“It's OK to have your eggs in one basket as long as you control what happens to that basket.” – Said Founder and CEO of Tesla Elon Musk
Mad Hedge Technology Letter
May 9, 2019
Fiat Lux
Featured Trade:
(APEX LEGENDS TO THE RESCUE)
(EA)
Fortnite roiled the video gaming industry last year reinventing the landscape with its freemium model that is available on every platform.
Its in-game add-on revenue strategy is the new model going forward and the first major video game studio to adapt to the new status quo is Electronics Arts Inc. (EA).
The successful earnings report by a newly minted super growth driver and Fortnite competitor called Apex Legends.
Apex Legends copied Fortnite with its 'Battle Royale' format incurring outsized user growth.
Overall, EA’s player base grew to more than 500 million active player accounts in 2019.
This was driven by engagement in the top franchises and live services on major platforms, the game-changing introduction of new IP, including the free-to-play game Apex Legends, offering reach to new audiences around the world is the crux behind short-term bullish momentum in the stock.
Other releases such as "Star Wars Jedi: Fallen Order" will provide another boost to sales momentum as well.
The sports side of the company is also working miracles in a year where both FIFA 18, including World Cup content and FIFA 19 with the UEFA Champions League, had more than 45 million unique players in total playing FIFA games on console and PC.
More than 100 million players engaged with EA’s FIFA franchises on mobile and PC free-to-play during the year as well.
Given investor paralysis across the video game space about revenue stability, competitive moat, and changing revenue models, the predictability and stability of sports demonstrates the breadth of EA’s asset.
Apex Legends is the fastest-growing new game in the history of EA quickly reaching a milestone 50 million players and millions more have continued to participate.
It has also helped EA accumulate new player audiences as nearly 30% of Apex Legends players are new to EA.
The plan for Apex Legends is to deliver this massive global community with a long-term live service, including new seasons with more robust Battle Pass content, new legends and exciting evolutions to the in-game environment.
EA is collaborating aggressively to bring the game to more players in more markets and platforms around the world, including Korea, to take advantage of an opportunity in the market and self-publish Apex Legends via Origin.
EA expects $300 million to $400 million in net bookings for Apex Legends in the fiscal year that ends next March, though that projection doesn’t take into account potential contributions from a mobile version of the game or a version for the Chinese market.
Annual targets were met with GAAP net revenue for the fiscal year registering $4.95 billion delivering EPS of $3.33.
These results enabled EA to deliver an operating cash flow of $1.55 billion and return over $1 billion to shareholders, about 83% of free cash flow, through the ongoing share repurchase program.
The prior quarter was a robust one with EA beating on the top and bottom line.
EA easily beat on the top line with GAAP net revenue for the quarter coming in at $1.24 billion, shattering guidance by $75 million.
Turning to the key catalysts of this quarter, net bookings were $1.36 billion, well above guidance of $1.17 billion, and up from $1.26 billion last year.
To reiterate, the beat was driven by Apex Legends and the outperformance in the blockbuster sports titles.
Digital net bookings were $1.19 billion, up 14% on the year-ago period, driven by strong digital sales of Apex Legends and Anthem.
Digital net bookings represented 75% of the business on a trailing 12-month basis, a new record compared to 68% in the prior year.
Live services net bookings were up 24% to $845 million, primarily driven by Apex Legends.
Live services at EA delivered its best year on record with FIFA and Madden Ultimate Teams both closed the year very strongly.
The gaming environment shows no let up in dollar terms, expect the gaming software market to grow 7% over the calendar year, with mobile up 12%, console up 4% and PC flat.
Estimates for 2020 is for net revenues of $5.4 billion, and cost of revenue of $1.3 billion and EPS of $8.56.
Gaming is still a hot part of tech and after 2018 that crushed Fortnite competition, EA should hold its own with Apex Legends and the strength of its sports franchises.
Shares are up over 20% this year and have more room to the upside.
“Capitalism has worked very well. Anyone who wants to move to North Korea is welcome.” – Said Co-Founder and Former CEO of Microsoft Bill Gates
Mad Hedge Technology Letter
May 8, 2019
Fiat Lux
Featured Trade:
(ELBOWED OUT OF THE WAY BY APPLE)
(SPOT), (AAPL)
I have turned bearish on online music streaming platform Spotify (SPOT) who have grumbled to EU about the charges they must pay Apple for selling through the Apple (AAPL) app store.
The charge reduces to 15% after 1 year but initially start at 30%.
These are the perils of not possessing your own proprietary platform, needing to jump through hoops to receive access to the lucrative North American market.
3rd party companies must oblige and pay the commissions or seek business elsewhere.
If the situation were the other way around, Spotify would charge Apple.
I hardly feel bad for Spotify, but Apple doubling down on the services story spells trouble for Spotify.
