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Saturday, September 18, 2021

Lemonade (LMND), a semantic analysis of earnings: time to buy?

or Why I am not investing in Lemonade - LMND (...yet)

Early in August Lemonade insurance company announced their earning and quarterly updates. The stock did not farewell, creating a potential buy opportunity. This was also discussed quite a bit on the various internet fora and there were many proponents of the stock as well as those who felt that perhaps it was not the right time. This piqued my interest in LMND since it is a finance-tech (fintech) insurance company. Lemonade Inc. offers a number of products including renters' insurance, homeowners' insurance, pet insurance and term life insurance in the United States. They also operate in limited areas of Europe such as Germany, the Netherlands, and France. They have a predominantly young demographic (approx 65-70%) and catchy ads to target to their target population. 

This encouraged me to dig deeper in to their earnings, operations and fundamentals with 'semantic network analysis'. You may perhaps know from my other articles on the site, I believe this method is unique in that it allows to seek hidden patterns or those connections that are not immediately revealed. 

The rationale for doing something like this is that ALL text has a linear structure (which is top-down, left to right etc) which  is the most common way of conveying information. However, in this linear flow, certain connections can be missed. Unsupervised Concept network analysis takes concepts in the text and breaks them into parts, which are then connected by common linkages. It is process intensive but is highly informational. This nonlinear text visualization of concept linkages allows for hidden patterns to be revealed, read between lines. 

With that brief intro, let me walk you through the process of my analysis of Lemonade's reports. The earnings came out on August 4th, 2021, right after this came out, I generated my unsupervised semantic network to analyze if it was a good opportunity to invest in LMND. This network model is shows in figure 1.

Figure 1: An unsupervised semantic text network analysis of Lemonade Co. earnings
Each node above, represents a tangible concept and entity and it is linked by edges (lines) which connect the related nodes.

  • Light blue nodes: pertain to discussion on Lemonade car, their car insurance product
  • Green nodes: pertain to their financial situation and their arrangement with reinsurance markets
  • Yellow nodes: are their existing products (home, pet etc)
  • Pink nodes: pertain to their progress and expansion plans
  • Purple nodes: pertain to their ESG efforts

Then using a computational algorithm (force-directed layout) to space them out, linked nodes are pulled closer while those that are not related are pushed apart. This is how patterns and connections emerge (figure 1).

FOUR broad themes emerge

1) Reinsurance drag: The is a big factor weighing down the business and that is the their necessary partnership with reinsurance industry. They are contracted to cede 75% of the premium they obtain from customers that obtain insurance through Lemonade. This is going to be a big drag until 2023, when they will renegotiate the terms of this contract. They are showing some improvement in reducing this percentage but it will continue to be a drag. Also there is 'new business penalty' which means as they expand into new lines of business, this penalty will tack on and eat into their profit margin. This was huge flag for me. A turnaround for me would be to see this at much lower percentage (ideally zero) to renegotiate after 2023 and see what terms are offered. Moreover, the location of this cluster of nodes right between Lemonade car (light blue) cluster and other products (yellow nodes), tell me of the profound impact this has on their operations.

2) Verticals need better performance and integration: Their products are mature and work HOWEVER, the performance across the board is lumpy. Some products (yellow nodes in graph) are floundering like life and renters while others are doing better (pet). A turnaround factor for me if, in next few quarters, we see company firing on all cylinders for ALL of their products.

3) Lemonade car still has to go live: there are significant goals that need to be met before their car insurance product is ready. It is revolutionary no doubt - where car insurance is going to based of telematics data and AI etc. So far they do not have regulatory approvals and did not provide launch dates. A turn around for me on this would be is a) they get regulatory approvals and b) they launch it.

4) The ESG nodes and the expansion nodes are sparse: This part of the network graph was anemic, at least as far as their discussion goes. I would like to see a much more robust patterning here.

The stock has fallen another 10-12% since and as of today the chart looks like this (figure 2, below)

Figure 2: Technical set up for traders (image courtesy: Stockcharts.com)
 

A technical view of the stock shows a divergence between stock price and RSI as well as MACD (image from www.stockcharts.com) which may suggest they a small price improvement is possible. This may be okay for stock traders who want to try and scalp some profits. However, the underlying fundamental story has not changed for me and so as a long term investor, I have NOT entered into a long position yet.

