Mad Hedge Technology Letter
June 27, 2022
Fiat Lux
Featured Trade:
(NOTHING ZEN ABOUT ZENDESK)
(ZEN)
Zendesk (ZEN) bought out for $10.2 billion is good business.
This is after ZEN declined a $17 billion offer just 4 months ago which in hindsight looks highly illogical.
This event crystallizes the souring mood in growth technology that has seen a colossal re-rating of its assets during a cringe-worthy stock market sell-off.
These micro-events bode poorly for growth tech and expect desperation from the illiquid.
Remember that the quickest way to go out of business is to not have any money.
Interest rates skyrocketing has really harmed the ability of growth tech to pay interest on their corporate bonds or to even issue reasonable debt.
The attack on balance sheets is what everybody is scared of and rightly so.
The investor consortium buying the company includes Hellman & Friedman, Permira, a subsidiary of the Abu Dhabi Investment Authority, and Singapore’s GIC sovereign wealth fund. Subject to shareholder approval, the deal is likely to close in Q4 this year, after which time ZEN will operate as a private company.
ZEN isn’t all that bad of a company based on pre-pandemic metrics.
However, fast forward to today and the goalposts have switched
, and investors will look at the last 4 years of unprofitable growth as a liability even if gross revenue has been gaining at a nice clip.
Investors need standalone businesses now, not later, and the zombie company of old are receiving the cold shoulder.
Mikkel Svane, Founder and CEO of Zendesk, had hoped to persuade shareholders to buy into a planned $4.1 billion takeover of Momentive Global Inc, owners of the SurveyMonkey platform.
But this was rejected by shareholders following lobbying by a number of activist investors. Around the same time, the firm rejected an unsolicited takeover bid from an unnamed private equity firm, reportedly offering $17 billion.
Svane clearly needs to be offloaded for such a rookie move.
The reading of the tea leaves in the short term is positive for ZEN as a business model with 30% growth rates year-over-year still in play.
My synopsis is that the next solution will be what private equity usually does, gut the company of high costs including expensive workers and spin it out into a profitable enterprise.
Outsource to poor countries like Moldova, and cancel all in-person office facilities.
Then go back to the public markets to fetch a premium before it goes ex-growth and collects a nice profit.
ZEN’s customers with more than $250,000 Annual Recurring Revenue (ARR) make up 39% of the total, up from 34% last year, while customers with more than $1 million ARR were up 65% year-on-year.
The management and shareholder kerfuffle highlights the sensitive times we are in for unprotected tech companies which are essentially the non-Apple, Microsoft, and Google tech firms.
It’s been a whole economic cycle since public tech companies really had any type of stress, and the stress in 2022 is disguised from all directions.
Just look at Founder of Tesla Elon Musk whose Tesla shares are down almost by half from its 2021 peak and most people will understand that it will be harder to buy Twitter when Tesla shares are crashing.
Existing on public tech markets is just harder when the Nasdaq is in a bear market.
Unfortunately for some, the bear market doesn’t treat everybody the same, and now the goal is survival.
Sure, management wants to fight workers on working remotely too much, but in a tight labor market, they understand it’s a battle to fight another day or just outsource abroad.
Egos must be put aside and when a firm fails to accept an offer $7 billion higher than what they settle on, it’s embarrassing.
This must be characterized and recorded as an unmitigated failure.
For a tech firm that only has revenue of $350 million per year, $17 billion is a ridiculous sum to pay.
I value this software company at half of that - $8.5 billion and paying $10 billion for it in this climate is plausible.
The financing for the deal will be provided by Blackstone, almost guaranteeing this will be a thorough gut job and spin back to the public arena.
Gone is the day of overpaying for mediocre tech.
“I don't want to fight old battles. I want to fight new ones.” – Said CEO of Microsoft Satya Nadella
Mad Hedge Technology Letter
June 24, 2022
Fiat Lux
Featured Trade:
(GETTING REAL WITH HOME-SHARING TECH)
(ABNB)
Airbnb’s (ABNB) stock has about halved from $206 at the tech market peak of 2021 to around $100 today.
The strength in the first half of 2021 resulted from the optimism coalescing in travel circles about the reverse of shelter-at-home lifestyle to unfettered international travel.
Remember back then, increasingly more countries were allowing Americans into their land with proof of 2 Pfizer shots.
The $130 to $206 rise was simple an overshoot.
Sentiment was at a generational low during 2020 and the upside was merely a result of the extreme reverse of great pessimism to ultra-optimism.
At a micro level, Airbnb’s business model mirrored the same sentiment of the 2020 tsunami of travel cancellations.
