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Top 8 Tech Trends of 2018

As 2019 christens us with new technological trends, building our portfolio and lives around these themes will give us a leg up in battling the algorithms that have upped the ante in our drive to get ahead.

Now it’s time to chronicle some of these trends that will permeate through the tech universe.

Some are obvious, and some might as well be hidden treasures.

Smart Areas Will Conspicuously Advance

American consumers will start to notice that locations they frequent and the proximities around them will integrate more smart-tech.

The hoards of data that big tech possesses and the profiles they subsequently create on the American consumer will advance allowing the possibilities of more precise and useful products.

These products won’t just accumulate in a person’s home but in public areas, and business will jump at the chance to improve services if it means more revenue.

Amazon and Google have piled money into the smart home through the voice assistant initiatives and adoption has been breathtaking.

The next generation will provide even more variety to integrate into daily lives.

Location-based Dispersion Will Ramp Up

The gains in technology have given the consumer broader control over their lives.

The ability to practically manage one’s life from a remote location has remarkably improved leaps and bounds.

The deflation of mobile phone data costs, the advancement of high-speed broadband internet services in developing countries, more cloud-based software accessible from any internet entry point, and the development of affordable professional grade hardware have made life easy for the small business owners.

What a difference a few years make!

This has truly given a headache for traditional companies who have failed to evolve with the times such as television staples who rely on analog advertising revenue.

Millennials are more interested in flicking on their favorite YouTuber channel who broadcast from anywhere and aren’t locally based.

Another example is the quality of cameras and audio equipment that have risen to the point that anybody can become the next Justin Bieber.

Music executives are even using Spotify to target new talent to invest in.

Overhyped Bitcoin Will Finally Take A Siesta From The Mainstream

Blockchain technology has the makings of transforming the world we live in.

And the currency based on the blockchain technology had a field day in the press and backyard summer barbecues all over the country.

Well, 2019 will finally put this topic on the backburner even though Bitcoin won’t disappear into irrelevancy, the pendulum will swing the other direction and this digital currency will become underhyped.

The rise to $20,000 and the catastrophic selloff down to $4,000 was a bubble popping in front of us.

It made a lot of people rich like the Winklevoss brothers Cameron and Tyler who took the $65 million from Facebook CEO Mark Zuckerberg and spun it into bitcoin before the euphoria mesmerized the American public.

On the way down from $20,000, retail investors were tearing their hair out but that is the type of volatility investors must subscribe to with assets that are far out on the risk curve.

The volatility that FinTech leader Square (SQ) and OTT Box streamer Roku (ROKU) have are nothing compared to the extreme volatility that digital currency investors must endure.

E-Sports Will Become Even More Popular

Video games classified as a spectator sport will expand up to 40% in 2019.

This phenomenon has already captivated the Asian continent and is coming stateside.

This is a bit out of my realm as standard spectator sports don’t appeal to me much at all, and watching others play video games for fun is something I am even further removed from.

But that’s what the youth like and how they grew up, and this trend shows no signs of stopping.

Industry experts believe that the U.S. is at an inflection point and adoption will accelerate.

Remember that kids don’t play physical sports anymore because of the risk to head trauma, blown ligaments, and the sheer distances involved traveling to and from venues turn participants away.

Franchise rights, advertising, and streaming contracts will energize revenue as a ballooning audience gravitates towards popular leagues, tapping into the fanbase for successful video game series such as Overwatch.

The rise of eSports can be attributed to not only kids not playing physical sports but also younger people watching less television and spending more time online.

Soon, there will be no difference in terms of pay and stature of pro athletes and video gaming athletes.

The amount of money being thrown at the world’s best gamers makes your spine tingle.

Data Regulation Will Tighten

The era of digital data regulation is upon us and whacked a few companies like Google and Facebook in 2018.

Well, this is just the beginning.

The vacuum that once allowed tech companies to run riot is no more, and the government has big tech in their cross-hairs.

The A word will start to reverberate in social circles around the tech ecosphere – Antitrust.

