Mad Hedge Technology Letter
March 19, 2018
Fiat Lux
Featured Trade:
(DON'T BUY THE SPOTIFY IPO ON PAIN OF DEATH)
(IHRTQ), (AMZN), (FB), (GOOGL), (P)
The music business has long been a graveyard for new startups and their business models, and it looks like we are about to get another victim.
Investors should avoid the upcoming Spotify initial public offering (IPO) as if it were the Black Plague.
Streaming live music is an impractical business and makes it impossible to turn a profit.
The model is a gift to consumers because unlimited music for $9.99 per month is a steal, and the service is free if users can endure annoying ads.
Apple music (AAPL) and Amazon prime music (AMZN) complicate Spotify's future because competing with Goliath is a guaranteed money loser.
These two FANGs also have the luxury of not worrying about losing money in music streaming, as it's just one miniscule slice of their overall business.
Apple music is second in market share with 37 million subscribers. However, Apple offers a multitude of integrated services, and its synergistic end products far surpass Spotify's music-only business.
Recent legislation has not cooperated either.
The Copyright Royalty Board (CRB) elevated royalty payments for songwriters from 10.5 percent to 15.1 percent of total revenue constituting a 43.8 percent increase.
The aftermath will stoke more operational losses for Spotify.
The modification is the largest in CRB increase in history and is a big win for the music industry against tech.
The 71 million Spotify subscribers are indeed formidable, but history is cluttered with examples of music streaming platforms gone astray.
Internet radio firm iHeartRadio (IHRTQ), mired in $15 billion of crushing debt, is the latest on the verge of bankruptcy.
Let's look at the only pure music streaming stock out there in Pandora (P): The original architect of this industry is a dud. Pandora's total subscribers peaked in Q4 2014 along with its share price at $37.42 and has taken investors on a downhill toboggan ride to $5 today.
Dispensing the former CEO and changing direction with new management were obvious considering Pandora is a bad business model. But there is only so much the board of directors with an inferior business model can do.
Spotify's most recently reported loss more than doubled YOY as the exorbitant royalty costs ate into gross margins. Compare Spotify with Facebook (FB), which pays nothing for its content and has terrific growth margins.
Spotify's royalty and distribution costs to the music industry amounts to 79% of total revenue. Ouch! In brief, it's incredibly expensive to corral together new users into the Spotify ecosystem.
Spotify has hyped up scale as its one-way ticket to profits, but scale is FANG's secret weapon along with unlimited cash flow to spruce up any desirable business. Apple and Amazon could easily target Spotify and dismantle their user ship.
To reach the scale desired, Spotify will have to really dig deep and splurge on adding incremental subscribers. This type of strategy is futile against deep pocketed Apple and Amazon.
YouTube, owned by Google (GOOGL), is the last part of the equation where music is completely free, and if you download an ad-blocker application, ads are removed as well.
In 2018, there is no reason to ever pay for music and that's why YouTube enjoys 1 billion monthly users. Users have voted with their wallets.
Spoiled Millennials, having grown up with Napster, expect and demand a world of downloadable free music.
Spotify's unconventional decision to directly list is also grounds to abstain.
Usually a company offers shares to the market to raise cash. Spotify isn't raising any cash, and the company must raise cash at some point. Any share dilution will occur after stock purchases, not before as in a normal IPO.
In a normal IPO banks normally put up their own capital to close the deal. They are responsible to make a market for the new shares once it is priced. However, in an unusual IPO process, banks have been completely shut out of the Spotify deal, which could result in a wave of extreme volatility on the first day.
Banks also "Build a book" to solicit interest from potential investors at specific prices leading up to the IPO day. Investors miffed at pricing will give an incentive to wait out the madness. The end result could be a disaster for this IPO.
Shareholders usually are subject to a lockup period to limit the potential shares offered for sale by "flippers." This new unconventional process allows investors to unload all Spotify shares anytime, which increases the downside risk on IPO day. This irregular method will lack a stable set of shareholders who buy and wait out the initial frenetic price movement.
The lack of a road show will harbor more confusion about the inner workings of the business.
Spotify is gambling that its brand is widespread enough to stir up a risky appetite, but this strategy could blow up in its face.
There is one way to save Spotify. Using an injection of funds to reinvest into enhancing the platform to gain more subscribers. Subscriber growth must outperform royalty costs on a relative basis or it never will recoup the losses. Ultimately, it's an insufficient endeavor because anything Spotify can do, the FANGs can do better.
