Mad Hedge Technology Letter
April 3, 2018
Fiat Lux
Featured Trade:
(THE BIG WINNER FROM THE PHOENIX CAR CRASH),
(WAYMO), (TSLA), (GOOGL), (AAPL), (AMZN), (UBER), (GM), (FB)
In 2014, the juicy sound clips recorded by NFL legend Chris Carter at the annual NFL rookie symposium would be enough for those at league headquarters to have nervous breakdowns.
During a keynote speech, Chris Carter recommended that every rookie about to kick-start a sports career should find a "fall guy" just in case they found themselves on the wrong side of the law.
Carter later rescinded his comments and sincerely apologized for insinuating marginal tactics.
Lo and behold, it seems the most attentive listeners at the symposium weren't the players but the swashbuckling chauffeur-share service that has become the "fall guy" of Big Tech, none other than Uber.
The great thing (read: sarcastic here) for Uber about killing a pedestrian with autonomous vehicle technology is that it does not need to change its Silicon Valley mind-set of "move fast and break things."
Everything Uber touches seems to turn to mush. At least lately.
This revelation is extremely bullish for the other big players in the A.I. (Artificial Intelligence) driverless car space, mainly Waymo and General Motors (GM).
Granted, Uber came late to the party, but that cannot be an excuse for the myriad of shortcuts it promotes to build its business.
Waymo, the autonomous subsidiary of Google (GOOGL), has been honing its software, algorithms, and sensors for the past nine years like a sage samurai swordsmith from Kyoto. This type of detailed nurturing has led Waymo to rack up more than 5 million miles of testing on live roads.
The company recently commenced the first niche ride-hailing service in Phoenix, AZ, and just announced that it will purchase up to 20,000 electric cars from Jaguar Land Rover in a $1 billion deal to outfit with its cutting-edge technology.
Every day is a joyous day for Waymo because the first mover advantage is in full effect.
GM, another laggard, though considered in the top three, won't commence its robotic car fleet until late 2019. However, by that time, Waymo could be on the verge of mass rollouts if there are no setbacks.
The cherry on top for Waymo is Uber's knack of making a dog's breakfast of anything it pursues, magnifying an insurmountable lead for Waymo to possess.
Granted, the autonomous vehicle brain trust expected casualties, and the firm that made news for this mishap would be stuck with this label along with suspended operations.
Waymo missed a direct hit thanks to Uber and Tesla.
Tesla also took a direct hit when it announced that Walter Huang, an Apple engineer, sadly was killed in a Model X accident last weekend while his car was on autopilot.
It capped a horrible week by announcing a comprehensive recall of every Model S made before April 2016 for a faulty part. After fighting tooth and nail to maintain the $300 support level, Tesla swiftly sold off down to $250.
The disruption fetish permeating the ranks of the tech industry has its merits. Often the end result manifests through cheaper prices and better consumer services.
However, Uber's over-aggressiveness has placed it at the forefront of the regulation backlash along with Facebook (FB).
Google has certainly been playing its cards right, and having not run over a pedestrian consolidates its leading position
Luckily, the National Transportation Safety Board does not punish every participant using this technology.
No news is good news.
An extensive review of internal processes will hit team morale, and the burden of blame with fall upon the engineers.
The fallout from the tragic incidents will set back Tesla and Uber at least three to six months.
The suspension of their operations is akin to a white flag because Waymo is currently leaps ahead and plans to ramp up the mass rollout in the next two years with technology that is best of breed.
The running joke in the industry is that Uber's autonomous vehicle engineers are comprised of Waymo rejects.
Waymo already has more than 600 for-profit vehicles in operation in Arizona. And as every day without a fatality is considered a success, the Jaguars are next in line to be tricked-out with sensors and software.
Unceremoniously, Waymo has focused on safety as the pillar of its autonomous driving operation. Its conservative attitude toward danger will serve it well in the future. Waymo even spouted that its technology would have avoided the Uber accident.