At some point towards the end of 2019, some of these mammoth technology companies could face the mother of all regulation in dismantling their business model through an antitrust suit.

Companies such as Amazon and Facebook are praying to the heavens that this never comes to fruition, but the rhetoric about it will slowly increase in 2019 because of the mischievous ways these tech companies have behaved.

The unintended consequences in 2018 were too widespread and damaging to ignore anymore.

Antitrust lawsuits will creep closer in 2019 and this has spawned an all-out grab for the best lobbyists tech money can buy.

Tech lobbyists now amount to the most in volume historically and they certainly will be wielded in the best interest of Silicon Valley.

Watch this space.

Software Favored To Hardware

The demand for smart consumer devices will fall off a cliff because most of the people who can afford a device already are reading my newsletter from it.

The stunting of smart device innovation has made the upgrade cycle duration longer and consumers feel no need to incrementally upgrade when they aren’t getting more bang for their buck.

The late-cycle nature of the economy that is losing momentum because of a trade war and higher interest rates will see companies look to add to efficiencies by upgrading software systems and processes.

This bodes well for companies such as Microsoft (MSFT), Salesforce (CRM), Twilio (TWLO), PayPal (PYPL), and Adobe (ADBE) in 2019.

Logistics Gets A Boost From Technology

This is where Amazon has gotten so good at efficiently moving goods from point A to point B that it is threatening to blow a hole in the logistic stalwarts of UPS and FedEx.

Robots that help deploy packages in the Amazon warehouses won’t just be an Amazon phenomenon forever.

Smaller businesses will be able to take advantage of more robotics as robotics will benefit from the tailwind of deflation making them affordable to smaller business owners.

Amazon’s ramp-up in logistics was a focal point in their purchase of overpriced grocer Whole Foods.

This was more of a bet on their ability to physically deliver well relative to competition than it was its ability to stock above average quality groceries.

If Whole Foods ever did fail, Amazon would be able to spin the prime real estate into a warehouse located in wealthy areas serving the same wealthy clientele.

Therefore, there is no downside short or long-term by buying Whole Foods. Amazon will be able to fine-tune their logistics strategy which they are piling a ton of innovation into.

Possible new logistical innovations include Amazon attempting to deliver to garages to avoid rampant theft.

This is all happening while Amazon pushes onto FedEx’s (FDX) and UPS’s (UPS) turf by building out their own fleet.

Innovative logistics is forcing other grocers to improve fast giving customers better grocery service and prices.

Kroger (KR) has heavily invested in a new British-based logistics warehouse system and Walmart (WMT) is fast changing into a tech play.

Tech Volatility Won’t Go Away

Current Chair of the Federal Reserve Jerome Powell unleashed a dragon when he boxed himself into a corner last year and had to announce a rate hike to preserve the integrity of the institution.

Markets whipsawed like a bull at a rodeo and investors lost their pants.

Tech companies who have been leading the economy and trot out robust EPS growth out of a whole swath of industries will experience further volatility as geopolitics and interest rate rhetoric grips the world.

Apple’s revenue warning did not help either and just wait until semiconductors start announcing disastrous earnings.

The short volatility industry crashed last February, and the unwinding of the Fed’s balance sheet mixed with the Chinese avoiding treasury purchases due to the trade war will insert even more volatility into the mix.

Powell attempted to readjust his message by claiming that the Fed “will be patient” and tech shares have had a monstrous rally capped off with Roku exploding over 30% after news of positive subscriber numbers and news of streaming content platform Hulu blowing past the 25 million subscriber mark.

Volatility is good for traders as it offers prime entry points and call spreads can be executed deeper in the money because of the heightened implied volatility.

December 19, 2018

Tech Letter

Mad Hedge Technology Letter
December 19, 2018
Fiat Lux

Featured Trade:

(HOW TECH IS EATING INTO HEALTHCARE COSTS)
(VEEV), (CRM), (GSK), (AZN), (MRK), (NVS), (DBX), (OKTA), (TWLO)

How Tech is Eating into Healthcare Costs

Tech Letter

It’s undeniable that American healthcare costs are a big part of a family’s monthly expenses.

