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The Great Tech Company You've Never Heard Of

As volatility rears its hideous head, it’s not necessarily the best time to catch a falling knife as tech companies have been scrutinized harshly lately.

But the market is always right, and waiting for them to drop into your lap will serve you in good stead, even more so for the higher beta tech names that can behave more petulant than a little child.

Roku (ROKU), AMD (AMD), and Square (SQ) are a few of these smaller names with prodigious growth stories backed by secular tailwinds.

These up-and-comers regularly experience 5-7% setbacks, while sturdier names such as Microsoft (MSFT) pull back 1-2% allowing you to sleep soundly at night.

Another influential company taking the liberty to infiltrate the backend of every global and local company is no other than communications software company Twilio (TWLO).

Many of you might not have heard of them, and it doesn’t sound like such a sexy company right off the bat but I am sure you have heard of companies such as Uber, Lyft, and Airbnb.

Why do I mention these three private tech companies that are on the verge of going public next year?

Because this trio of unicorns are all powered by Twilio’s communication technology that is best of breed in their genre of cloud software.

More specifically, Twilio is a platform as a service (PaaS) firm offering programmatic phone call functions, can automate sending and receiving text messages, and performs other communication functions using its web service APIs.

When your Uber driver calls asking you to reveal yourself out of a concrete apartment block or your lavish gated community, this is all facilitated by Twilio’s technology.

At the recent Twilio Signal Conference in San Francisco, Twilio indicated that its latest “call center in a box” product called Flex was up and running after announcing it this past March.

Prior to Twilio’s roll-out, this type of call center functionality was only reserved for the Fortune 500 companies that could afford expensive software to serve its minions of customers.

The small guy was left out in the cold as usual.

Twilio has reshaped the call center and, at $1 per hour or $150 per month, has made itself a gamechanger for SMEs who don’t have the manpower or capital to fund exorbitant back-end operations.

Twilio is really going after anyone with a light or bulky-shaped wallet as you see from their all-star lineup of customers. U-Haul, real estate website Trulia, and data analytic firms Scorpion and Centerfield are just a few of their customers proving the incredible flexibility of the software.

It’s not a shock that this stock has gone ballistic in 2018 surging over 200% and I must admit, investors need to wait for this molten hot stock to cool down.

But how can you blame a company that habitually tears apart any expectation of them devouring expectations because of its super growth model and rapid broad-based adoption?

From the fourth quarter of last year, revenue accelerated to 48% YOY and Twilio followed that up with a blistering 54% YOY quarter.

Then they pulled a shocker guiding down only expecting 35% to 37% growth but dismantled any whiff of jangling investors' nerves by posting another quarterly growth rate of 54%.

If you average out the three-year sales growth rate, few can topple the 57% Twilio has registered.

Performance has been fantastic, to say the least, and Flex could be the product that cements their industry lead and widens the moat around them.

Airbnb, Uber, and Lyft will avoid tinkering with the back end of their operations before their 2019 IPOs boding well for Twilio who are on a hot streak scoring a series of big contracts.

Twilio has been embroiled in further recent stock weakness as they gobbled up SendGrid (SEND), a mass-email marketing software service, for $2 billion.

SendGrid is growing sales at a lower rate in the mid-30%, and this move will add to top line growth.

Synergies from this acquisition are numerous and Twilio will be able to cross-sell to SendGrid’s customers who can apply other communication tools to use.

Telecommunication product in the past was truly unaffordable for the bulk of companies and now that Twilio can bring in all the smaller companies, the SME landscape is poised to change.

Software is becoming powerful to the point where one person living in a basement will have the access to a software that could convince customers a 100-man team is putting this product altogether.

Flex allows customers to personalize this contact-center-in-a-box software for each specification.

It can even quickly integrate into CRM platforms like Salesforce (CRM) which is a wildly popular interface for companies around the world.

Twilio Autopilot, Twilio’s oral conversational AI tool, offers machine learning bots who deliver automated voice-activated functions to customers.

