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Alphabet’s Big Miss

What comes up must come down, you didn’t expect Alphabet’s stock to explode on this earnings report, did you?

Alphabet shares have gone up in a straight line since the beginning of the year, and only a robust beat on the bottom and top line with raised guidance was going to push this stock to higher highs.

Chances of that were low.

I wouldn’t classify Q1 as an awful quarter, but Alphabet was in need of a reset and culling a few hogs from the litter is not always a bad thing.

Shares retraced more than 8% in trading which could be the beginning of a brief but much-needed mini earnings tech recession.

Tech shares have carried the load this year, every continent on the globe wishes they had a tech sector like America does.

Google still has its digital ad duopoly intact and results were driven by ongoing strength in mobile search along with important contributions from YouTube followed by Google Cloud.

Revenues of $36.3 billion, up 17% YOY did not capture the imaginations of investors and this was graded as a big miss by over $1 billion.

This signals a sharp deceleration from Q1 2018 when Alphabet posted revenue growth of 26% YOY.

Growth of over 20% cut down to the high teens is a big deal in the tech world for growth names, and this puts a cap on the price trajectory for the short-term.

Cost per click on Google properties was down 19% YOY which was extremely disappointing even though paid clicks on Google properties were up 39% YOY which somewhat softens the blow.

Most crucially, there is nothing structurally wrong with Alphabet and investors must galvanize themselves around this salient point.

Execution risk reared its ugly head with CFO of Alphabet Ruth Porat explaining “while YouTube clicks continue to grow at a substantial pace in the first quarter, the rate of YouTube click growth rate decelerated versus a strong Q1 last year, reflecting changes that we made in early 2018 which we believe are overall additive to the user and advertiser experience.”

Alphabet pulled a Twitter (TWTR), forgoing short-term profits to focus on maintaining the reputation of the platform and eradicating lingering problems with the algorithm.

The algorithm facelift will make the platform more attractive to digital advertisers going forward as their brand risk is mitigated by Alphabet optimizing their algorithms.

More specifically, this would mean identifying certain unpalatable content that needs to be flat-out removed, and certain ads that should not be bundled with certain content.

More advertisers will slash YouTube ad budgets if they aren’t satisfied with the overall product experience and cannot accumulate positive user feedback.

Getting into the weeds makes us aware that costs aren’t overly exorbitant this time around.

Total traffic acquisition costs (TAC) were $6.9 billion, 22% of total advertising revenues and up 9% YOY but down from 2% YOY from Q1 2018 reflecting a favorable revenue mix shift from network to sites as well as a decrease in the network TAC rate.

Alphabet’s TAC rate rose from the impact of the ongoing shift to mobile, which manifests with higher TAC, but was offset by the growth in TAC free sites revenue driven by YouTube.

The European Commission (EC) and its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law and the associated €1.5 billion fine with it didn’t help quarterly performance.

The fine, in no shape or form, is a threat to Google’s dominance in Europe.

The Google cloud services 9 of the world's 10 largest media companies, 7 of the 10 largest retailers and more than half of the 10 largest companies in manufacturing, financial services, communications, and software.

Some of the companies that will join the Google Cloud are American Cancer Society and McKesson in health care, media and entertainment companies like USA TODAY and Viacom, consumer packaged goods brands like Unilever, manufacturing and industrial companies like Samsung, logistics company UPS and public sector organizations like Australia Post.

The expansion of 2 new Cloud regions in Seoul and Salt Lake City which will open in 2020 will help build on the footprint of 19 Cloud regions and 58 data centers around the world.

Alphabet missed badly on the top line, but comps from last year because of the strength of YouTube would have been hard to eclipse.

Bask in the glory of the reset in price - now it's time to play Alphabet from the long side.

Moving forward, Alphabet has many levers to pull as CEO of Tesla Elon Musk’s rallying cry for the evolution of self-driving cars means that Waymo would reap the benefits first in automated vehicle technology.

Alphabet also has a few tools left in their toolkit such as monetizing Google Maps through selling digital ads on the Maps interface.

I expect a slow grind up for the rest of the year because Alphabet can brandish many weapons with little resistance in front of them, it’s up to them to execute.

