Mad Hedge Technology Letter
March 19, 2019
Fiat Lux
Featured Trade:
(GOOGLE’S AGGRESSIVE MOVE INTO GAMING),
(GOOGL), (AAPL), (FB), (NFLX), (MSFT) (EA), (TTWO), (ATVI)
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The saturation of tech is upon us.
That is the takeaway from Google’s (GOOGL) hard pivot into gaming.
The goal of their new gaming service is to become the Netflix (NFLX) of gaming allowing gamers to skip purchasing third-party consoles and playing games directly from an Android-based Google device.
Middlemen in the broad economy are getting killed and this is the beginning.
What we are really seeing is a last-ditch effort to protect gaming consoles - these devices will become extinct in less than 20 years boding ill for companies such as Sony and Nintendo
The cloud is still all the rage and companies such as Microsoft (MSFT), Alphabet (GOOGL), and Apple (AAPL) have the natural infrastructure in place to offer cloud-based gaming solutions.
Phenomenon such as internet game Fortnite have shown that consoles are outdated and relying on the cloud as a fulcrum to extract gaming revenue by way of add-ons and in-game enhancements will be the way forward
Another key takeaway from this development is that passive investment is dead, even more so in tech, where these big tech companies are starting to bleed over into each other's territory.
This dispersion will create opportunity and pockets of weakness.
I blame this on a lack of innovation with companies still trying to extract as much as they can from the current smartphone-based status quo which has pretty much run its course.
Technology is itching for something revolutionary and we still have no idea what that new idea or device will be.
The rollout of 5G is promising and companies will need some time to adapt to this super-fast connection speed.
In either case, I can tell you the revolution won’t include foldable smartphones.
In 2018, the gaming industry flourished on accelerating momentum by registering over $136 billion in sales, and the revenue growth rate is already about 15% and increasing.
Naturally, companies such as Amazon and Google want a piece of this action and are hellbent on making inroads in the gaming environment such as Amazon's ownership of Twitch, which is a game streaming service where viewers can watch live tournament-style competitions proving extremely popular with Generation Z.
I applaud this move by Google because they already have proved they can execute on certain mature assets such as YouTube which has become the Netflix replacement of 2019.
Doubling down in the gaming sector would be a bonus as they search a second accelerating revenue driver that will dovetail nicely with the overperformance in YouTube this year.
It’s even possible that YouTube could be modified to support live stream gaming, certainly various synergistic dynamics are at play here.
Even if they fail - it's worth the risk.
Revenue extraction will be painful for certain companies like Facebook (FB) in this new environment, who has seen a horde of top executives abort after the company drastically changed directions, believing the company is on a suicide mission to fines and more regulatory penalties.
I've mentioned in the past that Facebook no longer commands the same type of employee brand recognition they once cultivated.
Facebook will find a tougher time to find the right people they need to execute their private chat plan, by linking the likes of WhatsApp, Instagram, and Facebook Messenger.
This is a high-risk high-reward proposition that could end up with Facebook's co-founder Mark Zuckerberg in tears if regulators give him the cold shoulder, and that is why many executives who are risk-adverse want to cash in now because they sink with the Titanic.
Not only are gaming assets becoming saturated, but the general online streaming environment is attracting a tsunami of supply all at one time.
Online content is already veering into the same type of pricing structures that cable offered traditional customers.
Investors will have to ask themselves, how much will the average consumer spend in content-based entertainment per month?
My guess is not more than $100 per month.
The saturation will cause tech companies to become even more draconian.
Be prepared for some more epic in-fighting until a new gateway of internet monetization opens up.
There has never been a better time to be a tactical and active investor in tech.
The Fang trade has splintered off with each company facing unpredictable futures.
Unearthing value will become more difficult because these traditional bellwether tech stocks have decoupled and aren't going straight up anymore.
Those zigs and zags will still be buttressed by a secular tailwind of the migration to digital, but there are certain winners and losers that will result of this.
Apple announcing a new streaming product is proof that these Silicon Valley tech firms are desperate for new profit drivers as the woodchips that fuel the fire start to run noticeably short on supply.
At the bare minimum, this looks disastrous for the traditional gaming companies of Electronic Arts (EA), Take-Two Interactive (TTWO), and Activision (ATVI) whose shares have been effectively shelved due to the Fortnite revolution.
EA has fought back with their own Fortnite lookalike called Apex Legends which showed a Fortnite-like trajectory sucking in 10 million players in the first 72 hours.