Companies can easily type what they want bots to orate to customers and simply paste it into the code with ease and minimal hassle.

Twilio’s updated payment capabilities offer a new API for building payment experiences by contacting center agents who can now securely accept credit card payments from customers over the phone without the agents ever getting a whiff of the actual numbers.

Effectively, this allows any business in the world to professionalize their communications and backend department to a point they could have never imagined a few years ago.

The saying rings true when industry experts note that it’s the best time to become a billionaire and worst time to become a millionaire because the power of leveraging these robust software programs could potentially fuel the rapid rise of anyone in the world who will eat everybody else’s lunch.

If you break down the numbers, most companies are still holding on to their legacy systems of yore.

Being saddled with outdated hardware and software will doom companies going forward as the explosion of brilliant software modernizes companies in a few clicks of the mouse.

Twilio has added another 15,000 developers to the 35,000 already on the books and the purchase of SendGrid can no doubt be attributed partially to a talent grab of developers who have deep experience building communication-based products.

These types of developers don’t grow on trees.

Last year saw Twilio bring in about $400 million in sales and I am modeling for around $1 billion in sales by 2021.

This $7 billion market cap tech darling has a long runway ahead of itself and investors looking for high-volatility, high-reward stocks can tuck this one away in their sheath.

With earnings coming up and an already 200% plus pop this year, there will be better entry points into this ebullient company if investors are patient.

Wait for a dip to get in on the best communication-based cloud company on the market.

November 5, 2018

Tech Letter

Mad Hedge Technology Letter
November 5, 2018
Fiat Lux

Featured Trade:

(GET READY FOR ANOTHER BITE OF THE APPLE)
(AAPL), (ROKU), (MSFT), (PYPL)

Get Ready for Another Bite of the Apple

Tech Letter

The biggest news of Apple’s earnings results was what Apple decided they will not do in the future – stop publishing iPhone unit sales.

I applaud CEO of Apple Tim Cook for putting this to rest because it is starting to get out of hand. The outbreak of criticism and grief targeted at Cook has to stop because analysts do not understand.

On one hand, it’s important to be aware of the metrics tech companies are judged on, but if analysts aren’t in tune to what these numbers mean in the bigger scheme of things, then it is irrelevant.

Apple is doing everything it can to turn into a software company. They are not interested in battling it out at the low-end of the totem pole because that path is a scrap down to zero margins.

Migrating up the value chain is something that management has identified, and this strategic shift should be met with rapturous celebrations.

Unit sales growth, gross payment value, and monthly views are all metrics that growth companies hold dear to their heart and a way to show to investors they are worth investing in regardless of the cash burn and cringeworthy operating margins.

Apple is way past that point if you haven’t noticed and should be focusing on how to monetize the existing base of customers.

Plain and simple, Apple is not a start-up growth company and taking away this reporting metric will help investors refocus on the real story at hand which is its core of software and services.

With software and services, profitability by way of innovative software offerings will be magnified and highlighted as the roadmap ahead.

As for the last batch ever of iPhone data, Apple has done a brilliant job, to say the least. They exceeded all expectations by smashing the average selling price (ASP) of iPhones at $793.

This is a monumental jump from $618 at the same time last year, a 28% YOY increase.

I did not say that Apple is the world’s best tech company at the Mad Hedge Lake Tahoe Conference, but I did say Apple is by far the highest quality company and this earnings report is a great example of that.

EPS routinely is beat and raised on a sequential basis.

Doubling down on the theme of quality is the revenue numbers from Japan which were up 34% YOY for a group of people who have the harshest view of quality control in the world.

Believe me, Japanese consumers have no desire to ever buy a Chinese smartphone.

The spike in ASPs was triggered by a flight to its collection of ultra-premium smartphones that has enthralled consumers. The ballooning ASP prices led iPhone revenue to spike 29% YOY to over $37 billion crushing the almost $30 million in quarterly revenue the prior year.

