Category: Markets

Posts about financial markets, referencing indices and broad developments

Ark Invest’s Big Ideas

A lot of people are talking about the outsized influence that Cathie Wood’s Ark Investment Management has on technology investing.

Though I am not one to buy into the hype (particularly for things like bitcoin), there’s something to be said about focusing solely on disruptive technology investments at a time when there is no lack of capital around to fund big ideas.

This recent report from Ark Invest on their “Big Ideas” is definitely worth a look. There’s a lot here, but to start with here’s some charts that caught my eye on the issue of fintechs eating the banks’ lunch.

Something is going to have to give re banks and their credit card businesses. It’s getting harder to justify charging such high rates in a low interest rate/easy money environment and they will need to do more to show consumers the value of rewards programs.

And one on automation and the counterintuitive impact on the labor market:

Ark Invest slides

And hypersonic flight! (though I don’t think people will really be paying that much for a flight once it scales)…

Hypersonic flight

Bumble bonanza almost too good to be true

bumble

It’s a VERY happy Valentine’s Day for Bumble CEO Whitney Wolfe Herd. On Thursday, Wolfe Herd (reportedly) became the youngest female CEO ever to take a US company public when the Austin-based dating app’s IPO raised $2.15bn and the shares surged about 63% on their Nasdaq debut.

By the end of the week, Bumble was carrying a market cap of $15bn (and she owns about 10% of the company herself). That’s mind-blowing considering private equity firm Blackstone took control of Bumble barely a year ago in a transaction that valued the company at just $3bn.

Now I don’t know, maybe there were some non-financial reasons why Blackstone found such a willing seller in Russian entrepreneur Andrey Andreev, who started Badoo in 2006 and then helped Wolfe Herd start Bumble in 2014. The umbrella Bumble company that went public owns both Bumble and Badoo, the former being the “women-first” mostly US-centric app and Badoo being better known internationally.

Consider here that Blackstone not only takes home the bulk of the IPO proceeds (around $1.7bn of the proceeds are being used to buy back its equity interests), but it still holds a roughly 60% economic interest in the company.

Blackstone also collected the bulk of a $330m debt-funded distribution to pre-IPO holders paid in October. And remember this is just a dating app.

We also know Blackstone used lead left underwriter Goldman Sachs‘ new-fangled hybrid auction process (also used on the DoorDash and Airbnb IPOs late last year) to try to get a better IPO price than it might from a traditional bookbuild. Yet the stock still ran, probably because the Bumble name was recognized and resonated with the Robinhood/retail crowd in the aftermarket.

And remember all this is happening during Covid-19, a time when the romantic notions have been thwarted by everyone being confined in their homes (though this WSJ article suggests use of dating apps during Covid rose strongly).

The bullish view on Bumble is that its operating model of only letting women make the first move will mean that many, many women will join its site and the men will have no choice but to follow.

And while Bumble is not nearly as profitable as its more diversified rival and comp, Match, Bumble has big earnings upside as it improves its margins to Match’s level. Bumble’s adjusted Ebitda margin was 26.3% in the period from January 29, 2020 to September 30, 2020, whereas Match margin is consistently up around 40% (the IPO filing is here, incidentally).

Maybe Bumble is a great investment and, yes, it is tough to be short at the moment.

But in a market many believe is priced for perfection, there are at least a few reasons to wonder whether Bumble can meet the lofty expectations now built into its stock price.

For one, ask yourself why Blackstone cashing in its investment so aggressively and so quickly.

Logically it would have been better to wait for Bumble to show better post-Covid numbers, unless it turns out the post-Covid world is tougher and the dating app market more competitive than expected.

Of course, Blackstone is just being smart in taking advantage of a white-hot IPO market to effectively cash its original investment and leave only house money at risk.

By the way, there is nothing stopping women from making the first move on other dating apps. And if blocking men from doing so is such a winning strategy for Bumble, how hard is it for some other dating app to do the same? I just pose the question.

Also lost in the fanfare is that Bumble’s average revenue per paying user fell slightly last year, in part as it tweaked its subscription pricing during the pandemic. As the prospectus points out, if Bumble can’t get more money out of each existing paying user, it will have to rely more on turning non-paying customers into payers. Bumble is yet to really prove it can do that since only 2.5m of its circa-40m users are paying for the privilege. The point is that Bumble’s metrics are not as pristine as the stock price action seems to imply.

