ESTC - Elastic

[blainehodder]

Elastic has been annihilated on what appears to be a fantastic quarter and now trades at a very reasonable 9-10x fwd revs.  While the company faces intense competition, I think the market is missing just how central the ELK stack and Elastic support is to the functioning of 1000s of businesses. This seems to be the definition of a sticky service. While many are worried about the AWS fork it doesnt appear to be hurting ESTC growth. If anything I think the rampup of AWS ElasticSearch appears to be pushing conversions for Elastic.

 

The opportunity seems incredible at this price given the continued growth and abolutely massive and growing TAM. What are your thoughts on the Q? Did gov contracts slipping a Q really decimate the stock 20% on fear that SPLNK is eating their lunch, or is this a complete BTFD moment? I bought a pile as no matter how many ways i look at it I cant help but think this company is 3-4x the size or more in 10 yrs. Granted op margins are still horrible but I expect that to turn around with time. This company is just getting started. What are your concerns here and why wouldn't you take a position?

[Guest roark33]

For the vast majority of people, I imagine this business is just outside their circle of competence. 

[dwy000]

For the vast majority of people, I imagine this business is just outside their circle of competence.

 

Agreed.  I'm not sure it is really that central to the operating stack of 1000's of businesses.  There are literally dozens of companies in the Bay area tackling this space and I don't know enough about their product to say that it is better or the ultimate winner.  The space is moving and changing so quickly I'm not sure how you look out beyond 3 years with any sort of confidence.  Either way, is it worth $5bn?  If it doubled or dropped in half you could find arguments to justify both numbers.  I think investors are counting on buyout here as opposed to growing revenues and earnings to justify the valuation.

[RuleNumberOne]

They sell service plans for the free open-source ELK, so it depends on whether the customers are clueless enough to need it.

 

Another thing to note is that there are more and more log management companies coming on - Datadog had an IPO.

 

This entire sector without profits and with "cloud" buzzwords depends on sentiment - NOW, WDAY, OKTA. They don't have the wide moats of the high-tech companies.

 

Elastic has been annihilated on what appears to be a fantastic quarter and now trades at a very reasonable 9-10x fwd revs.  While the company faces intense competition, I think the market is missing just how central the ELK stack is to the functioning of 1000s of businesses. This seems to be the definition of a sticky service.

 

The opportunity seems incredible at this price given the continued growth and abolutely massive and growing TAM. What are your thoughts on the Q? Did gov contracts slipping a Q really decimate the stock 20% on fear that SPLNK is eating their lunch, or is this a complete BTFD moment? I bought a pile as no matter how many ways i look at it I cant help but think this company is 3-4x the size or more in 10 yrs. Granted op margins are still horrible but I expect that to turn around with time. This company is just getting started. What are your concerns here and why wouldn't you take a position?

[blainehodder]

They sell service plans for the free open-source ELK, so it depends on whether the customers are clueless enough to need it.

 

Another thing to note is that there are more and more log management companies coming on - Datadog had an IPO.

 

This entire sector without profits and with "cloud" buzzwords depends on sentiment - NOW, WDAY, OKTA. They don't have the wide moats of the high-tech companies.

 

Elastic has been annihilated on what appears to be a fantastic quarter and now trades at a very reasonable 9-10x fwd revs.  While the company faces intense competition, I think the market is missing just how central the ELK stack is to the functioning of 1000s of businesses. This seems to be the definition of a sticky service.

 

The opportunity seems incredible at this price given the continued growth and abolutely massive and growing TAM. What are your thoughts on the Q? Did gov contracts slipping a Q really decimate the stock 20% on fear that SPLNK is eating their lunch, or is this a complete BTFD moment? I bought a pile as no matter how many ways i look at it I cant help but think this company is 3-4x the size or more in 10 yrs. Granted op margins are still horrible but I expect that to turn around with time. This company is just getting started. What are your concerns here and why wouldn't you take a position?

 

I guess the counterargument is that the growth indicates that a massive number of ELK stack users do need Elastic, and even though AWS offers the cheaper solution, it isn't hindering Elastic growth. If anything it enables growth as AWS ElasticSearch users are the onramp.

 

Further, log management TAM is growing much faster than Datadog can swallow the customers so it seems highly likely Elastic can grow share in a huge and rapidly growing market.

