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Pass the Antacids for Cloud Software Stocks

Shira Ovide
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Pass the Antacids for Cloud Software Stocks

(Bloomberg Opinion) -- How do you feel about roller coasters? 

The nauseating jolt of a theme park ride is a useful metaphor for stock prices of young software companies this week. The stock prices of recently public Slack Technologies Inc., PagerDuty Inc. and CrowdStrike Holdings Inc. were punished after what seemed to be good or great earnings reports. But that volatility is the price of valuations that reached stratospheric levels. 

Shares of CrowdStrike, a cybersecurity software company, were down about 8% on Friday after it said fiscal second-quarter revenue nearly doubled from a year ago and it raised its annual forecast. That seems like good news, but it appeared there were some worries that CrowdStrike didn’t exceed its own revenue guidance by leaps and bounds.

It was a similar story for PagerDuty, Zoom Video Communications Inc. and Slack this week, when healthy growth and optimistic forecasts caused at least temporary stock sell-offs. Another cloud software company, Domo Inc., reported lackluster sales gains and a worse-than-expected outlook on Thursday, and its shares were down 32% in early trading Friday.

The share prices of Slack and the other software highfliers were destined for wild swings. Stock buyers are gung ho for fast-growing young companies that sell cloud software to businesses and are paying upward of $20 or more for each dollar of expected revenue. For comparison, the median of more than 150 software firms is less than $5 for each dollar of expected revenue, Bloomberg data show.

With heady share prices of young business software firms, it is inevitable that any tiny blemish risks a sell-off. That’s the high price of a high-priced stock. 

There are understandable reasons for investors’ willingness to pay unprecedented sums to own these relatively young business software firms. Companies like Slack, Atlassian or Veeva Systems charge companies a subscription fee to access software that can make salespeople more efficient, help cubicle workers collaborate with colleagues or automate rote tasks for information technology departments. Companies come to rely on the useful software, and the annuity-like subscription business model makes investors believe they can plot sales growing to the moon at rich profit margins. 

I am not yet convinced that these young software companies can grow large enough to justify the enthusiasm of their investors, particularly if an economic downturn forces companies to rationalize their technology budgets. Something real is definitely happening with software that improves companies’ or their workers’ performance, but the question as always is whether investors are paying the right price. 

The cost of richly valued companies’ volatile share prices isn’t measured only in antacid. Stock swings can also make a company structurally vulnerable. A few years ago, there was a mini wave of M&A activity after uneven earnings results cratered companies’ share prices and made them ripe for takeovers.

That’s what happened to LinkedIn, when a bad quarter and the resulting 50% wipeout in its share price invited Microsoft and other suitors to come knocking. On the flip side, high valuations for some young software companies may be a barrier to necessary consolidation in the category. 

Slack, Zoom Video and CrowdStrike went public in recent months, and it takes times for valuations to settle for such recently public companies. All signs, however, are that the top-tier of cloud software companies will remain richly valued. And that brings with it the thrills and potential spills of a roller coaster. 

To contact the author of this story: Shira Ovide at sovide@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shira Ovide is a Bloomberg Opinion columnist covering technology. She previously was a reporter for the Wall Street Journal.

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