Month: May 2020

Atomera: Premium Analysis

Posted on by io-fund

5def19a5-a8b7-456d-99e3-99ff81d19571_Atomera-Premium-Analysis-v.2.pdf

Atomera: Premium Analysis

Atomera

Please note that small cap stocks can be extremely volatile and high risk. Atomera has a market cap of $160 million with a current price-to-sales of 254. The forward price-to-sales is 29. This illustrates that a small cap needs very little revenue growth to move from an outsized valuation to one that is more aligned with the market. This also represents a fair amount of speculation as the forward price-to-sales is determined from a consensus of two analysts who are counting on deals moving through the pipeline. There is no guarantee this will happen.

Atomera’s extreme volatility was on display last week. The stock climbed 24% before erasing those gains by market close. Last month, Atomera offered 1.76 million shares for $5.00 per share to raise $8.8 million. This led to a 13% drop. Additionally, Atomera is expecting no revenue in Q2 due to the effects of the coronavirus. This could add to volatility. 

I am covering Atomera because I feel like there are some gains to be had in the breakup between Huawei and Western countries. There is a major restructuring going on. I also like how the market is attempting to price this company right now. We may wait until after the first Phase 4 deal (see below), as there will be plenty of runway left.  

Technical analysis can often be less important when a trend is in play and the story is well known. However, for stocks like Atomera, technical analysis is crucial. Knox will be updating our readers this weekend and as we go along on this company.

Please note, as one reader pointed out on the forum, there are bearish comments online about design challenges around MST. These comments are likely correct to some extent and the question is if the company can overcome them. I’ve included more information under the subheading “Design Challenges” below.   

I am still initiating coverage and asking Knox to track this stock for an entry because I am comfortable with the iteration process for technologies that solve big problems. The semiconductor market is old fashioned and moves very slowly at times around new processes. However, I am especially keen to find worthy stocks that help strengthen the domestic semiconductor market as China tensions heat up. 

Financials

Atomera’s revenue in Q1 2020 was $62,000 compared to $71,000 in the year-ago quarter. For Q4, the revenue was $138,000 compared to $150,000 in the year-ago quarter. 

The company’s net loss is $3.6 million per share, or negative ($0.22) EPS. Adjusted EBITDA was a loss of $2.9 million.  

The company has cash and cash equivalents of $11.4 million as of March 31, 2020. As mentioned, ATOM recently issued shares at $5.00, for gross proceeds of $8.8 million. 

For the full year 2019, revenue was $533,000 compared to $246,000 in fiscal 2018. Net loss was ($0.84) EPS in FY 2019 compared to ($1.02) EPS in FY 2018. TTM revenue is slightly down from FY 2019 at $520,000 and ($0.83) EPS.

The median forward revenue estimate from two analysts is $786,000 for 2020 with one analyst projecting $5.45 million in 2021. It’s the second estimate that makes Atomera exciting although the road may be bumpy between now and 2021. 

Roth Capital is the bullish analyst: “We regard ATOM as a highly differentiated silicon enhancement IP vendor that is gaining traction with large semiconductor supply chain companies. We believe the company continues to make solid progress across its significant base of engagements. We expect ATOM to continue to convert additional engagements to licensing revenue over the next few quarters. We maintain our Buy rating.”

Forward EPS estimates for 2020 is ($0.71) and ($0.61).

Integrated License Agreements

Revenue is generated from integrated license agreements. Customers pay a licensing fee to use MST technology in the manufacturing of silicon wafers. Royalties are paid for each silicon wafer or device that incorporates the MST technology (see below for more on MST). The company also generates revenue through engineering services revenue. 

According to the 2019 Investors Presentation, the company has an addressable market of $6-$7 billion in royalty fees primarily driven by FinFET and Advanced Nodes ($6 billion), RF SOI ($50 million) and 5V Analog ($660 million). 

Please note: I’ve reached out to Investor Relations to confirm these numbers have not changed from any design challenges and will update as we go along. 

Total addressable market as of 2018 was $7 billion at 2-3% licensing fees, or $140 million. The 5V analog market adds another $660 million to the addressable market figured on a market size of $33 billion. 

Valuation

The gamble that Phase 4 deals will go through is best understood when looking at the spread between forward PS ratio of 200 with the PS ratio in 2021 at 29. Due to Atomera’s tiny revenue of roughly $520,000-$530,000 per year, Phase 4 deals are imperative to reach the 1-year forward price-to-sales (i.e. this is an all or nothing stock).

Customer Pipeline

As of now, there are 19 customers with 26 engagements with 16 in Phase 3 (integration). The more bullish moves around this stock are due to the Phase 3 deals the company has in the pipeline. It would be easy to presume the Phase 3 deals are with larger semiconductor companies as Atomera has a very specific use for its product. TMSC is used often as an example in their Investor Presentations. 

According to the March 2020 Investors Presentation, the company is engaged with 50% of the world’s top semiconductor markets. The company states Asahi Kasei Microdevices and STMicroelectronics have licensed the technology plus “a large fabless semiconductor company” for mobile 5G markets. 

The coronavirus is a challenge for Atomera as the customers in Phase 3 are cautious with budgest. There is also a slight delay in R&D engineering for new programs. As the company explained on the earnings call, the production personnel are in the fab, but development engineers continue to work from home, which can limit the ability to start new R&D lots. 

Per the management, “where some customers would normally be starting wafers, they may be holding back until their engineers get back into the office to start pulling the levers on new lots.”

Here is what the company said about the coronavirus: “Due to the delays created by the coronavirus travel restrictions and the impact on our customer’s business, we are now expecting to have no revenue in Q2 2020. But as Scott indicated in his remarks, none of our customers have ceased work on MST and progress on the JDA contracts has been delayed but not canceled.”

Therefore, any investment in Atomera is a gamble on the company moving one or more customers to Phase 4 (installation). If/when the company moves to Phase 4 through Phase 6 (production), revenue levels become much more attractive. 

Notably, it can be viewed as concerning that the company held a secondary offering at $5.00 a share before securing a Phase 4 deal. On the other hand, this may be to buy time and create a necessary financial cushion as covid-19 delays budgets and capex/R&D spending. 

Product

Mears Silicon Technology (MST) is a performance enhancing technology that the company believes helps integrated circuits overcome a number of key engineering challenges.

Primarily, MST enhances transistor capabilities and reduces chip size. According to Atomera and a third-party study by PMIC published on their website, MST can result in a 16-21% reduced chip size. 

MST allows DRAM designers to reduce chip size without moving to a new technology node. According to Atomera, the IDM process/development is $10 million and the foundry equipment upgrade is $30 to $50 million. Meanwhile, a foundry for a new node can cost billions. 

MST is also beneficial in stopping dopant diffusion in high temperature manufacturing, which makes it helpful in chip designs. According to Tailwinds research, MST could become an essential element in FinFET production processes, as dopant diffusion is a major issue. The three major companies who have explored FinFET are Intel, Samsung and TSMC. 

According to Atomera, Mixed-Signal/RF devices can also achieve a 10-11% die size reduction. This is achieved with a lattice design that increases horizontal current flow and reduces vertical leakage. 

The CEO grew a $1 billion-plus division at Broadcom and also worked as an SVP and GM at Altera.  The CTO has been inventing and working on patents for broadband networks for 30 years. I don’t see any flags with the management (a common issue with small caps). 

Design Challenges

Atomera is as high-tech as a company and concept can be. Obviously, there are design challenges to overcome or the company would be generating more sales and would no longer be a tiny cap company. What I look for here is whether there will be enough demand to overcome the design challenges and to support the iteration process. I believe there is with the recent pressure on more domestic semiconductor manufacturing. 

There is an ongoing debate sparked on a thread by an anonymous commenter on Seeking Alpha. The comment asserts: “High temperatures of older nodes won’t let their concept survive. Finer nodes with finfets/nanowires don't need it.” The comments state that Atomera’s advantage lies in “surface inversion devices whereas finfet/nanowires are volume inverted.”

I try to stay as neutral as possible and weigh both sides of a debate like this. The truth is this company could go either way – boom or bust — but probably not much in-between. 

