Mad Hedge Technology Letter
June 4, 2019
Fiat Lux
Featured Trade:
(THE GOVERNMENT’S WAR ON GOOGLE)
(GOOGL), (FB), (AMZN)
I told you so.
It’s finally happening.
The Department of Justice (DOJ) preparing an antitrust probe on Google (GOOGL) was never about if but when.
The Federal Trade Commission is in the fold as well, as they have secured the authority to investigate Facebook (FB).
The probe will peel back the corrosive layers of Facebook and Google’s businesses such as search, ad marketplace and its other assets in order to excavate the truth.
Investors will get color on whether these businesses are gaining an unfair advantage and perverting the premise of fair competition that every tech company should abide by.
Tech companies skirting the law and living on the margins are in for a stifling reckoning if these probes pick up steam.
Facebook is about to get dragged through the mud kicking and screaming facing an unprecedented existential crisis that have repercussions to not only the broad economy for the next 50 years, but far beyond American shores with America mired in a trade war pitted against the upstart Chinese most powerful tech companies.
Even though I have consistently propped up Alphabet on a pedestal as possessing a few of the most robust assets in tech, I have numerous times flogged their dirty laundry in public view, referencing the regulatory risks that could rear its ugly head at any time.
These companies have been playing with fire and everyone knows it, but in the world of short-term results via stock market earnings report, this trade kept working until governments decided to get their act together because of the accelerating erosion of government trust partly facilitated by technology apps.
As much as a handful of Americans have monetized Silicon Valley to great effect, I can tell you that I spend a great deal of my time abroad, and American soft power is at a generational low ebb.
Blame technology - our dirty secrets are not only exposed in frontal view but it’s pretty much a 3D view of the good, bad, and the ugly and there is a lot of ugly.
I am not saying that punishment is a given for these ultra-rich firms swimming in money.
Historically, Alphabet has stymied regulators before beating out an antitrust investigation in 2013 after a two-year inquiry ended with the FTC unanimously voting to halt the investigation.
Remember that this time around, the probe follows the fine in Europe when The European Union slapped Google with a $1.69 billion for actively disrupting competition in the online advertisement sector.
The European Commission claimed that Google installed exclusivity contracts on website owners, preventing them from populating on non-Google search engines.
It was quite a dirty trick, but do you expect much of anything else from one of the most crooked industries in the economy?
And this wasn’t the first time that Google has run amok.
EU regulators levied a $5 billion penalty on Google for egregious violations regarding its dominance of its Android mobile operating system.
Google was accused by the EU of favoring its in-house apps and services on Android-based smartphones giving manufacturers no alternative but to bundle Google products like Search, Maps and Chrome with its app store Play ensuring that Alphabet would benefit from a lopsided arrangement.
Anti-trust legislation has a myriad of supporters including the current administration who have stepped up its onslaught on Silicon Valley.
President of the United States Donald Trump has even hurled insults at Amazon (AMZN) creator Jeff Bezos and even claimed that Alphabet’s artificial intelligence has aided China’s technological rise.
To say FANG companies are in the good graces of Washington would be laughable.
I would point to Facebook to accelerating the regulatory headwinds as investors have seen Co-Founder and CEO Mark Zuckerberg fire every major executive that has opposed his vision of merging Facebook, Instagram, and WhatsApp into a cesspool of apps that pump out precious big data.
The tone-deaf boss has doubled down to reinvigorate the growth after Facebook sold off from $210.
Board members want Zuckerberg out and he is defiant against any attack on his leadership spinning it around as a vendetta on his reign.
Facebook is walking straight into a minefield and the rest of Silicon Valley is guilty by association, the contagion is that bad.
Facebook is the one to blame because of the daily nature of social interaction on its platform and the pursuance of revenue through hyper-targeting data that 3rd party companies pay access for.
They have no product.
Amazon sells consumer goods which is not as bad.
Facebook facilitates the social dialogue that has unwittingly boosted extremism of almost every type of form possible.
It has given the marginal and nefarious characters in society a platform in which to engineer devastating results and Facebook have an incentive to turn a blind eye to this because of the lust for user engagement.
This has resulted in heinous activities such as terror attacks being broadcasted live on Facebook like the 2019 New Zealand massacre at a mosque.
