“If you make customers unhappy in the physical world, they might each tell 6 friends. If you make customers unhappy on the Internet, they can each tell 6,000 friends.” – Said Founder and CEO of Amazon Jeff Bezos
Mad Hedge Technology Letter
April 22, 2019
Fiat Lux
Featured Trade:
(HOW TECH IS CHANGING THE ECONOMICS OF BASEBALL),
(MAJOR LEAGUE BASEBALL ISSUE)
Several experts and even agents lament that baseball’s free agency is broken and in need of an urgent overhaul.
I would argue that baseball is merely rejigging the inefficiencies of a system from a previous broken era – a reversion back to the mean.
Technology has forced teams to evolve to survive and baseball players are divided into winners and losers with most the latter.
The digitization of baseball has given the best free agents epic paydays while feeding scraps to the rest.
Baseball is a business - they are like any firm with annual revenues, expenses, operating costs, and short-term financial goals.
This trend has picked up pace with the recent infusion of Wall Street knowledge into front offices indicating a sea of change in how management views its costs and revenues.
Expensive decisions in baseball and most any professional sport boil down to the contract length and salary of whom they employ including the groundskeeper and these decisions are made from data.
The book Moneyball by Michael Lewis was the first domino to drop and the financial side of baseball is still feeling the after-effects.
The publication became a must-read for anyone associated with professional sports and baseball with its contrarian statistic theories which promote searching a database to take advantage of unique peculiarities.
Pro sports have never looked back with many other sports taking Michael Lewis’s lead and cross-pollinating his theories into hockey, soccer, and most other industries.
Baseball’s free agency has gone through the meat grinder.
Why?
Big Data.
Superstars such as Manny Machado and Bryce Harper are the best young talents rewarded with a yearly salary of $30 to 40 million per year.
Machado was able to score a 10-year, $300 million-dollar contract with a 5-year opt out clause with the San Diego Padres, and Bryce Harper was able to land a $330 million, 13-year contract which averages over $25 million per year with the Philadelphia Phillies.
Remember that baseball contracts, unlike football contracts, are 100% guaranteed whether a player breaks a leg or not, they just need to show up to the games.
If baseball needed an encore, LA Angels capped off the shopping spree by signing baseball prodigy Mike Trout, giving him the most lucrative contract in sporting history, a 12-year, $430 million contract.
It’s no shock that the recipients are around 26-year-old because data proves this is the optimum time to make a big splash and flash the cash.
Older players aren’t so lucky.
The mid-market free agent environment has cratered, a stark difference from the Machado, Harper, and Trout market.
The hoard of data has concluded that aging 30-something baseball players post performances that deteriorate in an accelerating manner therefore are high-risk financial commitments.
Multi-year contracts are a dying breed for players who are over 30.
Veterans who were once easily commanding multi-year contracts, on the back of a famous household name, in the vicinity of $5-10 million no longer possess this type of earning power.
Aging pros in their early and mid-30s have been deemed expendable and replaced by cheaper and younger talent who teams can financially control yet produce similar stats to the aging veterans.
This development originated from teams attempting to mitigate mistakes in giving big contracts to veterans who stop producing as they got older.
Being on the hook for years of dead money has been pain points for MLB owners.
In 2019, MLB teams have never been more profitable stemming from the overall league delivering record profits from licensing advertisement, television contracts, and attendance gates.
Let me remind readers that baseball earned over $10 billion in total revenue in 2018 translating into a rise of 377% since 1992.
The teams certainly have the capacity to pay veterans more, but data suggests that only ponying up for the best and filling out the rest with younger, inexperienced players is the most prudent way to putting together a team.
The average paycheck in 2018 was around $4.1 million, down $1,436 from the 2017 season hinting that data-based decisions are filtering down to the bottom line.
Adam Jones’s case who had years of success with the Baltimore Orioles as an outfielder is a sign of the times.