Rising deductibles and out-of-network fees are a few of the out-of-pocket costs that can singe a hole in the average joes’ pocket.

It was only in 2016 when healthcare insurance costs eclipsed more than $10,000 a year per person, and over the past 12 months, 68% of people surveyed admitted that future healthcare costs would probably consume a larger part of their earnings.

The result is that healthcare companies are making money hand over fist.

Is there something that I deduce from this lucrative part of the economy that has the potential to feed into the tech sector?

The tidal wave of money spilling into the healthcare industry has also given impetus to these firms hoping to buttress their networks and IT with modern tech infrastructure to take advantage of the efficiencies on offer.

Building the best cloud services geared towards specific industries has been a winning formula and the generated momentum will continue into the next calendar year.

Prime models can be seen all over the tech ecosphere and they will be big winners of 2019.

One example is Twilio (TWLO) who has quietly risen the bar for communication cloud products.

A panoply of small companies can now offer professionalized email, text message, automated voice mail services amongst other services that do the work of 100 employees.

Recently, I touched on a cloud company named Okta (OKTA) responsible for managing the facilitation of passwords.

This identity management company was formed by a group of former Salesforce executives.

In my book, a Salesforce (CRM) credential is a golden stamp of approval for newly formed cloud-companies seeking to develop new cloud products in broad industries.

Why?

Salesforce’s client relationship management platform (CRM) is ubiquitous and the most popular enterprise software.

The way they develop their model is by launching and acquiring new e-commerce and marketing services - which lure in customers into its walled gardens.

Salesforce also applies its artificial intelligence platform Einstein to harness customer relationships and help businesses carry out decisions based on data alone instead of testosterone and emotion.

This all means that Salesforce executives have their finger on the pulse of the cloud landscape and know how to build a cloud business from scratch which is valuable.

They know what certain industries require to mushroom and can deploy resources in the quickest way possible while surrounding themselves by hordes of software engineers who can be poached for a certain fee.

The framework being in place is a massive bounty for these executives who just line up the dots then motor on to an industry confirmed by the data.

And remember that 99.9% of people do not have access to this proprietary data.

Consequently, they know more about corporate America than most Fortune 500 CEOs.

Marrying up the healthcare industry to the cloud was just a matter of time.

Veeva Systems (VEEV) is a cloud-computing company focused on pharmaceutical and life sciences industry applications.

Founder and CEO of Veeva Systems Peter Gassner cut his teeth at Salesforce serving as Senior Vice President of Technology.

His job was building the salesforce.com platform including product, marketing and developer relations.

Gassner has effectively transplanted the Salesforce platform model and applied it to the life sciences industry and has done a great job doing it.

The Veeva Commercial Cloud includes a CRM platform that aids drug company’s management of clients.

The Veeva Vault is a tool that tracks industry regulations, clinical trials, and recommends actionable habits in the cloud.

Veeva's CRM platform is powered by the Salesforce1 app development platform and is integrated into the broader Salesforce Marketing and Service Clouds.

The first mover advantage has offered all the low-hanging fruit for Veeva.

The lack of competition surely never lasts but the extra time to pad their lead is only a positive to its business model.

Veeva has already lured in some of the health industries biggest names such as GlaxoSmithKline (GSK), AstraZeneca (AZN), Merck & Co. (MRK), and Novartis (NVS).

These heavy hitters are meaningfully tied to its ecosystem, and it is safe to say that these relationships are only scratching the surface and have the potential to expand as Veeva installs more add-on tools into its platform.

The popularity shows up in the numbers with Veeva’s 3-year sales growth rate hovering around 30%.

Even better, the profitability of Veeva is indicative of the strength in its business model. They are simply at the right place at the right time to capture the momentum from the digital crossover in the healthcare industry.

Many similar names like Dropbox (DBX) are enormous loss-making enterprises but Veeva has shrugged off this stereotype that many cloud companies of its size can’t be profitable.

The effect of being strategically placed in a position to cherry pick the lucrative healthcare industry has also seeped into the strong profit margins of Veeva able to grow it to over 32%.

