Mad Hedge Technology Letter
April 30, 2018
Fiat Lux
Featured Trade:
(RIDING THE CHIP ROLLER COASTER),
(Samsung), (SK Hynix), (AMD), (NVDA), (INTC), (MU)
The supply side of the chip market is spectacularly volatile, rotating between supply constraints and times of overcapacity.
A good place to analyze the heartbeat of the chip market is across the Pacific on South Korean shores.
South Korea takes pride and joy in having given the world two first-rate semiconductor companies - Samsung and SK Hynix.
Samsung is just behind Intel (INTC) in total annual sales.
American consumers are more familiar with Samsung through its consumer electronics division that constructs Samsung smartphones and tablets.
Samsung's silicon business mirrors the elevated earnings results stateside, as muscular demand derived from global data center expansion devours more chips than Samsung can pump out.
Global data centers in the U.S. and Asia will sustain blistering growth levels into the second quarter.
Samsung has displayed resilience to seasonally shift in the consumer electronics segment by staunchly bolstering its relentless chip business.
Samsung is harvesting the benefits of bountiful investments from over the past decade when this overly cyclical industry was exposed to extreme shifts in worldwide appetite for consumer electronics devices.
More than 70 percent of revenue was generated by the chip division boasting quarterly revenue of $19.25 billion.
In the past, memory chip companies endured a ruthless market environment with a diverse set of players ratcheting up supply on a whim then finding demand crumbling before their eyes.
Restructuring has left the burden of supplying the next generation of technology a backbreaking burden.
Tight chip supply and the general shortage of hardware rears its ugly head in earnings reports with a slew of CEOs complaining about input prices rising worse than global warming sea levels.
In Samsung's earnings call, management groaned that "memory supply and demand fundamentals remain tight."
In SK Hynix's earnings call, it echoed that "demand and supply dynamics in the market will remain favorable."
As large cap tech expands data center initiatives and throws piles of money at autonomous cars, A.I. and cloud computing, Samsung's semiconductor division appears nearly immortal.
Chip prices skyrocketed in this sellers' market and the UBS downgrade of Micron (MU) was a headscratcher.
Analyst Timothy Arcuri turned bearish on Micron citing "cyclical memory concerns" and "big estimate cuts."
Sometimes it feels that analysts don't follow the industry they cover.
It is fair to say chip volume might face marginal cuts closer to 2019, but the pendulum hasn't even started to shift back over to that direction.
Suppliers and buyers both agree that capturing the appropriate volume of chips is the first order of the day.
In response to outsized demand, Samsung will double chip capital spending because of failing to match skyrocketing demand.
Fortifying the bull case, SK Hynix guesstimated DRAM demand for the rest of 2018 to be in the "low-20 percent" and even the injection of new funds for facility expansion is not a proper solution.
Samsung also hammered into investors that it is not in the business to drive the chip prices to zero, and the gross profit metric is more important to them than most people expect.
A goldilocks scenario could ensue with Samsung supplying enough to create price hikes and ploughing its cash back into more silicon expansion.
Korean memory chip producers are expected to enjoy a booming business during the remainder of this year as global DRAM chip demand will surpass supply.
SK Hynix also indicated that server products would supersede mobile products as data center related products are all the rage.
Korea's No. 2 said NAND demand would rise by "mid-40 percent" in 2018, which is double the rise in demand than DRAM products.
Instead of the estimate cuts on which UBS is waiting, the more likely scenario is an easing of chip constraints. The easing will last just long enough before the next massive wave of demand hits with a vengeance.
You read my thoughts - the generational paradigm shift due to hyper-accelerating technology has largely made the boom-bust cycle irrelevant.
Chip demand will go up in a straight line, and this is just the beginning.
Legend has it that demand weakness shows up every 15 years. The last one was the global financial crisis in 2008, and the one before that was the dot-com crash of 2001.