The stock exploded 16%, signaling this is the new way forward for gaming companies.
As a whole, these traditional gaming studios simply don’t have the firepower to compete with the big boys, let alone possess a strong cloud infrastructure.
Mad Hedge Technology Letter
March 18, 2019
Fiat Lux
Featured Trade:
(WHY ALPHABET IS THE BEST FANG TO BUY NOW),
(GOOGL), (NFLX), (FB), (TWTR), (DIS)
Why am I bullish on Alphabet (GOOGL) short-term?
Video has muscled its way to the peak of the digital content value chain.
If you don't have video streaming, then you are significantly depriving yourself of the necessary ammunition capable of battling against legitimate content originators.
The optimal type of content is short form yet engaging.
Interesting enough, the format method integrated into systems of Facebook (FB) and Twitter (TWTR) has experienced unrivaled success.
They have been leaning on this model as growth levers that will take them to the next stage of revenue acceleration and rightly so.
This has seen smartphone apps such as Instagram become game-changing revenue machines destroying all types of competition.
The x-factor that stands out in Instagram's, Facebook’s, YouTube’s model is that it's free and they do not absorb heavy expenses from content creation.
It’s certainly cheap when the user is the product.
Google’s YouTube service has morphed into something of a phenomenon.
Its interface is easy to use, and followers have a simple time navigating around its platform.
Familiar news outlets such as Sky News, Bloomberg News, and even CNBC news have recently installed their live feeds on YouTube's main platform scared of losing aggregate eyeballs.
And even more intriguing is that YouTube has become a legitimate competitor to Netflix's (NFLX) online video streaming platform.
YouTube has sensed the outsized pivot to their free platform and has double down hard by installing 5-second ads at the front end and middle of videos.
Of Alphabet’s total $39.3 billion revenue pocketed in Q4 2018, ads constituted 83% or an astounding $32.6 billion.
I feel that Alphabet shares are currently undervalued, and I believe that we will see outperformance from Alphabet shares for the rest of 2019 based on YouTube's performance relative to expectation.
YouTube’s ever-growing presence showing up in the top line will offer the growth investors desire to pile into these shares as the company wrestles with future projects such as Waymo.
That's not to say that their traditional advertisement business of Google Search is failing.
Investors can expect continuous 20% to 25% growth in this cash cow business, but the reason why Alphabet share has not been able to break out is that investors have baked this into the pie.
Therefore, YouTube is really the X Factor and will take them to this new promised land with shares surging past the $1,250 mark and more importantly, staying at that level.
YouTube brought in about $15 billion in 2018 and that consisted of about 10% of Alphabet’s total annual revenue.
However, the company is just scratching its surface of what it can accomplish with this fast-growing revenue driver and I can extrapolate this growth segment turning into 20% or 25% of the company’s annual revenue in the next few years.
Google does not strip out YouTube revenue in its reporting, therefore, it's difficult to put my finger on exactly how much YouTube is carving out in terms of revenue.
I can also assume that if Netflix continues to raise the cost of monthly subscription, this strategy will directly hurt its revenue acceleration ability as it relates to competing with Google's YouTube because YouTube's free service is demonstrably attractive to viewers hoping to discover high-quality content relative to a $20 per month Netflix subscription.
I do agree that Netflix is a great company and a great stock, but as they slowly raise the price of content, this will gift YouTube a huge chunk of Netflix’s marginal audience freeing itself from the shackles of Netflix’s price rises.
At some point, online video streaming will become as expensive as the cable bundles now, and at that point, we know that saturation is imminent boding negative for Netflix.
What I do envision in the short-term future are consumers in America will pay into several unique bundles such as Netflix, maybe Disney (DIS), ESPN and merely stick with these as their base content generators as more consumers cut their cord and hard pivot from traditional cable packages that are becoming less appealing by the day.
And don't forget that at some point, Netflix will have to demonstrate profitability and the huge cash burn that permeates throughout the business will be exposed when subscription growth starts to fade away.
In every possible variant, YouTube will become an outsized winner in the media wars because the quality of the free content keeps improving, the cost for consumers stays at 0, and their best of breed ad tech migrating from their Google search into YouTube just keeps getting more surgical and efficient.
Not only are the positive synergies from the best of breed ad tech aiding YouTube’s model, but just think about YouTube having access to the Google cloud and saving expenses by accessing this function to store data onto the Google Cloud.
