Tech Letter Archives - Mad Hedge Fund Trader

How Fortnite is Taking Over the Gaming World

One idyllic content company reshaping the content landscape as we know it is Epic Games who is the producer of the video game phenomenon Fortnite.

Not only is Epic Games rapidly altering the video game industry by itself, it is also starting to take a bite out of Netflix’s subscriber growth momentum.

The company was established by Tim Sweeney as Potomac Computer Systems in 1991, originally founded in his parents' house in Potomac, Maryland.

The most fascinating nugget of information that came out of Netflix’s most recent earnings call was not that Netflix has already corralled 10% of television screen time in America, but the reason why this percentage is lower abroad is because of Fortnite taking away Netflix’s mojo.

Netflix (NFLX) has lately been asked to measure their content lead to the likes of Hulu, HBO, and the potential Disney streaming product about to hit the market.

But they explicitly confessed they were more worried about Fortnite and the revolution it is spawning.

The key takeaway is that Netflix is not only competing with fellow online content streamers, but video games are more of a threat to them than ever as they compete for the cord cutters and the elusive “cord nevers”.

Cord nevers are consumers who are digital natives who bypassed traditional media channels altogether.

Echoing the stickiness that Netflix has with its younger demographics, the company has targeted mobile screen time as a core driver usurping around 8% of American mobile phone screen time.

And if you thought Netflix was trying to sort out its own Fortnite problem, then how do you think the traditional American video game cohort felt about their own Fortnite problem?

The traditional trio of EA Sports (EA), Activision (ATVI), and Take Two Interactive (TTWO) have been shredded to bits by Fortnite.

Late last year, I gave readers a steer clear synopsis of this company and the latest dead cat bounce in EA and Take Two Interactive should be chances to cut your losses instead of putting more money to work in these names.

Yes, the momentum in Fortnite is that palpable that you stay away from any name that this phenomenon affects.

Activision had no dead cat bounce being the weakest of the three and the stock has gone awry almost halving from $83 to $43 today.

EA’s earnings report was a disaster with their lead title, Battlefield V, doing 1 million fewer sales than the 7.3 million management expected.

During the same holiday season, Take Two Interactive issued a follow-up to a classic that was better than EA’s holiday flagship game called Red Dead Redemption 2 and Activision rolled out another iteration of Call of Duty: Black Ops 4.

Even between the three, the competition was fierce, then throw Fortnite into the mix and comps are getting killed with huge earnings misses penalizing the share prices of this once-vaunted trio.

With the explosion of content in the past several years, consumers are absorbing more content than ever.

Most of this avalanche of content is consumed on mobile phones or televisions, but the behavior varies when you look closer at the different demographics.

Cord cutters total in the low 20 million and are growing 30% annually.

Cord nevers amount to about 30 million growing at 66%.

This all amounts to Americans spending about 12 hours accessing content every day running up to the barrier of natural limits.

That might give consumers some allocated time to sleep, eat, and work, but not much else. We are robotically reliant on content providers to deliver us our fill of daily content.

When automotive technology comes online, it could potentially eke out an incremental 1-2 hours that Americans can stare at their content while being chauffeured around.

How is Fortnite doing financially?

Fortnite earned $2.5 billion in 2018 from a mix of in-game items and passes.

A seasonal Battle Pass is $10, and over 30% of American gamers have purchased this product.

Unlike traditional video gamers who are tied to certain consoles, Fortnite is available on seven platforms: PlayStation 4, Nintendo Switch, Xbox One, PC, Mac, iOS, and Android.

In a time of $60 video games, this new freemium model must shake the foundations of the video gaming establishment.

The rise of freemium games could eradicate the console completely.

A $200-300 console seems expensive if games are free on your $100 Android phone.

The worst side-effect of Fortnite for the traditional video game producers is not Fortnite itself.

It’s the fact that this new model has opened up a new can of worms proving this freemium model with no consoles is the key to unlocking gaming audiences with a 24-hour battle royale, free to play, on-demand, in-game currency, season pass model that was thought to be a hopeful wish by industry analysts.

Then the next question is when will the next Fortnite-esque freemium go viral and can these legacy gaming companies alter their model to accommodate this new business model?