Waymo has no desire to physically produce cars, but it aspires to sell licenses to the technology that could be installed in trucks and delivery vehicles, too.
The licenses could act as de-facto SaaS (software as a service) reoccurring revenue that has catapulted cloud companies to untold heights.
Google would also be able to integrate Google Maps, Google Docs, and all Google services into the robot-cab experience. The robo-taxi would merely serve as an incubation chamber to use the plethora of Google services while being transported from point A to point B.
And with Uber temporarily wiped off the map, Waymo seems like a great bet to monetize this segment at massive scale.
Google is truly on a roll as of late, even finding the perfect fall guy for the big data leak that has roiled the tech world, inducing a wicked tech sell-off - Facebook.
Instead of extracting data from user-posted content, Google's search builds a profile on users' search tendencies, and it is just as culpable in this ordeal.
Ironically, all the heat is coming down on Facebook's plate, and Mark Zuckerberg's lack of tactical PR noise is cause for investor concern.
The mountains of cash vaulted up over the years has made barriers of entry into new fields simple.
For example, Amazon's desire to lead health care came out of left field, and 10 years ago nobody ever thought the iPod company would make smart watches.
The interesting development in broader tech is the disintegration of unity that once supported the backbone of these firms.
Tim Cook, chief executive officer of Apple, railed on Facebook's business model and trashed Mark Zuckerberg's blatant disregard for privacy in order to profit from people's personal lives.
Large cap tech has never had as much overlap as it does now, and the new normal is throwing others under the bus.
If Google is dragged into the Facebook regulatory orbit, the silver lining is that the world's best autonomous driving technology will soon transform its narrative and put its incredibly profitable search business on the back burner.
Markets are forward looking and reward outstanding growth stories.
Tech is growth.
Morgan Stanley issued a report claiming the repercussions of mass-integrating this technology would be to the tune of about half a trillion dollars. That includes the $18 billion saved in annual health costs to automotive injuries. Also, 42% of police work ignites from a simple traffic stop. This would vanish overnight as well as concrete parking garages that blight cities. Car insurance is another industry that will be swept into the dustbin of ancient history.
Yes, tech has evolved that fast when Google can start claiming its revered search business as the daunted L word - legacy business.
The fog of war is starting to burn off and the visible winner is Waymo.
The shaping of its autonomous vehicle business is starting to take concrete form and although this won't affect earnings in the next few years, it will be a game changer of monumental proportions.
Uber is seriously in the throes of having an existential problem because of Waymo's outperformance. Venture capitalists heavily invested in Uber because of the promises of autonomous vehicle technology.
This is its entire growth story of the future.
Without it, it is a simple taxi company run on an app. There is no competitive advantage.
Waymo is on the verge of creating a scintillating growth business that is effectively Uber without a driver while simultaneously destroying Uber.
Ouch!
It speaks volumes to the ascendancy. And if Waymo miraculously capitulates, Google can always call Chris Carter and find another "fall guy."
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Quote of the Day
Asked what he would do if he was Mark Zuckerberg, Apple CEO Tim Cook said, "I wouldn't be in this situation."
Mad Hedge Technology Letter
April 2, 2018
Fiat Lux
Featured Trade:
(WHY THERE WILL NEVER BE AN ANTITRUST CASE AGAINST AMAZON)
(AMZN), (WMT), (MSFT), (FB), (DBX), (NFLX)
POTUS's Amazon tweet of March 29 has given investors the best entry point into Amazon (AMZN) since the January 2016 sell-off. Since then, the stock has essentially gone up every day.
Entry points have been few and far between as every small pullback has been followed by aggressive buying by big institutional money.
The 200-point nosedive was a function of the White House's dissatisfaction of leaked stories that would find their way into the Washington Post owned by Amazon CEO Jeff Bezos, my former colleague and good friend.
