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Why I Hate Chip Stocks

Now that the midterm elections are behind us, Congress will be gridlocked for the next two years portending well for tech stocks as a whole.

However, the gridlock will exacerbate negative sentiment in one small group of technology – the semiconductor chip sector.

I have been staunchly bearish on this cohort since the outset of the trade logjam with China and I recommend readers to avoid these stocks like the plague.

The split Congress could fuel an even more rigid stance towards the complicated tech situation, further clamping down on foreign IP theft and technological forced transfers.

Either way, there is no end in sight and as this administration is concretely in place for the next two years, doubling down on foreign policy wins could be the Republican party’s path to victory heading into the 2020 election.

This could mean the rhetoric towards China could ratchet up a few levels.

Soon enough, the tariffs levied on Chinese imports is set to increase to 25% in January.

Even before January, a planned meeting between Trump and Chairman Xi in Buenos Aires on Nov. 29 will take place and is creating a swirling tornado of uncertainty around chip sentiment that is on tenterhooks.

Any chance to resuscitate the sentiment in the industry could come and go with another gut-churning leg down in chip shares.

Unfortunately, the sword of Damocles hanging over the chip sector could drop in 2019 slashing profit margins, revenue, and damaging the all-important guidance.

Even if individual chip companies determine that the trade friction is too much to stomach, it would be expensive and lengthy to transfer an entire supply chain to Vietnam or Indonesia, hitting current R&D budgets and damaging future innovation affecting the pipeline of fresh products.

Time is not a friend to the chip sector.

If the China leveraged chip companies were to wait out this trade war, they risk further being enveloped into the eye of the trade storm if no quick agreements can be made.

They might have to wait a while as Beijing views waiting out Trump and dealing with the next administration in charge as the ideal option.

Chairman Xi conveniently removed term limits in the last congress, meaning he is in his job until death which could be another 40 years or so.

That is the time horizon the Chinese are playing with.

The timing couldn’t have been worse for the chip sector after a slew of weak guidance from upper management painted a downbeat picture for the sector as we inch towards 2019.

Texas Instruments (TXN) Chief Executive Rich Templeton started off his earnings report admitting, “demand for our products slowed across most markets.”

He later admitted that the semiconductor market is grappling with an imminent “softer” market.

Following up a growing chorus of chip executives flashing dangerous warnings signs, Lattice Semiconductors (LSCC) lamented that it was seeing slowness in the industrial and consumer markets in Asia as a result of macroeconomic conditions and tariffs.

Cypress Semiconductor (CY) also chimed in saying it was coping with “softness across the board.”

Making matters worse, Beijing has been showering capital on the local chip sector aimed at nurturing and developing Chinese chip companies poised to compete on the global stage.

Recently, Chinese state-backed semiconductor maker Fujian Jinhua Integrated Circuit was indicted by the U.S. Justice Department for industrial espionage.

The company allegedly stole trade secrets from Boise-based Micron (MU).

Micron could now become the first piece of collateral damage to the snarky trade war threatening huge swaths of American chip company's revenue.

And with the affected American chip companies waded in a quagmire, and chip market softness on the near horizon, semiconductor equipment firms have borne a good amount of the damage this year with Applied Materials Inc (AMAT), KLA-Tencor Corp (KLAC), and Lam Research Corp (LRCX) getting hammered.

Chips tied to Apple’s (AAPL) iPhone are also in for a drubbing with Apple suddenly announcing in their most recent report they would stop offering the unit sales of iPhones, creating more uncertainty around units sold for a massive end-market for global chip companies, adding to the swirling uncertainties overall Chinese chip revenue face.

Apple proxy chip stocks who lean on Apple for a big chunk of revenue such as Skyworks Solutions (SWKS) are getting crushed.

Skyworks was downgraded last week by Citigroup based on underperforming iPhone XR sales.

The rapid rush of chip downgrades has been fast and furious.

Skyworks will have pockets of strength when 5G is fully rolled out because they will supply critical components installed in this new technology for the new era of internet speed and performance.

But that pocket of strength is not now and will not happen tomorrow.

It’s time to duck out of Skyworks and I have been convincingly downbeat on this particular name since the inception of the trade war.

