“Be stubborn on vision, but flexible on details” – Said Founder and CEO of Amazon Jeff Bezos
Mad Hedge Technology Letter
November 13, 2018
Fiat Lux
Featured Trade:
(NO BIWEEKLY STRATEGY WEBINAR FOR WEDNESDAY NOVEMBER 14)
(WHY I HATE CHIP STOCKS)
(AAPL), (CY), (TXN), (LRCX), (KLAC), (LITE), (QCOM), (MU), (SWKS), (LSCC)
Now that the midterm elections are behind us, Congress will be gridlocked for the next two years portending well for tech stocks as a whole.
However, the gridlock will exacerbate negative sentiment in one small group of technology – the semiconductor chip sector.
I have been staunchly bearish on this cohort since the outset of the trade logjam with China and I recommend readers to avoid these stocks like the plague.
The split Congress could fuel an even more rigid stance towards the complicated tech situation, further clamping down on foreign IP theft and technological forced transfers.
Either way, there is no end in sight and as this administration is concretely in place for the next two years, doubling down on foreign policy wins could be the Republican party’s path to victory heading into the 2020 election.
This could mean the rhetoric towards China could ratchet up a few levels.
Soon enough, the tariffs levied on Chinese imports is set to increase to 25% in January.
Even before January, a planned meeting between Trump and Chairman Xi in Buenos Aires on Nov. 29 will take place and is creating a swirling tornado of uncertainty around chip sentiment that is on tenterhooks.
Any chance to resuscitate the sentiment in the industry could come and go with another gut-churning leg down in chip shares.
Unfortunately, the sword of Damocles hanging over the chip sector could drop in 2019 slashing profit margins, revenue, and damaging the all-important guidance.
Even if individual chip companies determine that the trade friction is too much to stomach, it would be expensive and lengthy to transfer an entire supply chain to Vietnam or Indonesia, hitting current R&D budgets and damaging future innovation affecting the pipeline of fresh products.
Time is not a friend to the chip sector.
If the China leveraged chip companies were to wait out this trade war, they risk further being enveloped into the eye of the trade storm if no quick agreements can be made.
They might have to wait a while as Beijing views waiting out Trump and dealing with the next administration in charge as the ideal option.
Chairman Xi conveniently removed term limits in the last congress, meaning he is in his job until death which could be another 40 years or so.
That is the time horizon the Chinese are playing with.
The timing couldn’t have been worse for the chip sector after a slew of weak guidance from upper management painted a downbeat picture for the sector as we inch towards 2019.
Texas Instruments (TXN) Chief Executive Rich Templeton started off his earnings report admitting, “demand for our products slowed across most markets.”
He later admitted that the semiconductor market is grappling with an imminent “softer” market.
Following up a growing chorus of chip executives flashing dangerous warnings signs, Lattice Semiconductors (LSCC) lamented that it was seeing slowness in the industrial and consumer markets in Asia as a result of macroeconomic conditions and tariffs.
Cypress Semiconductor (CY) also chimed in saying it was coping with “softness across the board.”
Making matters worse, Beijing has been showering capital on the local chip sector aimed at nurturing and developing Chinese chip companies poised to compete on the global stage.
Recently, Chinese state-backed semiconductor maker Fujian Jinhua Integrated Circuit was indicted by the U.S. Justice Department for industrial espionage.
The company allegedly stole trade secrets from Boise-based Micron (MU).
Micron could now become the first piece of collateral damage to the snarky trade war threatening huge swaths of American chip company's revenue.
And with the affected American chip companies waded in a quagmire, and chip market softness on the near horizon, semiconductor equipment firms have borne a good amount of the damage this year with Applied Materials Inc (AMAT), KLA-Tencor Corp (KLAC), and Lam Research Corp (LRCX) getting hammered.
Chips tied to Apple’s (AAPL) iPhone are also in for a drubbing with Apple suddenly announcing in their most recent report they would stop offering the unit sales of iPhones, creating more uncertainty around units sold for a massive end-market for global chip companies, adding to the swirling uncertainties overall Chinese chip revenue face.
