2020 Top Ten Predictions

I wanted to start this post by repeating something I discussed in my top ten lists in 2017 and 2018 which I learned while at Sanford Bernstein in my Wall Street days: “Owning companies that have strong competitive advantages and a great business model in a potentially mega-sized market can create the largest performance gains over time (assuming one is correct).” It does make my stock predictions somewhat boring (as they were on Wall Street where my top picks, Dell and Microsoft each appreciated over 100X over the ten years I was recommending them).

Let’s do a little simple math. Suppose one can generate an IRR of 26% per year (my target is to be over 25%) over a long period of time.  The wonder of compounding is that at 26% per year your assets will double every 3 years. In 6 years, this would mean 4X your original investment dollars and in 12 years the result would be 16X. For comparison purposes, at 5% per year your assets would only be 1.8X in 12 years and at 10% IRR 3.1X.  While 25%+ IRR represents very high performance, I have been fortunate enough to consistently exceed it (but always am worried that it can’t keep up)! For my recommendations of the past 6 years, the IRR is 34.8% and since this exceeds 26%, the 6-year performance  is roughly 6X rather than 4X.

What is the trick to achieving 25% plus IRR? Here are a few of my basic rules:

  1. Start with companies growing revenue 20% or more, where those closer to 20% also have opportunity to expand income faster than revenue
  2. Make sure the market they are attacking is large enough to support continued high growth for at least 5 years forward
  3. Stay away from companies that don’t have profitability in sight as companies eventually should trade at a multiple of earnings.
  4. Only choose companies with competitive advantages in their space
  5. Re-evaluate your choices periodically but don’t be consumed by short term movement

As I go through each of my 6 stock picks I have also considered where the stock currently trades relative to its growth and other performance metrics. With that in mind, as is my tendency (and was stated in my last post), I am continuing to recommend Tesla, Facebook, Amazon, Stitch Fix and DocuSign. I am adding Zoom Video Communications (ZM) to the list. For Zoom and Amazon I will recommend a more complex transaction to achieve my target return.

2020 Stock Recommendations:

1. Tesla stock appreciation will continue to outperform the market (it closed last year at $418/share)

Tesla is likely to continue to be a volatile stock, but it has so many positives in front of it that I believe it wise to continue to own it. The upward trend in units and revenue should be strong in 2020 because:

  • The model 3 continues to be one of the most attractive cars on the market. Electric Car Reviews has come out with a report stating that Model 3 cost of ownership not only blows away the Audi AS but is also lower than a Toyota Camry! The analysis is that the 5-year cost of ownership of the Tesla is $0.46 per mile while the Audi AS comes in 70% higher at $0.80 per mile. While Audi being more expensive is no surprise, what is shocking is how much more expensive it is. The report also determined that Toyota Camry has a higher cost as well ($0.49/mile)! Given the fact that the Tesla is a luxury vehicle and the Camry is far from that, why would anyone with this knowledge decide to buy a low-end car like a Camry over a Model 3 when the Camry costs more to own?  What gets the Tesla to a lower cost than the Camry is much lower fuel cost, virtually no maintenance cost and high resale value. While the Camry purchase price is lower, these factors more than make up for the initial price difference
  • China, the largest market for electronic vehicles, is about to take off in sales. With the new production facility in China going live, Tesla will be able to significantly increase production in 2020 and will benefit from the car no longer being subject to import duties in China.  
  • European demand for Teslas is increasing dramatically. With its Chinese plant going live, Tesla will be able to partly meet European demand which could be as high as the U.S. in the future. The company is building another factory in Europe in anticipation. The earliest indicator of just how much market share Tesla can reach has occurred in Norway where electric cars receive numerous incentives. Tesla is now the best selling car in that country and demand for electric cars there now exceeds gas driven vehicles.

While 2020 is shaping up as a stairstep uptick in sales for Tesla given increased capacity and demand, various factors augur continued growth well beyond 2020. For example, Tesla is only partway towards having a full lineup of vehicles. In the future it will add:

  • Pickup trucks – where pre-orders and recent surveys indicate it will acquire 10-20% of that market
  • A lower priced SUV – at Model 3 type pricing this will be attacking a much larger market than the Model X
  • A sports car – early specifications indicate that it could rival Ferrari in performance but at pricing more like a Porsche
  • A refreshed version of the Model S
  • A semi – where the lower cost of fuel and maintenance could mean strong market share.

2. Facebook stock appreciation will continue to outperform the market (it closed last year at $205/share)

Facebook, like Tesla, continues to have a great deal of controversy surrounding it and therefore may sometimes have price drops that its financial metrics do not warrant. This was the case in 2018 when the stock dropped 28% in value during that year. While 2019 partly recovered from what I believe was an excessive reaction, it’s important to note that the 2019 year-end price of $205/share was only 16% higher than at the end of 2017 while trailing revenue will have grown by about 75% in the 2-year period. The EPS run rate should be up in a similar way after a few quarters of lower earnings in early 2019. My point is that the stock remains at a low price given its metrics. I expect Q4 to be quite strong and believe 2020 will continue to show solid growth.

The Facebook platform is still increasing the number of active users, albeit by only about 5%-6%. Additionally, Facebook continues to increase inventory utilization and pricing. In fact, given what I anticipate will be added advertising spend due to the heated elections for president, senate seats, governorships etc., Facebook advertising inventory usage and rates could increase faster (see prediction 7 on election spending).  

Facebook should also benefit by an acceleration of commerce and increased monetization of advertising on Instagram. Facebook started monetizing that platform in 2017 and Instagram revenue has been growing exponentially and is likely to close out 2019 at well over $10 billion. A wild card for growth is potential monetization of WhatsApp. That platform now has over 1.5 billion active users with over 300 million active every day. It appears close to beginning monetization.

The factors discussed could enable Facebook to continue to grow revenue at 20% – 30% annually for another 3-5 years making it a sound longer term investment.

3. DocuSign stock appreciation will continue to outperform the market (it closed last year at $74/share)

DocuSign is the runaway leader in e-signatures facilitating multiple parties signing documents in a secure, reliable way for board resolutions, mortgages, investment documents, etc. Being the early leader creates a network effect, as hundreds of millions of people are in the DocuSign e-signature database. The company has worked hard to expand its scope of usage for both enterprise and smaller companies by adding software for full life-cycle management of agreements. This includes the process of generating, redlining, and negotiating agreements in a multi-user environment, all under secure conditions. On the small business side, the DocuSign product is called DocuSign Negotiate and is integrated with Salesforce.

The company is a SaaS company with a stable revenue base of over 560,000 customers at the end of October, up well over 20% from a year earlier. Its strategy is one of land and expand with revenue from existing customers increasing each year leading to a roughly 40% year over year revenue increase in the most recent quarter (fiscal Q3). SaaS products account for over 95% of revenue with professional services providing the rest. As a SaaS company, gross margins are high at 79% (on a non-GAAP basis).

The company has now reached positive earnings on a non-GAAP basis of $0.11/share versus $0.00 a year ago. I use non-GAAP as GAAP financials distort actual results by creating extra cost on the P&L if the company’s stock appreciates. These costs are theoretic rather than real.

My only concern with this recommendation is that the stock has had a 72% runup in 2019 but given its growth, move to positive earnings and the fact that SaaS companies trade at higher multiples of revenue than others I still believe it can outperform this year.

4. Stitch Fix Stock appreciation will continue to outperform the market (it closed last year at $25.66/share)

Stitch Fix offers customers, who are primarily women, the ability to shop from home by sending them a box with several items selected based on sophisticated analysis of her profile and prior purchases. The customer pays a $20 “styling fee” for the box which can be applied towards purchasing anything in the box. The company is the strong leader in the space with revenue approaching a $2 billion run rate. Unlike many of the recent IPO companies, it has shown an ability to balance growth and earnings. The stock had a strong 2019 ending the year at $25.66 per share up 51% over the 2018 closing price. Despite this, our valuation methodology continues to show it to be substantially under valued and it remains one of my picks for 2020. The likely cause of what I believe is a low valuation is a fear of Amazon making it difficult for Stitch Fix to succeed. As the company gets larger this fear should recede helping the multiple to expand.  

Stitch Fix continues to add higher-end brands and to increase its reach into men, plus sizes and kids. Its algorithms to personalize each box of clothes it ships keeps improving. Therefore, the company can spend less on acquiring new customers as it has increased its ability to get existing customers to spend more and come back more often. Stitch Fix can continue to grow its revenue from women in the U.S. with expansion opportunities in international markets over time. I believe the company can continue to grow by roughly 20% or more in 2020 and beyond.

Stitch Fix revenue growth (of over 21% in the latest reported quarter) comes from a combination of increasing the number of active clients by 17% to 3.4 million, coupled with driving higher revenue per active client. The company accomplished this while generating profits on a non-GAAP basis.