April 17, 2019

Tech Letter

Mad Hedge Technology Letter
April 17, 2019
Fiat Lux

Featured Trade:

(ALPHABET DOMINATES WITH GOOGLE MAPS)
(GOOGL), (AMZN), (YELP), (UBER)

Alphabet Dominates with Google Maps

Tech Letter

Remember Google Maps?

Google will start monetizing it, let me tell you about it.

The web mapping service developed by Google gifting access to satellite imagery, aerial photography, street maps, 360° panoramic views of streets has been around since the beginning of this generation of big tech and is what I would consider legacy technology.

Legacy technology is often associated with failure as the out of date nature isn’t applicable to the tech scene and the commercialization of it today.

In a candid letter, Jeff Bezos wrote to shareholders that Amazon will “occasionally have multibillion-dollar failures.”

Silicon Valley tech will have its share of implosions stemming from ill-fated industry decisions correlating to heavy losses.

Google Maps won’t be one of these slip-ups.

However, a whole catalog of instances can be chronicled from Microsoft’s purchase of Nokia’s handset division to Google’s social media foray in Google Plus.

It hasn’t gone all pear-shaped for Alphabet in 2019. I strongly believe they are one of the companies of the year harnessing YouTube in ways consumers never imagined.

Adding color to the story, any remnant of apprehension to any bearish feelings about Alphabet should vanish once investors understand how lucrative Google Maps will become.

Google has spent decades and billions of capital honing the application and in terms of market share they have cultivated a monopoly.

Uber’s S-1 filing shined some light on Google Maps characterizing it as a must-have input into their business saying, “We do not believe that an alternative mapping solution exists that can provide the global functionality that we require to offer our platform in all of the markets in which we operate.”

Uber sunk $58 million integrating Google Maps into its services from 2016-2018 along with continuous payments to its Google Cloud arm to host Uber’s data.

The strong relationship with Uber shows how Alphabet is adept at milking 3^rd party apps for what they are worth.

Alphabet’s stake in Uber is projected to be $5 billion from the $250 million investment in Uber in 2013.

The party doesn’t stop there with Uber paying Alphabet $631 million from 2016-2018 in digital marketing services and another $70 million for technology infrastructure.

To say that Google firmly has its tribal marks tattooed into Uber’s skin is an understatement.

Almost 80% of smartphone users regularly use navigation apps.

Google Maps is the most popular navigation app by a country mile with 67% of market share.

One billion people consistently use Google Maps.

It is the go-to navigation app for nearly 6x more people compared to the runner up app Waze with 12% market share.

The superior performance of the app has allowed it to branch off into a Yelp-like hybrid app accumulating reviews of businesses and institutions that are conveniently dotted around its map.

Multi-functional terrain was integrated to make the maps more 3D and route navigation from point A to B routes has steadily improved since its inception.

The increasing detail showing even roofs of sheds and the Google street view offering a point of view vantage point boosting the reliability of the app.

The result of making the app better is that navigators can easily discern locations and follow routes clearly.

Most would concede that they use the app to look up specific street routes.

By implementing digital ads into the experience, product and service offers will possibly populate in real time as the user glances at the app’s directions.

A vast amount of services such from food to personal grooming to even cannabis club ads could be applicable and ad companies will pay top dollar to post on Google Maps.

Google could also offer personalized recommendations to users and collect an affiliate fee if the user clicks on an attached link transferring the customer to a 3^rd party landing page.

They already benefit from this strategy on Google Flights.

Google might even be tempted to implement a Groupon model with group discounts on services positioned on Google Maps.

Google Maps is hands down the most underappreciated app and most under monetized tech asset in the world.

Another possible revenue generation avenue would be the advent of Google Maps voice ads en route to a destination that would promote a 5 or 10 second voice commercial of a businesses that the user is physically passing by.

The unintended effects of Google’s audacious transformation of their proprietary Map service spells doom for Yelp’s business model.

Google’s move into digital ads of maps effectively means that Yelp will be relegated to an inferior version of Google Maps without the map technology.

Google has accumulated enough personal data to draw up any type of profile for particularly Android users voraciously consuming data on Gmail, Google Maps, Google Search and Google Chrome.

