Tech Letter Archives

Cyber Security is Still a Buy

What does the technology sector’s “last gasp up” mean for tech stocks?

At the Mad Hedge Lake Tahoe Conference in late October, I correctly identified that the tech sector would experience a last leg to the price appreciation that has been part of a broader 10-year bull market in American equities.

The past 7 weeks have been nothing short of spectacular for tech shares as not only have the heavy hitters delivered in spades, like Apple (AAPL) and Microsoft (MSFT), but tech growth shares have been released from the penalty box after a short-dated growth scare and joined the rally with zeal.

How long will the “last gasp up” last?

The bar was set exceptionally low in 2019 because senior management spun the trade war acrimony into the accounting calculus effectively offering CFOs a chance to lower expectations to the point of getting away with murder.

Even with earnings’ expectations reset at nadir data points, performance was a mixed bag.

Superior tech companies were able to jump over the pitiful expectations, then if that wasn’t enough, they pushed backwards any inklings of earnings growth by guiding as low as they possibly could.

An archetypal example is Palo Alto Networks (PANW) whose shares dipped more than 8.5% in pre-market trading after issuing their quarterly earnings report.

The company announced sales of $771.9 million with an adjusted EPS of $1.05 topping analysts' estimates.

Why did shares sully?

Palo Alto Networks tanked guidance by telling investors they expect sales between $838 million and $848 million in the second quarter.

The expectation represented a midpoint sales forecast of $843 million, which is lower than the consensus estimates of $845.12 million.

The adjusted EPS in the second quarter is estimated to be $1.11–$1.13, below the consensus earnings forecast of $1.30.

Palo Alto Networks is forecasting sales between $3.44 billion and $3.46 billion with an EPS between $4.9 and $5.0 for next year, compared to analyst projections of $3.46 billion in revenue and an EPS of $5.07 in 2020.

PANW accounts for a big piece of the pie in the cybersecurity trade comprising 16.2% in 2019.

Overall industry growth is strong at 10.4%, and PANW managed to increase its sales by 22.3% to $633.7 million.

This cybersecurity company is one of my favorite tech stalwarts and is as rock-solid as they come for a second-tier tech growth company.

Another trend that dovetails closely with the last gasp up thesis is buying growth.

At this stage in the tech cycle, the low hanging fruit has been plucked and tech companies are increasingly finding it hard to generate organic growth.

Companies are now resorting to inorganic growth with Palo Alto Networks announcing that it will acquire Aporeto for $150 million in an all-cash transaction.

This isn’t just a one-off for PANW, they have acquired four other companies in 2019 to plug into their growth puzzle.

They have also completed the acquisition of an IoT cybersecurity firm Zingbox.

Palo Alto Networks acquired two cloud security startups in July as well - Demisto to gain traction in the AI security segment and Twistlock, the leader in container security.

The other top players in this field are Cisco (CSCO), Fortinet (FTNT) and Symantec (SYMC).

The bullish secular trend in cybersecurity is watertight and comments from Nikesh Arora, CEO of Palo Alto Networks, only reconfirmed the strength in cybersecurity when he said, “As a growing number of organizations move their business to the cloud, developers increasingly rely on cloud-native technologies such as containers and serverless infrastructure to accelerate the development, testing, and deployment of modern applications and services.”

What’s next for investors?

Barring any exogenous shocks, the last gasp up continues and recent macro policy developments have supported this hypothesis as well as the tailwinds of an improving economy.

Palo Alto Networks is part of a high growth segment and many corporates are on record contemplating lower enterprise tech spending heading into 2020.

This sets up another incredibly low bar for cybersecurity companies to hop over next year and I believe the best in show such as PANW, Fortinet, Cisco, and Symantec will pass with flying colors.

The interesting acid test will occur at the end of 2020 when tech firms and sub-segments of tech such, as cybersecurity, release commentary on whether 2021 guidance could signal ensuing risk of being dragged into recessionary turbulence.

A 2021 tech sector recession is certainly not priced into current tech share valuations in this frothy period of asset appreciation.

December 18, 2019 - Quote of the Day

Tech Letter

“I couldn't imagine a more incompetent politician than myself.” – Said Co-Founder and Co-CEO of Salesforce Marc Benioff

December 16, 2019

Tech Letter

Mad Hedge Technology Letter
December 16, 2019
Fiat Lux

Featured Trade:

(THE PELETON BUBBLE IS ON)
(PTON), (PLNT), (NFLX), (AMZN)

The Peleton Bubble is On

Tech Letter

Own a Peloton (PTON) bike, but don’t buy the stock.

That is the conclusion after deep research into this wellness tech company.

Peloton is an American exercise equipment and media company that bills itself as a tech company.