Although there are concerns about Amazon's business model, notably its lack of actual profits, there is no impending regulatory action. And, if there is one company that's in hotter water now, it's Facebook (FB), which inadvertently sells every little detail about your personal life to third-party Eastern European hackers.
Amazon's e-commerce business does not violate the Federal Trade Commission Act of 1914 of "deceptive" or "unfair practices."
The American economy has rapidly evolved thanks to hyper-accelerating technology, and the jobs required to support the modern economy have changed beyond all recognition.
The Clayton Antitrust Act of 1914 addressing harmful mergers that destroy competition hasn't been breached either since Amazon has grown organically.
Analyzing the most comprehensive law, the Sherman Antitrust Act of 1890, which was originally passed to control unions, espouses economic freedom aimed at "preserving free and unfettered competition as the rule of trade."
And, in a way, Amazon could be susceptible, but it would be awfully difficult to persuade the U.S. Department of Justice (DOJ) Antitrust Division and would take a decade.
Amazon's business model will change many times over by the time any antitrust decision can be delivered, or even entertained.
Helping Amazon's case even more is the DOJ interpretation of the three antitrust rules. It is the company's duty to first and foremost protect the consumer and ensure business is operating efficiently, which keeps prices low and quality high. Antitrust laws are, in effect, consumer protection laws.
Amazon's e-commerce segment epitomizes the DOJ's perception of these 100-year-old laws.
The controversial part of Amazon's business model is funneling profits from its Amazon Web Services (AWS) division as a way to offer the lowest prices in America for its e-commerce products.
This strategy has the same effect as dumping since it is selling products for a loss, but it is not officially dumping.
POTUS has usually delivered more bark than bite. The steel and aluminum tariffs went from no exceptions to exceptions galore in less than a week. Policies and employees change in a blink of an eye in the White House.
The backlash is a case of the White House not being a huge admirer of Amazon, but individual government workers probably have Amazon boxes stacked to the heavens on their doorsteps.
It is true that Amazon has negatively affected retail business. It is doing even more damage to traditional shopping malls, which it turns out are owned by close friends of the president. The mom-and-pop stores have disappeared long ago. But Amazon could argue this trend is occurring with or without Amazon.
In addition, Walmart (WMT) was the original retail killer, and it currently is morphing into another Amazon by investing aggressively into its e-commerce division. Does the White House go after (WMT) next?
Unlikely.
Amazon didn't create e-commerce.
Amazon also didn't create the Internet.
Amazon also does pay state and local taxes, some $970 million worth last year.
Technology has been a growth play for years.
Investors and venture capitalists are willing to fork over their hard-earned cash for the chance to own the next Google (GOOGL) or Apple (AAPL).
Many investors do lose money searching for the next unicorn. A good portion of these unicorns lose boatloads of money, too.
Spotify, slated to go public soon, is a huge loss-maker and investors will pay up anyway.
Investors went gaga for Dropbox (DBX), already up 40% from its IPO, and it lost $112 million in 2017.
The risk-appetite is hearty for these burgeoning tech companies if they can scale appropriately.
Should investors be prosecuted for gambling on these cash-losing businesses?
Definitely not. Caveat emptor. Buyer beware.
It is true that Amazon pumps an extraordinary percentage of revenues back into product development and enhancement.
But that is exactly what makes Amazon great. It not only is focused on making money but also on making a terrific product.
The bulk of its enhancement is allocated in warehouse and data center expansion. Splurging on more original entertainment content is another segment warranting heavy investment, too, a la Netflix (NFLX). Did you spot Jeff Bezos at the last Oscar ceremony?
Contrary to popular belief, Amazon is in the black.
It has posted gains for 11 straight quarters and expects a 12th straight profitable quarter for Q1 2018.
The one highly negative aspect is profit margins. It is absolutely slaughtered under the current existing model.
However, investors continually ignore the damage-to-profit margins and have a laser-like focus on the AWS cloud revenue.