If this was a standalone service, they would have to subcontract cloud storage functions to third-party cloud company causing the content service to spend millions and millions of dollars per year in expenses.
This would have the potential of crushing the bottom line.
That is just one example of the synergies that Google can take advantage of with YouTube under its umbrella of assets.
And think about self-driving vehicles, Google could potentially equip YouTube as a pre-programmed application inside of autonomous vehicle platform tech with YouTube popping up on the multiple screens.
I assume that there will be multiple screens inside of cars with self-phone driving technology because of the lack of driving required.
The worst maneuver that Alphabet could do right now is spinoff YouTube into its own company, and if that happens, YouTube won't be able to take advantage of the various synergies and benefits of being an Alphabet asset.
We are just scratching the surface of what YouTube can accomplish, and I believe this upcoming overperformance isn’t in the price of the stock yet.
If the Fed continues its “patient” strategy towards interest rates at a macro level, Alphabet will easily soar past $1,250 and it can easily gain another 10% in 2019.
If any “regulation” risk as a result of extremist content rears its ugly head, buy shares on the dips because the algorithms are in place to eradicate this material and any fine will be manageable.
Global Market Comments
March 6, 2018
Fiat Lux
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Mad Hedge Technology Letter
February 12, 2019
Fiat Lux
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(MEET YOUR HOME OF THE FUTURE),
(KASITA),
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Mad Hedge Technology Letter
February 11, 2019
Fiat Lux
Featured Trade:
(HOW FORTNITE IS TAKING OVER THE GAMING WORLD),
(TTWO), (EA), (ATVI), (NFLX), (FORTNITE)
One idyllic content company reshaping the content landscape as we know it is Epic Games who is the producer of the video game phenomenon Fortnite.
Not only is Epic Games rapidly altering the video game industry by itself, it is also starting to take a bite out of Netflix’s subscriber growth momentum.
The company was established by Tim Sweeney as Potomac Computer Systems in 1991, originally founded in his parents' house in Potomac, Maryland.
The most fascinating nugget of information that came out of Netflix’s most recent earnings call was not that Netflix has already corralled 10% of television screen time in America, but the reason why this percentage is lower abroad is because of Fortnite taking away Netflix’s mojo.
Netflix (NFLX) has lately been asked to measure their content lead to the likes of Hulu, HBO, and the potential Disney streaming product about to hit the market.
But they explicitly confessed they were more worried about Fortnite and the revolution it is spawning.
The key takeaway is that Netflix is not only competing with fellow online content streamers, but video games are more of a threat to them than ever as they compete for the cord cutters and the elusive “cord nevers”.
Cord nevers are consumers who are digital natives who bypassed traditional media channels altogether.
Echoing the stickiness that Netflix has with its younger demographics, the company has targeted mobile screen time as a core driver usurping around 8% of American mobile phone screen time.
And if you thought Netflix was trying to sort out its own Fortnite problem, then how do you think the traditional American video game cohort felt about their own Fortnite problem?
The traditional trio of EA Sports (EA), Activision (ATVI), and Take Two Interactive (TTWO) have been shredded to bits by Fortnite.
Late last year, I gave readers a steer clear synopsis of this company and the latest dead cat bounce in EA and Take Two Interactive should be chances to cut your losses instead of putting more money to work in these names.
Yes, the momentum in Fortnite is that palpable that you stay away from any name that this phenomenon affects.
Activision had no dead cat bounce being the weakest of the three and the stock has gone awry almost halving from $83 to $43 today.
EA’s earnings report was a disaster with their lead title, Battlefield V, doing 1 million fewer sales than the 7.3 million management expected.
During the same holiday season, Take Two Interactive issued a follow-up to a classic that was better than EA’s holiday flagship game called Red Dead Redemption 2 and Activision rolled out another iteration of Call of Duty: Black Ops 4.
Even between the three, the competition was fierce, then throw Fortnite into the mix and comps are getting killed with huge earnings misses penalizing the share prices of this once-vaunted trio.
With the explosion of content in the past several years, consumers are absorbing more content than ever.
Most of this avalanche of content is consumed on mobile phones or televisions, but the behavior varies when you look closer at the different demographics.
Cord cutters total in the low 20 million and are growing 30% annually.
Cord nevers amount to about 30 million growing at 66%.
This all amounts to Americans spending about 12 hours accessing content every day running up to the barrier of natural limits.