The long-lasting benefit of making it to FANG status is that FANGs can disrupt their competition better than anyone since they are the Original Disruptors.
It makes no sense for Spotify to skimp on the IPO process just to circumvent paying investment bankers their usual excessive fees. The wild card in this experiment is that an unequivocal IPO success could spell the imminent doom of the investment banking business.
A smooth IPO would mobilize Uber, which has a similar loss-making, user growth sensitive business to follow in Spotify's path and bypass the traditional route.
In one day, big banks could be condemned to the graveyard of tech victims in a blink of an eye.
Spotify could be a great buy after the dust settles, but it would be a mistake to get caught up in the pandemonium that will ensue the day Spotify goes public.
I did the same with Tesla (TSLA) many years ago, only buying after the IPO flopped. It turned out to be a stroke of genius.
Mad Hedge Technology Letter
March 16, 2018
Fiat Lux
Featured Trade:
(HOW ARTIFICIAL INTELLIGENCE WILL ENHANCE OR DESTROY YOUR PORTFOLIO)
(TSLA), (AMZN), (FB)
Mad Hedge Technology Letter
March 15, 2018
Fiat Lux
Featured Trade:
(THE STOCK THAT WILL STOP THE HACKING EPIDEMIC),
(FTNT), (EFX), (INTC), (IBM), (ORACL), (GOOGL), (MSFT), (BBY), (T), (AMKBF)
If you like Palo Alto Networks, which the Mad Hedge Fund Trader has been recommending for years, you absolutely have to love Fortinet (FTNT), which can protect you from the most barbaric online intruders on a large scale.
Fortinet cloud security provides tailor-made protection for the Google (GOOGL) Cloud Platform, Microsoft (MSFT), AWS (Amazon Web Services), IBM (IBM) and Oracle (ORCL).
Cyberespionage is going from bad to worse, and shrewdly scaling into a few shares of Fortinet (FTNT) is prudent.
It's been a dreadful 12 months for corporate security.
First, Equifax (EFX) dropped a bomb, disclosing the data breach of 148 million Americans.
Then there was the Intel (INTC) chip debacle forcing companies to reanalyze in-house security operations thanks to a chip design flaw.
Not only is corporate intrusion becoming more vicious, it's also becoming more ubiquitous.
The Mad Hedge Fund Trader sympathizes because our website has been the victim of several invasive hacks over the years from places as diverse as Russia and Indonesia.
In an era of record corporate profits, companies are woefully unprepared for the digital danger.
As organizations transfer critical data to the cloud circulating among a myriad of collaborating employees, the opportunities for crooks to hack are high-yielding and fruitful.
Why do people hack big corporate firms?
The simple answer is for profit.
Hackers understand there is a secondary market on the dark web waiting patiently to purchase stolen data. The data in the shop window is cut from all shades of cloth.
What is the dark web?
It is part of the Internet, accessible by means of special software, allowing users and website operators to remain untraceable.
Many illegal products and services are bought and sold there. Hackers can catch a bid, cash out through this de facto marketplace, and retire to a five-star palatial resort in a country with no extradition treaty.
The incentive to soak up sensitive data from corporate America is stoking a colossal outbreak of corporate malfeasance and pushing up cybersecurity costs to $90 billion this year, up 19% from last year.
Focal points of security investment will be around cloud security, next generation firewall technology, email security, threat vulnerability and identity access management.
On a macro level, Washington is doubling down on the cybersecurity phenomenon. The definition of national security has expanded to include all domestic technology.
Persistent threats against national infrastructure, such as power grids, nuclear facilities and water supplies, are turbocharging security budgets to protect national assets against these sophisticated attacks.
Groundbreaking technology is guarded even more so than the entrance to Fort Knox. The vigilance is necessary considering that lost funds related to data intrusion will reach $8 trillion by 2020. An example is shipping magnate Maersk (AMKBF), which estimates the revenue lost from hackers in 2017 to be in the $200 million to $300 million range.
As hyper-accelerating technology goes into overdrive, the situation could turn perilous. By 2021, 46 billion devices will be connected through the IoT (Internet of Things) that could start with a smart toaster connected to an iPhone.
It's entirely possible that a hacker could gain control to the whole shebang by accessing a connected toaster and moving laterally through the ecosystem destroying at will. Don't laugh. This already has happened.
A programmed smart home is the next battleground between consumer and large cap tech.
This is the conundrum that companies face. Firms are investing robustly in top-notch cybersecurity, but hackers are staying one step ahead of the curve. They learn from mistakes and expand an evolving tool kit of techniques to destabilize a bigger swath of the economy.
