Weekly readings – 7th August 2020

What I wrote last week

Uber’s latest quarter

Apple’s acquisition of this promising fintech startup from Canada

Business

Inside Netflix’s Quest to Become a Global TV Giant

US citizens increasingly moved to Canada through its Express Entry program

Content creators on YouTube that no longer rely on advertising dollars on the platform grew 40% between Jan and May 2020

Why Microsoft wants Tiktok

A sensible piece on Amazon, its private label and the antitrust issue that it has to deal with

Eugene Wei’s latest essay is on TikTok and it’s good

ARK’s latest white paper on SaaS

How Tim Cook has molded Apple into his own version, not Steve Jobs’

Technology

Apple secured a new patent that could equip Apple Watch with odor sensor technology

What’s the Big Deal About Revit? Understanding the Role of Autodesk Revit in Architecture, Engineering, and Construction

Other stuff that I think is interesting

Inside look at CloudKitchens

Bill Gates’ conversation on Covid-19

Uber’s change in segments’ names and profitability outlook

Uber announced their Q2 2020 earnings today. Overall, the business was significantly affected by Covid-19. Net loss to the company was $1.8 billion while total bookings were down 35% YoY, and net revenue slumped by 33%. There were on average 55 million monthly active customers, down from 99 million in Q2 2019. The number of trips was down 56% YoY as well.

Zooming in at a deeper level, there are two starkly different stories concerning their Ride and Delivery businesses. Ride gross bookings were down by 75%, contributing to the 66% drop in Ride revenue. Nonetheless. the segment was still the only profitable one at Uber with $50 million in adjusted EBITDA. To get a sense of how Covid-19 affected their Ride business, here is a chart that the company provided in their latest presentation

Figure 1 – Source: Uber

Even with the rise in Eats gross bookings which I will touch upon later, the gross bookings overall were down significantly after 9th March 2020. According to Uber CEO, the company saw recovery in Asia and Europe. Bookings in New Zealand and Hong Kong even exceeded the pre-Covid level at times. Of course, it doesn’t help that the situation in the US where several of their key markets are located is still dragging out.

Uber Eats

Gross bookings from Uber Eats grew by 106% in Q2 2020, resulting in 162% increase YoY in Eats net revenue. While the segment still recorded $232 million loss in EBITDA, it saw a 19% improvement to a year before. The segment now has over 500,000 partnered merchants on its platform. There are also more than 10,000 active merchants that offer grocery, convenience, prescriptions and pharmacy products. Uber reported 3 millions trips completed for Uber Connect since Mid April in 170 cities. Uber Connect allows consumers to send small packages.

Figure 2 – John Erlichman

Name change for segments

The company renamed their two main segments: Ride to Mobility and Eats to Delivery. The move signals a strategic shift in strategy. Mobility covers a lot more than just Ride. Uber doesn’t just want to provide a car ride to consumers. It wants to be associated with all kinds of mobility and transportation. There is already Uber helicopters. Uber has been trying to offer consumers public transportation options on their app as well.

With regard to Uber Delivery, I wrote about how Uber wants to move into the delivery service space with their acquisition of Postmates. Currently, there is also Uber Connect and a new service that allows delivery of groceries. Therefore, Delivery is a more apt name for the segment than just Eats.

If Uber’s ambition wasn’t clear before, it should be now.

Profitability

Personally, I think Uber’s struggle with their Mobility segment is just temporary. Once Covid-19 blows over or a vaccine is available, it will come back to what it was before, a revenue and profit machine for the company. Post Covid-19, as consumers are likely reluctant to use public transportation due to fear of being crammed in a closed space with strangers, there will be likely more demand for Uber’s ride hailing business. In fact, there is already some evidence to support the argument. Aggregate data from Hong Kong, New Zealand and Sweden markets showed some recovery on Mobility bookings compared to pre-Covid levels.

Figure 3 – Source: Uber

Additionally, even though Delivery has been highly unprofitable, Uber is pretty confident in its ability to achieve its long-term target. Here is what Uber CEO had to say on that:

Yes, Ross. As far as the debate goes, we stand firmly on the belief that pure-play delivery companies can and will be profitable. And we think it’s a pretty easy answer, but we don’t think that debate is worthwhile, so to speak. It’s only a question of when and it’s only a question of what question of when and it’s only a question of what those long-term margins will be. We have laid out a long-term margin profile of 15% of ANR and about 33% of EBITDA. We wouldn’t be doing it unless we felt confident there.

To be clear, Belgium is actually one of our smaller countries internationally, and we had said that we’re profitable in 2 of our top 5 international countries. And there are a number of other confident there. countries that that we are also profitable in, but we also wanted to make the point with investors that we’re profitable in countries that count. So it’s not just France and Belgium. It’s other countries.

But when we look from a structural basis or the margins of the business, you fast forward a couple of years now, we think we will be profitable in the vast majority of the countries in which we operate. If we’re not profitable, it’s specifically because we’re trying to achieve something strategically, whether it’s a growth target or we’re trying to expand the number of categories that we’re in, et cetera. So we land firmly on one side of the debate, and we have a lot of data internally and very very high confidence in the teams to win that debate.

Source: Uber Q2 2020 Earnings Call

Despite decimating Uber’s Mobility segment, Covid-19 has been a boost to its Delivery segment as it restricts trips outside of home. Driver incentives in Q2 2020 was only 27% of revenue, down significantly from 43% in Q2 2019. Furthermore, the grocery delivery space Uber is entering isn’t without fierce competitors. Behemoths like Amazon, Walmart or Target all invested in their grocery delivery services. When they announced the acquisition of Postmates, I wasn’t sold on their profitability in the short term. They proved me wrong when their net loss improved from $3 billion in Q1 2020 to $1.8 billion in Q2 2020. If and when Mobility segment returns to its full strength and if Uber can keep their momentum with Delivery, it will be even better for the company.

