by 2021 - seeking alpha

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Beth Kindig, San Francisco, CA Beth.Technology

2021

H1 2021 Cloud Software Update

By: Beth Kindig

Date: February 17th, 2021

https://beth.technology/

H1 2021 Cloud Software Update 02-17-2021

Beth.Technology, San Francisco, CA Page | 2

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H1 2021 Cloud Software Update

Don’t forget about cloud software!

In the excitement about SPACs and the flood of IPOs that have listed recently, it'd be easy to forget about the

tried-and-true.

Quick Note on the Current Climate …

My main thesis about cloud has not changed: it's secular and insulated from geopolitical risks and economic

drawdowns. Generally speaking, cloud software reduces costs for enterprises and SMBs. Therefore, the category

is more insulated from economic drawdowns. You can read more about my views on cloud’s resiliency here.

There's a caveat to this, which is that the market is flooded with cloud software solutions and tools – both in the

public markets and private markets. This is because cloud software has a low barrier to entry. The costs to develop

cloud software and go-to-market is very low compared to hardware or a solution that requires specialty engineers,

like AI, ML, robotics, etcetera. Venture capitalists are drawn to cloud software because it's relatively cheap to

create, and the margins are healthy due to recurring subscription revenue.

The window of time that you have to be wary is between years 8 and years 12 for a software company. Prior to

year 8, it's common for software and new tech startups to report rapid growth. VCs know this and are taking

companies public sooner to capitalize off momentum traders (and trading machines), that indiscriminately pile

into companies with high growth rates.

In this case, a VC firm can see a very large exit and move onto another company while the public markets sort out

the long-term growth rate and the company's ability to scale. Every startup looks strong at the beginning of the

marathon but which ones endure past mile 13? VCs don't have to worry about this as the goal in today's market

is to exit before the marathon is half-over.

The ramp-up period for startups is exciting because the product finds early adopters. Can the product sustain

long-term after year 8 and continue to take market share? This is a much more complex question. Private investors

exit before the long-term viability of a company surfaces and (us) public investors have to extrapolate the longer-

term trajectory.

https://www.marketwatch.com/story/how-to-pick-long-term-stock-winners-in-cloud-computing-2019-09-12



Consider the fact that 9 out of 10 startups fail. If you’re a VC, you’re going to get the startup to the public markets

as fast as possible to get your exit. If the company fails or the growth slows down, as it does for most tech startups,

then it's of no importance as the exit was made. Because of this dynamic (that startups are essentially

experiments) and there are many new SPACs bringing to market roughly 165 unvetted companies, I believe we

will see a string of failures at the peril of public investors. According to these statistics, we could see 148 fail out

of the 165, or on the low-end, 132 of the 165 fails. The low-end is the 80% failure rate for VC-backed companies

indicated by the statistics.

SPACs are not inherently wrong (and David pointed out a few benefits compared to IPOs). However, young

companies fail very frequently and the public markets are becoming the exit grounds for pre-revenue companies.

This piece is new and public investors aren’t prepared for the high failure rate that is a daily reality in the private

markets.

That’s a bit of a tangent to say we will continue to have plenty of exposure to cloud in our portfolio as a hedge

against any high-fliers we take. The fact that cloud is out of favor in the market right now is not a concern to us

because we know cloud has a resilient growth rate.

We also want to communicate that we are well-diversified. We have exposure to SPACs and small caps, but we

use cloud and semis as a safe haven. I think these comments will become more apparent as we move through the

year. Basically, I am contrasting why cloud deserves attention right now despite the fact speculative trading in

SPACs and Momentum has been in the driver’s seat.

Regarding valuations --- I've stressed this point with companies like Snowflake because we will see more of this

as time goes on and investors need to be careful of merely providing exits for VCs at sky-high valuations. Being

patient is an important tool in a retailer's arsenal when a valuation is high.

Please keep in mind, that we discouraged readers from buying Zoom Video when trading in the forward P/S range

of 50 despite owning this stock at a lower cost basis. Therefore, I am not singling out Snowflake but instead using

it as an example to illustrate why we have not bought this excellent company as "growth at any price" can lock-

up your money for a few quarters while the financials catch up to the valuation. This is exactly what has happened

with Zoom Video (it took a long breather) although the forward P/S is much more reasonable now.

https://www.failory.com/blog/startup-failure-rate

https://beth.technology/why-spacs-are-sometimes-better-than-ipos/

https://community.beth.technology/post/zm-357-tranche-only-5f8d9f34ef1a4e27e695269e



Our Focus: Product-Market Fit and Valuations

For our portfolio, cloud is a hedge as valuations may fluctuate, but growth will march onward for the companies

with product-market fit in this resilient category. The best illustration of product-market fit is Shopify and Zoom

Video as both their top and bottom lines prove they are efficiently meeting market demand.

