Mad Hedge Technology Letter
July 26, 2018
Fiat Lux
Featured Trade:
(THE TRADE WAR'S COLLATERAL DAMAGE),
(SWKS), (ACIA), (CRUS), (XLNX), (ROKU), (SQ)
As the trade ruckus rumbles on for the foreseeable future, there are some places to deploy cash and some places to avoid like the zika virus.
The one area of tech to avoid that is clearer than daylight is the small cap chips companies.
Like a fish out of water, you should not feel comfortable holding shares in this type of equity amid the backdrop of an unresolved trade skirmish.
Although the Mandarins ironically need our chips, the uncertainty permeating around small chip firms means it's not time to hold let alone initiate new positions.
Investors still don't know how this standoff with shake out.
Until, there is more clarity going forward, give way to the next guy who can take the heavy loss.
Keep the powder dry for better times.
The long-term demand picture is healthy with IoT, cloud, and software companies never being thirstier for chips.
Short term is a different story with many of these smaller chip companies subscribing to grotesque charts that will make your jaw drop.
Take Skyworks Solutions, Inc. (SWKS) whose shares have spent the majority of 2018 trending lower and are stuck in purgatory.
(SWKS) produces semiconductors deployed in radio frequency (RF) and mobile systems.
This stock has been tainted by the horrid reality that it generates 25% to 30% of revenue from China.
If you have been living in a cave for the past eight months, technology is the battleground for global supremacy pitting two of the leading technological heavyweights in the world against each other in a fiercely contested, drawn-out conflict.
Any American listed chip company doing at least 20% of revenue in China has the same chart trajectory and that is not up.
Adding insult to injury, (SWKS) generates 35% to 40% of its total revenue from Apple.
As we approach every earnings season, the story rewinds and plays again to loud applause.
A slew of analysts appears on air condemning Apple promulgating lower iPhone sales due to surveys taken across various key suppliers giving them a snapshot into production numbers.
Each time, the analysts are proved wrong. However, the avalanche of downgrades that ensues knocks the stuffing out of the small chip companies dipping viciously, at times more than 10% or more on the headline.
One of the larger Chinese contracts that was signed by (SWKS) was with ZTE. Yes, that ZTE, the one the U.S. administration temporarily put out of business for selling telecommunication equipment to North Korea and Iran.
That was the nail in the coffin.
According to the (SKWS) official website, it has an ongoing, expanding relationship with ZTE and its chips would be "powering data cards and USB modems" in ZTE-manufactured next-generation tablets.
Luckily, the American government reversed its initial decision restoring operations to ZTE.
That does not mean it is out of the woods yet as lingering risks still overhang over this company.
This revelation underscores the massive contract risk for companies that unlike behemoths such as Micron, are desperately reliant on just a handful of contracts to propagate short-term revenue.
Effectively, the U.S. administration views American chip companies as collateral damage to the bigger picture.
The only reason the ZTE ban was lifted was because it was a prerequisite to restart talks between both sides.
If the ban was upheld, 75,000 Chinese workers would have needed to polish the dust off their resumes to start a fresh job search.
The inability to sell components to service the Chinese consumer will strike where it hurts most: the bottom line.
Chip producers did $1.5 billion in sales with ZTE in 2017. That business is in a precarious situation when a tweet can just wipe out those contracts in one fell swoop.
Acacia Communications, Inc. (ACIA) churns out high-speed coherent interconnect products.
The stock was beaten down then beaten some more in 2018.
(ACIA) revealed 30% of its $385.2 million revenue derived from one contract with guess who...ZTE.
On word of ZTE ban, (ACIA) plummeted from $40 to $27.50 in one trading day.
The disappearance of a contract this vital to survival is tough for a small business to handle even if temporary.
Layoffs and a squeezed financial situation apply unrelenting pressure on management to find an elixir.
Cirrus Logic Inc. (CRUS) pumping out a mix of analog, mixed-signal, and audio DSP integrated circuits (ICs) was trading more than $62 just a year ago.
Fast forward to today and its shares are at a measly $39.
To say Cirrus Logic's eggs are in one basket is an understatement.
(CRUS) procures 80% of revenue from Apple.
It's all hunky-dory to develop a close relationship with Apple, but in light of this unpredictable economic climate, shares have been hit hard and there is no end in sight.
