Category: Stock Analysis PDFs

Twilio: 2019 Analysis

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Twilio: 2019 Analysis

Twilio

Twilio’s most recent earnings report saw a severe 17% drawdown due to lower-than expected guidance. The company guided for $0.01 to $0.02 EPS versus analysts expecting $0.07 per share. Meanwhile, the company beat on earnings at 3 cents per share compared to an expected 1 cent per share, according to Refinitiv. Revenue came in at $295.1 million compared to $287.8 million expected by analysts. 

The company missed estimates for the net-dollar retention rate, which came in at 132% compared to 138% expected. This was an oversight by analysts, as the 132% is quite healthy for a company of Twilio’s size. The median net-dollar retention rate for cloud software is at 104%. Twilio cites the miss as running up against the law of large numbers, which is a fair assessment.

Although I do not foresee rapid, hockey stick growth in Twilio’s future due to mobile maturation, there are some fundamental strengths to Twilio that the market will likely respond positively to. 

For instance, Twilio’s revenue is growing at 75% year-over-year, the company has crossed a $1 billion run rate, and the company has positive EPS with a consensus expectation of 92% EPS growth next year. Current fiscal EPS is $0.13 EPS for the year ending December 2019 and consensus is annual EPS of $0.26 EPS ending December 2020. 

Current fiscal revenue is expected in the $1.16 billion range with fiscal 2020 revenue in the $1.46 range for 31.45% growth.

PRODUCT

Twilio enables communications for mobile applications, such as voice or text. When you text or make a call inside of a mobile application, you are likely using Twilio’s APIs. The company works with over 1,000 mobile carriers in over 150 countries for voice and text/SMS services. 

A few examples:

•       Customer service calls on Zendesk are made through Twilio

•       Powers Facebook’s Whatsapp for availability inside of other apps

•       Messaging home owners inside the AirBnB app

•       Using the Uber or Lyft app to call your driver

•       When Netflix notifies you of new programming that meets your profile, they are using a Twilio product

•       Messaging businesses or receiving notifications about a dinner reservation inside the Yelp application

 Twilio has high switching costs and is one of the only solid VoIP/CaaS options for native mobile applications available. It’s very challenging for their existing customers to go with another VoIP/CSaaS service due to the required time to develop new features and test these features. This is a major plus.

The company caters to developers and this is another reason Twilio has done well, as developers decide the APIs for applications (i.e. not the CEO or a CTO). Twilio states they have 5 million developers as customers, which is about 20% of the 26 million developers in the world today. 

Competitors include Bandwidth, a company that is also a network carrier. As a network carrier, Bandwidth is able to undercut Twilio on pricing with cheaper outgoing and incoming calls plus free incoming SMS. Twilio costs $1 for a dedicated number while Bandwidth costs $0.35 per dedicated number. Bandwidth is the network provider for Google and Skype, however, it’s uncertain how many developers use the service for native mobile applications.

Another competitor is Nexmo, who was acquired by Vonage, and is second to Twilio for global presence with coverage in over 90 countries. Nexmo has attempted to undercut pricing by charging per second rather than per minute, yet is more expensive than Bandwidth. It is more likely that United States developers would choose Twilio over Nexmo.

I am less concerned with the competitors and more concerned with the risks associated with mobile saturation. It can be challenging to quantify the impact of a burgeoning technology that begins to plateau. For instance, on one hand, the trajectory of mobile app revenue is expected to nearly double between 2020 and 2023, from $581 billion to $935 billion. But on the other hand, 77% of app usage is spent inside of three applications and 96% of app usage is spent on the top 10 applications. 

The issue is what will happen to the other 1.8 million apps on the App Store, and 2.4 million apps on the Google Play store, who are fighting for the remaining 4% of app usage time? That’s where saturation comes in as consumers consolidate their time across fewer apps and become harder to convert to new services or applications (the thrill is gone, essentially). 

Twilio is a stable choice that should clear fundamental benchmarks that Wall Street rewards, which is why we are covering the company. Twilio may not be the biggest breakout story of 2020, but is a stable growth story. There should be a noticeable boost for Twilio when 5G is more widespread, however, it requires new applications to be developed for 5G for Twilio to benefit.

Twilio is Pivoting Beyond Mobile Applications …  

 Twilio has strong leadership that has been with the company since inception and is well ingrained in the mobile developer community. There was a time, in 2009-2010, when Twilio had the largest presence at mobile conferences and was everywhere (no exaggeration). Today, the company is much quieter and working on how to expand beyond mobile.

SendGrid Acquisition

Twilio completed the SendGrid acquisition in February of this year, a company that allows developers to create email messaging and marketing strategies through APIs. The acquisition will help Twilio to become an omni-channel offering for companies to communicate with their customers. 

Based on the closing price around the time of the acquisition, the all-stock deal was valued at $3 billion, up from the $2 billion amount at the time the acquisition was announced due to the strength of cloud stocks in end of January/early February of this year. 

Twilio paid 18 EV/sales for SendGrid if calculated on the last full annual revenue reported in 2017, or 13-14 EV/sales if based on the annualized 2018 revenue. 

According to Morningstar, the acquisition is value-neutral. Twilio and SendGrid have both stated they aim to be accretive on revenue while re-investing any savings on expenses to grow the business. Twilio had stated the annualized 2018 income would be $734 million, compared to Twilio’s $650.1 million. The company also stated on a conference call that the gross margins would be 59%, up from Twilio’s gross margin of 47.5%.

Twilio Flex

Twilio launched Flex a year ago, a cloud-based platform for routing calls and engaging with hundreds or thousands of customers. This is a move towards enterprise companies who require a user interface (or dashboard) and a full stack contact center they can customize.

Conclusion:

As stated above, Twilio is a stable choice that should clear fundamental benchmarks. The company is priced at current EV/sales of 11.87 and forward EV/sales of 10.71. This is currently one of the lowest valuations in the category while forward EPS consensus is one of the highest in the category.

Technical Analysis

The technical structure of most cloud stocks is lining up with the fundamental outlook. In other words, while the cloud complex is clearly in a sentiment driven correction, the growth in cloud is just getting started. Next year, it’s estimated that software-as-a-service will grow by 17%, which, once this correction plays out, should lead to a new uptrend to all new highs.  

Digging a little deeper, most of these stocks are clearly in a second wave, showing an overlapping corrective structure. Twilio and Alteryx are not exceptions (we are releasing a PDF on AYX shortly). Typically, second waves flush any remaining optimistic sentiment, causing investors to feel like the initial move up was false, and the current downtrend is here to stay. 

However, what follows the 2nd wave is a more important 3rd wave, which is what we want to participate in. The standard target for the 3rd wave’s completion is around 161.8% the length of the first wave, so this move to all new highs will be notable.  With Twilio’s revenue growing from $1.16B to $1.46B and analyst consensus of 92% EPS growth, as long as we avoid a larger macro pullback/recession, our goal is to add to cloud positions for this 3rd wave.

The red Fibonacci lines on the right indicate the retrace levels from the entire uptrend, which started in May of 2017. The Blue lines indicate the extension of the first leg down (A wave), assuming the first leg has bottomed and we are in a corrective retrace (B wave). The cluster gray lines indicate Fibonacci price levels taken from various swing lows based on Twilio’s price action, which is meant to reveal clusters of important price regions. When these regions line up, it signals a potential bottom, and trend reversal. 

My count has Twilio completing it larger degree 1st wave in red, and is currently in its 2nd wave retrace. The charts suggest that Twilio, like most cloud stocks, has not completed the retrace. Cloud stocks, and Twilio, will likely continue another leg lower, which is when I will consider this a buying opportunity. It will be in this correction that the sentiment towards cloud stocks will likely hit bottom, and be ripe for a reversal.

There is a high level of Fibonacci clusters around the $86, $73, $63 price region. These levels will be my targets for a potential counter trend position, and I will be looking for signs of a bottom as the price approaches these levels. 

Twilio is currently finding resistance just under the 23.6% retrace level at the $97-$103 price region. Furthermore, this level coincides with two huge volume spikes, both of which were initiated at the $100 level. This level will be difficult for Twilio to overcome, not only because it’s a key Fibonacci resistance level, but also because large amounts of money exited the stock at this level. 

The internals of Twilio also suggest more downside. The RSI has clearly broken into bearish internals, finding it difficult to break the 50 line, let alone the 60 line. I will want to see the RSI break the 60 line, and shift into a more bullish posture before considering the correction to be over. 

Furthermore, the MACD has begun to roll over again, suggesting that the downside is not over just yet.

My primary game plan is to initiate a position at lower levels. However, I will abandon this thesis, and assume the bottom is in if: TWLO can break through the 50 and 200-day MA; then break through the 61.8% retrace level with heavy volume, and do so with a 5-wave structure.

In conclusion, the first leg of the downturn appears to have ended, and we have retraced to heavy resistance at the $97-$103 price region. If Twilio cannot breakout here, expect the next leg of this downturn to flush out the remaining sentiment, while price finds support within the price zones listed above. The first support zone will be around $86, then $73, followed by $63. I will look to layer in my position as Twilio makes its next leg lower.

Market Update: December 3rd

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Market Update: December 3rd

The S&P 500 is currently on pace to have one of its best years since 2013 with a return north of 25%. The question on investors’ minds is – will the good times continue, or are we trading at the top? While many are hoping for a melt up or Santa Claus rally, we also saw the market approaching a bottom this time last year with fears of an economic slowdown.

The purpose of this update is to look at both sides of the argument on a deeper level and to provide indicators that we think are notable. First, we’ll explore the bear case, outlining the data points from both the economy and sentiment, which should be factored into any investor’s current game plan. Then we’ll look at the bull case, and finish up with a position update.

SECTION 1: Macro Outlook: Economic Inflection Point 

Since the current business cycle began in 2009, we’ve currently had the longest expansion in U.S. history. However, within this expansion, we have had 3 mini-cycles that lasted between three to four years. 

There are a number of ways to show these mini-cycles; however, the PMI over the prior 10 years provides a great visual.

United States ISM Purchasing Managers Index (PMI)

Chart Source: Trading Economics  

The first cycle started in 2009, was derailed by the European Debt Crisis, and bottomed in 2013. The second cycle began in 2013, was stopped by the crude oil collapse and Brexit, and it bottomed in 2016. The current cycle began in late 2016 and was halted by the trade war, and the Fed’s tightening cycle.

The market is assuming a rebound in economic activity. Equities are always a leading indicator to economic activity, and the market’s answer to the above question is a resounding affirmation for a new mini cycle. The below chart shows the divergence between the ISM Manufacturing Index and the S&P 500. 

Chart Source: Knox Ridley

SECTION 2: Earnings Slowdown

According to FactSet, 75% of the S&P 500 have reported a positive EPS surprise, which is above the five-year average. Total number of companies with sales above estimates is at 60% and is also above the five-year average. This can be misleading as the blended earnings decline is negative 2.3% and is the first time the index has reported three straight quarters of yearover-year declines since Q4 2015 through Q2 2016. It also marks the largest year-over-year decline in earnings since Q2 2016 at negative 3.2%.

FactSet also states that analysts are expecting a decline in earnings in the fourth quarter followed by 5-6% earnings growth for Q1 2020 and Q2 2020.  The forward 12-month P/E ratio is 17.5, which is above the five-year average and above the 10 year average.

SECTION 3: CEO Confidence vs Consumer Confidence

Source: Lance Roberts

The above graph is important to consider. The orange line represents a collective of CEO confidence about the state and future prospects of the economy. The purple line represents how the average consumer feels about the state of the economy and its future. The grey line is the return of the S&P 500. The shaded gray bars represent recessions. 

What’s notable is that the orange line consistently diverges downward long before the consumer realizes what is happening. Meanwhile, CEOs are paid very large salaries to forecast business revenue. CEOs are also experts in their sector of the economy, so it would make sense that CEO sentiment would precede economic slowdowns rather than consumer sentiment (which would react). They are our best insiders to the health of financials.

It’s also worth noting that consumer confidence peaks just before a recession, indicating exuberance for the economy before it reverses sharply. Today, there is a sharp divergence between CEO and consumer confidence. This divergence has historically taken years to unwind, but it’s worth monitoring that consumer confidence is at a cyclical high while CEO confidence is at a cyclical low. 

SECTION 4: Technical Warnings – breadth signals

Over the last couple of weeks, we’ve had an unusual number of breadth warnings, which basically monitor the number of stocks participating in the rally.

There are 2 popular signals that have been good harbingers of, at minimum, a large correction in the past – the Hindenburg Omen and Titanic Syndrome. We have seen a cluster of such signals trigger ranging over the NYSE and NASDAQ. In fact, we had an extremely rare occurrence where seven Hindenburg Omens triggered in a row on the NASDAQ recently.

The below chart was comprised by Jason Goepfert of Sentiment Trader, and it shows the instances going back 30 years where we had a combined 10 signals over 7 sessions between the NYSE and NASDAQ. The red dots show when these occurrences happened.

Chart Source: Sentiment Trader

SECTION 5:  Divergence in Semis

Chart Source: Knox Ridley

The above chart is showing the Philadelphia Semiconductor Index (SOXX) compared to the South Korean Kospi Index. South Korea is an economy that is fueled by some of the world’s largest semi-conductor companies, as well as many mid-level players. Companies such as Samsung, and SK Hynix supplied over 60% of the components used in memory chips sold globally in 2018. So, the KOSPI can provide more information about the global health of semiconductors. 

As you can see, these indexes are typically correlated. Today, we are seeing the widest divergence between the U.S. semiconductor index and the Kospi. This suggests that one of these indexes will need to correct, and a divergence like this amongst highly correlated stocks rarely lasts.

SECTION 6: Macro Outlook: Risk-on Assets are Breaking Out

Chart Source: Knox Ridley

On a more positive note, looking back through the most recent market rebound starting in late December of 2018, there has been a number of divergences between risk on assets and the market. In other words, we saw classic risk off assets like gold and treasuries going up with the market.

Also, transportation stocks, small caps and financials were not participating in the recovery. This is important because these sectors indicate a growing economy, which is necessary for a continued market breakout.

Recently, small caps and financial broke out to all new highs. This is important, because it’s showing that economically sensitive segments of the economy are beginning to participate. Transportation stocks are still lagging, trending up and are not far from new highs. 

SECTION 7: Housing

On another positive note, due to lower rates and easy money, housing has rebounded and doing quite well. We simply do not typically see housing report numbers like we are seeing today when a recession is on the horizon.

For example, New Home Sales are up +733,000 – best since 2007. Existing Home Sales Prices are up 6.2%. Building permits are up 5%, which is the best we’ve seen in 12 years. The Case-Shiller tracks 20 cities, and only San Francisco saw a year-overyear decline.

SECTION 8: Federal Reserve Policy

On October 8th, the Fed indeed announced they would begin expanding their balance sheet by buying $60 billion in treasury bills per month starting on October 15th and extending until at least mid-2020. They have injected hundreds of billions of excess capital into the system through a new on-going operation that they insist is not QE, but looks exactly like it. The reason for the actions is not as important as the results, which are higher asset prices for the time being. 