Bull case for Uber

Uber is now a household name. Years of hype and fast growth around the world while it was still a unicorn startup have made the brand very popular among consumers. It is a competitive advantage that poses challenges to any company that wants to enter the space. Plus, Uber’s global footprint gives it a leg up to those restricted to only one market. Even though a bigger footprint comes with a higher level of risk exposure, it does allow cross-market subsidies and more learning of consumers’ behavior. Uber has been conducting small tests in other markets before bringing new features to a bigger audience. In a business where consumer insight is so valuable, transfer of learning from one market to another is a luxury. To have the same luxury, Uber’s competitors would need to invest in multiple markets and be willing to take the same level of higher risks like Uber does.

Uber competes not only for consumers, but also for drivers. The company’s list of services available to drivers makes it a more attractive option than competitors. In my previous post, I wrote:

Furthermore, it can be a boon to drivers as well. To facilitate all the delivery services it wants, Uber needs drivers. Drivers have limited resources in the number of hours in a day and just one vehicle to drive. Hence, they will prefer working with a partner who can help them maximize revenue as much as possible. With a variety of delivery opportunities, Uber can sell drivers on that promise. In the future where Uber does indeed become an on-demand delivery platform, if a driver is without a Ride customer, he or she can either deliver food, grocery or basically an item ordered by another customer. Minimizing dead time and maximizing income can be an attractive value proposition to drivers.

To compete for drivers with Uber, any new rival would need to offer the same earning opportunities, in the form of either different services or a huge incentive. And that would require a lot of capital and years of investment.

With a variety of services thrown at consumers, Uber wants to establish a connection and relationship with users by being front and center in their lives, whether it’s ordering a ride, wanting to get some food from a restaurant, looking up a public transportation schedule, sending stuff to loved ones or fetching groceries. Once a connection is established, it will be a massive challenge for its competitors to overcome.

All Uber has been doing is to build its innovation stack. The more layers of the stack there are, the bigger their competitive moat is. However, execution is key, especially when it keeps moving the goal post in terms of profitability timeline and amid cash flow pressure.

Apple’s latest move to increase services revenue

Yesterday, Bloomberg reported that Apple made a very interesting acquisition of Mobeewave, a fintech startup, for an alleged amount of $100 million. From Bloomberg

Mobeewave’s technology lets shoppers tap their credit card or smartphone on another phone to process a payment. The system works with an app and doesn’t require hardware beyond a Near Field Communications, or NFC, chip, which iPhones have included since 2014.

The Cupertino, California-based technology giant paid about $100 million for the startup, one of the people said. Mobeewave had dozens of employees, and Apple has retained the team, which continues to work out of Montreal, according to the people familiar. They asked not to be identified discussing a private transaction.

What does Mobeewave do?

Mobeewave is a Canadian startup whose technology enables merchants to accept mobile-based contactless payment by just tapping customer contactless credit/debit cards or wallets such as Apple/Samsung Pay on the back of an NFC-enabled device such as iPhone. In partnership with Mobeewave, Samsung launched Samsung POS in Canada in 2019. Participating merchants only needed to download the Samsung POS app onto their phones and go through a quick sign-up process for immediate use of the service. Here is how Samsung POS works:

Benefits from this kind of service include secure payments, reduced costs for merchants and enhanced user experiences. These benefits are particularly attractive to micro merchants such as street artists, small restaurant owners, flee market vendors or delivery drivers to whom every saving is critical. As contactless payments become increasingly popular around the globe, there is a lot of adoption opportunity for technology like Mobeewave’s. In June, Visa report that excluding the US, 60% of global face-to-face transactions were tap-to-pay. In the US, Visa had 190 million tap-to-pay credit cards with the goal of having 300 million by the end of the year. From the merchant side, 80 out of the top 100 enabled tap to pay. Covid-19 aided the adoption of contactless payments and even when the pandemic blows over, I can see that the new trend will be here to stay.

In Canada, Australia and European countries, contactless payments are capped. In Canada, the cap amount is around $CAD 250 while that in Europe is usually €50 EUR, according to Mastercard. In Europe, banks are required to prompt a PIN request when 1) after a customer has five contactless payments or 2) payments total €150 EUR. Though the requirements are aimed to bolster security, they present additional user experience, investment in hardware and security challenges.

What to expect from Mobeewave in terms of security

Mobeewave’s solutions do address the security challenges across markets, including EU. But the most innovation and exciting solution from the startup is the Mobeewave Limitless, which leverages 3D Secure 2.0, a new security standard used for online transactions. With Mobeewave Limitless, a cap on payments as well as a PIN entry are removed. Also, the chargeback and fraud liability are shifted to card issuers, away from merchants.

PIN entry on a consumer off the shelf (COTS) device can present a number of issues when needing to make a high value purchase. Our Mobeewave Limitless™ solution eliminates all of these while shifting the liability of the transaction away from the merchant. With Mobeewave Limitless™, we combine risk mitigation best practices of both card not present and card present technologies…

Eran Hollander, EVP Product at Mobeewave – Per Financial IT

What does it mean for Apple?

Personally, I had some difficulties with Apple Pay at stores in Omaha in the past. For whatever reasons, my attempt to pay with Apple Pay sometimes failed and it wasn’t a nice experience, especially when you left your credit card and wallet home thinking that your iPhone should be sufficient. The acquisition of Mobeewave, I think, will not change much the flow of how a customer uses Apple Pay. If anything, I hope that the technology will make every NFC-equipped device a more reliable POS than the current hardware available on the market.

