I want to start by saying that Q2 will be lagging when the reports come out (Q2 likely to be low) and the market will be focused on Q3 guidance. It’s not possible for every single company to come in with strong reports, and instead, it’s our job to look for the companies most probable to find their legs again.
The hawkish FED stole the show but there were many headwinds that the tech industry faced – we’ve covered them in great depth including Apple’s privacy changes and supply chains including auto and lower consumer hardware sales (which has a trickle-down effect to ad-tech), plus the Ukraine war.
Even more important for our industry, tech has had to clear eight straight quarters of anomalous conditions with Q2 2022 guidance – notably, the tail spin on the high revenue water mark clears for nearly all companies by Q3 2022.
When we look at which companies are expected to have strong, accelerating revenue from the nadir of Q2, Unity stands out from the data below. We believe there could be early evidence of fundamentals lining up with technicals.
Here’s a brief description from Knox on what he wants to see before we enter Unity as a momentum play – he will post more on the forum tomorrow.
Unity is basing from the May 12th low. Interestingly, as the broad market made a lower low on May 20th as well as June 17th, Unity instead made a series of higher lows.
This is important, because it signals that the ratio of buyers to sellers from Unity’s all time low is shifting. What we need to see is a high volume breakout above $47 to signal that momentum has shifted to the upside, at least temporarily.
What’s worth pointing out is that Unity is currently holding a key support in red on the chart below. This is the 45 degree line (1×1) from the last high before Unity’s blowoff top. Note how price has used this line for key support and resistance since the downtrend began. It’s currently back above this line, which is important for halting the downtrend.
We need to reclaim the 2×1 line in blue, and breakout above the $47 resistance for us to buy. The weakness we are experiencing must hold 1×1 line as well as the May 12th low at $29. If another of these supports fail, we will step aside as the stock could reach new lows.
Analyst Consensus Showing Potential Q3 Rebound for Unity
Unity sits at the cross-section of cloud and ad-tech, and thus, it requires two looking at both categories to see the full picture for this company.
When comparing Unity to other cloud stocks, it ranks high for sequential growth from Q2 to Q3 at 17% from $305 million to $355 million, indicating the rebound is one of the best in the cloud category. If we look two quarters out to ensure the rebound is consistent, we see Unity is expected to increase revenue by 36% across two quarters from $305 million to $415 million.
Pictured Above: Unity leads but likely due to headwinds that ad-tech faced.
When we level the playing field and look at ad-tech stocks, which is probably a better indicator considering the transient headwinds facing the ad sector, Unity continues to rank high for the upcoming guide of Q3 yet is not as strong as ad-tech peers for Q4 indicating that two quarters out is when most ad-tech stocks will have rebounded.
Above: Unity leads Q2-Q3 sequential growth in ad-tech
Despite Unity showing a nice rebound for Q3 in analysts’ consensus, the far majority of ad-tech is showing a Q4 rebound:
It’s true that Q4 is affected by the holiday season yet we note many instances below where the growth is much higher between Q2-Q4 this year while these names are selling at much, much lower valuations. Please read the Q4 section below.
Unity has the following analyst consensus at this time:
Q2: +11% growth
Q3: +25% growth
Q4: +30% growth
On the bottom line, Unity expects to be consistently profitable by September of next year (2023). The biggest issue with earnings is also in the Q2 quarter while there’s a noticeable rebound for Q3 and beyond:
Q2: ($0.22) EPS
Q3: ($0.06) EPS
Q4: $0.02 EPS
Ad-Tech Showing a Rebound in Q4:
Unity:
Q3 consensus: +25% YoY growth
Q4 consensus: +30% YoY growth
Sequential growth for two quarters = +36% from $305M to $415M
Roku:
Q3 consensus: +36% YoY growth
Q4 consensus: +43% YoY growth
Sequential growth for two quarters = +55% from $805M to $1.24B
We already own Roku at a high allocation so this helps us keep the position in its current allocation going into earnings. There’s a caveat to Roku which is the hardware weighs on the bottom line but we have repeated (to the point where it’s probably becoming a bit repetitive) that we like it’s position on first-party data and we agree with its investments to strengthen what we’ve called the “Royal Flush” positioning. The company is expected to be profitable again by Dec 2023.
The Trade Desk has a rebound over a six-month period of 43% yet the valuation is quite a bit higher than its peers. There’s a great forum post here on The Trade Desk by a Member who invested in the stock. We love these long-form posts where Members discuss stocks they own outside of our portfolio – keep them coming! ☺
The Trade Desk:
Q3 consensus: +28% growth
Q4 consensus: +31% growth
Sequential growth 2 qtrs: $365M to $522M for 43% sequential growth
Snap’s rebound is slower on YoY basis yet from a Q2 low to a Q4 high in terms of sequential growth, the rebound is similar to its peers. Snap also has the highest revenue with roughly $6 billion in annual revenue compared to ad-tech peers with roughly $2 billion or less in annual revenue.
Among small caps, PubMatic actually is quite strong off the nadir of Q2:
Q3 consensus: +23% YoY growth
Q4 consensus: +22% YoY growth
Sequential Growth 2 qtrs: $61M to $96.5M for growth of 59%
Magnite is the small cap in ad-tech that we currently own and here is how the company compares. The growth listed is with SpotX.
Q3 consensus: +25% YoY growth
Q4 consensus: +16% YoY growth
Sequential Growth 2 qtrs: $125M to $165M for growth of +32%
This assumes each company will meet or exceed analyst guidance – there is no guarantee this will happen. This assumes each company will meet or exceed analyst guidance – there is no guarantee this will happen. What’s more important than making an exact prediction, however, is that we should be tracking when the rebound is scheduled to occur. We see real evidence of expectations this will occur in Q3. It’s important to remember too that ad-tech is below historic valuations and any improvement in growth will likely see these valuations return to average levels.
Consensus Shows Rebound Even with Q4 Holiday Comps
As stated above, you could argue that sequential growth across two quarters is less relevant considering that Q4 is the strongest quarter for ad-tech.
Here is last year’s Q2 to Q4 growth rates:
Unity: +15% from Q2-Q4 2021 = higher this year at 36%
Roku: +34% from Q2-Q4 2021 = higher this year at 51%
The Trade Desk: +41% from Q2-Q4 2021 = a tick higher this year at 43%
Snap: +32% from Q2-Q4 2021 = a few percentage points higher this year at 38%
PubMatic: +51% from Q2-Q4 2021 = higher this year at 58%
Magnite: +41% from Q2-Q4 2021 with two months of SpotX (lower this year at 32%)
In many cases, companies will bounce back with growth from Q2 to Q4 — yet, these companies were trading nearly 3-4X higher last year.
It should be noted that Unity typically is grouped with cloud for its valuation which is why it’s exceeded 45 forward sales in the past. When we look at the bottom line, it’s the small cap stocks that are most reasonable with Magnite and PubMatic trading in the 12 and 20 Forward P/E range, respectively.
Unity Earnings and Product Overview (Editorial):
Please note: We covered Unity following earnings on May 20, 2022 and have copied and pasted this information below as its current and timely.
Unity has demonstrated strong price action following the IPO last year due to its unique blend of cash efficient ad-tech monetization and near-monopolistic game development platform. The company is well suited for the Metaverse and industrial 3D worlds due to its history of supporting 3D game development.
In previous earnings calls, the management was confident they would not be affected by Apple’s IDFA changes or the other road blocks that caused ad-tech companies to lower guidance across the board. Unity’s confidence primarily came from their contextual ad positioning as compared to direct response. Therefore, there was high confidence going into earnings yet management delivered a sizable revenue miss due to a product mishap.
Unity previously guided for revenue growth of 36% for full year 2022, which would put the company as the leader in ad-tech growth and mid-range for cloud. In the recent call, the company lowered this guidance to 26% at the mid-point for a negative impact of $110 million. Guidance for Q2 2022 was at 7% at the midpoint, which would put Unity in the lowest quartile for ad-tech on growth and certainly for cloud. The stock dropped 35% following the announcement.
The surprise miss in revenue guidance was due to the company’s product Audience Pinpointer, which is a machine-learning powered user acquisition tool that allows game developers to acquire players based on a targeted return on their spend. Unity’s training data was also affected by ingesting bad data from a large customer. This led to Unity noticing less revenue coming from their monetization platform, and as advertisers saw less performance, they began to spend less.
Below, we weigh the pros and cons of an otherwise solid game engine and Metaverse stock.
Unity Has 2.8 Billion MAUs
Despite the temporary mishap with Audience Pinpointer, Unity has significant proprietary data and insights to feed contextual models. Unity is a game engine where more than 2.8 billion monthly active users (MAUs) play games or apps built on Unity compared to Facebook’s 2.9 billion monthly active users. The total addressable market for gaming exceeds 4 billion MAUs and Unity serves 61% of game developers.
It’s not exactly apples-to-apples with Facebook as Unity powers the games and is not a publisher like Facebook, yet it illustrates the scale the company is capable of. In the game development ecosystem, 72% of the top 1000 mobile games are made on Unity’s platform. There are 5 billion monthly app downloads.
Part of Unity’s substantial presence is the free tools it offers game developers who earn less than $100,000 annually, and for the most part they capture any developer between the indie (small) stage and up to AAA studios although many of these studios prefer to use their own in-house game engine. The company has especially found its stride on mobile.
Unity offers its products under two platforms, Create Solutions and Operate Solutions. The Create platform is used to create, edit and run 3D content. The Operate platform is used to grow and engage the user base and to also monetize content. The company derives 93% of 2021 revenue from these two platforms with a split of 64% Operate and 29% Create.
Create Solutions is where games are built and Operate Solutions is how games are monetized through ads and in-app purchases. There are also analytics offered through DeltaDNA, which collects information on end-user engagement and behavior.
Operate is successful through contextual ads rather than behavioral targeting, which has made the company resilient during Apple’s privacy changes.
On a contrarian note, because Unity has a very specific content type (gaming), there’s a chance the company is very resilient through the iOS 14 changes as targeting can occur through content type (i.e. Gaming, Financial News, Beauty & Health, etcetera). Previously, Unity Ads have been known to be more effective because the audience type and interests are narrow. There’s also a possibility that Unity is stronger with the IDFA changes as they own the game engine whereas their competitors are using third-party data only for targeting. These competitors include Vungle, AdColony, Facebook’s Audience Network, MoPub, Leadbolt, TapJoy, etcetera.Unity has a very specific content type (gaming), there’s a chance the company is very resilient through the iOS 14 changes as targeting can occur through content type (i.e. Gaming, Financial News, Beauty & Health, etcetera). Previously, Unity Ads have been known to be more effective because the audience type and interests are narrow. There’s also a possibility that Unity is stronger with the IDFA changes as they own the game engine whereas their competitors are using third-party data only for targeting. These competitors include Vungle, AdColony, Facebook’s Audience Network, MoPub, Leadbolt, TapJoy, etcetera.
Notably, Unity’s revenue miss was unrelated to Apple’s IDFA changes and was instead related to the company’s internal product Audience Pinpointer.
The Metaverse Opportunity
Developing games on Unity is low code and sometimes no code, which is ideal for 3D creators who are not necessarily developers. This lends itself well to the creator community that is most likely to drive forward the Metaverse, or Web3, and also the various industries that can benefit from 3D or AR/VR right now. The Create Solutions and tools are also great for prototyping, which speeds up the time to deployment. Unity is frequently acquiring tools and plugins to lower the barrier of entry for developers and creators. For example, Bolt2 helps developers implement logic without knowing how to code.
Last year, Unity developed a new architecture that provides native APIs to third-party providers and offers a high-level managed API to Unity developers. The new architecture fundamentally improves how Unity delivers and manages SDKs for XR platform integrations.
With Unity Pro, real-time 3D, AR and VR content can also be deployed on HoloLens and Oculus. The Unity Pixyz Plugin works with manufacturing software like AutoDesk to further industrial uses, such as automotive. Additionally, Unity does not compete with creators and is royalty-free.
The main thing to know about Unity’s products is they offer 3D creation for everyone, i.e., democratizes the process. This was initially intended for the gaming industry yet there is a natural affinity for gaming tools, IDEs, chips, etcetera, to be used for virtual worlds and the Metaverse.
The management had mentioned in the earnings call that the company was able to expand its market share in gaming and AR/VR. The company’s non-gaming business outpaced gaming business revenue as it grew 70% year-over-year. Digital twins and the metaverse are a substantial opportunity with 34 deals closed in the current quarter over $100,000, up 126% YoY.