This marks the end of the balance sheet shrinking. Over the past several weeks, the balance sheet increased by $324 billion, now exceeds $4 trillion and growing, which is four times higher than pre-crisis levels. At this pace, by mid-2020, we will likely be at new highs for the balance sheet.  

SECTION 9: Record Outflows in Equity Mutual

Funds/ETFs

Ciovacco Capital Management

We are currently seeing record outflows from equity mutual funds and ETFs. This may seem counterintuitive with prices at all-time highs; however, this chart isn’t showing an exit from equities, just the mutual fund and ETF flows, which are predominantly the results of average investors and historically reflects the herd sentiment. 

Furthermore, we are seeing very high short ratios in the NASDAQ (QQQ), which is also playing out across other major indexes.

Chart Source: Fintel.IO

The above chart shows that last week, between 12%-18% of all shares traded in the QQQ ETF, which tracks the NASDAQ, were short positions. This is an unusually high level of short interest, and this trend can be seen across the NYSE and S&P500 as well. The graph further shows that this trend has continued for most of 2019. 

It may seem counterintuitive that high levels of short interest can be a bullish sign, but if the index fails to breakdown, this will cause the shorts to cover their positions, in turn, pushing the index up. Short covering can move stocks and an index in meaningful ways. 

When we see a high level of short positions being taken across major indexes coupled with record level outflows in mutual funds and ETFs, it’s a contrarian indicator that stocks may have more upside in the near future.

In conclusion, these data points show that the case for the bulls and bears is equally strong today. Be careful of confirmation bias. If the market continues to move up, we will look to participate with tighter stops than we would normally do in a market with fewer warning signs.

SECTION 10: PORTFOLIO UPDATES

You can access the PDFs for these stocks that cover the fundamentals in-depth by clicking on the headlines below.

Zoom Video Communications (ZM) Zoom Video Communications (ZM)

Zoom retraced to its initial IPO price. It held and is now in an uptrend. The uptrend is overlapping, so it’s hard to get excited just yet. Also, it broke its new trend line to the downside on both price and RSI, confirming that the recent uptrend was corrective. I’m expecting more downside from ZM, will look to add in the mid to low $60s with a stop just below $59.90.

Zoom is also below its VWAPS, anchored at the all-time high and low, indicating that the bears are still in control. If ZM can break above the 50% retrace and its VWAPS, it’s a strong indication that ZM could see new highs. If you do want to play the long side today, I’d hold a stop just below its all-time low around $59.90.

Please keep in mind, Beth likes the fundamentals of Zoom as it’s growing 78% year-over-year from $330 million in annual revenue to an estimated $587 million-$590 million with gross profit margins in the 70-80% range. The company is profitable, which is rare among its SaaS peers. The business model has a viral mechanism, which helps drive adoption and retention. The valuation is high, as Zoom has the highest enterprise value to sales of any company over $500 million, and this is the company’s primary weakness.  

Microsoft

MSFT was stuck in a multi-month consolidation range, while its cloud counterparts saw drawdowns. The RSI exhibited a coiling pattern while price elevated, indicating that it was preparing to make the next leg up. We then had a clear break out with both price and the RSI. It has commenced on the next leg up, trading above its 10-day EMA. A breakout like we see above is usually an indication of more upside.  

We’re seeing a retest of prior support levels, which are currently holding. My current stop for this position is at $128.50. 

As Beth has covered extensively, the market is underestimating the importance of hybrid cloud, which is where Microsoft concentrated their efforts and why the company won the Pentagon contract. These distinctions are important as cloud infrastructure is expected to grow from $73 billion in 2019 to $166 billion in 2024.

Roku Roku

The $162-$165 region has been problematic for Roku in the past, and we saw evidence of this again this week. My primary count still has Roku seeing more downside, but I will scrap that for the alt count if Roku can push above the current region. If it can break above this region with heavy volume, my next target is in the $220 region. Roku is a classic momentum play until we have a larger market correction, so tight stops that move up with the gains will be crucial.

Buying Roku between $120 to $162 has proven to be a gamble, and something we cautioned against in previous analysis. Buy-and-holds should look under $120 with the $100 mark being a steal. 

Workday Workday

After hitting our stop, Workday then hit the upper mid our target zone for Wave 4, and the structure off the bottom is promising. It’s approaching heavy resistance, with fading volume and momentum. I favor more downside, before a breakout and have started layering in some longs. I will look to add on the next pullback, or if it breaks out, signaling a renewed uptrend.

Fundamental snapshot: Workday has beaten analyst estimates for twelve quarters in a row, and did again today. The company has not missed sales expectations since early 2014, according to FactSet. After adjusting for stock-based compensation, the company reported earnings of 53 cents per share, up from 31 cents per share in the same-quarter last year. Analysts had expected 37 cents per share on sales of $921 million, according to FactSet.

Alibaba Alibaba

Alibaba finally broke out of its year-long triangle pattern that we outlined twice over the months. The RSI broke into new bullish levels as Alibaba closed above $200. This is what we were hoping for when we wrote our analysis on the stock. 

Today we are seeing a retest of the upper wedge range with a close above the support. I will be adding to my position in any market weakness. For the new shares that were added, hold a stop just under $160 or close out for 13-15% gains. 

Nvidia Nvidia  

Nvidia has been in a strong uptrend ever since breaking the $190-$200 resistance region we outlined in the prior report. It has broken through $200 with heavy volume, which favors the bullish scenario outlined. 

The above chart shows Fibonacci price regions that will act as resistance for Nvidia to break. The $222 region has been important for Nvidia in the past, and it appears to have failed just under this level with a sharp reversal that broke through the base of its Bollinger Band. It found support at $200, with heavy volume coming into support this price. In short, we are range bound until one of these levels breaks. Below $197 and we could see a retest of the 200-day. My current stop for new positions is at $160. Anything close to this region should be considered a buy for long term investors.  

Uber Uber

Uber is currently at major resistance and struggling to break out. The blue lines indicate a price cluster of Fibonacci relationships, which also coincides with the red trend line. If Uber does break above this region, we will take the final gains in our current short, and look to re-enter at one of the above blue zones on the chart.

Bitcoin Bitcoin

Bitcoin had a strong bounce from our primary target in the high $7,000 range, breaking above $9,000 and then giving us a head fake. My updated structure is above, and it appears that BTC may have one more leg down before a bottom. There were heavy sellers at the $8150 range and heavy buyers at the $6500 range. I would hold a hard stop at $4300 for any longterm longs. 

 

Marvell Technology: 2019 Analysis

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Marvell Technology: 2019 Analysis

Marvell

Marvell’s sales are flat year-over year – reflecting the status of many semiconductors with exposure to Huawei. The company reported quarterly revenue of $657 million in fiscal Q2 2019 ending in July with GAAP net loss of $57 million or -$0.09 diluted EPS. The company reports on December 3rd and has guided for $660 million in the mid-range with diluted EPS of -$0.09 and -$0.05 and non-GAAP EPS of $0.15 to $0.19 EPS.

Marvell’s revenue peaked in the quarter ending October of 2018 at $851 million, and in the quarter ending January 2019 at $744 million. 

The company has guided for ongoing impact from the Huawei ban, yet stated it would be offset by a “stabilizing storage business and the earlier than expected first production shipments of our 5G solutions.” As many investors are aware, Huawei is building base stations without components made in the United States and this impacts Marvell as Huawei is the current leader in 5G infrastructure. The storage business was down 1% sequentially at $275 million due to the export restrictions on Huawei.

Samsung is increasing their orders, which helps Marvell. Nokia also uses Marvell’s chips. There was an important announcement from Microsoft in regards to using Marvell’s ThunderX in Azure for advanced programming. Lastly, Marvell has recently acquired a former-IBM ASIC chip company for $650 million (plus an additional $90 million when conditions are met), which will help its aim in 5G infrastructure as ASICs are becoming the go-to chip for customized, specific functions.

Beyond the Huawei risk, Marvell also took on quite a bit of debt in 2017 totaling $1.879 billion with a current balance of $1.685 billion in the most recent quarter. This can be problematic as the company is not currently profitable (although did achieve profitability between in 2018, 2017 and for many years prior to 2016). Cash flow from operations in the second quarter was $73 million.

In July of 2018, Marvell completed the acquisition of Cavium for $6 billion, a developer of ARM and MIPS-based SoCs. This helped broaden Marvell across the storage, networking and connectivity solutions markets and doubled the addressable market from $8 billion to $16 billion. The long term debt Marvell secured was due to this acquisition. 

Marvell has a forward PE ratio of 23 and a forward price-to-sales of 5.7. Historically, the forward PE ratio is lower than years past because Marvell is forecast to have 13% growth next year. The trailing EV to EBITDA is 54, which is very high. Marvell had a EV to EBITDA of 17 during 2017 and 2018, and this doubled to 30-38 during the first half of 2019. 

Although it’s good to be forward looking, to some extent, Marvell’s valuation does not leave room for the risks. This matches my opinion of nearly all semiconductors, as it’s better to buy on trade war pessimism for the long haul rather than all-time highs and trade war optimism.

5G

In the 5G premium analysis, I had outlined key technologies for 5G infrastructure including Massive Multiple Input and Multiple Output (MIMO). MIMO sends data through multiple streams, increasing throughput, and helps to avoid lost signals. Marvell’s fusion processors assemble antennas to help multiply the capacity of the network. Marvell’s Fusion processor also helps high capacity data throughput and reduce power consumption. The comprehensive 5G platform delivers baseband, transport, switching and front-haul and MIMO at base station OEMs.

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

According to Gary Mobley of Wells Fargo, Marvell can generate $600 million in incremental revenue from 5G base station customers compared to the $2.9 billion over the past four quarters (20%) of revenue. Marvell management confirmed they expect $600 million per year from 5G revenue on the last earnings call. The speed of this growth depends on Samsung and Nokia’s market share.  

Marvell stated on the most recent earnings call that 5G macro-base station penetration will grow “from about 10% this year to 38% next year, and then onto 55% in calendar year 2021.” According to the executive vice president of China Mobile, Zhengmao Li, 5G will require three times more base stations than LTE and will cost four times more than LTE. IDC states that

5G-related spending will grow at a compound annual growth rate of 118% through 2022. Therefore, there is plenty of green field.

As stated in the intro, one of the primary headwinds is the Huawei entity ban. In 2018, Huawei controlled nearly 30% of the 5G market compared to Nokia at 17% and Ericsson at 13.4%. Samsung had only 2-3% of the market. 

Source: SPGlobal  Note: other sources place Samsung at 6.6% and ZTE at 7.4%

Most developed countries today face a tough decision: move forward with Huawei’s radio access networks and core equipment or delay the 5G roll-out. According to Mobile UK, a partial to full restriction of Huawei could delay a full 5G launch by 18 to 24 months. This is due to many of the current 4G base systems containing Huawei’s core equipment. Non-standalone 5G systems leverage existing 4G for the roll-outs anticipated next year. In the future, new stand-alone systems will be built with new architecture and many Western countries are unlikely to choose Huawei for the rebuild. In the meantime, Europe, for instance, may be stuck with Huawei for the first roll-out. 

Marvell’s 5G potential is based on the likelihood that developed countries will delay roll-outs to minimize security risks. If this does not occur, and countries deploy non-stand-alone 5G based on current 4G base systems (under the assumption the 4G systems were also a security risk), then Marvell’s growth potential relative to 5G will be delayed until stand-alone systems are built. 

According to 2018 numbers, Samsung is not a lead competitor – but this could change. Newly available 2019 data tells a different story. Samsung reportedly took first position in global sales in Q1 2019 this year with 36% of sales compared to Huawei’s 28% and Nokia’s 14%. Notably, Samsung and Huawei are the only end to end providers of 5G infrastructure. Wins for Samsung and Nokia are wins for Marvell. Nokia announced 42 commercial 5G contracts in June of this year with 22 major customers such as T-Mobile, Telia Company and SoftBank.

ASICs

In May, Marvell announced plans to acquire Avera Semiconductor for $650 million in cash plus $90 million if the business does well within the next 15 months. The deal is expected to close at the end of fiscal year 2020. Avera is a player in the ASIC market, which will help diversify Marvell as 5G has begun to favor ASICs over FPGAs due to costs and power consumption. ASICs, which stands for application-specific integrated circuit, are customized to perform one very specific function repeatedly rather than general-purpose chips – hence the “application specific.” Broadcom could potentially be challenged by this acquisition. Avera will add $300 million per year to Marvell’s top line.

In contrast to ASICs, the traditional FPGA chips are high in cost and power consumption, according to critics. Marvell is attempting to offer end-to-end network infrastructure with baseband DSPs, Arm multi-core SoCs (system on chips), purposebuilt hardware accelerators, Ethernet connectivity engines and system-level security solutions. Although Marvell aims to offer specific-use ASICs and semi-custom ASICs, the 5G platform that Marvell offers will be adaptable for many use cases to expand on any ASIC limitations. 

The primary SoC competitor is Broadcom. NXP Semiconductors and Qualcomm also compete with Marvell. Xilinx is a competitor on FPGAs. 

Source: SDX Central

Cloud Infrastructure

It’s important to note that Marvell is also a supplier for cloud infrastructure and data center storage solutions. On November 12th, 2019, Marvell announced that Microsoft Azure is deploying production-level servers with Marvell’s Thunder X2 Armbased processors. 

Thunder X2 is the second generation of the Armv8-based server and is based on the computational performance of an Arm server along with balanced IO connectivity, memory bandwidth and capacity. 

Following this announcement, Nvidia announced a collaboration with Marvell’s ThunderX to port its CUDA-X AI and high performance computing libraries and tools to the platform. This will help Marvell secure an entry into the AI and ML market through the Arm architecture. ThunderX has over 100 partners across commercial, open source and industry standard engagements. The Nvidia partnership will open up more than 600 HPC applications and AI frameworks. 

If you’d like some history on ThunderX during the then-pending Cavium acquisition, this article on Forbes is a good resource. 

Conclusion:

Marvell is certainly a lesser known name at $17 billion market cap compared to the $100 billion market cap competitors. Typically, investors overestimate the ability of the larger competitors and don’t give enough attention to the fast-moving innovators. The reason I wrote this analysis is because Marvell is doing all of the right things across its product line to overcome the current challenges. 

Huawei is overshadowing their product strength and with some luck, this can subside and the Fusion processor can find real growth again. On one hand, you have the very real possibility that Samsung picks up market share and Nokia maintains market share, especially among Western regions. 

ASICs are also a strategic play as they are becoming favored over FPGAs. Lastly, there is the ThunderX platform that delivers acceleration in the cloud, which will need time to be adopted, yet is an area of product-market fit that I am tracking. 

At the right price, Marvell is worth the risk as any turn in one of these events can make an impact on the company’s fundamentals. Knox will follow up with some technical analysis shortly.

Have a great Thanksgiving!