Indeed, management must be freaking out. They thought they had a monopoly on the gaming industry but the nimbler and forward-thinking firm has won-out.

Even the most subscribed YouTuber PewDiePie from Sweden is using Fortnite to keep him in the lead for most YouTube subscribers as Indian music YouTube channel T-Series has caught up with his subscriber count that currently totals 84.3 million.

PewDiePie’s lead was cut down to 20,000 and decided to leverage playing Fortnite squad matches to boost his subs.

The upload got over seven million views in a day backing up my thesis that Fortnite has become the hottest media content asset for cord cutters and cord nevers around the world.

As for the video game stocks, don’t touch them until Fortnite trails off.

And if another freemium game comes to the fore that they aren’t on, run for the hills.

February 7, 2019

Tech Letter

Mad Hedge Technology Letter
February 7, 2019
Fiat Lux

Featured Trade:

(THE DEATH OF THE COLLEGE DEGREE),
(GOOGL), (IBM), (AAPL), (BABA), (BIDU)

The Death of the College Degree

Tech Letter

If you’re an educator not at a top 25 American university, you might want to stop reading right now.

Disruption.

You’re either on the right or wrong side of it.

I’ve detailed numerous subsets of the economy and society that have been transformed by sharp shifts in technological innovation.

But the one industry that has stealthily moved into the heart and center of technological disruption is education.

For centuries, universities and higher learning institutions had a stranglehold on critical information required to successfully perform in the cutting-edge knowledge economy of those times.

Then on September 15, 1997, a mere 21 years ago, Google search launched its free services to the world and grabbed the monopoly of information away from the college system.

This website effectively caused the cost of information to crater to zero and its free website is ranked #1 as of February 2019 with over 4.5 billion monthly active users.

The ensuing 21 years has been a renaissance in the ability to distribute information propelled by this one platform, and the result is that billions have the ability to study and read up on what they want and when they want.

The ability to learn for free combined with a tight labor market is a promising landscape for job seekers, with analysts forecasting more opportunities for professionals without a degree.

Job-search site Glassdoor amassed a list of various employers no longer bound by requiring applicants to possess a 4-year bachelor’s degree.

These firms aren’t your second-rate companies either made up of gold standard workplaces such as Google, Apple, and IBM.

In 2017, IBM's vice president of talent Joanna Daley confided that about 15% of IBM’s new hires don't have a four-year bachelor qualification.

She emphasizes hands-on experience through coding boot camp or industry-related vocational classes as explicit criteria to get hired.

This development bodes poorly for the future of universities and boosts the prospects of alternative education.

Online college offers working adults ample flexibility in furthering their education.

According to the most recent federal statistics from 2016, roughly one out of every three, or 6.3 million college students learned online.

Even though online courses are becoming more widespread, the best and brightest aren’t attending these schools.

However, it did hijack the marginal student that was on the fence for a 4-year university and brought them into the orbit of for-profit online courses and the revenues that came with it.

That was the first stage of online forces imposing financial pressure on the education marketplace.

Now analysts are discovering the second major trend with higher rated students opting out of the university system altogether.

In many cases, a 4-year university degree is a bad value proposition.

Why is that?

Costs.

In a capitalistic economy that lives and dies by the mantra of buy low and sell high – universities seem to be getting sold short lately.

The exorbitant costs to obtain a 4-year degree has led to an outsized student debt bubble and removed the mystique of this once treasured qualification.

A growing chorus of bipartisan voices has pigeonholed student debt as a major problem across the country.

In the previous presidential election, Democratic candidate Bernie Sanders called this situation “outrageous” as national student debt has spiraled out of control to the amount of $1.5 trillion.

This has been a terrible commercial for the younger generations to follow in the footsteps of the indebted Millennial generation.

And with Generation Z tech savvy at building stand-alone firms buttressed by Instagram and YouTube platforms, why go to college anymore?

Or to nail one of those jobs developing iPhones in Cupertino, why not take a few coder boot camps and self-develop a portfolio impressive enough to score an Apple interview?

The bottom line is that there are workarounds for a fraction of the price.

