Mad Hedge Technology Letter
March 27, 2019
Fiat Lux
Featured Trade:
(THE DEATH OF ANOTHER STARTUP)
(WINE.L)
In a story that starts across the pond in Watford, England, BevMo! look-alike wine retailer Majestic Wine (WINE.L) has landed itself on the endangered species list.
If you don’t know, Majestic Wine is the largest specialty wine retailer in Britain.
The company revealed it would shutter most domestic locations and change its name to the internet wine distributor it bought in 2015 called Naked Wines.
The news is another glaring reminder that niche retailers have been muscled out of the picture and don't possess the business model to compete in the most dynamic and innovative sector in the world – groceries and the ecommerce surrounding it.
America isn’t the only country grappling with the dreaded Amazon effect.
In a drastic readjustment of strategy, Majestic Wine has given up on its physical presence choosing to up their investment in the online space before the window of opportunity closes.
The decision to bet the ranch on its Naked Wines online division and the subsequent news of the restructuring hit shares hard dropping 10%.
As of today, Naked Wines loses money as it attempts to lure in new online customers, and the higher costs have hit the bottom line.
The downfall of companies such as Majestic Wine directly correlates with the success of deep discount German supermarkets Aldi and Lidl that take a refreshing surgical approach to cost and convenience.
They use data analytics to make bold decisions, but they aren’t online retailers.
Hybrid strategies are being increasingly effective at solving complicated transnational problems.
The rise of the duo has outsized ramifications for the US supermarket industry, just only a few years after coming to America, they have penetrated with success.
If I had to sum up their model, I would describe it as Whole Foods quality meets Walmart prices with a truncated catalog of items and a superstar German management team.
In 2018, Aldi had already captured over 3% of market share in six of eight American markets, while Lidl had seized 3% of market share in five and seven markets.
This might not seem impressive in the world of supermarkets, but this is a resounding victory, it usually takes more time to convince new shoppers to switch their allegiance.
Not only have they made inroads in the US market, but they are the fastest-growing supermarkets by market share in Britain.
Much of the blame of Majestic Wine’s demise can be levied on these deep discount upstarts that act in real time allowing management to seamlessly shift products, alter floor designs, and capitalize on operational efficiencies on the ground.
Aldi plans to ramp up its British operations by remodeling the current 1,800 stores and open another 400 stores by 2022.
Up to 20% of products are continuously changing, giving another nod to the efficient management team in place.
They plan to offer 40% more prepared foods and wholesale changes in the business model are a hallmark of the company.
Covertly, they have single-handedly crushed the competitive advantage for Majestic Wine by offering medium-tiered wines for as little as $2.
And the $2 price point is not just a teaser rate, their wine selection is stocked full of options of $2 to $4 making it strenuous to compete on price.
You don’t need a full-blown online operation if management systemically executes and these two are proof.
Consumers are voting with their feet for Aldi and Lidl with British market share doubling since 2012 while every other supermarket has flatlined or decreased.
Some of the tactics spearheading the new jolt of positivity are minimizing staff while implementing a cozy design layout making it possible to conclude shopping in a streamlined fashion.
They are pedantically selective in what products they sell by offering only 1,750 products compared to big-box supermarkets that routinely sell up to 40,000 products.
Why sell 10 versions of ketchup or 50 types of flavored soda?
Being able to truncate the floor space by not wasting it with unlimited choices allows the company to deliver cost savings back to the customers.
They have also gone the Amazon route by producing an in-house brand by sourcing local ingredients and again, seeking to deliver back savings to the consumer.
The smaller space of the stores means shelves are less deep and items leave quickly, a specialized team is in place to refill products as quickly as possible.
The employees are also benefiting from this scheme by becoming the highest paid grocery staff in England surpassing the average industry wage by more than $2 more per hour.
Effectively, Lidl and Aldi are cherry-picking the industries' best practices then marrying it up with big tech’s best practices, and executing on a superior level to rave reviews from the consumer from America, Britain, and continental Europe.
Applying data analytics to reformulate strategy can be used for a recipe for success instead of copying Amazon.com.
