Apple, Amazon, and other soon-to-be Trillion Dollar Babies

The summer of 2018 has been populated by speculation on the future of the tech industry and tempestuous debate on the direction of our economy. We have discussed the scandals of the likes of Facebook and Twitter but, this time, we are looking on the bright side of the tech industry with the frontrunners of innovation, Amazon and Apple. The recent highlight? Apple reached the inconceivable $1 Trillion valuation crux for a company… Amazon quickly followed suit.

The only way to aptly start this article is to awe over what ‘Trillion’ means and looks like. To begin, find the nearest ruler or roughly picture one foot in your head. Now, you need to visualize the distance between the earth and the moon. That distance is roughly 1.3 Billion feet long and in order to reach one trillion, take 770 trips to the moon or take a trip to Mars. Let that sink in. Comparing the companies to countries, per 2017 GDP data, both Apple and Amazon would find themselves beating all but 16 countries.

A year ago, Apple’s total Market Capitalization (total firm market value) sat at $830 Billion while Amazon’s fell short at $460 Billion. With Apple’s colossal popularity, we expected the firm to hit the milestone sooner or later. On the other hand, Amazon burgeoned from a new way to order textbooks to capturing 49% of the e-commerce market and now, potentially, a soon-to-be healthcare provider, all within the past decade.

Now that 2 of the 5 FAANG giants (Facebook, Amazon, Apple, Netflix, and Alphabet/‘Google’) have soared to a trillion dollar valuation, and with Alphabet flirting with $900 Billion after a strong Q2 earnings report was released, which company will join the podium? The tech industry has seen a jet-fueled growth due to strong quarterly reports, technological and e-commerce needs, and the continued expansion of the US economy. While Wall Street analysts expect to see the largest growth from a $530 Billion valued Berkshire Hathaway, the race boils down to two true contenders: Microsoft and Alphabet, yet two more tech companies.

In the case of Alphabet, despite a $5 Billion fine in Q2 from the European Union, the company still managed to have a strong quarterly performance. However, ever since the earnings report brought Alphabet’s peak, the firm has been in decline; Google’s absence at the congressional hearing did not help. With ensuing claims of shadow banning via Twitter, Facebook, and Google, the US Senate looks to further regulate the industry. Unlike Alphabet, Microsoft did not have to make an appearance at the September 5th congressional hearing. Much like Alphabet, they and many other tech stocks took a hit, with Microsoft falling 3%. The industry took a massive drop but this could just be the start of a drawn out regulatory battle.

According to Goldman Sachs Chief US Equity Strategist, David Kostin, we may see pressing regulation and even potential reclassification. Kostin speculates that this could separate the more “social” tech firms, such as Facebook and Google, to be redefined with a new industry description. Could they fall into a subdivision of tech or something new? Furthermore, Kostin mentions that the remaining ‘tech’ firms would be deemed “legacy” tech. By splitting the mammoth tech industry into two categories, investors will have a stabler, hopefully regulation-averse, positions that separate the hazy futures of the likes of Facebook, Twitter, and Google while maintaining the sincere domination of true tech firms. Since Alphabet is a conglomerate that has branched into social media with Google Plus, they have a large representation of information tech thanks to the Google Pixel and Chromebooks, technological research, and so much more. Seriously, click here to learn more. Goldman Sachs’s Kostin is trying to categorize a giant with arms in multiple industries; Facebook and Microsoft have far simpler distinctions. This is where I draw my conclusion and shift my focus back to the question at hand, who’s the next trillion dollar baby?

