Business Updates

Crowdstrike - Q1 2024, 31st May

Not spectacular but far from bad, there really wasn’t much to dislike about Crowdstrike’s Q1 earnings. The business is still churning out cash (FCF margin: 33%), subscription gross margins are rising slightly (80%), while year-over-year revenue growth continues to slowly fall (42%). There was also the first quarterly decline in cost of revenue since 2019, meaning GAAP profitability is again tantalisingly close (-3% of revenues).

There was a small matter of IL5 authorisation from the Department of Defense, but unsurprisingly, a large section of the prepared remarks focused on…. AI:

While we expect that LLMs will become commoditized over time, the data on which they are trained will not. CrowdStrike is uniquely positioned to benefit from this new technology. Our datasets spans petabytes and captures trillions of new events daily from our global fleet of sensors. Combine that with our over 10 years of attack data and Threat Graph that has been paired with high-quality human analysis from OverWatch, complete intelligence and intuitive response services and you get unrivalled telemetry. - George Kurtz, CEO, Q1 2023 earnings call

Simply put, we believe CrowdStrike has a sustainable data advantage.

From an adversarial perspective, we expect that the adoption of LLMs will lower the barrier of entry for malicious actors to create sophisticated cyberattacks. Generative AI is expected to make it even easier for less advanced attackers to craft nation-state calibre campaigns.

Which all leads to… who would have thought it?! It’s another AI-product announcement!

Charlotte AI represents CrowdStrike’s latest innovation helping security teams worldwide contend with the cybersecurity skills gap, respond to threats faster and reduce operational cost.

Further details available here - my (admittedly cynical) take is that, as with many other initial commercial applications of generative AI, all this really does is surface data that’s already contained in an existing dashboard/report. In theory, it lowers the barrier to using the software (assuming you have knowledge of the correct way to phrase your prompts) but how much value does it really add?

Adobe - Q2 2023, 15th June

Applied to Adobe, that question seems to have a far clearer answer: a lot!

Firefly has now developed into something very similar to DALL-E/Midjourney, except (once out of beta) it’ll likely be included in the Creative Cloud subscription price (at least, limited to a certain number of credits) and once you’ve generated an image you can import it into the Adobe program of your choice. That’s a pretty compelling offering! Separately, there were a spate of new AI capabilities announced during the quarter including Generative Recolor in Illustrator and a new Generative Fill mode that’s been added to Photoshop:

[Adobe Generative Fill.webp] Impressive stuff!

First, Firefly will be available both as a standalone freemium offering for consumers as well as an enterprise offering, announced last week. Second, co-pilot generative AI functionality within our flagship applications will drive higher ARPUs and retention. Third, subscription credit-packs will be made available for customers who need to generate greater amounts of content. Fourth, we will offer developer communities access to Firefly APIs and allow enterprises the ability to create exclusive custom models with their proprietary content. - Shantanu Narayen, CEO, Q1 2023 earnings call

Our priority for now is to get Firefly broadly adopted, and we will introduce specific pricing later this year.

As for the financials, Adobe posted revenues of $4.82b (vs analyst expectations of $4.77b), non-GAAP EPS of $3.91 (vs expectations of $3.79), and raised full year EPS guidance. Not bad at all!

Despite all of these positives, Adobe’s stock doesn’t appear quite as compelling as Adobe’s business, as discussed further below.

YTD return vs benchmarks

(Index source: Koyfin)

Portfolio Nasdaq S&P 500 FTSE 100
36.35% 38.75% 15.91% 7.56%

Portfolio

Holding Ticker(s) Weighting (%)
Nasdaq 100 Tracker XNAQ 17.9
Alphawave AWE 11.0
Twilio TWLO 5.5
Crowdstrike CRWD 5.1
Snowflake SNOW 4.9
Datadog DDOG 3.7
iShares Gilts IGLT 3.3
Team17 TM17 3.1
AMD AMD 2.8
Amazon AMZN 2.8
Howden’s HWDN 2.2
Cash - 37.8

Adjustments

With fewer business updates this month, portfolio composition became the core focus. While I expect to have a bias for holding technology businesses long into the future, since late last year my goal has been to reduce the number of Software as a Service (SaaS) holdings to the point where the portfolio wasn’t just a concentrated bet on this sector. As this group now accounts for less than 20% of the overall total, I consider that goal achieved.

Still, concentration risk remains and is particularly acute when considering business location: split between the US and UK only. Although I’m likely to maintain this preference going forward, I intend to at least partially address this bias in the nearer term by allocating to ETF positions that provide exposure to further regions.

