Table of contents:
- Spotify vs the record labels.
- Nvidia and the new industrial revolution.
- We have become an “asset-light” economy. Quote from Warren Buffett’s annual shareholder meeting.
- FAANG stocks were crushed in October. Rally over?
- These categories of smart home technology are poised for growth.
- Public offerings: How Moderna Therapeutics wants to revolutionize drug manufacturing.
- Two signs a recession “might” be near.
- Canada is fragile.
1. Spotify vs the record labels.
The above chart is Spotify’s gross margin since 2013.
As a refresher, gross margin is (Revenue – Cost of Revenue).
From an article by Music Business Worldwide:
During the last round of negotiations with the three major record labels (Universal, Sony, and Warner), Spotify was able to reduce their payout to the record labels from 55% towards 52%. Hence the bump in gross margin improvement
The reduction was granted on the basis that Spotify hit steep subscriber targets.
See the problem… The percentage Spotify pays out to the labels has a direct effect on their gross margin.
Recently, Spotify CFO Barry McCarthy said this:
“The [gross margin improvement] wasn’t a magic trick – the labels were acting in their own self-interest to shore up Spotify’s economically-challenged margin structure, because of the growing importance of a healthy Spotify to the entire music industry ecosystem.”
Spotify is now a large portion of the record labels revenue, so you would think that would give them leverage during the next round of negotiations…
One very senior US-based source at a major record company tells MBW: “If Spotify comes in here [during the 2019 re-negotiations] and asks for any sort of margin improvement, we’re going to laugh them out of the room.
Something has to give. The labels own the songs and the artist and Spotify owns the relationship with the end user. As long as Spotify is held captive by the labels, I think their business will be challenged. Not their popularity with consumers, but their business.
- Spotify is on a collision course with the major record label. Here’s why.
- One reason why Spotify’s deals with the record labels are balanced on a knife-edge.
How’s their stock doing?
This we know:
- Spotify owns the relationship with the end consumer. Which, in today’s world, seems to be a common trait in winning companies.
- The labels own the supply (artists, library of old songs, etc.).
Our view: It will be difficult to handicap the outcome of the battle between Spotify and the labels. Other companies, like Google, have been able to leverage their relationship with the end user over suppliers (publishers). Because in Google’s case, there are tens of thousands of publishers. This makes it impossible for any one publisher or group of publishers to dictate terms to Google.
In Spotify’s case, there are only three to five main suppliers (record labels). This makes it more difficult for Spotify to leverage their relationship with the end user.
What to watch for: Contract negotiations with the record labels will take place in 2019. They should be interesting…
2. Nvidia and the new industrial revolution
Nvidia (NVDA) has fallen 49% from their 2018 highs. I figured it would be a good time to take a look at what exactly they do, where their revenue comes from, and what the future looks like.
What is a GPU and why is it important
GPU stands for graphics processing unit. Its main responsibility is ensuring content renders on our screens (phones, desktops) correctly. They have been around since the mid-90s and were used in 3D games but today their popularity has surged because their adoption is becoming widespread among a range of industries. Nvidia currently has 87 GPU systems in the Top 500 Supercomputer List.
Three markets that are adopting the use of GPUs:
- Crypto mining
- AI/autonomous cars
The data center segment (red box) includes sales of crypto mining rigs; which the company says has fallen substantially and they don’t expect much revenue from that segment in the near-term.
Many technologists believe that AI and self-driving cars will cause the biggest restructuring of our economy since the Industrial Revolution. Who knows if their right but let’s assume they are.
What will those two industries need lots of?
DATA. and computers that can process that data, fast.
As an example. From Nvidia’s blog:
FAW Group, one of China’s largest truck manufacturers, is teaming up with autonomous driving startup PlusAI and Full Truck Alliance (FTA), a logistics company, to develop a driverless commercial trucking fleet planned for a large-scale truck-hailing service in 2021.
The companies said this week that they will use NVIDIA DRIVE AGX Pegasus, an AI supercomputer capable of 320 trillion operations per second (TOPS), to operate the self-driving trucks that are poised to transform China’s long-haul transportation industry.
(my mouth dropping)- 320 trillion operations per second…Wheww
What should we do?
If you believe the thesis that AI and self-driving cars will have a big impact on our future, then we want to own companies the provide and capture value within those industries.
Two options for you to research further:
- You can try to determine which companies will build the products for this new world and most importantly, which companies will capture the new value created.
- You can buy a basket of companies developing this technology through an ETF (more below)
ARK Invest has four ETFs focused on the future:
- ARQK: The Industrial Innovation ETF. These are companies ARK believes will kick off a new industrial revolution. One that moves us away from the industrial companies that were built in the 20th century. Some examples include:
- Autonomous Transportation
- Robotics and Automation
- 3D Printing
- Energy Storage
- Space Exploration
- ARKW: Web x.O ETF. These companies are expected to benefit from the shift to cloud computing and a mobile-first world. Some examples include:
- Cloud Computing & Cyber Security
- Big Data & Artificial Intelligence (AI)
- Mobile Technology and Internet of Things
- Social Platforms
- Blockchain & P2P
- ARKG: Genomic Revolution Multi-Sector ETF. These companies are focused on extending and enhancing the quality of human life. The companies will include:
- Targeted Therapeutics
- Molecular Diagnostics
- Stem Cells
- Agricultural Biology
- ARKK: ARK Innovation ETF. These are companies that introduce a new product or service that disrupts the old way and creates a new behavior. What defines “disruptive innovation” is broad but a few of their holdings are Tesla, Square, Twitter, and Nvidia.