Separating the non-information technology firms from the social media-esque firms will allow investors to capture the growth of the tech industry without having to deal with as much of its regulation and spotlight. On September 5th, the only companies that were scheduled to appear at the congressional hearing were Facebook, Google, and Twitter, and the largest of the three did not even show. Despite the hysteria of regulation focusing on Kostin’s “Communications Services” firms, Microsoft and other major tech “legacies” took huge hits. Goldman Sachs’s reasoning? The massive presence of contemporary tech positions in ETFs (exchange-traded funds). The split would tighten the current industry and shift the focus of investors to their respective sides. It would also reduce the overall volume of holdings and trades of tech companies that are included in the same indexes, but only because they are in the tech industry with the likes of Facebook. The chief US equity strategist states that the legacy firms will grow at a slower pace than the new communications services sector, despite including the burgeoning Amazon and Apple.

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Goldman Sachs’ David Kostin
With that being said, we’ve come to our answer. And the winner is… it depends. If Alphabet continues to face ensuing regulation, do not expect the company to reach $1 Trillion next. Unless the firm quickly survives the tumultuous sentiment of the public spotlight, expect Microsoft to take the crown.

Although we have crowned a winner- well two tentative winners- what if neither company hits the landmark soon? With all of the discussion surrounding continuously increasing market caps within the current tech industry, analysts often poke at the idea of potential overvaluation; and your local Pitt Business Review Analyst will quickly do the same. So, what is the major difference between the dotcom bubble and our hypothetical tech bubble? Well for starters, some of our major tech firms have lived through the bubble already, but the prime reason is that they were backed by tangible goods and technological advancements. FAANG is comprised of five leading tech corporations frontrunning advancements and differentiation in the tech industry, however, two of the firms generate their profits through intangible services: Netflix leading as the largest video streaming service (double that of YouTube) and  Facebook managing 2.5 Billion active individuals (with even more accounts) on its four media platforms. The companies’ values come from their massive user bases.

Nowadays, you cannot simply slap on a .com and see an immediate rise in stock price. If you’re looking for potential bubble speculation, I am sure you have read up on some of the ICO (independent coin offerings) names thanks to the crypto craze. Back in late 2017 and early 2018, with names including coin or blockchain, your stock could rise 200%; just ask the new and improved Long Island Iced Tea, which changed its name to Long Blockchain Corp. Or, maybe you have heard of DogeCoin, the coin named after an internet meme? While I will not touch upon cryptocurrency any further, focusing on the more qualitative side, name changing serves as a strong example of a potential bubble. Furthermore, many of our contemporary tech giants felt the wrath of the dotcom bubble and survived. Amazon in particular, now valued in the $1900 per share range, eclipsed at $107 and dropped to less than $7 per share during the crash. Companies like Amazon have already passed the hurdle by diversifying their companies internally to be more than just part of a new fad or craze. To add another point to the argument, strong consumer sentiment and economic expansion have driven every major index to new highs in 2018. With economic expansion comes an increase in equity and an increase in equity drives investor sentiment; just ask the roaring 20’s. As the FED moves closer to raising interest rates 4 times this year, thanks to continued growth, it is tough to ignore the paralleled growth of the S&P 500 and the Dow Jones Industrial Average specifically. Keep in mind that this is a quick qualitative analysis on a potential bubble and there is far more digging that can be done; I encourage you all to dig further yourselves. Lastly, in 1999, the Capital Markets were on a completely new level, with 468 firms seeing an initial public offering (IPO) in the US markets, while in 2017, we saw 174 IPOs. The US markets have learned their lesson on the maturity of firms and their readiness to see the public markets. The last questions remain, what does the future hold for the tech industry? Will we see a slip in tech market caps?

Within the tech sector, homing in on the “Communications Services” group, the major performers that come to mind will be the obvious Alphabet (depending on its distinction) and Facebook. However, most of the industry, in terms of frequency, are made of positions on the smaller, large-cap side. Can you guess one of the most infamous or, in better words, disappointing tech positions? Here is a clue, they opened up with a market cap of ~$28 Billion, hit its high the next day, and dropped 55% since its initial offering, which occurred a year and a half ago. If you guessed Snap Inc (or Snapchat) you have earned a pat on the back. Another security historically performing poorly, Twitter. Social media-esque firms have been criticized for their necessity to be a social ‘requirement’ and develop their revenue streams constantly.

