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Early Opportunities
Get in Before the Crowd

Cabot Early Opportunities 118

In February’s Issue of Cabot Early Opportunities we dig into the red hot IPO market.

We take a closer look at five recent IPOs that have been on my shopping list. It is not an Issue for the faint of heart. Several of these stocks have made significant moves in their short history as public companies.

There are strategies to mitigate the risks, however. And as we scan the universe of attractive stories today it is not hard to envision several of these stocks trading significantly higher a year from now.

Sit back and enjoy.

Cabot Early Opportunities 118

Stock NameMarket CapPriceInvestment Type
APi Group (APG)$3.6 billion19.25Growth & Value – Industrial Services
C3.ai (AI)$14.1 billion147.17Rapid Growth – Software
Fisker (FSR)$5.4billion19.46Development Stage – EV Designer
JFrog (FROG)
TopPick
$6.3 billion69.23Rapid Growth – Software
Poshmark (POSH)$5.4 billion73.29Rapid Growth – Resale/Social Platform

bull-bear-gauge-6

Current Investing Environment

Make Hay While the Sun Is Shining
This has been a phenomenal run for those of us that focus on early-stage companies.

The IPO market is as strong as it has been at any point in six years. Even if all the companies that have been coming public aren’t great buys right now, collectively they are recharging the pipeline of potential opportunities.

Consider these statistics.

In 2020 we saw 218 IPOs and $78.2 billion in IPO proceeds. The IPO market hasn’t been that strong since 2014, when there were 275 IPOs and $85.3 billion in IPO proceeds.

Furthermore, through mid-February 2020 we’ve already seen 55 IPOs and $21.7 billion in IPO proceeds. The trends suggest another strong year.

This hasn’t necessarily translated into a windfall for retail investors, however.

It is still nearly impossible to get into a new offering at the IPO price. One of the few exceptions was Airbnb (ABNB) which set aside shares that hosts could buy at the IPO price if they opened special accounts with Morgan Stanley.

While it would be wonderful to see more new economy companies follow Airbnb’s lead to help out the “little guy,” for now most retail investors need to evaluate IPOs after they have begun trading. This creates somewhat of a quandary.

Do we ignore these stocks altogether because they are too hot to touch (option A)?

Do we throw caution to the wind and buy the story and forget about valuation (option B)? After all, we’re not talking about GameStop (GME) here.

Or do we do something in between, possibly evaluating the fundamentals, story and limited stock action and then proceed bravely but cautiously to gradually establish a position (option C)?

Naturally, I’ve set up the choices so there’s only one logical choice! That, of course, is option C.

Before we get to the stocks, a few general comments about buying IPOs.

First, it’s important to recognize that when a company goes public it’s usually a liquidity event that allows early investors and/or employees to cash out part of their investment and/or stock options. Or it’s a capital raising event to fund growth initiatives (good scenario) or keep the lights on (bad scenario).

Bottom line – one needs to consider the potential impacts of the IPO (both positive and negative) on the company’s growth prospects and the stock’s potential.

Second, when investing in most IPOs there’s not enough trading history to gauge the stock’s trend very well. Lacking that information, it’s best to seek out businesses that interest you and have enticing growth stories, then average into them over time while being careful about position sizing.

Finally, if things don’t work out, it’s important to be comfortable walking away and coming back to the name later.

What to Do Now
Continue to evaluate your portfolio and focus on higher conviction positions while pulling back on lower conviction ones.

Consider taking partial profits on high-conviction ideas that have stalled and where it may make sense to diversify some of your capital gains into new ideas.

As always, a pullback or deeper correction could be right around the corner, or months away. We just don’t know. The persistent strength of this market, and with growth stocks in particular, has been surprising.

Rather than trying to call tops and bottoms, work with the evidence in front of you and try not to row against the current.

We believe we are in an extended economic recovery that should gain momentum with the accelerating pace of vaccine distribution and significant curbing of the Covid-19 pandemic. History suggests that during recoveries from severe economic shocks markets run longer than expected.

In summary, we are leaning cautiously bullish and trying to focus on stocks that can continue to lead the market higher, while acknowledging that pullbacks can be quick, sharp, and painful during bull markets.

STOCKS

APi Group (APG)
My quest to add some growthy stocks with a cyclical dimension brings us to APi Group (APG) this month. It’s best known as a provider of fire safety and sprinkler systems, but the business is really a diversified provider of safety (43% of revenue), specialty (36% of revenue) and industrial (21% of revenue) services to customers in the U.S., Canada and U.K.

