Cabot Early Opportunities Issue: August 21, 2024

Stocks in This Issue

An AST SpaceMobile (ASTS) Use Case Example

There are no material updates on most of our positions since earnings reports are so recent. So I’d like to talk a little about what AST SpaceMobile’s (ASTS) satellite launch and future services could mean for some potential customers.

As you know if you’ve paid attention to this company (our best-performing position), AST is building the world’s first space-based cellular broadband network that, when complete, could provide uninterrupted smartphone coverage across the globe.

That’s probably not important to people who never venture out of cell phone range or don’t care to use data-intensive applications while off WiFi.

But it matters a lot for those that do. And for those (and there are many) who don’t live in areas with good cell coverage, with reliable internet at home, and/or that venture off-grid where cell coverage doesn’t exist, this is a big deal.

Let’s talk about AST’s service in the context of offshore ocean expeditions. It provides a good example of how this technology and service is compelling.

Right now, if you have a boat big enough to go offshore you will likely lose cell coverage quickly. Where I live in Rhode Island that’s usually between 15 and 20 miles offshore.

At that point you are somewhat cut off, relying on VHF radio to communicate with other vessels but not able to send a text to friends and family or access any apps on your mobile device that require a connection.

To keep in touch, there are satellite-based services that work on devices from manufacturers like Garmin. These allow your mobile phone to connect to the device and, with a subscription service, relay text messages from your phone to whomever you wish. Handy for sure, but limited.

Another option is Starlink, which is owned by Elon Musk’s SpaceX. This is a no-contract satellite internet provider that offers various tiers of internet plans.

Starlink can work on land and at sea and a lot of people love it. But it has limitations as well. Unlike small “relay” devices like Garmin’s inReach, which have long battery life, it needs to be constantly powered. The antenna is about the size of a toaster tray and there is a router, so it’s a whole setup.

Starlink is increasingly popular on boats, but plans can get pretty expensive, especially for heavy users. For basic use, a couple hundred dollars a month can probably get the job done.

Now consider a service where all you need to do is sign up for a subscription plan on your mobile device, and head offshore. No extra gear to buy and install, no other devices to manage, just your phone, tablet or whatever you typically use.

This is what AST is offering – and why there is so much excitement around the company.

Now, obviously the market for offshore expedition users is pretty limited. But you get the picture. The company’s services should eventually be available around the globe, whether you’re at home, 50 miles offshore of Long Island, New York, hiking in the Himalayas, or on safari in Africa.

The company’s first five satellites are expected to launch in September. They won’t blanket the globe right away, or even provide continuous coverage over the U.S. for whoever wants to pay for a plan. More satellites will be needed.

But the BlueBird satellites represent a big leap forward in the race to provide convenient, reliable cellular broadband coverage using only the device in your pocket.

Starting a few weeks ago, the basic Starlink hardware package (the Starter Kit) went on sale, discounted from $499 to $299. I’m not saying there’s a connection here. But, I’m also not saying there isn’t!

What to Do Now

Continue to lean into the market as it recovers from the volatility earlier this month.

On the positive side of the equation, we have a Fed that’s likely to begin cutting rates soon and, at the moment, geopolitical risks are subsiding. Earnings season was solid.

On the other hand, we’re not expecting the Fed to take a machete to rates. The cadence and magnitude of cuts will likely be very measured and “data dependent.” We also have the presidential election coming up which is likely to create uncertainty, which is not the market’s friend. And the situations between Israel and Iran and Russia and Ukraine are very fluid.

In short, maintain a balanced approach and try to let winners ride while cutting underperformers loose before they become a drag. Don’t let your portfolio become too large and unmanageable. Better to keep it tight.

NEW STOCKS

Magnite (MGNI)

I added Magnite (MGNI) to our Watch List last month and think the stock’s pullback since has opened the door to take a position.

The stock’s lackluster and volatile action over the last three weeks may be due to broad market volatility and misunderstanding related to the timing of revenue from the Netflix (NFLX) deal.

First, let’s back up a little.

Magnite is an AdTech company with an omni-channel sell-side advertising platform used by content publishers to monetize their ad inventory across mobile, desktop and connected TV (CTV).

It should be a winner as streaming ad buying transitions from direct sales (requires a person) to programmatic (handled by technology without any human touch).

