The Market Ticker
Commentary on The Capital Markets- Category [Market Musings]
2017-06-14 07:00 by Karl Denninger
in Market Musings , 308 references
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When insanity rules all sorts of things that are fiscally impossible to actually "work" suddenly seem not only possible but reasonable.

It was recently pointed out that Amazon among other "high flying" tech stocks is basically a 2-n-20 hedge fund for its higher-level employees.  That is, the cash flow of the company has turned from a source of innovation and advancement into a means to funnel billions of dollars to those people via stock-based compensation.  That cash flow is supposed to inure to the benefit of all the shareholders but instead is being taken up to a huge degree by a handful of insiders.

This isn't illegal, but it's something that the market would normally not allow because it would be met by immediate and severe selling pressure in the shares, destroying the ability to promulgate the scheme.  In a hyped "market" however this doesn't happen because nobody thinks anything "bad" will come from the practice.

Likewise, companies like Tesla and Netflix could not exist as public firms, say much less those with the sort of market caps and stock prices they have.  Why?  Because neither is able to return any sort of profit at all on a pure operating cash flow basis.  Netflix has forward obligations for content that make this impossible at any time in the reasonable future and Tesla has never managed it without ridiculous levels of subsidy on a per-car-sold basis from the government.  Both firms exist solely because people believe their respective paradigms can exist forever.  This is a demonstrably false belief and has never worked in the history of markets on an indefinite forward basis but today that does not matter as both firms have nice stock prices instead of being zeros.

Then there's Facebook and Google.  Both exist in a legally-tortured alternate reality where selling information on you to people who you never consented to receive it for anything approaching the purpose it's used constitutes a huge percentage of their ability and reason to exist.  As just one example Google recently popped up a request that I review a business I just stepped out of.  I had not asked Google, maps or otherwise, to take me there and it was not open on my phone.  I have location history turned off.  Guess what -- Google's Android had irrespective of what I set not only recorded where I was it transmitted that back to Google and then generated the prompt in response.  Why was "location" turned on?  Because I wanted my phone to be able to get weather updates.  How is this legal?  I can't shut off the transmission of the data or prohibit it in the background for only things I don't want to happen because Google has "bundled" all this together with their operating system and then uses the data however it wants, with or without my consent.  What stops them from selling the fact that I went into a bar to my health insurance company?  Nothing.  Again, why is that sort of data mining and use wildly outside of whatever someone might have given consent to legal by these companies?  It shouldn't be and quite-possibly isn't even under existing law but nobody cares in the market today; if they did neither of those firms would sell at anywhere near the current stock price.

Of course all the "big guys" are into this crap -- or its derivatives, including some of recent note that look really shady.  Take this article on Apple's "app store" and how you can make $80,000 a month literally ripping people off via it.  That's not theoretical either; it's happening right here, right now, today.  Why doesn't Apple stop it?  That's simple: They get a piece of the action and since they didn't "actually do it" and nobody will charge them with racketeering for their part in making it both easy and profitable they have no incentive to put a boot on the necks of those who are perpetrating these sorts of schemes.

Then there are firms that have "popped up" like Uber, OfferPad and similar.  Uber is a great example; it allegedly claims to be a "ride sharing" firm.  Nonsense; you share something you're already doing.  Uber drivers would never go where you're going unless you were paying them, so there's no "sharing" going on.  They're simply a taxi hailing service and yet they can't make money either, despite finding new and inventive ways to screw drivers and, it appears, screw people in the company quite literally if recent reports of internal scandals are anything close to accurate. Why does such a firm as Uber have any access to "hedge fund" capital?  It wouldn't except for the hype.

How about "entities" like "OfferPad" which allegedly are attempting to "disrupt" home sales?  The conventional method of selling a house is bad enough with commissions of 6% -- which, if you think about it, is only enforceable due to monopolistic restrictions on access to the MLS!

Well the Realtors are pikers because these guys are trying to find a way to get double that commission on the sale -- and rather sneakily too, never mind that just like Uber there's no local force of people out there doing the work.  At least with a Realtor someone is actually showing the house and doing the legwork, albeit at a ridiculous price.

How does such an outrageous fee structure find any support in the VC community?  Only through hype and stupidity, that's how and it is you as one of their potential "customers" (if you're dumb enough to engage with them) that ultimately gets hosed.

Of course the big grand-daddy issues in this regard are found in Health Care and "higher" education, both of which have taken grift to ridiculous levels and profited mightily from it.

But the fact remains that none of this can or does work in a market that's "efficient", because nobody in their right mind would fund any of that sort of crap as it's patently obvious that it's all a game of grift that must end and when it does all the money put in will go up in smoke at once.

Yet today here we are, with the entire "FANG" stock paradigm alive and well, a "taxi" company that says its not with a "valuation" in the tens of billions yet it has never made a penny and "startups" that claim to be "disrupters" in real estate that instead of lowering costs for people to sell and buy houses are more than doubling said costs.

If you think this is all just about the public-facing side of these companies you're nuts. It's even more-so about the inward facing side, and these firms try like Hell to make sure nobody learns about that. Uber tried it for years and only recently failed; their "recent scandals" are nothing new but got shoved out into the open due to an allegation that they covered up the******of a passenger by a driver.  That was finally enough to force the "community" (mostly VC people) to blow the whistle on the game, and thus we now have the story emerging.

