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Watch Out for the Unicorn Stampede in 2019

I am always watching for market topping indicators and I have found a whopper. The number of new IPOs from technology mega unicorns is about to explode. And not by a little bit but a large multiple, possibly tenfold.

Six San Francisco Bay Area private tech companies valued by investors at more than $10 billion each are likely to thunder into the public market next year, raising buckets of cash for themselves and minting new wealth for their investors, executives, and employees on a once-unimaginable scale.

Will it kill the goose that laid the golden egg?

Newly minted hoody-wearing millionaires are about to stampede through my neighborhood once again, buying up everything in sight.

That will make 2019 the biggest year for tech debuts since Facebook’s gargantuan $104 billion initial public offering in 2012. The difference this time: It’s not just one company, and five of them are based in San Francisco, which could see a concentrated injection of wealth as the nouveaux riches buy homes, cars and other big-ticket items.

If this is not ringing a bell with you, remember back to 2000. This is exactly the sort of new issuance tidal wave that popped the notorious Dotcom Bubble.

And here is the big problem for you. If too much money gets sucked up into the new issue market, there is nothing left for the secondary market, and the major indexes can fall, buy a lot.

The onslaught of IPOs includes ride-sharing firm Uber at $120 billion, home-sharing company Airbnb at $31 billion, data analytics firm Palantir at $20 billion, FinTech company Stripe at $20 billion, another ride-sharing firm Lyft at $15 billion, and social networking firm Pinterest at $12 billion.

Just these six names alone look to absorb an eye-popping $218 billion, and that does not include hundreds of other smaller firms waiting on the sidelines looking to tap the public market soon.

The fear of an imminent recession starting sometime in 2019 or 2020 is the principal factor causing the unicorn stampede. Once the economy slows and the markets fall, the new issue market slams shut, sometimes for years as they did after 2000. That starves rapidly growing companies of capital and can drive them under.

For many of these companies, it is now or never. The initial venture capital firms that have had their money tied up here for a decade or more want to cash out now and roll the proceeds into the “next big thing,” such as blockchain, health care, or artificial in intelligence. The founders may also want to raise some pocket money to buy that mansion or mega yacht.

Or, perhaps they just want to start another company after a well-earned rest. Serial entrepreneurs like Tesla’s Elon Musk (TSLA) and Netflix’s Reed Hastings (NFLX) are already on their second, third, or fourth startups.

And while a sudden increase in new issues is often terrible for the market, getting multiple IPOs from within the same industry, as is the case with ride-sharing Uber and Lyft, is even worse. Remember the five pet companies that went public in 1999? None survived.

The move comes on the heels of an IPO market in 2018 that was a huge disappointment. While blockbuster issues like Dropbox (DB) and DocuSign (DOCU) initially did well, Eventbrite (EB), SurveyMonkey (SVMK), and Zuora (ZUO) have all been disasters.

Some 80% of all IPOs lost money this year. This was definitely NOT the year to be a golfing partner or fraternity brother with a broker.

What is so unusual in this cycle is that so many firms have left going public to the last possible minute. The desire has been to milk the firms for all they are worth during their high growth phase and then unload them just as they go ex-growth.

The ramp has been obvious for all to see. In the first nine months of 2018, 44 tech IPOs brought in $17 billion, according to Dealogic. That’s more than tech IPOs reaped for all of 2016 and 2017 combined.

Also holding back some firms from launching IPOs is the fear that public markets will assign a lower valuation than the last private valuation. That’s an unwelcome circumstance that can trigger protective clauses that reward early investors and punish employees and founders. That happened to Square (SQ) in its 2015 IPO.

That’s happening less and less frequently: In 2017, one-third of IPOs cut companies’ valuations as they went from private to public. In 2018, that ratio has dropped to one in six.

Also unusual this time around is an effort to bring in more of the “little people” in the IPO. Gig economy companies like Uber and Lyft are lobbying the SEC for changes in new issue rules that will enable their drivers to participate even though they may be financially unqualified.

As a result, when the end comes, this could come as the cruelest bubble top of all.

Don’t Get Run Over

October 17, 2018

Tech Letter

Mad Hedge Technology Letter
October 17, 2018
Fiat Lux

Featured Trade:

(THE SPOTIFY REGIME),
(SPOT), (AAPL), (NFLX), (MSFT), (AMZN), (GS)

The Spotify Regime

Tech Letter

It’s not earth-shattering to concede that our attention spans have shrunk and as a result, there are unintended consequences.