5. Amazon stock strategy will outpace the market (it closed last year at $1848/share).

Amazon shares increased by 23% last year while revenue in Q3 was up 24% year over year. This meant the stock performance mirrored revenue growth. Growth in the core commerce business has slowed but Amazon’s cloud and echo/Alexa businesses are strong enough to help the company maintain roughly 20% growth in 2020. The company continues to invest heavily in R&D with a push to create automated retail stores one of its latest initiatives. If that proves successful, Amazon can greatly expand its physical presence and potentially increase growth through the rollout of numerous brick and mortar locations. But at its current size, it will be difficult for the company to maintain over 20% revenue growth for many years (excluding acquisitions) so I am suggesting a more complex investment in this stock:

  1. Buy X shares of the stock (or keep the ones you have)
  2. Sell Amazon puts for the same number of shares with the puts expiring on January 15, 2021 and having a strike price of $1750. The most recent sale of these puts was for over $126
  3. So, net out of pocket cost would be reduced to $1722
  4. A 20% increase in the stock price (roughly Amazon’s growth rate) would mean 29% growth in value since the puts would expire worthless
  5. If the stock declined 226 points the option sale would be a break-even. Any decline beyond that and you would lose additional dollars.
  6. If the options still have a premium on December 31, I will measure their value on January 15, 2021 for the purposes of performance.

6. I’m adding Zoom Video Communications to the list but with an even more complex investment strategy (the stock is currently at $72.20)

I discussed Zoom Video Communications (ZM) in my post on June 24, 2019. In that post I described the reasons I liked Zoom for the long term:

  1. Revenue retention of a cohort was about 140%
  2. It acquires customers very efficiently with a payback period of 7 months as the host of a Zoom call invites various people to participate in the call and those who are not already Zoom users can be readily targeted by the company at little cost
  3. Gross Margins are over 80% and could increase
  4. The product has been rated best in class numerous times
  5. Its compression technology (the key ingredient in making video high quality) appears to have a multi-year lead over the competition
  6. Adding to those reasons it’s important to note that ZM is improving earnings and was slightly profitable in its most recent reported quarter

The fly in the ointment was that my valuation technology showed that it was overvalued. However, I came up with a way of “future pricing” the stock. Since I expected revenue to grow by about 150% over the next 7 quarters (at the time it was growing over 100% year over year) “future pricing” would make it an attractive stock. This was possible due to the extremely high premiums for options in the stock. So far that call is working out. Despite the company growing revenue in the 3 quarters subsequent to my post by over 57%, my concern about valuation has proven correct and the stock has declined from $76.92 to $72.20. If I closed out the position today by selling the stock and buying back the options (see Table 1) my return for less than 7.5 months would be a 42% profit. This has occurred despite the stock declining slightly due to shrinkage in the premiums.

Table 1: Previous Zoom trade and proposed trade

I typically prefer using longer term options for doing this type of trade as revenue growth of this magnitude should eventually cause the stock to rise, plus the premiums on options that are further out are much higher, reducing the risk profile, but I will construct this trade so that the options expire on January 15, 2021 to be able to evaluate it in one year. In measuring my performance we’ll use the closing stock price on the option expiration date, January 15, 2021 since premiums in options persist until their expiration date so the extra 2 weeks leads to better optimization of the trade.

So, here is the proposed trade (see table 1):

  1. Buy X shares of the stock at $72.20 (today’s price)
  2. Sell Calls for X shares expiring January 15, 2021 at a strike of $80/share for $11.50 (same as last price it traded)
  3. Sell puts for X shares expiring January 15, 2021 with strike of $65/share for $10.00 (same as last price it traded)

I expect revenue growth of 60% or more 4 quarters out. I also expect the stock to rise some portion of that, as it is now closer to its value than when I did the earlier transaction on May 31, 2019. Check my prior post for further analysis on Zoom, but here are 3 cases that matter at December 31, 2020:

  • Stock closes over $80/share (up 11% or more) at end of the year: the profit would be 58% of the net cost of the transaction
    • This would happen because the stock would be called, and you would get $80/share
    • The put would expire worthless
    • Since you paid a net cost of $50.70, net profit would be $29.30
  • Stock closes flat at $72.20:  your profit would be $21.50 (42%)
    • The put and the call would each expire worthless, so you would earn the original premiums you received when you sold them
    • The stock would be worth the same as what you paid
  • Stock closes at $57.85 on December 31: you would be at break even. If it closed lower, then losses would accumulate twice as quickly:
    • The put holder would require you to buy the stock at the put exercise price of $65, $7.15 more than it would be worth
    • The call would expire worthless
    • The original stock would have declined from $72.20 to $57.85, a loss of $14.35
    • The loss on the stock and put together would equal $21.50, the original premiums you received for those options

Outside of my stock picks, I always like to make a few non-stock predictions for the year ahead.

7. The major election year will cause a substantial increase in advertising dollars spent

According to Advertising Analytics political spending has grown an average of 27% per year since 2012. Both the rise of Super PACs and the launch of online donation tools such as ActBlue have substantially contributed to this growth. While much of the spend is targeted at TV, online platforms have seen an increasing share of the dollars, especially Facebook and Google. The spend is primarily in even years, as those are the ones with senate, house and gubernatorial races (except for minor exceptions). Of course, every 4th year this is boosted by the added spend from presidential candidates. The Wall Street Journal projects the 2020 amount will be about $9.9 billion…up nearly 60% from the 2016 election year. It should be noted that the forecast was prior to Bloomberg entering the race and if he remains a viable candidate an additional $2 billion or more could be added to this total.

The portion targeted at the digital world is projected to be about $2.8 billion or about 2.2% of total digital ad spending. Much of these dollars will likely go to Facebook and Google. This spend has a dual impact: first it adds to the revenue of each platform in a direct way, but secondly it can also cause the cost of advertising on those platforms to rise for others as well.

8. Automation of Retail will continue to gain momentum

This will happen in multiple ways, including:

  1. More Brick & Mortar locations will offer some or all the SKUs in the store for online purchase through Kiosks (assisted by clerks/sales personnel). By doing this, merchants will be able to offer a larger variety of items, styles, sizes and colors than can be carried in any one outlet. In addition, the consolidation of inventory achieved in this manner will add efficiency to the business model. In the case of clothing, such stores will carry samples of items so the customer can try them on, partly to optimize fit but also to determine whether he or she likes the way it looks and feels on them. If one observes the massive use of Kiosks at airports it becomes obvious that they reduce the number of employees needed and can speed up checking in. One conclusion is this will be the wave of the future for multiple consumer-based industries.
  2. Many more locations will begin incorporating technology to eliminate the number of employees needed in their stores. Amazon will likely be a leader in this, but others will also provide ways to reduce the cost of ordering, picking goods, checking out and receiving information while at the store.

9. The Warriors will come back strong in the 2020/21 season

Let me begin by saying that this prediction is not being made because I have been so humbled by my miss in the July post where I predicted that the Warriors could edge into the 2020 playoffs and then contend for a title if Klay returned in late February/early March. Rather, it is based on analysis of their opportunity for next season and also an attempt to add a little fun to my Top Ten List!  The benefit of this season:

  • Klay and Curry are getting substantial time off after 5 seasons of heavy stress. They should be refreshed at the start of next season
  • Russell, assuming he doesn’t keep missing games with injuries, is learning the Warriors style of play
  • Because of the injuries to Klay, Curry, Looney, and to a lesser extent Green and Russell, several of the younger members of the team are getting experience at a much more rapid rate than would normally be possible and the Warriors are able to have more time to evaluate them as potential long-term assets
  • If the Warriors continue to lose at their current rate, they will be able to get a high draft choice for the first time since 2012 when they drafted Harrison Barnes with the 7th pick. Since then their highest pick has been between the 28th and 30th player chosen (30 is the lowest pick in the first round)
  • The Warriors will have more cap space available to sign a quality veteran
  • Andre Iguodala might re-sign with the team, and while this is not necessary for my prediction it would be great for him and for the team
  • The veterans should be hungry again after several years of almost being bored during the regular season

I am assuming the Warriors will be relatively healthy next season for this to occur.

10. At least one of the major Unicorns will be acquired by a larger player

In 2019, there was a change to the investing environment where most companies that did not show a hint of potential profitability had difficulty maintaining their market price. This was particularly true of highly touted Unicorns, which mostly struggled to increase their share price dramatically from the price each closed on the day of their IPO. Table 2 shows the 9 Unicorns whose IPOs we highlighted in our last post. Other than Beyond Meat, Zoom and Pinterest, they all appear some distance from turning a proforma profit. Five of the other six are below their price on the first day’s close. A 6th, Peloton, is slightly above the IPO price (and further above the first days close). Beyond Meat grew revenue 250% in its latest quarter and moved to profitability as well. Its stock jumped on the first day and is even higher today.  While Pinterest is showing an ability to be profitable it is still between the price of the IPO and its close on the first day of trading.  Zoom, which is one of our recommended buys, was profitable (on a Non-GAAP basis) and grew revenue 85% in its most recent quarter. A 10th player, WeWork, had such substantial losses that it was unable to have a successful IPO.

