Baron Technology Fund: Latest Insights and Commentary

CONTRIBUTORS

• NVIDIA Corporation sells semiconductors, systems, and software for accelerated computing, gaming, and GenAI. NVIDIA’s stock rose on continued strong demand for its GPUs at the epicenter of the generative AI revolution. NVIDIA continued to report unprecedented rapid growth at scale, with quarterly revenues of $26 billion growing 262% year-over-year, datacenter segment revenues of $22.6 billion up 427% year-on-year, and operating margins of 69.3%. NVIDIA’s growth is even more impressive as it is nearing a new product cycle with the Blackwell chip going into production in Q3 and speaks to the urgency of demand for GPUs as customers are not willing to wait for the next generation architecture despite its improved performance-to-cost ratio. Management has commented as well that Blackwell would be supply constrained well into 2025. While the stock's strong performance has pulled forward some of the longer-term upside (which we manage through position sizing), it is still early in the accelerated computing platform shift and the adoption of GenAI across industries.
• Broadcom Inc. is a global technology leader with a broad range of semiconductor and infrastructure software solutions. Its semiconductor solutions focus on digital, mixed signal, and analog products across a variety of end markets, while its software products help customers plan, develop, automate, manage, and secure applications. The stock rose on strong earnings results on the back of two key growth drivers, AI semiconductors and the VMWare acquisition. The company once again increased its outlook for AI-related revenue, now expecting $11 billion or more this year, up from a prior estimated $10 billion. VMWare remains on track for rapid sequential growth while reducing operating expenses, driving faster-than-expected margin expansion and accretion. We believe Broadcom is a key beneficiary of AI infrastructure investment, with its industry-leading switching silicon and other chips and its custom silicon business supporting hyperscale customers with their own custom accelerators. We also believe the VMWare integration will drive more accretion than current consensus forecasts.
• Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited (TSMC) contributed in the second quarter due to expectations for a continued strong cyclical recovery in semiconductors and significant incremental demand for AI chips. We retain conviction that TSMC’s technological leadership, pricing power, and exposure to secular growth markets, including high-performance computing, automotive, 5G, and IoT, will allow the company to sustain strong double-digit earnings growth over the next several years.

DETRACTORS

• CoStar Group, Inc. is a provider of marketing and data analytics services to the real estate industry. Shares detracted from performance in the quarter along with the broader software sector. Most software companies experienced a slowdown in new sales activity in early 2024, leading to guidance reductions and multiple compression. We believe CoStar shares were also impacted by concerns that the company’s second quarter financial results will show a deceleration in net new sales of its residential product following outstanding first quarter performance. We remain encouraged by traction in CoStar’s residential offering although recognize that progress may not be linear. CoStar began to monetize its new Homes.com platform in February. We believe early momentum can be amplified by the recent NAR class action settlement, which has the potential to disrupt the residential brokerage industry and enhance the return on investment for brokers advertising on Homes.com.
• Advanced Micro Devices, Inc. (AMD) is a global fabless semiconductor company focusing on high performance computing technology, software, and products, including CPUs, GPUs, and FPGAs. Shares fell during the quarter as investors wrestled with AMD’s competitive positioning in the AI compute market relative to NVIDIA, which continued to strengthen its full-system solution offerings at a rapid pace. AMD also updated its MI300 revenue expectations for the full year to “greater than $4 billion," missing high investor expectations despite being more than $1 billion over the prior revenue estimate. Over the long term, we believe AMD and its unique chiplet-based architectures will play a meaningful role in the rapidly growing AI compute market while it takes share from Intel within traditional data center CPUs, albeit now a slower growth market than prior expectations. With its strong product portfolio based on proprietary designs and advanced packaging, AMD is well positioned to benefit from share gains and underlying market growth.
• Workday, Inc. is an on-demand financial management and human capital management software vendor. Shares fell in the quarter. While subscription revenue obligations and guidance were in line with consensus, this marks the second straight quarter of weaker bookings growth, with 12-month subscription bookings decelerating to 13% year-over-year in FQ4 2024 and 12% year-over-year in FQ1 2025. Management noted extended deal cycles and customers committing to lower headcount on renewals than the company expected. Workday appears to have derisked forward guidance by assuming that weaker headcount addition trends and lower close rates persist throughout the year. With shares trading at 22x enterprise value/fiscal 12 months, valuations appear attractive. 

Baron Technology Fund (the Fund) rose 7.09% (Institutional Shares) in the second quarter, failing to keep pace with the MSCI ACWI Information Technology Index (the Index), which increased 11.38%. The relative shortfall was driven by active security/industry exposures and, to a lesser extent, stock selection.