One thing I like about passionate bulls/investors and passionate bears/short sellers is they always bring to the surface the major catalysts or risks. 

Here is what Atomera’s Investor Relations team said when I inquired about these issues: “MST1 and MST2 have different properties for handling thermal budgets, depending on the application.  There is a lot of variability in customer processes and thermal budgets, and Atomera has worked with enough to have a good sense of how to navigate these types of engineering challenges.”

Below is what one of Atomera’s investors said (who also writes analysis). I’m pasting sections from his blog on the topic below. You can read the full blog here: “Are All the Atoms Aligned for Atomera?”  

“The first potential issue to be addressed relates to diffusion of oxygen in high-temperature processes. Which translates roughly into the question of can MST be applied to chips that have high heat during manufacturing? The concern here is that many production lines have stages in which chips are subject to annealing at very high temperatures. If the thin layer of oxygen that Atomera applies were to be diffused in these processes, this would greatly diminish if not alleviate all the benefits of MST. Taking it one step further, if MST is not going to be used in high-heat process manufacturing, the applicable market for MST would be greatly diminished making this truly only a niche product.

From my digging, it appears that this concern is very overblown but not completely without merit.

Atomera has developed a work-around solution whereby they can apply MST at later stages in the  process, thereby missing out on the high temperature steps that could diffuse the oxygen. This actually was discussed on ATOM’s Q2 2018 earnings call. Here’s what they said about this issue…

“I’m very pleased to tell you that during the last quarter, Atomera has started testing an optimized version of our film that shows remarkable potential by attacking the problem in a new way. Our approach has been to find a new material construction method that’s better at oxygen retention so it’s able to withstand a wider spectrum of processes surrounding MST…This should make it easier for customers to see better results earlier in their integration process and gain higher confidence in MST’s ability to withstand manufacturing variances during mass production which is a critical factor in their decision of whether to adopt our technology.”“I’m very pleased to tell you that during the last quarter, Atomera has started testing an optimized version of our film that shows remarkable potential by attacking the problem in a new way. Our approach has been to find a new material construction method that’s better at oxygen retention so it’s able to withstand a wider spectrum of processes surrounding MST…This should make it easier for customers to see better results earlier in their integration process and gain higher confidence in MST’s ability to withstand manufacturing variances during mass production which is a critical factor in their decision of whether to adopt our technology.”

I can also confirm that during conversations with management, they have specifically noted that oxygen diffusion is a potential issue, but they are very confident in their ability to deal with this. However, applying MST after annealing will certainly place constraints on the process. Some potential customers will need annealing too late, in the process, for MST to help them. Dopant implantation messes with the crystals, annealing heals them. Is it possible for doping to be accomplished without high energy, destructive implants? Maybe. But if not, how many customers are impacted by this?

At this time, I’m sure Atomera knows how big this potential issue is through their customer interactions, but it’s impossible for outsiders to have this knowledge. Having listened to the Company and learned what I can about semiconductor manufacturing processes, it seems likely that the truth lies somewhere between MST being a niche product and it working on any and all processes. I lean in favor of the market being much larger than some concerns have expressed.

Another issue mentioned by investors related to the stage of the product. Namely, all the white papers reporting the great gains of MST were based on simulations. Which implies that the process has yet to be replicated in the real world. Once again, here’s CEO Scott Bibaud, this time on last quarter’s conference call…

“These papers are based on simulation models and only limited experimental results since the advanced process nodes are not widely accessible and are extremely expensive, but they all show impressive performance improvements with MST. Over the last few months, we’ve had multiple test results from actual silicon runs, which have validated those fundamental mechanisms.”“These papers are based on simulation models and only limited experimental results since the advanced process nodes are not widely accessible and are extremely expensive, but they all show impressive performance improvements with MST. Over the last few months, we’ve had multiple test results from actual silicon runs, which have validated those fundamental mechanisms.”

So, yeah, it’s true that the papers were based on simulations, but Atomera has run their process on customer silicon many times. The theoretical gains were seen in these runs. However, “customer silicon” is, by definition, not Atomera’s. The data obtained from these trials is not Atomera’s to share with the world, and I don’t think a semiconductor company would be sharing their test results  

from a new process with their competitors. So, we’ve not seen the actual numbers from silicon runs and will need to base confidence here on management’s statements that those numbers are consistent with simulations.”

Conclusion:

This is a true Hail Mary small cap idea. The stock’s potential hinges on Phase 4 deals coming through (already a gamble) meanwhile the coronavirus may have delayed orders.  

However, one or two Phase 4 deals can really move the stock price for this company. The June 2019 investors report provided two scenarios showing $6.7 million in revenue up to $29 million in revenue as a result of signing one large customer. 

From a high-level overview, I like this company right now (given the ample risks) because I am keen to invest in the increasing pressure on semiconductor companies to reduce dependency on China and to make up for Huawei’s dominance. As one Seeking Alpha comment had also pointed out, the semiconductor industry can be slow to adopt new technologies. This is very true, however, the geopolitical tensions will put pressure on the manufacturing process.  

It’s important to emphasize that if Atomera signs a Phase 4 deal, there will still be time to invest. To reduce risk, we may explore waiting until the first Phase 4 deal is signed OR we will wait for a very clear technical breakout. We are not front-running this stock based on fundamentals. 

Knox is essential to navigate this and he will write a blog update on the technicals (and what he’s looking for) this weekend.

5G Update

Posted on by io-fund

Global supply chains are looking to move out of China. Last week, Taiwan Manufacturing announced plans to build a $12 billion factory in Arizona. The plant will focus on 5 nanometer chips and will take nine years to build. TSMC is a major supplier to Apple, Qualcomm and also generates 14% of sales from Huawei. The story is evolving with TSMC halting new orders from Huawei per the Nikkei Review. 

Although TSMC produces chips that power iPhones and consumer products, the main takeaway here is that the United States government is ramping up investment in 5G and artificial intelligence. The more advanced chips needed for defense can’t be made in China for obvious reasons.

Since last summer, we’ve been looking at when the Huawei tensions would fully play out and what companies would stand to benefit. Primarily, I was (and am) looking for companies that solve critical 5G infrastructure issues because it is incredibly costly to overhaul the 4G systems. There are also inherent issues to 5G with millimeter waves traveling short distances.

5G PDFs:
Overview
Semis
List of Stocks

HEROES Act: $1.5 Billion for Wi-Fi Hotspots (INSG, WIFI)

The HEROES Act was passed by the House and the bill is now moving towards the Senate, where the $3 trillion may not pass. Regardless, a bipartisan provision in the bill is the “Emergency Connectivity Fund” with $1.5 billion going towards the funding for “Wi-fi hotspots, other equipment, connected devices, and advanced telecommunications and information services to schools and libraries.”  There’s another $4 billion to be allocated to emergency broadband service.

Regarding hotspots, Inseego has prioritized working closely with the U.S. government. Here’s what Inseego said on their last earnings call:

Turning to our strategic initiatives. We mentioned in our prior earnings call that we began efforts to deepen our relationships with the U.S. government to increase awareness of Inseego as a U.S. supplier to the administration’s objective of a secure 5G network ecosystem.

Given the scale of potential opportunities, we wanted an executive to lead that effort and have recently appointed former Inseego senior executive, Chris Lytle, as head of government affairs, including our initiatives in the education sector. Now I’ll turn the call over to Steve to discuss our financial results.

Boingo also has experience working with the United States government as a preferred hotspot on military bases. In fact, one of Boingo’s revenue segments is dedicated to military bases and they have contracts through 2038 with the Air Force. From the PDF we published: “Boingo solves a substantial limitation to 5G, which is the inability for higher frequencies to penetrate buildings and walls. Eighty percent of all cellular traffic occurs indoors. Essentially, the high speeds that cellular 5G will become known for are not operable indoors at this time.”

One thing to note is that Huawei had outpaced Boingo on DAS systems with a new digital indoor system (DIS). The population and size of indoor spaces in China drives a greater need for an improved indoor cellular connection. However, with Huawei being cutoff, this puts Boingo in a critical place to supply this piece to not only the United States but potentially to other Western countries.