The former security chief at Facebook Alex Stamos hinted that Mark Zuckerberg’s tenure should wind down and the company needs to shape up and hire a replacement.
The security implications are grave, and many Americans have uploaded all their private information onto the platform.
What is the end game?
Facebook is in hotter water than Google, not by much, but their business model engineers more mayhem than Google currently.
Facebook could get neutered to the point that their ad model is dead and buried.
If Facebook goes down, this would unlock a treasure chest full of ad dollars looking for new avenues.
Facebook’s most precious asset is their data which might be blocked from being monetized moving forward.
Without data, they are worth zero.
The existential risk is far higher for Facebook than Alphabet.
No matter what, Alphabet will still be around, but in what form?
Assets such as YouTube, Google Search, and Waymo, which are all legitimate services, could get spun out to fend for themselves creating many offspring left to sink or swim.
In this case, YouTube, Google Maps, Chrome, Google Play, and Google Search would still possess potent value and offer shareholders future value creation.
Waymo would become a speculative investment based on the future and would be hard to predict the valuation.
Then there is the issue of whether Chinese companies would dominate the collection of FANGs after the split or not.
As I see it, Chinese tech companies will not be allowed to operate in the U.S. at all, and anti-trust repercussions will have many of these homegrown tech companies carved out of their parents to reset a level playing field in a way to re-democratize the tech economy.
This would spur domestic innovation allowing smaller companies to finally compete on a national stage.
The government finally clamping down epitomizes the current volatile tech climate and how Alphabet who has some of the best assets in the industry can go from barnstormer to pariah in a matter of seconds.
As for Facebook, they have always had a bad stench.
The cookie could still crumble in many ways, each case looks high risk for Facebook and Google for the next 365 days.
Stay away from these shares until we get any meaningful indication of how things will play out, but I have a feeling this is just the beginning of a tortuous process.
“Facebook was not originally created to be a company. It was built to accomplish a social mission - to make the world more open and connected.” – Said Co-Founder and CEO of Facebook Mark Zuckerberg
Mad Hedge Technology Letter
June 3, 2019
Fiat Lux
Featured Trade:
(WHY THE UBER IPO FAILED)
(UBER), (LYFT)
Do you want to invest in a company that loses $1 billion per quarter?
If you do, then Uber, the digital ride-sharing company, is the perfect match for you.
Uber couldn’t have chosen a worse time to go public, smack dab in the middle of a trade war almost as if an algorithm squeezed them into tariff headlines that are currently rocking the equity markets.
The tepid price action to Uber’s first period of being a public company has been nothing short of disastrous with the company tripping right out of the gate at $42.
The company that Travis Kalanick built would have been better served if they decided to go public in the middle of their growth sweet spot a few years ago.
Hindsight is 20/20.
Uber took in $2.58B last year during the same quarter and they followed that up with 20% growth to $3.1B, hardly suggesting they are delivering on hyper-growth an investor desire.
It will probably become the case of Uber hoping to manage growth deceleration as best as it can.
Infamously, the company has been busy putting out fires because of past poor leadership that threatened to blow up their business model.
The fall out was broad-based and current CEO of Uber Dara Khosrowshahi was brought in to subdue the chaos.
That worked out great in 2017 and damage control nullified further erosion in the company, but since then, management has not carved out an attractive narrative.
Just as bad, investors have no hope on the horizon that Uber can mutate into a profitable company.
It seems that costs could spiral out of control and even though the company is growing, the company is not a growth company anymore.
Investors must look themselves in the mirror and really question why they should invest in this company now.
In the short-term, positive catalysts are scarce.
The reaction to their first earnings report was slightly positive as management indicated that competition is easing up, spinning a negative issue into a positive light.
Remember that Uber bled market share after their management issues that I mentioned and Lyft (LYFT) has caught up significantly.
Lyft has also grappled with poor price action to their stock after they went public.
The result from both companies going private to public around the same time means that they will not be able to undercut each other on price because public investors will not give the same type of leash that private investors did.
This will cause losses to cauterize because subsidizing drivers will decelerate, and the pool of drivers will shrink.
In addition, passenger fares could rise because Uber will have no choice but to consider profitability when pricing rides meaning higher costs to the user.