(CRUS) even won a contract to help produce Apple's noise canceling and water-resistant AirPods, but that does not do anything to change the narrative.
The vultures are circling around this name and it was time to abort a long time ago.
Xilinx, Inc. (XLNX) is another small chip company and the first to create the first fabless manufacturing model headquartered in San Jose, California.
This company, founded in 1984, procures around 35% of revenue from China
The trade headwinds have set this stock in the crosshairs, being the victim of frequent 5% drops and two 10% slides in 2018.
It is a miracle this stock is slightly in the green this year, and (XLNX) is one of the lucky ones.
Skim through the rest of small cap chips stocks and the charts look the same. Dreadful with massive rally busting sell-offs.
The extreme volatility in and of itself is a sensible reason to steer clear of these names.
The headline risks that splash across the morning news spreads are a daily reminder that chip stocks, big and small, aren't out of the woods yet.
The Johnny-come-latelies must expose themselves to higher quality, unique assets which possess little or no China exposure.
For the experts, trade the volatility at your peril. But if volatility is what you want with scarcity of value, leg into Roku (ROKU) or Square (SQ) on moderate sell-off days.
________________________________________________________________________________________________
Quote of the Day
"Technological progress is like an ax in the hands of a pathological criminal," said German-born theoretical physicist Albert Einstein.
Mad Hedge Technology Letter
July 25, 2018
Fiat Lux
Featured Trade:
(PICHAI YOURSELF, EARNINGS ARE REALLY THAT GOOD),
(GOOGL), (MSFT), (AMZN), (AAPL), (TWTR), (DIS), (TGT)
Google Translate, Alphabet's (GOOGL) free, multilingual machine, foreign language translation service, translates an unimaginable143 billion words per day.
These were one of the pearls divulged in the conference call from Google's CEO Sundar Pichai.
A bump in usage coincided with the 2018 World Cup in Russia, and in the age of low-cost airfare and overpopulation, it could be Alphabet's new cash cow.
Google Translate has the potential to morph into one of the premier foreign language applications used by anyone and everyone.
Forget about the Amazon effect, the Alphabet effect could be just as pungent, albeit away from the trenches of e-commerce.
Thank goodness the application is still ad-free.
No doubt it would be inconvenient to sit through a 15 second ad while interacting with a concierge at a bed and breakfast in the South of France.
Analysts did not sound out Pichai's plans for Google Translate, but he did mention there are some monetization opportunities on the horizon.
The latest earnings report is the most recent indication that the FANGs along with Microsoft are pulling away from the rest.
The equity price action in 2018 vindicates this fact with more than 80% of the gains spread around just a few high caliber tech names.
Is this fair? No. But life isn't fair.
The too slow too late regulation that was supposed to put a cap on the vaunted FANG group has had the opposite effect, squeezing the small guy out of the picture.
The runway is all clear for the FANGs, and the only way they will be stopped is if they stop themselves or an antitrust ruling.
This all adds up to why Alphabet has been a perennial recommendation for the Mad Hedge Technology Letter.
Duopolies are few and far between and monopolies even rarer.
They are great for earnings and as the global digital ad pie grows, it falls down to Google's bottom line.
On the news of stellar earnings, Facebook shares jumped higher in aftermarket trading and powered on to trade around 5% the following day.
Expect a great earnings report from Facebook with robust ad revenue growth.
Nothing less would be a failure of epic proportions.
The migration to mobile is real and investors need to understand analysts cannot keep up with the rising year-end targets in these shares.
Alphabet had a high bar over which to pole vault, and it still managed to beat it handily.
And the $5 billion fine for bundling its in-house apps on Android fell on deaf ears.
Alphabet has $102 billion in the coffers, and $5 billion will do nothing to materially affect the company.
The cash reserves are up from $34 billion in 2010.
The market trampled on any sniff of a risk-adverse sentiment and powered into the green with the Nasdaq reaching another all-time high.
Let's not get too carried away. Alphabet's bread and butter is still its digital ad business with Alphabet CFO Ruth Porat confirming this fact saying, "One of the biggest opportunities for investment continues to be in our ads business."
Alphabet still breaks off 86% of revenue from its distinguished ad business.
"Other" is a category commingling Google Cloud, Google Play, and hardware that only comprised 13 percent of total revenue.
