Investors fearing recession continue to cut fastest growing cloud stocks

Nima Ghamsari, co-founder and CEO of Blend, speaks at the Sooner Than You Think conference in New York City on October 16, 2018.

Alex Flynn | Bloomberg | Getty Images

Tech investors finally got some relief last week as the Nasdaq snapped a seven-week losing streak, its worst streak since the dot-com meltdown in 2001.

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

Paradoxically, growth remains robust and companies are benefiting from the reopening of economies, but investors are still selling., Mixing laboratories and SentinelOne continue to double their revenue year over year, to 179%, 124% and 120%, respectively. Still, the trio is worth about half of what it was at the end of 2021. The market has taken a massive hit across the basket.

Byron Deeter of Bessemer Venture Partners, an investor in cloud start-ups and one of the most vocal commentators on cloud stocks, observed earlier this month that the earnings multiples of the BVP Nasdaq Emerging Cloud Index of the company had returned to their 2017 level.

Profits, please

One of Deeter’s colleagues at Bessemer, Kent Bennett, isn’t sure why the fastest growers don’t get passes to 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 shit, get me out of this market’ and then back to efficiency over time,” said Bennett, who sits to the restaurant software board. company Toastwho himself showed 90% growth in the first trimester. The stock is now down 52% since the start of the year.

leaked toast turnover down in 2020 as in-person visits to the restaurant thinned out, resulting in less intense use of the company’s point-of-sale hardware and software. Then online ordering took off. Now people are dining out more and more, and Toast is seeing stronger demand for its Go mobile point-of-sale devices and QR codes that let people order and pay on their own phone, CEO Chris Comparato said. in an interview with CNBC earlier this month. .

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

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

What Toast has come up with is new information about margins. During Toast’s first-quarter earnings call earlier this month, chief financial officer Elena Gomez said the guidance implies that its profit before interest, tax, depreciation and amortization margin in the second half 2022 will be 2 points higher than the first half as the company works to strengthen margins going forward.

“A few investors have pushed, and they want a little more detail, definitely,” Comparato said. “But a lot of them are like, ‘Okay, that was a different tone, Chris, thank you. Chris and Elena, please continue to implement that vision.'”

Other cloud companies also get the message.

Data analysis software publisher Snowflakewhich just ended a two-and-a-half-year streak of triple-digit revenue growth, is “not a growth-at-all-costs business,” CEO Frank Slootman said. declared in a call with analysts on Wednesday.

Zuora, which offers subscription management software, is “focused on building a successful long-term business that delivers sustainable, profitable growth for years to come,” CEO Tien Tzuo said on the quarterly call. to his company’s analysts. The company reported a net loss of $23.2 million on revenue of $93.2 million, compared to a loss of $17.7 million in the prior year quarter.

Back to the “rule of 40”

Even throughout the software industry, there is an acknowledgment of the old-fashioned view that software should make money. Splunkwhose software helps enterprise security teams collect and analyze data, included a slide in its presentation to shareholders called “Scale Profitability Growth”. He charted the last years of Splunk’s performance against the “Rule of 40“, a concept stating that a company’s revenue growth rate and profit margin should total 40%. Splunk called for 35%, the closest it has been in three years, in the fiscal year In progress.

The focus on efficiency isn’t completely missing at, whose software helps small and medium-sized businesses manage bills and invoices, but it’s easier to miss as revenue soars. faster than most businesses. Even before the start of software sales in November, executives touted the company’s economic health.

Blend Labs, which provides software banks can rely on for mortgage applications and other processes, has been more active in repositioning itself for the new market reality, but it’s also a ten- seventh the size of by market capitalization.

Despite hypergrowth, Blend reduced its workforce by 10% in April. Nima Ghamsari, the company’s co-founder and chief executive, told analysts the company was conducting a “comprehensive review to align our cash burn and near-term market realities, while charting a clear path to products and stronger operating margins which will lead to Blend having long-term profitability.”

SentinelOne, which sells cybersecurity software that detects and responds to threats, has been working on its cost structure. Co-founder and CEO Tomer Weingarten drew analysts’ attention to its margin improvement during a conference call in March, and he said the company aims to make more progress over the next year. .

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

“As we increase our growth estimates on S, we are reducing our PT to $48/share entirely due to a reduction in software multiples,” BTIG analysts wrote to clients. In other words, the category was crushed and SentinelOne was not exempt from it.

At that time, the WisdomTree Cloud Computing Fund, an exchange-traded fund that tracks the Bessemer index, had fallen 47% from its November 9 peak. The decline did not stop as the Federal Reserve reiterated its plans to fight inflation with higher interest rates.

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

“It’s going to take us a few months to get over this,” said Jason Lemkin, founder of SaaStr, a company that organizes cloud-centric conferences. He compares the decline to a hangover, after Covid made investors drunk on cloud stocks.” haven’t finished our Bloody Marys and aspirins,” he said.

Two of Covid’s biggest cloud divas, Shopify and Zoom Video Communications, saw triple-digit growth vanish last year as stores began to reopen and in-person social engagements 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’re getting back to average,” he said.

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

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

— CNBC’s Ari Levy contributed to this report.

LOOK: Tech will see cuts to marketing budgets, slower hiring and layoffs, says Deeter de Bessemer

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