While it’s a relatively small player, Magnite’s platform gives ad buyers a viable programmatic ad buying alternative to the Walled Gardens, the technology ecosystems where tech giants like Alphabet (GOOG), Meta Platforms (META), Amazon (AMZN) and Apple (AAPL) control all the user data and ad options.

The company is expected to generate $608 million in revenue this year, which translates to roughly 11% growth. That’s the same forecast as last month.

From the Q2 earnings call commentary and follow-up notes from sit-downs with analysts, it seems that management’s guidance reflects their desire not to overstate the near-term potential. That makes a lot of sense given the context of the market atmosphere when the company reported.

Guidance certainly does not include any contribution from a recent exclusive partnership (announced in May) with Netflix, which could add some revenue this year but more likely begins in 2025 (maybe $15 million) and could ramp to over $200 million in 2028.

Guidance also doesn’t factor in much political spend since it’s such a wildcard. Historically, 80% of this spend comes in over the span of a few weeks. That’s tough to guide for.

Management also talked about the international streaming ad market, which I hadn’t heard much about before. It seems that the international push from big players like Netflix, Disney (DIS), etc. is putting pressure on more local players, which may be turning to platforms like Magnite to remain competitive.

That all said, EPS estimates have fallen for the year, from $0.82 prior to the Q2 report to $0.75 since (despite beating by a penny in Q2).

Still, the mid-term growth story is as good as it was last month while the share price is lower. That’s not a bad setup for a company that has exposure to a major technology transition in AdTech and an exclusive deal with the biggest and baddest player in the market.

The Stock
MGNI has had a wild ride since coming public in the mid-teens in 2014. The stock has traded below 2, over 64, and everywhere in between. The pattern has become more enticing since May. MGNI had a positive intra-day reaction to the Q1 report then rallied after the Netflix deal was announced (9 to 12 in two days). In mid-June MGNI traded as high as 15.9. The stock then retreated and even fell as low as 10.4 the day after reporting on August 8, but volume wasn’t through the roof. Shares have been stable in the eight sessions since and have indicated a desire to move higher this week. BUY

Klaviyo (KVYO)

With many software stocks finally looking ready to move again I’ve been on the hunt for a mid-cap, high-growth name with a clean story and improving fundamentals.

Klaviyo (KVYO) fits the bill.

The company is only 12 years old and just came public last August. It has a marketing automation platform that helps business users (including those without a lot of experience) generate solid returns from marketing investments.

It’s mainly geared toward the retail and e-commerce areas of the market (95% of revenue), but recent efforts to expand into other verticals may be starting to bear fruit and could represent expansion opportunities.

Klaviyo’s solutions were designed mainly for online stores on Shopify (SHOP), BigCommerce (BIGC) and Magento (ADBE), and today Shopify (which reported a very solid Q2) is where most of the action is.

Thus far, email has been Klaviyo’s main channel through which customers reach consumers, but that’s beginning to change. The company has developed mobile push solutions like SMS (text messages). This gives customers the option to create campaigns leveraging both SMS and email, which can work well together.

Beyond SMS, other new solutions include Customer Data Platform (CDP) and Reviews, both of which are adding incremental growth now.

As you’d expect, AI is also part of the product development roadmap, though it’s not being monetized directly yet. Thus far the technology is being used as a productivity tool and to help optimize marketing campaigns.

We should hear more about new product performance on the Q3 call, which will wrap around the Black Friday and Cyber Monday shopping events.

Beyond product development, the company has been expanding its market both internationally (EMEA and APAC gaining steam) as well as with smaller customers, from the entrepreneur size up through small- and mid-size businesses (SMB).

While management said the SMB area continues to be challenged, I find it encouraging that Klaviyo is beginning to invest in that area again, as well as in the entrepreneur customer group.

A rebound in those areas would be very good, not just for Klaviyo but many other SMID-cap software players as well.

The bottom line here is that Klaviyo posted an impressive Q2 beat, with revenue growing 35% to $222 million and EPS growing 67% to $0.15.

That puts the company on track to grow both the top and bottom line in the 30% to 35% range this year, with upside potential from the growth initiatives just discussed.

The Stock
KVYO just came public last August at 30. After a sustained downtrend following its IPO the stock finally bottomed out in the 21 – 22 range this June. The stock entered the Q2 earnings report on August 7 trading at less than 23 and shot into the low 30s the next day (a 33% move), suggesting that the market was grossly underestimating the potential. KVYO has hung out in a tight range between 31 and 32.5 for the last two weeks. WATCH

UL Solutions (ULS)

You may have noticed a lot of electronic devices have a little stamp on them that has the letters “UL” in a circle, possibly with the words “certified” or “listed” as well.