Apple proxy chip stocks who lean on Apple for a big chunk of revenue such as Skyworks Solutions (SWKS) are getting crushed.
Skyworks was downgraded last week by Citigroup based on underperforming iPhone XR sales.
The rapid rush of chip downgrades has been fast and furious.
Skyworks will have pockets of strength when 5G is fully rolled out because they will supply critical components installed in this new technology for the new era of internet speed and performance.
But that pocket of strength is not now and will not happen tomorrow.
It’s time to duck out of Skyworks and I have been convincingly downbeat on this particular name since the inception of the trade war.
Today crawled in the next batch up negative chip news from Lumentum Holdings (LITE) who supplies 3D chips for Apple iPhone's facial recognition system.
Management reported that sales would be $20 million lower than originally forecasted because of a sudden reduction in shipments from an unnamed customer.
Another ongoing headache is the Qualcomm (QCOM) versus Apple marriage or divorce, depending on how you look at it.
They have been mired in a prolonged court case against each other, and Qualcomm’s share price has been dismal as of late.
Qualcomm recorded zero licensing revenue in the quarter from Apple who is withholding royalty payments from Qualcomm in a dispute over the company's licensing practices.
The move damaged quarterly licensing sales sliding 6% to $1.14 billion.
Qualcomm has lashed back at Apple pointing the finger at Apple for transferring its intellectual property to Intel (INTC) who is supplying chips for new-model iPhones which is possibly part of the reason they lost this contract.
Losing the iPhone contract to Intel is the main factor in Qualcomm expecting modem chip shipments to decline 22% to about 185 million units.
The fight has no end in sight but like Skyworks Solution, Qualcomm is on the forefront of the 5G revolution and provides a silver lining to embattled revenue growth that has been dragged down with the China mess.
At the end of the day, companies have less resistance when they aren’t belligerently brawling with their biggest purchasers.
Biting the hand that feeds you is a poor strategy that cuts across any industry.
Avoid chip companies for the short term and wait for sentiment to reverse course.
“The path to the CEO's office should not be through the CFO's office, and it should not be through the marketing department. It needs to be through engineering and design.” – Said Co-Founder and CEO of Tesla Elon Musk
Mad Hedge Technology Letter
November 12, 2018
Fiat Lux
Featured Trade:
(THE NEXT OVERHYPED TECH PRODUCT TO BOMB)
(SSNGY), (AAPL), (GOOGL)
I’m unimpressed.
The Samsung (SSNGY) Galaxy F foldable smartphone will be a complete failure just like the Google Glass.
Heralding this product as the new disruptor ready to displace the Apple (AAPL) iPhone is a bunch of garbage.
Yes, Korean stalwart Samsung did achieve success with their flagship smartphone device the Samsung Galaxy which took 6 years to produce. But don’t expect anything similar in terms of sales and scale of adoption.
This will be a dud.
I will outline some of the problems creating a foldable smartphone for mass use.
In fact, why not call a laptop a “foldable smartphone”? I routinely wield my Google (GOOGL) Voice and Skype to call my Rolodex of phone numbers around the world from my computer and my laptop definitely folds!
This smells like desperation from Samsung who has grossly miscalculated gimmicky innovation coining it as a true gamechanger.
Illogically, the act of folding creates a second layer that will result in a bulky product. Logically, it makes sense to have one layer and one layer only.
The sleek smartphones of today are trending towards becoming A2 paper thin and lugging around a brick is not what contemporary-minded netizens had in mind.
Naturally, each future iteration will gradually solve this problem just like Moore’s law observes that the number of transistors in a dense integrated circuit doubles about every two years, meaning you can pack more components into a product over time.
But will there be a second version of this foldable phone?
And then manufacturers must keep in mind which addressable market could this foldable device disrupt. Will it replace the smartphone or the tablet?
Smartphone screens have become bigger with each generation eroding the share and application of the tablet once the smartphone eclipsed the 6-inch screen size.
The tablet industry has suffered since with smartphone enhancements only adding to the misery. This is all evident in this year’s tablet sales down 5.4% YOY through September.
If this foldable phone is pigeonholed as a replaceable tablet product, then sales would address a niche market product at best and have a higher chance of being an outsized flop.
