News of the Week (July 25-29)

1. CrowdStrike (CRWD) -- New Module, M&A & Needham

a) New Module

CrowdStrike introduced the Falcon OverWatch Cloud Threat Hunting Module this week -- calling it the “first standalone threat hunting service for cloud environments.” This module comes with proactive alerts on adversary activity, zero-day threats (new threats) and vulnerable spots. With this new tool, vendors gain a 24-7 expert in cloud security without incurring the typically hefty overhead costs.

b) M&A?

CrowdStrike seems to be standing up an R&D team in Israel. This is prompting many to infer that it’s planning to make a $2 billion M&A splash to buy Radware. Radware engages in data center security, application security and, more interestingly, network security. Zscaler and Cloudflare are two close partners of CrowdStrike’s in the network niche, so I’m interested to see how this could impact those relationships.

CrowdStrike was able to buy Preempt to expand into Zero Trust and Identity in a way that complemented its identity partner Okta -- rather than competing. It did this by building its identity offering from the endpoint perspective, rather than focusing on Okta’s authorization prowess. I’d assume it would love to expand into network security in a way that keeps both CloudFlare and Zscaler -- two wonderful companies -- as allies vs. enemies. There seems to be slightly more overlap between Radware and Cloudflare. Cloudflare offers all of the same content delivery, web application firewall and bot security that Radware is known for. And again, Cloudflare is extremely capable.

c) Needham

Needham released some channel checks this week. The conclusions were encouraging and unsurprising: spend continues to gravitate to security and the cloud where investment levels remain robust.

2. The Trade Desk -- Industry Softness & an Executive Change

a) Industry Softness

Roku’s 20%+ Q3 2022 revenue guide down this past week paired with Snapchat’s unwillingness to offer guidance has ad-tech land spooked. This spook is warranted. Terrible macro first weighs on advertising budgets for corporations which is how these companies generate revenue.

While I don’t think The Trade Desk is immune from the issues, I do think it’s the best-equipped company in the space to most gracefully weather these tough times. Why? First -- as I’ve mentioned in the past -- the company has already recently re-affirmed its second quarter results. On May 26th, long after macroeconomic pain had begun, it re-assured investors that its rosy guidance was still in place. Considering how visible its revenues are, this makes me extremely comfortable assuming a strong Q2. Beyond that, CEO Jeff Green and his team have built a years-long reputation of candor -- regardless of how good or bad things get. If the company was seeing a drastically worse Q3 than everyone expected, I’d like to think it would tell us as it has in the past.

Finally, The Trade Desk’s value is born in delivering relative return on ad spend (ROAS) strength to its demand side. It does this through industry-leading (by a mile) data and market scale within the open internet. These advantages don’t vanish with a poor macro backdrop. Instead, they arguably become even more valuable as marketing departments are forced to extract as much value from shrinking advertising budgets as humanly possible. This should always be the goal, but it becomes a larger focus when things get tough. That’s why The Trade Desk has performed so well across cycles and why I think it will this time around as well.

Finally, programmatic advertising within open internet streaming remains vastly supply constrained which leaves room for some demand disruption. We’re also gearing up for the largest mid-term spend cycle ever and The Trade Desk will surely benefit. I’m more optimistic about the firm's 2022 than most seem to be today.

b) Chief Data Officer Departure

The company’s Chief Data Officer -- Michelle Hulst -- is stepping down effective at the end of the month. Never ideal, but not devastating. There’s always C-suite turnover, and The Trade Desk’s average tenure is much lengthier than most.

Click here for my TTD Deep Dive.

3. Shopify (SHOP) -- Earnings Review

a) Pre-Earnings Press Release

About 24 hours before Shopify’s earnings report, its charismatic CEO Tobi Lutke published a blog post. In it were two key pieces of news:

• Shopify would be laying off 10% of its workforce (with more possible layoffs to come later this year).

• Lutke acknowledged that Shopify’s forecasts were overly ambitious as the team extrapolated pandemic trends to be longer lasting than they turned out to be. Better late than never. E-commerce penetration pulled back to trend while Shopify thought that wouldn’t occur:

b) Demand

Analyst were estimating $1.33 billion in sales. Shopify did not offer revenue guidance, but posted $1.30 billion, missing expectations by 2.3%. This included a foreign currency headwind of 150 basis points. Constant currency, this represents a 0.8% miss.

More context on demand:

• Quarters when Shopify got its largest pandemic boost are highlighted in green.

• 11% GMV growth compared to 7% growth for the industry.

• Its 3-year revenue & volume CAGRs still sit at an elite 53% and 50%, respectively. This slowing growth is solely a matter of the pandemic hangover.

• In Q1 2022, Shopify changed its developer revenue take rate from a flat fee of 20% to 0% on the first $1 million and 15% thereafter. This quarter, that move erased 400 basis points of subscription revenue growth. That will continue through Q4 2022 when comps normalize. Also in Q1 2022, Shopify began recognizing theme (design) sales on a net (not gross) basis which will weigh on growth through Q4 2022.

• Q1 is seasonally Shopify’s slowest period. This makes this quarter’s sequential growth comps easier.

• Shopify Plus Merchants now = 31% of MRR vs. 26% YoY as customers trade up.

• Shopify issued $416 million in merchant credit -- up 15% YoY.

• Offline GMV grew 47% YoY after 266% growth in Q2 2021.

• GMV through key partners like Meta and Google 5X’d YoY.

c) Profit

Analysts expected $27.8 million in EBITDA (AKA adjusted operating income) & $0.03 in earnings per share (EPS). Shopify again offered no formal guidance besides “investing all gross profit dollars back into growth.” It posted an adjusted operating loss of $42 million and lost $0.03 per share. Both results sharply disappointed analyst estimates.

On GAAP Net Loss:

GAAP net income moved from $900 million to ($1.2) billion YoY -- that was predominately related to a $1.8 billion net difference in equity investment impacts. Q2 2021 representing a gain of $800 million; this quarter represented a loss of $1.0 billion. This is simply the result of mark to market GAAP accounting and is not all that important to me. The firm didn’t burn through remotely close to $1.2 billion in the quarter ($120 million in OCF burn still not good). When its equity investments exploded in value with the Fed Asset Bubble, it benefitted unsustainably. Now, this is the flip-side which will be very negative and very temporary.

More context on profit:

• Shopify continues its dedication to investing all gross profit dollars back into more growth and innovation. It’s not trying to earn operating profit -- but instead trying to operate at breakeven. I believe that’s both the correct approach and also a move that will be hated by markets amid our hawkish climate.

• Merchant service growth and the change in developer fees are weighing on margins. You can see that in the larger sequential step down in GPM for the merchant segment.

d) Balance Sheet

Shopify has $6.95 billion in cash, equivalents and marketable securities vs. $7.25 billion sequentially and $7.76 billion YoY. Please note that since the Deliverr acquisition closed after Q2 ended, the $1.7 billion cash expense has not yet been deducted in its audited financial statements. That will happen next quarter -- so cash & equivalents is really around $5.25 billion.

e) Guidance

Shopify doesn’t offer formal guidance, but did offer a rough framework of how to think about the rest of the year. Following this report, the mean analyst 2022 sales estimates fell by nearly 4% while earnings per share guidance flipped from a gain of 9 cents to a loss of 9 cents. Considering the 2nd quarter revenue results missed by about half of this drop, we can imply that the abstract guidance was still a slight disappointment to Wall Street.

Here were the vague details offered:

• Inflation will persist at high levels through year’s end.

• Merchant solutions growth will continue outpacing subscription growth -- which will weigh on overall GPM along with the developer fee change.

• Shopify’s volume growth will continue to outpace the broader market -- meaning it’s taking more share (although weak macro dampens the value of that share for now).

• Stock based compensation of $750 million (previously $800 million).

• A larger operating loss next quarter (so more than $42 million) with operating leverage expected to kick in starting in the 4th quarter this year as OpEx growth slows. 4th quarter loss is still expected to be larger than $42 million, but smaller than the 3rd quarter.

f) Past Quarter’s Headlines

• Added Deloitte and Accenture as new Partners to promote Shopify to their clients.

• Added Spotify, TikTok, YouTube & Twitter integrations to sync product catalogues.