Conclusion: Based on my semantic analysis I decided to not invest in Lemonade and wait till there are improvements in certain key issues.

Friday, September 17, 2021

Zoom Video Q2 2022 post earnings breakdown, a semantic network analysis

Zoom Video: With it being down 18% in my portfolio it is time to question my beliefs and decide whether to add, hold, pare or get out. The following post is a step-by-step walk through of my process, reasons and conclusions. Brace yourself, its a long one. TLDR at bottom. 

Lets begin,

On Zoom developments:

Figure 1: Zoom Apps discussion

Zoom apps section of Zoom has nicely thought out plan with an internal and external work force (Start ups, zoom apps fund). I think this will continue to crank out developments given its set up. The network model is shown in the figure (Fig. 1). CEO called this "internal innovation engine".

Figure 2: Zoom events discussion

Zoom events is presented as a step above webinars and meeting with its USP being a solution for mass reach to host and produce events. This is not experimental, but a fully functioning product which the company has tested on its own event 'Zoomtopia'. See figure 2 above.



Figure 3: Zoom 'wins' this quarter

In the sales (Figure 3), they made some good sales with both new large customers as well as up-sells to prior customer. Main emergent theme, I got was 'Zoom phone' is being offered as 'Chef's special' and is likely being pushed hard. If this is the case, then zoom phone numbers will improve QoQ and people will start seeing traction in addition to zoom meetings. More interestingly is the partnership with Telkomsel which is Indonesia's largest cellular/internet Telecommunications provider.

Figure 4: Zoom has identified a clear need that enterprises have

The CEO has nicely outlined what they see as their target audience. It is the offices, organizations they are going after and filling the enterprise need for a digital platform that does communication (Figure 4)

Chief Finance Officer's section

1. Enterprise customers spending more than $1 million in ARR up by 77% year over year
2. A lot of Zoom phone numbers - see the comment above on pushing this product.
    - number of customers spending more than $100,000 in ARR on Zoom Phone by 241% year over year.
    - 2 MM Zoom Phone seats, eight months after reaching first million.
    - Eight Zoom Phone customers with more than 10,000 seats in the first half of FY '22, to a total of 26.
    - largest Zoom Phone deal to date twice in the same day.

Cautionary comment (I): customers return to more thoughtful, measured buying patterns. While revenue, profitability, and cash flow were strong in the second quarter and the first half, other metrics have begun to normalize, especially when compared to the unprecedented year-over-year comps.

3. total revenue grew 54% year over year to $1.02 billion,
4. Strength in direct and channel businesses, which grew at twice the rate of online business.
5. Zoom Phone, Zoom Rooms, and Asia PAC growth also accelerated in the quarter
6. healthy mix between new (74%) and existing customers (26%) of incremental revenue.
7. Approximately 504,900 customers >10 employees, up 36% year over year and representing 64% of revenue.
8. Net dollar expansion rate for above group exceeded 130% for the 13th consecutive quarter as existing customers increased their spend
9. customers < 10 employees down to 36% of revenue (from 38% highest)

Cautionary comments (II): Small and medium sized businesses and consumers < 10 employees are expected to continue to decline as a percentage of revenue.

10. Regional news: Americas revenue grew 50% year over year. Combined APAC and EMEA revenue grew 62% year over year to be approximately 33% of revenue, up from 31% a year ago. significant investments in Asia Pacific, our direct sales team drove several strong wins in the enterprise segment (See NEC).'

Cautionary comment (III)
: headwinds in EMEA (Europe, ME and Africa) declines in the online segment.

On Their Spend :

1. Research and development expense grew by 89% year over year – needed for innovation. At present 5% of rev target is 8% (See below section)
2. Sales and marketing expense grew by 72% year over year to $211 million - plan to increase investment in global sales capacity, as well as digital marketing and events,
3. G&A expense in the quarter grew by 73% to scale and invest in systems, automation, and compliance to meet our new scale.
4. Remaining performance obligation (RPO) totaled approximately $2.3 billion, (up 66%) of which 69% will be collected over 12 months. Q1 represents largest renewal quarter.