As noted in the PDF, the fundamentals are not very good on Boingo whereas the product is very promising for 5G purposes. I believe the Huawei cutoff will benefit Boingo and strengthen this story.

Inseego PDF
Boingo PDF

I also recommended Marvell in December for similar reasons. It could take some time for Marvell to make up for the loss as 14% of revenue comes from Huawei. However, Marvell is in line to supply Huawei’s competitors – Nokia and Samsung.

Huawei is building base stations without components made in the United States and this impacts Marvell as Huawei is the current leader in 5G infrastructure. The storage business was down 1% sequentially at $275 million due to the export restrictions on Huawei. Samsung is increasing their orders, which helps Marvell. Nokia also uses Marvell’s chips.

Marvell supplies components for 5G base stations and both Nokia and Samsung are customers. In turn, Samsung works with Verizon, AT&T, SK Telecom, and KT. Samsung has been able to capture business that Huawei has lost, and the level of this future growth is an important catalyst.

Marvell PDF

There’s also a small cap breaking out that we had highlighted on our short list for the 5G report. The company is Atomera (ATOM). The company did a secondary last Wednesday at $5 per share. I’ve heard that in the discovery there was information on Phase 4 deals that may be coming to fruition. I’m still digging around on Atomera and any connection the price movement could have to the announcements on Friday (being a 5G play). Knox will be updating this on the forum for anyone interested.

Atomera was mentioned briefly in this PDF

Regarding F5 Networks and Telco Networking/Network Functions Virtualization (NFV), there was another acquisition announced in this space by Microsoft last week. You can read about it here. As you’ll see, this is an important space for cloud-native telecommunications.

Basically, I am betting that F5 can maintain its lead in a space where it has the superior solutions (according to Gartner and partners like RedHat and Datadog). As stated, revenue growth is mid-single digits and there’s a chance F5 can’t maintain a moat. On the other hand, F5 has owned the space in the hardware equivalent for a very long time and has this singular focus. I think F5 is making the right acquisitions with NGINX and security (as outlined in the PDF). This is a very new space, however, and will require some patience for the right entry.

F5 Networks PDF here.

F5 Networks: Premium Analysis

Posted on by io-fund

285039c6-615b-4a1f-a707-e3c6c73ea424_F5-Networks-Premium-Analysis.pdf

F5 Networks: Premium Analysis

F5 Networks

Overview:

Like many traditional hardware companies, F5 Networks is shifting from a hardware model to a software-driven business to accommodate an increasingly cloud-driven world. The effects of the shift to cloud services are not fully reflected yet in the company’s revenue growth, which was at 7% YoY in the most recent quarter. The company has been basically range bound with revenue growth around 5% since 2016.

F5’s cloud services are distinguished from running apps on virtual machines in a single cloud from being able to run distributed, container-based microservices across multiple clouds. The services have the added benefit of security, such as advanced web application firewalls. This is important because up to 40% of internet traffic comes from botnets with 20% being bad bots. 

The three main products which work to consolidate networking tasks and deploy apps faster., are BIG-IP, the NGINX Controller and a new SaaS offering called Beacon. These three products tie together traffic management, API management, app security and end-to-end app visibility and analytics.

There are a few trends that help to support F5’s future revenue growth. Primarily, the shift away from monolithic architectures and towards microservices architectures (and the popularity of containers orchestrated by Kubernetes). Also, the complexity of multi-cloud and hybrid cloud environments. 

However, it is the 5G catalyst that I am most interested in and the reason I am covering the company. 

F5 Product Summary:

F5 Networks is well known for its hardware-based Application Delivery Controller (ADC) product offerings. The company recognized a need to move to cloud based workloads due to the decline in ADC hardware and the shift to software-based solutions.

As the number of applications grow, the complexity increases. Companies must deploy, manage and secure applications across private data centers, private clouds, public cloud, microservices environments and multi-cloud environments. This complexity is how F5 hopes to gain and defend its market share. 

The customer base for F5 are companies that need to scale and deploy applications very quickly. Essentially, developers write the code for the applications (i.e. the business logic, backend components, and user interfaces). F5 helps to deliver the application to the device, machine and browser. 

The company acquired NGINX for $670 million in May 2019. This helped the company to expand to new addressable market opportunities including web servers, application servers, and API gateways. The company is seeing promising early wins for NGINX Controller 3.0. It is also seeing real traction with the F5 and NGINX combination. 

Another major recent acquisition was Shape security for $1 billion which helped the company to target the application security market. Shape is a leader in anti-fraud and abuse protection. The company’s existing Canadian banking customer is a BIG-IP customer and experienced an account takeover attack on their web application. With Shape in full mitigation mode, it was able to block a major attack.

Load Balancing

F5’s two products are the F5 BIG-IP Local Traffic Manager and the F5 BIG-IP DNS. The local traffic manager balances loads across servers in a single data center. The DNS uses topology-based load balancing to determine the closest data center. 

Load balancing refers to distributing requests across web servers to avoid overloading any one server. Load balancing distributes the requests based on the actual load at each server to ensure availability and helps with denial of service attacks.

Microservices

Microservices is a newer architectural framework designed so that changes won’t break the entire app. The core functions of a microservices framework can be deployed independently, meaning individual services can function without affecting the others. This is opposed to a monolithic approach where the source code is built into a single deployment. With a monolithic/single deployment, there is a lot of downtime as any update requires the entire app to be taken offline. 

Microservices closely resembles service-oriented architecture (SOA). In this architecture, individual services communicate through the enterprise service bus (ESB). This allows for iteration and deployment without monolithic development cycles but it also creates a single point of failure (the ESB).

Containerized microservices allow applications to be run independently on the same hardware with much greater control. This is the foundation for cloud-native applications. 

NGINX:

The main benefits to NGINX is the software approach to application delivery and API management, as well as the brand name in open source and DevOps. The acquisition creates end-to-end application infrastructure and allows F5 to transform into a more software and multi-cloud approach. The acquisition also helps to combine security technologies with web servers and load balancers. 

The goal of F5 and NGINX is to combine the application teams, developer teams and operations under one umbrella to include AppDev, DevOps, NetOps and SecOps. 

NGINX’s main competitor is Apache. F5 Networks is popular with the Fortune 500 and NGINX is popular with developers/open source community. More than 400 million sites use NGINX and NGINX Plus, including Netflix, Dropbox and Zynga. In 2019, it was reported that NGINX was closing the gap with Apache and Microsoft in webfacing computer market share to about 30% of the market.

This also provides F5 with inroads into servicing Kubernetes nodes. Kubernetes is a leading container platform that was designed by Google and is now used everywhere. Kubernetes has exploded in popularity with 78% of developers using it for cloud native projects. This is a tailwind for F5 (although not a major catalyst as NGINX is free, open source software).

The most recent product announced from the acquisition is the NGINX Controller 3.0 which helps development teams deploy applications in multi-cloud and hybrid cloud environments. In the recent quarter, F5 secured a leading oil and gas company in the Middle East from the new acquisition. The oil and gas company had both security and API management challenges, it opted to deploy NGINX for API management and F5’s advanced web application firewall for API security. 

Shape Security:

Shape Security protects against automated attacks, botnets and targeted fraud. The company mitigates more than 1 billion attacks daily and is deployed on more than 200 million mobile devices worldwide. The company is used by eight of the top twelve U.S. banks. The company separates good traffic from bad traffic. Shape Security will augment F5’s application infrastructures.  

According to F5, the acquisition will boost its software revenue growth from 35-to-40 percent to 60-to-70 percent next year. It expects to achieve breakeven non-GAAP EPS within 24 months of closing the acquisition.

5G: Network Slicing, Gi-LAN Consolidation and Edge Computing:

F5 Networks is positioned to help 5G infrastructure scale. The new 5G architecture will have the ability to “slice” the network into different segments from the radio network (RAN) to the core in order to help allocate resources according to various use cases and traffic spikes. The existing 4G core networks do not have networking slicing built into the system. F5 Networks can provide the existing 4G systems with GTP session directors and DNS session directors. 