[lnofeisone]

I switched from Splunk to Elastic 2 years ago and never looked back but the user camp is (sharply) divided so they will coexist (e.g., Tableau vs. Qlik). Few items:

 

1) https://trends.google.com/trends/explore?data-ipsquote-timestamp=2015-11-06%202019-12-06&geo=US&q=splunk,elasticsearch . Informative overall (Splunk is definitely ahead) and shows you where their customer bases are.

2) Gov't contracts are inherently volatile when it comes to bidding/winning but they tend to run long. It takes a certain level of skill and right partnering to be on the winning side

3) They are growing revenue nicely but margins need to improve. SG&A has been growing ahead of revenue and R&D.

 

Short term, I'd wait through December before buying. I wouldn't be surprised to see a 5 or even a 4 handle.

[blainehodder]

I switched from Splunk to Elastic 2 years ago and never looked back but the user camp is (sharply) divided so they will coexist (e.g., Tableau vs. Qlik). Few items:

 

1) https://trends.google.com/trends/explore?data-ipsquote-timestamp=2015-11-06%202019-12-06&geo=US&q=splunk,elasticsearch . Informative overall (Splunk is definitely ahead) and shows you where their customer bases are.

2) Gov't contracts are inherently volatile when it comes to bidding/winning but they tend to run long. It takes a certain level of skill and right partnering to be on the winning side

3) They are growing revenue nicely but margins need to improve. SG&A has been growing ahead of revenue and R&D.

 

Short term, I'd wait through December before buying. I wouldn't be surprised to see a 5 or even a 4 handle.

 

Sounds like a reasonable assessment, but what clarity do you think waiting through Dec buys you other than avoiding potential momentum sellers? What did you think caused the puke on the quarterly results? Would you have said you wouldnt be surprised to see a 5 or 4 handle 1 week ago, and if not, why not? Nothing material seems to have changed. As in why should the valuation have dropped?

[Spekulatius]

For the vast majority of people, I imagine this business is just outside their circle of competence.

I have started to follow ESTC as well as other clout companies and I think it is true for the majority of people who “invest” in these companies. It certainly applies to myself.

 

I have a material science and physics background and work in adjacent industries and can understand in broad terms how DD customers  think about their products, pricing power, replacement hurdles for example. I have no such idea about ESTC products. From my experience a lot of people who own these stocks don’t have it either. The crucial test is always if they average down , in case the stock price drops. After all, if something truly becomes cheaper , why wouldn’t you want to own more.? Of course there is always the very real risk of  thesis being broken, but if you can’t tell a real problem from a perceived or transient one, what do you really know?

 

I have seen quite a few folks on twitter owning and then selling these when the stock breaks down.  That in my opinion, is just momentum investing.

 

As far as many SAAS stocks, including Elastic are concerned, one of my concerns is with classification of cost. Who can tell what is really operating expense and what is marketing or R&D? With a bit creativity, ai can do custom work for a customer for free and call it R&D and /or marketing expensive  and one can probably do so repeatedly. That makes the gross margin appear higher than it really is and gives the promise of becoming very profitable in the future, even though it never will, be sure they can’t wean of customers from freebies.

 

I am not in the software business, but I can confirm that the above exists, in real business. It’s easy to hide and hard to tell apart from the outside as long as the company is growing fast.

 

This is just one issue they I have a hard time being comfortable with.

[glorysk87]

Haha...only in this market is 10x sales "very reasonable"

 

Here's the crux of the issue. At 10x sales, your discount window is quite long. Like 5 years plus. You need to reasonably believe that in that timeframe the company will be able to continue sustainably growing their topline to the point where they're able to scale to a decent level of profitability.

 

The problem with that is, no one seems to be contemplating the massive amount of capital funding competitors. ESTC is a decent business with a good product, but do they really have a competitive moat that defends them from competition until they can scale to a level of profitability that justifies the valuation? Eh. Maybe. But any concern over competition makes that a much more challenging hurdle for investors to overcome.

 

At the same time, they're issuing a pretty sizable amount of equity for compensation. Last year stock-based comp was 15% of revenues. Lower stock price makes that a much more expensive line, and becomes somewhat self-fulfilling.

 

All that combined makes it...challenging for me to get on board. Maybe it works out. I dunno. If I'm going to buy something in the software space I'd much rather buy something that's more competitively defensible

[lnofeisone]

I switched from Splunk to Elastic 2 years ago and never looked back but the user camp is (sharply) divided so they will coexist (e.g., Tableau vs. Qlik). Few items:

 

1) https://trends.google.com/trends/explore?data-ipsquote-timestamp=2015-11-06%202019-12-06&geo=US&q=splunk,elasticsearch . Informative overall (Splunk is definitely ahead) and shows you where their customer bases are.