Today crawled in the next batch up negative chip news from Lumentum Holdings (LITE) who supplies 3D chips for Apple iPhone's facial recognition system.

Management reported that sales would be $20 million lower than originally forecasted because of a sudden reduction in shipments from an unnamed customer.

Another ongoing headache is the Qualcomm (QCOM) versus Apple marriage or divorce, depending on how you look at it.

They have been mired in a prolonged court case against each other, and Qualcomm’s share price has been dismal as of late.

Qualcomm recorded zero licensing revenue in the quarter from Apple who is withholding royalty payments from Qualcomm in a dispute over the company's licensing practices.

The move damaged quarterly licensing sales sliding 6% to $1.14 billion.

Qualcomm has lashed back at Apple pointing the finger at Apple for transferring its intellectual property to Intel (INTC) who is supplying chips for new-model iPhones which is possibly part of the reason they lost this contract.

Losing the iPhone contract to Intel is the main factor in Qualcomm expecting modem chip shipments to decline 22% to about 185 million units.

The fight has no end in sight but like Skyworks Solution, Qualcomm is on the forefront of the 5G revolution and provides a silver lining to embattled revenue growth that has been dragged down with the China mess.

At the end of the day, companies have less resistance when they aren’t belligerently brawling with their biggest purchasers.

Biting the hand that feeds you is a poor strategy that cuts across any industry.

Avoid chip companies for the short term and wait for sentiment to reverse course.

July 26, 2018

Tech Letter

Mad Hedge Technology Letter
July 26, 2018
Fiat Lux

Featured Trade:
(THE TRADE WAR'S COLLATERAL DAMAGE),
(SWKS), (ACIA), (CRUS), (XLNX), (ROKU), (SQ)

The Trade War's Collateral Damage

Tech Letter

As the trade ruckus rumbles on for the foreseeable future, there are some places to deploy cash and some places to avoid like the zika virus.

The one area of tech to avoid that is clearer than daylight is the small cap chips companies.

Like a fish out of water, you should not feel comfortable holding shares in this type of equity amid the backdrop of an unresolved trade skirmish.

Although the Mandarins ironically need our chips, the uncertainty permeating around small chip firms means it's not time to hold let alone initiate new positions.

Investors still don't know how this standoff with shake out.

Until, there is more clarity going forward, give way to the next guy who can take the heavy loss.

Keep the powder dry for better times.

The long-term demand picture is healthy with IoT, cloud, and software companies never being thirstier for chips.

Short term is a different story with many of these smaller chip companies subscribing to grotesque charts that will make your jaw drop.

Take Skyworks Solutions, Inc. (SWKS) whose shares have spent the majority of 2018 trending lower and are stuck in purgatory.

(SWKS) produces semiconductors deployed in radio frequency (RF) and mobile systems.

This stock has been tainted by the horrid reality that it generates 25% to 30% of revenue from China.

If you have been living in a cave for the past eight months, technology is the battleground for global supremacy pitting two of the leading technological heavyweights in the world against each other in a fiercely contested, drawn-out conflict.

Any American listed chip company doing at least 20% of revenue in China has the same chart trajectory and that is not up.

Adding insult to injury, (SWKS) generates 35% to 40% of its total revenue from Apple.

As we approach every earnings season, the story rewinds and plays again to loud applause.

A slew of analysts appears on air condemning Apple promulgating lower iPhone sales due to surveys taken across various key suppliers giving them a snapshot into production numbers.

Each time, the analysts are proved wrong. However, the avalanche of downgrades that ensues knocks the stuffing out of the small chip companies dipping viciously, at times more than 10% or more on the headline.

One of the larger Chinese contracts that was signed by (SWKS) was with ZTE. Yes, that ZTE, the one the U.S. administration temporarily put out of business for selling telecommunication equipment to North Korea and Iran.

That was the nail in the coffin.

According to the (SKWS) official website, it has an ongoing, expanding relationship with ZTE and its chips would be "powering data cards and USB modems" in ZTE-manufactured next-generation tablets.

Luckily, the American government reversed its initial decision restoring operations to ZTE.

That does not mean it is out of the woods yet as lingering risks still overhang over this company.

