September 2020 Portfolio Review

Total Return: +162.7% YTD (+158.6% vs S&P)

Well, well, well. September sure was funky (sound on!).

After five straight positive months, the S&P and broader markets both took a turn for the worse. This was especially true for the Nasdaq. After a record high on September 2, the Nasdaq’s 10%+ correction over the next three days was the fastest in history. This is just another in a long line of 2020 records for the fastest [insert market event here] in history. The first nine months of the year have been about as volatile as it gets, and much of that trend is likely to continue in our current age of algorithmic trading (relatively new) and knee-jerk reactions (timeless!). We might as well get used to it.

With all that is going on, it is sometimes hard to keep everything straight. COVID-19 still rages, a chaotic US election creeps ever closer, and the Fed gives an update about every six seconds. After every breathless 24-hour cycle, financial pundits somehow tie it all together and boldly pontificate about what it all means. This usually includes an authoritative pronouncement that the market is sure to move up/down tomorrow unless of course it somehow moves down/up. It is a laughable amount of meaningless noise, and it can overwhelm if you let it. Don’t. Unless you invest strictly in index funds – which in all honesty can be a very good thing for most investors – you do not really own “the market” anyway. You own specific companies within it. So, tune out the mindless drone of monetary policy, electoral outcomes, and pundit predictions. Focus instead on prioritizing strong business execution and quality management. That should be the best ballast for what is almost certainly choppy waters ahead.

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2020 Results:

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September Portfolio and Results:

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2020 Monthly Allocations:

Key:

• darker green - started during month

• lighter green - added during month

• yellow - trimmed during month

• blue - bought and sold during month

• red - position exits

• positions >10% in bold

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Past recaps:

December 2018

December 2019 (contains external links to all 2019 monthly reports)

January 2020

February 2020

March 2020

April 2020

May 2020

June 2020

July 2020

August 2020

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Stock Comments:

I entered September at 7.2% cash and without the time to properly screen any new names. My initial plan called for holding at least through earnings for COUP and ZS to see if either impressed enough to grab any money. Neither did. I also irrationally hoped Snowflake would IPO at something that seemed reasonable, but that turned out to be a pipe dream. Oh well. I am totally OK waiting that one out. Still determined to put my cash to work, I ended up spreading it among all existing positions except ZM (big enough already) and called it a month. Now to sit back and watch for a spell.

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CRWD – CrowdStrike posted what I thought was another outstanding quarter. It recorded $199M in revenue for 84% YoY growth. That is fantastic for any company, let alone one this size. Subscriptions grew 89% and now account for a record 92.6% of revenues. ARR increased 87% with a record $104M in net new adds this quarter. CRWD also closed a record number of $1M+ deals. Gross profit grew 89%. Gross margin rose to 75% from 73% last year while subscription gross margin ticked to 78% from 76%. Finally, CrowdStrike added a record 969 net new customers to bring its total to 7,230 (+91% YoY). It was an excellent top-line performance.

Digging deeper, secondary execution impressed as well. CrowdStrike’s business model is designed to collect data once then reuse it repeatedly across modules and services. Each additional use provides a higher margin of return. With 57% of customers deploying 4+ modules and 39% using 5 or more, this model is working like a charm as the company scales. Expenses were a record-low 71% of revenues even as CRWD hires aggressively to meet demand. This in turn has led to CrowdStrike hitting profitability sooner than expected. It achieved operating profits for the second consecutive quarter and positive cash flows for the fourth. Management now projects a full year operating profit as well. The fact CrowdStrike appears to have flipped the profitability switch while still an 80%+ grower is a rare occurrence and phenomenal news for shareholders.

Like many SaaS firms, CrowdStrike has benefited greatly from the accelerated move online. It is rapidly displacing legacy systems while demonstrating the future of security resides in the cloud. The company also beefed up its zero trust and conditional access capabilities recently with a $96M tuck-in acquisition of Preempt Security. CrowdStrike’s ability to instantly analyze threats and update protections across its entire customer base is a huge differentiator. Preempt Security should help further that lead. CEO George Kurtz says, “cybersecurity is mission-critical and more important now that ever.” CRWD’s 2020 performance backs that statement in spades. The stock had spiked 40%+ the three weeks into earnings, so it was not surprising to see a pullback and some consolidation immediately after the actual release. No big deal. In fact, I couldn’t help but add a smidge when it dropped back below $127. CrowdStrike’s business continues to boom, and I am happy to keep it as a 20%+ holding.

