The higher enterprise spending on digital transformation amid the pandemic drove demand and share prices of software companies. What followed was a sharp pullback due to the valuation concerns, normalization in growth, tough year-over-year comparisons, and macro headwinds.
Despite the considerable decline in the prices of most software stocks, Jefferies analyst Brent Thill has turned cautious on the sector. Thill believes that the macro headwinds and a slowdown in the economy could weaken the fundamentals of the software companies, which are already under pressure.
The analyst warned of a “macro storm” that could impact the spending environment and lead to further correction in the software stocks. Given the challenges, Thill lowered his estimates and price targets on software stocks, including Cloudflare and Asana.
Against this backdrop, let’s understand why Thill has cut his estimates and price targets on these two stocks.
Cloudflare (NYSE: NET)
Shares of the cloud-based security services provider Cloudflare have decreased nearly 62% this year. This comes despite the company’s solid financial performance and growing addressable market.
It recently announced its Q1 financials, wherein its top-line surged 54% year-over-year. Cloudflare acquired 14,000 new paying customers during the quarter. Moreover, it added 121 new large customers (who spend over $100,000 per year).
Also, its large customers who pay more than $500,000 and $1 million a year increased by 68% and 72%, respectively, on a year-over-year basis.
What’s more, its dollar-based net retention hit a new record high of 127%. Meanwhile, the company expects its TAM (total addressable market) to expand further and reach $135 billion by 2024.
Its strong customer growth, product innovation, and growing TAM point to a solid future for Cloudflare and its shareholders. However, Thill is unimpressed with its valuation.
Thill has a Hold recommendation on the NET stock. Meanwhile, he lowered his price target to $55 from $75.
The analyst stated that the valuation multiples of software stocks continue to correct. He added, “despite the recent downdraft, we believe there could still be downside to multiples as fundamentals could weaken into a recessionary environment.”
Specifically for NET, Thill added, “we believe that valuation is currently full given it is the most expensive multiple in our universe.”
Including Thill, eight analysts have a Hold recommendation on the NET stock. Meanwhile, seven analysts have recommended a Buy. Given the steep decline, the average Cloudflare price target of $101.64 implies 101.3% upside potential to current levels.
Asana (NYSE: ASAN)
Shares of the workflow management platform provider, Asana, skyrocketed amid the pandemic. Stellar revenue growth, growth in enterprise customer base, and high retention rate led to a rally in its stock. The company ended FY22 on a solid note wherein its revenue soared 67% year-over-year, while its large customers (who spend over $50K annually) expanded to 894, up 125% year-over-year.
Asana’s overall dollar-based net retention rate was over 120%, while for large enterprise customers, it stood at 145%, which is encouraging.
Management remains upbeat and expects the momentum to sustain in FY23. For the full year, Asana’s revenue is projected to increase by 39-40%.
Despite the strength in the business, Asana stock reversed a substantial portion of its gains and declined over 75% on a year-to-date basis. Valuation concerns and an adverse macro environment are to be blamed for this decline.
Looking ahead, Thill expects “productivity apps that can be deferred could be at risk in a fundamental slowdown when discretionary spend tightens.” Thus, he lowered Asana’s FY23 revenue estimate “as an exercise of caution in the NT (near-term).”
The analyst lowered his price target to $23 from $40. Meanwhile, he has a Hold recommendation on the stock.
Overall, ASAN stock has received eight Buy, three Hold, and one Sell recommendations for a Moderate Buy consensus rating. Further, due to the substantial decline in ASAN stock, the average price target of $55.25 implies 198.2% upside potential to current levels.
Bottom Line
The ability of these companies to add and retain customers, as well as their focus on driving higher revenue from existing clients and a large addressable market, present a solid long-term growth opportunity. However, the macro concerns, fears of an economic slowdown, and sector-wide valuation compression play a spoilsport.
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