“I look forward to tapping into the power of technology to consider additional advancements that will continue to heighten the excitement of the game, improve the pace of play and attract more young people to the game.” – Said MLB Commissioner Robert D. Manfred, Jr.
Mad Hedge Technology Letter
April 18, 2019
Fiat Lux
Featured Trade:
(NETFLIX’S WORST NIGHTMARE)
(NFLX), (DIS), (FB), (AAPL)
Netflix came out with earnings yesterday and revealed guidance that many industry analysts were dreading.
It appears that Netflix’s relative subscriber growth rate has reached the high-water mark for now.
Competition is rapidly encroaching Netflix’s moat.
In a letter to shareholders, management opined revealing that they do not “anticipate these new entrants will materially affect our growth.”
I am quite bothered by this statement because one would have to be blind, deaf, and dumb to believe that Disney (DIS) or Apple’s (AAPL) new products will not take away meaningful eyeballs from Netflix.
These companies are all competing in the same sphere – digital entertainment.
Papering over the cracks with wishy washy rhetoric was not something I was doing backflips over.
Netflix’s management knew this earnings report had nothing to do with results because everyone wanted to reassess how bad the new entrants would make life for Netflix.
Disney has the content to inflict major damage to Netflix’s business model.
The mere existence of Disney as a rival weakens Netflix’s narrative substantially in two ways.
First, Disney’s entrance into the online streaming game means Netflix will not have a chance to raise subscription prices for the short to medium term.
The last price hike was done in the nick of time and even though management mentioned it followed through “as expected,” losing this financial lever gives Netflix less ammunition going forward and caps EPS growth potential.
Second, another dispiriting factor is the premium for retaining and acquiring original content will skyrocket with more firms jockeying for the same finite amount of actors, producers, directors, and writers.
This particular premium cannot be quantified but firms might try to bid up the cost of certain talent just so the other guy has to foot a bigger bill, this is done in professional sports all the time.
Firms might even take actors off the table with exclusive contracts just to frustrate the supply of content generators.
Uncertainty perpetuates with the future cost of content unable to be baked into the casserole yet, and represents severe downside risk to a stock which trots out an expensive PE ratio of 133.
Growth, growth, and more growth – that is what Netflix has groomed investors to obsess on with the caveat of major strings attached.
This model is highly effective in a vacuum when there are no other players that can erode market share.
Delivering on growth justifies heavy cash burn, and to Netflix’s credit, they have fully delivered in spades.
The strings attached come in the form of steep losses in order to create top of the line content.
Planning to revise down annual cash flow from $3 billion to $3.5 billion in 2019 will serve as a litmus test to whether investors are ready to shoulder the extra losses in the near term.
I found it compelling that Disney Plus will debut at $6.99 per month – add that to the price of Netflix’s standard package of $12.99 and you get a shade under $20.
Disney hopes to dictate spending habits by psychologically grouping Disney and Netflix for both at under $20.
The result of breaching the $20 threshold might push customers into ditching Netflix and sticking with the $6.99 Disney subscription.
Then there is the thorny issue of Netflix’s growth – the quality and trajectory of it.
The firm issued poor guidance for next quarter projecting total paid net adds of 5.0m, representing -8% YOY with only 300,000 adds in the US and 4.7m for the international segment.
Alarm bells should be sounding in the halls when the most lucrative segment is estimated to decelerate by 8% YOY.
Domestic subscriptions deliver higher margins bumping up the average revenue per user (ARPU).
Contrast this with Netflix’s basic Indian package costing $7.27 or 500 rupees and a mobile package of $3.63 or 250 rupees.
In my opinion, domestically decelerating in the high single digits does not justify the additional annual cash burn of half a billion dollars even if you accumulate millions of more Indian adds at lower price points.
This leads me to surmise that the quality of growth is beginning to slip, and Netflix appears to be running into the same type of quagmire Facebook (FB) is facing.
These models are grappling with stagnating or slowing North American growth and an emerging market solution isn’t the panacea.
The Netflix Indian packages are actually considered expensive by local standards meaning that Netflix’s won’t be able to crowbar in price hikes like they did in America.
On the positive side, Netflix did beat Q1 estimates with paid net adds up 9.6 million with 1.74m in the US and 7.86m internationally, up 16% YOY.
Netflix was able to reach revenue of $4.5B, a company record mostly due to the $2 price hike during the quarter in America.