Bad optics has been a staple for CEO Brian Chesky.
Then the onslaught of arbitrary refunds to customers alienated the Airbnb host.
They slowly changed their policy to remove “extenuating circumstances” as a reason to get a full refund.
It wasn’t that I had a problem with Airbnb going to $206.
Like many tech growth stocks, they tend to go parabolic during good times.
Tech firms with better balance sheets haven’t halved in value like Airbnb.
That being said, Airbnb is not worth the current $60 billion and a 74 P/E ratio is too expensive at a fundamental level.
After halving, I still think the valuation is a tad bit too generous.
I believe the company is worth $60 billion only if interest rates are close to zero and not the 3.1% we have today on the 10-year US treasury.
The company is worth significantly less in its current form in 2022 and as rates accelerate from 3.1% to 3.5 or 4%, I expect the company to be worth $45 billion.
On the demand side, travel is a lot more expensive now than ever.
I am not only talking about airfare, but also airport car transfers, price for baggage, entertainment, food, and accommodation which are all trending above 40%-80% depending on the item in tourist areas.
However, Americans are making summer of 2022 the “revenge” trip of a lifetime.
The pre-pandemic overtones of fear of missing out (FOMO) and you only live once (YOLO) are back stronger than ever on short-form video platforms like TikTok and Instagram.
One might believe Airbnb stock should be cruising on auto pilot, right?
Well, the revenge travel of summer 2022 is already baked into the price of the stock since this behavior was largely understood 6-8 months before.
The drop in shares has to do more with the lack of incremental demand that will follow the summer of 2022 as the US barrels towards a recession.
Yes, travel will decelerate fast after summer 2022 as Americans blow their load while failing to reload for the 2nd half of 2022.
This is awful news for Airbnb stock.
Another element is gas prices.
The cost of gas and groceries is about to explode as Americans need to fill up their tank and buy groceries for Independence Day celebrations all in unison.
The pitiful energy infrastructure that has been gutted by the current administration won’t be able to handle the elevated demand.
This will 100% limit the budget of Airbnb for Americans.
Airbnb posted an average daily rate (ADR) of $168.46 in Q1, up 5.3% YoY.
However, its growth has decelerated from previous quarters and I expect it to fall even more later this year.
Until we capitulate, the downtrend likely won’t reverse because the business model isn’t that bad and they do boast a monopoly.
“Life is too short for long-term grudges.” – Said CEO and Founder of Tesla Elon Musk
Mad Hedge Technology Letter
June 22, 2022
Fiat Lux
Featured Trade:
(EARNINGS REVISION IN THE PIPELINE)
(SARK), (ARKK), (AAPL), (UBER), (LYFT)
“We could have a couple of negative quarters” – uttered Federal Reserve Bank of Philadelphia President Patrick Harker.
We badly needed to hear that, because the jargon we’ve been offered so far from federal representatives has not been honest enough.
Ironically enough, saying the truth could offer relief to the Nasdaq index as pricing in a recession moves us along, but that doesn’t mean we are out of the woods yet.
Harker also said it is possible the U.S. economy might see a modest contraction in growth, but he expects the job market to remain strong.
Let me translate that for you.
Harker expects a soft recession, and he feels that it is increasingly priced into stocks.
However, the Nasdaq isn’t priced for a hard recession today, which could be the potential driving force for another dip in the index.
Adding some validation to a possible leg lower is that one of the biggest dip buyers out there, Blackrock (BLK), has said that it is not buying the dip in stocks, as valuations haven’t really improved.
Maybe they are targeting more single-family homes!
To get a real reversal of momentum, we will need not only big stocks like Apple to participate, but also the big buyers.
Don’t look at the Saudi’s either, they are busy earnings $2 billion a day selling oil.
From behind the scenes talks, there is still the hush hush feeling that positioning indicates that we are in for a sharp V-shaped rebound.
How do I know this?
Tech earnings still have a highly optimistic tinge to them, and lower inflation is built into earnings’ calculations.
Don’t forget that many garden-variety tech CFOs built low inflation into their 2nd half of the year revenue models.
Inflation, according to them, is supposed to subside triggering earnings’ beats around the pantheon of great tech companies.
This is what is supposed to happen if consensus plays out.
It rarely does.
Adding fuel to the fire is a proposed federal gas tax holiday by the current administration which is extraordinarily inflationary even if it does help marginal tech companies like Uber (UBER) and Lyft (LYFT) in the short run.
A tax holiday will destroy oil capacity by disincentivizing oil companies in capital investments.
Supply will also crash by encouraging gas hoarding by clever consumers and CEOs hellbent on taking advantage of this brief tax holiday.