The various smart devices and other technology vying for a slice of your precious attention have been accepted as the new normal.

Whether it’s binging on Netflix (NFLX) or gaming on a Microsoft Xbox (MSFT), consumers are absorbed obsessively staring into a screen most of the day.

As tech penetrates the core of our existence, the music industry has been the recipient of changes that were hard to fathom just a few years ago.

And as all businesses morph into pseudo-tech enterprises supported by data analytic teams, management is able to unearth some compelling data and utilize it to commercialize the audience.

Spotify (SPOT), the world’s leading music streaming platform, doesn’t monetarily reward music artists unless a stream surpasses a minimum of 30 seconds.

This is just one way that Spotify’s founder and CEO Daniel Ek has changed the music industry.

Think about the implications.

Gone are the elaborate instrumentals to warm listeners up before a catchy chorus hooks you forever.

Songs are entirely front loaded now with the end goal of persuading listeners to not swipe until the 30-second barrier is passed.

Whatever happens after that doesn’t matter – the song might as well go silent because Spotify will pay the artist.

According to Spotify data, Ed Sheeran’s “The Shape of You” is Spotify’s most-streamed song with 1.94 billion listens.

This is just one scant nugget of data in Spotify’s treasure trove of global music data that finely chronicles the state of the music industry and how consumers devour music.

Spotify CFO Barry McCarthy promptly explained the Spotify’s relationship with data and music at the Goldman Sachs’ (GS) Communacopia conference by saying, “The company with the most data wins. The company with the most data insights wins. The company with the engineering culture, software-driven business wins. And that’s the play we’re making.”

In the current tech climate, I will take software over hardware any day of the week.

Hardware sales are a one-off event until the next cycles bring an upgraded iteration which could take years to execute.

Software sales are an annual recurring revenue stream that is as sticky as the software's quality giving hope to company CFO’s of a perpetual income stream.

It doesn’t matter that Spotify isn’t profitable. The end goal isn’t to make money in an industry that is notoriously difficult to combat the royalty expenses eroding 70% of every $1 of revenue.

What has happened is that Spotify is too big to fail and it loves every second of it.

The music industry needs Spotify just as much as Spotify needs the music industry and this awkward partnership is far from a match made in heaven, but it works for the foreseeable future.

It helps that artists, for the most part, have bought into the data-based streaming model.

Music artists have turned into tech-like firms themselves.

Their new goal is to compile an audience then monetize like Spotify itself.

It speaks volumes of how the tech model has penetrated every corner of the world.

Apple (AAPL) is acutely aware of the potency a music streaming service offers and has been investing in Apple Music, its music streaming arm.

Rumors have been swirling that Apple absorbed the entire staff of a music analytics firm called Asaii including the owners, for a tad under $100 million.

This talent grab on the heels of the Shazam purchase indicates that Apple seeks a better understanding of how to curate music playlists and better serve music fans who own Apple devices.

Even though Apple has the second leading music streaming service, they have ceded the battle to Spotify.

CEO of Apple Time Cook is on record saying, “We’re not in it for the money.”

Indirectly, Cook means Apple Music is a loss-making division and he doesn’t care because it is just a small fragment of what makes Apple one of the best companies in the world.

Apple has also commissioned 24 television shows and 2 films costing them $1 billion.

A single billion is peanuts considering the eye-popping amount of Apple’s cash hoard. They can afford to take the long-term view and slowly enhance the ecosystem instead of Spotify whose eggs are all in one basket.

Apple is more concerned about offering iOS users the best experience possible and in return Cook hopes to count on them to use iOS devices for a lifetime.

Apple Music’s biggest weakness is its biggest strength.

In short, Apple music is tailored to the iOS operating system.

If you sign up, the app directs users to sign up for an Apple ID if you do not already have one.

Android lovers have little interest in signing up for Apple Music considering they do not have an Apple device and then must pay $9.99 per month after the introductory 3-month offer expires when Spotify is free. It’s not worth the extra hassle.

It is almost certain that Spotify will enact an Android operating system pivot to build a moat around its business and that is something Apple cannot do.

