Category: Tech Stocks

Roku and The Trade Desk: 2019 Analysis

Posted on by io-fund

99574f65-8ab7-4dc6-a844-cc770be96e4a_Roku-and-TTD-Premium-Analysis.pdf

Roku and The Trade Desk: 2019 Analysis

SECTION 1: Connected TV Advertising 

Connected TV advertising is in my top three favorite tech trends for serious gains in the near term of 2-3 years, and therefore, the opportunity requires a lengthier analysis. CTV ads offer investors a sizable opportunity, which has not been available for over a decade – since the early proliferation of mobile devices. The CTV ad market will take at least until 2021, and perhaps until 2023-2025, until the market is mature and the gains slowdown. 

Roku and The Trade Desk are first movers in connected TV advertising in their respective categories of OTT platform/player (ROKU) and third-party ad network (TTD). 

Roku investors are speculating the Roku Channel can compete with the big 4 for time spent on over-the-top applications: Netflix, Amazon Prime Video, Hulu and YouTube. Investors in The Trade Desk are speculating the third-party ad network can stave off competitors, which are likely to appear in droves over the next two years as the ad-tech space is the most crowded space across the technology sector with little IP to speak of. Those are the risks while the runway for this opportunity is quite long.

1.1 Overview of Connected TV Advertising 

Connected TV advertising is taking market share from mobile for a few reasons that are important to understand.

The first is that brands with the largest ad budgets prefer television advertising as opposed to desktop or mobile.                

I’m referring to companies such as McDonalds, Geico, Budweiser, Pizza Hut, Coca-Cola, Macy’s, BMW, Mercedes, Toyota, Loreal and Nike, for example. Big-budget brands have struggled over the past 10-20 years because mobile and desktop are not as effective for brand messaging yet these mediums have been stealing the eyeballs and are fueled by data. 

Budweiser ads are not plentiful on mobile or social but they continue to pile in the ads for televised sports and pay dearly for Superbowl ads. Beer drinkers are also on mobile but Budweiser can’t measure the impressions because the screen is small, the customer is distracted/on-the-go and these brands need at least 30 seconds for a proper impression. Mobile and desktop are better for companies that want clicks and “purchase intent” rather than brand impressions. 

However, despite the high cost of TV commercials, they do not offer data on the audience who is viewing the ad. The only information Budweiser has to buy an audience on traditional television is the content that is being watched (football). If Budweiser has determined that men between 25 to 45 are the heaviest beer drinkers, with Connected TV ads, they can now target them specifically on television. Perhaps Michelob Ultra wants to target people who are health conscious. They can do this with audience targeting through Connected TV ads rather than wasting money on showing ads to people who are not health conscious (general football audience) or guessing  on what health conscious beer drinkers watch in the evening. They can buy the exact audience “health conscious.” Pizza Hut can buy a college student audience. Geico can buy an audience of income earners in the $40,000 to $70,000 range. State Farm can buy families who own homes. Mercedes can buy audiences who make over $150,000. Macy’s can buy audiences of families who have children for school shopping ads.

These brands can buy audience targeting on television – and this has not previously been the case. 

Connected TV takes the best part of mobile (audience data) and combines it with the best part of television (brand messaging). This is a very important trend for brand dollars that should not be dismissed as “eyeballs migrating to OTT.” The opportunity is much larger than represented by the number of people who are cutting the cord as Connected TV ads are not merely a 1:1 ratio. Rather, these ads represent a higher ratio as the demand (advertisers) consider the medium more valuable. This places Connected TV ads in a league of their own. 

We are in the early days of Connected TV ads and already see a $20 average revenue per user. This is 200% more than social ads, such as Twitter, at $9 ARPU. It took Facebook over a decade to surpass $20 per user while we can trace the relevant emergence of Connected TV ads to late 2017/early 2018.

1.2 CTV Ads by the Numbers     

Mobile’s share of programmatic video will peak in 2020 at 53.9%. By 2021, mobile’s share will dip below the 50% mark due to the rise of CTV ads. To illustrate the growth of CTV, SpotX saw the share of impressions it serves through connected TV increase from 15% in Q1 2018 to 33% in Q1 2019. Innovid also saw CTV ads jump from 13% to 27% and Extreme Reach reported an increase from 15% to 44% over the time span of a year.

To date, CTV ads account for $8.2 billion of the $70 billion spent on global TV advertising in 2018. Data is driving personalized ads with data-driven video increasing 79% in 2018. Customized ads combining localization and personalization can generate over 12,000 unique versions with the largest customized ad having over 200,000 customized versions. This provides an engagement lift of over 78%.

According to CMO.com, an eye-tracking survey revealed that TV commands 2x the active viewing attention compared to YouTube and 15x the active viewing attention of Facebook. Completion rates are also higher on connected TV at 95% compared to 75% on desktop and 72% on mobile. Brands are convinced they should integrate with digital audience data with 28% saying they have already done so, but 68% plan to do so by September 2019.

SECTION 2: The Trade Desk 

 The Trade Desk is a “demand-side” or “buy-side” ad platform which allows advertisers to buy ads in an auctionlike format through real-time bidding. This is an automated method for buying and selling inventory that eliminates the need to call up an agency or salespeople to place the ads. The official term for this is programmatic, and the trend is popular in ad-tech, with over 50 demand-side platforms that transact programmatically. By utilizing machines instead of salespeople, the cost of the ads goes down and both parties (supply/publishers and demand/advertisers) prefer programmatic due to fewer middlemen and higher returns.

Strong drivers for The Trade Desk include omnichannel capabilities, which is the ability to buy ads across many channels, such as mobile, video, audio, display, social and native. The universal ad ID is another important differentiation as it offers an anonymized ID that helps track users, target audiences and provide attribution. This feature is rare for a third-party ad networks and helps The Trade Desk compete with first-party data companies (Google, Facebook, Amazon, Snapchat, Pinterest, etc.) To further compete with first-party data companies, The Trade Desk buys data. This is combined with the brand advertisers’ data on a data management platform for targeting purposes. 

Differentiation in this category is essential for investors in The Trade Desk to track closely. Risks are noted below, with the primary risk being the competitive ad ecosystem, which includes many companies that are able to copy ad-tech features as there is very little IP and/or complexities with these products. There is also little loyalty from advertisers who will quickly switch to the next best-performing programmatic DSP.

2.1 The Trade Desk and Connected TV Ads                

Connected TV ads is one of many revenue segments for The Trade Desk. In the most recent quarter Q1 2019,

The Trade Desk stated CTV spend grew over 300% from a year ago. In previous years, The Trade Desk reported 1000% growth in Connected TV advertising from Q3 2017 to Q3 2018 and 900% growth when adjusting for the period between Q4 2017 and Q3 2018.   

“We've never seen an opportunity like CTV before and I don't think we'll ever see one like it, again … It is the biggest opportunity we've ever seen (and) probably ever will.”  – TradeDesk CEO

2.1B Amazon Partnership

The Trade Desk shares jumped in late July following an announcement that Amazon Publisher Services is partnering with The Trade Desk and Dataxu TouchPoint, which will allow advertisers access to Amazon’s inventory on Amazon’s Fire TV marketplace. Publishers on Amazon’s Fire TV marketplace will also benefit from increased access to advertisers. 

There are a few things to note about this announcement:

•       Amazon will likely open up ads to more demand-side platforms with CTV advertisers. The Trade Desk will be competing with Dataxu and Amazon DSP on Fire TV inventory for now. However, it’s likely there will be more demand-side platforms joining as it’s common for the supply side (content publishers) to work with as many buyers (advertisers) as possible.

•       It’s not clear if The Trade Desk and Dataxu’s demand will be as competitive on CPMs. Amazon has the better in-house data and targeting information.

•       This could be a PR move for Amazon to be proactive on anti-trust while giving up a small amount of revenue (small for Amazon, not small for The Trade Desk) 

Regarding the PR move, the motivation behind the announcement may be that Amazon is being proactive in side-stepping anti-trust issues. The Trade Desk and Dataxu are competitors to Amazon’s own demand-side platform Amazon DSP. By giving away a small piece of the Connected TV pie, Amazon protects itself from regulation. If this is the angle, it’s an incredibly smart move by Amazon and third-party ad networks stand to benefit.  

2.2 The Trade Desk Financials                

The income statement on The Trade Desk is solid for a company of its size. Revenue in Q1 2019 grew 40% to $120M from $85M in the year-ago quarter with positive net income of $10M. Adjusted EBITDA grew from $18M to $24M. Growth YoY has been a consistent 50-60% for over 4 years posting 52% in 2017 from $202M to $308M and 55% in 2018 to $477M.

We already discussed rampant growth in Connected TV advertising, however, The Trade Desk is also strong on mobile at 45% YoY and mobile video at 60%. Customer retention at The Trade Desk is at 95% and has been in this range for 20 quarters, according to the 2018 Financial Results (note: many ad companies claim high retention). Data spend was up 80%, cross-device up 300% and audio up 270%.

However, these numbers come with an outstretched valuation of $12 billion market cap on $500M in annual revenue and $10M in profit. The price-to-earnings ratio is 135 and the price-to-sales is 24, at time of writing. 

The Trade Desk advertises that it has been profitable since 2013. This requires caution for buy-and-hold investors. There is very little R&D to be spent on ad-tech as there is no moat to protect. The ad ecosystem is capital efficient because the technology is not complex enough to require a large team of engineers. In technology, being capital efficient right out of the gate can often spell trouble long-term if the development of the product is easy for competitors to copy.

2.3 The Trade Desk Risks 

Competitors will not knock The Trade Desk out of position this year, however, the future for an ad network in CTV ads, omnichannel programmatic with a data management platform in the stack, and/or with an ad ID will become decisively hard turf to protect. The early profitability reveals the lack of complexity in the ad-tech stack, and this is true for all third-party ad networks. 

The ad industry is highly competitive, and the track record of third-party ad platforms performing well long-term is nearly non-existent following a year or two in the limelight (i.e. Millennial Media, Criteo, etc). This is due to hundreds of competitors globally. 