No matter how you cut it up, iPhone users won’t gravitate towards this gimmicky device and chuck their iPhones in the bin.
Cost is also a big factor in this type of product because of the capital thrown at it by Samsung.
They no doubt hope to recoup some of the exorbitant R&D that went into building a brand-new product from scratch.
Rumors floating around the Samsung developer conference pin this foldable phone at a retail price of around $2000.
With this high of price point, I would expect the phone to fly out of my pocket by itself and fold out without me physically doing anything or something similarly impressive.
I highly doubt that Samsung can pull off something that innovative.
The nature of Apple producing brilliant smartphones is that to topple the iPhone, something special is needed to clearly surpass the predecessor along with a must have “it” factor.
That is what you got with the hoards of customers camping overnight in a tent outside of Apple stores dotted around the world waiting to be the first to buy the next version of the iPhone.
That type of pandemonium and hoopla surrounding a consumer product hasn’t been replicated since the days of Steve Jobs.
In general, customers want convenience and the arduous nature of folding out a phone will become tedious in actual reality because most phone users have the propensity to check their phone 15 times per hour.
That also means folding out a phone 15 times per hour and that doesn’t dovetail well with most phone users who, as of now, just slip their phone in and out of a coat or trouser pocket ready in half a second to navigate the e-world.
In short, this device isn’t practical and the targeted market who has the cash to pay for this will dislike the inconvenience of the application.
The user experience is demonstrably inferior to the Apple iPhone.
On the surface, the Galaxy F phone looks innovative and the adaptable nature of the foldable screen is a novelty, but Samsung will have to go back to the drawing board on this one.
I incessantly drum up the issue of the lack of visionaries at the helm of tech companies. The number can be counted on one hand, maybe two.
The type of class where you find the Jack Dorsey and Elon Musk level of visionaries is not a dime a dozen.
When you have a lack of vision, consumers get foldable phones.
Forcibly wedging in hyper-charged display technology into a smartphone is a recipe for disaster.
Maybe someday this technology can be more relevantly applied to a consumer product, but this Frankenstein type product is a mix of two sets of technologies not meant to marry each other.
The act of intent is of equal importance.
The bigger takeaway from this fanciful experiment is that the next wave of innovation to replace the smartphone is in full swing and happening as we speak.
Even though Samsung’s Hail Mary pass looking for that elusive last-second touchdown on the last heave of the game will be a bust. It is only a matter of time before another Steve Job’s lookalike hits the jackpot with the perfect consumer device wooing the billions starting another cult-like phenomenon.
In the next 10 years, display technology will be completely revolutionized adorning our megacities and billboards in ways we never imagined.
This is all just the beginning and filtering out the right formula is what we see taking place from all these tech companies determined to become the king of the jungle.
All of this foldable display technology reverts back to one constant desire – the demand for larger screens.
The 6-inch smartphone was the first baby step to something brilliant.
But ultimately, producing a digital device that can easily fit into our pocket, instantaneously ready for action, possessing beautiful optics with the largest screen possible is the eventual chosen one who will win this sweepstake.
And the first company that can figure out how to get the phone out of our pockets, in front of our eyes without the need for human fingers will have the inside track to revolutionize the world.
We are not there yet, but we are inching closer every day because of the hyper-accelerating rate of technology.
Waiting in the queue are Samsung’s biggest rivals looking to enter the foldable phone market such as Huawei, LG, Lenovo, and many other Chinese Android manufacturers.
There have been whispers that Apple has had some patents filed for foldable technology. And with Sir Jonathan Paul Ive, the Chief Design Officer of Apple, a remarkably special talent designing Apple’s revolutionary products, he certainly has something special to offer hidden up his sleeves.
He always does.
“My style is to have a big vision, a big commitment.” – Said CEO of Softbank Masayoshi Son
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.
“I don't write about Google except to insult the company.” – Said Co-Founder of Recode Kara Swisher
Mad Hedge Technology Letter
November 7, 2018
Fiat Lux
Featured Trade:
(THE RELIABILITY OF ADOBE)
(ADBE), (GOOGL), (ZEN), (TWLO), (SQ)
