# MBI Deep Dives > Investment Research Public Ghost content for AI and LLM tooling. This file includes a bounded export of public pages first, then recent public posts. Append `.md` to any post or page URL to get the content in Markdown (for example, `/example-post.md`). ## Pages ### Start Here URL: https://www.mbi-deepdives.com/home/ Last updated: 2025-07-15T03:08:26.000Z ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2020/09/pexels-photomix-company-106344-1-1024x684.jpg) Welcome to MBI Deep Dives. I publish one in-depth research on a publicly listed company every month. Subscribers can download the pdf of the deep dives as well as detailed financial models, all of which can be found [here](https://www.mbi-deepdives.com/models/). Here are some sample deep dives you can explore before [subscribing](#/portal/signup) to my research: [Uber](https://www.mbi-deepdives.com/deep-dive-on-uber/), [Etsy](https://www.mbi-deepdives.com/etsy-a-handmade-giant-in-the-passion-economy/), [Lululemon](https://www.mbi-deepdives.com/lulu/), [Roku](https://www.mbi-deepdives.com/roku/), [Meta](https://www.mbi-deepdives.com/meta/). The next deep dive will be published on July 20, 2022. You may also consider reading MBI's [research process](https://www.mbi-deepdives.com/my-research-process/), [approach to valuation](https://www.mbi-deepdives.com/my-valuation-approach/), and latest [annual letter](https://www.mbi-deepdives.com/2021/) to subscribers. To know more about MBI, click [here](https://www.mbi-deepdives.com/about-mbi/). You can contact MBI at rezwan@mbi-deepdives.com. Follow MBI on [twitter](https://twitter.com/borrowed%5Fideas?ref=mbi-deepdives.com) or [LinkedIn](https://www.linkedin.com/in/abdullah-al-rezwan/?ref=mbi-deepdives.com). Once [subscribed](#/portal/signup), you can access the deep dives of following companies: Uber, Etsy, Lululemon, Angi, Ansys, Autodesk, Copart, Shopify, Otis, CrowdStrike, Roku, Boeing, Square, Trupanion, RH, Spotify, Pinterest, Twilio, Constellation Software, Ethereum, and Adyen. You can download PDF of the deep dives as well as excel models for each [here](https://www.mbi-deepdives.com/models/). For the latest posts, go [here](https://www.mbi-deepdives.com/latest-posts/). You can find our privacy policy [here](https://www.mbi-deepdives.com/privacy-policy/). ### Deep Dives URL: https://www.mbi-deepdives.com/models/ Last updated: 2026-04-28T13:49:49.000Z _This post is for paying subscribers only._ ### About MBI URL: https://www.mbi-deepdives.com/about-mbi/ Last updated: 2025-08-03T15:34:47.000Z MBI is the abbreviation for “Mostly Borrowed Ideas”, which is my pseudonym on [Twitter](https://twitter.com/borrowed%5Fideas?ref=mbi-deepdives.com). Why “Mostly Borrowed Ideas?” As a generalist, I do not have a background in any particular sector. I enjoy navigating across industries, businesses, and countries to learn, understand, and connect the dots. In any case, most ideas and innovations are [incremental](https://twitter.com/borrowed%5Fideas/status/1292262126246141958?ref=mbi-deepdives.com) in nature. Very few of us are smart enough to come up with truly original or groundbreaking ideas. I have background of working in the sell-side (outside the US) and in a long-only buy-side (US) shop before starting MBI Deep Dives. I also did my MBA, CFA, and FRM.... yes, people from South Asian background have this strange fascination with credentials and I humbly succumbed to that stereotype. Of course, the market does not care about anyone’s credentials. I could add two more certificates and could still be a terrible investor. **What can you expect from MBI Deep Dives?** You should expect one email **everyday** on companies I follow or/and content I find interesting. I also publish one Deep Dive on a publicly listed company every month. I will pick a company that I am curious about. I will spend hours on the company going through [my research process](https://www.mbi-deepdives.com/my-research-process/). I will build financial model to get a better sense of the sensitivity of variables and expectations embedded in the stock price. You can explore my approach to valuation [here](https://www.mbi-deepdives.com/my-valuation-approach/). Finally, I will write a detailed piece on the business. You can find all the past Deep Dives [here](https://www.mbi-deepdives.com/models/). I disclose my portfolio everyday on my daily emails. But if you want to subscribe to my website to receive just hot stock ideas, I will discourage you to subscribe to my work. My objective is to understand, analyze, and write about businesses. In some cases, after spending weeks on the business, I will conclude I am not comfortable with this business, and I want to write to explain why. Sometimes, the business