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Stock Purchase #5 Announced: Unity Software ($U)
Today, @brianferoldi and I announced the fifth stock in our portfolio.
Before diving in, we want to congratulate @stonkmetal who won $250 from @commonstock for the most insightful comment on our $MELI thread.
That said, let's dive into this week's pick.
Unity's mission is "enable more people to be creators."
Gaming is the primary industry it plays in. But the company's platform is allowing creators to build world's in the meta verse in a number of different areas -- which is something we're very excited about.
It's important to understand the business model.
CREATE SOLUTIONS: subscription-based. This is where the games or applications are built.
OPERATE SOLUTIONS: usage-based. This is where (primarily games) are monetized.
Overall, we're big fans of this two-pronged business model (technically, there are also strategic partnerships that bring in money)
And, overall, results have been very solid.
We also like the moat surrounding the company. The network effect is strengthened by all the data Unity can serve it's AI/ML in the operate sphere to place ads (that was, however, an area with huge snafus in the most recent quarter).
Beyond that, switching costs are very high, and this is essentially a duopoly in its niche (with Epic)
Revenue growth has been solid, but net income isn't great. Stock-Based compensation is a huge reason for that. In part, that's annoying -- since it was management mis-steps that led to a significant downward revision (more on that below). But it's also partly understandable, as it was due to the acquisition of Weta Digital (which is also why net cash is basically even today)
While the founders (board member and CTO) are still involved, John Riccitiello is at the helm. he's on the hot seat right now to fix the problems in Operate. But we love the reviews employees give and the level of insider ownership.
There's HUGE optionality -- especially outside of gaming. We're starting to see evidence of adoption well outside of the industry, which is a great sign long-term.
The stock, however, has been a stinker in it's short life as a publicly-traded company. We aren't too concerned, as we don't have enough time to really judge how the stock (and company) have done.
No surprises here: we already mentioned the duopoly status and high level of stock-based compensation.
While certainly not cheap on an absolute basis, it is cheaper than it has ever been
As for that near-term snafu, the way we understand it:
- Management realized in February that Operate revenue wasn't great
- When it checked under the hood, it realized its algorithm had ingested bad data
- To fix it, the company needs to go back -- check all the data manually -- and re-train the ML
- This will cost roughly $110M in revenue for the year
That shortfall explains the HUGE divergence between management's and Wall Street's expectations, and why the stock fell so much.
Here's what really matters to us moving forward
Finally, with all of these things being taken into consideration, here's how the stock scores on our frameworks.
But enough about what we think. What do YOU think of Unity?
Unity's Operate Solutions troubles are
83 VotesPoll ends on: 05/24/22
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I really like Unity for a while. I know Unity from my early days, as a gamer where many web-based games, Minecraft ripoffs, etc. were built using Unity3D, I think it was basically the only competitor to Flash in which many web games were built in, too. A few years later I got to know the company from investors perspective, and there's a lot I like. Their diversity makes it a very interesting company to me, especially as all the major industries they operate in face massive tailwinds. I like to invest in top notch technology that changes how we do things, and when I see how they are a part of revolutionizing content for example where essentially filmmakers won't have to really shoot films, they can essentially just model all the assets and compose a real-life like film because the depth of technology enabled by impressive AI/ML today already is very far (just look at their Ziva acquisition), then there's a solid question just about how valuable is that. And there's plenty of these examples that float around in my head in regards to Unity's solutions and really use cases under a tremendous amounts of verticals. Or even this concept of metaverse, which I suppose will be built around digital assets, which again will try to look as close as real-life things, and who do you think will be the one selling those picks and shovels for creators to make them? right, it's going to be Unity (and maybe a few other players), but I'm fairly certain Unity has tons of data that makes their lead almost unassailable. Now sure, there's a competition from Epic which has its UE, and that's going to be interesting to watch, how that fight unfolds, but I still believe Unity is in much better position given their vertical integration across all the platforms, starting from mobile devices, PCs, ending with consoles, all deployable for creators without additional variations of a code, and I think that itself is very valuable, that they have this sort of integration. When looking at things that are quantifiable, I look at healthy growth of >30% for probably years to come, I see a decent balance sheet, I see great scores on Glassdoor, so the culture is healthy, great insider ownership, even more so impressive that John Riccitello has 2,8% of the shares himself -- considering he's an outside CEO, that's a pretty substantial amount of skin in the game, I'm also seeing that they pulled off positive FCF this q despite the headwinds mentioned with the data regarding their usage based Operate segment, so I'm overall happy to buy at a discount here, hence why I 2,5x'd my position about a week ago.