According to data from Hyla Mobile Inc., American iPhones traded in between July 1 and the end of September were 2.92 years old on average, up from 2.37 years old the same period two years earlier.

The reasons are two-fold.

Companies are producing better performing smartphones negating the need to impatiently upgrade right away.

The second reason is that they are just plain out pricey, and not everybody will have the dough to splurge on a new iPhone every year or two.

Thus, Apple has strategically placed itself in the correct manner by producing the best smartphone that customers will eventually adopt but carving out as much revenue while consumers are using their phones longer.

During this time, data usage has exploded as consumers are addicted to their smartphones and relying on a whole host of apps to complete their daily lives.

Apple would be stupid to not position themselves to capture this tectonic shift to more hourly data usage and breaking itself from the reliance of smart device revenue itself.

This is what other tech companies are doing like Roku, albeit at an earlier stage in their growth cycle.

In the future, smartphones will become obsolete replaced by something smaller, nimbler, and perhaps integrated with our brain or body or both.

Apple is also acutely aware that the bombardment of Chinese smartphones and the upward trend in the overall quality of these phones has siphoned off part of the iPhone market in specific segments of the world.

Thus, Apple has barely even touched the emerging markets of India that has been flooded by Chinese mid-tier phones without the branding power of Apple.

Apple doesn’t create these trends, they are merely stitching together smart decisions based upon them.

The next step is also a two-pronged proposition.

Apple needs a full-blown enterprise service based upon the cloud.

They can either buy one and they certainly have the cash to do so. Or they can develop one internally from scratch.

The second issue is that Apple also needs to widen its product service offerings that not only include an enterprise cloud option but also entertainment, news, sports, and everything else that could hook user’s attention and stick them to the iOS operating system until death.

Cementing users to the iOS operating system is the overall goal of all of this software infusion because if users start migrating over to the Android platform, it’s real game, set, and match for Apple as we know it.

Instead of myopic analysts focusing on “unit sales”, smart analysts should be focusing on whether what Apple is doing will tie future users to iOS or not.

I am happy with what I have seen so far but there can be a great deal of improvement going forward.

I think my 2-year-old nephew even knows that iPhone sales are maturing by now. This has not been a new story and I would call it poor reporting from a group of lazy-minded analysts.

It’s true that Apple rode the coattails of its miracle hardware products to a $1 trillion market cap. It was a magnificent achievement. I pat all who were involved on the back.

However, it’s clear as daylight that hardware is not what is going to propel Apple to a $2 trillion market cap.

Lost in all the smoke and mirrors is that revenue was up 20% YOY which is a staggering feat for a $1 trillion company.

Even more muddied in the rhetoric is that there has been minimal slowdown in China even after all the trade war jostling which is a miracle in its own right growing 16% YOY.

Software and services were up 27% YOY pulling in $10 billion and the Apple ecosystem has now reached 330 million paid subscribers, a growth of 50% YOY.

Paid subscribers are the most important metric to Apple now as it shows how many users are percolating inside their eco-system wielding their credit card around for software and services whether its maintenance spend or Apple pay.

Apple pay transaction volume tripled in the past year with four times the growth rate of FinTech player PayPal (PYPL).

Wearables still maintain broad-based growth climbing 50% YOY which is slightly down from the 60% YOY last quarter.

All of the wearables such as the amazing Apple Watch, AirPods, and Beats products have a nice supplemental effect to the Apple eco-system and is an over $10 billion business per year.

I am interested to see if Apple can make the quick pivot to an enterprise software company, and Apple’s announcement of Apple business manager, a method to deploy iOS devices at scale, had an initial sign up of 40,000 companies. Apple needs to bet the ranch on this direction and do it fast.

I would like to see Apple attack the enterprise market with zeal because there is a long runway for them to scale and the bulk of companies would welcome Apple products and services littered around their mobile offices.

The most important soundbite was by CFO of Apple Luca Maestri saying, “Given the increasing importance of our services business and in order to provide additional transparency to our financial results, we will start reporting revenue and total services beginning this December quarter.”