"Other Bets" brings up the rear with 1% of total revenue comprising Waymo, Alphabet's self-driving unit, which is an industry leader putting Tesla and Uber in their place.
Waymo plans to shortly roll out a massive commercial operation. Along with Google Translate, it could carve out a nice position in Alphabet's portfolio going forward.
The most important metric was Alphabet's total ad revenue, which it locked in at $28.1 billion, a 23.9% YOY improvement.
Aggregate paid clicks, a model in which the advertiser pays Google for a user to click an ad, has been steadily rising to 58%, up from 52% from the same time last year.
The masterful efficiency circles back to Google's ad tech team, which is by far the best in the business and has outstanding management.
The Cloud is an area that Alphabet highlights as a place for improvement.
Alphabet's cash war chest allows the company to throw hoards of cash at a problem. When mixed with brilliant management it usually works out kindly.
CFO Porat mentioned that costs were particularly higher in the quarterly head count because of large investments in cloud talent.
Google is tired of playing third fiddle to Amazon (AMZN) and Microsoft (MSFT), and views enhancing the enterprise business as imperative.
This explains Alphabet's head count surge to more than 89,000 employees, sharply higher than the 75,600 employed a year earlier.
Every FANG and high-tier tech company is spending its brains out to compete with each other.
Expanding data centers is not cheap. Neither are the people to deploy it.
Alphabet has the cash to compete with the Amazons and Apples (AAPL) of the world.
They do not have to borrow.
The potential trip wire in Alphabet's earnings report was Google's traffic acquisition cost (TAC).
Alphabet's (TAC) is described as money paid to other companies to direct user traffic to its suite of Google products.
(TAC) went up to $6.4 billion, which is 23% of Google's ad revenue but down on a relative percentage basis of 24%.
This was enough to keep investors from sounding the alarm and was welcomed by analysts.
Alphabet pulled out all the stops this quarter and the momentum is palpable.
Top-line growth from its core ad business shows no sign of slowing.
Acceptable (TAC) was the cherry on the sundae for the quarter at a time when many industry insiders thought it would be around 25% or higher.
Hardware offered less punch than before, which is what all high-quality tech companies desire.
There were no obvious weaknesses and the 34 straight quarters of 23% YOY growth is hard to top.
Google pulls in 10% of all global digital ad dollars in one business.
Other highlights were Waymo eclipsing the 8-million-mile mark of self-driving on public roads as it is the next business to come to the fore.
Google cloud is at an inflection point attempting to win over corporate management.
It has already won contracts with heavy hitters such as Twitter (TWTR) and Disney (DIS).
Pichai mentioned Target (TGT) as a key new cloud client that just signed on with Google last quarter.
More importantly, Alphabet's brilliant quarter bolsters the macroeconomic picture heavily reliant on tech earnings to usher the market through the gauntlet.
Regulation has proved irrelevant. Whatever fine they are slapped with does not change that Google reaps the benefits from its market position as one of the duopolies in the global ad business.
Alphabet has been trading from the bottom left to the upper right via a consistent channel.
Do not chase the new all-time high of $1,270. Use any weakness around the $1,100 level to initiate new positions.
Owning a company this dominant has little downside. The regulatory burden was a myth and Pichai has handled this operation beautifully.
I am bullish on Alphabet and its partner in crime Facebook.
________________________________________________________________________________________________
Quote of the Day
"Man is still the most extraordinary computer of all," said the 35th President of the United States John F. Kennedy.
Mad Hedge Technology Letter
July 24, 2018
Fiat Lux
Featured Trade:
(SECURE THE GATES),
(FTNT), (PANW)
Does it give you the creepy-crawlies to know that while you are meandering around on your favorite website, nefarious forces are preying on your every click?
An entire industry is devoted to defending your needs, to ensure you can roam and frolic aimlessly on the World Wide Web.
The global cybersecurity industry aimed at protecting the end user is on pace to mushroom, surpassing $180 billion in revenue by 2023, a monstrous uptick in business activity from the $114 billion in 2017.
Recent political sable rattling and aggressive posturing underscores the seriousness of defending proprietary trade secrets and vital data, which are propelling these businesses to outperform.
The multitude of security breaches has fueled a security spending binge in 95% of firms.
And this is just the beginning.
Hyper-accelerating technology has augmented big data as the new oil, and this data is useless if hackers can infiltrate a system leaving it a shell of its former self, then selling it on to the highest bidder on the dark web.