Unity bought Weta Digital for $1.62 billion in exchange for the design tools, assets and data platform that drove film creations such as Lord of the Rings, Avengers, Avatar, and Game of Thrones. The goal is to bring the magic of film assets to the individual creator on Unity’s platform. It will also help the company to remain competitive against Epic’s Unreal Engine.
We had stated the following in a private note to our research customers when Unity acquired Weta:
“The Weta Digital acquisition helps Unity remain defensive against Epic’s Unreal Engine, which was used on virtual sets, such as Star Wars The Mandalorian. It also helps Unity build a Metaverse asset library, such as stadium scenes, character movements, large crowds, fantastical characters and backgrounds, etcetera, which can help the workflow for content creation for the metaverse. With that said, the more near-term opportunity for these acquisitions is for Unity to turn Hollywood into a customer.”is for Unity to turn Hollywood into a customer.”
Earlier this year, the company acquired Ziva Dynamics, the film software used for creating digital humans in Marvel movies, Hellblade, Jumanji, and Godzilla vs King Kong. In the recent quarter, the company received more than 8,000 sign-ups for the cloud uploads of beta version of Ziva Faces. Accroding to CEO John Riccitiello, “This service enables artists to use advanced machine learning models and massive data to train meshes for full expressiveness, instead of requiring teams of artists to spend weeks doing manual rigging.”
The company’s addressable market is growing and the management had mentioned in the last earnings call that the total addressable market for Create Solutions and Operate Solutions is $45 billion, up significantly from $29 billion during its IPO in 2020. The growth in the addressable market was due to the additions of new products and acquisitions.
Financials and Audience Pinpointer Issues:
The company finished the year 2021 strong with revenue growing 44% YoY to $1.1 billion and adjusted operating margins improved 200 bps to -4.6%. As a percentage of revenue, R&D is at 69%, which is slightly higher than it’s been in previous quarters. Expenses are frontloaded at the beginning of the year with the company expected to break even by 2023.
Q1 2022 revenue grew by 36% year-over-year to $320.1 million, which missed analyst consensus estimates by -0.32%. The company’s dollar-based net expansion rate came in at 135% compared to 140% in the same period last year and Q4 2021.
Unity’s management guided for revenue growth of 7% at the mid-point for Q2 2022. This was a stark surprise and lower than the 48% growth reported in Q2 2021. For the full-year, it has guided revenue growth of 26% at the mid-point which was lower than the earlier forecast of 36% provided during the year-end results.
The management mentioned in the earnings call that it was mainly due to two issues. According to John Riccitiello, CEO, “The first was a fault in our platform that resulted in reduced accuracy for our Audience Pinpointer tool, a revenue expensive issue given that our Pinpointer tool experienced significant growth post the IDFA changes. The second is that we lost the value of a portion of our data, training data due in part to us ingesting bad data from a large customer.”
Audience Pinpointer is a user acquisition product that is based on machine learning which helps game developers to acquire users based on a certain return on spending. The management expects these issues to be partially recovered in the third quarter and fully recovered by the end of the year. They reassured analysts on the call that there will no negative impact on the revenue for the year 2023.
As we had expected, the company was able to overcome the challenges of Apple’s iOS changes and the deprecation of the IDFA since a majority of games are built with Unity engine and analytics per the company saying: “Pinpointer tool experienced significant growth post the IDFA changes.” The CEO also stated, “We have proprietary data and insights coming from our reach to over three billion monthly active users feeding our contextual models. We have deep context, about game play, what players like to play, when and how they play games. And in gaming, this data has proven to be the most relevant for advertising.”
The management remains confident in the long-term opportunity. They estimate that there are more than four billion monthly active users and that less than 3% of users pay for games.
The company’s Create solutions is doing well and accelerated by 65% YoY to $116 million. This was driven by the strong adoption of real-time 3D. In the Content Solutions segment, some of the notable business use cases of big publishers include, “Angry Birds brought back Angry Birds Classic to mobile app stores using Unity to relaunch this treasured game and easily make it work across multiple modern devices. And Ubisoft used Unity to deliver incredible visuals and fast gameplay in Rainbow Six Mobile.”
The adjusted operating margin improved 280 bps to -7.2% which is lower than FY2021. The company had free cash flow of $86.4 million. However, the cash flow included the license fees for four years of $200 million relating to Weta FX.
Looking forward the management reiterated that it expects revenue to grow above 30% in the long-term. It also expects to be profitable in the fourth quarter of this year.
Conclusion:
Unity Software is the market leader in the fast-growing gaming industry. The company’s future growth opportunities extend beyond gaming to include industrial real-time 3D and the Metaverse. Due to its proprietary data from 2.8 billion MAUs and contextual targeting, Unity will likely come out stronger than other ad-tech companies following Apple’s privacy changes (and Google’s upcoming privacy changes circa 2023).
The market has been extraordinarily temperamental towards tech stocks and this is likely to be one of many instances where the current (low) stock price does not fully reflect the opportunity.
This article was originally published on Forbes on Jun 24, 2022,01:43am EDTForbes on Jun 24, 2022,01:43am EDT
Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.
Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, I would argue the day that Netflix’s stock price dropped 35% was consequently one of the most important days in the company’s history in terms of its chances for a boost in revenue and a renewed uptrend. Patience, though, will be required, as Netflix has work to do (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Netflix’s Q1 Earnings
The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.
Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.
Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers.
Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength.
Netflix Entering the Ad-Supported Market
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:
“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.
But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”
Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:
Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”
Here’s How Netflix Stock Could Make a New High
If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022, rather look for this in H2 2023.
On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low.
What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter.
Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.
The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close.
Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.
When you look at top line growth, the company has not traded this cheap since 2012:
Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.
Conclusion:
Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.
My firm’s preference is to wait until we are closer to the ad-supported tier rollout before considering a position in Netflix. When we do enter positions, we issue real-time trade alerts to our Members and publish deep dive analysis to accompany the entries we make. Please consult with your financial advisor on any stock trades you make.
It will be interesting to discuss someday how Netflix’s share price dropped 35% following the news of an ad-supported tier. The stock price took a historic hit after the company reported a subscriber miss of 200,000 and a guide of 2 million subscriber losses for the next quarter. Meanwhile, the company has a surplus of 100 million viewers sneaking passwords that the company can monetize. In my opinion, the market has lost perspective of the bigger picture.
There are two analysts who have started to crunch numbers on the opportunity and they believe it will add a base case of $12 billion in annual revenue and up to $25 billion to $35 billion in annual revenue by 2030.
“Assuming a domestic launch in the first quarter of 2023 and a global rollout over the following two years, Morris has layered in an advertising-supported tier to his multi-year forecast for Netflix and now sees total company revenue approaching $75B by 2030, he tells investors.”
Currently, Netflix is at $29 billion in annual revenue. So, wow — a doubling of Netflix’s revenue in 8 years compared to the nearly 25 years it took to get to the first $30 billion in revenue (Netflix launched in 1997).
There’s been plenty of rumors around who Netflix might choose as an ad server and supply side partner. One reason we think Roku is a candidate is because of its strong positioning with first-party data that can augment Netflix’s publisher data for enhanced targeting. Roku can also make deals around promoting Netflix on its platform, which it did for Disney, since Roku’s ad platform is the primary product compared to The Roku Channel. We think this is a strong possibility because Roku has the richest first-party data in the industry due to owning the operating system where it hosts many applications.
On the other hand, Google is not a good choice as it’s a major publisher itself. YouTube TV happens to be Netflix’s closest competitor in terms of total US TV time at 5.7% and 6.4%, respectively. It’s rare to see Big Tech competitors’ partner with one another, which can result in helping the competitor become stronger. Even though there are rumors that Netflix and Google are meeting about ads at Cannes, those events usually have meetings between all major players without any guarantee of an outcome.
Pictured Above: YouTube is Netflix’s biggest competitor
Magnite has been floated around, and this could be a strong choice for its global exposure and its ad server, SpringServe, helps put the company on par with Roku’s ad server. Comcast’s FreeWheel could also make a good partner for Netflix as the company focuses more on live broadcast and is not in direct competition to Netflix’s premium content.
We think it’s less likely that Netflix goes with The Trade Desk as a publisher, — although certainly anything could happen. However, The Trade Desk will benefit from the increased ad inventory from a demand perspective.
Truly, no matter what ad platform Netflix chooses, more than one CTV ad stock will participate as programmatic allows bidding across many sources to increase fill rates. Due to Netflix’s premium inventory, however, the company may go with a private marketplace where only two or three sources are allowed to bid.
In regards to timing, I foresee Netflix wanting to take full advantage of next year’s upfront season, which means testing and rollout will need to happen by this time next year. Otherwise, Netflix risks losing out on contracts from premium advertisers due to timing and will need to wait until the following year Q2 2024. It’s certainly feasible that strong ad partners can get Netflix’s global rollout accomplished in a year’s time – which is why I believe we will hear who Netflix has chosen as soon as Q2 earnings or by Q3 earnings. I don’t think we will need to wait until Q4 2022 as testing is likely to happen sooner.
Why is that important? Because the global juggernaut has the ability to raise the tide of all boats on CTV ads. This is the biggest news to happen to the CTV ad industry – ever, really, due to the sheer size of audience that Netflix is capable of bringing to the CTV market. There will be a compounding effect as Netflix’s entry will also more ad budgets, more premium advertisers, — and really marks the moment when CTV ads are being taken seriously even by subscription services.
I wrote an article on Netflix published in Forbes below. Of course, the real angle here is that we own Roku and Magnite and we hope one of these two is chosen as the premiere partner. It’s not speculation to say so, rather it’s taken quite a bit of conviction in the face of a fickle stock market to repeat that CTV ads have a large runway ahead of them. Four years and two years later, respectively, from our first analysis and we now have Netflix agreeing with the CTV-ads thesis. I think we should take a moment to let that sink in – as there is no company bigger or more important to agree at this juncture.
If we enter Netflix, it would be above the $450 price target outlined below. The majority of our bullishness resides with the companies we already own and our research is more about the effects on our current positions.
Netflix Stock Could Rally with Ad-Supported Content
Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.
Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, I would argue the day that Netflix’s stock price dropped 35% was consequently one of the most important days in the company’s history in terms of its chances for a boost in revenue and a renewed uptrend. Patience, though, will be required, as Netflix has a lot of work to do (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Netflix’s Q1 Earnings
The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.
Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.
Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers.
Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength.
Netflix Entering the Ad-Supported Market
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:
“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.
But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”
Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:
Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”
Here’s One Path to How Netflix Can Make a New High
If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022.
On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low.
What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter.
Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.
The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close.
Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.
When you look at top line growth, the company has not traded this cheap since 2012:
Despite the low valuation, Netflix now has a path to monetizing 50% more subscribers (100 million) including 30 million in the United States and Canada that are currently sharing passwords.
Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.
Conclusion:
Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.
It will be interesting to discuss someday how Netflix’s share price dropped 35% following the news of an ad-supported tier. The stock price took a historic hit after the company reported a subscriber miss of 200,000 and a guide of 2 million subscriber losses for the next quarter. Meanwhile, the company has a surplus of 100 million viewers sneaking passwords that the company can monetize. In my opinion, the market has lost perspective of the bigger picture.
There are two analysts who have started to crunch numbers on the opportunity and they believe it will add a base case of $12 billion in annual revenue and up to $25 billion to $35 billion in annual revenue by 2030.
“Assuming a domestic launch in the first quarter of 2023 and a global rollout over the following two years, Morris has layered in an advertising-supported tier to his multi-year forecast for Netflix and now sees total company revenue approaching $75B by 2030, he tells investors.”
Currently, Netflix is at $29 billion in annual revenue. So, wow — a doubling of Netflix’s revenue in 8 years compared to the nearly 25 years it took to get to the first $30 billion in revenue (Netflix launched in 1997).
There’s been plenty of rumors around who Netflix might choose as an ad server and supply side partner. One reason we think Roku is a candidate is because of its strong positioning with first-party data that can augment Netflix’s publisher data for enhanced targeting. Roku can also make deals around promoting Netflix on its platform, which it did for Disney, since Roku’s ad platform is the primary product compared to The Roku Channel. We think this is a strong possibility because Roku has the richest first-party data in the industry due to owning the operating system where it hosts many applications.
On the other hand, Google is not a good choice as it’s a major publisher itself. YouTube TV happens to be Netflix’s closest competitor in terms of total US TV time at 5.7% and 6.4%, respectively. It’s rare to see Big Tech competitors’ partner with one another, which can result in helping the competitor become stronger. Even though there are rumors that Netflix and Google are meeting about ads at Cannes, those events usually have meetings between all major players without any guarantee of an outcome.
Pictured Above: YouTube is Netflix’s biggest competitor
Magnite has been floated around, and this could be a strong choice for its global exposure and its ad server, SpringServe, helps put the company on par with Roku’s ad server. Comcast’s FreeWheel could also make a good partner for Netflix as the company focuses more on live broadcast and is not in direct competition to Netflix’s premium content.