You can learn more about ARK Invest here.
Many companies in the ARK suite of ETFs overlap. Going through their ETFs is a good place to hunt for new ideas.
3. We have become an asset-light economy.
The above is a quote from Warren Buffett during their last annual shareholder meeting.
His full quote read:
“The four largest companies today by market value do not need any net tangible assets. They are not like AT&T, GM, or Exxon, which require lots of capital to produce earnings.
We have become an asset-light economy.”
He went on to say that he erred by not by Google. That’s ok Warren, many people did…
The takeaway: In the 21st century, the valuable companies will likely be software driven companies and that’s where we will focus our research.
Many companies that were built during the 20th century will fall on hard times as software eats the world. Some of those stocks will look cheap and value investors will jump in and buy. But it will be a trap, as investors in GE and Sears have found out.
4. FAANG stocks were crushed in October. Rally over?
Look at your home screen on your phone.
- You are holding an iPhone or Android (owned by Google).
- Have the Facebook, Amazon, Netflix, and a Google app (maps or search) on your home screen.
These companies operate in a winner takes all (or most) markets. You want to be one or two in your category. Which all these companies are.
The hard part is determining how much growth has already been priced into these stocks and what numbers they will have to hit, to reach new highs.
Speaking of Facebook…
According to the WSJ, twenty-six funds dumped their entire stakes in Facebook in the third quarter, according to Goldman Sachs analysis of 13-F filings.
5. These categories of smart home technology are poised for growth
Our view: We will be watching companies in each of these categories. One company that’s on our radar is Sonos (SONO). They are known for making high-quality speakers and have recently entered the competitive, smart speaker market.
They went public in August and we look forward to reading their quarterly report. We will report back what we find.
Competing in with Amazon, Google, and Apple will prove tough sledding for Sonos. See chart below.
Sonos is so so tiny they are relegated to the ‘other’ category.
6. Public Offerings
Moderna Therapeutics, a Massachusetts startup that wants to revolutionize drug manufacturing, on Friday filed for what could be the largest-ever IPO for a biotech startup reports Axios.
What they do: The company creates synthetic mRNA that can be injected into patients to help them create their own therapies.
A little more:
- mRNA stands for messenger RNA. It is a subtype of RNA. An mRNA molecule carries a portion of the DNA code to other parts of the cell for processing.
- Every cell in the body uses mRNA to provide real-time instructions to make the proteins necessary to drive all aspects of biology, including in human health and disease.
- They believe mRNA could be used to create a new category of medicines with significant potential to improve the lives of patients.
Our view: We will never have insight into the potential of a company like this. We’re just curious. If your a doctor or scientist and would like to educate us, please reach out. You can email us at firstname.lastname@example.org.
7. Two signs a recession “might” be near
Looking at history, a clear pattern emerges. Auto sales tend to rise in the early stages on an expansion, but peak and decline shortly before a recession writes Noah Smith.
He cites a good reason for this:
There’s actually a fundamental economic reason why this should be true. Unlike nondurable goods and services such as food, heating and insurance that people have to purchase even in bad times, consumption of durable goods like cars and houses can be delayed.
If you’re unemployed, or worried about becoming unemployed, or if sales at your company are bad this year, you can keep driving your old car a little while longer, or put off buying that new condo.
Economist Ed Leamer argued that residential investment (new construction or improvements of single or multi-family housing) is the primary driver of the economic cycle.
Residential investment consistently and substantially contributes to weakness before…recessions…Eight of the ten [U.S. postwar] recessions [before 2007] were proceeded by sustained and substantial problems in housing.
Our view: Following economic forecasts do not provide an investor with actionable advice. However, I think it’s helpful to have a general idea of what’s going on in the economy.
8. Canada is fragile
The headline (Canada is fragile) is from Nassim Taleb’s book, “Anti-fragile.” The book’s premise is to help us become anti-fragile. Meaning, how can we insulate our business and life from shocks, such as financial crises.
In this situation, Canada is fragile because their economy over-indexed on energy. Which works well when energy is booming but is prone to severe shocks when oil prices fall.
9. What else went on…
The chart above shows that when fund managers cut back on their equity exposure, it’s often a good time to buy stocks. It’s not a perfect tool, but eventually, they will rotate back into the market and help push up prices.
Covenant-lite loans are loans that offer little protection for the lender. They are considered borrower friendly. A spike in this type of lending is considered late-cycle behavior as investors throw caution to the wind in the hunt for yield.
Thanks for reading. Have a great day!