The letter to shareholders simplifies Netflix’s tactics to investors explaining, “For 20 years, we’ve had the same strategy: when we please our members, they watch more and we grow more.”
What this letter doesn’t tell you is that Disney and the looming battle with Netflix will reshape the online streaming landscape.
In simple economics, an increase of supply caps demand, and don’t get sidetracked by the smoke and mirrors, Disney and Netflix are absolutely fighting for the same eyeballs no matter how much Netflix plays this down.
To highlight an example of how these two are directly competing against each other – let’s take the cast of Monica, Chandler, Rachel, Ross, Joey, and Phoebe – in the hit series Friends.
Netflix acquired the broadcasting rights from Warner Bros, who owns Disney, and it was the most popular show on Netflix.
Warner Bros, knowing that Disney were on the verge of rolling out an online streaming product, renewed Netflix for 2019 at $80 million.
Not only were they hand feeding the enemy in broad daylight, but they handicapped their new products as it is about to debut.
Whoever made that decision must go into the hall of shame of boneheaded online content decisions.
Once 2020 rolls around, Disney will finally be able to slap Friends on Disney Plus where it belongs, and the streaming wars will heat up to a fever pitch.
Ultimately, when Netflix brushes off reality proclaiming that if they please viewers with the same strategy, then everything will be hunky-dory, then I would say they are being disingenuous.
The online streaming industry has started to become more complex by the minute and the “same strategy” that worked wonders in a vacuum before must evolve with the times.
At $360, I would short Netflix in the short to medium term until they prove the headwinds are a blip.
If it goes up to $400, it’s a screaming short because accelerating cash burn, poor guidance, decelerating domestic net adds, and a jolt of new competition aren’t the catalysts that will take shares above the heavenly lands of $400, let alone $450.
Netflix is still a fantastic company though – I’m an avid viewer.
“Most entrepreneurial ideas will sound crazy, stupid and uneconomic, and then they'll turn out to be right.” – Said Co-Founder and CEO of Netflix Reed Hastings
Mad Hedge Technology Letter
April 17, 2019
Fiat Lux
Featured Trade:
(ALPHABET DOMINATES WITH GOOGLE MAPS)
(GOOGL), (AMZN), (YELP), (UBER)
Remember Google Maps?
Google will start monetizing it, let me tell you about it.
The web mapping service developed by Google gifting access to satellite imagery, aerial photography, street maps, 360° panoramic views of streets has been around since the beginning of this generation of big tech and is what I would consider legacy technology.
Legacy technology is often associated with failure as the out of date nature isn’t applicable to the tech scene and the commercialization of it today.
In a candid letter, Jeff Bezos wrote to shareholders that Amazon will “occasionally have multibillion-dollar failures.”
Silicon Valley tech will have its share of implosions stemming from ill-fated industry decisions correlating to heavy losses.
Google Maps won’t be one of these slip-ups.
However, a whole catalog of instances can be chronicled from Microsoft’s purchase of Nokia’s handset division to Google’s social media foray in Google Plus.
It hasn’t gone all pear-shaped for Alphabet in 2019. I strongly believe they are one of the companies of the year harnessing YouTube in ways consumers never imagined.
Adding color to the story, any remnant of apprehension to any bearish feelings about Alphabet should vanish once investors understand how lucrative Google Maps will become.
Google has spent decades and billions of capital honing the application and in terms of market share they have cultivated a monopoly.
Uber’s S-1 filing shined some light on Google Maps characterizing it as a must-have input into their business saying, “We do not believe that an alternative mapping solution exists that can provide the global functionality that we require to offer our platform in all of the markets in which we operate.”
Uber sunk $58 million integrating Google Maps into its services from 2016-2018 along with continuous payments to its Google Cloud arm to host Uber’s data.
The strong relationship with Uber shows how Alphabet is adept at milking 3rd party apps for what they are worth.
Alphabet’s stake in Uber is projected to be $5 billion from the $250 million investment in Uber in 2013.
The party doesn’t stop there with Uber paying Alphabet $631 million from 2016-2018 in digital marketing services and another $70 million for technology infrastructure.
To say that Google firmly has its tribal marks tattooed into Uber’s skin is an understatement.
Almost 80% of smartphone users regularly use navigation apps.