That might give consumers some allocated time to sleep, eat, and work, but not much else. We are robotically reliant on content providers to deliver us our fill of daily content.
When automotive technology comes online, it could potentially eke out an incremental 1-2 hours that Americans can stare at their content while being chauffeured around.
How is Fortnite doing financially?
Fortnite earned $2.5 billion in 2018 from a mix of in-game items and passes.
A seasonal Battle Pass is $10, and over 30% of American gamers have purchased this product.
Unlike traditional video gamers who are tied to certain consoles, Fortnite is available on seven platforms: PlayStation 4, Nintendo Switch, Xbox One, PC, Mac, iOS, and Android.
In a time of $60 video games, this new freemium model must shake the foundations of the video gaming establishment.
The rise of freemium games could eradicate the console completely.
A $200-300 console seems expensive if games are free on your $100 Android phone.
The worst side-effect of Fortnite for the traditional video game producers is not Fortnite itself.
It’s the fact that this new model has opened up a new can of worms proving this freemium model with no consoles is the key to unlocking gaming audiences with a 24-hour battle royale, free to play, on-demand, in-game currency, season pass model that was thought to be a hopeful wish by industry analysts.
Then the next question is when will the next Fortnite-esque freemium go viral and can these legacy gaming companies alter their model to accommodate this new business model?
Indeed, management must be freaking out. They thought they had a monopoly on the gaming industry but the nimbler and forward-thinking firm has won-out.
Even the most subscribed YouTuber PewDiePie from Sweden is using Fortnite to keep him in the lead for most YouTube subscribers as Indian music YouTube channel T-Series has caught up with his subscriber count that currently totals 84.3 million.
PewDiePie’s lead was cut down to 20,000 and decided to leverage playing Fortnite squad matches to boost his subs.
The upload got over seven million views in a day backing up my thesis that Fortnite has become the hottest media content asset for cord cutters and cord nevers around the world.
As for the video game stocks, don’t touch them until Fortnite trails off.
And if another freemium game comes to the fore that they aren’t on, run for the hills.
Mad Hedge Technology Letter
January 22, 2019
Fiat Lux
Featured Trade:
(HOW TO PLAY TECHNOLOGY STOCKS IN 2019),
(NFLX), (AAPL), (TSLA), (STT), (BLK)
In the past week, the tech sector has received information allowing investors to sketch a concise roadmap of what to expect in the tech sector for the rest of 2019.
One – the bull story in technology isn’t dead and the December sell-off in tech growth stocks was overdone.
Two – the path to tech profits is filled with more booby traps than in year’s past.
Three – the migration to digital is becoming more pronounced by the millisecond.
If you go back about a month ago when tech stocks were at their trough, traders were pricing in about a 60% chance of a recession in 2019 or early 2020 and the data didn’t support it.
What people were confusing themselves with was slowing growth instead of a lack of growth.
Then we got the disastrous news from Apple (AAPL) indicating business in China was petering out forcing them to change tactics cutting iPhone prices.
The tech market went into full-on panic mode and the revelation of weak China data did not help either.
Netflix (NFLX) reported and the online streaming app offered some respite with outperforming growth numbers.
Netflix has been a favorite of the Mad Hedge Technology Letter since its inception but the caveat with Founder and CEO of Netflix Reed Hastings brainchild is that the extreme volatility makes it difficult to trade around on a short-term basis.
The stock is up 50% from its nadir and its growth story is solid and will perpetuate.
The next bastion of juiced-up growth for Netflix is the international audience and these numbers are examined closely with a fine-tooth comb by investors attempting to understand the direction of the company.
The company audaciously added 8.8 million in new international subscribers last quarter which handily beat the 7.6 million estimates by 1.2 million.
Netflix also announced a few days earlier that it would raise the price of a monthly subscription between 13%-18%, and investors treated the news with celebratory shots of tequila.
It has been consensus for years that Netflix was severely underpricing their premium content, and analysts have been screaming and kicking trying to get Hastings to push up their monthly prices.
The price hike coincides with a year where I believe Netflix can grow revenue over 30%.
The mix of these two developments illuminate a few things about Netflix.
Netflix has the content that consumers want and even if competition rears its ugly head, they aren’t even in the same ballpark in terms of breadth and potency of content.
They are the king of contents and I don’t see anyone knocking them off their elevated perch in 2019.
In many ways, the Netflix long-term thesis mirrors the tech industry’s long-term thesis emphasizing supercharged growth by any means possible.