In addition to network slicing on existing 4G systems, F5 Networks can also improve the monolithic architecture of the Gi-LAN Networks, which are independent network functions on dedicated devices from a wide range of vendors. Latency increases with each hop in the chain the data packet has to traverse. The monolithic architectures — with individual service functions on different hardware — can have a major impact on latency. The monitoring of the system is challenging and security is also an issue. 

The solution is to consolidate Gi-LAN into one instance/appliance to reduce the latency and simplify the network design. F5 Networks offers a Gi-LAN consolidation solution that includes TCP/IP optimization, firewalls, traffic steering, deep packet inspection, URL filtering and DNS security. Most importantly, F5’s solutions are available in both physical and network function virtualization (NFV) environments. The company’s in-house load balancing is also important to scale and eliminate redundancy. 

F5 also facilitates edge computing with virtual edition software for load balancing, web application firewalls, service discovery and monitoring. The company is also well positioned for providing application delivery control and security services for microservices architectures within containerized infrastructures (i.e. Kubernetes). 

5G Case Study: Rakuten Mobile

The case study with Rakuten Mobile is especially interesting as a model for how important F5 Networks could become in the near future as telcos can reduce capex and physical infrastructure needs with cloud networks and network functions virtualization capabilities (NFV). 

Rakuten is Japan’s biggest mobile virtual network operator (MVNO). In early 2019, the company announced plans to build a network in 12 months without significant capex. The reduced capex is made possible through a cloudnative network. The goal is to shift towards Network Functions Virtualization (NFV) technology, which uses the principles of cloud computing to create service delivery platforms “with greater agility and customization.”

The end result is a Radio Access that is virtualized and running as a virtual network function on a private cloud. You can read more here and the press release regarding Rakuten’s partnership with F5 here.   

Financials

F5 Networks reported fiscal Q2 2020 earnings at the end of April. Revenue increased 7% year-over-year to $583 million with EPS of $2.23. This beat analyst estimates by $20 million on revenue and $0.24 on EPS. 

In the previous quarter, revenue increased 5% to $543 million.

On a non-GAAP basis, product revenue comprised approximately 45% of total revenue and it grew 10% year-overyear to $262 million. Of this, software represented 35% of product revenue and it grew 96% year-over-year. Excluding the partial contribution from Shape, software grew 65% year-over-year. Services revenue grew 5% to $324 million.

Full year revenue grew 4% to $2.2 billion with non-GAAP income of $626 million, or $10.36 per share, up from $612 million in fiscal year 2018.

The company has cash and cash equivalents and short-term investments of $820 million and $182 million in cash flow from operations. Long-term debt at the end of March 31, 2020 was at $380 million. The company repurchased $50 million worth of shares in the most recent quarter.  

For the fiscal Q3, the company expects both GAAP and non-GAAP revenue in the range of $555 million to $585 million and non-GAAP diluted earnings per share in the range of $1.91 to $2.13. 

The company withdrew the FY 2020 outlook provided in December 2019 when they announced the Shape acquisition. F5’s gross margins are forecast to be around 85% and operating margins to be 30-32% for full year 2020.

Following the Q2 report, F5 attracted some bullish analysts from Piper Sandler and Nomura who believe there is upside due to strong forward guidance and the current results coming from an acceleration of existing trends rather than a pull forward.

Despite these newly bullish analysts, the overall rating is neutral on F5. Notably, Goldman Sachs has a neutral rating due to the earnings stability being offset by the “less certain spending environment.”

F5 is holding up well with the current shift towards work from home. In the most recent earnings report, the company saw an acceleration in purchases of F5 solutions while some purchases were pushed out to future quarters. 

Here are some examples from the earnings call on how F5 Networks has been used during the coronavirus:

•       F5 enabled one of the largest banking and investment institutions in the United States to scale its VPN access from 400,000 to 500,000 remote users.

•       The company helped a multinational mass media conglomerate to increase network capacity within one day, so that 100,000 additional employees could work from home in the U.S. and London.

•       A fortune 10 Retail Healthcare Corporation added 160,000 remote workers to its network in under 24 hours. 

Addressable Market & Valuation

F5’s biggest risk is the number of competitors relative to addressable market. Often this level of competition leads to pricing wars. 

The total addressable market in the application security market has doubled to $8 billion from $4 billion with the Shape Security acquisition, according to F5’s Investor Presentation. Competitors include A10, Akamai, Cisco, Citrix, Imperva, Juniper, Radware, and Symantec.

The ADC market was valued at $2.9 billion in 2016 and will reach $4.2 billion by 2023, which is modest growth of 5%. According to MarketsandMarkets, the Application Security market size is expected to grow from $2.8 billion in 2017 to $9.0 billion by 2022. Competitors here include Citrix Systems, Radware, A10 Networks, AWS, Array Networks, Barracuda, HAPRoxy, Kemp, VMWare and Microsoft Azure. 

Application delivery controller revenue declined 4% to 7% in 2018 with F5 owning 47 percent of ADC market share at that time. This prompted the shift towards software. 

According to IDC, there were more than 700 million application instances in 2018 and this will grow to 3.7 billion by 2023 for growth of 500%. There were 314 million enterprise applications in 2018 and this is forecast to reach

1.8 billion by 2023. 

The company trades at a forward PE ratio of 15 and forward PS ratio of 3.5. This is at the low range for comparable companies. 

Conclusion:

There are reasons that F5 has a low valuation comparatively speaking. The company has been hit hard by the transition away from hardware and on-premise. The NGINX acquisition does little for F5’s top line, which has struggled to break out from 5% year-over-year growth. F5 Networks is also a company that has many competitors with a smaller addressable market than what I typically cover. 

However, as companies seek to scale application deployment, there are infrastructure-level issues that cloud software companies will struggle to solve. F5’s experience with hardware and a pivot towards software could be a winning combination. This goes beyond end-to-end application infrastructure, where the company already has a solid reputation (i.e. Datadog and IBM’s RedHat both favor F5 as a partner here). F5 is also doing a good job of staying in front of the trends of microservices and the Kubernetes platform. 

The more interesting catalyst for is whether F5 can solve major infrastructure and capex issues for telcos. F5’s network functions virtualization (NFV) capabilities can enable a higher throughput, low-latency network and ensure application availability for wireless networks. I believe F5 could be uniquely positioned to solve these issues which should be in high demand as global competition increases for scalable 5G deployment.

Will Roku Go Boom Or Bust In 2020?

Posted on by io-fund

This article was originally published on Forbes on Apr 30, 2020,01:41am EDTForbes on Apr 30, 2020,01:41am EDT

Roku has gained up to 600% in less than 3 years since its IPO despite having many objectors along the way. In light of these sizable gains, Roku has seen five significant drawdowns ranging between 41% to 67%. Therefore, when considering if Roku will go boom or bust this year, I believe it will do both. 

When I first began bullish coverage on Roku at $30, the company had a misunderstood business model. At the time I pointed out that Roku was an ad platform first and a hardware player second. At the time, the market was backwards-looking as Roku’s device sales made up 59% of total revenue in the six months leading up to its public offering. 

Through 2019, its device sales made up only 34% of its revenue, while the remaining majority came from its platform. What investors initially failed to realize was that the hardware player was a means to its high-yielding ad platform. Roku has an added advantage from the data it has on consumers due to owning the hardware and the many content apps that need access to an OTT device.  

With this history, my guess is investors will get Roku’s story wrong again this year as Roku must chose between its top line and bottom line. Covid-19 offers an important opportunity for Roku as OTT usage is skyrocketing and the company must expand globally for long-term growth. (I’ve covered extensively why the domestic market is no longer pertinent in my Netflix coverage). 

Often times, growth and earnings are at odds with one another as revenue requires sales and marketing (or other investments), which ultimately eat at the bottom line. Or, in Netflix’s case, revenue growth and free cash flow are at odds. Conceptually, most investors know there is a cost to hyper growth, but in practice, it’s hard to see one of your portfolio companies miss those magical analyst estimates.

