The digital age is upon us. Every investor needs to be on the lookout for innovative companies who are poised to become the next behemoths.
Investing in growth stocks require patience because they are yet to reach maturity. They will inevitably go through ups and downs so investors need to perform due diligence and adopt a 5-10 year mindset when purchasing them.
Today, I analyze three exciting tech stocks I will consider purchasing after a significant pullback.
Why wait for a pullback if I am investing for the long term? Simply because the coronavirus will send the USA into a recession and every company, even unicorn tech stocks, will be impacted to some degree.
1 – OKTA (Nasdaq: OKTA)
Cloud computing is revolutionizing the corporate world. The days of logging into secure networks operating behind company firewalls are coming to an end. Thanks to cloud services, anyone can sign in from anywhere on any device. The big issue now is security as companies want to ensure that only authorized people are granted access.
Okta is an identity management software platform. It sells six services, including a single sign-on solution that allows users to log into a variety of systems using one centralized process. For example, the company claims the ability to log into Gmail, Workday, Salesforce and Slack with one login.
What sets Okta apart from the cloud giants?
Okta’s potential competitive advantages are its independence and growing network effect.
Okta’s independence from giants such as Oracle and Microsoft allow its customers to integrate with virtually any software. Okta clients are able to integrate with multiple sorftware vendors, some of which are competitors, and this is a huge advantage. To date, it has developed integrations with over 6,500 cloud applications.
As more customers use its services, the network effect increases as the knowledge base expands, additional use cases are developed and the overall network security is improved. Okta says that when it solves an issue for one customer, the entire network benefits. Eventually, network effects generate economies of scale that reduce costs, increase margins and boos profits.
Rapid growth, but no profits
Since IPOing in 2017, Okta’s revenues have grown 265%, reaching $586M, and it has a cool $1.4bn in cash on its Balance Sheet.
By Q4 2020, its customer count is projected to reach 7950 clients. That’s twice the customers it had just two years ago. Even better, it has 1467 customers with an annualized contract value superior to $100K, which is 41% more than in 2019.
However, the company is not generating any profits. On 1/31/2020, Okta reported SG&A expenses (which are mostly sales and marketing) of $453.24m, which represent 77% of total revenues. This weighs heavy on the Net Income, which is ($208.9m). 1/31/2020 Net Income is 66% lower than 1/31/2019 Net Income of ($125.4). Losses are increasing and this is worrying.
However, Okta predicts a fiscal 2021 Operating Loss of ($65m) to ($57m). This would be less than half of the 1/31/2020 operating loss of ($185.8M). If this projection is honored, then it means that Okta will make significant progress and the challenge will be continuing this trend for the next years until profitability is reached.
When will Okta generate profits?
Whatever the outcome of the coronavirus, Okta will profit as cloud computing is revolutionizing both office and stay at home work.
Up and coming cloud computing providers need considerable investments to develop a stable infrastructure. To achieve profitability, they need high margins and effective cost control. Okta’s gross margin of 77% is high so its priority should be getting its SG&A under control to limit net income losses.
If Okta continues to increase its customer count and maintain its retention rate, I believe it will generate economies of scale that will eventually produce significant profits. The question is how long will this take rather than will this ever happen. I believe Okta’s future is very bright as long as it keeps investing and manages to control costs.
Is the stock overvalued?
The rise of cloud computing means that Okta’s business will continue growing.
However, like many promising growth stocks, Okta is very expensive. Considering that the road to profitability is still a long one, and that the USA is on the brink of a recession, its current price of $170 is off-putting. I expect share price volatility in the coming quarters so I will wait for a pullback in the $100-$130 range before investing.
2 – ROKU (Nasdaq: ROKU)
ROKU manufactures a variety of digital media players that allow customers to access Internet streamed video or audio services through televisions. To be clear, Roku is not a content creator: It is a platform that centralizes streaming offerings in order for customers to simplify their navigation between services.
Roku IPOed in 2017 at a share price of $14 and the stock price more than ten-bagged when it reached its peak of $178. It currently sits at just under $130 which means that in just two and half years, early investors have netted an incredible return of 828.5%.
Is Roku all hype or is there fundamental value in this stock?
As of Q1 2020, Roku has 39.8 million users. In 2019, active accounts grew 37% and streaming hours rose by 49% year over year to reach a record 13.2 billion. Between 2016-2019, Revenues rose to $1.12 billion from $398.64 million.
Roku’s growth is impressive and testifies to the product’s popularity among consumers. As of Q3 2019, Roku has a 38% share of the streaming devices market, ahead of Amazon Fire (33%), Apple TV (11%), and Google Chromecast (10%).
However, Roku is still unprofitable: Operating Expenses outweigh Gross Profits and Adjusted EBITDA is ($55.2M). In 2019 Roku, invested $265M in R&D (25% of total earnings) and $178.9M in Sales and Marketing (15.8% or total earnings). Q1 2020 Marketing spending is already $88.3M (27.5% of earnings), a 12% increase over Q4 2019 and a 58.5% increase over Q1 2019.
A very rudimentary calculation shows that in Q1 2020, Roku spent $88.3M on marketing to gain 2.9 million users: that’s a CAC of $30.44. Average Revenue per User is $24.35, so there’s a ($6.09) loss on every customer acquired.
Marketing is essential to gain visibility but it can also be a financial pit. Over the next few years, Roku needs to minimize customer acquisition costs (CAC), ensure customers stay loyal and increase average revenue per user.
Is there a clear path towards generating profits?
I believe so.
First of all, Roku is profiting from the general societal trend of “cord-cutting“: Millions of households are shunning cable and satellite TV in order to subscribe to online streaming services such as Netflix, Hulu, Amazon Prime and Disney+.