Demand-side platforms are especially at risk as the supply-side controls the relationship. In this case, The Trade Desk is at the mercy of the supply-side platforms who often work with as many demand-side platforms as possible to get the most demand and the highest ad rates on their content. (It’s called supply and demand for a reason, and the supply will, of course, want to increase demand with no loyalty provided to The Trade Desk).

The Trade Desk states the company is “one of the fastest growing and most profitable software platforms in any sector.” This is false advertising. The Trade Desk is a third-party programmatic ad network and this is a very distinct category from software. This statement is especially troublesome.

The company also claims a disproportionate total addressable market as they include TAM that is shared by Google, Facebook, Amazon, all social apps, and all television advertising ($1 trillion industry). The company states a $33B TAM for programmatic, although this is also shared by dominant digital FAANG companies. 

Conclusion:

CTV ads are a big enough opportunity for The Trade Desk to continue to perform well. The stable revenue segments of mobile video and desktop are diversified with the explosive revenue segment of CTV ads. There is no reason to believe The Trade Desk will miss earnings.  

However, the stock is very expensive and will be penalized due to price in broader market reversals. Please see the technical analysis for buy-and-hold entry/exit scenarios.

Regarding the next 1-3 years: one key differentiator for The Trade Desk is the universal ad ID. If The Trade Desk lost the universal ad ID capability to track users, this would impact the company negatively. On the flip side, Big Tech anti-trust issues or privacy regulations could strengthen The Trade Desk’s market position. The universal ad ID should be watched closely for positive or negative product announcements. 

Monitoring the competitive landscape will be essential for The Trade Desk over the next 1-2 years. I expect competitors to appear in droves with at least 7-10 new viable competitors for CTV ads in the next 24 months. If you are a Research Services subscriber, you will know of these competitors in advance.  

SECTION 3: ROKU

Roku is the only pure-play CTV ad option that owns its own hardware platform and operating system. This is an enviable position that only Google and Amazon claim, although notably, Roku has more hardware players in households than either Google Chromecast or Amazon Fire TV with 40 million U.S. customers using Roku once per month. Roku also has the advantage of knowing OTT better than any other company as the original provider of set-top-boxes. Connected TV ads and OTT hardware is the company’s 100% laser focus. 

Many investors over-estimate original programming and subscription services. According to Nielson, only 20% of time is spent on original programming while 80% of time is spent on catalog content. Meanwhile, Netflix is spending $8 billion per year to produce original programming. Many ad-supported choices have subscription fees, such as Hulu and YouTube TV, which forces consumers to pay for subscriptions while still seeing ads. 

Overall, there is subscription fatigue in the OTT space with individual channels charging $8+ for single channels to $45+ for YouTube TV. These fees add up to more than a cable bill, in some cases. Roku’s growth has come from executing well on a channel that is entirely free and supported by ad dollars – a welcomed business model compared to the competitors. 

Pay TV attrition funnels into Roku’s addressable market. For every dollar AT&T and Comcast lose, Roku is situated to gain. In 2011, pay TV subscribers fell by 8,000 in 2012 and the losses accelerated to 164,000 in 2014. Three years later, the losses grew 20x to 3 million subscribers. By 2023, live-linear OTT video subscriptions will surpass traditional broadcast TV. 

Beyond Connected TV ads, Roku is a hardware player and operating system. In Q1 2019, the company estimated that one-in-three smart TVs sold in the U.S. were Roku TVs. I originally covered Roku’s partnership with smart TVs in early 2018, and why being vendor agnostic would be a boon for future growth. In other words, in the arena where Apple, Amazon and Google compete, Roku is a neutral party. TCL, RCA and Samsung/Tizen chose Roku.  

The global OTT devices and services market is expected to reach $165 billion in 2025 compared to $29 billion in 2015. As stated in the introduction, there is phenomenal growth being reported across CTV ads with triple-digit and even four-digit growth percentages. As a pure play option, the majority of Roku’s revenue comes from capitalizing on this opportunity. 

Notably, Roku has a significant amount of proprietary data for advertisers to leverage. By owning the viewing platform, Roku is able to collect data across OTT apps. 

1.1 Roku’s Global Potential                  

I first covered Roku’s global potential in May of 2018, and we have yet to see Roku’s global expansion. I believe Roku will become a large cap stock with global execution and could reach a $100 billion valuation from the cheap hardware proliferation in global markets combined with the free-supported ad channel and primary driver of platform revenue.  

The low price point for the hardware coupled with the free content should be very desirable in emerging markets. Roku’s OS has 3,000 channels compared to the next competitor with 1,300 channels. This variety will do well for global audiences who have varying tastes in content. Roku also has a free mobile app that can reach the 3 billion smartphones in the world, 80% of which are Android due to the cheap average sales price.  

The bottom line is that Roku has maintained the lead in the United States as the top streaming media player by helping reduce costs for cord-cutters. Their business plan is to keep costs very low for their customers. It’s only a matter of time before they bring this to the billions of people overseas who want to reduce the cost of television.

2.2 Roku’s Financials    

In 2017, as a newly public company offering investors transparency, Roku revealed lackluster revenue growth leading up to its IPO.  In 2015, annual revenue was $319M, and in 2016, the annual revenue was $398M. This is why some investors had a hard time buying the stock when it listed in September 2017. 

The revenue turnaround is easy to understand when compared with the trajectory of CTV ads as analyzed by this report. CTV ads were nascent in 2017 and started gaining traction in 2018. Roku soon began posting revenue growth of $512M in 2017 and $742M in 2018.  

Most recently, Roku reported 79% growth YoY in Q1 2019 on its ad platform revenue with total revenue at $134M.

Roku is not profitable with net income of negative $10M. Adjusted EBITDA is positive $10M. 

In order to lock-in market share, Roku offers its hardware players at low prices, which eats at margins. In Q1, Roku lowered prices of its hardware by 4% YoY. Roku spends heavily on R&D at $55M in the last quarter to help maintain its lead as a top OTT player and ad platform. That’s nearly 40% of revenue spent on R&D. In Q1 2019, Roku had $265 million in cash and short-term investments. 

This quarter, Roku’s outlook calls for 42% year-over-year revenue growth to $223 million at the midpoint. Adjusted EBITDA will be a loss of roughly $7.5 million in Q2 at the midpoint. This is due to product development and a new lease. Keep an eye out for Roku beating on revenue and missing on net income or adjusted EBITDA over the coming year as the company fiercely protects its turf with R&D during this time of golden opportunity in CTV ads.

2.3 Roku’s Risks 

The majority of time spent on OTT is on Netflix, Amazon Prime Video, Hulu and YouTube. These channels comprise 75% of viewer time. In addition, the OTT market is heating up with the entry of Disney as a major player. Although most of these subscription channels do not directly compete with Roku for brand ad budgets (they are subscription channels), they do compete for time spent on Connected TV. Please keep in mind, these are viewing habits for the United States and global markets will change the trajectory of subscription vs ad-supported — with ad-supported being favored. 

On hardware, Google Chromecast and Amazon Fire can reduce prices to lock-in users with little effect on the mega-cap companies’ bottom lines. Roku may need to continue lowering prices on the hardware player to remain competitive. Amazon’s DSP remains Roku’s biggest competitor.

Conclusion:

Investors do not need to choose between The Trade Desk and Roku. Rather, investors need to get these companies at the right price for the highest returns. The Trade Desk has potential over the next two years and requires monitoring for a buy-and-hold strategy beyond this. Roku has potential for the next five years and may have a sudden, upward trajectory with global expansion. 

From a tech analyst perspective, Roku has a better moat than TTD. Amazon and Google have not been able to shake Roku — and there is no evidence that this will occur in the future. 

Roku will likely report strong revenue growth into the foreseeable future. The profitability could spook Wall Street, and there may be surprises in the operating expenses, but subscribers to Research Services should use this to your advantage as you are now well aware of the CTV ad opportunity. 

Connected TV advertising is going through a lucrative and important transition right now that will remain stable during economic downturns due to the free price point and the CPG brands who buy TV ads. I do not believe Roku is expensive relative to its growth potential. However, the technicals show weak internals and there may be better buying opportunities with patience. Please see the technical analysis for more information. 

How   Roku  and     The     Trade Desk  Compare:    

•       The Trade Desk has the same market cap as Roku with nearly 35-50% less revenue. 

•       Notably, TTD has better cash flow and is marginally profitable. 

•       Roku’s Cost of Goods Sold is bloated at 50% or more of revenue, which is a negative. Roku has thin margins on the hardware player revenue as it’s cheaply priced to get people locked into the ad platform. 

•       Roku does spend 2x more on R&D than TradeDesk, which is a positive as they should be investing to maintain their lead. 

•       I favor Roku between the two but CTV ads are a big enough opportunity to add both to your portfolio at the right price and/or to buy calls.

SECTION 3: Technical Analysis       

Provided by Knox Ridley

Section 3.1: The Trade Desk 

The Trade Desk has traded in a relatively uniform bullish channel.  I currently see it finishing 5 waves up from the December low in a larger degree 5 Wave count.  The larger degree 5 wave count has us completing a wave (3), which I believe is playing out now.  Below $226, and we will likely see this Wave (4) retrace fall somewhere into the green box – $174-$108.  This will be our target to ride Wave (5) to new highs and beyond.  If you are not invested in TTD, around $150-$135 will be a good entry.

It should be noted the strength of TTD’s uptrend.  It is currently above its 8-Day EMA and-21 EMA. The Trade Desk, like many stocks in the tech sector right now, are making higher highs with decreasing buying pressure.  This can be seen in the Pink Arrows, and if you’ve been keeping up with my analysis, you’ll recognize I’m using the term negative divergence frequently.  This is when the RSI/MACD is making lower highs while the stock price is making higher highs. This is a sign of weakening buying pressure and an unhealthy uptrend.  It typically leads to a correction, unless new material information is released to justify increasing buying pressure.

Another pattern to note is that TTD formed a classic candle stick pattern known as a 2-day reversal.  This is when a trend is interrupted by a massive spike up on higher than normal volume, and then the next day reversed in full on even higher volume.  This is a signal of exhaustion, and can signal a trend reversal.  

You’ll also notice how the 50-day EMA acted as a major support in the picture above.  If we break this trend, we will likely find our entry in the green box targeted on the chart.  For now, let’s see what TTD gives us.  