2) Gov't contracts are inherently volatile when it comes to bidding/winning but they tend to run long. It takes a certain level of skill and right partnering to be on the winning side

3) They are growing revenue nicely but margins need to improve. SG&A has been growing ahead of revenue and R&D.

 

Short term, I'd wait through December before buying. I wouldn't be surprised to see a 5 or even a 4 handle.

 

Sounds like a reasonable assessment, but what clarity do you think waiting through Dec buys you other than avoiding potential momentum sellers? What did you think caused the puke on the quarterly results? Would you have said you wouldnt be surprised to see a 5 or 4 handle 1 week ago, and if not, why not? Nothing material seems to have changed. As in why should the valuation have dropped?

 

I'd want to avoid momentum sellers and selling for tax purposes. I didn't expect 5 or 4 handles last week but after reading the earning call it appears their window for executing seems very tight especially with Gov't contracts.

 

I agree with Glorysk87 - there is a massive amount of capital funding competitors so the name of the game is to get to the customer and entrench. Switching costs are not trivial (going from Spunk to ELK or the other way) in terms of $s, hours, and skills. I think this is where Elastic can make a strong play (and I'll watching for this). Splunk is mostly ready to go out of the box, can be deployed without a lot of specialized skill, and provides good support. ELK is basically the opposite but provides a lot of flexibility and will be closing the gap with Splunk in terms of functionality. Elastic is also open-source and that has been gaining a lot of tractions at enterprise levels lately.

 

Basically, all problems of a growth company. I'd want to get in at lower prices  8).

[RuleNumberOne]

I have set up ELK (for my job) - the procedure is on the Internet in message boards and tutorials. There may be cases where customers don't want to do it themselves and buy a service plan from Elastic. Elastic then is just a labor arbitrage business. They can't charge too much or someone else may do it for less. If you buy product/service X from company Y, the vendor would have engineers who set up ELK for free, thereby cutting out Elastic. Elastic needs to find enough customers who can't do it themselves.

 

But it does appear that a lot of people are willing to pay for log management - SPLK and DDOG. I don't think it can be a profitable business though. Where are the GAAP profits? Splunk IPO'ed in April 2012, close to the start of this bull market.

 

Your point about averaging down is a good one, but it depends on the experience-level of the investor.

People might average a stock all the way down to zero, as often happened in 2008. If the longest correction someone has ever seen has lasted 2 months, they may average down a stock that has gone from $100 to $80. Many investors in today's market haven't seen their stocks go from $100 to $20.

 

 

For the vast majority of people, I imagine this business is just outside their circle of competence.

I have started to follow ESTC as well as other clout companies and I think it is true for the majority of people who “invest” in these companies. It certainly applies to myself.

 

I have a material science and physics background and work in adjacent industries and can understand in broad terms how DD customers  think about their products, pricing power, replacement hurdles for example. I have no such idea about ESTC products. From my experience a lot of people who own these stocks don’t have it either. The crucial test is always if they average down , in case the stock price drops. After all, if something truly becomes cheaper , why wouldn’t you want to own more.? Of course there is always the very real risk of  thesis being broken, but if you can’t tell a real problem from a perceived or transient one, what do you really know?

 

I have seen quite a few folks on twitter owning and then selling these when the stock breaks down.  That in my opinion, is just momentum investing.

 

As far as many SAAS stocks, including Elastic are concerned, one of my concerns is with classification of cost. Who can tell what is really operating expense and what is marketing or R&D? With a bit creativity, ai can do custom work for a customer for free and call it R&D and /or marketing expensive  and one can probably do so repeatedly. That makes the gross margin appear higher than it really is and gives the promise of becoming very profitable in the future, even though it never will, be sure they can’t wean of customers from freebies.

 

I am not in the software business, but I can confirm that the above exists, in real business. It’s easy to hide and hard to tell apart from the outside as long as the company is growing fast.

 

This is just one issue they I have a hard time being comfortable with.

[brianr27]

There are some insightful comments on glassdoor especially this one:

 

https://www.glassdoor.com/Reviews/Employee-Review-Elastic-RVW26181872.htm

 

[Spekulatius]

I have set up ELK (for my job) - the procedure is on the Internet in message boards and tutorials. There may be cases where customers don't want to do it themselves and buy a service plan from Elastic. Elastic then is just a labor arbitrage business. They can't charge too much or someone else may do it for less. If you buy product/service X from company Y, the vendor would have engineers who set up ELK for free, thereby cutting out Elastic. Elastic needs to find enough customers who can't do it themselves.