End market customers come from commercial, high tech, manufacturing, medical, utilities, infrastructure, telecom, energy, security and defense markets and more.

At the low end of the project size spectrum are safety services (backflow devices, controls, lighting, fire suppression, alarm and detection systems, HVAC systems, security systems, etc.) which have an average project size near $10,000. Specialty services (fiber optic and cellular installation systems, water lines and sewer systems, insulation, ventilation and temperature control systems, etc.) tend to cost around $60,000, while industrial services (oil pumping stations, gas compressors and transmission and distribution services, etc.) come in closer to $725,000 per project.

One of the key attributes of APi Group is the recurring nature of its revenue base. The types of services it provides are not optional. Regulations, public awareness about safety and legitimate concerns of “what ifs” drive an ongoing cycle of inspections, which lead to installations, maintenance, upgrades and design/engineering and fabrication work.

This means a lot of potential recurring service revenue (mostly maintenance and inspection), which APi group is working hard to capture. It is doing well – recurring service revenue is approaching 50% of total revenue.

No customer accounts for over 5% of revenue. But there are some big names on the client list, including Google, Microsoft, Walmart, Verizon, Shell, Pfizer, Disney, Apple, AT&T, Honeywell and Facebook.

Big picture, this company should do well as the economy recovers, but it’s also not likely to implode when things slow down. Even when industrial activity stalled in 2015 and 2016 revenues inched up a little.

That said, 2020 is an outlier since so many businesses were forced to temporarily shut down and/or scale back operations. After growing revenue by 10% in 2019, APi Group says preliminary 2020 results show revenue decreased by around 13%, factoring in both divestments and acquisitions. Adjusted EPS should have been around 1.14. Stepping out a year into 2021, revenue should be up at least 7% (I expect more, especially with acquisitions) and adjusted EPS should rise in line with revenue, to around $1.22.

The Stock
APG came public on April 29, 2020 through a merger with the SPAC J2 Acquisition Limited. Shares closed at 10.4 on the first day, retreated to 9 within a couple of weeks and then took off. They’ve made a series of higher highs and higher lows since, mostly above the 50-day line. The pullbacks have been getting smaller, with the first (July 2020) a 25% decline and the most recent (January 2021) just a 9% decline. APG hit an all-time high of 19.2 just a couple of weeks ago then traded mostly sideways into the release of preliminary 2020 results on Monday, which sent the stock higher Tuesday.

APG-021721

C3.ai (AI)
C3.ai (AI) has developed a software platform for big organizations to develop large-scale and complex artificial intelligence (AI) systems capable of predicting key operational business performance metrics.

Specific examples include measuring drilling integrity for oil exploration, predicting maintenance for aircraft fleets, preventing energy theft for large utilities and discouraging money laundering for banks.

These powerful and hugely valuable applications are possible because C3.ai has an end-to-end platform that includes data integration, data management, analytics processing, stream processing, machine learning, app development tools and visualization.

The company’s founder, Thomas Siebel, founded the company in 2009 and spent the next decade investing in thousands of developer hours.

The value proposition is enticing for large organizations as C3.ai’s patented model driven architecture speeds up app development by a factor of 26, with up to 99% less code. The platform operates independently from the apps that sit on top of it. Even small teams of engineers can crank out programs quickly and deploy them in weeks, not months or years.

Moreover, the platform integrates with almost 800 enterprise data sources and all the big cloud infrastructure providers (Azure, AWS, Google Cloud, VMWare, IBM, etc.), with which C3.ai has alliances to coordinate sales and engagement efforts.

In addition to an internal direct sales force the company also has alliances with a growing list of key industry partners in major verticals, including Baker Hughes (oil and gas), FIS (financial services) and Raytheon (defense and intelligence). These alliances are a key part of the growth story and in the coming quarters I expect to hear about new partnerships in healthcare, utilities, telecom and manufacturing markets.

The product mix includes the C3 AI Suite (roughly $1 million per year per developer) at the high end, C3 AI Applications (around $500,000 per application) in the middle, and C3.ai Ex Machina at the low end, which can be test driven with a free trial.

Growth is fantastic but was hurt badly by the pandemic, and C3.ai won’t be profitable for years. The company’s fiscal 2020 ended in April, when it reported full year revenue of $157 million, up 71%. In the first two quarters of fiscal 2021 (ending July and October) revenue was up just 16% and 6.3%, respectively. Analysts are looking for growth to bounce back in the second half of fiscal 2021 (which ends in just 1.5 months) and bring full year growth to just over 13%.