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DDOG – Datadog made a flurry of significant announcements this month. The first was achieving AWS Outpost Ready Designation. According to the release, this “designation recognizes that Datadog has demonstrated successful integration with [Amazon Web Services] Outposts deployment.” That means DDOG’s products will work smoothly with any AWS deployment. As noted many times, I am no technical expert so I can’t comment much beyond that. However, I don’t need to be an expert to understand it is a positive development any time Datadog further embeds itself with a major cloud provider.

Another relationship was strengthened a few days later through a new integration with ServiceNow. This new feature lets joint Datadog and ServiceNow customers better monitor their systems by:

• better understanding the business context of resources or services being monitored in Datadog

• gaining improved visibility into applications, services, and their relationship with the underlying infrastructure that powers them in the Service Graph and CMDB.

Again, I’m no techie. Full transparency, I have no idea how to tell my Service Graph from my CMDB. Yet this looks to me like another positive move with another big partner.

Finally, DDOG capped an excellent September on 9/30 with the announcement of a new strategic partnership with Microsoft Azure. The details include automatic setup for customers choosing Datadog and the option for Azure clients to pay for Datadog directly through their committed Microsoft spend. This arrangement marks the first time ever Microsoft has integrated a third-party service as a native offering in Azure. The money quote is, “With the deepest integration and the easiest configuration, Datadog is now clearly positioned as the premier monitoring solution for Azure.” Heady stuff. In my opinion, this is a huge development likely to pay off in a big way going forward.

Announcements like these seem to be the norm for Datadog lately. The company continues to impress with its ability to innovate and is my runaway leader for the number of enhancements publicly released the last couple of months. The fact major clients are lining up to back these products only reinforces my belief Datadog is very much on the right track. The market seemed to agree, sending the shares soaring 15%+ to new all-time highs right after the MSFT release. Good doggie!

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DOCU – I was really curious to see DocuSign’s September 3 report. In last month’s recap I wrote, “I saw several promising trends in DOCU’s performance when I opened this position in June. We will see if any came to fruition when the company reports.” I am glad to say at least a few of them did.

On the top line, DocuSign’s $342.2M in revenue was a strong beat and sequential acceleration from 39% growth to 45%. Subscription growth accelerated as well from 39% to 47% and accounted for 94.6% of total revenue for the quarter. Gross profit growth jumped to 45% leading to 78% gross margin. Subscription gross margin was even better at 83%. Those are excellent rates, especially for a company that just raised revenue guidance to $1.4B for the year.

While those numbers were nice, the top line was never my focus. I mentioned when opening this position, “What intrigues me more are [underlying] signs DocuSign may see accelerated business over the next few quarters.” I then noted some trends that grabbed my attention. I have relisted them below adding this quarter’s results (bolded). Let’s see how DocuSign did:

• Billings growth the last four quarters: 36%, 40%, 59%, 61%. Management guides for a pullback to 45% in Q3, but let’s not forget it guided for 36% growth this quarter before posting 61%. Either way, DOCU will post its highest billings growth as a public company this year. The top end FY21 guide is 49%, meaning 50%+ is likely. Given FY20 finished at 38%, billings seem to be in a great spot. I would also point out it was last year’s Q3 billings dip that caused the stock to pause before its 2020 rip. I’m not concerned in this area.

• Growth in current contract liabilities: 34%, 33%, 43%, 55%.

• DocuSign added roughly 27,000 customers per quarter for six quarters heading into the year. It added 68,000 in Q1 and 88,000 this quarter. Total customer growth the last three quarters: 24%, 31%, 40%. In total, DOCU has added more customers in the first half of this year than it did all last year. That is remarkable considering DOCU just reported 749,000 total customers.

• Along the same lines, DocuSign added roughly 6,000 enterprise customers per quarter for six quarters heading into the year. It added 10,000 in Q1 and another 10,000 this quarter. Enterprise customer growth the last three quarters: 34%, 48%, 55%. That is also remarkable considering DOCU just reported 99,000 enterprise customers.

• Growth in customers with an Annual Contract Value >$300K: 41%, 41%, 46%, 41%. 520 total. This appears to be right on track.

