Our Last SaaS Turn Around Chegg up 105%--CLDR Could be 250%

Dear Subscriber,

I have been ultra conscious of the wild 30-40 times sales valuations on Enterprise SaaS cloud app companies that we love at Transformity Research. They all walk a very thin tightrope of 30X+ sales valuations that means when they report earnings it HAS to be "Beat Revenues, Beat EPS  and Raise Guidance/" When they do, the scream ahead. When the don't they get destroyed like Stamp.com or Pivotal or like Cloudera--all down 45%+ from their tight rope highs.

But in a world with slowing world GDP, $15 trillion in sovereign debt paying negative rates, the defensive sectors way overpriced and retreating and the trade war truce divided into a) the easy stuff that can be done by end of the year and 2) the hard, fundamental stuff that will NOT GET done ever (and the market now understands this and is OK with it because its now ignoring bellicose Trumpian tweets because it has the Fed easing monetary policy to offset trade treaty), the 25-40% growth rates of very sticky cloud-based enterprise Software-as-a-Subscription and Platform-as-a-Service and Digital-Infrastructure-as-a-Service rock.

They empower the enterprise digital transformations that every organization must successfully execute or they become a legacy corporate loser: The Internet of Things/Cloud-based Business Process Applications/AI/Machine Learning/Data Science/Direct-to-Consumer eCommerce/Supply Chain-as-a-Service and Customer Relationships/Sales/Digital Marketing as a service. 

We have chosen to make our money mostly in the digital enterprise conversion with the technology "picks and shovel" that empower and enable the enterprise digital transformation and of course have earned big 200%-400%-700% winners to show for that strategy. 

But I never want to miss a chance to pick up a ridiculously low valued SaaS company that needs a turnaround OR our favorite Enterprise Digital Transformation platforms (aka the Enterprise Platformity Principle) on the regularly scheduled every 6 month 10% corrections (which in these stocks are 20-30% corrections as the momentum trading algorithms automatically sell all at one time). 

SaaS/PaaS/IaaS stocks are the darlings for 20%+ CAGR growth investors and the momentum algorithmic trading CTA's that now are 20% of the market trades every day. With 70% of the market in an index fund, what we have is a self-reinforcing high growth stock-in-a-low growth-world feedback loop.
1) The high growth high-quality cloud stocks "Beat, Beat, Raise" with their 80% gross margins and $1M+ sales per employee
2)  That raises their market cap so the index funds have to buy more shares to keep their percentage allocations
3)  That price momentum attracts the algorithmic CTA trading pools who buy stocks going up that meet their technical and economic and operational "factor" rules.

This process, however, goes into a complete reverse or reciprocal of this virtuous feedback circle when a fast-growing $1 billion "unicorn" tech stock "Misses, Misses and Lowers" guidance.--and with Cloudera they added a botched $billion merger and a C-Suite shit show during the combination.

First, the momo money bails, then the brokerages lower targets, then the indexes trim and then the active managers use the losses to wash profits in their portfolios. And THEN the stock is washed out (everyone who was going to sell has sold) and with a well-executed turn around plan and new CEO and C-Suite team, you grind back.

That is the Cloudera story--here is what that reverse schwing looks like in a chart. But this washout it also is a way for us to make great profits over the next year, too with either in-house or private equity turn around.

Buy Cloudera (CLDR) up to $6.50 with $18 Target.
Buy the $6 January 2020 Calls Under $2

Cloudera and their arch-rival Hortonworks merged in January because they were bleeding cash as the two data software providers spent years going head-to-head to lure businesses onto their fledgling big data science analytics technology. They joined forces against a common enemy: Amazon.
The all-stock deal did unite two most prominent vendors of Hadoop open-source software, which customers can use to store, process and analyze many different types of data located in their data center and on any public cloud vendor (read Amazon, Alibaba, Google, Microsoft). Valued at $5.2 billion when the merger was announced in October, the companies are now worth just north of $1 billion yet have $500+ million in cash on the balance sheet and a $1 billion revenue run rate in the fiscal year 2021.

This turnaround is going to be a lot more than we had with Chegg (CHGG) when they suddenly lost their CFO and CMO in November 2017. We are up over 100% on Chegg and we are raising price target to $50.

The Eye-Popping Upside

With the average S&P 500 company valued at nearly 5 times revenues, and database providers selling at 7-8X annual sales, Cloudera (the Hortonworks name was dropped) is being priced as if 1) they are going out of business or 2) they are dropping to $200 million in sales from $750 million over the last twelve months.

The Scoop on Cloudera
We have talked with a LOT of our Transformity Alliance members who are Cloudera users and consultants who resell Cloudera to enterprise clients and the uniformly say “not possible.” What they DO say is that

1. The merger was a disaster tactically but not strategically

2. The CEO got canned because he was over his head and created a shit show for the new Hortonworks team who fled

3. Cloudera needs to include an Artificial Intelligence (AI) functionality/engine to its system to compete well against Amazon and Microsoft. Everyone knows this—that is one must-do move.

4. A new CEO is going to shake up, strip down and right the ship or

5. One of a dozen technology private equity funds is going to come in a buy the company for $10-$12 a share with 50% leverage and execute the turnaround themselves

The Cloudera-Hortonworks merger fit into a big technology theme in 2018 — the growth of value-added open-source software. IBM bought server open source king Red Hat for $34 billion, Microsoft acquired GitHub for $7.5 billion and Salesforce purchased MuleSoft for $6.5 billion. Elastic (ESTC) whose software helps companies embed search functions in their apps, had one of the bigger IPOs of the year and is now valued at about $5 billion.

