Mad Hedge Technology Letter
May 14, 2019
Fiat Lux
Featured Trade:
(CHINA’S COUNTERATTACK)
(AAPL), (MSFT), (ADBE), (PYPL), (QCOM), (MU), (JD), (BABA), (BIDU)
Ratcheting up the trade tensions, China is pulling the trigger on retaliatory tariffs on $60 billion worth of U.S. goods, just days after the American administration said it would levy higher tariffs on $200 billion in Chinese goods.
American President Donald Trump accused China of reneging on a “great deal.”
The mushrooming friction between the two superpowers gives even more credence to my premise that hardware stocks should be avoided like the plague.
I have stood out on my perch in 2019 and proclaimed to buy software stocks and if you need one name to hide out in then I would confidently choose Microsoft (MSFT).
Microsoft has little exposure to China and will be rewarded the most on a relative basis.
The last place you want to get caught out is buying hardware stocks exposed to China and Apple is quickly turning into the largest piece of collateral damage along with airplane manufacturer Boeing.
Remember that 20% of Apple’s revenue comes from China and Apple bet big to solidify a complex supply chain through Foxconn Technology Group in China.
When history is recorded, CEO of Apple Tim Cook not hedging his bets exposing Apple’s revenue machine could go down as one of the worst ever managerial decisions by tech management.
The forced intellectual property transfers in China from western corporations was the worst kept secret in corporate America.
Being an operational guru as he is, and the hordes of data that Apple have access to, this was a no brainer and Cook should have mitigated his risks by investing in a supply chain that was partially outside of China, and not incrementally spreading out the supply chain through other parts of Asia is coming back to bite him.
China's most recent tariffs will come into effect on June 1, adding up to 25% to the cost of U.S. goods that are covered by the new policy from China's State Council Customs Tariff Commission.
The result of these newly minted tariffs is that importers will probably elect to avoid absorbing the costs themselves and pass the price hikes to the consumer sapping demand.
The American consumer still retains its place as the holy grail of the American economic bull case, but this will test the thesis.
For the short term, it would be foolish to hang out to Chinese companies listed in New York through American depository receipts (ADR) such as JD.com (JD), Alibaba (BABA).
Baidu (BIDU) is a company that I am flat out bearish on because of a weakening strategic position versus Alibaba and Tencent in China.
Even with no trade war, I would tell investors to short Baidu, and the chart is nothing short of disgusting.
Wei Jianguo, a former vice-minister at the Chinese Ministry of Commerce who handled foreign trade, said to the South China Morning Post that “China will not only act as a kung fu master in response to U.S. tricks but also as an experienced boxer and can deliver a deadly punch at the end.”
It is clear that any goodwill between the two heavyweight powers has evaporated and the hardliners inside the communist party pulled all the levers possible to back out at the last second.
Many of us do not understand, but there is a complicated political game perpetuating inside the Chinese communist party pitting reformists against staunch traditionalists.
This is not only Chairman Xi’s decision and appearing weak on the global stage is the last concession the communist government will subscribe to.
Along with the iPhone company, semiconductor stocks will be ones to avoid.
The list starts out with the chip companies leveraged the most to Chinese revenue as a proportion of total sales including Qualcomm (QCOM) with 65% of revenue in China, Micron (MU) who has 57% of sales in China, Qorvo who has half of sales from China, Broadcom who has 48% of sales from China, and Texas Instruments rounding out the list with 43% of total revenue from China.
The first 5 months of the year saw constant chatter that the two sides would kiss and makeup and chip stocks benefitted from that tsunami of positive momentum.
The picture isn’t as pretty when you flip the script, and chip stocks could suffer a gut-wrenching summer if the two sides drift further apart.
After Microsoft, other software names I would take comfort in with the added bonus of strong balance sheets are Veeva Systems (VEEV), PayPal (PYPL), and Adobe (ADBE).
The new tariffs will burden American households to up to $2 billion per month going forward, and new purchases for discretionary items like extra electronics will be put on the back burner extending the refresh cycle and saddling chip companies and Apple with a glut of iPhone and chip inventory.
Buy software companies on the dip.
“These trade relationships are big and complex and do need a level of focus and updating and modernization, so I’m optimistic that the countries can work these things out for the benefit of everyone.” – Said CEO of Apple Tim Cook
Mad Hedge Technology Letter
May 13, 2019
Fiat Lux
Featured Trade:
(THE TIDAL WAVE OF EUROPEAN EV SUPPLY)
(TSLA)
It’s not Volkswagen’s first attempt at an all-electric car, but it’s certainly the most crucial attempt in their long history.