I think this is a play to increase the Total Addressable Market (TAM) and services revenue for Apple. Reportedly, there are 25 million micro merchants and 5 million merchants in the world. There will be a small cut for Apple for providing this technology to merchants. Even at 0.01% of a transaction value, millions of transactions can result in a nice additional revenue source for Apple. While big name retailers can be a potentially massive market, there are a few operational challenges and quirks to figure out. I don’t expect Apple will reach this kind of market any time soon. If how Apple usually rolls out its products, services and updates teaches me anything, it may take one or two years before we can see Mobeewave available in countries.

Even though Mobeewave technology is available on Android, I won’t be surprised that in the future it will not be. Restricting the technology to only iOS will contract the TAM, but making it available to other app stores presents some challenges: 1/ will Apple create an app that works well on every both iOS, Windows and Android, and maintain it? and 2/ Apple is notoriously known for wanting to keep an iron grip on total user experience. Lending Mobeewave’s technology to other phone manufacturers may not make sense from this perspective.

Apple’s M&A success is something that, in my opinion, goes under the radar quite a bit. They have been pretty successful so far as CNBC noted:

Cook bolstered his point: “An example of that was Touch ID. We bought a company that accelerated a Touch ID at a point.”

There are other examples, too: In 2017, Apple bought Workflow, an automation app, which is now the Shortcuts app built into iPhones. In 2018, it bought Texture, a digital magazine subscription service, which is now the basis of Apple News+. The Animoji avatars users can drop into texts came out of the 2015 acquisition of FaceShift. Siri was the product of an acquisition. Apple’s industry-leading mobile chips are a direct result of the 2008 purchase of P.A. Semi.

Other deals were for companies that are closer to being competitors to Apple. In 2017, Apple bought Beddit, a hardware sleep tracker from Finland. Apple still sells Beddits, and even updated the hardware, but they had a lot of features removed in 2019, and Apple will add sleep tracking as a feature in its latest Apple Watch software this fall.

In short, I see a lot of potential and good things out of this acquisition and am excited to see how it will pan out in the future.

Disclaimer: I own Apple stocks in my personal portfolio.

Weekly readings – 1st August 2020

What I wrote

This sleeping software company has a lot of growth. Learn how the maker of of AutoCAD has a bright future ahead

I gave reasons why I am pessimistic about America’s outlook till the end of the year

Read my thoughts on the antitrust hearing this week

Take a look at this hybrid product of a credit and debit card

My notes on Amazon Q2 FY 2020. A very impressive performance

Business

Paypal’s study on how consumers used their rewards during the pandemic

A good thread on the CEO and Founder of Amazon

American SMBs had an average of $160,000 in sales by selling on Amazon, up year-over-year from about $100,000.

Technology

The Next Generation of Fintech Infrastructure: How API Platforms are Disrupting Banking & Payments

What I find interesting

A story on how Iceland managed to persuade teenagers to stay away from drinking & drugs

The percentage of 15- and 16-year-olds who had been drunk in the previous month plummeted from 42 percent in 1998 to 5 percent in 2016. The percentage who have ever used cannabis is down from 17 percent to 7 percent. Those smoking cigarettes every day fell from 23 percent to just 3 percent.

Source: The Atlantic

This country regrew its lost forest. Can the world learn from it?

The 2nd stimulus package, if passed, is going to be an important event in our fight against Covid-19 and its implications. Both parties offered their own version of the package. The New York Times broke it down visually so that everybody can follow

Image

An excellent commercial ads by Nike. This is very very well-done

Amazon – A giant with momentum and growth

On Thursday, Amazon released their Q2 FY 2020 results and it was nothing short of impressive. Below are my notes:

Even during the pandemic, Amazon net sales were $89 billion in Q2, up 40% YoY. In fact, if you look at their net sales in Q2 in the last 5 years, it’s an astounding 31% CAGR.

Figure 1 – Data Source: Amazon. Chart by me

North America still led the way among their three main segments with more than $55 billion in net sales. AWS is now an annualized $43 billion business and responsible for 13% of Amazon’s total net sales. In the last 5 years, CAGR for North America, International and AWS is 33%, 23% and 39%! If you look at a deeper level, online stores were still responsible for the bulk of Amazon’s net sales while 3rd party and AWS were the next two largest segments. Advertising accounted for 5% of Amazon’s net sales. Their shares have stayed largely the same for the past 3 years,

Figure 2- Data Source: Amazon. Chart by me
Figure 3- Data Source: Amazon. Chart by me

AWS continued to account for more than half of Amazon’s operating income. Historically, Amazon lost money on their International front, but in this quarter, the segment recorded $345 million in Operating Income. Total operating income was up to more than $5.8 billion, almost up by 90% YoY. Once again, this was during a pandemic.

Figure 4 – Data Source: Amazon. Chart by me

Shipping costs grew to more than $13.6 billion in Q2 FY 2020, from $4.56 billion in Q2 FY 2017. In the last four years, shipping costs rose at a faster pace (44% CAGR) than the combined net sales of online stores and 3rd party (28%). As share of cost of sales, shipping costs accounted for 26% of total cost of sales (AWS’ cost of sales weren’t recorded here), up from 19.5% in Q2 FY 2017. According to Amazon’s 10Q, here is how they define Cost of Sales

Cost of sales primarily consists of the purchase price of consumer products, inbound and outbound shipping costs, including costs related to sortation and delivery centers and where we are the transportation service provider, and digital media content costs where we record revenue gross, including video and music.

