Tech Letter Archives - Mad Hedge Fund Trader

It’s All About Software, Software, Software

If you thought software week at the Mad Hedge Technology Letter was over, you were absolutely wrong.

I have done my best to offer a barrage of cloud-based software stocks with monstrous upside potential that would put any other industry companies six feet under.

Silicon Valley software companies have access to quinine in a mosquito-infested market – digitally savvy talent.

This talent is the best and brightest the world has to offer, and they want to work for a dominant company that gets it.

Much of this involves companies with bright futures, career opportunities galore, solving deep-rooted problems, all applying a treasure trove of data and a mountain of capital your rich uncle would giggle at.

In the short term, I have been succinctly rewarded by my software picks with communication software Twilio (TWLO) rocketing upward 35% intraday at the time of this writing from when I recommended it just a few days ago.

Another Mad Hedge Technology Letter recommendation Zendesk (ZEN), a software company solving customer support tickets across various channels, is up a tame 10% after the election.

All in all, I would desire readers to access due caution as the volatility can bite you badly with crappy entry points, but the upside cannot be denied.

The turbocharged price action means the pivot to software with its new best friend, the software as a service (SaaS) pricing model, encapsulates the outsized profits this industry will rake in going forward.

Without further ado, I’d like to slip in two more companies rounding out a robust quintet of software companies – I bring to you Workday (WDAY) and Service Now (NOW).

Workday is a software company based on a critical component of every successful company – human resources.

Unsurprisingly, human resources are tardy to this wave of software modernization.

Sensibly, companies have chosen short-term software fixes that drive profits with instant success rather than to update its human resource department’s processes.

Big mistake.

I would argue that getting the right people in the doors is paramount and can save substantial time because of the wasted time rooting out toxic employees who weren’t suitable fits.

Ultimately, I have concluded the worst-case scenario entails the enterprise resource planning market stagnating driving minimal growth to the cloud, however, this minimal growth would be substantial enough for Workday to outperform.

The landscape as of now only involves several vendors with a competitive (SaaS) solution auguring well for Workday allowing them to capture a further chunk of market share.

Workday’s growth metrics back up my thesis with its businesses posting a 3-year EPS growth rate of 291% and a 3-year sales growth rate of 36%, painting a picture of a company that will turn profitable in the next few years.

They can even showboat their glittering array of heavy-hitting customers who purchase their software that include Walmart (WMT), Target (TGT), and Bank of America (BAC).

The one headwind tarnishing these types of software companies is the stock-based compensation awarded to employees.

SBC rose 21% YOY and is slightly worrying in an otherwise stellar company. This method of compensation only works when the stock is rising and is a major issue for new Facebook (FB) hires who will prefer cash over its burnt-out share price.

If Workday doesn’t whet your appetite, then how about sampling a main dish of ServiceNow.

This company completes technology service management tasks offering a centralized service catalog for workers to request technology services or information about applications and processes that are being used in the system.

Admirably, this software helps IT workers fix IT system problems which in this day and age is useful considering the bottleneck of chaos many tech and non-tech companies face.

And more often than not, the chaos inundates the in-house IT departments causing the whole business to go offline.

Putting out digital fires is a perpetual business that will never flame out.

As websites and enterprise systems become more complicated, a bombardment of errors are prone to crop up and instant remedies are crucial to carrying out businesses in a time sensitive manner.

Even ask the best tech company in the universe Amazon (AMZN), whose move off Oracle’s (ORCL) database software was the ultimate reason for a serious outage in one of its biggest warehouses on this past Amazon Prime Day, according to Amazon’s internal documents.

The faux paux underscores the hurdles Amazon and other companies could face as they seek to move completely off the Oracle legacy database software whose development has stayed relatively stagnant for a generation.

The slipup was minutes and snowballed into excruciating hours on Amazon Prime Day resulting in over 15,000 delayed packages and roughly $90,000 in wasted labor costs.

Crikey!

These numbers didn’t even consider the wasted man-hours spent by developers troubleshooting and solving the errors or any potential lost sales.

When these mammoth tech giants are running at an incredible scale, a small blip can result in job losses, lost revenue, lost time, a slew of IT engineer sackings, and for some smaller companies, an existential crisis.

