The dirty dozen of bloated tech - a short story

The_Ni · February 18, 2022, 5:57am

What with interest rates going up, the market has taken a chainsaw to the stock prices of overvalued tech companies. This earnings season has been brutal, with many losing 15-30% of their market cap overnight with earnings releases. We’re about half way through, but perhaps there are some still left that will be sheared down to size with earnings and guidance.

This thread is an attempt to identify some of those stocks, to short in some manner.

This is the shortlist I’ll be working with: BOX, COUP, CRWD, DOCU, ESTC, MDB, OKTA, PANW, PING, SUMO, ZS, ZUO

They were chosen because most of these apply to them: a) they have a market cap in the billions, b) their revenue is in the tens or hundreds of millions, and c) they have negative net income in the order of tens or hundreds of millions.

(Data from SeekingAlpha data tables; sorted by earnings date.)

I will be collating brief DDs for each of these over the weekend, but wanted to share this list now so that anyone who knows these companies well can pitch in already. I have at least passing familiarity with all of them, not an expert by any measure. A crowd-sourced short-list would therefore be great.

A note of caution: earnings plays are extremely tricky. For example, if played with options, they can result in significant loss due to IV crush. It’d therefore only make sense to short if we feel reasonably confident that there will be an earnings miss and/or will guide below expectations. As an example of the challenge we face, CRWD, MDB, OKTA, and ZS seem particularly bloated. However, they are also best of breed, and have had stellar performance so far. If winners keep winning, are these really the ones to short?

And while this is not the focus of this play, it is possible that some of these have been beaten down too much already and may rebound on earnings. Let’s point them out too.

The_Ni · February 18, 2022, 5:58am

[Reserved for summaries and results.]

Added on Feb 29:

ZScalar (ZS) - waiting through earnings.
Palo Alto Networks (PANW) - waiting through earnings.
Elastic N.V. (ESTC) - would have considered shorting, but the next few option chains don’t have liquidity.

helix · February 18, 2022, 6:10am

An effective way to play earnings like this, especially if you are targeting a number of overinflated stocks, are as follows:

Buying an ATM straddle will limit your profitability but will allow you to profit from large moves in either direction. ROKU yesterday is a perfect example of this.

If you still wish to sell the premium going into earnings you can sell a strangle/IC that is skewed to absorb a lot of downside movement. However, in the case of ROKU yesterday, you could have gotten burned if you did not choose an extremely conservative strike.

If you want to ignore the ER movement, and take any gambling out of the equation, you want to not take a position going into earnings. Conqueror has warned several times since I have joined to NOT hold a position through earnings if you aren’t prepared to see it open at zero the next day.

These covid bubble stocks have had a lot of movement the days following their earnings, Leaving room to play them the following morning.

I have played a mix of straddles, strangles, and jade lizards this round of earnings depending on the profitability of the company and I have been very successful with conservative entries. Being conservative with strike choice has protected me from the surrounding market volatility and kept me green

EDIT: by conservative with strike choice i mean sub 10 delta strikes.

The_Ni · February 18, 2022, 6:21am

Thank you @helix - this is very helpful advice!

The_Ni · February 19, 2022, 9:42pm

ZScalar (ZS)

ZScalar seems too hot to short. It has a massive 50x price/sales ratio, based on a projected growth rate of 40% for the next five years. Started my analysis with ZS since they seemed most bloated, and therefore more likely to be susceptible to correction. However, I have not been able to find any data points that suggest any obvious weakness.

Analyst PTs all have upside, with their faith in the revenue growth relying on large contracts coming in for them.

Tipranks sentiment is very bullish.

The SA thought pieces can be found here: Zscaler, Inc. (ZS) Stock Price, Quote, News & Analysis

And Gartner confirmed their status as a market segment leader in Feb 2022.

Now, analyst PTs, sentiment etc. all lag actual news/data, but all this is to say that there doesn’t seem to be anything here that makes this an obvious short.

ZS will have to be their own undoing. If the forward guidance fails to confirm the 40%-over-5-years expectation, this stock will crater so hard. I’ll therefore wait until their earnings, and react accordingly.

