Mad Hedge Technology Letter
February 6, 2019
Fiat Lux
Featured Trade:
(ALPHABET WOWS THEM AGAIN),
(GOOGL), (AMZN), (AAPL), (MSFT)
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 3rd 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.
"Android was built to be very, very secure." – Said CEO of Google Sundar Pichai
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)
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.
“If you don't jump on the new, you don't survive.” – Said CEO of Microsoft Satya Nadella
Mad Hedge Technology Letter
February 4, 2019
Fiat Lux
Featured Trade:
(WHY AMAZON IS TAKING OVER THE WORLD),
(AMZN)
Amazon, being the best publicly traded company in America, has more than one way to skin a cat.
That is what I took away during the mixed bag of an earnings call.
The road forward for most companies are defined by one maybe two unforgiving directions that the company has no choice but to migrate down through no fault of their own due to market forces.
Amazon operates in a different universe and the breadth of optionality for Amazon is breathtaking.
They have chosen to try to spike their future core business which has traditionally proven to pay dividends within three years or less.
Investors have always allowed Amazon to revert back to the reinvestment blueprint for added profitability - profits should reaccelerate once more in 2020.
Take into consideration that 2018 was a “light” year in Amazon’s reinvestment cycle in which Amazon only grew its fulfillment and shipping square footage by 15% and its headcount by 14%.
Amazon has used this playbook before. The warehouse efficiencies that benefited margins in 2018 was a direct result of massive capital expenditures into robot technology in the preceding years before that.
Amazon guided weakly on top line growth because of several regulation quagmires in India.
The Indian government began banning foreign online retailers from selling products from marketplace vendors that they have an equity stake in, leading Amazon to shelf items from its Indian site including its popular Echo speakers.
The $72.38 billion translating into 20% YOY fourth quarter revenue growth was its weakest since 2015.
They still have some work to do with physical stores, mostly Whole Foods, which saw a dip of 3% YOY in revenue.
Investors shouldn’t worry too much about this because Amazon can quickly switch back and ramp up revenue expansion when need be.
India is what China was 15 years ago and will morph into its own consumer supergiant with a population to service Amazon sales in the future.
Even with these headwinds that could frustrate operating margins and top-line revenue, Amazon still has some robust drivers in its portfolio in the form of cloud division Amazon Web Services (AWS) that grew 45% YOY and its advertising business which will perpetuate 50% YOY growth trajectory going forward.
Some other highlights were outperformance in voice tech with Amazon CEO Jeff Bezos gloating that “Echo Dot was the best-selling item across all products on Amazon globally, and customers purchased millions more devices from the Echo family compared to last year.”
In hindsight, the report wasn’t bad considering Q4 is the quarter Amazon usually diverges the most with expectations because of the sky-high expectations of the Christmas season.
Digital advertising is already a $12 billion-plus annual business and earned Amazon over $3 billion last quarter.
These lucrative businesses give Amazon more leeway into combatting headwinds that slow down its e-commerce engine.
The e-commerce side of business changes rapidly causing capital to be earmarked for reinvestment as others catch up to its latest iteration of Amazon.com.
That being said, operating income margins are still over 4% and for the business model Amazon is trotting out, it is still a healthy number.
Not only that, AWS’ margins still remain intact at a robust 29%.
Consumers will agree with you admitting they can visibly notice the e-commerce platform improving over time.
The mixed results dinged shares 4% and I would classify this as a positive down day considering that from peak to trough, Amazon gained 35% after the December sell-off.
If these earnings came out in December, I would not have been shocked with a 15% haircut, but this speaks volumes to how tech shares have been resilient.
And tech earnings, for the most part, have been encouraging relative to expectations.
The change in rules has bred uncertainty in its Indian operation and management will wait for the dust to settle to carve out a plan ahead, but this is small potatoes in the larger picture because of the cash cow that is rich western countries.
To sum things up, Amazon’s services and e-commerce platform is still humming along, but growth is tapering off just a tad.
Amazon plans to juice up their business model by reinvesting into their model extracting the bounty in the years ahead.
The lead up to this will be a broad-based harvest resulting in stock price acceleration.
Do not forget we just went through a global growth scare, and I still believe that if the overall market will rise, the tech sector will need to participate with the bigger names carrying a substantial load.
An even more positive signal are the likes of Facebook, Apple, and Netflix buoying nicely, boding well for short-term price action.
This all means that Amazon should be a buy on the dip company with its long-term growth story more attractive than any other tech name, and by a wide margin.
Margins could come down temporarily in the spring and summer offering weakness for investors to buy into.
Amazon is truly a multi-dimensional beast that uses its capital wisely to create red hot businesses that never existed before.
Such is the magnitude of innovation at Amazon to the point that I would argue that Amazon is the most innovative American company today, period.
I sit on the edge of my seat to see what Amazon does next and you should too.
The easiest way to play this is to buy and hold shares for the long term on any major ephemeral stock offloading because they dominate like any other company in their field in relative terms.
Amazon will be back above 2,000 later in 2019 or early 2020.
“One of the huge mistakes people make is that they try to force an interest on themselves. You don’t choose your passion; your passion chooses you.” – Said CEO of Amazon Jeff Bezos
Mad Hedge Technology Letter
January 31, 2019
Fiat Lux
Featured Trade:
(APPLE SEIZES VICTORY FROM THE JAWS OF DEFEAT),
(AAPL)
