Tech

Cloud stocks look frothy, but companies are proving they can cut costs and keep growing

Key Points
  • Investors are paying a hefty premium for subscription software companies that are getting major boosts from shelter-in-place orders.
  • DocuSign is up 181% this year, while Zoom has climbed almost 300%.
  • Some cloud companies have been able to reduce their costs, helping profitability.
Zoom founder and CEO Eric Yuan
Victor J. Blue | Bloomberg | Getty Images

The more the coronavirus spreads, the more investors keep pouring money into cloud software stocks.

Zoom, Okta, DocuSign, Datadog and Twilio are among the stocks that closed at records on Wednesday. Their gains this year range from 149% (Twilio) to 293% (Zoom). They're worth over $200 billion combined, and you could add a number of other high-growth companies to the mix.

While the broader market has benefited from government stimulus money and the Federal Reserve's purchase of corporate bonds to ease credit concerns, subscription software companies are doing just fine on their own.  

Providers of cloud-based infrastructure, productivity software and collaboration tools are proving they can maintain revenue growth amid a slumping consumer economy while simultaneously reeling in costs. They've slowed the pace of hiring, cut down on travel for salespeople, switched in-person events to virtual gatherings and, in some cases, signaled that real estate costs will be on the decline.

"As we continue to move through Covid and assess the 'new normal', we continue to believe that an element of the WFH environment that we have gotten used to, is here to stay," Evercore ISI analysts led by Kirk Materne wrote in a note to clients on Monday.

More mature software companies with billions in annual revenue are also getting favorable treatment from Wall Street. Salesforce, Adobe and Autodesk are each up 24% to 39% this year. The tech-heavy Nasdaq is up 17% for the year, compared with the 1.9% decline for the S&P 500.

Cloud stocks surge during Covid-19
CNBC

At the fastest-growing cloud companies, the stock rally has lifted price-to-sales multiples to historic highs, suggesting the market could be frothy. But investors are paying up for the future growth they expect and the improving prospects for profitability.

For example, Okta, a provider of security and identity management software, is trading at 31 times projected revenue over the next 12 months. Compare that with Microsoft and Google, two mega-cap tech companies that are also trading at or near records but have forward price-to-sales ratios of 14 and 6, respectively.

In the quarter that ended April 30, Okta reported better-than-expected revenue and operating expenses that were below what management had predicted. That all helped the company narrow its loss.

Part of the cost savings came from moving the company's Oktane conference at the end of March from a San Francisco exhibition center to the internet. Around 20,000 people registered for the virtual show, three times more than the number of people Okta had expected in person.

Okta now has more sales leads than it was expecting for the next few quarters, COO Frederic Kerrest told CNBC on Wednesday.

"I don't think you're going to see Oktane go back to what it was is my guess," Kerrest said, adding that the same would probably be true for Salesforce's annual Dreamforce conference and Workday Rising.

Kerrest said the company also expects to save on real estate. Okta CEO Todd McKinnon posted a video on Twitter on May 27, showing him packing up his stuff at his office and declaring that the company would be remote by default "until there's a treatment or vaccine for Covid-19."

Zoom has generated the most buzz among the work-from-home beneficiaries because the video chat software has picked up so much use for such a wide variety of activities. Even as the company has ramped up spending to meet demands on engineering and security, it reported adjusted profit that was twice as high as analysts expected along with 169% revenue growth for the quarter that ended April 30.

Zoom is trading at 38 times revenue for the next year. Monitoring software company Datadog, which went public less than a year ago, is valued at about 44 times future sales. Annualized revenue growth accelerated to 87% in the second quarter from 85% in the prior period. 

Datadog CEO Olivier Pomel said on the company's conference call in May that less than 10% of annual recurring revenue comes from areas like hospitality, travel, airlines and entertainment.

"On the other hand, we also have exposure to categories that have experienced an increase in traffic, such as streaming media, gaming, food delivery, e-commerce and collaboration," Pomel said.

DocuSign's revenue growth ticked up to 39% in the latest period, up from the prior quarter and the previous year, as more businesses rely on e-signatures for critical documents. At the same time, the company cut travel and entertainment expenses.

"Even when the Covid-19 situation is behind us, we don't anticipate customers returning to paper or manual-based processes," CEO Dan Springer said in June on the company's earnings call. "Once they take their first digital transformation steps with us and they realize the time, cost, and customer experience benefits, they rarely go back."

WATCH: Okta CEO says long-term cloud trends are 'very clear' despite coronavirus

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Okta CEO says long-term cloud trends are 'very clear' despite coronavirus