News of the Week (March 4 - 8)

News of the Week (March 4 - 8)

30 min read

Table of Contents

1. MongoDB (MDB) – Earnings Review

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MongoDB is a key player in data storage and analytics with a document-oriented setup. Last earnings review, I covered MongoDB’s niche and product suite overall. I think that’s an important read for folks wanting to understand this business. It defines key terms with needed context. That can be found in part 3, section e of this article.

Its most exciting product is called MongoDB Atlas. This is a cloud-native database service that implements a group of servers (or a cluster) used to actually store the data. The nature of MongoDB’s product allows clusters to be easily added to or subtracted from for easier flexing up & down as needs fluctuate. It also offers MongoDB Realm as a mobile environment for app creation, MongoDB Stitch to build apps without servers or any needed infrastructure maintenance and MongoDB Search for data querying. Finally, it offers MongoDB Data Lake specifically for unstructured data, which directly competes with players like Snowflake. There are more products, but these are the big ones with new releases discussed below.

a. Results

  • Beat revenue estimates by 5.1% & beat guidance by 6.3%.
    • Net revenue retention was 120%.
  • Crushed EBIT estimates by 86% & Crushed guidance by 89%.
  • Beat $0.48 earnings per share (EPS) estimates by $0.38 & neat guidance by $0.41.
  • Met free cash flow (FCF) estimates.

Gross margin (GPM) of 77% worsened from 78% Y/Y. This is due to a 250 basis point (bps) boost to last year’s GPM due to “one-time cloud contract benefits.” It expanded by about 150 bps Y/Y without this headwind.

b. Annual Guidance & Valuation

  • Missed revenue estimates by 5.9%.
  • Sharply missed EBIT estimates by 34%.
  • Missed $3.22 EPS estimates by $0.84.

MDB trades for 163x next year’s earnings. Earnings are set to shrink Y/Y. Wait what? MongoDB’s guidance was shockingly poor, but there’s decent reasoning for this. The company pocketed $80 million in unused Atlas commitment revenue and multi-year licensing revenue (large Alibaba contract extension) last year. It expects that to fall to $0 this year, with non-Atlas revenue growth turning negative. This implies continued strong Atlas growth, which is by far its most important product. From a margin perspective, the $80 million in lost revenue was basically pure profit, which again won’t recur. These were the sources of the misses. (MDB’s team also loves to sandbag on their initial annual guides.)

The misses were not at all related to competition. Its win rates vs. all competitors rose Y/Y and its new product uptake is going very well. MongoDB is rapidly rounding out its product suite to consolidate vendors and cut costs within databases and app development. In a world obsessed with point solution displacement, this is a great focus area and is working. That’s likely why it now has 259 customers with over $1 million in annual business vs. 213 Y/Y.

c. Balance Sheet

  • $2 billion in cash & equivalents.
  • No traditional debt.
  • $1.1 billion in senior convertible notes.
  • Shares +4.1% Y/Y.
  • $109.9 million in FCF vs. -$24.7 million Y/Y.

d. Call & Release Highlights

Atlas:

Atlas’s new workload growth was strong while its retention and consumption trends were too. It sees consumption growth continuing throughout next year. This product had a great quarter despite tough comps related to lapping unused commitment revenue. It greatly changed its sales team incentives to minimize this stream of revenue and focus on consumption growth. 34% Y/Y Atlas growth would have been 36% Y/Y without this headwind.

GenAI:

MongoDB released a few GenAI products this year. Vector Search makes it easy to query needed data with slick integrations to plug that data into GenAI apps. GenAI apps and models insatiably consume data. The more data, the better; the more relevant that data is, the better. MongoDB provides data scale and secure access to a client’s first party insights. It pairs these data skills with ample programming language frameworks to free developers to bring their work to their data. This new tool offers Semantic Search, which allows clients to seamlessly scrape insight from data. It allows for theme-and-idea-based querying rather than just word-based. It also provides retrieval-augmented generation (RAG). This pushes semantic search results into associated large language models to uplift querying precision. It also debuted Stream Processing to utilize data as it is generated in real time. This will surely be a popular tool for GenAI app builders too.