The 800-pound gorilla in the room is clearly China.
Imagine if the Communists finally start to peel back their dystopian arbitrary lockdowns and what that will do for rampant inflation.
Pork prices will rise 25% and more importantly oil prices will revisit the peak we had from the on set of the military event East of Poland.
All of this matters for tech companies that consummate contracts for chips, parts, pay salaries to inflationary traumatized coders and build computers.
The conundrum here is that CFOs and CEOs might be guilty of being too positive in regard to the economic cycle.
Consensus estimates (IBES data by Refinitiv) still show very healthy levels of earnings growth. S&P 500 earnings per share for 2022 remain at +10.8%, but the expectations for 2023 continue to reflect a probably optimistic +8.1% growth, with revenues up 4%.
This is ridiculously overly optimistic and isn’t in tune to the realities on the ground.
It is highly plausible we will experience another bear market rally in tech only to be reminded by upcoming earnings’ revisions that there’s still multiple contractions that needs to be rammed down our throat.
Tech stocks will be the most volatile during this period and traders looking for the best bang for a buck should look at smaller positions but in higher beta names like Tuttle Capital Short Innovation ETF (SARK) for the post-bear market rally and ARK Innovation ETF (ARKK) for the current bear market rally.
It’ll be interesting to see if stocks like Apple (AAPL) can eclipse their previous bear market rally peak of $151.
Apple stands at $138, and I presume with these lower gas prices, it should eke out at least $145 before another acid test.
“If you really look closely, most overnight successes took a long time.” – Said Co-Founder and Former CEO of Apple Steve Jobs
When the sushi hits the fan – the sushi really does hit the fan.
We are at the beginning of a massive tech reckoning, and many will shed a tear because of the new changes.
The lavish era of artificially rock-bottom-priced interest rates that fueled an unconscionable tech bubble has now reached an end.
There wasn’t even a main street parade for the closing.
Many fortunes were christened over the past 13 years, mostly by the "Who’s Who" of Silicon Valley as founders and CEOs.
This meant that wild speculation was the flavor of the day which was a force that delivered the equity markets astronomically high tech valuations that we have never seen before.
Those likely won’t be back any time soon.
Many investors haven’t adjusted to the new normal yet.
Similar to 2009, the founders & executives that run VC-backed companies have been quick to figure it out.
They understand that the cost of capital is now exorbitantly high and that high cash burn rates are now impossible.
These artisanal tech companies with zero killer technology like Uber, Lyft, and Peloton are more or less screwed in this new environment.
Even though the executives and founders get what is going on, the same can’t be said on the field of play.
Tech employees who may have enjoyed higher than average success aren’t prepared to enter this new era where accountability and costs matter.
When I talk about employees, I am referring to the ones working in technology in the Bay Area.
Up until now, tech employees have been used to pretty much naming their benefits and compensation package and companies fighting over them.
A rude awakening meets them as tech companies who once showered stock options on new employees now wait in horror as that same method of payment is demonstrably less attractive to future employees with low stock prices.
Most employees have only experienced this amusement park-like setting in the Bay Area, which is what led to many employees dictating the work-from-home situation.
Unfortunately, they might now have to come into the office or get fired.
In many ways, this is not their fault. Excess capital led to excessive showering of employee benefits and heightened expectations.
Unfortunately, you can't ignore the fact that if your company isn't cash flow positive & capital is now expensive, you are living on borrowed time.
During the arbitrary societal lockdown, many companies experimented with remote workers, most from outside of the Bay Area.
Based on anecdotal conversations, this trend is likely to continue post-pandemic. This means the Bay Area employee is now competing with a broader set of alternatives.
In today's world, positive cash-flow matters & surviving requires outmaneuvering competitors.
You need teammates that are ready to grit it out and not whine like an adolescent teenager.
Sadly, we may have conditioned a contingent of employees in a way that is incongruent with this mindset.
As we enter the cusp of layoffs, the guy at the bottom is clearly hurt the most or the last one in is usually the first out.
There is nobody to blame for this situation.
The low rates encouraged that type of poor behavior because they could get away with it.
When everybody is making money, most companies don’t clamp down and top employees can’t get away with a lot.
Tech firms like Teledoc (TDOC) and DocuSign (DOCU) are in real trouble if the capital markets only offer them 10% cost of capital for the next few years.
As the greater economy looks to reset, the goalposts have narrowed in the technology sector and the firms considered “successful” from here on out will have a checkmark next to profitability.
Growth at all costs has now been substituted with survive at all costs in Silicon Valley, so get used to it.
