No. of Recommendations: 182
Category Crushers and my portfolio

About a year ago, in May last year, I realized that one of my criteria for investing was to pick companies that dominated their markets. I made up a list of categories, which follows below:

First there’s a Category Crusher, which completely dominates its space (Amazon is an example, in online retail).

Second would be a Category Leader, which puts this company in first place in its space, but where there are significant competitors.

Another category would be a Disruptor, a company trying to disrupt a stagnant market with new stuff.

New Market Stocks with respect especially to Big Data New Market Stocks. (Othalan suggested this addition and it’s a great suggestion).

Then there is a Rapidly Growing Company in a Rapidly Expanding (New) Market. It’s not dominant, and not necessarily the leader, but it’s growing rapidly because its market is growing rapidly.

Then there’s a Rapidly Growing Company in a Normal Market.

I thought it would be interesting to give a capsule on each of my current stocks, and try to categorize them the same way, which I will do below. I’ll also describe my confidence level and position size in my portfolio. Please feel free to argue with me about my placement, as long as you give good reasons, as I’m no techie and I may put companies in the wrong place easily.

First, looking back at my portfolio from a year ago I see that most of the stocks are gone. Some were fairly recently departed (Shopify and Arista), but Amazon, Mulesoft, Hubspot, Splunk, Ubiquiti and Hortonworks have been gone for months now. Some of the long-gone stocks have done great since I sold them, others not so great, but I haven’t followed them for the most part.

My two top stocks are Alteryx and Twilio. They are by far my largest positions and each makes up over 17% of my portfolio (mostly because they were already my first and second positions when they announced great results and bounded ahead in price). They are both small companies but in my opinion they have each created their market categories and each dominate the market they are in with no credible competition (except do-it-yourself). I’d have to call each of them a Category Crusher.

Let me talk about Alteryx first. They enable non-techies to quickly and easily analyze data. Their clients therefore love them. Their revenue percentage growth looks like this:

2016: 57 67
2017: 61 50 55 55
2018: 50 54

That looks solid as a rock to me. Their adjusted gross margin this quarter was 90%, up from 84% a year ago. 90% gross margins!

Their deferred revenue at the end of the year the last four years, in millions of dollars, has gone: 29, 44, 71, 114. Take a good look at that!

Their dollar based net retention rate has been over 130% for the last seven quarters. Before that it was in the 120’s, so it’s improved with age and size.

Their number of customers, 3940 at their last report, is more than a quadruple of the number of customers that they had three years ago.

The number of shares grew only 4% from a year ago, which is remarkable for one of these super fast growing companies.

They feel they have no competition. Here’s from the conference call: We’re really the only general-purpose data science networks platform on the market today. I feel justified calling it a Category Crusher, with very high confidence level. I’d give it six stars out of six.

Next Twilio. They provide communication services and they seem to have no viable competition in what they do besides do-it-yourself. One company, Uber, who had been a big customer, decided to do-it-themselves, which caused weak year-over-year revenue growth comparisons over the past year. That is, if you can call 40% revenue growth weak…that was the lowest, in the December quarter… revenue growth is now back up to 54% and climbing. It always stayed above 60% year-over-year growth if you excluded Uber. They hit adjusted profit this last quarter unexpectedly, and will probably be profitable for the year. Their dollar-based net expansion rate was 137% including Uber, and 145% excluding the effect of Uber’s withdrawal.

They had a euphoric conference call:

… If you actually look at Base Revenue growth excluding Uber, that was in the mid 60% range, and that number has been in the low and mid 60% range over the last eight quarters, so as we scale this business we maintain consistently high revenue growth…

… I think that that means there's a runway for us for many, many years to be replacing old legacy technology… I think there is going to be no shortage of opportunity for us to do that for years to come.

They are also euphoric about their new Flex call center product, for which the beta was oversubscribed.

…we’re targeting some of the most demanding contact centers that are out there, some of the largest with the most customer-issue requirements of the contact center market… and so as we work with customers we’re not trying to be the lowest cost transaction out there, we’re trying to provide very sophisticated solutions for some of the most demanding customers that are out there.

Clearly another Category Crusher and very high confidence. I’ll give it six stars as well. Actually I think of each of these two companies as juggernauts. They are each a one-of-a-kind company. Each controls its space and is growing like mad.

Next come Square and Zscaler which I’ve given five stars to each.