That should be a low, low water mark as revenue should reaccelerate to at least 30% in the coming years, and could even jump closer to 50%, or more, depending on how things shake out.

The power of this platform and the growth potential is reflected in the very richly valued shares, but for aggressive growth investors this is a stock that’s likely worth the premium.

The Stock
AI came public on December 9 and jumped 120% the first day. Ten days later the stock peaked at 184 as valuation took a back seat to investor euphoria. The stock then slid 40%, bounced of the 112 level on January 6, and has spent the last six weeks making a series of higher highs and higher lows. The most recent intra-day high of 177 was struck on February 10. AI is currently trading around the 160 mark. AI represents an aggressive selection and investors are urged to average in. We will start with a half-sized position. BUY A HALF

AI-021721

Fisker (FSR)

In an increasingly crowded electric vehicle (EV) market, auto designer Fisker (FSR) stands out for having an enticing business model that increases the company’s odds of getting cars on the road in 2022.

There are three main parts to the story, which at a high level begs the analogy that Fisker is to the EV market what Apple is to the smartphone market.

That analogy, while possibly setting unattainably high expectations, seems apt because of Fisker’s focus on design, software and the customer experience (user interface, connectivity, sales, etc.), which is where Apple excels.

Such a focus is only possible if there is a manufacturing partner. For Apple that partner is Foxconn. For Fisker, that partner is Magna, the largest auto parts manufacturer in North America. Magna supplies automotive systems, assemblies, modules and components to BMW, GM, Ford, Mercedes, Toyota, Tesla and VW, among others.

There is potential that Fisker could build its own EVs at some point. But for now, this team-based approach should allow the duo to bring vehicles to market more quickly and for thousands less per vehicle than Fisker could on its own. Magna is a proven manufacturer that is incentivized to show other auto manufacturers what it is capable of.

Magna brings to the table a complete vehicle underbody system – one that is already being used by an undisclosed automaker – that includes everything but what the consumer sees and experiences. This includes suspension, steering, chassis, HVAC, battery pack, motor, brake system and power electronics.

Fisker’s engineers make tweaks here and there, but roughly 65% is original to the Magna platform. This allows Fisker to focus on what consumers care about, namely the interior, instrument cluster, infotainment system, software, buying experience, and so on.

Founder Henrik Fisker has designed some spectacular cars, including the Aston Martin DB9, the Aston Martin V8 Vantage and the BMW Z8 Roadster. A decade ago he failed in the launch of Fisker Automotive, which relied on 3rd party suppliers at a time when few of them cared about working with a small, start-up EV company. Things are different now and the experience of having failed once likely informs many decisions being made now, including the partnership with a reliable manufacturer in Magna.

The first car in the pipeline is the Fisker Ocean, a mass market luxury crossover likely to price in the $39K to $70K range. Full specs and a final production vehicle are scheduled to be released in May, with production starting in Q4 2022.

Management says it has plans to build three vehicles off the same platform, then branch out. Fisker will sell direct to consumer, so no dealers. Just order and receive (where available).

Forecasting unit sales and revenue is more art than science for a pre-revenue EV company. But going on management’s goal of 200,000 to 250,000 units by 2025 suggests revenue could ramp from (very roughly) $580 million in 2022 to $3.3 billion in 2023 to $12 billion in 2024.

Will it work? That’s the billion-dollar question!

I think the potential is there, and for the patient and risk-tolerant investor it’s worth starting to build a position.

The Stock
FSR came public via SPAC IPO when it merged into Spartan Energy Acquisition Corp. (SPAQ). When the deal was first announced last July, SPAQ stock shot up from around 11 to 21.6. The stock was all over the place until the deal actually closed on October 28, when it closed just under 10. FSR then rallied to an all-time high of 23.6 on November 27, after which the stock settled down and began to trade in the 14.5 to 18 range. That was the stock’s comfort zone until last Friday when Morgan Stanley surprised the market with a bullish initiation on FSR, which closed at 19. Look to buy on a pullback. As with our other aggressive selections this month we’ll start with a half-sized position. BUY A HALF

FSR-021721

JFrog (FROG)

TopPick

As software continues to devour the world and organizations treat digital transformation as an ongoing process rather than an endgame, there is a constant need to write new software to automate their businesses.

This has set fire to the DevOps revolution.

DevOps marries software development (Dev) with the operations of those programs (Ops). The idea is that by putting developers and operators together they can continuously innovate and deliver/upgrade apps in hours, days, or weeks, not the months and years that it took in the past.