By 2023, there will be an estimated 56.1 million non-pay TV households in the USA, compared to 20.6M in 2013; the number of pay TV households is projected to decrease to 72.7M in 2023 from 100.5M in 2013. Thus, the potential market for Roku devices and Roku TVs is massive.
Roku is capitalizing on this phenomenon by partnering up with global brands to ensure customers get access to its platform. TV companies such as HCL, Sanyo, Sharp RCA, Hisense and Westinghouse all offer Roku TVs. This means that millions of potential customers will have immediate access to Roku when they buy a new television.
This partnering strategy is proving to be very successful: Currently, 9 of the 10 best selling TVs on Amazon are Roku TVs. Similarly, thousands of Roku TVs are sold in department stores throughout the USA and Canada.
Second, in addition to being a content aggregating platform, Roku also sells advertising. Since it aggregates many streaming paltforms in one place, it collects a lot of user data. This information is very valuable to advertisers and they are willing to pay top dollar to reach Roku’s nearly 40 million customers with targeted advertising.
In November 2019, Roku announced the acquisition of dataxu, a demand-side platform that enables marketers to plan and buy video ad campaigns. Roku now offers the OneView Ad Platform which allows marketers and content owners to “manage their entire campaigns – including OTT, linear TV, omnichannel, and more – all in one place“.
Lastly, Roku is expanding internationally. Currently, 90% of its revenues originate in the USA but Roku is trying to establish a strong presence in Latin America. In Brazil, Roku is partnering with AOC and Globoplay for new smart TVs. This market presents a huge opportunity because Amazon’s presence there is still minimal.
Will the coronavirus impact Roku’s march to profitability?
The coronavirus will have several short to medium term impacts on the firm’s path to profitability.
In his May 2020 letter to shareholders, Roku founder and CEO Anthony Wood predicts that 2020 advertising revenues will increase at a lower rate than originally expected. Indeed, the challenging economic environment will force many companies to reduce their advertising budgets. Nevertheless, companies are expected to shift part of their ad spending away from cable and satellite television towards streaming platforms and Roku is poised to benefit from this.
Woods also says that the coronavirus has forced Roku to scale back its Capex for 2020. This will slow down the company’s growth but will preserve precious capital that will finance operational expenses during these turbulent times.
In concusion Woods states that “In the years ahead, we believe that the vast majority of TVs will use a modern TV streaming OS to connect to the internet; more TV brands will adopt a licensed OS; cord-cutting will continue; ad-supported content will unlock enormous value for consumers; and shifting audiences and innovative ad tech will shift billions of advertising dollars from linear TV to OTT“.
I agree with his remarks and I believe that Roku is well positioned to become the market leader. The company has established key partnerships with TV manufacturers, has millions of existing customers, is collecting data on users it can sell to advertisers and is close to being profitable.
The only risk is that the possibility of creating a wide moat with the Roku device alone is slim. Apple and Amazon have their own competing devices and the brand power to back them up. The real moat opportunity lies in the collection of user data that allows the firm to sell targeted advertising space. If Roku can keep growing its customer base both in the USA and abroad, then they will become a behemoth in their own right.
What’s a fair price for this stock?
It’s very tough to determine an intrinsic value due to the fact that it’s still unprofitable. A couple of disappointing quarters could send the stock crashing back down to sub-$100 levels.
However, the growth and future prospects are exciting and the company is on par to become a real leader.
I will wait for a pullback under the $100 level before buying shares.
3 – MONGODB (Nasdaq: MDB)
MongoDB is an American software company that develops and provides commercial support for the open source database MongoDB, a NoSQL database that stores data in JSON-like documents with flexible schemas.
Basically, MongoDB offers a cloud-based database platform service which permits the storage of messy, unstructured data. MongoDB’s main product is Atlas, a cloud-based, fully managed, database-as-a-service product. The list of users is already impressive.
Growth prospects are favorable
The cloud computing database market is a growing very fast and is projected to reach almost $100 billion by 2023. Given that MongoDB currently has less than 1% of the total market share, its growth potential is massive.
The company’s Investor Relations page states that they already have “more than 14,200 customers in over 100 countries” and that the MongoDB database platform “has been downloaded over 70 million times“. Further, the company claims that it is already “the world’s most popular modern database with more than 90 million downloads, 1.5M Atlas free tier users, 17,000 customers, nearly 2000 employees in 26 countries“.
Promising growth…and growing losses
From Jan 2019 to Jan 2020, the company’s Revenues increased 57.9%, to $421.7M from $267M. From 2017-2020, revenues were multiplied by a factor of 4. Its Current Ratio of 4.59 is exceptional and it reports having $986.5M in cash on it Balance Sheet, so there are no liability problems.
However, the company is far from being profitable: EBITDA is ($135M), Net Income is ($175.5M) and Free Cash Flow is ($33M). Even worse, Net Income is falling deeper in the negative every year, going from ($86.6M) in 2017, to ($96.3M) in 2018, ($99M) in 2019 and finally ($175.5M) in 2020. This represents a 102% increase in negative net income in just 4 years.
The main culprit are the SG&A costs of $295M, which I assume are mostly marketing expenses. They represent a whopping 69.9% of total revenues. R&D of $149M is also high (35% of revenues) but this expense is necessary to continue developing the products and services.
Is the stock fairly valued?
Given the huge losses, the stock price appears very expensive. I like the product’s popularity and the company’s growth but I will wait for the stock to fall to more reasonable levels before investing. I consider $140 a decent entry.
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DISCLAIMER: This is not financial advice. Do your own research before investing.