Despite monetizing through ads rather than subscriptions, Roku’s best role model for becoming a global media company is Netflix. What Netflix has done beautifully is ignore the pressures that comes with being a public company in favor of being a hyper growth company. This included taking on debt and other risks to gain ground. While I’m not suggesting Roku should take on the debt levels that Netflix has, it wouldn’t hurt for Roku to do whatever it takes to solidify itself as the leading global AVOD channel and ad platform this year.

International Expansion

Roku predicts that by 2024 roughly half of all U.S. TV households will have cut the cord or never had traditional pay TV. 

Earlier this year, Roku began its expansion into emerging markets by entering Brazil. Strategically, Roku has partnered with the electronics company AOC to launch AOC Roku TV. The AOC TV/Roku platform will feature popular local content from Globoplay. With over 5,000 channels and over 1,000 free channels, Roku should do well in emerging markets. (I’ve also covered this in detail in a previous analysis.) 

Furthermore, Roku has announced fifteen TV brands that come integrated with the Roku platform models. These models are available not only in the U.S., but also in the UK, Canada, and Mexico as of 2020. This kind of strategic partnership with TV models will help the company scale globally, which is a critical next step for Roku.

Pandemic Outlook

Roku recently stated that its commission revenue is  expected to jump as viewing hours have increased due to COVID-19. However, it will still feel the shock of ad demand drying up. 

Oppenheimer analyst Jason Helfstein cut the price target from $165 to $110. He forecasts Q2 ad platform growth to be around 18% YoY from the previous estimate of 62% growth. With that said, AVOD views are expected to grow 50% and streaming hours increase by 22%.

Needham forecast one or two more quarters of ad weakness, with ad growth uncertain in 2021. Analyst Laura Martin, who has a strong track record on this stock, said Roku may be able to withstand the storm with its unique model. “A key thing that differentiates Roku in this environment is that it doesn't set its ad-prices at auction,” Martin said in a Tuesday note. “It uses a direct sales force to set negotiated prices, just like traditional linear-TV. We believe that, even though ad-demand has been falling, Roku is still charging $30 + CPMs, and instead, is cutting the number of ads it runs per hour.” 

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Any weakness in Roku’s price will likely be temporary, considering its financials and positioning. Although you could argue this is the case for many advertising companies, connected TV ads are in a growth trend while mobile is reaching saturation. 

Unlike many ad-tech peers, Roku is well diversified. According to emarketer, Roku collects $1 million for letting a service like Disney+ take over the Roku home screen. Other companies like Netflix pay $1 for every Roku sold with a Netflix quick-launch button on them.

For every new market Roku expands into and every unit sold, these numbers will only increase with Roku’s brand and helps diversify the company from varying levels of ad demand.

Recent Financials

The company released a preview of Q1 results on April 13, 2020 and reported revenue in the range of $307 to $317 million. This suggests growth of 51% YoY.

For Roku, it matches the same growth we saw in Q1 of 2019, which shows the continued demand in this growing space. Roku estimates 39.8 million active users as of March 31, 2020, which is a net increase of 3 million since December 31, 2019. 

It estimates streaming hours of 13.2 billion, which is a 49% YoY increase.

Gross profits were in the range of $139 to $144 million, which suggests a growth of 40% YoY, while net losses were in the range of $60 – $55 million, compared to a net loss of $9.7 million for the same period last year. 

As Roku scales internationally, profitable earnings are not expected within the next year. This is the part that Wall Street can often be uncomfortable with; however, it should be factored in that Roku’s revenue growth is solid. As stated above, it has little competition in the niche area of OTT it dominates with manageable debt.

Technical Analysis

Roku Technical Analysis

Roku has moved in a clear uptrend off the March lows. It recently hit a wall of resistance, which includes a key level around $125-$120, the 200-Day SMA, as well as a downward sloping trend-line from its recent peaks. 

With low participation at current prices, as exhibited in the volume, it will need to find more buyers to break through this region. The MACD shows weakening momentum on the daily chart and the RSI shows that its uptrend has broken, as well. We can expect a pullback in Roku in the coming days/weeks. 

The key support level to watch is the $102-$86 region. If this zone is broken, we can expect a retest of the recent lows. However, if it holds, we expect new highs for Roku in the coming months.

The Trade Desk: Effects of Lower Ad Demand In 2020

Posted on by io-fund

This article was originally published on Forbes on Apr 30, 2020,03:15am EDTForbes on Apr 30, 2020,03:15am EDT

On recent earnings calls, Snap and Google have confirmed that record ad demand in January and February was met with a significant pullback in March. While many investors are speculating the bounce back in ad tech will happen as quickly as Q3, the respective companies are declining to comment on forward guidance for the rest of the year.   This analysis will look at how this will effect The Trade Desk.

In my recent analysis, I question if the market has priced in the advertising downturn. Notably, Google has plenty of cash to weather a downturn while Snap has turned towards raising debt. Meanwhile, ad exchanges, such as The Trade Desk, are particularly exposed.

Here are a few reasons why I’m pivoting away from the bull thesis for The Trade Desk in 2020 and possibly into 2021.

The Bull Case for The Trade Desk:

To be transparent, I had predicted ad-tech to be one of the best tech trends in 2020. This prediction came true as January and February were record months for ad revenue. However, the story has changed now that large brands are reducing ad spend, or as Google recently said in their earnings report, March “experienced a significant and sudden slowdown in ad revenues.”

The Trade Desk is a “demand-side” or “buy-side’ ad platform which allows advertisers to buy ads in auction-like format through real-time bidding. This is an automated method for buying and selling inventory that eliminates the need to call up an agency or salespeople to place the ad. The official term for this is programmatic, and the trend is popular in ad-tech, with over 50 demand-side platforms that transact/broker programmatically. 

By utilizing machines instead of salespeople, the cost of the ads go down and both parties (supply/publishers and demand/advertisers) prefer programmatic due to fewer middlemen and higher returns.

Strong drivers for The Trade Desk include omnichannel capabilities, which is the ability to buy ads across many channels, such as mobile, video, audio, display, social and native. The universal ad ID is another important differentiation as it offers an anonymized ID that helps track users, target audiences and provide attribution. This feature is rare for a third-party ad network and helps The Trade Desk compete with first-party data companies. 

Connected TV ads is the segment with the most growth. Winterberry Group research predicts ad spending on addressable TV and OTT will see a 44% boost in 2020, while linear TV barely have a 1.9% increase. 

Another major bull case for The Trade Desk is the trailing financials and growth have been solid. The company released its Q4 and 2019 results on February 27th. The total spend reached a record $3.1 billion in 2019, an increase of 33% year-over-year. Total spend in Q4 was $1 billion.

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Revenue grew 39% to $661 million with Q4 revenue growing 35% year-over-year to $215 million. Net income grew 23% YoY to $108.3 million.

Non-GAAP net income grew 42% and the company reported non-GAAP EPS of $3.69 compared to $2.70 for 2018. Quarterly non-GAAP EPS was $1.49 compared to $1.09 in the year-ago quarter. 

Looking forward, The Trade Desk is expecting EPS of $0.45 and revenue of $797 million for the year — although this is likely to come under revision due to covid-19.

Additionally, Gartner has named The Trade Desk a Peer Insights 2020 Customers Choice for Ad Tech. 

Why The Trade Desk May Be More Exposed in 2020

The primary reason that The Trade Desk may be more exposed in 2020 is that they are not the publisher of the content where the ads are sold. For instance, Amazon Fire will fill their inventory first from Amazon’s DSP before pulling from the secondary market (or further down the waterfall). As Amazon will likely illustrate, the only real moat that exists in advertising comes from owning the audience as a publisher — or even better — by owning the device.  

There is also little loyalty from advertisers who will quickly switch to the next best-performing programmatic DSP. Switching costs for ad exchanges are very low and this creates fickle behavior in times of distress. 

According to Interactive Advertising Bureau (IAB), digital ad spend is down 33% and 24% of advertisers are pausing all ad spend for the rest of the year. For the period between March through June 2020, 70% of buyers adjusted or paused their planned ad spend.  