Amazon's AWS segment could be a company in itself. Cloud revenue last quarter was $5.11 billion, which handily beat estimates at $4.97 billion.
Amazon's cloud revenue is five times bigger than Dropbox's.
The biggest threat to Amazon is not the administration, but Microsoft (MSFT), which announced amazing cloud revenue numbers up 98% QOQ, and has grown into the second-largest cloud player.
(MSFT) is equipped with its array of mainstay software programs and other hybrid cloud solutions that lure in new enterprise business.
(MSFT) has the chance to break Amazon's stranglehold if it can outmuscle its cloud segment. However, any degradation to Amazon's business model will not kill off AWS, considering Amazon also is heavily investing in its cloud segment, too.
Lost in the tweet frenzy is this behemoth cloud war fighting for storage of data that is somewhat lost in all the political noise.
This is truly the year of the cloud, and dismantling Amazon is only possible by blowing up its AWS segment. The more likely scenario is that AWS and MSFT Azure continue their nonstop growth trajectory for the benefit of shareholders.
Antitrust won't affect Amazon, and after every dip investors should pile into the best two cloud plays - Amazon and Microsoft.
__________________________________________________________________________________________________
Quote of the Day
Mad Hedge Technology Letter
March 29, 2018
Fiat Lux
Featured Trade:
(TECHNOLOGY'S UPSIDE IN THE TRADE WAR)
(RHT), (DBX), (SPOTIFY)
After watching the performance of technology stocks over the past two weeks, you may be on the verge of slitting your wrist, overdosing on drugs, and then jumping off the Golden Gate Bridge.
However, the results reported by tech companies this week say you should be doing otherwise.
As tech companies confront upcoming regulation and an overseas trade war, it has felt like a death by a thousand cuts.
It almost is starting to feel as if being a technology company is akin to drinking from a poisoned chalice.
I beg to differ.
I will tell you why the destiny of tech is quite positive.
The long-term secular growth drivers will prevail of accelerated earnings amid a backdrop of global economic synchronized expansion.
Assiduous capital reallocation programs will attract investors instead of detract from them.
The ironic angle to the precarious diplomatic tumult is that regulation will ultimately benefit the current pacesetters and culprits of technology because the barriers of entry become insurmountable.
The trade war has the same effect as the data regulation because it is ultimately for the betterment and protection of domestic, made-in-USA technology.
Washington knows the FANGs all too well, and the bull market will cease to exist if Beijing buys out our technological expertise.
Short-term pain for long-term gain. That's it in a nutshell.
The White House further understands that it's better to start a trade war now when it holds a stronger hand. No doubt after 20 more years of an ascending China, the Middle Kingdom will leverage its economic clout for diplomatic power dictating the outcome more ruthlessly.
Effectively, Trump's trade fracas is a one step back and two steps forward policy. During the one step back phase simply seems as if the economy is taking a nosedive into the ocean floor.
Love it or hate it, technology is becoming more (and not less) ubiquitous. However, it's gone too far too fast, and society and public officials require time to absorb the new environment or you risk the current backlash.
Simultaneously, America is in the one step back phase of data regulation, trade laws, and society's backlash of encroaching tech.
Bad timing.
The teething problems will gradually subside, the stock market will re-ignite, and tech will advance further into regular life.
The market even has seen some green shoots with the blockbuster Dropbox (DBX) IPO up over 40% intraday on the first day of trading.
In the S-1 filing required for IPOs, (DBX) stated that it may "not be able to achieve or maintain profitability" because of increasing expenses. The disclosure also prefaced its "history of net losses" to justify the business direction.
(DBX) lost $111.7 million in 2017, on revenues of just over $1 billion.
Technology must be doing something right if loss-making firms are treated with a 40% gain on IPO day; and, Spotify, an even bigger money loser, will go public next week.
If investors are smitten with loss-making tech companies, I imagine they feel quite comfortable with the ones earning billions in quarterly profits and growing at a pace where analysts cannot hike their price targets quick enough, making them look foolish.