Source: Amazon’s Q2 FY 2020 10Q

There are two ways to look at Amazon’s shipping costs in my opinion. First of all, the increase in Q2 FY 2020 is likely due to Covid-19. The rising trend can also come from Amazon’s effort and investment in last-mile delivery which is the most expensive delivery type. Amazon is now the fourth largest delivery service as of May 2020. If other retailers want to compete in terms of delivery, this level of commitment and investment will likely await them. In fact, Figure shows the level of capital expenditure by Amazon over the years. Just. Look. At. The. Growth!

Figure 5- Data Source: Amazon. Chart by me

Figure 6 – Source: Koyfin

In business, cash is king and Amazon is a phenomenal cash-generating machine. As of Q2 FY 2020, their operating cash flow trailing twelve months (TTM) stood at $51+ billion, up 42% YoY. Free Cash Flow TTM was almost $32 billion.

Figure 7- Data Source: Amazon. Chart by me

Additionally, AWS’ momentum is reflected in the remaining performance obligation in the last three years. Performance obligations from contracts whose original terms exceed one year stood at $41 billion as of June 2020, up from $16 billion two years ago. It’s indicative of the revenue in pipeline for AWS.

Figure 8- Data Source: Amazon. Chart by me

Lastly, I think this is the first time Amazon broke out their expenses for digital content, including video and music.

The total capitalized costs of video, which is primarily released content, and music as of December 31, 2019 and June 30, 2020 were $5.8 billion and $6.1 billion. Total video and music expense was $1.8 billion and $2.8 billion in Q2 2019 and Q2 2020, and $3.5 billion and $5.2 billion for the six months ended June 30, 2019 and 2020.

Source: Amazon’s Q2 FY 2020 10Q

In summary, I am in awe of Amazon as a well-oiled company. Even at its size, the company seems to have a lot of good things going in their direction and real competitive advantages. The retail and cloud markets are big enough for Amazon to grow more in the future.

Disclaimer: I own Amazon stocks in my personal portfolio.

Where debit meets credit – This debit card features credit card benefits

I came across an interesting startup called Point, which offers Point App and Point Card. Point App is a mobile wallet application from which you can apply for and manage your Point Card. Point Card is a debit card that offers benefits similar to those of a credit card. Benefits include 5x points on subscriptions such as Netflix, Spotify, Hulu and some others, 3x points on food delivery & ride share, 1x points on everything else, no foreign transaction fees and more. Instead of banking on your missing your payments, Point makes money from interchange fees which are a small percentage of your spend and a subscription fee. In order to use Point Card, a customer must pay $7/month or $5/month on an annual plan.

I think this card will be helpful to those who are conscious of their budget and interested in credit-card-like benefits. 47% of Americans carry credit card debt that amounts to $890 billion in total in Q1 2020. Failure to make payments on time results in a high interest which often comes in the range of 13% – 26%. Further inability to make payments repeatedly will put a revolving customer in a vicious cycle as in that case, compounding interests work against him or her. I work for a bank and a credit card issuer and let me tell you: we want you to be delinquent on your credit card debt. It’s a significant source of revenue and profit to issuers. With Point Card, the risk of delinquency is taken away as you can only spend money that you actually have. There is no temptation to make impulsive purchases on credit and break personal budget.

Point Card may not make sense for every one, though. I mean, if you are willing to pay a few bucks a month to have a cool-looking debit card and some nice features that mimic those of Apple Card, by all means. If you want to break even on a $5/month annual subscription at 1x points redemption rate, you’ll need to spend at least $500/month for this investment to make sense financially. If a family puts all utilities, car insurance and subscriptions, and other discretionary expenses on a Point Card, it can easily exceed $500 while the family can avoid the risk of delinquency.

I do think it’s an interesting concept that can appeal to a group of consumers. As a fan of personal finance, I want to see more folks in control of their own finance and stay away from the temptation from card issuers. I hope that as Point scales and continues to be nimble without a big budget in marketing as well as physical branches, it can offer more rewards to attract more customers.

Antitrust hearing with 4 big-tech CEOs

A disappointing hearing

Today, the long anticipated hearing by The House Subcommittee on Antitrust, Commercial, and Administrative Law which features Jeff Bezos, Tim Cook, Sundar Pichai and Mark Zuckerberg, the four powerful CEOs of big tech companies, took place. Suffice to say, I am not surprised at what transpired, but I am pretty disappointed. I don’t think that there is an objective or a desirable outcome from this hearing. While Democratic officials focused more on the issue at hand which concerns antitrust practices by these companies, their Republican colleagues, in particular Representative Matt Gaetz and Jim Jordan, were more interested in an entirely issue: alleged bias and censorship of conservative views on social media. Jim Jordan even compared Apple’s famous 1984 ads campaign to the so-called cancel culture almost 40 years later! Ranking Member Sensenbrenner even mistook Facebook with Twitter when he tried to question Mark Zuckerberg on Twitter’s decision to temporarily suspect Don Jr’s account. You don’t need to spend time on the hearing, but you can get some idea on the quality of this event based on those incidents.

Notwithstanding the difference in pointed questions, every lawmaker in this hearing did more grandstanding than listening. The 5-minute rule is there to ensure that every lawmaker has a chance to ask questions and that witnesses don’t digress. However, the rule’s side effect is that lawmakers don’t wait for witnesses to answer. Instead, they push their own assumptions/allegations on witnesses or just restrict complicated matters to a “Yes/No” question. If this hearing is to uncover how these CEOs approach competition, why is it that they weren’t allowed to talk more and elaborate?