Google Maps is the most popular navigation app by a country mile with 67% of market share.
One billion people consistently use Google Maps.
It is the go-to navigation app for nearly 6x more people compared to the runner up app Waze with 12% market share.
The superior performance of the app has allowed it to branch off into a Yelp-like hybrid app accumulating reviews of businesses and institutions that are conveniently dotted around its map.
Multi-functional terrain was integrated to make the maps more 3D and route navigation from point A to B routes has steadily improved since its inception.
The increasing detail showing even roofs of sheds and the Google street view offering a point of view vantage point boosting the reliability of the app.
The result of making the app better is that navigators can easily discern locations and follow routes clearly.
Most would concede that they use the app to look up specific street routes.
By implementing digital ads into the experience, product and service offers will possibly populate in real time as the user glances at the app’s directions.
A vast amount of services such from food to personal grooming to even cannabis club ads could be applicable and ad companies will pay top dollar to post on Google Maps.
Google could also offer personalized recommendations to users and collect an affiliate fee if the user clicks on an attached link transferring the customer to a 3rd party landing page.
They already benefit from this strategy on Google Flights.
Google might even be tempted to implement a Groupon model with group discounts on services positioned on Google Maps.
Google Maps is hands down the most underappreciated app and most under monetized tech asset in the world.
Another possible revenue generation avenue would be the advent of Google Maps voice ads en route to a destination that would promote a 5 or 10 second voice commercial of a businesses that the user is physically passing by.
The unintended effects of Google’s audacious transformation of their proprietary Map service spells doom for Yelp’s business model.
Google’s move into digital ads of maps effectively means that Yelp will be relegated to an inferior version of Google Maps without the map technology.
Google has accumulated enough personal data to draw up any type of profile for particularly Android users voraciously consuming data on Gmail, Google Maps, Google Search and Google Chrome.
These four data generators will allow Google to formulate a shadow profile based on individual tastes with daily use of these four Google properties.
Alphabet has a time-honored model of building assets that become utilities and once they monopolize the utility, they sprinkle the digital ad pixie-dust effectively monetizing the asset that was once free of charge.
They have followed the same road map for Gmail, Google Search, YouTube, and if Waymo can become a utility, prepare from Google digital ads inside the screens of Waymo autonomous cars.
When many sulked that this could be one of those billion-dollar failures that Bezos whined about, Google has decided to supercharge Google Maps by cross-pollinating the power of Google maps with its digital advertising knowhow.
This powerful cocktail of forces working in tandem will accelerate its revenue growth along with the resurgence of its YouTube digital ad revenue.
I believe this new lever of revenue growth isn’t priced into Alphabet shares yet, and withstanding any random black swan shocks to the broader economy, Alphabet is poised to outperform the rest of the trading year.
Short Yelp on any and every rally - Google has made their business model redundant.
“If you step back and take a holistic look, I think any reasonable person would say Android is innovating at a pretty fast pace and getting it to users.” – Said CEO of Google Sundar Pichai
Mad Hedge Technology Letter
April 16, 2019
Fiat Lux
Featured Trade:
(UBER’S DARK AND DIRTY SECRETS)
(UBER), (LYFT)
The granddaddy of IPOs awaits us – Uber has filed an S-1 with the SEC detailing plans to go public.
Uber can’t do this any sooner as they preside over a decelerating ride-share operation and its high margin Uber eats division, food delivery business, that has experienced slowing margins.
Once helmed by swashbuckling entrepreneur Travis Kalanick, Uber was infamous for its cultural problems that played out in real time in the media with sexual harassment accusations amongst other things.
They were castigated for its environment of testosterone overload that current CEO Dara Khosrowshahi has rooted out.
Khosrowshahi is pinning the blame on the past leadership in the S-1 filing explaining they are still fine-tuning these problems and its inherent risk could be detrimental to the growth model.
The Iranian-American CEO needs as many outs as he can find because Uber is a high-risk, high-reward model that has revealed no possible way to becoming profitable.
Sequentially, Uber’s core growth has stagnated with revenues last quarter of 2018 coming in at $2.314 billion, decelerating from $2.315 billion in the third quarter.
This is a sensitive spot for Uber because it correlates to 91% of its revenue.
Its Uber Eats division has also presided over two sequential quarters of deceleration indicating the low-hanging fruit has been picked.