5G Premium Analysis: Semis Overview

Posted on by io-fund

571aad9a-7a1b-4b56-ad9a-d8ee5d69096c_5G-Semis-Premium-Analysis.pdf

5G Premium Analysis: Semis Overview

Introduction:

Semiconductors are going through an important divergence between earnings and stock price. Earnings are flat to negative YoY and QoQ, and yet stock prices are reaching 52-week highs. Although a rebound was forecast for 2020, semiconductors have blown past price targets, leaving little left to be desired in their valuation. 

This is not a good time to initiate semiconductor positions purely based on 5G. My preference is to wait until forward earnings/guidance and valuations are more aligned, especially with the trade war risk, capex costs for cloud and 5G expansions that will affect some companies, and the slower recovery than current valuations suggest. For instance, only 12 of 30 semiconductor companies plan to return to growth next year. The majority are expected to report below 10% growth next year and will remain below 2017 sales levels. 

Regarding semiconductors for 5G, it will be important to differentiate between consumer use cases and business use cases. The latter is 5G’s true growth opportunity yet is much further out from deploying. To illustrate, Bernstein Research, a renown sell-side analyst firm, believes 5G will be more of a replacement cycle for 4G, so the unit opportunity will not be as significant as previous generations in the consumer category.

Another challenge, which I will cover in a separate analysis, is the end-to-end 5G infrastructure. Gartner predicts that half of communication service providers (CSPs) will fail to monetize back-end infrastructure due to systems not fully meeting 5G use case requirements. A complete infrastructure will be built by the 2025-to-2030 time frame, with 5G radio deploying first, then core slicing and then edge computing. 

Regarding the consumer 5G opportunity, Qualcomm predicts 200 million 5G smartphones to be sold next year and 450 million 5G smartphones in 2021. Currently, there are 1.5 billion smartphones shipped annually. The semiconductors below primarily benefit from consumer 5G. 

The global 5G infrastructure market is currently valued at $371 million in 2017 and is projected to reach $58 billion by 2025, growing at a CAGR of 95.8% from 2018 to 2025. We will cover infrastructure and business/industrial 5G use cases in a future analysis. 

5G Semiconductor Overview

Qualcomm is an interesting opportunity because they are dominating consumer 5G across many geographies and smartphone manufacturers while positioning themselves for business use cases in the future. This is unique compared to opportunities where you are confined to either consumer or business. I cover Qualcomm in length below.  

Lam Research is being aggressive with buybacks with one analyst forecasting the company will return about $12 billion to shareholders from 2018-2023. This is about 30% of Lam’s market cap. The company stands to gain from the upgraded memory that will be required from 5G.

This analysis also covers Qorvo, a company that exceeded analyst expectations recently. The company has quite a bit of exposure to Huawei and China, where 5G is ramping up quickly yet carries very high risk. However, 35% of revenue is derived from Apple and may help to offset any trade war issues with 5G in the United States. 

Broadcom had a peak year in 2018 with $20.8 billion in revenue and is expected to reach $16.97 in fiscal year

2019. According to current guidance, Broadcom will report $19.52 in fiscal year 2020 and $22.36 in fiscal year 2021. Like Qualcomm, Broadcom should make up to 50% more on chips from 5G than 4G (see Qualcomm for stats). 

Qualcomm

Qualcomm is a company that has been working towards the 5G rollout more aggressively than almost any other company on the market today. Qualcomm was a first mover in 5G technologies, such as mobile mmWave, flexible frameworks, scalable OFDM numerology and reciprocity-based massive MIMO. 

Basically, Qualcomm is well diversified and singularly focused on 5G. This market lead was demonstrated when Intel exited the 5G smartphone modem business last April and sold its offerings to Apple for $1 billion. This was around the time when Apple acquiesced and struck a deal with Qualcomm, their long-time nemesis. This supports Qualcomm’s assertion they have the best chip on the market as there had been rumors Apple was designing their own chip or would go with MediaTek. 

Qualcomm’s market lead has also allowed the number one chip designer to be the provider of 5G modem chips for Xiaomi, LG Electronics and ZTE – plus Samsung although not exclusively. Qualcomm estimates their serviceable market to be $65 billion now and $100 billion in three years (always consider the source).

On that note, Qualcomm can charge more for 5G chips. Analysts estimate 5G smartphones will offer Qualcomm the opportunity to sell 50% more dollar chip content per device versus the prior 4G generation, due to the increasing complexity and higher pricing. Dollar chip content refers to the dollar value of chips that a device holds. (source: Barrons). 

As stated in the intro, Bernstein Research, a renown sell-side analyst firm, believes 5G will be more of a replacement cycle for 4G, so the unit opportunity will not be as significant as previous generations. This is because 4G delivered mobile broadband with smartphones being the primary benefactor. The next generation will deliver the wireless edge with 5G New Radio (NR), with the main benefactor being new platforms of interconnected devices and M2M communication. 

It helps that Qualcomm is diversified. The number of 5G-capable devices will rise from fewer than 5 million in 2019 to more than 50 million in 2020 due to phones, routers and hot spots.

Qualcomm is positioned for both consumer and business use cases through over-arching infrastructure. The global 5G infrastructure market was valued at $371 million in 2017 and is projected to reach $58 billion by 2025, growing at a CAGR of 95.8% from 2018 to 2025. 

Here is the list of the suite of 5G related technologies offered by Qualcomm:

•       Private networks

•       5G internet of things (IoT)

•       5G broadcast

•       mmWave evolution and also Sub-6Hz spectrum

•       XR Devices such as Augmented Reality and Virtual Reality  

•       Shared, unlicensed spectrum

•       5G NR C-V2X smart transportation (autonomous vehicles)

•       Industrial IoT with eURLLC

Holistically speaking, 5G will enable fully-distributed artificial intelligence rather than cloud-centric AI. This goes beyond lower latency and customized/local value. Soon, AI will occur on-device for internal optimizations. This will create:

•       On-premise control for factories and manufacturing robotics and machinery

•       On-device intelligence assisted by the cloud; critical for autonomous vehicles to operate

•       Distributed processing for XR devices.

•       Cloud computing, storage and instant access

•       Low-latency gaming 

•       Better AI voice assistant and AI user interfaces

For enterprises, Qualcomm offers 5G New Radio (NR) mmWave private networks. The most likely industry to adopt private networks is the industrial sector. Release 16 for 5G will occur in the H1 of 2020 and private networks will begin to scale in 2021. Private LTE provides a clear and committed upgrade path to 5G. 

The term “private networks” refers to networks with radio core, and transmission resources dedicated to the enterprise. Most importantly, the private network is under the control of the enterprise. 

Less industrial businesses are unlikely to upgrade to 5G until there is a clear cost-benefit ratio. There are also other options which leverage LTE and WiFi that are less expensive than 5G mmWave technology.  

Cellular vehicle-to-everything (C-V2X) will be included in future 5G releases for autonomous driving. The enhanced network communication proposes vehicle-to-vehicle, and vehicle-to-infrastructure communication. For instance, not only will the vehicle you’re driving communicate with the vehicles around you to assist with braking and lane changes, but the vehicle will also communicate with street light infrastructure. This is a future technology and not a serious catalyst at this time. 

Fundamentals

Qualcomm’s fundamentals reflect many of the risks involved with the stock. The first is the ongoing lawsuits Qualcomm is involved with, and the second is licensing fees, which Huawei is currently withholding. To put it plainly, most of Qualcomm’s partners do not like Qualcomm.  

The current semiconductor rally would cause one to believe we have found a bottom for semiconductors. By my estimation, this is not true for Qualcomm. Next quarter, the company is forecasting $4.8 billion in sales and $0.85 EPS, which is relatively flat. Combined with the current stretched valuation for semiconductors, there should be a lower entry. 

With that said, expected sales increase for Qualcomm for 2020 is 17%. For 2021, a sales increase of 21% is expected. This is substantially better than the previous three years, which posted negative sales growth.

Risks:

Qualcomm’s Snapdragon X50 5G modem is considered the industry’s most advanced offering. However, Huawei openly challenges this assessment. Last March, the CEO of Huawei stated that the Balong 5000 modem can download at double the speed of the Qualcomm X50. 

Whether this is true is irrelevant. Huawei is essentially stating it has no plans of using Qualcomm, and China overall is likely to be less dependent on foreign chipmakers in the 5G era. 

As of now, Huawei builds up to 60% of their Kirin mobile processors. Bernstein Research has stated they expect HiSilicon Technology to be Asia’s biggest chip designer by revenue in 2019. HiSilicon Technology has tripled its revenue from $2.4 billion in 2014 to $7.6 billion in 2018. MediaTek supplies Oppo, Vivo and Xiaomi. Samsung has developed its own 5G modem chip for high-end devices in markets, such as South Korea.

Therefore, it’s very possible that whatever United States mobile technologies gain from 5G will be offset in what these companies lose from China’s nationalist stance. Also, Qualcomm enjoyed 5G hegemony in fiscal 2019 with 230 5G design wins across 40 OEMs, and this will be challenged in 2020 and beyond. 

Qorvo

Qorvo is a provider of radio frequency chips for mobile products (MP), and infrastructure and defense products (IDP). The mobile product is a radio frequency solution that performs various functions in the cellular radio front end section of smartphones and other cellular devices. The IDP segment supports global applications, including high-speed network connectivity to the cloud, data center communications, and internet connectivity. 

Qorvo has beat quarterly estimates for the past four quarters. The company recently experienced a surge in stock price due to reporting Non-GAAP EPS of $1.52 versus $1.30 and also beat the revenue consensus by 7%. On a GAAP basis, Qorvo reported revenue of $807 million with gross margins of 40% and diluted EPS of $0.70. The company also announced $1 billion in buybacks.

Notably, despite beating earnings, the company has had relatively flat revenue growth of 4% in 2019 following negative growth in 2018, and continues to forecast for minimal growth of 2.3% growth in 2020. Compare this to 2015-2016, when Qorvo saw about 50% revenue growth YoY. 

Earnings are expected to grow at 56.9% annual growth through 2022, which exceeds the industry average of 19.6% and the market’s 14%.  

Qorvo is an Apple supplier with 35% of revenue derived from the iPhone. The Huawei ban is an important consideration for Qorvo. There continues to be extensions on the entity list that bans US suppliers from selling components to Huawei. The extensions on the ban have allowed chip companies to recover from May lows.

As of now, another reprieve will be needed when the extension expires in December. According to author KwanChen Ma on Seeking Alpha, a full Huawei ban knocks off 13% of Qorvo’s revenue.  

Notably, according to Mayfield Recorder, institutions have taken gains on Qorvo recently with outflow exceeding inflow for the first time since Q2 2017.

Lam Research

Lam Research provides micro-processors, memory devices, various processing solutions and fabrication equipment for semiconductor companies. Front-end wafer processing solutions from Lam Research help to create chips and applications for nearly every edge device on the market. Wafer processing create transistors, capacitors and wiring for semiconductors. 

Lam Research has a potential growth opportunity due to the increase in demand for memory from artificial intelligence, IoT devices, and 5G mobile communication. Down the line, memory will also be needed for autonomous vehicles. Memory manufacturers need wafer fabrication equipment. 

Despite negative year-over-year growth and only 5% growth forecast for 2020, Lam Research has rallied. The stock is trading 116% higher from December lows. One catalyst is Lam’s buyback program. The company is returning 50% of its free cash flow to shareholders through dividends and buybacks with plans of returning a total of $12 billion to shareholders by 2023. This will lead to a 11.5% decline in shares. 

One argument for Lam Research is that the company is protected from supply and demand in memory as memory manufacturers will continue to buy from Lam even during a low point in the cycle. This was proven during 2015 when Lam did not feel the effects of the memory trough. Secondly, Lam spans across Micron, Samsung and Intel, and therefore, is more diversified. 

As recent as last July, Lam Research’s profits were nearly 50% less than the year-ago quarter at $541.8 million compared to $1.02 billion a year ago. Sales were $2.36 billion compared to $3.13 billion in the year-ago quarter. In current quarter, Lam reported -8% year-over-year sales. As stated, the company is forecasting only 5% growth next year. 

Although Lam is situated nicely for memory growth, the numbers are not reflective of the opportunity. It’s likely we see a lower entry for this stock.

Broadcom

Broadcom is one of the rare semiconductor companies that is expected to post increasing revenue and EPS this year. Next year, the company is expected to grow 4-5% across the top line and bottom line. Historically, Broadcom has been on a nice trajectory compared to many semiconductor peers, with 50%+ increases in annual revenue and some years posting triple digits (2015-2016). This growth has clearly slowed down yet earnings are forecast to grow from $16.97 in fiscal year 2019 to $19.52 in fiscal year 2020 and $22.36 in fiscal year 2021. 

The only drawback to Broadcom is the 5G push will be consumer oriented only. The company sells a variety of chips that enable wireless capabilities in smartphones, such as Wi-Fi, Bluetooth, and cellular. Apple makes up over 60% of Broadcom’s overall wireless revenue. Similar to Qualcomm, Broadcom will make more from 5G chips than from previous generations. 

 

 

 

Market Update: October 29th

Posted on by io-fund

bd18aad4-63df-4273-86ed-3e074f105d44_Market-Update-October-29th.pdf

Market Update: October 29th

Introduction

The purpose of this market update will be to discuss the current risk in the market, how to protect positions, and to update you on stocks we have covered previously. We will start by looking at the risks involved in the current market to set the proper stage for a reasonable exit strategy. The second section reviews the stocks we have previously covered on our premium site.

There will be situations where great companies are misunderstood by the market – and the opposite, where companies on the decline are over-hyped. Often times, the analysis we release takes some time to play out. Our fundamentals can give you an edge on companies and stock picks; timing the analysis is the next question. In other words, entry and exits should receive equal consideration in this market.

Our goal is not to be right 100% of the time, but rather to make profits. We would rather make money than be right. If we are correct 60% of the time, yet close any positions that hit our stops, and maintain positions that are winning, then we will be profitable. The only way to responsibly do this is to manage risk. 

SECTION 1: MANAGING RISK

1.1 The Importance of Price-to-Sales

Warren Buffet recently told his shareholders that earnings, or net income, “are not representative of the business at all.”  Buffet is in essence rewording an old Wall Street adage that net income is an opinion, but cash flow is a fact. 

Using PE ratios to gauge the value of the market, especially in the era of large buy-back programs, is not as accurate as using a metric like sales. Top line revenue, like free cash flow, cannot be distorted. The problem with using free cash flow to gauge the market is that not all great companies are positive free cash flow, yet the common denominator is they all make sales. 

That being said, the Price-to-Sales Ratio (P/S) of the S&P 500 is currently around 2.2.  Anything over 1.5 has historically been considered as expensive. It’s worth noting that there are only two other times in history where the broad market was trading above two price-to-sales – in 1929 and in the dot-com era. The current P/S of the broad market has exceeded both of those time frames. 

Asset Manager and writer, John Hussman, has done some good work on this subject. In summary, he has proven that anytime the market is trading at such high valuations, the following years of returns have been historically low. 