• For the second quarter in a row, international growth impressed. In Q1 international revenue grew faster than domestic, finishing at 46% YoY and $55M total. This quarter was even better at 59% and $67M. The CEO stated on the call “every single geography that we have was above plan in the quarter.” DocuSign’s self-service option is available in roughly 150 countries, and the CFO was just promoted to President of International. Management clearly sees a large opportunity here and intends to take advantage of it. I say more power to them.

• Net Retention Rate: 112%, 113%, 117%, 117%, 119%, 120%. A strong trend with a new record. ‘Nuff said.

I wondered in June whether DOCU’s recent performance might represent “a legitimate buildup of customers, contracts and NRR expansion that should positively influence future quarters.” September’s result suggest that is indeed the case. In addition to the figures above, expenses were a record low 68% of revenues despite increasing headcount 44% to 5,000+ employees. That is a major investment, but I have no issues given it was driven mostly by the need to meet increased demand. The increased operational efficiency led to a healthy bottom line of $33.7M in operating income (10% margin), $34.8M in net income (10%), and $99.8M (!!!) in free cash flow (29%). The dollar amounts and margins were all new records. Even better, I would expect at least a couple of these marks to fall again in upcoming quarters.

Overall, there is little to nitpick here. DocuSign’s flagship eSignature business is flourishing, and its Contract Lifecycle Management (CLM) platform continues to gain exposure. The CLM build-out is right on schedule and should be ready to fully contribute to revenues in 2021. The recent Liveoak Technologies acquisition adds e-notary capability, which DOCU expects to be in beta release later this year. The TAM for the notary module is estimated at just $1B but embedding it into DOCU’s eSignature ($25B TAM) and CLM ($25B) offerings should give it a differentiator in both markets.

Management’s comments noted strength not only in its traditional real estate and contract business, but also increased usage in areas like telehealth and government services as COVID-19 has increased the need for remote transactions. Given the convenience and efficiencies in electronic administration, it is reasonable to think a considerable portion of this business will stick post-virus. Simply put, the world has been moving away from paper transactions for quite some time, and DocuSign is leading the charge. As CEO Dan Springer stated:

"I spoke last quarter about how so many [customers] faced a sudden need to transition to remote work when the pandemic was hit. Today, that need has evolved from an initial crisis response to a business necessity. And because Agreements are central to doing business, the need to agree electronically and remotely has never been stronger. This is causing greater adoption of our offerings; something we believe will persist beyond the crisis, because in our experience it’s very rare to see anyone go back to paper."

Heading into this report, I thought DocuSign had a chance to reset itself as a profitable 40%+ grower. I was mistaken. It appears to have reset as a profitable 45%+ grower instead. How many companies can say that at a run rate creeping toward $1.5B? I don’t want to sound greedy but think it fair to point out a reasonable beat of Q3’s 45% top end guide could once again have DocuSign challenging 50% growth. Regardless of how it turns out, I believe DOCU has rebranded itself as a profitable high-growth company with an increasing TAM and accelerating prospects. As a result, it will retain a healthy spot in my portfolio.

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FSLY – Fastly has had a busy couple of months. August saw earnings and a large acquisition. September saw some significant news as well. First was an announcement Fastly became “the first partner edge cloud-based content delivery solution to be offered within the Google Cloud Marketplace.” I will leave the technical implications for others to explain. As a shareholder, I will happily take the additional exposure and expanded partnership with one of the world’s biggest cloud platforms. Full steam ahead, Fastly.

The second piece of news was a resolution of TikTok’s status as a Fastly client. Or not. Apparently, Oracle and Walmart have joined forces to purchase TikTok. Or not. Maybe it is more of a partnership. Or not. Maybe the news was the alternating updates from the US and Chinese governments on the deal. Or not. Maybe it was the courts deciding whether TikTok will be banned in the US. Or not. It is still quite murky exactly what is transpiring here, especially because we have heard almost nothing from the companies themselves. The on-again-off-again, tit-for-tat quality of this deal would certainly make any soap opera proud. I guess the main point is it appears something will get worked out to keep TikTok operational in the US. That was all the market needed to hear to push FSLY’s shares back up from its recent dip into the 70’s. I would expect the volatility to stick around a while, at least until this saga plays out. Fortunately, I also expect more up moves than down long term.