Personally I think this is yet another stock that has raced well ahead of its true value (it now trades at more than 25x trailing revenue). I think few investors in their hearts (!) would contest this statement. And with markets at a point at which it is hard to think they could get any better, to me it seems a decent bet that Bumble will struggle to maintain its current levels ($75.46 on Friday) once the post-IPO honeymoon period is over.

Let us know what you think.

Nobody knows anything: the Netflix story

I just finished reading Netflix founding CEO Marc Randolph’s That Will Never Work: The Birth of Netflix and the Amazing Life of an Idea. While it trails off a little towards the end, I highly recommend it, both for investors and aspiring entrepreneurs.

At a time of peak cynicism about the companies/IPOs coming out of Silicon Valley, Randolph’s “memoir” of the DVD rental-cum-streaming service’s early years offers a timely case study of an idea that not only worked but overcame many of the challenges/issues that have plagued today’s up-and-coming tech stars.

Netflix today

The book covers the period roughly from the company’s foundations in 1997 to its IPO in 2002, since Randolph bowed out not long after the company went public.

Here are some insights that I took away from reading the book:

  1. Success is not linear, even for really good ideas. It’s tempting to think the setbacks that startups face reveal some fatal flaw in their business model that will eventually bring them undone. Not really. Netflix had its share of existential moments, not least the tech bust in 2000 which dried up sources of capital and forced the company to put its finances on a sustainable footing and refocus by slashing its staff. But it came back stronger after that setback, as it has done a few times. Luck cannot be underestimated as an element of success either. Netflix got into DVD rentals before/just as DVD players and DVDs began replacing video cassettes, and was lucky that the big electronics manufacturers were prepared to support it (by putting its promotional material in their boxes). Even then it wasn’t clear that online DVD rental would be a success. Later on, Netflix didn’t let success go to its head, recognizing the need to constantly reinvent itself. The company knew that DVDs would not be the preferred format forever and made an early effort to investigate streaming, even when download speeds were too slow to support it.
  2. Leadership is everything. Already a seasoned and successful tech entrepreneur, Reed Hastings put up much of the early money. But he wasn’t so hands-on until he realized Netflix could be something really big. Hastings comes across in the book as an enigmatic figure (I suspect the full extent of Randolph and Hastings’ relationship is a little sanitized), but an extremely decisive person and someone not afraid to make very tough business decisions or criticize the way the business is run. Randolph often doesn’t agree with Hastings but later accepts that he was right almost every time. Hastings’ track record prompted the VCs to overlook some deficiencies in the company’s pitch, enabling Netflix to get enough early financing.
  3. Focus on where there is less competition. A key early decision was to ditch DVD sales and focus solely on rentals, even at a time when sales of DVDs were overwhelmingly the company’s largest source of revenue. Hastings and Randolph knew that Amazon (which also offered to buy Netflix early but not for much) would eventually sell DVDs as well as books and margins would collapse. It was much harder for anyone else (even Blockbuster as it turns out) to get into the online DVD rental business, which didn’t really take off until the company introduced a monthly subscription service.
  4. Balancing scale and profitability is not easy. It is easy to criticize recent IPOs for coming to market before they are showing profits. But businesses that are growing fast and are subscription-based will chew up cash. Netflix was giving away free rentals to new subscribers while collecting only a small amount on a monthly basis from its existing subscribers. Though the book did not mention it, I went back and checked the original IPO filing. Netflix went public when it had 600,000 subscribers and was still to pass through $100m of revenue. It had just reported a $30m quarter so it would have passed through that threshold that year. The company also reported a $4.5m loss in that quarter, but was Ebitda positive and operating cash flow positive. WeWork has a lot more revenue but reports negative operating cash flow. Incidentally, Netflix went public at $15.00 (versus the $13-$15 range) with a $310m market cap, whereas the shares now trade at more than $260.00 each with a $115bn-plus mark cap (the shares traded as high as $386.00 last year). To the extent that WeWork was/is looking to get a $10bn-$47bn valuation, it is a lot harder to see WeWork producing Netflix-like returns (if WeWork ever goes public).
  5. Nobody knows anything. Randolph cited screenwriter William Goldman for this line, which is saying no one really knows what the future holds. When we see the hype around WeWork and Uber, it is sometimes easy to think their success was pre-destined. Similarly, when analysts and others write them off they are stating an opinion – they may be right but a lot comes down to whether management makes the right decisions about the next steps for these businesses.
  6. Rules for success. Randolph provided a list of rules for success handed down from his father. These are particularly good for modern kids whose parents are starting to worry they are getting a little too entitled. Here they are: “Do at least 10% more than you are asked. Never, ever, to anybody present as fact opinions on things you don’t know – takes great care and discipline. Be courteous and considerate always—up and down. Don’t knock, don’t complain—stick to constructive, serious criticism. Don’t be afraid to make decisions when you have the facts on which to make them. Quantify where possible. Be open-minded but skeptical. Be prompt.”