The large-scale acts as a powerful multiplier to the lost resources and cost, and as you can see with the Amazon debacle, a few hours can make or break a developer’s career.

Fortunately, IT budgets are higher up the food chain than human resource budgets while more than inching up every year. This is the main reason why I believe ServiceNow will outperform Workday.

The proof is in the pudding and when I scrutinize various metrics, the truth is filtered out.

ServiceNow’s quarterly growth rate is 35% which is higher than Workday’s who slipped back to 28% last quarter even though the 3-year growth rate is in the mid-30%.

Put mildly, accelerating sales growth is better than decelerating sales growth.

Both companies have a market cap in the low $30 billion and almost identical annual sales in the $2 billion range.

However, ServiceNow presides over significantly higher quarterly profit margins than Workday and will achieve profitability sooner than Workday.

In short, Workday loses more money than ServiceNow.

I believe in the underlying thesis of HR modernization underpinning Workday’s rapidly growing revenue and this secular trend is here to stay.

But I much rather put my hard-earned money on a company tied to IT modernization which is imminent and harder to put on the backburner because of its strategic position at the forefront of the tech curve.

HR CAN be put on the backburner and kept analog longer, and as the economy inches closer to a recession, this expense will be shifted further away from greener pastures supported by the fact that companies decelerate hiring new talent in poor economic environments.

To wrap it up, I do believe ServiceNow is the Burmese python consuming a cow, but that doesn’t mean I am bearish on Workday.

Workday will flourish, just not as much on a relative basis as ServiceNow.

Effectively, these stocks are well placed to move higher even after the violent moves upward this year. As the economic cycle moves further into the late innings, the importance of cloud-based software companies will become magnified further.

As for the software week at the Mad Hedge Technology letter, these solid five picks will offer deep insight into one of the most compelling parts of the internet sector.

As many observers have found out, not all tech firms are created equal and that is made even trickier with the existence of the vaunted FANGs who are the real Burmese python in the current tech landscape.

November 8, 2018 - Quote of the Day

Tech Letter

“I don't write about Google except to insult the company.” – Said Co-Founder of Recode Kara Swisher

November 7, 2018

Tech Letter

Mad Hedge Technology Letter
November 7, 2018
Fiat Lux

Featured Trade:

(THE RELIABILITY OF ADOBE)
(ADBE), (GOOGL), (ZEN), (TWLO), (SQ)

The Reliability of Adobe

Tech Letter

Tech companies have a habit of suddenly coming and going because of the nature of the relentless environment that spits out losers and celebrates winners.

It’s hard-pressed to find software companies that pass the test of time but there is one that is healthily chugging along that most people know quite well.

Adobe (ADBE) was established 35 years ago in co-founder John Warnock's garage.

This legacy software company’s name, Adobe, was named after the Adobe Creek in Los Altos, California, which ran behind Warnock's house.

Adobe cut its teeth in an era when tech CEOs were not larger-than-life cult figures, and all Adobe has done is quietly infiltrating its way into everybody’s devices by way of Adobe Flash Player and its smorgasbord of useful software applications.

Adobe acquired Macromedia in 2005 which was responsible for building Adobe Flash Player.

This Macromedia software has been developed and distributed by Adobe Systems ever since the purchase and its functions involve viewing multimedia contents, executing rich internet applications, and streaming audio and video. Flash Player can run from a web browser as a browser plug-in or on supported mobile devices.

Flash player was its second hit success software program after its Adobe Acrobat and Reader software introduced PDF, the Portable Document Format, which is still ubiquitously used today even after all these years.

Most software companies are relatively new to the scene and like companies I have recently written about such as Zendesk (ZEN) and Twilio (TWLO), they can brag about growing sales of 30% or 40% plus per year.

Adobe isn’t too shabby itself growing sales at over 24% annually – remarkably high for such an ancient tech company.

The company’s strengths are similar to that of Apple (AAPL) – high-quality products and high profitability.

There will be no back-to-back doubling of the stock like some hyper-growth tech stocks because Adobe doesn’t subscribe to the type of growth trail that Square (SQ) has blazed.

What you can expect from Adobe is a slow grind up in share price stoked by its outperforming EPS expansion and acceptable sales growth of mid-20%.

Its annual operating margins have essentially tripled since the beginning of 2015 from around 10% and now boasts an Apple-like 30%.

