Mad Hedge Technology Letter
May 7, 2019
Fiat Lux
Featured Trade:
(THE LURKING DANGERS BEHIND FACEBOOK)
(FB), (WFC), (NFLX)
Posts
The current business model of social media is dead, and the future model seems in doubt – that was the take away from world's largest social media platform at F8 that I attended, its annual developer conference.
Co-founder and CEO Facebook (FB) Mark Zuckerberg stated at the event that “in our digital lives, we also need both public and private spaces,” an impromptu call to action to migrate users into a new private digital world with Facebook dictating the terms.
The sushi must really be hitting the fan for Zuckerberg to announce his future vision of social media, and the writing is on the wall for his current social media experiment, that is, if he continues along at the same rate.
The projected $5 billion fine incurred by Facebook from the Federal Trade Commission over its privacy handling of personal data is peanuts for the social media company, but this could be the first of numerous fines doled out by regional and national regulatory bureaus that span from the Bay Area to Vietnam.
Facebook is a company that made over $55 billion in revenue last year and the $5 billion would amount to less than 10% of annual sales.
From that $55 billion, Facebook earned profits of over $22 billion, and this $22 billion is what the regulatory battles are about, along with the co-founder’s tenacious defense of deploying his users as free content.
The firm has continued to post operating margins of over 40% and delivered margins of 46% last quarter, a sequential rise of 4% in Q4 2018.
The Oracle of Omaha better known as Warren Buffet cited necessitating accountability for CEOs that drive a company into a government bailout especially banks.
He advocated that these executives and their spouses should be stripped of their net worth if they damage shareholder value.
The comments were directed at the way Wells Fargo’s (WFC) former CEO Tim Sloan crippled Wells Fargo and has since been sidelined during the long bull market in equities.
At some point, Zuckerberg could confront similar ructions because of his efforts at perverting democracy that has caused innumerable damage to American democracy and global society, and I am certain his legion of lawyers are already hatching a plan to tackle this thorny predicament.
If you ponder about his announcement in a zero-sum environment, it makes no sense for Facebook to pivot to “private” messages.
This leads me to believe his words are smoke and mirrors so that Facebook can perpetuate its duopoly and force digital ad players to continue to drink from the same Kool-Aid.
As before, Zuckerberg still believes this game of cat and mouse is a half-baked marketing fix.
This is why many of his trusted disciples such as former executive Chris Cox left under a shroud of mystery citing “artistic differences” in terminating his tenure at Facebook.
It is clear to many that Facebook is barreling straight into an even more frightening future.
What does the announcement mean from a business perspective?
Zuckerberg will continue to purge anyone that disagrees with him, even trusted lieutenants, and continue to integrate the family of apps into one big platform that includes Facebook, Instagram, and WhatsApp messenger.
These three will become one and thus, Zuckerberg’s ad machine rolls on like the dystopian action film Mad Max.
Let me remind you, these drastic measures boil down to Facebook doing everything they can to keep content costs down.
If they, for example, have to go the same route as Netflix (NFLX) - overpaying for the best actors and directors to generate premium content, the stock would halve the next day.
And that is what Zuckerberg is desperately hoping to avoid after the 30% dip in shares in 2018 because of regulatory headwinds.
Combining the three apps would be impossible to regulate at a time that regulation is rearing its ugly head.
Zuckerberg is intentionally upping the ante and accruing more risk in the hope that Facebook can outmuscle its way through in one piece.
The ad industry is crying out for something new, but as long as Zuckerberg’s claws are firmly into the meat of the digital ad budgets for most companies, he gets to decide how the industry develops because he knows the ad dollars will stick.
In the future, your private chats won’t be private because Zuckerberg will be mining the data for ad dollar revenue.
No matter what he says, nothing will change unless Facebook goes in an entirely new direction which would inhibit sales.
Until the fines become material, let’s say 70% of annual revenue or something of that nature, a $5 billion hit to the bottom line will not persuade the management to transform their practices.
Expect less privacy, and WhatsApp and Instagram to be heavily monetized through ad promotion and data mining even though Zuckerberg pledging his company won’t hold user data “longer than necessary.”
As for Facebook itself, Zuckerberg can’t throw his baby out with the bathwater and will hope to minimize its deceleration by bundling it with the growth trajectory of WhatsApp and Instagram.