What I am saying rings true for many tech companies and raising prices to satisfy shareholders is not a groundbreaking phenomenon.
As I see it, offering rides on the cheap could be coming to a screeching halt and nurturing margins could be the new order of the day.
The subsidizing effect can be found in the higher than normal gross bookings for the quarter of $14.65 billion, up 34% from the same period in 2018.
Cheaper fares will drive demand, and if Uber stopped helping out with the cost of rides, the 34% would fall to single digits in a heartbeat.
Even more worrying is the negative core platform contribution margin falling 4.5%, meaning the amount of profit it makes from its core platform business divided by adjusted net revenue is on the down.
Uber was able to post a positive 17.9% growth rate during the same period last year.
When the core business is reacting negatively, it’s time to go back to the drawing board.
I believe that the underlying problem with Uber is that they aren’t making any big moves to their business model that would put them in the position to foster hyper-growth.
Incremental changes like removing drivers who fail to collect a 4.6 or above rating and creating a subscription model for its higher growth Uber Eats division are just a drop in the bucket of what they could be doing with its brand and clout.
If investors were waiting for a big step forward with shiny announcements during the first earnings call as a public company, then they were left thirsting for more.
Uber gave us a mini baby step when they need leaps in 2019.
The bigger success might be that Uber had no monumental blow ups which is a telling sign that Uber has at least stabilized operations.
The downside with its food delivery business is that private businesses such as Postmates and DoorDash are private and can still tolerate even bigger losses which will put pressure on Uber Eats to endure the same type of losses.
As it stands, net revenue for its Uber Eats segment rose 31% to $239 million, but then investors must understand this business is scarily exposed and could be attacked by the venture capitalists boding ill for the stock.
Then considering that Uber’s fastest growing geographical segment is Latin America, last quarter was nothing short of abysmal with revenue cratering by 13% to $450 million.
Regulatory risks will cause American companies to take big write-downs the further away they operate from America, and Indian regulation is rearing its ugly head with e-commerce companies bearing the brunt of it.
Looking down the road, Uber has a faulty business model because of a lack of autonomous driving technology, and they will need to partner with a Waymo or Tesla which will destroy margins even more.
Uber has no chance of profitability in the near term, and the data suggests they have lost their growth charm.
Do not buy Uber here, it will become cheaper, and at some point, around $30, this name will be a good trade.
Management needs to up the ante in order to show investors why they are better than Lyft.
“Based on my experience, I would say that rather than taking lessons in how to become an entrepreneur, you should jump into the pool and start swimming.” – Said Co-Founder and Former CEO of Uber Travis Kalanick
Mad Hedge Technology Letter
May 30, 2019
Fiat Lux
Featured Trade:
(IS TARGET THE NEXT FANG?)
(TGT), (AMZN), (WMT)
This is the Mad Hedge Technology Letter finding you the best technology recommendations and sometimes, they come from unpredictable sources.
Retail and the digitization of this industry has made this area one of the biggest recipients of technology through the e-commerce portals such as Amazon (AMZN) and its competitors.
I have gone on record saying that Walmart is the next FANG and I do stand by that assertion.
Another company nipping at the heels of Walmart (WMT) and vying to become the next tech gamechanger is Target.
Target (TGT) has made all the right moves in all the right places by hyper digitizing their own operations, so much so, that it has morphed straight into the firing line of Silicon Valley and its commercial interests.
The first quarter marked Target’s eighth consecutive quarter of comparable sales increases.
Comparable sales growth of 4.8% exceeded even the most outlandish expectations.
There has been a positive response to Target’s same-day digital fulfillment services which was a response in large part to their competitor Amazon.
The fulfillment operations drove well over half of digital sales growth in the quarter.
The crucial ability to offer these same-day services, which delivers customers a high level of satisfaction, is a result of a carefully orchestrated strategy to put stores in the center of fulfillment.
In fact, Target stores handled more than 80% of the first quarter digital volume, including all of the same-day options combined with digital orders shipped directly from stores to guests’ homes.
The first quarter performance was also stronger than expected, up against an expectation for a rate decline, operating margins increased about 20 basis points in the quarter.
This performance reflected the precision of disciplined expense control tied with a favorable mix of digital fulfillment meaning that first quarter earnings per share grew more than 15% at the top end of the guidance range.