We gets down to work

Update 9/16/19: Latest reports say WeWork is considering delaying its IPO until next month at the earliest, and maybe until next year.

It’s hard to think of a recent IPO that has garnered as much bad press as The We Company, better known as flexible office space provider WeWork. And it hasn’t even launched yet.

For contrarians like me, poor headlines are not necessarily a reason to keep away from an IPO (or a stock). All that negativity can sometimes translate into a bargain buying opportunity.

Yet the reality here is the majority of investors are going to remain extremely cautious about backing the WeWork story, whatever the price.

The deal has zero momentum heading into its possible launch tomorrow, though there is a faint hope the cut-price valuation lures in some meaningful interest.

As you might have read once or twice, there are big reservations about WeWork’s business model, including that its growth depends on entering into more long-term leases (with the associated long-term liabilities) or buying real estate, both requiring WeWork to come up with billions more in cash with no guarantee it will turn a profit.

I have heard some sources suggest the business, which charges entrepreneurs a membership fee rather than rent to use its space, could become profitable in just a few years if it slowed down its growth rate.

But it’s a Catch-22 situation because without growth investors are unlikely to be much interested in paying up for the stock. And WeWork starts to look more like a boring REIT than a sexy technology company (which it is not, but anyway).

There is also the awkward timing of the deal and how WeWork would fare in a recession. WeWork’s members are highly sensitive to any change in economic (and financing conditions), plus start-ups can find cheaper alternatives if they are feeling the pinch (after all, WeWork is all about flexible use of space).

Then there’s the potential for commercial landlords to essentially copy the WeWork model to deal with their vacant space.

Still, investors should reserve judgment until they see the valuation, which is only revealed at the launch of the offering.

That is supposed to happen tomorrow (Monday) morning, which means the official roadshow will begin (with the release of a slick online version for retail investors) and the IPO probably price on September 25 or thereabouts ahead of the stock’s Nasdaq debut the next day.

Of course, a late change of plans is always possible, especially as investors might be facing a volatile week after the troubling events in Saudi Arabia over the weekend (production disruptions from a drone strike on the country’s oil facilities). So really nothing is going right for WeWork and its 40-year-old founder Adam Neumann.

In recent weeks, WeWork’s purported valuation (market capitalization or enterprise value we are not sure) has reportedly come down on several occasions to just $10bn from more than $20bn and versus the last private financing round at $47bn (not a real number to be fair but we won’t go into that).

The company has made a series of corporate governance concessions as well, including reducing the number of votes attached to Neumann’s supervoting shares. Not to diminish the importance of corporate governance, but generally it is not a huge consideration for investors in tech IPOs because they tend to be more focused on the growth prospects of the company concerned.

WeWork’s biggest supporter, Japan’s SoftBank, is expected to take $750m of the shares in the offering. Its name is bound to be emblazoned on the cover of the IPO filing to highlight its show of support.

As embarrassing as it is for SoftBank to be averaging down from its previous pre-IPO investment at a $47bn valuation, this anchor order will leave less stock for others.

Without SoftBank, WeWork would be selling 30% of the company at the IPO – it has to raise $3bn in order to also secure $6bn in debt from the banks – yet this is far larger than the 10%-15% free float on hot tech IPOs (tight supply and excess demand is one of the reasons they often surge massively on debut).

