What’s Cabot’s May “Stock of the Month” in the Cloud Computing Sector?

Sleuthifying Cabot's new teased "Double your money guaranteed" pick

Like several other newsletter families, Cabot runs a relatively low-cost service that culls picks from all of their newsletters and picks a monthly favorite — the service is called the Cabot Stock of the Month Report, and they typically tease it with their “double your money guarantee.” (That guarantee is not terribly different from the guarantees of other publishers — in this case, they say that if you don’t have the opportunity to double your money with their picks in the next year you “won’t pay a dime.” Not that they’ll make up for the absence of doubling stocks, of course, just that they’ll refund you your newsletter subscription price.)

I haven’t looked at one of these teasers for a while, but after immersing myself in “value” stocks for a week or two I thought it was high time to take a look at something a bit “growthier” … the Cabot folks tend to focus on technicals and momentum growth stocks most of the time, so as I glance into my crystal ball I foresee that we’ll end up with a teased pick that’s a rapid grower and that looks pretty expensive. Sometimes that works out great, obviously, so even though I tend to be wary of growth valuations (I failed to buy Netflix when I was writing about it in the teens back in 2007, he reflects bitterly), I do like to give them a chance. And readers are asking, so it’s answers we’ll seek.

Here’s the come-on in the email from Timothy Lutts:

“Just look at our May Cabot Stock of the Month and you’ll see why I can make you this money-doubling guarantee.

“Like Amazon, this company is also riding the wave of profit growth but it’s in the fast growing cloud computing sector. So it’s no wonder analysts are forecasting Amazon-like earnings growth for this sector leader: 100% for next quarter and 600% earnings growth next year!

“With 12 months gains of 64%, we see this as the beginning of a huge new profit run as the company just received approval from the U.S. General Services Administration to contract federal, local, and state customers.”

And then, in the full ad letter that links to, we get a few more clues:

“Big name insiders at T. Rowe Price, Morgan Stanley, and Greylock LLLC Group—along with 17 other top institutional fund mangers—together—own shares worth more than $2.5 billion because they see what we do here: Another game-changing Amazon.com with a 1290% gain.

“It’s no wonder: The company’s Q1 revenue and billings crushed analyst’s expectations, led by 81% revenue growth and 96% renewals.

“And that’s just fundamentally. On the technical side the company boasts a terrific chart. The company came public in June of 2012 at 18, topped above 39 in September, bottomed at 26 in January, and returned to 38 in March, where it spent six weeks gathering strength before breaking out on big volume last month after an excellent earnings report.”

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Amazon is another growth stock that I’ve missed, so we can break out the pity party now — though Amazon certainly hasn’t been climbing because they “crushed expectations” for earnings, it’s all been about revenue growth for them and I remain uncomfortable with the valuation Amazon stock carries. (For what it’s worth, as I examine my blind spot in this area, I thought it was expensive at $50 years ago … it’s now near $300 as they continue chocking up giant revenue gains and deciding not to be profitable — the theory is that they’ll just someday decide they’ve gotten big enough, and then Jeff Bezos will stop investing in expansion and decide to start making money, but until then the big revenue growth and almost nonexistent earnings have so far worked spectacularly for shareholders).

But anyway, we’re not talking about my past failures to buy rapid growth stocks (if we were, we’d have to throw Priceline on the pile, and Boston Beer, and … Arg! OK, I’ll stop now). What’s this pick from the Cabot folks?

According to the Mighty, Mighty Thinkolator, which continues to stand by its 99% accuracy record, today we’re looking at ServiceNow (NOW).

Which I’ve never looked at before in my life. This was an IPO last June, it did indeed book 81% revenue growth last quarter, and all those past price points are accurate — it’s been a wild ride in this stock’s short history. It’s not a tiny stock, the company has a market cap of $5 billion and it’s got plenty of cash (thanks to that IPO), but it has been growing revenues very quickly and not turning a profit. Analysts are projecting the company to turn profitable in 2014, with an estimated forward PE of about 200, and they are projecting 600% growth next year and 50% annual growth for several years out into the future. They’re also looking for revenue to jump from a little under $250 million last year, to almost $400 million this year, and then to more than $575 million in 2014. So this is definitely a growth story.