These four data generators will allow Google to formulate a shadow profile based on individual tastes with daily use of these four Google properties.

Alphabet has a time-honored model of building assets that become utilities and once they monopolize the utility, they sprinkle the digital ad pixie-dust effectively monetizing the asset that was once free of charge.

They have followed the same road map for Gmail, Google Search, YouTube, and if Waymo can become a utility, prepare from Google digital ads inside the screens of Waymo autonomous cars.

When many sulked that this could be one of those billion-dollar failures that Bezos whined about, Google has decided to supercharge Google Maps by cross-pollinating the power of Google maps with its digital advertising knowhow.

This powerful cocktail of forces working in tandem will accelerate its revenue growth along with the resurgence of its YouTube digital ad revenue.

I believe this new lever of revenue growth isn’t priced into Alphabet shares yet, and withstanding any random black swan shocks to the broader economy, Alphabet is poised to outperform the rest of the trading year.

Short Yelp on any and every rally - Google has made their business model redundant.

April 15, 2019

Tech Letter

Mad Hedge Technology Letter
April 15, 2019
Fiat Lux

Featured Trade:

(XXXXX)
(SNAP), (FB), (PINS), (TWTR), (GOOGL)

Reaching Peak Social Media

Tech Letter

America is full – that is what domestic social media growth is telling us.

The once mesmerizing service that captured the imagination of the American public has soured in the country that created it.

Online advertising consultant emarketer.com issued a report showing that Snapchat (SNAP), the worst of the top social media outlets, will lose users in 2019.

The 77.5 million users forecasted by the end of 2019 represents a 2.8% YOY decrease.

This report differs greatly from the report eMarketer issued just past August showing that Snapchat was preparing for a rise of 6.6% YOY in 2019.

The delta, rate of change, represents a massive downshift in expectations and the sentiment stems from the widespread saturation of social media assets.

Market penetration has run its course and the players have run out of bullets mainly targeting Generation Z.

These platforms have given up on baby boomers and Snap feels that pursuing the millennial demographic would be an exercise in futility.

Even more disheartening is that between 2020-2023, there will be only a minor uptick of user growth by 600,000 users clamping down on the impetus of a comeback of sorts shackling the business model.

The trend is not mutually exclusive to Snap, Twitter or Facebook, social media as a group will only expand the overall user base by 2.4% in 2020 hardly satisfying the appetite for growth that these companies publicly advertise.

Remember that much of Instagram’s growth originates from borrowing Snapchat users by way of copying their best features.

Even with this dirty tactic, growth seems to be petering out.

Snap’s shares have made a nice double after peaking shortly over $25 after the IPO.

But the double was a case of investors believing that management and execution had hit rock bottom – the proverbial dead cat bounce in full effect.

Now investors will pause to reassess whether there is another reasonable catalyst to drive the stock higher.

First, investors will need to ask themselves, is Snap in for another double?

Absolutely not.

So where does Snap go from here?

I believe they will borrow from the playbook of Mark Zuckerberg and attempt to emphasize supercharging average revenue per user (ARPU).

Whether the company arrives at this conclusion by chance or strategy, they must confront the reality that there are almost no other levers to pull if they want to perpetuate this growth story.

M&A is also off the table because the company is burning through cash.

Facebook’s (ARPU) came in at $7.37 last quarter indicating how Snap needs to make substantial headway in this metric with last quarter’s paltry (ARPU) at $2.09.

Essentially, management will conclude that each user isn’t absorbing enough ads because of declining user engagement.

Snap CEO Evan Spiegel will need to improve the pricing power charging advertisers at higher rates.

Obviously, the lack of an attractive platform resulting from poor execution and engineering problems needs a quick turnaround.

It’s not all smooth sailing for Facebook either, they keep chopping and reshaping strategy by the day attempting to minimize costs as the regulation burdens rot at the bottom line.

On the bright side, regulation hasn’t been as bad as initially thought – usership hasn’t dropped by orders of magnitudes.

In fact, Facebook’s users have shown a resurgent indifference to Facebook chopping up their data and repackaging it to 3^rd parties, meaning Facebook has come through rather unscathed in the face of a PR storm.

