Posts

August 5, 2019

Mad Hedge Technology Letter
August 5, 2019
Fiat Lux

Featured Trade:

(THE CHINA TARIFF BOMBSHELL AND TECHNOLOGY),
(AAPL), (NVDA), (INTC), (MU), (WDC), (BBY)

The China Tariff Bombshell and Technology

With one little tweet, the state of technology and the companies that rely on the public markets that serve them went haywire.

U.S. President Donald Trump levied another 10% on the $300 billion that had not been tariffed up yet compounding the misery for anyone who has any vested interest in trade with mainland China.

The tariffs will take effect on September 1st.

How does this shake out for American technology?

Any brand tech name that has substantial supply chain operations can kiss their stay in the Middle Kingdom goodbye.

If management didn’t understand that before, then it’s clear as night that they need to shift their supply chain out of the reaches of the Chinese communist party.

The U.S. Administration tripling down on China being our archnemesis means that any sort of cross-border economic trade or cultural exchange will be viewed through the prism of warped geopolitics.

The U.S. President Donald Trump has in fact taken a page out of the Chinese playbook turning everything he sees and touches into a transactional tool for what he is pursuing at the time or in the future.

Specific companies facing the wrath of the tariffs are companies as conspicuous as Apple filtering down to the SMEs that make local business local.

Semiconductor chips are a huge loser in this new development as the price of electronic goods will rise with the tariffs.

If you want a name that lies in the heart of electronic consumer goods, then BestBuy (BBY) would encapsulate this thesis and unsurprisingly they were taken out to the back of the woodshed and taught a lesson dropping 10% on the news.

Any technology outfit that imports goods from China will be hit as well and this means semiconductor chips along the lines of Nvidia (NVDA), Intel (INTC), Western Digital (WDC) and Micron (MU) among others.

Chips are the meat and bones that go into end products like iPads and a slew of smart devices.

Demand will be hit because of the cost of producing these types of consumer products will rise.

The softness is showing up in the numbers with Apple’s iPhone revenue down 12% year-over-year.

Samsung of Korea also showed that this isn’t just an American problem with their semiconductor division’s operating profits down 71% year-over-year.

The Korean conglomerate is in a spat with the Japanese government over war crimes from the second world war causing the Japanese government to bottleneck the supply of chemicals needed to produce high-level semiconductor chips.

The export restriction will drag down SK Hynix display business who is one of the largest producers of DRAM chips and also a Korean company.

Consumers are also using their phones longer with Apple iPhone customers holding their device up to 4 years delaying the refresh cycle.

The company that Steve Jobs built will have to repurpose themselves for a brave new tech landscape that includes heavier regulation, trade tariffs, and device saturation.

When investors talk about the “low hanging fruit,” at this point, Apple isn’t one of them.

And if you think the services business is a cakewalk, ponder about how many apps and behemoths that spit out a whole lineup of apps.

Apple still has its ecosystem and should guard it with its life, this is the same ecosystem that can charge Google around $10 billion per year to slap on Google search as the primary search engine on Apple devices.

Expect tech to telegraph a deceleration in revenue for the last quarter and next year.

The tech environment is brittle at this point and uncertainty wafts in the air like a hot stack of pancakes.

 

 

June 6, 2019

Mad Hedge Technology Letter
June 6, 2019
Fiat Lux

Featured Trade:

(THE SHAKEOUT IN GAME STOCKS)
(GME), (MSFT), (GOOGL), (APPL), (STX), (WDC)

The Shakeout in Game Stocks

Do not invest in any video game stocks that don’t make video games.

If you want to simplify today’s newsletter down to the nuts and bolts, then there you go.

The company that I have been pounding on the table for readers to sell on rallies has convincingly proven my forecast right yet again with GameStop (GME) capitulating 35%.

It’s difficult to find a tech company with a strategic model that is worse than GameStop’s, and my call to short this stock has been vindicated.

Other competitors that vie for awful tech business models would be in the hard disk drive (HDD) market, and that is why I have been ushering readers to spurn Western Digital (WDC) and Seagate Technology (STX).