The format of the hearing needs to change in order to yield results. I have a few thoughts in mind on what can be implemented:

  • Every question at a hearing should stick to a topic. Anyone who violates this rule twice should be kicked out of a hearing. For example, Jim Jordan today didn’t ask questions on anti-competition. He threw allegations towards the witnesses on alleged bias to conservatives. So did several other GOPs. How do those questions belong to the Antitrust conversation at hand?
  • Every lawmaker should have 5-10 minutes, but there should only 5-10 questions allowed. A limit on the number of questions can help ensure the quality of questions, give witnesses more time to elaborate and reduce grandstanding. Many issues are complicated and take some explanations.
  • Before a hearing, questions should be compiled in advance on a portal/website and witnesses must answer in writing before appearing in front of lawmakers. Written answers offer witnesses space and time to elaborate and remove the constraints of time. During hearings, lawmakers can just build off of the written answers submitted in advance.
  • Similarly, there should be a collection of follow-up questions that are answered after a hearing.

Not every acquisition of a competitor violates antitrust laws

Facebook and Google were grilled today on their previous acquisitions: Facebook on Instagram, WhatsApp and Google on DoubleClick. I was baffled by this line of question. Take Facebook’s acquisition of Instagram several years ago as an example.

When Facebook paid $1 billion to acquire Instagram in 2012, nobody could be 100% sure that it would be what it is today. At the time of the acquisition, Facebook was already a big player primed for its IPO and heavily invested while even though it was growing fast, Instagram had around 30 million users, generated no revenue and was valued at $500 million. The startup was struggling to grow its team and infrastructure. Joining Facebook did give Instagram benefits on the way to having more than 1 billion users, as the book No Filter noted below

“It was the most dire server problem in company history. Instagram was now important enough to be mentioned in every press story about the meltdown, alongside Pinterest and Netflix. Coworkers, none of whom did that kind of engineering, sent ice cream to the office as support. Sweeney ate several scoops to try to make it through the night, though he accidentally fell asleep multiple times on his keyboard.”

“The infrastructure wasn’t the only problem bubbling up to an intensity the tiny team could barely handle. Spam was everywhere on Instagram. So was troubling and abusive user content, which the community team could no longer finish sifting through in its shifts—and which was starting to appear in their nightmares. Frustration over the financials aside, selling to Facebook might give employees their lives back.”

Excerpt From: Sarah Frier. “No Filter.” Apple Books.

“Systrom gave four reasons. First, he reiterated Zuckerberg’s argument: that Facebook’s stock value was likely to go up, so the value of the acquisition would grow over time. Second, he’d take a large competitor out of the picture. If Facebook took measures to copy Instagram or target the app directly, that would make it a lot more difficult to grow. Third, Instagram would benefit from Facebook’s entire operations infrastructure, not just data centers but also people who already knew how to do all the things Instagram would need to learn in the future.”

Excerpt From: Sarah Frier. “No Filter.” Apple Books.

“So that summer, Zuckerberg directed Javier Olivan, Facebook’s head of growth, to draw up a list of all the ways Instagram was supported by the Facebook app. And then he ordered the supporting tools turned off. Systrom again felt punished for Instagram’s success.

Instagram was also no longer allowed to run free promotions within the Facebook news feed—the ones that told people to download the app because their Facebook friends were already there. That had always brought a steady stream of new users to Instagram.

Another of the new changes would actually mislead Facebook users in an attempt to prevent them from leaving for Instagram. In the past, every time an Instagram user posted with the option to share on Facebook, the photo on Facebook said it came from Instagram, with a link back to the app. Instagram’s analysis showed that between 6 and 8 percent of all original content on Facebook was cross-posted from Instagram. Often, the attribution would be a cue for people to comment on the photo where it was originally posted. But with the change mandated by the growth team, that attribution would disappear, and the photo would seem as if it had been posted to Facebook directly

Excerpt From: Sarah Frier. “No Filter.” Apple Books.

Consolidations in the same industry always involve reduction of competition. The fact that Facebook is a giant company doesn’t make every single acquisition it made illegal or inappropriate. That’s why I don’t get folks are so upset about Facebook’s acquisition of Instagram. I think it’s safe to say that having Instagram at its current size benefits end users, entrepreneurs and small businesses. There is no guarantee that without Facebook, Instagram would have had the same achievement. It’s also worth noting that the FTC, at the time, approved this merger. As a result, why suddenly did this issue become trending again?

Using data to launch private labels isn’t illegal or bad in and of itself

One of the popular themes in this hearing is the use of data from other businesses by big tech companies to launch competing products. Amazon is accused of using data from startups that work with its investment arm and from sellers on its website to launch competing products. First of all, if Amazon violates any confidentiality term to gain illegal access to sensitive data, then yes they should be held accountable. However, I don’t think using aggregate data stemming from activities on its own website to launch private labels is inappropriate or illegal. What do you think Target, Walmart, Kroger or a litany of other retailers do? Where do you think they got intelligence before launching their own private labels? Here is the revenue share by private labels of retailers. The practice went back to several decade. So, why suddenly is it an issue?

Furthermore, even though Amazon has 35%-40% of the US eCommerce, it still has to compete with brick-and-mortar stores. Hence, if you account for physical stores and the whole US retail market, Amazon occupies only 6%, according to Ben Evans. It’s a bit of a Catch-22 situation for lawmakers. Focus on eCommerce alone and it’s not fair. Look at the whole retail segment and Amazon is likely off the hook as they have only 6% of market share. Imagine that as a successful business owner, you were told not to venture in a different segment, how would you feel? You’d probably say: “wait a minute, that’s unAmerican and against capitalism. Why aren’t I allowed to compete in another category just because I was successful in one?”