Touching more on the profitability, EPS has kicked into gear sequentially rising 80%, and the long-term outperformance is backed up with a 3-year EPS growth rate of 41%.

This cloud company is incredibly profitable for its size, and part of that is the absence of competition which increases pricing power.

Dropbox does not have that luxury of favorable pricing schemes which cripple profitability and leads to attrition and just as harmful – a price war.

Veeva’s forecasts for next year blew past Wall Street’s estimates and the company is modeling for EPS of $1.58 and revenue around $856 million in 2019.

Gassner has even publicly acknowledged that he expects 2019 revenue to come in between $1 billion and $1.1 billion which is a full year ahead of schedule.

The bullish guidance is a clue that the overall cloud story is alive and kicking, and there is absolutely no weakness whatsoever.

Making this story even more compelling is that in the last five years, profits are up six-fold, revenue is up four-fold, and the number of new products is up three-fold.

As we advance into 2019, I believe Veeva is a buy-on-the-dip candidate because of its favorable market position, rapidly expanding margins, and its low enterprise value of $11 billion which deems it, as I daresay, a lucrative buyout target for larger industry cloud players like Salesforce.

The tech industry has a habit of coming full circle become of its network effect of capital, talent, and management.

I would be interested in dipping my toe into any of Salesforce’s offspring because these models are built to scale and are waiting on the doorstep to seize revenue from industry migrating to digital.

Okta did it, and Veeva Systems made the leap of faith too, confirming that the Salesforce method is a path to untold profits for cloud-based software companies.

When the market can finally digest the macro rigmaroles, shares for this innovative and hyper-growth cloud company is set to take off.

December 13, 2018

Tech Letter

Mad Hedge Technology Letter
December 13, 2018
Fiat Lux

Featured Trade:

(HOW PAYPAL IS DESTROYING LEGACY BANKING)
(MSFT), (TWLO), (ADBE), (PYPL), (CRM), (SQ), (ROKU), (AMZN)

How PayPal is Destroying Legacy Banking

Tech Letter

Gazing into the future, investors know it’s time to deploy strategies to make money in 2019.

This year has been a bizarre one for technology stocks.

The industry was overwhelmed by a relentless geopolitical circus that had more sway on tech stock’s price action than in any year that I can remember.

Technology stocks have never been more intertwined with politics.

The so-called FANGs have really been taken out behind the woodshed and beaten, and their get-out-of-jail card is no longer free to access with politicians eyeing them as take down targets.

They are no longer invincible even if they still earn bucket loads of money.

A good amount of the public animosity towards the big tech companies has been directed to socially awkward CEO of Facebook Mark Zuckerberg and his negligence towards the concept of personal data.

Facebook was once the best company in technology to work, I can tell you now that prospective applicants are scrutinizing Facebook’s actions with a gimlet eye and turning to other opportunities.

Current Facebook employees are putting in feelers out to former colleagues planning optimal exit strategies.

Remember that it’s not my job to always tell you which tech stocks are going up, but also to tell you which tech stocks are going down.

One stock poised to outperform in 2019 is international FinTech company PayPal (PYPL).

The stock has proven to be Teflon-like deflecting the pronounced volatility that has soured the tech sector in the second half of the year.

The pendulum of regulation-flipping will concoct new winners for 2019 and I believe PayPal is one of them.

PayPal is in a dominant market position with a core customer base of 254 million users and growing.

The company is so dominant that it processes almost 30% of all global payments excluding China where foreign companies are barred from operating in the FinTech space.

The quality of the product is demonstrated by a recent note from research firm Nielsen offering data showing that on average, PayPal customers complete transactions 88.7% of the time.

This astoundingly high number for PayPal checkout conversion is about 60% better than “other digital wallets” and 82% better than “all payment types."

PayPal’s home country, United States, is still vastly unmonetized in terms of the breadth of penetration of online and e-commerce payments.

America has failed so far to adopt the amount of FinTech that Chinese consumers have rapidly embraced.