In both instances, the disappearance of demand contributed to massive oversupply. The declining prices set off a price war eradicating margins and revenue.
SK Hynix net profit was $2.89 billion last quarter, an increase of 64.4 percent YOY.
SK Hynix capital allocation layout includes a spanking new factory in Cheongju, a city in South Korea.
The insatiable demand brought on by China's quest for technological supremacy is the market the new Cheongju factory will serve.
International chip directors fret that a sudden breakthrough in local Chinese technology could ignite a supply bonanza of cut-rate semiconductors, forcing a recapitulation of the entire industry that encountered egregious oversupply issues about 10 years ago.
But China can't dump low-cost chips into the market due to technological frailties.
Notice that Chinese capital has been flirting with American chip companies for years without success.
The Chinese government even initiated an investigation at the tail end of last year because DRAM price spikes were indigestible for local Chinese companies.
The dearth of supply is not just restricted to one extraneous niche of the hardware industry, as the tightness is broad-based.
Don't look further than AMD (AMD), which specializes in GPU (graphics processing unit) products and has received glowing reviews for its Ryzen and EPYC CPU processors that boast higher-level performance than previous products.
The RX Vega series is the new line of GPUs from AMD that launched last August. Tech-enthusiast website techspot.com described finding these GPUs on sale in stores as "next to impossible."
AMD is well informed of the market outlook and NVIDIA (NVDA) notes that hardware-intensive cryptocurrency mining is stoking excess marginal demand for its products.
AMD is boosting production, but manufacturing is set back by a component shortage in GDDR5 memory, which is needed in the RX 400 card.
The RX 500 card, part of the RX Vega line, is also having delays with a lack of HBM2 memory.
Crypto-fanatics aren't the only consumers clamoring for extra GPUs; gamers require GPUs to perform at top levels.
AMD has even urged retailers to advise gamers of any outlets where they can buy GPUs because of the dearth of supply.
Gamers are being outmaneuvered for GPUs as crypto-miners usually buy up every last unit to transport to mining farms in far-flung places with cheap energy.
Hardware products cannot be produced fast enough to meet demand.
Other industries vying for a portion of chips are military, aerospace, IoT (Internet of Things) products, and autonomous cars.
Incremental supply is accruing but often the supply is added slower than initially thought. Suppliers are hesitant to double down on new factories because of past, bitter experiences at the end of a cycle.
Management monitors inventory channels like a hawk eyeing its prey, and it's clear that organic demand is following through.
After running away with 22.2% growth in 2017, the semiconductor industry is due to take a quick breather expanding in the upper teens in 2018.
A year is an eternity in technology and calling for production "cuts" in a period of massive undersupply is premature.
The claim of "cyclical" headwinds comes at a time of a new-found immunity to cyclical demand and is dubious at best.
This secular story has legs. Don't believe every analyst that pushes out reports. They often have alternative motives.
Nvidia (NVDA) reports earnings on May 10, and CEO Jensen Huang does a great job explaining the development at the front-end of the tech revolution.
Earnings should be extraordinary. Imagine if the price of bitcoin stabilizes, GPU manufacturers will wrestle with continuous quarters of strained supply.
I am bullish on chips.
_________________________________________________________________________________________________
Quote of the Day
"Focus on the 20 percent that makes 80 percent of the difference." - said Salesforce CEO Marc Benioff when asked to explain the story of his cloud business.
Mad Hedge Technology Letter
April 27, 2018
Fiat Lux
Featured Trade:
(WEDNESDAY, JUNE 13, 2018, PHILADELPHIA, PA, GLOBAL STRATEGY LUNCHEON)
(THURSDAY, JUNE 14, 2018, NEW YORK, NY, GLOBAL STRATEGY LUNCHEON)
Come join me for lunch at the Mad Hedge Fund Trader's Global Strategy Update, which I will be conducting in Philadelphia, PA, on Wednesday, June 13, 2018. An excellent meal will be followed by a wide-ranging discussion and an extended question-and-answer period.