Corporations are furiously spending on the newest cutting-edge fortifications.
CEOs have awoken and realize getting nicked of a precarious treasure trove of data is a sackable offense.
The trend in global cybersecurity spending augurs well for Fortinet (FTNT), a company I have touted in the past. To read my recommendation for this stock click here. Please note you must be logged in to read the article.
I urged readers to dip their toe in this stock when shares were trading at $54 in the middle of March.
The ensuing price action has been nothing short of spectacular with frequent antagonistic macroeconomic headlines boosting the stock.
Fortinet is trading at $68 today, levitating over 20% since I recommended it barely four months ago.
Fortinet has the pulse on the cybersecurity industry and provided some insight to the industry combat zone from its 30,000-foot perch as one of the leading lights of the industry.
This is what it deals with on a daily basis.
Intrusion methods are constantly transforming to keep the cybersecurity forces off-kilter.
The game of cat and mouse has become a zero-sum proposition deploying massive scale. This newfound acceleration is forcing cybersecurity companies to up their game.
The latest data from Fortinet illustrates cybercriminals malware usage has crept up in sophistication relying on formulating modern zero-day vulnerabilities, better understood as attacks exploiting previously unknown security vulnerabilities, operating with lighting quick speed and mammoth scale.
Unique exploit detections surged by 12%, and from these intrusions, 73% of firms were materially damaged.
These aren't your father's cybercriminals.
The newfound mainstream popularity of cryptocurrency has caused a new wave of fiat money to funnel through Internet checkpoints into their crypto brokerage accounts.
This fashionable asset class for Millennials has coincided with a major increase in "cryptojacking," the theft of crypto assets.
The aforementioned malware is becoming uber complex undetectable to the unexperienced cybersecurity professional.
The migration into cryptomining has given cybercriminals another platform to strike it digitally rich.
The activity of cryptomining malware has shot up doubling the amount of malware permeating through the system.
Cryptomining malware has demonstrated a vast array of variations of malware. This brand of stealthier, fileless malware deploys infected, undetectable code into browsers.
Hackers aren't just targeting one type of cryptocurrency. They are going after the alternative currencies such as Dash and Monero that knock about in the crypto asset ecosphere.
Monero is a favorite of the North Korean state hacker team.
Hackers are employing a trial and error strategy, aggregating the industries' best practices to mold into an even more deadly weapon.
These dark forces aren't just spraying around attacks mindlessly. To cause maximum damage, hackers are growingly deploying their venom in a targeted fashion, pinpointing the exact weakness in a system, providing a timely entry point into a gateway allowing them to open a Pandora's box when inside.
Worldwide events are magnets to this bombardment of attacks, and these hackers are routinely carrying out diligent reconnaissance work to lay the groundwork for a laser-like, designed attack.
These digital Ocean's 11 are hard to stop unless you call on Fortinet.
The scope of damage is increasing over time with hackers directing malware to disperse laterally throughout a network before triggering the most vicious phase of the attack.
The Olympic Destroyer malware and the SamSam ransomware rearing its ugly head in Q1 2018, demonstrate how cybercriminals fused together a designer attack with a destructive payload for devastating results.
Some examples of the rapid escalation in expertise are GandCrab ransomware that turned up in January. It was the first ransomware demanding Dash cryptocurrency as a payment.
Complicating the matter, attacks aren't just pointed at one direction. A multifaceted pronged attack has proved effective for expert hackers and mobile is becoming a habitual point of entry.
Hackers would target routers or Internet hardware exploiting these soft spots contributing to 21% of corporations being blindsided by malware, a sharp increase from 7%.
The explosion of IoT devices such as Amazon Echo and Apple's HomePod will be a battleground arena for this industry to stop probing hackers from extracting the treasure trove of data.
Unpatched software and hardware are also ripe for penetration.
Microsoft ranked as the most targeted firm. The other avenue for attacks mainly fell to routers that garnered a substantial portion of malware volume.
Botnets are described as a network of private computers infected with malware while controlled without the owners' knowledge.
Logically, the longer the botnets are in the system, the more havoc they cause.
Same-day detection and removal of botnets came in at 58.5% of infections.
Unfortunately, it took two days to get rid of 17.6% and three days to oust 7.%.
Further down the time horizon, it took more than a week to dispose of 5%.