Furthermore, Hussmen recently posted the following chart:

He further claimed that the most overvalued 10% of stocks in 2000 lost 80% of their value in the bear market that followed the 2000 peak. He then claimed that roughly 90% of U.S. equities, according to their price-to-sales ratio, are more expensive right now than they were at the peak of the dot-com bubble. 

The implication here is that the bear market we face could be more painful than the 2000-2002 bear market considering the overvaluation is not isolated to just one segment of the market.

1.2 Top Dog Phenomenon

Another point worth noting while we flirt with new highs, was made by Rob Arnott, the founder of fundamental indexing as well as the founder of Research Affiliates. He coined what he calls the “Top Dog” phenomenon.  These are companies that have the largest market caps in the world, and what happened to them after they reached this feat. 

In short, nearly every time, they had a significant drawdown and continued to perform poorly in the years to come. The below chart shows performance of these top companies leading up to the top spot, and their subsequent performance in the years that follow.

The above graph shows that this phenomenon is not just unique to American markets. Sooner or later, prices start to matter, and the risk of investing in the top companies today is higher than most investors think. To further elucidate this point, here is a list of the top 10 companies in the S&P 500 each decade going back to 1980.

Notice how transient this list is. You will notice we did not recommend Google per our PDF last earnings report in July, and we have not focused on many of these mega-cap companies with the exception of Microsoft. In fact, Beth is particularly bearish on Facebook due to reputation issues and Apple due to mobile saturation. Therefore, we are believers that top dogs are as suspect, if not more, than high-growth smaller companies.

Point being, just because a company has done well in the past, does not mean it will do well in the future. The market is complacent with the top dogs. 

1.3 Q3 Rotation

We have talked about the rotation out of growth and into value. If you owned the S&P 500 only, and held it over the last 3 months, you are up. However, if you are heavily weighted in high beta stocks, you are noticing significant losses. This is telling you that money is rotating out of cloud and high growth and into value and defense. When investors get scared and want to prepare for the worst, they sell higher-valuation companies and buy lower-priced ones.

The Leuthold Group did a remarkable piece on this shift, titled “Portraits of a Split Market.”  I encourage you to read this to see just how large of a rotation we are seeing. It warrants caution, because we see this rotation preceding all major drawdowns. 

SECTION 2: Our Take on the Market

Regarding price-to-sales, it’s worth noting that a single metric cannot be used in a vacuum to make a broad statement in finance. Today’s market is not like the markets of the past. With historically low interest rates, QE programs, and a record margin expansion with corporate companies, and higher than normal Free Cash Flow in modern companies, the extreme that Hussmen is pointing out, may not be as extreme as the image suggests, and shouldn’t be assumed across the board.  

For example, Microsoft operates with a 32% profit margin, which is sizable compared to the typical cash-burn tech companies that are hitting the market today. Furthermore, its profits have grown around 20% over the past year, with sales growth of 14%. These metrics aren’t typically what you’d find in a company trading at 8 x sales.   

However, even in the most conservative interpretation, there should be caution with current market valuations. The goal is not to ignore the data nor to become overly-confident. We are in unchartered territory. Nobody can tell you exactly how this will end, or when sentiment will shift. The market is historically expensive right now. What we can tell you is that high valuations do not cause bear markets, but they can intensify the velocity.

Some analysts have been calling for the end of the bull market for two years, many others joined in on market crash predictions this year with the inversion of the yield curve. 

We do not get involved with market crash predictions. Instead, our service has worked diligently to provide stock picks and entry/exit timing that we feel is pertinent in this market. Admittedly, it’s a little bit like playing dodgeball as we’ve already seen Amazon and Alphabet miss earnings, yet Microsoft and Intel come in strong. 

The risks in today’s market should cause one to reflect on their strategy. We could see the market rise 30% from current levels, or retrace 30% from current levels; no one really knows. The historical data presented coupled with the frenetic behavior in the IPO market warrants all investors to take note of a few key points: 

(1) Proper position sizing: how much risk are you taking on? When the market is down 0.5% and your portfolio is down 5%, you may want to consider the level of risk you are taking. We personally don’t put more than 5% in a single position during market extremes. 

We are not in a buy-and-hold environment for new positions, thus 5% is the maximum for allocation that we personally follow. (We’ve mentioned on the forum that we plan to increase this to 10-15% after a pullback for our top two to three positions).

(2)  What’s your exit plan when the market turns? We have stops on our positions, which we follow. Losing 50% in a position requires that position to go up 100% to break even. And, the space we are participating in can see 20% plus losses in after hours – Facebook, Twitter, Grubhub are all examples. Stops prevent catastrophic losses that you can’t recover from. We place stops based on tight support zones, and will move them up as the position increases to protect our gains and minimize risk. 

3) How much cash? The most gains will not be made at the top of a market, so having cash if we see a meaningful pullback is important. We are personally at 40% cash right now. Our plan is to play momentum now and build a sold buy-and-hold portfolio to capture the last of the cloud cycle and to get far ahead of momentum on the AI economy.

4) Are you hedged. We provide short ideas as well as long. Uber and Lyft – both of these ideas returned around 30% on the downside from previous ideas. We still believe in all of these companies as hedges for your portfolio.  Make sure you have a short position or two. Possibly look into buying long dated puts on weak companies. Think of it as insurance. But, if you do hold a short, we recommend a 25% trailing stop on those positions.

We realize that some of our favorite companies have very high price-to-sales; such is the challenge of tech-specific analysis. The only way either of us have been able to do well in tech no matter the market conditions is with trailing stops. 

Many of our best performing tech stocks have lost 50% of their value very quickly. Within 3-6 months, these stocks are in the black, often by triple digits. We work hard to make sure you don’t buy high and sell low – especially with TA on Shopify, Roku, The Trade Desk, etcetera, which fluctuate wildly. 

You’ll notice that even though we held some of these positions, we pushed for patience and a lower entry that materialized fairly quickly. We don’t see many premium services provide this level of dedication to guide you for the best possible returns after the portfolio manager or analyst has initiated coverage. Typically, the portfolio manager or analyst continually hypes the stock after initiating a position and/or aggressively raises price targets. This is not our style. We will always strive to guide entry at the lowest price possible, and we believe it will serve our readers especially during a choppy market.

We like bitcoin and Chainlink per our August PDFs. We’ve included updates on these below. We feel it is to your advantage to weigh Beth’s opinion heavier than those who are not from the tech industry on disruptive tech trends and product positioning. 

It is nearly impossible to predict futuristic tech trends, and to sift through the noise, if you are not experienced in the tech industry. We saw this with her call on Facebook’s Libra, which was bold to state it would fail the day it launched. China recently announced a strategic move into blockchain, which should not be surprising with Beth’s thesis on bitcoin (i.e. that the pressure would come from overseas). In addition to the PDF on bitcoin and Chainlink, there is  additional free analysis on bitcoin from June on her free blog.

SECTION 3: 

Technical Analysis of the Market/Game Plan

By Knox Ridley

The game plan, which I’ve highlighted in the prior market update in September, and have slightly updated in this report, is straight forward. Bull markets rarely die in a whimper and high valuations do not prick the bubble. They are usually preceded by euphoric buying that makes no sense in retrospect. There’s a chance the many “market crash” predictions of 2019 are wrong and we have a final push to new highs and beyond. 

Recently, we have seen the market pushed to new highs by Staples, Utilities and Semiconductors. In order to sustain this move, and push us beyond, we will need to see growth, specifically tech, resume a leadership role, which we are starting to see. 

Not only has tech broken its resistance at $82.50 (IYW), but so has the financial sector and healthcare. These are positive signs for a continued push higher. However, if these levels cannot hold, we could see a reversal. This is something we monitor closely.

Simply using technicals, if the 2725 level is broken, that is a major warning to the long side of the market with potential to reach 3150. If 2600 is broken, I expect the bear case to be more likely, which can see us go much lower (some forecasts call for 2200 if 2600 is broken). 

This view has not changed since September; although to the frustration of any technical analyst, we have continued to trade range bound for a sideways market throughout most of 2019.  This is why many market forecasts have been wrong this year. We’ve seen little progress in either direction. Fortunately for us, we are not market forecasters and our readers have been able to make gains in small pockets of the market.

Most important, if we close above 3150 in the S&P 500, I will view that as the indication that the final bull push is here, and I will personally allocate more into high beta stocks with very tight stops.  

In conclusion, and most importantly, as tech investors, this is not the market that you establish a buy and hold position, in our opinion. This is the market where you play the momentum in the market, with tight stops – i.e. a rules-based and well-defined exit strategy. Please keep this in mind with your positions – check position sizing and exit strategies with your financial advisor well in advance of needing to execute on them. 

SECTION 4: Portfolio Updates

Snap:

Fundamentally, Snap is much weaker than during Q2 earnings. The market has not penalized Snap, however, and it’s trading above $14 after breaking this support briefly. If we see Audience Network announced, the company will become much more interesting on a fundamental level. 

Roku:

Roku is one of our highest conviction long term plays. Anyone who has followed Beth for a while has made out nicely in this trade. Recently, it appeared to have a blow-off top and then a sharp retrace that found support just above the $96 target zone following our encouragement to not buy at the $160 level and to wait for this retrace. It has since corrected upwards in a 3-wave corrective structure, touched the 61.8% retracement level and then turned down again, and is now testing the 73.2% retrace level at $155. Roku is trading above its 20-day EMA, which lighted in light blue. If it falls below and stays below this level, a new downtrend could occur. 

If you want to go long Roku at current prices, I’d recommend a stop at $122.50. Keep in mind, Beth is bullish on Connected TV ads and, as of now, we don’t foresee any negative earnings surprises due to strength of this trend. 

The main risk to Roku is market perception. The stock gets rocked with OTT news. My primary target for a buyand-hold position is highlighted in the yellow box on the chart (sub-$90), if you care to be patient. In the meantime, due to Connected TV ads, Roku is a solid momentum play. 

Zoom (ZM):

Zoom broke the 61.8% and 78.6% retracements and dipped below our $68 stop. Knox closed the position for a small loss while Beth remained in her position due to her current thesis that cloud is not slowing down this quarter (these published in September on free blog regarding all cloud stocks and in October on MSFT ahead of earnings).   

Zoom is now hovering around the 200% extension. In other words, the length of the C-wave is exactly twice the length of the A-wave. This is likely due to Zoom’s lockup period expiring. As long as this level holds, and ZM does not dip below its IPO price, I’ll consider this a deep Wave-2, which can lead to new highs in a Wave-3 push. However, if ZM closes below its all-time low, the structure will become complex and one that I will step aside until a clearer uptrend forms. 

You can take a shot at catching the bottom, buy at the current levels, and place a stop just below the low at $59.90. Stay cautious until the RSI breaks 60 and at least one resistance zone is cleared with force.

Uber:

Uber has completed its A-wave down, and is currently in a corrective B wave. I’m expecting this renewed uptrend to end soon and commence the downtrend to the target zone in the yellow box. Keep in mind, even if Lyft comes in strong, Uber’s lock-up is expiring and we expect this to strengthen the short thesis that we put into motion at the IPO. Place a trailing stop on that short at 25% for safety. 

Workday:

We are still monitoring Workday as we understand the financial analyst day caused a sell-off.  Our original analysis had stated:

“(the) ideal buy-and-hold from technical analysis is in the $142-$140 regions, with a possibility of trading as low as the $120 region. If the earnings report is weaker than expected, I’d see that as a buying opportunity – especially if the price breaks the $172 support and we get a deeper correction.” 

At this point, Workday has not chosen a clear direction and has remained between bearish and bullish trends, even with the negative news. If Workday goes to the 50% retracement level, we consider these prices to be a gift, and will be strong buyers. 

Beth will be writing a new analysis on Workday ahead of earnings and this will cover the financial analyst day in detail. 

Bitcoin:

Bitcoin (BTC) has followed our plan perfectly. It has retraced to the lower end of our target box, around $7400.  The chart below speaks volumes to the excitement we have of a possible bottom being in place. As BTC touched the long-term support region of 7430, which coincided with the Fibonacci time zone of 61.8% of the previous uptrend. At this moment, the RSI broke its downtrend, while the Stock/RSI bottomed and turned up.  

If you have not taken out a position in BTC, we recommend that you consider this. Above is the long-term chart, and the rough path that we expect BTC to take to all new highs and beyond. BTC is known for extending, and the below chart is a very vanilla, no extension 5 -wave uptrend. As you can see, there is a lot of meat on this bone.  

You have not missed the move, it’s just beginning. But, please keep in mind that this is Bitcoin – it’s extremely volatile, known for major extensions, and can reverse on a dime. So, maintain reasonable position sizes. We are not putting in more than 3-5% of a portfolio in BTC, at most. The new stop for BTC is $7500. If it closes below this price, sell and we will regroup. We firmly believe any small losses will be made up on a trend reversal and the goal will be to not miss out on the uptrend.

ChainLink:

Link has also followed our trading plan quite well. It traded into the middle of our target zone – around $1.75 to $1.50, and then shot above the $2 resistance. It’s now trading around $2.75 in a clear 5 wave pattern. We see Link as just beginning its uptrend as well, and we see new highs and beyond as a strong possibility. Link is a high conviction choice. If you start a position now, place a stop just below the $2 region.

BABA:

Trading within the large degree triangle pattern, both on the RSI and the price. It should be due for a sharp move once this pattern is broken. Stop remains just below $146. This stock is fundamentally stronger at the current valuation than it’s peers and has a reasonable probability of doing well in the near term.

Telaria:

Telaria is up about 4% so far. Stop remains just below just below $5.75. This stock is a small cap Connected TV ads play with a low valuation headed into earnings. We believe there is room in this price.

Pinterest:

We like Pinterest more than its peers and believe there’s a reasonable probability of the company reporting strong growth into the near future. This PDF was released last week. We believe the market will reward Pinterest in either this quarter or next quarter for its consistent revenue growth. 

Shopify:

This stock has seen continued volatility and corrections since our last report. Last week, it was trading back at support around $290. The large degree head and shoulders pattern is still in play. Below $280, and it will be confirmed. If you want to go long, keep this price point in mind for a stop. We believe Shopify’s strategy to serve the merchants, and improve their process, will help the company compete with eBay and Amazon. 

Mongo DB:

This stock has continued its downtrend and is currently trading within our original target box. We had stated in the PDF that the more likely scenario is that MongoDB will break support at $141 and allow for an entry between $95 and $128.

The red circles are showing a positive reversal signal, which is telling me that the selling in MDB may be slowing down, and it’s due for at minimum a short-term reversal. It’s holding at a key support level – 23.6% retracement and 200% extension. If this level breaks, expect it to find support at the 38.2% retracement around $85. 

One scenario to consider if you want to attempt to catch the bottom, is to go long today as the stock has a reasonable probability of reversing, and place a stop just below the 23.6% retracement level at $114.