This revelation underscores the massive contract risk for companies that unlike behemoths such as Micron, are desperately reliant on just a handful of contracts to propagate short-term revenue.

Effectively, the U.S. administration views American chip companies as collateral damage to the bigger picture.

The only reason the ZTE ban was lifted was because it was a prerequisite to restart talks between both sides.

If the ban was upheld, 75,000 Chinese workers would have needed to polish the dust off their resumes to start a fresh job search.

The inability to sell components to service the Chinese consumer will strike where it hurts most: the bottom line.

Chip producers did $1.5 billion in sales with ZTE in 2017. That business is in a precarious situation when a tweet can just wipe out those contracts in one fell swoop.

Acacia Communications, Inc. (ACIA) churns out high-speed coherent interconnect products.

The stock was beaten down then beaten some more in 2018.

(ACIA) revealed 30% of its $385.2 million revenue derived from one contract with guess who...ZTE.

On word of ZTE ban, (ACIA) plummeted from $40 to $27.50 in one trading day.

The disappearance of a contract this vital to survival is tough for a small business to handle even if temporary.

Layoffs and a squeezed financial situation apply unrelenting pressure on management to find an elixir.

Cirrus Logic Inc. (CRUS) pumping out a mix of analog, mixed-signal, and audio DSP integrated circuits (ICs) was trading more than $62 just a year ago.

Fast forward to today and its shares are at a measly $39.

To say Cirrus Logic's eggs are in one basket is an understatement.

(CRUS) procures 80% of revenue from Apple.

It's all hunky-dory to develop a close relationship with Apple, but in light of this unpredictable economic climate, shares have been hit hard and there is no end in sight.

(CRUS) even won a contract to help produce Apple's noise canceling and water-resistant AirPods, but that does not do anything to change the narrative.

The vultures are circling around this name and it was time to abort a long time ago.

Xilinx, Inc. (XLNX) is another small chip company and the first to create the first fabless manufacturing model headquartered in San Jose, California.

This company, founded in 1984, procures around 35% of revenue from China

The trade headwinds have set this stock in the crosshairs, being the victim of frequent 5% drops and two 10% slides in 2018.

It is a miracle this stock is slightly in the green this year, and (XLNX) is one of the lucky ones.

Skim through the rest of small cap chips stocks and the charts look the same. Dreadful with massive rally busting sell-offs.

The extreme volatility in and of itself is a sensible reason to steer clear of these names.

The headline risks that splash across the morning news spreads are a daily reminder that chip stocks, big and small, aren't out of the woods yet.

The Johnny-come-latelies must expose themselves to higher quality, unique assets which possess little or no China exposure.

For the experts, trade the volatility at your peril. But if volatility is what you want with scarcity of value, leg into Roku (ROKU) or Square (SQ) on moderate sell-off days.

________________________________________________________________________________________________

Quote of the Day

"Technological progress is like an ax in the hands of a pathological criminal," said German-born theoretical physicist Albert Einstein.

July 20, 2018

Tech Letter

Mad Hedge Technology Letter
July 20, 2018
Fiat Lux

Featured Trade:
(A SELLERS' MARKET)
(CSCO), (MSCC), (GOOGL), (MCHP), (SWKS), (JNPR), (AMAT),
(PANW), (UBER), (AMZN), (AVGO), (QCOM), (CA), (CRM)

A Sellers' Market

Tech Letter

I bet you are wondering where all that money from the tax cuts is going.

Believe it or not, the No. 1 destination of this new windfall is technology companies, not just the stocks, but entire companies.

In fact, the takeover boom in Silicon Valley has already started, and it is rapidly accelerating.

The only logical conclusion in 2018 is that tech firms are about to get a lot more expensive. I'll explain exactly why.

The corporate cash glut is pushing up prices for unrealized M&A activity in 2018. U.S. firms accumulated an overseas treasure trove of around $2.6 trillion and the capital is spilling back into the States with a herd-type mentality.

I have chewed the fat with many CEOs about their cash pile road map. All mirrored each other to a T: strategic acquisition and share buybacks, period. The acquisition effect will be felt through all channels of the tech arterial system in 2018.

