Note: As usual, I tried to keep this brief. I’m not sure I succeeded. submitted by
After my monstrous WIX play
(1500%+ returns), many have been asking for my next play. Well, at long last, here it is: Elastic NV, ticker symbol $ESTC
. Before I get into it, shout out to u/Frostyfragzz
for his fine DD post
that put Elastic back on my radar. I first looked into Elastic circa July 2019 and have been monitoring ever since. Today, I’m going to build on Frosty’s thesis and lay out a case for why Elastic not only has strong long-term fundamentals, but also short term tailwinds and a compelling technical setup. TL;DR: Long ESTC because this is one of the times in the stock market when other people’s trash will become your treasure. ESTC has been the trash, and will soon be the treasure. The company is misunderstood, mispriced, and undervalued compared to its peers (I can’t help but laugh at saying that a P/S of 16.1 is “undervalued”, but we’re here to make money, not be Warren Buffet). In short, we’re about to see some serious price discovery. History, whether you liked it in school or not, is telling you that ESTC will run up to earnings, and likely after. The all-time high ($104.1) is in the sights. TL;DR of the TL;DR: $ESTC Calls The Plan:
Summary of Frosty’s DD
- Brief summary of u/Frostyfragzz 's DD
- The business model (how Elastic actually makes money), and why COVID plays right into it
- What Splunk’s earnings are telling you
- The technicals and what history is trying to tell you
- Risks, concerns, and counterarguments (for all the nonbelievers)
- The optimal way to play it (from a risk management standpoint)
If you haven’t read Frosty’s DD
, go ahead and do that. Or just read my summary 🤷♂. In any case, there is no point in me merely repeating his (wonderful) points. Summary Starts Here
Marc Cohodes (awesome short-seller and all-around cool guy even though Frosty spelled his first name wrong, you should check him out) was bullish on Camping World ($CWH) in late April. The stock went from ~$8 then to ~$20 today. The reason? Marc was able to “look at an obvious shift (quarantine) in behavior and identify a non-obvious beneficiary (RV / outdoor equipment sellers).”
With Elastic (ESTC), Frosty is doing just that. The obvious shift in behavior is that COVID 19 has radically sped up a paradigm shift already in motion: the shift of companies, workers, and consumers to online. The non-obvious beneficiary is Elastic, a company that enables advanced search features on apps and websites (think matching you to your Uber, or enabling you find matches on Tinder).
Now, why is Elastic a (relatively) “non-obvious” beneficiary? Two reasons.
- It should benefit tremendously from increased web and app usage, which means higher revenue not in spite of COVID, but because of it (Elastic as a company is better because of COVID)
- Unlike SHOP, TWLO, FSLY, MDB, DDOG, Elastic’s stock is still a ways away from its all-time high.
Now, let's talk about the product, offered through a “freemium” model: a consortium of open-source software offerings with search, logging, security, and analytics use cases. Elastic has some heavyweight customers: Shopify, Uber, Stack Overflow, Twilio, and over 32% of the Fortune 500, among others. Some of Elastic’s primary competitors are: Splunk and Amazon (which doesn’t turn out to be a big deal, much like how Prime Video hasn’t killed off Roku, and Disney Plus hasn’t destroyed Netflix). Combine Elastic’s product functionality with their penetration (freemium model, remember?) and exceedingly high DBNER of > 130% (net expansion rate, so how much more existing customers spend every year) and you have a company that appears poised to thrive in the world of COVID.
In terms of revenue (this seemed to be where some were confused in the comments of Frosty’s post), Elastic thrives in COVID in 2 ways: 1) existing paying customers spend more because of increased usage, and 2) existing non-paying users make the switch and become paying customers because of, again, increased usage.
What does all the above mean in terms of numbers? Elastic has been growing revenue at ~60% (with accelerating SaaS revenue), and yet still trades at EV/S multiples that are far below competitors (and even Elastic’s past self), because of unfounded competition worries and worries over high R&D spend (which is actually a good thing long term, think early Amazon).
The play? Take advantage of Elastic’s strong fundamentals in the COVID world, its unfairly low (relative) multiples, and the fact that the stock price should not just recover to pre-COVID levels but exceed them (like almost all other cloud tech guys, many of which are at ATHs, ex. MDB, FSLY, DDOG) by their upcoming earnings on 6/3. Buy calls. Summary Ends Here The Business Model (How Elastic Actually Makes Money), and Why COVID Plays Right Into It
While Frosty did a great job at providing a high-level overview of what Elastic does, it seems as though there was some confusion in the comments with regard to how Elastic actually makes money (business model) and how COVID ties into it. Let’s clear that up.