The great news is that late-stage adoption of FinTech services will offer PayPal a path to profits that bodes well for the earnings and its share price in 2019 and beyond.

Investors can expect total payment volumes (TPV) consistently nudging up in the mid-20% range.

The firm helmed by Dan Schulman is just scratching the surface on pricing power.

PayPal has changed its approach of ‘one‐size‐fits‐all’ in merchant contracts to a dynamic pricing model reflecting the value‐add of recently acquired products that are more powerful.

Jetlore, launched in 2014, is a provider of predictive artificial intelligence for retail companies able to comb through the data to help boost sales.

Hyperwallet distributes payments to those that sell online, and its purchase was centered around protecting the company's core business, enabling marketplaces to pay into PayPal accounts.

iZettle, an international mobile point-of-sale (POS) provider, is better known as the Square of Europe and has a large footprint. The relationship in PayPal has sounded alarm bells in Britain for being too dominant.

Simility, an AI-based fraud prevention specialist, round out a comprehensive list of new tools and services to PayPal’s all-star caliber lineup that can offer upgrades to businesses through a hybrid solution.

This positivity surrounding the sum of the parts will allow the company to build custom solutions for merchants of all sizes.

Augmenting a solid, stable business is a start-up inside of PayPal’s umbrella of assets with enormous growth potential called Venmo making up one of PayPal’s large future bets.

Venmo is a peer-to-peer payment app acquired by PayPal in 2013.

It is a favorite and mainstay of Millennial users who have gravitated towards this FinTech platform.

PayPal is intently focused on monetizing Venmo and the strategy is paying dividends with last quarter seeing 24% of Venmo traffic monetized which is up sequentially from 17% the quarter before.

Part of the increase in profits can be attributed to integrating Uber Eats into the platform, tacking on a charge for instant money transfers linked to bank accounts, and a Venmo debit card rolled out to the masses.

This innovation was not organic and in fact borrowed from FinTech Square, a great company led by Jack Dorsey, but the stock is incredibly volatile scaring off a certain class of investors.

Former CFO of Square Sarah Friar left her post at Square to boldly take on a CEO job at Nextdoor, a social network app, illustrating that an executive management job at Square is a golden credential able to springboard workers to a CEO job in Silicon Valley.

Shares of Square have doubled in 2018 and 2017, and the recent weakness in shares is more of a case that Square went too far over its skis than anything materially wrong with the company as well as a harsh macro climate that stung most of tech.

The price action can sometimes be breathtaking with 7% moves up and down all in a few days.

If you are searching for a slow grinder on the way up, then Microsoft (MSFT) would be a better tech play to plop your money into.

In my eyes, Microsoft is the most durable, all-terrain tech stock that will weather any type of gale-force squall in 2019.

For me, CEO of Microsoft Satya Nadella is the best CEO out there in the tech industry minus Jeff Bezos at Amazon (AMZN).

The Azure Cloud business is ferociously nipping at Amazon’s heels and Nadella has created a subscription-based monster out of legacy components left behind by failure Steve Ballmer who almost sunk Microsoft.

The stock has risen three-fold since Nadella took the reins, and I believe that Microsoft will soon surpass the trillion-dollar market capitalization level and end 2019 as the most valuable tech company.

Microsoft is indestructible because it’s a hybrid mashup of a growth company whose legacy products are also still delivering fused with a top-notch gaming division and a chance at catching the Amazon cloud.

The only company that can compare in terms of potency is Amazon.

Microsoft is not a one-trick pony like Apple, Facebook, Netflix and the way I see it, there are only two top companies in the tech landscape that will leave the last three companies I mentioned in the rear-view mirror.

Echoing Microsoft, PayPal has adopted a similar magical formula with its legacy core growing at 20% yet has growth levers with Venmo layered with targeted add-on companies that will enhance the firm’s offerings.

Moving forward, tech companies that have one or more growth drivers funded by a successful legacy base will become the ultimate tech stocks.

Playing on the same trope, Adobe (ADBE) is another company that has a software-based iron-clad legacy twinge to it and has the potential to spread its wings in 2019.