can be great, but the valuation is perhaps too rich to my taste. I do believe errors of omission is far more expensive than errors of commission. One of the reasons I want to write on ideas I am not bullish about is to document my thought process in detail and then build a Bayesian mindset to track these companies. Perhaps I will change my mind at some point as new information comes along. I believe it is impossible to find one great stock every month. So it is possible that in the next 12 months, I may only be “long” in 3 out of 12 stocks I will write about. As an individual investor, I do not want to have a portfolio of 40 stocks. Ideally, my ceiling in terms of number of stocks is 20 and the floor can be as low as 10. If you subscribe, I promise you to provide in-depth research on companies without the typical sell-side biases (e.g. 80-90% “Buy” recommendations). You will also receive the downloadable detailed excel model in which you can change the assumptions to fit your narrative. As a generalist, I constantly feel I do not know enough. If you have expertise on a company I have already written or will write in future, please feel free to share your opinion. If you think I am wrong, you are probably right and don’t hesitate to contact me and leave me feedback. Although I have been investing since 2013, I am deeply aware of the fact that I have not experienced any prolonged recession. It takes years and perhaps decades to evaluate an analyst or investor just how good he/she actually is across the market cycle. I will try my absolute best to produce high quality research and ideas that survive the test of time. 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We will ask for written permission before we ever use your or your firm/fund’s name in our promotion. ### Audio URL: https://www.mbi-deepdives.com/audio/ Last updated: 2026-04-28T13:39:20.000Z _This post is for paying subscribers only._ ### Portfolio URL: https://www.mbi-deepdives.com/portfolio/ Last updated: 2026-05-31T04:26:03.000Z _This post is for paying subscribers only._ ## Posts ### Danaher 2Q'26: Yet Another "Meh" Quarter URL: https://www.mbi-deepdives.com/dhr2q26/ Last updated: 2026-07-22T15:25:05.000Z _This post is for paying subscribers only._ ### The Geopolitics of Open Weights URL: https://www.mbi-deepdives.com/open-weights/ Last updated: 2026-07-21T14:56:11.000Z _This post is for paying subscribers only._ ### TSMC 2Q'26: Stratospheric Margins Amidst the AI Super Cycle URL: https://www.mbi-deepdives.com/tsm2q26/ Last updated: 2026-07-17T15:16:56.000Z _This post is for paying subscribers only._ ### ASML 2Q'26: Time to Flex Pricing Power URL: https://www.mbi-deepdives.com/asml2q26/ Last updated: 2026-07-16T14:38:39.000Z _This post is for paying subscribers only._ ### Airbnb’s Cost of Market Creation and Regulatory Survival URL: https://www.mbi-deepdives.com/abnb_ban/ Last updated: 2026-07-15T14:34:33.000Z _This post is for paying subscribers only._ ### WhatsApp's New Era URL: https://www.mbi-deepdives.com/whatsapp/ Last updated: 2026-07-14T16:56:39.000Z _This post is for paying subscribers only._ ### Defending the Enterprise Castle from the Model Layer URL: https://www.mbi-deepdives.com/enterprise-vs-model_layer/ Last updated: 2026-07-13T15:00:53.000Z _This post is for paying subscribers only._ ### What Makes Us Rich URL: https://www.mbi-deepdives.com/rich/ Last updated: 2026-07-12T14:35:15.000Z **Programming Note**: As a reminder, every Sunday, I write pieces that are predominantly based on personal experiences which may or may not be loosely connected with investing. If you are reading MBI Deep Dives everyday, I think it would be rather useful for my readers to understand my personal lens a bit better since that presumably affects (at least in some capacity) the way I analyze businesses as well. --- When I was dealing with the [**transfer saga**](https://www.mbi-deepdives.com/its-not-a-lie-if-you-believe-it/) i.e. moving \~85% of my portfolio from Canada to the US, my wife could perhaps sense how stressful it was for me. So, after I mentioned to her that I might need to go to Canada for a few days to deal with it, she suggested that she, along with our son, travel with me. While finalizing the travel plan, it suddenly occurred to us that we should perhaps make lemonade out of the lemons life seems to be throwing at us. We decided to go for a road trip in Canada. After crossing the border via Washington State, we drove through British Columbia (BC) to all the way to Banff! Right after crossing the border, I went to one of the branches of TD Bank in Canada and initiated the wire transfer to my bank account in the US. Everything went smoothly and I had a huge sigh of relief thinking I will get to