SoftBank’s enthusiastic backing is a small positive, but a positive nonetheless (worth watching if the stake is locked up for six months or a year).

At $10bn, WeWork will be coming to public markets at a significant discount on an EV/sales basis to Uber (roughly 3x-4x 2019 sales of around $3bn at the current growth rate versus 4.5x for Uber). WeWork’s underwriters clearly figure some will find WeWork irresistible at these levels, but the risk is they will be hedge funds rather than long-only/long-term investors, increasing the chances of a calamity on debut.

A WeWork office in Harlem, New York City.

The “R” word: Possible, yes, but how bad will it be?

Recent surveys suggest as many as three in four economists believe the US will go into a recession by 2021. Maybe they are right. I don’t know about 2021 (and they don’t really either) but as night follows day, there will be a downturn eventually.

To me, the bigger question is this: How deep the next downturn will be?

Now I am not really going to answer that question but I think this is what people should consider before they buy into doom-and-gloom prognostications.

There hasn’t been a US recession since 2007-2008, which means forecasting one in the next year or two is almost like insurance for a professional forecaster. Forecasts are mostly wrong too but that doesn’t stop people from making them.

In fact, countries can go for very long periods without a recession (Australia, for instance, hasn’t had one since the early 1990s).

Next year’s US Presidential election also means there is a huge political dimension to the economic commentary that appears in the press, and one should be especially wary of any politician trying to pass themselves off as an economist.

A recession is arguably the only event that assures Donald Trump will lose. His opponents know that when they discuss the economy.

I think it is possible that the next recession could well be more of the “statistical” variety and quite shallow.

For one thing, economic activity in the past year or so has been juiced by the 2018 corporate tax cuts (people seem to forget about them).

Greater corporate earnings flow through to the economy in a variety in different ways and quite quickly too (one reason why governments prefer tax cuts to spending on big projects when trying to quickly stimulate the economy).

If the growth numbers were in any way exaggerated in the past year, which seems entirely possible, then it is simply a mathematical reality it is going to be harder to grow at the same rate and better those conditions a year or two hence.

Real GDP grew 2% year-on-year in the second quarter of 2019, but you can see on a long-term chart (below) GDP growth has flattened over time as the economy has got bigger and bigger save for large blips like 2007-2008.

Growth is harder to come by when you are already the biggest economy in the world (a $20trn economy), so let’s not pretend it is easy to do so.

US GDP through time. Source: US Bureau of Economic Analysis

A recession also means different things to different people.

Here’s an article from the New York Times published in December last year:

“Some say (a recession) happens when the value of goods and services produced in a country, known as the gross domestic product, declines for two consecutive quarters, or half a year.

“In the United States, though, the National Bureau of Economic Research, a century-old nonprofit widely considered the arbiter of recessions and expansions, takes a broader view.

“According to the bureau, a recession is ‘a significant decline in economic activity’ that is widespread and lasts several months. Typically, that means not only shrinking GDP, but declining incomes, employment, industrial production and retail sales, too.”

All true, but you might also say that a recession means different things to different people, in that during this period one person can lose their job and come under financial duress, and another can be completely unaffected (if they have a steady job in a good industry). What I am trying to say is that the numbers in themselves don’t matter as much as how a recession actually affects people’s lives.

A deep recession would mean a spike in unemployment, which is really the key statistic.

Yet the data continue to show US job growth.

The chart below shows US unemployment (3.7%) is at its lowest level since the 1960s. Is a big spike in unemployment around the corner? Are these numbers even relevant any more?

The gig economy seems to be changing the definition of work and driving down the unemployment rate with lowly paid jobs. This may also mean unemployment doesn’t rise sharply in a downturn like it might have done in the past (as everyone picks up gig jobs if they have to).

US unemployment rate through time. Source: Bureau of Labor Statistics

Though some are talking about another credit crunch, there is no doubt the economy and companies are cushioned by low interest rates, in turn facilitated by low inflation.

By the way, that is another thing many economists have got wrong in the past decade. They expected inflation to break out because of the Fed’s rampant money printing, but funnily enough, it never happened and the Fed has had no choice but to keep rates low to try to ward off outright deflation.

The Fed is likely to cut rates later this month for the second consecutive meeting, somewhat reluctantly and unusually all while the economy and jobs are still growing.