Instead of major structural changes, Zuckerberg continues to beat around the bush saying, “You should expect that we’re not going to store your data in countries where there's weak data protection.”
This is not the crux of the problem and shows Zuckerberg is still paying lip service and not ponying up to reality.
Attaching Facebook and its dying model is not an attractive strategy leading to a slew of executive resignations.
I believe this could all end in calamity for Zuckerberg as he figures piling on more risk onto the elevated risk levels is the right decision making Warren Buffet’s point for him about CEO’s accountability.
Should Zuckerberg refund shareholders if his flight turns into a suicide mission then claims to be an unwitting victim?
And how does he even refund democracy with his apps causing major unrest to society such as killings that occur because of the distribution of fake news on his platforms?
Making a hot potato hotter might work for the short term and if ad dollars stream into WhatsApp and Instagram, Zuckerberg will claim victory.
But at some point, the potato will scald his hands so bad that it will drop.
Your private chats will be the content at the fulcrum of his data broker empire since his “digital town square” approach isn’t working anymore.
The company is utterly incentivized to figure out how to continue this ad revenue carnival because 93% of total revenue last quarter came from digital ads which is up from the prior year when it constituted 89%.
It all sounds like a big brother apocalyptical novel, which we are in, scarily, in putting out this dialogue before the firestorm starts, Facebook wants to normalize, and front runs the craziness of selling your private chat data before it becomes a national issue.
Will regulators shut this down or will they be naïve and turn a blind eye?
Mad Hedge Technology Letter
April 25, 2019
Fiat Lux
Featured Trade:
(THE RESILIENCE OF TWITTER)
(TWTR), (FB)
Twitter’s (TWTR) earnings offer a rough snapshot into the health of current internet users and Twitter pulling off a strong quarterly performance is a strong indication of how tech earnings as a whole will pan out.
Readers of the Mad Hedge Technology Letter know well that CEO of Twitter Jack Dorsey is one of my favorite tech CEO’s in the valley and I believe he should be leading Apple instead of Twitter and Square.
Twitter had an ideal quarter smashing estimates by surpassing every meaningful metric.
This company has turned the corner and has become the choir boy of social media in relative terms.
Purging the bots in the summer of 2018 was the right move in hindsight, and the performance in the first quarter vindicates Dorsey in making the tough decisions to clean out its system.
As Twitter grows in its Daily Active Usership (DAU), they risk becoming too large to regulate and grabbing back control over their model was the smart thing to do at the time.
Twitter has shifted from emphasizing Monthly Active Users (MAUs) to Daily Active Users (DAUs) in a sign of intent preferring to become integrated with users on a daily basis.
Total revenue of $787 million was up 18% YOY batting away any whispers that the company could be decelerating.
Another bonus was the diversity in ad revenue with 46% coming from the international segment signaling to investors that Twitter is not over-reliant on American Tweets.
American ad revenue rose 26% compared with international ad revenue rising just 10% showing that if you do social media properly instead of hatching cunning plans, it is still a growth business at its core.
The company has started to rev up profitability by reporting first-quarter earnings per share of 37 cents crushing the consensus of 15 cents.
The healthy trajectory of the company is summed up by its rise in Daily Active Users to 134 million, an increase of 11% YOY in an environment where Twitter’s competitors aren’t growing at all.
The concerns that I had about last quarter’s tech earnings report had more to do with forward guidance than the past quarter’s performance because of the supposed deceleration of the global economy.
Twitter passed with flying colors predicting next quarter’s revenue should come in between $770 million to $830 million and operating income between $35 million to $70 million.
Dorsey sees no let down in the coming quarters as the domestic economy will attempt to push its way into its 11th year of expansion.
Headcount is estimated to rise 16% in 2019 after a 2018 where staff grew by 18%.
Total ad engagements increased 23% resulting from higher ad impressions and improved clickthrough rates (CTR) across most ad formats.
Cost per ad engagement (CPE) decreased 4% due to like-for-like price decreases across most ad formats because of an improved CTR which results in advertisers achieving the same number of engagements at a lower price, and a mix shift toward video ad formats that have lower CPEs and higher CTRs.
CPE can differ from one period to another based on geographical performance, ad formats, campaign objectives, and auction dynamics.