As the global race to acquire the best next generation technology heats up, domestic mergers could pierce the 400-deal threshold after a lukewarm 2017.

Spend or die.

Apple alone boomeranged back more than $250 billion with hopes of selective mergers and share buybacks. Cisco (CSCO), Microsoft (MSFT), and Google (GOOGL) were also in the running for most cash repatriated.

The tech behemoths are eager to make transformative injections into security, big data, semiconductor chips, and SaaS (service as a software) among others.

Hint: You want to own stocks in all of these areas.

Even non-traditional tech companies are getting in on the act with Walmart concentrating the heart of its strategic future on the pivot to technology.

Walk into your nearest Walmart every few months.

You'll notice major changes and not for decorative measures.

U-turns from legacy technology firms hawking desktop computers and HDD's (Hard Disk Drive) suddenly realize they are behind the eight ball.

M&A activity will naturally tilt toward firms dabbling in earlier-stage software and 5G supported technology. This flourishing trend will reshape autonomous vehicles and IoT (Internet of Things) products.

The dilemma in waiting to splash on a potential new expansion initiative is that the premium grows with the passage of time. Time is money.

It's a sellers' market and the sellers know this wholeheartedly.

Unleashing the M&A beast comes amid a seismic shift of rapid consolidation in the semiconductor sector. Cut costs to compete now or get crushed under the weight of other rivals that do. Ruthless rules of the game cause ruthless executive decisions.

The best way to cut costs is with immense scale to offer nice shortcuts in the cost structure. Buying another company and using each other's dynamism to find a cheaper way to operate is what Microchip Technology's (MCHP) culling of Microsemi Corporation (MSCC) in a deal worth $10bn was about.

Microsemi, based in Aliso Viejo, California, focuses on manufacturing chips for aerospace, military, and communications equipment.

Microchip's focal point is industrial, automobile and IoT products.

Included in the party bag is a built-in $1.8 billion annual revenue stream and more than $300 million of dynamic synergies set to take effect within three years. The bonus from this package is the ability to cross-sell chips into unique end markets opposed to selling from scratch.

Each business hyper-targets different segments of the chip industry and is highly complementary.

Benefits of a relatively robust credit market create an environment ripe for mergers. Some 57% of tech management questioned intend to go on the prowl for marquee pieces to add to their arsenal.

Then we have chip company Broadcom (AVGO) led by CEO Hock Tan, whose entire strategy is based on M&A and minimal capital spending.

His low-quality strategy of buying market share will ultimately fritter out. His lack of capital spending was also a salient reason for blocking Broadcom's purchase of Qualcomm (QCOM), which if stripped of its capital spending budget would have fallen behind China's Huawei to develop critical 5G infrastructure.

Tan's strategy flies in the face of the most powerful tech companies that are using M&A to enhance their products expanding their halo effect around the world.

Gutting innovation and skimming profits off the top is an entirely self-serving, myopic strategy to the detriment of long-term shareholders.

Investors punished Broadcom for it's latest investment of CA Technologies (CA) for $18.9 billion, even though this pickup signals a different tack.

CA Technologies is a leading provider of information technology (IT) management software, which suggests a belated move into the enterprise software market dominated by incumbents such as Salesforce (CRM).

Better late than never.

No need to mince words here as 2018 won't see any discounts of any sort. Nimble buyers should prepare for price wars as the new normal.

Not only are the plain vanilla big cap tech firms dicing up ways to enter new markets, alternative funds are looking to splash the cash, too.

Sovereign wealth funds and private equity firms are ambitiously circling around like vultures above waiting for the prey to show itself.

Private equity firms dove head first into the M&A circus already tripling output for tech firms.

Highlighting the synchronized show of force is none other than Travis Kalanick, the infamous founder of Uber. He christened his own venture capital fund that hopes to invest in e-commerce, real estate, and companies located in China and India.

The new fund is called 10100 and is backed by his own money. All this is possible because of SoftBank CEO Masayoshi Son's investment in Uber, which netted Kalanick a cool $1.4 billion representing Kalanick's 30% stake in Uber.