Square makes up 13.5% of my portfolio, but Man! I don’t know which of those categories to put it in. It has so many moving parts, in so many markets, that various pieces of it could be Category Crusher or Category Leader or Disruptor, or Rapidly Growing Company in… Well, you get the idea. It’s like the blind men with the elephant.

Square’s total revenue has grown year-over-year by 39%, 41%, 45%, 47%, 51%, and 60% in its last six quarters. Yes, you read that correctly! Instead of revenue growth returning to the mean (whatever that means) the rate of revenue growth has increased each quarter. Extraordinary.

How is that happening? It’s because its Subscription and Service Revenue which is its high margin revenue, the good stuff, is growing at about 100% (last six quarters it’s grown year-over-year by 104%, 97%, 86%, 98%, 98%, and finally 131% (!) last quarter.

They’ve been adjusted profitable in 2016 and 2017, and 2018 so far… and profits are growing. Maybe the best I can do is to call them a Rapidly Growing Company in a Rapidly Expanding Market.

Zscaler has an interesting, innovative and revolutionary idea in Internet security (and insecurity). They feel that putting a hardware firewall around a company doesn’t work anymore, now that the enterprise company is partly in the cloud and people can sign in from anywhere, and sign on to other outside programs from within the enterprise. Zscaler provides native cloud-based security, and as far as I can tell they are far and way the leader in this, if not the only player. They have 100-plus data centers all around the world, which would be almost impossible for a competitor to replicate. Zscaler has been building them out and operating them for ten years. It is growing revenue at 50% and growing billings at higher than that. Their adjusted net loss is 5% of revenue. (Compare that with Mongo’s loss of 45% of revenue, a little further down the page!) Zscaler sounded pretty euphoric too, in their conference call:

Zscaler delivers advanced security and policy enforcements, no matter where the users are, connecting users to the nearest Zscaler data center, hence taking the shortest path to the application…

…We believe we are the solution to secure the cloud-first, mobile-first, world. We have 10 years of operational experience running our security cloud at scale. We process in excess of 45 billion internet requests per day during our peak periods. Each day, we detect and block over 100 million threats and perform more than 120,000 unique security updates. This cloud effect delivers far superior security than traditional appliances for all of our customers... We feel the world is coming towards us!

In my opinion they are a Disruptor and a Category Crusher, and a juggernaut like Twilio and Alteryx. The traditional security providers can’t compete with Zscaler because their businesses are built around high-priced hardware and firewalls, and they don’t have the data centers all over the world that Zscaler has. Zscaler is just an 8.9% position position for me right now. The position size is as small as it is as small as it is because it just IPO’ed and it’s very new to me. I’ve been building it gradually. Doing this summary today made me re-evaluate Zscaler and I added 10% to my position.

Next level down I have Nutanix, Mongo, and New Relic in that order, at a confidence level of four stars, and at 10%, 8% and 6% of my portfolio.

What does Nutanix do? Damned if I know. To quote from the MF: “Nutanix's Enterprise Operating System enables a data center filled with hardware, storage, and networking, to behave as if it were a public cloud like AWS.” Doesn’t really clarify it enough for me, but it sounds impressive though, I have to admit.

Nutanix is phasing out the zero-margin pass-through hardware that they had been counting in revenue in the past. This makes revenue comparisons a bit complicated and obscure. At any rate their deferred revenue in millions of dollars, at the end of the June quarter these last three years was: $172, $332, $540 million. You read that right! Subscription revenue this last quarter was up 55%, and Subscription billing was up 67%. Those are some pretty impressive percentages.

I’m embarrassed to say that I don’t know enough about the tech to know if it’s a Category Crusher or a Category Leader (please help me out on this), but I could safely put it down as a Rapidly Growing, Big Data, New Market Stock. I do know though, from what they’ve said in recent conference calls that they feel that they basically have no viable competition at the present time, so they probably are at least a Category Leader and maybe a Category Crusher. They are at 10.3% of my portfolio. Oh, and in June an analyst said they won a $45 million contract with the US Air Force, the largest contract in Nutanix’s history.

MongoDB has pretty much invented its solution and category, although it does have competition. It’s the leader in NoSQL data storage and it’s growing revenue at about 50% per year. It has chosen to put all its money into growing and thus its adjusted loss is about 45% of revenue, which is why I only give it a 4 out of 6 confidence rating. It’s about an 8.4% position.