[Edit 2/22 - please continue discussions on ZS here: ZS - 40% growth over 5 yrs = 50x P/S? Guidance is all]

The_Ni · February 19, 2022, 10:18pm

Palo Alto Networks (PANW)

Second to be analyzed is the one which has earnings coming up on Tuesday. It’s the largest company on the list, and one that has shown great relative strength compared to its peers. Or QQQ in general:

PANW is a turnaround story, going from mostly hardware to an increasing focus on software based security solutions. They had handily beat earnings last quarter and guided for 50% growth over 2 years.

Sentiment continues to be quite bullish:

And PTs seem to have significant upside.

Worth noting though that while they show up at a relatively weaker position compared to ZS on the SSE magic quadrant, they do show up as the leader for Network Firewalls.

A thing about Gartner charts - they create all these niche categories so that they can show as many companies as being leaders in their little (and not so little) corner of the world, so worth discounting for this.

Given PANW’s relatively lower valuation compared to its bloated peers, there is a possibility that their prices might actually go up from an earnings beat, confirmation or improvement of guidance, and … share repurchases. They had already earmarked 676M for this last quarter, and either progress on that repurchase or adding to the repurchase amount might provide tailwind. They certainly seem to have the FCF for it.

In summary, going in with slightly bullish feelings, but not looking to initiate positions pre-earnings.

[Edit 2/22 - please continue discussions on PANW here: PANW - surviving sell-off better than others]

The_Ni · February 20, 2022, 3:21am

Elastic N.V. (ESTC)

Another one of those game-changer type of solutions that made search over large, distributed datasets feasible, and is seen almost as “infrastructure.”

The usual stuff applies here too - sentiment is even better than ZS and PANW.

And even the lowest PT from analysts has a 48% upside.

And the commentators love, love, love this stock: Elastic N.V. (ESTC) Stock Price, Quote, News & Analysis

Yet, the market has punished ESTC’s stock price quite a bit, bringing its P/S to ~10.

Weird, right?

Well, there are three flags that showed up for ESTC:

ESTC won a copyright infringement lawsuit against AMZN last Wednesday, forcing AMZN to change the name of its forked ElasticSearch offering to OpenSearch. Normally, this should be bullish news, yet the stock price didn’t even flicker upward one bit.
About a month ago, they promoted their Chief Product Officer to CEO, and the CEO became the CTO. In itself, this is not a bad thing. Most companies do not do the founder-CEO thing too well for too long, and bringing in someone better suited for a maturing business is a good thing. The markets did not like this though, and prices fell for the next 10 days. Now, all tech spaces were falling during this time too, so hard to separate the two. At any rate, the stock price did not respond positively.
It turns out their product has some challenges. Now, every complex product needs some RTFM and getting hands dirty, and ESTC’s products are at the apex of their area of service. However, in these discussions others usually pitch in and balance the discussion out. That balance is missing here. To the extent that there are other competitors out there, like Solr, retention cannot be taken as a given. Although to be fair, the search that is at the heart of systems is harder to replace than other components.

Having built up this bear thesis, imagine my disappointment when I realized that liquidity in their March options is terrible. Grr

Interestingly, there seems to be a 3K OI 95/125 call spread for the April opex.

Can we tell if this is a bull or bear spread?

In summary, this feels like one that could have some more innate downside to it.

[Edit 2/22 - please continue discussions on ESTC here: ESTC - going into earnings with disquietude in the house]

Autogreens · February 21, 2022, 3:43pm

With regards to Palo Alto, Cisco just beat on earnings. They have a much broader product portfolio and it is difficult to identify what portion of that earnings correlate with Palo Altos product line, but if Ciscos firewall/security portfolio did well last quarter maybe that signals strong demand that may also benefit Palo Alto.

Autogreens · February 21, 2022, 7:03pm

How about Lucid and Rivian? At 43B and 58B market cap these loss-making machines may be ready for another drop. Lucid has earnings(losses) on feb28 and Rivian on Mar10, according to yahoo finance. Nikola is down to 3B market cap now.

The_Ni · February 22, 2022, 4:14am

These are good ones to look into, too!