Saxo Bank: "Technology sentiment, Palantir earnings, and discount rates"

Market Insights Podcast (Episode 329) | Oanda

Summary:  Technology sentiment is as dark as when the dot-com bubble burst with many companies seeing their stocks decline by 50-90%. We take a look at some of these names, but which are also profitable, because it is during these periods when some of these companies can be bought at good risk-reward levels. We also take a look at Palantir's Q1 earnings release which disappointed on its Q2 revenue outlook sending the shares down in pre-market trading. Finally, we show how equity valuations are impacted from higher interest rates without any change to the underlying business.


Sentiment in technology stocks is plummeting

The tweet last Wednesday by David Sacks that “Investor sentiment in Silicon Valley is the most negative since the dot-com crash” tells you everything you need to know. The decline in high growth non-profitable companies, which we call bubble stocks, has been -69% since the peak in February 2021. Our bubble stocks basket has basically come back to the levels from before the pandemic. For some stocks it has been brutal such as Zoom, Teladoc, PayPal, and Pinterest, and we have seen that crypto related instruments are a high beta expression of liquidity preference and technology sentiment. The higher discount rate on cash flows are not only compressing equity valuations but also changing investors’ time preference demanding break-even faster than before.

Not all technology stocks are created equally with some of these fallen technology stocks actually being profitable. The list below is a list of US-listed stocks which are down more than 50% since 14 February 2021 and have a positive free cash flow yield; the list below is not meant as investment recommendations but highlighting companies with positive free cash flows yields that have been beaten down heavily. While many investors are suffering it is often during these periods of stress where investors can find very attractive long-term opportunities.

  • Teladoc Health (Return: -88.6%, FCF yld: 4.95%)
  • Zoom Video (Return: -77.8%, FCF yld: 5.2%)
  • Pinterest (Return: -73%, FCF yld: 4.6%)
  • PayPal (Return: -72.6%, FCF yld: 5.2%)
  • DocuSign (Return: -71.7%, FCF yld: 3.0%)
  • Bumble (Return: -71%, FCF yld: 3.3%)
  • Alibaba (Return: -66.4%, FCF yld: 8%)
  • Etsy (Return: -63.1%, FCF yld: 4.8%)
  • Baidu (Return: -62.7%, FCF yld: 3.4%)
  • Rackspace (Return: -60.6%, FCF yld: 12.9%)

 

The list below shows that current constituents in our bubble basket.

Name Mkt Cap (USD mn.) 12M Fwd EPS 12M Fwd EV/Sales Diff to PT (%) 5yr return (%) YTD return (%)
Lucid Group Inc 30,271 -1.09 13.2 97.0 NA -52.3
Cellnex Telecom SA 29,281 -0.15 12.4 57.4 228.2 -20.3
Rivian Automotive Inc 25,929 -6.04 2.7 155.0 NA -72.2
NU Holdings Ltd/Cayman Islands 24,248 0.01 6.0 96.6 NA -44.2
Seagen Inc 22,722 -2.58 10.3 30.2 97.4 -20.2
MongoDB Inc 20,250 -0.18 15.3 55.4 NA -43.4
SenseTime Group Inc 20,062 -0.07 16.1 39.7 NA -14.5
Unity Software Inc 16,971 -0.09 10.3 130.6 NA -59.9
BeiGene Ltd 16,673 -10.48 6.0 116.9 288.1 -45.6
Argenx SE 16,369 -17.60 51.7 15.2 1,650.9 -8.4
Alnylam Pharmaceuticals Inc 16,280 -4.49 11.6 51.8 141.9 -20.5
Okta Inc 16,054 -1.06 8.0 112.0 336.9 -54.3
Brookfield Renewable Corp 13,005 0.20 9.9 8.3 NA 0.7
Shanghai Junshi Biosciences Co Ltd 12,664 -1.09 26.6 34.1 NA 1.3
Bill.com Holdings Inc 12,616 -0.37 13.9 98.9 NA -51.4
Grab Holdings Ltd 11,532 -0.37 3.3 85.6 NA -57.8
Plug Power Inc 11,221 -0.42 7.4 112.6 804.9 -31.2
Qualtrics International Inc 10,464 0.03 6.4 101.4 NA -49.2
Wolfspeed Inc 10,000 -0.02 9.7 45.7 254.9 -27.6
Robinhood Markets Inc 8,823 -1.07 8.2 45.2 NA -43.0
Novocure Ltd 7,653 -0.54 12.9 40.6 494.9 -2.5
SentinelOne Inc 7,253 -0.71 13.0 89.9 NA -48.3
Affirm Holdings Inc 7,097 -1.82 3.7 143.7 NA -75.2
Avalara Inc 6,890 0.02 6.8 57.6 NA -39.3
Procore Technologies Inc 6,777 -0.70 8.6 61.0 NA -37.5
Kingdee International Software Group Co Ltd 6,700 -0.05 7.4 60.7 365.1 -36.9
Confluent Inc 6,605 -0.69 9.1 101.2 NA -68.9
Guidewire Software Inc 6,450 -0.16 7.1 44.6 26.5 -32.0
Biohaven Pharmaceutical Holding Co Ltd 6,365 -6.39 6.2 74.8 312.7 -34.5
Gitlab Inc 6,254 -0.91 12.4 73.3 NA -51.3
Elastic NV 6,092 -0.25 5.4 90.8 NA -47.0
10X Genomics Inc 5,804 -0.79 7.8 85.6 NA -65.6
Smartsheet Inc 5,625 -0.59 6.4 52.8 NA -43.6
Samsara Inc 5,625 -0.24 7.8 148.9 NA -60.7
Monday.com Ltd 5,550 -2.85 8.7 87.8 NA -60.0
Ginkgo Bioworks Holdings Inc 4,810 -0.20 9.3 243.2 NA -67.4
Asana Inc 4,752 -1.24 8.1 112.7 NA -66.5
Ascendis Pharma A/S 4,730 -7.71 41.5 114.1 200.0 -38.2
Guardant Health Inc 4,008 -4.56 7.3 211.2 NA -60.7
Intellia Therapeutics Inc 3,608 -5.79 56.5 187.3 234.5 -59.8
Aggregate / median 464,083   8.7 86.7 271.5 -44.9