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While these products are compelling, they’re not really moving the financial needle just yet. Almost all GenAI spending is happening within model training and inference. Very little spend has happened to date within the app layer of GenAI, which is where MongoDB expects to carve its niche. It provides endless and cohesive access to data and tools to automate app creation from within its platform. It marries these strengths with powerful integrations to ensure a developer can easily deploy apps in runtime elsewhere. It sees strong evidence and early cases of its platform being used to build GenAI apps. Most of the demand tailwind from this, however, will take place in the future.

2024 Priorities:

  • Keep investing in the core platform and GenAI products like Vector Search.
  • Obsess over new workload growth.
  • Alter sales incentives to align go-to-market with workload growth maximization goal.
  • Accelerate sales team growth.

Relational Database Migration Opportunity:

As the MDB intro I linked to at the beginning of this spells out, displacing legacy relational databases is MDB’s biggest opportunity. It’s great at automating the preparation and data movement of these antiquated products. It’s not great at rewriting application code as that data enters its ecosystem. It plans to lean into GenAI products to internally automate that code writing process. It thinks this will significantly diminish migration friction for new customers. They’re probably right.

f. Take

Great quarter and an awful annual guide. If history is any indication, it will raise that guidance consistently throughout the year. It loves to under-promise when it offers initial annual guidance just like it should. Atlas revenue and guidance were strong, the margin trend excluding special items last year was very strong and commentary surrounding competition was encouraging too. Like with Snowflake, the multiple is simply far too lofty for me to start a position just because I think guidance is conservative. At 163x forward EPS, perfection is needed and I’m not willing to assume perfection at this stage. This was not perfect, but I do see why bulls defended the print. 

2. Visa (V) – CEO Ryan Mclnerney Investor Conference Interview

Mclnerney talked about strong demand for services like cybersecurity and Visa’s work to drive productivity, diminish friction and lower fraud rates through GenAI. He spoke about Visa’s massive data set putting it in pole position to win in this new wave. It has firm-specific models now being built with partners. That was interesting, but all review.

What wasn’t review was his updated pulse on the health of the U.S. and global economies. Visa has arguably the best gauge of global economic health in the world. Their CEO is spending time to tell you how that economic health is shaping up. These are highly valuable insights to gather… so let’s gather them.

Mclnerney talked a lot about “stability as he looks around the world right now.” Nothing in their data is pointing to a recession. There’s some decelerating spend growth in the U.K. and Australia, but not in the USA and not across most regions. He called USA spending “as steady as she goes” with payment volume quarter-to-date in line with last quarter. There has been no further slowing. Content creators and social media experts sure do love to offer their macro opinions. I’d rather get those opinions from Visa’s CEO.

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3. SoFi (SOFI) – Complex Capital Maneuvers

The News:

SoFi announced two different pieces of complex capital structure news this past week. First, SoFi plans to raise $750 million in convertible senior notes maturing in 2029. Net proceeds will be about $845 million as options to purchase up to $112.5 million in additional notes were broadly exercised.

Secondly, it will exchange $600 million worth of its 0% convertible senior notes (maturing in 2026) for common stock. These two moves make it sound like SoFi is aggressively diluting shareholders, but much more context is needed.

I’m going to cover some complex accounting items in this section. This gets way more into the weeds than an investor needs to go, but I love to know everything about my investments. It’s how I am most comfortable with holding through turbulence. If you don’t need this level of detail, simply know the following things about these deals:

  • They boost net income and tangible book value.
  • They are neutral for net income and tangible book value per share.
  • They boost SoFi’s capital ratios significantly.
  • They will lead to at least 3% total dilution. If the stock goes above $14.54 before March 2027, there’s additional dilution risk.