The politics can’t be discounted here either, by which I mean the Trump Administration has much riding on there being no recession in the next year at least. This is why Trump is riding Fed chair Jerome Powell to cut rates and holding out the prospect of more tax cuts.

There is always a risk of a large downturn and the US economy has problems that stem from too much consumer and government debt and high healthcare costs, but my point is that pays to keep things in perspective.

S&P 500 earnings per share to fall in Q1 2019 – is this really priced in?

Stocks are up for a seventh day and the pundits at CNBC and elsewhere think they will keep rising, but here’s a burning question.

Why should stocks keep rising if their ultimate driver, earnings, are falling? That’s the expectation for Q1 and as the chart shows, earnings growth expectations have been dwindling consistently in past six months.

One reason is lower interest rates, though today’s good economic numbers don’t really support the case for a cut (whatever the President says).

If earnings ease and rate cuts don’t materialize, it will be hard for the run in stocks to continue. Or will it?

What is clear is that with the 2020 presidential election campaign warming up (easy to forget it is not until November next year), the current administration is eager to keep the economy and markets humming, whatever it takes.

The good news for investors is that after weak Q1 earnings growth, admittedly a function of outsized gains last year due to tax reform, growth should resume in the following quarters (see chart below).

Or at least that is what is in the forecasts, notwithstanding the likelihood they will be revised as time goes by.

Lyft and the mysteries of the US tech IPO market

Twitter is alight this morning with angst about newly public ride-sharing unicorn Lyft’s dismal second-day performance.

The stock’s slump below its $72.00 IPO price yesterday is at odds with reports that the offering was more than 20 times oversubscribed and Lyft’s nearly 10% gain on day one.

CNBC’s Jim Cramer, in particular, is taking some lumps for his rosy predictions, which just goes to prove that forecasting stock prices in the short-term is a mug’s business (remember that as you are watching CNBC). Still love ya Jim, despite what people say.

But how does a 20-times oversubscribed IPO trade below the offering price so soon after the deal?

This is far from the first time it (a high demand IPO that stumbles on debut) has happened, yet it remains a question whose answer eludes investors.

That’s partly because of the inherent lack of transparency of IPO demand and allocations.

But it can sort of be explained in broad terms.

Such disappointments tend to happen in situations like Lyft where the broader market is strong and the tech stocks are running (which is one reason a lot of IPOs are pricing now), but where there is no consensus on the company in question’s long-term prospects.

Lyft was able to justify a high IPO price/valuation (let’s say a high single-digit multiple of sales) akin to the hottest cloud software names, but it was by no means cheap.

“Not cheap” might be another way of saying that the company’s long-term prospects are not clear or that new investors (the existing ones not participating in the IPO are the true believers) are not sure whether they think this company will prosper long-term.

Offsetting this was the momentum behind the IPO in recent weeks (the hype) and the FOMO factor, the fear among investors they would miss out on easy gains by not participating in the IPO and look silly for doubting that momentum.

A couple of specific technical factors also contributed to the speedy reversal of fortunes.

The big one is that IPO allocations were very tight, so few institutional investors got enough stock to make Lyft a core holding. At the margin (which is all that is needed to determine stock momentum), many investors decided to sell when it became clear the early gains were going to be unsatisfying relative to the hype.

Additionally, Lyft debuted on the final day of the month/quarter, which may have given investors some incentive to book profits on the first day of the new quarter.

The other issue to keep in mind with all IPOs is the quality of the book of demand. If the shares go to short-term investors or hedge funds that see this as a momentum investment and don’t really believe in the business long-term, then it is hardly surprising they will sell when the momentum moves against the stock.

I think there are legitimate concerns about Lyft’s ability to make a profit long-term, which is central to the bear case. Cramer’s view is that Uber and Lyft are forming a duopoly that will eventually be able to lift prices. He could be right but he might not be.

The problem with this line of argument is that a large part of the value proposition for ride-sharing customers is price, and if the price is too high they will use public transport or their own cars.

The disruptive forces unleashed by unicorns have certainly been deflationary and may continue to be so for a long time as other competitors come up with twists on the ride-sharing idea and Uber and Lyft undercut each other to win the doubtful loyalty of drivers. Maybe you don’t really want to invest in an industry where price deflation is at play.