One glaring example was the Andromeda botnet removed in Q4 2017, but it was still running riot prominently in Q1 2018.
An elixir to solve the problem is not always perfect, but Fortinet manages to successfully smother potential carnage leading to a slew of massive contracts.
All of these aforenoted dangers are on what Fortinet clamps down.
It does its best to put a muzzle on the hideous activity. Then the review and enhancement of products will only help them generate a flurry of sales going forward.
The cybersecurity sector is relatively new and swiftly evolving to the forefront of corporate governance.
The speed of change in technology is outstripping the development of academic qualifications for cybersecurity experts.
Consequently, an acute scarcity of qualified technicians could stifle the effort to combat these wicked forces. Reports suggest a substantial number of middle-tier specialist positions cannot be found causing strain further down the pecking order.
Fortinet uses the most modern A.I. (artificial intelligence) algorithms to address these hyper-critical security threats, whether in networks, applications, cloud, or mobile environments.
The company is the industry leader along with Palo Alto Networks Inc, (PANW), hawking premium firewall technology, end-point security software, and cloud protection solutions.
They have been consistently growing the top line while expanding their hybrid-solutions product lineup.
Just four years ago Fortinet took home $770 million of revenue Fast-forward to 2017, and Fortinet ended the year with $1.49 billion in revenue.
Fortinet continues to hit all-time highs as its stock is on fire.
Its total addressable market maintains robust, and Fortinet is well placed to reap the benefits moving forward.
Its revenue mix is slowly changing from a reliance on hardware to a pivot to software and services boding well for the future.
Gross margins are healthy ticking higher to 77% in Q1 2018, a small increase of 2% YOY.
Revenues are set to blow past $3 billion by 2022, and Fortinet is an all-around great company.
Shares have run too far too fast. Wait for shares to drop anywhere close to the 50-day moving average to put new money to work in this high-caliber cybersecurity stock.
________________________________________________________________________________________________
Quote of the Day
"A company shouldn't get addicted to being shiny, because shiny doesn't last," - said Amazon founder and CEO Jeff Bezos.
Mad Hedge Technology Letter
July 23, 2018
Fiat Lux
Featured Trade:
(THE SKY IS THE LIMIT),
(NFLX), (FB), (AAPL), (MSFT), (GOOGL)
After Netflix (NFLX) laid an egg, the tech sector badly needed a cure to calm the fierce, open waters.
Netflix missed expectations by about a million subscribers and weak guidance shredded the stock almost 15% in aftermarket trading.
The FANG boat started to rock and large cap tech needed a savior to quell the increasingly downside risk to the best performing sector in the market this year.
You can rock the boat all you want, but when Microsoft (MSFT) shows up, the seas turn tranquil and placid.
Microsoft delivered a dominant quarter.
I expected nothing less from one of the best CEOs in America, Satya Nadella, and his magic touch is the main wisdom behind the loquaciousness when the Mad Hedge Technology Letter delves into the Microsoft business.
I rate Microsoft as a top three technology stock, and it should be a pillar of any sensible equity portfolio, unless you believe throwing away money in the bin is rational.
Born in Hyderabad, India, Nadella has worked wonders inheriting the reins from Steve Ballmer who was more concerned about buying an NBA team than running one of the biggest American companies.
Ballmer had Microsoft barreling unceremoniously toward irrelevancy.
It got so bad for Microsoft, the "L word" started to pop up.
Legacy tech is the lousiest label a tech company can be pinned with, because it takes years and gobs of cash to turn around investor sentiment, the business, and the share price.
Under Nadella's tutelage, Microsoft has burst through to another all-time high, which is becoming a regular occurrence in 2018 for Microsoft's shares that languished in purgatory for years.
If the macro picture holds up and if the administration can keep quiet for a few news cycles, investors can expect a minimum of 15% appreciation per year in this name.
And that is a conservative estimate.
Microsoft is already up over 20% in 2018.
Queue the applause.
Nadella has orchestrated a 300% jump in valuation during his four and half years at the helm.
Microsoft is now valued at more than $800 billion and climbing.
The only other tech members of the prestigious $800 billion club are Apple (AAPL), Amazon (AMZN), and Alphabet (GOOGL).
Apple leads the charge to claim the prize as the first trillion-dollar company, and it is within striking distance valued at $951 billion.
