A few weeks ago, we covered the progressive sports gambling tax policy adopted in the new Illinois state budget. This implemented a step-series of effective tax rate hikes as sports gambling vendors crossed certain revenue thresholds. Rising tax levels for sports gambling over time (and also iCasino) are quite likely. Budgets and deficits need to be addressed and this is a very easy way to do that. 

Higher tax rates in isolation foster black market momentum and make converting gamblers to legal channels more difficult. And while that headwind may be inevitable, it’s not what was alarming here. DraftKings and Fanduel both do very well in New York despite that state’s up-to-51% tax rate. DraftKings also does very well in New Hampshire with its identical tax ceiling, but it’s a monopoly in that state, which makes winning far easier. Overall, higher tax rates have shown to accelerate the death of smaller, weaker players and expedite the consolidation process. They’ve made the big boys bigger and stronger.

What is alarming about the Illinois law is that it forces DraftKings and Fanduel to pay higher blended tax rates than anyone else. The key here is the relative disadvantage both will have to overcome in Illinois, as the smaller players are gifted with a cost base advantage. The changes in Illinois mean DKNG’s tax rate roughly doubles from 15% to 30% for a $60 million EBITDA hit (6% of next year’s profits). They’ll have promotional and marketing levers to reduce this impact, but the headwind will still be largest for this player and Fanduel.

Massachusetts was considered a state where tax hikes and a progressive tax policy were possible. Encouragingly, last month, a proposal to hike the rate there from 20% to 51% was struck down. New Jersey and Michigan are the two other states considered to be the most vulnerable (mainly just for flat rate hikes, but still progressive policy too). And? There has been nothing in the proposals or developments for either state suggesting a progressive system was imminent. That could always change, but isn’t likely at this point. That’s led to growing confidence in the tax status quo next year. New Jersey does have a proposed bill to hike the tax rate from a flat 13%-15% to a flat 30%. It doesn’t seem to be a priority – at least as of now. And even if it were, the proposal avoids the least compelling progressive tax outcome. Illinois is looking more and more like an anomaly in terms of tax policy. That’s great news for the budding duopoly in this space.

There were three Netflix expansion questions analysts have been asking for years. When will you introduce ads, when will you enter live sports and when will you go omni-channel? The ads and live sports questions have been answered with the new subscription tiers and purchase of NFL rights. Now its omni-channel plans are becoming clearer. Netflix plans to open two large “Netflix Houses” with experiential events and accommodations. Rumored attractions include a Squid Game replica of the Glass Bridge Challenge episode. In-person isn’t brand new to Netflix. It’s done some live plays and other small experiences around the globe like its Knives Out murder mystery party. This simply represents a larger push into the space.

The two planned destinations will fill currently vacant malls in the greater Dallas and Philly areas; they are tiny in size compared to Disney and Universal resorts. Still, if those two companies are any indication at all, this should be a positive financial driver for Netflix. The omni-channel leveraging of valuable IP has been the secret sauce of Disney and Universal for decades. The added consumer touch-points work to deepen the connection and relationship a fan has with a brand or character. Netflix has been missing that. Now? It’s plugging the gap.

The Acolyte’s (new Star Wars show) early reviews have been bad. Interestingly, Forbes and some other outlets are reporting large cohorts of “review bombers” dead set on bringing down the ratings. This appears to be anti-woke blowback as, incredibly, there are already 10,000 reviews on Rotten Tomatoes 3 episodes into the new season. The wildly popular Mandalorian show got 2,500 reviews during the entirety of its last season. I say this to point out how noisy the initial takeaway from the show has gotten. Let’s see what they have to say about how it drove streaming sign-ups during its next quarterly report.

Conversely, Disney’s Inside Out 2 movie is thriving at the box office. The film crossed $155 million in its opening weekend in the U.S. alone, which means the $200 million budget production will likely be very profitable. It should also be a great subscription driver for Disney+.

A key theme within data observability and analytics is bringing work, assets and insights directly to the data. This has a way of cutting data transfer and storage costs and uplifting applications with more context-rich insight. It’s why Snowflake and MongoDB are so focused on helping developers use their platforms to not only query needed info, but also to build apps. Datadog is making a similar push within the somewhat related observability and monitoring realms of data architecture.

This week, the firm debuted the Datadog App Builder to “make self-service apps and integrate them right into monitoring stacks.” The focus of this app-building tool is enabling companies to power granular use cases and accelerate the remediation of any observed issue within their ecosystems. It also comes with pre-built templates and no-code writing tools to shrink app creation time from weeks to hours – even for beginners. 

By putting overarching observability, issue flagging and remediation under one roof, Datadog tears down vendor silos, creating a faster course of action and better-informed reparation. It eliminates the need for data scientists and security analysts to go hunting for needed context to diagnose & repair. This further amplifies Datadog’s ability to consolidate point solutions within the broad DevSecOps sector. More vendor consolidation means more revenue, better margins, better retention and better outcomes. It helps everywhere.

RxPass is now available for Prime Members with Medicare. This allows 50 million more consumers to access 60 common prescriptions, with fast and free delivery all for $5 per month. Whether it's this development, Prime Video investments, Project Kuiper, grocery delivery, music streaming etc., the world-class Prime subscription keeps getting… well… more world-class. There’s a reason why so many other companies are trying to emulate the value of this subscription in their own sectors to improve revenue quality and overall retention. More utility is what creates the justification to flex pricing power and still enjoy very low churn. That’s what Amazon Prime does, and this announcement is simply one more compelling product within a sea of value creation.

In other potential up-selling and retention-juicing news, Amazon is gearing up to debut Alexa AI this summer. This, as with Apple’s Siri, should greatly bolster the actionable use cases that can be conversationally queried/activated. It could easily be used to perfect product discovery and to support its thriving e-commerce marketplace. I’m sure there are many more plans for it than I can’t even fathom. There will be a basic version of this product and a premium version costing $5-$10 per month. 

Meta’s CTO Andrew Bosworth sent an internal memo to Reality Labs employees this week about an organizational re-shuffle. In it, he announced that Reality Labs would be splitting into a Metaverse division and a Wearables division. The Metaverse group will include its Quest headset and the Horizon operating system (OS), with wearables including all other hardware.

Wearables like its Ray Ban smart glasses were designed with augmented reality (AR) in mind; the Quest 3 device, conversely, “brought Mixed Reality (MR) into the mainstream.” MR and AR are very similar ideas; Still, Meta feels that focus on each should be split, with AR use cases perhaps more ready for deployment today and MR use cases offering a higher future value ceiling (just more immersive). To the team, the Quest MR unlock gives them a more intuitive and concrete path to drive Horizon OS traction. It now has a “long-term vision of how that software experience will evolve over the next two years.” Despite the lackluster Horizon traction thus far, Meta remains “deeply committed to investing in this. It is still viewed as the core software foundation to “power high quality experiences across MR and mobile.” 

On the wearables side, the memo included more upbeat commentary on how well the Ray-Ban Meta glasses are going vs. expectations. Bosworth called this the “leading AI device on the market right now.” Meta is “doubling down” on building a wearables business around its Meta AI product. Part of these investments will be within the next generation of these glasses (which are expected to have hand controls) and its higher-cost hardware project called Orion.

Again, to me this is essentially splitting Reality Labs into near-term monetization and product opportunities (wearables) vs. longer term opportunities (Metaverse). It thinks the move will accelerate product velocity, improve communication and better separate the systems designed for AR (such as Meta AI so far) vs. those created for MR (such as Quest). We shall see.

Oppenheimer issued a bullish note on Shopify this week. It’s incredible how hated this stock was at $50 and how fashionable it suddenly is to like it once more at $65… but I digress. The source of the bullishness is highly encouraging. It stems from strong merchant momentum leading to great top line growth for this year and heading into next year. Specifically, it sees this growth offsetting temporary take-rate pressure via mix-shift to larger enterprise customers. All in all, its channel checks indicate $67.5 billion in gross merchandise volume (GMV) for Q2 compared to $65.5 billion consensus. A 3% beat would be a large one for this specific metric.

Lemonade now trades for less than 2x enterprise value to 2024 gross profit (EV/GP). It has a $1.16 billion market cap, with $925 million in cash and equivalents on its balance sheet. That gives it an enterprise value of $240 million – and the cash pile is actually mostly safe. Through its synthetic financing agreement, it has consistently moved up its path to breaking net cash flow positive, with the end to its now modest cash burn coming this year. It also continues to move up its schedule to FCF and EBITDA, as it now expects those milestones to come in 2025. Furthermore, it recently hinted at its 25% annual top-line growth forecast being raised in the near future. 

This company is better at managing growth and margin than any young, $1 billion enterprise should be. It has a masterful ability to control spending, manage headcount with more automation and deliver more profit when it needs to. That was demanded throughout 2022 and 2023 as cost of capital rose, investor preferences changed and it awaited regulatory approvals to hike premiums amid rampant inflation. It pulled back heavily on growth to reach profitability and to wait for the regulatory backdrop to enable profitable expansion. It did so beautifully, and managed to maintain 20%+ premium growth despite the aggressive cuts. 

Now? It’s ready to start leaning back in with the same added spending scrutiny that it has embraced. This GenAI-native company has obsessively infused more AI into everything it does to unlock greater scale… without headcount or OpEx growth occurring in tandem. This should enable more explosive operating leverage, more profit beats and more progress to breakeven – all while it accelerates demand growth considerably through 2024. This will play out as entrenched incumbents have vacated some markets like California. This is also playing out as inflation rates cool, premium approvals flow in and Lemonade enjoys much larger portions of the country to profitably sell its products to.

Let’s do some extremely speculative and overly simplistic modeling for more context. Say Lemonade compounds revenue at a 25% clip for the next 4 years. Assume its gross margin does not improve at all from the 30% level where it sits today. Then assume it reaches a 5% EBITDA margin in 2028 (similar FCF margin). That’s still materially worse than incumbents, conservative on growth estimates and conservative on gross margin. This scenario would leave us with $65 million in 2028 EBITDA. Even if we assume its EBITDA multiple is far below its EBITDA growth rate, call it 15x, that puts it at a $1 billion enterprise value in 4 years vs. $240 million today. With around $1 billion in net cash, that would leave it at about a $2 billion market cap vs. $1.16 billion today. This investment is still extremely speculative and the company still has a lot to prove. Things could always turn sour, underwriting progress could revert, growth could slow more sharply than I expect and this investment could always fail. If they continue to execute exactly how they have since the end of 2022, I think there’s a lot to like here.

In other Lemonade news, CFO Tim Bixby bought about $300,000 in stock to raise his common equity stake by 7%. This breaks a trend of the last 5 insider transactions being open market sales.

For years, Lemonade has been arguing that its tech-native, AI-first, cohesively-designed infrastructure and app form its edge. It has been telling investors that its ability to ingest and utilize vast sums of data differentiates it from other insurance disruptors. It has been explaining how legacy incumbent systems are too manual, too siloed and too entrenched for competition to appropriately utilize data scale advantages… with it also being too costly for them to rip and replace systems. And? It has been insisting on this set-up powering immediate claim handling, compelling unit economics, and the beginnings of a giant corporation. 

We're starting to see real proof beyond internal NPS claims and asserting that its underwriting models are better. Proofpoint number one is the wonderful loss ratio trends that we’re now seeing play out as of last quarter:

For the chart above, focus on the trailing 12-month improvement more so than the gray line. Weather and catastrophic (CAT) events are seasonal; looking at annualized progress helps to eliminate this noise. The main source of improvement here was encouragingly not CAT event favorability. Instead, it was premium rate filing approvals and its discipline to wait out these approvals before it leaned back into originations. It wasn’t willing to originate cash-burning plans for the sake of growth. With approvals coming in for key states like California, growth opportunities are becoming profitable once again (more on this later). Excluding CAT events, a 63% GLR improved 10 points Y/Y and 9 points Q/Q  to offer more proof of this improvement being structural in nature.

Proof-point number two is a favorable cost to serve vs. others. Insurance is a commodity. Lemonade does stand out within customer service and app interface, but the best way to differentiate within insurance is via cost advantages. Last quarter, Lemonade offered new disclosures showing its advantage in these areas. Loss Adjustment Expense (LAE) measures cost associated with handling claims and operating efficiency. It’s one thing to say Lemonade’s tech-native ecosystem offers cost edges. It’s another thing to show it in LAE. Per Capital IQ, a typical LAE is about 10% for a mature brand with fully realized economies of scale. Lemonade is far from mature, yet boasts an LAE of 7.6% (lower is better). The compelling trend is expected to continue.

This is intuitive. It has no agents to pay perpetual commissions to; its real estate footprint is comparatively tiny. Its AI-first product suite automates a large chunk of claims and customer service responses… and that automation frees Lemonade to grow its business while avoiding costs scaling in tandem. The margin trend charts above are evidence that as OpEx growth stays near 0% and the business expands. Lemonade is forming a defensible, structural competitive advantage in a sector where that’s tough to pull off.

Where else does an overall cost-to-serve edge help? I’m so glad you asked. It allows Lemonade to rationally undercut competition, boost growth spend or simply harvest more margin from its book of business. It already offers best-in-class rates on renters insurance; lower fixed costs allow Lemonade to rationally pursue these tiny premium plans. That has made Lemonade a share leader for young, first-time U.S. renters. These customers will need much more insurance over time, and Lemonade’s customer delight gives it a great chance of securing that added business.

Other signs of GenAI prowess:

The Trade Desk’s take rate of roughly 20% is among the highest in business-to-business enterprise software. It has been remarkably stable since it went public nearly a decade ago, and that makes perfect sense. The company simply provides superior value to its customers. They do this by infusing more customer data into every ad-buying decision. It’s morphing the purchase of millions of impressions, months in advance to buying impressions a few at a time and in real-time. It pushes advertising from “spray and pray” to being able to precisely connect dollars spent to revenue generated. 

It pairs this superior targeting with a cross-channel identifier, which means buyers know who to reach and how to reach them. Whether it’s television, audio, mobile, desktop, gaming etc. The Trade Desk “buys the entire open internet” on behalf of its customers and makes sure client campaigns are more successful than they can be anywhere else. That is The Trade Desk value proposition in a nutshell.

The effect is cutting impression booking costs in half, or said another way, doubling the return on ad spend (ROAS) that it delivers to its buyers vs. others. The ROAS boost is often even higher. When considering this, of course it makes sense that TTD demands a durable 20% take rate with near-perfect gross revenue retention. And while that formula is clear at this point, it’s still nice to reiterate it with more case studies. This week, TTD published a new case study with U.S. Cellular. The vendor wanted to bolster its advertising reach across premium programming. 

With TTD, it raised conversion by 71%, reach by 66% and lowered cost per customer acquisition by 24%. Not only does this bode well for TTD’s value proposition overall, but also for the continued shift away from walled garden, user-generated content (UGC), to premium content (TTD’s specialty). UGC has a way of driving risky scenarios for quality brands that don’t want to be associated with inappropriate materials. TTD’s premium TV quantity index (TVQI) ensures companies remove these impressions from their campaign bidding to eliminate brand safety concerns. Yet another reason why all publishers, agencies and retailers are flocking to this platform.

Thank you to Isaac for recommending that I start putting these in weekly articles. I’m going to start doing one per week between earnings seasons. They will only be published here. This week uses an EBIT lens for high growth tech firms. Next week, I will use the same metrics but for the more mature and established names in the network. FCF comp sheets will come after that.

PayPal named Srini Venkatesan as its new Chief Technology Officer (CTO). He comes over from Walmart where he spent 8 years. Most recently, he was that retailer's Executive Vice President (EVP) of U.S. Omnichannel and Platform Technology. He has also been StubHub’s CTO, and a Senior Director of Product Development at eBay. It also seems to have conducted another round of layoffs based on some LinkedIn posts that I saw.

Tesla laid off 14% of its workforce. This sucks for those involved, but it should be great for Tesla’s somewhat bloated cost structure and its current margin issues. If they do figure out how to commercialize Optimus, that should greatly diminish headcount needs and augment its margin ceiling. TBD.

CrowdStrike, KKR and GoDaddy will be added to the S&P 500 on Monday.

McDonald’s is debuting a $5 value meal to combat inflation and cater to price conscious consumers. They join Target, Amazon, Airbnb, Starbucks, Wendy’s, Uber and many, many more firms adding renewed focus on consumer affordability.

Palantir caught a downgrade this week from Monness, Crespi, Hardt. The company acknowledged Palantir’s great progress in GenAI and strong execution. It just thinks the stock’s valuation is ahead of itself.

Snowflake is dealing with a customer credentials vulnerability at the moment affecting 10 clients including LendingTree and potential ransom payments of somewhere between $3 million and $50 million. It would be easy to pick on Snowflake here, but this doesn’t seem to be their fault. This was based on stolen customer credentials via malware. There were no direct breaches.

Apple is delaying the rollout of its new AI product suite in Europe amid regulatory issues.