One of the practical challenges is that with so many development languages and options to deploy (private cloud, public cloud, on premise, etc.) DevOps teams need tools to connect the development side with the operations side for purposes of storing, managing, and releasing their new software solutions. This connection, or bridge, is called an artifact repository.

The hands-down leader in providing artifact repositories is JFrog (FROG). It has been doing so since 2009 and the company’s core product, Artifactory, leads in a specialized market.

That said, while the DevOps movement is gaining ground, many organizations still don’t fully understand how artifact repositories can help them. Over time they will, and in the meantime, JFrog’s growth should expand with clients that have already seen the light.

JFrog has also been expanding its offerings. In addition to Artifactory, a few other offerings now include Xray (code scanning security), Pipelines (moving software packages) and Distribution (distributes software to the product site).

The company has also created different tiers of its solutions, ranging from a free tier up to an Enterprise+ tier. In Q4 2020 (reported last week) sales in the Enterprise+ tier grew roughly 180% (26% of total revenue).

Management said the free tier has brought in thousands of new signups and some conversions to paid. This tier was just announced in Q3 so its early, but the hope is the free tier will help reaccelerate customer count growth that stalled when the pandemic hit. As a point of reference, JFrog added 940 customers in 2019 but only 400 in 2020. It should have just over 6,000 customers now.

The pandemic put a temporary dent in revenue, which was up 65% in 2019 and 44% in 2020. It’s reasonable to expect mid-30% revenue growth for several years as a baseline. If things go better than expected, we could be closer to 40%.

JFrog generates positive free cash flow and is profitable now. Adjusted EPS in 2020 was $0.13. Factoring in investments, EPS should be modestly above breakeven this year.

JFrog is not the easiest story to grasp, but it’s a big idea and could become a major force in a few years or be an attractive acquisition target for larger companies – Microsoft (MSFT) and Atlassian (TEAM) jump to mind – that want to build out offerings around artifact repositories.

The Stock
FROG came public on September 16, 2020 at 44 and jumped 47% the first day. By late October FROG had traded as high as 95. Shares came back to earth to settle in the low 60s as management’s caution on the pandemic’s impact in Q3 settled in. Since late-November FROG has been trading mostly in the 60 to 70 range. With the Q4 earnings report having little impact on the stock, but viewed very favorably by analysts, the case for higher prices should begin to resonate with investors.

FROG-021721

Poshmark (POSH)
Online marketplaces for selling used and gently used items is nothing new. Both eBay (EBAY) and Craigslist have been in the game of selling all manner of items for years while newer entrants, like Farfetch (FTCH) and the RealReal (REAL), have come on strong as marketplaces to buy and sell luxury fashion goods.

Poshmark (POSH), which was founded in 2011 and just came public on January 14 occupies a somewhat unique space in the broader U.S. resale market. It sells mostly apparel and accessories (a combined 95% of gross merchandise value) and offers a social engagement angle on a platform where over 30 million active users spend roughly half an hour per day.

That time of engagement puts Poshmark on par with much bigger platforms, including Instagram, Pinterest (PINS) and SnapChat (SNAP), and only slightly below engagement on Twitter (TWTR).

In terms of the user experience Poshmark is sort of like Instagram mashed together with a better-curated eBay. The goods are nicely displayed, and most are not at all sketchy looking. It doesn’t have all the random crap that’s on eBay. It’s easy to find what you want, and if it’s not there you move on. Pretty simple.

Poshmark takes 20% of the selling price, except for items under $15, where it takes $2.95 per sale. The company only physically handles and/or authenticates items over $500, so relative to many other marketplaces, it’s a very scalable business with little inventory. Gross take rate is 18.5%, which puts Poshmark above most other marketplaces, but below the luxury consigners.

The average user places six orders per year, averaging $33. Almost all sales are from within the U.S. and 80% of users are Millennials or Gen Z. Interestingly, Poshmark’s existence as both marketplace and social engagement platform means 45% of sellers become buyers within five years, and vice versa.

People that use Poshmark almost always come back. While the stock is expensive on valuation (like ETSY, ABNB and SNAP) and it will take some time to scale up the business to cover marketing spend and expansion initiatives, the long-term growth trajectory is compelling with revenue growth likely averaging 25% or more over the coming years.

Poshmark generated $205 million in revenue in 2019 (up 38%) and is expected to generate $260 million in 2020 (up 27%). At the expected growth rates Poshmark may turn profitable in 2023.