Table 2: Recent Unicorn IPOs Stock Price & Profitability Comparisons

Something that each of these companies have in common is that they are all growing revenue at 30% or more, are attacking large markets, and are either in the leadership position in that market or are one of two in such a position. Because of this I believe one or more of these (and comparable Unicorns) could be an interesting acquisition for a much larger company who is willing to help make them profitable. For such an acquirer their growth and leadership position could be quite attractive.

Recap of 2019 Top Ten Predictions

Bull Markets have Tended to Favor My Stock Picks

I entered 2019 with some trepidation as my favored stocks are high beta and if the bear market of the latter portion of 2018 continued, I wasn’t sure I would once again beat the market…it was a pretty close call last year. However, I felt the companies I liked would continue to grow their revenue and hoped the market would reward their performance. As it turns out, the 5 stocks I included in my top ten list each showed solid company performance and the market returned to the bull side. The average gain for the stocks was 45.7% (versus the S&P gain of 24.3%).

Before reviewing each of my top ten from last year, I would like to once again reveal long term performance of the stock pick portion of my top ten list. For my picks, I assume equal weighting for each stock in each year to come up with my performance and then compound the yearly gains (or losses) to provide my 6-year performance. For the S&P my source is Multpl.com.  I’m comparing the S&P index at January 2 of each year to determine annual performance.  My compound gain for the 6-year period is 499% which equates to an IRR of 34.8%. The S&P was up 78% during the same 6-year period, an IRR of 10.1%.

The 2019 Top Ten Predictions Recap

One of my New Year’s pledges was to be more humble, so I would like to point out that I wasn’t 10 for 10 on my picks. One of my 5 stocks slightly under-performed the market and one of my non-stock forecasts was a mixed bag. The miss on the non-stock side was the only forecast outside of tech, once again highlighting that I am much better off sticking to the sector I know best (good advice for readers as well). However, I believe I had a pretty solid year in my forecasts as my stock portfolio (5 of the picks) significantly outperformed the market, with two at approximately market performance and three having amazing performance with increases of 51% to 72%. Regarding the 5 non-stock predictions, 4 were right on target and the 5th was very mixed. As a quick reminder, my predictions were:

Stock Portfolio 2019 Picks:

  • Tesla stock will outpace the market (it closed last year at $333/share and opened this year at $310)
  • Facebook Stock will outpace the market (it closed last year at $131/share)
  • Amazon Stock will outpace the market (it opened the year at $1502/share)
  • Stitch Fix stock appreciation will outpace the market (it closed last year at $17/share)
  • DocuSign stock will outpace the market in 2019 (it is currently at $43/share and opened the year at $41)

5 Non-Stock Predictions:

  • Replacing cashiers with technology will be proven out in 2019
  • Replacing cooks, baristas, and waitstaff with robots will begin to be proven in 2019
  • Influencers will be increasingly utilized to directly drive commerce
  • The Cannabis Sector should show substantial gains in 2019
  • 2019 will be the year of the unicorn IPO

In the discussion below, I’ve listed in bold each of my ten predictions and give an evaluation of how I fared on each.

Tesla stock will outpace the market (it closed last year at $333/share and opened this year at $310)

Tesla proved to be a rocky ride through 2019 as detractors of the company created quite a bit of fear towards the middle of the year, driving the stock to a low of $177 in June. A sequence of good news followed, and the stock recovered and reached a high of $379 in front of the truck unveiling. I’m a very simplistic guy when I evaluate success as I use actual success as the measure as opposed to whether I would buy a product. Critics of the truck used Elon’s unsuccessful demonstration of the truck being “bulletproof” and the fact that it was missing mirrors and windshield wipers to criticize it. Since it is not expected to be production ready for about two years this is ridiculous! If the same critics applied a similar level of skepticism to the state of other planned competitive electric vehicles (some of which are two plus years away) one could conclude that none of them will be ready on time. I certainly think the various announced electric vehicles from others will all eventually ship, but do not expect them to match the Tesla battery and software capability given its 3 to 5-year lead. I said I’m a simple guy, so when I evaluate the truck, I look at the 250,000 pre-orders and notice it equates to over $12.5B in incremental revenue for the product! While many of these pre-orders will not convert, others likely will step in. To me that is strong indication that the truck will be an important contributor to Tesla growth once it goes into production.

Tesla stock recovered from the bad press surrounding the truck as orders for it mounted, the Chinese factory launch was on target and back order volume in the U.S. kept factories at maximum production.  Given a late year run the stock was up to $418 by year end, up 34.9% from the January opening price. But for continuing recommendations I use the prior year’s close as the benchmark (for measuring my performance) which places the gain at a lower 25.6% year over year as the January opening price was lower than the December 31 close. Either way this was a successful recommendation.

Facebook Stock will outpace the market (it closed last year at $131/share)

Facebook, like Tesla, has many critics regarding its stock. In 2018 this led to a 28% decline in the stock. The problem for the critics is that it keeps turning out very strong financial numbers and eventually the stock price has to recognize that. It appears that 2019 revenue will be up roughly 30% over 2018. After several quarters of extraordinary expenses, the company returned to “normal” earnings levels of about 35% of revenue in the September quarter. I expect Q4 to be at a similar or even stronger profit level as it is the seasonally strongest quarter of the year given the company’s ability to charge high Christmas season advertising rates. As a result, the stock has had a banner year increasing to $205/share at year-end up 57% over the prior year’s close making this pick one of my three major winners.

Amazon Stock will outpace the market (it opened the year at $1502/share)

Amazon had another very solid growth year and the stock kept pace with its growth. Revenue will be up about 20% over 2018 and gross margins remain in the 40% range. For Amazon, Q4 is a wildly seasonal quarter where revenue could jump by close to 30% sequentially. While the incremental revenue tends to have gross margins in the 25% – 30% range as it is heavily driven by ecommerce, the company could post a solid profit increase over Q3. The stock pretty much followed revenue growth, posting a 23% year over year gain closing the year at $1848 per share. I view this as another winner, but it slightly under-performed the S&P index.

Stitch Fix stock appreciation will outpace the market (it closed last year at $17/share)

Stitch Fix, unlike many of the recent IPO companies, has shown an ability to balance growth and earnings. In its fiscal year ending in July, year over year growth increased from 26% in FY 2018 to over 28% in FY 2019 (although without the extra week in Q4 of FY 2019 year over year growth would have been about the same as the prior year). For fiscal 2020, the company guidance is for 23% – 25% revenue growth after adjusting for the extra week in Q4 of FY 2019. On December 9th, Stitch Fix reported Q1 results that exceeded market expectations. The stock reacted well ending the year at $25.66 per share and the year over year gain in calendar 2019 moved to a stellar level of 51% over the 2018 closing price.

DocuSign stock will outpace the market in 2019 (it is currently at $43/share and opened the year at $41)

DocuSign continued to execute well throughout calendar 2019. On December 5th it reported 40% revenue growth in its October quarter, exceeding analyst expectations. Given this momentum, DocuSign stock was the largest gainer among our 5 picks at 72% for the year ending at just over $74 per share (since this was a new recommendation, I used the higher $43 price at the time of the post to measure performance). The company also gave evidence that it is reducing losses and not burning cash. Since ~95% of its revenue is subscription, the company is able to maintain close to 80% gross margin (on a proforma basis) and is well positioned to continue to drive growth. But, remember that growth declines for very high growth companies so I would expect somewhat slower growth than 40% in 2020.

Replacing cashiers with technology will be proven out in 2019

A year ago, I emphasized that Amazon was in the early experimental phase of its Go Stores which are essentially cashierless using technology to record purchases and to bill for them. The company now has opened or announced 21 of these stores. The pace is slower than I expected as Amazon is still optimizing the experience and lowering the cost of the technology. Now, according to Bloomberg, the company appears ready to:

  • Open larger format supermarkets using the technology
  • Increase the pace of adding smaller format locations
  • Begin licensing the technology to other retailers, replicating the strategy it deployed in rolling out Amazon Web Services to others

Replacing cooks, baristas, and waitstaff with robots will begin to be proven in 2019

The rise of the robots for replacing baristas, cooks and waitstaff did indeed accelerate in 2019. In the coffee arena, Briggo now has robots making coffee in 7 locations (soon to be in SFO and already in the Austin Airport), Café X robotic coffee makers are now in 3 locations, and there are even other robots making coffee in Russia (GBL Robotics), Australia (Aabak) and Japan (HIS Co). There is similar expansion of robotic pizza and burger cooks from players like Zume Pizza and Creator and numerous robots now serving food. This emerging trend has been proven to work. As the cost of robots decline and minimum wage rises there will be further expansion of this usage including franchise approaches that might start in 2020.

