Mad Hedge Technology Letter
June 23, 2021
Fiat Lux
Featured Trade:
(IGNORE THE GOOGLE COMPLAINTS)
(GOOGL), (AAPL), (MSFT), (FB), (AMZN)
The five largest tech companies last Fall 2020, Apple, Microsoft, Amazon, Alphabet, and Facebook, accounted for 23.8% of the S&P 500 and now that figure has surpassed 25%.
As much as we like to bring out the champagne and celebrate how well big tech has done, the euphoric times often lay the groundwork for the dramatic downfall.
A few warning signs have started to rear their ugly head.
These business models are rock-solid now, but that doesn’t mean the people who manage these business models are always rock-solid too.
Today, I would like to zone in on one of the architects of big tech that have taken one of these behemoths and juiced it up for shareholders — Alphabet CEO Sundar Pichai.
I am not arguing that returning capital to shareholders is bad, but when other critical elements are ignored, it sets the stage for toxicity to fester from the top down.
Don’t get me wrong, revenue and profits are charting new highs every three months for Alphabet.
They are now worth $1.67 trillion and rising. Google and its array of apps have made themselves indispensable in the lives of everyday Americans.
But an increasingly hostile workplace is taking hold that has been made worse by decisive leadership and improving the company has been shelved for a stultifying mindset of incrementalism and bureaucracy.
This is the 2021 version of Alphabet and attrition rates have soured at the management level.
Many of these key managers blame Pichai for leaving mentioning a bias toward inaction and a fixation on public perception as the real mantra inside Google headquarters.
This has created a workplace that has devolved into culture fights, and Pichai’s attempts to “wait out” the problems have an air of arrogance about it that employees don’t like.
Internal surveys are also hard to analyze as employees are indirectly encouraged not to speak out against positions of authority.
However, recently left employees do admit that Google is a more professionally run company than the one Pichai inherited six years ago.
During Pichai’s leadership, it has doubled its workforce to about 140,000 people, and Alphabet has tripled in value. It is not unusual for a company that has grown so quickly to get cautious.
At least 36 Google vice presidents have left the company since last year, according to profiles from LinkedIn.
Google executives proposed the idea of acquiring e-commerce firm Shopify as a way to challenge Amazon in online commerce a few years ago.
Rumor has it that Pichai was turned off by the high price of the asset even though SPOT has tripled in value since then.
As time goes by, Pichai is becoming known as the steward of what Google built before he got there and just a guy there to squeeze out the numbers.
Google was once known as the scruffy start-up and it’s only natural that it has become more conservative in its approaches. They simply have more to lose now.
The meteoric growth has also led to rising concerns about the U.S. stock market becoming increasingly concentrated in a just a few names.
The total market capitalization of U.S. tech stocks reached over $11 trillion, eclipsing that of the entire European market—including the UK and Switzerland, which is now valued at $9 trillion.
Although there are some flaws popping up in Google’s business model, and management appears to be getting worse, I don’t believe we are even close to any sort of in-house meaningful reckoning that would adversely affect its share price.
The external risks are currently far greater than the risk of Google blowing up from the inside.
And while I do acknowledge, it might not be the workplace it once was and much less than ideal, it still pumps out record earnings and the degree to which it outperforms earnings’ expectations is uncanny.
That’s why I would recommend trading this stock aggressively in the short-term while rumors of broken management model are unfounded, because fundamentally and technically, it’s hard to find a better business model and more beautiful chart.
While the golden goose is feeding you eggs, you eat as many eggs as you can and ride this trade until Google management finally runs into REAL problems and I am not talking about petty anti-trust fines by European regulators.
Simply put, even the best companies run into vanity problems that are storms in teacups. Artificially creating problems sure has to be a first world problem and until there is true evidence that Google’s ad tech is being dismantled, I don’t believe investors have anything to worry about with the ad dollars coming in.
Big tech is on the verge of breaking out after being range-bound, and it would be daft to overthink this move and not participate in the melt-up.
Short-term, I would be inclined to buy on any big or little dip in GOOGL, take profits, and wait for the next dip to get back into the same position.
“Cinema reflects culture and there is no harm in adapting technology, but not at the cost of losing your originality.” – Said Hong Kong-born Actor Jackie Chan
Mad Hedge Technology Letter
June 21, 2021
Fiat Lux
Featured Trade:
(SOFTBANK’S EPIC COMEBACK)
(SOFTBANK), (CS), (CPNG), (GRAB), (AAPL), (GOOGL), (BABA)
I haven’t touched on the Softbank Vision Fund since pre-pandemic times, but it is time to take a barometer of the state of their fund because they also represent a snapshot of the state of emerging technology.
The Fund reported a massive loss of $18 billion during the nadir of the tech correction in 2020, and its clout in the tech world fell by epic proportions to almost pariah status.