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NET – First, anyone owning or even considering Cloudflare needs to stop and read this. It is often noted buying a stock really means you are becoming part-owner of the company behind it. This is an incredible breakdown of your partners if you decide to own Cloudflare. I, for one, am glad to have Matthew Prince and Michelle Zatlyn are on my side.

In addition, this week marks NET’s Birthday Week 2020. Cloudflare launched September 27, 2010 and celebrates the day each year by releasing new products to further its mission of helping build a better internet. 2020 is an extra special occasion as Cloudflare turns 10. Taking a glance at the festivities linked above, it does appear there is quite a bit to celebrate. Happy Birthday, NET!

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OKTA – Things have been fairly quiet since Okta’s rock-solid August earnings report. The only news was a couple of hiring announcements, although one looks like it could be fairly significant. The first was naming a Japan Country Manager, Takashi Watanabe, along with the launch of a new Japan office. Okta obviously sees enough traction for the hire, and Watanabe has 25+ years of experience driving Japanese interest in brands like Adobe and SAP.

The second and likely more notable hire was Susan St. Ledger as President, Worldwide Field Operations. St. Ledger starts in February 2021. She will join Okta after 4.5 years in a similar role at Splunk where she helped grow revenues from $700M to almost $2.5B today. Anything comparable at Okta would obviously be a smashing success. These moves suggest Okta sees quite a bit of international business to be done. That is fine by me.

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TWLO – Twilio hit my news feed a couple times this month. The good news was a release introducing Deloitte Digital, a part of Deloitte Consulting, as a member of the Twilio Build partner program. According to the release, “Deloitte Digital now brings the highest level of Twilio platform knowledge to the Global 2000 customers they serve across industries including consumer, financial services, government & public sector, life sciences & healthcare, technology, and media & telecommunications.” Twilio’s business has been on a nice run lately, and more positive exposure is always better. Having a large partner like Deloitte in your corner only helps.

The bad was Microsoft launching Azure Communication Services and potentially encroaching on Twilio’s turf. This service will “enable developers to add voice and video calling, chat and text messaged to their apps.” On one hand, there is always cause for concern when a behemoth turns its attention toward your niche. On the other, this further validates Twilio’s market since MSFT would not show interest if it did not think that niche was both big and profitable. Like many smaller companies in these David and Goliath battles, TWLO has the head start and more focused business plan. I will be watching closely to see if these advantages are enough for Twilio to maintain its recent success.

On a slightly lesser note, Twilio hired its first Chief Diversity, Inclusion and Belonging Officer. I have no idea how this ultimately affects the business but thought I would mention it anyway simply because we can all use a little diversity, inclusion and belonging right now.

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ZM – Well, that was timely. After building this position up into 8/31 earnings, Zoom responded by crushing its report and soaring 40%+ on 9/1. That almost instantly pushed it from 21.7% of my portfolio to 28.1%, which is by far the most I have ever held in one stock. That led to an interesting dilemma. My allocation suddenly became much larger than I had planned, but at the same time I had little interest in selling any shares. I mean, isn’t this why I built the position in the first place? I strongly believe Zoom is my most likely holding to thrive both during and after COVID. That has not changed one iota. Yet my mental model of a hypothetical 25% max in any one stock got stretched so quickly it broke. Staying true to that plan initially, I trimmed from 27% to 26% a couple days later only to watch ZM regrow. And you know what? I found I had no real concern holding that much. Being honest, this was the case even before I made the trim. I had simply pre-anchored on an arbitrary 25% mark. So, I decided to look away for a few days and see how I felt after things stabilized.

During that time news hit the wire Zoom was working on an upgrade to its messaging function that would make it more like Slack. While I sold Slack the stock, I really like Slack the platform. A similar feature here could make Zoom even stickier with enterprise clients. The link above is a third-party report rather than details from the company itself, but it supports the idea ZM has no intention of standing still while it has nearly the whole world’s attention. And it shouldn’t. Zoom has as many potential avenues for growth as any firm on the planet right now. It would be foolish not to explore every single one of them, especially with plans for two new R&D centers well underway. Again, Zoom is doing everything I expected when I put it in position to challenge for my top spot. To fellow shareholders I say bully for us.