A 2011 Aalto University research study discussed, in the abstract, what MySpace could do to keep up with the fast-paced growth of the social media realm. As abundantly clear now, MySpace is virtually non-existent. They have gone through different remodelings and ownerships but the platform is painfully on the verge of extinction. For this reason, if social media were the main a driver of the tech industry, there would be a much more concerning question about bubble potential. However, the only social media-esque firm in FAANG is Facebook and the strongest performers in the tech industry fall under the “legacy” category anyway.

Ultimately, the growth of the legacy group is not in question, especially if separated from the communications services sector. Citing Kostin, “The Zuckerberg hearing revealed to many government officials the scale of personal data that FB users had agreed to allow the firm to gather, raising regulatory risks.” And now under fire for allegations of improper shadow banning, there is a grim uncertainty for firms connected to Facebook, which focus mainly on Alphabet but further extend to the rest of the FAANG group. Companies connected with Facebook on Goldman Sachs’s radar have underperformed the industry.

With ensuing regulation, Alphabet’s strong connection with Facebook, and no apparent tech bubble, the future shines brightest for Microsoft, taking its third place spot on the trillion-dollar pedestal. I will be checking back in once we see a company approach quadrillion!

 

Sources:

{1}http://fortune.com/2017/03/06/apple-iphone-use-worldwide/

{2}https://www.marketwatch.com/story/this-is-how-much-money-exists-in-the-entire-world-in-one-chart-2015-12-18

{3}https://www.nytimes.com/2018/09/04/technology/amazon-stock-price-1-trillion-value.html

{4}https://ycharts.com/companies/GOOGL/market_cap

{5}https://abc.xyz/investor/

{6}https://abc.xyz/investor/pdf/2018Q2_alphabet_earnings_release.pdf

{7}https://www.watchlistnews.com/q3-2018-eps-estimates-for-alphabet-inc-class-a-reduced-by-analyst-googl/2329901.html

{8}https://www.cnbc.com/2018/08/03/these-are-the-next-companies-poised-to-hit-1-trillion.html

{9}https://www.investopedia.com/terms/f/faang-stocks.asp

{10}https://ca.finance.yahoo.com/news/goldman-regulation-hit-big-tech-134500977.html

{11}https://9to5google.com/2018/07/23/alphabet-q2-2018-earnings/

{12}https://www.cnbc.com/2018/07/10/eu-hits-alphabet-google-with-android-antitrust-fine.html

{13}http://www.proactiveinvestors.com/companies/news/204268/faang-report-google-snubs-us-senate-hearing-on-election-meddling-j-crew-sets-up-shop-in-amazoncom-204268.html

{14}https://ycharts.com/companies/MSFT/market_cap

{15}https://www.cnbc.com/2018/01/31/microsoft-earnings-q2-2018.html

{16}https://ycharts.com/companies/SNAP/market_cap

{17}https://seekingalpha.com/article/4079526-tech-stocks-overvalued-market

{18}https://seekingalpha.com/article/4079735-overbought-overvalued-top-tech-stocks-much-might-think

{19}https://www.bbc.com/news/technology-33862367

{20}https://www.cnbc.com/2018/07/18/microsoft-earnings-q4-2018.html

{21}http://epub.lib.aalto.fi/en/ethesis/pdf/12544/hse_ethesis_12544.pdf

{22}https://www.geekwire.com/2016/study-amazon-video-now-third-largest-streaming-service-behind-netflix-youtube/

{23}https://www.lombardiletter.com/companies-that-died-and-survived-the-dotcom-bubble/9106/

{24}https://www.nasdaq.com/article/the-number-of-2018-us-tech-ipos-will-double-over-the-next-10-days-cm949716

{25}http://www.historyofdomainnames.com/dotcom-bubble/

{26}https://www.cnbc.com/2017/12/21/long-island-iced-tea-micro-cap-adds-blockchain-to-name-and-stock-soars.html