And because tech firms have outpaced analog companies in salaries and hiring for the past two decades, there is an outsized bias on compiling technical skills that will lead a candidate down a path to a salary of over $100,000 quicker than a 4-year degree can.

Not many other industries can claim the same.

The cracks are beginning to reveal themselves in the overall university apparatus.

Universities had years of record revenue that they reinvested into the system to enhance programs, staff, buildings, stadiums, and infrastructure.

The financial catalyst was the rise of the Chinese college student.

The latest statistics nailed the number of Chinese nationals in America studying for 4-year degrees at over half a million.

Many of those were trained up with engineering-related degrees and bolted back home to find jobs at Baidu (BIDU), Tencent, or Alibaba (BABA) powering Chinese Inc.

However, the drop off in demographics from young Chinese and Americans are forcing universities to fight for a shallower pool of candidates with less attractive degrees relative to the value of degrees of past generations.

The second-tier universities are hardest hit with examples galore.

Alcorn State University in Mississippi saw a dramatic 69.45% decrease in applications in 2018 and its rural location didn’t help either.

Alabama State University is feeling the pinch with a 33.06% drop in application in recent years.

If you thought the University of New Orleans was clawing its way back to relevancy after Hurricane Katrina, you are mistaken with its 38.23% drop in applications.

Military schools haven’t been spared either with applications to The United States Air Force Academy crashing 28.12% over the past ten years.

A confluence of deadly trends is about to beset the university system and schools will likely go bust.

Technology is giving a reason for students to bypass the system while also speeding up the financial timebombs many universities are about to confront.

Then we must ask ourselves, will universities even exist in the future?

Probably, but perhaps just the top 25 elite schools that are still worth the high costs.

IS IT STILL WORTH IT?

February 6, 2019

Tech Letter

Mad Hedge Technology Letter
February 6, 2019
Fiat Lux

Featured Trade:

(ALPHABET WOWS THEM AGAIN),
(GOOGL), (AMZN), (AAPL), (MSFT)

Alphabet Wows Them Again!

Tech Letter

Alphabet (GOOGL) is entangled in the same imbroglio as Apple (AAPL), that is why I have held back on issuing any trade alerts on this name.

The stalwart is still grinding out a respectable 20% of revenue growth in their core business but the underlying conundrum is that their hyper-growth segments are 5 times or more diminutive than their bread and butter of digital ads.

Apple is addressing the same type of strain in attempting to flip high octane revenue drivers into a bigger piece of the pie – the services business trails the hardware business by a large margin.

This phenomenon highlights how investors demand tech companies to grow at elevated rates and a maturing business model isn’t given any free passes.

Investors simply migrate towards higher growth names period.

That being said, Alphabet’s digital ad business is one of the premier tech divisions in all of technology and the American economy.

How powerful is it?

They did $32.6 billion in sales last quarter.

If you look at that number without context, it is quite impressive, but there are several lurking impediments.

This 20% QOQ growth is flatter than a pancake offering evidence that the best days are behind them.

No investors like to hear the dreaded “P word” thrown into a company’s business trajectory – peak.

In respect to revenue growth rates, I expect Google’s digital ad business to gradually decline relative to competition.

This segment also battles with the law of large numbers.

It’s simply difficult to accelerate revenue rates at a 25% YOY clip when revenues are already over $30 billion per quarter. Again, this is another Apple problem and a side effect of being overly successful in one part of the business model.

If investors' tepid reaction about these aspects of the core business telegraph dissatisfaction, then discovering further ancillary problems might be the final dagger in the heart.

Google search’s price per click cratered 29% YOY indicating that variables in the current marketing environment have significantly blunted Google’s pricing power.

Traffic Acquisition Cost (TAC) represents the cost for a company to acquire internet traffic onto their assets.

Alphabet faced a 15% YOY rise in TAC costs last quarter to $7.44 billion illustrating the difficulty in keeping these high costs down.

The bulk of the $7.44 billion stems from a widely known agreement with Apple contracting Google search as its default search engine on Apple devices.

This TAC expense has been surging the past few years and Alphabet has little negotiating power.