Influencers will be increasingly utilized to directly drive commerce

The use of influencers to drive commerce accelerated in 2019. Possibly the most important development in the arena was the April 2019 launch by Instagram of social commerce. Instagram now let’s influencers use the app to tag and sell products directly, that is, their posts can be “shoppable”. Part of the series of steps Instagram took was adding “checkout” which lets customers purchase products without leaving the walls of the app.

A second increase in the trend is for major influencers to own a portion of companies that depend on their influence to drive a large volume of traffic. In that way they can capture more of the value of their immense influence. Using this concept, Rihanna has become the wealthiest female musician in the world at an estimated net worth of $600 million. The vast majority of her wealth is from ownership in companies where she uses her influence to drive revenue. The two primary ones are Fenty Beauty and Fenty Maison. Fenty Beauty was launched in late 2017 and appears to be valued at over $3 billion. Rihanna owns 15% – do the math! Fenty Maison is a partnership between LVMH (the largest luxury brand owner) and Rihanna announced in May of 2019. It is targeting fashion products and marks the first time the luxury conglomerate has launched a fashion brand from scratch since 1987. Rihanna has more than 70 million followers on Instagram and this clearly establishes her as someone who can influence commerce.

The Cannabis Sector should show substantial gains in 2019

The accuracy of this forecast was a mixed bag as the key companies grew revenue at extremely high rates, but their stock valuations declined resulting in poor performance of the cannabis index (which I had said should be a barometer). A few examples of the performance of the largest public companies in the sector are shown in Table 2.

Table 2: Performance of Largest Public Cannabis Companies

*Note: Canopy last quarter was Sept 2019

In each case, the last reported quarter was calendar Q3. For Tilray, I subtracted the revenue from its acquisition of Manitoba Harvest so that the growth shown is organic growth. I consider this forecast a hit and a miss as I was correct regarding revenue (it was up an average of 282%) but the stocks did not follow suit, even modestly, as the average of the three was a decline of 54%. While my forecast was not for any individual company or stock in the sector, it was wrong regarding the stocks but right regarding company growth. The conclusion is humbling as I’m glad that I exercised constraint in not investing in a sector where I do not have solid knowledge of the way the stocks might perform.

2019 will be the year of the unicorn IPO

This proved true as many of the largest unicorns went public in 2019. Some of the most famous ones included on the list are: Beyond Meat, Chewy, Lyft, Peloton, Pinterest, Slack, The Real Real, Uber and Zoom. Of the 9 shown, four had initial valuations between $8 billion and $12 billion, two over $20 billion and Uber was the highest at an $82 billion valuation. Some unicorns found the public markets not as accepting of losses as the private market, with Lyft and Uber stock coming under considerable pressure and WeWork unable to find public buyers of its stock leading to a failed IPO and shakeup of company management. There is more to come in 2020 including another mega one: Airbnb.

2020 Predictions coming soon

Stay tuned for my top ten predictions for 2020…but please note that all 5 of the stocks recommended for 2019 will remain on the list.

Soundbyte

  • Before the basketball season began, I had a post predicting that the Warriors still had a reasonable chance to make the playoffs (if Klay returned in late February). Talk about feeling humble! I guess, counting this I had 3 misses on my predictions.

R&D: Amazon’s Dirty Little Secret Weapon

 

Why doesn’t Amazon produce more earnings given its dominance?

Amazon just reported earnings and, as was the case in 2017 and 2016, emphasized that 2019 will be an investment year, so the strong operating margin expansion of 2018 would be capped in 2019. This, of course, is great fodder for bears on the stock as Amazon gave sceptics renewed opportunity to point out that it is a company that has a flawed business model and would find it difficult to ever earn a reasonable return on revenue.

In contrast, I believe that Amazon continues to transform itself into a potential strong profit performer. For example, taking the longer perspective, Amazon’s gross margins are now over 40% up from 27.2% five years ago (2013). So why doesn’t Amazon deliver higher operating margin than the slightly over 6% it reported in 2018? Amazon’s dirty little secret is that it continues to invest heavily in creating future dominance through R&D. Had it spent a similar amount in R&D to its long time competitor, Walmart, EBITDA would have nearly tripled… to over 17% of revenue! I must confess that in the past I haven’t paid enough attention to how much Amazon spends on R&D. As a result, I was surprised that Apple and Microsoft trailed it in voice recognition technology and that Amazon could lead IBM and Microsoft in cloud technology. The reason this occurred is not a surprising one: Amazon outspends Apple, Microsoft and IBM in R&D.

In fact, Amazon now outspends every company in the world (see Table 1) and have been dedicating a larger portion of available dollars to R&D (as measured by the % of gross margin dollars spent on R&D) than any other large technology company, except Qualcomm, for more than 10 years. Even though Amazon had less than 50% of Apple’s revenue and less than 1/3 of its gross margin dollars 5 years ago (2013) Amazon spent nearly 50% more than Apple on R&D that year… by 2018 the gap had increased to close to 100% more.

Table 1: Top 10 (and a few more) U.S. R&D Spenders in 2018 ($Bn)

Sources: market watch, analyst reports, annual filings

Note 1: Ford and GM may be in the top 10 but so far have not reported R&D in 2018. If they report it at year end the table could change. Walmart does not report R&D and their spend is generally unavailable, but I found a reference that said they expected to spend $1.1M in 2017.

Note 2: A 2018 global list would include auto makers VW and Toyota (with R&D of $15.8B and about 10.0B), drug company Roche (&10.8B) and tech company Samsung at $15.3B in place of the lowest 4 in Table 1.

The Innovators Financial Dilemma: Increasing Future Prospects can lower Current Earnings

When I was on Wall Street covering Microsoft (and others) Bill Gates would often point out that the company was going to make large investments the following year so they could stay ahead of competition. He said he was less concerned with what that meant for earnings. That investment helped drive Microsoft to dominance by the late 1990s. Companies are often confronted with the dilemma of whether to increase spending to drive future growth or to maximize current earnings. I believe that investment in R&D, when effective, is correlated to future success.

It is interesting to see how leaders in R&D spending have transitioned over the past 10 years. In 2008 the global leaders in R&D spending included 5 pharma companies, 3 auto makers and only 2 tech companies (Nokia and Microsoft which subsequently merged). In 2018, 6 of the top 7 spenders (Samsung plus the 5 shown in Table 1) were technology companies.

Table 2 – 2008 global R&D leaders ($Bn)

Note: *Facebook data from 2009, first available financials from S-1 filing

It’s hard to change without tanking one’s stock

When a company has a business model that allocates 1% of gross margin dollars to R&D, it is not easy to turn on the dime. If Walmart had decided to invest half as much as Amazon in R&D in 2018, its earnings would have decreased by 80% – 90% and its stock would have depreciated substantially. So, instead it began a buying binge several years ago to try to close the technology gap through acquisitions (which has a much smaller impact on operating margins). It remains to be seen if this strategy will succeed going forward but in the past 5 years Walmart revenue (including acquisitions) increased only 5% while Amazon’s was up 130% in the same period (also including acquisitions).

Whatever Happened to IBM?

When I was growing up, I thought of IBM as the king of tech. In the early 1990s it still seemed to rule the roost. The biggest fear for Microsoft was that IBM could overwhelm it, yet now it appears to be an also ran in technology. From 2014 to 2018, a heyday era for tech companies, its revenue shrank from $93 billion in 2014 to $80 billion in 2018. I can’t tell how much of the problem stems from under investing in R&D versus poor execution, but for the past 5 years it has spent an average of about 13% of GM on R&D, while the 6 tech companies in Table 1 have averaged about 24% of GM dollars with Apple the only one under 20%.

 

Soundbytes

Soundbyte I: Tesla

  • I recently had a long dialogue with a very smart fund manager and was struck by what I believe to be misinformation he had read regarding Tesla. There were 3 major points that he had heard:
    • The quality of Tesla cars was shoddy
    • Tesla could not maintain reasonable margins as it began producing lower priced Model 3s
    • The upcoming influx of electric cars from companies like Porsche, Jaguar and Audi would take substantial market share away from Tesla

I decided to do a bit of research to determine how valid each of these issues might be.