•       Most likely scenario: TTD breaks support at $224, and we wait for a bottom to form, followed by a renewed uptrend to enter a long position.

•       Less likely scenario: TTD breaks out to new highs on high volume to $285.  If this happens, we will also initiate a position with wide stops.

•       Notably Beth is bullish on TTD and does not foresee any fundamental issues. Rather she sees Connected TV ads as an opportunistic trend with a long runway. Keep this in mind for earnings.

Section 3.2: Roku             

Since its IPO, Roku has been trading within a well-defined trend channel (in solid blue lines).  It has bounced multiple times from the top of the trend line to the bottom channels, trading within a uniform fashion within this band.  As you can see, Roku is at the top of the trend channel again, and has been bouncing around the ceiling, trying to break through.  It’s worth noting, the more a support/resistance level is tested, the weaker it become – this holds true for the $114 level, which would make a new high, and the $88 support, which is the line in the sand for Roku’s continued advance.  

The upper trend channel has been significant resistance for Roku, marking a short-term top twice before, followed by a decline in price.  Today, we are, once again, testing this trend line with some notable differences:

•       Roku is staying on the trend line for an extended period. It tried to turn down, found support around $88 and is back on the trend channel again. This is a show of strength, which needs to be factored.

•       Negative Divergence: as Roku’s price increases, its RSI is decreasing, signaling a weakening buying pressure (note the pink arrows’ divergences). The same can be seen in the MACD’s peaks – as the price of Roku increases, the MACD is making lower highs. This is a show of internal weakness, which usually precedes a pull back.

•       The Volume is decreasing as the price advances. In a bull trend, we want to see volume expanding along with the price. This is a signal that the buying pressure is thinning out. 

•       The MACD has rolled over from a high point and is pointing down. This is a sign of weakening internals, and usually precedes a pull back.

•       Roku has broken the 21 Day Moving Average and is touching its 50 Day (orange).

•       Notably Beth is bullish on Roku and does not foresee any fundamental issues. Rather she sees Connected TV ads as a very opportunistic trend with a long runway. Keep this in mind for earnings.

One final point, if you look at the chart below, you’ll see an outside reversal pattern (or bear engulfing pattern).  This is when the high and low of the day is at greater highs and greater lows than the day before.  What makes this pattern strong is: (1) the more days it engulfs the stronger (2) the larger the engulfing pattern vs the days prior is a show of strength (3) the engulfing pattern happens on higher than normal volume.  

This pattern engulfs 7 prior trading days on higher than normal volume.  I’d consider it a relatively strong indication of a trend reversal.  

Technical Analysis operates within probabilities.  The weight of evidence supports lower prices for now. Let’s see how it performs around this area. If it breaks through the $88 range, we could easily see it trade between the $60-$45 rather quickly (green box in the graph). On the other hand, if it can break through the long-term uptrend channel with heavy volume, this will be a bullish reversal. 

Conclusion:

(1) With this being one of our highest conviction ideas, we want you to get the best price possible to hold for the long haul. We believe you have a chance to secure Roku in the high $50s to low $60s with patience. For now, we need more information on how the stock trades between the $88-$114 range to improve the odds of the gamble. 

(2) Notably Beth is bullish on Roku and does not foresee any fundamental issues. Rather she sees Connected TV ads as an opportunistic trend with a long runway. Keep this in mind for earnings. Roku’s pullback will likely require a broader market sell-off.  

 

               

               

July 25th – Social App at $17

Posted on by io-fund

The fundamental analysis and technical analysis provided prior to earnings played out nicely this week. Snap crushed on DAU (daily active users), as our data had indicated the company would. For ad companies, DAU plays into higher revenue. The bigger story for Snap this year has not officially launched – Audience Network.

We will keep you updated if anything changes fundamentally. 

Technical Update:

Provided by TA contributor, Knox Ridley:

Snap broke out yesterday.  As you can see in the chart above, Snap was following a steady trend channel (in blue), bouncing between this channel until today. 

Our previous TA noted that Snap’s support was $14 and resistance was $17. Snap retraced, closed just above $14 on Friday/Monday and then sky rocketed above $17 the day following earnings. It not only closed above $17 but did so with high volume.

This is always a bullish sign.  We will likely see it retest the upper trend channel (outlined in the lite blue dotted line, trending up), before testing the $20 resistance level above (in yellow).  As long as Snap stays within this upward trend (outlined by the lower blue line), Snap should continue it’s upward movement. 

Regarding the internals of Snap – notice the top yellow circle.  This is highlighting the current price breaking through the upper Bollinger Band, while the lower Bollinger Band moves down. This is a very bullish indicator, which is supportive of higher prices. 

Further supporting the internal strength, the RSI closed above the descending trend line, showing some new found buying pressure.  As long as Snap holds the 55-50 region on the RSI, we should continue upward. However, keep in mind that broad market forces can raise and sink all ships, regardless of fundamentals.  If the $14 support region is broken due to a weakening broader market, we could see the price fall into the green box on the chart ($12.50-$9.50). 

Per Beth’s analysis, fundamentals are strong. The should be seen as a long term hold that will benefit from Audience Network in the second half of the year. If you’re in, mind your stops if the broader market moves downward. If you have yet to make a position, follow Snap’s retrace to the upper trend channel previously mentioned. That would be a good time to enter. 

SNAP Forum:

Please check out our forum and post there if you traded Snap or have questions on Snap for community discussion. One user posted some great information on the number of funds moving into the stock over the past two quarters. Here’s the post:

Institutions have been moving into SNAP over the last 2 quarters:
Date # funds:

Sep 2018, 177 funds
Dec 2018, 168 funds
Mar 2019, 198 funds
Jun 2019, 321 funds

Google: 2019 Analysis

Posted on by io-fund

f9dc9f4f-29dc-45a7-a961-cd287b452262_Google-2019-Analysis.pdf

Google: 2019 Analysis

INTRO          

Financial analysts and journalists continue to question why Google missed in Q1 2019. Without properly identifying the cause of the revenue miss, which was the slowest sales growth since Q4 2015, it is nearly impossible to predict how Google will perform in the future. Google executives offered very little on the earnings call.

“Alphabet Inc.’s growth is slowing, and analysts don’t have a clue as to why because executives aren’t talking … After releasing disappointing first-quarter results in late April, executives were vague, if not outright unresponsive, about slowing growth.” -Marketwatch, July 19th, 2019

Deciphering exactly why Google missed is impossible to prove, although we believe the quiet contention between Apple and Google on browser ad-tracking may have played a role. The Safari browser captures 58% of overall mobile traffic in the United States with Chrome capturing 33.3%. In the UK, 45% of users use Safari and Mozilla. Therefore, Google’s revenue is susceptible to Apple’s Intelligent Tracking Prevention (ITP), with tighter restrictions going into effect throughout 2019. 

There is also evidence of weakening fundamentals that extend beyond any one change to the way ads are targeted and monetized. We lay out these details below.

SECTION 1: PRODUCT OVERVIEW

1A. Apple’s Intelligent Tracking Prevention (ITP   2.1 and ITP 2.2)    

Launched in 2017, Apple’s Intelligent Tracking Prevention (ITP) places a limit on how long cookies are available for third-party contexts. ITP restricts cross-site tracking for targeted advertising purposes by removing cookies after 24 hours. Login cookies are available for up to 30 days, however, login cookies do little for targeting purposes as they do not track a user’s activity. After 30 days, the login cookie is purged.

When Apple first introduced ITP in 2017, it did not have an effect on Google as users of Google’s search service and other properties visit these sites daily. ITP 2.0 was aimed towards third-party trackers, such as Criteo and Doubleclick. Some critics state ITP strengthened Google as one of few remaining options to target niche audiences at scale. 

Apple continued to battle data collection on the Safari browser in 2018 by shutting down finger printing, a method of triangulating who a user is through fonts, screen dimensions and plugins. 

We’ve seen statistics from publishers where they get half the CPM value as a result of ITP’s impact. If they can’t have good targeting, some of their sites become less worthwhile for their advertisers.” – Google, CES 2019

In March of 2019, Apple announced ITP 2.1, which prevents third-party cookies from being stored as first-party cookies. This update also puts a limit on how long first-party cookies can be stored of up to 7 days. To put this in perspective, a Google Analytics cookie, in theory, would last for up to two years. Safari can now delete it within 7 days.

The final hammer was dropped in May of 2019, when Apple announced ITP 2.2. This update is intended to limit any workarounds by limiting all tracking to 24 hours. This includes Google and Facebook. The result will be weakened attribution, which in turn, lowers CPMs due to weakened ad targeting.

Here’s a description from Digiday that puts into context how ITP 2.2. works:

 “ITP 2.2 cuts the first-party cookie’s lifespan from seven days to one day. As a result, the first-party cookies that Facebook and Google have introduced in order to continue measuring site traffic and attributing ads will be deleted after 24 hours. As a result, if a person clicks on an ad for a product on Friday and decides to take the weekend to think about buying, then the cookie wouldn’t be around on Monday to register when the person returns directly to the site to buy the product.” -DigiDay, May 2019

 ITP 2.2 will have more of an effect on Google and Facebook than the previous ITP releases. This release will prevent Facebook’s pixel and Google’s tag from using unique identifiers to store information. These tracking mechanisms allow Facebook and Google to track a person’s visits long after they have clicked on an initial link, as the first-party cookie had not expired due to their strong first-party relationships (most people use Google and Facebook every 7 days).

 As DigiDay states, Google and Facebook are the companies most affected by ITP 2.2.    

1B. GOOGLE’S CHROME BROWSER     

The privacy changes implemented to the Safari browser and Mozilla’s Firefox puts Google between a rock and a hard place on the privacy terms and conditions for the Chrome browser. Either Google proactively follows Apple and Mozilla, or Google risks Chrome’s reputation. 

 On April 9th, 2019, an insider leak in Adweek stated Google is “contemplating a number of changes to its consumer and advertiser-facing tools.” The translation is that Google may follow ITP 2.0 by disallowing thirdparty ad tracking software across browsing sessions. The market penalized Criteo with a 30% stock pullback, TradeDesk with a 15% pullback, and Alphabet’s stock was penalized with a 5% pullback. 

 “According to sources, certain Google teams want to placate the growing zeitgeist around the protection of consumers’ data privacy, which has grown ever louder since the Cambridge Analytica scandal last year. These internal discussions also follow the implementation of third-party tracking restrictions on Apple’s web browser, Safari, and similar moves from Mozilla’s Firefox and Brave’s offering in recent months. Although the various businesses within Google advocate similar measures, the breadth of the company’s interests (i.e., the dominance of its Chrome browser and ad-tech stack) make its decision-making process more complex.” -Adweek article Google Mulls Third-Party Ad-Targeting Restrictions:

And as part of that, we will have more changes through the course of this year, be it Chrome — Chrome is super committed to making sure it's best-in-class in privacy and security, and we always put user experience first and follow through. -Q1 2019 earnings call

Privacy restrictions have not been implemented for Chrome, however, we are watching this closely.

PRODUCT OVERVIEW CONCLUSION:        

 Google’s revenue is susceptible to stricter browser ad-tracking policies. Due to some iterations occurring in Q1, this may have affected the decrease in revenue that was reported. Regardless, Apple’s ITP 2.2 is specifically aimed at Google and Facebook. 

We know that ITP 2.0 affected third-party ad companies by reducing CPMs by nearly 50%. If targeting is weakened through ITP 2.2, we will see a decline in click-through rates (CTRs) and CPMs as the people seeing the ads are not as likely to engage with the ad due to a lack of tracking/targeting. There is evidence that ITP 2.0 and ITP 2.1 may have already affected CPMs and CTRs (see below). 

 If this is the cause of the minor revenue miss, the situation should surface by Q3 – and most certainly by Q4. 

 Recommended Reading: Fallout from Apple’s ITP is Severe  

SECTION 2: FUNDAMENTALS   

 2A. Q1 EARNINGS 

Google is transitioning into a slower-growth company across most metrics. Earnings per share are expected to grow 4% to $45.46 although analysts are calling for a rebound of 18% EPS to $53.65 per share in 2020[1]. 

Google on April 29 reported earnings that topped expectations, excluding a $1.7 billion European Union fine. However, revenue fell short of estimates. Google’s advertising revenue rose 18% to $30.7 billion, missing estimates of $31.5 billion. This caused Google’s stock to sell off, falling below 1,236.54. 

Analysts have a consensus of $11.49 EPS for the upcoming quarter (source: NASDAQ). Notably, Google beat on earnings but missed on revenue in the last quarter. 

 ·         Google’s 2019 revenue is expected to grow 17.3% to $160.5 billion from 23% sales growth in 2018. 

·         Revenue is projected to slow to 16.7% to $187.3 billion in 2020.

·         Operating margin fell 21% in the December 2018 quarter, down from 26.5% in the first quarter of 2017. 

·         Capital spending rose to 18% of revenue in December 2018 quarter, up from 10% two years earlier. 

Notably, EBIT, EBITDA and FCF were all stronger than expected, but the concerns around slowing growth in the Websites revenue segment is likely to affect stock price in the near-term.

"As expected, Google ad revenue growth has been slowing amid downward pressure on ad prices, especially for revenue coming from international markets," -Monica Peart, senior forecasting director at eMarketer.

 “We appreciate quarterly results can be volatile and acknowledge the company’s long-term focus, but the magnitude of the deceleration on a constant-currency basis marked the largest sequential move down since 3Q12,” -Deutsche Bank’s Lloyd Walmsley.  

 “Overall, we expect GOOGL shares to be under pressure in the near-term given sub-20% revenue growth & downward earnings revisions. As noted above, the exact drivers of GOOGL’s slowing topline are unclear, & we believe frustration around GOOGL’s lack of transparency will only increase.” – JP Morgan

SECTION 2.2: Key Metrics

Aside from regulatory pressure, Google is already seeing some weakness in its core business with ad click volume rising but cost-per-click (CPC) growth trending downward. According to Marin Software and Merkle, CPC has slowed over the past five quarters. 

Source: Marin Software

According to last quarter’s earnings, paid clicks on Google properties grew 39 percent, down from 66 percent in Q4 2018. The cost of the clicks also declined by 19 percent. 

FUNDAMENTAL ANALYSIS CONCLUSION:

From an analyst’s perspective, it is very difficult to say a debt free company with $110 billion in cash that is growing at a rate of around 17% is at high risk over the next 2-3 earnings seasons. There are plenty of ways the product issues noted above could be alleviated. Placing ads in Google Maps could make up for lost revenue from browser changes, with one estimate valuing ads in Google Maps at $9 billion by 2023.

However, we feel that the changes to Apple’s Safari browser and Mozilla’s Firefox will have an effect on both Google and Facebook. Combined with weak technicals, I am placing a Hold on these two stocks with the anticipation they may enter a Sell recommendation over the next two quarters. 

PART TWO: TECHNICAL ANALYSIS    

Time Frame Comparison             

 Currently, Google’s price action is in a weakened state that warrants caution for longs.  Some have likened Google’s current price movements to 2011, which a case could be made.  I believe its price is eerily similar to late 2014, which is highlighted in the yellow circle in the chart.  

That yellow circle shows where we are today vs. where we were in late 2014.  What you’ll notice is that in both time frames, we completed a double top pattern on decreasing volume (where the yellow circle highlights the completion of that pattern).  The initiation move down then took us below the 50 Day Moving Average.  

Also, you’ll notice the similarity of the internals, as outlined in the RSI.  Google, on higher volume, was in a strong uptrend in 2014, which can be seen in the elevated RSI levels in green.  Then, as volume began to decrease, the RSI suddenly drops below 50 and starts to make lower highs, unable to break back above 60.  In fact, at the double top peak in 2014, you’ll notice the RSI dropped below 50 and began the bearish internal pattern in red.  

There is similarity between 2014 and today.  We have the same double top confirmation with light volume, and very similar RSI changes from bullish in green to bearish in red.   

Today, we have broken the 50 line on RSI, attempted to retest it, and broke below it again. 

Further evidence of weakness in Google is found in the pink arrows.  You’ll notice as the price of Google increased, the RSI was making lower highs, which is negative divergence – and usually indicates weakness in buying pressure and signals a drop in the near future.  

And finally, the blue dotted line indicates long term support, which started at the beginning of this cycle uptrend in March of 2009.  This is very strong support, which did not break in 2015 or 2016.  Today, we are comfortably below this support, which, once again, is not a good sign for the near term.

Elliot  Wave Analysis       

According to Elliot Wave Theory, the 5 waves up/3 waves down framework is fractal.  So, this is happening on multi-decade super cycles to minute moves in the market.  In interpreting where we are, the 5-wave impulsive move up started in March 2009 and has completed its Wave 3 (July of 2018), and we are currently in the 4th Wave retrace.  

Google, being a major part of the broad market, mimics the same movements.  Thus, Google is currently in the middle of an A-B-C, Wave 4 retrace, which began in Late 2018 and appears to end in late 2019/early 2020.  I believe we have completed the B wave and are now beginning the C wave down, which has the potential to take us sub $1,000, and in a worst case scenario, as low as the mid $700 region.

Based on my primary count using Elliot Wave as well as the internal structure of Google, I believe a retrace is likely.  What would invalidate this count, which would force me to reassess a new count, would be if Google makes new highs – around $1300. An update will be provided if this occurs.

Scenarios:   

•      If you are long on Google, put a disciplined trailing stop on the stock and re-enter when the technicals and fundamentals agree on a more bullish outlook.

•      If you want to trade conservatively, wait for Google to miss on revenue a second time between Q2-Q4 2019 and enter a short position or long-dated put. Especially watch for the effects of Apple’s ITP 2.2 as if/when effects are reported in Q2 or Q3, they will worsen over the course of the year.  

•      Higher risk scenario would be to purchase OOM puts that ends in March of 2020 prior to earnings.  

•      Any short positions should be closed if Google makes all new highs around the 1300 mark. Shorting stock is all about timing and discipline. We will update as we go along if support or resistance is broken.

 

July 22nd Update: Social App Pivot

Posted on by io-fund

There was a new web analytics report from SimilarWeb released last week that showed an increase of traffic to Snap’s advertising URL, up 23% YoY, compared to Facebook’s URL, up 4%. The comparison is provided to illustrate a common growth metric for ad URL traffic on social ads with the understanding FB receives much higher traffic volume. 

This is positive news. The report also confirmed that the popular filters maintained an increase in daily active user growth, up from 10 million to 11.6 million (peaking around 13 million with the new filters). One concern was if the filters had created an artificial new high, which does not look to be the case.

Due to the increase in app usage from this past quarter, illustrated in the PDF, the probability that Snap will beat earnings is the more likely scenario. If for some reason Snap does not beat earnings, I will still have a buy rating on the stock due to Audience Network. This will be a major breaking out point for the company’s revenue (Audience Network in testing as of April). 

In the article released 7/19, Audience Network is what Goldman is referring to as “Our checks with advertisers also lead us to believe that the company’s continued innovation in its ad-stack, particularly in self-serve, should allow SNAP to substantially improve monetization of user time spent on the platform over time.”

Technical Update:

Snap is currently trading at the $14 support level, and is holding as of today. Per our technical analysis, if Snap closes below $14, we could see it trade within the green box on the original chart ($12.50 – $9.50 range), before taking us up beyond the $20 range.  Listen to your stops, and understand that Snap’s growth story regarding Audience  Network is a matter of when, not if. The increase in app usage should also translate to an increase in quarterly revenue.

Keep in mind, there is high volatility in this stock. With the price retreating down to support levels as we head into earnings, there is likely to be a strong reaction tomorrow after- hours. Snap has jumped as much as 22% after a strong earnings report and dropped as much as 14%.

Regarding stops, we purposefully suggested wider stops to keep you from exiting prematurely, but also to get you out with a minor loss in case a correction occurs.  We may be early to Audience Network compared to the broader market, but that’s by design.

Social App Pivoting – July 2019

Posted on by io-fund

Social App Pivoting – July 2019

SECTION 1: SNAP – Fundamental Analysis   

1A. SNAP’s Bad Streak Coming to an End    

Snap has seen remarkable volatility in its stock price this year, down 80 percent from its peak in March of 2017 at $29 to a low of $5 in December of 2018. The stock is currently trading in the $15 range, at time of writing. 

Previously, in August of 2018, I had a sell recommendation on Snap. I am changing this to a buy

recommendation due to a few key reasons. For one, Snap should report higher than usual user growth, which has become known to the market. Secondly, Snap is extending its monetization methods and this is not widely known to the market. The increase in user growth should be reported in Q2 and the new monetization method should take effect by Q3.  

Background:

Snapchat is one of the best platforms for Millennials and Gen Z audiences. The company reaches between 75% to 90% of people aged 13 to 35. The issue that Snapchat has faced is flat to declining daily active users (DAU) and monthly active users (MAU). Overall, the company does not report enough growth to command a social network multiple. 

Revenue growth and profit margins have been problematic for Snap. The most recent quarter showed an improved gross profit margin of about 36%, however, in the quarters following the IPO, Snap reported negative gross profit. 

The company switched to selling ads programmatically through software algorithms instead of through salespeople – this led to lower ad prices and resulted in lower revenue. Snap also had a redesign that halted Snapchat’s user growth. 

2A. App Sessions Skyrocketing         

Snapchat’s new gender-swapping filter has been extremely popular and this should show up in the earnings results for Q2 2019. Downloads and sessions have surged causing Snapchat to rank #4 overall in China’s App Store, its highest rank there in more than four years. 

According to app intelligence provider, Adam Blacker of Apptopia, Snapchat had its most downloads ever dating back to January 1st, 2015 at 2 million compared to the average daily downloads of 665,000. As Apptopia has noted, retention will need to be proven, with retention likely higher for Snapchat Games than Snapchat filters. 

Regardless of retention, the surge in user activity will be a welcome relief for investors. 

Predictably, this app activity placed Snapchat as the number one downloaded app in the United States for the first time since March of 2017. We will be monitoring this intelligence closely to see if Snapchat places in the top spot for June of 2019, as this would indicate further additional strength in the stock’s key metrics for the upcoming quarter. 

3A. Average Revenue Per User  

Snap’s average revenue per user (ARPU) is on an upward trend. This helped cause the stock rally we saw in the past few quarters. 

4A. Audience Network      

Less widely known to the market is Snap’s plans to monetize its Millennial data across other mobile applications. Snap will no longer be confined to monetizing the 190 million users on the platform, and instead, will use the data to broker ads across various mobile applications. This will have a parabolic effect on the company’s average revenue per user (ARPU).

Audience Network is a software development kit (SDK) that allows advertisers to use Snapchat data to reach audiences outside of Snap on the applications that install the software. The flat daily active users (DAU) growth on Snap will become less important as Snap will effectively broker ads to a scalable audience outside of the native Snap application. Full-screen, vertical video ads will appear across third-party mobile applications. 

Snap has data on a lucrative demographic that few companies have ownership of, as both Facebook and Twitter are out of favor with this age group. Snap’s Audience Network will open up the ability to reach the Millennial and Gen Z audience segments across a much larger total addressable market.  

The product was announced on April 4th, however, the company will now need to sign up application developers and advertisers before the revenue shows up in quarterly results. The formal launch will occur later this year. 

Conclusion: Buy recommendation on Snap with price target of $17-$23  

Catalyst: Audience Network should not be underestimated. Facebook launched an Audience Network in 2014 when the average revenue per user (ARPU) hovered around $12 in the United States. Audience Network was the turning point for Facebook’s ARPU reaching the $26 we see today in the United States region. The market is preparing for renewed user growth from Snap in the current quarter, however, Audience Network is what will cause the stock to climb and is still relatively unknown to the broader market. 

SECTION 2: SNAP –  Technical Analysis       

Technical Analysis provided by Knox Ridley

Background:          

Snap is out of favor with a tarnished sentiment – and for good reason based on a string of bad earnings and questionable management decisions in 2018.  As mentioned in the fundamental analysis, the stock was down 80 percent from its peak in March of 2017 at $29 to a low of $5 in December of 2018.

However, Snap currently is in a quiet and strong uptrend.  We do not think the market will ignore Snap for long, and we believe their next earnings report could be a turning point. Regardless of the upcoming earnings, we want to enter Snap before Audience Network goes live and becomes public knowledge. 

The technicals of Snap are strong, as it just confirmed an inverse Head and Shoulders pattern by breaking the $14.47 neckline, then re-testing that support, and trending upward from there. Holding for 6-18 months will be important to let Audience Network take effect, while keeping a close eye on privacy laws. Because of this time frame, we can get a clear picture of Snap’s price pattern on the daily chart – below.

2B: Technical Overview    

 Using the RSI to measure Snap’s internal strength, Snap is clearly in a bullish position (holding above 65).  However, you’ll notice that the buying pressure is starting to falter.  This is evident in how the RSI is making lower highs while the price of Snap is making higher highs.  This is Negative Divergence, with a sign of weakening buying pressure, and could signal a short term draw down.  As long as Snap does not break below 60 on the RSI, it will remain in a strong bullish position.

Regarding the price pattern of Snap, we can a see a classic Inverse Head and Shoulder pattern, outlined in blue, that was recently confirmed once Snap broke above the neckline around $14.47.  This is a bullish pattern that has played out.  As long as Snap can hold the $14 support, the stock has the potential to trend higher to the $20-$23 range.

If the RSI breaks 50 and then moves below 43, which has recently been a strong ceiling for Snap once it enters a sustained downtrend, we will be looking to our stops to exit our position, or add more depending on the price action.  However, in a market environment like the one we have, where we see a divergence between the upwards price of the broad market and the decelerating data in the economy, using stops is highly suggested.  This will allow you to lower risk while investing in the remaining upside of this bull market.  

2C: Elliot  Wave Analysis       

 With limited price data due to Snap’s IPO in 2017, we’ll use this data as a rough guide to Snap’s general direction.  It appears as though we are finishing an impulsive 5 waves up in a Wave (1) of (5).  This is very bullish for the intermediate to long term for Snap, while being bearish in the short term.  The question remains: how far will the Wave (2) retrace take us?  As long as the broad market cooperates, and based on the current strength of Snap’s price action this year, a large retrace is not anticipated.  The green box indicates the most likely target if Snap cannot break the $17 range.  Above $17, and the Wave (2) retrace will be moved significantly up, making our current entry much safer.  

 Conclusion:

The line in the sand will be $14.  Below $14, and we will likely see the green box come into play. On other hand, above $17 and our next level of pullback will likely be around the $20-$23 range, before taking us higher.  Keep in mind that Snap is a volatile stock, so we will set a wide stop to give it room to breathe; however, we do not want to get caught up in a major market downturn, so our stop will allow us to play the upside, while avoid any severe losses. We recommend a 25-35% trailing stop.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Pinterest Stock: Price-to-Sales Risky

Posted on by io-fund

Despite Pinterest’s stock climbing from its initial public offering last month, analysts are expecting a first-quarter loss of 16 cents a share, adjusted, compared to a 10-cent loss in the year-ago quarter. With that said, analysts are expecting revenue of $197 million, reflecting growth of 50%, however there are discrepancies between the user base that is growing and the user base that is monetizing, which is what is causing the losses.

Last month, I wrote an article on how mobile application companies hide user attrition and how Pinterest and Snap bury important key metrics in 10-Ks and S-1 filings. One thing I stated is that financials in tech companies can be misleading when not accompanied by scrutiny of the underlying business.

The key metrics to watch for when evaluating Pinterest stock include monthly active users (MAU), daily active users (DAU) and average revenue per user (ARPU). I’ll review some information here from my last analysis before I go into why Pinterest is seeing an increase in revenue yet a slight decrease in net income.

Pinterest Stock: Company Struggles to Monetize International Audiences

Thus far, Pinterest has struggled to monetize global users. The difference in average revenue per user (ARPU) in the United States compared to the global users is astonishing – and uncommon for social media. We see the United States users monetize at $9 average revenue per user while the international users monetize at a mere 25 cents per user. This is what the graph looks like:

The user growth in the United States shows saturation in previous quarters with flat to declining growth between Q1 2018 to Q4 2018. This means the areas where there actually is user growth (international) does not contribute to profits as the costs of operations likely exceeds 25 cents per user annually. Facebook’s international ARPU is currently at $7 and has never been below $1.50 as a public company even with the stock struggled in 2012. Twitter has seen below $1 international ARPU as reported in 2017 but was also hovering at 5 price-to-sales during some of this time period compared to Pinterest’s 20 price-to-sales (more on this below).

Meanwhile, Snap which is a more direct comparable as both companies are newer to the public markets, shows nearly 1500% more ARPU in the Rest of World region. Yes, you read that right – 1500% with 9 cents from Pinterest ROW compared to $1.24 ROW.

This helps complete the issues Pinterest faces globally as the user growth is coming regions which result in losses. I believe this may be the culprit as to why Pinterest is expected to post 50% revenue growth yet slightly higher losses from -10 cents per share to -16 cents per share. You’ll see below that the United States has stagnated.

According to data from Apptopia, a provider of app intelligence that partnered with Bloomberg in February, Pinterest downloads in Brazil surpassed United States downloads for the first time on Android. This gives us a glimpse as to where the user growth is coming from; which are regions that create a loss.

The information above means investors are doing one of the two:

  1. Betting the United States will monetize higher than $9 per user
  2. Betting the global audience will monetize higher

My best guess is that number one is likely to occur while number two will present a challenge. The issues here are surmountable and we may see some progress here in the next earnings report; however, I do not believe we will see enough from this quarter’s earnings to justify Pinterest’s stock price due to the flat United States base and the lack of revenue coming from the international base. This leads me to ask how overpriced is Pinterest stock?

Pinterest Stock Trading 30-50% Too High

Pinterest’s IPO stock price was originally $15-$17 and went public at $19. My analysis points to this pricing being correct while the current trading price of $28.50 at time of writing is 30-50% too high due to the constraints of social media valuations.

With total revenue at $775 million in 2018 and a market cap of about $15 billion, Pinterest stock is at a 19.3 price to sales ratio. When adjusted for 50% revenue growth this quarter, Pinterest will have about $100 million more in revenue for the past twelve months, which puts the price to sales at 17.14 – if the price remains the same. If investors run up the price after earnings due to revenue growth, we will be right back where we were with a 19 or 20 price-to-sales ratio. This will be on revenue of about $197 million with 50% growth same-quarter YoY.

Meanwhile, Facebook is at 8.8 price-to-sales with 26% same-quarter YoY revenue growth at $15 billion per quarter, Twitter at 8.8 price-to-sales with 20% same-quarter YoY growth on $787 million quarterly revenue and Snap with 39% same-quarter YoY growth on $320 million quarterly revenue at 10.8 price-to-sales.

Historically, Facebook did trade at a price-to-sales above 15 between 2013 and 2016, however, we see that the time period when Facebook was able to command a price-to-sales above 15 was when the company had crossed 1.2 billion monthly active users and was growing towards 2 billion monthly active users. At that time, the company posted 63% YoY growth with $1.5B to $3.0B in profits. With this user base, Facebook is an outlier. Pinterest’s stock is a better comparable to Twitter and Snap with all three social media companies having users in the 270-325 million monthly active user range, with Pinterest being the smaller user base of all three.

Twitter’s price-to-sales history has also been at a high price-to-sales ratio over 15 when posting over 75% growth (Pinterest is expecting growth at 50%). Even with solid growth, Twitter’s price-to-sales did not last long at the 15-20 range and the price was down nearly 50% within two quarters. The second time Twitter tried to get above 10 price-to-sales in early 2018, the price again corrected the following quarter to below 10 price-to-sales.

Snap has met a similar fate of having a short-lived price-to-sales above 15 before correcting to 10 or below where it has been for the last few quarters. Again, the correction in price-to-sales happened despite Snap reporting 50% YoY quarterly growth.

Takeaway: Do you remember Twitter at $50? Snap at $20? Pinterest at $28-$30 is kinda like that. Social media companies with a 10 or higher price-to-sales ratio have not fared well in the immediate quarters that followed with both Twitter and Snap seeing their value cut in half when reaching the price-to-sales where Pinterest is at today.

The market has created a valuation that will be hard for Pinterest to live up to. Pinterest priced correctly at the IPO as I believe the price should be in the $15-$19 range as this would be in the reasonable 8-10 price to sales range. Even if Pinterest beats expectations and we see a bump up in price, I stand by my analysis that the stock’s price-to-sales is 30%-50% too high – and the valuation will be short-lived.

Update on $ROKU – Will Roku Miss Earnings?

Posted on by io-fund

Will Roku miss earnings? I believe Roku will miss earnings at times, but for the big picture, Roku is at the center of an important trend in advertising and this will make for decent returns now and sizable returns in the future. I also don’t play the earnings game often with stocks as my analysis does not change monthly or quarterly. My conviction on Roku is high and can withstand trade war news or a fledgling quarter, which is normal for smaller companies on the edge of incipient trends.

What Investors Got Wrong With Roku

The first thing Wall Street got wrong with Roku is that investors thought Roku was a hardware player. Although it is clear now that the ad platform is what will drive the profits, this wasn’t evident in the financials for a few earnings reports. My three pieces of analysis in 2018 were the opposite; I made my readers aware the ad platform was where the growth potential was.

The second thing Wall Street gets wrong is assuming Google or Amazon can dominate over-the-top television because they are Big Tech and smaller companies don’t have a chance. Google struggles here and recently raised the prices on YouTube television to $49, which for the most part, negates the purpose of cord-cutting when you add a few subscriptions like Netflix or HBO Go, and end up at the monthly cost of cable. Amazon is pushing into ads for OTT, however, there will be privacy regulations to face as the data powering those ads is being brokered without consent from e-commerce and Prime purchases. You can ask Facebook how that is going for them.

Roku has all of the pieces to the stack. The hardware is a razor-razor blade model that locks in their ad-supported platform. They’re OTT-only, and this prevents privacy issues for the data they collect from the device (this is why Apple is always in the clear with privacy issues – data stay s on the device).

Also Read : Prediction: Here’s Why Roku Will Be The Next Tech Darling

Analyst Expectations Low for Q1 2019

Interestingly, the consensus EPS forecast for Roku is negative $0.24 compared to negative $0.07 same quarter last year with analyst expectations of declining growth. Meanwhile, Roku had posted EPS of $0.05 last quarter. Here’s a screenshot of Roku’s earnings per share vs. consensus:

TradeDesk is also a Connected TV advertising player and reports on May 9th with analysts expecting declining growth from the previous quarter with estimates at $0.07 per share.

With that said, advertising is driving record profits for many companies who have already reported this quarter, such as Facebook and Twitter. This is why I’m surprised (and don’t necessarily agree with) the low analyst expectations for both Roku and TradeDesk as these expectations of -$0.24 for Roku and $0.07 for TradeDesk are some of the lowest in these stocks’ earnings histories (1+ year or more).

Also Read : Roku Q3 Earnings: Choppy But Unshakeable Long-Term

My Opinion “Long on Roku Even if They Miss Q1 Earnings”

That was my headline last May in 2018 even though Roku did not miss Q1 2018 earnings. My stance on this stock remains the same. Roku is a core holding of mine because of the mega trend towards Connected TV advertising. To put it simply, and as I wrote before Q1 2018 earnings were reported, Roku beating or missing earnings is not my focus for a long strategy based on an important trend. I fully expect tech companies to miss earnings from time to time (this creates better buying opportunities). This won’t change my conviction that Connected TV advertising is on an important upward trajectory.

Here’s some more information on the Connected TV market:

“Two of the big trends in digital media aren’t compatible: The drive to enforce viewability standards and the shift to mobile, particularly apps.” – Digiday

Viewability issues are a serious issue for big brands who are averse to mobile in-app advertising because it’s too challenging to track. In addition, many big brands do not need immediate purchases which is called “purchase intent” – which is mobile’s main value over television.

For instance, Coca-cola doesn’t expect you to buy a soda immediately after seeing an ad. Audi doesn’t expect you to buy a car immediately either. So, a lot of the benefits of mobile aren’t worth the downside to these big brands. Advertising budgets shifted to mobile because they had to find audiences, not because it’s a superior method to advertise.

 Here’s how the two compare:

  • Pay TV has high completion rates as viewers are comfortable in their homes and better prepared to receive advertisements.
    undefinedundefined
  • Mobile offers audience data to better target viewers based on individual preferences.
    undefinedundefinedundefined

Connected TV advertising, which is Roku’s specialty, combines the best of both television and mobile. It offers 100% viewability and completion rates with the audience data and dynamic ad insertion found on mobile. Forbes covered this in a recent article which stated Ad Supported OTT is the future reporting OTT ads have a 97% completion rate and 100% viewability.

In a recent study by FreeWheel, 200 billion video starts found OTT ads had ballooned from 2% to 32% in a four-year period due to heavier investments from advertisers.

In the Q2 2018 Video Advertising benchmark study released by Extreme Reach, a tech platform for video ad campaigns, connected TV impressions overtook mobile, accounting for 38 percent of all video ad impressions down from 33 percent in Q1.

Also Read : Roku’s Stock Price: Will There Be Another Pullback?

Here’s a quote from Extreme Reach:

“CTV is clearly on the path to becoming the dominant platform for media consumption, and premium inventory is the most sure-fire audience draw.”

– Mary Vestewig, Senior Director, Video Account Management at Extreme Reach.

AppNexus, the world’s leading independent advertising technology company, announced in July of 2018 that advertiser spend in its connected TV marketplace grew 748% year-over-year versus the second quarter of 2017 and 68% quarter-over-quarter. AppNexus currently sees 20 billion monthly connected TV impressions per month.

From an investment standpoint, the implications of attracting more advertising dollars than mobile is enormous. Big brand budgets have been looking for a solution to traditional television that isn’t confined to the attention span and limited screen size of mobile viewers. With Roku, that option is finally here.

Please note: I’ve also covered TradeDesk, another stock doing well by capturing the Connected TV advertising trend. You can read that analysis here on FATrader and why the risks with TradeDesk have personally kept me from buying the stock although many of my readers have seen 400% returns on $TTD.

This analysis is not an earnings call. The purpose of this article is to revisit a few trends and predictions I made around this time last year in regards to Roku.

Facebook Stock: Too Good to Be True

Posted on by io-fund

Facebook has financial statements that Wall Street dreams are made of. Profit margins are at 40 percent, free cash flow outperforms due to low capex, and annual growth exceeds 20 percent year-over-year. In fact, FB posted 35 percent growth this past year with lots of runway to go. Meanwhile many of its FAANG peers struggle with high capex (Netflix) and diminishing growth (Apple).

To put it simply, Facebook’s cash flow and profit margins are not only some of the best in the S&P 500, but the best in the world. The ad dollar machine has incredible inertia and advertisers simply can’t turn away.  If you are looking at the income statements, then you have every reason to go all-in on this company.

The more insidious issue at hand is that Facebook is posting meteoric growth of 35% year-over-year in the middle of a tech slump, yet the stock price does not reflect the growth. The current earnings should have caused a rally, instead Facebook is at a PE ratio of 19 while posting better growth than Netflix with a PE ratio of 150, Google at 24 and Microsoft at 23.

In fact, Facebook is growing faster than 95% of the S&P 500 with margins higher than 90% of the S&P, but Facebook stock is hovering at post-Cambridge Analytics levels. If financials and free cash flow “never lie,” then this stock should be at $240 right now (well past the stock price it was when posting $40 billion annual revenue)

In April, I published “Facebook’s Challenges are Much Bigger than Cambridge Analytica.” You’d have to go back in a time machine to remember all of the stock investors insisting Cambridge Analytica was “priced into the stock” and Facebook would be the bull story everyone was betting on. Before the Q2 Facebook stock plunge, I insisted that the GDPR was a much bigger deal than investors realized and I broke down the various ways Facebook illegally (in the EU) takes data from users and non-users outside of Facebook. (Jeffrey Gundlach, the Bond God, may have stated the stock would be hurt by regulations, but he most certainly couldn’t explain why revenue would be affected or why investors should care. Likewise, Citron said Facebook was a long-term short, but has now reversed their recommendation to a buy with a fairly sensational report about Facebook being evil, which drove the price down making it a great opportunity – again, not explaining much in the way of the business model).

The goal of this article is to break down the risk of Facebook stock for any investor who wants to know. I realize a large majority of Facebook investors may not want to know, because, well, numbers don’t lie.

First-party data vs. Third-party data

Data extraction that is done inside the apps of FB, Instagram and Whatsapp is fair use and legal. You’ve given consent to use these apps, and how they use your data, within reason, is within the realm of a first-party relationship. This is very similar to how you engage with every company who you provide information to.

For the rest of this article, we are placing those applications aside. They are not at risk. What is at risk is that Facebook collects data from millions of applications and websites it does not own. This is called third-party data because you are not a party to the customer relationship in order to collect the data. As of May 25th, the European Union made this illegal in those geos.

Take a look at your smartphone right now. Facebook is collecting data from your applications through software called Audience Network. If you have 25 apps on your phone, Facebook’s software is tracking you inside 12 of those applications, for example. (Again, we are not talking about Facebook-owned apps – these are not apps owned by Facebook).

The GDPR is concerned with tracking that occurs outside of a first-party relationship, and Facebook’s revenue will be affected when third-party data collection is cut off.

Don’t believe me? You don’t have to. Facebook has stated they expect single digit losses and they list the GDPR and data regulation as a risk in their SEC filings. The window of opportunity here, if you like to bet against Facebook (like I did and will again), is that Facebook investors are walking towards a mirage of uninterrupted returns. They, again, think Facebook’s problems are in the rear view, and that these privacy issues are within Facebook’s domain, such as FB, Instagram and Whatsapp. Perhaps more concerning, is that investors don’t have a means of determining how third-party sites (that Facebook does not own) contributes to the $55 billion in revenue.

Germany is Hot on the Trail

Despite all of the investigations on privacy this past year, regulators and the press struggle to organize the issues into one clear thesis. Are we worried that Facebook is leaking data to profiling agencies like Cambridge Analytica? Is Facebook politically motivated and censoring posts or is this a free platform for people to express their ideas? Or what about the pixel we keep hearing about? Or that Facebook should censor what teenagers post? What was that thing about George Soros and Sheryl Sandberg? It’s a complete mess.

The FTC is unlikely to understand how a software development kit (SDK) works and what kind of device signals SDKs can extract, and why that threatens privacy[1]. The FTC is still reacting to fairly insignificant data leaks and the accusations of political brainwashing (this is what the FTC is likely to fine Facebook for). It clouds the actual practices that lie beneath, and it’s unintelligible as to why Facebook investors should care about any of this.

Not to fault the FTC. Since I wrote my article in April, hundreds of journalists have covered Facebook’s privacy issues, and not one reporter has clearly described how Facebook’s software extracts data across billions of users the company doesn’t have a relationship with, and why this is illegal in the EU as of May 25th, 2018.

My newsletter subscribers get this information first. Sign up here.My newsletter subscribers get this information first. Sign up here.here.

Germany, however, is hot on Facebook’s trail. Last month, I read an article that spelled out exactly how and why Facebook’s business models are at risk. If you’re an investor in Facebook, you’ll want to read it and follow what Germany is doing. As the article pointed out, Facebook is collecting data off-site from millions of applications and websites it doesn’t own, and Germany most certainly doesn’t want its citizens tracked by a company in the United States with this software.

Therefore, the approaching FTC fine for political issues or fake news is a red herring. The important regulations to watch are from the European Union as their concerns will have the greatest impact on Facebook’s revenue, which I believe is unsustainable in the current regulatory environment.

What is Audience Network and the Pixel Worth?

Hopefully, Facebook bulls have stopped reading the article by this point as they definitely will not want to hear the specifics on how much revenue is generated from the third-party data that Facebook doesn’t have consent to collect. (If bulls are still reading this article, I am sure to hear about it in the comments).

A few stats:

  • Facebook’s “third-party website and application” revenue is not in their SEC filing. Google clearly discloses this and the company makes $17 billion per year off third-party sites. (I think the fact FB didn’t break out this line item is a bit misleading, but that’s up to the SEC and anyone who experienced losses from Facebook stock to determine).
  • The official statistic I have in my research is that Facebook’s software is in approximately 40% of the mobile applications on the market. That exceeds Google’s third-party reach on mobile and would be about 2 million iOS and Android apps. If you look collectively at these 2 million applications, all of the 3-4 billion smartphones in the world today will have at least 1 of these 2 million applications installed.
  • Facebook Audience Network directly monetizes over 2 billion users (off-Facebook and off-Instagram) yet collects data on approximately 3-4 billion users. The value of this exceeds the value of Instagram (which has 1 billion users).
  • The data from the software informs the entire ad machine for higher average revenue per user. (Lookalike modeling is somewhat complicated but that’s the easiest way I can describe it within this article). I wrote about lookalike modeling a few years back. You can read about it here.
  • In 2016, Facebook executives warned of ad load issues. This means that the Facebook properties of FB and IG can only handle so many ads as there is finite inventory. The majority of the revenue made past this date would have relied on the Audience Network 2 million app-reach.

I put the value of Audience Network and third-party data at $20 billion in annual revenue. This is conservative considering Google makes $17 billion and when comparing apples to apples, mobile is worth much more than desktop (mobile can extract location, text/SMS and app activity across the device). You could probably add about $5 billion in brand reputation issues, as well, if/when third-party revenue is cut off. In addition, Facebook has added about $35 billion in revenue since the warning of ad load issues [2] in 2016, and at the time, Audience Network was stating massive user growth of over 1 billion users. Assuming half of this came from the new software with a reach 3-4 billion people is, again, conservative.

Is Facebook still a great stock at $30 billion annual revenue? Yes, in fact, I think it’s priced pretty close for a company with those financials. The adjusted expectations of the market could cause a shock for a year or two, but in the long-run, a $30 billion in annual revenue with low capex is still a solid business.

Takeaway: If you’re one of my readers who is invested in Facebook, keep a close eye on the EU and don’t get a false sense of confidence if the FTC clouds the press with fines for fake news or political ads while Germany and the EU pursues the software that collects third-party data.

The timing of this is probably 2020-2021, maybe even 2022 for all of the third-party data collection to be regulated. My prediction is that 2019 will be the year the European Union cuts off the third-party software and the United States may catch up during the election year or shortly thereafter. I’m watching the EU closely for a put option now. If they go forward, I’ll enter a short position again (as I did when the GDPR went into effect end of May 2018 and was rewarded for that courage).

[1] For reference purposes, an SDK has the capability to track every activity performed on the smartphone across ten device signals and sensors. They track everything you click, say or text inside the apps, and they can track your location whether you are inside the application with the SDK or not.

[2] Ad loads refer to the limited amount of ads social media feeds can show. For instance, one social media user may see a ratio of one ad per seven posts, which restricts the number of ads Facebook can serve within its own properties of Facebook and Instagram, creating finite limitations.

Prediction: Here’s Why Roku Will Be The Next Tech Darling

Posted on by io-fund

Roku’s earnings report for Q3 is scheduled on a potentially volatile trading day depending on how the broader markets react to the mid-term elections. The uncertainty around this outcome, along with rising rates, geopolitical trade uncertainty, and a host of companies tempering their Q4 outlook has caused a style rotation, which has pummeled tech stocks. Regardless, Roku is a mid-cap growth stock in the tech sector that will continually prove itself against headwinds as the company is poised to become one of the most opportunistic growth stories in the market by 2023.

The reason for this is simple: connected TV advertising combines the high engagement of traditional television with the audience targeting capabilities of mobile. These previously two competing forces will combine to create the next advertising phenom, and Roku will emerge as the tech darling of this ever-important shift in ad dollars.

Pay TV Attrition is a Blood Bath

Pay TV has had better decades. The peak for Pay TV user growth in the United States occurred in 2011 when it began an inevitable erosion due to bloated, costly monthly packages, a lack of flexibility for on-demand, and advertising-stuffed programming choices. The following year, pay TV subscribers fell by 8,000 in 2012, which accelerated to 164,000 subscriber losses in 2014. Three years later, those losses grew 20x to a staggering 3 million subscribers (source: Leichtman). And by 2023, live-linear OTT video subscriptions will surpass traditional broadcast TV[1].

Cord-cutters have driven a formidable marketplace. In fact, the global OTT devices and services market will reach $165 billion in 2025 compared to $29 billion in 2015[2].

Also Read : Update on $ROKU – Will Roku Miss Earnings?

“All TV is now OTT” –ABI Research

Roku offers the most synonymous OTT business model with cable and satellite TV providers and can capitalize long-term on this massive subscriber loss by leveraging its advertising, audience development and content distribution services, which make up 89% of gross margins from the platform. As of Q2 2018, if Roku were a traditional cable TV company, the 22 million active subscriber base would rival Comcast as second largest distributor of content in the United States. Only AT&T has more with 47 million DirecTV subscribers. Compare this to Charter Communications, which has a $65 billion market cap and only 16 million users or Comcast with a $171 billion market cap with the aforementioned 22 million subscribers. Roku’s market cap is at $6 billion with shares priced at $56 with the same number of users as Comcast.

The Next Phenom in Tech is Connected TV Advertising

I’ve covered Roku extensively in previous analysis including strengths on how the company is vendor agnostic, player vs platform revenue and the company’s global potential. Connected TV advertising, however, is by far the most important piece for Roku’s trajectory.

Bear with me here as I talk about some of the problems and technicalities in the advertising industry, and why Roku is well positioned.

As Digiday puts it, “Two of the big trends in digital media aren’t compatible: The drive to enforce viewability standards and the shift to mobile, particularly apps.”

Viewability issues are a serious issue for big brands who are averse to mobile in-app advertising because it’s too challenging to track. In addition, many big brands do not need immediate purchases which is called “purchase intent” – which is mobile’s main value over television.

For instance, Coca-cola doesn’t expect you to buy a soda immediately after seeing an ad. Audi doesn’t expect you to buy a car immediately either. So, a lot of the benefits of mobile aren’t worth the downside to these big brands. Advertising budgets shifted to mobile because they had to find audiences, not because it’s a superior method to advertise.

Also Read : Roku Q3 Earnings: Choppy But Unshakeable Long-Term

Here’s how the two compare:

  • Pay TV has high completion rates as viewers are comfortable in their homes and better prepared to receive advertisements.
    undefinedundefined
  • Mobile offers audience data to better target viewers based on individual preferences.
    undefinedundefinedundefined

Connected TV advertising, which is Roku’s specialty, combines the best of both television and mobile. It offers 100% viewability and completion rates with the audience data and dynamic ad insertion found on mobile. Forbes covered this in a recent article which stated Ad Supported OTT is the future reporting OTT ads have a 97% completion rate and 100% viewability.

In a recent study by FreeWheel, 200 billion video starts found OTT ads had ballooned from 2% to 32% in a four-year period due to heavier investments from advertisers.

In the Q2 2018 Video Advertising benchmark study released by Extreme Reach, a tech platform for video ad campaigns, connected TV impressions overtook mobile, accounting for 38 percent of all video ad impressions down from 33 percent in Q1.

Here’s a quote from Extreme Reach:

“CTV is clearly on the path to becoming the dominant platform for media consumption, and premium inventory is the most sure-fire audience draw.”

– Mary Vestewig, Senior Director, Video Account Management at Extreme Reach.

AppNexus, the world’s leading independent advertising technology company, announced in July of 2018 that advertiser spend in its connected TV marketplace grew 748% year-over-year versus the second quarter of 2017 and 68% quarter-over-quarter. AppNexus currently sees 20 billion monthly connected TV impressions per month.

From an investment standpoint, the implications of attracting more advertising dollars than mobile is enormous. Big brand budgets have been looking for a solution to traditional television that isn’t confined to the attention span and limited screen size of mobile viewers. With Roku, that option is finally here.

Also Read : Roku’s Stock Price: Will There Be Another Pullback?

Subscriptions are Saturated

Subscription video-on-demand (SVOD) comprises 40 percent of the OTT market with the majority of the revenue coming from the United States. By 2022, SVOD penetration will be 132% of US TV households with many homes having more than one SVOD platform[1].

Total SVOD is expected to reach 171 million by 2022 – up from 59 million in 2016 reflecting a 53% increase.

Previously, viewing data and ratings on SVOD (subscription video on demand) such as Netflix (NFLX), Hulu Plus, and Amazon Prime and other OTT content was not disclosed even by Nielsen (NLSN). However, in a recent interview, Nielsen COO Steve Hasker revealed four previously undisclosed statistics about SVOD such as 89.5% of SVOD content is primarily viewed on the television glass whereas 11.5% is viewed on smartphones and tablets.

Of this time, 80% is spent on catalog programming whereas 20% is spent on original content. For definition purposes, Netflix is original content and something Roku or Amazon Prime offers is considered catalog programming.

Meanwhile, as competition increases, the costs for original programming are escalating with Netflix spending $8 billion in 2018 in order to remain competitive for a small piece of the pie (20% of how time is spent).

Roku has held firm on not creating original programming and the statistics support this. The costs for original programming are likely to escalate as HBO, Showtime, Apple, and now Disney developing its own channel for 2019, will continue to compete for this space.

In addition, subscribers pay for quite a few premium $8+ subscription channels, which will eventually lead to subscription fatigue – not to mention mitigate the reason cord-cutters leave pay TV services – which is to lower costs. For a subscriber with YouTube TV ($40) and three premium channels ($24-26), they are paying $65+ per month. This pricing will meet resistance by cord cutters and ad-supported OTT will continue to be a solid choice for viewers.

Conclusion:

Roku is executing on a market trend that will defy typical growth trajectories. Brand budgets are migrating towards Connected TV as a superior method of advertising over mobile. The Roku Channel launched in October 2017 and is already a top 5 channel by active account research. Investors should keep a close eye on platform revenue, which was up 96% YoY to $90.3 million in Q2. The trailing 12-month ARPU in Q2 increased 48% YoY to $16.60 and was “driven by strong growth in video advertising as we continue to capture more share of TV ad budgets,” as the company stated in their shareholder letter.  Due to connected TV advertising trajectories, I am long on Roku for the next 3-5 years.

Click here for more information on why Roku stock will reach $100 in the next two years.

All analysis contained herein should be appropriately credited to Beth Kindig.

Can Programmatic Ads Save Spotify?

Posted on by io-fund

Summary: According to Q3 earnings calls, Spotify may seek to broker user data in order to keep average revenue per user afloat. Known as programmatic advertising, this method of monetizing data to supplement music revenue may be Spotify’s only hope to stave off competitors who nip at the heels of the music-streaming app

Portions of this article were originally published September 27th, 2018 under 8 Reasons Spotify will be a Sell Recommendation by 2019 at $184 per share. This analysis has been updated to include the recent partnership with Google and programmatic offering Ad Studio.Spotify will be a Sell Recommendation by 2019 at $184 per share. This analysis has been updated to include the recent partnership with Google and programmatic offering Ad Studio.

Half Full or Half Empty? -6% ARPU in Q3 Compared to -12% ARPU in Q2

Spotify Technology met its Q3 forecast for paying subscribers and a few other metrics, but average revenue per user declined due to promotional accounts for families and students. Spotify ended the period with 87 million Premium subscribers worldwide, up 40% year-over-year. Spotify has 109 million monthly active users of its advertising-supported streaming service, up 8 million from Q2 or 20% YoY.

This quarter, Spotify’s average revenue per user percentage has improved but QoQ growth is still in the red. Average revenue per user declined to $5.50 in Q3 from $5.83 in Q2, or -6% following -12% the previous quarter.

Costly Partnership with Google

Spotify lacks the razor-razor blade Gillette analogy for tech companies, which in this case states you should have ownership of a device if you want to bank on the subscriptions. This is one reason I’ve been long on Roku since its IPO. Roku players are the cheap razors that will deliver the razor blades of ad-supported content in the OTT market. (You can read my analysis on Roku here). However, this lack of device ownership is causing trouble for Spotify. Smartphones dominated by Apple and Google are only part of the story. At home assistants such as Alexa are being designed and leveraged specifically for AI activated music services. To get a glimpse of Spotify’s future, consider that major record labels let Amazon offer a reduced Alexa version of the premium service at $3.99 per month and Apple is requiring users to sign in to Apple Music to power the HomePod – which completely shuts out devout Spotify users.

Spotify’s new strategy is to partner with Google to offer free Google Home Mini speakers to users who subscribe to the Family plan as part of a holiday season promotion. The partnership comes at a cost of approximately 50 basis points to the Gross Margin profile in Q4, the company noted. From Google’s standpoint, they get their entry level smart speaker into more homes, while Spotify benefits by having a partner for smart home infrastructure. Ultimately, this is one example of the lengths Spotify will have to go to in order to compete with Apple and Amazon on their home turf.

My newsletter subscribers get this information first. Sign up here.My newsletter subscribers get this information first. Sign up here.here.

Apple has Homefield Advantage

Most certainly, Apple won’t be beat in its own ecosystem. Apple revolutionized digital music with the iPod and iTunes. With smartphone penetration, the Beats acquisition, its Homepod ecosystem and a huge push into connected car infotainment, Apple can surround Spotify in nearly every direction. Keep in mind, that 66% of the world’s paying app users are iPhone users who trend towards higher incomes (vs. only 34% on Android), so Apple users are supremely important for Spotify’s $9.99 subscriptions.

In fact, the turf war has already receded Spotify’s market share. Record industry sources state Apple is adding paying subscribers at a rate of 5 percent in the U.S. versus 2 percent for Spotify, and that Apple Music may have already taken over Spotify as the number one streaming service in the United States.

In addition, Apple was cleared to complete the acquisition for UK-based music recognition app Shazam Entertainment for $400 million. Due to the threat this poses to Spotify and other smaller apps, regulators in seven countries contested the acquisition when Apple’s plans were first announced. Despite these efforts, the acquisition was approved in August of 2018. To date, Shazam has had well over 1 billion downloads, last reported in 2016, and owns a wealth of information on what music is trending with over 20 million searches per day.

Can Programmatic Ads Save Spotify?

Tim Cook is a chief critic on how applications and websites use private data to increase the accuracy of targeted advertising. Therefore, one area Apple clearly won’t compete is in the brokering of programmatic ads based on users’ music choices. Meanwhile, Spotify has every intention of letting advertisers target its users through Ad Studio.

Spotify would not be the first mobile application to supplement its core product with a programmatic offering. Facebook and Twitter owe at least 1/6thto 1/4thof their current revenue to programmatic proving it can substantially increase average revenue per user. Therefore, if Ad Studio is executed correctly, it may have the potential to limit stock losses even with stiff competition from Apple and Amazon.

Here’s a statement from Spotify’s press release:

“Last quarter we said that we expected our Programmatic and self-serve products to become a significant portion of our Ad-Supported revenue. If we’re successful in achieving this shift in revenue mix, then we also expect to achieve significant operating leverage in the ad sales business, increasing our operating margins. Last quarter we reported on our new automated self-serve platform, Ad Studio, which is live in the US, UK, Canada, and Australia. Ad Studio revenues are still quite small, but we’re seeing exponential growth, so expect to hear more about this product in future quarterly updates.”

Note About Tencent Music IPO:

Spotify owns Tencent Music Entertainment (TME) shares and it’s been stated in past financial reports that “a TME IPO would trigger a fair market value adjustment to the carrying value of our investment recognized in other comprehensive income. The gain could be significant.”  This one-time, non-recurring event would generate a Net income for Spotify with a Net loss returning in the following quarters. Spotify stock holders should be aware that this one-time wave may be worthwhile to hold on for, but that the long-term prospects of the company are still not proven.

Conclusion

Spotify is a small fish in deep waters. Q3 earnings prove music streaming is a tough business. The company is attempting to partner with device owners, like Google, but these partnerships will eat away at Gross Margins in future quarterly earnings. I’m forecasting that Spotify will be in sell status through 2019 unless they can prove themselves with a strong programmatic offering through Ad Studio. Note the Tencent Music IPO will generate a net income for Spotify in the current quarter.

You can access more analysis on Spotify here.

This article and previous Spotify analysis written by Beth Kindig has been published on Seeking Alpha. All original analysis contained herein should be appropriately credited to Beth Kindig.