About two-thirds of the underperformance came from the Fund’s unique exposure to certain technology-related companies that are classified outside of Information Technology, such as CoStar Group, Inc. in real estate management & development, Amazon.com, Inc. in broadline retail, and Ibotta, Inc. in media. CoStar’s share price declined alongside the broader software industry during the quarter. Many software companies experienced slowing new sales activity in early 2024, leading to guidance reductions and multiple compression. We believe CoStar shares were also impacted by concerns that the company’s second quarter financial results will show a deceleration in net new sales of its residential product following outstanding first quarter performance. We remain encouraged by traction in CoStar’s residential offering although recognize that progress may not be linear. CoStar began to monetize its new Homes.com platform in February. We believe early momentum can be amplified by the recent NAR class action settlement, which has the potential to disrupt the residential brokerage industry and enhance the return on investment for brokers advertising on Homes.com.

Shares of Amazon, the world’s largest retailer and cloud services provider, underperformed despite rising more than 7% in the period. The company reported results that were better than expected, particularly with another large beat in overall operating profit. We believe Amazon is well positioned in the short to medium term to meaningfully improve core North American retail profitability to above pre-pandemic levels, benefiting from its new regionalized fulfillment network and its fast-growing, margin-accretive advertising business. We also believe Amazon's cloud division is re-accelerating from a period of customer cloud optimization. Longer term, Amazon has substantially more room to grow in e-commerce, where it has less than 15% penetration in its total addressable market. Amazon also remains the clear leader in the vast and growing cloud infrastructure market, with large opportunities in application software, including enabling generative AI workloads.

The Fund acquired shares of Ibotta when the company came public during the quarter. Ibotta is the leader in consumer rewards and incentives, with more meaningful scale, better technology, and sharper focus than legacy competitors, in what we believe is a winner-take-all market. After rising initially from its initial offering price of $88 per share, Ibotta’s stock declined after the company’s financial results fell short of lofty Street expectations. While the Walmart partnership is ongoing and other potential retailer partners remain in discussion, the extended timing of new initiatives from the partner side led to a slower ramp in third-party users. Longer term, we see multiple drivers for a long runway of more than 20% year-over-year growth and expect the model to generate significant free cash flow. In the blue sky scenario, there are potential opportunities beyond traditional rewards, specifically access to item-level transaction data and the massive value that can be unlocked through this level of targeting and personalization.

The remaining allocation-related shortfall came from the Fund’s significantly lower exposure to Index heavyweight Apple Inc. in technology hardware storage & peripherals, whose strong performance was a 140-plus basis point headwind in the period. Apple’s shares rose after the company delivered better-than-expected fiscal second quarter earnings results where strong Apple Services sales drove above-consensus earnings and free cash flow. Moreover, during Apple's annual Worldwide Development Conference in June, management unveiled its new Apple Intelligence strategy, which was positively received by investors. Apple introduced impressive new on-device AI capabilities across its iPhone, MacBook, and iPad products that enable users to create new images, summarize and generate text, and more efficiently navigate and perform actions across their digital applications - all while maintaining user privacy and security. The company is also integrating with AI partners like OpenAI to expand AI use cases, and it plans to integrate with other large language model providers soon.

Aside from active security/industry exposures, stock selection was negative due to disappointing performance from the Fund’s holdings in semiconductors & semiconductor equipment and software, where Advanced Micro Devices, Inc. (AMD) and GitLab Inc. were material detractors. AMD’s shares fell during the quarter as investors wrestled with the company’s competitive positioning in the AI compute market relative to NVIDIA, which continued to strengthen its full-system solution offerings at a rapid pace. AMD also updated its MI300 revenue expectations for the full year to “greater than $4 billion," missing high investor expectations despite being more than $1 billion over the prior revenue estimate. Over the long term, we believe AMD and its unique chiplet-based architectures will play a meaningful role in the rapidly growing AI compute market while it takes share from Intel within traditional data center CPUs, albeit now a slower growth market than prior expectations. With its strong product portfolio based on proprietary designs and advanced packaging, AMD is well positioned to benefit from share gains and underlying market growth. Apart from AMD’s underperformance, poor stock selection in semiconductors & semiconductor equipment was exacerbated by the Fund’s lower exposure to NVIDIA Corporation, whose shares continued their strong run of performance during the quarter.

GitLab fell alongside other high-growth software stocks during the quarter after several industry bellwethers like Salesforce.com and Workday (another Fund holding) reported soft results. Investors appeared concerned about IT budget weakness and are evaluating which software companies are at greater risk of disruption from AI. Despite the noise, GitLab reported good Q1 results, with adjusted revenue growth accelerating to more than 34% year-over-year and strong incremental margins. Free cash flow margins exceeded 13% on a trailing-12-month basis, up 27 points year-over-year. User growth was solid, and customers continue to adopt GitLab's higher-priced Ultimate Tier as they seek to utilize developer security features. Both factors led management to raise guidance by more than the Q1 revenue beat. While it is still early to assess the impact of AI on GitLab's business, we were encouraged to hear several case studies about customers adopting GitLab's new Duo AI suite. The new products use AI to help developers write and summarize code, help security teams discover and remediate security vulnerabilities, and accelerate the application development cycle. Longer term, we remain opportunistic that GitLab can continue to win share and grow profitably in the $40 billion developer tool market as customers consolidate more software planning, development, and security work on the platform. Fortunately, weak stock selection in software was offset by the Fund’s lower exposure to this lagging industry.