The outstanding gains by (DBX) was for one reason and one reason only.
It's a pure cloud play, and pure cloud plays have been rewarded in spades.
Red Hat's (RHT) stellar earnings were on the heels of the (DBX) IPO success.
Red Hat is a medium-size unadulterated cloud play that lacks the financial resources of the FANGs but is still turning a profit.
It is the poster boy for enterprise cloud companies flourishing in an unrelenting fierce environment.
If the world is going to hell in a handbasket, then how did Red Hat achieve aggregate billings growth of 25%?
Everyone and their uncle expect tech companies to start floundering, but the opposite is true. They overpromise then over deliver to the upside every quarter.
Red Hat booked the most deals over $1 million in Q4 2017 in its history.
Cross-selling cloud applications was especially strong with 81% of deals over $1 million spending on multiple software services.
The critical subscription revenue comprised 88% of Q4 revenue and is up 15% YOY. Application development-related subscriptions were up 42% YOY, higher than the infrastructure-related subscription revenue growing 17% YOY.
Companies are churning out innovation on top of their existing platforms using various software solutions. And every company in the world is migrating toward cloud software and infrastructure. There has never been a better time to be a pure cloud company.
The most poignant telltale sign was that Red Hat renewed 99 out of 100 of its top deals and disclosed that multiyear deals were healthy.
Ansible, its software for automating data center operations, OpenShift, its software for container-based deployment and management, and OpenStack, an infrastructure-as-a-service (IaaS) for cloud computing are the underpinnings to Red Hat's supreme business.
The reoccurring revenue salted away is legion.
The FY 2018 guidance was even more impressive than the quarterly earnings report. Red Hat expects a revenue range between $800 million and $810 million, up from the $748 million last quarter and expects quarterly EPS at $0.81, up from $0.70 last quarter.
Toward the end of the earnings call, Red Hat CEO Jim Whitehurst described the cloud growth environment as "very, very, very fast growth."
Market conditions and heightened volatility could stay irrational for longer than expected but leadership stocks are always the last to fall.
If (DBX) can catch a bid, and headway is made on political issues, then jump back into the cloud names that perform like Red Hat and about which I have been beating the drum.
And don't forget that these regulatory and political hindrances all point toward giving big cap tech cozier conditions and an elevated runway from which to operate.
__________________________________________________________________________________________________
Quote of the Day
"We know where you are. We know where you've been. We can more or less know what you're thinking about." - said Eric Schmidt in 2010, the former executive chairman of Google from 2001-2017
Mad Hedge Technology Letter
March 28, 2018
Fiat Lux
Featured Trade:
(HOW THE COBALT SHORTAGE WILL LEAD TO THE $2,000 IPHONE)
(AAPL), (SSNLF), (CMCLF), (FCX), (VALE), (GLNCY), (VLKAY), (BMWYY)
Hello $2,000 iPhone.
Flabbergasted consumers reacted last holiday season when Apple dared offer a $1,000 smartphone.
How confident this company has become!
Well, this is just the beginning.
Apple (AAPL) will be the first smartphone maker to offer a $2,000 phone, and I will tell you why!
The tech industry is going through a cumbersome wave of repricing after several high-profile debacles that have cast the light on the true value of data.
The upward revision of data has seen more players pour into the game attempting to carve out a slice of the pie for themselves.
The reason why tech companies will start offering their products at higher price points is because the inputs are rising at a rapid clip.
Apple's Development and Operations (DevOps) costs to design and maintain this outstanding product is going through the roof.
Apple's DevOps employees earn around $145,000 per year and compensation is rising. Granted, the technology is developing and batteries smaller, but salaries are rising at a quicker relative pace because of the dire shortage of DevOps talent in Silicon Valley.
It's possible that living in a shoebox at $4,200 per month in Mountain View, Calif., is off-putting for potential staff.
The most expensive part of an iPhone X is the OLED screen.