• Launched with JD.com’s marketplace in China.

• Debuted “Tap to Pay” on iPhone & was listed as 1/9 partners for Apple’s BNPL launch.

• Shop Payments debuted in France. Point of Sale (POS) launched in Italy & Singapore.

• Debuted “Business to Business Selling” with wholesale and custom discount features.

Click here and scroll to the Shopify section to learn more about these launches.

g) Conference Call Notes From President Harley Finkelstein

On Logistics:

Harley covered the three main pieces of Shopify’s logistics ambitions -- Freight, Distribution and Fulfillment.

Shopify Fulfillment Network (SFN) is enhancing freight with its Flexport partnership to automate that end-to-end process. This also means that a merchant can ship at the pallet level vs. container level and have “just in time” access to deliver goods to an SFN hub. This eases inventory glut concerns and keeps businesses nimbler. Early results here are revealing that SFN delivers 50% faster service with a massive drop in freight cost per unit.

Distribution is an optimization problem: Uncovering the most profitable way to accumulate and release inventory. Deliverr is its solution here:

Click here to learn more about what Shopify saw in Deliverr

Finally on Fulfillment, Shopify’s aim is to guarantee shorter and shorter delivery times. This greatly boosts merchant conversion rates. For example, Shop’s 2 Day Promise (in pilot) raises conversion by 30% -- it matters a lot. The company accomplishes shorter delivery through another past acquisition -- 6 Rivers Software:

Shopify addresses all 3 of these segments with the same utility building, yet asset-light approach. It is not trying to be Amazon, although is trying to eventually match its 1 day shipping capability through innovation and partnerships. That will take time.

100% of SFN fulfillments are now processed by its 6RS fulfillment system -- right on time. Shopify’s orders delivered in 2 days or less rose from under 2% pre-software integrations to 70% afterwards.

On Layoffs:

On Shopify Plus and Audiences Case Studies:

Recall that “Shopify Audiences” is a targeted marketing tool for merchants. Merchants tell Shopify what they want to sell more, Shopify uses its algorithms to source a curated list of high intent buyers and sends those buyers to the ad platform of the merchant’s choice.

• Blender Bottle ROAS 6Xed with Audiences.

• L’Amarue enjoyed a 48% click through rate (CTR) spike and a 26% decline in customer acquisition cost (CAC) with Audiences.

Notable Shopify Plus Client Wins during the quarter:

• ASICS

• Ashley HomeStore

• Hewlett Packard

• Derek Jeter and Wayne Gretzky’s Brand “Greatness Wins”

• More celebrity brand winds included: Dwayne Wade, Kim Kardashian and Hailey Bieber

Shopify Markets (Cross Border):

• Shopify Markets drives 40% higher cross-border conversion rates via storefront localization.

• 100,000+ merchants now use this (launched in Q1 2022).

• Introduced local subscription pricing plans in 200 countries to “better reflect the country’s purchasing power and lower the financial barrier to access Shopify.” This is contributing to Shopify’s belief that it will add more merchants in 2H 2022 vs. 1H 2022.

Go-To-Market Change:

h) CFO Amy Shapero Miscellaneous Notes:

• Shopify is now around 10% of U.S. e-commerce and that keeps growing.

• Shopify will continue to hire to “only the most strategic” positions. Headcount growth will greatly slow.

• Shopify doesn’t expect its new compensation packages to have an impact of proportion of compensation paid out in cash vs. stock.

• The 10% layoff and coinciding re-structuring will cost the company $50 million in 2022 before providing operating leverage thereafter.

• Shopify continues to expect to spend $1 billion in CapEx for SFN over the next 5 years and $2 billion for Deliverr. That has not changed.

I) My Take

I don’t think anybody who closely follows this name was expecting this to be a positive quarter. It wasn’t -- but in my view this could have been much worse. The large operating loss and guidance there was the clear negative to me. But at the same time, that loss is via investments that I view as needed. With its large cash position, demonstrated track record of success and vast integration network, I see this as an elite player in e-commerce. It’s just that e-commerce will be a tough place to play in for 2022. I want to own this, but at still 150X 2023 EBITDA, it’s too expensive. I’m forcing myself to wait for it to come to me, and if it doesn’t I will happily congratulate shareholders from the sidelines.