What I’d have a problem with is if Amazon abuses of its power to promote its private labels without merits. Specifically, if Amazon pushes its own labels which don’t have any positive reviews at all ahead of more established brands with a lot of reviews, then it’s problematic and not in the best interest of consumers. In that case, Amazon’d deserve scrutiny and criticisms.

App Store commissions

I’ll write about this issue in more details later, but here are a few basic points I want to bring up. Every company that plows resources properly into an operation earns the right to make money from such an operation. Even as one of the biggest and richest corporations in the world, Apple should be able to do that too. As a result, when Apple is responsible for manufacturing its own devices and creating the operating systems that include the App Store, Apple earns the right to monetize their effort. It’s unreasonable to expect Apple to run a charity out of the App Store. Whether the 30% or 15% commission is too high warrants a legit discussion, but I strongly disagree with folks who say Apple should just charge developers its cost of running the App Store.

While developers are important, they are just one side of the coin. The other side is Apple customers. Apple needs to ensure that the user experience on the App Store is as pleasant as possible. Otherwise, they wouldn’t sell as many devices and make as much money any more in the near future. That’s why they have guidelines on the App Store. It’s not reasonable to expect Apple let developers do whatever they want when Apple’s brand is on the line. In life, there is no free lunch. Developers shouldn’t expect to leverage Apple’s infrastructure and reach to customers without abiding by their rules. We all know the saying that goes “my house, my rules”, don’t we?

There is a legitimate concern over the inconsistency of Apple’s rule enforcement. The concern is amplified when it comes to select cases in which Apple has a conflict of interest with regard to its own apps. On that front, I do agree Apple should be held accountable and scrutinized by users, developers, media and the authorities.

In summary

The hearing is a waste of time for the most part, in my opinion. There are interesting discoveries revealed by the committee in the documents submitted by the companies; which you can find here, but the format of these hearings needs upgrading and the answers we got today from the CEOs weren’t that meaningful. I do believe that some of the anti-competition claims on big techs should be fleshed out more.

Disclaimer: I own Apple and Amazon stock in my personal portfolio

Grim outlook for America for the rest of the year, at least

I don’t have high hope for America till the end of 2020. Here’s why:

First of all, unlike in many other countries, I expect that we will still struggle with the pandemic in the next few months. If the last 6 months is any indication, it proves that we are not handling this crisis well. We reopened states not when we slowed down the spread sufficiently to the hundreds or teens, but when we were just past the worst point at the time. What happened two months after the reopening? The number of cases has been rising. We repeatedly hit record for the number of cases in a day. Deaths are rising. Yet, the folks in charge are still imploring parents and schools to send kids back to classes while a lot of people don’t wear masks, a proven method to slow down the spread. Even though there are some positive developments with regard to a vaccine, I expect that we are still months away from having the vaccine produced in mass for everybody. So, don’t be surprised that when winter comes, we are still in this mess.

Just to give you some perspective. Vietnam has had around 15 new cases in the last 4 days after 99 days without a community transmission. The country has been very careful and cautious when it comes to Covid-19. Despite the success that garnered global accolade, the borders have been closed to international flights since February. That’s how seriously we have taken this issue, and yet we still have new cases. In the US, not only do we not have a coordination between the federal government and states, but at the state level, there are some whose leadership is just outright terrible. What could possibly go wrong?

Secondly, this is an election year. It will get messy. Politics has always been messy, but if there was respect between candidates in the past (McCain and Obama, or Romney and Obama), the same can’t be expected of Trump, who is known for lies, misinformation and vulgar insults. In addition to the attacks from either candidate, there will be contesting of the results. Trump already laid the foundation for it. He and his officials voted by mail-in ballots in the past themselves, but have been campaigning hard against it, even though the current pandemic makes it dangerous for people to go vote. Unlike other candidates, he hasn’t committed to accepting the election results. Hence, I sometimes shudder when I think about what will happen between November 2020 and January 2021, if Trump loses.

Also, what has been happening in Portland is deeply troubling. The federal government sent in unnamed federal agents to the city to suppress protests that are largely peaceful, despite opposition from the governor, mayor and the state of Oregon’s senators. The violence depicted in the altercation between the agents and citizens is horrifying. It is the stuff of authoritarian regime that we lament in other countries, yet it is happening here in America. Trump already announced that he would do the same to other cities such as Albuquerque, Kansas or Chicago. All this travesty takes place without oversight. How is that not worrying?

There are other downstream effects such as the economy, job losses, healthcare, eviction, etc…But those three factors alone already make me pessimistic of America’s next 5 months now that July is almost over.

What can we do? I can’t do anything since I am just a lawful immigrant abiding by the laws and paying taxes without representation. But I do hope that Americans will stay focused on the upcoming elections, whether it’s for a Senate, Governor, Mayor or Congress seat, and vote. For the presidential election, I hope people will vote for Biden. Not because I like him. I don’t. I don’t like the fact that he invokes Obama whenever it’s convenient, but doesn’t own up to mistakes they made. I also prefer somebody younger. But Biden and Trump are the choices we have, and I do hope that Americans will vote at least for somebody who is a decent human-being. Even Lindsay Graham said in the past Biden was a decent man. Every progress that Biden may make, if he wins, will be incremental. Don’t expect drastic changes or progress overnight. The way the three branches are set up doesn’t allow for fast and dramatic changes, especially when the partisanship is so toxic now. But as long as we don’t stand still or go backwards, even when we are just inching forward a little bit at a time, I’ll take that.

This sleeping software giant has a lot of room for growth

What does Autodesk do? What were the significant events in the past 5 years?