We think it’s less likely that Netflix goes with The Trade Desk as a publisher, — although certainly anything could happen. However, The Trade Desk will benefit from the increased ad inventory from a demand perspective.
Truly, no matter what ad platform Netflix chooses, more than one CTV ad stock will participate as programmatic allows bidding across many sources to increase fill rates. Due to Netflix’s premium inventory, however, the company may go with a private marketplace where only two or three sources are allowed to bid.
In regards to timing, I foresee Netflix wanting to take full advantage of next year’s upfront season, which means testing and rollout will need to happen by this time next year. Otherwise, Netflix risks losing out on contracts from premium advertisers due to timing and will need to wait until the following year Q2 2024. It’s certainly feasible that strong ad partners can get Netflix’s global rollout accomplished in a year’s time – which is why I believe we will hear who Netflix has chosen as soon as Q2 earnings or by Q3 earnings. I don’t think we will need to wait until Q4 2022 as testing is likely to happen sooner.
Why is that important? Because the global juggernaut has the ability to raise the tide of all boats on CTV ads. This is the biggest news to happen to the CTV ad industry – ever, really, due to the sheer size of audience that Netflix is capable of bringing to the CTV market. There will be a compounding effect as Netflix’s entry will also more ad budgets, more premium advertisers, — and really marks the moment when CTV ads are being taken seriously even by subscription services.
I wrote an article on Netflix published in Forbes below. Of course, the real angle here is that we own Roku and Magnite and we hope one of these two is chosen as the premiere partner. It’s not speculation to say so, rather it’s taken quite a bit of conviction in the face of a fickle stock market to repeat that CTV ads have a large runway ahead of them. Four years and two years later, respectively, from our first analysis and we now have Netflix agreeing with the CTV-ads thesis. I think we should take a moment to let that sink in – as there is no company bigger or more important to agree at this juncture.
If we enter Netflix, it would be above the $450 price target outlined below. The majority of our bullishness resides with the companies we already own and our research is more about the effects on our current positions.
Netflix Stock Could Rally with Ad-Supported Content
Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.
Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, I would argue the day that Netflix’s stock price dropped 35% was consequently one of the most important days in the company’s history in terms of its chances for a boost in revenue and a renewed uptrend. Patience, though, will be required, as Netflix has a lot of work to do (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Netflix’s Q1 Earnings
The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.
Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.
Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers.
Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength.
Netflix Entering the Ad-Supported Market
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:
“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.
But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”
Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:
Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”
Here’s One Path to How Netflix Can Make a New High
If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022.
On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low.
What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter.
Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.
The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close.
Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.
When you look at top line growth, the company has not traded this cheap since 2012:
Despite the low valuation, Netflix now has a path to monetizing 50% more subscribers (100 million) including 30 million in the United States and Canada that are currently sharing passwords.
Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.
Conclusion:
Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.
Fintech companies are disrupting the global economy with new and innovative products. Technological advancements have led to considerable investments in this sector and traditional finance companies have not been able to efficiently cater to changing business needs. Of the recent fintech quarterly earnings, D-Local stood out for its strong bottom line. The company’s cloud-based payment platform is popular in the emerging markets of Latin America, including Brazil, Argentina, Mexico, Colombia, Uruguay, and Chile. It allows international enterprises to operate in the emerging markets by using the company’s payment platform to receive and make payments, and comply with local regulations, taxes, foreign exchange, and fraud management. The payment service is used by companies such as Amazon, Microsoft, Didi, Mailchimp, Wix, Shopify, Wikimedia, etc.
DLocal released its Q1 2022 results last month. The company’s revenues grew by 117% year-over-year to $87.5 million. It beat the Wall Street revenue estimates by 5.9%. The company also reported a 30% net profit margin in the recent quarter. The solid top-line growth, earnings beat, and good profits sent the stock soaring 15% the following day of the announcement of the results.
Below, we discuss the market opportunity, the company’s background and a full financial picture on this hot fintech stock.
Market Opportunity
According to Vantage Market Research, the fintech market is expected to reach $332.5 billion by 2028 from $112.5 billion in 2021, growing at a compound annual growth rate (CAGR) of 20% from 2022 to 2028.
KPMG published a Pulse of Fintech H2’21 report suggests that the investment in the fintech sector was strong in 2021, and the trend is expected to continue in 2022. According to the report, the global fintech investment reached $210 billion in 2021. The payments category drew a record in venture capital funding. The report also highlights the record investment in emerging markets like Latin America and Africa.
Mike Louw, Partner, Head of M&A KPMG South Africa, said, “The northern hemisphere is a crowded marketplace and multiples are at an all-time high. This makes Africa an attractive alternative. Global PE firms and investors are seeing the opportunity. It’s put the continent on the fintech map.”
Ricardo Anhesini, Head of Financial Services, LATAM KPMG Brazil said, “The growth of fintech in Latin America is a classic example of ‘leapfrogging’ — fintechs have leveraged the need for financial inclusion amongst large swathes of the population to move straight to a new generation of services.”
Company Overview and product niche
The company was founded in 2016 in Uruguay. The shares were listed on the Nasdaq stock exchange in June 2021. Through its single API, technology platform, and a single contract, the company helps global enterprise merchants to be paid (pay-in) and make payments (pay-out) in the countries it operates. The company’s cloud-based platform can make cross borders and local payments in 37 countries while enabling global merchants to connect to over 700 local payment methods.
The company’s Marketplace payments solutions allow its sellers to receive payments in the local payment methods through credit or debit cards, bank transfers, and cash. The company makes it easier for global enterprises to operate in the region by partnering with a local payment platform by saving the hassle of complex regulations and solving difficulties that arise due to the lack of efficient banking facilities in these countries.
The company’s tie-up with alternative payment methods (APM) providers plays a role in the unbanked population. In Brazil alone, there were 34 million unbanked adults, according to a study by Instituto Locomotiva conducted in January 2021.
The company also cited in the F-1 the research from Americas Market Intelligence (AMI). In Brazil, domestic credit cards constituted 55% of the total e-commerce payment volumes, followed by alternative payment methods at 21%, cash at 14%, and the rest 10% of international credit cards. It highlights why the company has been popular in emerging markets and can easily bridge a gap in places with a high percentage of cash transactions and consumers using local payment providers.
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For example, one of Brazil’s popular alternative payment methods is Boleto Bancario. Boleto means a ticket with a due date and the amount to be paid. Previously, it was only cash, and now the payment can also be made through bank accounts or in various branches, post offices, and ATMs to use the goods and services. Boleto payments were typically confirmed in 2-3 days, however, this time is reduced to a few minutes through the company’s API’s. This shows how the company’s tie-ups with APM providers are successful.
The company has been a boon to global enterprises by solving the problem of dealing with tough regulations, tax complications, and fraud detection. The emerging markets are witnessing rapid e-commerce growth. Due to the under penetration of the digital economy, emerging markets are the hot spot for fintech companies.
Pay-In
The company’s pay-in solution helps merchants to offer services and receive payments in various payment methods like international and local cards, bank transfers, cash, and other alternative payment methods. Examples include: Microsoft sells its products in Nigeria and can accept payments from local payment providers. Due to the company’s single API they can easily expand to all countries where DLocal operates.
Pay-Out
The company’s pay-out solution facilities global companies to make payments in the countries in which DLocal operates. The company ensures that the payments are to the registered bank accounts of the users in accordance to the regulatory requirements. For example, Ride-hailing companies can make secure payments to their drivers in the emerging markets through the DLocal platform.
Marketplaces
Marketplaces allow sellers to sell internationally and receive money in their local currency. For example, in many cases, international sellers will not be able to sell in emerging markets since they will not have local bank accounts to collect payments. In this case, the marketplace onboards the sellers as they need to comply with local regulations and DLocal will facilitate receiving the payment in the local country and then send money to the international sellers.
Financials
The company has delivered strong top-line growth with good profit margins. In the recent Q1 2022 results, revenue grew by 117% YoY to $87.5 million. It was the fifth consecutive quarter of triple-digit growth. While the triple-digit growth rate is not sustainable into the future, Wall Street analysts still expect strong revenue growth to continue as they forecast revenue to grow 74% in the next quarter, followed by 58% in Q3 and 59% in Q4.
For the full year 2021, revenue grew by 134% YoY to $244 million. Wall Street analysts expect revenue to grow 73% YoY to $422 million in 2022 and 52% YoY to $640 million in 2023.
Source: YCharts
The company earns revenues from fees charged to the merchants for payment processing services. The company’s total payment value (TPV) accelerated by 127% to $2.1 billion. The take rate was 4.2% in Q1 2022 quarter compared to 4.1% in Q4 2021 and 4.3% in Q1 2021. The formula for take rate is revenues/ total payment volume.
The company’s business is not dependent on a single industry and has a diversified base of more than ten business verticals. The company is also geographically diversified to over 37 countries which is positive.
The LatAm region revenue grew by 116% YoY to $78 million and accounted for 89% of the Q1 2022 revenue. The Asia Africa region’s revenue grew by 127% YoY to $10 million and accounted for the remaining 11%. The company expects the revenue share from Asia and the African region to gradually increase over a period of time as the company cross-sells to merchants that originally began their relationships in the Latin American area.
The company has been able to grow its revenues with its existing customers, which is demonstrated by the strong net retention rates (NRR). The NRR in the Q1 2022 was 190% compared to 198% in Q4 2021. The high NRR is not sustainable, and the management expects the NRR to be over 150% for the full year of 2022, which is still good.
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Sebastian Kanovich, CEO of the company said in the recent earnings call, “So we built the whole platform in local on the premise that it's one API, one contract and one platform for everything we do. So it's extremely simple for merchants to expand with us. That's the key driver behind our NRR. Merchants start with us in one geography, and they continue to move into other products and geographies without any friction. That's why you see us continue expanding geographically. We want to make sure we have more attachment.”
The company’s gross profits grew by 87% YoY to $43.6 million, with a gross profit margin of 49.8%. The company’s CFO, Diego Canay, said in the earnings call, “We continue to expand our gross profit and EBITDA. Starting with our gross profit, as we have mentioned in the past, our commercial focus is to increase our gross profit dollars per merchant. As a result, our gross profit continues to grow at a healthy rate.”
The company’s CEO also echoed a similar tone. He said, “When we ask our commercial teams and the way we incentivize them, it's purely on gross profit dollars to make sure that we are adding more dollars to [our] P&L.”
Source: YCharts
The company’s net profit came in at $26.3 million compared to $16.9 million for the same period last year. The net profit margin was 30% in Q1 2022, which is at the same level as the H2 2021 and lower than the 42% in Q1 2021.
The adjusted EBITDA margin was 38% in Q1 2022 compared to 38% in Q4 2021 and 44% in Q1 2021. The adjusted EBITDA margin was partly lower due to the higher share-based compensation in the recent quarter. However, the management is guiding an above 35% EBITDA margin for the full year, which is positive.
Risks:
The company’s revenue growth is slowing down from the triple-digit growth in the past five quarters is a risk to consider. The company’s costs have increased due to the return of in-person marketing and travel expenses. Also, the stock is currently trading at a forward P/S ratio of 17. The high valuations are another risk to consider with rising interest rates and macro uncertainty.
Our firm tends to be wary of IPOs in general and we covered the risks associated to IPOs last year here. We are particularly sensitive to companies that go public with very high growth rates that decelerate quickly, in this case, DLocal will have decelerated by nearly 50% from 186% in Fiscal Q2 to 74%.
Conclusion
The company has demonstrated strong revenue growth with good profits. It has developed a niche in the fast-growing emerging markets. However, considering the current macro uncertainty and the risks mentioned above, we are not interested to buying the stock at the current levels.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund do not own DLocal at time of writing and have no plans to enter the stock in the next 72 hours.
This article was originally published on Forbes on Jun 10, 2022,12:19am EDTForbes on Jun 10, 2022,12:19am EDT
The market has indiscriminately penalized tech stocks across the board and cybersecurity stocks are simply caught in the cross fire. Q1 earnings proved that cybersecurity stocks are insulated from supply chain issues and remain a number one priority across corporate budgets. Specifically, cybersecurity-related companies reported top line and bottom line beats plus a handful raised guidance while consumer-related tech and less cash efficient cloud verticals lowered or missed guidance this past quarter.
The analysis below looks at why cybersecurity is a more insulated trend and a few of the cybersecurity stocks that stood-out.