Spotify will start partnering with Samsung, Microsoft, and the Android-based Asian manufacturers to focus on monetizing the Android audience and make it even more inconvenient for listeners to access Apple Music.

Signing up for Spotify and listening to its ad-free subscription without creating an Apple ID is more appealing.

And after three months, users have the option to continue a free version of Spotify, albeit with digital ads popping up.

This leads me to the belief that there is definitely space for more than one player in the music streaming industry.

Amazon is another tech firm who has a music streaming service but are more concerned if they convert users into prime memberships.

If compiling the most music data wins out, then Spotify is in the lead with its 83 million paid users and 101 million free users.

Apple trails in second place with 50 million users which is still an extraordinary number of listeners and easily monetizable.

The way music streaming platforms works is that users are more likely to listen to the most popular artists and songs and not look for an adventure.

The app is merely there to locate the songs they already like or click on a recommendation produced by an algorithm.

It’s not like going out on a Friday night to experience some unknown singer in a grunge basement and becoming a new fan. Users know what they want, and they desire to access it. Such is the nature of internet search.

Spotify’s data shows that out of 3 million artists on the platform, 200,000 artists receive 70% of the music streams, clearly segmenting the haves and have-nots.

The rest of the 2.8 million are struggling to be discovered and cannot cut a wage off of Spotify’s platform.

Online music streaming products also align perfectly well with artificial intelligence-based voice activation technology.

These services will deeply integrate this technology into its services as they desire to ramp up the quality of services.

As for the music streaming business hopefuls, it's game over as the three major players have the leverage to put out any fires that crop up.

When you break it down, Spotify has a 180 million user audience growing at 30% YOY and is hellbent on becoming profitable.

As they enhance the platform’s tools and services, gradually expect more subscription-based products to entertain users.

And even if Spotify doesn’t become profitable as soon as they would like, the aggregate hoard of data will multiply in value.

Spotify is already the most prized music asset in the world with a market cap of $26 billion, about $10 billion higher than all global music revenues.

Yes, Spotify destroyed album artwork and its audio quality of 320 kilobits per second is no match for CD-quality audio. But this is the world we live in today and Daniel Ek’s Spotify is the 800-pound gorilla in the room.

Spotify is a great long-term buy-and-hold asset. Take the latest weakness to add to your position.

October 12, 2018

Diary, Newsletter, Summary

Global Market Comments
October 12, 2018
Fiat Lux

Featured Trade:

(WHY THE STOCK MARKET IS BOTTOMING HERE),
(SPY), (INDU),
(NETFLIX SAYS WE BECOME A NATION OF COUCH POTATOES),
(NFLX), (M), (AMZN), (TSLA), (DIS), (GOOG)

Netflix Says We Become a Nation of Couch Potatoes

Diary, Newsletter

While much of the artificial intelligence focus has been on Amazon (AMZN), Apple (AAPL), Tesla (TSLA), and Alphabet (GOOG) this year, there is another firm in the field making money hand over fist.

That would be Netflix (NFLX), whose earnings have been on a tear all year, sending the shares soaring.

By this summer the company boasted a staggering 130 million subscribers, with much of the recent growth coming from overseas.

Traders went gaga over the numbers.

Indeed, the firm tracks every keystroke you make.

Watch the sultry tropical thriller Bloodline (sadly scheduled for cancellation), and the company’s clever AI will steer you straight into a like-minded series.

It’s like the “roach motel” network. Once you check in, you can never check out.

Analysts briefly worried about Netflix when Disney (DIS) announced it was pulling its offerings from the omniscient online streaming company, a major seller.

To watch Buzz Lightyear, Woody, and an interminable number of nearly identical princesses (I have three daughters) you’ll have to seek out Disney’s own distribution channel sometime in the future.

But the firm shot back with an $8 billion budget for original content for 2018, in one fell swoop making it one of the largest Hollywood production firms.

Now Netflix is a regular feature of the annual Oscar presentations. Last month it won an impressive 23 Emmys, tying AT&T Warner Media’s HBO for the first time.

They say a picture is worth a thousand words, and I just found 3,000 of them.

Look at three stock charts and you will immediately understand some of the most important structural trends now sweeping through our economy.

Those would be the charts for Amazon (AMZN), Netflix (NFLX), and Macy's (M).