Founded in 1982 and headquartered in California, Autodesk creates software for professionals in engineering, architecture, construction, manufacturing, media and entertainment industries. Some of you may know Autodesk by its notable product AutoCAD. Basically, what Autodesk is to architects, engineers, manufacturing professionals is what Adobe is to creative folks. See below for a few examples of what Autodesk software can do.

Figure 1 – Some of what you can do with Autodesk software. Photo source: Autodesk

The company’s main business segments include AEC (Architecture, Engineering & Construction), AutoCAD & AutoCAD LT, Manufacturing (MFG) and Media & Entertainment (M&E). Below is a summary of some of the main products offered in each business segment:

Figure 2 – Autodesk Products. Information source: Annual Report FY 2020

In FY 2020, revenue share of these segments was 42% for AEC, 29% for AutoCAD, 22% for MFG and 6% for M&E. Compared to FY2019, share of AEC and AutoCAD increased by 200 and 100 basis points respectively, while that of MFG and M&E decreased.

Regarding distribution, Autodesk employs three different distribution options. Firstly, the company sells products through its online store to end users and through dedicated internal salesforce. Secondly, Autodesk sells directly to resellers who, in turn, sells to end users. The last option is a two-tiered distribution in which Autodesk sells to tier-1 distributors who sells to resellers before products get to end users. Combined, the two largest distributors (Tech Data and Ingram Micro) were responsible for 45% of the company’s revenue in FY2020. Given that indirect sale was 70% of total revenue, those two distributors occupied 64% of the indirect sale.

Geographically, EMEA and the US were Autodesk’s two biggest markets with 40% and 34% share of revenue in fY 2020 respectively, followed by APAC (19%) and other Americas (7%). Emerging economies such as Brazil, China, Russia and India made up 12% of the total revenue. These figures have stayed largely consistent in the last 3 years for the most part.

Just like most software companies, Autodesk traditionally sold their products through perpetual licenses and earned additional revenue through maintenance plans which allowed customers to receive future upgrades. Perpetually-licensed users could use the software forever, but without new features. Companies could buy a multi-user license or a network license.

The transition was first signaled by the current CEO Andrew Anagnost, who was then the Senior VP of Strategy & Marketing. Later, in February 2016, Autodesk announced that it would stop selling standalone licenses. The only way that customers could use its software individually is through a subscription. The announcement was made in advance to smooth out the transitions in the near future. But why did Autodesk move to subscriptions? There are several reasons:

  • Subscriptions allow management to make reliable forecast on the business in terms of revenue and cash flow; which is important to any executives.
  • By continuously delivering new updates and features frequently, Autodesk can increase customer satisfaction. Additionally, Autodesk can also receive customer feedback through data analytics and incorporate such feedback into product development faster.
  • Frequent updates also bring more security .
  • Instead of a hefty sum upfront, a smaller subscription fee makes it easier to convince potential customers to buy in.
  • Plus, customers can easily scale up and down investments on a monthly/yearly basis, if necessary.
  • The longer a customer stays subscribed, the more profitable he or she is. Hence, Autodesk is incentivized to deliver on products and services to keep customers happy & locked in.
  • The company probably took notice of the success of the trailblazer Adobe, which also switched to subscriptions in 2012.

In June 2017, Autodesk revealed a Maintenance-to-Subscription (M2S) which enabled customers on maintenance plans to trade in their seats and credit for subscriptions. At the same time, Autodesk increased the price of maintenance plans to make them financially unattractive to nudge customers towards subscriptions. The company later said that it would retire maintenance plans by 7th August 2021. On the 2020 Analyst Day, Autodesk declared that their transition to subscriptions was complete and the company is now onto the next targets.

Financials and fruits of the switch to subscriptions

In FY 2020, Autodesk recorded its highest revenue ever at almost $3.3 billion, up 27% from FY 2019 which in turn was up 24% from FY 2018. Recurring revenue rose from 46% in 2015 to an astonishing 96% in 2020. Remaining Performance Obligation (RPO), which refers to revenue that is contractually stated, yet realized, in FY 2020 was more than $3.5 billion. Subscription Annual Run Rate, a key performance metric in subscription model, went up to $3.1 billion in FY 2020 from $1.2 billion in FY 2018. Subscription revenue in 2020 stood at $2.7 billion, up 53% YoY, offsetting the decrease in maintenance revenue.

This is the power of subscriptions. The management team can forecast future revenue very reliably. As a result, they can plan ahead for strategic moves and allocate resources accordingly.

In FY 2020, Autodesk delivered $1.36 billion in Free Cash Flow (FCF), meaning that their Fresh Cash Flow Margin (over revenue) was 41%. To put the figures in perspective, in fiscal 2019, Autodesk’s FCF was $310 million. The outstanding growth in FCF showed that the company became much more efficient in generating cash from its operations.

For the first time since 2016, Autodesk was profitable operationally with $343 million in operating income (a tad over 10% operating margin). It was due to the economies of scale when revenue grew substantially and marginal cost was minimal. Furthermore, Autodesk’s operational leverage was higher in 2020.

Expenses as % of revenue rose from 2016 to 2018 and gradually declined in 2019 and 2020. Marketing expense as % of revenue in 2020 was actually a bit lower than that in 2016, and so were other expenses. This proves that even though expenses in absolute dollars increased, the company became more efficient and grew the top line as a faster pace than expenses’ growth.

What is next for Autodesk?

Guidelines till FY2023

On 2020 Analyst Day, Autodesk announced targets for FY2023 that include 16% – 18% Revenue CAGR, $2.4 billion in FCF and 55% – 65% of FCF Margin + Revenue Growth. In the SaaS world, there is a rule of 40 which states that if your FCF and revenue margin combined is 40%, your company’s efficiency is pretty awesome. Hence, Autodesk’s target of 55-65% is pretty incredible.