The clear outperformance occurred from multiple drivers, including strong holiday performance in the Valentine's Day and Easter periods, along with the powerful everyday traffic in the Food, Beverage, and Essential categories.
Target’s customers are responding passionately, driving rapid growth of the same-day options, including Drive-Up, and in-store pickup.
Perusing recent results, last year’s tariffs passed with minimal carnage and Target has put in motion contingency plans this time around to mitigate the impact of additional tariffs already scheduled for next month.
The China trade war does pose a serious potential drag on margins, and if e-commerce gets hit with higher cost of goods, then not only will Target feel the torture, but so will the likes of Amazon and Walmart.
Geopolitical risk is the main burden holding back the broad market, and the price action has reflected the increasing risk that the trade war will destroy earnings growth and become a strong catalyst for an equity reset.
This is the main reason why I cannot say with utter conviction to buy the company today.
In a top down world, the issues at the top take precedent and investors must absorb this.
Ultimately, Target’s growth strategy entails building and rolling out a comprehensive set of digital fulfillment capabilities, allowing them to provide customers with a convenient fulfillment option for every shopping journey.
As a result of those efforts, Target now offers more digital fulfillment options across more of the country than anyone else in retail.
When customers are planning on being out and about, they can shop on their digital device and Target is able to deliver their order in an hour or two.
Target offers in-store pickup in every one of the 1,851 locations, and Target even walks the order out to the parking lot in more than 1,250 stores.
There are no fees for either of the same-day options.
Shipt, the same-day grocery delivery service acquired by Target last year, offers unlimited free same-day delivery from Target and more than 50 other retailers across the country for $99 annual fee.
A portion of Target’s digital orders are and will continue to be shipped from upstream fulfillment centers. And other items will continue to be shipped directly by other vendors.
Target has effectively transitioned into the Amazon style fulfillment center strategy based on speed and scale.
Target is on track to grow digital sales by more than $1 billion in 2019 and fulfilling even higher percentages of this volume from in-house stores.
Using stores as digital hubs enhances Target’s speed and reduces cost, and importantly, moving to store fulfillment does not increase the frequency of split shipments.
In fact, even though store fulfillment continues to grow rapidly, the rate of split shipments this year is running lower both in Target stores and in total compared with last year.
This allowed management to enhance customers experience which can be seen by repeat business.
There are essentially only three e-commerce companies that have taken full advantage arming themselves with a wicked fulfillment center operation – Amazon, Walmart, and Target.
Other retailers that either do not have the capital to scale, and the resources to digitize will continue to lose business because they simply can’t provide the same quality of customer experience these trio offer.
The financials reflect the great success Target is experiencing today.
Over the last 2 years, earnings results have beaten EPS estimates 63% of the time and have beaten revenue estimates 88% of the time.
Target has taken some apparel market share away from the mall group with comp sales up 4.8% when consensus was 4.2%.
Digital sales were up 42% year-over-year in Q1 signaling that the success or failure of digitizing a business is the x-factor in 2019.
That trend could perpetuate this summer, with Target executives convinced today that the company's brand-new partnership with Vineyard Vines is already one of the most successful in its history.
Digital purchases that originate online now represent 7.1% of Target’s total transactions, up from 5.2% a year ago showing how the digital business is making even deeper inroads each year.
Total revenue was up 5% to $17.63 billion from $16.78 billion last year, smashing estimates of $17.52 billion.
These three e-commerce companies will be the ones standing when the dust settles, and unluckily, there will be some periods when geopolitics and other macroeconomic issues overwhelm the individual stock story.
All else being equal, Target is a smart long-term hold and this firm is in the first innings of a massive digital transformation.
I am confident they will overdeliver on the rest of their annual financial targets.
“If you go back to 1800, everybody was poor. I mean everybody. The Industrial Revolution kicked in, and a lot of countries benefited, but by no means everyone.” – Said Founder of Microsoft Bill Gates
Mad Hedge Technology Letter
May 29, 2019
Fiat Lux
Featured Trade:
(CHINA TO BAN FEDEX)
(HUAWEI), (AMZN), (FDX), (UPS), (DPSGY), (BABA), (ZTO)