It is undeniable that valuations are exorbitant, but all data and chip related companies are selling for huge premiums. The premium will only increase as the applications of 5G, A.I., autonomous cars start to pervade deeper into the mainstream economy.

Adding fuel to the fire is the corporate tax cut. The lower tax rate will rotate more cash into M&A instead of Washington's tax coffers enhancing the ability for companies to stump up for a higher bill. Sellers know firms are bloated with cash and position themselves accordingly.

Highlighting the challenges buyers face in a sellers' market is Microsemi Corp.'s (MSCC) purchase of PMC-Sierra Inc. Even though PMC-Sierra had been looking to get in bed with Skyworks Solutions Inc. (SWKS) just before the MSCC merger, PMC-Sierra reneged on the acquisition after (SWKS) refused to bump up its original offer.

(SWKS) manufactures radio frequency semiconductors facilitating communication among smartphones, tablets and wireless networks found in iPhones and iPads.

(SWKS) is a prime takeover target for Apple. (SWKS) estimates to have the highest EPS growth over the next three to five years for companies not already participating in M&A. Apple (AAPL) could briskly mold this piece into its supply chain. Directly manufacturing chips would be a huge boon for Apple in a chip market in short supply.

In 2013, Japan's Tokyo Electron and Applied Materials (AMAT) angled to become one company called Eteris. This maneuver would have created the world's largest supplier of semiconductor processing equipment.

After two years of regulatory review, the merger was in violation of anti-trust concerns according to the United States. (AMAT), headquartered in Santa Clara, California, is a premium target as equipment is critical to manufacturing semiconductor chips. (AMAT) competes directly with Lam Research (LRCX), which is an absolute gem of a company.

Juniper Networks (JNPR) sells the third-most routers and switches used by ISP's (Internet Service Providers). It is also No. 2 in core routers with a 25% market share. Additionally, (JNPR) has a 24.8% market share of the firewall market.

In 2014, Palo Alto Networks (PANW), another takeover target focusing on cybersecurity, paid a $175 million settlement fee for allegedly infringing (JNPR)'s application firewall patents.

In data center security applications, (JNPR) routinely plays second fiddle to Cisco Systems (CSCO). Cisco, the best of breed in this space would benefit by snapping up (JNPR) and integrating its expertise into an expanding network.

Unsurprisingly, health care is the other sector experiencing a tidal wave of M&A, and it's not shocking that health care firms accumulated cash hoards abroad too. The dots are all starting to connect.

Firms want to partner with innovative companies. Companies hope to focus on customer demands and build a great user experience that will lead the economy. Health care costs are outrageous in America, and Jeff Bezos could flip this industry on its head.

Amazon (AMZN) pursuing lower health costs ultimately will bind these two industries together at the hip and is net positive for the American consumer.

Ride-sharing company Uber embarked on a new digital application called Uber Health that book patients who are medically unfit for regular Uber and shuttle them around to hospital facilities.

Health care providers can hail a ride for sick people immediately and are able to make an appointment 30 days in advance. It is a little difficult to move around in a wheel chair, and tech solves problems that stir up zero appetite for most business ventures. Apple is another large cap tech titan keeping close tabs on the health care space.

It's a two-way street with health care companies looking to snap up exceptional tech and vice versa.

It's practically a game of musical chairs.

Ultimately, Tech M&A is the catch of the day, and boosting earnings requires cutting-edge technology no matter how expensive it is. Investors will be kicking themselves for waiting too long. Buy now while you can.

Yes, It's All Going Into Tech Stocks

________________________________________________________________________________________________

Quote of the Day

"Companies in every industry need to assume that a software revolution is coming," - said American venture capitalist Marc Andreessen.

May 24, 2018

Tech Letter

Mad Hedge Technology Letter
May 24, 2018
Fiat Lux

Featured Trade:
(MICRON'S BLOCKBUSTER SHARE BUYBACK)
(MU), (AMZN), (NFLX), (AAPL), (SWKS), (QRVO), (CRUS), (NVDA), (AMD)

Micron's Blockbuster Share Buyback

Tech Letter

The Amazon (AMZN) and Netflix (NFLX) model is not the only technology business model out there.

Micron (MU) has amply proved that.