Cybersecurity Budgets are Expanding in 2022
Enterprise spending is expected to increase in 2022 from the previous year, according to Chief Information Security Officer (CISO) surveys. Considering the level of cloud spending in both 2020 and 2021, an increase on already high budgets is impressive. The CISO survey states that 44% increase budgets to increase in 2022 compared to 41% in 2021 and only 2% expect a decrease compared to 6% the previous year.
In a similar study from PricewatershouseCooper, 69% predict a rise in cyber spending for 2022 and 26% expect a surge of 10% or higher spending year-over-year. This survey was done across a broader C-suite and executive sampling.
According to a Gartner survey, 88% of the Board of Directors viewed cybersecurity as a business risk. According to Paul Proctor, VP at Gartner, “The influx of ransomware and supply chain attacks seen throughout 2021, many of which targeted operation- and mission-critical environments, should be a wake-up call that security is a business issue, and not just another problem for IT to solve.”
Gartner has also reported from a CIO survey that cyber and information security is the top priority of planned investments for companies for 2022 with 66% planning to increase investments.
Monika Sinha, VP at Gartner, said, “There is a continued need to invest in cybersecurity as the environment becomes more challenging. A high level of composability would help an enterprise recover faster and potentially even minimize the effects of a cybersecurity incident.
According to Global Market Insights, the cybersecurity market is expected to reach $400 billion by 2027 from $170 billion in 2020, representing a compound annual growth rate (CAGR) of 15% during this period. The report mentions that rapid technological advancement is driving the shift to cloud-based solutions. The increasing use of the digital world increases cybercrime, which increases enterprises' spending on cybersecurity.
Cybersecurity Stocks Report Strong Q1 Earnings
We had stated on Fox Business News that a small cohort of companies emerged this past quarter to increase the top line while also reporting narrowing losses on the bottom line. We feel not losing site of opportunities during selloffs is how generational wealth is built.
This quarter, we saw on average a 5% top line beat above guidance across major cybersecurity stocks, including Crowdstrike, Okta, SentinelOne and Zscaler. This is coupled with a beat on the bottom line across all major cybersecurity stocks with both Crowdstrike and Palo Alto Networks proving the sector can be profitable and also increase cash efficiency at scale.
Source: YCharts and Investor Relations (I/O Fund)
Zscaler’s Q3 FY 2022 revenue accelerated by 63% YoY to $286.8 million in the recent quarter. It was the seventh consecutive quarter of above 50% growth. The growth was led by the strong adoption of the company’s Zero Trust Platform. Zscaler has a free cash flow margin of 15% and management expects this to expand to a free cash flow margin of 20% for the full-year ending July 2022.
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Credit Suisse analyst Phil Winslow lowered the company’s price target to $310 from $410 and kept an Outperform rating. He said, “Zscaler reported strong Q3 results, with revenue growth greatly surpassing consensus estimates and operating margins and billings also exceeding consensus. He believes a meaningful runway exists for the company.
CrowdStrike stole the show this quarter with a beat on both top and bottom line; but it was the raised guidance line that stood out. Revenue accelerated by 61% YoY to $487.8 million and annual recurring revenue (ARR) also accelerated by 61% YoY to $1.92 billion. This company has an impressive cash flow margin of 32%.
Crowdstrike also raised revenue guidance for FY 2023 ending January to $2.19 billion to $2.21 billion from the earlier guidance of $2.13 billion to $2.16 billion, representing a YoY growth of 52% at the mid-point of the revised guidance. It also raised guidance of adjusted income from operations from a midpoint of $300.5 million to $312.2 million. Similarly, the adjusted net income from a mid-point guidance of $262.4 million to $289 million.
Morgan Stanley analyst Hamza Fodderwala upgraded the stock to overweight from equal weight. The analyst said, “CrowdStrike (CRWD) is seeing further adoption based on conversations with Chief Information Officers and is seeing 100% growth from its non-endpoint offerings, which now account for 15% of its annual recurring revenue, showing that its total addressable market could be $30B bigger than first thought.”CRWD) is seeing further adoption based on conversations with Chief Information Officers and is seeing 100% growth from its non-endpoint offerings, which now account for 15% of its annual recurring revenue, showing that its total addressable market could be $30B bigger than first thought.”
(I/O Fund)
Cloudflare company reported 54% revenue growth, beating estimates by 3%, with 49% growth expected next quarter. The company raised full year revenue guidance to $957 million, at the mid-range, for growth of 46%.
There is additional supporting evidence that growth is not an issue for Cloudflare, including remaining performance obligations (RPO) up 57% year-over-year and dollar-based net retention up 400 bps YoY. Customers paying over $100K increased 63% year-over-year to 1,537. This outpaced total customer growth of 29%. Large customers contributed 58% of revenue. There was solid growth in the >$500K customer base of 68% year-over-year growth, and >$1 million customer base grew by 72% year-over-year.
Needham analyst Alex Henderson has kept the buy rating but lowered the company’s price target to $100 from $245. He reduced the target multiples in his valuation model to enterprise value to expected FY23 sales of 23-times, down from 64-times, given the sell-off in growth equities, but maintains that Cloudflare should be a core long-term holding in all growth portfolios and recommended that investors buy the recent weakness.
Palo Alto’s Q3 FY 2022 revenue grew by 29% YoY to $1.4 billion. The billings and remaining performance obligation grew by 40% to $1.8 billion and $6.9 billion, respectively. The management mentioned in the earnings call that it was the highest billings growth in the past four years. The company raised the full-year ending July revenue guidance from a mid-point of $5.46 billion to $5.49 billion, representing a YoY increase of 29% at the mid-point.
Wedbush analyst Daniel Ives lowered the company’s price target to $580 from $660 and kept an Outperform rating on the shares. He said, “The shift to cloud is a massive tailwind for Palo Alto as the company is in the right spot at the right time to benefit from this multiyear tidal wave of cybersecurity enterprise spending.”
Conclusion:
Cybersecurity is a top priority in budgets and the results are showing up. We found a strong pattern with cybersecurity stocks sustaining growth rates and strong bottom lines this quarter. The cybersecurity sector overwhelmingly beat estimates compared to other sectors within tech and investors may want to take notice.
Zscaler’s product has done exceptionally well considering the crowded cybersecurity market. This is due to its best-of-breed, singular focus on security edge and zero trust. Primarily, Zero Trust architecture began to replace VPNs in a meaningful way in 2020 and this has sustained due to the Zero Trust model offering deeper and more scalable protection by eliminating implicit trust.
Zero Trust Security is built on the premise that no one should be trusted within or outside the network. In the traditional security systems, it is difficult to obtain access from outside the network while those located inside the network were trusted. With Zero Trust, these trust assumptions are removed with tools such as multi-factor authentication, giving access for a limited time and to also verify, authorize and to have a continuous check on all the data points that are given access.
Zscaler released its third-quarter fiscal year 2022 results on May 26th with revenue accelerating 63% year-over-year to $286.8 million, which beat consensus by 5.6%. The company also raised full-year revenue guidance by 2.9%. The stock rose 13% the following day from the results.
On the bottom line, Zscaler has a 15% free cash flow margin with a goal to increase this to 20% FCF margin this year. The company saw an increase in adjusted operating income and adjusted net income yet is reporting slightly higher losses on a GAAP basis from (25%) to (30%) due to stock-based compensation.
Cybersecurity Spend is Increasing in 2022
We will copy a few points from our upcoming Forbes analysis on Cybsersecurity stocks here for easy reference. Note: we covered these points in our Q2 2022 analysis. For the full article, please check the forum on Friday.our Q2 2022 analysis. For the full article, please check the forum on Friday.
Enterprise spending is expected to increase in 2022 from the previous year, according to Chief Information Security Officer (CISO) surveys. Considering the level of cloud spending in both 2020 and 2021, an increase on already high budgets is impressive. The CISO survey states that 44% increase budgets to increase in 2022 compared to 41% in 2021 and only 2% expect a decrease compared to 6% the previous year.
In a similar study from PricewatershouseCooper, 69% predict a rise in cyber spending for 2022 and 26% expect a surge of 10% or higher spending year-over-year. This survey was done across a broader C-suite and executive sampling.
According to a Gartner survey, 88% of the Board of Directors viewed cybersecurity as a business risk. According to Paul Proctor, VP at Gartner, “The influx of ransomware and supply chain attacks seen throughout 2021, many of which targeted operation- and mission-critical environments, should be a wake-up call that security is a business issue, and not just another problem for IT to solve.”
According to Global Market Insights, the cybersecurity market is expected to reach $400 billion by 2027 from $170 billion in 2020, representing a compound annual growth rate (CAGR) of 15% during this period.
Although that’s a small CAGR, many best-of-breed companies are only reporting around $1 billion in annual revenue right now, therefore, the size of pie is quite substantial for those that outperform competitors.
According to Gartner’s CIO survey concluded in 2021, cyber and information security is the top priority of planned investments by companies for 2022. Monika Sinha, VP at Gartner, said, “There is a continued need to invest in cybersecurity as the environment becomes more challenging. A high level of composability would help an enterprise recover faster and potentially even minimize the effects of a cybersecurity incident.”
Zscaler’s Product Leadership
Zscaler has been successful in capturing the cybersecurity growth trend with evidence the growth can sustain post-Covid. This is key as Covid was a major catalyst as Zero Trust began to replace VPNs. Although employees are returning to the office, the hybrid nature of work will persist, which means companies will face challenges in protecting their network since most of the information is stored in the cloud and the applications are SaaS-based.
Companies have realized that VPNs and firewalls are no longer safe, and the majority of them are adopting Zero Trust Security. The main reason is allowing remote workers to access through a VPN makes it easier for attackers to gain access through the internet to the company’s networks and gain access to data points. This can be efficiently tackled only by Zero Trust Security which is built on the premise that no one should be trusted within or outside the network.
The company has a large serviceable market of $72 billion. The company is benefiting from the shift from traditional cybersecurity solutions to cloud-based Zero Architecture. The Internet of Things and remote working has further increased the long-term opportunity for the company.
Zscaler primarily protects cloud workloads by controlling access through implementing policy-based access and interconnects for a company’s data centers, cloud infrastructure, software and third-party services. Zscaler is cloud native and its growth is related to growth in cloud migrations. SASE and zero-trust became especially important during the hybrid work-from-home rush that occurred during Covid.
The company offers the following products, Zscaler Internet Access (ZIA), Zscaler Private Access (ZPA), Zscaler Digital Experience (ZDX), and Zscaler Cloud Protection (ZCP). The company offers the flexibility for its customers to purchase products separately, which allows for flexibility in pricing.
ZIA is a security stack that offers reliable access to the internet and apps regardless of their location. ZIA is suited for connecting to external apps like Zoom or Office 365. Since it goes to third-party applications and the public internet, all the traffic is inspected so that no malware attacks occur and the data is secure.
ZPA provides secure access to internal applications that are hosted in data centers or in private/public clouds. ZPA offers secure private app access to its users across all locations with the company’s Zero Trust Network Access (ZTNA) platform. The main advantage is that the apps are not exposed to the internet, limiting external cyber-attacks.
Traditional network performance analysis tools have become obsolete due to the applications moving to the cloud and users being in various locations. Previously, enterprises used to own the network and the applications used to run in their own data centers to identify any issues efficiently. ZDX solves this problem in the modern cloud environment since it helps companies know exactly where the issues lie and how many users are affected.
The company is a leader in the Zero Trust Platform, particularly in the Security Service Edge in the Gartner Magic Quadrant which can be seen in the graph below. The company’s demand for products remains strong, evident from the large multi-year contracts signed by the company. In the recent earnings call, the management mentioned they witnessed solid growth in $1 million annual contract value deals broadly across business verticals and geographies. The remaining performance obligation (RPO) grew by 83% YoY to $2.21 billion, indicating future revenue for the company.
Zscaler has a strong base of growing enterprise customers. The company also has been able to increase the number of Global 2000 customers. In the last two quarters alone, the company added 80 Global 2000 customers. It currently has 30% of the Global 2000 companies and 40% of Fortune 500 companies as its customers.
The company has been able to upsell its products which is evident with the company maintaining the dollar-based net retention rate of over 125% for the sixth consecutive quarter. The company had 288 customers in the recent quarter with annual recurring revenue (ARR) of over $1 million, up 77% YoY.
How is Zscaler Different?
Zscaler management is often asked how the company is different from its competitors. The main thing Zscaler accomplishes when competing against more legacy virtual private network (VPN) offerings is they are able to replace global load balancers, DDoS protection, external firewalls, intrusion prevention system (IPS) and also VPNs. Hackers use numerous attack vectors and Zero Trust is a solid replacement for VPN systems because it aggregates the appliances while broadening the protection.