Retail Sales are clearly in a secular long-term decline. Indeed, Macy’s (M) announced last year that it is closing 100 of its 769 stores.

Are these numbers revealing a major new trend in our society? Are we soon to have our every need catered to without lifting a finger?

Have We Become a Nation of Couch Potatoes?

After spending weeks preparing a major research piece for a private client on artificial intelligence, I would have to say that the answer is an overwhelming “Yes!”

Artificial intelligence, or AI, is far more pervasive than you think. Half of all apps now rely on some form of AI, and within five years, all of them will.

Within a decade, AI will cure cancer and most other human maladies, drive our cars, decide our elections, and do our shopping.

You probably all know that Northern California has been besieged with wildfires lately.

Guess what has suddenly started populating my screen? Adds for smoke detectors!

AI has become the leading market theme for 2018.

People my age all remember George Jetson, the space age cartoon series, who only had to work an hour a day because machines did the rest of the work for him.

The modern incarnation of his ultra-light workweek will be far darker and more sinister.

Instead of a one-hour day, it is far more likely that one person will keep a full time eight-hour a day job, while another seven unfortunates become full time unemployed.

By the way, I am determined to be that one guy with a job. So should you.

Indeed, I am increasingly coming across dire predictions that 30% of all jobs will disappear within ten years.

I’m sure that they will.

The real question is whether that 30%, or more, will be replaced by jobs yet to be invented. I bet they will.

Evolution and creative destruction are now happening on fast forward.

After all, some 25% of the professions listed on the Department of Labor website did not exist a decade ago.

SEO manager? Concert social media buzz creator? Online affiliate manager? Solar panel installer? Reputation defender?

What does the stock market do in this new dystopian society? It goes through the roof.

After all, far fewer workers creating a greater output generate much larger earnings that send share prices soaring.

It is all a crucial part of my “Golden Age” scenario for the 2020s.
Having said all that, I think I’ll go binge-watch Netflix’s tropical film noir “Bloodline.” I hear it’s hot.

“Game of Thrones” and “House of Cards” don’t restart until next year.

Our Future?

October 11, 2018

Diary, Newsletter, Summary

Global Market Comments
October 11, 2018
Fiat Lux

Featured Trade:

(REACHING PEAK TECHNOLOGY STOCKS),
(GOOGL), (MSFT), (NFLX), (FB), (AAPL),
(LOCKHEED MARTIN’S SECRET FUSION BREAKTHROUGH),
(LMT), (NOC), (BA)

Reaching Peak Technology Stocks

Diary, Newsletter, Research

I drove into San Francisco for a client dinner last night and had to wait an hour at the Bay Bridge toll gate. When I finally got into town, the parking attendant demanded $50. Dinner for two at Morton’s steakhouse? How about $400.

Which all underlines the fact that we have reached “Peak” San Francisco. San Francisco just isn’t fun anymore.

The problem for you is that if the City by the Bay has peaked, have its much-loved big cap technology stocks, like Facebook (FB), Alphabet (GOOGL), and Netflix (NFLX) peaked as well?

To quote the late manager of the New York Yankees baseball team, Yogi Berra, “Nobody goes there anymore because it’s too crowded.”

What city was the number one creator of technology jobs in 2017?

If you picked San Francisco, you would have missed by a mile. Anyone would be nuts to start up a new business here as rents and labor are through the roof.

Competition against the tech giants for senior staff is fierce. What, no fussball table, free cafeteria, or on-call masseuses? You must be joking!

You would be much better off launching your new startup in Detroit, Michigan. Better yet, hyper-connected low-waged Estonia where the entire government has gone digital.

In fact, Toronto, Canada is the top job creator in tech now, creating an impressive 50,000 jobs last year. Miami, FL and Austin, TX followed. Silicon Valley was at the bottom of the heap.

It’s been a long time since peach orchards dominated the Valley.

Signs that the Bay Area economy is peaking are everywhere. Residential real estate is rolling over now that the harsh reality of no more local tax deductions on federal tax returns is sinking in.

To qualify for a home loan to buy the $1.2 million median home in San Francisco, you have to be a member of the 1%, earning $360,000 a year or better.

Two-bedroom one bath ramshackle turn of the century fixer uppers are going for $1 million in the rapidly gentrifying nearby city of Oakland, only one BART stop from Frisco.