The street is ignoring national security weakness related to tech because tech earnings are stellar. The market is closer than ever before to an inflection point. The "aha" moment will be when a Fortune 500 firm is toppled by one of these digital miscreants.
Russia's Kaspersky Lab came and went like nothing happened. The market is still immune to cyber hacks but all that could change. This Russian firm was pigeonholed as a Russian secret service affiliate.
Kaspersky Lab sells antivirus, Internet security, password management and endpoint security products. You might even see a sexy ad for its products on the margin of your computer screen right now.
Best Buy (BBY) reacted fast, removing Kaspersky products immediately. Russian national CEO Eugene Kaspersky vehemently denies any link with the Federal Security Service of the Russian Federation, even though he graduated from The Technical Faculty of the KGB Higher School and was a former Soviet military software engineer.?
Keeping with the trend, lawmakers applied pressure to AT&T (T), gutting a deal with Huawei, a Chinese telecom company, to sell smartphones through its retail dealership. The government has publicly advised Americans to avoid buying Chinese smartphones at all costs.
Regulation soon will blanket the tech industry from head to toe and the big winner is Fortinet.
Fortinet has a four-point plan to invigorate sales to even higher levels.
First, the core business of network security continues to offer growth in new, adjacent markets. FortiGate 6000 series will reap further market share gains. The 6000 series is the fastest next-generation firewall application among peers.
Second, increasing adoption of public cloud will push companies to Fortinet Security Fabric adoption. Safeguarding Wide Area Networking infrastructures that can reliably and efficiently connect branch offices to corporate resources and this technology is about a quarter of the business.
Third, cloud security is the fastest-growing segment. Fortinet delivers the most diverse portfolio of cloud security applications, all managed through a single, integrated management console with automated threat response and policy, unified control, workload visibility and management across all cloud environments.
Lastly, strengthening broad security to IoT and OT (operational technologies) environments is the last growth driver.
On the financial side, quarterly revenue drifted up to $417 million, up 15%, and revenue performance was bolstered by 25% YOY services revenue growth.
The shift toward higher-value security subscriptions and support services is the catalyst for a larger portion of revenue being deferred onto the balance sheet at a total of $1.336 billion, up 29% YOY.
As security techniques complicate, cybersecurity companies will have further demand to protect shareholder value.
To visit Fortinet's website, click here: https://www.fortinet.com/
Mad Hedge Technology Letter
March 14, 2018
Fiat Lux
Featured Trade:
(WELCOME TO THE NEW MICROSOFT)
(MSFT), (CRM), (RHT), (GOOGL),
(CVX), (KR), (LOW), (AMZN), (JCI)
Investors are clamoring for cloud plays, which along with artificial intelligence (AI) have become the hottest investment themes of 2018.
However, many are ignoring one of the best new cloud plays of all, and that would be Microsoft (MSFT). However, this is not your father's Microsoft.
Microsoft (MSFT) is the poster boy for legacy tech turned cutting edge once again. It is now one of the top three cloud companies behind Amazon (AMZN) and Google (GOOGL) and is closing fast.
In fact, most people have been using their products for years and have no clue of this amazing turnaround.
This year, 2018, has been the year of the cloud. As such, cloud stocks have been bulletproof, with leaders including Salesforce (CRM) and Red Hat Inc. (RHT) celebrating all-time highs.
The cloud companies are basking in the momentum of rising earnings and accelerating growth. Their fundamental stories are solid, and growth drivers unrelenting.
The No. 1 reason is the sheer increase in global data. Market intelligence services predict total data will grow to 163 zettabytes by 2025, which is 10 times the data generated in 2016.
For all the math geeks out there, 1 zettabyte is a trillion gigabytes.
This incredible volume of data will uncover new types of business and the user experience will evolve. In the near future, more than 20% of the data will be imperative just to normally function by 2025.
Big data is smartly harnessed by all profitable companies today and this data needs storage - huge amounts of it.
Fortune 500 companies operate from cloud software that streamlines and harmonizes operations, which is called enterprise software. The data accumulated on these platforms is digital gold, and infers trends and paradigm shifts on which CEOs base game changing-decisions.
The best up-and-coming cloud business is hands down Microsoft Azure. The existential threat of (MSFT)'s Azure is probably the only thing that keeps Jeff Bezos awake at night.
Azure produced a revenue beat for the ages, increasing by 98% QOQ. Microsoft's Azure public cloud is eating into Amazon Web Services (AWS) market share.