I know that Bert likes it, and the MF likes it, and that Mongo has come out with Atlas which gives it a fully managed cloud solution, and that Steppenwulf said MongoDB is the story of 30 year old technology (SQL) being replaced by more modern technology. This story is only tangentially about the cloud - with or without the cloud, the amount of data is exploding and old technology can't handle it…. but still! Losing 45% of revenue is a bunch, even if you are growing at 50% year-over-year.

I’ll call it a Disrupter, a Category Leader, and a Big Data New Market Stock.

New Relic is a relatively new position, and only 5.8%. It has four stars of confidence because I don’t have much experience with it, and because it’s growing a little slower than the others, but confidence and position size are growing.

What does it do? To quote Bear, New Relic monitors web and mobile applications in real time, detecting issues before they become problems, and helping companies figure out where the pain points may be before it costs them sales, or even customers.

This is called the APM space (or the Application Performance Monitoring space). They are adding NPM (or Network Performance Monitoring), and they have developed a realtime Dashboard. APM didn’t use to be very sexy, but with the rise of the cloud, people in your enterprise may be using all kinds of applications, including ones that are on the web and in the cloud. APM is becoming much more important for enterprise companies. To quote the MF:

New Relic makes software that ensures that everything behaves the way it should whether applications are in the cloud, on premises, or part of a hybrid system. As a pioneer of what it calls Application Performance Management (APM), it allows companies to see what's working, what isn't, and why. That's important for making sure your back-office systems function the way they should, and it's critical for understanding your customers' experience… New Relic is a "land and expand" business. While older APM software tends to be expensive and difficult to use, New Relic's platform works entirely in the cloud, making it easy to add new applications. It's also cheap.

How are they doing? They grew revenue at 35% last fiscal year (ending in March). That was amazing by old standards, but it’s lower than most of my other companies. However, earnings per share are something else again:

At the end of June 2016 their TTM earnings were minus 84 cents.
At the end of June 2017 their TTM earnings were minus 38 cents.
At the end of June 2018 their TTM earnings were plus 23 cents.

Read that again! APM may not be sexy, but that sequence is!

Their adjusted gross margin is 85% which isn’t bad either.

Their TTM adjusted Free Cash Flow margin has gone from minus 56% to plus 11% in five quarters.

Their adjusted Op Margin percent has gone from minus 44% to plus 8% in the same five quarters.

I’d call them a Category Leader and a company that took an old space that was going nowhere and turned it into a cloud based New Market space.

My last two actual positions are Okta, and Pivotal.I’d give them each three stars. They average about 7% positions.

Okta is a 7.4% position and it is only down at the three star level because I don’t know enough about the tech to tell whether they could be bypassed by someone like Zscaler. What Okta does is control individual sign-on using a native cloud SaaS platform. It’s called identity and access management. It is loved by the people who use it, because they no longer need a million passwords for each program they sign on to. It only has one real competitor, Sailpoint, who it turns out can only really compete for on-premises projects.

Okta is growing revenue at 60% and its net loss is down to 11% of revenue. It seems to be in command of its own future.

This is a Disruptor and Category Leader, and a Cloud-based New Market Stock.

Pivotal is hard for me to figure. It’s only a three star position because there are so many complications. The problems aren’t with their revenue growth or margins or other financials. Those are amazingly superb. The problems I’m talking about are like being 90% controlled by Dell. Like how do containers and kubernetes fit in? Like why don't they grow the number of customers faster, etc. Like it’s nice that they hardly have any S&M expense, but is that realistic for the future if they actually have to go out and find their own customers?

I think I’d call it a Rapidly Growing Company in a Rapidly Expanding (New) Market, and a Category Leader in its own niche. It’s a 6.6% positions for the reasons I just listed.

Those are my nine real positions. Then I have four little “think-about-it” positions which total just 4.5% for all four combined. They include Paycom, Wix, Pure and Talend, in that order of size. But I don’t want to have to deal with 13 companies so I need to get rid of one or two. I just haven’t been able to decide at this point. I’d rate Paycom and Wix two as two stars of confidence, and Pure and Talend as one star. Well, Sell the last two! you say. But I only have 0.30% and 0.15% positions (really, really tiny), so it won’t free up much cash for me, and I’m holding them because I want to see what their next quarterly reports are like. I may sell them anyway.

I hope this musing has proved useful for some of you.


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