{27}https://www.fxstreet.com/news/fed-on-its-way-to-raise-rates-four-times-this-year-uob-201809100642

{28}https://www.marketwatch.com/story/ipos-shatter-records-in-1999

{29}https://www.statista.com/statistics/270290/number-of-ipos-in-the-us-since-1999/

{30}https://www.ey.com/Publication/vwLUAssets/ey-global-ipo-market-climbs-to-10-year-high-in-2017/$FILE/ey-global-ipo-market-climbs-to-10-year-high-in-2017.pdf

 

Why Subprime Lenders Still Haven’t Learned Their Lesson

I believe that the opening of this article is the perfect time to make this confession: I have no idea how the complexities of the market fully work. Yes, that’s not a particularly pristine way to introduce one’s piece. And, for an article written by an aspiring professional, it might come across as being extraordinarily flippant or careless, but, in a lot of ways, it is the absolute truth. The market, in essence, is a recorded history of human transactions, and, like traditional history, it sputters and grows and sometimes acts in unexplainable ways. However, most of all, actions on the market tend to repeat themselves over time in the same maddeningly crazy way that actions of the course of human history tend to do. And, the nature of why people do things over and over again in the market usually boils down to a very simple but understandable reason: everyone is just looking for that extra dollar.

So, when dealing and gambling with subprime mortgages and mortgage backed-securities, it’s like sticking your finger into a shark tank and hoping that you still have that finger when you pull back. During the 2008 financial crisis, subprime loans were one of the foremost culprits of the market catastrophe as homeowners with unsatisfactory credit histories began defaulting on their loans. This, in turn, left mortgage holders and owners of mortgage-backed securities holding the bag as a domino effect ensued in which the housing market began to decline. As a result, lenders and insurance companies were pulled right into the pit of bankruptcy and disaster. Now, ten years after the crisis, some private equity firms still see it fit to issue subprime loans. This time, however, it is the auto market which has come under target of finance firms and investors looking to take advantage of rapidly changing investor demand.

Of course, while many analysts might want to point out the necessities or even benefits of issuing subprime loans, there is a really fundamental factor that needs to be established: the auto market is not the housing market. Now, while that insight seems banal at best, it is a crucial element that plays into this story. You see, if I buy a home on the market, its value does not diminish just because I bought it. The housing market varies based on a multitude of factors, but a home can still appreciate in value after it is purchased. On the other hand, the auto market (usually) does not work that way. When one buys a vehicle, it usually depreciates far below its original cost. There are some exceptions to this rule; for example, a vintage Ferrari might not depreciate like this, but this is usually not the case.

But, that should not be news to anyone, especially not to seasoned analysts and investors. So, why the interest in issuing loans to those who could possibly leave you with less-than-valuable collateral? Well, the answer, again, is pretty obvious: higher risk leads to a higher demanded return. Because the auto market, by nature, deals with assets that do not appreciate in value, it puts financiers and investors in a tight spot if loans are defaulted on. This is because the collateral that the vehicle provides will not cover the original loan value. On top of that, after the 2008 recession, some analysts felt that if new credit restrictions were too tight, economic growth could be artificially hindered. So, while many large-scale national banks – still understandably shaken by the housing crash – only dipped their feet into the auto market, auto lenders and private equity (PE) firms jumped head first into the subprime pool. As the auto market grew, this gamble appeared to pay off for them as this newfound market spurt led to a huge boost in sales and profits.