As I write this, I realize this month’s Zoom ramblings have very little to do with the company and almost everything to do with personal max allocation. It is a good problem to have. I don’t pay much attention to valuation for buy/sell/hold decisions since I believe underlying business metrics are much more important. However, I do occasionally look at run-rate P/S (current quarter’s earnings * 4) as a rough gauge of market enthusiasm. By this metric, the market had valued ZM in the 55-65 range pretty much all year heading into 8/31 earnings. At its current price, I have run rate P/S a little under 53. This means two things:

1. even after a +44.6% September price gain the market currently values ZM slightly lower than prior to its historic Q2 report, and

2. while ZM remains expensive, it is not at all overstretched relative to where it has been valued for most of 2020.

I realize that is a very rough metric, but it is a good illustration of just how much room there is to grow into a multiple after a quarter with 355% (not a typo) revenue growth. I like the odds of something similar occurring in Q3, which is a major reason why I am so comfortable being overweight in the shares. Zoom is currently my best idea…and my highest conviction…and what I believe to be my best-positioned holding for the remainder of the year. Maybe the thing to do is just sit back and let it ride until something changes my mind. Yeah, let’s go with that. Heading into October I plan to hang tight, see if ZM keeps zooming, and maybe think a little more about max allocation.

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My current watch list…

…in rough order is SHOP, TTD, ROKU, ZS and MDB. ZS rejoins after a strong quarter and future guides which suggest its sales stumble a couple quarters ago has been smoothed out. COUP joins AYX in my bucket of good companies that need to reprove themselves post-COVID before I would consider rebuying, though I could see that happening with both. Peloton is putting up crazy-good numbers, but I just haven’t had the time to properly dig in on it. My main concern – if you can call it that – is wrapping my head around the split between equipment sales and recurring revenues. I would not stay true to my vetting process if I jumped in without thoroughly breaking it down. It is sometimes hard to stay disciplined when Fear of Missing Out creeps in, but I’ve been able to resist on PTON thus far. I am hoping to give it a closer look in October.

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And there you have it.

The market giveth, and the market taketh away. Luckily, the market also giveth back again every once in a while. On September 1, my entire portfolio Zoomed – see what I did there? 😏 – just over 17% to its biggest ever one-day gain and an all-time high. It immediately cratered 5%+ and 9%+ the next two days as the Nasdaq tumbled. September 4 began with another 9%+ plunge before rebounding to finish down 3%+ for the day. In total, it was a -21% peak drawdown and -15% portfolio loss in just three days. Holy volatility, Batman! That is an awful lot of movin’ and shakin’ for what turned out to be a virtually flat -0.2% week.

Perspective matters, and I am pleased to say the longer I do this the easier it gets to ride out these crazy swings. I was comforted the entire time by the fact absolutely nothing had changed about the business prospects for my companies. On the contrary, I thought ZM and DOCU’s reports strengthened their case for spots in my portfolio. Doing the work helps. So does having conviction in what you own and why you own it. That makes ignoring short-term moves infinitely easier. These are lessons we are constantly retaught, even when we might think we no longer need them. Unfortunately, Mr. Market has always been a kinda stubborn teacher.

Lucky for me, the rest of September saw my portfolio steadily regain the ground it lost after that initial 9/1 burst. Most of the comeback was led by ZM. Zoom’s run to $520+ resulted in a portfolio high of +163.2% YTD on 9/22 before settling back this week. DDOG’s pop after the Microsoft news pushed me back over that mark intraday on 9/30 before fading at the end to fall just short. No complaints here though as I couldn’t be happier with how things played out, especially considering the rest of the market.

Taking a step back, 2020 continues to be an inexplicable year. September is the second month in a row I went from a new high to a 20% drawdown to another new high in under 3 weeks. I have no idea WTF is going on, but this has been par for the course in an insanely volatile year. It just goes to show the importance of being able to sit tight when things feel unsettled because there is no way to accurately predict these kinds of swings. As they sometimes say, "You pays your money and you takes your chances." Like the rest of you, I have no idea what chance will bring in October. I can only hope it includes more treats than tricks. In the meantime, keep your head down and good luck out there.

Thanks for reading, and I hope everyone has a great month. Oh, and please don’t forget to wash your hands, wear your mask and vote early if you need to. Peace.