Bulls were dancing in the streets when Micron announced a blockbuster share buyback of $10 billion starting in September.

This is all from a company that lost $276 million in 2016.

The buyback is an overwhelmingly bullish premonition for the chip sector that should be the lynchpin to any serious portfolio.

The news keeps getting better.

Micron struck a deal with Intel to produce chips used in flash drives and cameras. Every additional contract is a feather in its cap.

The share repurchase adds up to about 16% of its market value and meshes nicely with its choreographed road map to return 50% of free cash flow to shareholders.

Tech's weighting in the S&P has increased 3X in the past 10 years.

To put tech's strength into perspective, I will roll off a few numbers for you.

The whole American technology sector is worth $7.3 trillion, and emerging markets and European stocks are worth $5 trillion each.

Tech is not going away anytime soon and will command a higher percentage of the S&P moving forward and a higher multiple.

The $5 billion in profit Micron earned in 2017 was just the start and sequential earnings beats are part of their secret sauce and a big reason why this name has been one of the cornerstones of the Mad Hedge Technology Letter portfolio since its inception as well as the first recommendation at $41 on February 1.

Did I mention the stock is dirt cheap at a forward PE multiple of just 6 and that is after a 35% rise in the share price so far this year?

What's more, putting ZTE back into business is a de-facto green light for chip companies to continue sales to Chinese tech companies.

China consumed 38% of semiconductor chips in 2017 and is building 19 new semiconductor fabrication plants (FAB) in an attempt to become self-sufficient.

This is part of its 2025 plan to jack up chip production from less than 20% of global share in 2015 to 70% in 2025.

This is unlikely to happen.

If it was up to them, China would dump cheap chips to every corner of the globe, but the problem is the lack of innovation.

This is hugely bullish for Micron, which extracts half of its revenue from China. It is on cruise control as long as China's nascent chip industry trails miles behind them.

At Micron's investor day, CFO David Zinsner elaborated that the mammoth buyback was because the stock price is "attractive" now and further appreciation is imminent.

Apparently, management was in two camps on the capital allocation program.

The two choices were offering shareholders a dividend or buying back shares.

Management chose share repurchases but continued to say dividends will be "phased in."

This is a company that is not short on cash.

The free cash flow generation capabilities will result in a meaningful dividend sooner than later for Micron, which is executing at optimal levels while its end markets are extrapolating by the day.

As it stands today, Micron is in the midst of taking its 2017 total revenue of about $20 billion and turning it into a $30 billion business by the end of 2018.

Growth - Check. Accelerating Revenue - Check. Margins - Check. Earnings beat - Check. Guidance hike - Check.

The overall chips market is as healthy as ever and data from IDC shows total revenues should grow 7.7% in 2018 after a torrid 2017, which saw a 24% bump in revenues.

The road map for 2019 is murkier with signs of a slowdown because of the nature of semi-conductor production cycles. However, these marginal prognostications have proved to be red herrings time and time again.

Each red herring has offered a glorious buying opportunity and there will be more to come.

Consolidation has been rampant in the chip industry and shows no signs of abating.

Almost two-thirds of total chip revenue comes from the largest 10 chip companies.

This trend has been inching up from 2015 when the top 10 comprised 53% in 2016 and 56% in 2017.

If your gut can't tell you what to buy, go with the bigger chip company with a diversified revenue stream.

The smaller players simply do not have the cash to splurge on cutting-edge R&D to keep up with the jump in innovation.

The leading innovator in the tech space is Nvidia, which has traded back up to the $250 resistance level and has fierce support at $200.

Nvidia is head and shoulders the most innovative chip company in the world.

The innovation is occurring amid a big push into autonomous vehicle technology.

Some of the new generation products from Nvidia have been worked on diligently for the past 10 years, and billions and billions of dollars have been thrown at it.

Chips used for this technology are forecasted to grow 9.6% per year from 2017-2022.

Another death knell for the legacy computer industry sees chips for computers declining 4% during 2017-2022, which is why investors need to avoid legacy companies like the plague, such as IBM and Oracle because the secular declines will result in nasty headlines down the road.

Half way into 2018, and there is still a dire shortage of DRAM chips.