Amazon, Facebook and Tesla all have similar stories somewhere -- if you look hard enough.  The abuses that these firms heap on their employee base is there.  It might not be reported -- today -- but it's there.  You can bet on it and you can also bet on it remaining hidden right up until something happens that forces it into the open.  For public firms one of the "forcing" mechanisms is for the stock price to stop going up, at which point the ability to get away with being ridiculous about your "expectations" of employees because they are willing to put up with it silently for the possibility of a big payoff from the stock price disappears.  Is that day today, tomorrow, or next week?  Nobody knows but the fact of the matter is that forward exponential expansion forever is mathematically impossible and thus that day will come for all of these firms and those who were seen as Jesus, able to walk on water, will be recast as nothing more than spawn of Satan.

The problem with such a "culture" is that while it may drive "ever greater" valuations for a while when it stops you can have companies that look like they have actual businesses become literal zeros almost overnight.  Yes, firms like Facebook and Amazon, which do make (a small) amount of money can actually implode and go out of business this way due to a newfound inability to keep any of their talent on-staff.  Once the abuse is no longer compensated with an ever-increasing stock price (and thus delusions of wealth dancing in people's heads in exchange for being screamed at and berated) every last one of those so-called "overachievers" will quit and the firm is literally ****ed.

There used to be a web site called **** that detailed these sorts of things in the 1990s; they got sued out of existence but the amusing part of the story isn't that they got sued and ultimately folded -- it's that they were right far more often than they were wrong.

Is all of this a huge and outrageous bubble?

Oh you bet -- and there are pins sticking up all over the place.

/Long bacon in size (popcorn is too-high in carbs)

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2017-06-01 16:21 by Karl Denninger
in Market Musings , 257 references
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It's a fair question, is it not?

If you'll pay 187x earnings for Amazon and over three times sales for a company with a 2.89% operating margin (that is, you're willing to pay 92x its operating leverage for a share of stock) is there any price that is too high?

Of course not -- if the premise is that someone will pay more.

That is your premise.

Today, that appears to be a good premise, just as it did in 1999.

I remind you that the Nasdaq doubled in 1999 in the face of exactly this dynamic.

Salesforce (CRM) makes Amazon look like an absolute charmer in many regards.  It sells at 476x earnings and more than seven times sales, with an operating margin of 0.21%!  That's a company that sells "software as a service", which should have an insane profit margin, but is factually incapable of making ANYTHING after expenses are paid!

Netflix has negative cash flow and has for the last couple of years.  That is, without the ability to go back to the market for more money on a continual basis it is a literal zero -- just like PETS.COM.

So is Tesla, for that matter.

In this "paradigm" Facebook actually looks reasonable.  It "only" sells at 38x earnings but 14x sales.  But it has a rich operating margin of 46%, which means you're "only" paying 28x its operating leverage.

The smiles are everywhere on Cucksuckers Never Believe Crap today.

They probably will be tomorrow too.

At some point people will realize this is just tulip mania, as it is with Bitcon.  Yes, there are a deflating number of Bitcoins but there are an infinite number of real and potential digital currencies!

Musk says he's done with the President's "advisory councils" but in fact what's probably done is Tesla.  The inability to force theft out of your wallet for his cars and his "solar roofs and battery packs", which is what Trump leaving the Paris accord has done, dooms his company to extinction.  It's simply a matter of time before the current $340 Tesla stock price is zero because the ability to force others to pay for reserve capacity and overpriced cars just went up in smoke like a big fat joint on the top of a Colorado mountain.

The same paradigm is going to bite the rest of these "high flyers."  It's not that they don't have businesses -- it's that they are all experiencing slower revenue acceleration due to both market saturation (e.g. Facebook) and competition in their high-margin segments (Amazon and Salesforce.)

The latter always happens when you are in a commodity market, and cloud services are exactly that.  You stop being a price maker and become a price taker -- not by choice, but by competitive force.

The Market Ticker currently runs on $25/month worth of cloud infrastructure.  It used to run on a machine here and a fairly-expensive commercial internet link and prior to that it ran on a dedicated server in a colocation facility.  Over the last few years what was a big bill has become a tiny one; I can now easily drink my monthly hosting costs in one evening at the bar.

More to the point that $25/month is less than the power bill I used to pay to run the machine and A/C to remove the heat from my home.

Additionally to the point with regards to Amazon it was impossible for me to figure out what it would cost to put The Market Ticker on AWS for comparable capacity and performance instead of at Digital River, which is where I have it today.

AWS and the rest of the cloud providers are being eaten from the outside in and Amazon is trying to obfuscate their cost numbers so customers will have trouble making exactly this sort of comparison!

You've often heard me say that cloud is dangerous to your data security, oversold and not really cheap when you add everything up.  That's all true at scale, but it's far worse for the provider than the customer because the squeeze on him is what makes it possible for me to pay $25 instead of 10 or 100x as much.  Five years from now that $25 will probably be $5 -- where will this leave Amazon and AWS?

When I was running MCSNet I figured out how to virtualize a web server at the kernel level before there was software support for it in the various web server code bases.  We were first in-market, anywhere, to do this and charged $75/month for it with a fixed storage limit and a per-megabyte additional storage fee.  That service had a very nice operating margin.  But within a couple of years that $75 price got hammered by competition and not long after the 2000 tech wreck it was down to about 1/5th of that with far more transfer bandwidth and storage capacity.  The fall in price didn't stop there either -- you can buy hosting service for less than the cost of one foofoo coffee monthly today.

Thus it always is, thus it always will be when it comes to anything that becomes a commodity.

Computer hardware and internet-related services are always a commodity, although some people do get in first and for a while enjoy fat margins.  Those fat margins inevitably attract competition and while sales can continue to grow operating margins always shrink.


When people wake up to this none of these stocks will sell at more than 25% of their current price and those with negative cash flows will be literal zeros.

All of them.

You do remember Cramer and his "Winners of the New World", right?

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