  • Tesla Quality: I found it hard to believe that the majority of Tesla owners thought the car was of poor quality since every one of the 15 or so people I knew who had bought one had already bought another or were planning to for their next car. So, I found a report on customer satisfaction from Consumer Reports, and I was not surprised to find that Tesla was the number 1 ranked car by customer satisfaction.
  • Tesla margins: this is much harder to predict. Since Tesla is relatively young as a manufacturer it has had numerous issues with production. Yet it is probably ahead of many others when it comes to automating its facilities. This tends to cause gross margins to be lower while volume ramps and higher subsequently. The combination of that, plus moving up the learning curve, should mean that Tesla lowers the cost of producing its products. However, Tesla charges more for cars with higher capacity for distance, but as I understand it uses software to limit battery capacity for lower priced cars. This would mean that a portion of the difference between a lower priced Model 3 and a higher priced one (the battery capacity) would be minimal change in cost, putting pressure on margins. The question becomes whether Tesla’s improving cost efficiencies offset the average price decline of a Model 3 as Tesla begins fulfilling demand for lower priced versions.
  • March 1 Update: After this post was complete (Thursday February 28) the company announced it was closing many showrooms to reduce costs. Then late today (Friday) announced that the $35,000 version of the model 3 is now available. So, we shall soon see the impact. I believe that if Tesla has increased capacity there will be very strong sales. It also likely will experience lower gross margin percentages as it climbs the learning curve and ramps production.
  • Will the influx of electric cars from others impact Tesla market share?

 

  1. Porsche is an electric sports car starting at $90K – at that price point it is competitive with model S not model 3. In competing with the S it comes down to whether one prefers a sports car to a sedan. I have owned a Porsche in the past and would only consider it if I wanted a sports car with limited seating capacity (but very cool). I loved my Porsche but decided to switch to sedans going forward. Since then I’ve owned only sedans for the past 10+ years. It also appears that early production is almost a year away, so it is unlikely to be competitive for 2019.
  2. Audi is at price points that do compete with the Model 3 and expects to start delivering cars in March. However, I think that is mainly in Europe where Tesla is an emerging brand so it might not impact them at all. When I look at the Audi models I don’t think they will appeal to Tesla buyers as they are very old-line designs (I would call them ugly). The range of the cars on a charge is not yet official but seems likely to be much lower than Tesla which has a big lead in battery technology.
  3. The Jaguar competes with the Tesla Model X but while cheaper, appears a weak competitor.

 

I don’t want to dismiss the fact that traditional players will be introducing a large number of electronic vehicles. The question really is whether the market size for electric cars is a fixed portion of all cars or whether it will become a much larger part of the entire market over time. I would compare this to fears that analysts had when Lotus and Wordperfect created Windows versions. They felt that Microsoft would lose share of windows spreadsheets and word processors. I agreed but pointed out that Windows was 10% of the entire market for spreadsheets, so having a 90% share gave Microsoft 9% of the overall spreadsheet market. I also predicted Microsoft would have over a 45% share when Windows was 100% of the market. So, while this would decrease Microsoft’s share of Windows spreadsheets, it would grow its total share of the market by 5X Of course we all were proven wrong as Microsoft eventually reached over 90% of the entire market.

For Tesla, the question becomes whether these rivals are helping accelerate the share electric cars will have of the overall market, rather than eroding Tesla volumes. I’m thinking that it’s the former, and that Tesla will have a great volume year in 2019 and that its biggest competitive issue will be whether the Model 3 is so strong that it will get people to buy it over the Model S. Of course, I could be wrong, but believe the odds favor Tesla in 2019, especially the first half of the year where the competitors are not that strong.

Soundbyte II: The NYC / Amazon Deal Collapses

I never cease to be amazed at how little regard some Politicians have for facts. I should likely not have been surprised by the furor created over Amazon locating a major facility in New York City. I thought the $44 billion or more in benefits to the City and State and massive job creation were such a win that no one would contest it. Instead, the dialog centered around the $ 3 billion in tax benefits to Amazon. All but 1/6 of the benefits (which was cash from the state) were based on existing laws and amounted to a reduction of future taxes rather than upfront cash. What a loss for the City.

2019 Top Ten Predictions

Opportunity Knocks!

The 2018 December selloff provides buying opportunity

One person’s loss is another’s gain. The market contraction in the last quarter of the year means that most stocks are at much lower prices than they were in Q3 of 2018. The 5 stocks that I’m recommending (and already own) were down considerably from their Q3 2018 highs. While this may be wishful thinking, returning to those highs by the end of 2019 would provide an average gain of 78%. Each of the 5 had revenue growth of 25% or more last year (and 3 were over 35%) and each is poised for another strong year in 2019.

For the 4 continued recommendations (all of which I mentioned I would recommend again in my last post), I’ll compare closing price on December 31, 2019 to the close on December 31, 2018 for calculating performance. For the new add to my list, I’ll use the stock price as I write this post. I won’t attempt to predict the overall market again (I’m just not that good at it) but feel that the 14% drop in Q4 means there is a better chance that it won’t take a nosedive. However, since stock picks are always relative to the market, success is based on whether my picks, on average, outperform the market.

I’ll start the post with stock picks and then follow with the remaining 5 predictions.

 2019 Stocks  

Tesla stock will outpace the market (it closed last year at $333/share and is essentially the same as I write this)

In Q3, 2018 the Tesla model 3 was the bestselling car in the U.S. in terms of revenue and 5th highest by volume. This drove a 129% revenue increase versus a year earlier and $1.75 in earnings per share versus a loss of $4.22 in the prior quarter. I expect Q4 revenue to increase sequentially and growth year/year to exceed 100%. In Q3, Tesla reported that nearly half of vehicles traded in for the Model 3 were originally priced below $35,000. As Tesla begins offering sub-$40,000 versions of it, demand should include many buyers from this high-volume price range. Since the backlog for the Model 3 is about 300,000 units I expect 2019 sales to remain supply constrained if Tesla can offer lower price points (it already has announced a $2,000 price reduction). The important caveat to demand is that tax credits will be cut in H1 2019, from $7500 to $3750 and then cut again to $1875 in the second half of the year. Part of Tesla’s rationale for a $2000 price drop is to substantially offset the initial reduction of these tax credits.

Tesla began taking orders for its Q1 launch in Europe where demand over time could replicate that in the U.S. The average price of a Model 3 will initially be about $10,000 higher than in the U.S. Tesla is also building a major manufacturing facility in China (where Model 3 prices are currently over $20,000 higher than the U.S.). This Giga-Factory is expected to begin production in the latter half of 2019. While moving production to China for vehicles sold there should eliminate trade war issues, Tesla still expects to begin delivering Model 3s to Chinese customers in March.

The combination of a large backlog, reducing prices within the U.S. and launches in Europe and China should generate strong growth in 2019. Some investors fear price reductions might lead to lower gross margins. When I followed PC stocks on Wall Street, this was a constant question. My answer is the same as what proved true there: strong opportunity for continuous cost reduction should enable gross margins to remain in the 20-25% range in any location that is at volume production. So, perhaps the Chinese Giga-Factory and a future European factory will start at lower margins while volume ramps but expect margins in the U.S. (the bulk of revenue in 2019) to remain in the targeted range. Higher prices in Europe and China due to massive initial demand allows premium pricing which may keep margins close to 20%+ in each.

Facebook stock will outpace the market (it closed last year at $131/share).

Facebook underperformed in 2018, closing the year down 28% despite revenue growth that should be 35% to 40% and EPS tracking to about 36% growth (despite a massive increase in SG&A to spur future results).  The stock reacted to the plethora of criticism regarding privacy of user information coupled with the continuing charges of Russian use of Facebook to impact the election. Before the wave of negative publicity, Facebook reached a high of $218/share in July. Facebook is likely to continue to increase its spending to address privacy issues and to burnish its image. However, scaling revenue could mean it keeps operating margins at a comparable level to 2018 rather than increasing them. Rumors of Facebook’s demise seem highly exaggerated!  According to a December 2018 JP Morgan survey of U.S. Internet users, the three most used social media products were Facebook (88% of participants), Facebook Messenger (61%) and Instagram (47%). Also, 82% of those surveyed picked a Facebook-owned platform as being the most important to them. Finally, the average Facebook user reported checking Facebook roughly 5 times per day with 56% of users spending 15 minutes to an hour or more on the platform on an average day. While Facebook has experienced a minor decrease in overall usage, Instagram usage has increased dramatically. Facebook, Instagram, and WhatsApp together give the company a growing and dominant position.

At the beginning of 2018 Facebook stock was trading at 34 times trailing EPS. By the end of the year the multiple of trailing EPS was below 18. If I assume EPS can grow 20%+ in 2019 (which is below my expectation but higher than the consensus forecast) than a multiple of 20 would put the stock at about $180/share by December 31. If it grew EPS, more in line with revenue and/or returned to a multiple closer to 34 it could reach well over 200.

Two key factors:

  1. A 20% increase in revenue (I expect the increase to be about 30%) adds over $11 billion in revenue. A comparable 20% increase in SG&A would provide over $4 billion in additional money to spend, affording the company ample dollars to devote to incremental marketing without impacting operating margins.
  2. Given the “low” stock price, Facebook increased its buyback program by $9 billion to $15 billion. Since it generates $6B – $7B in cash per quarter from operations (before capex) and has roughly $40 billion in cash and equivalents it could easily increase this further if the stock remains weak. The $15 billion could reduce the share count by as much as 3% in turn increasing EPS by a similar amount.