If they think competition is brutal now, Apple is certain to make life harder to sell through the Apple store when actively promoting a direct competitor through Apple music.
Much of the gloss is being rubbed off of Spotify who are trying harder these days just to tread water.
The company reported total Q1 revenue of $1.69 billion (€1.511 billion), eclipsing analysts’ expectations of $1.64 billion.
That was the good, now some of the bad.
Spotify posted a net loss of $158 million (€142 million), versus a net loss of €169 million ($189 million) in the year-earlier period.
The net loss of 88 cents per share (€0.79) missed consensus EPS of 39 cents (€0.35), a wayward miss that epitomizes the inherent problems with this unprofitable business model.
The numbers revealed that Spotify was overextending itself to acquire incremental revenue and is unable to generate the high-quality growth that tech companies relish.
According to Spotify, Q1 headwinds consisted of “significantly increased operating expenses” and much of that has to do with the exorbitant royalty expenses doled out to the music industry.
When a company goes the route of cheap tricks like nonsensical promotions to boost revenue, there is a material risk that customers won’t retain subscription at higher price points after the promotions drop off.
The EPS miss was horrid, but Spotify did deliver on its growth estimates delivering 26% YOY growth in Monthly Active Users (MAUs) to 217 million, slightly lower than the midpoint of the company’s guidance range of 215-220 million MAU.
Another cavity emitting pain from the mouth was Average Revenue Per User (ARPU) of only EUR4.71, roughly flat from the prior year.
Spotify has experienced a deceleration in ARPU due to shifts in product and geographic mix.
The company believes the downward pressure on ARPU has moderated and now hopes ARPU declines through the remainder of the year to be in the low single digits.
The inability to accelerate the ARPU tells us that the product’s viability in the lucrative North American market could be waning and thawing out North American revenue drivers won’t automatically guarantee a renaissance in higher ARPU.
This could be the new normal with the company presiding over lower ARPU and a big part of that stems from its penetration into lower-income countries such as India.
In February, Spotify launched its service in India and has racked up over 2 million users in the country. The company’s global market footprint now impressively spans 79 countries.
Spotify’s key areas of growth during the quarter were measurement and programmatic revenues.
Measurement-related revenues doubled from 20% to 40% of total ad revenues year-over-year.
Programmatic and Self-Serve grew 53% from last year and now account for 26% of total ad-supported revenue.
Premium subscribers increased 32% year-over-year to 100 million, reaching the high end of the 97-100 million guidance.
The outperformance was aided by a better than plan promotion in the US and Canada and continued expansion in Family Plan.
For next quarter, Spotify expects revenue to grow 18-35% YOY to EUR1.51 billion to EUR1.71 billion.
Total MAUs are expected to increase 23-27% year-over-year with the premium segment boosted by 29-34% to EUR107-110 million.
“Competition is really not a big factor for us,” CEO Daniel Ek who chimed in on the earnings call.
This couldn’t be further from the truth with Spotify unhappy that Apple is charging them 30% commission to sell from the Apple app store which all boils down to stifling the competition.
Apple has made it clear to investors that ramping up service growth is one of the key pillars to Apple’s story, and music will be a cornerstone of the service transformation.
Competition will heat up creating a more fractious relationship between Apple and penetrating the Android users won’t cut it.
Spotify still hasn’t offered investors an intriguing way to put the kibosh on royalty expenses and in the near future, Spotify will need to prove they can increase margins which I believe they won’t.
My bet is that operating margins are squeezed, cash burn increases, EPS goes further south and the stock show softness in the near-term.
“Spotify is a platform: it could be expanded to other types of content.” – Said CEO of Spotify Daniel Ek
Mad Hedge Technology Letter
May 7, 2019
Fiat Lux
Featured Trade:
(THE LURKING DANGERS BEHIND FACEBOOK)
(FB), (WFC), (NFLX)
The current business model of social media is dead, and the future model seems in doubt – that was the take away from world's largest social media platform at F8 that I attended, its annual developer conference.
Co-founder and CEO Facebook (FB) Mark Zuckerberg stated at the event that “in our digital lives, we also need both public and private spaces,” an impromptu call to action to migrate users into a new private digital world with Facebook dictating the terms.
The sushi must really be hitting the fan for Zuckerberg to announce his future vision of social media, and the writing is on the wall for his current social media experiment, that is, if he continues along at the same rate.
The projected $5 billion fine incurred by Facebook from the Federal Trade Commission over its privacy handling of personal data is peanuts for the social media company, but this could be the first of numerous fines doled out by regional and national regulatory bureaus that span from the Bay Area to Vietnam.
Facebook is a company that made over $55 billion in revenue last year and the $5 billion would amount to less than 10% of annual sales.