I'll be giving you my up-to-date view on stocks, bonds, currencies, commodities, precious metals, and real estate. And to keep you in suspense, I'll be throwing a few surprises out there, too. Tickets are available for $238.
I'll be arriving at 11:45 AM, and leaving late in case anyone wants to have a one-on-one discussion, or just sit around and chew the fat about the financial markets.
The lunch will be held at an exclusive downtown private club. The precise location will be emailed with your purchase confirmation.
I look forward to meeting you and thank you for supporting my research.
To purchase a ticket, please click here.
Come join me for lunch at the Mad Hedge Fund Trader's Global Strategy Update, which I will be conducting in New York City on Thursday, June 14, 2018. An excellent meal will be followed by a wide-ranging discussion and an extended question-and-answer period.
I'll be giving you my up-to-date view on stocks, bonds, currencies, commodities, precious metals, and real estate. And to keep you in suspense, I'll be throwing a few surprises out there, too. Tickets are available for $278.
I'll be arriving at noon and leaving late in case anyone wants to have a one-on-one discussion, or just sit around and chew the fat about the financial markets.
The lunch will be held at an exclusive downtown private club. The precise location will be emailed with your purchase confirmation.
I look forward to meeting you and thank you for supporting my research.
To purchase a ticket, please click here.
Mad Hedge Technology Letter
April 26, 2018
Fiat Lux
Featured Trade:
(THE SMALL AI PLAY YOU'VE NEVER HEARD OF),
(BOX), (GOOGL), (MSFT), (AMZN), (IBM)
The cloud segment of technology is hotter than hot, and as this sector starts to trade at a big premium, investors will have to look further down the chain of command to find a reasonable deal.
An up-and-coming cloud service Box (BOX) has gone undiscovered and is in position to seize a larger share of the cloud market moving forward.
The firm is led by CEO Aaron Levie who dropped out of my old alma mater USC in 2005 to start a cloud company with acting CFO and childhood friend Dylan Smith.
Last quarter was record-setting for Box, and it had a number of significant six- and seven-digit deals. Keep in mind Box's revenues are paltry compared to the behemoths that run this industry.
The platform has seen gradual success from all corners of the business world with various businesses from insurance claims processors to wealth advisors who use Box as a back-end platform.
Health care is another industry deploying the Box platform to aid and develop cloud services for patients.
In a general sense, the beauty of the cloud is the propensity to adapt to any company that is willing to go digital.
Even though many legacy companies are not natively digital, the cloud can twist and contort to fit the customers' needs.
Levie raised some compelling arguments for the continued tech momentum stating that imminent regulation in Europe through General Data Protection Regulation (GDPR) will act as a "broader tailwind in compliance and security efforts."
Box also announced a "readiness (GDPR) package" revealing that tech companies have been planning for the regulation overhaul up to 18 months in advance.
Even though mass media sensationalism would lead investors to believe the threat of regulation is about to blindside this whole sector, the unrest has been bubbling up for quite some time allowing tech companies ample time to get their houses in order.
Box actually sees the genesis of GDPR as a critical part of the cloud adoption process.
As dinosaur systems become outdated, a sense of safety reinforced by strong cybersecurity protection, strong privacy rules, and content compliance will nudge companies to head for the cloud like a drunk sailor to a pub.
Legacy platforms are the most susceptible to cyber-criminals and rogue hackers.
The analog defense is no match for sophisticated cyber-espionage, and GDPR will be another "driving force" behind the macro-migration shift to the cloud, just based on the security aspect alone.
Another pearl of wisdom offered by Box is that the bulk of clients requiring cloud products are integrating Microsoft Office 365.
This software acts as a lynchpin to any cloud service.
I must confess that I am writing this story on Microsoft Office 365 now, and most businesses cannot function without the dizzying array of Excel, PowerPoint, and Word.