Apple estimated costs of $120 per screen manufacturing the Apple iPhone X. The cost doubled from LCD panels from $60 per screen.
Samsung (SSNLF) has been best of breed for screens for a while, and it is currently working on the next generation of Micro LED tech, which is the next gap up from the OLED displays of today.
Samsung has an inherent conflict of interest with Apple, creating tension between these tech stalwarts. Apple made the contentious decision to procure in-house screens at a secret manufacturing facility in Santa Clara, Calif., to avoid the constant friction.
It's common knowledge that the average price of technology shrinks over time, but the American smartphone industry has defied gravity with expected prices to shoot up 6% to $324 in 2018.
The Apple iPhone X raw costs were around $400 per phone. There is zero chance that a next gen, enhanced Apple smartphone will cost this low ever again.
Confirming this trend are Chinese smartphones retail prices rising at 15% last year.
The cost of memory, DRAM and NAND chips, rose dramatically this past year. As more memory is designed into these devices, the costs keep trending higher.
Lithium-ion batteries only add up to 1% to 2% of OEM (Original Equipment Manufacturers) cost and probably only bumps up the cost of iPhones incrementally.
The more skittish situation is the EV (Electric Vehicles) snafu.
Volkswagen (VLKAY) announced it will transform its entire fleet of 300 models into electrified versions by 2025.
In order to achieve this lofty objective, Volkswagen has earmarked $25 billion for batteries from Samsung, LG, and Contemporary Amperex. Volkswagen hopes to have 16 up and running (EV) factories by 2022, up from three today.
The goal is unattainable because of a lack of in-house battery production.
CEO Matthias Muller said the reason for not manufacturing in-house batteries was, "Others can do it better than we can."
Muller will rue the decision down the line as a myriad of companies migrate toward in-house solutions, giving firms more control over the process and overhead.
More importantly, Muller will have to rely on the ebb and flow of rising cobalt prices.
A battery for an (EV) ranges between $8,000- to 20,000, comprising the largest input for the (EV) makers such as Tesla (TSLA) and Ford (F).
Making matters worse, companies cut from all cloth are hoarding cobalt reserves based on anticipating the potential demand.
This phenomenon will cause all big tech players to replenish any reserves of base materials immediately.
Apple has had chip shortage problems in the past. This year is even worse than 2017, with NAND and DRAM chip supply trailing the demand by 30%. Tech companies have been hastily locking down contracts in advance to ensure the necessary materials to produce their flashy gadgets.
Lithium battery demand is expected to rise 45% between 2017 and 2020, and there has been no meaningful large-scale investment into this industry.
Battery production made up 51% of cobalt demand in 2016 and will hit around 62% by 2022.
Compounding the complexity is 60% of global cobalt production is found in one country - the Democratic Republic of the Congo (DRC).
DRC is a hotspot for geopolitical fallout and its history is littered with civil war, internal conflict, and poor infrastructure.
The 21st century will be dependent on a chosen group of valuable materials. Cobalt is shaping up to be the leader of this pack and is needed in a plethora of business applications such as EV, lithium-ion batteries, and PCs.
Cobalt is vital in metallurgical applications that include aerospace rotating parts, military and defense, thermal sprays, prosthetics, and much more.
The DRC recently proposed a revised mining law increasing taxes on cobalt and other precious metals. The legislation has yet to be written into stone and would certainly jack up the price of cobalt.
Glencore's (GLNCY) management has noted this mining tax is "challenging" at a time it is just completing its Katanga expansion.
Katanga has the potential to become the largest global copper and cobalt producer.
Copper is equally important to cobalt since cobalt production is a by-product of copper and nickel mining. Only 2% of cobalt results directly from cobalt mining, and 60% via copper mining, and 38% via nickel mining.
Last year, Freeport-McMoRan (FCX) was dangling its cobalt project to outside investors in the DRC but was unable to fetch a premium price.