There are no bones about it – Adobe has high-quality software across its diversified portfolio.

Other Adobe software products universally soaked up are its stable array of graphic design software such as Adobe Photoshop and Adobe Dreamweaver.

Adobe has also ventured into video editing, animation, and visual effects with Adobe Premiere Pro.

Not only that, Adobe has forayed into more conventional types of software such as digital marketing management software and server software.

Simply put, Adobe’s assortment of digital media software products has a religious-like following especially for iOS users.

As you might have guessed correctly, the lion’s share of Adobe’s revenue stream stems from its software as a service (SaaS) segment contributing 80% to the top line.

More narrowly, the digital media segment makes up almost 70% of the subscription-based revenue. This division will expand at least 20% each year boding well for Adobe to maintain its 20% plus sales growth that any legacy software company would sacrifice a right leg to achieve.

It’s digital marketing software products rub up against stifling competition in Alphabet (GOOGL) amongst others and contribute a less robust 30% to overall sales.

I am less bullish on this part of the business because they have it rough competing against one of the Fangs, the path of less resistance clearly sides with its bread and butter of the digital media offerings.

Its subscription-based pricing model was the catalyst for boosting profitability causing the stock to experience massive price gains. The stock has doubled in the past two years which is unheard of for most legacy software companies.

No longer does Adobe need to manufacture the ancient CD of yore physically delivering it to customers, users can briskly download these products directly from the official website, receive constant upgrades over broadband internet, and pay Adobe monthly for their humble services.

In fact, any investors looking for some hot software stocks only need to find companies that recently shifted to a subscription-based pricing model. It’s pretty much a license to print money if the software quality can backup the monthly costs for the user.

I can tell you that Adobe’s software has remained world class, embedded at the heart of most digital devices at home and in the office, and who would have thought that just a little shift to the pricing model would have doubled the stock price?

Well, instead of one-off sales, Adobe can book revenue month after month, and year after year demonstrating the supercharged effect of shifting to a recurring revenue stream model.

Highlighting the pivot to profitability is Adobe’s three-year EPS growth rate of 48% turning this company into a mammoth software company with a $117 billion market cap.

Another positive for Adobe’s future sales are its fertile addressable markets in Europe and Asia.

There is ample room to expand in these geographical regions with Europe already chipping in with almost $2 billion of revenue per year and Asia with another $1 billion.

Future harvests look even more bountiful.

These two regions make up almost 40% of sales and as the Asian middle class is poised to elevate a giant swath of its people to middle class, Adobe will be a handsome beneficiary of this trend as middle-class families tend to pump out more university graduates who migrate to software-based occupations.

Even though Adobe isn’t the sexiest name out there, it certainly is in the category of “safe.”

In no way do I see an eradication of its embedded software spread widely throughout the tech universe.

Its digital media software tools are best-in-show and loyally followed with a long-lasting revenue stream that has room to grow abroad.

Do not expect Adobe to debut any earth-shattering products, but I fully anticipate Adobe to become even more profitable to the point that they might offer a dividend or reallocate capital to shareholders through stock buybacks.

Apple has similar strengths in its business model, albeit on a much grander scale.

I feel that Adobe doesn’t get the credit it deserves because of its steady as it goes drivers that keep motoring higher in an industry that adores groundbreaking products that revolutionize the world.

I would wait for a major sell-off because a double in two years has bid up the stock to expensive levels represented in its premium forward PE multiple of 35.

However, as the conclusion of the mid-term elections offers some certainty to the market, tech stocks could get swept up in a positive rush to round out the year.

Luckily for Mad Hedge Tech readers, this is the golden age for software companies and we are just scratching the surface of the capability software efficiencies can deliver to small and large companies across every bit of the economy.

Another Apple-like similarity is that Adobe is annually voted one of the best places to work according to Fortune, stacked up against companies represented across the full economic spectrum and not just tech.

If you have a kid, tell him to find a job in San Jose, he or she could find worse places to cut a paycheck.