Microsoft:

We recently published quite a bit of information on Microsoft ahead of earnings as part of the thesis that cloud is not likely to slow down this quarter. The company went on to win the Pentagon contract, which was nice timing for our readers. Notably, Beth predicted MSFT would win the Pentagon contract in December of 2018 when only IBM, Oracle and Amazon were being considered due to Microsoft not having the correct security clearance. You can find this prediction on her free blog.

Pinterest Premium Analysis

Posted on by io-fund

46042228-46d0-40bd-961c-f35d9bb304d6_Pinterest-premium-report.pdf

Pinterest Premium Analysis

Pinterest – Timing Looks Better Now  

I’ve been cautious about Pinterest in the past as social media often has a hard time holding its value in the months that follow the IPO. Pinterest’s lock-up period is behind us with the expiration having occurred on October 15th – same day as Zoom. 

My best guess is that the IPO lock-up is already reflected in the price going into these earnings, and Pinterest has a high probability of doing well in the next quarter. Pinterest has proven itself as a solid social app in its first few quarters on the public market – something that few of its predecessors have done.  

Pinterest is strongest in the fourth quarter. Unlike Snap which lowered guidance going into Q4, this should be Pinterest’s best quarter. In fact, Pinterest is second to Facebook for generating holiday revenue (although Facebook in the lead by a wide margin). In the event Pinterest remains steady this earnings season, I’m interested to see if the issues with Twitter and the lowered guidance from Snap will help investors view Pinterest as a good option, comparatively. 

Q4 tends to outperform historically …. 

Overall, Pinterest has a stellar business model that functions like a hybrid between e-commerce, social media and display advertising. Pinterest refers to this as a discovery engine. Similar to Shopify, Pinterest challenges the dotcom era e-commerce companies that still dominate retail, such as eBay and Amazon, an area overdue for disruption. 

In the past, I have been critical of Pinterest’s international ARPU. In the S-1 filing, the company was somewhat evasive about it when quoting the overall key metrics. I was vocal about this around the IPO as it’s the lowest ARPU I’ve ever seen from a social site. Note: overall ARPU for Pinterest is healthy due to the United States averaging out international. I expand on this point below.

Ben Silberman is a classic founder-CEO who flies under the radar. I’ve seen him speak quite a few times and he has an excellent reputation in Silicon Valley as someone who is ahead of the trend curve and is patient in his outlook. He is not hasty and you won’t see him in the limelight much, although he has the ideal, impassioned Founder-CEO recipe. 

Fundamentals & ARPU

In Q2 2019, Pinterest reported 62% revenue growth year-over-year of $261 million. Analysts were expecting $233.7 million in revenue. Adjusted EPS was -$0.06 versus expected -$0.08. The company raised revenue guidance slightly from $1.06 billion at the midpoint to $1.105 billion. This was a solid earnings report. Monthly active users also exceeded expectations at 300 million versus 291 million.

Average Revenue Per User  

In the past, I have been a critic of Pinterest’s international ARPU. To be clear, I still see this as an important risk to continually monitor as a disproportional amount of growth is coming from international (80% growth) yet the ARPU is so low, that it could damage operating margins long-term and lead to losses. 

The United States users monetize at $9 average revenue per user annually while the international user monetize at a mere 25 cents per user, as of 2018. This is what that looks like:

Pinterest’s international revenue is growing at 199% last quarter, but this is because the numbers are so small. To compare, Facebook’s international ARPU is 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 ARPU but was also hovering at 5 price-to-sales during some of this time period compared to Pinterest’s 16 P/S. Meanwhile, SNAP has nearly 1500% more ARPU in the rest of world region at $1.24.

Pinterest is Niche, yet Fires on Many Cylinders     

The United States is where nearly all of Pinterest’s revenue originates. Pinterest’s top five countries are the United States, Brazil, India, Turkey and Russia. Many investors are discouraged by the skew in demographics towards women, as they view this as limiting the addressable market. However, 80 percent of household purchases are decided by women. 

In addition, Pinterest is adding many male subscribers; depending on the source the percentage of new subscribers that are male falls between 40-50%. This will put the gender split between women and men at 70/30 by 2022. 

Relative to market cap, Pinterest is ranked among heavyweights when you consider its digital reach. It nips at the heels of eBay and Twitter and could easily rival Wal-mart in a couple of years (on digital reach). This is important because 87% of Pinterest users have purchased a product due to exposure on Pinterest and nearly half of Pinterest users have a household income over $100,000. 

For retailers, Pinterest rivals Instagram despite having a fraction of the user base. One out of every 2 Millennials use Pinterest with Pinterest driving the same percentage of product discovery among Millennials as Instagram despite having one-fourth the user base. 

Source: Kleiner Perkins

Valuation                 

Pinterest I wrote at length about Pinterest’s valuation on my free blog when the company went public. There aren’t many examples of successful investments in social media trading at above 10 price-to-sales. Historically, Facebook traded at a price-to-sales of 15 between 2013 and 2016, however the company had 1.2 billion users at that time and 63% YoY growth and $1.5 billion to $3 billion in profits. 

Pinterest is a better comparable to Twitter and Snap’s user base in the 300 million range. Twitter did have a P/S above 15 when posting 75% growth but did not last long as the price was down nearly 50% within two quarters. Notably, Pinterest is a discovery engine and I believe the ARPU has the ability to surpass Twitter and to steadily climb rather than be driven by only traditional ads. Snap has also seen sudden corrections above the 10 P/S mark even when reporting 50% YoY quarterly growth. 

With that said, as noted above, advertisers and retailers see Pinterest as a more valuable platforms as users are in a shopper mindset.

In the conclusion below the technical analysis, I point out the probability is higher that Pinterest remains strong this quarter and next quarter fundamentally when compared to peers Twitter and Snap. The technicals are setting up nicely and don’t raise any flag, with the information we have today. 

For a larger buy-and-hold investment, I’d like to get Pinterest below 10 P/S but I am playing momentum in the short-term. 

Technical Analysis                   

By Knox Ridley

Symmetrical Correction  

Pinterest, from a technical perspective, is suggesting a nice set-up. 

First of all, the structure of PINS is a clear 3,3,5 correction. In other words, if you follow the blue A, B, C, they each have an internal structure, which is highlighted with the orange circled letters.  So, the A-wave is a 3-wave move, the B-wave is a 3-wave move, and the C-wave unfolded in a 5-wave drop. This 3,3,5 structure is very common with corrections. 

Most notably, the length of the A-wave drawdown is the exact length of the C-wave drawdown. In other words, we have a symmetrical A=C correction, which is also very common.  This is referred to as the 100% extension of Wave A (So, A=C), which is shown as the blue support on the right. Another visual of this is below.

The length of the first drawdown was about 33.5%. The length of the second drawdown was a little over 34%. Price tends to correct in symmetry, which can offer a guidepost for bottoms as well as help guide risk/reward setups. 

RSI Divergence 

If you look at the RSI pattern in relation to the price action above, we have a clear positive divergence between the RSI and the price. As the price is making lower lows, the RSI is making higher highs, suggesting fading downside momentum. This suggests a possible trend reversal. 

Furthermore, the price is trading just below the 10-day exponential moving average (EMA), and the 20-day EMA. These moving averages give more weight to recent price action, and are indications of short term and mediumterm trends. They should act as resistance, but I’m expecting PINS to take them back, which will add further evidence of an upward trend reversal in progress.

Conclusion  

The market has been challenging lately, but we like this set-up. The fundamentals and technicals seem to agree that Pinterest has a higher probability of receiving a positive reaction to earnings. You can place a stop just under the 100% extension at $24.50. If you want to give it more breathing room, place your stop below the 123.6% extension at $22.00.

Connected TV Small Cap

Posted on by io-fund

cb15be9f-e24f-4cf4-94d0-d62736934ca2_Telaria-2019-Analysis.pdf

Telaria 2019 Analysis

Overview of Connected TV Advertising:

 Connected TV advertising is in my top three favorite tech trends for near-term gains, as discussed in the PDF that covers Roku and The Trade Desk. This is a massive opportunity that is occurring right now and should be given close attention. 

 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. There is evidence that Connected TV is closer to a 2:1 and up to a 5:1 ratio in terms of its value to advertisers in terms of the rates they are willing to pay.

 It may be hard for investors to imagine that some advertisers don’t like working with Google, Facebook and mobile or desktop, in general. This is a very real issue in the advertising world. Many big brands are not convinced that these mediums offer true, lasting impressions. They also do not trust the measurement offered as it’s behind a blackbox that they have no control over. Nielson offers an audience measurement system that many brands are accustomed to for traditional television. 

Below is an illustration of television holding its own against mobile. Keep in mind, this is despite 5 billion mobile devices entering the market over the past decade compared to 2 billion television sets. The 34% who have held onto their television budgets are the advertisers this PDF is referring to, plus any of the remaining advertisers who are frustrated with a lack of measurement and click fraud on the other mediums.  

Connected TV ads already see a $20 average revenue per user, according to Roku’s earnings. 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. You’ll also see below that Telaria’s CPMs on Connected TV ads are nearly 5x higher than average CPMs and have surpassed Facebook’s CPMs at the height of its dominance (and even with all of that Facebook data).  

For quick reference, here are some CTV ad statistics referenced in the August PDF which related to the overall size of the opportunity:

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. Telaria reported triple digit growth in revenue from Connected TV ads at 133% year-over-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.

Telaria Overview

Telaria is a volatile small-cap stock and even solid earnings has not helped to stabilize the price. Revenue was up 47% with the CTV business growing 133% year-over-year. Gross profit of $14.7 million was up 31% year-overyear in the last earnings report. The company increased the full year revenue guidance to $68-$72 million, up from $66-70 million.

When comparing Telaria to other connected TV stocks on the market, the two differentiators are that it’s headquartered in Israel, which may position it better for global inventory. The opportunity for CTV ads is global, and this could be a major positive for Telaria. 

The second differentiator is that Telaria is primarily a sell-side or publisher platform – rather than a demand-side platform. For comparison purposes, The Trade Desk is a demand-side platform. More on this below.

Telaria is not a pure play but they are focused enough on connected TV to almost meet the criteria. They also sell mobile and desktop inventory, which is not as interesting to me in the current environment as these are not hyper growth categories.  

Telaria Fundamentals

The most important key metric to focus on in Telaria’s report is CPMs, or the cost per 1,000 impressions, which grew from $11.58 to $15.41 year-over-year. These are very impressive CPMs, although not entirely surprising as in my previous report, I have stressed the importance of CTV ads for brand advertisers. 

Brands who have the big advertising budgets, such as Coca-Cola, Geico, McDonalds, etcetera, are willing to pay much more for television. Compare this to Facebook’s 2018 CPMs which are driven by hordes of data and were considered “skyrocketing” when they hit $11 CPM at Facebook’s 2-billion user peak in 2017-2019.

Due to Connected TV ads and high CPMs, Telaria was able to report $2 million over the $15.5-16.5 expected at $18.2 million in the last quarter. The company reported adjusted EBITDA of $1 million with EPS of -$0.03. 

Full year guidance was raised from $66-$72 million to $68-$72 million with Q3 2019 guidance at $16-$17 million. 

Notably, there is no long-term debt on the balance sheet and the company has $58 million in cash.

Valuation is another area where Telaria checks quite a few boxes. Roku and The Trade Desk can wildly fluctuate, but at time of writing, forward price to sales is 14 for both companies while Telaria is at 4.8. 

In the recent earnings report, leadership stated, “This quarter, we also advanced our technology leadership by becoming both the first video platform to provide Nielsen verified audiences to programmatic CTV buyers and by launching our addressable audience targeting solution.”  

This is intriguing as traditional television buyers are impartial towards Nielson for measurement and verified audience purposes. The majority of the television advertising industry is tied to Nielson data. 

The company also expanded the addressable market feature, although addressable is a common offering among

ad companies these days. The more important announcement is Nielson as the brands who are buying Connected TV inventory rely on Nielson for broadcast and linear television ads. 

As you’ll see in the Risks section below, executives at Telaria come from Nielson, which is an interesting advantage for supply-side partnerships.

Sell Side Vs. Demand Side

Put simply, the sell-side works with publishers (inventory or supply). For Connected TV, the publishers are the apps where you view content: Hulu, HBO, Netflix, Vudu, ESPN, etcetera. Sell-side platforms have direct relationships with publishers. 

The demand-side works with advertisers (demand). This is companies like Expedia, Coca-Cola, Geico, McDonalds, T-Mobile, Verizon, BMW, Mercedes, and sometimes other publishers who want to advertise their services (ESPN could buy advertising on Vudu, for instance). 

Programmatic is real-time bidding that removes salespeople. Ad companies often talk up this piece, but in reality, just about all ad-tech is programmatic and offers real-time bidding these days (and has been since about 2012-2014 when ad-tech underwent this evolution for mobile and desktop ads). This is not a differentiator. It does help to facilitate more ad placements and some brands who were adamantly against mobile or desktop will use programmatic for the first time with Connected TV. 

There are strengths to the sell-side approach. The first is that switching costs are higher for publishers than for advertisers as publishers have to install software into their applications to serve the ads. They’ll typically limit the number of sell-side platforms they work with as it can create app bloat to broker with too many sell-side platforms (SSPs). 

Telaria advertisers an impressive client list, including Sling, Hulu, PlutoTV, A&E and the Discovery Channel. One thing to note: ad-tech companies can integrate via server to server rather than through software. The latter is a much stronger relationship. Telaria, and other ad-tech companies, typically don’t disclose if the client list is a direct software installation or a server-to-server integration. In the case of a server to server integration, the switching costs are not high and the relationship is similar to DSPs who have to consistently outperform in order to win the business. 

For example, Telaria may have a direct relationship with Warner Brothers but not with Hulu (who likely uses more than one SSP).

To contrast, the demand-side is almost never loyal and almost always has low switching costs. Often, advertisers will run campaign tests across as many as twenty DSPs and will run the campaign on those who perform the best. This is the downside to programmatic and server-to-server integrations across ad exchanges. Even when the SSP is a server-to-server integration, they are not as aggressive as advertisers in switching. 

It requires very little time or energy to run these tests. Some advertisers will repeat this process frequently before every campaign, going with only the DSP who is performing well in that month. DSPs will differentiate among themselves with features such as omni-channel advertising to become a one-stop shop for campaigns across multiple mediums and device types. 

Of course, as the world is well aware at this point, data is king. The publisher will be paid more if the advertiser can target the audience with more precision. Therefore, the sell-side has an advantage because the direct relationship with the publisher provides the best data. To illustrate, Roku is a publisher of the Roku Channel and a platform owner, as well. There is a lot of data here from these sources, and therefore, the average revenue per user is very attractive at the $20 ARPU. 

Demand-side platforms, such as The Trade Desk, rely on the identifier for advertisers (IDFA) from Apple and their own Universal Ad ID. This helps to track the user for omni-channel advertising and retargeting, such as when a person switches from watching OTT apps to browsing on mobile. However, the playing field is equal for IDFA across all advertisers while The Trade Desk is attempting to have an advantage with their own proprietary Ad ID. 

