Pedestrians wearing protective masks walk past a banner displaying Asana Inc. signage during the company’s initial public offering (IPO) at the New York Stock Exchange (NYSE) in New York, United States on Wednesday, 30 September 2020.
Michael Nagle | Bloomberg | Getty Images
Cloud software has been one of the best bets for investors over the past five years. But this trade has quickly settled down in recent times.
The crisis, which began in November and worsened this week, is partly market rotation, partly the reopening of the economy after the pandemic, and partly fears that interest rate hikes expected by the Federal Reserve have a disproportionate impact on this particular sector.
For years, cloud computing services have been among the biggest winners in technology, which has itself outperformed the market at large. Since Bessemer Venture Partners created the BVP Cloud Index of publicly traded companies in August 2013, the basket has risen 909%, almost triple the gains of the Nasdaq and five times better than the performance of the S&P 500.
Covid-19 has proven to be a massive boon as businesses, schools and government agencies have accelerated their transition to the cloud so they can access communication, collaboration and storage tools remotely. E-commerce software provider Shopify, video chat service Zoom, and e-signature provider DocuSign were among the big winners, all seeing strong revenue growth in 2020 and well triple-digit inventory gains.
This software as a service, or SaaS, has since gone out of fashion. As former computer and printer maker HP Inc. hit new highs and the Dow Jones Industrial Average has fallen only slightly this year, work-from-home darlings are suddenly in a bear market.
Zoom and DocuSign are each at over 50% of their 52-week highs, and Shopify is down 34%. Asana was the top performing U.S. tech stock last year through mid-November. The project management software vendor has since lost 58% of its value.
Cloud stocks as an index are down 29% from their November high.
Byron Deeter, a venture capitalist who invests in software start-ups in Bessemer, said on Tuesday that the market had “taken a 30% discount after the Christmas sale” on stocks in the cloud.
“Overall, the cloud industry and software globally have just been hammered out,” Deeter told CNBC’s “TechCheck”. “Basically these companies are still the engines of the new economy, and we have to remember that all of these trends that people were excited about a year ago in the 2020 market, when this basket returned almost 100%, these remain today. “
Higher interest rates can present challenges for much of the market, but they represent a noticeable hurdle for cloud stocks, especially for companies that are not yet making money. Investors value companies based on the present value of future cash flows, and higher rates will reduce the amount of those expected cash flows.
The December Fed meeting minutes, released on Wednesday, gave new impetus to investors positioning their portfolios for a rate hike, as the central bank prepares to slow its accommodative monetary policy in an era of the pandemic.
The WisdomTree Cloud Computing Fund was down 6% Wednesday and 10% for the week at the close on Thursday. The index is on track for its second worst week since the start of the pandemic, with the single largest drop occurring about a month ago.
“I think SaaS is generally down because interest rates are going up and there’s usually a pretty close correlation between high growth software and interest rates,” said Khozema Shipchandler, director of the operation at Twilio, which resells. -end of software for communications.
Twilio’s share price has fallen 46% from its high at the start of last year, even though both earnings and revenue have beaten estimates every quarter. Third-quarter sales jumped 65%, as its stack of cash and marketable securities climbed to $ 5.4 billion from $ 3 billion at the end of 2020.
“I’m not very worried about it,” Shipchandler said of the share price. “I have $ 5 billion in cash on the balance sheet. I know I can survive virtually any cycle.”
Investors in space see the same thing.
“I think this is a buying opportunity,” said Nina Achadjian, partner at Index Ventures who previously worked at Google. “The fundamentals of these companies have not changed.”
The continued growth in income coupled with falling prices means that the sales multiples paid by investors have been squeezed. As of February, cloud stocks were trading on average at 16 times futures earnings, according to the BVP Index. They are now at 10, the lowest since May 2020.
Zoom is trading at 14 times sales on a sliding basis, up from a peak of 189, according to FactSet. The DocuSign multiple sits at 15, after dropping from a high of 50.
While not all cloud providers have the cash cushion of Twilio, Zoom, or DocuSign, many companies in the space industry have high software margins and are driven by subscription companies which continue to display high retention.
“These are recurring patterns,” said Michael Turrin, an analyst who covers cloud computing companies at Wells Fargo. “They have very good visibility into the underlying business models.”
Turning these fundamentals into good investments can take patience. The Nasdaq index has beaten the Dow Jones every year from 2017 to 2021. In the first week of 2022, the Dow Jones managed to achieve a narrow gain, while the Nasdaq is down 3% and stocks of the cloud are collapsing.
– CNBC’s Ari Levy contributed to this report.
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