It was founded in 2012 and launched with help from a Kickstarter funding campaign in 2013. Its main product is a stationary bicycle that allows users to remotely participate in spinning classes that are digitally streamed from the company's fitness studio and are paid for through a monthly subscription service.

Peloton is wildly overpriced with the enterprise value of each subscriber at $15,631.

Contrast that with other comparable firms such as Planet Fitness (PLNT) whose enterprise value per subscriber is $553 or even streaming giant Netflix (NFLX) whose enterprise value per subscriber comes in at $895.

There are three massive deal breakers with this company – software, hardware, and the management team.

The management team acts as a bunch of cheerleaders overhyping a simple exercise bike with a screen that has no deeper use case and in turn an unrealistic valuation that has disintermediated from all reality in the post-WeWork tech world.

What’s the deal with the hardware?

Some recognition must be given to Peloton for creating a nice bike and interactive classes that mesh with it. That idea was fresh when it came out.

The marketing campaigns were attractive and allured a wave of revenue and these customers were paying elevated prices.

But the bike itself has not developed and advanced in a meaningful way since it debuted in 2014 and back then the valuation of the company was $100 million.

The first-mover advantage was a godsend at the beginning, but the lack of differentiation is finally catching up with the business model and now you can get your own Peloton carbon copy on Amazon (AMZN) for $500 instead of $2,300.

Instead of focusing on the meat and bones of the company, Peloton has doled out almost $600 million over the last 3 years in marketing to capture the low hanging fruit that they most likely would have seized without marketing while competition was low.

Competition has intensified to the point that some of its competitors are giving away bikes for free justifying to never cough up cash for a $500 exercise bike let alone a $2,300 genuine Peloton bike.

The first-mover advantage when Peloton had the best exercise bike is now in the past and the company is attempting to move forward with a stagnant bicycle.

The Peloton treadmill came out much later but has not caught on and has many of the barriers to success I just talked about.

What about the case for owning the stock for the software?

Peloton is charging an overly expensive $39 per month for a “connected experience” to anyone who has bought the $2,300 Peloton bike.

But if the user happens to not buy the bike, they can download the digital app and pay $12.99 per month for the same connected experience.

Why would someone pay $2,300 for an overpriced exercise bike when they can just sign up to a full-service gym and just use the Peloton app with some headphones for $12.99 per month?

This illogical strategy means that less than 10% of Peloton subscribers have bought their bike.

Peloton’s competitors have shredded apart their strategy by essentially underpricing their bike and mentioning that they can use the Peloton app with their bike.

And even if you thought that Peloton’s live streaming fitness classes were the x-factor, users can just add a nice little removable iPad holder to the exercise bike and stream YouTube for free or any other digital content on demand.

The cost of adding an iPad holder is about $13-$15 which is a cheap and better option than paying $12.99 or $39 per month for Peloton’s fitness classes.

Users will eventually migrate towards cheaper packaged content because of the overpriced nature of Peloton’s digital content.

Is Management doing a good job?

Peloton’s CEO John Foley most recently told mainstream media that the company is profitable when it is not.

He has repeated this claim several times throughout the years as well. The company has never been profitable and lost $50 million on $228 million of revenue last quarter.

Each quarter before that has also lost between $30 million to $50 million as well, and Foley is outright dishonest by saying the company is profitable.

Peloton relies on top 100 billboard songs to integrate with their fitness streaming classes and the company just got slammed with a $300 million lawsuit from music publishers claiming they have never actually paid for music licensing.

Music is core to their streaming product and without the best songs, users won’t tune in just for the instructor.

Working out and live music go hand in hand and stiffing the music industry on licensing fees is just another example of poor management.

In March 2020, the lockup expires and top executives are free to dump shares which will happen in full force.

Management has one unspoken mandate now – attempt to buoy the stock any way possible until they can cash out next March.

This group of people is only a few months away from their payday.

There is no software or hardware advantage and management is holding out for dear life until they can kiss the company goodbye.

Do not buy shares and I would recommend aggressively shorting this pitiful attempt of a tech company.

Peloton is a $6 stock – not a $30 stock.

December 16, 2019 - Quote of the Day

Tech Letter

“Basically, we juiced our expense line but think it will pay dividends down the line.” – Said CEO of Peloton John Foley on why Peloton loses money

December 13, 2019

Tech Letter

Mad Hedge Technology Letter
December 13, 2019
Fiat Lux

Featured Trade:

(WHY THE FANGS ARE BREAKING INTO YOUR HOME)
(GOOGL), (AAPL), (AMZN), (ALRM), (ADT), (ARLO), (RESI), (PANW), (CRWD), (FTNT), (CSCO), (CMCSA), (BBY)

Why the FANGs are Breaking Into Your Home

Tech Letter

The house is the new smartphone and I will tell you why.

The projected market growth of 18% in smart home technology sales according to Acumen Researching and Consulting will deliver opportunities to shape and prioritize this sector.