When comparing apples to apples, the sell-side is better positioned as they hold the data and the inventory in a space that is more limited in inventory than in advertisers. The relationship that is created by installing software holds more weight than the relationship that is dependent on monthly pricing. 

You can see evidence of the value of SSPs historically in the mobile ecosystem. The larger players acquired sellside platforms, such as Google’s acquisition of AdMob for $750 million and Twitter’s acquisition of MoPub for $350 million. These ad companies have little reason to acquire a DSP as this is where they already excel and is easy enough to build, if you have the data. Similarly, Facebook acquired LiveRail for $500 million for its premium video publishers. 

Risks

As noted in the supply-side discussion, ad-tech companies don’t disclose if their client list is a direct software installation or a server-to-server integration. The impressive client list that Telaria discloses, including Sling, Hulu, PlutoTV, A&E and the Discovery Channel, may be brokered to Telaria through server-to-server integrations rather than directly served through ad software. This is a risk because another SSP can easily establish a serverto-server relationship through a web of ad exchanges. Direct software is a more protected relationship.

A primary risk is that Telaria does not have a straight path behind ownership and management. We do not have a passionate-founder type like Anthony Wood or Jeff Green at the helm. I’ll outline what I’ve been able to gather and add some information as to my experience with ad-tech companies during that era. 

Founded in 2012, Telaria’s former company, Taptica, was a mobile user acquisition company. Interesting enough, Neilson EVP Itzhak Fisher was an early investor, which may be why we see Nielson recently partnering with the company on audience measurement. By April of 2014, Taptica wasn’t doing well and sold a purchase option for a $1.5 million line of credit. By October 2014, Marimedia purchased Taptica for $13.6 million. 

By May of 2015, the company issued a profit warning and Marimedia changed its name to Taptica. The company then went through a series of acquisitions, including Tremor Video’s demand-side platform for $50 million. There were mergers in 2018 and 2019, resulting in Taptica renaming itself to Tremor International.

Notably, Hagai Tal, the CEO had to step down due to concealing material facts during a sale in 2011. The former CEO of Matomy Media, Ofer Druker, then took over as CEO of Taptic and Termor International. Mark Zagorski has been CEO of Taptica since 2017, and has connects to Nielson, having served as CEO of a Nielson company named eXelate, and EVP of Nielson’s Marketing Cloud.

Needless to say, the history is complicated. Taptica and Telaria have decent client lists, which helps. This was an era which was particularly hard on ad companies. Part of the anti-trust issues we see with Google and Facebook is that they forced many ad-tech companies out of business. 

There is always a lot of risk when investing in an ad-tech company, and I pointed this out with my analysis on The Trade Desk. There is endless competition as there is no intellectual property to speak of. Advertisers are looking for the best addressable media at the best price, and publishers are looking for the highest returns. Whoever is capable of climbing to the top of the pile (of the 2,000 ad-tech companies on the market) usually isn’t there for very long (1-3 years) The only exceptions are if you have proprietary first-party data or other direct relationships.  

Technical Analysis

By Knox Ridley

Telaria (TLRA) has had a rather complex structure ever since it began trading in 2013 under Taptica/Tremor. In fact, its all-time high occurred on its IPO around $11.09. Since then, its structure has been a complex, overlapping, corrective (A,B,C) structure up until today. 

In other words, it bottomed in early 2016 at $1.29, and though it’s been in an uptrend, that uptrend has been characterized by a series of 3-wave corrective moves. This would put us in the final C-Wave push of this uptrend. So, after a massive move from $1.29 to $10.66, the structure of this uptrend seems to be part of a larger degree corrective structure, which is highlighted by the blue A,B,C. 

That being said, the structure of TLRA is not as reliable as the current trend currently in place. Time and time again when I’ve seen these larger-degree, corrective moves up, over time, and with some additional momentum, morph into a larger degree 5-wave structure, which I never want to miss out on. 

Or, I’ve seen them morph into an even more complex structure or extend to much higher levels. This can be especially true when analyzing the charts of small to micro-cap stocks that are thinly traded. In short, seeing a complex corrective structure in a small cap stock, I take this as the market not really sure what to think of TLRA at the moment.

As you can see in the chart, TLRA reached the 100% extension of the A wave (A=C in blue), and then turned down hard. It found support at the 23.6% retrace level, which coincides with the 200-day moving average. I outlined this region in yellow, and would place a stop just below $5.75. Below this region and the likelihood of closing the massive gap around $3.70 becomes elevated. This will provide entry with a rather tight stop – low risk with high reward.

Furthermore, the MACD has found a base, and is now turning up, while we go into earnings.This is a sign that momentum is shifting back to the upside. Also, note the volume has elevated to new heights, which is signaling increased interest, which has been heavily tilted to the long side. With volume lowering into this pullback, and the stock resting over the 200-day, it appears that TLRA is in a wait and see mode with their earnings on deck.

Alibaba Premium Analysis 2019

Posted on by io-fund

fe5dd2d0-c208-4bd7-8d85-d9b1caa0d308_Alibaba-Premium-Analysis_2019.pdf

Alibaba Premium Analysis 2019

Introduction:         

Alibaba is situated between two of the major growth drivers in tech: cloud infrastructure and B2B eCommerce. China is the world’s leader in manufacturing, and this country has the widest gap between the current cloud IaaS and future cloud IaaS market.

Alibaba would be a breakaway stock if not for the trade war and China’s slowing economy. The second-largest economy in the world grew 6.2% in the second quarter of 2019, a drop from 6.4% in the first quarter. This is the slowest growth since 1992. Industrial output growth slowed to 4.8% in July, which is the weakest pace since February 2002.

This analysis will outline the major industry verticals that Alibaba is uniquely positioned to benefit from along with technical analysis to help guide entry in a choppy geo-political environment. 

SECTION 1: Fundamentals        

Alibaba trades at 25x forward earnings and 21x cash flow, while growing revenue at 40% with long-term earnings growth projected at 26% and a PEG of 1.1. Amazon trades at a forward PE of 45 and MercadoLibre at 111. 

Alibaba’s projected earnings growth is higher than its mega-cap peers at 26%, including Facebook at 21.6%, Apple at 4.53%, Amazon at 18.9%, Microsoft at 11.1%, or Alphabet at 17.6%, placing its implied share price at a minimum of $231 when comparing P/S ratios to forward growth. Based on P/E ratios to forward growth, Alibaba is also undervalued relative to its peers. 

According to MarketBeat, analysts have a consensus price target of $221.64, representing 33% price target upside. Analysts have had a BABA price target above $200 since early 2018. Since the last earnings report, HSBC, Morgan Stanley, Raymond James, Goldman Sachs, Bank of America and a few others have either set price targets above $200 or boosted their price target. 

•       Revenue last quarter rose 42% year-over-year to $16.8 billion compared to 51% growth YoY in the last quarter

•       Operating income grew 27% year-over-year excluding stock-based compensation from Ant Financial. Adjusted EBITDA increased 35% year-over-year to $5.7 billion

•       Net income was $2.79 billion with non-GAAP net income of $4.05 billion, with an increase of 54% yearover-year

•       Diluted earnings were $1.17 and non-GAAP of $1.83, or an increase of 56% YoY. 

Core commerce revenue was up 44% and “other revenue” was up 134%, consisting of new retail and direct sales businesses. The company reported strong growth in Southeast Asia, with orders growing over 100% for the third consecutive quarter. Cloud computing was up 66%.

The most recent earnings report called attention to the fast-growing Taobao, the world’s biggest eCommerce site, and Tmall, a spinoff of Taobao. These platforms grew 44% and 34%, respectively. Taobao has 730 million active buyers across its marketplaces, representing about 50% of the Chinese population.  

The last earnings report also highlighted additional revenue drivers such as the grocery retail chain Freshippo, and the Cainiao Network, which offers cross-border fulfillment and last-mile solutions. As of June 30th, 2019, there were over 150 self-operated Freshippo stores.

Alibaba may hold a separate listing in Hong Kong for as much as $20 billion this year. 

SECTION 2: B2B eCommerce            

The B2B eCommerce opportunity is tremendous with estimates the market will reach $12.2 trillion in 2019 compared to $2 trillion for the B2C market. Of this, Asia Pacific contributes 80% to the market with North America and Europe’s share being 12% and 3%, respectively. The four largest markets are China, Japan, South Korea and the United States.

According to Gartner, spending on B2B eCommerce platforms is expected to grow at a CAGR of over 15% during 2015-2020. The Asia Pacific B2B eCommerce market will be worth an estimated $9.8 trillion in 2019, up from $4.7 trillion in 2013. Compare this to the North American market, valued at $1.4 trillion in 2019.

According to Accenture, 50% of B2B companies around the world began to implement a digital strategy in the last three years, rather than rely on a salesperson’s personal relationship with the client. B2B eCommerce follows either a direct model that allows companies to sell directly to buyers, or a marketplace model where products are sold alongside competitors. The marketplace model has gained the most traction due to the ability for wholesalers, distributors, and manufacturers to test new geographic markets. 

Alibaba claims 30% of the Chinese B2B market and is expanding its operational base into India, Europe and the United States. Due to a vast network of low-cost suppliers, Alibaba is able to dominate the market. Alibaba’s main strategies include adopting an online to offline (O2O) approach and collaborating with local finance and logistics companies in international markets. 

China is the largest B2B eCommerce market in the world and is expected to grow from $1.3 trillion in 2013 to an estimated $3.5 trillion in 2019, at a CAGR of 17%. China’s market is bigger than both North America and Europe combined. 

In 2018, the top three B2B platforms in terms of revenue were: Alibaba, HC350 and Cogobuy. Together, these three companies make up 57% of the Chinese market. Alibaba is now focused on the Indian market, where the company competes with Amazon. 

SECTION 3: Ant Financial                  

Ant Financial is the Alibaba affiliate that operates the Alipay payment service. Operating income tripled in the most recent earnings report. Alibaba’s share was $237 million, representing 7% of operating income, which was the highest in two years. In the past, Ant Financial has run at a loss or provided zero earnings. 

Ant Financial is worth about $150 billion and serves about 1.2 billion users with 300 million users outside of China.  The company is considered one of the most valuable private sector FinTech companies in the world. Due to a recent restructuring deal, Ant Financial is eligible for an IPO in the coming years. 

SECTION 4: China’s Cloud IaaS Market         

China has been more than fashionably late to cloud infrastructure with a total market size of $1.2 billion in 2018 compared to the United States’ $40 billion in 2018, which affords a window of opportunity. The majority of the 20x growth of this segment in China will funnel into Alibaba with the company already owning 90% of the market. 

China’s enterprise IT market is five to seven years behind the United States and Western European markets. Once fully mature, China’s need for cloud infrastructure will rival the United States with 3x the population and a bottomless appetite for smart cities, artificial intelligence and machine learning plus manufacturing IoT automation. 

The reversal of where China is today with cloud IaaS, and where China will be in five years, could be a bigger story than the B2B marketplace as the growth is closely tied to China’s position as a global leader. 

In 2017, China published a roadmap on how it seeks to become a global powerhouse in AI. According to the report entitled “Next Generation Artificial Intelligence Development Plan,” the domestic AI market will be worth a total of $150 billion. Today, China’s AI market is worth $6.2 billion.

Artificial intelligence and machine learning require private cloud and public cloud infrastructure-as-a-service (or a hybrid mix with on-premise servers) as storing data in separate silos weakens AI and ML capabilities, reduces training performance and lowers accuracy. Artificial intelligence and machine learning require speed with most AI solutions split between 40/60 with private/public cloud or 60/40 if you’re a regulated industry. The United States CIA describes moving to the cloud in 2013 the “best decision we’ve ever made” as what used to take 180 days to provision a server improved to 60 days, and now takes minutes. 

At roughly fifty percent year-over-year growth, China’s AI market will reach approximately $60 billion by 20232024, which is in line with China’s Development Plan. This is also in line with the global market forecast which puts the AI market at $190 billion by 2025. The overall Chinese AI industry is growing at a rate of 67 percent and the country is now producing more AI patents than the United States. On that note, Alibaba’s cloud growth is currently at 66% year-over-year with $1.13 billion in quarterly revenue. 

4B. Alibaba Cloud

Amazon is the perfect example of how profits from a cloud economy can outpace eCommerce income. The parallels between Alibaba and Amazon are easy to see. Both are e-commerce companies that are pioneers in cloud infrastructure as a vast number of servers had to be built to handle traffic spikes and large work-loads on peak days, such as Black Friday and Singles Day. 

In the most recent quarter, AWS accounted for 13% of Amazon’s overall revenue and 52% of Amazon’s $3.1 billion operating income and is growing at 37% year-over-year. Microsoft’s cloud IaaS is growing at 64% YoY.

As stated previously, China has been late to adopt IaaS cloud, and this likely contributed to Alibaba’s delay as the first serious investment by the company was made in 2015, six years after the launch in 2009. Since 2015, it has taken Alibaba only three years to reach a $1 billion run rate compared to Amazon’s six years (2006-2012).

In addition, tech developers are responding to Alibaba with over 120,000 people attending its cloud conference compared to the AWS conference, which attracts 50,000 attendees. This is important intel that financial statements don’t reveal. 

Alibaba Cloud reported 66% year-over-year growth in Q2 2019, primarily driven by enterprise customers. During the June 2019 quarter, Alibaba Cloud announced the SaaS accelerator plus over 300 new products and features. This is what the current YoY cloud growth trajectory looks like when modeled. 

The law of large numbers could slow the trajectory depicted on the chart, although China’s late entry to the cloud IaaS market is likely to do the opposite and accelerate (or at least sustain) the YoY growth in the nearterm. 

Today, AWS reports about 40% growth YoY more than a decade after it launched. Microsoft’s Azure reported 300% growth between 2015-2016 and 90-100% growth for the following years. 

Globally, Alibaba has quietly become the number four cloud services provider worldwide, behind Amazon, Microsoft and Google when Synergy Research Group placed Alibaba ahead of IBM. Note, Gartner places Alibaba as the number public cloud provider. Across Asia-Pacific, Alibaba is the number two cloud services provider. 

Alibaba Cloud was launched in 2009, however, the company did not take the IaaS revenue segment seriously until 2015, when Alibaba made its first investment of $1 billion. As stated in previous analysis, China has been late to adopt IaaS cloud, and this likely contributed to Alibaba’s delay. When adjusting Alibaba Cloud to 2015, we see it took 3 years to reach $1 billion run-rate (2015-2018) while it took Amazon 6 years to reach a $1 billion run-rate on AWS (2006-2012).   

                               

4C.  Capex for Cloud IaaS               

For the most recent quarter, adjusted EBITDA margin for Alibaba Cloud was -5% compared to -10% and -4% in previous quarters. According to the company, infrastructure and capacity investments triggered the quarterly loss. 