Those were perilous times for Softbank Founder and CEO Masayoshi Son who held the distinction of losing the most wealth in the world before making it all back.
The ensuing flood of liquidity, accessible at the tech lows, catapulted most of Softbank’s investments in the U.S. tech market and they recently reported the highest-ever profit for a Japanese company.
Softbank Group reported profits of $48 billion for the fourth quarter, while Softbank Vision Fund, which invests in startups, reported a profit of $37 billion.
After massive weakness in assets including Airbnb, Oyo, and WeWork, we saw the value in these startups dip to an all-time low, then they were essentially bailed out by the Fed.
During that recapitalization process, Softbank Vision Fund fired 10% of its employees to cut costs.
When you combine that with big up moves from South Korean e-commerce company Coupang (CPNG) and ride-hailing firm Grab planning to go public via an SPAC, betting all his chips in emerging tech was the right thing to do and Son was handsomely rewarded for this outsized risk.
Son is quite famous for some of his speculative energy that he has channeled towards China’s Alibaba (BABA) before Alibaba became famous.
More than a decade later, that investment is worth $130 billion, becoming one of the most successful startup bets in history. He then aggressively invested in several startups around the world, including Snapdeal, Oyo, Ola, and Paytm in India.
For as many lemons in his basket, he’s had his fair share of 10-baggers and 433-baggers like Alibaba that validated his aggressive tech strategy.
Son got into many investments before venture capitalists in tech started being copied around the world and before the Arab sovereign funds and Chinese could get their house in order to partake as well.
He wasn’t the first, but the first group mover advantage made these deals possible, and by borrowing heavily against his Softbank equity, he was able to bet the ranch on many emerging techs by acquiring the proper financing and leverage.
However, the Softbank Vision Fund is a harbinger for what’s to come in tech and Son laughing all the way to the bank could also be loosely translated as the low hanging fruit in tech and its harvest has been plucked dry.
Venture capitalists are having a harder time in 2021 finding those 433-baggers or even 3-baggers.
An ominous sign that bodes ill for emerging tech is the financing hawks that have started to highlight the extreme risks involved in investing big in little-known business models with the propensity to fail.
Credit Suisse (CS) has put Son recently on notice by dissolving a longstanding personal lending relationship as the bank clamps down on transactions with his company, according to regulatory filings and people familiar with the situation.
The moves came after the collapse of SoftBank-backed Greensill Capital that caused turmoil for Credit Suisse forcing them to book a massive loss.
That was on the heels of Credit Suisse’s $5.5 billion loss originating from trading by family office Archegos Capital Management.
The bank is now avoiding business with big tech investors who are likely to reach further up the risk barometer and inflict heavy damage.
Does this mean the era of subsidized tech business models is over?
No, but it will become more difficult to originate financing from traditional methods like European banks to invest in these types of exotic tech projects.
Mr. Son had long used Credit Suisse and other banks to borrow money against the value of his substantial holdings in SoftBank.
As recently as February, Mr. Son had around $3 billion of his shares in the company pledged as collateral with Credit Suisse, one of the biggest amounts of any bank, according to Japanese securities filings.
The share pledge loan relationship stretched back almost 20 years. By May, that lending had gone to zero.
Bloomberg News reported in May that Credit Suisse refuses to do any new business with SoftBank, but the silver lining is that Softbank has $48 billion in new profits to theoretically spin into some new projects it likes.
Of course, it’s always easier when you use other people’s money, but these are then new rules of the game.
Its bounty from the liquidity surge will help them advance into this new post-pandemic tech ecosystem with substantial gunpowder.
So I can’t say it’s been all bad for everyone at the individual level because this pandemic divided the masses into tech winners and losers.
Notice that many Bay Area tech investors were taking profits from the tech pandemic stock surge and rolled the capital into $3-5 million Lake Tahoe Mountain chalets as a summer house or dinner party house.
And if they didn’t do that, they were rolling these profits into Hawaiian beachfront properties with views of Diamond Head in Oahu or even dabbling in villas on the Kauai Island.
This could partially explain why Apple (AAPL) has gone sideways for the past 11 months.
This year has instigated a tech reset and in the short term, the Nasdaq has been overwhelmed by external headlines like of perceived inflation fears, chip shortage, and a built-in assumption that earnings will be perfect.
These sky-high earnings expectations have created a “buy the rumor and sell the news” type of price action with only a handful of companies able to top these insane expectations like Google (GOOGL).
“Men have become the tools of their tools.” – Said American Philosopher Henry David Thoreau
Mad Hedge Technology Letter
June 18, 2021
Fiat Lux
Featured Trade:
(A CROWN JEWEL OF AD TECH)
(ROKU)
If Apple is a $2.2 trillion company, then Roku growing from today’s $47 billion to $100 billion is highly likely.
