Tech guru Rob DeFrancesco sees opportunity—and potential takeovers—following the pullback in momentum stocks, particularly in the cloud and security software sectors. The editor of Tech-Stock Prospector highlights some of his favorite ideas.
Steven Halpern: Joining us today is technology sector expert Rob DeFrancesco, editor of the Tech-Stock Prospector.How are you doing today, Rob?
Rob DeFrancesco: Hi Steve, I’m doing great; nice to speak with you again.
Steven Halpern: Now, you recently noted that momentum stocks have been particularly hard hit, especially the next generation software stocks, but you suggest that these pullbacks should be viewed as an opportunity. Could you expand on that?
Rob DeFrancesco: Yes, sure. We’ve had a broad valuation reset across the momentum space. According to Goldman Sachs, the average price-to-sales ratio—using enterprise value—for growth software companies has come down to 3.8 from 6 in December. So that’s about a 37% pullback.
For long-term investors, if you can find a company that still has solid growth prospects, these pullbacks are a good thing because it allows you to build positions over time in companies where…valuations did get pretty high last summer and fall for a lot of these names.
For example, consider companies such as Workday (WDAY) in human capital management; Tableau Software (DATA) in data visualization, ServiceNow (NOW) in enterprise service automation, and Palo Alto Networks (PANW) in network security.
Companies like these—where their long-term prospects are strong and that have had some short pullbacks—it gives you a chance to accumulate shares.
Steven Halpern: Now you’ve also pointed out that these pullbacks can act as a catalyst for M&A activity, and that cloud and security stocks in particular are ripe for a wave of takeovers. Could you share your thoughts on that?
Rob DeFrancesco: Yes. You know, I mean, obviously when valuations are too high, you’re not going to get the M&A because acquirers aren’t going to pay those valuations, so, as you get a pullback, you might get some more buyouts.
There was some chatter that in the security space that at these lower valuations companies are getting some in-bound interest. That doesn’t mean that they’re going to sell because maybe for a lot of companies, they’ll says, “This valuation is too low so we’ll bounce back.”
I think that over the next few months we may see some more deals, particularly, in the security space, in particular, is ripe for some buyouts.
We’ve had a big pullback in valuations there. Even among some of the big names like Palo Alto Network. I think that’s an attractive segment for M&A.
Steven Halpern: Now, one company you recently highlighted is Salesforce (CRM), what’s the attraction there?
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Rob DeFrancesco: Right, Salesforce is the largest cloud software company. For not doing the huge growth that they did in the past, I think for fiscal ‘17 they should do about 21% revenue growth, still pretty solid growth, but they were doing over 30% in the past.
With them, there are several drivers; their core sales are cloud, but they also have a customer service cloud and a marketing cloud. I think that gives you a broad presence in cloud software so it’s a good solid core holding there.
Steven Halpern: You also point to Splunk (SPLK) and suggest that might be a good buyout target. What does that company do and what makes it attractive?
Rob DeFrancesco: Splunk is in analytics software; its software analyzes machine-generated data. I suggested this; I’m not the only one who thinks IBM (IBM) might be a good buyer for them. The stock has come down a lot.
It was trading at almost $77 back down to $35 and solid growth on this one. Revenue for fiscal ‘17 should be up about 30 to 31%. I think that in the mid-$30s the valuation has come down a lot and there’s another example of a company with solid long-term prospects.
Steven Halpern: You’ve also pointed to a company called New Relic (NEWR). What’s the story here?
Rob DeFrancesco: New Relic, they have cloud-based analytics software, and basically, their software analyzes other software. It’s a cheaper alternative to application performance management and monitoring solutions.
This is another one where the stock has come down a lot, but here you’re getting even better growth. Fiscal 17% and in March top line to grow 35%. That stock has really been hit hard back in the low $20s. I think it’s attractive.
Steven Halpern: We’ve only got another minute, but I was wondering are there any other stocks in the current environment that stand out in your analysis?
Rob DeFrancesco: Yes, real quick, HubSpot (HUBS) is a cloud-based inbound marketing software so they help small businesses get noticed by…they pull in customers via strong content. They just had revenue growth in Q4 of 55% and they should deliver, in 2016, revenue growth of 38%.
Another one is a company called Atlassian (TEAM). It’s a recent IPO, they do team collaboration, messaging, and projects management software. They went public on December 21.
The stock had run up to the low-$30s, it’s back down to $22 and it has solid growth for fiscal year of 16%—end of June—and they should do revenue growth of around 39%. That’s an IPO, so it’s a riskier investment. But the valuation has come down a lot on that one as well.
Steven Halpern: Again, our guest is tech expert Rob DeFrancesco of the Tech-Stock Prospector. Thank you so much for your time today.
Rob DeFrancesco: Great, Steve, thanks.