And it’s clearly not a terrible business, even though it might well be considered awfully expensive — they don’t have earnings over the past year, but they do have positive cash flow and free cash flow, which might partly be because they sell a subscription-based service (subscription revenue usually gets received as cash up front, but only recognized as earnings over the course of the subscription period, so for most companies like this it shows up in cash flow before it shows up in profits).

What do they do? Here’s how they pitch their business on their website:

“ServiceNow is the Enterprise IT Cloud Company. Transform enterprise IT. Automate and standardize business processes. Consolidate global IT to a single system of record.”

You can check out their analyst day presentation here if you’d like to see that fleshed out a bit — according to that presentation, they’re “on track” to hit a billion dollars in sales in three years or so based on their growth rate trajectory, and they say they’ll be growing their R&D and SG&A much more slowly than the revenue grows, so those will stop sucking up all of their cash flow at some point in the long term and give them an expected “long term” operating margin of about 20%.

If the operating margin is going to be 20%, and we assume that nearly all of that is really net profits, and we assume that their growth gets them to a billion dollars in sales in 2016, much of which will be very nice recurring revenue (they have really had strong renewal rates, 96-98%), then you’d be looking at $200 million in profits in 2016.

That’s a wild guess, since they fully admit that the billion-dollar revenue target is clearly not a forecast (they probably, I assume, are pushing to make that number higher). But if they book $200 million in profits in 2016 and haven’t diluted shareholders meaningfully (they say they’ll dilute by about 3% a year, which is within a normal range for a young tech company that loads people up with stock options), then that means you’re now paying roughly 25X 2016’s profits (well, the wild guess about 2016 profits).

I don’t understand much about the company — I looked through their basic info and they see to be a broad platform for running all kinds of IT for enterprise (big business) customers, including data center and cloud management, HR, service desks, project management, CIO offices, and I simply have no real concept for whether their offerings are better or stronger or in some other way unique. They do see themselves as having a huge universe for potential growth, with a target market that’s almost ten times larger than their customer list and a broad ambition to expand their product set and upsell their current customers. Growth looks good, their renewal rates and upsell rates are good, but that’s a lot of growth — and it’s growth that assumes some pretty ambitious improvements in margins, considering that they are currently in the “investment” phase of bringing on lots of sales people to try to get that growth in the first place. I suspect that it will be hard for them, when the time comes in a couple years, to sacrifice growth for margins, especially in cases (as with Amazon) when investors want growth at almost any price, but that’s just my musing.

The company is fairly large, and hasn’t been public for very long, but they have been growing nicely for several years before going public (they say that this last quarter is their 27th consecutive quarter of 80%+ revenue growth), so the growth has, at least, been evident. You can see the conference call transcript from their latest quarter here (and yes, that quarter did encourage investors to bid the price up).

So … are you up for buying shares of this company at this kind of valuation? It is in what seems to be a growing sector, even if I don’t understand it very well, and it’s certainly putting together (and projecting) excellent revenue growth. The company will almost certainly continue to be volatile based on their own growth projections, since that growth is really the reason anyone is buying the stock. That’s about all I can tell you in my short look today (and I’ve already told you about my blindspot when it comes to growth stocks) … so please, let us know what you think with a comment below.


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JO
Member
JO
May 16, 2013 11:56 am

It sounds interesting..

Walt Nied
Member
Walt Nied
May 16, 2013 3:54 pm

As much as I like the cloud computing sector, the only stock in that area I own is Dupont Fabros Technology ( DFT ) Good solid company, good quarterly dividend.

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Dan Nix
Member
Dan Nix
May 16, 2013 3:59 pm

It is a very confusing industry, but this may be a growth potential.