Alibaba’s quarterly free cash flow in Q2 2019 was $3.8 billion with net cash of $5 billion. Therefore, like Amazon, the e-commerce business is able to carry the capex requirements for the cloud business. With that said, investors should be aware that building modern cloud computing services requires billions every quarter. For historical. comparison, Google spent $5.6 billion in accrued capex in Q3 of 2018 and Microsoft spent $4.3 billion on capex during the same period for “ongoing investment to meet demand for our cloud services,” as pointed out by Amy Hood, Microsoft’s CFO.

Please keep in mind, there will be opportunities for an attractive entry as Alibaba Cloud will not command AWSlevel and Azure-level percentages of revenue until H1 2020/H2 2020 and onward. 

However, once AWS and Azure reached $5 billion in revenue, stock prices were around $300 and $70, respectively so entering Alibaba before the Cloud revenue reaches $2-$4 billion in quarterly revenue is important. While IaaS did not account for all of the increase in revenue (obviously) from the $300 and $70 stock price mark for AMZN and MSFT, I want to emphasize that cloud IaaS is Amazon’s top growth driver still today and Microsoft’s fastest growth driver for many years is Cloud IaaS. 

The capex costs will affect free cash flow at times, however, this is not a concern long-term as typical cloud profit margins are around 58 percent and typical operating margins are at 22 to 32 percent.

Time  Machine:      Time  Machine:     

I wanted to leave you with a fun, little blurb from Amazon’s earnings in 2011 on AWS when it was at $1 billion in revenue (it’s now at $25 billion in annual revenue in 2018). Alibaba Cloud is at the $1 billion barrier right now.

“The speculation that Amazon's cloud is breaking the $1 billion barrier in the very near future comes as the cloud giant prepares to announce its 2011 second quarter earnings Tuesday.

"While still very small for Amazon (likely about $750 million revenue run rate), given the size of the market opportunity and Amazon's strong competitive positioning, we believe that this could soon be a $1 billion revenue segment," Citigroup Internet analyst Mark Mahaney said in a note to investors last week.

And Mahaney isn't alone in his lofty Amazon cloud expectations. In fact, his estimate could be seen as conservative. JPMorgan Chase's Dough Anmuth told Reuters that he expects Amazon's AWS to generate a whopping $2.6 in revenue come 2015.”

SECTION 5: TECHNICAL ANALYSIS                

By Knox Ridley

5A. Overview – Weekly Chart

Looking at the weekly price action, along with the weekly Relative Strength Index (RSI), provides us a with a view of the overall health of a trend. Providing this history helps to also filter out any short term moves that are based on emotions. The above chart is Alibaba’s (BABA) weekly chart going back to 2016.  

Long-Term Trend Lines 

The dark blue trend lines highlight the long-term trends in play. The uptrend line started with the 2016 bull market. The price has tested this trendline 4 times on the weekly chart, going back approximately three years. It’s worth noting, the more a stock tests a support/resistance region, the weaker it becomes.  

There is also a downtrend line, highlighted in blue that has been pushing the price of BABA down since the June high in 2018. These 2 trend lines are converging into a triangle pattern. The price of BABA is being forced to a decision soon, and we will know rather soon if the bottom is in for BABA, and the uptrend will continue, or if we could get a retest of the December lows. 

5B. Moving Averages     

The 50-Day Moving Average is in orange. The price of BABA is trading just below the 50-day. This average is acting as resistance, and is sandwiched between the 50-day, above, and the blue long-term trend line below. The pressure is currently down, but what BABA does in the next few days will determine the next move in the trend.

The 200-Day Moving Average is in green. The 200-day is commonly looked at as the final stand for a bull pattern. It’s worth noting that the 200-day is currently just below the $130 region, which coincides with the December 2018 bottom and 39.2% retrace level. Any pull back from here, and the 200-day will be major support to follow. 

5C. Intermediate Trend Lines and RSI Warnings    

The two dotted lines are lower time frame trendlines. Note how the price trends coincide with the RSI trendlines below. This is always a sign of a healthy trend. When I see a trend like this – both down and up – I follow the RSI to get a clue as to when the trend may be over. 

The red X indicates the point where the price and RSI both broke their trends. As usual, this happens in unison, and is a major warning for anyone long the position. Leading up to this trend break, the RSI started making lower  highs, warning of a momentum slow down. These valuable tools that Technical Analysis can offer help to manage risk. 

Conversely, we have the opposite scenario on the downside. The price and RSI followed a downtrend into the December low 2018, which is shown by the second dotted line. Just after this moment, both the RSI and the price broke their downtrends. The RSI made higher highs as the price made its final low. All of these signs indicate a reverse of trend to the upside.

I’m pointing this out because we have a similar pattern unfolding today. The RSI and the price are hovering just above their respective trendlines. If they both break, I would take that as a warning of further down side to prepare for.

In conclusion, because we are trading at the end of a triangle pattern, BABA is about to give us an indication as to the direction of the next move. Below, I outlined the bear and the bull cases. 

5D. Elliot Wave – Bear Count

The bear count has us currently in a larger degree Wave 4, which are the numbers #1-#3 highlighted with the blue count. The extensions of this count are in blue on the far right. These extensions act as guides for moves higher and lower and they are important for determining the likely target of any additional pullback.  

If we look one degree lower, you’ll see the red 5 count, which is the internal waves of the blue count.

Remember, the pattern of 5 waves in the primary direction and 3 waves in a corrective direction is occurring on 

All levels – larger degree and smaller degree. So, the larger degree Blue count, has its own internal count, which can give us clues as to where the market may be leaning.  

So, we have a clear 5 waves up in red, which completes wave 3 in the blue count. The retrace levels of this count, are shown in red on the right. We touched the 38.2% retrace level, which acted as final support for the previous pullback. 

I put the 50% retrace level on the chart as well, which is the bottom of the bearish target box in green. I don’t see BABA going lower than this level, even in a worst-case scenario. Furthermore, I believe you have to have a “good enough” price tag for a solid long-term investment in a downtrend. Baba at or below $130 is a steal, even if it goes lower. 

A pattern that keeps showing up within this pullback is a classic A,B,C correction, where the C wave extends with 5 waves to at least the 138.2% extension. This can be seen with the first drawdown move with the orange A,B,C count, and with the 5 wave count of the final C wave revealed in teal roman numerals. This pattern is a clue to 

the likely path of the larger degree pattern, and I am expecting this pattern to unfold to the downside in my primary count. The extension to this final C wave down is shown in pink. 

If we break the $146 support region, I will consider this count in play, and suggest preparing accordingly. I will consider this count to be invalidated if we break the triangle pattern to the upside and close above $185. At this point, we will likely be in the bull count, which is listed in the next section.

5E. Elliot  Wave – Bull Count

The Bull Count has the larger degree wave 4 ending at the December low. We have all the waves and the proper structure in place to justify this; also, the time frame works to justify this count as well. If this count is where we are, then we are in the final 5th Wave push, and just about to begin the heart of this move, which I calculate will take us well beyond the all-time highs. This count will be invalidated if we move beyond the $146 support region. If this happens, we will likely revisit the $130 support region and possibly beyond. 

Because of the fundamental story in BABA, we have a high conviction on the company, yet naturally, are unsure of the geo-political environment. For now, we favor the bull case absent any news around the trade war, the delisting of Chinese companies, etcetera. At minimum, I’d place a stop just below $146. If you want further confirmation, wait for $185. 

Shopify 2019 Analysis

Posted on by io-fund

Shopify has made it clear they are in the product-market fit stage and will scale between 2021-2023, as referenced in a recent investor presentation. Product-market fit is an exploratory stage where profits are not prioritized. Once product-market fit is achieved, the growth trajectory can move very quickly. 

Gross Merchandise Volumeis growing 51% year-over-year at $13.8 billion.

Shopify makes 2.63% of GMV, or $361M of the $13.8 billion. Compare this to Amazon.com who makes 26.7% of GMV ($42.7 billion on $160 billion GMV, in 2018) and eBay who makes 11.7% of GMV ($10.86 billion on $92.6 billion, in 2018).

In June, Shopify announced the Shopify Fulfillment Network to serve as a dedicated fulfillment center and to speed up deliveries to help merchants remain competitive. The goal of the fulfillment center is to put independent retailers with 10 to 10,000 orders per day on par with the fulfillment centers of larger retailers. To date, only early access to the fulfillment center is available.

faf607f5-be25-40d7-8f8a-579174b86d69_Shopify-Premium-Analysis-10-2019.pdf

Shopify 2019 Analysis

Introduction:         

Shopify is a stock that comes with a heated debate due to prospects for high growth and immense volatility. The stock has a high valuation (at times), and momentum traders are attracted to the stock, which hasn’t helped the volatility. To illustrate, 52-week low is $117.64 and the 52-week high is $409.61.

This analysis will look at where Shopify is today, and Shopify’s potential by 2023, with ideas for entry. From Shopify’s acquisition strategy and fulfillment plans, it is very unlikely the Shopify we see today will be the Shopify of the future. This is due to the acquisition strategy, and Shopify’s clear ambitions to be more than point-of-sale software. 

The risk is Shopify’s high valuation compared to the timing of when Shopify will report the anticipated profits from the new fulfillment center and expansion potential (2021-2023). New investors risk over-paying now for the Amazon-like aspirations that may materialize in two years from now. In addition, investors who have early positions risk exiting due to broader market volatility that is driven by momentum reversals and rotation into value. The goal will be for new investors to enter at a price where there is upside potential and for existing investors to remain invested at an unshakable valuation. 

The reason to stay long on Shopify, is that industries get disrupted and e-commerce is overdue for disruption. Amazon’s pay structure is not fair to merchants at 26%. eBay is stagnant in revenue growth for nearly 10 years (fluctuating between $8B to $10B). Shopify is already the third largest online retailer in the United States and is doing one thing very well that the others neglect: emphasizing the merchant (whereas Amazon’s focus is the customer). I believe this piece to the product-market fit will carry Shopify through the hurdles of taking market share from one of Wall Street’s favorite darlings (Amazon) – more on this below.

Product Overview    

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

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

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

Amazon had a very successful pivot from selling books to selling all retail items. For an investor to see a pivot, it requires looking beyond where the company is today. 

Shopify counts over 800,000 merchants as customers compared to Amazon’s 5 million marketplace sellers. Shopify charges the sellers 2-3% compared to 26.5%. Amazon is also predominantly a United States presence with about ¾ of sales occurring domestically. Shopify does not break out these numbers but it is widely understood to have a global strategy. 

As mentioned previously, an important distinction between Shopify and Amazon is that Shopify places the importance on the merchant while Amazon places the importance on the retail customer. While Amazon builds out 1-day shipping, Shopify is building out tools for platforms and tools for merchants. 

Perhaps unfamiliar to public markets, the phrase “chicken and the egg” is often talked about in private markets. This phrase refers to the question of which comes first for a product or service – the buyers or the sellers. Shopify’s strategy to attract merchants through increased services and decreased costs is a very valid approach, and in my opinion, this is what will cement Shopify’s success.  

Shopify is very clear they are in the product-market fit stage and will scale between 2021-2023, as referenced in a recent investor presentation. Product-market fit is an exploratory stage where profits are not prioritized. Once product-market fit is achieved, the growth trajectory can move very quickly.  

Source: Shopify 2019 Investor Day

Fundamentals        

Shopify has grown at a pace of roughly 55%-60% year-over-year or more for quite a few consecutive years. The company is profitable on an adjusted basis, yet is not profitable by GAAP standards. The adjusted operating margins are at an estimated $20 to $30 million this year. 

Adjusted earnings came in at 14 cents in the most recent quarter, up from 2 cents a year ago. Shopify reported revenue of $362 million, up from $245 million, and ahead of earnings estimates of $350 million. Net losses were at $28.7 million, or 26 cents per share, compared to $24 million, or 23 cents per share in the year-ago quarter. 

Shopify’s full year revenue is expected to be in the range of $1.51 billion to $1.53 billion. GAAP operating loss is expected to be between $145 million and $155 million with an adjusted operating income of $20 to $30 million. 

Next quarter, Shopify expects to report revenue between $377 million to $382 million, above consensus estimates of $374 million. GAAP operating loss is $44 million to $47 million with adjusted operating income between $0 to $3 million. 

There is some criticism around the stock-based compensation that has been paid, as the spread between GAAP and non-GAAP is wider than many other companies in a similar revenue bracket. 

Shopify has held frequent, secondary-offerings. In September, Shopify offered 1.9 million shares, raising $600 million. In December, Shopify sold 2.6 million shares, which followed a 4.8 million share offering earlier in the year. 

GMV  

Gross Merchandise Volume is growing 51% year-over-year at $13.8 billion. 

Shopify makes 2.63% of GMV, or $361M of the $13.8 billion. Compare this to Amazon.com who makes 26.7% of GMV ($42.7 billion on $160 billion GMV, in 2018) and eBay who makes 11.7% of GMV ($10.86 billion on $92.6 billion, in 2018). 

Percentage of GMV illustrates the power of owning the domain. Notably, from an investment standpoint, eBay is not a growth stock with stagnant revenue and Amazon is not a pureplay – therefore, these are not perfect comparables for valuation even if their business models are similar. 

With that said, eBay makes 7x more in quarterly revenue than Shopify and roughly $500 million in net income per quarter, yet Shopify commands a higher market cap than eBay. Therefore, Shopify’s growth is being duly rewarded and the question remains if there is upside potential for new investors.

Product Launches & Acquisitions           

In June, Shopify announced the Shopify Fulfillment Network to serve as a dedicated fulfillment center and to speed up deliveries to help merchants remain competitive. The goal of the fulfillment center is to put independent retailers with 10 to 10,000 orders per day on par with the fulfillment centers of larger retailers. To date, only early access to the fulfillment center is available. 

In the most recent earnings call, COO Harley Finkelstein stated Shopify will spend $1 billion on the fulfillment center over the next five years, while CFO Amy Shapero said the company plans to bring seven warehouses online this year. 

The announcement of the fulfillment center places Shopify closer to online retail rivals, such as Amazon and eBay, while distancing Shopify competitively from point of sale systems, such as Square or Stripe. Shopify will also offer custom shipping boxes and additional value adds, although the real value is in easing the inventory and fulfillment details that can become complicated with third-party logistics providers. 

Notably, eBay announced a rival fulfillment center at their user conference in July. 

This month, Shopify announced the acquisition of 6 River Systems, which will add collaborative robot fleets to Shopify’s Fulfillment Network. 6 River Systems builds robots that speed up production in warehouses. The company’s collaborative robot named “Chuck” guides employees through facilities and each step of the packaging process. The acquisition will bring on board robotics experts who worked on Amazon’s Kiva Systems. 

The acquisition of 6 Rivers is strategic as the company will have annual revenue of $30 million in 2020 and will increase the company’s expenses by $25 million in the current year, adding no material value. 

Last May, Shopify acquired the B2B wholesale purchasing platform, Handshake. Handshake’s platform offers the ability for merchants to handle sales directly rather than pass off the sale to a third-party marketplace. The team from the acquisition became part of Shopify Plus, the enterprise-level part of the business that can handle over 10,000 transactions per minute. B2B e-commerce sales in the United States reached $1 trillion in 2018, with Shopify Plus making up 24% of revenue in 2018. 

