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The Red Light Is On (Cestrian Stocks Bulletin #11)

The Red Light Is On (Cestrian Stocks Bulletin #11)
By Cestrian Capital Research, Inc • Issue #11 • View online
DISCLAIMER: This note is intended for US recipients only and in particular is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Cestrian Capital Research, Inc., its employees, agents or affiliates, including the author of this note, or related persons, may have a position in any stocks, security or financial instrument referenced in this note. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note’s date of publication and are subject to change without notice. Companies referenced in this note or their employees or affiliates may be customers of Cestrian Capital Research, Inc. Cestrian Capital Research, Inc. values both its independence and transparency and does not believe that this presents a material potential conflict of interest or impacts the content of its research or publications.

RFA Partners x Tigger
We run a buyside investment research business. If you don’t know what that is, don’t worry. We’re like Tigger. We might be the only one. We do a bunch of work in pursuit of better investing and trading in staff personal accounts, and we publish it. We charge “money” (oldcoins) for the best stuff, which is nice for us, but more than that it forces us to do good work, rather than just gunslinging. When it’s your own money and you answer only to yourself, it’s easy to adopt the principles of that well-known perenially underperforming fund, RFA (Ready, Fire, Aim) Partners, LP. But when you have to put your ideas in print, you get to see if they look dumb or not before you act on them. It works. We’ve gotten to be much better public-stock investors and traders since we’ve been doing this thing.
Anyway, as part of running Tigger Partners, LP, we get to listen to a LOT of earnings calls. And we have to say that whilst this might be a necessary part of the business, it is a long way from being our favorite waste of time. (That honor is reserved for playing comments tennis with trolls).
Here’s how most earnings calls go. (1) Market closes. (2) Stock starts moving before there is any sign of the earnings release. (3) Earnings release arrives. (4) Scan release for the important numbers on that company. (5) Live blog the important bits for subscribers. (6) Update model and post that for subscribers. It’s usually about 4.20pm Eastern by now. Calls start at 4.30 or 5.00pm Eastern for the most part. So, (7) log on to webcast and then for half an hour listen to management team read stuff that we have already modeled, peppered with some hyperbole. Then (8) the more interesting part, listen to what the sellside analyst community has to say, because that gives you some insight into what their ratings will be the next day. (9) Try not to doze off, it’s warm in the office. (10) Publish earnings review for subscribers, mainline caffeine, rinse and repeat if it’s a multiple earnings day. If that looks like fun to you then all we can say is, you must have even fewer outside interests than us. Because we love stocks and numbers and charts and stuff and even we get bored doing earnings calls.
But not this week. This week we had two corkers.
Outlier One - How Not To Deliver Not Bad News
Maxar Technologies ($MAXR), a name we’ve had great success with, sailed into earnings Monday under a beleaguered star. The market has been grumpy with Maxar since it raised $400m equity at $40 and change in order to redeem some horrendously expensive debt which was itself raised in order to fend off a short-term redemption requirement during MAXR’s annus horribilis, 2019. We thought this was a good move (as did Goldman and Morgan Stanley who got paid to sell the issue) but apparently we stood alone on that front. So, cue company on the back foot, so-so earnings - not worse than that although certainly not better - and in particular a big non-cash charge relating to the failure of a customer satellite (the causes of which nobody is prepared to discuss so we can only think it due to James Bond Moonraker type stuff). And, surely to the surprise of nobody, a delay to the upcoming launch of the company’s new earth observation satellite fleet. The management team attempted to style it out on the call when perhaps they might have just said, here’s the bad stuff, suck it up folks, now here’s the good stuff. Stock promptly ran to the basement and started digging. Now way oversold in our view and we’ve been adding to our MAXR holdings ever since. You can read all about it here. One thing the call was not, was, boring. Blessed relief!
Outlier Two - How To Get Cynical Old Tech Lags All Excited
We’ve been doing tech a long time and we don’t get excited about much. We still don’t have the fiber to the home line that in 1997 we were told faithfully by, oh, everyone, that we would have in 1999. So forgive us if we take everything hypey and futurey with a giant pan of salt and a big ol yawn. Whatever it is that your favorite FinTwit bod is telling you about their overweight, levered-up bag-HODLing stock this week, we can tell you, we heard it all before and it still hasn’t happened. So when assessing tech stocks we lean numbers and we lean charts. Between the numbers and the charts that doesn’t leave much room for romance. Our motto is, invest and trade like you be dead inside. Leave your feelings at the door along with your politics.