One way that Zscaler offers enhanced protection for the attack surface is that nothing sits between Zscaler Private Access and the applications and workloads. Rather than build a VPN replacement, the company has extended ZPA to include browser isolation, app protection, interior deception and EIM based policy. This equates to Zscaler offering the widest and deepest coverage.
Secondly, attackers have a hard time finding where to attack with Zscaler’s Zero Trust architecture because the products act like a shield with the applications hiding behind Zscaler. The company’s proxy architecture scales rapidly as applications and workloads scale rapid. The CEO has said “[Zscaler] scales like nothing else out there.”
Regarding CDNs such as Cloudflare entering the market, Zscaler’s response in the earnings call is that it will take a long time for a CDN and DDoS provider that is focused on servers to catch up to the best-of-breed, singular focus Zscaler has. “We start focusing on users to start with. It takes a lot of time and experience to build our richness and breadth of functionality we have built with ZIA, ZPA and associated functionality. I think it will take a long, long time for someone to try to catch us. And we are setting. We are innovating at a very fast pace.”
With that said, certainly Cloudflare aggregates many products under its umbrella and does well on Zero Trust against more VPN-related solutions.
Notably, Zscaler is moving into machine learning-based cybersecurity. Zscaler processes more than 240 billion transactions per day and the company’s AI/ML models can block many types of known threats in real-time before the endpoint delivery. They are also designed to identify unknown phishing webpages before they appear in the end user’s browser. This proactive approach was not possible with traditional cyber security solution providers.
Financials
The company continued to deliver strong revenue growth. Revenue accelerated by 63% YoY to $286.8 million in the recent quarter. This is the seventh consecutive quarter of above 50% growth. The growth was led by strong adoption of the company’s Zero Trust Platform, as discussed above. The management expects revenue to grow 55% at the mid-point of the guidance in the Q4 FY2022 ending July.
Source: YCharts
The company’s key metrics are growing, indicating that growth is expected to continue. The remaining performance obligation grew by 83% YoY to $2.21 billion. The company’s billings grew by 54% YoY to $346 million.
The company reported GAAP operating margin of -30% compared to -25% in Q3 FY2021. The rise in operating expenses is partly due to the return of travel expenses which was absent during the Covid lockdowns. The company’s adjusted operating margin was 9% compared to 13% in the same period last year. The difference in GAAP and non-GAAP operating margins is primarily due to the stock-based compensation. The management mentioned in the earnings call that it should come down as a percentage of total revenue over a period of time. Recently, the market has been concerned about companies using high stock-based compensation, so this is a risk to watch in the coming quarters.
The company reported a net loss of $101.4 million compared to a net loss of $58.5 million in Q3 FY2021. The adjusted net income was $24.7 million compared to $21.4 million in the same period last year.
The company has strong cash flow. In the recent quarter, the free cash flow margin was 15%, and the management expects it to be 20% for the full year.
Conclusion
The strong revenue growth has given the company a premium valuation. The stock is currently trading at a P/S ratio of 22 with year ending in July and forward one-year P/S ratio of 15. The company is not without GAAP losses yet adjusted operating margin and cash flow margin helps offset profitability concerns.
We had discussed cybersecurity being strong this quarter going into Q2 2022 with our Quarterly Webinar presentation and the current earnings season supports this prediction. Primarily, the cybersecurity sector is insulated from supply issues (which we do expect to ease eventually) and also is a #1 must-have in budgets, per the many CISO and C-suite surveys published by multiple third-party consultants.
Undoubtedly, cybersecurity was the strongest category in tech this past earnings season and Zscaler was one of handful that put up a strong report.
The FANG acronym rose to popularity in 2013 and was extended in 2017 to FAANG to include Apple. If history is any indication, the world’s most valuable companies over the next ten years will not look like the previous ten years. Being early to identify which companies can take over this coveted status is how generational wealth is built.
As a tech industry analyst who has seen what one generous winner can do for an entire portfolio, I want to pause and acknowledge that an investor needs to only identify one company that can hold a top 5 position in order to see life-changing gains. To choose all five would be to defy incredible odds. This analysis is aimed at identifying what companies we believe will hold “world’s most valuable” by 2030.
Not only is tech the most valuable industry today, but what the tech industry is setting up to do over the next ten years will provide exponential gains compared to the 2020-2030 era. With that said, tech is going through a period of consolidation and this means the stakes are high in identifying the winners. To complicate matters, the market is not efficient with tech stocks as each product is quite nuanced and impossible to efficiently price without manual deep dives. Instead, the market will indiscriminately penalize all tech and indiscriminately reward all tech — and each time the liquidity tide rolls in and then out again, it becomes sink or swim. At times like this, we are very flexible as we know we only need to identify a handful of winners.
Our portfolio has twenty positions at any given time, yet we believe it will be 5-10 positions total that create 90% of our wealth by 2030. We are long-term buy and hold investors yet we acknowledge and accept this means we exit those who show weaker-than-expected results for more than one quarter — or we trim to 1% to hold a place for the stock in our coverage. Because we are flexible, we can always revisit a stock when the story resumes and the earnings match the thesis again.
The equity market is driven by sentiment and macro factors, which we expand on herewe expand on here, yet the underlying strength of tech fundamentals is hard to deny. The best way to predict what will happen next is to look closely at what happened over the past decade.
In 2007, following Steve Jobs famous iPhone keynote, a burgeoning app economy was driven forth by iOS and Android developers. Google’s search engine was already a success yet mobile catapulted it’s use by putting the mobile device into far more hands over three years’ time than personal computers did over two decades.
There were many ways to capitalize on this massive addressable market — the iPhone and iOS apps dominated the highest spend on mobile, Facebook proliferated to 2 billion people and Google expanded to acquire YouTube. In this way, mobile drove gains for three FAANGs.
The adage is that history rhymes but it does not repeat. I believe a large addressable market is certainly required to produce the new wave of FAANGs – however, rather than consumer driving the gains, I believe it will be enterprises.
Below, I discuss the enterprise-level market that will be four times larger than mobile and two stocks that will directly participate. Imagine participating in 4X the FAANGs by 2030. That’s what I believe will happen due to one key trend and I discuss exactly why this will be achieved below.
Later in the analysis, we look at cloud and the trends that will drive cloud over the next ten years. This will catch investors who are complacent off guard as cloud is already going through a period of consolidation and we are seeing new business models emerge, such as the consumption model whereas the SaaS model with annual recurring revenue has dominated the past decade. Microsoft helps prove that cloud is certainly capable of FAANG-status.
We will also look at blockchain and crypto as I have been covering this space since 2013, which predates the Ethereum network. I was trained in Silicon Valley and my role is to introduce public investors to the next wave of innovation in as safe a manner as possible. I agree that 90% of cryptos will go to $0 yet I/O Fund has been firm for years that Bitcoin would reach $1 trillion in market cap and we have two Layer 1 networks to discuss with you plus a middleware company. Whether you’re ready for it or not, Web3 will replace the internet by 2028-2030 and we are fully prepared to participate in the substantial gains the blockchain will produce.
Lastly, FAANG is not entirely dead and consumer will have its moments too. We discuss the two FAANGs we own and what major catalysts these companies have in their future. We also briefly touch on some consumer-facing stocks we own and the large addressable markets they have the potential to capture.
For those of you who are new to the I/O Fund, we are prolific in our analysis. I began writing analysis on products, startups and enterprise-technologies in 2011 and moved over to the public markets seven years later. There is a library of analysis available to you that dates back to our launch in 2019 and additional free analysis in 2018. Due to the sheer number of products I have analyzed, we are able to hold an all-tech portfolio across semiconductors, cloud, ad-tech, blockchain and more.
We also encourage you to sign up for trade alerts as Knox’s active tradesKnox’s active trades help frame the market and whether we are risk-on or risk-off. We also have an automated hedge signal and are audited annually. You can learn more about how we manage an all-tech growth portfolio here.
Yet, the investors on our site need to do their part, which I can summarize as the following:
Speak with your financial advisor about your risk level. We are not financial advisors. Instead, we simply show you the trades we are making with our own money.
Use our pie chart to view our allocations. The larger the allocation, the higher the conviction – and vice versa, the lower the allocation, the lower the conviction.
As stated, we are flexible as we expect a handful of companies to drive the majority of our gains. If we receive new information, we will manage risk accordingly by lowering allocation or exiting the position.
We firmly believe all tech investors need a long-term time frame for tech. The best tech investors in the world are venture capitalists and they seek an exit 5-7 years after they’ve funded a round. The reason to have a long holding period is that it’s nearly impossible to time an entry, therefore professionals instead time their exit. By having a long-term horizon, you can be patient until the market conditions are in your favor to take your exit.
Accept that tech is volatile. For example, high beta tech has sold off around 40%/year since 2018. I have been down this much and more so on positions that became 1,000% and 2,000% winners. This is not value investing, it’s an entirely different sport.
We have a proprietary hedge that we developed. The hedge went live in April and is designed to help us remain comfortably invested during drawdowns. You can learn more about the hedge here and watch the webinarhedge here and watch the webinar.
Without further ado, let’s talk about who will be the world’s most valuable companies in 2030
Artificial Intelligence and Machine Learning will Exceed the Mobile Economy
Smartphones had a 10-year cycle of maturation with the iPhone distribution beginning in 2008 and the app economy had a similar 10-year maturation for digital advertising. We know mobile is reaching saturation as the iPhone often has flat quarters and Facebook’s DAUs are also flat. Following a decade-long run:
The smartphone market was valued at $720 billion in 2019 and the global mobile application size was $155 billion.
The mobile advertising market was valued at $60 billion — Facebook
The market is roughly $2 trillion for mobile yet the market cap of these companies combined is $4 trillion. Meanwhile, Pricewatershousecooper is predicting the AI market to reach $15.7 trillion with some believing AI will be the next electricity. Semiconductors will not comprise the entire $15.7 trillion but according to McKinsey, they will “capture 40 to 50 percent of the total value from the technology stack.”
“Many AI applications have already gained a wide following, including virtual assistants that manage our homes and facial-recognition programs that track criminals. These diverse solutions, as well as other emerging AI applications, share one common feature: a reliance on hardware as a core enabler of innovation, especially for logic and memory functions.”These diverse solutions, as well as other emerging AI applications, share one common feature: a reliance on hardware as a core enabler of innovation, especially for logic and memory functions.”
The artificial intelligence economy will be four times larger than the mobile economy. Put differently, mobile gave us companies with up to $2 trillion market caps and AI will give us companies with $8-$10 trillion market caps. Let’s break this down.
The size of total addressable market is critical to produce the world’s most valuable companies. FAANG companies have illustrated this well and that the private markets base nearly every investing decision on TAM.
Pictured above: Google’s search engine revenue growth from 2008-2022
Google’s search engine is used by over 4 billion people
Android is used by 2.5 billion people and YouTube 2 billion people.
Facebook is at 2.9 billion users
Apple has 1.8 billion active devices (about 1 billion iPhone)
Microsoft Windows has 1.4 billion users and MS Office has 1.2 billion users = Microsoft coming from the dot-com era shows us that mobile produced much larger addressable markets across three companies compared to the previous decade.
However, not only will AI semiconductors power the accelerated computing and the training and inference that reaches every person on earth, it will ultimately power the automobiles, the streetlights, vehicles, refrigerators, factories, cities and spaceships. This will extend the addressable market beyond the 7 billion global population to reach 100 billion connections. Now, imagine this – it will be writing the software too and running the machine-to-machine automations.
View my Bloomberg appearance here where I discuss the AI market being 4 times larger than mobile.Bloomberg appearance here where I discuss the AI market being 4 times larger than mobile.
Here is a glimpse of what AI will do for GDP in each country:
AI is expected to nearly double GDP in the United States by 2035 and across Europe and Japan. The same study shows the American worker will increase productivity by 35% due to AI.
Accelerated Computing Required for Artificial Intelligence and Machine Learning will Produce Two (New) FAANGs: Nvidia and AMD
Accelerated computing is a term first used by the gaming industry when graphic accelerators were put into use to accelerate the work of a central processing unit (CPU). Nvidia created GPUs to offload tasks from CPUs for rendering 3D images. The CPUs provide the instructions while GPUs perform multiple calculations from streams of data. Parallel processing became a natural fit for the data center including training artificial intelligence and deep learning models due to processing multiple computations simultaneously.
Please reference the additional resources below where we have done previous deep dives on every company mentioned in this summary.Please reference the additional resources below where we have done previous deep dives on every company mentioned in this summary.
Nvidia’s Moat is Called Cuda:
Nvidia has a parallel computing platform and programming model called CUDA that is universally known due to the company’s first mover advantage in GPUs. The GPUs themselves do not create the moat. The compute platform creates the moat. Universities teach CUDA, which helps strengthen the universal platform for building GPU-accelerated applications as students graduate with this universal skill.