enjoy the rest of the trip. I drove for almost seven hours on the first day in our trip, but the drive through BC was so beautiful that I didn’t get exhausted at all. The real estate prices in BC almost started to make sense to me! We booked an Airbnb right in the middle between BC and Banff. After spending the night there, we drove for another five hours to Banff the next day. I have across pictures of Banff from friends who visited the place and frankly speaking, one of the “complaints” I had about Banff before visiting the place is the pictures look so incredibly beautiful that they appear to be almost AI-generated! However, while driving to Banff, I could soak in the natural beauty and appreciate the very real landscape in front of me! (see video captured through my Glasses) 0:00 /0:08 1× After waking up the next morning, I went out in the backyard of our Airbnb at Banff and almost uttered “Hallelujah” while looking at the mountains! 0:00 /0:17 1× Then I decided to open my phone and buyback the stocks I sold. It didn’t take too long for my face to turn pale once I realized for some indiscernible reasons, all the stocks I sold started rallying. I could hardly see any beauty around me after noticing that since internally I was basically like Michael Scott screaming “Noooo, God, Please Nooo”! If you’re not quite following what happened, I don’t want to repeat the story and you can read it [**here**](https://www.mbi-deepdives.com/its-not-a-lie-if-you-believe-it/). ![a man in a suit and tie is making a funny face and says no .](https://substackcdn.com/image/fetch/$s_!9c0g!,w_1456,c_limit,f_auto,q_auto:good,fl_lossy/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F51458398-70c0-4c4a-848e-a276b5d61d49_244x244.gif "a man in a suit and tie is making a funny face and says no .") Since I paid close attention to daily stock price movements during those couple of weeks of transfer saga, I started noticing some really strange aspects of market these days that I didn’t quite appreciate before. For example, I noticed the iShares Semiconductor ETF: SOXX routinely goes up or down 4% on many days without much of a concrete news flow. One would imagine an index would not act so volatile, but that’s clearly not the case. Even more perplexingly, if someone told me what SOXX was doing on a particular day, there was a very good chance I could guess what stocks in very different sectors are doing on that day. The day to day trading perhaps was always somewhat incomprehensible, but staring at the daily stock prices reminded me of the privilege of being long-term investors who can choose not to go through these whipsaws on such regular basis. In fact, I think no matter how wealthy I may become, if my strategy depends on looking at stock prices on a daily basis, I am not sure I could ever quite enjoy the fruits of such wealth. Moreover, if your mood swings too much based on short-term stock prices, I think it’s going to be increasingly more and more difficult to be public equities investor. Charlie Munger used to preach about the importance of equanimity for any investor and I suspect the importance of such equanimity and emotionally stable frame of mind will be of paramount importance to survive in the market over the long term. I would like to carry this newfound appreciation for long-term investing with me even though I fully acknowledge the challenges associated with such a strategy given the lengthy feedback loop. Of course, even though daily volatility has reached somewhat incomprehensible territory, most investors will never quite give up the idea that they know why XYZ stock is going up or down. Perhaps we are “designed” to be incapable of sitting with the discomfort of admitting to ourselves “I don’t know”. It reminds me of the following excerpt from the book “[The Blank Slate](https://www.amazon.com/Blank-Slate-Modern-Denial-Nature/dp/0142003344/ref=sr%5F1%5F1?adgrpid=183621799142&dib=eyJ2IjoiMSJ9.G4BjCcz6OvEqvEyXJPxbNm0l6SWNiRQdSuhLTyJRR9xQJpPJMUDZ4vTAT9oSpGdMj6SDBoFkwx5LfmubJk875T-fdRIDnErjn4HosNJgKJw3Wnw3w3u%5FtQg5HHMh7b3cY5um6197xdDzV%5Fq2nOK3-fv1c2x8Sa6Ce1SqfBeV2k645YBeX4nNGUyoR4ZgsfY1pTKQD6W4Z5ySfsgWm7zPSXj90Ls9Uekbr6f0Ss1JXwo.SnITq%5FOVKBdDDdfXhdd%5Fa9dmWdWtEc8YrQy0BQHisNk&dib%5Ftag=se&hvadid=792847865179&hvdev=c&hvexpln=0&hvlocphy=1014166&hvnetw=g&hvocijid=11940727392626543211--&hvqmt=e&hvrand=11940727392626543211&hvtargid=kwd-296135859323&hydadcr=19131%5F13735104%5F2447939&keywords=the+blank+slate&mcid=9cad3370c1913e68a1d5f387e98398ad&qid=1783864965&sr=8-1&ref=mbi-deepdives.com)” that often reminds me how easy it is to fool ourselves: > “One of the most dramatic demonstrations of the illusion of the unified self comes from the neuroscientists Michael Gazzaniga and Roger