Just as important, the customer experience for advertisers is always improving with enhancements to Twitter’s ad platform and ad formats.
Twitter is committed to delivering better relevance making it simpler for advertisers to declare their objective, initiate a campaign, and measure performance.
The possible destructive black swan strongly hovering over social media and its business model is the threat of data privacy and the subsequent regulation to it.
Facebook (FB) and less so Twitter have been dragged into the data privacy debacle, but I believe Twitter has made the moves to get the monkey off their back for at least the next two quarters.
They have also benefitted from being more conservative in how they handle data and from the bulk of tweets being parts of public discourse instead of personalized baby photos.
The structure of Twitter has led to less chaos than Facebook, and Twitter tightening the amount of acceptable mainstream topics even more will close more loopholes into the extreme parts of society that want to disperse content through Twitter.
Twitter is taking a more proactive approach to reducing abuse on the platform and its effects in 2019 with the aim of reducing the burden on victims of abuse and, where possible, taking action before abuse is reported.
As a result, enhancements in Q1 revolved around proactive detection of rule violations and physical, or off-platform, safety — including making it easier to report Tweets that share personal information, helping Twitter remove 2.5 times more of this type of content.
Twitter has also deployed upgraded machine-learning models to detect potential policy violations enabling Twitter to pinpoint Tweets to agents for review, proactively.
The result is Twitter removing more abusive content with better efficiency.
The data backs up Twitter’s abuse prevention initiative with approximately 38% of categorized abuse proactively detected.
Twitter has been profitable for a string of quarters now, responded well to looming regulation fears, and as long as the economy chugs along at its current rate, I believe Twitter will outperform the rest of tech and the domestic economy.
The short-term health of social media also opens the path for Facebook to continue the positive momentum as the summer approaches.
Wait for an entry point on the dip to buy Twitter.
Mad Hedge Technology Letter
April 18, 2019
Fiat Lux
Featured Trade:
(NETFLIX’S WORST NIGHTMARE)
(NFLX), (DIS), (FB), (AAPL)
Netflix came out with earnings yesterday and revealed guidance that many industry analysts were dreading.
It appears that Netflix’s relative subscriber growth rate has reached the high-water mark for now.
Competition is rapidly encroaching Netflix’s moat.
In a letter to shareholders, management opined revealing that they do not “anticipate these new entrants will materially affect our growth.”
I am quite bothered by this statement because one would have to be blind, deaf, and dumb to believe that Disney (DIS) or Apple’s (AAPL) new products will not take away meaningful eyeballs from Netflix.
These companies are all competing in the same sphere – digital entertainment.
Papering over the cracks with wishy washy rhetoric was not something I was doing backflips over.
Netflix’s management knew this earnings report had nothing to do with results because everyone wanted to reassess how bad the new entrants would make life for Netflix.
Disney has the content to inflict major damage to Netflix’s business model.
The mere existence of Disney as a rival weakens Netflix’s narrative substantially in two ways.
First, Disney’s entrance into the online streaming game means Netflix will not have a chance to raise subscription prices for the short to medium term.
The last price hike was done in the nick of time and even though management mentioned it followed through “as expected,” losing this financial lever gives Netflix less ammunition going forward and caps EPS growth potential.
Second, another dispiriting factor is the premium for retaining and acquiring original content will skyrocket with more firms jockeying for the same finite amount of actors, producers, directors, and writers.
This particular premium cannot be quantified but firms might try to bid up the cost of certain talent just so the other guy has to foot a bigger bill, this is done in professional sports all the time.
Firms might even take actors off the table with exclusive contracts just to frustrate the supply of content generators.
Uncertainty perpetuates with the future cost of content unable to be baked into the casserole yet, and represents severe downside risk to a stock which trots out an expensive PE ratio of 133.
Growth, growth, and more growth – that is what Netflix has groomed investors to obsess on with the caveat of major strings attached.
This model is highly effective in a vacuum when there are no other players that can erode market share.
Delivering on growth justifies heavy cash burn, and to Netflix’s credit, they have fully delivered in spades.
The strings attached come in the form of steep losses in order to create top of the line content.
Planning to revise down annual cash flow from $3 billion to $3.5 billion in 2019 will serve as a litmus test to whether investors are ready to shoulder the extra losses in the near term.