There have even been recent reports of Zuckerberg being persuaded to start paying journalists for original content, a vast pivot for his hyped-up propaganda machine of being in the distribution business.

Juicing up (ARPU) is the lowest hanging fruit on offer for Snapchat and Facebook right now, overperforming in this sphere will improve financials and keep the mosquitoes away while affording them time to ponder how to reaccelerate user growth.

One outsized negative trend is that 90% of user growth appears to originate from undeveloped nations with a lack of discretionary spending power showing that this strategy has its limits.

Searching for another tool in its toolkit will redefine Snapchat, Twitter, and Facebook as we know it.

I would even classify it as an existential crisis.

Instagram have bought Facebook the most time to readjust its future direction highlighting that stealing Snapchat’s audience is still effective, expecting user growth to climb to 106.7 million US users, up 6.2% from 2018.

Instagram will continue its expansion by adding nearly 19 million new US users by 2023, but as much as it adds to its new social media asset, Facebook will be struggling for new net adds.

Snapchat is in dire straits and the stock market bubble could support the share price for up to another 8-12 months, but when the guillotine drops on Snapchat, the blood will smatter everywhere.

The company also plans to introduce a gaming service to take advantage of the popularity with its core users, Generation Z.

This should be the trick that breathes life into operating margins and (ARPU) which is why I believe the stock will hold up for the next period of time.

But with the gaming initiatives also comes rampant competition with the likes of Alphabet (GOOGL) and don’t forget Fortnite is still the 800-pound gorilla.

These trends also bode negatively for Pinterest (PINS) who might be going public as the last shot of tequila is downed at the after party.

SNAPCHAT ARPU

April 11, 2019

Tech Letter

Mad Hedge Technology Letter
April 11, 2019
Fiat Lux

Featured Trade:

(THE MEANS TO A FRIGHTENING END)
(AMZN), (FB), (GOOGL), (AAPL)

The Means to a Frightening End

Tech Letter

Death of websites.

I love doing presentations to small businesses on my free time, partly to stay in touch with the pulse of the Davids who have the unenviable task of fighting uphill against the Goliaths.

It’s bad enough that the tech giants have scaled locally turning one’s local playground into a disadvantage.

The presentation is aptly titled "Content is King... But Only Through One’s Ownership" where the same parallels are explored and unpacked for my audience.

Proprietary Content – must be yours and you must own it on your own turf - your blog, your vlog, your app, and so on, it goes for everything.

Repurposing content on other platforms as a supplement to your own is one thing, but the moment you adopt an enemy platform as your main platform, that’s your coup de grâce.

SMEs (small businesses enterprise) believe it’s plausible to work with the higher ups, but don’t forget they have every incentive to cut you off from the fountain of youth.

One could say the best skill big tech has today is undermining their competition.

Facebook doesn’t allow posting content that criticizes Facebook, have you ever wondered why?

Website innovation has grinded to a halt because of the PageRank algorithm from Google, everybody is making websites the same, a top nav, descriptive text, a smattering of images and a handful of other elements arranged similarly.

Google’s algorithms and the self-regulating nature of their ecosystem have perverted the chance to have a unique online experience.

Most internet users have probably discovered that most websites don’t work well and the execution of them is lousy.

Many companies are not contributing enough resources to build out their site properly, or just don’t have the cash to fund it or a mix of the two.

About 95% of customer service calls originate from the company’s webpage because of payment problems, disfunction, misleading content, or simply because the website is down.

Ask any small business and they will tell you they deal with their domain being down for hours at a time because of some unknown server problem.

Not only is capitalism only working for a small group of Americans, but so are websites, such as massive companies like Amazon.com who have worked wonders with its e-commerce site.

Because the internet and namely websites are the key to building businesses, Silicon Valley is now using the concept of websites and their position as de-facto moderators to prevent others from developing proper websites, killing off the competition.

Alphabet is notorious for ranking their own products at the top of page one of any Google search.

Amazon has followed the same practice by sticking their in-house brands at the top of any Amazon search on Amazon.com.