November 7, 2018 - Quote of the Day

Tech Letter

“You are cruising along, and then technology changes. You have to adapt.” – Said Silicon Valley Venture Capitalist Marc Andreessen

November 6, 2018

Tech Letter

Mad Hedge Technology Letter
November 6, 2018
Fiat Lux

Featured Trade:

(THE GREAT TECH COMPANY YOU’VE NEVER HEARD OF)
(TWLO), (ROKU), (MSFT), (SQ), (AMD), (CRM), (SEND)

The Great Tech Company You've Never Heard Of

Tech Letter

As volatility rears its hideous head, it’s not necessarily the best time to catch a falling knife as tech companies have been scrutinized harshly lately.

But the market is always right, and waiting for them to drop into your lap will serve you in good stead, even more so for the higher beta tech names that can behave more petulant than a little child.

Roku (ROKU), AMD (AMD), and Square (SQ) are a few of these smaller names with prodigious growth stories backed by secular tailwinds.

These up-and-comers regularly experience 5-7% setbacks, while sturdier names such as Microsoft (MSFT) pull back 1-2% allowing you to sleep soundly at night.

Another influential company taking the liberty to infiltrate the backend of every global and local company is no other than communications software company Twilio (TWLO).

Many of you might not have heard of them, and it doesn’t sound like such a sexy company right off the bat but I am sure you have heard of companies such as Uber, Lyft, and Airbnb.

Why do I mention these three private tech companies that are on the verge of going public next year?

Because this trio of unicorns are all powered by Twilio’s communication technology that is best of breed in their genre of cloud software.

More specifically, Twilio is a platform as a service (PaaS) firm offering programmatic phone call functions, can automate sending and receiving text messages, and performs other communication functions using its web service APIs.

When your Uber driver calls asking you to reveal yourself out of a concrete apartment block or your lavish gated community, this is all facilitated by Twilio’s technology.

At the recent Twilio Signal Conference in San Francisco, Twilio indicated that its latest “call center in a box” product called Flex was up and running after announcing it this past March.

Prior to Twilio’s roll-out, this type of call center functionality was only reserved for the Fortune 500 companies that could afford expensive software to serve its minions of customers.

The small guy was left out in the cold as usual.

Twilio has reshaped the call center and, at $1 per hour or $150 per month, has made itself a gamechanger for SMEs who don’t have the manpower or capital to fund exorbitant back-end operations.

Twilio is really going after anyone with a light or bulky-shaped wallet as you see from their all-star lineup of customers. U-Haul, real estate website Trulia, and data analytic firms Scorpion and Centerfield are just a few of their customers proving the incredible flexibility of the software.

It’s not a shock that this stock has gone ballistic in 2018 surging over 200% and I must admit, investors need to wait for this molten hot stock to cool down.

But how can you blame a company that habitually tears apart any expectation of them devouring expectations because of its super growth model and rapid broad-based adoption?

From the fourth quarter of last year, revenue accelerated to 48% YOY and Twilio followed that up with a blistering 54% YOY quarter.

Then they pulled a shocker guiding down only expecting 35% to 37% growth but dismantled any whiff of jangling investors' nerves by posting another quarterly growth rate of 54%.

If you average out the three-year sales growth rate, few can topple the 57% Twilio has registered.

Performance has been fantastic, to say the least, and Flex could be the product that cements their industry lead and widens the moat around them.

Airbnb, Uber, and Lyft will avoid tinkering with the back end of their operations before their 2019 IPOs boding well for Twilio who are on a hot streak scoring a series of big contracts.

Twilio has been embroiled in further recent stock weakness as they gobbled up SendGrid (SEND), a mass-email marketing software service, for $2 billion.

SendGrid is growing sales at a lower rate in the mid-30%, and this move will add to top line growth.

Synergies from this acquisition are numerous and Twilio will be able to cross-sell to SendGrid’s customers who can apply other communication tools to use.

Telecommunication product in the past was truly unaffordable for the bulk of companies and now that Twilio can bring in all the smaller companies, the SME landscape is poised to change.

Software is becoming powerful to the point where one person living in a basement will have the access to a software that could convince customers a 100-man team is putting this product altogether.

Flex allows customers to personalize this contact-center-in-a-box software for each specification.

It can even quickly integrate into CRM platforms like Salesforce (CRM) which is a wildly popular interface for companies around the world.

Twilio Autopilot, Twilio’s oral conversational AI tool, offers machine learning bots who deliver automated voice-activated functions to customers.

Companies can easily type what they want bots to orate to customers and simply paste it into the code with ease and minimal hassle.