An example of a company that I have picked on for not having product-market fit is Uber and Lyft as they must

subsidize rides. The market price that customers will pay is lower than its operational costs. The market may still

move the stock based on the promise of autonomous vehicles or robotaxis but today's financials do not suggest

there is product-market fit.

Opendoor has a similar issue. The financials are upside down as the more the company makes, the more the

company loses, and this is inherent to the current business model (not a one-time event or the cost to scale).

Opendoor was hoping to charge 10% in commissions which is about 4% more than Realtor fees for the

convenience of buying the house in cash. The market will not pay this extra 4% and Opendoor is forced to match

Realtors at 6% commissions. Like Uber, the price does not cover the operational costs. However, we are in a period

of historic liquidity and QE. The market may pile in based off sentiment or other speculative reasons (we’ve

entered this stock ourselves and it’s performed well), but the financials today do not show a company that has

achieved product-market fit.

You could argue Fubo does not have product-market fit as seen in the financials. The cost of licensing the content

does not cover the cost of operations. So, why am I invested? Because this is the year for CTV ads and OTT live

content so we think the trend is so early and so massive that we are comfortable taking a flier on this company.

I’ve said before that OTT live sports is the holy grail and cable networks/media conglomerates will do what it takes

to own this transition. There are many market forces at play here and Fubo is centered perfectly in the middle.

Therefore, this is an investment in the trend of Live Sports OTT.

Product-market fit is important to this discussion because finding the gems will protect us from any downside in

the market. Even if the market temporarily sells-off in certain names, we can rest easy if we stick to quality.

https://beth.technology/profitability-uber-lyft-dead-end/

https://www.lightreading.com/cablevideo/the-bauminator/comcast-holds-93-stake-in-fubotv-/a/d-id/767413



The best examples of product-market on the public markets are the FAANGs – where the top line defies the odds,

and the bottom line continues to deliver. There are others in the $200B+ market cap range that illustrate this:

Salesforce for CRM, Adobe for design and its developer moat, Nvidia for the CUDA platform and its developer

moat, etc. Sticking with these companies through market ups and downs did well for early investors.

Cloud investing was fairly predictable in the previous years because there were clear winners in terms of forward

growth. Due to tougher comps, nearly half of all cloud stocks guide between 20% and 40% with very few above

this range and priced dearly if they are (see the chart below).

The other factor we will be considering as we move into 2021 is valuation. There is a disconnect in a few names

where the market has not been perfectly efficient. Below, we pull out a few names that have room and rely on

Knox for any breakouts in valuation.



As was posted on the forum last week, those with room in valuation include Bandwidth, Asana and Crowdstrike.

We are also pleasantly surprised to see Kingsoft Cloud having quite a bit of room although some of this likely

represents the risk in China. In the Macro section, you'll see that China's Cloud IaaS is set to take off with Alibaba

surpassing Google Cloud for the number three spot. We think this foreshadowing growth for Kingsoft.

Macro Outlook:

The big takeaway from the cloud market going into 2021 is that hybrid work-from-home is here to stay. The

market is pricing cloud productivity software as a temporary COVID tailwind but the analysis shows a

permanent shift that will accelerate this year.

According to IDC, the cloud market will grow at a CAGR of 15.7% through 2024 to become a $1 trillion market in

2024. This forecast includes software-as-a-service (SaaS), platform-as-a-service (PaaS), and infrastructure-as-a-

service (IaaS).

The research firm also states that by 2021, 90 percent of enterprises will be relying on a mix of on-

premise/dedicated private clouds, multiple public clouds and legacy platforms. Therefore, IDC predicts this to be

the year of multi-cloud, which we covered in our Microsoft earnings report write-up here. We see multi-cloud as

the first step towards edge computing to where servers from various hyperscalers or CDNs work cooperatively to

deploy 5G workloads.