This is a time when everybody and their grandmother are ditching hard drives and migrating to the cloud, while GameStop is a video game retailer who is set up in malls that add zero value to the consumer.

This also dovetails nicely with my premise that broker technology or in this case retail brokers of physical video games are a weak business to be in when kids are downloading video game straight from their broadband via the cloud and don’t need to go into the store anymore.

Let’s analyze why GameStop dropped 35%.

The rapid migration of the digital economy does not have room to accompany GameStop’s model of retail video game stores anymore.

It’s a 1990 business in 2019 – only twenty years too late.

This model is being attacked from all fronts – a live sinking ship with no life vests on board.

GameStop was already confronted with a harsh reality and pigeonholed into one of a handful of companies in need of a turnaround.

This isn’t new in the technology sector as many legacy firms have had to reinvent themselves to spruce up a stale business model.

The earnings call was peppered with buzz words such as “transformation” and “strategic vision.”

And when the Chief Operating Officer Rob Lloyd detailed the prior quarter’s results, it was nothing short of a stinker.

Total quarterly revenue dropped 13.3% in Q1 2019 which was down from the prior year of 10.3%.

The headline number did nothing to assuage investors that the ship is turning around, it appears as if the boat is still drifting in reverse.

Diving into the segments, underperformance is an accurate way to capture the current state of GameStop with hardware sales down 35%, software sales down 4.3% and selling pre-owned products declining 20.3%.

Poor software sales were blamed on weaker new title launches this year and comping the strong data war launched last year with increasing digital adoption.

The awful hardware sales were pinned on the late stages of the current generation PS4 and Xbox One cycle with GameStop awaiting an official launch date announcement from Sony and Microsoft for their new console products.

Pre-owned business fell off a cliff reflecting tepid software demand for physical games and the increasing popularity of the various digitally offered products via alternative channels.

The only part of GameStop going in the right direction is the collectibles business that increased 10.5% from last year but makes up only a minor part of the overall business.

Management has elected to remove the dividend completely to freshen up the balance sheet slamming the company as a whole with a black eye and giving investors even less reason to hold the stock.

Indirectly, this is a confession that cash might be a problem in the medium-term.

The move to put the kibosh on rewarding shareholders will save the company over $150 million, but the ugly sell-off means that investors are leaving in droves as this past quarter could be the straw that broke the camel’s back.

They plan to use some of these funds to pay down debt, and GameStop is still confronted by a lack of transformative initiatives that could breathe life back into this legacy gaming company.

It was only in 2016 when the company was profitable earning over $400 million.

Profits have steadily eroded over time with the company now losing around $700 million per year.

Management offered annual guidance which was also hit by the ugly stick projecting annual sales to decline between 5-10%.

GameStop is on a fast track to irrelevancy.

If you were awaiting some blockbuster announcements that could offer a certain degree of respite going forward, well, the tone was disappointing not offering investors much to dig their teeth into.

Remember that GameStop is now on a collision course with the FANGs who have pivoted into the video game diaspora.

GameStop will see zero revenue from this development and a boatload of fresh competition.

Microsoft (MSFT) has been a mainstay with its Xbox business, but Apple (AAPL) and Google are close to entering the market.

Google (GOOGL) plans to leverage YouTube and install gaming directly on Google Chrome with this platform acting as a new gaming channel.

The new gaming models have transformed the industry into freemium games with in-game upselling of in-game items, the main method of capturing revenue.

The liveliest example of this new phenomenon is the battle royale game Fortnite.

Nowhere in this business model includes revenue for GameStop highlighting the ease at which game studios and console makers are bypassing this retailer.

In this new gaming world, I cannot comprehend how GameStop will be able to stay afloat.

Unfortunately, the move down has been priced in and at $5, the risk-reward to the downside is not worth shorting the company now.

The company is the poster boy for technological disruption cast in a negative light and the risks of not evolving with the current times.