Twilio’s updated payment capabilities offer a new API for building payment experiences by contacting center agents who can now securely accept credit card payments from customers over the phone without the agents ever getting a whiff of the actual numbers.

Effectively, this allows any business in the world to professionalize their communications and backend department to a point they could have never imagined a few years ago.

The saying rings true when industry experts note that it’s the best time to become a billionaire and worst time to become a millionaire because the power of leveraging these robust software programs could potentially fuel the rapid rise of anyone in the world who will eat everybody else’s lunch.

If you break down the numbers, most companies are still holding on to their legacy systems of yore.

Being saddled with outdated hardware and software will doom companies going forward as the explosion of brilliant software modernizes companies in a few clicks of the mouse.

Twilio has added another 15,000 developers to the 35,000 already on the books and the purchase of SendGrid can no doubt be attributed partially to a talent grab of developers who have deep experience building communication-based products.

These types of developers don’t grow on trees.

Last year saw Twilio bring in about $400 million in sales and I am modeling for around $1 billion in sales by 2021.

This $7 billion market cap tech darling has a long runway ahead of itself and investors looking for high-volatility, high-reward stocks can tuck this one away in their sheath.

With earnings coming up and an already 200% plus pop this year, there will be better entry points into this ebullient company if investors are patient.

Wait for a dip to get in on the best communication-based cloud company on the market.

November 6, 2018 - Quote of the Day

Tech Letter

“Your brand is what other people say about you when you’re not in the room.” – Said Founder and CEO of Amazon Jeff Bezos

November 5, 2018

Tech Letter

Mad Hedge Technology Letter
November 5, 2018
Fiat Lux

Featured Trade:

(GET READY FOR ANOTHER BITE OF THE APPLE)
(AAPL), (ROKU), (MSFT), (PYPL)

Get Ready for Another Bite of the Apple

Tech Letter

The biggest news of Apple’s earnings results was what Apple decided they will not do in the future – stop publishing iPhone unit sales.

I applaud CEO of Apple Tim Cook for putting this to rest because it is starting to get out of hand. The outbreak of criticism and grief targeted at Cook has to stop because analysts do not understand.

On one hand, it’s important to be aware of the metrics tech companies are judged on, but if analysts aren’t in tune to what these numbers mean in the bigger scheme of things, then it is irrelevant.

Apple is doing everything it can to turn into a software company. They are not interested in battling it out at the low-end of the totem pole because that path is a scrap down to zero margins.

Migrating up the value chain is something that management has identified, and this strategic shift should be met with rapturous celebrations.

Unit sales growth, gross payment value, and monthly views are all metrics that growth companies hold dear to their heart and a way to show to investors they are worth investing in regardless of the cash burn and cringeworthy operating margins.

Apple is way past that point if you haven’t noticed and should be focusing on how to monetize the existing base of customers.

Plain and simple, Apple is not a start-up growth company and taking away this reporting metric will help investors refocus on the real story at hand which is its core of software and services.

With software and services, profitability by way of innovative software offerings will be magnified and highlighted as the roadmap ahead.

As for the last batch ever of iPhone data, Apple has done a brilliant job, to say the least. They exceeded all expectations by smashing the average selling price (ASP) of iPhones at $793.

This is a monumental jump from $618 at the same time last year, a 28% YOY increase.

I did not say that Apple is the world’s best tech company at the Mad Hedge Lake Tahoe Conference, but I did say Apple is by far the highest quality company and this earnings report is a great example of that.

EPS routinely is beat and raised on a sequential basis.

Doubling down on the theme of quality is the revenue numbers from Japan which were up 34% YOY for a group of people who have the harshest view of quality control in the world.

Believe me, Japanese consumers have no desire to ever buy a Chinese smartphone.

The spike in ASPs was triggered by a flight to its collection of ultra-premium smartphones that has enthralled consumers. The ballooning ASP prices led iPhone revenue to spike 29% YOY to over $37 billion crushing the almost $30 million in quarterly revenue the prior year.

According to data from Hyla Mobile Inc., American iPhones traded in between July 1 and the end of September were 2.92 years old on average, up from 2.37 years old the same period two years earlier.

The reasons are two-fold.