Hardware does not offer a moat. The iPhone was not the moat. Instead, it was the strength of the developer ecosystem that propelled Apple to become a $2 trillion company. The moat that Apple has enjoyed was created by the third-party developers who created iPhone applications in C and C++ with XCode, which made the device more attractive due to the mobile app ecosystem.
Android then became the second operating system in the mobile duopoly. Due to the friction of learning too many languages, the mobile ecosystem did not entertain any further competitors. This is despite there being 4 to 5 billion smartphones globally (i.e. it’s certainly feasible from a consumer supply/demand view point to entertain more operating systems and app stores), yet the limitation came from the number of languages developers are willing to learn. Microsoft Windows failed because it launched too late, and developers had already chosen the two languages they were willing to work with.
Developers create a moat because they don’t want to learn new systems – the cost of time, especially when bringing products to market is very valuable. For instance, AI startups are not going to shop a new software layer to program GPUs right now as it’ll slow down their time to market and it’s critical to launch products quickly. If there’s a competitor to Nvidia and the startup is already developing on the CUDA platform, then it better be a heck of a value proposition.
Nvidia’s Game Changer Was the A100 GPU:
In 2019, I had already stated to our premium research customers that Nvidia would become one of the world’s most valuable companies. However, the path became clearer in 2020 when the company released the A100 GPU which combines both training and inference onto one chip. The result is a 20X performance boost from a multi-instance GPU that allows many GPUs to look like one GPU. The A100 offers the largest leap in performance to date over the past 8 generations.
Note: Reference the resources below for more information on the A100 GPU including our coverage in 2020.
Fast forward, and nearly two years later after the A100 GPU launched, Nvidia had this to say in the most recent earnings report:
“[Data center revenue] doubled year-over-year. and we're seeing really strong adoption of A100. A100 is really quite special and unique in the world of accelerators. And this is one of the really, really great innovations as we extended our GPU from graphics to CUDA to Tensor Core GPUs. It's now a universal accelerator […] And so from database queries to data processing, to extraction, and transform and loading of data before you do training and inference and whatever image processing or other algorithmic processing you need to do can be fully accelerated on A100.”
Buried a bit deeper into the previous earnings call, management stated this: “The flagship NVIDIA A100 GPU continue to drive strong growth. Inference-focused revenue more than tripled year-on-year.”Inference-focused revenue more than tripled year-on-year.”
These are the kinds of critical moves we try to get in front of by covering the A100 GPU at its launch. Two years later, and we see management saying inference revenue has tripled and data center revenue doubled due to this specific product.
View my interview on TDAmertrade where I discuss Nvidia’s data center segment and why automotive will be strong in the second half of 2022.my interview on TDAmertrade where I discuss Nvidia’s data center segment and why automotive will be strong in the second half of 2022.
AMD: The Dark Horse of AI Chips
The Dark Horse refers to an underdog or an overlooked competitor that emerges seemingly from nowhere to succeed. We believe AMD is a force of nature that the market often underestimates due Intel’s overhyped public relations strategy. Meanwhile, the competitive prowess of Lisa Su has led to the second biggest comeback in the history of the tech industry after she took over AMD in 2014 on the brink of bankruptcy.
Note: We’ve done a 1-hour webinar exclusively on AMD. Reference the resources below.
AMD’s Strength Came from the Zen Architecture
The Zen architecture was introduced under Lisa Su in 2017. These processors are chipset free and fully integrated. Communication between CPUs is done through Infinity Fabric protocols. The result of the new architecture was more energy efficiency and the ability to execute more instructions per cycle.
The company released the second generation of its Zen architecture and this is when AMD started to clearly outpace Intel in terms of computing power, memory and energy use – all at a lower cost. This was due to multi-chip modules that combine a 7nm with a 14nm to use the most advanced technology when and where it’s needed most by leveraging the more mature process node. The L1 cache and L2 cache locations in the core and across the core also helped the company beat Intel on memory bandwidth.
Intel was still producing a 14nm chip with a 10nm supposedly on the way. Essentially, AMD leapfrogged the incumbent with a product that is more power efficient and allows for more cores per chip.
Note: read more about the Zen architecture in the resources listed below.
If technical jargon around chips isn’t your thing, then this is probably the most important line from our original analysis in terms of AMD’s competitive prowess: “It’s estimated that for every $1.00 in Rome chip sales, Intel loses $2.25 on average in Intel Xeon SP sales. The savings are then deployed to buy more Rome chips, which can further depress Intel’s revenue.”
We can clearly see AMD taking market share in server CPUs although losing ground in desktops and laptops (our thesis is server market share so that’s less important to us). Notably, overall CPU market share for AMD is up.
Most importantly, look at where AMD was when it launched the second generation of Zen (roughly 2%) to today (roughly 11%) market share – or nearly 6X from this major design win. Moving forward, Intel will need to deliver a 7nm chip – but by then Lisa Su will already be releasing a 5nm design.
As the analysis below points out, Intel needs to make up for lost time, meanwhile, Lisa Su is unlikely to allow that now that AMD has clawed its way back from near-zero. Our site was early to AMD overtaking Intel and this was the analysis we chose to publish during the Covid selloff in March of 2020.
Tech investors should pay attention to AMD’s ability to stave off the competitor and the new inroads AMD will have following the Xilinx acquisition. Xilinx’s FPGAs are particularly well suited for accelerated computing yet require an easier software development platform – which I suspect AMD and Lisa Su will fully deliver in the next year.
So far, Lisa Su has simply set the foundation for her company to see substantial AI tailwinds.
AI Acceleration Goes Far Beyond Data Centers
In the months to come, I will detail for I/O Fund members the additional revenue segments that will cause Nvidia and AMD to catapult their current market caps. The data center does not even scratch the surface.
Primarily, these companies will participate in the lion’s share of AI acceleration in the automotive industry, edge computing and edge devices, 3D virtual worlds and robotics simulation, industrial automation, software automation — and probably most crucially, why the leading hardware companies of today are moving into licensing software and why that will cause an eruption in revenue for these particular hardware companies. Look for this special report before next earnings season.
Before I move onto cloud, I’d like to mention that we hold two more semiconductor positions – Marvell and Lam Research. We foresee holding these companies for the long haul and linked resources below spell out why we’ve chosen these two names out of the hundreds of semiconductors on the market.
2030 Cloud Companies Won’t Look like 2020 Cloud Companies
Tech is synonymous with innovation, and consequently, innovation is synonymous with the word change. This is why winning cloud investments from the past ten years will not look like the next ten years. Cloud has treated investors well, yet cloud is going through a transformation that will shake up the previous paradigm. The previous paradigm was one where most cloud stocks were successful, and was distinguished by easy cash. Now that cash is tighter, there will be fewer winners in this category. We covered the fundamental change to cloud’s bottom line here in: Compartmentalizing Cloud Stocks.
Cloud: Only the Strong will Survive
In 2010-2021, the public markets saw hundreds of cloud companies go public. Yet anyone with a decade or more experience in tech will tell you that consolidation eventually will come knocking.
Consolidation is a natural part of the tech industry where competitors become acquired or they merge with stronger companies to avoid failing entirely. This helps a small minority to emerge as the defacto leaders. I believe that cloud companies will survive either through consolidation or standardization, which means cloud companies that have evolved to serve more than one market, which in turn helps drive down costs.
Let me illustrate:
Recently, a report came out that repatriation, or moving some workloads back to on-premise, has resulted in quite a bit of cost savings for companies like Dropbox, Crowdstrike and Zscaler, who use hybrid approaches. The report is quite surprising as the conclusion is that $100 billion to $500 billion in market value is lost on cloud deployments in terms of margins. One use case that is detailed is Dropbox, a company that reported savings of $75 million in two years after repatriation, which in turn, helped the company’s gross margins increase from 33% to 67%.
The problem with cloud is that it’s not uncommon for companies to spend about 60% of their revenue towards committed cloud spend. The solution is aggregating services and products to drive down costs.
Two companies we own that offer standardization are Datadog and SentinelOne. Standardizing means interoperability between various cloud environments and integrated interfaces. This is especially important with multi-cloud or hybrid cloud where companies have more than one environment. This is becoming the new normal to prevent vendor lock-in.
If corporations continue to standardize on Datadog’s platform, then the company will continue to capture market share. Since dealing with multiple cloud vendors quickly becomes cumbersome, there is a natural tendency to standardize in tech, especially with software. Moreover, cloud applications need to communicate, so having everything on one platform can make detecting and resolving issues less complex and costly. The cloud industry is on the cusp of this standardization trend with cloud software vendors, with Datadog leading the way. In this way, Datadog is best positioned to benefit from both the rise in cloud usage and the standardization of cloud software.
SentinelOne is a security position we own. Although the company has many competitors in the EDR space, they extend the acronym to XDR to not only include devices and workstations, but to also include other data points on the network, such as containers and cloud-native applications, and also across the entire stack, such as email, the network, and identity.
SentinelOne uses many data sources to create a data lake. The single pool of raw data is built across a wide range of sources, including other vendors or internal data sources. What matters to customers is that every threat is detected very quickly, and SentinelOne proposes a solution that is able to do both because automation and AI is best done at the data level rather than managing thousands of user endpoints to mitigate attacks.
According to SentinelOne, using their products can produce cost savings can be up to 353% – granted this number is a marketing department, however, the point is that any company increasing ROI in cybersecurity has a real chance of taking market share if their product improves the results. The savings quoted is achieved by reducing the amount of cybersecurity tools a company needs by standardizing endpoint security across more data types. The consolidation in this case saves up to $3 million over a three-year period and the enhanced threat detection saves $671K over three years. Due to automation, $1.2 million can be saved over three years by reducing time and employee hours across the IT team.
Big Data and Analytics/ML – Consumption Model is Here to Stay
There is an oft-quoted statistic that 90% of the world’s data was created in the last two years – and this stat is from 2018. The world produces 44 zetabytes of data across the digital universe as of 2020 and there is expected to be 200+ zetabytes of data in cloud storage by 2025. Each zettabyte has 21 zeroes or is 1,000 bytes to the 7th power. By these estimates, we can expect to see up to 5X growth specifically in data centers. Statista places the number at 181 zetabytes by 2025 up from 64.2 zettabytes in 2020.
In regards to data integration in the cloud, this spans from data lakes, to ETL pipelines, cloud data warehouses and object storage. Data fabrics and data virtualization is key to both hybrid and multi-cloud strategies.
The key thing to know about Big Data, Analytics/ML is that these companies will test financial analysts as they do not bill according to subscriptions like many software companies do. Instead, companies like Snowflake, MongoDB and Confluent bill customers based on consumption. This is a relatively new approach to software billing, which makes it harder to model and forecast near term sales.
As data creation, ingestion and storage soar in the cloud environment, cloud software providers are starting to migrate away from subscription agreements, which are fixed, to a consumption-based pricing model, which are uncapped.
Consumption-based pricing has a few drawbacks. For example, its less predictable than subscription revenue and there isn’t a ‘floor’ on revenue, because if consumption declines then so will sales. However, the flip side is also true, consumption billing does not have a ‘ceiling’ on revenue, so if customer consumption rises, so does sales. This uncapped revenue potential is key to why growth could be quite substantial in this category compared to cloud SaaS peers.
Here is a disclosure from Snowflake in the 10Q:
“Consumption for most customers accelerates from the beginning of their usage to the end of their contract terms and often exceeds their initial capacity commitment amounts. When this occurs, our customers have the option to amend their existing agreement with us to purchase additional capacity or request early renewals”
We want CAGRs that are larger than mobile’s CAGR for 5-10 years. According to industry analysts, the CAGR for machine learning is at 38% between 2022-2029, growing from $15 billion in 2021 to over $200 billion in 2029. Some of this is being driven by Big Tech yet as more companies seek a vendor agnostic approach and multi-cloud workloads, there is ample room for agnostic companies to do well.
Compare this to the smartphone market which grew at 24.9% CAGR with some years in the 12% CAGR range. Here’s an example of a reference for CAGR during Apple’s high-growth years: “The Asia-Pacific smartphones market shipment stood at 87.8 million in 2010 which is expected to reach 294.1 million in 2015 growing at a CAGR of 27.3% during 2010 – 2015.”
Here's how Datadog’s CEO describes what is going on in terms of big data in the Q2 earnings call: “it's almost a given that there will need to be a different way of charging for capturing some of the value provided to customers that can't just be attached to the straight volumes of data that are being exchanged because those volume of data are exploding exponentially while our customers' revenues are not going to explode exponentially.”
