Tech Letter Archives

Will Investors Pay the High Premium for Zillow?

In a typical year, spring begins the traditional home-buying season. But we know that this past year was anything but ordinary.

An internal Zillow (Z) report indicated that the pandemic has indeed caused people to rethink where they live and concludes that approximately 8 million existing homeowner households that have been on the sidelines may enter a real estate market already beset by unrelenting demand.

Also, 8.9% of consumers plan to purchase a home in the next six months near a 20-year high per the conference board's April consumer confidence survey.

The housing market is underpinned by demographic and economic tailwinds that will persist for the foreseeable future.

Millennials are moving up.

Baby Boomers are downsizing and in between, people of all generations are rethinking their lives.

Zillow (Z) is the most popular real estate portal in the country with hundreds of millions of consumers visiting the platform.

It’s easy to put up an advertisement on Zillow, while other competitors need to spend tens of millions of dollars to generate those leads.

It’s a sustainable competitive advantage which is one of the main factors for the stock going from $20 to $200 last year.

This effectively makes Zillow’s customer acquisition cost zero!

And because of that, it’s disappointing that they aren’t more profitable.

The PE ratio is currently 517 and as we look forward, we need to ask ourselves, will investors continue to bid up this high growth real estate tech stock?

This past quarter’s revenue growth was strong with Zillow reporting Q1 revenue of $1.2 billion, exceeding the high end of the forecast.

Q1 Internet, media, and technology (IMT) segment revenue was $446 million, grew 35% year-over-year, as this company continues to see accelerated growth in Premier Agent and strong growth in rentals.

This is Zillow’s bread and butter and represented over 37% of their total revenue.

Premier Agent revenue that connects realtors to consumers grew 38% year-over-year in Q1, the accelerated growth was primarily driven by connections growing faster than traffic, as well as focus on providing outstanding service and optimizing to connect high intent customers with high performing partner agents.

The inherent strength of the company lies in being the Uber of real estate and matching up ad-paying agents to customers.

However, I do believe we are hitting the high-water mark in the short-term as housing inventory levels hit generational lows and sellers stop putting their homes up for sale.

Therefore, it’s easy to argue that Zillow and its revenue growth will have a hard time pushing incremental growth now, and like many other tech firms, are facing tough metrics to beat year-over-year in for next earnings’ season.

Cratering interest rates of 2020 was the catalyst that drove the incremental buyer into the market, and I believe that harvest has mostly been collected.

Prospective buyers simply are at the extreme upper limit of affordability, now that the median house for sale in the U.S. is around $400,000.

Growth in Zillow Offers which is direct purchase and sale of homes continued to reaccelerate in Q1.

Zillow reported home segment revenue of $704 million, which exceeded the high-end outlook with 1,965 home sales.

Purchases increased to 1,856 homes in the quarter from 1,789 homes purchased in Q4, but not quite at the rapid pace planned as Zillow continued to work on retooling algorithm models to catch up with the rapid acceleration in home price appreciation.

The flipping game is just becoming too expensive, even for a subsidized tech corporation like Zillow and the algorithms are having a hard time competing with properties selling for $50,000 over the asking price!

Zillow is now competing with Qatar Sheikhs, sovereign wealth funds, and family offices of the elite who are piling into U.S. residential real estate at the same time.

Management has said they “buy homes at the median”, but wait, I thought technology would find the market inefficiencies in the pricing and Zillow would be able to find discounts.

Apparently not and that goes out of the window in an era of ultra-liquidity.

Management also claims they avoid buying houses in “really wealthy or really unique neighborhoods because they’re harder to resell and harder to price.”

The problem I have with Zillow Offers is that this division would be sucker-punched by a devastating blow from a property market pullback and be stuck with the carrying costs of thousands of mortgages and homeowner association fees per month.

That’s most likely the real reason for avoiding pricey areas.

Also, there is the conundrum that in market downdrafts, pricing power in the neighborhoods that Zillow targets fall fastest in terms of velocity of price and quality of buyer.

Even more worrying, Zillow charges the seller a fee of about 7.5% on average, which is notably higher than the traditional 6% commission a seller pays to realtors.

I thought technology was supposed to incite a deflationary effect?

Apparently not.

Mortgages segment revenue increased 169% year-over-year in Q1 to $68 million and was primarily driven by mortgage loan origination volume, which was up more than 8x year-over-year.