Expect an annual 15-20% rise in TAC expenses as long as Alphabet’s digital ads are expanding the standard vanilla 20% most investors expect them to grow.

As a whole, TAC costs soaked up 23% of the digital ad revenue which was in line with analysts’ expectations.

However, I expect this number to surpass 25% before winter because I believe Google search’s ad business will confront ceaseless growth problems.

Amazon’s (AMZN) new-found digital ad business is an influential factor in this story.

New marketing dollars aren’t being showered on Google as they once were, over 50% of product searches populate from Amazon.com today boding poorly for the future of Google search.

This optionality could be a large reason in driving the cost per click downwards.

CEO of Amazon Jeff Bezos refused to enter the digital ad game for years but his recent change of heart will correlate to subduing Google digital ad model.

Consumers are finding less incentive to search on Google for products when they just can smartly and efficiently search on Amazon directly.

Clearly, this only affects product searches and not searches on other informative content such as widely popular searches including “top 10 places to travel in Europe” or “best Thanksgiving recipes.”

Google’s “other revenues” is chugging along nicely with 31% YOY growth headed by Google’s cloud business and hardware division.

This is what Alphabet needs to focus on going forward similar to Microsoft and Amazon web services.

Yes, Google is the 3^rd biggest cloud player but miles behind the top two.

Being in catch-up mode is no fun and is part of the reason capital expenditures exploded and came in $1.38 billion higher than expected.

Alphabet simply isn’t doing a good job at executing relative to Amazon and Microsoft frittering away more capital in the name of growth but not curating the type of growth that current expenses justify.

Higher costs damaged operating margins coming down 2% YOY to 21%.

Even more worrisome is that there has been no material progress on the Waymo business.

This is the year that Alphabet expected the technology to roll out to the masses.

However, this broad-based integration will not happen as fast as they would like.

I blame regulation and consumers' hesitation to quickly adopt this new technology.

Alphabet is reliant on this business to carry them to the next level of growth and I believe it can become a $100 billion per year business in a $2 trillion addressable market.

But when you peruse through the “Other Bets” category which houses Alphabet’s other companies such as health venture Verily, the $154 million in revenue was a huge miss against the $187.4 million expected.

Estimates aside, the pitiful fact that Waymo only brings in revenue of less than 1% of total revenue is disappointing.

Summing things up, Alphabet is a great company and is a long-term buy and hold stock even with short term transitory headaches.

In the near term, there is uneasiness about the decreasing profitability, exploding expense factors, a heavy reliance on weakening core business revenue, and a lack of top-line contribution of “other revenues” relative to their core business.

Long term, Alphabet’s game-changing investments have yet to show signs of life in terms of real revenue expansion even though Alphabet is the global leader of artificial intelligence and self-driving technology.

Investors would like to see actionable steps to incorporate this best of breed technology that funnels down to the top and bottom line.

Investors are stuck with a stale digital ads business that has locked the stock into a holding pattern essentially trading sideways for the past year until they prove they are ready to take the next step up.

Looking at Alphabet’s chart, the stock has iron-clad support at $1,000 which it tested in April 2018 and December 2018.

Using this entry point as the lower range would be sensible as I don’t foresee any demonstrably negative news blindsiding the stock, and I surmise that investors will start receiving positive news on Waymo’s roll out towards the middle of the year.

February 6, 2019 - Quote of the Day

Tech Letter

"Android was built to be very, very secure." – Said CEO of Google Sundar Pichai

February 5, 2019

Tech Letter

Mad Hedge Technology Letter
February 5, 2019
Fiat Lux

Featured Trade:

(THE FINTECH COMPANY YOU’VE NEVER HEARD OF),
(FISV), (AAPL), (GOOGL), (FDC), (PYPL), (SQ)

The FinTech Company You've Never Heard of

Tech Letter

Here’s a company for you involved in technology’s tectonic shift towards FinTech in 2019.

They aren’t new, but you’ve probably never heard of them.

It’s Fiserv Inc. (FISV) which sells financial technology and can include customers such as banks, credit unions, securities broker-dealers, leasing, and finance companies.

An inflection point is occurring within the global business and that is financial technology and the rapid integration of it.