And remember that none of this can be called “antitrust” because these borderline tactics offer consumers lower prices but that is only because consumers are brainwashed to believe Amazon offers the lowest price.

What if the same products are available for half of Amazon’s in-house brands, would Amazon volunteer to post their in-house brands on the second page, the graveyard of search results?

I would guess no.

Websites used to give businesses a chance, remember in the mid-90s when a website of any ilk was impressive as if someone was walking on water.

What can we expect next?

Amazon, Google, and Apple are taking their shows to artificial intelligence voice platforms.

SMEs could at least throw hail marys on standard internet searches with visual screens, but once content migrates over to voice platforms owned by Silicon Valley, then its game, set, and match.

For instance, a local business such as Joe’s Furniture Moving Business who, with the internet and visual screens, is searchable through search engines and can be even located on Google Maps with a concrete address.

Once we migrate the lions share of content to voice platforms over the next 15 years, Google Home, Apple HomePod, or Amazon Alexa could easily choose to remove Joe’s Furniture Moving Business information because they make more money offering you information of a moving service they own or have a stake in.

The advent of 5G will refine the voice technology and enhance the machine learning techniques needed to complete the migration of content.

Once the world crosses an inflection point where the technology and volume of content on smart speakers outweigh the hassle to use a keyboard or mobile screen, this effectively makes these smart speaker manufacture Gods of the World because they will own the voice-based internet.

They will be the gatekeepers of all global information, business, and development in the world and we will need to satisfy their algorithms to get our own content uploaded on their voice platforms.

And because of the nature of voice, users cannot see what else is out there, users will only hear what these companies tell us offering an outsized opportunity to manipulate the user experience generating more dollars for these powerful platforms.

By the end of 2019, 74 million Americans will be using smart speakers, giving these smart speaker firms adequate data to fine tune their products.

Eventually, all Americans will be forced to use it or will not be able to function, similar to the effects of a laptop, email, and smartphone combination now.

Once these voice platforms become ubiquitous, websites will be deemed irrelevant – consumers will simply have a choice of Google Home, Amazon Alexa, and Apple HomePod and blindly trust what they tell you is in your best interests.

Pick your poison.

That’s right, users won’t control content in about 15 years, a scary thought, and now you understand why these companies will even give their voice A.I. platforms for free if they have to and probably will in the future.

April 3, 2019

Tech Letter

Mad Hedge Technology Letter
April 3, 2019
Fiat Lux

Featured Trade:

()
(GOOGL), (NFLX), (AMZN)

YouTube’s Big Move Into India

Tech Letter

YouTube has to be the online streaming asset of the year even relegating Netflix (NFLX) to the minor leagues – I’ll tell you why.

India is the new China.

Netflix’s growth strategy is intertwined with India and the management has been extraordinarily vocal about their interests there.

The Indian online streaming renaissance isn’t just fueling Netflix’s rise. In fact, YouTube and its free platform are performing miracles along the Ganges River.

How big is YouTube in India?

YouTube already has 245 million monthly active users in India penetrating 85% of the country’s internet population making India one of its best-performing markets.

The company says more than 60% of its streaming hours in India come from outside the six metros, meaning YouTube has captured the hearts and minds of the rural population who cannot afford to pay for online content.

KPMG forecasts India’s online streaming audience to surpass 550 million by 2023 and YouTube will capture 70% of the 550 million audience.

How did YouTube manage to do this?

First, the content is free with ads allowing rural Indians to join in.

Second, local Indians became hooked on Alphabet’s YouTube with Alphabet (GOOGL) taking an already brilliant platform and supercharged it by tailoring it to popular local influencers that are joining in droves inciting a massive network effect.

Effectively, YouTube attracted these influencers with eye-popping audiences to create organic and original content without the $8 billion Netflix planned content budget in 2019.

YouTube was able to do this by borrowing the Instagram format but transferring it to a more effective video platform model.

Take for instance Nisha Madhulika whose channel has blossomed into one of the most popular Hindi language-based online cooking channels on the internet.

To see one of her videos, please click here.

Her channel has over 6.8 subscribers, yet, accumulating subscribers is one thing, and making money is another.