You can sum up Elastic’s model up in a couple words: the freemium model
. What does that mean? They give away a free version of their software offerings, and then charge for additional features/more advanced offerings. On some level, this is similar to free-to-play video games with microtransactions (like Clash of Clans or COD Warzone).
So how does that work in practice? First of all, unlike competitors like Splunk, Elastic is open source. For all the non-software engineers out there, the term open source is defined as the following (and I’m quoting here from Google himself
): “denoting software for which the original source code is made freely available and may be redistributed and modified.” Essentially, Elastic allows developers (and their target audience is
techies, which explains their tech-oriented CEO and how it’s not super obvious/easy to understand what they do) to download their ELK stack for free, and to modify it however they see fit. This has two benefits. First of all, it means that Elastic is a much more flexible and customizable offering than its full-service, more rigid (and oftentimes more expensive) competitors (like Splunk). Second, by prioritizing adoption, Elastic has built up an enormous user base, with more than 350M downloads as of 2018, and likely somewhere closer to .5-1B today.
Seems simple right? Like free-to-play games, all Elastic has to do now is convince its free users to give it money. The “microtransactions” of its software offerings are simply added features and support. There are a number of paid offerings that I won’t go into detail here, but suffice it to say that they have cloud-based SaaS offerings as well as on-premise offerings. Now, why would an existing user of Elastic’s free open source software decide to become a paying customer? Primarily for one reason: once usage increases to a certain level (either because “search is the product” (Scott Miller) or because of sheer volume), having the best tools and support available is more than worth the relatively small cost. Furthermore, once a user becomes a paying Elastic customer, the vast majority of the customer’s cost is based on resources used, not by host, endpoint, or ingests. So more usage = more revenue.
Here is some visualization of their pricing models: Cloud SaaS: Stand-alone On-premises: Now, understanding the business model is great and all, but what does any of this have to do with COVID?
It’s actually quite simple. 1) COVID will make existing paying customers spend more. 2) COVID will force more non-paying users to become paying customers.
Starting with #1, we have already seen (from released earnings) that COVID has resulted in massive usage increases in some of Elastic’s largest paying customers--such as Shopify, Twilio, and Tinder. More usage = more resources used = higher cost = higher revenue.
For #2, COVID is radically speeding up the rate at which business and consumption moves online. As business’ online presence become increasingly mission critical, the services that Elastic provides--search, observability, and security--also become mission critical. What this does is push more existing non-paying users past the level where having the best of class tools and support more than pays for itself. Splunk’s Earnings and How It Ties Into Elastic
Splunk reported earnings after the close this last Thursday, 5/21. Why is this relevant? Although Splunk is not Elastic’s closest competitor (that honor goes to Lucidworks’ Apache Solr, which I talk about below in the “Risks, Concerns, and Counterarguments” section), the two’s stock prices are quite correlated and Splunk’s earnings provide a hint at what could lie ahead for Elastic. Note that Splunks’s bread and butter is the observability category while Elastic’s is search.
While Splunk’s overall quarterly revenue was only up 2% QoQ to $434.1M, its cloud services segment revenue for the quarter was up 80.7%, to $112.2M! It is highly likely that we see something similar with Elastic’s earnings: cloud (SaaS) revenue will likely continue its acceleration, becoming an ever-large part of revenue. What's also important about Splunk’s earnings was the market’s reaction. Even though revenue missed expectations by $9.53M (2.2%), after a brief dip after hours, the stock rallied strongly, set a new all-time high, and finished the next trading day up 12.73%. Even if Elastic’s non-SaaS revenue underperforms (which I don’t believe will happen), Splunk’s earnings tell us that blowout SaaS numbers will still likely result in stock price appreciation. Assuming Elastic crushes earnings on all fronts (the thesis), markets are indicating that a dramatic surge in Elastic’s stock could be in the cards.
Note: this all assumes the run-up doesn’t occur before earnings, in which case it becomes a bit more complicated (I talk about this below). SPLK 20-Day Chart: The Technicals and What History Is Trying To Tell You
Let’s take a step back and approach this from a slightly different angle for a little bit. While the majority of this post so far (and Frosty’s) focused on fundamentals and the post-earnings thesis, there is a strong technical case to be made that the entire run-up to a new all-time high could occur before
Here’s why. For a large part of this earnings season, one theme has dominated: tech companies have run up to earnings. As we go deeper into earnings season, this has only become more true. Apart from general market movement, I believe that this is due to a simple realization--that some companies (and much of tech) are not just alive, but better off because of COVID. The farther we go into earnings season, the more proof there is of this truth.