There you go…Apple explicitly saying they are the newest software company on the block that should go alongside the likes of Microsoft (MSFT).

The software theme will continue with the Mad Hedge Tech Letter because there are some real gems out there in the software landscape tied to the cloud.

As for Apple, the earnings report reaffirms my opinion that they just keep getting better and are magicians at adjusting to the current tech climate.

Wait for the stock to find some footing then it’s a definite buy, and for long-term holders, it’s a screaming buy.

November 2, 2018

Diary, Newsletter, Summary

Global Market Comments
November 2, 2018
Fiat Lux

Featured Trade:

(OCTOBER 31 BIWEEKLY STRATEGY WEBINAR Q&A),
(EDIT), (TMO), (OVAS), (GE), (GLD), (AMZN), (SQ), (VIX), (VXX), (GS), (MSFT), (PIN), (UUP), (XRT), (AMD), (TLT)

October 31 Biweekly Strategy Webinar Q&A

Diary, Newsletter

Below please find subscribers’ Q&A for the Mad Hedge Fund Trader October 31 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader.

As usual, every asset class long and short was covered. You are certainly an inquisitive lot, and keep those questions coming!

Q: I would like to keep CRISPR stocks as a one or two-year-old, or even longer if it is prudent. What do you think?

A: Yes, there is a CRISPR revolution going on in biotech—I’m extremely bullish on all these stocks, like Editas Medicine (EDIT), Thermo Fisher Scientific (TMO), and Ovascience Inc. (OVAS). If any of these individual companies don’t move forward with their own technology, they will get taken over. The principal asset of these companies is not the patents or the products, it’s the staff, and there is an extreme shortage in CRISPR specialists (and anybody who knows anything about monoclonal antibodies).

Q: Could you explain how to manage LEAPs? For example, the Gold (GLD) and the General Electric (GE) LEAPs. Sit and leave them or trade them short term?

A: You make a lot of money trading long-term LEAPs. Just because you own a year and a half LEAP doesn’t mean that you keep it for a year and a half. You sell it on the first big profit, and I happen to know that on both the Gold (GLD) and the (GE) LEAPs we sent out, people made a 50% profit in the first week. So, I told them: sell it, take the profit. The market always gives you another chance to get in and buy them cheap. You make the money on the turnover, on the volume—not hanging out trying to hit a home run.

Q: Why did you only close the Amazon (AMZN) November $1,550-$1,600 vertical bull call spread and not roll the strike prices down and out?

A: Well I actually did do the down and out strike roll out first, which is the super aggressive approach. By adding the November $1,350-$1,400 vertical bull call spread position on Monday at the market lows and doubling the size—we took a huge 30% position in Amazon and that position alone should bring in about $3600 in profits in two weeks, at expiration. And when I put on that second position I told myself that on the next big rally I would get out of the high-risk trouble making position, which was the November $1,550-$1,600 vertical bull call spread. So that’s how you trade your way out of a 30% drop in three weeks in one of the best tech stocks in the market.

Q: Is AT&T (T) no longer a good buy at these prices?

A: All of the telephone companies have legacy technology, meaning they are all dying. Basically, AT&T is about owning a bunch of rusting copper wire spread around the country. They haven’t been able to innovate new technologies fast enough to keep up with others who have. The only reason to own this is for the very high 6.56% dividend. That said, dividends can be cut. Look at General Electric which cut its dividend earlier this year. Whatever you make of the dividend can get lost in the principal.

Q: Do you think Square (SQ) is a good buy at this level?

A: Absolutely, it’s a screaming buy. It’s one of the favorite companies of the Mad Hedge Technology Letter and one of the preeminent disruptors of the banks. We think there’s another 400% gain in Square from here. It’s dominating FinTech now.

Q: When do you expect to close the short position in the iPath S&P 500 VIX Short-Term Futures ETN (VXX)?