It is no surprise that Lyft and Uber are pursuing opportunities in autonomous vehicles since replacing human drivers would remove a big cost item (change the whole business model) and lead to lower prices for consumers (witness how so-called “monopolist” Amazon is looking to cut prices significantly at Whole Foods Market).

Offsetting this is that not all costs are going to be under the control of Uber and Lyft and governments will tax them (congestion pricing for instance) to help underpin the viability of public transport. That’s exactly what is happening in New York City at the moment.

All that said, Lyft still has an opportunity to prove the naysayers wrong and it is only day two. Theoretically the stock price doesn’t matter though it does if Lyft wants to come back to raise more capital, which it would have to do if it burns cash long-term.

Investors are not going to want to put more money into a losing investment and the company is not going to want to dilute existing shareholders by issuing stock at low prices.

It is possible that the stock continues to slump but more likely is that over the coming weeks it stabilizes somewhere in touching distance of the IPO price, giving the company a chance to wow investors with its first set of earnings (reported in early May).

This can work both ways. Facebook and Alibaba both saw their stock prices tumble in the early period after going public but have gone on to be fantastic investments. Then there are the disasters like Snap, Blue Apron and going back further, Groupon and Zynga, that saw lasting shareholder value destruction.

Investors really need to get straight in their minds whether Lyft (and soon Uber) is a Amazon/Facebook/Alibaba-type story or a Snap/Blue Apron.

There is some hope of the former because even if Lyft’s stock comes under pressure, the trends “driving” ride-sharing are likely to continue and Lyft might even become a target for big tech or maybe even an auto maker or a rental car company.

What does it mean for the Uber IPO next month? Well, Uber has waited so long to go public, it might be tempted to delay. Indeed the Lyft experience is more evidence the IPO market is broken.

But the impact on Uber may also be muted by investor recognition of its greater scale and wherewithal. All things being equal, it should win the long-term battle for ride-sharing marketshare simply because of the depth of its pockets.

Let’s see how Lyft trades today but the bears seem to be in charge for now (it was down again in early action today).

A little taste of John Bogle wisdom

Some quotes from Bogle’s book Enough

The passing of Vanguard founder and index fund pioneer John Bogle was rightly big news in finance this week. Truly selfless individuals are hard to find in any walk of life, let alone Wall Street, but Bogle probably did more than anyone to lower costs for small investors and champion investor rights, and he was someone with a strong moral compass about the bad things that often happen on Wall Street.

Last year I read one of his many books –
Enough: True Measures of Money, Business, and Life and, like all the books I read, highlighted some passages that resonated with me. Here they are:

“Some men wrest a living from nature and with their hands; this is called work. Some men wrest a living from those who wrest a living from nature and with their hands; this is called trade. Some men wrest a living from those who wrest a living from those who wrest a living from nature and with their hands; this is called finance.”

“Innovation in finance is designed largely to benefit those who create the complex new products, rather than those who own them.”

“Above all, remember (again, courtesy of Warren Buffett), ‘What the wise man does in the beginning, the fool does in the end.’ Or, as the Oracle of Omaha sometimes expresses it, ‘There are three i’s in every cycle: first the innovator, then the imitator, and finally the idiot.’ No matter what fund managers may offer you, don’t you be the idiot.”

“My faith in trust goes back to the Golden Rule. We are, after all, implored in the Bible to love our neighbors, not to quantify their character; and to do unto them as we would have them do unto us, not to do unto them in exact equal measure what they have done to us.”

“Returning professional conduct to a more important role in business affairs will be no easy task. One avenue to pursue, curiously enough, was suggested by a mailing that arrived on my desk with a typographical error that I just couldn’t ignore. Sent out by the Center for Corporate Excellence to announce that General Electric would receive its Long-Term Excellence in Corporate Governance award, the flyer quoted GE president Jeffrey Immelt on the importance of ‘sound principals of corporate governance.’ Clearly, the quotation should have read principles, not principals.”

“We are now seeing in our corporations and our financial markets the result of the triumph of business standards over professional standards—far too much of the former, not nearly enough of the latter.”

“As René Descartes reminded us four full centuries ago, ‘A man is incapable of comprehending any argument that interferes with his revenue.'”