Quick Thoughts: 2Q20 Earnings – The Stragglers

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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September 1, 2020

Quick Thoughts: 2Q20 Earnings – The Stragglers

  • The last flurry of 2Q TMT earnings cemented several key observations about the sector: 1. Enterprise adoption of SaaS applications has accelerated with the pandemic; 2. The shift to the cloud continues to drive datacenter investment; 3. WFH has sparked strong PC sales; 4. Cloud-based cybersecurity is a top priority for IT spending; and 5. No one has good visibility, but those managements that admit it get punished.
  • CRM posted a big upside surprise. WDAY posted a big upside surprise. Earlier in the season, MSFT, ADBE, NOW, TEAM, WORK, ZEN, and a host of other SaaS names also posted significant upside surprises for 2Q. YoY revenue growth across the top SaaS names was 29.7%, a mild deceleration from 33.5% in 2Q19.
  • NTNX, which sells software to facilitate the integration of cloud datacenter resources into traditional enterprise IT, popped 29% on its big 2Q beat (accompanied by a capital infusion and the retirement of CEO Dheeraj Pandey). We think its potential is still underappreciated. VMW, whose growth is driven by the same cloud integration demand, also surprised. Finally, MRVL beat handily, driven by strong cloud datacenter capex, and echoing previous reports from NVDA, AMD, INTC and AVGO.
  • HPQ and DELL both beat expectations on strong consumer PC sales, results that had been presaged by MSFT, INTC, and others. Weakness in other areas (Printing for HPQ and Enterprise servers for DELL) took some of the shine off, but the market responded enthusiastically.
  • Cybersecurity firms OKTA and PANW reported resounding beats on both topline and bottom line, but both stocks fell on guidance that was perceived as cautious. This follows the similar treatment of FTNT, QLYS, PFPT and CYBR, which all reported beats earlier in the quarter. ZS and CRWD report this week and should easily top expectations. We think the selloff is shortsighted, and prefer names focused on cloud-based solutions, like OKTA, ZS, CRWD, PFPT, and SAIL.
  • The selloffs of OKTA and PANW reflect a broader trend. No CEO has visibility into 2021, but the CEOs that admit that get punished. Companies like BKNG and DIS that have been badly damaged by the pandemic and could take years to recover are on a roll on confident management commentary, while cybersecurity and SaaS companies, delivering big beats and with beneficial impact from the crisis tradeoff on CEO “body language”.

By now, it should be obvious to everyone. The pandemic has accelerated the enterprise shift to the cloud. On Tuesday, Salesforce celebrated its impending inclusion in the Dow by delivering a resounding beat on both sales and earnings accompanied by a boost to guidance. On Thursday, Workday followed with 20% sales growth and a margin jump, easily beating its 2QFY20 bogey and prompting upgrades and estimate

Exh 1: Avg. top-line surprises posted by SaaS stocks with >$1B market cap

revisions across Wall Street. Its actually hard to find a SaaS name that missed estimates in the quarter – PayCom was the only one of any size, and then it only missed the topline by 0.4% while beating on earnings. Collectively, the 75 SaaS names with market caps greater than $1B that have reported since the beginning of June have beaten sales estimates by an average of 5.8% and EPS by 39.2% (Exhibit 1). Nonetheless, the SaaS group has outperformed the tech components of the S&P500 by a tiny 445bp in the same timeframe, as investors turned their attention to sifting through the pandemic roadkill in search of names that might bounce back.

The enterprise cloud acceleration played out more broadly than SaaS. Hybrid cloud facilitator Nutanix, which has been slogging along with a painful transition from selling software licenses bundled with dedicated server hardware to a cloud-based subscription model, finally turned the corner, delivering a big beat on 9.3% sales growth (29% growth in its pipeline of new business) (Exhibit 2). Its report was announced alongside a $750M cash infusion from Bain Capital and the retirement of CEO Dheeraj Pandey. The departure Pandey, well respected as a scientist/engineer but widely criticized for his opaque leadership, helped push the stock to a 29% step up on the Friday after. Nutanix’s main competition, VMWare also reported a beat last week, with its subscription business (20% of total sales and up 40% YoY) the main driver. The rest of VMW – primarily its server virtualization software – weighed down the total sales number, which grew 10% YoY. This is an obvious trend.

Hyperscale datacenter capex is also a part of the enterprise cloud migration story. Marvell Technology Group, a chipmaker with a focus on datacenter-relevant parts – including high speed interfaces, switches,

Exh 2: NTNX growth is returning as the company wraps subscription transition

storage controllers, and specialty processors – beat handily, crediting its datacenter sales in the process. This echoes the results from Nvidia, AMD, Broadcom, and Intel earlier in the quarter. The preferred analyst narrative seems to be that the boost to cloud capex is temporary, but we are MUCH more optimistic.

PC sales were also in the spotlight, with Hewlett Packard and Dell both beating consensus – no surprise to us after Microsoft, Intel and AMD all called out strong PC sales in the quarter. In both HP and Dell’s cases, the strong consumer PC sales for work-from-home were partially mitigated by weakness in other businesses – printing for HP and enterprise servers for Dell. With the pandemic stubbornly persistent and workers growing more productive at home, we believe the home PC/laptop trade will be in play for at least a few more quarters.

Cybersecurity stocks seem to be a bit out of favor for the moment. Okta and Palo Alto Networks both reported substantial upside sales and earnings surprises with meaty boosts to guidance yet took haircuts on management commentary that was judged to be too cautious about 2021. This follows similar treatment for Fortinet, Qualys, Proofpoint and CyberArk earlier in the season. We see this as profoundly shortsighted, given that no CEO has reasonable visibility more than a few weeks forward given the immense confusion around COVID-19 and the impending US elections. While investors throw money at the hope that badly damaged companies like Booking Holdings and Disney can be quickly reanimated by a V-shaped recovery, cybersecurity companies that have delivered strong double digit growth straight through the public health crisis are under the microscope for the slightest flaws. We’d use this as an opportunity to add to the group (Exhibit 3). We particularly like the fully cloud-based players, like OKTA, ZS, CRWD, PFPT, and SAIL.

Exh 3: OKTA consensus sales growth estimates continue to project pessimism


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