Cautionary comments(IV): Zoom expects that front-weighted seasonality will persist and potentially become even more pronounced given the scale of user base. They expect total deferred revenue and RPO to be modestly down from Q2 to Q3. RPO serves as a proxy for future revenue, the RPO growth rate provides a leading indicator of growth but Zoom indicates that may not be the best measure to gauge one aspect of their growth.

My take

The market has reacted appropriately to the cautionary comments provided with gap down in the price of ZM stock after earnings. However, I believe this setback is transient and the business will get over the headwinds and declines noted. Based on the goal identified by CEO, they are going to target enterprises hence, they may not be planning to target the small <10 employees companies anyways. RPO is expected to be down from Q2 to Q3, due to seasonality..look at this as not QoQ but a Year over years comparison. 

Q and A highlights

"headwinds in the online segment (zoom meetings) of our business but continued strength in the upmarket enterprise in both Meetings and Phone."

General: The tone and sentiment of the earnings call was mixed which was aptly correspond with the drop in share price after the earnings conference. That being said lets dig in, I personally do not want to focus exclusively on online segment to decide Zoom's worth. The reduction in usage here, is expected, people are not "zooming" as much since they are going out and doing things in person. Also, individual users, smaller users are sort of the 'side shuffle'. This reduction in online segment is also what management thinks is the headwind for the Europe, middle east and Africa. 

The CEO has made it clear that zoom is targeting the enterprise segment which is doing very well. Areas of growth are Zoom phone (presently adding about 500K seats every Quarter), Zoom corporate licenses and Zoom Rooms all which are showing good numbers in growth. 

Zoom online had a different motivation when people jumped in on it, it was "desperation", but now with vaccine and better understanding of the situation, people can be deliberate in their purchases. The latter is whats happening to Zoom Phone, the fact that it is showing improvement, is telling  me, that the decision to increase corporate licenses and buying more seats on phone are deliberate decisions and not desperate actions. Deliberate actions provide a stable revenue, as opposed to volatility of desperate actions.

On Five9 acquisition: Current users (including enterprise customers) per zoom want to migrate from on-premise to the cloud. Having an integrated phone and contact center solution (Zoom + Five9) would be attractive to companies. This would be new revenue stream and grow Zoom business. Based on this assessment, CEO believes it is appropriate to double down on the cloud as the contact center of those.

On monetization of free users: Schools through K-12 will not be monetized. Kudos on firm moral compass and karmic gains on goodwill. Also, this is a long term investment, kids who use and are familiar with zoom tech are going to be adults who will use zoom tech. bravo! I also like the fact, they the leadership is acutely aware of where and when to monetize, for example, they felt that further monetization of online users (mom and pop store, smaller companies individual users) may not be the sustainable strategy. Hybrid adoption in EMEA is lagging APAC which is lagging US (my impression) when these pick up, these will be stimulants for higher growth.

On vision to sustain growth:
"Yesterday":    Zoom videoconferencing
"Today":         Zoom Videoconferencing PLUS Zoom Phone
"Tomorrow":     Zoom Videoconferencing PLUS Zoom phone PLUS Zoom platform/Full suite

On predicting user trajectory: One analyst asked when the zoom online (smaller users) will trough out and growth of enterprise segment will dictate the discussion. This was an unfair question since boom in online users was pandemic driven, and attempting to answer this question is akin to predicting future course of pandemic.

On relationship of zoom phone and zoom meeting numbers: Analyst at Piper-Sandler asked a good question IMO. They wanted to know if zoom phone is leading to a greater number of seats at existing customer. The CEO's answer was not as clear on this one. It may seem that one year ago, Zoom did not expect it would up sell phones to existing base in amount that it did. They were anticipating new customers to bundle video and voice through phone. But it seems that more customers are going to deploy video first and then deploy Phone.

On competition from other services: Future work will be hybrid work and mainstream. Embracing hybrid work by employees, students, WFH, will require a solution. Per Zoom, a 'good enough' solution will not do well (which Zoom claims are other services). Zoom claims it is best-of-breed with better IT support and productivity tools  (which others do not have same level of). 