 

 

Since you are in the IT business, it would be beneficial for me and possibly for others to understand what made you chose ESTC product compared to competitors like DDOG, the AWS solution or Splunk etc. Also, do I understand you correctly and you just use the “freeware?” ESTC open source solution that doesn’t really cost you anything?

 

I am not too hung up on EV/revenue multiples or even GAAP profit metrics if I understand why their product is better than competitors and might continue to be so in the future.

[RuleNumberOne]

Yes, Elasticsearch-Logstash-Kibana (ELK) is free (if you install it and manage it yourself) whereas Splunk and Datadog are paid proprietary non-open-source products. Elasticsearch/Lucene is used by a lot of public companies for other search features and ESTC has nothing to do with it. You don't have to pay ESTC a penny to use ELK. ESTC doesn't own it. Just like ESTC, AWS also has a paid service to manage Elasticsearch or ELK. So you can either do it all yourself, or pay ESTC to do it, or pay AWS to do it.

 

I think all three companies (ESTC, SPLK, DDOG) are primarily labor arbitrage businesses (and a lot of the labor compensation is in stock which gets waived away with a non-GAAP EPS). Instead of doing it yourself, just outsource it. It is not as if the software is too complex, but the combined market cap of these 3 companies is $40 billion! One model we can use is that the cloud is moving all the on-prem opex to the "cloud" companies. For an external onlooker it becomes hard to say how much of "cloud" revenue is just labor arbitrage that may never be profitable.

 

If you are a cloud company with an insanely high valuation, just pay in stock and report a non-GAAP EPS. Another important thing is the reported SBC can be far lower than the shareholder dilution. For example, if we issue 10 million pre-IPO options for a stock that would hit $100, we can report an SBC much lower than $1 billion because of all the assumptions that go into Black-Scholes stock option pricing. This is very common and you won't see the fake-SBC-expense effect wear off until many years after the IPO. Even the start of vesting can be a few years after the IPO.  You can report $50 million in SBC instead of the $1 billion that shareholders get hit with.

 

 

I have set up ELK (for my job) - the procedure is on the Internet in message boards and tutorials. There may be cases where customers don't want to do it themselves and buy a service plan from Elastic. Elastic then is just a labor arbitrage business. They can't charge too much or someone else may do it for less. If you buy product/service X from company Y, the vendor would have engineers who set up ELK for free, thereby cutting out Elastic. Elastic needs to find enough customers who can't do it themselves.

 

 

Since you are in the IT business, it would be beneficial for me and possibly for others to understand what made you chose ESTC product compared to competitors like DDOG, the AWS solution or Splunk etc. Also, do I understand you correctly and you just use the “freeware?” ESTC open source solution that doesn’t really cost you anything?

 

I am not too hung up on EV/revenue multiples or even GAAP profit metrics if I understand why their product is better than competitors and might continue to be so in the future.

[hasilp89]

I never invested initially 1) circle of competence 2) it appeared that it wasn’t that valuable as an open source model (Amazon was able to sell it as it’s own).

 

I’ve kept an eye on just for fun. Saw news about them going to a license model. Basically an FU to Amazon.

 

Am I right in thinking this has a big impact on how they can/will make money going forward - in short it’s better for them financially.

 

 

https://www.elastic.co/blog/license-change-clarification

 

 

[MattR]

I have sold most of my position. I use Elastic in my job and think it a great product, but I don't think that the current market cap is justified. My model had them at 140$ in  2022, and they already shot over that quite a lot. I still think it is a company that will have a bright future. I will wait for a market pullback and then buy back again.

[Spekulatius]

I never invested initially 1) circle of competence 2) it appeared that it wasn’t that valuable as an open source model (Amazon was able to sell it as it’s own).

 

I’ve kept an eye on just for fun. Saw news about them going to a license model. Basically an FU to Amazon.

 

Am I right in thinking this has a big impact on how they can/will make money going forward - in short it’s better for them financially.

 

 

https://www.elastic.co/blog/license-change-clarification

 

 

Sounds like they essentially forked the tech roadmap for their userbase. Either stay with the open source branch or go with the ESTC branch? This doesn’t seem risk free for them either.

The argument to begin with for open source is that it helps with the land grab in the new space, I think.