Sure, the 8x growth looks great on paper, but this division is still only 5% of total revenue and is a recipient of the law of small numbers looking better than they are.

In Q1, refinance loan origination volume comprised 90% of total origination volume.

There will be no refi boom in 2021.

Zillow really missed a gold mine in the mortgage division last year when they couldn’t even turn a profit in this division.

For the IMT segment, Zillow is forecasting 66% year-over-year revenue growth in Q2.

This is Zillow’s strength and you can expect Premier Agent revenue to be between $342 million to $350 million up 80% year-over-year.

On a sour note, they expect mortgage segment revenue to be down from Q1 and with respect to margins, Zillow’s Q2 IMT margin is expected to be 41% down sequentially from the 47% in Q1.

It’s clear that on the horizon, margins will shrink and nascent businesses will stall, and that’s a poor recipe for short-term price action in shares.

I don’t think investors will pay the current high premium for Zillow at these inflated levels, and yes, it’s a great buy and hold long term company, with a superior ad business that connects agents, but I do not see the case for the next leg up in the next few months.

This year will be remembered as a consolidation year as a few years of revenue were brought forward because of a once-in-a-lifetime interest rate collapse and pandemic tailwind.

Unfortunately, this year might just be too boring to 10X Zillow’s stock.

zillow

May 10, 2021 - Quote of the Day

Tech Letter

“It is only when they go wrong that machines remind you how powerful they are.” – Said Australian Journalist Clive James

May 7, 2021

Tech Letter

Mad Hedge Technology Letter
May 7, 2021
Fiat Lux

Featured Trade:

(TWITTER LOOKING MORE ATTRACTIVE AFTER THE DIP)
(TWTR)

Twitter Looking More Attractive After the Dip

Tech Letter

Selling off from $77 — Twitter is an internet stock to put on the watchlist.

Twitter is a unique asset that is enriching and powerful, especially for the long tail of niche topics.

If I had to point to one area that will accrue a meaningful impact on people’s experience, and business as a whole, this would be it.

Topics and interests are good for businesses on Twitter too, especially for local small businesses, as they contribute stronger signals around intent, and Twitter profits by serving relevant ads, which will ultimately lead to a transaction like a donation, subscription, or purchase.

These ads that are distributed and embed around the tweets are called Twitter’s Mobile App Promotion (MAP) business.

This division was up more than 50% year over year revenue growth in the fourth quarter of 2020 thanks to the public health situation making Twitter more relevant than ever.

Twitter is taking steps to make the platform more attractive now. For instance, take audio rooms, which they call Spaces, and long-form newsletters, made possible by the acquisition of Revue.

It’s easy to imagine starting with a tweet, moving a conversation to real-time audio, and recapping the conversation with long-form text.

It’s this in-between interaction that will prove to be powerful. The same is true for revenue-generating products, as more accessible advertising models will encourage the use of commerce tools and loop back into more advertising.

On the technical side of it, Twitter simply got ahead of itself on the stock chart but cemented its broad strength with an emphatic beat of total revenue reaching $1.04 billion, up 28% year-over-year.

Total ads revenue grew 32% year-over-year, driven by strong brand advertising in March and accelerating year-over-year growth in MAP revenue.

Interestingly enough, topics like sports betting, crypto, and personal investing gained traction in an accelerated way, and these MAP advertisers, who advertise into those areas benefit from a surge in app downloads for crypto or investing or betting.

These specific categories received 10X higher spend in Q1 relative to what they spent last year, demonstrating how Twitter is cleaning up from strong secular trends and with an enormous growing audience.

This active and pertinent conversation around the topic simply allows Twitter to turn on the cash spigots and this ad format delivers relevant ads.

Strength in these MAP advertisers means crypto ads won’t be going away anytime soon and it appears as if these topics have become a bigger conversation in everyday American life among consumers perhaps than they were in years past because the price of bitcoin is at an all-time high.

Also, legal betting is coming to the leagues in the United States, and mainstreaming will cause full-scale adoption, meaning the betting tweets are about to snowball.

Expect a lot more sports betting ads along with your garden variety crypto app download ads on Twitter.

I am optimistic that these are secular trends that can continue for a long time especially when you consider the Millennials' stranglehold on American demographics.

This pivot is also indicative of Twitter’s ability to deliver for advertisers at the right moment aligning the right conversation on Twitter.