Financial institutions are building products around this concept and Fiserv has a head start on the others with more than 30 years of experience in aiding banks, thrifts, and credit unions, managing cash and processing payments, loans, and account services.

The Wisconsin-based company constructed an unstoppable machine leveraging its time-honored relationships and expertise to bring banking to all the screens that pervade daily life.

“Innovation, Integration and Scale” has been the motto that has served this company well for so long.

The company cut its teeth in the trenches helping banks move money long before it became the next big thing.

Five years ago, under the leadership of CEO Jeff Yabuki, there was a corporate flashpoint with upper management realizing they needed to evolve or die.

Yabuki anticipated a near future fueled by mobile wallets and changing consumer expectations - an always-on, never-off connected world.

An environment where consumers want what they want when they want it.

There has been no letup in this trend.

Silicon Valley companies were always the 800-pound gorilla in the room and Fiserv didn’t want to become sideswiped by them.

And in 2014, at the Money 20/20 conference in Las Vegas, Yabuki set out his vision that continues to prevail today.

The financial services industry had become obsessed with point-of-sale transactions.

And at $200 billion in annual domestic sales, it was a business that resonated to all corners of the FinTech world.

It was sensical to persuade consumers to use branded credit or debit cards to pay for stuff in stores and online.

At the time, that was bread-and-butter banking.

To the banks' chagrin, Silicon Valley has gotten in on the act with the likes of Apple (AAPL), Alphabet (GOOGL), PayPal (PYPL), Square (SQ) firing warning shots.

They formulated products of their own, whipped up the necessary scale and maximized the reverberating network effects.

Yabuki urged financiers at the conference to double down on what they did best while looking to grab low-hanging fruits in the short-term.

The business beyond point-of-sale was theirs waiting on a decorative platter – the opportunity was a $55 billion behemoth consisting of consumer-to-consumer, business-to-business and consumer-to-business transactions.

Embracing FinTech translated into massive speed advantages, stauncher security-laced products while offering traditional bank customers higher quality service at their convenience.

Fiserv erected a platform to help financial institutions focus on payments beyond POS called Network for Our World.

The goal of this NOW Network was to help customers' flow of money by paying bills and getting paid.

These entrepreneurs are looking for more efficient ways to collect money owed - they are a lucrative addressable audience for bankers.

The Fiserv sales pitch is working wonders according to the data. The company has 12,000 clients worldwide, with 85 million online banking end-users.

It has rolled out innovative products for payments, processing, risk and compliance, customer service and optimization.

The company has become ever so profitable with a 3-year EPS growth rate of just 15%, but in the last quarter, this metric surged to 23% and projected to rise.

Fiserv also dabbled with some M&A hauling in debit-based assets of Elan Financial Services.

The stellar acquisition, with annual revenue of over $170 million, extends Fiserv’s leadership in payments, broadens client reach and scale, and provides new solutions to enhance the value proposition of the existing 3,000 debit solutions clients.

The deal also gave Fiserv ownership of Money Pass, the second largest surcharge-free ATM network in the U.S., with over 33,000 in-network ATMs.

They also added other major pieces with the purchase of First Data Corp (FDC).

The maneuver is strategically solid, and Fiserv will benefit from a parlay of idiosyncratic opportunities from the combined synergies.

Fiserv will be able to refer First Data's merchant-acquiring services to the banks it currently works with.

I predict cost savings of $1 billion from the deal and potential upside from platform rationalization, which has not yet been included in synergies.

There will be significant upside potential from interest expense savings given refinancing FDC's debt at investment-grade.

Dipping your toe into this name before its multiple inevitable expands is a good long-term strategy.

Profitability is increasing while management has made moves that will fatten its top line business from the 5% internal growth today.

All these growth levers will push up revenues in the upcoming quarters - Fiserv happens to be the right company in the right industry at the perfect time in the technology cycle.

The stock is up over 1,000% in 10 years.

In February 2009, the stock was meddling around $8 and the $83 it trades at today demonstrates the potency of FinTech and the strength in their underlying business model.

I would wait for a sell-off to get into this one, but it’s a keeper.