The ad industry is highly competitive, and the track record of third-party ad platforms performing well long-term is nearly non-existent following a a few years in the limelight (i.e. Millennial Media and Criteo). These ad exchanges saw how fickle advertisers can be when Google and Facebook expanded their ad platforms in 2012-2014 and the demand quickly shifted towards working directly with the walled gardens. 

If you do not recognize these names, it is because Millennial Media’s stock cratered and was bought out by AOL while Criteo has also seen a drastically lower stock price over the past few years. In fact, there are very few cases where ad exchanges have done well for a significant period of time due to a lack of intellectual property, which becomes apparent during transformative shifts. 

Most importantly, despite The Trade Desk having solid financials and growth, the company’s valuation is outsized. As of now, forward price to sales is at 21. If/when The Trade Desk lowers its revenue guidance, the P/S will be approximately 25 P/S — or the highest in its history. This is despite having the most uncertainty and the highest risk in the company’s history.

Conclusion:

The stock market may be rallying off Q1 ad-tech performance, yet the earnings calls have been very clear about the steep drop in ad revenue and uncertainty of when a rebound will occur. Facebook called it “facing a period of unprecedented uncertainty.”

One could argue that valuations are forward looking to a rebound in 2021. Yet, the majority of ads are closely tied to consumer spending.

Notably, The Trade Desk has been a recommendation of mine throughout the past and up until this month. The company may become a recommendation again in the future.

May Convictions: Blog Update

Posted on by io-fund

The May spreadsheet will be out soon. The spreadsheet will reflect the information in this blog update.

In September, when many cloud software stocks sold off in the so-called value rotation, I wrote the following: How to pick long-term stock winners in cloud computing

“My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Lastly, cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech — such as mobile, e-commerce and advertising — which are reaching saturation, are finding themselves in the cross hairs of anti-trust and are susceptible to consumer spending changes.

The best companies in the category of “cloud software” will continue to post rapid growth regardless of economic conditions, and the investors who run from this sector will suffer bigger losses from missed opportunities than investors who know their winners.”

The reason that cloud is more insulated is that it reduces costs and improves efficiency. Basically, things happen quicker for businesses and are cheaper to run when workloads are in the cloud. Therefore, the idea there would be a value rotation away from cloud didn’t make much sense to me as it was my prediction cloud would perform/grow like value stocks during a time of uncertainty. (Valuations are another matter which I plan to cover this month at a detailed level for my premium readers.)

The main thesis of the article quoted above is that you should know your winners because the market is telling you it does not know who the winners are when it goes through phases of indiscriminate selling. You can also say this is the case when the market goes through indiscriminate buying. To me, the market has been playing the game pickle; rushing in and out of cloud. My goal is to position you with the winners for 2020 but also in any beat-up stocks that will soar in 2021 (and beyond) once the economy resumes.

Most of you know that I don’t trend follow or trade on prices. Meaning, I don’t recommend stocks based on their price movements. This is the major advantage to this website because the gains are much higher if you can get in before the quants are turned onto a stock. I’d say the majority of my recommendations (80-90%) on the premium site are written while the stock price is near a low. It also helps to keep a steadfastness when the market panics and sells out of a promising company.

After solidifying my convictions with you in May, and getting you set up to weather the storm that has become 2020, I am going to turn towards emerging technologies again in the second half of the year. This is 5G, artificial intelligence, blockchain and various small cap stocks. I had only just begun to do this before covid-19 broke out and we very quickly had a top performing stock in our coverage (INSG) plus some nice returns on (WIFI) and (TLRA) if you followed Knox’s entries/exits.

For anyone joining us recently, here is our plan and an introduction to how we enter/exit stocks:

  • We have core holdings that will not be traded or sold under any conditions. These are MSFT, ROKU, NVDA, ZM, WORK, BABA, DDOG, DT, BTCUSD.
  • Up until the market sell-off in March, we held the stocks listed on the spreadsheet until we stopped out with gains. You can access the prior spreadsheets here and here.
  • For any stocks we stopped out of, we plan to build more core holdings this year with buy and hold entries that we believe we will see at some point in 2020. These are on the March and April spreadsheet.
  • We will buy at the upper end of these price ranges for any data center stocks (see below) and in the mid to lower region for stocks that may see headwinds from the current economic situation.
  • In an effort to stay open to all possibilities, including that the market may go up before it goes down (and to buy insurance against all scenarios), we will continue to look for entries and trade stocks. This also helps us to serve various styles on the site. Please note that we only recommend stocks that make great buy and holds. We don’t trade into stocks that we wouldn’t want to own long-term.
  • Although we believe valuations will eventually settle down from 2019 and 2020 pricing, we still look for break outs with stops where we can participate in momentum.
  • Knox enters and exits stocks via real-time updates on the forum. It’s essential to subscribe to his chat room and my chat room if you want real-time updates as we can’t fill your inbox with blog updates for every instance of communication. Please also subscribe to the stocks you are interested in on the forum as we have chat rooms set aside for each stock. This will help you get the most value from the site.
  • Knox posted on Pinterest yesterday on the forum prior to earnings, as well as Roku and Alibaba

Below, I break down my ongoing high convictions around the Data Center, Productivity Tools, and other Outliers for May. This is in an effort to come full circle on companies I’ve covered in the past and my plan moving forward. Please also keep in mind these aren’t earnings calls as we have some earnings this week and in the near future.

 

Data Center

This earnings season showed serious strength in the data center with Microsoft beating pre-coronavirus earnings. I like Alibaba here, as well, as the trajectory of their data center growth will surprise the market. This is because China is going from 0 to 100 on their data center growth as a country that has lagged the United States yet has aggressive ambitions to catch up. I’ve been forecasting this for quite some time now (published on FATrader and pre-dating my premium site) and I believe this analysis is currently in play.

Looking beyond Microsoft and Alibaba, Nvidia and AMD are even stronger choices for the data center but will take time to play out. This is because you’ll see companies reduce capex this year and tighten their budgets, which will affect Nvidia and AMD. Don’t be discouraged by that. Our plan is to use this as the final opportunity to lock-in our ten-year position on these companies.

The next layer of the data center is security and monitoring. For every enterprise that moves over to the cloud, especially the hybrid cloud which I’ve covered in great detail for my premium readers, there will need to be endpoint security and network/application/infrastructure monitoring. This is where it can get tricky as the field opens up and there are many competitors in each area. My favorite companies — relative to the competition — are Datadog, Dynatrace and Okta. This means that even if these companies miss earnings that my conviction will remain.

Also downstream from cloud infrastructure is MongoDB and Elastic. I like them both. I’m not sure exactly when the revenue will show up as these are not essentials for all businesses but they should see a boost from the ongoing cloud migrations at some point this year.

PDFs for reference:

 

Productivity Tools

When I wrote out my convictions for the premium site this year, I talked about productivity tools being a hot space. These tools, especially, save time and reduce costs. Therefore, don’t be surprised if Zoom, Slack and DocuSign continue to climb this year. I do believe valuations will come down at some point across the board as economic data and Fed stimulus battle it out. With that said, I believe these three will continue to break out as their revenue should grow at a clip and you can expect them to have higher valuations than their peers. If you believe there are others that will sustain high valuations this year, feel free to ping me on the forum to discuss.on the forum to discuss.

Knox especially thinks there is strength in Slack’s chart. I think the market is still confused on the company. That’s a good combo to have.

One thing I’d like to make very clear about Slack is that it has one of my favorite components across all tech stocks which is a strong developer community (even though Slack is not open source, there are many custom APIs being developed).

Investors may not realize that Apple’s success is due not only to the iPhone but also the developer community that supported the iPhone/iOS operating system and developed third-party applications. This created a robust ecosystem that was impossible for any competitor to shake. Design played a role too, of course, however Microsoft’s Windows mobile OS got shut out because it did not have the developer following to develop apps. In the beginning, Facebook also had a large developer community that propelled the platform forward which is how Zynga became popular.