However, a different tune is now being sung. As they often do, many borrowers are defaulting on their loans. Now, some lenders and PE firms such as Ally Financial have preemptively set aside emergency funds as a means to deal with the looming problem, but for some firms, it just hasn’t been enough. Thanks to the toxic twin combination of a waning car market and rising delinquencies, operating margins for these firms have now shrunk. There is an additional wrinkle that these companies have to deal with that relates specifically to the availability of working capital. Of course, I am not really talking about the big equity lenders such as Ally. The firms who are really hit hard by this are firms that basically have been operating on a considerable amount of margin just to issue these loans. As a result, it really doesn’t help when one considers that subprime auto loan defaults for private lenders are hovering near 10% — which is a delinquency rate not seen since the recession of ten years ago. As such, with soaring loan defaults on the horizon, there is no guarantee that these smaller firms that dove head-first into this pool can even survive, and, like the 2008 crisis, lenders to these finance firms might end up feeling a bit of a pinch, too.

However, It needs to be made clear that this crisis will not reflect the seriousness or scope of the 2008 crash. For one thing, as I previously mentioned, banks and other large firms have learned their lesson from the 2008 crash and have chosen to invest in prime borrowers, which, although it has taken time to do so, has started to pay off in the form incremental revenue increases. So, this craze does not occupy a plethora of capital space on the market. In fact, overall, private firms roughy have $3 billion tied up in the auto loan market. That may sound like a significant amount, and it definitely is. But, in spite of this, it still makes for a fascinating case study that is a little funny, a little sad, and says a lot about how our markets work. It shows that, at any point in time, old things become new again, and dying trends of the past begin to rise from the ashes again.

On the one hand, it is perfectly understandable to see why small lenders and private equity firms would choose to hedge their bets on such a risky market. Of course, when one sees an opportunity to make an excess return, it is understandable to want to jump on it, especially if that opportunity has the backing of a high-demand industry like auto sales were. However, one could still make a counter argument that the impatience shown by these firms in not allowing the prime auto loan market to thrive is counterintuitive. It is the equivalent of waiting for your phone to charge and going out into a lightning storm to speed the process up a bit. However, the interesting point in all of this is that, larger firms who had the wisdom to limit the issuance of subprime auto loans instead chose to focus on creditworthy borrowers are not incurring these kinds of devastating losses. In fact, while some of these larger institutions do have some subprime loans sitting on their books, their default rates currently sit somewhere around 4.4%, which arguably does not indicate any dire level of emergency. It certainly does not sit anywhere near a recession-level.

There is one final thought to consider here, and it is really about how these events will continue to unfold. It is obvious that some of these firms will recover and some will not. But, in the end, what have businesses learned from this? Well, it’s hard to say that we’ve learned anything new because the lessons here are the same as they have always been. Sometimes, firms find an outlet for growth and take it, despite the risks involved. Sometimes, those risks work, and, at other points, firms just go too far and unintended — yet avoidable — consequences occur. Granted, one would like to think that, as history continues to move forward, we as a society become smarter in spotting these kinds of situations, and, in many ways we do. It is a long, arduous process, but mankind tends to learn from its mistakes in an incremental fashion. So, yes, some firms will learn their lesson. And, some will look at this situation, think it over, then promptly re-stick their fingers back into the shark tank. That, all in all, is just another lesson of market behavior at work.

 

 

http://www.valuewalk.com/2017/12/auto-loan-quality/

https://www.washingtonpost.com/business/subprime-loans-return-with-economic-risk-and-rewards-quicktake/2018/01/02/47ca5854-f003-11e7-95e3-eff284e71c8d_story.html?utm_term=.1a64da5db826

https://www.google.com/amp/s/www.bloomberg.com/amp/news/articles/2017-11-14/subprime-auto-delinquency-near-crisis-levels-at-non-bank-lenders

https://www.google.com/amp/s/www.bloomberg.com/amp/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out

https://www.bloomberg.com/news/articles/2018-02-02/never-mind-defaults-debt-backed-by-subprime-auto-loans-is-hot

Is Tesla Pioneering a New Age of Compensation Plans for Executives?

Elon Musk has always been a dreamer. He has been a visionary in space travel in the 21st century with his company SpaceX while also revolutionizing the automobile industry through his company Tesla. He is considered one of the most powerful people in the world by many standards. However, his new contract as CEO of Tesla could result in him not making a single penny from the company in the next ten years.