But sometimes, just sometimes, even we get pumped about something. And that something ladies and gentlemen is none other than 2020 FinTwit darling, Cloudflare ($NET). You know, Akamai for the modern age. (You see? Seen it all before. Yawn.). Fastly but a bit better and less hypey. Right? Great Covid work-in -your-PJs stock. Off the boil now everyone that isn’t retiring early is being dragged back to the office by their double-vaccinated boss who hates being home so much they are making you leave yours just to make their own fractious family relationships seem normal.
We have news. We think this $NET thing is the real deal. For all the boring numbersy stuff, our most recent free non-subscriber note is here and our Q1 earnings review for subscribers is here. For the purposes of this newsletter which is supposed to be a little easier to digest than our usual analytical gumph, we’ll leave you with a couple points arising from the earnings call after the close Thursday.
One, growth in recognized revenue growth is accelerating. This is one of very few tech companies that is doing so right now. And it’s not like it’s accelerating from 10% growth. It just turned in Q1 ‘21 vs Q1 '20 growth of +51%, up a point from Q4 vs Q4.
Two, remaining performance growth (RPO) is accelerating. RPO is the total book of contracted business. And boy is it accelerating. First up, in Q4 it grew at +75% vs Q4 '20. And in Q1 it grew at +88% vs Q1 '20. The total RPO book is equivalent to 92% of TTM recognized revenue right now. So we have a big ol chunk of yet to be recognized revenue which is growing at 88% p.a. whilst recognized revenue is growing at 51% pa. And that to our jaded eyes spells … more acceleration ahead.
Three, it just turned TTM EBITDA positive. We take no notice of EPS here. It’s not a real thing. It’s just a construct loved by the sellside. Now, EBITDA isn’t a real thing either but at least you don’t have to sweat about tax rates or depreciation rates or any of that nonsense. We define EBITDA as operating income + deprecation & amortization + stock based comp. TTM EBITDA margins at NET stood at 3% in Q1. Not much. But positive. The same number was -32% back in Q2 '19. So it’s come a long way.
Four, change in working capital was positive. We won’t bore you with the guff behind that statement. What it means is, the company is starting to manage its cash properly, and it has been lax in the past on this front. We complained about their previously habitual cash leakage into working capital when we last spoke to NET’s IR people so no doubt they acted on our criticism. Pretty sure we’re top of their speed dial list.
Five, they have $643m net cash in the bank, enough to weather a storm or two.
So the numbers? They’re good. And the stock has been unceremoniously dumped along with everything else in tech that isn’t Microsoft or Google. So it’s looking less expensive. But here’s the thing that got us all pumped. Founder & CEO Matthew Prince said, and we paraphrase a little but only a little, “we want to be the #1 application development environment of any kind”. Not, “the best edge toolkit”. Not “the fastest CDN”. No, “we want to offer a platform where a single developer can write and deploy and run $1bn app by themselves, and we think that is closer to happening than people realize”. So he is telling you that he wants to own the development environment and the runtime for the Internet. Read that last sentence again. And realize that he means it.
On top of their basic acceleration service, on top of their DNS service, their in-network security services, and their intelligence-at-the-edge platform - oh and the fact that something like 16% of all internet requests flow through Cloudflare at some point … you know what that is? That’s Internet 3.0. And we believe Prince. We think he and his team can execute and do this. And we will remind you, we’re dead inside and never get excited about this kind of stuff. Why do we believe it? Because, one, the numbers. But mainly, two, because Prince is not a hype merchant. Normally Cloudflare’s earnings calls are all aw-shucks-what-us? and not in that annoying humblebrag way but for real. And what we got this week was, in a nice way, hey, can everyone get out of our way while we get this done. And when you get that from a not-hypester, that’s when to get excited in our experience.
So, at Cloudflare, the red light is on. We know that feeling. We love that feeling. That’s what keeps the CPUs churning here at Cestrian late into the night. The red light, burning bright. Out the way while we do this.
Good enough for us. Now, we already own a bunch of NET stock across our various staff personal accounts, and we can tell you we’ll be adding to those holdings in the coming days. Internet 3.0. You heard it here first.
Cestrian Capital Research, Inc - 6 May 2021.
DISCLOSURE - Cestrian Capital Research, Inc staff personal accounts hold long positions in NET, MAXR, FSLY, MSFT.
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