Sperry, who showed that when surgeons cut the corpus callosum joining the cerebral hemispheres, they literally cut the self in two, and each hemisphere can exercise free will without the other one’s advice or consent. Even more disconcertingly, the left hemisphere constantly weaves a coherent but false account of the behavior chosen without its knowledge by the right. For example, if an experimenter flashes the command “WALK” to the right hemisphere (by keeping it in the part of the visual field that only the right hemisphere can see), the person will comply with the request and begin to walk out of the room. But when the person (specifically, the person’s left hemisphere) is asked why he just got up, he will say, in all sincerity, “To get a” “Coke”—rather than “I don’t really know” or “The urge just came over me” or “You’ve been testing me for years since I had the surgery, and sometimes you get me to do things but I don’t know exactly what you asked me to do.” Similarly, if the patient’s left hemisphere is shown a chicken and his right hemisphere is shown a snowfall, and both hemispheres have to select a picture that goes with what they see (each using a different hand), the left hemisphere picks a claw (correctly) and the right picks a shovel (also correctly). But when the left hemisphere is asked why the whole person made those choices, it blithely says, “Oh, that’s simple. The chicken claw goes with the chicken, and you need a shovel to clean out the chicken shed.” > > The spooky part is that we have no reason to think that the baloney-generator in the patient’s left hemisphere is behaving any differently from ours as we make sense of the inclinations emanating from the rest of our brains. The conscious mind—the self or soul—is a spin doctor, not the commander in chief. Sigmund Freud immodestly wrote that “humanity has “in the course of time had to endure from the hands of science three great outrages upon its naïve self-love”: the discovery that our world is not the center of the celestial spheres but rather a speck in a vast universe, the discovery that we were not specially created but instead descended from animals, and the discovery that often our conscious minds do not control how we act but merely tell us a story about our actions. He was right about the cumulative impact, but it was cognitive neuroscience rather than psychoanalysis that conclusively delivered the third blow.” After realizing I don’t want to ruin my holidays by staring at stock prices, I just decided to accept my fate and buyback all the stocks I sold. I felt like 20 lbs lighter after doing that and could again see the beauty right in front of my eyes. While strolling through Moraine Lake with my family later on that day, I almost admonished myself for even entertaining the idea that my fate hasn’t been kind to me. ![](https://substackcdn.com/image/fetch/$s_!hd43!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffce39123-1c6e-469d-abbe-044503a31eb5_1200x1600.jpeg) The highlight of our time at Banff came when we were driving through the I[cefields Parkway](https://icefieldsparkway.com/?ref=mbi-deepdives.com). I am running out of adjectives to describe that drive, but one broad takeaway from the whole trip was that road trips are perhaps quite underrated. The major highlight during the Icefields Parkway drive happened when we decided to stop at Coleman Creek. As my son and wife were running around the bank of the creek while the sound of the turquoise colored streams soothed our mind, it was impossible to not feel rich! 0:00 /0:18 1× The funny thing about memory is it is very hard to predict in the moment whether a certain moment will be etched in your memory for decades to come. So, I don’t know if I will remember it vividly, but one of the memories I would indeed like to reminisce in my old age is the laughter of my wife and son while running around Coleman Creek. It is perhaps a good reminder what makes us rich in the first place, and it’s not necessarily always the stock prices going up and to the right! --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Matan on Stitch Fix URL: https://www.mbi-deepdives.com/matan-on-stitch-fix/ Last updated: 2026-07-11T14:03:12.000Z [Matan Zinger](https://94040.substack.com/?ref=mbi-deepdives.com) has been writing a very interesting series on Stitch Fix over the last couple of weeks. I typically don’t spend much time on companies with less than a billion dollar market cap, but given the hype this company briefly enjoyed back in 2020-21, I was genuinely curious why the stock crashed by 95%. Matan’s pieces not only covered that question, but also were genuinely reflective of what can potentially lead to such unmitigated business disasters. Sometimes, studying