Box has a strong relationship with Microsoft and has incisive insight into the synergies the cloud industry spins off.
The integration of Office 365 has complemented the Azure cloud with tighter cohesiveness.
The school of thought is the collective cloud industry is a $50 billion per year market and growing, offering smaller firms healthy growth levers to advance at the same time that the Microsofts (MSFT) and Amazons (AMZN) overperform.
At the Sohn Investment Conference in New York, Chamath Palihapitiya, a venture capitalist and former Facebook executive, extolled Box as a great way to play Artificial Intelligence (AI).
The shares spiked almost 13% upon his adulation.
A recent completed survey showed 66% of business leaders feel the pace of digitization must pick up in their own offices.
The speed of innovation is something that keeps most CEOs up at night. Wake up tomorrow and it is possible their core products could be outdated or disrupted by a new Amazon threat.
That is the world we live in now.
Only 42% of CIOs admitted they have a digital strategy. And of those digital strategies, they are mostly digital second or third, not digital first, blueprints.
In the same PricewaterhouseCoopers (PwC) survey, companies conceded that only 40% of IT teams are able to pursue the newest innovations with adopting specific operational needs in mind.
The micro-environment harbors the same bullishness as the macro-factors.
Box is hitting all the right notes.
Revenue is advancing at a 24% per year clip, and annual revenue surpassed the half a billion mark.
Box has indicated it expects to cross the $1 billion annual revenue threshold sometime in mid- to late 2021, giving the company more than three years to double revenue.
Recent reports support Box's growth trajectory.
About 60% of revenue derives from firms that employ more than 2,000 workers, highlighting Box's propensity to emphasize enterprise cloud development instead of small individual users.
Working with larger companies gives Box the opportunity to cross-sell more powerful add-ons, delivering a net expansion rate of 14%.
Migrating to a new cloud platform is incredibly sticky boosting retention rates. Box's churn rate is flourishing with a best of breed 4% per year. The key to expediting cloud success is quickening its pace of new product rollout.
Box attempts to give exactly what customers need with a spate of new concoctions.
Box GxP is a new product calibrated around life science companies. The Box GxP compliance is up to date with FDA regulations. And, Box has the ability to retire legacy ECM (Enterprise Content Management) systems.
This new service has experienced solid traction around the world as we head toward a world where legacy software becomes obsolete.
The second new offering is Box Skills, still in beta mode, which is a part of Box's artificial intelligence strategy.
Box is platform neutral allowing in-house architecture to support partnerships with Google, Microsoft, Amazon, and IBM to nail down third-party cloud tools that Box customers need.
Box Skills is a framework that brings the best machine learning innovation to content securely stored in Box.
This is managed through artificial intelligence, which automatically contextualizes images through detection protocols. Text recognition is automated for the benefit of the user, too.
Audio intelligence renders text transcripts and detects topics that can be searched in Box to locate an audio file by words or topic.
Video intelligence offers transcription, topic detection, and facial recognition allowing users to jump around video files in a non-linear fashion.
Palihapitiya effectively gave Box a free commercial to the tech investing world. His bull thesis for Box squarely centers around its AI innovations, specifically Box Skills.
The last new service to market is Box Transform, which is the advanced consulting arm of Box.
The goal of Transform is to arrange a concierge-like Box advisor that can help companies accelerate digital transformation throughout an organization while unlocking efficiencies and productivity for employees.
This service originated from Box's consulting advanced professional services team and will give Box another growth lever. Companies such as Red Hat and Intel have made the consultant- and support-side of the business a robust part of their organizations.
Impeding growth is the cutthroat competition in this space with Amazon, Microsoft, and Google (GOOGL).
However, margins remain strong at 75.5% last quarter, and Box expects margins to slightly dip around 74% this year.
Box has found a warm welcome for its newer products, deriving almost 70% of its new deals from fresh cloud offerings.
Partners are also a big source of new deals comprising more than half the deals over $100,000.