On a trailing basis, cloud spending grew from $183 billion in 2018 to $233.4 billion in 2019. This puts the $1 trillion

prediction into context as IDC calls for roughly 400% growth over the next five years. In 2019, SaaS accounted for

$148 billion, or about 64% of the public cloud market.

https://community.beth.technology/post/stocks-we-are-watching-60257b2f4a65d780811bc4ca

https://www.idc.com/getdoc.jsp?containerId=prUS46934120

https://www.forbes.com/sites/bethkindig/2020/12/03/google-cloud-will-not-be-able-to-overtake-microsoft-azure/?sh=6d71b2f85af9





SaaS dominating the IT spend for cloud is important because it means there will be many winners in this category

as it marches onward to the $1 trillion mark.

According to IDC, more than half of the global revenue in the PaaS and IaaS markets was captured by AWS (33.6%)

and Microsoft (18.0%) leaving 34.90% for the rest of the market.

This is not the case with SaaS where the rest of the market captured 73.9% and the top two vendors, Salesforce

and Microsoft, caught 7-8%.

This is also important for perspective as smaller companies own the SaaS market while Big Tech dominates IaaS

and PaaS. Therefore, there is a solid opportunity for investors in cloud software now and into the future. The

graph below helps to visualize the opportunity for smaller players:

Source: IDC 2019 Report




According to Gartner, worldwide public cloud spending will grow 18% in 2021 to total $304.9 billion. Relative to

overall IT spend, cloud still has a long runway and is projected to make up 14.2% of total global enterprise IT spend

in 2024 compared to 9.1% in 2020.

Gartner’s survey indicates that there is still quite a bit of growth ahead despite the harder comps the cloud

software leaders face in 2021. The data shows that 70% of organizations using cloud services plan to increase

their spending, stating “the proportion of IT spending that is being allocated to cloud will accelerate even further

in the aftermath of the COVID-19 crisis.”

The analyst firm points towards mobility, remote working and hybrid workforces as trends that will lead to further

market growth.

Source: Gartner CIO Survey

In the graph above, we see survey respondents and Gartner forecast an increase in work-from-home. Meanwhile,

the market has been cautious about cloud software post-vaccine, which may be unwarranted with hybrid

workforces.

https://www.gartner.com/en/newsroom/press-releases/2020-11-17-gartner-forecasts-worldwide-public-cloud-end-user-spending-to-grow-18-percent-in-2021

https://emtemp.gcom.cloud/ngw/globalassets/en/publications/documents/top-priorities-for-it-leadership-vision-for-2021-ebook.pdf



Here is what Gartner states, “For example, customers and citizens shifted their activity online during the

lockdown, but that shift will increase, not reverse, in 2021.”

Forrester’s recent survey showed similar results with 47% of North American managers anticipating a

permanently higher rate of full-time remote employees and 53% of employees wanting to work from home post-

pandemic.

Although budgets will only increase 2% in 2021, according to Gartner, CIOs' top priorities are digital workplace

technologies to support work-from-home, and then AI/ML, robotic process automation (RPA), distributed cloud

and multi-experience platforms.

Forrester states 35% of companies will double down on workplace AI with one in four workers supported by

automation either directly or indirectly by the end of 2021. B2B sellers will rely on AI and automation with

predictions that 60% will rely on tools with these functionalities embedded.

The analyst firm also states the hyperscale cloud market will “return to hypergrowth” of 35% to $120 billion in

2021. This is up from the original prediction that cloud IaaS would grow 28%. The analyst firm also predicts

Alibaba will take the number three spot instead of Google Cloud.

Adopting serverless apps and containers will continue to grow with increased demand for multi-cloud container

development platforms and public-cloud container/serverless services. Forrester also believes a leading trend will

be disaster recovery moving to the public cloud.

Cloud Stocks for H1 2021

I wrote my first thematic PDF on cloud in December of 2019 during an intense cloud sell-off. The First Trust Cloud

Computing ETF (SKYY) had posted 22% returns YTD at time of writing in December and closed the year with 24.55%

returns for full-year 2019.

https://go.forrester.com/wp-content/uploads/2020/10/Forrester_Predictions_2021.pdf



https://seekingalpha.com/research/45714056-elisabethkindig/5385560-top-cloud-stocks-for-2020



Last year, cloud performed much better due to its fundamental, secular strength during COVID with the SKYY ETF

closing out with 57.41% returns in 2020.