Even though this strategy is risky, it is working for Netflix and the capital isn’t drying up to go after the best content producers money can buy.
This earnings report should put to rest the growth warning sirens for now, tech will grow this year, but earnings results will be more of a mixed bag with the occasional miss.
This is in stark comparison to early 2018 where every tech company and their mother were scorching earnings forecasts by a magnitude of two or three.
Last September, the tech market looked above its head and saw a few boulders about to crush the herd, but investors shrugged it off.
As we move forward, the tech sector and the overall market is inching closer to a recession.
The low-hanging fruit has been pocketed and incremental gains aren’t no-brainers anymore – this can be gleaned from Tesla (TSLA) curtailing their workforce by 7%.
This news was delivered by a letter from CEO of Tesla Elon Musk noting that these decisions have been made with the goal of “increasing the Model 3 production rate and making many manufacturing engineering improvements in the coming months.”
Basically, Musk has telegraphed that staff needs to perform better, identify efficiencies that will save costs which in turn will boost profit margins.
This doesn’t mean that the era of tech growth is over, but this signals that tech companies are becoming more fidgety about loss-making operations and have ultimately targeted profits which shout at investors' late-cycle economics.
Musk needs to turn Tesla into a perennial profit machine to prove naysayers wrong, and now is the time to turn the page and max out his rocket fuel.
If the recession hits, investors could turn against Tesla and capital could dry up.
This newfound modesty towards the e-car business model is, in no doubt, exacerbated by the ratcheting up of fierce competition from the traditional automobile makers.
Tesla is in the e-car lead for battery technology, revolutionary production processes, and have a treasure trove of data that German companies would do anything to get their hands on.
Musk knows Tesla has fought this hard to get to this point, and he'd rather have the ball in his hands with 10 seconds left and a tie game just like Michael Jordan of the Chicago Bulls did.
Shaving off the excess has meant removing the customer referral program that was too costly that included benefits like half a year of free charging.
Part of this also has to do with Tesla losing their tax credit at the end of the year as well as giving more impetus to trimming costs.
Becoming a mass-market car manufacturer means it is important to price the car at affordable price points and that will be extremely difficult.
The goal is to deliver a $35,000 e-car that performs comparably to the rest of the fleet but produced with 7% less hands.
Can Musk do it?
I wouldn’t bet against him.
Musk means business and is hellbent for revenge against his arch enemies – the Tesla short community who he has habitually dragged under the bus through the media.
Piggybacking on this tougher profit-making climate is Boston-based finance company State Street Corporation’s (STT) announcement reducing headcount by 1,500 amounting to 6% of the global workforce.
The firm cited the urgent need to automate processes that will give the company a bigger foothold into the digital sphere.
The same theme was echoed at BlackRock Inc. (BLK), the world’s largest asset manager, who will eliminate 3% of its global workforce, or 500 people, amid an existential threat from the temporary ineffectiveness of passive investing.
In a rising market, it is guaranteed that assets at these types of funds almost always go up.
However, with an injection of recent volatility, passive investors have seen their balances dwindle with the market spawning abrupt outflows.
The need to zig and zag with the market is now painfully obvious and using technology to plug in the gaps will be cheaper and more appropriate for late cycle price action.
This is a suitable segue way into the third point – the fluid follow-through of the digital migration and the debacle of Sears prove my point.
Hedge fund manager Eddie Lampert and his firm ESL have navigated this famous American retailer into the ground.
This is what happens when the entire retail industry goes online when you don’t.
To make matters worse, Lampert has probably never set foot into his own investment.
Each time I roam the aisles of Sears, it’s about as crowded as a mortuary at midnight – an elementary story of a mismanaged enterprise.
Sears is an example of digital ignorance and it’s not the only one.
Gymboree Group, the baby clothing company, is another one to put on the list – the firm filed for Chapter 11 bankruptcy protection.
The company will close more than 800 Gymboree and Crazy 8 stores, this is the second time they have filed for bankruptcy protection in the past two years.
Unsurprisingly, the firm cited a sudden decrease in mall traffic and a surge in online alternatives as the reason for the economic softness.
The economy does not operate in a vacuum and any analog company who voluntarily misses the pivot to digital is voluntarily digging their own grave.
These three trends will only become more exaggerated moving forward threatening companies like Apple who fail to innovate after more than a decade of selling the same product, other companies don’t have the balance sheets to handle the same weakness.