Palantir down 11% on outlook miss

Palantir is another very popular technology and growth stock that was IPO’ed in late 2020 which has seen it share price collapse to below $10 last Friday from as high as $45 in January 2021. The big data analytics company with prominent US government contracts reported Q1 results that were in line with estimates growing revenue 31% y/y in Q1 and still delivering an operating loss. However, it was the Q2 revenue guidance of $470mn vs est. $487mn that caused investors to sell shares in pre-market taking the shares down by 11%. The operating margin is improving but judging from the market reaction investors want to see it improving faster per our discussion of equity valuation dynamics related to discount rates (see section below).

Source: Saxo Group

Discount dynamics on equity valuation

The venture capital investor Bill Gurley said in late April that entire generation of entrepreneurs and technology investors will learn equity valuation the hard way and that the “unlearning” process could be painful, surprising and unsettling to many, and that he anticipates denial. Equity valuations like interest rates have had one direction only culminating in late 2020 and early 2021. But with rising interest rates and inflation the entire equity valuation game is changing and investors will demand business models that can break-even faster than before.

To get a sense of what the US interest rate move is doing to equity valuations let us look at a very simplified example. We have a company (no debt and no non-operating assets), growing revenue at 20% p.a. for 10 years with a NOPAT (net operating profit after tax) margin of 20% with a reinvestment rate of 10% per incremental revenue. The equity risk premium is 5% and in the first period the risk-free rate is 0.5% (equivalent to the US 10-year yield in 2020). The present value of those future free cash flows including the terminal value (the present value of continuing value) is $1,359 equating to a 1-year forward free cash flow yield of 1.6%. What happens to this company if everything is unchanged except for the risk-free rate moving from 0.5% to 3.2%? The value of those future cash flows drop to $831 and the equity valuation (1-year free cash flow yield) goes to 2.6%. The drop in equity value is equivalent to 39% for a 2.7%-points move in the risk-free rate which equates to an equity duration of 14x.

Anyone that knows equity valuation dynamics understand the importance of continuing value (terminal value). The dynamic that is amplifying the moves in equity valuation when you have a large correction in technology stocks is that technology investors are beginning to cut their expectations for the long-term outlook for margins and reinvestment rate etc. so the upward move in interest rates are amplified through several factors in the modelling of the present value of future cash flows.Source: Saxo GroupSource: Saxo Group

Source: Saxo Bank

Market Insights Podcast (Episode 329) | Oanda

Peter Garnry

Garnry developed Saxo Bank’s Alpha Picks which is a monthly publication selecting the most attractive stocks across the US, Europe and Asia. He also contributes to the Saxo Bank Quarterly Outlooks and the annual Outrageous Predictions and is a regular commentator on television, including CNBC and Bloomberg TV.