Investors are trying to decide if the risk/reward balance on Elastic (ESTC) is now attractive following the stock’s 40% drop from the all-time high set in July.
It has been a volatile year for shares of Elastic. At the record high of $104.10, the stock was up 45% YTD. But the good times didn’t last, as selling pressure started to emerge in late summer.
Earlier this month, a sharp deceleration in fiscal Q2 (ended October) license revenue growth combined with a billings disappointment sent Elastic shares tumbling nearly 18% in one session. After that harsh pullback, the stock, recently trading around $62, is down 13% YTD versus a gain of 32.8% for the Nasdaq Composite.
With its open-source search technology at the core, Elastic operates across several different IT segments—including enterprise search, app search, logging, APM, infrastructure monitoring and endpoint security. Facing plenty of tough competitors, the company works to drive product innovation and expand the number of addressable use cases on the platform. In the latest quarter, Elastic’s R&D budget represented 31% of total revenue.
Elastic delivered solid FQ2 results. Total revenue of $101.1 million (4.8% above the consensus estimate) rose 59%, a slight acceleration from growth of 58% in FQ1. Subscription revenue of $91.6 million was up 57%, with SaaS (cloud) revenue of $20.6 million expanding 106%, a sharp acceleration from the FQ1 growth rate of 71%. RPO of $410 million advanced 53%. The company added 900 new subscription customers, up from 700 adds in the previous quarter. The total customer count of 9,700+ rose 54% year over year.
But the latest quarter wasn’t all positive. License revenue growth decelerated to 20% from 36% in FQ1. Billings of $125.3 million rose 41%, but the growth rate decelerated from 51% in FQ1. In constant currency, the FQ2 billings growth rate of 45% was down 800 basis points sequentially. Management blamed the slower billings growth on some deal delays in the U.S. federal business, saying it was simply a matter of contract timing, not anything related to competition. The federal deals were only pushed out of the quarter, so they remain in the pipeline.
The billings explanation makes sense. But it didn’t sit so well with investors because they saw that other vendors recently turned in strong federal quarters. For example, competitor Splunk (SPLK) was able to close some big government deals in its latest quarter. While a slight billings stumble doesn’t change the overall narrative for Elastic, investors will now be on alert for any signs of further deceleration.
Wall Street bulls on Elastic argue that investors should be paying more attention to the company’s fast-growing SaaS unit, which now accounts for 20% of total revenue. The company’s largest FQ2 transaction was a multimillion-dollar SaaS deal. On the FQ2 call, management pointed out that the monthly portion of the SaaS business, which makes up nearly half of total SaaS revenue and almost 10% of total revenue, doesn’t involve any deferred revenue or RPO.
Piper Jaffray believes the SaaS model transition may continue to moderate the company’s short-term billings and license revenue growth metrics, but says the shift could better position Elastic over the longer-term, where growth is more closely tied to consumption. While Piper Jaffray kept its “Overweight’ rating on Elastic, it lowered its price target to $85 from $93. Stifel reduced its target to $84 from $100, citing the mixed quarter and large federal deal push-outs.
Barclays thinks Elastic shares could struggle over the short-term, but remains among the most bullish on the company, saying management’s explanation for the billings growth deceleration was “credible.” While the firm trimmed its price target to $97 from $105, it believes the long-term story remains compelling and views the stock’s sharp pullback as a buying opportunity.
There are plenty of reasons to be positive on Elastic. The company has a broad portfolio of products across key growth segments. There are healthy customer growth and retention rates. The enterprise business is doing well, as there are now more than 525 customers with annual contract value over $100,000, up 54% from the year-ago level.
Plus, the valuation is more attractive after the recent sell-off. The enterprise value is still 11.2 times the FY’20 (ending April) consensus revenue estimate of $416.5 million (representing growth of 53.4%), but the forward multiple of 8.2 on the FY’21 consensus of $566.7 million looks more reasonable relative to expected growth of 36.1%.
While the valuation has come down, investors should keep in mind that Elastic operates in highly competitive markets and faces various formidable challengers. Elastic is the leader in enterprise search, but its observability and security products go up against specialist vendors—such as Splunk (SPLK), Datadog (DDOG), Dynatrace (DT), New Relic (NEWR) and CrowdStrike (CRWD)—that have strong point solutions and excellent competitive positioning in each of their respective sectors.
In security, the recent expansion in endpoint protection via the $234 million acquisition of Endgame brings some risk, as there are already plenty of established players in the space. Elastic is combining its SIEM product for security analytics with endpoint protection to enable customers to automatically respond to threats in real-time.