Most school districts have frozen inter-district transfers because they are all chock-a-block with students. And good luck getting your kid into a private school like University or Branson. There are five applicants for every place at $40,000 a year each.

The freeways have become so crowded that no one goes out anymore. It’s rush hour from 6:00 AM to 8:00 PM every day.

When you do drive it’s dangerous. The packed roads have turned drivers into hyper-aggressive predators, constantly weaving in and out of traffic, attempting to cut seconds off their commutes. And there is no drivers ed in China.

I took my kids to the city the other day for a Halloween “Ghost Tour” of posh Pacific Heights. It was lovely spending the evening strolling the neighborhood’s imposing Victorian mansions.

The ornate gingerbread and stained-glass buildings are stacked right against each other to keep from falling down in earthquakes. It works. The former abodes of gold and silver barons are now occupied by hoody-wearing tech titans driving new Teslas.

We learned of the young girl forced into a loveless marriage with an older wealthy stock broker in 1888. She bolted at the wedding and was never seen again.

However, the ghost of a young woman wearing a white wedding address has been seen ever since around the corner of Bush Street and Octavia Avenue. Doors slam, windows shut themselves, and buildings make weird creaking noises.

Then I came to a realization walking around Fisherman’s Wharf as I was nearly poked in the eye by a selfie stick-wielding visitor. The tourist areas on weekdays are just as crowded as they were on summer weekends 30 years ago, except that now the number of languages spoken has risen tenfold, as has the cost.

It started out to be a great year for technology stocks. Amazon (AMZN) alone managed to double off its February mini crash bottom, while others like Apple (AAPL) rocketed by 56%. But traders may have visited the trough once too often

The truth is that technology stocks have not performed since June, right when the Mad Hedge Fund Trader dumped its entire portfolio. Only Microsoft (MSFT) and Amazon (AMZN) have managed to eke out new all-time highs since then, and only just.

The rest of tech has been moving either sideways in the most desultory way possible, or suffered cataclysmic declines like Facebook (FB) and Micron Technology (MU).

Of course, the trade wars haven’t helped. It’s amazing that big tech hasn’t already been hit harder given their intensely global business models.

Nor has rising interest rates. Big cap tech companies have such enormous cash balances that they are all net creditors to the financial system and actually benefit from higher interest rates. But dear money does slow the US economy and that DOES hurt their earnings prospects.

No, I’m not worried about tech for the long term. There is no analog company that can compete with a digital company anywhere in the world.

Accounting for 26% of the stock market capitalization and 50% of its profits, it’s only a question of when we get a major new up leg in share prices, not if.

The only unknown now is whether this next leg will take place before or after the next recession. Given the rate at which interest rates and oil prices are rising in the face of a slowing global economy, it’s looking like the recession may win the race.

As our tour ended, who did we see having dinner in the front window of one of the city’s leading restaurants? A young woman wearing a white wedding dress.

Yikes! Maybe the recession is sooner than I thought.

October 11, 2018

Tech Letter

Mad Hedge Technology Letter
October 11, 2018
Fiat Lux

Featured Trade:

(WHY SNAPCHAT SNAPPED),
(SNAP), (FB), (AMZN), (NFLX)

Why Snapchat Snapped

Tech Letter

To the dismay of tech shares, the tech industry doesn’t operate in a bubble.

The broader landscape is experiencing a dose of volatility triggered by the ratcheting up in interest rates.

There’s not much tech can do to change the narrative.

The back and forth political saber rattling isn’t helping either.

Tech is experiencing a swift rotation out of hyper-growth names such as Amazon (AMZN) and Netflix (NFLX) with investors taking profits on these names that have gone up in a straight line this year.

This does not mean you should fling these stocks into tech heaven yet.

The hardest hit names will be the marginal tech firms in the marginal tech spaces headed by dreadful management.

This narrow criterion conveniently perfectly fits one company I have written about extensively.

Enter Snapchat.

It’s been a year to forget or remember - depending on how you look at it for CEO of Snapchat Evan Spiegel.

Snapchat was one of my first recommendations of The Mad Hedge Technology Letter when I told readers to run for the hills.

To read my story on Snapchat, please click here.

At that time, the stock was trading at a luxurious $19.