Borderless Retail & B2B eCommerce

Shopify’s mission is to offer borderless retail. The company envisions a future where North American shoppers can easily and seamlessly purchase from Europe, Asia and other continents without the level of friction and delays experienced today. Expanding globally is an area where Shopify plans to offer expertise. The company offers many tools and marketing ideas for small to medium-sized retailers. Statistics provided by Shopify indicate that 57% of online shoppers make purchases from overseas retailers. 

B2B eCommerce, which is the exchange of goods and services between companies, has overtaken B2C eCommerce. According to Statista Digital Market Outlook, the global B2B eCommerce market will be worth $12.2 trillion in 2019 compared to $2 trillion for the B2C market. Keep in mind, Asia Pacific contributes 80% to the market, with the majority off limits in China, with North America’s share being 12%. According to Gartner, spending on B2B eCommerce is expected to grow at over 15% during 2015-2020. According to Statista, the North American Market is estimated to be worth $1.4 trillion in 2019, up from $606 billion in 2013, growing at 15.3%. Europe is growing at 5.6% CAGR. 

source: Statista

Shopify is not on the map as a competitor in the B2B eCommerce space. The major players are Amazon, Alibaba, Rakuten, Mercateo, Global Sources, Walmart and IndiaMART. 

Amazon, especially, is doing well in this space and has made an effort to work with startups with Amazon’s newer B2B platform called Launchpad. The company partnered with crowdfunding platforms, venture capitalists and startup accelerators, like Kickstarter, IndieGogo and Y Combinator, to provide capital to help B2B startups launch and scale. The UK launch of the platform was also supported by the startup community and platforms such as Crowdcube. This is more of the level where Shopify competes, compared to Alibaba or Mercateo. 

Conclusion: 

Shopify has stated they are in the product-market fit stage. Investors should use this to their advantage as many doubting investors may lose patience by the time the company reaches its growth trajectory stage. The financials are not likely to provide the safety net most investors need to be comfortable as the company is 1-2 years from its major growth phase. 

Shopify currently has a forward price-to-sales of 24, and thus, you should believe in a company’s strategy when there is a higher valuation. From a go-to-market strategy and unique value proposition perspective, Shopify has an excellent strategy, in my opinion – which is to focus on the merchants. You can expect Shopify to undercut Amazon on the merchant costs while iterating until their fulfillment is on par. This is attacking Amazon on the flank, so to speak, rather than head-on by focusing on the customer. Therefore, with proper execution, Shopify has a viable competitive advantage. 

Technical Analysis       

By Knox Ridley

Moving Averages     

Shopify (SHOP) has broken both its 20-day and 50-day moving average, with the 20-day crossing over the 50 to the downside. This crossover is notable, but as you can see, this happens quite frequently when SHOP goes into a correction.  

The 20-day is typically viewed as a normal pullback defense, while the 50-day is considered an uptrend defense. 

The 20-day is clearly pointing down, which can be seen in the above chart by looking at the orange line, while the 50-day is just beginning a slower arch down, which can be seen in green. When the 50-day begins to shift its direction, it’s much more notable, and warrants caution.

The 200-day is highlighted in purple. As you can see, the price is approaching this average, but is still above it. We will want to watch how the price reacts to this level. Typically, the 200-day is strong support, so any break below should be noted.

Internal Strength      

Relative Strength Index (RSI):   

Regarding Shopify, there are a few points worth noting. First, notice the blue trend lines in the price of SHOP and in the RSI. These trendlines started at the December 2018 bottom. As the price moved along a specific upward trendline, highlighted in blue, so did the RSI, also highlighted in blue, which is indicating a healthy uptrend. Both of the trends broke in unison, which is highlighted by the black arrows, indicating that the current uptrend is over. The extent of the downtrend is the question to answer.  

if you look at the horizontal red line at the 27 mark of the RSI, this line has acted as support for the uptrend since 2016. Until the RSI breaks above 60, the momentum is pushing down.  

Moving Average Convergence/Divergence (MACD):              

The MACD is an indicator used to gauge momentum as well as changes in trends. You’ll notice the intensity of the current downtrend in the MACD. The redline running along the -5.75 line has acted as strong support going back to 2016. The MACD’s momentum never broke this level. Today, the MACD broke through this support with force, making much lower lows. Therefore, the downtrend we are in may not be over.

Conclusion:             

According to the MACD, the current downtrend has a level of momentum that we have not seen in Shopify, so far. The 50-day is beginning to point down, which is a further indication of weakness. We will want to watch the 27 line on the RSI as well as the below moving averages. If we break these levels, expect more downside to follow. 

Head and Shoulder

     

A Head and Shoulder pattern is a widely regarded bearish pattern. The dotted black line indicates the “neckline,” or support at $281.75. If this level breaks, and is confirmed by price failing to break back above the price region, expect downside to follow. Anyone holding Shopify and is looking to protect gains, I would hold a stop just below this level at $281. As you’ll see in the next section, this support level also lines up with an important Fibonacci level as well, which adds to the importance of this support region.

Elliot Wave                    

Elliot Wave Theory is, in my opinion, one of my favorite tools for organizing a game plan for a position. According to Elliot Wave, the market moves in a 5-wave, move in the primary direction of the trend, and then 3 moves in a corrective direction, and then repeats. These moves line up with and are confirmed by Fibonacci ratios, which are viewed as accurate in many instances. Whether you believe in this theory or not does not matter, because the market believes it. In other words, time and time again we see the market react to these ratios, which is why I use it to gauge a general game plan.

Aerial View (primary count):         

In the case of SHOP, from the 2016 uptrend, we can see a clear 5-wave up trend, highlighted in green. My primary count has us completing 5 waves up; however, it’s worth noting that SHOP has a history of extending its 5th wave.  My primary count will be invalidated with new highs. 

If you want to play this bullish scenario before confirmation, place a stop below the neckline of the head and shoulders pattern, which also coincides with the 138.2% extension within Wave 5’s count ($281). I see this support region as the determining factor – if it holds, expect an extended 5th wave and new highs, but if it breaks, I’m expecting a deeper than expected pullback.  

If the head and shoulders pattern is confirmed, we will likely reach the box in green highlighted in the graph, which coincides with a cluster of extensions and retrace levels. It’s worth noting that there are not a lot of support levels below the current level we are hovering over. If this level breaks, I’m expecting a retrace to at least the 23.6% retrace level ($196 region).  

Fibonacci ratios place a low point is around the 38.2% retrace – around the $125 region. This is unlikely even in a worst-case scenario, however, some Wave 2s hit these Fibonacci ratios. Due to Shopify’s fundamental strength, this is unlikely.

Once the wave-2 retrace is complete, we will start a powerful wave 3 on this larger degree in blue, which my calculations have us going well beyond to new highs. The primary goal is to catch the wave-3. 

Close Up View:

The above chart offers a significant clue to where we are in the overall count, and further evidence I am using to justify caution. When we see 5-waves on any level, it indicates the direction of the main/primary trend. When we see 5-waves down on a smaller level, after a 5-wave uptrend, it’s an indication of a trend change.

We can clearly see a 5-wave pattern down from the highs, which is highlighted in magenta, and a retrace back to the exact 50% retrace level. This retrace level unfolded in a 3-wave corrective pattern. This information on the micro level tells me that more downside could follow. This is important because even if you want to play the upside, then please mind the $281 region as an appropriate stop. 

Uber and Lyft Premium Analysis 2019

Posted on by io-fund

Core Platform Contribution Margin is described as “profit (loss) as a percentage of core platform adjusted net revenue.”  This describes the profit margins from every ride-hailing trip or food delivery, (the latter applying only to Uber). This margin falls between gross margin and operating margin.

CPC Margin is calculated by starting with core platform net revenue, minus costs like marketing research-and-development costs, and the result is the “core platform contribution (profit) loss. Divide this by core platform net revenue.

The operating profit margin is lower than the Core Platform Contribution Margin as the latter doesn’t include R&D from autonomous vehicles. Conveniently, they’ve come up with a metric to remove these investments.

df814209-09dc-4fb5-85a5-b1bb6f03ecbd_Uber-and-Lyft-Premium-Analysis-2019.pdf

Uber and Lyft Premium Analysis 2019

SECTION 1: Contribution Margins       

I’ve written about Uber and Lyft extensively and want to expand on a few key metrics that are causing further concern. There are thousands of key metrics across the technology industry not recognized by the financial industry. Venture capitalists rely solely on these key metrics to make informed decisions around which companies they should invest in. 

Popular key metrics in mobile are monthly active users, daily active users, average revenue per user, churn and retention. For cloud SaaS, net retention rate, monthly retention rate, gross revenue retention, customer lifetime value and customer acquisition cost are a few key metrics that are important.

Here’s a snapshot of key metrics tracked by a VC on a SaaS investment:

Uber and Lyft’s Key Metric:         

Core Platform Contribution Margin is described as “profit (loss) as a percentage of core platform adjusted net revenue.”  This describes the profit margins from every ride-hailing trip or food delivery, (the latter applying only to Uber). This margin falls between gross margin and operating margin.

CPC Margin is calculated by starting with core platform net revenue, minus costs like marketing research-anddevelopment costs, and the result is the “core platform contribution (profit) loss. Divide this by core platform net revenue.

The operating profit margin is lower than the Core Platform Contribution Margin as the latter doesn’t include R&D from autonomous vehicles. Conveniently, they’ve come up with a metric to remove these investments. 

Here’s a snapshot of Uber’s contribution profit (loss) worsening quarter-over-quarter (40)% and also the decline in contribution from the core platform over the past six months (87)% with an increase in other bets.

As a percentage of revenue, the Uber’s most recent contribution margin is 8.2%. Here is what the contribution margin looks like historically:

Compared to Lyft’s contribution margin, which is nearly 5x better and has been very consistent, as well:

Negative (or very low) contribution margins indicate that Uber is becoming less profitable as it gains more customers. This could be due to Uber competing in global markets and needing to lower prices to remain competitive. 

The problem for Lyft, is that due to its association as a ride-share company, it will continue to be overshadowed by Uber’s performance. From a key metrics standpoint, Uber is weaker than Lyft. Regardless, both companies are weak fundamentally and provide an excellent opportunity to hedge long positions. 

Additional Reading on Uber and Lyft’s Fundamentals:

Path to Profitability is a Dead End

Uber: Q1 Earnings

Uber’s IPO Lyft’s IPO

SECTION 2: Lyft Technical Analysis                   

By Knox Ridley

We don’t have a full year of price action for Lyft, but we do have some information to work with. First off, if we look at the Anchored Volume Weighted Average Price (AVWAP), which is anchored to the opening high, you’ll notice that Lyft’s price has predominantly stayed below that line, which is highlighted in aqua blue. Furthermore, the recent leg down is showing significant weakness, which can be seen in the separation between the AVWAP and the current price. 

This same weakness is further highlighted between the separation in the long-term trend line, highlighted in black and the current trend price. As the RSI approaches the 60 line, the price is making a much lower low, which is not even approaching this trend line or the AVWAP. The continued separation between the AVWAP, long term trendline and the price is an indication of increasing weakness in Lyft.

Institutional Buyers/Sellers:     

Those massive spikes in volume indicate institutions buying and selling at specific prices. Because of this, these price points will mark significant support/resistance zones. This is noticeable in how the price bounced around the institutional price clusters, highlighted by the black lines, before finally giving way to the downside last Tuesday, September 25th. This most recent selloff not only broke with force through this support region, but also the 61.8% extension, making all time new lows.     

This is notable for a few reasons. One, there is institutional money that sees Lyft as a buy at these levels, so a large amount of money is pegged at these prices. Also, these levels indicate strong support for this very reason, which now will act as resistance.  

Negative RSI Reversal:     

The negative RSI reversal pattern is currently playing out in Lyft. This happens when the price is making lower lows, while the RSI makes higher highs. This is an indication of fading momentum, and a great indication of further downside ahead. This pattern is highlighted with the blue circles in the chart.

Furthermore, the internal strength of Lyft is quite weak. It has been stuck in bear internals, unable to barely break the 50 line before turning back down to oversold levels. In a bear market, the RSI will not cross the 60 line. When I see a stock unable to cross the 50 line before turning back, it’s a sign of a strong downtrend in play.

Elliot  Wave:           

There’s a clear first leg down (A Wave), corrective move back up (B Wave), and we are now in the process of a new leg down (C Wave). I’m targeting the 100% extension of the A Wave, which puts us in the $27-$27.50 range. 

Typically, we’ll see the down legs in a corrective move that are of equal length (A=C). We will see bounces along the way, but as long as Lyft stays below its AVWAP and the long-term trend line, I will be targeting this zone as a profit taking zone for my short.  

SECTION 3: UBER TECHNICAL ANALYSIS                

By Knox Ridley

There’s slightly less price action with Uber. For a brief period, it engaged in a slight uptrend, spending half of its time trading above the Anchored Volume Weighted Average (AVWAP), anchored to the high of its open, which is highlighted in aqua blue. However, once it broke the AVWAP, it started a downtrend that appears intact and pointing to more downside.      

Negative RSI Reversal:     

The RSI is showing the same negative reversal pattern we see in Lyft. This pattern is very reliable in indicating that a new leg is developing in the downtrend.  I think it’s very likely that we will make new lows.  

Further evidence that the price is rolling over can be found in the KST indicator. The KST is one of my favorite change in direction indicators. It’s a combination of short-term and long-term Rate of Change indicators combined into one. As you can see, the KST has moved back up to the high, while the price of Uber is making lower highs.  The KST is currently rolling over hard, which I use in conjunction with the other indicators to help me determine a short.

Elliot Wave:           

All corrective retraces move in a 3 wave pattern (A,B,C). The 3rd leg (C), is typically the length of the first leg (A).  Now the internal structure of these corrective moves can move in a 3-3-5, pattern or a 5-3-5 pattern, but the larger pattern is usually a 3-step move. Furthermore, when a stock has very little price action, the Fibonacci ratios tend to be great sign posts for a change in trend, or an indication of a further decline.

I currently see the A-wave as complete, and then the market began an brief uptrend – the corrective B-wave.  I was expecting the B-wave to be longer, which I highlighted the likely regions in blue.  However, once the price action hit the long-term trend line in black, which coincided with the 23.6% retrace line of Wave A, the downtrend commenced, which is an indication that the B-wave is over.

The market likes symmetry, and 3-leg corrections will typically exhibit this symmetry. So, the length of the A-wave (1st leg) will determine the length of the C-wave (3rd leg). This final push will typically be of equal length or an extended ratio of the A-wave (first leg).  So, if the C-wave will be a similar length as the A-wave, that will put us around $25.75.  This is my final target for my short position before we should see a corrective rally, which will either be the start of a new uptrend, or a corrective rally in a much larger 3-wave correction.