The bear market of 2022 was especially unkind to many cloud software stocks, but things started to look up for some of them in 2023. As measured by the First Trust Cloud Computing ETF, the cloud software stock sector is up over 30% through the first nine months of 2023.
Though software businesses are incredibly promising with generally high profit margins and the ability to infinitely scale, not all business models are created equal. Two former darlings are rebounding, but one of them could be a value trap. Here's why.
Alteryx: A transition to the cloud isn't easy
Alteryx (AYX) got some bullish sentiment in the last month, including an analyst upgrade. Share prices are down nearly 30% so far this year, horribly underperforming peers, but have rallied from their lows earlier this summer on cost-cutting optimism and management's belief it will remain a growth business through 2028.
Rumors have also surfaced that the company could be exploring selling itself to a larger tech company -- like Splunk's recently announced sale to Cisco Systems -- or to a private equity firm.
However, this data analytics software specialist has been trying to make a difficult transition from legacy software to cloud-based. Legacy software sales are realized upfront, while cloud revenue is realized over time. That shows up in the difference between lower quarterly revenue growth versus higher annualized recurring revenue (ARR) growth as some customers start to migrate to cloud products.
ARR was up 22% year over year in the second quarter to $890 million, but quarterly revenue was up just 4% to $188 million. Some of the sluggish results also have to do with some customers cutting costs of their own to conserve cash, but it's also a competitive marketplace for data analytics software.
ARR is expected to further decelerate to just 12% to 13% for full-year 2023, and Alteryx no longer has a squeaky clean balance sheet. Cash and investments totaled $749 million at the end of June, offset by debt of $1.2 billion. The company is still at least a couple of years away from generating a profit by all measures, too.
Data by YCharts. TTM = trailing 12 months.
Perhaps a reward is in store if Alteryx sells itself, or if revenue growth and profit margins can improve in 2024. But for now, this stock looks like it has too many risks going against it to warrant a buy.
AppLovin: A value on a successful rebound story?
AppLovin (APP 6.66%) is another pandemic-era darling. It has rallied an incredible 260% so far in 2023, though it remains some 67% below all-time highs reached in late 2021. Even after this big recovery, the stock trades for just under 15 times expectations for full-year 2023 earnings per share. Is this a value, or a value trap?
The secret to AppLovin's comeback is in its software business, which provides services for app developers trying to monetize their work via methods like user acquisition and digital ads. In the second quarter, software platform revenue increased 28% year over year to $406 million. But that was offset by a 25% decline in its apps revenue to $344 million. AppLovin owns a few mobile game studios that make up most of these sales.
Management sees stabilization in its apps business, though that segment is being prioritized to maximize profits. It's the software platform that's really moving the needle, however.
Further growth, driven by AppLovin's latest AXON 2.0 artificial intelligence software-driven services, is expected to push third-quarter revenue to as high as $800 million, a very healthy sequential increase over last quarter's $750 million.
AppLovin is also profitable on all fronts and has been using its positive free cash flow to repurchase stock, including $572 million worth in the first half of this year alone.
Data by YCharts.
One key risk to monitor is the balance sheet, which ended June 2023 with cash and short-term investments of $876 million, offset by debt of $3.2 billion. Nevertheless, with AppLovin having turned a corner on profitability, it looks like it has more than enough quarterly cash flow to service this debt over time.
AppLovin isn't perfect, but this looks like a successful turnaround story in the making. The business is back in growth mode, profitable, and starting to return cash to shareholders via stock repurchases. Don't expect more stock price performance like what happened in the first half of this year, but AppLovin looks like the real deal. It's back on my watch list for cloud-based software stocks.