Lionizing this shoddy company would be a stretch as shares have parachuted down to the $6.60 level.

The latest word is that Snapchat is burning money fast.

The cash crunch will quickly force them to raise some capital and this is just one of the many litanies of spectacular misfortunes that have beset this Venice, California social media starlet.

Maybe management is spending too much time ripping the bong on Venice Beach because the decisions being made are of that ilk.

The first catastrophic move out of many was the botched redesign alienating the core base who were dazed and confused by the new interface and functionality.

Social media works poorly when you can’t find your friends on it.

Spiegel admitted the redesign was “rushed” and it behooves me to let readers know that the redesign was the worst redesign I have ever seen in my life as I tested it out in my office.

Snapchat quickly restored the previous interface calming their shrinking core audience.

The self-inflicted wound was deep, and earnings reflected the quicksand Snapchat quickly found itself in.

Snapchat announced that global daily active users (DAUs) shrank from 191 million to 188 million.

A company at this early stage in the growth cycle should be reeling in the users non-stop.

This is far from a mature company and if executed properly the company should have the ability to cast their net far and wide scooping up new users left and right.

Let’s remember that Instagram, the Facebook (FB) owned direct competitor, is growing their user base parabolically.

Simply put, Snapchat has had no answer to Instagram’s rapid rise to fame, and that was the center of my thesis to turn my back to this rapidly deteriorating company.

Snapchat has offered no meaningful innovation to combat the terrorizing force of Instagram.

The dearth of innovation has caused the average time spent on the platform to dip from 33 minutes to 31 minutes per session.

Instagram has stretched the lead on Snapchat. In fact, it was Instagram that cleverly borrowed Snapchat’s best features and integrated them into their platform.

Sentiment has turned rotten as the stock sold off when Spiegel announced that he wants the company to turn profitable in 2019.

Investors don’t believe this one iota.

Snapchat is expected to burn through $1.5 billion in 2019, and Spiegel’s pipedream of scratching out a profit is implausible.

Snapchat is not executing on the digital ad front.

It was a year and a half ago when consensus believed Snapchat was able to churn out revenue of $540 million this quarter, but it looks more likely that Snapchat is set for revenue of just a shade over $280 million.

The severe underperformance is due to a lack of advertisers causing the eventual price of digital ads to fetch a lower price in an auction-based model.

Stinging as it might be, the lower costs of ads is also caused by the average age group of Snapchat’s core base.

Snapchatters are usually teenagers and have low purchasing power.

Targeting an older user base would improve margins significantly.

However, the conundrum is that the core user base might jump ship like they did to Facebook and shifted over to Facebook-owned Instagram.

Snap doesn’t have a Facebook posing an acute problem that could likely backfire.

General Data Protection Regulation (GDPR) in the European Union made the issue of securing personal data a national issue.

Facebook poured fuel on the fire when they disclosed several breaches clobbering their share price.

Mark Zuckerberg’s company is still reeling from the series of mishaps.

Ironically, Facebook debuted a smart speaker with prime access to user’s home when trust is at its lowest ebb around Facebook’s data collection practices.

Investors really need to ask themselves if Facebook’s management has any common sense at all.

Any decent company would have halted this project and I expect it to be a complete disaster.

Part of Snapchat’s turnaround strategy involves releasing scripted shows as short as five minutes long.

Entering into the original content wars is a tough sell. The competition is becoming fiercer and this move hardly will differentiate itself from ad buyers who already avoid Snapchat. In fact, it smells of desperation.

Snapchat has seen a brutal brain drain with management leaving in droves.

They have voted with their feet.

Chief Strategy Officer Imran Khan was the latest to announce his upcoming departure.

Others to jettison are the VP of product, VP of sales, VP of engineering, and its general counsel.

The high turnover rate will make it more complicated to execute a drastic reversal of fortune.

The only silver lining is if Zuckerberg manages to screw up Instagram after forcing the creators out with his behind-the-scenes meddling, giving a glimmer of hope to Snapchat.

A stellar performance from the execution team along with a Facebook mess of Instagram could resuscitate the user base if users start to flee Instagram in droves.

There aren’t many alternatives unless a user is inclined to quit social media.

Snapchat badly needs to build up its user base or else digital ad buyers will stay away.

I am still bearish on this stock and it would take a small miracle to spruce up the share price again.