In a blink of an eye, China Molybdenum Co. (CMCLF) swooped in and (FCX) accepted an offer of $2.65 billion. (FXC) used the sale to pay down debt while the price of cobalt has taken off to the moon.
It gets worse, China owns 80% of refined global cobalt production and 90% of its operations are in the DRC.
China is attempting to corner the cobalt market in the DRC, gaining a stranglehold on future technological devices, (EV)s, and big data.
The keys to future technological hegemony lie in the jungles of the DRC, and China has the first mover advantage and backing of the communist party as (CMCLF) strives to be a global leader in cobalt production.
China has smartly wriggled its way down to the bottom of the supply chain capturing cobalt resources, and if a trade war ensues, China can simply cut off cobalt supply lines to whomever.
There is nothing CFIUS or Donald Trump can do.
America's 14% of global cobalt production will be insufficient to produce the new (EV)s, iPhone 11s, gizmos and gadgets that American consumers demand for daily life.
Analysts expected Apple to acquire some supplementary companies that will aid in expansion following the overseas repatriation.
A thriving software outfit or a company of cloud developers would have sufficed. However, reports streaming in that Apple has entered into negotiations to buy a five-year supply of cobalt directly from miners for the first-time underscore where Apple's priorities lie.
Cobalt demand expects to increase by 30% from 2016 to 2020.
Apple is scared it will be locked out of the cobalt market or forced to pay ludicrous prices for its cobalt needs.
Considering the price of cobalt has quadrupled since June 2016, and smartphones are 25% of the cobalt market, it's a strategically prudent move by Apple's CEO Tim Cook in light of BMW (BMWYY) announcing the need of 10X more cobalt by 2025.
Going forward anything comprised of cobalt-based technology will garner a higher premium resulting in higher prices for consumers including that $2,000 iPhone.
(FCX) is a must buy for those who believe precious metals are the foundation to all future technology. Other intriguing names include Brazilian company Vale S.A. (VALE), and Glencore, the largest Swiss company by revenue.
Or if you have the cash, plunk it down on a cobalt mine in the DRC. But only if you're insane.
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Quote of the Day
"Heavier-than-air flying machines are impossible." - Lord Kelvin, President of the Royal Society, in 1895
Mad Hedge Technology Letter
March 27, 2018
Fiat Lux
Featured Trade:
(SUDDENLY, INTERACTIVE BROKERS IS A LOT MORE VALUABLE)
(IBKR), (SCHW), (AMTD)
Longtime followers of the Mad Hedge Technology Letter know that I rely on Interactive Brokers (IBKR) for my pricing and execution.
It is fast, accurate, user friendly, and cheap.
Recently, more traders have been discovering these benefits. A lot more.
The halcyon days of January 2018 brought investors euphoria and hockey stick shaped charts.
Bitcoin even tickled the $20,000 mark.
Every risk asset minus interest rate sensitive stock relentlessly exploded skyward.
Then a funny thing happened.
The short volatility industry vanished in the space of one night and unleashed a new epoch of wild market gyrations.
One clear victor rises from the embers of the pandemonium and that is online broker Interactive Brokers Group, founded by Hungarian entrepreneur, Thomas Peterffy.
The all-important gauge of Daily Average Revenue Trades (DARTs), the income stream from generated commission, will hoist the stock to new plateaus.
Total (DART)s rose 14% YOY with historic low volatility in 2017, down 27% from 2016 and (IBKR)'s stock still muscled out performance from $37 to $64, almost doubling.
The recent inflow of February reports indicates fixed-income revenue and currency trading set record highs.
TradeWeb, one of the largest bond trading platforms in the world, reported a 73% February YOY boost of European corporate and financial bonds. Bonds usually are traded via phone, and new trends show the push into electronic trading is advancing unabated.
A return to "normal" levels of volatility will propel online brokers to new heights. Low volatility diminishes trade volume while increased volatility spurs on trading volume.
