MongoDB’s share price (NASDAQ: MDB) has fallen 15% since it released second-quarter results last week. There are legitimate concerns about rising costs and growing competition. However, the company’s business model also opens the possibility for upside surprises in coming quarters.

An important support level has now broken and will result in one of two scenarios playing out. Both would provide trading opportunities in the next few months.

 

Steady Revenue Growth, Accelerating Costs

Second-quarter revenue grew 66.7% year-on-year to $99.4 million. This was $7.67 million ahead of analyst estimates. The bulk of revenue came from subscriptions which grew 71%. The Atlas product grew 240% and now accounts for 37% of sales.

When this company listed in October 2017, year-on-year revenue growth was 113%, though it immediately dropped to 45%. Since then, trailing 12-month sales have grown between 63 and 67% every quarter, and for now, remains steady.

The Non-GAAP loss per share was $0.26, 2 cents ahead of estimates, while the GAAP loss per share was a lot wider at $0.67, and 10 cents behind estimates. The wider than expected loss is a result of increasing costs as the company expands its sales force.

 

Revenue Growth May Accelerate

MongoDB’s solutions to organizing and storing unstructured data are crucial for many businesses moving data and computing to the cloud. So far, the company’s free database has been downloaded 60 million times. The number of paying customers stands at 15,000, more than double where it was a year ago.

The price to sales ratio is 23, which is high but can be justified if sales keep growing at the current pace. Given that Atlas grew sales 240% and is now contributing more to the top line, overall revenue growth may even accelerate.

As with other rapidly growing tech companies, there is a danger that MDB is spending too much to keep the sales momentum going. While many tech companies are trading at very lofty valuations, investors are beginning to pay more attention to profitability, rather than revenue growth.

However, in this respect, there is an essential difference between MDB and many of its peers. MDB uses a freemium business model, allowing companies to use the database for free, up to a certain capacity. As mentioned, the database has been downloaded 60 million times, so far resulting in 15,000 paying customers. That implies a massive pool of potential customers. As non-paying users become more reliant on MongoDB products, they become more likely to become paying customers.

 

A Short Squeeze or a Deeper Correction?

The stock price gapped 15% higher when first-quarter earnings were released in June. Since then the price has formed a head and shoulders pattern, trading as high as $183, and now well below the neckline which is at $138. This implies the gap will close, taking the stock back to the support at $107. This may offer long-term investors an attractive entry point.

It’s also possible the break turns out to be a false break. If that happens and the price does get back above $138, short interest in the stock is very high, and conditions for a short squeeze are ripe.

The bottom line is that if the price bounces, there will be a short to medium-term opportunity for a long position, and, if it stays below $138, long term investors may get a much better chance around $107. Shorting the stock is also an option – but that trade is crowded and needs to be treated with caution.