from a simple online book shop to an e-commerce and cloud computing behemoth. The company made several important investments. 

In the early days, it invested in growing its product suite beyond books.

Another major pivot was growing its third-party marketplace. In 2020, analysts estimate that Amazon’s third-party marketplace makes up US$300 billion of its total US$490 billion in gross merchandise volume. The third-party market place is a more profitable business as it is high margin. Amazon makes money through commissions, ads, and other services it provides to sellers.

But perhaps the best investment that Amazon made was to build AWS. While the company may have chanced on the opportunity due to its massive cloud computing requirements, Jeff Bezos was quick to realise that he could profit by providing other companies with cloud computing infrastructure services. AWS now has US$54 billion in annualised revenue and in 2020 accounted for 60% of Amazon’s profit. 

Common traits

As we pull back the curtain, a recurring pattern emerges. The biggest companies in the world all tend to be able to invest and grow new and meaningful revenue streams. Rather than sitting on their cash flows, these companies find thoughtful ways to put their cash to use in unexpected but useful ways.

As investors, we can analyse a business to death but over a truly long time frame, even the best businesses will start to slow down. This is normal as competitors erode margins and as industries mature.

However, the truly lasting compounding machines are able to allocate capital to grow new lines of businesses. 

The three companies mentioned above are not isolated cases. 

Facebook Inc’s (NASDAQ: FB) acquisition of Instagram. Alphabet Inc‘s (NASDAQ: GOOGL) acquisition of Youtube and Android. Berkshire Hathaway’s (NYSE: BRK.B) consistently smart use of capital to purchase whole or minority stakes in companies. Salesforce.com Inc‘s (NYSE: CRM) expansion of its product suite. The list goes on. These companies have each become long-term “compounders”.

All of them have grown their businesses through smart capital allocation decisions. Some investments may have seemed strange at that time, such as Google’s purchase of Android, but they have paid off handsomely. The biggest companies today have businesses that look very different from where they started.

The lesson here is, rather than simply focusing on a company’s business, it is also wise to look at the company’s track record of capital allocation decisions. Over a sufficiently long period of time, the companies with the best capital allocators will become the fastest and most reliable compounders.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Facebook, Amazon, Alphabet, Microsoft, Salesforce and Apple. Holdings are subject to change at any time.