On expenses: Zoom was not able to hire and invest in proportion to revenue growth. They are under-invested in our R&D (5%), with goal of 8%. Continue to spend on marketing.  G&A is in range of where it needs to be. Cost of good sold (COGS) will reduce as services move from public cloud to Zoom data centers. As K-12 schools go back to campuses, expect to see  improvement in our gross margins.

On Zoom events: This was a redesign of OnZoom to meet the demand of enterprises for corporate events. Consumers (like online fitness or cooking class) are expected to catch on.

Approximately a 1/3 of the analysts were focused on the online meetings, and small users segment which may have given an overall disappointing tone to the discussion. There are however quite promising pieces of information which are reassuring.

Verdict: I will hold on to my Zoom shares, as of time of this note they were down ~18%, if they drop more, I will add to lower the cost basis and to keep the draw down around 20%.

Sunday, September 12, 2021

Fastly (FSLY) versus Cloudflare (NET): Which stock is better on cash flow (operations) metric?

As noted before, I like to look at cash flow from operations, since it is one metric that tells me how good is a company at generating cash/revenue from its day to day operations. This money can be reinvested into the company for organic growth, acquisitions, research etc. Other mechanisms to raise cash are from investing activities and from financial endeavors. This has been nicely outlined in the article I did on Palantir, and would recommend giving it a read, if not already done so

I own Cloudflare (NET) stock but Fastly (FSLY) is a competition that has recently lost much of it value and is down considerably. In fact, at the time of this note, FSLY was down 40% and NET was up 280%, over a span of 1 year.  In order to see if the market had mispriced FSLY and if it could be considered a buy, I analyzed the CFO metric between the 2 companies. Perhaps, this will be a clue, to answer why one company has tanked while other has done so well. Moreover, it will allow us to examine if there may be opportunities to buy either of the companies. This is shown in figure below.

Figure 1: Comparison of Cloudflare and Fastly, operational cash flow, stock price and expenses

On balance cash flow from operations compared to stock price at time of earnings for NET (panel A, top left) compared to FSLY (Panel D, bottom left). The stock price shows overall congruence for both stocks. 

Cloudflare: Next, I would like you to focus on the earnings report quarter ending 12/31/2020, look at the on balance net cash from operations compared to reported sales and marketing expense (panel B), and reported research and development expense (panel C). There was a drop in the cash flow from operations (solid blue arrow)  which piqued my interest and then I want to see why – as you can see this drop actually corresponds to a rise in expense for S&M and R&D. So this likely is not reduction in cash flow from problems in company operations but likely allocation of cash to good use. Hence this drop is “reassuring”. The market likely responded to this report in a positive manner and hence the price went up (hollow blue arrow – panel A).  This is shown below which is the same figure as 1 but panels are expanded for detail (below)

Figure 2: Cloudflare
Fastly: Now in contrast, lets focus on the earnings report quarter ending 3/31/2021 for FSLY (bottom row), look at the on balance net cash from operations compared to reported sales and marketing expense (panel E), and reported research and development expense (panel F). There was a drop in the cash flow from operations (solid red arrow)  which piqued my interest as well and then again I want to see why – as you can see this drop actually does NOT correspond to a rise in expense for S&M (you can see that S&M expense 'gold diamond shape' is actually flat) and R&D there was an increase in spend but not commensurate with the drop in operational cash flow. I take this reduction in cash flow as problematic, a possible reflection of issues with company operations and this drop is “concerning”.  This was the opportunity to get out, sell the stock (red hollow arrow). This is shown below which is the same figure as 1 but panels are expanded for detail (below)

Figure 3: Fastly

In conclusion, NET has a stronger cash flow sheet and this is reflection of excellent operations, high efficiency and robust execution. If FSLY is able to improve on the on balance cash flow over the next few quarters, then I would be a potential buy opportunity but for now, Cloudflare looks more attractive. Hopefully, this helps readers to assess companies for themselves. If you have any comments or would like help refine this method, please message me on twitter (handle in figure).

Disclaimer: I own shares of Cloudflare (NET). The analysis if for my personal understanding of companies I invest in, but am sharing it for other in case, someone else finds it useful. This is not investing advice. All data were obtained from public sources.