This UL certification mark shows that the product has been certified to meet scientific safety, quality and/or security standards.

The company that awards those marks, UL Solutions (ULS), came public in April and is a steady, modest grower with the big tailwind of a world that’s converting to electric power (appliances, automobiles, energy, healthcare, etc.).

It has a market cap of $10 billion.

The company owns the UL Mark brand and is the largest testing, inspection and certification (TIC) provider in the U.S. that’s focused on physical products.

As new technologies are developed, as is happening now across many industries, businesses reach out to third-party TIC companies to make sure their solutions meet safety standards.

Other players in the market include Intertek, SGS (SGSOY) and Bureau Veritas. But UL Solutions has been around for 130 years and has arguably developed the best product portfolio, as evidenced by having the highest profit margins.

Electric vehicles (EV) are a particularly exciting area of the company’s business right now. Market analysts see EV production growing by around 18% a year through 2031. That means a lot of batteries to test.

UL is investing in labs to get the job done, with the company’s latest and biggest facility (Auburn Hills, Michigan) just opening in August and located next door to the world’s automotive capital.

Other labs in Illinois, Germany, Spain, China, South Korea, Japan and Taiwan round out UL’s portfolio.

The growth story here is all about consistency. Revenue expanded by 8.4% to $730 million in Q2 (reported July 31), beating by about three percentage points. Adjusted EPS of $0.44 beat consensus by $0.06.

While there’s plenty of excitement (justifiably) around the EV opportunity (the Korea lab is expanding to test EV chargers), UL also did well in rebounding consumer end markets such as HVAC, consumer electronics and retail.

A couple of tuck-in acquisitions (part of the growth strategy) added a little boost (about $20 million) as well.

Looking through the end of 2024, it’s reasonable to expect full-year revenue to grow by 5.5% to $2.83 billion and EPS to jump over 12%, to $1.46. Revenue growth should stay steady at that pace for several years, opening the door to upside surprises and allowing UL to continue paying a dividend, which gives the stock a yield of 1%.

The Stock
ULS came public last November at 28 and has been grinding higher since. The ascent has been steady, with two notable rallies around earnings reports (May 20 and July 31). There was a little give back after each of those rallies, but the trend has clearly been up and to the right, and ULS hit a new fresh high this week. BUY

Varonis (VRNS)

We’ve made money both times (2020 and 2023) that we jumped into Varonis (VRNS), and with the stock acting well now, we’ll move it back onto our Watch List.

The company is a data security specialist, protecting sensitive enterprise files like emails, customer and patient records, financial data, strategic and product development plans and more.

With ransomware attacks on the rise and breaches expected to happen every two seconds by 2031 (compared to every 11 seconds a few years ago), demand for data security tools is very resilient.

Accelerated adoption of generative AI is only adding to the list of data challenges. Companies need a very clear data governance framework that stops large language models (LLM) from leaking all the info they try so hard to protect.

Varonis has one of the best data security platforms out there, and there are multiple growth catalysts in the quarters ahead that can drive upside in an already strong market.

First is the AI opportunity, which is there but hasn’t yet translated into revenue. Look for this to happen as we exit 2024.

Second is the company’s new MDDR service (introduced in Q1), which is focused on monitoring and protecting critical data on its SaaS platform. Early feedback from management is that it’s driving larger deals and customer retention.

Third is the FedRAMP certification opportunity, which should be in play for the next federal budget cycle, assuming Varonis achieves certification (it recently achieved “In Process” status).

The company is pursuing these opportunities while transitioning the business from the “old” licensing model to the Software-as-a-Service model, which has the effect of tamping down revenue short-term while driving greater growth and profitability long-term, not to mention shorter sales cycles, better user experiences, better retention and more efficient product development/rollout enhancements.

In Q2, reported on July 29, Varonis beat expectations and delivered revenue of $130 million (+13%) and adjusted EPS of $0.05 (up from $0.01 in Q2 2023).

Management issued guidance that calls for revenue to grow around 10% for the full year and EPS of around $0.23.

Given the trends, growth on both the top and bottom lines looks to be stronger in 2025, with analysts currently expecting revenue to jump 13% and EPS to grow 27%.