Amazon stock will outpace the market (it closed last year at $1502/share).

While its stock dropped from its September high of $2050, Amazon remained one of the best market performers in 2018 closing the year at $1502/share. At its 2018 high of $2050, It may have gotten ahead of itself, but at year end it was up less than 2018 revenue growth. Leveraging increased scale meant net income grew faster than revenue and is likely to triple from 2017. Growth will be lower in Q4 then Q3 as Q4 2017 was the first quarter that included all revenue from Whole Foods. Still, I would not be surprised if Amazon beat expectations in Q4 since this is already factored into analyst forecasts. Amazon trades on revenue coupled with the prospect of increasingly mining the revenue into higher profits. But the company will always prioritize making long term investments over maximizing near term earnings. Growth in the core ecommerce business is likely to gradually slow, but Amazon has created numerous revenue streams like its cloud and echo/Alexa businesses that I expect to result in maintaining revenue growth in the 20% plus range in 2019. The prospect of competing with an efficient new brick and mortar offering (see prediction 6 in this post) could drive new excitement around the stock.

Profitability in 2019 could be reduced by: announced salary increases to low end workers; increasing the number of physical store locations; and greater marketing incentives for customers. Offsets to this include higher growth in stronger margin businesses like AWS and subscription services. The stock may gyrate a bit, but I expect it to continue to outperform.

Stitch Fix stock will outpace the market (it closed last year at $17/share).

In my 2018 forecast I called this my riskiest pick and it was the most volatile which is saying a lot given the turbulence experience by Facebook, Tesla, and Amazon. I was feeling pretty smug when the stock reached a high of $52/share in September! I’m not sure how much of the subsequent drop was due to VCs and other early investors reducing their positions but this can have an impact on newly minted public companies. Whatever the case, the stock dropped from September’s high to a low point of $17.09 by year’s end. The drop was despite the company doing a good job balancing growth and profitability with October quarter revenue up 24% and earnings at $10.7 million up from $1.3 million in the prior year. Both beat analyst expectations. The stock was impacted because the number of users grew 22% (1-2% less than expected) despite revenue exceeding expectations at 24% growth. I’m not sure why this was an issue.

Stitch Fix continues to add higher-end brands and to increase its reach into men, plus sizes and kids. Its algorithms to personalize each box of clothes it ships keeps improving. Therefore, the company can spend less on acquiring new customers as it has increased its ability to get existing customers to spend more and come back more often. I believe the company can grow by roughly 20% or more in 2019. If it does and achieves anything close to the revenue multiple that it started with in 2018 (before the multiple doubled in mid-year), there would be a sizeable stock gain this year. But it is a thinly traded stock and likely to be quite volatile.

Docusign Stock will outpace the market in 2019 (it is currently at $43/share).

Docusign is a new recommendation. Like Stitch Fix, it is a recent IPO and could be volatile. Docusign is the runaway leader in e-signatures, facilitating multiple parties signing documents in a secure, reliable way on board resolutions, mortgages, investment documents, etc. Strong positives include:

  • A high value for a reasonable price – I am increasingly annoyed when I need to deal with manual signatures for documents.
  • As of October 31, 2018, Docusign had over 450,000 customers up from 350,000 customers one year earlier. Of which 50,000 are Enterprise/Commercial accounts;
  • There are hundreds of millions of users whose e-signatures are stored by the company making the network effect quite large;
  • Roughly 95% of revenue is from its SaaS product which has 80% gross margin with the rest from services where margins have improved and are now positive;
  • As a SaaS company with a stable revenue base growth is more predictable. The company exceeded revenue guidance each quarter with the October 31, 2018 quarter revenue up 37%;
  • Most customers pay annually in advance. This means cash flow from operations is positive despite the company recording an operating loss;
  • Customers expand their use resulting in retained customers growing revenue faster than decreases from churned customers making net revenue retention over 100%;
  • International expansion remains a large opportunity as international is only 18% of revenue.

Picks 6 – 10: Major Trends that will surface in 2019

I developed my primary method of stock picking at my first Wall Street firm, Stanford Bernstein. The head of research there, Chuck Cahn, emphasized that you could get small wins by correctly determining that a stock would trade up on certain news like a new product, a big customer win, and beating consensus forecasts. But larger and more predictable wins of 5X or more were possible if one identified a long-term winner riding a major trend and stuck with it for multiple years. All 5 of my stock picks fall into the latter category. I’ve been recommending Facebook, Tesla, and Amazon for 4 years or more. All 3 are now over 5X from when I first targeted them as I bought Tesla at $46 and Facebook at $24 in 2013 (before this blog) and they have been in my top 10 since. Amazon was first included in 2015 when it was at $288/share. Stitch Fix and DocuSign are riskier but if successful have substantial upside since both are early in their run of leveraging their key trends.

The next 4 picks are in early stages of trends that could lead to current and next generation companies experiencing benefits for many years. The first two go hand in hand as each describes transformation of physical retail/restaurants, namely, replacing staff with technology in a way that improves the customer experience. This is possible because we are getting closer to the tipping point where the front-end investment in technology can have a solid ROI from subsequent cost savings.

Replacing Cashiers with technology will be proven out in 2019

In October 2015 I predicted that Amazon (and others like Warby Parker) would move into physical retail between then and 2020. This has occurred with Amazon first opening bookstores and then buying Whole Foods, and Warby Parker expanding its number of physical locations to about 100 by the end of 2018. My reasoning then was simple: over 92% of purchases in the U.S. were made offline. Since Amazon had substantial share of e-commerce it would begin to have its growth limited if it didn’t create an off-line presence.

Now, for Amazon to maintain a 20% or greater revenue growth rate it’s even more important for it to increase its attack on offline commerce (now about 90% of U.S. retail) I’m not saying it won’t continue to try to increase its 50% share of online but at its current size offline offers a greater opportunity for growth.

A key to Amazon’s success has been its ability to attack new markets in ways that give it a competitive advantage. Examples of this are numerous but three of the most striking are Amazon Cloud Services (where it is the industry leader), the Kindle (allowing it to own 70% share of eBook sales) and Prime (converting millions of customers to a subscription which in turn incentivized buying more from Amazon due to free shipping).

Now the company is testing an effort to transform brick and mortar retail by replacing staff with technology and in doing so improving the buying experience. The format is called Go stores and there are currently 5 test locations. Downloading the Amazon Go App enables the user to use it to open the automated doors. The store is stocked (I think by actual people) with many of the same categories of products as a 7-Eleven, in a more modern way. Food items include La Boulangerie pastries, sushi, salads, an assortment of sandwiches and even meal kits. Like a 7-Eleven, it also has convenience items like cold medicine, aspirins, etc. The store uses cameras and sensors to track your movements, items you remove from the shelves and even whether you put an item back. When you leave, the app provides you with a digital receipt. Not only does the removal of cashiers save Amazon money but the system improves customer service by eliminating any need to wait in line. I expect Amazon to open thousands of these stores over the next 3-5 years as it perfects the concept. In the future I believe it will have locations that offer different types of inventory. While Amazon may be an early experimenter here, there is opportunity for others to offer similar locations relying on third party technology.

Replacing Cooks, Baristas and Waitstaff with robots will begin to be proven in 2019

The second step in reducing physical location staff will accelerate in 2019. There are already:

  1. Robotic coffee bars:  CafeX opened in San Francisco last year, and in them one orders drip coffee, cappuccino, latte, or hot chocolate using an app on your phone or an iPad available at a kiosk. The coffee is made and served by a robot “barista” with the charge automatically put on your credit card. Ordering, billing, and preparation are automatic, but there is still one staff member in the shop to make sure things go smoothly.
  2. The first robotic burger restaurant: Creator opened in San Francisco last June. It was in beta mode through September before opening to the general public. While a “robot” makes the burgers, Creator is not as automated as CafeX as humans prepare the sauces and prep the items that go into the machine. Creator also hasn’t automated ordering/payment. Startup Momentum Machines expects to open a robotic burger restaurant and has gotten substantial backing from well-known VCs.
  3. Robots replacing waitstaff: For example, at Robo Sushi in Toronto, a “Butlertron” escorts you to your table, you order via an iPad and a second robot delivers your meal. Unlike the robots in the coffee bar and burger restaurant these are made into cute characters rather than a machine. Several Japanese companies are investing in robotic machines that make several of the items offered at a sushi restaurant.
  4. Robotic Pizza restaurants: The furthest along in automation is the Pizza industry. Zume Pizza, a startup that uses robots to make pizzas, has recently received a $375 million investment from Softbank. Zume currently uses a mix of humans and robots to create and deliver their pizzas and is operational in the Bay Area. Pizza Hut and Dominos are working on drones and/or self-driving vehicles to deliver pizzas. And Little Caesars was just issued a patent for a robotic arm and other automated mechanisms used to create a pizza.