We covered many cloud names at their lows during Q3 and Q4 2019 due to our thesis that cloud is insulated and

secular. At the time, we pointed out that cloud services were expected to grow 4.5 times more than the IT industry

and that future growth through 2022 would be 3 times higher than IT (page 3 from this report).

I believe we are here again in a very similar spot. The market thinks cloud is going to be stunted and forward

guidance isn't saying otherwise. However, the analyst firms are predicting we will accelerate and are raising

forecasts. We will side with Gartner, IDC and Forrester who do a particularly great job in the cloud category.

Prior to COVID, our thesis was this: “cloud software is more sheltered from overseas economies, supply chains,

trade wars and shifting government policies” and “truly, there is few safer places to invest in technology if the

trade war resumes or we see the recession that many economists are predicting.”

https://seekingalpha.com/research/45714056-elisabethkindig/5385560-top-cloud-stocks-for-2020



My thesis this year is that work-from-home and hybrid work environments will be the new norm which will keep

cloud growth steady and that AI and ML will be another catalyst. You simply can’t compete with AI and ML with

on-premise servers and software. Edge computing and 5G is another accelerant for cloud IaaS, PaaS and software.

Below are the top 35 cloud stocks listed by revenue growth that we consider to be in our universe. The top 10 are

shaded in yellow.

In a Motley Fool podcast, I had said that this would revert to about a 30 forward P/S and we are here now.

Symbol Name Forward P/S Revenue Est Current Fiscal Year Revenue Estimates for Next Fiscal Year Percentage Change

SNOW Snowflake Inc 77.1486 579.95 1095.56 89%

API Agora Inc 62.4293 168.69792 243.82762 45%

KC Kingsoft Cloud 9.477 1618 2556 89%

CRWD CrowdStrike Holdings Inc 43.2667 860.3552 1235.45578 44%

SHOP Shopify Inc 46.3787 3818.53033 5307.85058 39%

BAND Bandwidth Inc 9.87 326.82 451.79 38%

AI C3.ai Inc 60 177.12287 235.1089 33%

TDOC Teladoc Health Inc 21.6058 1970.26455 2658.44389 35%

DDOG Datadog Inc 41.2332 803.27188 1067.49035 33%

ASAN Asana Inc 21.8174 221.34643 294.0211 33%

ZS Zscaler Inc 49.6113 612.59773 808.08628 32%

NET Cloudflare Inc 44.8588 569.54064 743.70858 31%

BILL Bill.com Holdings Inc 73.733 212.03028 276.35265 30%

FROG JFrog Ltd 29.7519 195.35179 253.6782 30%

SMAR Smartsheet Inc 21.1111 378.31308 488.79291 29%

U Unity Software Inc 35.6376 962.97918 1244.12087 29%

AMWL American Well Corp 29.1202 238 264.56545 29%

TWLO Twilio Inc 31.5828 2205.8383 2849.66347 29%

OKTA Okta Inc 35.2101 1072.86257 1381.349 29%

FSLY Fastly Inc 30.5245 379.49228 487.268 28%

DOCU DocuSign Inc 26.6421 1890.16288 2424.82457 28%

MDB MongoDB Inc 34.5988 576.39379 736.54512 28%

PLTR Palantir Technologies Inc 42.2844 1412.40365 1803.67643 28%

COUP Coupa Software Inc 39.7198 524.03127 665.99831 27%

ZI ZoomInfo Technologies Inc 37.4006 602.06928 757.57635 26%

PAYC Paycom Software Inc 23.5654 1004.45981 1259.27543 25%

ESTC Elastic NV 25.4887 572.32021 715.65261 25%

NOW ServiceNow Inc 20.134 5729.64876 7152.27568 25%

PLAN Anaplan Inc 21.1493 551.88678 687.81332 25%

ZEN Zendesk Inc 14.1394 1296.81648 1615.79221 25%

DT Dynatrace Inc 21.6506 698.69966 866.12078 24%

PD PagerDuty Inc 17.6743 211.75694 262.28754 24%

ZM Zoom Video Communications Inc 36.1517 3496.93554 4327.6849 24%

RNG RingCentral Inc 27.6218 1438.43702 1778.14802 24%

NCNO Ncino Inc 29.8875 200.96977 247.26176 23%

https://beth.technology/podcast-motley-fool-big-tech-plus-stock-buy-right-now/



Some conclusions:

• Kingsoft Cloud has a compelling risk/reward ratio as the company will deliver Snowflake-level revenue at rock-bottom valuation.

