“There are seven billion people in the world. And I think phones are the first time most people will have access to a modern computing device. With Android, we want to enable that for people.” – Said CEO of Google Sundar Pichai
Mad Hedge Technology Letter
February 19, 2019
Fiat Lux
Featured Trade:
(THE SAFE PLACE TO HIDE IN TECH),
(CSCO), (ORCL), (WDAY), (ZEN), (HUBS), (NOW), (PYPL), (VEEV), (TWLO)
Great quarter by Cisco (CSCO).
That was the first thought in my head when perusing their quarterly earnings.
It’s been hit or miss for tech companies lately and at the end of 2018, I stood up and told readers to double down on software companies and specifically enterprise software companies.
Well, Cisco has skin in this software game because corporations cultivating software need the best type of network infrastructure money can buy.
Cisco is the foundational hardware on what current high-end software is built on.
It is all rosy to have a spectacular roof design, but without a solid foundation, we have nothing more than a house of cards.
The great part about Cisco is that they are immune to the software battle taking place inside of industries because they do not build the enterprise software that is built on top of the Cisco infrastructure.
We have seen our fair share of software companies go sideways such as Oracle (ORCL) who have presided over a stale patchwork of database system software created last gen.
However, on the other side of the coin, my prediction of enterprise software companies leading tech has been spot on.
Zendesk (ZEN), HubSpot (HUBS), ServiceNow (NOW), Workday (WDAY), PayPal (PYPL), Salesforce (CRM), Veeva Systems (VEEV), and Twilio (TWLO) are software companies that I was incredibly bullish on as we turned the calendar year and they have not disappointed with nearly all of these names flirting with all-time highs.
All these software companies need Cisco.
What stood out for me was that public sector orders grew 18% last quarter signaling that not only are the private corporations snapping up Cisco products, but governments are embedding their offices with Cisco’s Internet Protocol-based networking and other products related to the communications and information technology industry.
And if you wanted a general tech stock to capture the migration from analog commerce to digital and stay out of the high stakes online media segment, this would be the stable name that would check all the boxes.
And if you thought this was just a domestic story, once again, the scope is wider with Europe, the Middle East and Africa (EMEA) sales expanding by 11% which eclipsed America sales by 4%.
The only blip on the radar was service revenue slipping by 1% to $3.17 billion, but I do not view that as a pattern of sequential deceleration and pricing mechanisms can be altered to relaunch growth.
If you thought that Cisco doesn’t sell any software – you are wrong.
The software they do sell applies to operating the proprietary hardware that they produce.
Cisco’s wide competitive advantage stems from the industries toweringly high barriers of entry and that they make great products relative to other players.
The infrastructure software that liaises brilliantly with its hardware is succinctly named Cisco ONE Software.
This software suite is molded to face the most relevant use cases in the data center, WAN, and access edge.
CEO of Cisco Chuck Robbins characterized the current geopolitical and overall economic landscape as “complex” but experienced “zero difference” in Chinese revenue giving the company a quarterly victory in the Middle Kingdom.
China’s economy is decelerating faster than we can understand. The latest details of ride-hailing leader Didi sacking 2,000 employees is a warning flare to the rest that open wounds are appearing in the economy and are becoming harder to conceal.
And for Cisco to do a quarter with no significant Chinese downdraft is a good sign that the company can handle the upcoming recession in 2020.
As a sign of further strength, Cisco raised its dividend and boosted stock buybacks which are all the trappings of what great companies do.
Cisco already made $5 billion of repurchases last quarter which was on top of the $6 billion they bought in October 2018.
This method of financial engineering helps put a solid floor under the stock delighting investors and ignites the share price.
And the capital allocation encore means that Cisco will pile $15 billion into its buyback program with this fresh authorization, and the company is forecasted to produce at least $15 billion in free cash flow over the next year.
Cisco’s balance sheet is glistening and even has options to adventure into meaningful M&A if they see something that catches their eye without any real hit to the balance sheet.
These multiple tailwinds in a precarious economic point in the cycle have investors aware that there are worse options out there to invest capital than tech thoroughbred Cisco.
And if you thought the one variable that could turn this earnings report from good to bad was expenses and margins, well, Cisco covered their bases on that one too.
Margins came within the forecasted guidance with gross margins slightly trending down by 1% to 64.1%.
Expenses were reigned in and management saw a small nudge up of 3% causing investors to take a deep sigh of relief.
Cisco is in a superior strategic spot to most tech companies and is a staunch participant of the migration to digital.
Buy shares on the dip.
“Any product that needs a manual to work is broken.” Said Founder and CEO of Tesla Elon Musk
Mad Hedge Technology Letter
February 14, 2019
Fiat Lux
Featured Trade:
(FACEBOOK’S NEW PROBLEM),
(FB), (GOOGL), (TRIP), (EXPE)
A major catalyst exacerbating recent tech layoffs has been a decline in referral traffic to news publishers from Facebook (FB).