Specifically, IBM (IBM) made up a swath of its larger deals. In a sense, competitors are not really competitors.
They are frenemies. They compete against each other yet innovate and do deals together.
The core growth is supplemented by existing customers that are the best source of extra marginal revenue.
In short, once firms are firmly lodged on a platform, they buy everything on that platform.
Enter a supermarket, and odds are if goods are purchased, the receipt will be from the entered supermarket.
Box is entirely leveraged toward mid-sized and large enterprise business. That is where it makes its money.
The emphasis on large players boosts the ACV (Average Contract Value), which is regarded as a sacrosanct metric for Box.
The amount of data created in 2017 was more data created in the past 5,000 years. In the next five years, data volume with grow by 800%.
Box has continually positioned itself as the firm that can extract a staggering amount of unrealized value locked away in the nooks and crannies of legacy models.
Box is a great long-term hold as these diminutive cloud assets become more valuable by the day.
_________________________________________________________________________________________________
Quote of the Day
"Television won't be able to hold onto any market it captures after the first six months. People will soon get tired of staring at a plywood box every night." - said Darryl F. Zanuck, co-founder of Twentieth Century-Fox Film Corp.
Mad Hedge Technology Letter
April 25, 2018
Fiat Lux
Featured Trade:
(FANGS DELIVER ON EARNINGS, BUT FAIL ON PRICE ACTION),
(GOOGL), (AMZN), (MSFT), (AAPL), (FB),
(DBX), (NFLX), (BOX), (WDC)
Alphabet (GOOGL) did a great job alleviating fears that large-cap tech would be dragged through the mud and fading earnings would dishearten investors.
The major takeaways from the recent deluge of tech earnings are large-cap tech is getting better at what they do best, and the biggest are getting decisively bigger.
Of the 26% rise to $31.1 billion in Alphabet's quarterly revenue, more than $26 billion was concentrated around its mammoth digital ad revenue business.
Alphabet, even though rebranded to express a diverse portfolio of assets, is still very much reliant on its ad revenue to carry the load made possible by Google search.
Its "other bets" category failed to impact the bottom line with loss-making speculative projects such as Nest Labs in charge of mounting a battle against Amazon's (AMZN) Alexa.
The quandary in this battle is the margins Alphabet will surrender to seize a portion of the future smart home market.
What we are seeing is a case of strength fueling further strength.
Alphabet did a lot to smooth over fears that government regulation would put a dent in its business model, asserting that it has been preparing for the new EU privacy rules for "18 months" and its search ad business will not be materially affected by these new standards.
CFO Ruth Porat emphasized the shift to mobile, as mobile growth is leading the charge due to Internet users' migration to mobile platforms.
Google search remains an unrivaled product that transcends culture, language, and society at optimal levels.
Sure, there are other online search engines out there, but the accuracy of results pale in comparison to the preeminent first-class operation at Google search.
Alphabet does not divulge revenue details about its cloud unit. However, the cloud unit is dropped into the "other revenues" category, which also includes hardware sales and posted close to $4.4 billion, up 36% YOY.
Although the cloud segment will never dwarf its premier digital ad segment, if Alphabet can ameliorate its cloud engine into a $10 billion per quarter segment, investors would dance in the streets with delight.
Another problem with the FANGs is that they are one-trick ponies. And if those ponies ever got locked up in the barn, it would spell imminent disaster.
Apple (AAPL) is trying its best to diversify away from the iconic product with which consumers identify.
The iPhone company is ramping up its services and subscription business to combat waning iPhone demand.
Alphabet is charging hard into the autonomous ride-sharing business seizing a leadership position.
Netflix (NFLX) is doubling down on what it already does great - create top-level original content.
This was after it shed its DVD business in the early stages after CEO Reed Hastings identified its imminent implosion.
Tech companies habitually display flexibility and nimbleness of which big corporations dream.