Twitter’s tough comparable data to last pandemic season made a selloff in shares inevitable — Q2 2021 metrics will perform poorly against Q2 2020’s.

Management had no choice but to guide down and expect Monetizable Daily Active User (mDAU) growth rates to be “in the low-double digits on a year-over-year basis in Q2, Q3, and Q4, with the low point likely in Q2.”

A period of consolidation is upon us in Twitter, and they will be retooling the wagon.

Another headwind to note that along with Facebook, Twitter has been actively preparing for the changes that Apple just released as part of iOS 14.5 update.

Twitter’s outlook for Q2 and 2021 assumes a “modest impact from the rollout of changes” associated with iOS 14.5 across owned and operated ads.

The covid surge added about 5 million mDAUs in the U.S. and Europe or North America and Europe, to 38 million from 33 million.

The answer is that I do believe that Twitter will retain the cohort that entered with Covid even if Covid will end.

They will stick with the platform because the use case for it enriches their business, personal life, and keeps their pulse on the on-goings in the world and the U.S.

That is very powerful.

Losing this group would mean another leg down for the stock into the low 40s, which would be a no-brainer buy.

What is Twitter’s short-term roadmap?

They plan to double development velocity by the end of 2023, resulting in doubling the number of features per employee that directly drives either mDAU or revenue.

Second, they have a goal of at least 315 million mDAU in the fourth quarter of 2023, which requires continued compounding growth at about 20% per year from the base of 152 million mDAU reported in the fourth quarter of 2019.

Lastly, Twitter’s goal is to more than double total annual revenue to over $7.5 billion in 2023.

This requires Twitter to gain market share with performance ads, grow brand advertising, and expand products to small and medium-sized businesses.

If the investors sniff out they are on the right track to achieve these three initiatives, I do believe Twitter stock will be well over the last peak of $77 in 2022.

Expect Twitter’s shares to appreciate into the year-end.

It’s right to consider a period of consolidation as a reversion to the mean. This was inevitable after the opportunistic covid surge, but the handoff back to 20% growth is not as easy to communicate as it seems.

Twitter is still a great stock to get into if it drops to the $40-$50 range.

May 7, 2021 - Quote of the Day

Tech Letter

“We could use technology to help achieve universal health care, to reach for a clean energy future, and to ensure that young Americans can compete -- and win -- in the global economy.” – Said Former U.S. President Barrack Obama

May 5, 2021

Tech Letter

Mad Hedge Technology Letter
May 5, 2021
Fiat Lux

Featured Trade:

(THE BOOMING SUB-SECTOR OF ECOMMERCE FURNITURE)
(OSTK)

The Booming Sub-Sector of eCommerce Furniture

Tech Letter

Growth has been pummeled the last few days as the U.S. government has sent mixed signals from Fed Chair Jerome Powell and Treasury Secretary Janet Yellen.

On one hand, Powell has been steadfast, saying he will not even think about raising rates for years, but Yellen came out yesterday admitting the turbo-charged US economy might need a rate hike.

Growth companies get penalized the most for the perception of rising rates while banks get rewarded.

Rising rates mean that loss-making tech firms will need to bear a higher cost of financing while needing more things to go their way to become profitable.

They also need more time because theoretically, exorbitant financing raises the bar to becoming profitable.

For the real speculative tech firms in nascent sub-sectors, this is the last thing you want to hear.

We have seen this concept run amok in the SPAC market with many of these newly listed vehicles down big over this consolidation move.

One ecommerce firm on the brink of profitability that I might consider taking a look at if it drops to $50 from the current $78 is volatile furniture seller Overstock.com (OSTK).

Remember it's typical of OSTK to drop 7% on down days and surge 7% on up days.

Enter into this stock with caution.

Why do I ultimately like OSTK at $50?

OSTK is now a top four brand in the large and growing U.S. online home furnishings market, this up from the 5^th spot.

The total addressable market is growing and now estimated at $325 billion, up from $300 billion last year.

A true secular shift in consumer behavior is underway and not going away.

Permanent moves from cities to suburbs feel like a lasting structural shift in American life, one of the impactful themes to come out of the public health crisis.

Consumers have become accustomed to buying home furnishings online, just like they do so many other products.

It’s not a question of whether consumers will buy furniture and home furnishings.

It’s a question of where: online or in-store? As you know, housing starts surged in March, growing 37% versus March 2020, to the highest level since June 2006, exceeding economists' forecasts.