Nadella bet the farm on software subscriptions and migration to the cloud.
It was the perfect strategy at the ideal time.
Shares cracked the $108 mark at the market open even as the administration kept up its pugnacious rhetoric threatening to topple the overall market.
Tech has held up through these testy times confirming the fluid migration by the scared investor souls into big cap tech.
How can you blame them?
Amazon prime day saw record numbers visit its platform to the point it crashed from overloading the servers.
Coresight Research predicted users would fork over $3.4 billion on Prime Day in 2018, an increase of 40% YOY.
More than 100 million products were sold in the 36 hours.
The staggering Prime Day sales came on the heels of Alphabet being fined $5 billion for being too dominant in Europe.
The market shrugged it off as the fine does nothing to change Alphabet's dominance in Europe.
Android has harvested 80% of the smartphone market and was slapped on the wrist for bundling Google apps out of the cellophane packaging is a cheap trick by the European regulators.
Imagine frequenting a restaurant that cannot serve its own food.
Alphabet even allows users to download whatever bundle of apps through the Google Play app store. It should be enough.
Alphabet is another solid Mad Hedge Technology Letter pick, albeit it is the weaker tier of the vaunted FANG group and just celebrated all-time highs.
Amazon and Netflix (NFLX) still lead the charge at the top tier of the FANG group, and Facebook's risky business model has it grouped with Alphabet in the lower tier.
At the end of the day, a member of the FANG group is a member of the FANG group.
Microsoft should be part of the FANGs, but the acronyms start becoming too pedantic.
The breadth of the tech sector means many winners.
Microsoft is one of the biggest winners.
Microsoft's total revenue levitated 17% YOY to $30.1 billion.
The number every investor was patiently waiting for were insights into the cloud business.
Microsoft Azure was up 89% YOY and cemented together with strong guidance, ensured Microsoft's shares would continue on its merry way upward.
Gross margins for the commercial cloud offerings, grouped as Azure, Office 365, accelerated to 58% YOY from 52%.
Microsoft's intelligent cloud described by Nadella as "Microsoft's drive to build artificial intelligence into all its apps and services" rose 23% YOY to $9.6 billion.
Management said that it expects Cloud margins to ameliorate through the rest of 2018.
Even the hardware side of the operations caught an updraft with Microsoft Surface, a series of touchscreen Windows personal computers, pole vaulted by 25% YOY.
Simply put, Microsoft is a lean, mean cash-making machine. Last quarter's profit of $8.87 billion coincided with the first time the company eclipsed $100 billion in annual sales.
Microsoft Azure's 16 percent share of the global cloud infrastructure market, according to data by research firm Canalys in April, is rapidly approaching Amazon's Amazon Web Services (AWS) business.
A Morgan Stanley poll of 100 U.S. and European CIOs gleaned insight into the broad-based acceptance of Microsoft's products.
The poll saw 34% planned to upgrade to a higher and more expensive tier of Office 365 software in the next two years, and more than 70% plan to deploy Microsoft Azure and its collection of hybrid cloud solutions.
Microsoft still has its cash cow business injecting healthy profits into its business with Microsoft's productivity and business processes unit, including Office 365, rising 13.1% YOY to $9.67 billion.
The tech sector needs the mega cloud stocks to stand up and be accountable at a precarious time when the macro picture is doing its best to suppress the robust tech sector.
Amazon and Alphabet are in the limelight next week, and Amazon will divulge frighteningly strong cloud numbers along with the braggadocio numbers about its record-breaking Prime Day.
The more I look at Microsoft's last quarter performance, it becomes harder and harder to identify any chink's in Microsoft's armor.
This is not your father's Microsoft.
This is the flashy, innovative Microsoft on top of the most influential trend in the technology sector - the migration to the cloud.
Sticking to this stock could be the rich new uncle of which you've always dreamed. But in this case, it's Satya Nadella providing the free flow of funds.
The spike in the shares is well deserved and any remnant of a retracement should be bought with two hands.
Saying that I am bullish about Microsoft's prospects is an understatement.
________________________________________________________________________________________________
Quote of the Day
"Your margin is my opportunity," said founder and CEO of Amazon Jeff Bezos.