He grappled with an off-season attracting no offers until the last moment when the Arizona Diamondbacks offered him a 1-year, $3 million contract.
Jones admitted that he was ready to be sat at home on the couch watching his fellow ballplayers on tv if he hadn’t received the last second offer.
Jones is 33, a death sentence in the world of baseball statistics.
Data suggests that his performance will stagnate and become worse as he ages.
One-year contracts are the best he can expect moving forward.
As negotiations approach for the next collective bargaining agreement, veterans and owners are digging their heels in threatening a player strike.
But what these aging veterans don't understand is that this is just the beginning of technology permanently reshaping how sports are managed and how players are valued.
The top 1% of premium talent will continue to accumulate rich premiums to those of mediocre standard.
A massive hollowing out of the baseball middle class will continue to purge the ranks of veterans and give chances to cheap, young upcomers.
The youth have shown to replicate similar statistics of the mediocre veterans but for a fraction of the cost.
Many accuse teams of being anti-competitive, and teams in the league benefit from being a closed off nature spurning relegation and promotion.
Another contentious issue is the pressure to digitize the game because information suggests that baseball is not attracting new or young fans.
The average age of baseball fans is over 50 and creeping older every year.
I blame the slow pace of the game.
Examples are rife with pitchers being able to step off the mound multiple times before pitches, only to face one batter before being subbed out again, forcing viewers to wait for another 5 to 7 minutes before they can watch another pitch.
Content providers must be aware of viewers' shorter attention spans and adjust content models accordingly.
The league wants to implement a pitch clock, quickening the pace of the game, but the measure was rejected by the players in 2017 and 2018.
Players are resistant to new technology in the game, because of the fear it will reduce their value even more.
Umpiring is a pain point with the status quo unable to offer competent judgments on balls and strikes.
Technology offers an in-game on-demand analysis of the ball placement and some umpires are underperforming to the extent they are perverting the course of the game and the result of it.
It’s gotten so bad that some fans suggest the sport is rigged by umpires who attempt to uphold the rules of the game.
Eventually, sports will eliminate referees and only elite players will be able to play into their 30s.
Baseball will look vastly different as a future product, and my guess is that players above 30 will go extinct in 10 years.
BATTING AGAINST THE ALGOS
“I look forward to tapping into the power of technology to consider additional advancements that will continue to heighten the excitement of the game, improve the pace of play and attract more young people to the game.” – Said MLB Commissioner Robert D. Manfred, Jr.
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.
“Most entrepreneurial ideas will sound crazy, stupid and uneconomic, and then they'll turn out to be right.” – Said Co-Founder and CEO of Netflix Reed Hastings
Mad Hedge Technology Letter
April 17, 2019
Fiat Lux
Featured Trade:
(ALPHABET DOMINATES WITH GOOGLE MAPS)
(GOOGL), (AMZN), (YELP), (UBER)
Remember Google Maps?
Google will start monetizing it, let me tell you about it.
The web mapping service developed by Google gifting access to satellite imagery, aerial photography, street maps, 360° panoramic views of streets has been around since the beginning of this generation of big tech and is what I would consider legacy technology.
Legacy technology is often associated with failure as the out of date nature isn’t applicable to the tech scene and the commercialization of it today.
In a candid letter, Jeff Bezos wrote to shareholders that Amazon will “occasionally have multibillion-dollar failures.”
Silicon Valley tech will have its share of implosions stemming from ill-fated industry decisions correlating to heavy losses.
Google Maps won’t be one of these slip-ups.
However, a whole catalog of instances can be chronicled from Microsoft’s purchase of Nokia’s handset division to Google’s social media foray in Google Plus.
It hasn’t gone all pear-shaped for Alphabet in 2019. I strongly believe they are one of the companies of the year harnessing YouTube in ways consumers never imagined.
Adding color to the story, any remnant of apprehension to any bearish feelings about Alphabet should vanish once investors understand how lucrative Google Maps will become.