AWS is critical to Amazon's (AMZN) fortunes as its outperformance allows Bezos the cash flow to dump products on its e-commerce platform at or below cost, seizing market share and a higher stock price.
Microsoft delivers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance on Azure to its corporate customers. Partnering with other firms to provide cloud services is punctuated by bottom- and top-line outperformance.
At the micro level, investors can deduce the sticky underpinnings that are creating a profitable moat around Azure with these few examples.
Microsoft has an important relationship with Chevron (CVX), which uses Azure IoT to harness massive amounts of seismic data from its oil fields to accelerate deployment of modern, intelligent solutions for oil exploration.
Azure's cloud services also help Chevron manage thousands of oil wells dotted around the world, increasing revenue and operating safely and reliably.
Kohler is another company to link up with Microsoft's cloud bundle by building connected, voice-activated products powered by Azure IoT and Johnson Controls (JCI). GLAS thermostat with Cortana voice control uses scalable device management capabilities in Azure IoT and Windows IoT.
The Kroger (KR) supermarket chain is deploying Azure to fuel its digital grocery store display for real-time pricing, discounts and promotions based on shoppers' data to levitate sales.
Home improvement company Lowe's (LOW) in-store robot uses Azure to manage inventory and notify human management of out-of-stock or misplaced items. This is yet another example of humans and robots working in perfect harmony.
These are some of the examples of why Microsoft Azure is tearing into AWS's market share. Azure simply offers a more robust set of cloud software solutions compared to AWS because of its better enterprise functions, and it may become the future for all of us.
Another segment that gets little love is the LinkedIn purchase by Microsoft in 2016. LinkedIn, the employment networking site, aided by strong sales execution totaled $1.3 billion in quarterly revenue. Higher user engagement, customer acquisition, renewals and upsell performance make this the preeminent platform for business networking.
The next step is further integrating the leading professional cloud with the leading professional network. This marks the fifth consecutive quarter of more than 20% growth for LinkedIn. I believe more can be done to monetize LinkedIn, and the potential is enormous.
Another segment that really cuts across the majority of the tech ecosphere via GPUs, A.I., hardware and software is gaming. Today, gaming is as hot as cord cutters, and millennials love playing video games.
Microsoft has been in the gaming space since the beginning, and revenue sprouted up by 8% QOQ driven by hardware revenue growth of 14% QOQ. The hardware comes in the form of premium console, the Xbox One X, the top-selling console in the US this past holiday season.
Microsoft has parlayed its commitments in gaming into acquiring PlayFab, which serves upward of 700 million avid gamers with more than 1,200 games from Disney, Rovio and Atari. It's a unique backend platform for mobile, PC and console game developers to scale up cloud-connected games linked with Azure to provide a world-class cloud platform for the gaming industry.
Microsoft is so much more than just an operating system and Microsoft Office in 2018. That is the old Microsoft. And that being said, Office 365 increased subscribers to 29.2 million last quarter, up from 28 million QOQ.
We have been in and out of Microsoft many times. Now, if it would only give us another decent dip, we could revisit the trough one more time.
Mad Hedge Technology Letter
March 13, 2018
Fiat Lux
Featured Trade:
(WHY YOUR HATED CABLE COMPANY IS ABOUT TO DIE),
(AMZN), (NFLX), (APPL), (DIS), (GOOGL), (TWTR), (FB), (ROKU)
Look at any survey of the most despised companies in America and there is always one industry that comes out on top: cable companies such as AT&T, (T), Comcast (CMCSA) and Charter Communications (CHTR).
We all have been reading about cord cutting and the death of cable for years. However, this trend is about to vastly accelerate.
The death of cable is upon us in full force and streaming plays should represent a heavy weight in any aggressive portfolio.
Jerry Seinfeld and David Letterman are two Hollywood names gracing the broadband waves of Netflix (NFLX). Add one more superstar name to the mix as that of former President of the United States, Barack Obama.
Obama has tentatively agreed to produce new content centered on inspirational people and their stories. Add in former First Lady Michelle Obama who also will play a part in compiling the new content. You can expect about half the country to watch it.
Amazon (AMZN) and Apple (APPL) were lining up deals before Netflix scored the arrangement. Music streaming giant Spotify, set to go public later this month, also has a deal on the table with former President Obama to be the face of a presidential playlist.