2029 Notes Offering:

On the 2029 notes offering, some of the proceeds (and some cash on hand) will be used to retire $325 million in 12.5% preferred shares outstanding. These shares were set to see rates materially jump this spring. SoFi needed to redeem them before May to avoid paying the higher rate for the next 5 years. SoFi will only pay a 1.25% annual interest rate on the $750 million in fresh funding. This means it swapped out about $57 million in annual interest expense for $9 million in annual interest. But wait, there’s more. SoFi will use part of the remaining $425 million to refinance expensive debt, thus adding to the interest expense savings. This will be positive for net income, positive for retained earnings and so accretive to overall tangible book value.

The notes mature in March 2029. SoFi has the right to redeem these notes for cash if the stock price reaches $12.29 for a 30 day period (130% of $9.45 conversion price) at any point after March 2027. Note holders can convert the notes before September 2028.

2026 Convertible Notes Exchange:

Relatedly, SoFi will also exchange $600 million of its roughly $1.1 billion in 2026 convertible senior notes for roughly 61 million shares of its common stock. That news in isolation is a bit concerning and seems to indicate significant dilution. But again, more context is needed. Convertible notes are already part of fully diluted share count (which is what SoFi uses in its EPS guidance). So? While 61 million common shares are being created, $600 million from the 2026 convertible note balance is being retired. That $600 million represents about 54% of its 49.6 million share convertible note balance. 54% of 49.6 million is 26.8 million, which is deducted from 61 million shares. This leaves us with ~34.2 million shares being created for ~3% total dilution.

3% dilution is not crazy, but ideally we’d like no dilution. There are three explanations I see for why this second deal happened, which I'll cover in order of probability. First, it could have been a necessary amendment for buyers of the $750 million note offering to get that done at the terms SoFi wanted. Secondly, this may just be the company wanting excess capital ratio flexibility due to its pessimistic macro forecast. Finally, perhaps it’s seeing lending greenshoots and wanted extra balance sheet capacity to accelerate origination growth this year. That would be fantastic news, but also somewhat surprising considering Lapointe recently spoke of an overly cautious lending outlook.

These notes are trading at a more than 10% discount to par value. That means retiring them now allows SoFi to use about $60-$70 million less in stock vs. retiring at par. It also means capital ratio relief. Had this been done in Q4 2023, its total risk-based capital ratio would have been 17.3% instead of 15.3%. SoFi doesn’t plan to utilize excess capital ratio flexibility this year as Chris Lapointe told us in a recent investor conference. Still, it’s always nice to have for the future when macro does brighten and it leans back into origination growth. If it does use up this capacity down the road, it has more convertible bonds that it could potentially buy back at a discount for more capital ratio relief. That would also shrink fully diluted share count, effectively reversing some of the minor dilution from these moves. There are many, many levers this firm can pull under GAAP accounting to keep its balance sheet strong. Just keep growing profits & keep underwriting responsibly to maintain that flexibility.

SoFi Capped Call Transactions & Dilution:

Capped calls are option contracts that a convertible note issuer like SoFi will buy from financial institutions. SoFi pays a premium for this contract type up-front, which in this case will be $79 million. The counterparty will purchase some shares upon agreement to cover the potential obligation and shrink the tradable share float. 

Why will SoFi and the option counterparty enter into an arrangement like this one? Firstly, Sofi enjoys dilution protection from the $9.45 conversion price up to the $14.54 cap price. It can avoid creating a large portion of the 78.6 million potential shares ($750,000,000 / $9.45 conversion price or 8% total dilution potential over 5 years) with this secondary transaction.