A: If we can get the Volatility Index (VIX) down to $15, the (VXX) should crater. We’ll take a hit on the time decay and that’s why I say we may be able to sell it for 20 cents in the future when this happens. We’ll still take a 50% hit on the position, but half is better than none.

Q: What happened to Microsoft (MSFT) last week?

A: People sold their winners. They had a great earnings report and great long-term earnings prospects, but everyone in the world owned it. Buy the long-term LEAP on this one.

Q: If we want to double up on the iPath S&P 500 VIX Short-Term Futures ETN (VXX), how do you plan to do it?

A: Go out to further with your expiration date. When you go long the (VXX) you only buy the most distant expiration date. I would buy the February 15 expiration as soon as it becomes available.

Q: How do you see Goldman Sachs (GS) from here to the end of the year?

A: It may go up a little bit as we get some index money coming into play for year-end, but not much; I expect banks to continue to underperform. They are no longer a rising interest rate play. They are a destruction by FinTech play.

Q: Is it too soon for emerging markets in India (PIN)?

A: As long as the dollar (UUP) is strong, which is going to be at least another year, you want to avoid emerging markets like the plague. As long as the Federal Reserve keeps raising interest rates, increasing the yield differential with other currencies, the buck keeps going up.

Q: What are your thoughts on retail ETFs like the SPDR S&P Retail ETF (XRT)?

A: You may get lucky and catch a rally on that but the medium term move for retail anything is down. They are all getting Amazoned.

Q: Is it better to increase long exposure the day before the election?

A: No, what we saw starting on Tuesday was the pre-election move. That said, I expect it to continue after the election and into yearend.

Q: Any opinions on Advanced Micro Devices (AMD)?

A: Yes, this is a great level. It was extremely overbought two months ago but has now dropped 50%. It is a great long-term LEAP candidate.

Q: What about the W bottom in the stock market that everyone thinks will happen?

A: I’m one of those people. So far, the bottom for the move in the S&P 500 is looking pretty convincing, but we will test the faith sometime in the next week I’m sure. We got close enough to the February $252 low to make this a very convincing move. It sets up range trading for the market for the next year.

Q: How do you figure the inflation rate is 3.1%?

A: The year-on-year Consumer Price Index for September printed at 2.3%, and the most recent months have been running at an annualized 2.9% rate. Given that this data is months old we are probably seeing 3.1% on a monthly annualized basis now given all the anecdotal evidence of rising prices and wages that are out there. That is certainly what the bond market believes with its recent sharp selloff and why I will continue to be a fantastic short. Sell every United States US Treasury Bond Fund ETF (TLT) rally. Like hockey great Wayne Gretzky said, you have to aim not where the hockey puck is, but where it's going to be.

Q: Will rising interest rates kill the housing market?

A: It already has. A 5% 30-year mortgage rate shuts a lot of first time Millennial buyers out of the market. We are seeing real estate slowing all over the country. Los Angeles is getting the worst hit.

Q: How do you see the Christmas selling season going?

A: It’s going to be great, but this may be the last good one for a while. And Amazon is getting half the business.

Q: October was terrible. How do you see November playing out?

A: It could well be a mirror image of October to the upside. We are already $1,000 Dow points off the bottom. So far, so good. Throw fundamentals out the window and buy whatever has fallen the most….like Amazon.

Did I mention you should buy Amazon?

Good luck and good trading
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader

Ten Years of Consumer Price Index

November 1, 2018

Tech Letter

Mad Hedge Technology Letter
November 1, 2018
Fiat Lux

Featured Trade:

(LOOK AT ZENDESK FOR YOUR NEXT TEN BAGGER)
(ZEN), (RHT), (AMZN), (MSFT), (CRM), (IBM), (SNAP)

Look at Zendesk for your Next Ten Bagger

Tech Letter

At the recent Mad Hedge Lake Tahoe Conference, I pinpointed software companies as a robust group of tech stocks that are the perfect late cycle investment in the economic environment we find ourselves in now.

To add some granularity about my thesis, I would like to start elaborating on an up-and-coming software stock that I find compelling and in the middle of a growth sweet spot.