From that $55 billion, Facebook earned profits of over $22 billion, and this $22 billion is what the regulatory battles are about, along with the co-founder’s tenacious defense of deploying his users as free content.
The firm has continued to post operating margins of over 40% and delivered margins of 46% last quarter, a sequential rise of 4% in Q4 2018.
The Oracle of Omaha better known as Warren Buffet cited necessitating accountability for CEOs that drive a company into a government bailout especially banks.
He advocated that these executives and their spouses should be stripped of their net worth if they damage shareholder value.
The comments were directed at the way Wells Fargo’s (WFC) former CEO Tim Sloan crippled Wells Fargo and has since been sidelined during the long bull market in equities.
At some point, Zuckerberg could confront similar ructions because of his efforts at perverting democracy that has caused innumerable damage to American democracy and global society, and I am certain his legion of lawyers are already hatching a plan to tackle this thorny predicament.
If you ponder about his announcement in a zero-sum environment, it makes no sense for Facebook to pivot to “private” messages.
This leads me to believe his words are smoke and mirrors so that Facebook can perpetuate its duopoly and force digital ad players to continue to drink from the same Kool-Aid.
As before, Zuckerberg still believes this game of cat and mouse is a half-baked marketing fix.
This is why many of his trusted disciples such as former executive Chris Cox left under a shroud of mystery citing “artistic differences” in terminating his tenure at Facebook.
It is clear to many that Facebook is barreling straight into an even more frightening future.
What does the announcement mean from a business perspective?
Zuckerberg will continue to purge anyone that disagrees with him, even trusted lieutenants, and continue to integrate the family of apps into one big platform that includes Facebook, Instagram, and WhatsApp messenger.
These three will become one and thus, Zuckerberg’s ad machine rolls on like the dystopian action film Mad Max.
Let me remind you, these drastic measures boil down to Facebook doing everything they can to keep content costs down.
If they, for example, have to go the same route as Netflix (NFLX) - overpaying for the best actors and directors to generate premium content, the stock would halve the next day.
And that is what Zuckerberg is desperately hoping to avoid after the 30% dip in shares in 2018 because of regulatory headwinds.
Combining the three apps would be impossible to regulate at a time that regulation is rearing its ugly head.
Zuckerberg is intentionally upping the ante and accruing more risk in the hope that Facebook can outmuscle its way through in one piece.
The ad industry is crying out for something new, but as long as Zuckerberg’s claws are firmly into the meat of the digital ad budgets for most companies, he gets to decide how the industry develops because he knows the ad dollars will stick.
In the future, your private chats won’t be private because Zuckerberg will be mining the data for ad dollar revenue.
No matter what he says, nothing will change unless Facebook goes in an entirely new direction which would inhibit sales.
Until the fines become material, let’s say 70% of annual revenue or something of that nature, a $5 billion hit to the bottom line will not persuade the management to transform their practices.
Expect less privacy, and WhatsApp and Instagram to be heavily monetized through ad promotion and data mining even though Zuckerberg pledging his company won’t hold user data “longer than necessary.”
As for Facebook itself, Zuckerberg can’t throw his baby out with the bathwater and will hope to minimize its deceleration by bundling it with the growth trajectory of WhatsApp and Instagram.
Instead of major structural changes, Zuckerberg continues to beat around the bush saying, “You should expect that we’re not going to store your data in countries where there's weak data protection.”
This is not the crux of the problem and shows Zuckerberg is still paying lip service and not ponying up to reality.
Attaching Facebook and its dying model is not an attractive strategy leading to a slew of executive resignations.
I believe this could all end in calamity for Zuckerberg as he figures piling on more risk onto the elevated risk levels is the right decision making Warren Buffet’s point for him about CEO’s accountability.
Should Zuckerberg refund shareholders if his flight turns into a suicide mission then claims to be an unwitting victim?
And how does he even refund democracy with his apps causing major unrest to society such as killings that occur because of the distribution of fake news on his platforms?
Making a hot potato hotter might work for the short term and if ad dollars stream into WhatsApp and Instagram, Zuckerberg will claim victory.
But at some point, the potato will scald his hands so bad that it will drop.
Your private chats will be the content at the fulcrum of his data broker empire since his “digital town square” approach isn’t working anymore.
The company is utterly incentivized to figure out how to continue this ad revenue carnival because 93% of total revenue last quarter came from digital ads which is up from the prior year when it constituted 89%.
It all sounds like a big brother apocalyptical novel, which we are in, scarily, in putting out this dialogue before the firestorm starts, Facebook wants to normalize, and front runs the craziness of selling your private chat data before it becomes a national issue.
Will regulators shut this down or will they be naïve and turn a blind eye?
“Our philosophy is that we care about people first.” – Said Co-Founder and CEO of Facebook Mark Zuckerberg