• Bandwidth has the ingredients to pass the pack of cloud stocks stuck in the sub-40% growth range. Let’s see if the company can do this – and if the valuation will finally match its potential.

• Asana is not in our top 10 due to competition across productivity tools, but we see room here in the valuation. This will be something Knox spearheads as he sees the right setup including this one from last week.

• Crowdstrike and Zscaler are both leaders in revenue growth and EPS growth.

• Zoom Video and Shopify are both strongest in terms of a large base in EPS and we think the products will perform well in the face of tough comps this year.

• This year is very unique for cloud software because so many stocks are sub-40% growth and tightly ranked (see the chart above). We are not surprised to see mixed-reactions to the earnings reports as the market is holding its breath to see what the covid comps will be for the March quarter.

• We are not too concerned about the market taking a breather or responding to uncertainty. There is only one way forward for SMBs and enterprises (which is adopting cloud IaaS, platforms and software). Traditional IT is expensive and will only hinder a company from taking advantage of AI and 5G. Competitively it can be very harmful to not transition to cloud right now as we've seen in my past reports citing McKinsey.

• The last time I talked about cloud on the Motley Fool podcast, I thought valuation was a serious risk as we saw many names trading in the 50 forward P/S range whereas 30 forward P/S is the mean for high-growers and 20 P/S is the mean for average growers.

• Now that we have reverted to the mean, we plan to allocate for cloud while the trend is out of favor.

My Top 10:

We stand by Zoom Video and Shopify as the relationship between the top-line and the bottom-line proves

product-market fit. We understand there will be harder comps this year but these companies are releasing new

products to grow market share and continue to be centered in important trends. These were strong companies

prior to COVID and we thnk they will be strong companies post-COVID.

Crowdstrike and Zscaler are stocks that David follows closely and are the best positioned cybersecurity companies

to benefit from the growing security spending cycle. The Covid-19 pandemic and the Sunburst hack uncovered a

number of major gaps, highlighting the need for organizations to transform their legacy security architectures.

Credit Suisse’s recent CIO survey suggests that security spending is the top spending priority in 2021, even more

so than in July.

https://community.beth.technology/post/asan-momentum---bought-at-40-80-602bdfe7e066a94e2671cbef

https://seekingalpha.com/research/45714056-elisabethkindig/5526435-ai-accelerator-and-5g-chips-connecting-dots

https://seekingalpha.com/research/45714056-elisabethkindig/5526435-ai-accelerator-and-5g-chips-connecting-dots



Kingsoft Cloud and Bandwidth are both undervalued in terms of forward-growth. China's cloud IaaS should be in

the breakout year as Alibaba takes over Google Cloud as number three. Bandwidth is centered in the hardware-

as-a-service trend, which may not be as exciting as EVs or SPACs but is essential to the digital transformation

we've seen this past year and a hybrid work environment.

We could not be more bullish on Twilio’s long-term trajectory. The company has a moat in cloud communications

for native apps and the management is taking on the omni-channel marketing to increase the addressable market.

Should the management pull this off (and we think they will), then Twilio is setting up to be a leader in marketing

and sales data with Adobe/Salesforce long-term potential.

Datadog has auspicious positioning for hybrid cloud and multi-cloud. The three analyst firms agree that the public

cloud is going to accelerate this year and we want exposure. The market taking a breather does not affect our

conviction and we think DDOG is the best way to participate in the growth of Azure, AWS and Google Cloud plus

the trend towards multi-cloud (which also directly relates to edge computing).



Teladoc’s low forward P/S (comparatively) is a mystery as this is a mega-trend that will be unstoppable as artificial

intelligence continues to merge with health care. We can't think of an industry more ripe for disruption as health

care costs have risen 400% in the last decade while wages have stagnated. AI and genomics are able to cure

terminal diseases, although TDOC is centered in the first problem (health care costs).

DocuSign is a steady performer with solid top-line and solid bottom-line growth. The market tends to overlook

this one, but we like DocuSign as the primary choice for legal, real estate and financial industries. There is very

little room for competitors as DocuSign delivers a superior product that can become the universal standard. We

do not think the world will reverse to paper.

We continue to want exposure to telehealth and so have allocated to Amwell as an 11th position in cloud.

by 2021 - seeking alpha

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