The waters are treacherous for Majestic Wine as reverse globalization cast a dark cloud over consumer sentiment with Brexit causing the British pound to materially weaken stripping Brits of discretionary income.
The currency weakness has increased import costs of wine and an immediate threat of a hard Brexit forced the firm to import an extra 5 million to 8 million pounds of stock guaranteeing it is hedged against any delivery bottlenecks in the case of a calamitous “no deal.”
If Brexit does leave the European Union without a deal, tariffs will be slapped on imports the next day amongst other headaches.
Just as heinous, a “no deal” will force wine companies to fill out more than 600,000 additional forms that will cost the wine industry £70 million, and the need to carry out thousands of individual laboratory tests on all wine imports.
UK wine inspectors will face an immediate uptick in workloads with every handwritten VI-1 form needing to be analyzed and stamped before wine can enter from Europe.
If you visit Britain this summer, expect pricier spirits, expect more Lidls and Aldis in the area, and short the new e-commerce firm Naked Wines on every rally on the London Stock Exchange.
THE CALM BEFORE THE STORM
“We're running the most dangerous experiment in history right now, which is to see how much carbon dioxide the atmosphere... can handle before there is an environmental catastrophe.” – Said Founder and CEO of Tesla Elon Musk
Mad Hedge Technology Letter
March 26, 2019
Fiat Lux
Featured Trade:
(PINTEREST COMES OUT)
(PINS), (FB), (AAPL), (GOOGL), (AMZN)
The Facebook (FB) of digital images is on deck and has filed to go public.
I'll give you the skinny on it.
Pinterest (PINS) has slightly different lingo - they call digital images pins, a collection of pins, a pinboard, and the users that post pins are pinners.
Aside from this little creative wrinkle, Pinterest does little to help flow my creative juices.
That's not to say they are a bad company, in fact, it's quite refreshing that on the financial side of the equation, Pinterest is a solid financial enterprise.
They make money and aren't going to burn through their cash reserves anytime soon.
This should give some peace of mind to potential investors looking at snapping up shares of Pinterest.
Even though they are not a bad company, I cannot promote them as a firm revolutionizing technology in the way we know it, they certainly don’t, and never will, at least at the current pace of innovation.
Pinterest derives almost 100% of its revenue from digital ads à la Facebook, they do not sell anything and much like Facebook, the user is the product by way of mining private data and selling them over to third-party ad agencies who subsequently sell targeted ads on Pinterest’s platform.
As I read through Pinterest’s S-1 filing with the SEC, an overwhelming portion of the content is reserved for the litany of regulatory risks that serving digital ads, curating others' content, and the international risks that pose to Pinterest growth story.
As with most tech growth stories, this particular narrative must orbit around the strength of incessantly growing its domestic and international user base.
I surmise that part of the reason they desire to go public is because of the 265 million in global quarterly monthly users have reached the high watermark.
Therefore, this calculated risk of going public is entirely justified as the cash out for the venture capitalist and private owners that invested in this company as a burgeoning toddler.
Or the owners see catastrophic downside from the regulatory landscape which has been increasingly volatile in the past few quarters and wish to get out as soon as they can.
Let's make no mistake about this, Pinterest does not control its own destiny, and their success will be based upon external factors that they cannot control.
Some of these factors have already reared their ugly head, the most relevant example was when Google (GOOGL) changed its image search algorithm which disrupted Pinterest’s image function.
This was an example of third-party content originators clamping down on their willingness to allow Pinterest to populate content on their proprietary platform, and the lack of availability of content or the decreasing nature of it will sting the hope of increasing web traffic on Pinterest going forward.
Pinterest has clearly disclosed in its IPO filing that they are reliant on crawling third-party search engine services for third-party photos, this content is curated into their platform and credited to the original user.
I would classify this type of technology as unimpressively low grade and Pinterest will be susceptible to many more possible disruptions in the future.
In layman terms, if the stars do not align, Pinterest will be the first to feel it, and strategically speaking, this is a poor position to strategically operate from.
If Pinterest cannot serve the specific content that incites the tastes of pinners, this could destroy retention and engagement rates leading to a damaging downdraft of ad revenue.