On January 23, Tesla announced that Elon Musk would stay on as CEO for the next ten years. During this span of time, Musk will not receive any guaranteed compensation. For Musk to receive any compensation for his work, he must reach certain performance objectives that Tesla has set for the company. Tesla has broken the objectives down into two separate categories: market cap milestones and operational milestones. Each category consists of 12 tranches, or levels, that Musk much reach in order to gain more compensation. Both the market cap milestones and operational milestones must be met in order for Musk to move up a tranche. Upon completion of each tranche, Musk will receive “stock options that correspond to 1% of Tesla’s current total outstanding shares.” With 1.69 million outstanding shares, Musk has the potential to gain approximately.

Tesla CEO Performance Award-2The market cap milestones are based on Tesla’s market valuation. The first tranche is completed once the company is worth $100 billion. Each subsequent tranche is completed for every $50 billion added to Tesla’s value, topping off at $650 billion. Musk is optimistic about his ability: “I actually see the potential for Tesla to become a trillion-dollar company within a 10-year period.”

The operational milestones Musk must meet are slightly different than the market cap milestones. For these, Musk only needs to reach 12 of the 16 levels to reap the full benefits of the payment plan. The 16 levels are divided into two categories, revenue and Adjusted EBITDA, of 8 levels each. The revenue path is simple; when Tesla’s revenue reaches each level, it will have been completed and can be used to move up a tranche, granted that the market cap milestone has already been met for that level. Adjusted EBITDA is Tesla’s earnings before interest, taxes, depreciation, and amortization. This essentially measures a firm’s profitability; if Musk can increase the profits of Tesla then these levels should gradually be completed over the next ten years.

The new payment plan for Musk comes at a time of concern for the company. Musk has been ambiguous in the past about continuing as the CEO of Tesla. However, this new deal ensures that he will stay on for the next ten years, either as CEO or as the Executive Chairman and CPO of Tesla. Regardless, Tesla has just locked down one of the most innovative minds in the world for ten years, something shareholders should be very content with. This news also comes just weeks after Tesla delayed releasing the production targets again for the Model 3. Tesla has been on fire lately, but Musk must continue directing the company towards new heights if he wishes to be compensated for all of his time and effort.

With Tesla being one of the leaders in the automobile industry lately, Musk’s new payment plan may spark similar plans from other companies. In regard to the effect of the new compensation plan on Tesla shareholders, compensation committee chairman Ira Ehrenpreis stated, “It’s heads you win, tails you don’t lose.” If Musk reaches all tranches of the plan, then he would have increased Tesla’s valuation by almost 11 times its current amount, a feat that is almost unthinkable in a ten-year span. This would be fantastic for shareholders as their shares would correspondingly increase in value. If Musk fails to meet even one tranche, then the shareholders do not need to pay the CEO that failed to do anything for them. This plan puts the majority of the responsibility for the company on Musk and it is up to him to move this company forward if he wishes to be compensated for his work.

Other companies should develop similar compensation plans to shift more accountability to the leaders of companies. If all executives in companies are not given guaranteed salaries but rather compensated based on performance of the company, then these executives will ostensibly put much more effort into their work and moving their companies forward. Shareholders will no longer have to worry about paying the salary of a CEO who fails to do anything for the company. By increasing accountability, top executives will strive to make their companies better, which can only mean good things for the average consumer. Elon Musk has the confidence in himself to achieve the goals set forth by his company, but do other Fortune 500 executives have the same faith in their own abilities? Only time will tell, but Musk’s new plan may be the start of a new age in compensation for executives.

Sources:

https://www.nytimes.com/2018/01/23/business/dealbook/tesla-elon-musk-pay.html

https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/profile/elon-musk/&list=powerful-people&refURL=&referrer=

http://ir.tesla.com/releasedetail.cfm?ReleaseID=1054948

https://www.wired.com/story/musk-model-3-tesla-production-delays-january/