Past videos that were posted around 2-3 weeks ago have views between 200,000 to 400,000.

These influencers build up revenue by displaying 3^rd party ads generated by Alphabet.

A general rule of thumb is that for every 1 million view, ad revenue collected is around $2,000.

Therefore, Nisha and fellow YouTubers with massive audiences are incentivized to pump out high-quality content in high volume.

Scrolling through her numbers, Nisha appears to average around $700 of revenue per video.

She sprinkles in the occasional viral video that garners 1.5 million views which would earn her a tidy $3,000 for a single video.

Not bad and that is before any of the possible marketing opportunities are quantified.

As long as she focuses on the quality of the videos, she can consistently earn $700 per video, then she can do more by partnering with affiliates to sell 3^rd party products and receive a commission that is trackable through the links she leaves at the bottom of her videos.

Nisha’s video business works like this, her channel entails producing 3-5 short videos per week producing around 9-11 million views per month adding up to between $18,000-$22,000 in revenue per month.

Remember that while she is accumulating views for newly posted videos, there are still viewers rummaging through her older content demonstrating the beauty of the network effect.

Older videos in Nisha’s case usually add an extra $3,000-$5,000 per month to the bottom line in pure profit.

Many influencers curate, edit, design, and film the content themselves, or subcontract these jobs for a cheap fee.

An influencer could run their YouTube channel for less than $100 per month minus the fees for the equipment.

YouTube has created a powerful platform for content creators to monetize their original content and give them incentives to stick around and build a business.

Netflix has more of a mercenary model where they contract highly paid actors to contribute a finite amount of content for a fee.

YouTube’s model penetrates to the heart of the average person with regular people instead of propping up overpaid Hollywood actors like Netflix.

In many cases, YouTube’s influencers offer live, raw, and personal access, and the data suggests that live, unscripted content are one of the most monetizable types of content on the market due to its original nature and unpredictability.

That is why live sports like the NFL and NBA are easy to sell, monetize, and in great demand.

I do believe that Netflix has a great product but overpaying for Hollywood’s best talent is not sustainable because the cost-benefit ratio isn’t worth it, which is why Netflix is raising customer prices to monetize the quality of streaming content better.

With other big tech players coming into the market, it will push up the costs for Hollywood talent putting more short-term pressure on their financial model.

Even if Netflix does get the right actors to provide content, they do have their fair share of bad movies.

YouTube’s performance in India will be hard to compete with, even harder when they avoid expensive mistakes, a bad video is simply glossed over and ignored.

Netflix is in the midst of testing a mobile-only Indian subscription package for around $3.64 per month, or 250 Indian rupees, to respond to YouTube’s godlike presence there.

Remember that most rural Indians do not have access to hardware such as computers, laptops, or tablets, and run their lives with cheap Chinese smartphones from Oppo and Vivo.

If you thought $3.64 was a cheap streaming package, then Amazon (AMZN) takes it one step further by offering Amazon prime video for $1.88 per month or 129 Indian rupees.

I like Netflix’s product and the narrative is still intact, but I adore and love YouTube’s transformation that has caught many of us by surprise.

This massive shift wouldn’t be possible without Google’s army of best of breed ad tech.

Even more poignant, YouTube takes direct to consumers to a rawer entry point enhancing the special experience.

The problem with Hollywood talent is that reformulating them onto Netflix’s platform brings them closer to the audience to a certain degree, but not like Nisha’s cooking channel where she can speak directly to the viewer and even interact with her audience in the comment section.

YouTube has mastered this relationship between content creator and audience, and no matter how many times I watch Will Smith’s Bright, I can’t expect him to reply to my comments.

Well, there’s not even a comment section on Netflix’s platform.

In short, Netflix’s Indian strategy is incomplete and I predict that YouTube will extend its lead there because the scalability is well-suited for the Indian rural audience who have little or no discretionary income.

The freemium model wins out again.

Affixing a Netflix grade streaming asset to Alphabet’s booming digital ad business is a match made in heaven.

Buy Alphabet on the dip – YouTube’s outperformance in 2019 will surpass expectations and carry Alphabet shares to new all-time highs this calendar year.