The revenues up for grabs from the smart home mean that internet of things’ (IoT) companies will create systems that mesh together with the bare minimum human participation, meaning that tech will have a dramatic influence in our daily lives.

I get several moans and groans a day that the Mad Hedge Technology Letter only shines the spotlight on the FANGs.

But it is hard not to when it comes to the future of the home.

Just look at recent M&A activity.

Automation and connected smart appliances have consumed Amazon by recently acquiring Eero, producer of routers for apartments, houses, and multi-story homes, and after already paying $1 billion to acquire Ring, a doorbell-camera startup. It had also bought Blink, a smart camera maker in 2017.

Google hasn’t shied away either by investing in smart home products pocketing Nest, a firm producing smart home products, for $3.2 billion.

Nest took a few years to sort out its production phase but finally managed to launch new temperature sensors, a video doorbell, and an outdoor smart camera.

What are the trending IoT products now?

The flavors of the day are smart lights, security, entertainment systems, and temperature control.

They are the low hanging fruit of the smart home industry – a de facto gateway into this world.

Most of these smart devices operate with voice assistants, but because of the nature of competition, certain products are aligned with certain ecosystems and compatibility issues will persist until the competition flushes itself out.

A layman’s example would be Apple’s Homekit dovetailing nicely with Apple’s Siri.

Companies are in the first innings of the product iteration cycle and the variations of smart home products are endless stemming from showers that remember preferred water temperature and flow rates or climate-control systems that change in real-time to suit the user.

Security of home networks and connected devices are still a controversial question mark because the receiver of this type of data has the keys to the most intimate details of personal lives.

Even avid technologists are hesitant to dive in and put up smart home products all over the house, and most are being cautious.

In fact, privacy issues are the most distinct headwind to fresh adoption rates.

Many people simply aren’t willing to make the jump yet until they are more convinced of its use case.

Even with all the reservations, an alternative global shipment company believes smart home devices will post 24% in growth next year.

For the smart home device believers, this cohort averages 6 smart home devices per household and will certainly rise to 7 or 8 by the end of 2020.

Popular items include the Amazon Echo, Google Home, and Apple (AAPL) HomePod.

Smart speakers are already present in 36% of American homes and rising.

Consumers are also worried about technology invading their daily lives along with allowing artificial intelligence to dominate personal decision making.

Others have concluded that items such as smart microwaves are a waste of money and are unneeded when analog devices function admirably.

Another legitimate reason is that the software and technology involve a perceived steep learning curve to operate which many people do not have the patience for.

And some are just burnt out by the volume of technology thrown in our faces.

Who wants to operate 50 apps on their phone to control their smart home devices when there are other pressing needs in life?

Companies with skin in the game are Alarm.com (ALRM), ADT (ADT), Arlo Technologies (ARLO) and Resideo Technologies (REZI) and they will be outsized winners if they can solve many of the industries lingering issues.

The value thesis in the case of home automation companies is that they are financially efficient, time-effective, boost wellness and will be easy to use.

About 11% of U.S. broadband households have smart thermostats and Nest’s smart thermostat is the most popular.

Networked security cameras by Arlo are in 10% of homes.

Video doorbells from Amazon.com (AMZN), Google are in 8% of homes and help deter theft of e-commerce packages.

Smart light bulbs and lighting are at 8% market share while smart door locks are at 7% penetration.

There are several second derivates bet on this as well.

The most common user interface for the smart home is apps on a smartphone or tablet and voice commands to smart speakers are second.

The conundrum of installation complexities leads to the demand of professional installers.

This demand has delivered opportunities for companies like Comcast's (CMCSA) Xfinity and Vivint.

Electronics retailer Best Buy (BBY) has stepped up its footprint in this market as well.

Another stock play would be cybersecurity companies because they will win contracts protecting the software that smart home products rely on.

Hackers are getting more sophisticated and a private cybersecurity company Firewalla can track where data is flowing to and from your devices.

Firewalla management recommends buying devices from reputable home automation companies like Amazon and Google because they have more accountability and are of higher quality.

There will be a huge onramp of cybersecurity contracts doled out to the likes of Palo Alto Networks, Inc. (PANW), CrowdStrike Holdings, Inc. (CRWD), Fortinet, Inc. (FTNT), and Cisco Systems, Inc. (CSCO).

We are in the first mile of a marathon and smart home product manufacturers, cybersecurity companies, 5G internet, and semiconductor companies will all benefit from the broad-based integration of these next-generation home consumer products.

December 13, 2019 - Quote of the Day

Tech Letter

What we saw in the 4G era was enormous innovation coming with that greater coverage and that speed over 3G. It’s going to be the same with 5G for sure.” – Said CEO of Verizon Communications Hans Vestberg

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