Mad Hedge Technology Letter
July 20, 2018
Fiat Lux
Featured Trade:
(A SELLERS' MARKET)
(CSCO), (MSCC), (GOOGL), (MCHP), (SWKS), (JNPR), (AMAT),
(PANW), (UBER), (AMZN), (AVGO), (QCOM), (CA), (CRM)
I bet you are wondering where all that money from the tax cuts is going.
Believe it or not, the No. 1 destination of this new windfall is technology companies, not just the stocks, but entire companies.
In fact, the takeover boom in Silicon Valley has already started, and it is rapidly accelerating.
The only logical conclusion in 2018 is that tech firms are about to get a lot more expensive. I'll explain exactly why.
The corporate cash glut is pushing up prices for unrealized M&A activity in 2018. U.S. firms accumulated an overseas treasure trove of around $2.6 trillion and the capital is spilling back into the States with a herd-type mentality.
I have chewed the fat with many CEOs about their cash pile road map. All mirrored each other to a T: strategic acquisition and share buybacks, period. The acquisition effect will be felt through all channels of the tech arterial system in 2018.
As the global race to acquire the best next generation technology heats up, domestic mergers could pierce the 400-deal threshold after a lukewarm 2017.
Spend or die.
Apple alone boomeranged back more than $250 billion with hopes of selective mergers and share buybacks. Cisco (CSCO), Microsoft (MSFT), and Google (GOOGL) were also in the running for most cash repatriated.
The tech behemoths are eager to make transformative injections into security, big data, semiconductor chips, and SaaS (service as a software) among others.
Hint: You want to own stocks in all of these areas.
Even non-traditional tech companies are getting in on the act with Walmart concentrating the heart of its strategic future on the pivot to technology.
Walk into your nearest Walmart every few months.
You'll notice major changes and not for decorative measures.
U-turns from legacy technology firms hawking desktop computers and HDD's (Hard Disk Drive) suddenly realize they are behind the eight ball.
M&A activity will naturally tilt toward firms dabbling in earlier-stage software and 5G supported technology. This flourishing trend will reshape autonomous vehicles and IoT (Internet of Things) products.
The dilemma in waiting to splash on a potential new expansion initiative is that the premium grows with the passage of time. Time is money.
It's a sellers' market and the sellers know this wholeheartedly.
Unleashing the M&A beast comes amid a seismic shift of rapid consolidation in the semiconductor sector. Cut costs to compete now or get crushed under the weight of other rivals that do. Ruthless rules of the game cause ruthless executive decisions.
The best way to cut costs is with immense scale to offer nice shortcuts in the cost structure. Buying another company and using each other's dynamism to find a cheaper way to operate is what Microchip Technology's (MCHP) culling of Microsemi Corporation (MSCC) in a deal worth $10bn was about.
Microsemi, based in Aliso Viejo, California, focuses on manufacturing chips for aerospace, military, and communications equipment.
Microchip's focal point is industrial, automobile and IoT products.
Included in the party bag is a built-in $1.8 billion annual revenue stream and more than $300 million of dynamic synergies set to take effect within three years. The bonus from this package is the ability to cross-sell chips into unique end markets opposed to selling from scratch.
Each business hyper-targets different segments of the chip industry and is highly complementary.
Benefits of a relatively robust credit market create an environment ripe for mergers. Some 57% of tech management questioned intend to go on the prowl for marquee pieces to add to their arsenal.
Then we have chip company Broadcom (AVGO) led by CEO Hock Tan, whose entire strategy is based on M&A and minimal capital spending.
His low-quality strategy of buying market share will ultimately fritter out. His lack of capital spending was also a salient reason for blocking Broadcom's purchase of Qualcomm (QCOM), which if stripped of its capital spending budget would have fallen behind China's Huawei to develop critical 5G infrastructure.
Tan's strategy flies in the face of the most powerful tech companies that are using M&A to enhance their products expanding their halo effect around the world.
Gutting innovation and skimming profits off the top is an entirely self-serving, myopic strategy to the detriment of long-term shareholders.
Investors punished Broadcom for it's latest investment of CA Technologies (CA) for $18.9 billion, even though this pickup signals a different tack.
CA Technologies is a leading provider of information technology (IT) management software, which suggests a belated move into the enterprise software market dominated by incumbents such as Salesforce (CRM).
Better late than never.
No need to mince words here as 2018 won't see any discounts of any sort. Nimble buyers should prepare for price wars as the new normal.