The Stock
POSH came public on January 14 at 42 and jumped 141% to close at 101.5 the first day. After several days of selling POSH fell briefly below 70, reaching a low of 66 on February 2. It’s been trending higher since, though a few days does not make a trend. This is one of those stocks where it’s more about averaging in than trying to get the perfect price. Therefore, we will start with a half-sized position. BUY A HALF

POSH-021721

Previously Recommended Stocks
We’ve made several changes since the January Issue of Cabot Early Opportunities, all communicated via Special Bulletins.

On January 27 we stepped away from Berkeley Lights (BLI). On January 28 we sold one quarter of our position in Virgin Galactic (SPCE). On February 5 we sold Avantor (AVTR) and e.l.f. Beauty (ELF). On February 9 we sold Corsair Gaming (CRSR). On February 10 we sold TFFP Pharmaceuticals (TFFP) and Lawson’s Products (LAWS). On February 12 we sold Nevro (NVRO) and a quarter of our position in Cloudflare (NET).

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

Please note that stocks rated BUY are suitable for purchasing now. In all cases, and especially recent IPOs, 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 call or email with any questions.

StockSymbolDate CoveredNotesOriginal Price^Price 2/16/21 Current Gain
BUY
APi GroupAPG2/17/21NEW19.25NEW
ArcosaACA1/21/2161.9465.055%
Altair EngineeringALTR8/26/2042.7565.0152%
C3.aiAI2/17/21Buy 1/2NEW147.17NEW
CertaraCERT1/21/2136.5838.956%
FiskerFSR2/17/21Buy 1/2 NEW19.46NEW
FreshpetFRPT11/20/1954.31170.47214%
Farfetch LimitedFTCH11/18/20Buy 1/245.1169.7555%
Halozyme TherapeuticsHALO12/16/2041.749.0918%
JfrogFROG2/17/21Top Pick NEW69.23NEW
Kornit DigitalKRNT11/18/2078.0697.4925%
LyftLYFT1/21/2148.5858.4620%
NuanceNUAN10/21/2033.9649.0044%
PinterestPINS10/21/2050.4389.1577%
PoshmarkPOSH2/17/21Buy 1/2 NEW73.29NEW
PurplePRPL1/21/2135.6639.019%
Solaredge Tech.SEDG1/15/20104.18331.35218%
VaronisVRNS9/16/20112.59216.2092%
HOLD
10x GenomicsTXG12/17/1966.78192.43188%
Adaptive BiotechADPT4/15/2027.9164.21130%
Array TechnologiesARRY12/16/20Top Pick39.5243.4710%
Bill.comBILL6/17/2077.73183.46136%
Castle BiosciencesCSTL1/21/21Top Pick81.2193.2515%
ChewyCHWY1/15/20Hold 1/231.22114.74268%
CloudflareNET7/15/20Hold 3/435.8582.07129%
CrowdStrikeCRWD12/17/19Hold 3/449.45242.42390%
CryoportCYRX10/21/2043.872.0765%
DatadogDDOG4/15/20Hold 1/238.69107.56178%
Five9FIVN11/20/19Hold 1/264.37182.74184%
Shift4 PaymentsFOUR12/16/2064.3181.5727%
Sprout SocialSPT2/19/2020.3881.58300%
Virgin GalacticSPCE4/15/20, 6/5/20Hold 3/417.6650.36185%
UpworkUPWK10/21/2020.3157.04181%
RECENTLY SOLD POSITIONS
Company NameTickerDate CoveredDate SoldReference Price^Price Sold^Gain/Loss
Berkeley LightsBLI11/18/20, 12/16/201/27/202188.574.84-15%
Virgin Galactic (sold 1/4)SPCE4/15/20, 6/5/201/28/202117.6645.74159%
AvantorAVTR11/18/202/5/202127.2329.9310%
e.l.f. BeautyELF11/18/202/5/202122.0123.045%
Corsair GamingCRSR12/16/202/9/202136.2844.7723%
TFF PharmaceuticalsTFFP8/26/202/10/202113.1919.6249%
Lawson ProductsLAWS12/16/202/10/202150.2052.565%
Cloudflare (sold 1/4)NET7/15/202/12/202135.8585.45138%
NevroNVRO9/16/202/12/2021146.68180.7823%

^Average of high and low price if published intraday, or closing price if published after 4 PM ET


The next issue of Cabot Early Opportunities will be published on March 17, 2021.

Cabot Wealth NetworkPublishing independent investment advice since 1970.

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Chairman & Chief Investment Strategist: Timothy Lutts
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