I found it compelling that Disney Plus will debut at $6.99 per month – add that to the price of Netflix’s standard package of $12.99 and you get a shade under $20.
Disney hopes to dictate spending habits by psychologically grouping Disney and Netflix for both at under $20.
The result of breaching the $20 threshold might push customers into ditching Netflix and sticking with the $6.99 Disney subscription.
Then there is the thorny issue of Netflix’s growth – the quality and trajectory of it.
The firm issued poor guidance for next quarter projecting total paid net adds of 5.0m, representing -8% YOY with only 300,000 adds in the US and 4.7m for the international segment.
Alarm bells should be sounding in the halls when the most lucrative segment is estimated to decelerate by 8% YOY.
Domestic subscriptions deliver higher margins bumping up the average revenue per user (ARPU).
Contrast this with Netflix’s basic Indian package costing $7.27 or 500 rupees and a mobile package of $3.63 or 250 rupees.
In my opinion, domestically decelerating in the high single digits does not justify the additional annual cash burn of half a billion dollars even if you accumulate millions of more Indian adds at lower price points.
This leads me to surmise that the quality of growth is beginning to slip, and Netflix appears to be running into the same type of quagmire Facebook (FB) is facing.
These models are grappling with stagnating or slowing North American growth and an emerging market solution isn’t the panacea.
The Netflix Indian packages are actually considered expensive by local standards meaning that Netflix’s won’t be able to crowbar in price hikes like they did in America.
On the positive side, Netflix did beat Q1 estimates with paid net adds up 9.6 million with 1.74m in the US and 7.86m internationally, up 16% YOY.
Netflix was able to reach revenue of $4.5B, a company record mostly due to the $2 price hike during the quarter in America.
The letter to shareholders simplifies Netflix’s tactics to investors explaining, “For 20 years, we’ve had the same strategy: when we please our members, they watch more and we grow more.”
What this letter doesn’t tell you is that Disney and the looming battle with Netflix will reshape the online streaming landscape.
In simple economics, an increase of supply caps demand, and don’t get sidetracked by the smoke and mirrors, Disney and Netflix are absolutely fighting for the same eyeballs no matter how much Netflix plays this down.
To highlight an example of how these two are directly competing against each other – let’s take the cast of Monica, Chandler, Rachel, Ross, Joey, and Phoebe – in the hit series Friends.
Netflix acquired the broadcasting rights from Warner Bros, who owns Disney, and it was the most popular show on Netflix.
Warner Bros, knowing that Disney were on the verge of rolling out an online streaming product, renewed Netflix for 2019 at $80 million.
Not only were they hand feeding the enemy in broad daylight, but they handicapped their new products as it is about to debut.
Whoever made that decision must go into the hall of shame of boneheaded online content decisions.
Once 2020 rolls around, Disney will finally be able to slap Friends on Disney Plus where it belongs, and the streaming wars will heat up to a fever pitch.
Ultimately, when Netflix brushes off reality proclaiming that if they please viewers with the same strategy, then everything will be hunky-dory, then I would say they are being disingenuous.
The online streaming industry has started to become more complex by the minute and the “same strategy” that worked wonders in a vacuum before must evolve with the times.
At $360, I would short Netflix in the short to medium term until they prove the headwinds are a blip.
If it goes up to $400, it’s a screaming short because accelerating cash burn, poor guidance, decelerating domestic net adds, and a jolt of new competition aren’t the catalysts that will take shares above the heavenly lands of $400, let alone $450.
Netflix is still a fantastic company though – I’m an avid viewer.
Mad Hedge Technology Letter
April 15, 2019
Fiat Lux
Featured Trade:
(XXXXX)
(SNAP), (FB), (PINS), (TWTR), (GOOGL)
America is full – that is what domestic social media growth is telling us.
The once mesmerizing service that captured the imagination of the American public has soured in the country that created it.
Online advertising consultant emarketer.com issued a report showing that Snapchat (SNAP), the worst of the top social media outlets, will lose users in 2019.
The 77.5 million users forecasted by the end of 2019 represents a 2.8% YOY decrease.
This report differs greatly from the report eMarketer issued just past August showing that Snapchat was preparing for a rise of 6.6% YOY in 2019.
The delta, rate of change, represents a massive downshift in expectations and the sentiment stems from the widespread saturation of social media assets.