4. Progyny (PGNY)-- Moat… Yes a Moat

For years, Progyny has posted data in conjunction with The Society for Assisted Reproductive Technologies (SART) depicting its key performance indicator leads vs. the field. It’s the only company that does this as its complete treatment cycles mean it has complete data -- others don’t. This year, Progyny used another independent 3rd party, Milliman, to audit its methodology used to compare to benchmarks. Milliman reaffirmed most of the findings and also reiterated that Progyny’s leads vs. the pack continue to consistently grow in two key categories:

• +17% pregnancy rate per IVF transfer compared to the filed vs. 16% YoY

• +27% higher live birth rate compared to the field vs. +25% YoY

For the other 3, Milliman revised down Progyny’s YoY leads which still remain quite wide:

• -25% lower miscarriage rate compared to the field vs. -26% YoY

• +26% single embryo transfer rate vs. +41% YoY

• -66% IVF multiple rate vs. -72% YoY

For 6 years, Progyny has sold commercial fertility benefits packages. And for 6 years, Progyny has delivered better outcomes than any other player by leaps and bounds. That is a moat -- and I do not offer that overused word lightly.

Click here for my Progyny Deep Dive.

5. Lemonade -- M&A

Lemonade officially closed its acquisition of Metromile for $145 million in stock. In exchange for the $145 million in stock, Lemonade got:

• $155 million in cash (not a typo -- this was essentially a cash raise with free assets)

• $110 million in auto insurance premiums

• 49 auto insurance licenses (had just a handful)

• A shot in the arm for seasoning its auto risk models to expedite the loss rate declines via 500 million miles of driver data.

Total steal.

Just one day after this closed, Lemonade announced it would fire 20% of Metromile’s workforce. This was unfortunate but necessary. These two teams had a lot of overlap within them, and that has now been resolved. I like to see Lemonade making prudent decisions like this and hope all of the affected employees expediently land on their feet.

Click here to read more about what Lemonade saw in Metromile.

6. PayPal Holdings (PYPL) -- Activists

Prominent activist firm Elliott Management has built a stake in PayPal. The size of the position and its plans have not yet been disclosed, but I’m sure Elliott has some changes in mind. Talks between the two are underway and it’s widely speculated that Elliott will pursue board seats as it often does. Considering how unfortunately “adventurous” the last year+ of guidance has been for PayPal -- this makes sense. Still, I believe in Schulman and don’t think this is required (but I’ll take it).

Elliott has also taken a recent stake in Pinterest and previous M&A rumors between the two make me a little nervous that it may try to force this transaction. The proposition was uniformly hated by investors the first time around, so it’s hard to see them succeeding there. Let’s hope that’s not the goal.

Click here for my PayPal Deep Dive. :)

7. Upstart (UPST)-- Auto & The Economic Opportunity Coalition

a) Auto

Automotive Market Data named Upstart Auto Retail the fastest growing auto software in the United States for Q2 2022. Upstart had the highest net growth in dealer and OEM count among digital providers. Upstart Auto Retail is still growing from a very small base, but it’s good news regardless to see momentum strong out of the gate.

b) Economic Opportunity Coalition

Upstart was named as a founding member of the “White House-led” Economic Opportunity Opportunity (EOC). As a reminder, it also works with the National Banker Association’s to offer its credit models to minority depository institutions (MDIs).

Other founding EOC members include Ford, Google and Bank of America. As part of the news, Upstart will offer “preferred access to its AI lending platform with no implementation fees” for Community Development Financial Institutions (CDFIs). The coalition goes hand in hand with Upstart’s guiding mission: to expand access to credit and economic prosperity.

When a company’s value is predicated on AI/ML models creating more accurate credit, that leaves the firm especially vulnerable to regulation. For this reason, I’ll take as many Upstart relationships like this as we can get.

Click here for my Upstart Deep Dive.

8. SoFi Technologies (SOFI) -- APY and Student Loans

a) Annual Percent Yield (APY)

SoFi’s Checking and Savings APY was a robust 40X the national average at 1.25%. Well, now it’s 58X the national average at 1.8% for direct deposit customers. This is the luxury afforded from tech stack vertical integration, ample cross-selling, the charter and limited physical fixed costs. Its operations are comparatively asset-light vs. its legacy competitors. With these advantages, it can stand out in a commoditized space via more yield -- it’s as simple as that. And with the vast positive lifetime value (LTV) boost direct deposit customers deliver for SoFi, it can afford this added cost.

I would note that management in the past told us that its direct deposit growth rate was at $100 million per week. It said it wouldn’t raise the APY again until that rate slowed, meaning this news may mean this was a lever it needed to pull to re-accelerate direct deposit growth. Conversely, it could simply be due to precipitously rising treasury rates over the past year. I’ll be laser-focused on commentary surrounding this on the upcoming call.

b) Student Loans

The Biden Administration is telling student loan firms to stop outreach on re-payments -- per the Wall Street Journal. Last time this happened, it meant a future extension of the Student Loan Moratorium. So it seems like another extension is coming, which is assumed in SoFi’s guidance anyway. Good job getting in front of this and ripping off the Band-Aid, Noto.

9. Lululemon Athletic (LULU) and Revolve Group (RVLV) -- Macro Insulation

a) Macro Insulation

Tanking consumer confidence, soaring inflation and diminishing liquidity are all weighing on aggregate economic spend. We’ve seen this with titans like Amazon cutting capacity and Walmart and Target slashing prices.

While the consumer discretionary category fundamentally performs poorly during weak spots in economic cycles, I see Lulu and Revolve as enviably insulated. Why? Both cater to a very affluent consumer cohort. The unfortunate reality of inflation is that it hits the lowest earners the hardest as things like gas and rent take up a larger portion of their more finite resources. Affluent consumers don’t feel the pain nearly as much -- and that’s who these two companies sell to. They’re not impervious, but they’re better-positioned than most. For evidence of this, Revolve’s growth continued in excess of its 20%+ long term target well into May 2022 -- after the economy had already shown signs of real weakness.

• For Lulu, the end of the pandemic should be a headwind as Athleisure got a large pull-forward -- but again more insulated than most.

• For Revolve specifically, it benefits from an end to the pandemic which should accelerate its brand marketing and growth even more.

Finally, Bank of America double downgraded Revolve to underperform with a $22 price target based on broad macro concerns (which, again I think it’s relatively insulated from). I’d love to buy more shares at $22 -- 19X earnings for a 20X+ compounder with expanding margin? Yes please.

Click here for my Lulu overview.

10. Match Group (MTCH) -- Meta

Meta is halting its messaging service, “Tuned,” for romantic partners in the latest sign that Match Group’s 50%+ global market share is durable. Even vs. the deepest pocketed company on the planet with half the world already on its apps, Match is prevailing.

Click here for my Match Group overview.

11. Olo -- Case Study

Waba Grill and its hundreds of chains was among the first adopters of Olo Pay. It switched from a legacy payment processing solution to go with Olo Pay’s software that unifies the wildly disparate pieces of restaurant payment stacks. Olo Pay delivered for Waba:

• 31% less fraud

• A 1.1% authorization rate boost

• More revenue

• On-boarding time for a new franchise location falling from several weeks to 5 days

If this becomes a theme for Olo Pay, the module should find rapid traction like the rest of its products have been able to enjoy. With that traction comes 4X the revenue per order for Olo.

Click here for my Olo Deep Dive.

12. JFrog (FROG) -- AWS

JFrog launched a new integration with JFrog Xray and the AWS Security Hub. This deepens the close partnership between the two. In recent quarters, partner-sourced revenue like from relationships with Amazon have allowed JFrog to accelerate growth and surpass expectations. This should be another key tailwind for that revenue segment starting in Q3 2022.

13. iShares Chips ETF (SOXX) -- CHIPS

Congress passed the CHIPS act this past week with over $50 billion earmarked for Semiconductor infrastructure. This won’t be an immediate boon to the industry -- these projects take time. But still, it is an encouraging piece of news as a holder of SOXX (semiconductor ETF).

14. Macro

a) FOMC Highlights

• Expect more rate hikes with the Fed Funds rate approaching 3-3.5% by end of 2022. Powell wants policy to be “moderately restrictive” by then.

• Expect a lot more balance sheet runoff.

• Recent spending and production data is softening but the job market remains overly supply constrained.

• Russia is contributing to inflation persistence.

• The size of future rate hikes was not guided to. Good, it’s supposed to be “data driven” anyway.

• His view of the “terminal rate” has evolved meaning it could be higher than the roughly 3.5% rate previously stated.

The Federal Reserve unanimously raised its Fed Funds rate by 75 basis points this past week from 1.5%-1.75% to 2.25%-2.5%.

b) Key Data from the Week

• GDP came in at -0.9% vs. 0.5% expected. This was the second straight quarter of negative growth. This means that following final revisions, we will likely officially be in a recession.

• July Consumer Confidence came in at 95.7 vs. 97.2 expected and 98.4 in June. This has declined in 3 consecutive months.

• New home sales for June came in at 590,000 vs. 660,000 expected and 642,000 in May. Pending Home Sales came in at -8.6% vs. -1.5% expected. A large miss.

• Core Durable Goods Order beat expectations, rising 0.3% MoM vs. 0.2% expected. A rare bright spot.

• Initial jobless claims came in roughly in line with expectations.

• The Core PCE (arguably the Fed’s favorite inflation gauge) rose 0.6% MoM in June. This was unfortunately hotter than the 0.5% MoM growth expected.

• The PCE similarly rose 1.1% MoM in June vs. expectations of a cooler 0.9% growth rate.

• The Chicago PMI disappointed at 52.1 vs. 55.0

5 year breakeven inflation rates are unfortunately beginning to tick back up again:

The U.S. Dollar has fortunately given back SOME of its previous gains after FOMC:

High Yield Corporate Credit Spreads still look fragile, but better. Previous cycles tell us there could be more pain here to come. We'll see:

2-Year Treasury Yield continues to cool as recession expectations build (Upstart is happy about this):

The first Atlanta Fed GDPNow estimate for Q3 2022 came in at +2%:

c) Level setting the Data

We’re probably in a recession -- and that was an all but inevitable piece of this tightening cycle. History books tell us we cannot bring the CPI from 9% to 2% without causing some economic contraction and this time likely won’t be different. I’ve said it before and I’ll say it again: Recessions suck for everything except structural growth stock multiples. The downturn will eventually force the Fed to pause and turn accommodative at some point. The sooner the downturn comes, the sooner we can stop discounting future cash flows as aggressively as we currently are.

Broadly underwhelming data does point to us getting closer to the end of this tightening cycle. But at the same time, inflation is priority 1 at this point in time with labor markets still relatively strong. Metrics like multiple job rates throw cold water on the hot labor market argument -- but it’s still healthy enough. Yellen has even explicitly told us she will take 4-5% unemployment for controlled inflation. That means more tightening to come. We’re getting closer, which is why you’ve seen me begin to gradually accelerate my accumulation, but this storm is likely not over.

The Fed is going to tighten until it breaks something. My favorite sign of breakage comes from high yield corporate credit spreads, and those are still well below other periods of turmoil. It does seem like the hawkish cadence has eased a little bit, but policy and expected policy both remain extremely hawkish.

I would also like to remind everyone that despite all of this, I’m still ~80% invested. Why? Because macro and the coinciding stock market’s reaction is about as predictable as the weather next month. We can forecast, but so many different things can happen to make those forecasts worthless. While I think more turbulence ahead makes perfect sense with things like balance sheet runoff having barely begun, I don’t know if that turbulence will come for certain. So: 80% invested despite the pessimism.

15. My Activity

I added to Lululemon Athletica, Meta Platforms, The Trade Desk (pre-Roku report), Revolve Group and Lemonade. If you’d like to see my portfolio and/or know when those transactions occur in real time, you can sign up for live text or email updates through the linked image below. It's all FREE. Shout out to my friends at Savvy Trader for enabling this added layer of transparency

In case you missed it, this week I also published my PayPal Deep Dive and a Meta Platforms earnings review. Enjoy your weekend!