The Blow Off Phase

Recurring revenue, subscription revenue and razor-razor blade businesses are “the bomb” for investing in “compounders”, until they slow or become over-valued by investors with unreasonable expectations of future cash flows. And, of course, history often repeats itself. Who can forget the America Online subscriber boom of the 1990’s, the Blackberry craze thereafter and more recently the penultimate WFH (work from home) stocks with high growth, recurring revenues including Zoom, Docusign, Square, Paypal and Ring Central. CFO’s running around with the “rule of 40, 60, 80 and 100” to describe revenue growth plus operating margins. As a practical matter, it is prudent to run recurring revenue businesses with those “rules” in mind. However, once the revenue growth slows, valuation compression generally crashes stocks back to earth. But, it can take time to change the market psychology and pry shares from investors hands. It starts with “but the stock has already been cut in 1/2” whining with SQ and PYPL being prime examples of a year long slide from mid 2021 to mid 2022 with few bounces. It ends with “but the stock is now crazy cheap on an P/E and EV/EBITDA basis”. SQ trades at a “cheap”22x 2024 EPS estimates and PYPL at 12x estimates.

I have witnessed many booms and busts in technology. The booms all seemingly will last forever “this time”. Dell, Cisco, Peoplesoft and EMC (remember them!?) all led the networked computing enterprise boom of the 1990’s and early 2000’s and their stocks peaked at 50x forward EPS and troughed in the low teens once growth slowed. By my recollections, the winning investors owned the stocks when the stories seem open-ended, the growth appears strong, accelerating and sustainable and sold them once you can no longer put pen to paper and justify, logically, the valuation. You won’t catch the top in your sales but the risk of overstaying your welcome can be round tripping the entire move. Simple rules to state, but very hard rules to follow! After all, EMC was “the” data storage is growing exponentially “play”, until it wasn’t. Cisco was selling equipment to so many start-ups that eventually went bankrupt and they never told you until the quarter where orders tanked. Dell stole everyone’s lunch money growing 30-50% per year with an unheard-of negative cash conversion cycle until the market maturation hit and it became a game of price, not speed.

You know where this is going, don’t you? Artificial intelligence plays! AI! Where do things stand?