Instead of pulling entirely from treasury stock to dilute shareholders, SoFi can use the capped call seller’s shares from this in-the-money contract to help cover the liability. That’s why capped calls diminish dilution risk. Any price beyond $14.54 (the “cap price”) could lead to more dilution. That outcome would represent a minimum 24% return CAGR for SoFi shares from now to then and would be fine with me. Furthermore, SoFi is currently inflecting to profitability and enjoying strong capital market demand for its loans. If it owes more shares in the future, it’s rapidly becoming more capable of using profits to fund the liability rather than treasury stock. In this case, it would likely have the flexibility to purchase additional options with higher cap prices for more dilution protection. Think about it… if the stock price skyrockets, will that be because SoFi is struggling with liquidity and profit compounding. Probably not.

The point here is that it has options to make the dilution tied to this raise very modest. It’s all about profits continuing to ramp like they’re expected to.

If SoFI the stock struggles to get above the conversion price and starts to struggle with liquidity and profit compounding, there is a risk of it needing to raise cash to cover principal and interest payments. Note holders wouldn’t convert until the stock passes conversion levels as that would result in no capital gains and forgone interest expense. They can just hold the notes, collect interest, know they’ll get their principal back and partake in any potential stock upside as well. SoFi, in this case, would be at higher risk of covering liabilities with dilution. Its inflection to GAAP profitability diminishes this concern significantly and I consider this outcome to be highly unlikely.

This maneuver makes sense for SoFi, but why would the counterparty grant this option? Aside from the upfront premium collected, it provides a compelling profit structure for the capped call seller. If the stock does nothing, they keep their premium and nothing else happens. As the stock moves up to the $14.54 cap price, the shares they’re holding increase in value to offset the diminished value of the capped call contract that is sold. Beyond $14.54, losses are capped as the contract is settled. Downside risk protection paired with a large upfront premium makes it clear why the counterparty would do this deal.

And finally, for the buyers of the original convertibles, they don’t care about these secondary deals taking place. They solely care about their notes becoming more valuable over time and collecting that 1.25% annual yield. The buyers of the notes could easily be the same sellers of the capped call transactions (we won’t know for sure). Regardless, the point remains. Convertible note holders will still want more valuable notes regardless of whether they also sold the capped call to SoFi or not.

From this week’s news, there are a few capped call transaction items to note. SoFi will enter capped call arrangements that “initially cover the number of shares of common stock that initially underlie the notes.” Separately, it will amend the current capped call transaction connected to retiring 54% of its 2026 notes. While all of this is commencing, counterparty hedges will be built and unwound, which will likely create some incremental share volatility.

Eventual Dilution and Financial Impact of all items together:

We know there’s about 3% dilution from the $600 million 2026 note conversion. The eventual true dilution of the $750 million note raise is uncertain for SoFi. I’m still getting through the final 8K published last night and will include details about potential dilution outcomes from my learnings next week. What we do know is that all of these announcements taken together will boost net income, boost tangible book value and boost its capital ratios. For vitally needed context, per SoFi leadership, it will be neutral for profit per share. This means the earnings boost will roughly offset the dilutive impact on a 1-for-1 basis. The reason I can’t stand dilution is because it erodes earnings power. This context means that dilution in this case won’t. SoFi leadership knows its plans for handling these deals better than you or I ever could. It has earned my trust consistently since going public. I trust them here when they say this.

Stock Volatility Following the News:

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On the stock’s volatility following the news, I think there’s actually a solid explanation aside from the 3% dilution with the 2026 note conversion. This news took me a few days to understand. I have a Master’s Degree in Finance. I have direct capital market and RIA experience and conduct fundamental stock research for a living. If I had trouble fully grasping this (I did), I’m confident that most other investors (including sell-side analysts) did too. I say it to explain that when headlines like this surface, people will assume liquidity issues, crippling dilution and sell. They’ll ask questions later. Further, convertible note holders had strong motivation to see the stock tank up to the closing of the offering yesterday. They want the conversion price to be as low as possible so they can make more if the stock price rises over the coming years.

4. Disney (DIS) – CEO Interview with Morgan Stanley

Financial News: