“It’s the Economy, Stupid,” is a famous line about focusing a political campaign on one central focus. It was used by Clinton during a recession when George Bush was out of touch on what Americans were experiencing during 1992.

Management teams over the last 24 hours are saying it’s the economy and it’s out of our control. I used that headline because there is one central focus right now and its probably time to set nuances and other explanations aside.

Today, it was announced that GDP declined for two quarters in a row, which technically puts us in a recession. This happened around the same time that three management teams said ad spend on their platforms was paused (Meta, Snap last week, Roku). Not only did ad spend halt suddenly in Q2 but it has not gotten better one month into the third quarter.

What do Roku, Snap and Shopify have in common? They are ad-tech and e-commerce related but otherwise there’s not much in common product-wise. Snap and Roku have little to no overlap in advertisers or audience being mobile vs CTV ads and Roku has zero effects from Apple’s iOS changes. In fact, one thing that bothers me about Roku’s report is we now know that Snap’s Q3 miss was not due to the Ukraine war or Apple’s IDFA changes. We also know that Shopify’s margins are not worsening due to the fulfillment center or something management did. We also now know that tough Q2 Covid comps are not the issue or else the guidance would have been strong.

The common thread across these management teams is that the economy is greatly affecting them and there’s no way to manage this except to cut headcount and muscle through it. What they are also saying is that a recovery is not on the horizon at this time.

Roku actually had surprising account growth of 1.8 million — higher than Q2 of last year. Snap also grew 18% despite tough audience growth comps. Shopify believes their Merchant growth in the second half will accelerate from the first half. Yet, this is not translating to more revenue, and in all cases, is translating to more losses on the bottom line.

This is because we are in a recession.

There’s no reason to discuss the nuances of the products, the management teams, or too many details if we are in the midst of a fierce, macro headwind that is not letting up. We know macro is challenging but the headlines want to make it about the actual company.

“Tiktok is taking too much market share.” Well, Snap had strong user growth of 18% and this will be the highest across all media by the time the reports come in. In a normal economy, dollars follow eyeballs. “Roku faces too much competition” – well, the company added 1.8 million active accounts in a quarter when juggernaut Netflix was negative roughly 1 million this quarter. Netflix’s guide next quarter is for 1 million, so Roku’s Q2 is two times Netflix’s Q3 guide right now. All around, the evidence is not there it’s a competitive issue.

I’m not going to elaborate on product because it’s in the rear seat right now and the economy is in the driver’s seat.

Here’s the question — will these three companies be the only ones to discuss broad economic headwinds that they’re not able to overcome evidenced by flat to negative revenue growth and worsening margins?

Our analysis on SHOP and ROKU is fairly similar which is that Q2 was a miss on the top line and management in both cases said Q3 is faring worse than Q2 in terms of revenue at this time. In addition to the top line issues, the losses on the bottom line are increasing.

I’ve pulled out quotes about what was said in terms of a potential recovery (it’s not going to be a Q3 rebound and Q4 is in question). It’s easy to fall into black and white thinking (one stock is bad because it’s down right now and another stock is good because it’s up right now), but I think something broader is going on.

The earnings calls over the past 24 hours have been nearly identical in tone and statements:

Here is Meta from Q2 call:

“That said, we seem to have entered an economic downturn that will have a broad impact on the digital advertising business. And it's always hard to predict how deep or how long these cycles will be, but I'd say that the situation seems worse than it did a quarter ago.”but I'd say that the situation seems worse than it did a quarter ago.”

Meta also said this:

“Now of course, the third challenge that we're facing here is the macro economy. And we can't control the timing of when things will bounce back, but I'll note that periods like this are when marketers reevaluate their budgets and are even more focused on finding the highest-performing advertising. And in the last recession, we invested in our ads business through the downturn and came out stronger on the other side, and I'm focused on making sure that we do the same today.”but I'll note that periods like this are when marketers reevaluate their budgets and are even more focused on finding the highest-performing advertising. And in the last recession, we invested in our ads business through the downturn and came out stronger on the other side, and I'm focused on making sure that we do the same today.”

I was encouraged by Big Tech’s earnings but now it’s looking like Google and Microsoft are simply more defensible.

With that said, we are likely to reconsider quite a few of our positions — not because a product is weak or a conviction of ours is gone for good. It’s because management teams across the board are saying that Q3 is worse than Q2 right now and as tech investors we’re not going to ignore that message.

Shopify:

I want to pull out only a few numbers for easy comparison:

This means Shopify’s revenue is essentially flat across a six-month period. There is year-over-year growth, but sequentially, it’s not moving much.

 Here are the operating margins:

The adjusted operating loss for the second quarter of 2022 was $41.8 million, or 3% of revenue, compared with adjusted operating income of $236.8 million or 21% of revenue in the second quarter of 2021.

I was earnestly hoping for a bottom on these margins, but management said the opposite:

“Factoring in these expectations, we expect to generate an adjusted operating loss for the second half of 2022 with Q3 adjusted operating loss, excluding severance costs expected to materially increase over Q2.”we expect to generate an adjusted operating loss for the second half of 2022 with Q3 adjusted operating loss, excluding severance costs expected to materially increase over Q2.”

“As we significantly decelerate operating expense growth into Q4 and with Q4's higher seasonal GMV and revenue, we expect an adjusted operating loss in Q4 that is significantly smaller than in Q3, but larger than in Q2.”, we expect an adjusted operating loss in Q4 that is significantly smaller than in Q3, but larger than in Q2.”

Net margin is a bit of a mess for Shopify because they have investments in Affirm, Global-E and Slivergate. The unrealized losses are at $1.2 billion this quarter and were at $1.5 billion last quarter. However, adjusted net losses were at $38.5 million compared to income of $285 million last quarter. The company missed on EPS with expected adjusted EPS of $0.03 versus ($0.03) EPS reported.

Stock Based Compensation increased from $151 million in H1 2021 to $257 million in H1 2022. The company stated that SBC plus payroll taxes is at $750 million for the full year.

In the call, an analyst asked if the company was planning on exceeding the $1 billion investment that was already discussed in regard to Shopify Fulfillment Network and the CFO said there are no plans to expand that amount at this time.

Comments on the Economy:

“While the macro environment exited tough COVID year-over-year comps in mid-Q2, consumer spend on services and in-person shopping remained high and persistent inflation at 40-year highs dampened online sales globally. In the face of rapidly escalating prices for essential goods and energy, consumers have been favoring discount retailers and reducing their spend on other goods categories.”consumers have been favoring discount retailers and reducing their spend on other goods categories.”

“Consistent with this, we are taking actions to recalibrate our investment spending to build for long-term success. We are keenly aware of what's happening around us. We anticipate that inflation and the continued softness in consumer spending on goods will persist through the remainder of the year. Throughout the organization, our teams are mindful of the macro environment and have been rigorously evaluating and adjusting our spending priorities. And we have taken this time to also make adjustments to ensure we have an efficient, productive and highly motivated team.”We anticipate that inflation and the continued softness in consumer spending on goods will persist through the remainder of the year. Throughout the organization, our teams are mindful of the macro environment and have been rigorously evaluating and adjusting our spending priorities. And we have taken this time to also make adjustments to ensure we have an efficient, productive and highly motivated team.”

“We expect 2022 will be different, more of a transition year in which e-commerce is largely reset to the pre-COVID trend line and is now pressured by persistent high inflation.”more of a transition year in which e-commerce is largely reset to the pre-COVID trend line and is now pressured by persistent high inflation.”

“Our financial outlook for the rest of 2022, which includes the impact of Deliverr and our new compensation system, assumes that higher inflation will persist for the foreseeable future and, combined with rising interest rates, will pressure consumers' wallets for purchases of goods.”assumes that higher inflation will persist for the foreseeable future and, combined with rising interest rates, will pressure consumers' wallets for purchases of goods.”

Note: Microsoft said FX headwinds are expected to ease Jan-June of next year.

Roku: 

Roku’s current quarter came in strong all things considered. The problem is the Q3 guide is a substantial miss of $200 million with management guiding for 3% growth to $700 million compared to $902 million expected.

This is surprising given the company had secured $500 million last year and secured $1 billion in the current upfront season in committed ad spend. What Roku calls the scatter market, or ad spend that can be turned on/off, is what is weighing on the current guide.

The company missed on gross profit for a guide of $395 million and reported gross profit of $355 million.

The company reported operating losses of ($110.5) million and net income losses of ($112) million.

Adjusted EBITDA also went negative to ($12.1) million so that’s weighing on the report. The guide is for ($190) million in net losses and Adjusted EBITDA of ($75) million.

So, not only has Roku firmly been in negative territory on their margins but these losses are increasing for Q3. The player gross margin weighs on this, which we knew would happen and this is not a deterrent as we want the audience growth that has come from keeping player prices low. However, the slowing revenue growth puts pressure on these margins and that’s not something management prepped investors for.

Roku also pulled full year guidance which I can’t recall has happened in the past.

The first analyst had the same question I have – where did this dramatic pullback in ad spend come from?

Cory CarpenterCory Carpenter

Hey, thanks for the question. Hoping you could expand a bit on what you're seeing in the ad market. It sounds like you saw a pretty dramatic, broad based pullback, but any color on when you started to see the market turn or what verticals perhaps were most impacted would be helpful. Thank you.It sounds like you saw a pretty dramatic, broad based pullback, but any color on when you started to see the market turn or what verticals perhaps were most impacted would be helpful. Thank you.

Anthony WoodAnthony Wood

Hey Cory. This is Anthony, I'll take that and then turn it over to Steve to add some more color. So, at a high level, of course we are seeing advertisers worried about a possible recession, and so we're seeing them reduce their spend in places that are easy for them to turn off and turn back on. So for example, the scatter market which is, an important source of ad revenue for Roku is an easy market for advertisers to turn off and turn back on, and so that's one of the big factors we're seeing from the macroeconomic environment and that's impacting the growth rate in the short term.So, at a high level, of course we are seeing advertisers worried about a possible recession, and so we're seeing them reduce their spend in places that are easy for them to turn off and turn back on. So for example, the scatter market which is, an important source of ad revenue for Roku is an easy market for advertisers to turn off and turn back on, and so that's one of the big factors we're seeing from the macroeconomic environment and that's impacting the growth rate in the short term.

Steven LoudenSteven Louden

Yeah. Just adding some color on the advertiser pullback in the scatter market overall. Certainly that was a significant factor in the quarter in progress as the quarter went on, but an advertiser perception survey noted that almost half of advertisers in Q2 made pauses on their ad TV spend on TV streaming, which was similar to the amount that passed on digital video and traditional TV.but an advertiser perception survey noted that almost half of advertisers in Q2 made pauses on their ad TV spend on TV streaming, which was similar to the amount that passed on digital video and traditional TV.

So this is definitely a broad scale, significant pullback that that happened within the quarter itself and one that's pretty similar to other historical times of a degree of uncertainty or advertisers worried about impending economic downturns. For example, at the start of the pandemic, this is very similar to when a lot of advertisers paused or greatly detailed their spend and then once they got a better handle on which way the world was going, they added those budgets back.So this is definitely a broad scale, significant pullback that that happened within the quarter itself and one that's pretty similar to other historical times of a degree of uncertainty or advertisers worried about impending economic downturns. For example, at the start of the pandemic, this is very similar to when a lot of advertisers paused or greatly detailed their spend and then once they got a better handle on which way the world was going, they added those budgets back.

Additional Comments on the Economy:

“In Q2, we saw a significant slowdown in TV advertising spend due to the macroeconomic environment, which is pressuring Roku's platform business growth in the short term.”

“The current economic state is causing TV advertisers to pause and reconsider spend, which is painful in the short term, but it also causes them to seek greater efficiency and ROI, which will benefit Roku in the mid and long term. This reminds us of when advertisers pause spend during the 2008 recession, but it became a catalyst that accelerated the shift of ad spend from print publishing to digital.”The current economic state is causing TV advertisers to pause and reconsider spend, which is painful in the short term, but it also causes them to seek greater efficiency and ROI, which will benefit Roku in the mid and long term. This reminds us of when advertisers pause spend during the 2008 recession, but it became a catalyst that accelerated the shift of ad spend from print publishing to digital.”

“Going forward, we expect reduced consumer discretionary spend to pressure Roku TV and player unit sets.”

“As we look ahead to the third quarter, we are facing an increasingly difficult and uncertain environment. Recessionary fear, inflationary pressures, rising interest rates and ongoing supply chain issues will continue to impact both consumers and advertisers. We believe consumers are going to continue to moderate discretionary spend and the ad scatter market will remain pressure.”We believe consumers are going to continue to moderate discretionary spend and the ad scatter market will remain pressure.”

“Our player margins will continue to be pressured as we insulate consumers from cost increases caused by ongoing headwinds from supply chain disruptions and inflationary pressures.”

“Given the volatility and uncertainty of the current macroeconomic environment, we are withdrawing our previous full year revenue growth outlook for 2022. Our outlook has always been based on our assessments of both our business and the broader macroeconomic environment and at this point we feel that there is too much macro uncertainty for us to provide a full year outlook.”

Here is a quote from Snap’s earnings report where the company said the same as Roku and also why digital ads can often be more forward-looking than other areas that are slower to respond to economic pressures:

“You alluded to this in your question in terms of it making — when it turns — it's easier to turn on. It's definitely easier to turn off. So as companies are reevaluating their priorities and their cost structure, they are looking at things like digital ad spend. It's easy to pause, reevaluate and move forward there. So those same tools and services that make it easy to ramp up, make it easy to ramp down. And we know that our advertising partners are facing significant uncertainty, and we talked about that a few times. So I'll focus on the others.”So as companies are reevaluating their priorities and their cost structure, they are looking at things like digital ad spend. It's easy to pause, reevaluate and move forward there. So those same tools and services that make it easy to ramp up, make it easy to ramp down. And we know that our advertising partners are facing significant uncertainty, and we talked about that a few times. So I'll focus on the others.”

This is a longer quote that has increasing importance in terms of when the slowdown occurred.

“And then beginning — later in Q4 and certainly through the first half of this year, we've seen macroeconomic challenges have built. While there have been lingering supply chain and labor supply issues impacting certain segments that began during the pandemic, more recently, we've seen the impact of persistently high inflation, then rising interest rates and rising geopolitical risks associated with the war in Ukraine. Those macro headwinds have disrupted many of the industry segments that have been most critical to the growing demand for advertising solutions over prior years.

We're seeing these various headwinds put pressure on the earnings of a wide variety of companies, and this is directly impacting the demand for advertising. Specifically, advertising spending, in particular, auction-driven direct response advertising is among the very few line items in a company's cost structure that they can reduce immediately in response to pressure on their top line or their input costs. As a result, as many industries and verticals have come under top line or input cost pressure, advertising spending has been amongst the first areas impacted.”We're seeing these various headwinds put pressure on the earnings of a wide variety of companies, and this is directly impacting the demand for advertising. Specifically, advertising spending, in particular, auction-driven direct response advertising is among the very few line items in a company's cost structure that they can reduce immediately in response to pressure on their top line or their input costs. As a result, as many industries and verticals have come under top line or input cost pressure, advertising spending has been amongst the first areas impacted.”

If you recall, Snap also reported a flat Q3 along with Meta and now Roku – with a specific mention of the slowdown happening in the last 90 days.

Conclusion:

I wanted to connect the dots here because two days ago, it looked like Snap was a turbulent product with a management team that had become hard to rely upon.

If you recall, analysts had slated a Q3 rebound and Q4 rebound for many ad-tech stocks while being wary of Snap’s ability to overcome Apple’s changes. Shopify was similar to ad-tech with consensus of 26% growth for Q3 and 29% growth for Q4. Those estimates have been lowered since this morning.

Some investors will want to make this a Snap problem, a Roku problem, a Shopify problem and a Meta problem (side note: Meta might have a product specific problem ….).

You can see what I’m getting at – how many companies does it take to have slowing growth before it stops being about the company and instead is seen as a problem with the economy? The issue with the current earnings reports is this was not slowing growth; it was halted growth. I very much want this to be an insulated case but there’s at least a 50/50 chance that the abrupt pause in digital ad spend will translate to more companies and industries as we move along.

Note from Knox: If we continue to receive broad confirmation of the developing thesis, expect us to strategically raise cash while in the current bounce. I’ve been providing daily levels and targets, which we will continue to use if we see a larger bear market rally as the most likely outcome over the coming weeks-months.

Positioning changes we are considering:

• Reducing our Roku position to 3% range and we will buy back in when we see evidence of a rebound
• It’s likely we close Twilio before earnings
• It’s likely we close Asana before earnings
• We may close Magnite as it’s tough to foresee this company doing well given the issues across ad spend
• Across cloud, Snowflake has exposure to discretionary spending and we might reduce our position here. We would likely wait for Datadog to come in although SNOW had more exposure last quarter

We will put this money into the companies that show strength given tough macro and we will revisit our thesis on any closed or heavily trimmed positions once the economy bounces back. I’m aware it’s natural to want to make this about a company or a product or “Covid winners,” but we are not in consensus with this.

To complicate matters, the market is forward looking so Knox’s technicals are likely to front run fundamentals on a recovery. This means the market will start buying again before management teams provide strong earnings reports.

We want to be very careful with this decision and will wait for technical triggers to act. If we do get the signal to raise cash, we will buy/re-enter when a renewed uptrend begins, and our hedge signal is flashing all-clear.