The company is shifting towards higher volume, lower margin restaurants in more competitive locations hinting that the gangbuster years of high margin food delivery service growth is over.
The proposed $90 billion IPO also marks the high-water mark to the Silicon Valley IPO parade with only smaller fish from the sea debuting after them.
Uber has altered economic and consumer habits as we know it and the size of the business means it’s no Lyft (LYFT) – Uber is global, and its revenues are six times larger than its American competitor.
Becoming an enormous start-up also means heavier losses, the company had $3 billion in operating losses last year while its smaller competitor Lyft had only $911 million.
Lyft is solely focused on the ride-share industry capping upside potential while Uber has more gunpowder to load if it wants to ammo up in the business world.
One direction Uber hopes to explore is under the banner of Uber Freight which plans to monetize the deeply fragmented logistic industry.
It can take sometimes days for suppliers to deliver shipments with most of the process conducted over the phone or by fax.
Uber Freight mitigates logistical risks by providing an on-demand platform to automate and accelerate logistics transactions end-to-end.
The software smoothly connects carriers with the most appropriate shipments available, and offers carriers upfront, transparent pricing and the ability to book a shipment with the touch of a button.
As of the end of 2018, Uber Freight delivered $125 million in annual revenue and they hope to ameliorate many of the same logistical pain points that occur around the world.
This division of Uber is one that Lyft lacks, thus Uber should be granted a higher multiple when shares go public.
A huge addressable market awaits Uber Freight, but as many know, logistic routes have been formed over many years, and disruptors won’t be able to come in overnight and sign up new contracts.
Revenue should be slow but steady, and not the sugar high rush of revenue management is wishing for.
Uber’s heavy cash burning enterprise needs to offer some glimmer of hope of becoming profitable in the future whether it's five or twenty years out.
Without this x-factor of potential profitability, committed capital could become strained as investor will shy away knowing that a solid balance sheet might be a pie in the sky.
Since 2015, Uber has paid drivers $78.2 billion in renumeration - Uber will need to curtail heavy costs like these to raise operating margins.
One upside to its model is that its software platform possesses synergetic effects cutting costs for rolling out newer software for Uber Freight and Uber Eats.
Uber is still growing, albeit at a slower rate, 2018 Gross Bookings grew to $49.8 billion, up 45% from $34.4 billion in 2017.
The growth contributed to revenues of $11.3 billion in 2018. While a mammoth number, Uber still needs to absorb capital hits from M&A when they acquired Careem, the Uber of Middle East, North Africa, and Pakistan, for $3.1 billion last year.
Uber clearly choreographed a future strategy in the S-1 filing saying, “Our strategy is to create the largest network in each market so that we can have the greatest liquidity network effect, which we believe leads to a margin advantage.”
Details of this strategy include more drivers, more riders, more rides per hour, lower fares, and smaller waiting times.
I believe Uber is biting off more than they can chew on this front.
To overcome the regulatory hurdles and the social backlash while offering cheaper fares and simultaneously increasing driver payout will be impossible unless drivers start shuttling around 5 or 6 people in one ride.
I do acknowledge that Uber has massive scale, first move advantage, and a handsome margin advantage working on their side.
But will this be enough if Uber adds more drivers and effectively piles more money into the same strategy?
I would say no and that could mean that growth rates could slip severely which leads me to suggest that Uber has a problem with the quality of growth.
On the bright side, the business model with be compensated by enhancements in the routing algorithms, payment technologies, in-car user experience, and user interface.
These incremental gains won’t help offset the relative weakness in the growth numbers that possess less and less quality in them.
The overarching theme of what to do when the low-hanging fruit is picked off the branch is a tough one, because any further incremental gain is negated by higher costs or competition.
Uber’s get out of jail free card is the eventual paradigm shift to aerial ride sharing, and if they are the leaders in that transition, it could offer another massive pay day and steeper growth trajectory that would propel the company into a realm of many more possibilities.
Whether Uber can complete this tectonic shift is too far away to predict, time could become a significant headwind in this case since mainstream adoption of autonomous driving has been relatively sluggish.
Expect heightened volatility as the main characteristics of Uber’s price action - it’s certain to be a bumpy ride.
Abstaining from Uber shares would be the smart play here while some more detective work can be deployed.
“Put the right people in the right places, and then you trust them to do the right stuff.” – Said CEO of Uber Dara Khosrowshahi