Micron's DRAM segments make up 71% of its total revenue, and the 76% YOY increase in sales underscores the relentless fascination for DRAM chips.

Another superstar, Advanced Micro Devices (AMD), has been drinking the innovation Kool-Aid with Nvidia (NVDA).

Reviews of its next-generation Epyc and Ryzen technology have been positive; the Epyc processors have been found to outperform Intel's chips.

The enhanced products on offer at AMD are some of the reasons revenue is growing 40% per year.

AMD and Nvidia have happily cornered the GPU market and are led by two game-changing CEOs.

It is smart for investors to focus on the highest quality chip names with the best innovation because this setup is most conducive to winning the most lucrative chip contracts.

Smaller players are more reliant on just a few contracts. Therefore, the threat of losing half of revenue on one announcement exposes smaller chip companies to brutal sell-offs.

The smaller chip companies that supply chips to Apple (AAPL) accept this as a time-honored tradition.

Avoid these companies whose share prices suffer most from poor analyst downgrades of the end product.

Cirrus Logic (CRUS), Skyworks Solutions (SWKS), and Qorvo Inc. (QRVO) are small cap chip companies entirely reliant on Apple come hell or high water.

Let the next guy buy them.

Stick with the tried and tested likes of Nvidia, AMD, and Micron because John Thomas told you so.

_________________________________________________________________________________________________

Quote of the Day

"Bitcoin will do to banks what email did to the postal industry." - said Swedish IT entrepreneur and founder of the Swedish Pirate Party Rick Falkvinge.

May 23, 2018

Tech Letter

Mad Hedge Technology Letter
May 23, 2018
Fiat Lux

Featured Trade:
(WHY THE BIG DEAL OVER ZTE?),
(MU), (QCOM), (INTC), (AAPL), (SWKS), (TXN), (BIDU), (BABA)

Why the Big Deal Over ZTE?

Tech Letter

Here's the conundrum.

Beyond cutting-edge technology, there's nothing that China WANTS OR NEEDS to buy from the U.S. China's largest imports are in energy and foodstuffs, both globally traded commodities.

China is playing the long game because it can.

Earlier this year, China altered its constitution to remove term limits and any obstacle that would hinder Chairman Xi to serve indefinitely.

If it's two, four, eight or 10 years, no problem, China will wait it out.

As it stands, China is enjoying the status quo, which is a robust economic trajectory of 6.7% economic growth YOY and at that rate will leapfrog America as the biggest economy in the world by 2030.

China does not need handouts.

It already has its mooncake and is eating it.

The Chinese are also betting that Donald Trump fades away with the passage of time, possibly soon, and that a vastly different administration will enter the fray with an entirely different strategy.

The indefinite "hold" pattern is a polite way to say we surrender.

ZTE Corporation is a Chinese telecommunications equipment manufacturer and low-end smartphone maker based in Shenzhen, China.

This seemingly innocuous company is ground zero for the U.S. vs China trade practice dispute.

The U.S. Department of Commerce banned American tech companies from selling components to ZTE for seven years, crippling its supply chain after violating sanctions against Iran and North Korea.

ZTE uses about 30% of American components to produce its smorgasbord of telecom equipment and down-market cell phones.

What most people do not know is that ZTE is the fourth most prevalent smartphone in America, only behind Apple, Samsung, and LG, commanding a 12.2% market share, and its phones require an array of American made silicon parts.

In 2017, the company shipped more than 20 million phones to the United States.

The ruling effectively put ZTE out of business because the lack of components shelved production.

Low-end smartphones account for almost one-third of total revenue.

ZTE could very well have survived with a direct hit to its consumer phone business, but the decision to ban components made the telecom equipment division inoperable.

This segment accounts for a heavy 58.2% of revenue. Therefore, disrupting ZTE's supply chain would effectively take down more than 91% of its business for a company that employs 75,000 employees in over 160 countries.

Upon news of ZTE's imminent demise, the administration made a U-turn on its initial decision stating "too many jobs in China lost."

The reversal made America look bad.

It shows that America is being dictated to and not the other way around.

When did it become the responsibility of the American administration to fill Chinese jobs for a company that is a threat to national security?