Not only are the plain vanilla big cap tech firms dicing up ways to enter new markets, alternative funds are looking to splash the cash, too.
Sovereign wealth funds and private equity firms are ambitiously circling around like vultures above waiting for the prey to show itself.
Private equity firms dove head first into the M&A circus already tripling output for tech firms.
Highlighting the synchronized show of force is none other than Travis Kalanick, the infamous founder of Uber. He christened his own venture capital fund that hopes to invest in e-commerce, real estate, and companies located in China and India.
The new fund is called 10100 and is backed by his own money. All this is possible because of SoftBank CEO Masayoshi Son's investment in Uber, which netted Kalanick a cool $1.4 billion representing Kalanick's 30% stake in Uber.
It is undeniable that valuations are exorbitant, but all data and chip related companies are selling for huge premiums. The premium will only increase as the applications of 5G, A.I., autonomous cars start to pervade deeper into the mainstream economy.
Adding fuel to the fire is the corporate tax cut. The lower tax rate will rotate more cash into M&A instead of Washington's tax coffers enhancing the ability for companies to stump up for a higher bill. Sellers know firms are bloated with cash and position themselves accordingly.
Highlighting the challenges buyers face in a sellers' market is Microsemi Corp.'s (MSCC) purchase of PMC-Sierra Inc. Even though PMC-Sierra had been looking to get in bed with Skyworks Solutions Inc. (SWKS) just before the MSCC merger, PMC-Sierra reneged on the acquisition after (SWKS) refused to bump up its original offer.
(SWKS) manufactures radio frequency semiconductors facilitating communication among smartphones, tablets and wireless networks found in iPhones and iPads.
(SWKS) is a prime takeover target for Apple. (SWKS) estimates to have the highest EPS growth over the next three to five years for companies not already participating in M&A. Apple (AAPL) could briskly mold this piece into its supply chain. Directly manufacturing chips would be a huge boon for Apple in a chip market in short supply.
In 2013, Japan's Tokyo Electron and Applied Materials (AMAT) angled to become one company called Eteris. This maneuver would have created the world's largest supplier of semiconductor processing equipment.
After two years of regulatory review, the merger was in violation of anti-trust concerns according to the United States. (AMAT), headquartered in Santa Clara, California, is a premium target as equipment is critical to manufacturing semiconductor chips. (AMAT) competes directly with Lam Research (LRCX), which is an absolute gem of a company.
Juniper Networks (JNPR) sells the third-most routers and switches used by ISP's (Internet Service Providers). It is also No. 2 in core routers with a 25% market share. Additionally, (JNPR) has a 24.8% market share of the firewall market.
In 2014, Palo Alto Networks (PANW), another takeover target focusing on cybersecurity, paid a $175 million settlement fee for allegedly infringing (JNPR)'s application firewall patents.
In data center security applications, (JNPR) routinely plays second fiddle to Cisco Systems (CSCO). Cisco, the best of breed in this space would benefit by snapping up (JNPR) and integrating its expertise into an expanding network.
Unsurprisingly, health care is the other sector experiencing a tidal wave of M&A, and it's not shocking that health care firms accumulated cash hoards abroad too. The dots are all starting to connect.
Firms want to partner with innovative companies. Companies hope to focus on customer demands and build a great user experience that will lead the economy. Health care costs are outrageous in America, and Jeff Bezos could flip this industry on its head.
Amazon (AMZN) pursuing lower health costs ultimately will bind these two industries together at the hip and is net positive for the American consumer.
Ride-sharing company Uber embarked on a new digital application called Uber Health that book patients who are medically unfit for regular Uber and shuttle them around to hospital facilities.
Health care providers can hail a ride for sick people immediately and are able to make an appointment 30 days in advance. It is a little difficult to move around in a wheel chair, and tech solves problems that stir up zero appetite for most business ventures. Apple is another large cap tech titan keeping close tabs on the health care space.
It's a two-way street with health care companies looking to snap up exceptional tech and vice versa.
It's practically a game of musical chairs.
Ultimately, Tech M&A is the catch of the day, and boosting earnings requires cutting-edge technology no matter how expensive it is. Investors will be kicking themselves for waiting too long. Buy now while you can.
Yes, It's All Going Into Tech Stocks
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Quote of the Day
"Companies in every industry need to assume that a software revolution is coming," - said American venture capitalist Marc Andreessen.