As more trading traverses to digital platforms, the digitization of buying and selling stocks and the advent of crypto trading will entice risk-adverse Millennials to pile into risk assets.
Numbers show that Millennials have an affinity for options trading, suggesting the dynamic short termism of options provides the experiential thrill they seek in life.
Interactive Brokers was voted best of breed of online brokers in 2018 by the prominent financial publication Barron's. This annual edition gives the skinny on online trading platforms and a rough guide to which service best suits each investor.
I single out (IBKR) as a stellar company because the e-broker industry is experiencing a mammoth period of consolidation amid a price war.
E-brokers such as Fidelity slashed its commission rates from $7.95/trade to $4.95/trade in February 2017. As trading becomes commoditized, it's a race to the bottom and whoever is a volume leader with the best platform technology will be the last one standing.
This trend all favors (IBKR) which is positioned for scale like the FANGs. If customers do not possess the scale, the ultra-cheap commissions are unavailable.
The backdoor strategy here is the access e-brokers have to customer data flows. The treasure trove of trade flow data will become even more valuable with the upward re-pricing of data following the Cambridge Analytica mess.
Online brokers profit off customers' data by selling the information to High Frequency Traders (HFT) that input the data into evolving proprietary algorithms, which legally front run retail and institutional money.
(IBKR) fits (HFT) like a glove and the synergies are robust. The most lucrative accounts derive from the new batches of prop desks and hedge funds that trade heavily, desiring the best online platform technology for minimal slippage and smooth execution. (HFT)s trade in milliseconds and comprise 60% to 70% of daily trading volume, signifying immense bullishness for (IBKR).
The strategy so far is a winner, increasing customer accounts by 25% YOY, up to 483,000 in Q4 2017. Profit margins benefited as well, rising 15% to 71% YOY.
The second part of (IBKR)'s handiwork is net interest. Margin accounts due to fractional banking allow brokers to lend to clients. Any serious trader is using leverage to amass profits. At the height of financial malpractice in 2007, too-big-to-fail banks boasted leverage of 50x.
Total customer equity elevated by 46% YOY to $124.80 billion. IBKR also profits from the cash sitting in its own accounts, which accumulate higher relative returns from higher interest rates.
(IBKR)'s margin rates are lowest in the industry and still incredibly lucrative.
Every time the Fed raises the Fed funds rate, (IBKR) can ring in the cash register. The Fed is on an aggressive quantitative tightening agenda and a good omen for the upcoming earnings' report.
The trends ongoing in this industry overwhelmingly favor (IBKR). The shift to mobile will become more pervasive. Only a few years ago, mobile platforms were arcane and unintegrated with desktop platforms, forcing traders to disregard the mobile method.
Times have changed and (IBKR) cannot find enough developers to head its operations. The shortage of talented developers is causing a backlog of new projects, but this highlights the growing emphasis on its trading platform technology.
Offerings don't stop at trading execution. (IBKR) has built out a robo-advising service called IB Asset Management and via iBot, an A.I. assistant, traders can use prop-desk level algorithms to nimbly dip in and out of positions. The analytical features to dissect price data is breathtaking these days and will satisfy chart lovers.
The runway is long as the eye can see because many of these offerings can be transformed into reoccurring subscription services. Furthermore, brokers make money if the market ascends or declines as long as traders do something to stockpile data.
Other competitors to consider are Charles Schwab (SCHW), which recently acquired optionsXpress and TD Ameritrade (AMTD), which purchased Scottrade for $4 billion. (AMTD) cut 1,100 employees in the St. Louis, MO, branch lately and, in return, will replace them with a handful of techies to work on platform enhancement.
The broad-based consolidation reflects the grab for market share since many of the players have come to terms with the market's obsession for scale. Implementing scale directly means snagging more client accounts as the marginal cost per client barely budges with the tech infrastructure already established for all the big players.
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Quote of the Day
"I think there is a world market for maybe five computers." - IBM Chairman Thomas J. Watson, 1943