Market penetration has run its course and the players have run out of bullets mainly targeting Generation Z.
These platforms have given up on baby boomers and Snap feels that pursuing the millennial demographic would be an exercise in futility.
Even more disheartening is that between 2020-2023, there will be only a minor uptick of user growth by 600,000 users clamping down on the impetus of a comeback of sorts shackling the business model.
The trend is not mutually exclusive to Snap, Twitter or Facebook, social media as a group will only expand the overall user base by 2.4% in 2020 hardly satisfying the appetite for growth that these companies publicly advertise.
Remember that much of Instagram’s growth originates from borrowing Snapchat users by way of copying their best features.
Even with this dirty tactic, growth seems to be petering out.
Snap’s shares have made a nice double after peaking shortly over $25 after the IPO.
But the double was a case of investors believing that management and execution had hit rock bottom – the proverbial dead cat bounce in full effect.
Now investors will pause to reassess whether there is another reasonable catalyst to drive the stock higher.
First, investors will need to ask themselves, is Snap in for another double?
Absolutely not.
So where does Snap go from here?
I believe they will borrow from the playbook of Mark Zuckerberg and attempt to emphasize supercharging average revenue per user (ARPU).
Whether the company arrives at this conclusion by chance or strategy, they must confront the reality that there are almost no other levers to pull if they want to perpetuate this growth story.
M&A is also off the table because the company is burning through cash.
Facebook’s (ARPU) came in at $7.37 last quarter indicating how Snap needs to make substantial headway in this metric with last quarter’s paltry (ARPU) at $2.09.
Essentially, management will conclude that each user isn’t absorbing enough ads because of declining user engagement.
Snap CEO Evan Spiegel will need to improve the pricing power charging advertisers at higher rates.
Obviously, the lack of an attractive platform resulting from poor execution and engineering problems needs a quick turnaround.
It’s not all smooth sailing for Facebook either, they keep chopping and reshaping strategy by the day attempting to minimize costs as the regulation burdens rot at the bottom line.
On the bright side, regulation hasn’t been as bad as initially thought – usership hasn’t dropped by orders of magnitudes.
In fact, Facebook’s users have shown a resurgent indifference to Facebook chopping up their data and repackaging it to 3rd parties, meaning Facebook has come through rather unscathed in the face of a PR storm.
There have even been recent reports of Zuckerberg being persuaded to start paying journalists for original content, a vast pivot for his hyped-up propaganda machine of being in the distribution business.
Juicing up (ARPU) is the lowest hanging fruit on offer for Snapchat and Facebook right now, overperforming in this sphere will improve financials and keep the mosquitoes away while affording them time to ponder how to reaccelerate user growth.
One outsized negative trend is that 90% of user growth appears to originate from undeveloped nations with a lack of discretionary spending power showing that this strategy has its limits.
Searching for another tool in its toolkit will redefine Snapchat, Twitter, and Facebook as we know it.
I would even classify it as an existential crisis.
Instagram have bought Facebook the most time to readjust its future direction highlighting that stealing Snapchat’s audience is still effective, expecting user growth to climb to 106.7 million US users, up 6.2% from 2018.
Instagram will continue its expansion by adding nearly 19 million new US users by 2023, but as much as it adds to its new social media asset, Facebook will be struggling for new net adds.
Snapchat is in dire straits and the stock market bubble could support the share price for up to another 8-12 months, but when the guillotine drops on Snapchat, the blood will smatter everywhere.
The company also plans to introduce a gaming service to take advantage of the popularity with its core users, Generation Z.
This should be the trick that breathes life into operating margins and (ARPU) which is why I believe the stock will hold up for the next period of time.
But with the gaming initiatives also comes rampant competition with the likes of Alphabet (GOOGL) and don’t forget Fortnite is still the 800-pound gorilla.
These trends also bode negatively for Pinterest (PINS) who might be going public as the last shot of tequila is downed at the after party.
SNAPCHAT ARPU
Mad Hedge Technology Letter
April 11, 2019
Fiat Lux
Featured Trade:
(THE MEANS TO A FRIGHTENING END)
(AMZN), (FB), (GOOGL), (AAPL)
Death of websites.
I love doing presentations to small businesses on my free time, partly to stay in touch with the pulse of the Davids who have the unenviable task of fighting uphill against the Goliaths.