At CES, a robot that makes breads was announced. What all these have in common is replacing low end high turnover employees with technology for repetitive tasks. The cost of labor continues to rise while the cost of technology shrinks a la Moore’s Law. It is just a matter of time before these early experiments turn into a flood of change. I expect many of these experiments will turn into “proof points” in 2019. Successful experiments will generate substantial adoption in subsequent years. Opportunities exist to invest in both suppliers and users of many robotic technologies.

“Influencers” will be increasingly utilized to directly drive Commerce

Companies have long employed Influencers as spokespersons for products and in some cases even as brands (a la Michael Jordon and Stephan Curry basketball shoes or George Forman Grills). They appear on TV ads for products and sometimes used their social reach to tout them. Blogger, a prior Azure investment, understood how to use popular bloggers in advertising campaigns. But Blogger ads, like most TV ads did not directly offer the products to potential customers. Now we are on the verge of two major changes: tech players creating structured ways to enable fans of major influencers (with millions of followers) to use one-click to directly buy products; and technology companies that can economically harness the cumulative power of hundreds of micro-influencers (tens of thousands of fans) to replicate the reach of a major influencer. I expect to see strong growth in this method of Social Commerce this year.

The Cannabis Sector should show substantial gains in 2019

In my last post I said about the Cannabis Sector: “The industry remains at a very early stage, but numerous companies are now public, and the recent market correction has the shares of most of these at more reasonable levels. While I urge great care in stock selection, it appears that the industry has emerged as one to consider investing in.” Earlier in this post, I mentioned that riding a multi-year wave with a winning company in that segment is a way to have strong returns. I’m not knowledgeable enough regarding public Cannabis companies, so I haven’t included any among my stock recommendations. However, I expect industry wide revenue to grow exponentially. The 12 largest public Cannabis companies by descending market cap are: Canopy Growth Corp (the largest at over $11B), Tilray, Aurora Cannabis, GW Pharmaceuticals, Curealeaf Holdings, Aphria, Green Thumb Industries, Cronos Group, Medmen Enterprises, Acreage Holdings, Charlotte’s Web Holdings and Trulieve Cannabis.

I believe one or more of these will deliver major returns over the next 5 years. Last year I felt we would see good fundamentals from the industry but that stocks were inflated. Given that the North American Cannabis Index opened this year at 208 well down from its 2018 high of 386 investing now seems timely. I’ll use this index as the measure of performance of this pick.

2019 will be the Year of the Unicorn IPO

Many Unicorns went public in 2018, but this year is poised to be considerably larger and could drive the largest IPO market fund raising in at least 5 years.  Disbelievers will say: “the market is way down so companies should wait longer.” The reality is the Nasdaq is off from its all-time high in August by about 15% but is higher than its highest level at any time before 2018. Investment funds are looking for new high growth companies to invest in. It appears very likely that as many as 5 mega-players will go public this year if the market doesn’t trade off from here. Each of them is a huge brand that should have very strong individual support. Institutional investors may not be as optimistic if they are priced too high due to the prices private investors have previously paid. They are: Uber, Lyft, Airbnb, Pinterest, and Slack. Each is one of the dominant participants in a major wave, foreshadowing substantial future revenue growth. Because information has been relatively private, I have less knowledge of their business models so can’t comment on whether I would be a buyer. Assuming several of these have successful IPOs many of the other 300 or so Unicorns may rush to follow.

It will be an interesting year!

The Argument for Curry as a Unicorn

In our previous post we posed the potential for Stephen Curry to become a Unicorn (in venture this is a company that reaches $1 billion in value). While it was mostly for fun, on reflection we decided that it actually could prove valid. This post will walk you through why an athlete like Curry (or potentially James Harden, Russell Westbrook or Anthony Davis) could become a Unicorn should they be elevated to the elite status of a LeBron James.

curry unicorn

The Precedent for Creating a Corporation Owning an Athlete’s Earnings Exists

In April 2014, Vernon Davis offered stock in his future earnings via a venture with Fantex, Inc. as part of a new financial instrument being sold by Fantex. Davis offered a 10% share of all future earnings from his brand marketing company to Fantex, which would then turn around and divide it into shares of a tracking stock that can be traded within their own exchange. The offering was 421,100 shares, valued at $10 each, for a total of $4.2 million. This implied a total value of the “Vernon Davis Corporation” of $42 million. Davis’ current salary is $4.7 million and endorsement income about $1.75 million for a total income of $6.5 million. Given that the longevity of football players is rarely into their mid-thirties coupled with Davis being over 30 at the time, it seems likely that he had no more than 3-4 years left in his playing career. Putting those facts together makes it appear that Davis was unlikely to earn much more than $42 million going forward and might earn less as we would expect his income to drop precipitously once he retired. So buying the stock was probably viewed as more of a symbol of support for Davis and its “market cap” appears about equal to his expected future earnings.

NBA Stars are Among the Highest Earning Athletes’

The current highest earner of endorsements in the NBA is LeBron James at about $44 million per year (Kevin Durant is second at $35 million). The highest contract in the league is Kobe Bryant at about $23 million per year (and had been $30 million previously) with the 10 highest players in the league making an average of over $21 million. Given the new TV contract scheduled to go into effect in the 2016-2017 season, it’s been projected that the cap will increase from about  $63 million today to $90 million in 2017 and be nearly $140 million by 2025 (10 years from now, at age 37, Curry should still be playing). Let’s make the following assumptions:

  1. Curry’s salary will go from a current level of $11 million in 2015 and 12 million in 2016 (4 other Warriors will be paid more that year) to about $30 million in 2017 assuming the top salaries tend to be about 1/3 of their team’s cap as they are today.
  2. It will be up to $40 million in 2025, or less than 1/3 the projected $140 million cap.
  3. His endorsements will reach midway between the current levels experienced by LeBron and Durant, to about $40 million by 2017 (they are currently at about $5.5 million from Under Armour)
  4. His endorsement income will rise by about 10%/year subsequently, through 2025 to reach $92 million in 2025
  5. He will continue to earn endorsement income (but will retire from playing) subsequent to the 2025 season.
  6. The level post 2025 will average $60 million per year for 10 years and then go to zero.

The last assumption is based on observing the income of retired stars like Michael Jordan (earning $100 million/year 12 years after retirement), David Beckham (earned about $75 million the first year after retiring), Arnold Palmer (earned $42 million/year 40 years after winning his last tournament), Shaq ($21 million), Magic Johnson is now worth over $500 million. Each are making more now than the total they made while playing and, in several cases, more per year than in their entire playing careers. So assuming Curry’s income will drop by 1/3 after retirement is consistent with these top earners.

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This puts his total income from 2016 through the end of 2035 at over $1.5 billion. All of the above assumptions can prove true if Curry continues to ascend to super-star status, which would be helped if the Warriors win the championship this year. They could even prove low if Curry played longer and/or remained an icon for longer than 10 years after retiring. Thankfully, Curry has remained relatively injury free and our analysis assumes that he remains healthy. Curry is not only one of the most exciting players to watch, but is also becoming the most popular player with fans around the league. Curry now ranks second overall in total uniform sales, behind LeBron James.

So while the concept of Stephen Curry as a Unicorn (reaching $1 billion in value) started as a fun one to contemplate with our last post, further analysis reveals that it is actually possible that Fantex or some other entity could create a tracking stock that might reach that type of valuation.

As a VC, I would love to invest in him!

SoundBytes:

  • In the recent game against the Blazers there was further validation of Curry’s MVP bid. Curry delivered eight 3-pointers, hit 17 of 23 shots and went 7-of-7 in his 19-point fourth quarter. His last two threes were a combined distance of 55 feet, setting a new record for threes in a season and breaking his own record!
  • To understand just how well Curry shot, his Field Goal Efficiency was 91% (he had 8 threes bringing his equivalent field goals to 21/23). Not only was this higher than anyone who scored 40 points this year or took at least 20 shots in a game, we believe it may be among the highest ever for someone taking 20 shots in a game.
  • As a comparison, the two Portland stars, Aldredge and Lillian, each had strong games and scored 27 and 20 points, respectively. But, to do that, they took 46 shots between them (double that of Curry) and only scored 2 more points in total for the extra 23 shots!
  • The 4th quarter performance by Curry, cited above, translates to a 114% FGE rating, which is averaging more than 100% shooting as he scored 16 points on 7 shots. When foul shots are taken into account, his True Shooting % was 137% as he scored 19 points on 8 field goal attempts (counting the one on which he was fouled).To draw a comparison, when Russell Westbrook scored 54 points against Portland on April 12 he took 43 shots, 20 more than Curry (23 more if we include shots that led to foul shots).

Is Stephen Curry Becoming a Unicorn?