To capitalize on the Big Data, Analytics and ML trend – which we fully believe has the potential to produce a FAANG – we hold long-term positions in MongoDB and Snowflake. We are comfortable with the fluctuations of the consumption model, which means some volatility at times, as the consumption model will be tied to higher revenues in the long-term.
Note: We hold a 1% position in Confluent which translates to a lower conviction than MongoDB and Snowflake for this trend. We have recently trimmed 2.5% from Snowflake with the goal of building a bigger position in MDB. Please reference Knox’s trade alerts for more information on these positions and others in real-time.
We encourage tech investors to look at cryptocurrencies with a level head. It’s easy to dismiss the blockchain as a fad and it’s also easy to gamble on crypto for a quick gain. We think both approaches are wrong. Instead, our approach is to fully embrace the blockchain and it’s volatility by being willing to trim when the uptrend hits our targets close to the top and layer back in around the bottom.
Knox has a strong track record in navigating Bitcoin’s volatility and we fully expect to continue to trim at the top and layer-in at subsequent bottoms for the next five years – with real-time trade alerts sent to our premium members.
We own the following cryptocurrencies in a longer-term fashion: Bitcoin, Ethereum, Chainlink and Avalanche. The first three come with a higher conviction simply due to the size of their ecosystems yet we think Avalanche stands-out as a secure, decentralized protocol that can scale.
We also own very small, token positions in what we call a YO/LO portfolio (You Only Live Once) where we are a bit more liberated to take higher risks than we would with our core portfolio. Reference the resources below for more information.
Bitcoin:
We covered Bitcoin within a month of launching our premium site in 2019 and it’s in my top 5 for FAANG status. Notably, we had predicted Bitcoin would reach $1 trillion market cap when it was selling off from the $7-$10,000 range to $3,000 range.
The primary reason we are proponents of Bitcoin is that it is the world’s most secure financial network with a higher level of security than the 10,000 global banks combined. This solves a genuine need for the financial system as payments and transfers cannot be automated without a decentralized blockchain solution.
Crypto transfers eliminate processing fees and also hedges against inflation. There are transaction fees charged by crypto exchanges but these fees are not inherent to Bitcoin and will lower in time with more competition.
Apple, Google, Microsoft, and Amazon crossed market caps of $1 trillion because their products scale to global populations and are required on a daily basis. Bitcoin not only scales to global populations, but it also protects their livelihood – a necessity rather than a convenience. This is why we see populations that are not necessarily tech-savvy most enthusiastic about Bitcoin. In 2019, I argued that Bitcoin will reach a $1 trillion market cap as solving a real financial need for global populations should be worth as much as a search engine, enterprise software, social media network, warehouse fulfillment (AMZN), or iPhone hardware company.
In our original report we used the example of Venezuela, where during a period of hyperinflation, the price of a cup of coffee rose to 2,800 bolivars up from 0.75 bolivars within one year, representing an increase of 373,233%, according to Bloomberg data. Essential goods such as toilet paper and medicine were also very costly.
Bitcoin was immediately available to Venezuelans as a store of value and offered them an option to cross the border and escape an autocratic regime. Since then, El Salvador has adopted Bitcoin as their country’s currency.
Currently, the United States is at debt levels of about 133 percent of gross domestic product (GDP). There has been a steady rise in the level of national debt to GDP due to decreased tax revenue and increased spending, especially on health care.
The United States is unlikely to see hyperinflation to the level of Venezuela (at least, let’s hope not). However, trust in fiat currencies will erode as debt continues to climb.
Japan is an excellent case study for an economy that is struggling due to quantitative easing. The Japanese debt-to-GDP ratio is at an all-time high at 254% due to its quantitative easing. Government debt to GDP in Japan averaged 137.4% from 1980 to 2017.
Easy money policies from Japan’s central bank harmed domestic asset returns by suppressing local interest rates. Ranking as the world’s third largest economy, Japan resorted to negative interest rates in 2016. In April 2016, it was reported that a “Japanese bank buying 5-Year U.S. Treasuries with perfectly hedged currency and duration risk would (lose) 0.9% a year.”
Consequently, Japan is a thriving bitcoin market and has seen increased crypto deposits. According to the Japan Virtual and Crypto assets Exchange Association (JVCEA) Japan’s virtual currency deposits recorded 1.41 trillion yen or about US$13 billion in March last year, the volume was about seven times more than in March 2020.
During the recent Ukraine-Russian war the use of crypto has once again taken prominence. The Ukrainian government has also accepted crypto donations during this crisis. In the words of Alex Bornyakov, Deputy Minister of Ukraine’s Ministry of Digital Transformation, “In times like these, response time is crucial. Crypto is playing a role to give us flexibility to respond really quickly to deliver the army’s required supplies.” The lack of financial access might also increase the use of crypto in both the countries. The Ukraine central bank had suspending electronic transfers and reduced cash withdrawals and there were reports that Ukrainians were turning to cryptocurrency.
According to Alex Gladstein, Chief Strategy Officer at the Human Rights Foundation, “The fact that it can’t be frozen, the fact that it can’t be censored, and the fact that it can be used without ID is very, very important,” He further added, “And they are why bitcoin is such an important humanitarian tool.”
We’ve written extensively on Bitcoin and we encourage you to read more about the importance of the Lightning Network in our resources below, which is a payment protocol that operates on top of cryptocurrency blockchains and enables fast transactions.
The Lightening Network will be used for small transactions that don’t require the security of the bitcoin network. Large transfers that require decentralized security will continue to take place on the original layer.
The final iteration for the Lightning Network will be the cross-chain atomic swaps, which will exchange crypto tokens between different blockchains without the need for a crypto currency exchange.
Benefits of the Lightning Network:
Transactions will take place on the Lightning Network channels and outside of the blockchain:
Fees will be minimal to non-existent for small payments like coffee, dinner, and local stores.
Quick transactions no matter how busy the network is. The transactions will be instantaneous and able to keep pace with Visa, MasterCard and Paypal.
Cross-chain atomic swaps will eliminate the need for separate crypto exchanges.
The Lightning Network can reach 1 million transactions per second.
If you want a perfect parallel to the mobile duopoly of Android and iOS, then it will be Web3. We began with artificial intelligence because by increasing GDP, AI/ML promises to be the technology that delivers the most gains in the public market’s history – far exceeding mobile. Yet, the blockchain offers a parallel to mobile as what layer one networks set out to achieve is very similar to what Apple’s app store achieved.
The primary difference between Ethereum and Bitcoin is that Ethereum is not trying to compete as a currency. The focus of Ethereum is on its network, not the coin. Butkin’s vision is to create an open network for decentralized applications (dapps) and smart contracts based on the Turing complete programming language Solidity. The takeaway is that just like Apple hosted apps on its operating system, Ethereum hosts d’apps on its network.
These three benefits are: decentralization, security and scalability. The issue is that most decentralized networks cannot offer all three without some compromise.
Ethereum faces constraints in transactions per second (TPS) and how to overcome the high energy costs of mining that comes with decentralized security. The network simply can’t scale without the upcoming release of Ethereum 2.0.
In our premium analysis last year on Ethereum here, we discussed the difference between Proof of Work (PoW) and Proof of Stake (PoS). In addition to the Proof of Stake merge that Ethereum must complete, the network must also launch shards. Nodes in the previous network must download a transaction, calculate it, archive it and read every transaction in Ethereum’s history, which is terribly inefficient. Shards create a subset of the network where nodes are dispersed for more efficient processing. Ethereum 2.0 must also replace Plasma with ZK Rollups, which allow for hundreds of transfers to be rolled into a single transaction.
In November, we wrote another update on crypto and Ethereum, stating that the expectation was for Proof of Stake to merge in late 2021 with Shards and Rollups expected by late 2022 or early 2023. The timeline for PoS is delayed yet again until Q3 2022, which puts Sharding and Rollups out another year potentially to Q3 2023. (Read more in the resources below).
The takeaway: Ethereum has a wide lead in terms of number of d’apps and developers (remember that developers adopting CUDA created Nvidia’s moat). However, the Merge to Proof of Stake is an unknown which leaves the Layer One network market wide open for now.
Avalanche
Layer One Networks are considered early-stage tech investing which carries higher risk. Ethereum clearly has a head start, and after the proof of stake merge, we could see the network take off in a meaningful way.
However, there are other Layer One networks to consider. We hold an allocation in Avalanche due to it’s Ethereum Bridge, application-specific subnets, and the launch of a consumer-facing app over the next quarter. Avalanche also has a high Nakamoto Coefficient, which is a number that designates the number of nodes that would need to be corrupted to slow or prevent a chain from functioning properly.
Avalanche launched with three chains. Per our YO/LO write-up: The X-Chain is for creating and exchanging assets including NFTs, the P-Chain validates and creates subnets, and the C-Chain is for executing Ethereum Virtual Machine (EVM) contracts. The C-Chain offers interoperability with Ethereum, which is why the Avalanche bridge is the most popular ETH Bridge currently. The P-Chain is what is used to create and manage subnets. The coordination of Avalanche validators occurs on the P-Chain and it can support thousands of subnets and millions of validators.
As we stated in the AVAX write-up: “Ethereum is running into issues with 500,000 to 1 million daily active users. Meanwhile, a single mobile application sees hundreds of millions of users, such a Twitter or Spotify. What Layer 1 can handle this level of adoption? That is a platinum-level question for investors to answer. To be clear, it could be Ethereum in 2023 if the developers and users prefer to not migrate. However, if the ecosystem runs out of patience and seriously looks for an alternative, then Avalanche is a candidate.”
Warren Buffet famously said: “The stock market is a device for transferring money from the impatient to the patient.” I believe Chainlink could be our best performing asset in our portfolio by 2030 as the middleware that enables smart contract through decentralized oracles.
Smart contracts are a more advanced use of blockchain where an exchange between two parties is automated based on conditional provisions. These self-executing contracts are written into lines of code, and the agreements contained exist across a distributed, decentralized blockchain network.
Smart contracts offer a more complete use for blockchain. First discussed in 1996 by Nick Szabo, some claim that smart contracts are the real use case for blockchain as they aim to automate financial transactions, and in the future, can automate machines.
We have written extensive deep dives and webinars on what the company does but for those who would rather get the elevator pitch, it’s this: Chainlink is the most likely candidate to become the Google of Web3. In fact, ex-Google executives are joining Chainlink as strategic advisor, former CEO Eric Schmidt, new Chainlink Chief Product Officer, Tensorflow’s Kemal El Moujahid.
We are very bullish on Chainlink and it was our first one-hour deep dive webinar for this reason. However, it requires a longer-term mindset, which we certainly have at the I/O Fund. Our goal for our position is sizable gains by 2025 with an exit in 2028-2030.
“Winners keep winning” is a reliable and true statement. We began this analysis by showing you a chart of how the world’s most valuable companies change every 10 years. However, there is an important caveat: tech overtook oil to become the world’s most valuable industry in 2010 and we have yet to see the pattern that tech sets in terms of how often the top 5 will rotate now that tech is in the driver’s seat.
Microsoft:
We were one of the first analysts to cover Microsoft Azure’s hybrid computing strategy and why that could narrow AWS’ lead in the cloud IaaS market. At the time, tech was selling off in Q4 2018 yet we were firm that Microsoft would emerge as a significant leader in this space by specializing in a mix of on-premise and cloud deployments.
Hybrid cloud allows for scenarios where customers can keep their most sensitive data on their own servers while sending workloads to the private or public cloud that gain an advantage from mining data more efficiently and requires improved accuracy and productivity.
Azure’s strength in offering both on-premise and cloud in a hybrid solution has prompted Amazon to chase Microsoft with recent efforts to improve its hybrid strategy. Today, Azure claims more than 95% of the Fortune 500 as customers because of its hybrid flexibility.
Azure growth of 46% is performing quite well given the tough comps it has overcome, and Microsoft’s best financial metric during this tech selloff is that commercial bookings increased 28% this quarter following 32% increase last quarter. I would look for Azure to remain elevated against AWS and Google Cloud for those two reasons – hybrid cloud leader which attracts large enterprises and its ability to reduce costs with its tech stack.
In our latest Q2 webinar, I discussed why reducing cloud costs is a key trend for 2022 and beyond. To put it simply, Sayta Nadella said in this quarter’s earnings call: “More value for less price means you win.” In the same breath, he also said: “Most businesses are not looking to their IT budgets or to digital transformation for budget cuts.” These two statements echo my first point in the Q2 2022 webinar which is that both are true: increase in cloud spending will continue and companies will want to lower costs associated with cloud.
That’s going to be the trick moving forward – which companies assist cloud migrations while lowering costs. Microsoft is the leader here as the company aggregates many cloud services and products under one umbrella which creates substantial leverage to undercut on price.