It’s bad enough that the tech giants have scaled locally turning one’s local playground into a disadvantage.
The presentation is aptly titled "Content is King... But Only Through One’s Ownership" where the same parallels are explored and unpacked for my audience.
Proprietary Content – must be yours and you must own it on your own turf - your blog, your vlog, your app, and so on, it goes for everything.
Repurposing content on other platforms as a supplement to your own is one thing, but the moment you adopt an enemy platform as your main platform, that’s your coup de grâce.
SMEs (small businesses enterprise) believe it’s plausible to work with the higher ups, but don’t forget they have every incentive to cut you off from the fountain of youth.
One could say the best skill big tech has today is undermining their competition.
Facebook doesn’t allow posting content that criticizes Facebook, have you ever wondered why?
Website innovation has grinded to a halt because of the PageRank algorithm from Google, everybody is making websites the same, a top nav, descriptive text, a smattering of images and a handful of other elements arranged similarly.
Google’s algorithms and the self-regulating nature of their ecosystem have perverted the chance to have a unique online experience.
Most internet users have probably discovered that most websites don’t work well and the execution of them is lousy.
Many companies are not contributing enough resources to build out their site properly, or just don’t have the cash to fund it or a mix of the two.
About 95% of customer service calls originate from the company’s webpage because of payment problems, disfunction, misleading content, or simply because the website is down.
Ask any small business and they will tell you they deal with their domain being down for hours at a time because of some unknown server problem.
Not only is capitalism only working for a small group of Americans, but so are websites, such as massive companies like Amazon.com who have worked wonders with its e-commerce site.
Because the internet and namely websites are the key to building businesses, Silicon Valley is now using the concept of websites and their position as de-facto moderators to prevent others from developing proper websites, killing off the competition.
Alphabet is notorious for ranking their own products at the top of page one of any Google search.
Amazon has followed the same practice by sticking their in-house brands at the top of any Amazon search on Amazon.com.
And remember that none of this can be called “antitrust” because these borderline tactics offer consumers lower prices but that is only because consumers are brainwashed to believe Amazon offers the lowest price.
What if the same products are available for half of Amazon’s in-house brands, would Amazon volunteer to post their in-house brands on the second page, the graveyard of search results?
I would guess no.
Websites used to give businesses a chance, remember in the mid-90s when a website of any ilk was impressive as if someone was walking on water.
What can we expect next?
Amazon, Google, and Apple are taking their shows to artificial intelligence voice platforms.
SMEs could at least throw hail marys on standard internet searches with visual screens, but once content migrates over to voice platforms owned by Silicon Valley, then its game, set, and match.
For instance, a local business such as Joe’s Furniture Moving Business who, with the internet and visual screens, is searchable through search engines and can be even located on Google Maps with a concrete address.
Once we migrate the lions share of content to voice platforms over the next 15 years, Google Home, Apple HomePod, or Amazon Alexa could easily choose to remove Joe’s Furniture Moving Business information because they make more money offering you information of a moving service they own or have a stake in.
The advent of 5G will refine the voice technology and enhance the machine learning techniques needed to complete the migration of content.
Once the world crosses an inflection point where the technology and volume of content on smart speakers outweigh the hassle to use a keyboard or mobile screen, this effectively makes these smart speaker manufacture Gods of the World because they will own the voice-based internet.
They will be the gatekeepers of all global information, business, and development in the world and we will need to satisfy their algorithms to get our own content uploaded on their voice platforms.
And because of the nature of voice, users cannot see what else is out there, users will only hear what these companies tell us offering an outsized opportunity to manipulate the user experience generating more dollars for these powerful platforms.
By the end of 2019, 74 million Americans will be using smart speakers, giving these smart speaker firms adequate data to fine tune their products.
Eventually, all Americans will be forced to use it or will not be able to function, similar to the effects of a laptop, email, and smartphone combination now.
Once these voice platforms become ubiquitous, websites will be deemed irrelevant – consumers will simply have a choice of Google Home, Amazon Alexa, and Apple HomePod and blindly trust what they tell you is in your best interests.
Pick your poison.
That’s right, users won’t control content in about 15 years, a scary thought, and now you understand why these companies will even give their voice A.I. platforms for free if they have to and probably will in the future.