Why Curry should be the clear NBA MVP

Much has been written about the importance of discovering and investing early in “Unicorns”, companies that eventually cross the $1 billion valuation threshold. In basketball, teams make tough decisions as to whether to sign individual players to contracts that can be worth as much as $120 million or more over six years. The top few players can earn a billion dollars over their career when endorsements are added to the equation, assuming they can last as long as a Kobe Bryant or Tim Duncan. Clearly part of the road to riches is getting the recognition as one of the elite. This year, several players previously thought of as “quite good” are emerging in the quest to be thought of as “great”. Nothing can help a player put his stamp on such a claim as much as winning the MVP. In the spirit of trying to identify a future “Unicorn” in professional basketball, I thought it would be fun to analyze the current crop of contenders.

Given an unusual emergence of multiple stars, this year’s NBA MVP race is one of the most hotly contested in years. There are five legitimate candidates: Stephen Curry, Russell Westbrook, James Harden, Anthony Davis and LeBron James. All of them are having spectacular seasons and in most years that would be good enough for them to win. But only one can take the MVP crown. LeBron is the reigning king of the league and has long ago hoisted his flag atop the mountain. But, he has won the MVP title a number of times and while he remains a solid choice, he is not a clear choice. Therefore, it appears almost certain that most voters will favor a candidate who has yet to win. In the last few weeks Davis seems to have faded from consideration so, in this post, I will provide the analysis that has led me to determine that Curry is a more worthy recipient than Westbrook and Harden.

Scoring

Basketball columnists and analysts often focus too much of their evaluation of success on a player’s scoring average. In an attempt to help understand a player’s full value, John Hollinger created a Player Efficiency Rating (PER) that incorporates several statistics in the hope it provides a single rating that determines the best player. While it is a truly worthy effort, we feel there is quite a bit of judgement incorporated in what value to place on different statistics.  For example, it rewards players who take more shots even when the extra shots are 2-pointers at a low field goal percentage (taking extra 2-point shots at over a 31% increases the rating even though that is well below what the rest of his team would likely shoot). We would place more value on giving the ball up (and having a lower scoring average) than taking a low percentage shot.

I am surprised that the simplest calculation of scoring efficiency does not surface as a regularly reported statistic. Some sources occasionally report an “Adjusted Field Goal Percentage” (AFG%) that counts a 3-point field goal as worth 1.5 times a 2-point field goal. We believe this is the correct way of viewing a shooter’s effectiveness and called it field goal efficiency (FGE%). It calculates the percentage as the equivalent of 2-point field goals made per field goal attempt (FGA):

FGE% = (2-point shots made + 1.5 x 3-point shots made)/FGA

There is one statistic that analysts call True Shooting Percentage (TS%) that goes one step further. It also takes foul shots into account. It assumes that 1 of every 9 foul shots is part of a 3-point (or 4-point) play and therefore considers 2.25 foul shots as the same as one field goal attempt (since most pairs of foul shots replace a field goal attempt). TS% is calculated by adding the field goal attempt equivalent of foul shots to normal field goal attempts to determine the equivalent number of attempts used by a player. By dividing points scored by 2 we know how points scored equates to 2-point field goals made (FGME). This translated to the following formula for TS%:

Equivalent field goal attempts (EFGA) = FGA + FTA/2.25

FGME = points scored/2

TS% =FGME/EFGA

Now let’s compare Curry, Harden and Westbrook based on these statistics all on a per game basis:

Slide1

Harden and Westbrook are neck-and-neck in scoring average, each about four points per game higher than Curry. But Curry plays fewer minutes per game and takes fewer shots. His shooting efficiency at 58.6% is by far the highest of the three by a significant amount (a full 14% higher than Westbrook and 7% higher than Harden). It is also the highest in the league for players that have taken at least 8 shots per game (which includes all of the top 100 players by scoring average). At over 90%, Curry is the number one foul shooter in the league. But Harden and Westbrook are also hitting roughly 85% of their foul shots. Therefore, the fact that they get fouled much more than Curry brings each of their TS%s closer to Curry’s. Still, Curry is a whopping 10% higher than Westbrook and 2.5% higher than Harden. It is apparent that the scoring average advantage is more a function of Curry playing fewer minutes and being more selective in his shots.

To see the impact of this we calculated their scoring average per 36 minutes played (which we consider about average for a team’s star) and points scored per 25 equivalent field goals attempts:

Slide2

So, even if he played the same amount of time as Harden and Westbrook, Curry would trail in average points per game, primarily because he still would take fewer shots. But if he took the same number of equivalent shots he’d have a higher scoring average than both.

A Few Other Statistical Comparisons

While scoring efficiency is an important measure of a players value to his team, several other statistics like assists, rebounds, and steals are also considered quite relevant. To make comparisons fair, we adjusted to the average per 36 minutes for each:

Slide3

For steals, Westbrook and Curry are close to dead even with Harden about 11% behind. However, Westbrook is the clear leader in rebounds and has 7% more assists than Curry with both well ahead of Harden.

Each of these three players leads their team’s offense. They all control the ball attempting to score themselves or assist others in scoring without turning the ball over, as every turnover is a lost scoring opportunity. The ratio of assists to turnovers helps capture effectiveness as a guard. On the defensive end they each can compensate for a portion of their turnovers by stealing the ball. The ratio of steals to turnovers captures how well they are able defensively to partly compensate for depriving their team of a scoring opportunity. But attempts to steal the ball can lead to more personal fouls. The ratio of steals to personal fouls helps understand defensive effectiveness. Here are the comparisons:

Slide4

Harden and Westbrook are 25%-40% behind Curry in all of these categories. What the first ratio tells us is that Curry passes the ball more accurately and/or takes less risk so that he gets his assists without turning the ball over as frequently as the others. Another way of looking at it is that the extra 0.6 assists that Westbrook averages per 36 minutes comes at the expense of one extra turnover vs Curry.  The steal/turnover ratio tells us that for every 3 turnovers Curry has, he is able to get the ball back twice through steals. The others recover less than half of their turnovers through steals. Finally the steals/personal foul ratio shows that Curry is quite effective defensively with a ratio that is over 30% better than either of the others.

 

Curry Creates the Most Team Success

So, what is the bottom line that helps capture the impact of the various statistics we have shown? Of course one measure is the fact that Curry has helped his team achieve a much better record. What other measure should be considered in evaluating a potential MVP’s impact on a team? Given Curry’s extremely high Field Goal Effectiveness, does his taking fewer shots help the team more than Harden and Westbrook taking more shots and scoring more? The league average for scoring per game is roughly 99.9 points (through about 76 games of the season). Each of the three help their team score at a higher rate than that, but Curry has led the Warriors to the highest scoring per game in the league. The comparison:

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A natural question is whether this superior offensive performance comes at the expense of inferior defense.  So we should include the average points given up per game by each team to round out the picture. Notice the Warriors allow fewer points per game than the league average while both the Thunder and the Rockets allow more than the league average. The combination for the Warriors means that they have the highest plus/minus in the league by quite a bit (the Warrior’s 10.4 is 60% higher than the Clippers who are second at 6.5), and it is nearly double the sum of the plus/minus for the Rockets and Thunder combined.

Slide6

The league also maintains plus/minus differential by player. That is how many more points a team scores than opponents when that player is on the floor.  In all three cases, it seems clear the players are driving the team’s effectiveness as their differential exceeds that of the teams (meaning that without them on the floor, the other team, on average, outscores their team). This statistic takes offense and defense into account and helps measure the influence a player has on his team’s effectiveness.

Slide7

This means that Curry is responsible for a 12.0-point improvement in plus/minus when on the floor versus how the team does when he isn’t, while both Westbrook and Harden improve their team’s plus/minus by 5.0 points. Given his top score in plus/minus, much higher Field Goal Effectiveness and TS%, combined with driving the Warriors to the top record in the league, it seems that Curry should be the league MVP and is on his way to becoming a Unicorn. As a VC, I would love to invest in him!

SoundBytes:

  • The recent ESPN selection of the top 20 players of the past 20 years is quite enlightening in how well the NBA markets their elite players compared to other sports. Despite the fact that football and baseball have a multiple of the number of players and are more popular sports, five of the 20 were from the NBA:
    • Number 1: Michael Jordon
    • Number 2: LeBron James
    • Number 8: Kobe Bryant
    • Number 11: Shaquille O’Neal
    • Number 14: Tim Duncan
  • There were 3 from football (all quarterbacks) and 2 each from baseball, tennis and soccer. And one each from 6 other sports (hockey, boxing, golf, swimming, track and cycling).
  • The four emerging stars (this includes Anthony Davis) we have discussed all have the potential to be on a future such list but their status among the greatest will also be dependent on their ability to win multiple championships. Winning MVPs makes a player great, winning multiple championships makes them one of the greatest.
  • Last night’s game against the Blazers was further validation’s of Curry’s MVP bid. Curry delivered eight 3-pointers, hit 17 of 23 shots and went 7-of-7 in his 19-point fourth quarter. His last two threes were a combined distance of 55 feet, setting a new record for threes in season and breaking his own record!