 

 

BYPASSING THE RETAILER THANKS TO THE CLOUD

May 16, 2019

Mad Hedge Technology Letter
May 16, 2019
Fiat Lux

Featured Trade:

(WHY YOU SHOULD AVOID INTEL)
(INTC), (QCOM), (ORCL), (WDC)

Why You Should Avoid Intel

In the most recent investor day, current CEO of Intel (INTC) Bob Swan dived into the asphalt of failure below confessing that the company would have to guide down $2.5 billion next quarter, 25 cents, and operating margins would shrink by 2 points.

This is exactly the playbook of what you shouldn’t be doing as a company, but I would argue that Intel is a byproduct of larger macro forces combined with poor execution performance.

Nonetheless, failure is failure even if macro forces put a choke hold on a profit model.  

Swan admitted to investors his failure saying “we let you down. We let ourselves down.”

This type of defeatist attitude is the last thing you want to hear from the head honcho who should be brimming with confidence no matter if it rains, shines, or if a once in a lifetime monsoon is about to uproot your existence.

In Swan’s spiffy presentation at Intel’s investors day, the second bullet point on his 2nd slide called for Intel to “lead the AI, 5G, and Autonomous Revolution.”

But when the company just announces that its 5G smartphone products are a no go, investors might have asked him what he actually meant by using this sentence in his presentation.

The vicious cycle of underperformance leads back to Intel seriously losing the battle of hiring top talent, and purging important divisions is indicative of the inability to compete with the likes of Qualcomm (QCOM).

Assuaging smartphone chip revenue isn’t the only slice of revenue cut from the chip industry, but to take a samurai sword and gut the insides of this division as a result of being uncompetitive means losing out on one of the major money makers in the chip industry.

Then if you predicted that the PC chip revenue would save their bacon, you are duly wrong, with global PC sales falling 4.6% in the first quarter, after a similar decline in the fourth quarter of 2018, according to analyst Gartner Inc.

The broad-based weakness means that revenue from Intel’s main PC processor business will decline or be unchanged during the next three years, which leads me to question leadership in why they did not bet the ranch on smartphone chips when the trend of mobile replacing desktop is an entrenched trend that a 2-year old could have identified.

The cocktail of underperformance stems from slipping demand which in turn destroys profitability mixed with intensifying competition and the ineptitude of its execution in manufacturing.

In fact, the guide down at investor day was the second time the company guided down in a month, forcing investors to scratch their heads thinking if the company is fast-tracked to a one-way path to obsoletion.

If Intel is reliant on its data centers and PC chip business to drag them through hard times, they might as well pack up and go home.

Missing the smartphone chip business is painful, but if Intel dare misses the boat for the IoT revolution that promises to install sensors and chips in and around every consumer product, then that would be checkmate.

Adding benzine to the flames, Intel’s enterprise and government revenue saw the steepest slide falling 21% while the communications service provider segment declined 4%.

The super growth asset is the cloud and with Intel’s cloud segment only expanding 5%, Intel has managed to turn a high growth area into an anemic, stale business.

Then if you stepped back a few meters and understood that going forward Intel will have to operate in the face of a hotter than hot trade war between China and America, then investors have scarce meaningful catalysts to hang their hat on.

Swan said the company saw “greater than expected weakness in China during the fourth quarter” boding ill for the future considering Intel derives 24% of total revenue from China.

Investors are fearing that Intel could turn into additional collateral damage to the trade war that has no end in sight, and chips are at the vanguard of contested products that China and America are squabbling over.

Oracle (ORCL), without notice, shuttered their China research and development center laying off 900 Chinese workers in one fell swoop, and Intel could also be forced to cut off limbs to save the body as well.

The narrative coming out of both countries will not offer investors peace of mind, and a primary reason why the Mad Hedge Technology Letter has avoided the chip space in 2019.

It’s hard to trade around the most volatile area in tech whose global revenue is becoming less and less certain because of two governments that have deep-rooted structural problems with each other’s trade policies.

Today’s tech letter is another rallying cry for buying software companies with zero exposure to China in order to shelter capital from the draconian stances of two tech sectors that are at odds with each other.

Let me remind you that Intel and Western Digital (WDC) were on my list of five tech stocks to avoid this year, and those calls that I made 6 months before are looking great in hindsight.