David Siegel and John Overdeck run Two Sigma Investments, while Ken Griffin runs Citadel Advisors, and all three hedge fund managers have a place on the Bloomberg Billionaires Index. Interestingly, all three hedge fund managers also bought shares of Etsy (ETSY -2.17%) and Cloudflare (NET -0.23%) during the first quarter.
Siegel, Overdeck, and Griffin own thousands of stocks, and Etsy and Cloudflare account for small fractions of their portfolios. But the purchases are still noteworthy given the success the hedge fund managers have achieved. Beyond their status as billionaires, Two Sigma and Citadel beat the market in the first quarter, and Citadel recently became the most successful hedge fund in history.
Currently, shares of Etsy and Cloudflare are trading down 70% and 74%, respectively. Investors should treat that drawdown as a buying opportunity.
1. Etsy
Etsy operates several e-commerce marketplaces, including Reverb for musical instruments, Depop for fashion resale, and Elo7 for handmade goods. But the company is best known for the Etsy marketplace, which specializes in unique and creative goods, the kind of items that cannot be mass-produced or commoditized. That strategy has paid off handsomely. Etsy is the sixth-most popular online marketplace worldwide as measured by monthly visitors.
Etsy reported mixed financial results in the first quarter. The number of active buyers was flat compared with the prior year, and gross merchandise sales (GMS) declined by 5%. Revenue rose 11% to $641 million as the take rate improved by 300 basis points due to higher transaction fees and greater advertising revenue, but cash from operations declined 7% to $56 million. The decline in GMS and cash flow can likely be attributed to economic headwinds, but investors should monitor those metrics closely as economic conditions improve.
Etsy has executed on an ambitious growth strategy in recent years. Its 2020 launch of offsite ads gave sellers the ability to run campaigns outside the marketplace, and its 2021 acquisitions of Depop and Elo7 gave Etsy a stronger presence in the apparel vertical and a better foothold in Brazil. More recently, the company launched a purchase protection program to improve buyer confidence, and it launched a star seller program to identify exceptional customer service.
More importantly, Etsy has ambitious plans for the future, and improving marketplace search and discovery with generative artificial intelligence is a top priority. Management believes adding a conversational component to search (much like ChatGPT) will help buyers find the perfect product more quickly. Etsy also uses AI to better personalize the search experience and showcase the highest-quality products on the marketplace.
Etsy currently has a market cap of $11 billion, and investors may wonder if the niche e-commerce company can get much bigger, but management sees plenty of room for growth. Etsy values its addressable market at $466 billion, or $2 trillion if products currently sold offline are included.
With that in mind, shares currently trade at 4.6 times sales, very near the cheapest valuation in the last five years. That creates an attractive buying opportunity for patient investors.
2. Cloudflare
Cloudflare offers a broad range of cloud computing services that enhance the performance and security of corporate applications and infrastructure. It also provides developer tools and storage solutions that allow businesses to build performant software and websites. Cloudflare has distinguished itself through engineering expertise; it operates the fastest cloud network and developer platform on the market, and its infrastructure is effectively the backbone of the internet. About 20% of the web runs on Cloudflare.
Cloudflare delivered solid financial results in the first quarter, though growth has slowed amid the challenging economic climate. Its customer count rose 13% to 168,000, and the average customer spent 17% more. In turn, revenue climbed 37% to $290 million, and the company reported $36 million in cash from operations, up from a loss of $36 million one year earlier. Investors have good reason to believe that momentum will continue and perhaps even accelerate as economic conditions improve.
Cloudflare values its total addressable market (TAM) at $146 billion, and three products account for a big portion of that sum. The first is Cloudflare One, a secure access service edge (SASE) that protects and connects users with corporate resources from any device or location. Consultancy Gartner believes SASE platforms are the future of corporate networking; analysts believe that 80% of enterprises will deploy SASE solutions by 2025, up from 20% in 2021. Cloudflare is well positioned to benefit from that tailwind because it powers 20% of the web, meaning it has deep insight into security threats across the internet.
The other products that account for a large portion of Cloudflare's TAM are its developer platform (Cloudflare Workers) and its object storage solution (R2 Storage). Here again, the company is operating from a position of strength. Workers are the market-leading edge development platform, according to Forrester Research, and R2 Storage is faster and cheaper than its direct competitor Amazon S3 Standard. Cloudflare made R2 generally available last September, but many up-and-coming internet companies are already using the product, including several generative artificial intelligence companies.
Cloudflare is well positioned to grow its business, and with shares trading at 17.4 times sales -- a discount to the three-year average of 41.8 times sales -- now is a good time to buy a small position in this growth stock.