As the great reshuffling persists and home buying continues to increase, so too will demand for home furnishings.

Consumers will increasingly migrate to optionality, looking to marry up the best selection with high value and convenience of buying online.

Overstock’s motto is “where style and quality cost less.”

They hope to capture the smart value customers of home furnishings.

OSTK offers a value proposition that resonates with a particular subset of the market. The firm only specializes in furniture and home furnishings.

They posted revenue of $660 million in the first quarter, an increase of 94% year over year or 82% versus 2019.

This increase was primarily driven by a 66% increase in pandemic customer orders and a 17% increase in average order size.

Increased order activity was largely driven by new customer growth and strong repeat behavior catalyzed by work-from-home dynamics.

OSTKs gross profit came in at $154 million in the first quarter, an increase of $79 million year over year and an increase of $82 million versus Q1 of 2019.

Gross margin came in at 23.3%, which is an improvement of 141 basis points, compared to a year ago and 342 basis points compared to two years ago.

Active customers, meaning the total number of customers who made at least one purchase over the prior 12-month period, as of March 31, grew to 9.9 million.

This is the highest in OSTK’s operating history and represents an increase of 92% or 4.8 million active customers, compared to the first quarter of 2020 and a 60% increase versus 2019.

On a trailing 12-month basis, orders delivered reached a record 16.5 million as of March 31.

This is an increase of 88% compared to the prior year or 7.7 million orders and a 52% increase versus 2019.

Average order value increased by $27 or 17% versus the first quarter of 2020. This is mainly driven by a successful sales mix shift into core furniture and home furnishings.

Another key point I would like to touch on is the logistic solutions.

Free shipping is a key component of smart value. It also happens to be a top purchase driver, particularly for OSTK’s target customers.

OSTK has permanently launched free shipping on everything in 2020.

The word is out, at least with their existing customer base, which continues to rate OSTK favorably on shipping charges.

Pricing is also a key element to OSTK’s success.

Because savvy shoppers seek value, OSTK product pricing must be competitive.

One of their 2020 strategic initiatives was to clarify promotional messaging and refine the pricing model.

This meant ensuring OSTK’s products are optimally priced compared to the competition: not too low; and post promotion, certainly not higher.

As a result, 85% of OSTKs product is competitively priced in March 2021 compared to 55% in December 2019.

Lastly, unfortunately, the company does not provide guidance which doesn’t help quell the extreme volatility in the stock.

However, management did say that they face an imminent “difficult year-over-year second quarter comparison” which is the case for many tech firms that went gangbusters in Q2 2020.

Home furnishing revenue represents 93% of total revenue and the tough comparable data leave me no choice but to recommend waiting for this stock to drop to $50.

In the future, the company plans to expand into Canada and enter into government business, and these two planks of growth could help extract the incremental dollar.

However, I believe $70 is too high for OSTK and as many tech firms impossible benchmarks from 2020 to beat, I do believe a sell-off is more than likely in high growth names like OSTK.

In the end, I do believe $50 is a fair price for OSTK and should be bought and held if it comes down to that level.

May 5, 2021 - Quote of the Day

Tech Letter

“Artists work best alone.” – Said Co-Founder of Apple Steve Wozniak

May 3, 2021

Tech Letter

Mad Hedge Technology Letter
May 3, 2021
Fiat Lux

Featured Trade:

(BUY FACEBOOK ON THE DIP?)
(FB), (APPL)

Buy Facebook on the Dip?

Tech Letter

A company such as Facebook (FB) simply must be on investors’ radar all the time because of the profitability element to it.

In a truncated period where growth stocks are out of favor, these bottom-line tech behemoths can weather the storm.

This tech firm doesn’t produce any real products because the user is the product.

A favorable expense layout is why net income this past quarter was $9.5 billion on $26.17 billion revenue.

Even a grossly profitable company such as Apple (AAPL) does a lot worse per dollar generated.

For every $3.79 billion in revenue at Apple, they only profit $1 billion, which is great compared to the status quo except Facebook.

Yes, it costs money to source raw materials and supplies to construct iPhones, iPads, and iMacs, which makes Apple’s operation much more impressive than Facebook.

Strip the hassle of making stuff like iPhones and iMacs and you have Facebook, an online portal to post stuff and serves no real purpose but to display ads to people.

Their attempts to get into the device and ecosystem games have utterly fizzled because users simply have no trust in Facebook management and how they fumble around personal data.