The bidding war for top content is hugely bearish for traditional media companies such as Disney (DIS), which is subject to stringent regulation from the FCC (Federal Communications Commission). Disney stock has been languishing in the doldrums for years, peaking at $120 in mid-2015. It is still hovering around the $100 level 3 years later.
The recent risk-off move in (DIS) can be attributed to one horrific segment of the business that was its main growth driver for 25 years - ESPN.
In the 1990s, ESPN was a media darling for the ages. It could do no wrong. Its base, mainly young tech-savvy males, loved every piece of content from the daily sports news to the live games that permeated its channels.
Then cord cutters started appearing out of the woodwork and swiftly migrated to (NFLX)'s attractive pricing at $8.99 per month in 2015, which sure beats cable at upward of $100 per month.
Better late than never is that Disney finally announced a unique proprietary streaming service straight to the consumer in 2018. The three years of inaction put the company three years further back in the quickly growing broadband streaming revolution. Disney also stated it will pull all (DIS) content from competitor (NFLX).
Legacy companies have a two-pronged problem: saddled with irrevocable multi-year commitments absorbing capital and a behemoth legacy business in marginal decline that is a headache to shift. Asking the Titanic to suddenly transform into a fancy speedboat is a tough ask for anyone.
The red flags are unbridled in the cable universe. Fox Networks plans to readjust hourly ad load down to 2 minutes within 2 years! Fox has some work to do to whittle down the ad load because last year's hourly ad load clocked in at 13 minutes. Advertising executives indeed feel aghast in what will be known as the first phase of the death of cable. This machination is unquestionably bullish for social media platforms such as Facebook (FB) and Twitter (TWTR) because net ad loads are migrating to millennial eyeballs on those platforms.
Millennials, currently the biggest consumer-ready demographic, are the most advertising-adverse generation ever to exist. Stories of binge-watching (NFLX) are rife, and live sports shows increasingly are found pirated online from Eastern Europe.
TV ratings are rapidly declining to the degree that bottom line growth will be materially harmed. Traditional media is experiencing a cocktail of lethal headwinds that could wipe it out totally. Simply put, commercials negatively affect the user experience and the plethora of options in the streaming world makes it a buyers' market.
(NFLX)'s hyper-accelerating subscriber growth begets higher growth. Love them or hate them, (NFLX) and (AMZN) business models are the architectural blueprints applied to every tech stock. To be condemned as a legacy business is the most damning label in the tech industry.
Hiring Bill Ackman is probably the only move that would be worse. Anyone not betting the ranch on broadband streaming is quickly banished to investor purgatory with the likes of GameStop Corp. (GME).
Tech is starting to get priced as a luxury. Gone are the days of disheveled mopheads joining forces in a shabby Los Altos, Calif., garage as did Steve Jobs and Steve Wozniak. Groundbreaking tech is power, and big tech knows it.
As much as I would like to rain on (NFLX)'s parade, I cannot. Investors only look at one number as they do with many other tech companies. The company's license to spend gobs of cash on new content revolves around subscriber growth.
Last year was full of whispers that (NFLX)'s domestic mojo would start to neutralize. Quarter over quarter estimates came in at 1.29 million new domestic subscribers, and international estimates were expected to net 5.10 million. Domestic net adds were almost 35% higher than guidance at 1.98 million.
International net add growth is viewed as the source of a long runway, and it did not disappoint, beating QOQ guidance by 20% with 6.36 million new net adds. Overall, total net adds beat QOQ estimates by 23.2% and is the biggest reason (NFLX) is up over 70% in 2018.
Where does this all lead?
Do not buy any media stock without a thriving streaming business. The shift in buying power from baby boomers to tech-reliant younger generations will exacerbate cord cutting, and users will naturally deviate toward online streaming.
The most popular streaming services in 2017 were (NFLX) and (AMZN), which should be part of every investor's portfolio. Google (GOOGL) has YouTube, which also is no pushover. Another wild card is smart TV company Roku (ROKU), which is the (FB) of smart TVs and procures revenue from ad load. (ROKU)'s active accounts are up 44% year over year, and revenue per user has increased more than 30% YOY.
If you look down the road, the legacy companies that can smoothly transform into streaming content companies will be rewarded by investors but stocks such as (DIS) are in a wait-and-see mode.
Mad Hedge Technology Letter
March 12, 2018
Fiat Lux
Featured Trade:
(WHERE ALL THAT TAX CUT MONEY WENT)
(CISCO), (MSCC), (MCHP), (SWKS), (JNPR), (AMAT), (PANW), (UBER), (AMZN)