Pinterest's feeble business model will certainly call for new investments in and around more innovative parts of technology.
What we have seen most successful technology companies flirt with are full-fledged recurring revenue models, and bluntly, Pinterest does not have one.
The likes of Microsoft, Amazon, Google, and Apple have pivoted hard towards this subscription model proving they can have their own cake and eat it too.
Funnily enough, Pinterest pays AWS, Amazon’s cloud arm, an extraordinary amount of money to store the pins or digital images on AWS Cloud platform to the tune of almost $800 million per year showing how beneficial it is to be on the other side of the equation.
Pinterest does benefit from a robust brand reputation and its footprint in America is quite large.
However, one group of potential customers have clearly been left out in the cold - Males.
The firm has been famous for being the go-to image platform for young mothers and generally speaking, American women born in the 1980s.
According to data analytics, it appears that content that males gravitate towards is not present on the platform and will need to be addressed going forward to grow users.
Another crucial problem that must be addressed is the lack of domestic growth in the user base.
In Q1 2018, Pinterest achieved 80 million monthly active users, however, fast forward to Q4 in 2018 and the number had barely inched up to 82 million monthly active users.
From Q1 to Q2, there was a dramatic deceleration in the number of monthly active users falling by 5 million to 75 million monthly active users.
The company blamed this on Facebook changing their password security causing users who rely on Facebook passwords and username entrance data to be temporarily stonewalled from entering Pinterest.
Millions decided to avoid the hassle and just stop using Pinterest because they were unable to enter the platform, causing major carnage to Pinterest’s ad-supported revenue model because of the hemorrhaging usership.
Unfortunately, bigger platforms such as Facebook and Google are not responsible to telegraph these structural changes in policy to Pinterest which means that this type of loss of usership could be a bi-annual or annual exercise in damage control.
Losing 10% of your user base based on someone else’s systemic changes is a bitter pill to swallow.
Investors must ask themselves why a premium search engine like Google search want to allow Pinterest to continue to curate its images for ad revenue effectively skimming off of Google’s top line?
As you have seen, Google has hijacked many of these types of business initiatives by taking on these opportunities themselves, dismantling the choke points, and going in for the kill.
The main avenue of user expansion is its international audience, and sadly, the average revenue per international user is a paltry $0.09. This number was up sequentially from the prior quarter which was $0.06.
If you compare the revenue per user with America, then it's easy to understand why the company wants to go public now.
Management presided over a sequential increase of American revenue per user from $2.33 to $3.16 in the prior quarter and the same growth will be hard to maintain and replicate spurring the higher-ups to cash out.
International growth is staring down a barrel of a gun with restricted access by governments who do not allow this type of service in their countries such as China, India, Kazakhstan, and Turkey.
The impact of these broad-based bans decodes into Europe being the only possible answer to user growth in revenue terms and total usership.
To state that Pinterest is confronted by widespread global risk is an understatement.
However, the low-hanging fruit would be squeezing more revenue out of the American user and I would guess that the ceiling would be around $7 per user in the near-term.
If management hopes to eclipse the $7 per American user, they will have to migrate into more data generative strategies such as video.
“When you innovate, you've got to be prepared for everyone telling you you're nuts.” – Said CEO of Oracle Larry Ellison
Mad Hedge Technology Letter
March 25, 2019
Fiat Lux
Featured Trade:
(APPLE’S BIG PUSH INTO SERVICES)
(AAPL), (GS), (NFLX), (GOOGL), (ROKU)
The future of Apple (AAPL) has arrived.
Apple has endured a tumultuous last six months, but the company and the stock have turned the page on the back of the anticipation of the new Apple streaming service that Apple plans to introduce next week at an Apple event.
The company also recently announced a partnership with Goldman Sachs (GS) to launch an Apple-branded credit card.
In the deal, Goldman Sachs will pay Apple for each consumer credit card that is issued.
These new initiatives indicate that Apple is doing its utmost to wean itself from hardware sales.
Effectively, Apple's over-reliance on hardware sales was the reason for its catastrophic winter of 2018 when Apple shares fell off a cliff trending lower by almost 35%.