Microsoft is increasingly becoming a cybersecurity company, as well, with $15 billion in revenue and growing at a rate of 45%. Microsoft was careful to build a multi-cloud product and is the only Big 3 cloud vendor to be multi-cloud on security right now. This also helps to drive down costs for Microsoft’s customers.
There are additional catalysts for Microsoft beyond Azure’s winning streak, its large security footprint, and the ability to lower costs. The first catalyst is that Microsoft is setting up to own the edge through its telecom partnerships. Another catalyst is that when more enterprises adopt AI/ML, whether it’s automation, super computers and/or other use cases for training and inference, it will a natural decision to use Microsoft if they’re already optimized for Azure. As discussed, enterprises will drive forward the next major market in tech (AI/ML) and Tier 1/Fortune 500 will be the largest customers for AI/ML. Power Automate was up 72% year-over-year, surpassing $2 billion in revenue, and this is only the beginning.
Third, the company ranks with Nvidia and Unity for inroads to the Metaverse as it owns many gaming publishers now and is the most widely used VR headset (HoloLens). The company also has Teams to introduce Metaverse-like qualities to business meetings. It will be industrial that drives forward 3D worlds (not consumer) and Microsoft is auspiciously positioned.
We have been meticulously building our portfolio for the next FAANGs of 2030 since we launched the site in 2019 with the understanding that even getting 1 or 2 correct can create generational wealth. Our goal from the beginning has been to stick with our winners and to cut our losers and we have compiled quite a bit of research along the way.
Alphabet is a new addition to our portfolio and one we’ve been circling for some time. If the 2014-2022 era in digital advertising was known as the walled garden era primarily fueled by third-party data then 2022-2030 will be known as the brick walls of first-party data – meaning, publishers controlling their data become the trend that drives forward digital advertising as we move into more AI/ML-driven ads.
In fact, we are in the midst of what is the biggest shift in digital advertising since advertising went digital. The shift is due to Apple and other real estate owners shutting off how data is collected across mobile and desktop. In the mobile era, third-party data was rampant but all of that changed with the release of iOS 15.
Note: We were one of the top authors on this topic with coverage dating back two years before the change occurred on both Forbes and MarketWatch here.
Google will be following in Apple’s footsteps by changing how third-party data is collected on Android and Chrome. This will greatly strengthen the company as not only is Google an equal or greater real estate owner compared to Apple but the company is also a publisher for the purpose of ads with Search and YouTube. This means long-term ads placed on Google will be more effective and produce higher ROI than those with less signals to work with.
These data collection changes are coming just in time for the advantage from first-party data to be realized across AI/ML (with digital ads) and a myriad of other uses cases.
We’ve focused quite a bit on enterprise for the purpose of this article yet we want to acknowledge that consumer-facing tech carries strength in most macro environments.
We hold the following stocks to capture consumer-driven gains. Notably, we’ve covered in the past how supply chains are contributing to consumer spending and inflation. We are watching this closely for when growth in this area rebounds. You can access our research on this here.
Roku: Netflix made it into FAANG and CTV ads will be a bigger market than subscriptions – primarily CTV ads will do well globally. Roku must prove its hardware strategy will pay off in global markets starting with LatAm.
Snap:: This company has had a brutal month – yet audience metrics have been strong post-Covid and the Gen-Z/Millennial concentration is important to take note of.
Shopify: This company is spending an unknown amount on the fulfillment center yet can rival Amazon simply through unlimited distribution channels. Social commerce will eventually take off despite the setback from Apple’s iOS changes.
Twilio The Twilio management team is known to be visionaries and they are pivoting into an API-forward marketing platform with strong PII data – they are early to API-driven automation taking over marketing and advertising.
Conclusion:
Thank you for taking the time to read this report. Despite tech being one of the most volatile sectors in the market, it is also the most rewarding. Had you entered Apple between 2008-2010, it would have blown away all other positions in your portfolio across all other industries. The same goes for a Facebook or a Google position. Half the battle is finding them, which we think we are particularly well suited for, and the other half of the battle is knowing which stocks to sell and which ones to hold when the tide rolls out. We show you how we do this with real-time trade notifications plus a hedge for ample insurance during drawdowns. There are many positions we own today that we will own in 2030 with the goal of perfectly timed exit. We are patient and thorough in our research as we acknowledge and accept that approximately 5 companies will lead to 90% of our wealth in 10 years.
SentinelOne continues to be the strongest cloud stock on the top line. This earnings report did not disappoint on the top line with 109% revenue year-over-year of $78.3 million compared to consensus of $74.64 million. ARR was up 110% year-over-year to $339 million. Customer count with ARR over $100K also outpaced revenue growth at 131% increase. Net retention rate grew to 131% which is above the 130 line.
The company is expecting growth of 109% at the midpoint for next quarter with $8 million coming from the Attivo acquisition. My notes have analysts expecting $84.83 million so if we add the $8 million for $92.83 million, the company is beating those estimates (consensus would have been for 103% growth including Attivo). Organic is expected to be in “the low to mid 90%” range, which reflects a raise from the 85% consensus for Q2.
The company raised full year organic revenue to “the midpoint of 80% range” up from the previous guidance of 80%. The full year guidance was raised to 98% including Attivo for revenue of $405 million. The company stated Attivo would contribute $30 million to full year revenue (although one analyst felt the math was off and has Attivo contributing $35 million). Previously, organic revenue growth was guided at $368 million for FY2022 with analyst consensus slightly higher at $370 million.
To SentinelOne’s credit, the company offers clear communication about margins. It’s one of the few companies where the CEO will discuss this at the onset of the opening remarks.
Per the analysis on compartmentalizing cloud stocks here, we went into the earnings report wanting to see an improvement in operating margin. The company was expected to report (86%) to (84%) Non-GAAP operating margin and provided a beat at (73%). This is up from (127%) last year for an expansion of 54%.
The GAAP operating margin remains an eyesore due to stock-based compensation at (115%) of revenue, up from (165%) in the year-ago quarter.
SentinelOne demonstrated strong improvement in gross margin from 51% in the year-ago quarter to 65% in this quarter. It’s up 2 basis points sequentially and up 15% YoY and is the highest GM for the preceding four quarters.
The one thing that could have weighed on the AH price action was the guide on operating margin for Q2 being (75%) to (73%) – as the critical point here for SentinelOne is that the full year guide management has provided for two quarters is for Non-GAAP op margin for FY2023 to be (60%) to (55%). Even though Q1 was a beat on Non-GAAP margin, the path to delivering on the guidance becomes a bit obscure the longer we remain above this level.
The reason we’ve accepted the weaker (albeit improving) margins is that the company is working towards being FCF positive by 2025 and is not likely to raise cash before this occurs. Any change to this would cause us to look at our thesis again.
The company expects to improve adjusted gross margin to 69%-70% and if we assume similar GAAP percentage as this quarter, it would be about 66% GAAP GM for FY2023.
Singularity Cloud was the company’s fastest growing module, growing over 50% sequentially.
Management focused on the strength of their MITRE Attack results with 100% protection, 100% detection, 100% real-time protection, 99% visibility, 99% analytic coverage. I’m sure we will hear Crowdstrike’s response to this on Thursday 🙂
One analyst asked about the European segment and management stated there is a wholesale movement away from Kaspersky either by choice or by mandate and this is a tailwind for them. Secondly, the Broadcom-VMWare acquisition is favorable for them as they are now capturing CarbonBlack business. In terms of taking business from these two vendors: “We expect that to accelerate in the quarters to come.” I’ll expand more on this when I get the transcript.
“Will SentinelOne be able to provide a meet/beat on operating margin in the upcoming quarter and a meet/beat for the full year guide? This must happen and we also need revenue to remain strong.”
SentinelOne’s operating expenses were front-end weighted last year with Q1 being the steepest operating loss and the year getting progressively better (nearly 100% improvement on weak numbers).
If last year is any guide, then SentinelOne is capable of meeting their full year guidance of (60%) to (55%). The company did beat its operating margin guidance this quarter and revenue was strong including key metrics.
I continue to believe the key to this stock is the ongoing revenue strength and its ability to prove to analysts and institutions that it’ll generate cash by 2025. Due to Crowdstrike being a close comparable, it’s likely SentinelOne can (and must) follow in Crowdstrike's cash efficient footsteps, which is what the market will want to see. The product continues to prove itself as exceptional and there was evidence of this in terms of high ARR customer growth, beat/raise on revenue, strong growth on cloud product, and we are likely to see nice movement in the identity product soon. We are keen on SentinelOne's ability to standardize multiple areas of cybersecurity and to do so at a high MITRE ranking.
Despite the red AH on the stock, I see no notable issues with this ER from my perspective.
MongoDB carries a bit of nostalgia for our team as it was one of the first stocks we covered after launching the premium site in July of 2019. At the time, there were concerns DocumentDB would rival Atlas yet Amazon had declared Atlas the segment winner at the open-source conference OSCON that month.
The company reported revenue of $285 million compared to estimates of $267 million for a $18 million beat. This represents growth of 57% and is the highest growth rate since Q3 2019. Particularly, it proves MongoDB can accelerate post-Covid which is rare among its peers.
The company had a sizable beat on adjusted EPS of $0.20 compared to estimates of ($0.10) EPS, which was a ($0.30) beat. The company’s adjusted operating income was $17.5 million compared to a loss of $2.8 million in the year ago quarter.
On a GAAP basis, the company reported EPS of ($1.14). Notably, GAAP losses increased this quarter to ($75.9) million compared to a GAAP loss of ($61.4) million in the year ago quarter. This is due to stock-based compensation expenses of $91 million with shares increasing from 61 million to 67 million over the past 12 months.
Gross margin expanded from 72% in the year ago period to 75% for gross profit of $214.3 million. The company stated this was due to increased efficiencies in Atlas. The company has $1.8 billion in cash and cash equivalents of which $456 million is cash. The company’s cash flow this quarter was $8.4 million, which is down from $16.8 million sequentially. Operating cash flow was $11.6 million compared to $22.3 million last quarter which management explained is partly because Q4 has more days than Q1 for consumption.
MongoDB is estimating a $30 to $35 million headwind. With that said, MongoDB reiterated guidance for the full year at $1.18 billion which would imply the company had expected to beat by $30 to $35 million. Management is also forecasting a $4 to $5 million headwind for next quarter yet was still able to raise guidance from $277 million expected next quarter to $279 million-$282 million provided as new guidance. The headwind of 1% sequential growth this quarter came from slower-than-expected customer growth in self-serve and mid-market channels in Europe yet could spread to impact all geographies.
The earnings guide for next quarter is for adjusted EPS of ($0.31) to ($0.28).
As we had covered three years ago, the MongoDB story centers around Atlas. This was the fourth quarter of over 80% growth and it now comprises 60% of revenue compared to 51% of revenue in the year-ago quarter.
There were ample questions about why MongoDB was able to weather the weakness in consumer-facing businesses better than Snowflake. The management feels they are more insulated because their consumption is tied to the value and usage of the applications and databases are not something that can be shut on, shut off or moderated by choice.
Here is the exact quote:
So the people are not using their application, something has gone wrong. So the more they use the application, the more value they’re seeing. So there’s a direct correlation between the value they get from the apps running on MongoDB and the value we get from those customers. Other software companies that you mentioned, I think are being forced to consider alternatives to be because there’s a trend where there’s a slight mismatch between price to value because as they suck in more data, it’s not completely clear how much incremental value that data is providing. So we don’t see that problem.
Probably the biggest contrast between Snowflake’s call and MongoDB’s call was that Snowflake noted a slowdown in a few of their biggest customers while MongoDB noted only a slowdown in their self-serve and mid-market. MongoDB also emphasized they are well diversified with six times more customers than Snowflake “tens and tens of thousands of customers” and due to representing more industries.
Conclusion:
We had stated the following:
“As stated above, MongoDB’s cash flow margin is what can keep the stock strong given stock based compensation is weighing on GAAP operating margin. We want a meet/beat on revenue, strong Atlas growth (bonus for acceleration) and we must continue to have a healthy, positive cash flow margin.
Analyst consensus has MongoDB reaching profitability on an adjusted basis by calendar year 2023.”
MongoDB proved they can become profitable on an adjusted basis in calendar year 2022 so that’s a plus. The company maintained its cash flow positive status. There were beats and raises alongside conservative guidance, which was really the ticket this quarter. It was easily the better report over Snowflake primarily because Snowflake has begun to concern analysts that the exposure to consumer could cause the company to become discretionary (more information is needed beyond one quarter). Meanwhile, MongoDB clearly illustrated this quarter its document databases are not discretionary.