PayPal, Microsoft, and Adobe do not have the potential to double like Square or Roku next year, but they have minimal China trade war risk if things turn ugly, highly profitable with growing EPS, and are pure software companies whose CEOs put a massive emphasis on software development.

Expect this trio to melt up in 2019, and be prepared to strap on call spreads at advantageous entry points.

Another pure software service stock I love for 2019 is Twilio (TWLO) who I chronically use when I call an Uber to shuttle me around and take weekend getaways on Airbnb.

I would also lump Salesforce (CRM) into the discussion for stocks to buy in 2019 too.

Notice that all the stocks I favor next year are heavily weighted towards software and not hardware.

Hardware is going out of fashion at warp speed, the China tariffs just exacerbated this trend since most of the hardware supply chains are based in China.

Currently, the Mad Technology Letter has open positions in Microsoft and PayPal and if you are like most people online, you will probably use their service next year and more than a few times.

November 29, 2018

Tech Letter

Mad Hedge Technology Letter
November 29, 2018
Fiat Lux

Featured Trade:

(SALESFORCE KNOCKS IT OUT OF THE PARK)
(CRM), (AAPL), (PYPL), (ADBE), (TWLO), (MSFT), (AMZN)

Salesforce Knocks It Out of the Park

Tech Letter

It’s been a grueling winter for tech stocks and countless number of positive earnings reports have fell on deaf ears.

Will the bloodletting stop?

Not if Salesforce (CRM) has something to say about it!

And if you thought that tech’s secular tailwinds had vanished, this latest earnings report confirmed that software stocks are alive and are as potent as ever.

That is why I have identified software stocks as the best tech play in the current late-stage economic cycle.

At the Mad Hedge Lake Tahoe Conference, I clearly telegraphed that companies do not pour capital into capex for large and risky projects at this late stage, they search for the additional incremental dollar by arming their staff with optimal and efficient software programs to squeeze more juice out of the lemon.

Salesforce is a great example of this.

Moving forward, Salesforce is on the A-team of the software squad, and ideally positioned to harpoon any whales that come near their boat.

Companies are looking to double down on software initiatives at this point which is another reason why annual IT budgets have shot through the roof.

I have met countless CEOs who guide thousands of staff throughout branches around the world and they told me that one of the big in-house additions has been integrating Salesforce as the main customer relationship management system deleting legacy systems of yore that have pooped out.

The switch bears fruits immediately with operations supercharged like a 5-star high school football prospect on his first month of ‘roids.

Simply put, everything just works a lot better with access to this software.

What CEO wouldn’t want that?

Even more salient is that Salesforce has promoted itself as the emblematic tech growth stock promising to smash $16 billion of annual revenue by next year.

I love that Salesforce commits to ambitious sales targets and always delivers the goods.

A talking head on a prominent financial TV show went on record saying that Apple is the key to the tech narrative perpetuating, I would completely disagree with this statement.

Everyone and his mother have absorbed that Apple iPhones sales have plateaued, I am honestly sick of hearing the same story in the news over and over again.

That is why Apple has been trying to morph into a software and service stock. They are doing a great job at it by the way.

The real conclusive acid test to the tech story are these high growth software stocks because they should be the ones outperforming at this stage in the economic cycle.

If companies tilted towards software like Salesforce, Twilio (TWLO), PayPal (PYPL), Microsoft (MSFT), and Adobe (ADBE), just to name a few of the crown jewels of software stocks, start laying eggs then I would admit the tech story is dead.

But it’s not.

Salesforce is poised to continue its ascent and that basically means quarterly sales growth in the mid-20s for the foreseeable future.

There is an addressable market of $200 billion and the pipeline is rich as ever could be.

Salesforce has really turned the corner with free cash flow and profitability. It was only a few years ago they were turning in heavy losses, but this new Salesforce will be even more profitable as the network effect makes the sum of the parts and each add-on cloud-based software tool even more valuable.

Companies just love the breadth of functionality that Salesforce offers and their pension for product enhancement is really owed to CEO Marc Benioff who never shies away from calling his peers out and never cuts corners.