This new Apple is finally here to save the day and will demonstrate the high-quality of engineering the company possesses to roll out such a momentous service.
Frankly speaking, Apple needs this badly.
They were awkwardly wrong-footed when Chinese consumers in unison stopped buying iPhones destroying sales targets that heaped bad news onto a bad situation.
I never thought that Apple could pivot this quickly.
Apple's move into online streaming has huge ramifications to competing companies such as Roku (ROKU).
In 2018, I was an unmitigated bull on this streaming platform that aggregates online streaming channels such a Sling TV, Hulu, Netflix and charges digital advertisers to promote their products on the platform through digital ads.
I believe this trade is no more and Roku will be negatively impacted by Apple’s ambitious move into online streaming.
What we do know about the service is that channels such as Starz and HBO will be subscription-based channels that device owners will need to pay a monthly fee and Apple will collect an affiliate commission on these sales.
Apple needs to supplement its original content strategy with periphery deals because Apple just doesn’t have the volume to offer consumers a comprehensive streaming product like Netflix.
Only $1 billion on original content has been spent, and this content will be free for device owners who have Apple IDs.
Apple's original content budget is 1/9 of Netflix annual original content budget.
My guess is that Apple wants to take stock of the streaming product on a smaller scale, run the data analytics and make some tough strategic decisions before launching this service in a full-blown way.
It's easier to clean up a $1 billion mess than a $9 billion mess, but knowing Apple and its hallmarks of precise execution, I'd be shocked if they make a boondoggle out of this.
Transforming the company from a hardware to a software company will be the long-lasting legacy of Tim Cook.
The first stage of implementation will see Apple seeking for a mainstay show that can ingrain the service into the public's consciousness.
Netflix was a great example, showing that hit shows such as House of Cards can make or break an ecosystem and keep it extremely sticky ensuring viewers will stay inside a walled pay garden.
Apple hopes to convince traditional media giants such as the Wall Street Journal to place content on Apple's platform, but there has already been blowback from companies like the New York Times who referenced Netflix’s demolition of traditional video content as a crucial reason to avoid placing original content on big tech platforms.
Netflix understands how they blew up other media companies and don’t expect them to be on Apple’s streaming service.
They wouldn’t be caught dead on it.
Tim Cook will have to run this race without the wind of Netflix’s sails at their back.
Netflix has great content, and that content will never leave the Netflix platform come hell or high water.
Apple is just starting with a $1 billion content budget, but I believe that will mushroom between $4 to $5 billion next year, and double again in 2021 to take advantage of the positive network effect.
Apple has every incentive to manufacture original content if third-party original content is not willing to place content on Apple's platform due to fear of cannibalization or loss of control.
Ultimately, Apple is up against Netflix in the long run and Apple has a serious shot at competing because of the embedment of 1 billion users already inside of Apple's iOS ecosystem that can easily be converted into Apple streaming service customers.
If you haven't noticed lately, Silicon Valley's big tech companies are all migrating into service-related SaaS products with Alphabet (GOOGL) announcing a new gaming product that will bypass traditional consoles and operate through the Google Chrome browser.
Even Walmart (WMT) announced its own solution to gaming with a new cloud-based gaming service.
I envision Apple traversing into the gaming environment too and using this new streaming service as a fulcrum to launch this gaming product on Apple TV in the future.
The big just keep getting bigger and are nimble enough to go where internet users spend their time and money whether it's sports, gaming, or shopping.
Apple is no longer the iPhone company.
I have said numerous times that Apple's pivot to software was about a year too late.
The announcement next week would have been more conducive to supporting Apple’s stock price if it was announced the same time last year, but better late than never.
Moving forward, Apple shares should be a great buy and hold investment vehicle.
Expect many more cloud-based services under the umbrella of the Apple brand.
This is just the beginning.
“Our goal has never been to make the most. It's always been to make the best.” – Said CEO of Apple Tim Cook
Mad Hedge Technology Letter
March 21, 2019
Fiat Lux
Featured Trade:
(THE ALPHABET NO-BRAINER)
(GOOGL)
