MDB - MongoDB: Time To Lock In Gains (Rating Downgrade)

2023-06-27 03:45:17 ET

Summary

• MongoDB has seen a significant rally year to date, with its stock price up more than 100% year to date.
• The company benefits from strong growth at scale and secular tailwinds but faces risks such as large GAAP losses and competition from Oracle.
• The recent rally positions MongoDB's valuation at ~17x forward revenue, which makes these risks more transparent to highlight.
• The fact that over-enthusiasm for generative AI (for which MongoDB has noted some workload shift over into its platform) may lead to a bust makes me additionally wary of this stock.

With the Fed not quite committing yet to lowering or even pausing interest rate hikes, many investors are wondering if the sharp rally that we've seen in the markets since the start of May can be sustained. The gains have been especially notable in tech stocks, which shook off a very weak second half of 2022 to rebound.

MongoDB ( MDB ), in particular, has nearly clawed its way back to 2022 levels. Up more than 100% year to date, the gains started accelerating in June as MongoDB reported excellent Q1 results. The question for investors now is: can the rally keep going?

I made a fortunate bullish call on MongoDB at the start of this year that has, needless to say, paid off handsomely. It's tempting to look at the strength of MongoDB's price chart over the past two months and say the stock has reached a cliff, but now is not the right time to be greedy - especially with so much uncertainty over interest rates. Owing primarily to valuation, I'm pivoting to neutral on MongoDB and locking in the gains on my trade.

It would be remiss not to acknowledge the fact that MongoDB is still a fantastic company, fundamentally speaking. I still see a number of tailwinds driving the bull case for MongoDB:

• Growth at scale. Very few companies that have reached a >$1 billion annual run rate are still growing revenue north of >50% y/y, and MongoDB is one of those few. That's a testament to the all-encompassing, horizontal nature of MongoDB's product. Almost all companies now have a use for managing unstructured data, and its technology is broadly applicable across a wide variety of use cases.

• Secular tailwinds. More and more these days, companies and brand marketers want to capture consumer data coming from "unstructured" sources - Tweets, social media posts, and the like. Traditional databases which store data in a columnar format are not equipped to handle this. MongoDB's generous growth rates are a reflection of the largesse of the company's space.

At the same time, however, at higher prices I'm more cognizant of several risks:

• GAAP losses are still large. Though MongoDB has notched positive pro forma operating and net income levels, the company is still burning through large GAAP losses because of its reliance on stock-based compensation. In boom times investors may look the other way, but in this more cautious market environment MongoDB's losses may stand out.
• Competition. MongoDB may have called itself an "Oracle killer" at the time of its IPO, but Oracle ( ORCL ) is also making headway in autonomous and non-relational databases. Given Oracle's much broader software platform and ease of cross-selling, this may eventually cut into MongoDB's momentum.

The biggest thing we have to watch out for, however, is MongoDB's enormous valuation. At current share prices near $390, MongoDB trades at a market cap of $27.33 billion. After we net off the $1.90 billion of cash and $1.14 billion of convertible debt on MongoDB's most recent balance sheet, the company's resulting enterprise value is $26.57 billion.

Meanwhile, for the current fiscal year MongoDB has guided to $1.522-$1.542 billion in revenue, representing 19-20% y/y growth:

Taking even the high end of this guidance range at face value (as MongoDB has had an unbroken tendency to "beat and raise"), the stock's valuation stands at 17.2x EV/FY24 revenue. Let's not even mention that from a P/E basis (though as EPS growth is still in its nascent stages, this isn't an entirely fair valuation either) MongoDB is trading at a >200x P/E ratio.

The bottom line here: I view MongoDB as one of the few tech stocks to have returned very close to pandemic-era mania levels. While I can't argue that the company's fundamentals and market opportunity is very strong in a vacuum, it's difficult to see any further upside at MongoDB's high-teens revenue multiple.

Q1 download

Let's now go through MongoDB's latest quarterly results in greater detail. The Q1 earnings summary is shown below:

MongoDB's revenue grew 29% y/y to $368.3 million, beating Wall Street's expectations of $347.1 million (+22% y/y) by a seven-point margin, but also decelerating seven points from Q4's growth rate of 36% y/y. Subscription revenue also grew at 29% y/y, while the smaller slice of professional services revenue grew 25% y/y.

Where MongoDB also exceeded expectations was on net customer adds, adding 2.3k net-new customers in the quarter to end with 43.1k total customers. As the company has focused more on its direct-sales business, it has been able to bring in a wider net of smaller self-service customers. That being said, MongoDB also added 110 net-new customers with greater than $100k in ARR, up 28% y/y.

Management noted that customer consumption trends are above expectations, driven by higher-than-expected underlying application usage. That being said, consumption growth levels are still lower than where they were when MongoDB entered into the macro-driven slowdown in Q2 of last year. Net ARR expansion rates were 120%, indicating that a typical installed base customer spends 20% more in the following year.

Additional investor enthusiasm poured into MongoDB as the company highlighted that customers are choosing the MongoDB platform to build and deploy AI-driven applications. Per CEO Dev Ittycheria's remarks on the Q1 earnings call:

Moreover, the shift to AI will favor modern platforms that offer a rich and sophisticated set of capabilities, delivered in a performance and scalable way. We are observing an emerging trend where customers are increasingly choosing Atlas as a platform to build and run new AI applications. For example, in Q1, more than 200 of the new Atlas customers were AI or ML companies. Well finance startups like Hugging Face, Tekion, One AI are examples of companies using MongoDB to help deliver the next wave of AI-powered applications to their customers. We also believe that many existing applications will be re-platformed to be AI-enabled. This will be a compelling reason for customers to migrate from legacy technologies to MongoDB.

To summarize, AI is just the latest example of the technology that promises to accelerate the production of more applications and greater demand for operational data stores, especially the ones best suited for modern data requirements such as MongoDB.

From a profitability standpoint, MongoDB's pro forma gross margins lifted one point y/y to 76%. Pro forma operating margins clocked in at 12%, six points richer than 6% in the year-ago Q1.

Key takeaways

In my view, the ~2x gain in MongoDB since the start of the year has been a generous run. Yes, a good chunk of that is justified by fundamentals as MongoDB continues on a path of ~30% y/y growth alongside substantial margin expansion, fueled by potential further tailwinds from AI workloads migrating onto the platform - but it's difficult to justify a ~17x forward revenue multiple. Retreat to the sidelines here.

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