There are numerous examples of this playing out. Wix is one, for instance. After the case for Wix was validated (in part) by Shopify's earnings, it hit an all-time high before earnings, and then continued to soar after earnings. WIX YTD-Chart:
Shopify is another example that, after being validated by Amazon's earnings and common sense, set a new all-time high well before its earnings date. It continued to soar after. SHOP YTD-Chart:
Since the market has already seen a number of cloud tech companies performing better because of COVID and setting new all-time-highs (DDOG, SPLK, TWLO, etc.), the odds that ESTC sets a new all-time high before earnings are quite good. Remember that markets are not a real-time gauge of value; in the short-run at least, they’re a voting machine of people trying to decide what they think
a company will be worth in the future. Markets generally try to price current sentiment in as quickly as possible (hence why most significant market moves lately have happened quite quickly with lots of nothing in between). With Splunk’s earnings acting as a tailwind--and with Friday’s near 10% move for ESTC lending momentum--it is entirely possible that Elastic hits, or at least approaches, a new all-time-high before earnings.
Now, whether it happens before earnings or after, there is a strong technical case for a new ATH. ESTC 1-Year Chart
Looking at ESTC’s 1 year chart, Elastic recently broke out of a downward channel it had been in since setting its all-time-high in July 2019. It also broke through two key resistances, most notably its pre-COVID level, with strong volume. Its accumulation distribution indicator is at its highest level since October of 2019, and increasing (as Frosty stated, ESTC was one of the top 10 stocks that hedge funds moved into this quarter). From a momentum standpoint, Elastic’s chart looks solid: still relatively early in a new wave up, with funds flowing in from big money. A run-up to earnings here is very high conviction, and, depending on what the stock does until earnings and the fundamentals presented, momentum could continue after earnings. Risks, Concerns, and Counterarguments (For All the Nonbelievers) 1. COVID 19 has affected the cash flow of a wide variety of businesses. For businesses (especially small and medium-sized) that are strapped for cash and looking to cut costs, would Elastic’s suite of products be some of the first costs to be cut? Even if they are not, is it actually likely that new businesses would start paying additional money to use their services, right now?
From a fundamental side, I’d say this is the strongest argument against the thesis. But I would argue it doesn’t hold merit for a couple reasons. First of all, Elastic has a relatively small number of paying customers compared to its install base, and these paying customers tend to be the very big guys (lots unicorns and the Fortune 500). Some of these companies (where search often “is the product”) have actually benefited from the pandemic and seen increased usage, so they would spend more, if anything. Even for paying customers that have been harmed by the pandemic, the overwhelming majority will be reducing spend on traditional items and moving more money into online operations (ex. anything retail). Offering the best online experience for customers will be paramount here, so if anything, even these companies will spend more. For the last part of the question, I would argue that COVID 19 will serve as a sort of tipping point for companies to jumpstart their online operations. Whether that is stores or other offerings, the sheer increase in web traffic is likely to push many non-paying users past the point I referenced above in the business model section: where usage numbers make the cost benefit analysis for having the best tools and support favorable. Lastly, I think other cloud tech companies’ earnings have shown that the concern, while valid in some areas, has been dwarfed by the sheer scale of the move to online and the acceleration of a paradigm shift in how the world does business and consumption. 2. What about competitors such as Lucidworks’ Apache Solr (and Fusion)?
While Frosty primarily compared Elastic to Splunk and Amazon’s version of Elasticsearch, I believe that Elastic’s closest competitor is Lucidworks’ Apache Solr (open source search engine, used by Bank of America, Lenovo, and Reddit (this one makes me sad) ). Even so, I believe that Elastic has Solr beat on features, quality, and satisfaction. Solr is a distant 3rd place in the May 2020 DB-Engines ranking for search engines, while Elasticsearch is first (with increasing popularity). Apart from Splunk (which was discussed earlier), other search-capable platforms are very limited in search and analysis capabilities. Elasticsearch completely dominates search as its core competency, and has intrinsic advantages over more rigid competitors like Splunk. https://preview.redd.it/v7sr37aoo2151.png?width=640&format=png&auto=webp&s=e7bc97e8bd0a6c088c3674b59607b1b5d33dbd8a 3. Should I be concerned that they are open source?
