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Cabot Early Opportunities Special Bulletin

There’s been a lot going on lately as earnings season has heated up. With many of the stocks covered in the September and October Issues of Cabot Early Opportunities we have a few updates to get into.

Earnings Updates

There’s been a lot going on lately as earnings season has heated up. With many of the stocks covered in the September and October Issues of Cabot Early Opportunities we have a few updates to get into.

But before that, stepping back I’d say the IPO market isn’t that strong. The headlines certainly aren’t selling IPOs as the place to be, instead highlighting the lackluster returns of high profile stocks like Lyft (LYFT), Uber (UBER), Peloton (PTON) and SmileDirectClub (SDC). All of these stocks are well off their IPO prices. At the same time, there are plenty of IPOs that are doing quite well, particularly in the biotech space.

The message is that, as always, when investing in IPOs you should be prepared for volatility. And balance this out by averaging into these stocks over time, especially if buying within the first six months of the stock going public.

Moving on to the small cap asset class, we’ve seen the small cap index move up near its 2019 highs and make a couple of attempts at breaking out to new year-to-date highs. There’s been no decisive move yet, but with other major market indices hitting all-time highs, momentum creeping back into growth areas like cloud software and small caps, we’re certainly seeing some trickle-down strength in the types of early-stage stocks we focus on.

Somewhat ironically this all means that the average gain across the 10 stocks we’ve covered in the last 2 months is nil. There have been outsized returns from companies like Deciphera Pharma (DCPH), which is up 36% over just the last three weeks. And high single digit returns from the likes of Kornit Digital (KRNT) and Digital Turbine (APPS). But lackluster performance from The RealReal (REAL) and, lately, Arco Platform (ARCO) have served to even things out.

Still, no stock is down over 20%, which is the loss level where I’d suggesting closing out a position to limit more destructive returns. And, we’re only looking at results from the last two months. The intent of Cabot Early Opportunities is to bring high-potential names to your attention and help you get in at good prices to the ones that fit your investment style/criteria.

We’re not yet deep enough into things to start weeding out the laggards and focusing on the winners. But we’ll get there!

OK, on to brief earnings-related updates.

Digital Turbine (APPS) reported that Q3 revenue was up 37.5% to $32.8 million and that adjusted EPS rose from $0.01 in Q3 2018 to $0.05 in Q3 2019. Both results beat expectations. On the conference call management said it doesn’t have a ton of new info to share on android smartphone device growth in 2020 because it seems we’re in a bit of a lull and it’s just waiting for the next round of product releases and upgrades. But it did have really interesting commentary around expanding its platform to other devices, including TV. And it talked about how Verizon awarded it the deal to deliver the Disney+ app for the holiday period and beyond. That feels like another big win and when viewed in the context of others (Facebook, Netflix, Apple music, etc.) it’s clear that Digital Turbine is a trusted partner. Taking it all in I see this stock holding its gains because of upside potential but probably not blasting off to new all-time highs in the next month or so. Long-term investors can still buy as the growth story remains intact. However, if you’re looking for a short-term trade there are probably other opportunities out there. BUY.

The RealReal (REAL) fell sharply after reporting, but not because results were bad. In fact, they were quite good. Revenue was up 55.3% to $80.5 million (beating by $4.6 million) while adjusted EPS of -$0.27 beat by $0.03. Gross merchandising volume was up 38% and management guided for full year GMV growth of just over 40%. The catalyst for the slump was that CNBC wrote a report (some might call it a hit piece) talking about fakes, bad process control and customer complaints. The CNBC piece featured some ex-employees who probably weren’t entirely psyched with their careers that added fuel to the fire.

My take is that The RealReal operates in a challenging environment of collecting, storing, authenticating and shipping out high value used pieces. That business sounds like a logistical nightmare. If they can figure out how to do it well, like other companies that make pain-in-the-neck things easier, it should be a winner. Is it a surprise that there are issues, disgruntled employees and scams? Heck no!

Do you think everything on Craigslist and Amazon is real, or that there are no scam artists on HomeAway and VRBO (both owned by Expedia)? Of course not. I’m not saying The RealReal gets a free pass here. And I definitely don’t want to be labeled as a cheerleader for The RealReal. I’m simply saying that it’s not ever going to be perfect. And the company is under the lens now because it is a recent IPO and it’s pretty easy to take shots at the concept of selling luxury used goods.

Clearly, The RealReal has a public image issue on its hands and has to figure this out—and make the solutions public. With the stock down over 15% from when I featured it, I wouldn’t run out and buy it now. But I wouldn’t necessarily sell your starter position either. I suggest holding on and seeing what happens over the coming week or so, then taking it from there. If shares drop over 20% from your entry point, let it go. But we’re very early here (even pre-lock up expiration) so big picture, volatility should be expected. HOLD.

Dynatrace (DT) delivered the goods recently and Q2 fiscal 2020 revenue was up 27% to $129 million (beating by $5.8 million) while adjusted EPS of $0.06 beat by $0.02. Growth in annualized recurring revenue (ARR) was up 44%, which illustrates a successful (so far) transition to the subscription model (hence, recurring revenue). And net revenue retention (how much revenue from existing customers is retained) was 120%, implying current customers are spending more. That’s good.

The company, which competes with Datadog (DDOG), New Relic (NEWR), Splunk (SPLK) and Elastic (ESTC) in the application performance monitoring space, is seen as a potential big winner due to digital transformation initiatives. Analysts see a shift of sales team resources to focusing on growth once Dynatrace gets through the majority of its shift to subscriptions, which I suspect will begin to happen in 2020. Management also says it will be paying down debt, which it should have no problem doing given the cash generation in the business (free cash flow margins of around 30%).

This is a recent spin-out/IPO, and is pre-lockup, so don’t expect a calm and soothing ride! But we jumped in at around this level as we looked to take advantage of the post-IPO selloff. So far that strategy is working. BUY.

Deciphera Pharma (DCPH) has absolutely exploded to the upside recently. The company, which develops novel drug candidates to fight cancer, released preliminary Phase 1 data evaluating ripretinib in patients with GIST in 2nd, 3rd and 4th line settings. Reptreinib is currently being evaluated in both the INVICTUS and INTRIGUE Phase 3 trials, as well as a number of early stage trials for a variety of solid tumors. The recent data increases confidence in the treatment, as does the recent award of Breakthrough Therapy Designation, which suggests priority review, and potentially, early approval. Management is working on an NDA and an Expanded Access Program to get the drug candidate to more patients. It also has over $630 million in the bank which should fund to 2022. It’s still risky, but the probabilities of success here are going up. That said, given that DCPH is up over 35% since I covered it three weeks ago I think a little conservatism here is prudent. HOLD.

Frontdoor (FTDR) took a hit after reporting that Q3 revenue was up 8% to $407 million, missing by $4.1 million) and that adjusted EPS came in at $0.73, which beat by $0.07. There was also a reduction in full-year guidance of $10 million at the high end, largely because of softness in the Real Estate channel (19% of revenue). The disappointing quarter isn’t a great confidence booster but big picture, this company, which provides home service plans, isn’t meant to be a rapid growth name (more like high single digits). On the conference call, management talked about more growth-oriented initiatives in 2020 (like on-demand services) now that more cost-saving measures have already been completed. It can still be bought. BUY.