Blame the algos!
Referral traffic is a way of reporting visits coming from a site from sources outside of the original site.
When someone clicks on a hyperlink leading to a different website, data analytics classified this as a referral visit to the second site by tracking mechanisms.
The truth is that news publishers have a painfully smaller window to monetize content than ever before and this opinion is echoed by some of big media’s stalwarts such as Rupert Murdoch, the chairman of News Corp.
Facebook decided to give preference to content in the news feed that is shared between Facebook users over those by news organizations, ironically, the news is being stripped out of the news feed whether that seems logical or not.
Under the guise of protecting the platform, Facebook is applying this ploy to further cut off users from escaping its walled garden trapping them inside for the purpose of clicking around the Facebook website even more.
As the technology evolves, companies are becoming increasingly pedantic in finding any practical method of allowing users to escape to another part of the internet.
Diminishing user time equals fewer clicks followed by reduced digital advertising revenue.
Another shift in Facebook rules entails elevating and demoting media outlets by trust levels and credible content that ultimately Facebook makes the decision on.
The algorithms in this case would prop up the more renowned institutions and essentially cut out minnow news organization.
Algorithms are inherently biased, and sources of revenue are cut off or opened up by these algorithmic shifts.
The monopolistic status of Facebook has made it near impossible for stand-alone firms to develop organically and ramping up digitally means leveraging Facebook ads to lure new customers.
What does this all mean?
News publications are bracing themselves for an atrocious year.
The side effect from recent changes mean that Facebook will ultimately become the God of the news cycle choosing which news populates where on the news feed or if it shows up at all.
Being a left-leaning company, Facebook is likely to anoint left-leaning news organizations as “trustworthy” while demoting more right-wing news feeds pushing them further down the pecking order.
And for marginal start-up news companies praying for any exposure, this is effectively a death sentence because of the lack of footprint inside of Facebook’s current database.
Machine learning cannot account for new developments in the system, let alone system altering shifts causing this technology to be defective.
The technology handsomely rewards the entrenched that have cultivated a big footprint inside the database that decisions hinge on.
Its backward-looking nature to carry out a business that is forward-looking is utter nonsense.
Many third-party businesses attempt to stimulate Facebook users’ appetite in order to bridge them over and act as a stepping stone to their own website.
Small businesses should prepare for an era where this type of digital reach is stunted and at some point, completely disengaged.
Effectively, Facebook and the rest of the FANGs will do its best to cut off outside activity preferring to keep usership in-house.
News organizations are feeling the full brunt of these ripple effects with online media firms such as Vox Media and BuzzFeed cutting staff in response to these Facebook algorithm changes.
Which industry will get chopped down next?
Online travel aggregators.
TripAdvisor (TRIP) had a great winter quarter in 2018, but looking down the line, the business model could get bogged down by the algorithm problem.
For instance, take the best flight purchase algorithm in the world Google Flights.
The United States Department of Justice Antitrust Division approved Google's $700 million purchase of ITA Software in 2011.
Within a few months, Google bent its algorithm into shape and reformulated it as Google Flights.
How does it stack up?
Easy to use, lack of digital ads, best of breed, and innovative are all ways I would describe this service.
That is why consumers prefer Google Flights over any other service.
It offers open-ended searches making the traditional flight search software seem pathetic.
Simply input the departure location and Google Flights will show the user every price to every location in the world on a visual map.
It’s travel transparency at its brightest and users can change trips in an instant if something attractive catches their eye.
The user can mix and match different destinations and dates until an optimal time and place can be calibrated along with a suitable price.
This gives the power back to the consumers.
Once in a while, dispersion between the Google Flight price and the official airline site price can be irritating, but the accuracy has improved over time.
Truth be told, it’s a waste of time to use a different flight search engine now after the existence of Google Flights.
Google is able to do this because they are masters at building algorithms and have an army of engineers at their disposal.
Online flight brokers such as Expedia (EXPE) and TripAdvisor are on a collision course for the beast that is the Google algorithm division.
This dovetails astutely with my overarching theme of technology destroying every broker industry because FANG algorithm teams do a way better job enhancing this segment of business than anyone else.
As you correctly guessed, I am bearish Expedia and TripAdvisor long term.
Travel fare aggregators can’t compete with Google and former CEO of Expedia Dara Khosrowshahi was smart to take the head job at Uber saving him from the future carnage.
“As companies get bigger, they tend to slow down. It's a universal law.” - Said CEO of Uber Dara Khosrowshahi
Mad Hedge Technology Letter
February 13, 2019
Fiat Lux
Featured Trade:
(WHY THE FUTURE IS NOT IN FURNITURE),
(W), (NWARF), (AMZN)
Avoid online furniture e-store Wayfair (W) – it’s too expensive.