While being open source has some cool things going for it--namely, adoption and flexibility--it also has one downside: competition. People can monetize your technology without giving anything back. For example, Amazon has been doing this through some strip mining.
While this may appear concerning on the surface, Amazon's Elasticsearch product has structural disadvantages to Elastic's own suite and has not seen anything close to widespread adoption. Moral of the story: it's a nonissue, but you can't stop Amazon from being a douchebag (except through lawsuits). 4. Is IV and the risk-reward a concern?
While Frosty stated that IV was relatively low compared to historical pre-earnings levels, this is borderline not the case anymore (similar to pre 2/26 earnings but higher than pre-earnings levels further in the past). The latest IV-percentile is 82.8 (which means that in 82.8% of trading days in the last 52 weeks, IV was lower than what it is now). But even though IV is relatively high, it isn’t outrageously so--and I think it continues higher. While it might not have quite the same risk-reward as, say, BJs did (post-earnings, I caught a 13 bagger with the 6/19 35c on a 15% move in the underlying), there is still 10 bagger potential here, depending on how far out of the money you go. And if ESTC decides to obliterate the thesis as well--and significantly passes up the previous all-time-high--then there is huge potential for outsized returns. Of all the opportunities on my radar right now, I would say almost bar none. Historical IV 5. Is it too late to get in after Friday’s 9.18% rise?
Honestly? Not at all. I believe a new all time high (so above 104.1) is the target, and if the underlying gets there before earnings the 6/19 105c (based on current prices) would become pretty close to a 5 bagger (more with IV). I'd still be a buyer if the stock moves up significantly Tuesday morning. While I have a couple grand in calls right now, I plan to average up and go in big on Tuesday morning. And, while $104.1 is the target, remember that it's just the target; it is entirely possible that ESTC continues climbing past that ATH level. The Optimal Way to Play It (Risk Management)
Risk management is heavily dependent on the individual, so I’m not necessarily telling you what to do here. But from my experience, the hardest thing about a play is not finding companies or even researching (or writing this)--the hardest part is the exit strategy.
But I’ll briefly go over entries and exits, assuming you truly believe the thesis (like I do). If ESTC runs up to anywhere close to $104.1 before earnings, as predicted, the most profitable play percentage-wise pre-earnings will be far OTM June (95-110) or way OTM July calls (July goes up to 140, June to 110). However, this can be dangerous if the stock doesn’t run up pre-earnings. Now, whether you hold through earnings is completely up to you, but it does depend on a few things. First, keep in mind that your risk generally increases as the price of the underlying increases (but with momentum situations, this is not always a bad thing). If we run up to $100 before earnings, holding through earnings will be significantly riskier than holding if the underlying is at $90 right before earnings. Second, keep in mind that (especially with a run-up) holding through earnings is inherently dangerous. Companies can easily crush earnings and still fall, or vice versa. This is relatively less likely with a lesser-known stock like Elastic, but still be open to the possibility. If you do decide to hold through earnings, I’d adjust your strike so that you are (mostly) near the money (with maybe a couple yolos).
If the stock runs up to earnings, I recommend selling at least enough to cover your cost before earnings. The rest is up to you.
Or, there’s always the hold till 0 approach🤷♂ TL;DR $ESTC Spreads are we really discussing this? 6/19 75c your name is Frosty 6/19 80c must have bought in early 6/19 85c boring 6/19 90c sensible 6/19 95c 4 bagger 6/19 100c more like it 6/19 110c almost the best you can do 7/17 140c the warren buffett, now this is where champions are made I already have most of em, at some point tomorrow I’ll have all of em. A lot of all of em, too. And while Elastic doesn’t believe in investor presentations, this DD was fun writing (and digging). Happy hunting, my fellow autists. Positions
I have a couple grand in right now, but I’ll be loading up the truck Tuesday morning. https://preview.redd.it/x3xdkou3p2151.png?width=1566&format=png&auto=webp&s=2c1cc36215b8fd496d1980c8a2386a6a6629d385 https://preview.redd.it/yr6m1zr6p2151.png?width=1228&format=png&auto=webp&s=6d671ccad959e3122b45e8ef90ae5408fc144104
Edit: So apparently this post got removed. While I have no idea why (someone doesn't want people making money), it's back now.