Companies are producing better performing smartphones negating the need to impatiently upgrade right away.

The second reason is that they are just plain out pricey, and not everybody will have the dough to splurge on a new iPhone every year or two.

Thus, Apple has strategically placed itself in the correct manner by producing the best smartphone that customers will eventually adopt but carving out as much revenue while consumers are using their phones longer.

During this time, data usage has exploded as consumers are addicted to their smartphones and relying on a whole host of apps to complete their daily lives.

Apple would be stupid to not position themselves to capture this tectonic shift to more hourly data usage and breaking itself from the reliance of smart device revenue itself.

This is what other tech companies are doing like Roku, albeit at an earlier stage in their growth cycle.

In the future, smartphones will become obsolete replaced by something smaller, nimbler, and perhaps integrated with our brain or body or both.

Apple is also acutely aware that the bombardment of Chinese smartphones and the upward trend in the overall quality of these phones has siphoned off part of the iPhone market in specific segments of the world.

Thus, Apple has barely even touched the emerging markets of India that has been flooded by Chinese mid-tier phones without the branding power of Apple.

Apple doesn’t create these trends, they are merely stitching together smart decisions based upon them.

The next step is also a two-pronged proposition.

Apple needs a full-blown enterprise service based upon the cloud.

They can either buy one and they certainly have the cash to do so. Or they can develop one internally from scratch.

The second issue is that Apple also needs to widen its product service offerings that not only include an enterprise cloud option but also entertainment, news, sports, and everything else that could hook user’s attention and stick them to the iOS operating system until death.

Cementing users to the iOS operating system is the overall goal of all of this software infusion because if users start migrating over to the Android platform, it’s real game, set, and match for Apple as we know it.

Instead of myopic analysts focusing on “unit sales”, smart analysts should be focusing on whether what Apple is doing will tie future users to iOS or not.

I am happy with what I have seen so far but there can be a great deal of improvement going forward.

I think my 2-year-old nephew even knows that iPhone sales are maturing by now. This has not been a new story and I would call it poor reporting from a group of lazy-minded analysts.

It’s true that Apple rode the coattails of its miracle hardware products to a $1 trillion market cap. It was a magnificent achievement. I pat all who were involved on the back.

However, it’s clear as daylight that hardware is not what is going to propel Apple to a $2 trillion market cap.

Lost in all the smoke and mirrors is that revenue was up 20% YOY which is a staggering feat for a $1 trillion company.

Even more muddied in the rhetoric is that there has been minimal slowdown in China even after all the trade war jostling which is a miracle in its own right growing 16% YOY.

Software and services were up 27% YOY pulling in $10 billion and the Apple ecosystem has now reached 330 million paid subscribers, a growth of 50% YOY.

Paid subscribers are the most important metric to Apple now as it shows how many users are percolating inside their eco-system wielding their credit card around for software and services whether its maintenance spend or Apple pay.

Apple pay transaction volume tripled in the past year with four times the growth rate of FinTech player PayPal (PYPL).

Wearables still maintain broad-based growth climbing 50% YOY which is slightly down from the 60% YOY last quarter.

All of the wearables such as the amazing Apple Watch, AirPods, and Beats products have a nice supplemental effect to the Apple eco-system and is an over $10 billion business per year.

I am interested to see if Apple can make the quick pivot to an enterprise software company, and Apple’s announcement of Apple business manager, a method to deploy iOS devices at scale, had an initial sign up of 40,000 companies. Apple needs to bet the ranch on this direction and do it fast.

I would like to see Apple attack the enterprise market with zeal because there is a long runway for them to scale and the bulk of companies would welcome Apple products and services littered around their mobile offices.

The most important soundbite was by CFO of Apple Luca Maestri saying, “Given the increasing importance of our services business and in order to provide additional transparency to our financial results, we will start reporting revenue and total services beginning this December quarter.”

There you go…Apple explicitly saying they are the newest software company on the block that should go alongside the likes of Microsoft (MSFT).

The software theme will continue with the Mad Hedge Tech Letter because there are some real gems out there in the software landscape tied to the cloud.

As for Apple, the earnings report reaffirms my opinion that they just keep getting better and are magicians at adjusting to the current tech climate.

Wait for the stock to find some footing then it’s a definite buy, and for long-term holders, it’s a screaming buy.