The Stock
VRNS went public in February 2014 at 22 and reached a pandemic-era high near 75. Things then fell apart and VRNS hit a bear market low near 16 in November of 2022. After that washout VRNS began to gain altitude again and traded up into the low 50s in February and March. A decline to the stock’s 200-day line at 41.1 ended in early June and VRNS has moved higher – albeit with some volatility – since. Shares popped to 57 after reporting a few weeks ago, sold off right afterward, and are right back near that 57 level now. Let’s keep an eye on it. WATCH

Veralto (VLTO) ★ Top Pick ★

Veralto (VLTO) is a pure-play water and product quality company that came public last September when it was spun out of Danaher (DHR), a large life sciences company.

The company says it plays a major role in preserving the planet by selling goods and services to customers that ensure clean water, safe foods and trust in essential goods.

It does this through two business segments.

Water Quality (60% of 2023 revenue) has a portfolio of water analytics and treatment solutions (testing and treatment equipment, software platforms, hardware, monitoring, etc.) that reliably deliver safe drinking water for public and private utilities.

The company’s water products treat and/or recycle over 12 trillion gallons of water each year and reach roughly 40% of the world’s population.

The Product Quality and Innovation segment (40% of revenue) is focused on industrial printers, color measurement, color standards and software and hardware for packaged goods processes.

Roughly 80% of the top global consumer packaged goods and pharma brands use Veralto’s product quality and innovation solutions.

Management says that around 80% of sales come from water, food and pharma companies. Nearly 60% of sales are recurring, in the form of consumables, software and services or some variation of the razor/razor blade model.

I find the company intriguing for a couple of big-picture reasons.

First, water quality is something just about everybody in the world sees as a priority. As water sources become challenged it’s increasingly important to use technology that can tell if the water being delivered to end consumers or in manufacturing processes is acceptable or not, and what needs to be done to make it “good,” then treat it accordingly.

Second, the world of product packaging is just insane, both in terms of how important it is from a consumer attention-grabbing perspective as well as a recycling perspective.

Both of these are relatively stable businesses with stable cash flow and high margins.

In Q2, the company beat expectations. For full-year 2024 current consensus is calling for 3% revenue growth (to $5.17 billion), accelerating to 5% in 2025, with EPS growth of 7.5% (to $3.43) this year picking up to 8% in 2025.

Keep in mind that current year comparisons are relative to Veralto when it was part of Danaher last year. Now that the spin-off is complete the company is free to operate without all the distractions that come from being part of a much larger enterprise, including pursuing accretive M&A.

The Stock
VLTO was spun out last September and closed near 80 the first day. Shares sold off in the weeks afterward but after reporting earnings in early February, when the stock was trading near 75, VLTO has put up a compelling chart pattern. Shares have tended to climb steadily for a few months, pause and/or give a little back, then move higher again. The last drawdown was in late June and early July and pulled VLTO down from 102.6 to 93.8. Shares were back to 100 a few weeks later for the Q2 earnings report on July 25 and have moved to 109 since. BUY

PORTFOLIO CHANGES SINCE LAST ISSUE

On July 30 we sold our half-sized position in Netflix (NFLX) for a 10% gain and our position in Celestica (CLS) for a 14% loss. This past Monday, August 19, we sold Nova (NVMI) for a 4% gain in a month.

An updated table of all stocks rated BUY, HOLD and WATCH as well as recent stocks SOLD, is included below.

Stocks rated BUY are suitable for purchasing now. I suggest averaging into every stock to spread out your cost basis.

For stocks rated BUY A HALF, you should average into a position size that’s roughly half the dollar value of your typical position. We may do this when stocks have little trading history (for instance, IPOs), when there is more uncertainty in the market or with a stock than normal, or if a stock has recently jumped higher.

Those rated HOLD are stocks that still look good and are recommended to be kept in a long-term-oriented portfolio. Or they’ve pulled back a little and are under consideration for being dropped.

Stocks rated SOLD didn’t pan out, or the uptrend has run its course for the time being. They should be sold if you own them. SOLD stocks are listed in one monthly Issue, then they fall off the SOLD list.

Please use this list to keep up with my latest thinking, and don’t hesitate to email with any questions.

Active Positions

Recently Sold Positions

The next issue of Cabot Early Opportunities will be published on September 18, 2024.

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