And with the rapacious pullback, the tech sector has experienced as of late, this high-octane growth stock is poised to rev back up, albeit with more than your average volatility attached to its stock symbol.

If you can stomach the volatility, then Zendesk (ZEN) is the company for you to dip your toe in.

Zendesk is a customer service software offering solutions to clients through a flexible platform revolving around customer service tickets.

This $6 billion market cap tech firm thriving in the dodgy San Francisco Tenderloin district only need to be reminded of how fast a tech firm can be disrupted by stepping out of the office and experiencing ground zero of the San Francisco homeless movement in the scruffy Tenderloin.

I usually get lambasted for the lack of time I spend following budding tech firms, but you cannot blame me when the bulk of this year’s stock market gains have been extracted by the biggest and mightiest tech titans.

That does not mean all small tech is dead, but they certainly do have heightened existential risk because of the Amazons (AMZN) and Microsofts (MSFT) of the world, spreading their network effects far and wide.

International Business Machines Corporation’s (IBM) purchase of cloud company Red Hat (RHT) underscores the value of applying M&A to grow the top and bottom line, and the chronic bidders of these smaller minnows are usually the Amazons and Microsofts themselves who have the cash to dole out.

Salesforce (CRM) is always adding to its arsenal of integrated software companies that can scale up in the cloud, and Marc Benioff’s M&A strategy has thrived to devastating effect boosting the bottom and top line.

I must admit, tech does get the rub of the green over other industries because of the scaling effect afforded to profit poor tech companies.

The ample time to prove to investors they can snatch a growing user base, enhance product offerings, and develop an eco-system intertwined with recurring subscription products is not fair to other industries who are judged on different metrics mainly profits and profits now.

Well, life isn’t fair.

The addressable market is usually massive causing investors to stick with these burgeoning tech firms through thick and thin.

Zendesk is another company burning money, but let me tell you, they are no Snapchat (SNAP).

Operating margins are marching towards positive territory, meaning this outfit is well-run.

It was only at the beginning of 2015 when Zendesk’s operating margin registered -53%, and since then, they have dramatically reduced it to -36% at the end of 2016 and now -24% in 2018.

Gross margins next quarter will be hit a bit with its acquisition of Base CRM, headquartered in Mountain View, California and R&D offices in Krakow, Poland, offering a web-based all-in-one sales platform featuring tools for email, phone dialing, pipeline management, and forecasting.

Improving service offerings in the tech world usually means nabbing niche cloud companies that can easily be integrated into the larger eco-system and Base CRM, even though it has lower margins than Zendesk, is a nice pickup for the company boosting the top line while expanding cross-selling activities.

Then there is the sales revenue growth demonstrating all the hallmarks powerful software companies live up to with its 39% quarterly revenue growth.

Zendesk’s management has remarked that they fully expect to hit $1 billion in total sales by 2020 which is more than double the 2017 annual revenue of $430 million.

This year, Zendesk is forecasted to post just shy of $600 million in sales.

Large clients keep piling in hoping to modernize their customer service operations and wean themselves off the siloed legacy systems.

Disruption by some fresh newcomer in a disruptive industry that they operate in is usually the trigger forcing companies to spruce up their customer service software.

This path of migration will healthily continue for Zendesk reaffirming management’s thesis of $1 billion in sales by 2020.

Zendesk, flaunting off their innovation skills, identified the universal popularity of messenger app WhatsApp as an effective platform for its services and rolled out a product that integrates Zendesk services with WhatsApp.

This will allow businesses to manage customer service interactions and engage with customers directly on WhatsApp.

The customized integration links conversations between businesses and their customers on WhatsApp within Zendesk.

This move will allow Zendesk to stretch their tentacles further and wider while being able to provide faster support for customer service tickets which are incredibly time-sensitive.

Since management highlighted that WhatsApp is the go-to messenger in Asia Pacific and Latin America, there was no reason not to extend their offerings in a way that captures this vital userbase.