The Chinese refused to continue talks with the visiting delegation until the ZTE situation was addressed.

Treasury Secretary Steve Mnuchin and company were able to "continue" the talks then were politely shown the door.

Bending the rules for ZTE should have never been a prerequisite for talks, stressing the lack of firepower in the administration's holster.

However, stranding the delegation in Chinese hotel rooms for days waiting in limbo, without offering an audience, would have caused even more humiliation and anguish for the administration.

China is not interested in buying much from America, but one thing it needs -- and needs in droves -- are chips.

Long term, this ZTE ban is great for China.

I believe China will use this episode to rile up the nationalistic rhetoric and make it a point to wean itself from American chips.

However, for the time being, American chips are the most valuable import America can offer China, and that won't change for the foreseeable future.

The numbers back me up.

Micron (MU) earns more than $10 billion in revenue from China, which makes up over 51% of its total revenue.

Qualcomm (QCOM), mainly through its lucrative licensing division, makes more than $14.5 billion from its Chinese revenue, which comprises over 65% of revenue.

Texas Instruments (TXN) earns more than 44% of revenue from China, and almost a quarter of Intel's (INTC) revenue is derived from its China operations.

The biggest name embedded in China is Apple (AAPL), which earned almost $45 billion in sales last year. Its China revenue is three times larger than any other American company.

In less than a decade, China has caught up.

China now has adequate local smartphone substitutes through Huawei, Oppo, Vivo, and Xiaomi phones.

Skyworks Solutions (SWKS), a chip company reliant on iPhone contracts, is most levered toward the Chinese market capturing almost 83% of revenue from China.

You would think these chips would be the first on the chopping block in a trade war. However, you are wrong.

China needs all the chips it can get because there is no alternative.

Stopping the inflow of chips is another way of stopping China from doing business and developing technology.

The Chinese economy has been led by the powerful BATs of Baidu (BIDU), Tencent, and Alibaba (BABA) occupying the same prominent role the American FANGs hold in the American economy.

They are not interested in digging their own grave.

To execute the 2025 plan to become the world leaders in advanced technology, they need chips that power all modern electronic devices.

The most likely scenario is that China maintains development using American chips for the time being and slowly pivots to the Korean chip sector, which is vulnerable to Chinese political pressure.

Remember that South Koreans have two of the three biggest chip companies in the world in Samsung and SK Hynix. China has used economic coercion to get what it wants from Korea in the past or to prove a point.

Korean multinational companies, shortly after the Terminal High Altitude Area Defense (THAAD) installation on the Korean peninsula, were penalized by the Chinese government shutting down mainland Korean stores, temporarily banning Chinese tourism in South Korea, and blocking K-pop stars from performing in the lucrative Chinese market.

The Chinese communist government can turn the screws when it wants and how it wants.

Therefore, the next battleground for tech could migrate to South Korean chip companies as China is on a mission to suck up as much high-grade tech ingenuity as possible while it can.

China has some easy targets to whack down if the administration forces it into a corner with a knife to its throat.

Non-tech companies are ripe for massacre because they do not produce chips.

Companies such as Procter & Gamble, Starbucks, McDonald's, and Nike could be replaced by a Chinese imitation in a jiffy.

Apple is the 800-pound gorilla in the room.

An attack on Apple would hyper-accelerate tension between two leaders to the highest it's ever been and would be the straw that breaks the camel's back.

Technology has transformed the world.

Technology also has been adopted by nations as a critical component to national security.

Nothing has changed fundamentally, and nothing will.

China will become the biggest economy in the world by 2030.

China will kick the proverbial can down the road because it can. It never has to cooperate with America again.

Contrary to expectations, American chip companies are untouchable, and investors won't see Micron suddenly losing half its revenue over this trade war.

Until China can produce higher quality chips, it will lap up as much of Uncle Sam's chips until it can force transfer the chip technology from the Koreans.

American chip companies can breathe a sigh of relief.

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Quote of the Day

"If we go to work at 8 a.m. and go home at 5 p.m., this is not a high-tech company and Alibaba will never be successful. If we have that kind of 8-to-5 spirit, then we should just go and do something else." - said Alibaba founder and executive chairman Jack Ma.