Portfolio changes - update 9
Hello friends, today I moved further with my portfolio consolidation process.
- I sold out of $S, there's nothing specific wrong there, but I stay stunned by just how Microsoft's position throughout all kinds of enterprise software is strong. Crowdstrike, Microsoft and SentinelOne usually score the best in all sorts of 3rd party research, therefore it makes sense for me to consolidate.
SentinelOne is great, but we are entering a very unkeen environment for companies heavily spending instead of bringing cash flows, which I'm fine with, but when looking at the optionality, profitability and growth, I'm very much fine with $MSFT here. Many maybe don't know, but $MSFT is growing its CyberSec division by 50%, or at least did YoY, pulling about $15B in sales last year, which is just INSANE! So, from now on my coverage of CyberSec will be through $GOOGL (soon to likely buy $MNDT), $NET $DDOG $MSFT $ZS and $SNOW.
- I also sold a position in $SE as I'm beginning to be very concerned about their tempo of cash burn (about $1,9B in Q4 and additional $1,6B in Q1) despite management's encouraging comments regarding coming profitability. So for now, no $SE for me. $MELI in this condition looks like a better R/R now to me.
- I added significantly to my $MSFT position, should be visible by tomorrow. I also added to my other favorites such as $AAPL $TTD $TSLA and $NVDA.
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I like the stable growth companies with a long track record of success. So I’m definitely with you on the $GOOG, $MSFT, and $NVDA. Analyzing the newer companies is out of my wheelhouse. I like the valuation of Microsoft and Google especially, but bought Nvidia for both kids’ custodial accounts. Personally, I don’t think there are two better companies on the planet than Google and Microsoft to own. When my safety of principle is considered. Especially after they were the sole two companies standing after last weeks research. Impressive.
I write a lot of stuff, so the idea is to offer a filter to what you cannot miss. Enjoy it.
The ranking is based on unique views, free/paid new subscribers, and open rate — all relative.
### Top 5🌟
#### 30 Days
- MercadoLibre ($MELI)
- Food for Thought #16 (FED and China)
- Food for Thought #17 (About Stone)
- Stone's Biggest Moat
- Brazil April Wrap-Up
#### 7 Days
- Food for Thought #17 (About Stone)
- Stone's Biggest Moat
- $SE 1Q22: Upside Risk on Monetization
- $NU 1Q22: The Purple Wave
- Expert Interview - Sinqia
> 🌟 Top Percentile on Unique Viewers
5-min recap on what we wrote this week
Food for Thought🌟
- Since Thursday, the market has been speculating that BTG Pactual and Stone would be negotiating an M&A.
- What is in there for BTG Pactual? Stone is one of the top five players in the industry, with a considerable capillarity, good tech resources for scaling its operations, and top-notch logistic capabilities.
- The market still has a high consideration for Street, so he returned and joined meetings with crucial investors — we had access to a person who joined one of those meetings and took a few notes.
- We believe Esteves knows that his name associated with Street's would fully restore investors’ confidence in management and probably would use this to convince Street.
- What is in there for Stone? Even though Stone isn't facing a liquidity issue, the company could use more resources to accelerate its strategy and resume its credit operation.
- With BTG, Stone could strengthen its position as a payment gateway for merchants using BTG's capital to leverage the existing operation.
- Also, we wrote yesterday about a new player gaining market share in the Brazilian Payment Industry that faces a new threat to market participants.
- Stone could leverage its platform to gain stickiness with its clients by offering complex products, such as lending, insurance, investment, etc.
Keep Reading 🔽🔽🔽
Big Piece on Stone 🌟
- In the past years, we’ve heard that the most significant competitive advantage Stone had was its tech, though it always sounded like an empty speech.