They all are keeping a close eye on AWS. The leader in cloud infrastructure has successfully pulled companies’ core workloads into its data centers and is now adding new features, functions, and services that are easy to use once a business is already on Amazon’s machines. Amazon has also been investing heavily in databases. AWS’ competitive products include Elastic MapReduce, for storing and processing different data types, and Redshift, a data warehouse system.

The Good News—Cloudera is a Software Private Equity Investors Dream
 Cloudera-Hortonworks expected 2020 revenue to exceed $1 billion--now it looks like $800 million. With $500 million in cash on the balance sheet, this is a software turn-around private equity firm dream company.  

The beefed-up Cloudera has many very key strengths as it stares down Amazon. Cloudera works in corporate data centers and across multiple clouds that AWS does not. Unlike Cloudera, AWS doesn’t have a way to let companies use many of its software products on clouds operated by Microsoft or Google. Thus Amazon will never be able to deliver multi-cloud—and big worldwide companies do NOT want to be locked into AWS—especially ones that compete with Amazon.

Plus more and more, users are deploying Cloudera’s software in the cloud anyway. As of June, 26 percent of customers that provide diagnostic information to the company is using the software on a public cloud like Amazon, up from 22 percent one year earlier.

Our timing here is good, too. Cloudera has its big annual user convention starting August 8 in SF. There will be a lot of news coming out on the turnaround—and the new CEO search is close to over we are told and down to 2 tech players.

Driving to profitability
A big advantage for the new Cloudera is it no longer has to spend money taking on Hortonworks, and vice-versa. Cloudera lost $111 million in its previous three quarters, and Hortonworks reported a $114.8 million loss over that stretch. Together, they spent more than 55 percent of revenue on sales and marketing.
A revamped Cloudera should have at least a 15 percent operating cash flow margin, a key measure of profitability. $150 million of the free cash flow will service $2+ billion of the low-cost debt available to private equity.
“The combined entity is better positioned to compete against those players,” D.A. Davidson’s Jaluria, who has a buy rating on Cloudera at $18 target.

We agree. 

The KEY Valuation Catylst Trigger—Software License Changes

One thing Cloudera has to do is impose software-licensing changes like other big PaaS players that will protect it from larger cloud providers who are not paying full price. like Amazon. MongoDB and others have done this with their cloud PaaS software and it sent their stock to the sky.

Heather Meeker, a lawyer with software licensing experience and a portfolio partner at OSS Capital, said she expects more companies involved with open-source projects to introduce constraints.
“At the end of the day, I think all of these companies are trying to make sure they don’t get starved for resources when there are a bunch of big users benefiting from what they’re doing, but they’re just going down different routes,” Meeker said.

Key point: There is NO way that Cloudera does not upgrade their licenses so they get paid for new functionality.

The Bad News Was Bad
Five months after merging with top rival Hortonworks, Cloudera continues to bleed cash and is struggling to generate consistent growth. The company, valued at $4.1 billion in a 2014 financing round led by Intel, is now worth just $1.2 billion, even with the addition of Hortonworks.
Their last quarter was the “disastrous quarter” with the dreaded trifecta of bad news” — weak results, bad guidance and the CEO departure.

The merger with Hortonworks in January was designed to pull together sales and marketing resources and cut down on costs the companies were spending to compete with one another. Its pipeline isn’t materializing fast enough for investors. Cloudera said it expects revenue for the full fiscal 2020 year of between $745 million and $765 million, down from a previous of $835 million to $855 million. Net loss will be 28 cents to 32 cents a share, the company said.

Mike Olson, Cloudera’s chief strategy officer, co-founder, and former CEO also left the company.
 
■ Realistic Synergy Targets: We believe >$125mn of annualized savings over a combined ~$1bn cost base is a realistic target, representing 12% of COGS + Opex. With >$125mn of savings, the combined company aims to achieve >15% operating cash flow margins and $150mn OCF. Manage indicated it hasn’t built in any revenue synergies into its model. While not providing explicit guidance, management has provided a framework for $1bn revenues, growing at more than 20% with 10% operating margin in CY20.
 
■ Valuation: Our $18 target price implies 5.4x EV/CY 19 revenues for the combined company, in-line with on-premise infrastructure peer group at 5.4x.

IF you like options, I'd buy the stock and the long term option -- that way IF a private equity player swoops in with a $15 or higher offer, you get a huge 1000%+ win.

We are waiting to add more SaaS/PaaS/IaaS leaders on market pullbacks. But I will throw in some option plays if we start to get an August/September melt-up in growth stocks as the Fed lowers rates and global enterprise SaaS/PaaS/IaaS leaders go on another 25-40% run from here.

July NL out this week--need some data points from Xilinx and a few others to plan our 2nd half plays. 

With AMD NVDA Xilinx Chegg extending their  1H runs, and our high yield "ballast stocks" up nicely including dividends, I think our 54% annual returns are highly likely--or more with some well-timed options plays that date in January 2020 (for tax purposes!). 

Get some CLDR before the world knows the real story!

Toby