Viktor M
Member
May 17, 2013 1:06 am

If it continues to grow at 80% per quarter, in 10 quarters it will have expanded by a factor of 357, i.e., 35705%. With a cancerous growth rate like this it should be able to subsume much of the cloud market within 5 years.

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goldpricedirection
Member
goldpricedirection
May 17, 2013 5:00 am

Interesting but there is much confusion as well.

Robert Lamoreaux
Irregular
May 17, 2013 1:56 pm

I am an IT Consultant specializing in Project Management for a long time. For the past year, I have been working with a Higher Ed Institution in California supporting their Service Now implementation for the past year. So I thought I would give you my two cents on the subject.
First, and this is important, you need to understand that IT Executives (CIOs, CTOs, etc.) are buzz-word junkies. And Service Now is IT heroin.
Service Now offers a SaaS/Cloud Computing product based on ITIL principals. Be still my heart, I get shivers up and down my spine when I say that. These are three of the hottest buzz-words in the IT world currently.
SaaS – Software as a Service, a pay as you go model; Cloud Computing – using someone else’s computer to run an application by connecting to that computer/application via the Internet; ITIL- a set of principles on how to run an IT service organization, developed years ago by the British Post Office and updated by many high price consultants since.
The Service Now product is used by organizations to manage change to their IT environments. A very critical challenge to an organization and an increasingly complex problem as the IT environment becomes larger and more integrated. You have all been victims in the past when a change was made to an application in Production and it broke it, either at your workplace or using Facebook, Twitter, Amazon, etc. This is a very expensive problem for most companies due to loss productivity/revenue because of system non-availability and also from the increasing expense to try and prevent these outages from happening.
There are many other companies offering similar offerings, but most are not as encompassing as Service Now nor are they SaaS/Cloud Computing ITIL solutions. What makes SaaS/Cloud Computing so hot you ask? Let’s take the example of flying from San Francisco to New York as an example. There are basically two options. First, I could buy a jet, hire and train a flight crew, hire and train a maintenance crew, build a runway and a hanger to put the Jet into. I could then fly to New York when I need to. The second option is I could buy a ticket from an Airline and fly to New York. Option 1, very expensive and it is how most IT organizations were/are built today. They own datacenters filled to the brim with expensive Mainframes/Servers. Hired and trained lots of developers, techies, management to keep it all running and then went and bought expensive applications from vendors to install in the data centers. Option 2 is what Service Now is, you pay for what you use and you connect to it via the internet. This is really attractive to IT Execs and loved by the CFO and CEO because it is much cheaper at start up and probably on-going as well.
Service Now is attractive to small to medium companies that need to manage their IT environments but cannot afford the expense to buy all the tools and expertise to run them to do it. It is attractive to Higher Education and Government Organizations because they are really behind the curve when it comes to IT maturity and this is an easy and cheap way to raise their IT maturity. It is attractive to companies that have merged with other companies; it’s an easy way to standardize their change management process. And it is attractive to larger companies that have been trying to manage their change process but are failing to do so.
So will Service Now be another Amazon, Netflix, etc? Probably not, those were customer oriented plays, it is more like PeopleSoft, SAP, etc, products that companies will buy. And I think it has a good chance of at least 100% to 200% increase in stock value over the next 2-3 years. So much so that I have put 8% of my portfolio into NOW.
Sorry to be so long winded, but I hope this helps for what it’s worth.
Bob

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Dick
Guest
Dick
May 17, 2013 2:08 pm

Good explanation. Thanks, it’s always good to have an opinion of somebody who has boots on the ground.
As to Cabot, they were bullish on TRIP, TSLA, I mean they are good to spot growth stocks and this one hasn’t gone to the moon yet.

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mwinfrey
Irregular
mwinfrey
May 17, 2013 4:34 pm

Great explanation – thanks, Bob!
-Matt

Jon Freeman
Member
May 18, 2013 12:21 pm

I greatly appreciate your explanation. I have been out of IT for a while now, but this helps me see in the way I should have seen in previous decades with Microsoft and Cisco.