Nasdaq 100 Tracker - XNAQ

That was one reason for a significant reduction in my biggest holding, but more pertinently it seemed wise to reduce my position following the massive run-up in tech stock prices since the start of the year, driven by the AI frenzy. It’s entirely possible the index will go on to gain another 30% or more from here, but taking some profit while increasing diversification (once these profits are re-invested into the ETF positions mentioned above) was too attractive an opportunity to pass up.

iShares Core UK Gilts - IGLT

A new position to gain some fixed-income exposure. Despite the fact that this is likely to amplify rather than hedge the returns of the rest of the portfolio - any decrease in interest rates will cause a rise in gilt prices (and a fall in their yields), just as it will benefit tech companies who can more easily finance investment - the benefit of having non-equity exposure outweighed this in my mind, regardless of it being through an ETF rather than purchased outright. It also seemed an opportune moment to open the position, with the Bank of England last week raising interest rates to 5%, causing gilt prices to fall significantly. This is essentially a longer-term bet that interest rates will return somewhere close to the range of the past decade. And, if not, at least the yields will increase, and in turn, the dividends!

Adobe

Another great MBI piece caused me to reflect on my Adobe position shortly after earnings, particularly the following snippet:

I think of valuation in terms of questions the stock price asks me and my job is to assess my confidence or comfort level in answering the questions.

The question I asked myself back in March when initiating the position was something like: ‘Regardless of whether the Figma acquisition goes through, can Adobe grow cash flow at a mid-to-high single digit percentage over the next few years?’

And I felt I could answer that with a relatively high level of confidence.

The 40% stock price rise in the interim, along with news that yet another regulator is threatening to block the deal has now altered the question to: ‘Given the extremely high chance that the Figma acquisition will be blocked, are Adobe able to fend off this competition while also growing cash flows at low double digit rates over the next few years?’

That’s a much tougher ask, and ultimately one that caused me to sell out of my small position. That’s not to say that I’ll never revisit Adobe. Purely from a business stand-point, they’re one of the most well-run and impressive software companies I’ve looked into so far. I’d love to own shares again, just not at this price.

Additions

Howden Joinery Group

Howden’s is the UK’s leading specialist kitchen supplier. Selling only through trade customers, the company own their entire distribution operation, from central warehouses to local depots. They have consistently growing revenues (excluding 2020), gross margins of ~60%, and EBITDA margins of ~20%. The group is debt-free, with cash and cash equivalents sitting at £308m. Excess cash after re-investment is returned to shareholders via a 3% dividend and the company regularly repurchases shares to return further value.

Growth potential is boosted by the current state of the UK housing market: the average age of UK housing stock is 70 years, with half of all housing equity owned by Baby Boomers with significant purchasing power. The group also has a fast-growing Contract division to win business providing kitchens for new-builds. Depots currently number 808, 60, and 5 in the UK, France and Republic of Ireland, respectively, with a view to a UK total of one thousand in future.

2023 is likely to be a tough year for Howden’s against the backdrop of a potential UK recession and squeeze on mortgage-holders’ purchasing power (although this may incentivise homeowners with the means to invest in their current home instead of moving) but with shares trading at a P/E of just under 10, I viewed this as a good entry point for a long-term position.

Team17

Team17 is a games label, developer and publisher, best known for the ‘Worms’ games. The business is split into three distinct divisions: Team17 Games Label, Astragon, a simulation division (think ‘Construction Simulator’), and StoryToys, an ‘edutainment’ arm. The label is currently responsible for ~65% of revenues and Astragon, ~25%, with StoryToys making up the remainder.

2022 was a busy year for the group, with acquisitions contributing £44.2m in revenue, more than the entire group generated in 2018(!), when it consisted solely of the games label. Overall revenues were £137.4m. The acquisitions were unfortunately dilutive for shareholders, with just over 13m shares (or ~9% of outstanding shares) issued to fund the acquisitions. Nevertheless, with the exception of the past year, the group has a history of increasing earnings per share, acquiring IP that adds value to their portfolio, and successfully identifying opportunities for growth.

Shares have seen a decline since the start of the year, particularly following the announcement that CEO of 14 years, Debbie Bestwick, would be standing down (though staying on as a non-executive director) on 31st December 2023. She will be replaced by Steve Bell, former CEO of Iris Worldwide Holdings, a global marketing agency which he co-founded. While there is always a large element of uncertainty around such a large change in leadership, I felt the current share price represented a fair opportunity given the risks.

Other

The final adjustment this month was a small addition to my Amazon position which I feel - even given the run-up in price since the start of the year - currently offers the best potential for return on investment of ‘big tech’ (perhaps with the exception of Meta).

Closing Remarks

I’m starting to wonder if I’ll ever read another earnings call transcript without the letters ‘AI’…

Next month:

  • Howden’s H1
  • Amazon’s Q2