There have been iterations such as the e-Golf and other pure-electric vehicles before.
This time around, VW will debut the ID.3 and its new MEB platform.
The newest architecture for electric vehicles will be the lynchpin for several models across all of VW Group’s brands.
According to VW, “The architecture is aimed to consolidate electronic controls and reduce the number of microprocessors, advance the application of new driver-assistance technology and somewhat alter the way cars are built.”
The German company has committed $48 billion in car battery supplies too and plans to run 16 factories to build electric cars by the end of 2022.
At the lowest rung, there’ll be a battery expected to get around 205 miles and this ID.3 will be priced at under 30,000 euro ($33,650) before any subsidies or incentives.
In the middle, there’ll be an ID.3 capable of roughly 261 miles on a full charge which could mushroom into the most popular battery size.
Lastly, there’ll be a 342-mile battery option.
VW is certainly betting big on EVs along with its other in-house brands.
In March, VW announced it plans to launch 70 battery electric vehicles over the next decade and sell 22 million of them.
Previously, VW had said it would sell 15 million battery-electric vehicles by 2025.
The previous plan called for 25% of its global sales to be all-electric by 2025.
VW in-house brands are cranking up launches of new all-electric models.
Audi has started with the e-tron SUV and Porsche’s Taycan goes on sale in September.
VW brand’s I.D. and I.D. Crozz will appear next year while its subsidiaries like Skoda and SEAT are also going electric.
VW is not without its problems.
The recent charge by the European Union (EU) that it colluded with other German manufacturers to limit advances in clean emissions technology was another management misstep.
And the EU provides another challenge to all European carmakers with its harsh rules for 2020 fuel efficiency.
Recent research showed that it could cost VW up to 10 billion euros ($11.3 billion) in fines if it is unable to reduce its current fleet average of 123 grams per kilometer.
Cars like VW’s Audi e-tron offer zero reasons for consumers to buy, costing upwards of 70% more than conventionally powered equivalent vehicles.
The efficiency of the Audi is poor compared with Tesla models and the e-tron’s 95kWh battery offered a range of 2.5 miles per kWh, while the Tesla Model X managed 3.25 miles and the long-range Model 3, 4.13 miles.
Costs should come down substantially for vehicles deploying the MEB platform.
Theoretically, it’s the MEB platform that will serve further electric models going forward.
Yet, it’s highly possible the market is being overly optimistic that VW can deliver on its EV strategy and targets, which is the underlying thesis of the bull story.
VW’s lack of transformative structural improvements and its difficulties in making value-accretive strategic decisions that could unlock shareholder value means multiple upgrades in share price is less than probable.
Volkswagen is offering a Tesla style pre-booking to those who purchase an ID.3 and the possibility of charging electric power at no cost for the first year up to a maximum of 2,000 kWh at all public charging points connected to the Volkswagen charging app WeCharge and using the pan-European rapid charging network IONITY.
The ID.3 is to be delivered to customers in carbon-neutral form.
Production of the ID.3 1ST is to start as planned at the end of 2019 and the first vehicles will be delivered in mid-2020.
With its electric offensive, the Volkswagen brand plans to become the world's number one by 2025.
Mercedes is getting in on the act as well with the EQC Edition 1886 aiming to deliver 292 miles per charge and, with an output of 402 horsepower.
The metrics indicate that it will pose a direct threat to both Tesla's older Model X and upcoming Model Y.
The new Mercedes isn’t attacking the low-end of the market where Volkswagen hopes to apply pressure by offering the base version at 71,281 euros, or just short of $80,000, slightly less expensive than the e-tron quattro in Europe.
The new product from Mercedes qualifies for Germany's 4,000-euro federal tax incentive for EVs.
Ultimately, the avalanche of supply from the European high-end carmakers will heap more pressure on Tesla’s Elon Musk to deliver outperformance.
The entire pivot to EVs is predicated on millennials picking up the demand slack and buying into this story when the Baby Boomer generation did not.
By then, the stringent requirements from government and regulators in tackling climate change by itself might offer a massive customer base to tap into EVs whether they like it or not.
EVs have come a long way since the Chevy Bolt, but it’s far from certain that the Europeans will destroy Tesla, but the new developments will sap German demand for Tesla’s car with a domestic alternative.
Volkswagen Group MEB platform
“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)