That was my conclusion after going over the company’s data with a fine-tooth comb.
The stock is up over 600% over the past 5 years, it’s certainly a performance of a rock star in retrospect but it is far from a guaranteed indicator of future success by any means.
Shares have outgained the broader market by a wide margin resulting from January’s snapback in oversold territory scorching skyward 22% compared to an 8% spike in the S&P 500.
Investors must look at the performance of the company and deduce if the path forward is littered with booby traps or if it is as smooth as a slab of granite.
I would argue the former.
Just because the company is in e-commerce doesn’t mean it gets a free pass.
When you hear the word e-commerce, the mind darts and dives to the success of Amazon (AMZN) and observers must assume that if it’s doing the same job as Amazon, cash must be falling from the sky.
Well, the truth is sometimes harsh, and unfortunately, this company is nothing close to Amazon.
Wayfair sells furniture, a tough business from the onset.
Investors must ask themselves - does Wayfair optimally sell furniture and run its company efficiently?
First, the good.
Sales have gone gangbusters the past few years and this is the catalyst driving the stock northwards.
The company presided over a 3-year sales growth rate of 44% - impressive for a cloud company, let alone an online furniture company.
In the past 3 years, the company has more than doubled sales from $2.25 billion in 2015.
Noticeably, tech growth investors have piled into this name propping it up irrespective of any problems behind the lipstick.
The knock on Wayfair is not the amount of growth but the net quality of growth.
These two must be differentiated and have ramifications affecting the firm’s ability to nurture return business down the road.
Take a quick spin on their official website by clicking here.
Right away, before the user can even take a glance at what the website has to offer, the company is vigorously fishing for an email address to allow the reader to continue.
Without entering an email, the prospective customer is stopped dead in its tracks clicking out of the website – too aggressive for my taste.
Why hand over a personal email when any Amazon prime user can just migrate to Amazon’s search bar without all these hoops that need to be jumped through?
The subsequent message attached to the email signup form says, “Up to 70% off Every Day - Shop every style of furniture and décor at up to 70% OFF. - Exclusive sales start daily.”
If you finally decide the site is worth your time and want to insert your email to move forward pass the first barrier, almost every inch of the site is peppered with over excessive 70% sales reminders.
Don’t forget the first pop-up described the same thing – and now it’s sales promotion overload.
This aggressive marketing push reminds me of a company who knows they cannot compete long-term and believes a marketing solution is the elixir to all of its ills.
Wayfair has performed admirably at growing sales the past few years, and that cannot be taken away.
But its sales success has been carried out in an over-reaching way with respect to the health of the company.
Effectively, Wayfair has been sacrificing margin and burning cash at a high rate potentially disenfranchising its shareholder base in the near future.
This will end in tears.
I cannot envision a scenario where this same business model perpetuates due to a lack of a differentiated advantage.
They do nothing more than the next guy does.
The more I use the website, the more I want to revert back to Amazon and buy furniture from Jeff Bezos.
The situation echoes the current situation with low-cost airlines Wow Airlines from Iceland and Norwegian Air Shuttle (NWARF) who doubled down on the same type of strategy that took them to the brink of solvency.
Wayfair’s advertising and marketing expenses have been growing 30-40% per year along with customer service expenses.
Net income has gotten clobbered during this time span as well.
Wayfair lost less than $50 million in 2015. The losses have racked up to almost $450 million at the beginning of 2019.
As quarterly EPS has cratered, Wayfair has missed the past 4 quarterly EPS forecasts demonstrating a continuous lack of execution from management and an inferior strategy.
The EPS percentage change on a sequential basis was negative 97% last quarter.
This company will end up as a pump-and-dump stock, and I speculate no viable path forward to profitability unless major surgery is done to this business model.
I highly doubt that Wayfair can consistently maintain mid-40% sales expansion, and if it does, it is only a matter of time until the ripcord is pulled and the pilots abort the plane before it crashes into the ocean.
As soon as this turns sour, whether it be a recession or the sales strategy becomes impotent, shares will face Armageddon.
Ultimately, the risk/reward proposition is poor, but that doesn’t mean this stock can’t rally a further 30% on the back of a dovish Fed and kick the can down the road trade deal.
If they can clock in mid-40% sales growth, it doesn’t matter if they slaughter net income and expenses because growth investors will come out the woodwork to buttress this online furniture store.
Stay away from this high-risk company.
This is almost a tale of the emperor's new clothes.
Mad Hedge Technology Letter
February 12, 2019
Fiat Lux
Featured Trade:
(MEET YOUR HOME OF THE FUTURE),
(KASITA),
(PLEASE SIGN UP NOW FOR MY FREE TEXT ALERT SERVICE NOW)