Why buy a Facebook Portal, the firms’ microphone video tablet, when there are trustful options out there without sacrificing the quality?

Before releasing the Portal, during the product announcement, Facebook initially claimed that data obtained from Portal devices would not be used for targeted advertising.

One week after the announcement, Facebook changed its position and stated that “usage data such as length of calls, frequency of calls” and “general usage data, such as aggregate usage of data will also feed into the information that we use to serve ads”.

So Facebook is quite stuck with what they have now, which is a blossoming Instagram and legacy Facebook portal both of which are cash cows.

They aren’t able to do M&A because of fear of anticompetitive legislation and their debauchery of privacy has locked them out of the hardware market.

Facebook wants to monetize WhatsApp, Facebook’s wildly popular chat app, but is finding resistance in funneling user data with an updated user agreement being criticized heavily worldwide with users deleting the app and downloading an alternative mainly the app Telegram.

Facebook rescinded the user agreement and has delayed their WhatsApp targeting ad division until they can ram the updated agreement down WhatsApp users’ throats.

I will say that “what they have” has been working out extremely well for the company when Facebook reported daily active users reaching 1.88 billion, up 8% or 144 million compared to last year.

Q1 total revenue was $26.2 billion, up 48% and this is attributed to growth in advertising revenue largely driven by continued strength in product verticals such as online commerce.

If investors don’t remember, Facebook was dragged down to the 20% revenue growth level just a few quarters ago on all the privacy hullabaloo.

To reaccelerate revenues is a major win for Facebook that can’t be understated.

Growth was broad-based across all advertiser sizes, with particular strength from small- and medium-sized advertisers.

Facebook’s year-over-year ad revenue growth also benefited from lapping pandemic-related demand headwinds experienced during March of last year. On a user geography basis, ad revenue growth accelerated in all regions.

Facebook’s bread and butter are the strength of their advertising revenue growth in the first quarter of 2021, which was driven by a 30% year-over-year increase in the average price per ad and a 12% increase in the number of ads delivered.

What is Facebook doing to branch out revenue channels?

They haven’t quit the hardware game with their Virtual Reality (VR) headset product called Oculus Quest 2 and management only played it down by saying they saw “sustained strength” without busting out any specific metrics.

I read the tea leaves as this isn’t doing enough for management to offer real data on it.

When I analyze the Oculus Quest 2 VR headset, the $299 retail price, it practically means they are losing money on it by a wide margin.

There is no premium in the pricing because the price is one of the few ways that consumers can overlook data privacy issues.

The $299 gets you a robust virtual reality headset with 6GB of RAM, a Qualcomm Snapdragon XR2 CPU, 64GB of storage, 1832x1920 per eye display, and a pair of controllers.

The jury is out whether the stickiness of VR will actually continue and if it does, how long full-scale adoption will take.

But it is painfully clear that Facebook will be losing money even on Oculus Quest products until there’s a 5^th or 6^th or even 7^th iteration or even further.

There is nothing to suggest that VR is on the verge of full-scale adoption.

CEO and Founder Mark Zuckerberg must be tearing his hair out about how he has effectively been locked out of hardware products since the inception of his empire.

And no, data centers, their largest expense along with remunerations, to hold the data you give him don’t count as hardware.

A few headwinds to take note of, in the third and fourth quarters of 2021, Facebook expects year-over-year total revenue growth rates to significantly decelerate sequentially as they are facing tough comparable data from the prior year.

Lastly, Facebook will continue to expect increased ad targeting headwinds in 2021 from regulatory and platform changes, notably the recently launched Apple iOS 14.5 update, which will have an impact in the second quarter.

As the global economy and US economy open back up in a roaring fashion, it’s hard not to like this stock.

Ad budgets are on the verge of exploding and Facebook is still one of a nicely forged duopoly.

Even if they haven’t been able to branch out, they are incredibly proficient at what they do, and serving ads to a 2 billion plus user base will become more voluminous and expensive as the year advances.

No surprise the stock is at $325, another all-time high, and even if I personally hate the company, the stock is a viable candidate to buy on any dip.

As we move into the next part of the year, I do believe the buyback story will accelerate for big tech and cash cows like Facebook, and its stock will hit $400 by the year-end.

At the end of the day, this a story of the big getting bigger.

OCULUS QUEST 2 – THE NEXT DISASTROUS FACEBOOK HARDWARE?