I would agree that the digital migration and transformation are mainly funneled into the profit models of the big tech players, but tech companies created from the ilk of Roku aren’t shabby either.
The TV streaming platform Roku has a 3-year revenue growth rate of 54% showing they are a true growth firm no matter what metric you want to measure them against.
The pandemic supercharged their business with revenue growth rates soaring to a record 79% year over year to $574.2 million.
Roku users streamed 18.3 billion hours in the quarter, an increase of 49% year over year. Platform monetization continued to increase with average revenue per use (ARPU) of $32.14 on a trailing 12-month basis, up 32% year over year.
This was in large part because they added 2.4 million incremental active accounts in Q1, ending the quarter with 53.6 million.
The success can also be attributed to a secular shift in the advertising industry.
Historically, the biggest impediment or headwind to Roku’s ad business growth has been TV buyers' buying patterns.
Buyers traditionally tend to prefer traditional linear TV versus a bold new phenomenon-like streaming.
Certainly, there's a gap there as viewers move over to streaming versus the ad dollars.
That gap is now closing and there’s still room to expand.
For example, according to Nielsen, in March ratings, linear TV ratings for adults 18 to 24 were down 22%. Q1 TV ad spending was down 11%, according to MediaRadar. Meanwhile, Roku was able to double monetized video ad impressions on the platform.
Ad spending by major agency holding companies with Roku more than doubled. We saw strength really up and down Roku’s ad business. An area of strength is inevitably the entertainment side of Roku’s ad business and it’s to the point where every major direct-to-consumer service has launched.
Those launches have created great opportunities for Roku to partner with major service providers, HBO Max, Discovery Plus, and the who’s who to really drive the adoption of these services, and these partners are leaning in closely and investing with Roku to promote their services to Roku’s users.
Another example is Home Chef, a performance-based advertiser, who invested with Roku and saw 2.4 times return on ad spend and then came back and significantly invested more with Roku after the preliminary success.
Similar case studies pop up like that left and right.
What we are seeing now is the reallocation of TV budgets, as well as digital and social budgets toward streaming and it is here to stay.
As the sales growth rate has gone from the mid 50% to the high 70%, Roku forecasts the same type of outperformance which calls for robust growth with total net revenue of $615 million at the midpoint, up 73% year over year; and total gross profit of $300 million at the midpoint, up 104% year over year, implying an overall gross margin of approximately 49%.
As streaming becomes the dominant source of entertainment around the globe, advertisers are moving much of their traditional TV budgets to over-the-top media services (OTT). The need for programmatic, measured, and scalable advertising opportunities across devices is more important than ever.
This bodes well for continuing to be able to command premium cost per mille (CPMs).
Advertisers will increasingly be looking not just at the top-line CPM that they buy the media at, but the effective cost, cost per site visit, cost per product purchase.
And what that means long term is that, unlike traditional TV, streaming CPMs aren't just going to be sort of one price rules them all type scenario, but rather a whole spectrum of prices where the pricing into the auction is ultimately dictated by the tactic that the advertiser is executing on and the outcome that they're trying to drive.
As Roku delivers enhanced tools to navigate this type of auction and pricing and allow effective strategies to flourish, they will benefit from all of this.
One note investors need to take heed of is that even though Roku anticipates revenue growth rates in the second half of 2021 will be robust, they will be “at a slower rate than the first half.”
The reason they give for this is because they expect the “outperformance of content distribution to normalize in Q2 and in the back half of the year.”
If we look at Roku’s stock chart, Roku has come back drastically from $470 in mid-February to $350 today as the market had to absorb perceived higher interest rate fears and accelerating inflation.
There was a swift rotation out of high growth names during this period causing a rapid pullback in Roku.
Theoretically, the upside is capped in 2021 in the second half because growth rates will moderate, and the stock will be reliant on a Nasdaq lunge forward as in index to carry them back to the highs of February.
The low-hanging fruit has been harvested because the premium entertainment deliverers have already signed up for the Roku platform.
Thus, don’t expect any paradigm-shifting announcement in 2021 but expect solid earnings and higher profitability.
I would put new capital to work around the support levels of $315 or $300.
Roku is still performing at growth rates in the high 70% year-over-year and has been a profitable company since Q3 2020.
These two trends will stick and if you remember in 2018, I recommended this stock at $26 and still love it at around $300.
“Technology is just a tool. In terms of getting the kids working together and motivating them, the teacher is the most important.” – Said Co-Founder of Microsoft Bill Gates
Mad Hedge Technology Letter
June 16, 2021
Fiat Lux
Featured Trade:
(SMARTPHONES AREN’T GOING AWAY)
(AMZN), (TSLA), (FB), (GOOGL), (AAPL), (NFLX)