In the S-1 Filing, Slack stated there are over 450,000 third-party applications or custom integrations. The number is likely much larger now. What is important to understand is that it’s nearly impossible to envision where Slack will end up in five years from now because the level of iteration and creativity that comes from these customizations is impossible to predict. The forward innovation will come from technologists who are not employees of Slack. They are in need of a messaging system they trust and that can be customized.

For instance, security professionals are now using Slack for anomaly notifications. When there’s a breach, or anything suspect, the security team is notified on Slack. Wall Street investors can set up price movement alerts on stocks. I’ve seen others use Slack to program robots and control commands.

With that said, Slack is following a popular maneuver for monetization that confuses the financial industry and will require a bit of patience before the profitability unfolds. Slack is choosing to scale while being underpriced and then will convert down the road to being priced more in-line with the value of the platform. For now, this means there will be questions around the path to profitability.

Shopify is an outlier that we covered with a prediction that the company would outpace the market due to the focus on merchants rather than customers. Perhaps with covid-19, the emphasis on merchants is more important than ever as many will lose brick-and-mortar sales. I do want to point out that Shopify released a new application. This was something I had predicted they’d do as it was the next natural step after the fulfillment center (an aggregated store front). I thought it might be a website but a native app makes perfect sense. This product announcement is very important for the long-term trajectory.

From the Shopify PDF in October:

“The question many investors ask about Shopify is whether it can compete with Amazon — or even Alibaba? Today, this is not a possibility as Amazon and Alibaba drive traffic to products and take a premium for helping secure the sale. They own the domain website, so customers are loyal not to the merchant, but to Amazon and Alibaba.

I believe this could be where Shopify will end up, eventually. If the fulfillment center is a success, which will take some time to test and gather traction, then the back-end will be set up for the front-end development of a website or some kind of product aggregator – whether that’s a website domain or another recommendation engine.

For Shopify, it makes sense to first build out the fulfillment center for their point-of-sale software in order for a successful pivot.”

Although I have not written a formal PDF on Docusign, the company fires on a lot of cylinders. The addressable market the company will (finally) be able to serve can become quite large as industries shift towards work from home policies. I will try to write something up officially soon although I’ve favored covering others, such as Lam and Micron, as most know/understand the Docusign story. Regardless, it’s worth repeating that I think their story has improved and is strengthened beyond 2020 by the work-from-home trends.

PDFs/References:

 

Downgrades For Q2-Q4

Alteryx priced at $5000+ is steep and I pointed this out in previous reports. I would never suggest someone sell a winning position; however, you may want to determine how much downside you’re willing to stomach if the market were to go red. I’m pulling AYX out of the pack as an example because unlike other cloud software, the price is not cheap. If the economy goes back to normal tomorrow, this won’t be an issue. If there are tech layoffs announced in Q2 and Q3, you might want to keep it in mind.

From the Alteryx PDF:

“Alteryx primary risk is the high pricing. The company will have to continually iterate to demand its current pricing while staving off competitors. At over $5,000 per user for the Designer product (and much steeper across other products), economic headwinds could affect Alteryx if companies seeks to reduce costs.”

And …

“Designer costs $5,195 annually per user with optional add-ons, such as location insights for $11,700 and business insights for $33,800. Server expands the offerings from Designer to include APIs and applications for more customized and automated analytic workflows. Enterprises especially have a need to improve internal server architectures for multiple employees and cross-functional teams with custom options. Server costs $58,500 per user per year with add-ons, such as Connect for $39,000.

Connect allows for data cataloging and the discovery of data with the goal of accelerating productivity. This is not a core product for Alteryx at this time, rather it provides an end to end pipeline for a full range of needs. There is indication from the Server add-on pricing that the cost is in the $39,000 range.”

We’ve also seen initial reports that human resources software is not holding with SAP expecting a decline this year and analysts downgrading similar companies, like COUP, PAYC. (The market has not taken notice). This means Workday could be exposed. Workday also carries over $1 billion in debt and may need to borrow more in the future.

PDFs:

 

Ad-Tech

As you know by now, I’m concerned about ad-tech for a few reasons. The peak to trough that occurred between Jan/Feb and March has been hard to quantify as company executives provide fairly vague overviews of “single digit declines” or “double digit declines” or “approximately flat” or “stabilized” while avoiding hard and fast numbers. Those that gave more specific numbers sold off (PINS and TWTR). All around, guidance is being pulled for the year, which is unique to ad-tech within the industry of tech. Meanwhile, ad-tech is trading at all-time highs.

I’ve covered this in great detail already as to why I began the year with ad-tech as one of my top trends and changed my position on this for Q2-Q4 2020 and maybe early 2021. For me, there is too much risk with stocks trading at all-time highs that are going through a major readjustment in supply/demand. I’d need more information on forward revenue this year and next year before committing to these valuations. Considering companies can’t provide this, then I’d want a discount in valuation.

I want to follow up on Roku specifically. The difference between Roku and the other ad-tech companies is that it’s situated in the center of an important micro-trend as a pureplay. This means it’s a gamble as to when the true breakout occurs because the trend is so strong.

On one hand, Roku may have a tough year as a company that is not profitable and relies on advertising. On the other hand, Roku may have a breakout year as a company that sees record adoption at a time when connected TV is already one of the best trends in technology. Knox will do his best to provide for both situations but I want to emphasize we are long on Roku and it’s one of my highest long-term convictions even with advertising headwinds. With that said, it’s likely Roku misses earnings or negatively surprises the market in some fashion this year. Follow Knox on the forum if you’re building a new position here.

For Q2 through Q4, I have changed my viewpoint on The Trade Desk. I think Snap is weak too (I understand the market doesn’t think this right now). The market beating up Pinterest and not Snap is interesting to me on many levels (and the lack of response when Snap raised debt immediately following earnings).

I personally feel that Facebook and Google are somewhat saturated and will need new growth markets but that’s counter to the market (I’ve felt this way about Apple too for most of 2019 and into the near future). Those three have enormous amounts of cash so micro-trends/growth markets are irrelevant because of traditional DCF analysis.

 

5G

Our 5G coverage was primarily focused on business cases. I believe the government will continue to push for 5G and that INSG and WIFI are solid choices as they require little to no capex. In fact, they lower capex depending on the situation.

I also like Twilio as a very early 5G play. Twilio is exposed to many different industries and we will find out in the earnings report tomorrow if retail/ecommerce and health care offset any of the others (such as Lyft and Uber) plus the decreased marketing budgets that SendGrid likely saw.  

PDFs:

 

Outliers & New Coverage

Lam Research, Micron and Qualcomm are solid choices to keep an eye on. Knox will update in the forum if he sees something interesting here price wise.

I’m still very bullish on Chainlink for reasons that are not obvious right now. I believe Chainlink will jump from being a crypto to a reputable form of collateral for blockchain smart contracts. I want to emphasize that Google and Oracle are early backers.

Bitcoin is also going through the four-year halving this month. I’ll write up an editorial in advance.

Regarding blockchain, I had written an article about how blockchain and health care will one day merge in order to make data more available for cures. This is an area that should take off with the pandemic. I’ll be hunting for breakthroughs here.

PDFs:

Micron: Premium Research

Posted on by io-fund

b7b18088-7198-48b2-93e0-6d2a7967e43d_Micron-Premium-Research.pdf

Micron: Premium Research

Micron Overview:

Our goal is to catch Micron for the 2021 rebound which is likely delayed a year from the anticipated 2020 rebound. This rebound should occur when high-end smartphones are released again and the automotive market comes back to help drive demand in embedded DRAM. Mobile and automotive are the hardest hit segments in 2020. Data center segment remains strong.

Due to the cyclical nature of memory and storage, Micron is likely to become a 1-2 year holding rather than a permanent buy-and-hold.

Product:

Micron is the only company in the world with a portfolio of DRAM, NAND, and 3D XPoint technologies. X100 is the fastest storage device in the world. The company has also entered into a new 3D XPoint wafer sale agreement with Intel that replaces the previous agreements.

In the most recent fiscal year, DRAM comprised two-thirds of Micron’s revenue and NAND one-third of revenue.