The WhatsApp pivot has been a nice addition with Zendesk’s management remarking that they “handle over 20% of our order status inquiries daily with WhatsApp and Zendesk, which is much faster than traditional methods.”

Omnichannel support within Zendesk’s platform will be key to securing the growth it needs to reach its $1 billion of sales milestone.

Innovation is the crucial ingredient in constructing the perfect products that can maximize customer service performance.

Its overseas exploits are not just a flash in the pan with its services supported in 30 languages and offices in 15 different countries. It all makes sense considering half their revenue is outside of America.

With IBM’s recent acquisition of Red Hat, buyers are still hunting for the right pieces to add to their portfolio.

The Red Hat purchase proved that demand still eclipses supply by a far margin.

Zendesk is one of those in the queue for a big buyer to swoop in with a mega offer.

It’s no guarantee that a company will pay a 63% premium like IBM did, but some sort of premium will be definitely warranted.

Zendesk offers the type of robust growth and premium cloud services that could easily fit into a bigger cloud player looking to improve their assortment of cloud tools.

This type of tailwind itself will naturally boost the stock by 5-10% alone if the macro picture can somehow manage to gain footing for the rest of the year.

As with the rest of tech, Zendesk dipped about 20% in the last 30 days but by no means does that mean this is a bad company with a weak future.

I would very much argue the opposite.

The weakness in sales offers a prime entry point in a fast-growing company that is part of the software and cloud movement that I have incessantly harped about.

If this company can show continued operating margins growth, maintain sales growth of above 30% YOY, and demonstrate product innovation, this stock will break out to higher levels.

As of now, that is exactly the road they are headed down.

Business abroad is doing so well that Zendesk recently splurged on a Europe, Middle East and Africa (EMEA) headquarters in Dublin, Ireland coined as the “the tech capital of Europe.”

Zendesk started with two employees in Dublin in 2012 and now boast over 300 employees occupying 58,000 square feet in a new office costing $10 million.

By 2020, Zendesk expects to build their Dublin branch to over 500 employees implying that the overseas pipeline is ripe for the taking.

I am highly bullish Zendesk and recommend that readers check out this attractive growth story.

SNAZZY NEW HEADQUARTER IN DUBLIN

October 31, 2018

Tech Letter

Mad Hedge Technology Letter
October 31, 2018
Fiat Lux

Featured Trade:

(IBM’S PUTS ON A RED HAT)
(RHT), (IBM), (AMZN), (MSFT), (GOOGL), (ORCL)

IBM’s PUTS on A Red Hat

Tech Letter

What took you so long, Ginni?

That was my first reaction when I heard International Business Machines Corporation (IBM) was making a big strategic shift by purchasing open source cloud company Red Hat (RHT) in a landmark $34 billion deal.

Ginni Rometty, IBM’s CEO since 2012, has presided over persistent negative sales growth and has done zilch for investors to conjure up some type of lasting hope for this company.

Not only has Rometty failed to grow the top line, but with an underwhelming 3-year EPS growth rate of -2%, the execution and performance haven’t been there as well.

Somehow and someway, she has maintained an iron-clad grip on her job at the helm of IBM and her legacy at IBM will be wholly determined by the failure or success of this Red Hat acquisition.

IBM shares sold off on the news as shareholders digested this bombshell.

Rometty took a hatchet to share buybacks and suspended them for 2020 and 2021 alienating a segment of their loyal shareholder base.

I can tell you one thing about this move – it smells of desperation and it won’t vault IBM into the conversation of Amazon (AMZN) Web Services or the Microsoft (MSFT) Azure.

The biggest winner of this deal is Red Hat’s CEO Jim Whitehurst who has been dangling the company for sale for a while.

Alphabet (GOOGL) was in the mix and had the opportunity to snag a last-second deal, but it never came to fruition.

The 63% premium IBM must pay for a company who only grew quarterly sales 14% YOY and quarterly EPS by 10% is expensive, but that is where we are with IBM.