Noncompliant and legacy users

One of the main initiatives is to convert legacy users who are on perpetual plans and noncompliant users that refer to those who are using Autodesk’s software illegally. According to Autodesk, in addition to the existing 5 million paying subscriptions, there are 12 million noncompliant users and 2 million legacy users. Out of the 12 million noncompliant users, they estimate to have 7 million users that opened their software at least 11 times in the last 90 days and are using a version released in the last 5 years, a population considered to be highly convertible.

There are several initiatives aimed at converting these noncompliant and legacy users, including:

  • Stop offering maintenance plans in 2021
  • Harden student verification process
  • Ban offline activation
  • Switch from serial numbers to named users, a change that can allow corporate IT teams to avoid leaks and control usage
  • Apply concurrent user limits
  • Message target users with in-app messages and emails

Untapped market

Autodesk has a lot of tailwind behind them. Lisa Campbell, Chief Marketing Officer, estimated that in FY2025, the total addressable market (TAM) for Autodesk would be $69 billion. Given that the company’s FY2020 revenue was around $3.3 billion, the estimate implies a lot of room for growth for Autodesk. The confidence stems from favorable trends such as 1) collaboration between professionals from different backgrounds on increasingly complex projects in architecture, manufacturing and construction; 2) digitization in industries that use Autodesk’s products; 3) suburbanization; 4) Building Information Model (BIM) mandates in countries.

Source: Autodesk

In addition, Autodesk can also grow horizontally by expanding its footprint in overseas markets. In some areas, its penetration is still low, signaling that there is a lot of opportunity at play. Take BIM penetration as an example. Building Information Modeling (BIM) is a process that essentially enables Architecture, Engineering and Construction professionals to collaborate effectively and efficiently during the entire construction project. In some countries, there are BIM mandates in construction projects while a growing number of other countries are planning to introduce their own mandates. Below is Autodesk’s map of BIM footprint. Almost all countries where Autodesk’s presence is low are developing countries whose need for building new infrastructure will undoubtedly grow in the future.

Source: Autodesk

Summary

The decision to switch to subscriptions is massive for Autodesk. It enables the company to be more agile and unlock more value for both customers and shareholders. From what I have seen, the future is bright for the company. There are a lot of tailwinds behind Autodesk and the fact that its revenue has grown since the switch to subscriptions signals a positive acceptance from customers. One look at Adobe can offer a bit more perspective. Adobe started its journey to subscription-based model in 2012. Below is how much the company has grown since then

The trend looks familiar. If Adobe’s 2012 is Autodesk’s 2016, the former’s 2016, when its growth really kicked into high gear, can really be Autodesk’s 2020. Hence, Autodesk can likely follow the trajectory of Adobe and grow its top & bottom line further in the years to come.

Disclaimer: This post took me a few days to write. When I first started, I was looking into it as a potential investment. By now, I own the stock in my personal portfolio

Weekly readings – 25th July 2020

What I wrote

Slack filed an antitrust complaint against Microsoft over Teams to the EU. On the surface, I don’t think Slack is going to win the case, if the EU decides to formally launch an investigation. How Microsoft structures their Microsoft 365 offers does give customers a choice to include Teams or not, a counterpunch to the core of Slack’s complaint. I wrote my thoughts here

I also wrote about matcha, how it can beneficial to our health and why it and its accessories are expensive

Business

In investing, when truly exceptional opportunities present themselves, Charlie Munger said: use a shovel, not a teaspoon

Both strategies yield the same result: that foreign affiliate employment increased as a direct response to increasingly stringent restrictions on H-1B visas. This effect is driven on the extensive and intensive margins; firms were more likely to open foreign affiliates in new countries in response, and employment increased at existing foreign affiliates. The effect is strongest among R&D-intensive firms in industries where services could more easily be offshored. The effect was somewhat geographically concentrated: foreign affiliate employment increased both in countries like India and China with large quantities of high-skilled human capital and in countries like Canada with more relaxed high-skilled immigration policies and closer geographic proximity. These empirical results also are supported by interviews with US multinational firms and an immigration lawyer

Source: NPER

How Ben & Jerry’s Perfected the Delicate Recipe for Corporate Activism

A look at how influential Facebook is in Bangladesh

Apple’s report on their sustainability progress

Where banks really make money on IPOs

An investigative piece by WSJ that looks into accusations that Amazon used confidential information accessed through its investment arm to launch competing products.

Shopify Saved Main Street. Next Stop: Taking On Amazon

An interesting piece on what appears to be a change in strategy for Apple TV+. This streaming space is highly competitive. I look forward to how Apple will compete with other heavyweights. On a side note, I really enjoyed Greyhound. You should give it a try

Technology

Giving GPT-3 a Turing Test

A good blog post on the behind-the-scenes technology that changed air travel

A report commissioned by Apple on commission rates of other marketplaces, compared to Apple Store. It’s an interesting study and it’s definitely good to have all the facts in one document. On the surface, Apple Store’s commission rates don’t look outrageous, compared to those of other marketplace platforms. However, the debate doesn’t end only at take rates

What I think is interesting

The Last Hunter Gatherers

A great write-up on beaches in Quy Nhon and Phu Yen in Vietnam. If you visit my country, I highly recommend that you go there. Wonderful beaches, few tourists, and great sea food

For years, African countries have taken loan money for China to improve their infrastructure and economy, in exchange for the use of these countries’ vast reserve of rare metal and resources. Now, a report said that Africa is more aware of the strings attached to loans from China. For a good reason!