NAND memory saves data even when the power is removed, such as when a cell phone is turned off. DRAM only saves memory when a device has power but is much faster than NAND and lasts longer. Beyond mobile devices, NAND is found in traffic lights, digital advertising panels/displays, and anything with artificial intelligence that needs to store data.

As covered in the Lam Research report, NAND has been around since the 1980s but got a much-needed boost from 3D NAND, which stacks vertical chips. Historically, Micron focused on DRAM for PCs and servers an expanded into NAND over the past ten years.

One risk to Micron is the thin moat as competitors Samsung and SK Hynix outpace Micron in total memory/storage shipments. With little differentiation, these companies have pricing wars with Samsung generally considered the industry leader. Toshiba and Western Digital (SanDisk) are also competitors.

This is one reason Micron continues to invest in R&D in products such as 128-layer 3D NAND, 3D XPoint and also 1Z-nanometer DRAM.

“The Memory Guy” Jim Handy has a great write-up describing how Micron has improved its profitability in the DRAM market. His analysis points towards Micron holding a leadership position in 1Znm production over Samsung and Hynix. The new DRAM was introduced at CES and is geared towards the server and hyperscale markets.

One of the bull cases for Micron right now is DRAM and NAND pricing, which is high due to low inventory and previous capex cuts. There is low supply right now regardless of contracting demand. Prior to Covid-19, the market believed pricing had bottomed in 2019.

Micron is one of the most volatile semiconductor stocks with lows around $10 in 2016 and highs around $60 in 2018. Regarding valuation, the stock is trading at double its current PE ratio as 2019 and similar forward PE ratio as 2019. The issue here is any data center strength may not be able to offset the weakness in the mobile and automotive segment.

Historically, buying Micron at a price-to-book value of 1 has done well. The stock is currently trading at a price-tobook of 1.439.

Micron Financials:

In the most recent quarter ending in February, Micron’s revenue beat estimates yet fell 18% year-over-year to $4.80 billion. Revenue was down 7% from $5.14 billion quarter-over-quarter. TTM revenue was $19.6 billion with non-GAAP net income of $2.9 billion, or $2.54 EPS.

DRAM sales were down 11% sequentially and NAND sales were up 6% sequentially. DRAM was impacted by flat sales prices and lower bit shipments.

Earnings were also down YoY with Micron reporting GAAP net income of $405 million, or $0.36 EPS, compared to $1.62 billion, or $1.42 EPS in the year-ago quarter and $0.45 EPS last quarter. Non-GAAP income of $517 million or $0.45 per share beat estimates by $0.08 compared to $1.71 EPS.

Capital expenditures were $1.94 billion in Q2 2020. Management expects FY 2020 capex to be $7 to $8 billion. For fiscal Q2 ending in February, the company had cash and investments of $8.12 billion with a net cash position of $2.7 billion. The company has about $5 billion in long term debt. Recently, Micron drew on a $2.5 billion revolver to have cash on hand.

Margins are decreasing with gross margins of 28% in Q2 2020 compared to 49% in Q2 2019. Operating margins were at 9.2% in the most recent quarter compared to 33.5% in the year-ago quarter.

The median forecast for FY 2020 ending in August is $20.11 billion, down 14.7% year-over-year.

The median forecast for FY 2021 is $24.49 billion, up 21.74% year-over-year. Forward estimates for EPS of $4.90 for FY 2021 will represent an increase of 124% YoY.

QLC SSD bit shipments rose 60% sequentially in the 2Q FY2020. The company expects QLC SSD to grow in the 2H 2020.

The company began to deliver LP5 mobile DRAM products to customers including Xiaomi, which is using LP5 in its 5G-capable Mi smartphones in 8GB and 12GM configurations.

In the graphics market, GDDR6 bit shipments increased more than 40% q-o-q. In the new gaming consoles the company will deploy SSD’s in place of hard drives for the first time.

Effects of Covid-19:

Micron is more exposed than other semiconductors to consumer spending.

About 15% of Micron’s revenue comes from China, where there was weaker sell-through of consumer electronics and factory shutdowns in the fiscal second quarter ending in February. According to the most recent earnings call, some of this was offset by stronger data center demand due to increased gaming, e-commerce, and remote-work. Management expects this trend to continue globally.

Due to Covid-19, Micron expects to see lower demand for smartphones, consumer electronics, and automobiles than prior expectations. Anticipating changes to customer demand, Micron is moving supply from smartphones to service the strength in the data center markets for both DRAM and SSDs.

Some equipment companies have also indicated delays in equipment deliveries due to the impact of various government actions to combat COVID-19.

The Malaysian government issued lockdown orders on March 16 and Micron closed the manufacturing plants in Muar and Penang. Later, the Malaysian government declared semiconductor production as essential and after a few days the production resumed on a limited basis. In the earnings call, the company stated it’s using its global supply chain to mitigate production impact.

For the most part, analysts are cutting their forecasts for Micron, primarily due to Covid-19. Goldman Sachs, Piper Sandler, KeyBanc and Morgan Stanley have all lowered price targets.

Revenue Segments & Addressable Market:

Micron’s business composition is 64% DRAM, 32% NAND and 4% 3D XPoint memory.

Micron has four business units, which are reportable segments:

• Compute and Networking Business Unit (CNBU) — 41%

• Mobile Business Unit (MBU) — 26%,

• Storage Business Unit (SBU) — 18%

• Embedded Business Unit (EBU) — 15%

Micron has the following revenue segments. According to recent earnings reports from various semiconductor companies, mobile and automotive are exposed.

• Mobile — 25%

• Client and Graphics — 20%

• Enterprise and Cloud Server — 20%

• SSDs and other storage — 15%

• Automotive, Industrial and Consumer — 15%

Country 2019 Revenue in US$ Mil %

  • United States 12,451 53
  • Mainland China excl Hong Kong 3595 15
  • Taiwan 2,703 12
  • Hong Kong 1,614 7
  • Other Asia Pacific 1,032 4
  • Japan 958 4
  • Other 1,053 4
  • 23,406 100

One of Micron’s strongest selling points is the addressable market of $83 billion for DRAM and $99 billion for 3D NAND by 2025. This is a combined addressable market of $182 billion.

Source: Micron Presentation

Future catalysts for NAND and DRAM include artificial intelligence and autonomous vehicles requiring data storage and memory capacities. In the long-term, the management believes it will benefit from secular growth in the industrial IoT market as 5G rolls out. Current markets include the data center and internet of things in addition to PCs and mobile smartphones

According to TrendForce, YMTC, a new competitor located in Wuhan, China, is set to compete with 128L products by the end of the year.

Technical Analysis

The above chart is a look at the weekly price pattern of Micron (MU). The larger the trend, the more important it is to the direction of the price. Since 2009, Micron has been trading within a leading diagonal pattern. This is a 5wave pattern that tracks along a trend channel (in gray). Each of the larger degree 5 waves (in red) are comprised of 3-waves (in blue).

According to this pattern, we are in the larger degree 4th wave (in red). Within this wave, we have completed the A and B wave. Therefore, we are in the middle of the final C-wave down. I will target the lower end of the trend channel, which we have not touched. There are a cluster of Fibonacci price levels around the trend channel between $34-$22.

The weekly RSI is also confirming that we are not yet in a renewed uptrend for MU. Until the RSI can break above the downward sloping trend line as well as break above 60, the momentum suggests the current uptrend off the March lows is a corrective move in a larger degree trend, which is pointing down.

It would be rare to see this larger degree pattern not follow the current trend. However, if price can break above the $61 level, which is confirmed by the weekly RSI, I will look at that level as a bullish move and a targeted entry to ride the new bull market in MU.

The daily chart shows this trend unfolding in real time. The uptrend’s structure off the March lows is overlapping and symmetrical. It further suggests weakness. This is also confirmed by the internals.

The volume is slowing down at current levels, suggesting that the participation at current prices is weakening. The Accumulation/Distribution line suggests that the smart money has not been buying into this uptrend, and in fact using it to unload shares. The MACD histogram and the MFI are showing notable weakness below the price as well.

All of this together further supports a topping pattern that is unfolding. If price can break below $41, this will confirm the target entries below.