In fact, Marc Benioff is one of the good guys in an increasingly rotting Silicon Valley, part of this has to do with him growing up as a local lad in Burlingame, just a stone throw from his newly built palatial Salesforce Tower gracing downtown San Francisco’s picturesque skyline.

Benioff has more skin in the game as a local and publicly supported Proposition C, effectively a bill that would charge a homeless tax on big earning corporations in San Francisco.

Benioff has also promised to fund any subsequent legal attack that attempts to unravel this homeless tax putting his money where his mouth is.

Benioff noted that he has seen no softness in the macro spending environment.

And even with all the crazy headlines spinning around in the media, there has been no material impact from any supposed peak or downshift in the business environment.

Not only is Salesforce dredging up SME deals at a fast rate, they are quickly targeting the big kahunas.

The number of deals generating more than $1 million was up 46% YOY in the third quarter.

The volume of $20 million-plus relationships is also growing significantly.

In the past quarter, Salesforce renewed and expanded a 9-figure relationship with one of the largest banks in the world.

Salesforce is able to upsell their cloud tools to customers and these firms eat up the Einstein built-in functionality that uses artificial intelligence to improve the existing software.

North America comprised 71% of total revenue which is why this software company will reap the rewards for any extension of this economic cycle because they are largely domestic and best in show.

Salesforce beat and raised its outlook calming the frayed nerves of investors looking to dump software stocks.

Just look at the billings growth that was anticipated at 19%, Salesforce smashed it by 8% coming in at 27%.

Not only are they scooping up new customers, but renewals have been just as robust.

The truth is that Salesforce can’t roll out enough cloud-based software products to meet the insatiable demand.

All of this backs up my thesis that software stocks will be the outsized winners of 2019.

The FANGs are not dead, I rather hold an Amazon (AMZN) or Apple (AAPL) long term if I had the choice.

But at this stage, investors should be piling into all the crème de la crème software stocks.

Avoid them at your peril.

November 7, 2018

Tech Letter

Mad Hedge Technology Letter
November 7, 2018
Fiat Lux

Featured Trade:

(THE RELIABILITY OF ADOBE)
(ADBE), (GOOGL), (ZEN), (TWLO), (SQ)

The Reliability of Adobe

Tech Letter

Tech companies have a habit of suddenly coming and going because of the nature of the relentless environment that spits out losers and celebrates winners.

It’s hard-pressed to find software companies that pass the test of time but there is one that is healthily chugging along that most people know quite well.

Adobe (ADBE) was established 35 years ago in co-founder John Warnock's garage.

This legacy software company’s name, Adobe, was named after the Adobe Creek in Los Altos, California, which ran behind Warnock's house.

Adobe cut its teeth in an era when tech CEOs were not larger-than-life cult figures, and all Adobe has done is quietly infiltrating its way into everybody’s devices by way of Adobe Flash Player and its smorgasbord of useful software applications.

Adobe acquired Macromedia in 2005 which was responsible for building Adobe Flash Player.

This Macromedia software has been developed and distributed by Adobe Systems ever since the purchase and its functions involve viewing multimedia contents, executing rich internet applications, and streaming audio and video. Flash Player can run from a web browser as a browser plug-in or on supported mobile devices.

Flash player was its second hit success software program after its Adobe Acrobat and Reader software introduced PDF, the Portable Document Format, which is still ubiquitously used today even after all these years.

Most software companies are relatively new to the scene and like companies I have recently written about such as Zendesk (ZEN) and Twilio (TWLO), they can brag about growing sales of 30% or 40% plus per year.

Adobe isn’t too shabby itself growing sales at over 24% annually – remarkably high for such an ancient tech company.

The company’s strengths are similar to that of Apple (AAPL) – high-quality products and high profitability.

There will be no back-to-back doubling of the stock like some hyper-growth tech stocks because Adobe doesn’t subscribe to the type of growth trail that Square (SQ) has blazed.

What you can expect from Adobe is a slow grind up in share price stoked by its outperforming EPS expansion and acceptable sales growth of mid-20%.