- Tech is important, indeed. It enables the company to expand over a smaller structure, minimizing the growth friction and improving sunk costs over time.
- However, we see tech as an enabler, not a competitive advantage. If you had Stone’s software, you would not be able to compete against them. Stone’s most significant competitive advantage relies on distribution due to its hub strategy.
- Stone’s strategy is looking for cities with +500k inhabitants in Brazil as a possible spot for a hub. Usually, they place ten sales representatives, three logistic employees and one leader for 100sqm rented spaces.
- The sales team's goal evolves to increase the number of clients, lower the churn, solve daily routine problems, such as malfunctioning POS machines, and, mainly, sell pre-payment to customers.
- Also, Stone offers to franchisees most of the back-office needed for the operation (HR, Accountancy), reducing the back-office costs for the business owner.
- There is a substantial competitive differential having franchises in smaller locations. First, incumbents, such as Itaú (Rede), and Cielo, will never (ever) sell franchise licensing.
- Second, franchises allow Stone to offer a last-mile solution in smaller regions. For instance, imagine you own a restaurant and operate under Cielo. It’s 12:30PM, the restaurant is full, and your POS dies.
Keep Reading 🔽🔽🔽
$SE 1Q22: Upside Risk on Monetization🌟
- We’ll go briefly on Sea’s earnings and its highlights in this post. Then, we intend to extend to a discussion about the company’s operation in LatAm.
- Sea Limited ($SE, “Shopee”, “Shopee Brazil”) reported 1Q22 results, largely in-line on the top line and much better than expectations on cash burn level.
- The eCommerce segment delivers GMV growth of 39% YoY, while its cash burn also lowers QoQ. We welcome the message from management that Sea may achieve profitability sooner than expected.
- Also, management reduced its GAAP revenue guidance to US$8.5-9.1bn from US$8.9-9.1bn reflecting the growing uncertainties in macro conditions, which could impact the spending power of consumers.
- We believe that the guidance now implies that the GMV growth outlook for 2022 is now +30-40% YoY for the consolidated company, with LatAm growing 100% YoY.
- Management reaffirmed that they focus on profitability over growth, which is an encouraging message. As a result, we believe Sea could deliver high double digits growth without cash burn, which, in our view, would be great.
- The positive highlight was the monetization increase in the eCommerce operation, as the GAAP marketplace revenue as a percentage of total GMV rose to 7.2% during the quarter compared to 5.7% last year.
- As expected, gaming faced pressure in 1Q22, with bookings down 24% QoQ. However, the company started to see the monthly user trend showing early signs of stabilization towards the end of 1Q22.
Keep Reading 🔽🔽🔽
$NU 1Q22: The Purple Wave
- Nubank reported a $45mn net loss vs. the company-provided consensus of a $77mn loss. Similar NPL rises to the incumbent consumer segment, but without payroll and mortgage to smooth the hit.
- We see the quarter with solid credit balance growth. Specifically, total loans rose 122% YoY. In addition, consumer loans, an investor focus, rose to $2bn and now represent 23% of total loans vs. 21% in 4Q21.
- Card TPV rose to $15.9bn, up ~112% YoY and ahead of GIROe's $14.8bn. Interchange revenues increased 127%, with flattish yields at 1.19%.
- Asset quality did not erode as most buy-side analysts expected, with 90-day NPLs up 70bps QoQ vs. Bradesco’s consumer segment’s 60bps and Itau’s 30bps, although this comparison tells only half true (keep reading).
- While fast loan growth helps NPLs, we see Nubank’s figures as substantially better than other neobanks. Provisions rose 287% YoY, driven by loan growth. Overall, Nu presented a strong beat vs. our expectations.
- Under IFRS9, Nubank has to front-load the recognition of credit loss provisioning whenever a loan is booked. So, the faster Nubank grows the credit book, the more short-term pressure it brings to our gross profit margin.
- We must consider how interest on cash balance hurts the short-term PnL. As interest rates go up, Nubank earns more money on our large pool of cash balance, even if it is partially or wholly offset by higher funding expenses.
- But it drives our revenue up and leaves our gross profit essentially unchanged. This pushes down our gross profit margin as it enlarges the denominator of the gross profit formula.
- We ran a few tests assuming stable growth (only to offset churn) and rates at 6%-8% and found a 55%-65% range for gross profit (versus the actual 34% in the 1Q22).
Keep Reading 🔽🔽🔽
Expert Interview - Sinqia
- Giro: The market had problems related to the registration of receivables, which impacted TAG (Stone), and some players, such as N26, are still having difficulty putting the PIX on the street, while others face problems related to latency or settlement. Why do you believe that players are having difficulties? Is it related to the design proposed by the regulator, or is there another reason?
- Saldanha: Every innovation has advantages and difficulties. If you take Open Banking, why didn't it pop and Pix went? The Open Banking concept is a road that needs to be built.
- Pix is transactional. The market was not prepared for this. It's a 24/7 model with an SLA (“Service Level Agreement”) ready for it. The banks were not ready for that. The provider may be ready, but he needs to connect it all to the legacy.
- The bank needs one year and two more to implement to carry out a legacy structure, although they only had two years to prepare.
- The Central Bank protected itself a lot in the regulatory environment. Of course, there was a problem with timing the distribution of Central Bank regulations, but it was always very clear and transparent about the rules.
- In fact, he always gave options, such as indirect and direct Pix. If you don't have the conditions to perform, you can opt for indirect and pay a fee for it. Banks have been able to adapt, while others opt to switch to software.
- Perhaps the PIX is the most sensitive topic. However, with over 12 months on the road, Pix is a huge success in P2P transactions, even if retailers are still not convinced about him.
Keep Reading 🔽🔽🔽
Top Gainers Today @ 10am
Top Gainers Today @ 10am: $PDD, $SHOP, $SNPS, $MELI, $DDOG, $AEM, $HUBS, $COIN, $U, $GRAB, $BILL, $DT, $Z, $BILI, $BJ, $TOST, $DOCS, $EXP, $SID, $COUP, $PAAS, $CD, $WE, $LTHM, $BROS, $AGI, $DOCN, $NEWR, $GOOS, $ARCH, $LFST, $DH, $HL, $SG, $VCSA, $AG, $SPT, $KRO
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6 Additions for This Week
Through my regular dollar-cost averaging in my $HOOD account on Monday and my Stash account Thursday, I added to the following stocks: $TTD, $SHOP, $MELI, $U, $UPST, and $SE.
These may be my single highest conviction stocks and make up a portion of my core 34 holdings.
Trade Desk will benefit from the steady shift to connected TV, alongside $ROKU.
Shopify, MercadoLibre, and Sea are fascinating at these prices and offer increasingly strong optionality as time goes on, it seems -- not to mention they dominate their niches already.
Unity faced a significant issue regarding its advertising, but it appears to be a one-off event. I cannot like this company's optionality more.
Upstart's sell-off completely confuses me. While risks remain, the risk/reward potential for the company has become far too interesting.
These are six great businesses with high growth optionality for the long term, now trading at significant discounts.
I am also planning to add to one of my "higher-risk" core holdings Monday -- who would you all pick?
Which riskier stock should I buy Monday?
25 VotesPoll ended on: 05/16/22
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Update From My Weekly Plan
Given the higher than expected CPI numbers, the market was unable to bounce. At the current moment, we are not seeing any signs of a reversal. I am watching $IWM closely as its now completed a round trip to its Pre-Covid highs and is showing relative strength to $SPY and $QQQ. If $IWM shows signs of reversal, I will look to sell cash secured puts on it for a short term bounce before going lower to fill its gaps. IV is very high on cash secured puts which is why I will look to use those for my long exposure instead of equities or calls.
$MELI did complete its gap fill down under $700 as mentioned in the plan and better prices are arising each day.
Its important to stay nimble in this market as all bounces are continuing to be sold off. Like I mentioned - I am in 100% cash waiting for opportunity to arise.
I will happily update when I start to see signs of trend reversal. Until then, I sit in cash and wait.
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