Google has spent decades and billions of capital honing the application and in terms of market share they have cultivated a monopoly.
Uber’s S-1 filing shined some light on Google Maps characterizing it as a must-have input into their business saying, “We do not believe that an alternative mapping solution exists that can provide the global functionality that we require to offer our platform in all of the markets in which we operate.”
Uber sunk $58 million integrating Google Maps into its services from 2016-2018 along with continuous payments to its Google Cloud arm to host Uber’s data.
The strong relationship with Uber shows how Alphabet is adept at milking 3rd party apps for what they are worth.
Alphabet’s stake in Uber is projected to be $5 billion from the $250 million investment in Uber in 2013.
The party doesn’t stop there with Uber paying Alphabet $631 million from 2016-2018 in digital marketing services and another $70 million for technology infrastructure.
To say that Google firmly has its tribal marks tattooed into Uber’s skin is an understatement.
Almost 80% of smartphone users regularly use navigation apps.
Google Maps is the most popular navigation app by a country mile with 67% of market share.
One billion people consistently use Google Maps.
It is the go-to navigation app for nearly 6x more people compared to the runner up app Waze with 12% market share.
The superior performance of the app has allowed it to branch off into a Yelp-like hybrid app accumulating reviews of businesses and institutions that are conveniently dotted around its map.
Multi-functional terrain was integrated to make the maps more 3D and route navigation from point A to B routes has steadily improved since its inception.
The increasing detail showing even roofs of sheds and the Google street view offering a point of view vantage point boosting the reliability of the app.
The result of making the app better is that navigators can easily discern locations and follow routes clearly.
Most would concede that they use the app to look up specific street routes.
By implementing digital ads into the experience, product and service offers will possibly populate in real time as the user glances at the app’s directions.
A vast amount of services such from food to personal grooming to even cannabis club ads could be applicable and ad companies will pay top dollar to post on Google Maps.
Google could also offer personalized recommendations to users and collect an affiliate fee if the user clicks on an attached link transferring the customer to a 3rd party landing page.
They already benefit from this strategy on Google Flights.
Google might even be tempted to implement a Groupon model with group discounts on services positioned on Google Maps.
Google Maps is hands down the most underappreciated app and most under monetized tech asset in the world.
Another possible revenue generation avenue would be the advent of Google Maps voice ads en route to a destination that would promote a 5 or 10 second voice commercial of a businesses that the user is physically passing by.
The unintended effects of Google’s audacious transformation of their proprietary Map service spells doom for Yelp’s business model.
Google’s move into digital ads of maps effectively means that Yelp will be relegated to an inferior version of Google Maps without the map technology.
Google has accumulated enough personal data to draw up any type of profile for particularly Android users voraciously consuming data on Gmail, Google Maps, Google Search and Google Chrome.
These four data generators will allow Google to formulate a shadow profile based on individual tastes with daily use of these four Google properties.
Alphabet has a time-honored model of building assets that become utilities and once they monopolize the utility, they sprinkle the digital ad pixie-dust effectively monetizing the asset that was once free of charge.
They have followed the same road map for Gmail, Google Search, YouTube, and if Waymo can become a utility, prepare from Google digital ads inside the screens of Waymo autonomous cars.
When many sulked that this could be one of those billion-dollar failures that Bezos whined about, Google has decided to supercharge Google Maps by cross-pollinating the power of Google maps with its digital advertising knowhow.
This powerful cocktail of forces working in tandem will accelerate its revenue growth along with the resurgence of its YouTube digital ad revenue.
I believe this new lever of revenue growth isn’t priced into Alphabet shares yet, and withstanding any random black swan shocks to the broader economy, Alphabet is poised to outperform the rest of the trading year.
Short Yelp on any and every rally - Google has made their business model redundant.
“If you step back and take a holistic look, I think any reasonable person would say Android is innovating at a pretty fast pace and getting it to users.” – Said CEO of Google Sundar Pichai
