The Market Ticker
Commentary on The Capital Markets- Category [Earnings]
2017-05-04 07:00 by Karl Denninger
in Earnings , 840 references
[Comments enabled]  

There was a little company called "Micro Strategy" (by the way they still exist.)

In the first week of March the stock had skyrocketed by over 50%.  The next week it "checked back" most of those gains.

The following week the stock collapsed.

A couple of weeks later, the Nazdaq cracked big.  I was house-shopping, in a hotel, woke up to CNBC full of crying babies and chuckled.

I will note that MicroStrategy was a little dogsqueeze company.  In terms of market cap it was a nothing - literally.  Even today, 17 years later, it's a little $2 billion firm -- granted, much smaller today in market cap than it was then.

In the run-up of the previous weeks and months there had been plenty of indications of trouble.  Many companies had reported slashing prices, increasingly-saturated markets were well-understood and of course there was the "burn rate" nonsense of the period.

It's arguable that it was that MSTR collapse that upset the apple cart.  You see, when people are buying stocks of companies that have nothing but negative free cash flow as far as the eye can see or sky-high P/Es of 60, 80, 100 or more they're betting with their eyes taped over on exactly one thing: Indefinite exponential growth of the business and, of course down the line, profits.

The problem is that this is an impossible premise.  There is no way for that to ever happen because it is mathematically impossible.

Today we have Amazon, Facebook and Apple all priced in this way.  Of the three only Apple has some argument for its valuation, but even there given the recent run of almost 50% it's priced for indefinite exponential growth of a saturated product -- iPhones.

Facebook is even worse; they added 80 million users last quarter out of 2 billion, or a paltry 4%.  Yet they sell at 16x sales and 43 times current earnings.  The oft-quoted 23 P/E assumes continued strong forward expansion against a 4% user base increase.

Amazon is the worst of all.  For 10 years Amazon has sold at P/Es that are ridiculous -- currently at 177x earnings but it has traded as high as 1,000x or more.  Yes, it has revenue growth but just the other day Bezos announced yet another price cut on AWS -- their high-margin cloud server business.  The rest of Amazon actually operates at breakeven or even a loss, especially when shipping is considered.  So when you take 5 or 10 points off AWS margins what you're really doing is to destroy the entire profitability of the company!  Oh, and AWS is not the low-cost provider of these services either; I recently tried to compare their service against Digital Ocean's (where The Market Ticker currently resides after I moved it off my own infrastructure) and was unable, with ~30 minutes of study, to determine exactly what I had to buy to be equal to what I could easily understand at Digital Ocean and how much it would cost.  Amazon lost as a result and for many workloads this will continue since I can't be the only geek who throws up his hands when I can't figure out how to compare apples to apples easily.  In short AWS pricing looks a lot like trying to figure out how much your doctor is going to gang***** you for in the hospital!  The problem for Amazon is that unlike the medical system there's no protection from competition for them.

The last two, Tesla and Netflix, are even worse.

Netflix has been running perennial negative free cash flow.  The only reason they're in business at all is that the bond market continues to allow them to borrow money!  That's right, without that they're out of business immediately because they have forward commitments to spend on content but don't generate enough cash to pay for that commitment.  The market "believes" that some day all that programming will continue to generate cash flow without having to continue to spend on it.  Really folks?  Ever look at the residual fees for a TV show?  They're worth almost nothing!  So Netflix must continue to spend more and more and what's worse is that their US market is saturated and all their growth, in percentage terms, is coming from overseas.  That would great except that most of those people don't speak English and have different cultures so now you need differentiated programming for them at even more cost!  This is a company that on an operating basis has, in my opinion, negative current value as a going concern but it sells for about $155 a share.  Yeah.

Then there's Tesla.  Tesla loses money on every car they sell even with government subsidies!  In other words it's a tax farm and yet it loses money even after stealing funds for every car from the taxpayer!  Those subsidies, by the way, will eventually expire and when they do the company will lose even more money per vehicle sold.  The only reason Tesla is still in business is that it, like Netflix keeps going back to the bond market and convincing them to pour more cash on a bonfire and, by the way, their total debt load is now greater than their annual revenue!  This is a company that, on a current operating basis is an outrageous zero and exists only because it manages to convince the bond market and steal from the taxpayer.

I've seen this movie before, and by the way, most of the recent gains in the market and a huge percentage of the gains since the 2008 recession have come from these companies.

Every morning some percentage of people wake up with a raging hard-on and then buy stock.  They believe.  They believe that a company that already has 2 billion of the 7 billion people on the planet can "grow to the moon" and can increase the amount of advertising on the site without limit and not suffer a revolt.  They believe that a company that is cutting prices on what feels like a weekly basis while dozens of competitors seek to (and in many cases do) eat them from the bottom can somehow increase margins.  They believe that a company that went from a diversified computer and software company into one that is 90% one product, has found the saturation point on that product and in fact is seeing declining sales numbers in China, will reverse that trend immediately and go back to double-digit sales increases.  They believe that a company that has negative free cash flow, forward commitments to spend billions not reflected on their balance sheet and has a saturated US market with all growth coming from international consumers who need even more and different content due to demographics, language and cultural differences will manage to indefinitely get Wall Street to continue pouring water into a flushing toilet.  And finally, they believe that a company that has never turned an actual stand-alone profit, grabs tens of thousands of dollars per unit sold in tax subsidies from the taxpayer and also has convinced Wall Street to throw $100 bills into a roaring bonfire on an every quarter or two basis will continue to be able to do all of the above.

Then there are some percentage of people who wake up in a cold sweat.  They ate the red pill.  They used to believe, but today they do not.  Something changed their mind.  They recognize that Amazon isn't a zero, but it's probably only worth 10% of its current stock price.  Apple isn't a zero either, but as a commodity player it's priced at twice it's value -- so it's worth $70-75, not $150.  Facebook is worth $30 or $40, because you can't keep growing user base in a saturated market, those not on the platform are either too young, too old or make $2 a week and you also can't keep adding ads without eventually causing a user revolt.   Netflix is worth $10 for its user base but zero for anything else and Tesla is a literal zero.  They add up their shares, they multiply by the current prices, compare with the above and immediately vomit.

The day that there are a lot of the second and few or none of the first is the day the suspension of disbelief and continued buying into what is outrageously overpriced, and in many cases arguably worthless securities, ends and selling in size begins.

Is it tomorrow?  Probably not.  But today feels eerily familiar.  The vomit-inducing upward spikes have come, and now we're seeing people starting to ask questions.

All you need is something like MSTR from March of 2000 -- the one event that creates that cold sweat.

The screams, cries, and gun-in-mouth suicides are coming folks.  I can't give you a date and neither can anyone else but this is the exact pattern that I've seen play out before, and this movie ends with the protagonist jumping out of a 75th floor window.

My camera is pointed upward and I'll have film of the splat at 11.

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