Clearly overpaying was better than doing nothing at all.

IBM continues to hemorrhage sales and stopping the blood flow is the first step.

Rometty was responsible for the utter failure of artificial intelligence initiative Watson whose terrible management was a key reason for its implosion.

Analyzing this historic company gave me insight into the pitiful causing me to write a bearish story on IBM last month. To read that story, please click here.

Not only was the agreed price exorbitant, but Red Hat’s stock was trending south even before the interest rate induced sell-off rocked the tech sector of late.

Red Hat missed on sales revenue forecasts and offered weak guidance.

It could be the case that Whitehurst was actively seeking a buyer because he felt that Red Hat would go ex-growth in the next few years.

Red Hat was rumored to be on the market for quite a while looking to fetch a premium price for a company starting to stagnate with its visions of grandeur growth.

Rometty’s career-defining moment is high-risk and high-reward and is born out of being cornered by leading tech companies leaving IBM in their dust.

The deal finally allows IBM to return back to sales growth which will occur two years later, and Rometty will finally have that monkey off her back for now.

But the bigger question is will Rometty still have her job in two years if this experiment becomes toxic.

My guess is that Red Hat CEO Jim Whitehurst is automatically the next in line for the IBM throne if Rometty missteps, and piling on pressure will force IBM to evolve or die out.

And even though they will return back to growth, 2% growth is no reason to do cartwheels over.

The real work starts now and it will take years to turn around this dinosaur.

On the brighter side, the massive deals instantly improve sentiment that was flagging for years and puts IBM back on the map.

The synergies between IBM and Red Hat could be robust.

Red Hat can surely help IBM become a higher-quality hybrid cloud solutions company.

Models like this are the industry standard as luring a company into your cloud is one thing, but being able to cross-sell a plethora of extra add-on software services in the cloud is the necessary path to raising profitability.

IBM also inherits a slew of talented software engineers that it can mobilize for innovative cloud products. Red Hat’s products such as JBoss middleware and the OpenShift software for deploying applications in virtual containers could make IBM’s hybrid cloud more appealing and could help retain customers with the additional offerings.

Doubling down on the software side of the business was a strategy I pinpointed at the Mad Hedge Lake Tahoe conference and deals like this highlight the value of this type of assets.

There is a hoard of legacy tech companies like Oracle (ORCL) that is in dire need of such strategic injections and fresh ideas.

This won’t be the last deal of 2018, other cloud deals could shortly follow.

On the other side of the coin, hardware deals have turned rotten quickly with stark examples such as Hewlett-Packard’s (HPQ) $25 billion acquisition of Compaq, Microsoft’s $7.2 billion disastrous buy of Nokia’s mobile handset business and Google’s unimpressive $12.5 billion deal for Motorola Mobility that they later unloaded to Chinese PC company Lenovo.

Investors must be patient if IBM has any chance of completing this turnaround.

Listening to Rometty talk about this deal clearly reveals that she is hyping it up for something way bigger than it actually is.

Let’s not forget that Rometty’s tenure as CEO began in 2012 when IBM shares were trading north of $200 and she has presided over the company while the stock got pulverized by almost 30%.

It pains me that she is the one given the chance to turn the company around after years of underperformance.

Let’s not forget that at the end of 2017, IBM only had a 1.9% share of the cloud infrastructure, about 25 times smaller than Amazon Web Services.

The costly nature of the deal could also put a dent into IBM’s dividend, alienating another swath of its hardcore shareholder base.

Historically, IBM has had minimal success with transformative M&A and the industry competitors dominating IBM magnify the poor management performance headed by Rometty.

Rometty declaring that this deal means IBM will be “no. 1 in hybrid cloud” is overly optimistic, but this is a move in the right direction and could keep IBM spiralling out of control.

A return to sales growth might help stem the bleeding of its downtrodden share price, but Amazon and Microsoft are too far ahead to catch.

Investors will need to wait and see if the synergies between IBM’s and Red Hat’s products are meaningful or not.