Mad Hedge Technology Letter
June 29, 2022
Fiat Lux
Featured Trade:
(CHINESE TECH ROTATION)
(NIO)
When stocks capitulate, the initial reversion to the mean often is a lucrative bounce.
Chinese tech stocks are going through that honeymoon process right now.
After being targeted systematically, the Chinese communist party changed its tune.
A clearer and more defined regulatory framework around these internet businesses is a definite positive.
There is a growing consensus that the “worst is behind us” for Chinese tech stocks and investment banks have been shooting out stock upgrades.
However, I would recommend readers to never touch Chinese tech stocks like your life depends on it.
Having traveled and lived in the country numerous times, I can say that the foundations are rotten to the core there causing buildings literally to fall over and balance sheets even more rotten than the felled buildings.
Even more damning is that locals assume that everyone else is being shady as well which they feel justifies themselves to participate in less than stellar business practices.
So when I read a report of Chinese EV maker NIO (NIO) denying a report published by short-seller Grizzly Research claiming the company is exaggerating revenue and profit margins, I am not surprised.
Grizzly Research said that NIO is playing “accounting games to inflate revenue and boost net income margins to meet targets.”
The report examined the company’s creation of Wuhan Weineng Battery Assets Company.
The company was created in 2020 and includes NIO, EV battery giant Contemporary Amperex Technology.
The business owns the batteries that NIO drivers can, essentially, pay a monthly fee for in what NIO calls BaaS, short for battery as a service.
NIO pioneered separating the car purchase from the battery purchase. A NIO buyer can choose to buy an EV for a lower price and then pay for the battery on a monthly basis. It’s a way to lower the cost of an EV and make it more comparable to buying and filling up a gasoline-powered car.
NIO recognizes sales when it sells batteries to Weineng. That’s the issue Grizzly has with the company.
Plastering fake sales on the balance sheet that are in effect a sale to oneself and clocking that as gross income is not a shocker.
In fact, I would be surprised if that is all they are doing behind the scenes. Usually, it’s a million times worse in China.
At least there is a product and it’s not a Potemkin product!
Chinese tech companies are not beholden to the same accounting standards as United States registered companies.
They are not GAAP-stamped companies and more or less just fill out their balance sheet as they see fit.
They then register on America’s public exchanges as an American Depositary Receipt (ADR) which doesn’t stringently check the financial health to the same degree as if an American company went public in New York.
Even more bonkers, Chinese management isn’t exposed to any criminal or civil liability which emboldens Chinese tech firms listed as ADRs to lie and cheat as much as possible to boost the share price.
It is now fashionable to say investors are rotating back into China after a year of heavy selling that wiped out almost $2 trillion.
Just be aware that your money could experience a covid zero reaction from the Chinese government and these companies are all dealing in fake numbers to a substantial degree.
That is why I can never recommend buying any Chinese tech stock.
There are so many better opportunities in America.
“A founder is not a job, it's a role, an attitude.” – Said Founder and CEO of Twitter and Square Jack Dorsey
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)
