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COVID’s Impact On Cloud Software Stocks

This is an update to the article “Playing Defense with Cloud Software Stocks” published on May 27th, 2020

Rebound numbers from Q3 will look spectacular following the paralyzing effects of strict shelter-in-place orders in Q2. The economy is officially in a recession after posting two negative quarters of GDP growth at (5%) in Q1 and (32%) GDP in Q2. The latest estimate from Atlanta’s Fed GDPNow for Q3 2020 is showing a record rebound of 35.3%.

This represents an increase of 7.9% quarter-over-quarter and 3.1% below the pre-recession high. For comparison purposes, the Financial Crisis of 2008 bottomed at 4.0% below its pre-recession during the third and fourth quarters of its recession.

The chart above shows the projected Q3 rebound of 35.3% from the Atlanta Fed’s GDP Now released on October 6th, 2020.

Cloud and IT Budgets: Staying Objective

Some will argue the market is not the economy (which is true), however, cloud software can’t stop the spiraling effects of lower IT/cloud spending and tighter budgets that follow a weaker economy. One area that companies might reduce costs is to trim down on the number of cloud software and tools they use. Unemployment could exacerbate this if the subscriptions are paid per employee.

Spiceworks recently released a survey that shows 80% of IT-decision makers expect IT budgets to grow or stay steady over the next 12 months. This supports the notion that even during periods of uncertainty, IT and cloud are central and critical to operations.

With that said, the decision-makers polled stated the primary drivers in IT budgets are noted to decrease year-over-year except covid-related budget allocations. In the past, drivers such as employee growth, security concerns, and the need to upgrade IT infrastructure were expanding to support higher budgets.

Perhaps more indicative is the decrease in revenue that is being forecast across the 1,000 IT-decision makers that were polled. One-third of businesses expect revenues to increase from 2020 to 2021 which is down from 58%. One-third also expects revenues to decrease YoY which is up significantly from the previous two years when only 7% expected a decline in revenue.

As the survey illustrates, cloud software will be more resilient than many other categories. However, there will be some cloud software companies that see an impact on one side of the equation or both sides of the equation – this means either fewer new customers or more churn or downgrades in existing customers or both. There are three points where weakness can occur (fewer sign-ups, churn, and downgrades). Notably, companies that have annual recurring revenue will be more protected.

In this article, we go back through earnings calls to see what management is saying in each respective company:

These companies had positive things to say about budgets …

Twilio:

“Our customers in nearly every industry have had to identify new ways to communicate with their customers and stakeholders,