Its annual operating margins have essentially tripled since the beginning of 2015 from around 10% and now boasts an Apple-like 30%.

There are no bones about it – Adobe has high-quality software across its diversified portfolio.

Other Adobe software products universally soaked up are its stable array of graphic design software such as Adobe Photoshop and Adobe Dreamweaver.

Adobe has also ventured into video editing, animation, and visual effects with Adobe Premiere Pro.

Not only that, Adobe has forayed into more conventional types of software such as digital marketing management software and server software.

Simply put, Adobe’s assortment of digital media software products has a religious-like following especially for iOS users.

As you might have guessed correctly, the lion’s share of Adobe’s revenue stream stems from its software as a service (SaaS) segment contributing 80% to the top line.

More narrowly, the digital media segment makes up almost 70% of the subscription-based revenue. This division will expand at least 20% each year boding well for Adobe to maintain its 20% plus sales growth that any legacy software company would sacrifice a right leg to achieve.

It’s digital marketing software products rub up against stifling competition in Alphabet (GOOGL) amongst others and contribute a less robust 30% to overall sales.

I am less bullish on this part of the business because they have it rough competing against one of the Fangs, the path of less resistance clearly sides with its bread and butter of the digital media offerings.

Its subscription-based pricing model was the catalyst for boosting profitability causing the stock to experience massive price gains. The stock has doubled in the past two years which is unheard of for most legacy software companies.

No longer does Adobe need to manufacture the ancient CD of yore physically delivering it to customers, users can briskly download these products directly from the official website, receive constant upgrades over broadband internet, and pay Adobe monthly for their humble services.

In fact, any investors looking for some hot software stocks only need to find companies that recently shifted to a subscription-based pricing model. It’s pretty much a license to print money if the software quality can backup the monthly costs for the user.

I can tell you that Adobe’s software has remained world class, embedded at the heart of most digital devices at home and in the office, and who would have thought that just a little shift to the pricing model would have doubled the stock price?

Well, instead of one-off sales, Adobe can book revenue month after month, and year after year demonstrating the supercharged effect of shifting to a recurring revenue stream model.

Highlighting the pivot to profitability is Adobe’s three-year EPS growth rate of 48% turning this company into a mammoth software company with a $117 billion market cap.

Another positive for Adobe’s future sales are its fertile addressable markets in Europe and Asia.

There is ample room to expand in these geographical regions with Europe already chipping in with almost $2 billion of revenue per year and Asia with another $1 billion.

Future harvests look even more bountiful.

These two regions make up almost 40% of sales and as the Asian middle class is poised to elevate a giant swath of its people to middle class, Adobe will be a handsome beneficiary of this trend as middle-class families tend to pump out more university graduates who migrate to software-based occupations.

Even though Adobe isn’t the sexiest name out there, it certainly is in the category of “safe.”

In no way do I see an eradication of its embedded software spread widely throughout the tech universe.

Its digital media software tools are best-in-show and loyally followed with a long-lasting revenue stream that has room to grow abroad.

Do not expect Adobe to debut any earth-shattering products, but I fully anticipate Adobe to become even more profitable to the point that they might offer a dividend or reallocate capital to shareholders through stock buybacks.

Apple has similar strengths in its business model, albeit on a much grander scale.

I feel that Adobe doesn’t get the credit it deserves because of its steady as it goes drivers that keep motoring higher in an industry that adores groundbreaking products that revolutionize the world.

I would wait for a major sell-off because a double in two years has bid up the stock to expensive levels represented in its premium forward PE multiple of 35.

However, as the conclusion of the mid-term elections offers some certainty to the market, tech stocks could get swept up in a positive rush to round out the year.

Luckily for Mad Hedge Tech readers, this is the golden age for software companies and we are just scratching the surface of the capability software efficiencies can deliver to small and large companies across every bit of the economy.

Another Apple-like similarity is that Adobe is annually voted one of the best places to work according to Fortune, stacked up against companies represented across the full economic spectrum and not just tech.

If you have a kid, tell him to find a job in San Jose, he or she could find worse places to cut a paycheck.