One of the few negatives in an otherwise solid earnings report was the TAC (traffic acquisition costs) reported at $6.28 billion, which make up 24% of total revenue.
An escalation of TAC as a percentage of revenue is certainly a risk factor for the digital ad business. But nibbling away at margins is not the end of the world, and the digital ad business will remain highly profitable moving forward.
TAC comprised 22% of revenue in Q1 2017, and the rise in costs reflects that mobile ads are priced at a premium.
Google noted that TAC will experience further pricing pressure because of the great leap toward mobile devices, but the pace of price increases will recede.
The increased cost of luring new eyeballs will not diminish FANGs' earnings report buttressed by secular trends that pervade Silicon Valley's platforms.
The year of the cloud has positive implications for Alphabet. It ranks No. 3 in the cloud industry behind Microsoft (MSFT) and Amazon.
Amazon and Microsoft announce earnings later this week. The robust cloud segments should easily reaffirm the bullish sentiment in tech stocks.
Amazon's earnings call could provide clarity on the bizarre backbiting emanating from the White House, even though Jeff Bezos rarely frequents the earnings call.
A thinly veiled or bold response would comfort investors because rumors of tech peaking would add immediate downside pressure to equities.
The wider-reaching short-term problem is the macro headwinds that could knock over tech's position on top of the equity pedestal and bring it back down to reality in a war of diplomatic rhetoric and international tariffs.
Google, Facebook, and Netflix are the least affected FANGs because they have been locked out of the Chinese market for years.
The Amazon Web Services (AWS) cloud arm of Amazon blew past cloud revenue estimates of 42% last quarter by registering a 45% jump in revenue.
Microsoft reiterated that immense cloud growth permeating through the industry, expanding 99% QOQ.
I expect repeat performances from the best cloud plays in the industry.
Any cloud firm growing under 20% is not even worth a look since the bull case for cloud revenue revolves around a minimum of 20% growth QOQ.
Amazon still boasts around 30% market share in the cloud space with Microsoft staking 15% but gaining each quarter.
AWS growth has been stunted for the past nine quarters as competition and cybersecurity costs related to patches erode margins.
Above all else, the one company that investors can pinpoint with margin problems is Amazon, which abandoned margin strength for market share years ago and that investors approved in droves.
AWS is the key driver of profits that allows Amazon to fund its e-commerce business.
Cloud adoption is still in the early stages.
Microsoft Azure and Google have a chance to catch up to AWS. There will be ample opportunity for these players to leverage existing infrastructure and expertise to rival AWS's strength.
As the recent IPO performance suggests, there is nothing hotter than this narrow sliver of tech, and this is all happening with numerous companies losing vast amounts of money such as Dropbox (DBX) and Box (BOX).
Microsoft has been inching toward gross profits of $8 billion per quarter and has been profitable for years.
And now it has a hyper-expanding cloud division to boot.
Any macro sell-off that pulls down Microsoft to around the $90 level or if Alphabet dips below $1,000, these would be great entry points into the core pillars of the equity market.
If tech goes, so will everything else.
If it plays its cards right, Microsoft Azure has the tools in place to overtake AWS.
Shorting cloud companies is a difficult proposition because the leg ups are legendary.
If traders are looking for any tech shorts to pile into, then focus on the legacy companies that lack a cloud growth driver.
Another cue would be a company that has not completed the resuscitation process yet, such as Western Digital (WDC) whose shares have traded sideways for the past year.
But for now, as the 10-year interest rate shoots past 3%, investors should bide their time as cheaper entry points will shortly appear.
_________________________________________________________________________________________________
Quote of the Day
"Technology is a word that describes something that doesn't work yet." - said British author Douglas Adams.
Mad Hedge Technology Letter
April 24, 2018
Fiat Lux
Featured Trade:
(WHAT THE MEDIA REALLY WANTS FROM YOU),
(TRNC), (AMZN), (FB), (GOOGL), (USPS), (SFTBY)