debacles can be more useful than dissecting success stories. In fact, I enjoyed the part-3 of this series so much that I decided to re-print it with his permission. I encourage you to check out [part 1](https://94040.substack.com/p/what-happened-to-stitch-fix-part?ref=mbi-deepdives.com) (the rise of Stitch Fix) and [part 2](https://94040.substack.com/p/what-happened-to-stitch-fix-part-dd4?ref=mbi-deepdives.com) (its bold bet during COVID) before reading the part-3 of this series, but in case you don’t, let me get you up to speed so that you can read part-3 of this series even without all the granular details. Stitch Fix was that rare 2010s e-commerce company that grew while actually making money. The entire business was built around a single product: the “Fix,” a box of five clothing items curated by human stylists working alongside recommendation algorithms, aimed mostly at busy, suburban millennial women. Founder Katrina Lake raised just $42.5M in venture capital, obsessed over unit economics, and tuned every part of the operation e.g. warehouses, software, inventory, marketing, and thousands of part-time stylists around that five-item box. When COVID crushed brick-and-mortar apparel while Stitch Fix’s growth accelerated, the market re-rated it as “the Netflix of shopping”: the stock ran from a \~$2B valuation to \~$11B in six months, and a nascent “direct buy” channel which let customers shop individual items outside the box fueled predictions that Stitch Fix would disrupt all of apparel retail. Then came the bet-the-company pivot. In April 2021, Lake abruptly stepped down as CEO, handing the reins to Elizabeth Spaulding, who had joined only 15 months earlier to run direct buy. Spaulding rebranded the channel “Freestyle,” opened it to brand-new customers Stitch Fix had never served and had no data on, and redirected marketing and onboarding toward it in pursuit of the entire women’s apparel market. The rushed rollout cannibalized the core: prospective customers were funneled into an untested Freestyle experience instead of the proven Fix onboarding, net client adds collapsed, active clients began shrinking outright, and less than a year into the pivot Stitch Fix reported the first revenue decline in its history, followed by layoffs. Part 3 picks up from there: how deep the self-inflicted damage ran, and why it proved so hard to reverse. I'll let Matan continue that story below. --- # [**What Happened to Stitch Fix? Part 3: Freestyle Freefall**](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com) *This is part 3 in What Happened To Stitch Fix; for better context, check out* [*part 1*](https://94040.substack.com/p/what-happened-to-stitch-fix-part?ref=mbi-deepdives.com) *(the rise of Stitch Fix) and* [*part 2*](https://94040.substack.com/p/what-happened-to-stitch-fix-part-dd4?ref=mbi-deepdives.com) *(its bold bet during COVID).* The hasty rollout of Freestyle ([*discussed in part 2*](https://94040.substack.com/p/what-happened-to-stitch-fix-part-dd4?ref=mbi-deepdives.com)) didn’t happen in a vacuum. In July 2020, Shopify’s Tobi Lütke argued that “2030 has gotten pulled forward into 2020.” [A McKinsey report](https://www.mckinsey.com/industries/consumer-packaged-goods/our-insights/high-growth-low-profit-the-e-commerce-dilemma-for-cpg-companies?ref=mbi-deepdives.com) stated in 2021 that the pandemic “accelerated the migration to e-commerce—the expected five-year trajectory happened in a matter of months.” This belief led to an e-commerce investment frenzy. In that environment, the biggest risk was missing the train by moving too slowly. Racing Freestyle to market made sense. Except the train never really left the station. [Shopify CEO Tobi Lütke wrote in July 2022](https://www.shopify.com/news/changes-to-shopify-s-team?ref=mbi-deepdives.com): > \[...\] Given what we saw, we placed another bet: We bet that the channel mix - the share of dollars that travel through ecommerce rather than physical retail - would permanently leap ahead by 5 or even 10 years \[...\] > > It’s now clear that bet didn’t pay off. Meta’s Mark Zuckerberg and Amazon’s Andy Jassy made similar concessions that year. But while these companies could contain their failed bets – by shutting down initiatives meant to serve the demand that never materialized – Stitch Fix kept declining. The failed bet Stitch Fix had made was much harder to undo. ## **“A Loss Of Focus”** “There’s some macro headwind, but I’m not willing to accept that it’s all macro,” Katrina Lake insisted on her first earnings call back. Spaulding’s tenure didn’t last long. Seventeen months after handing over the company, Lake returned as Interim CEO at the beginning of 2023\. The business was in far worse shape than she’d left it. Active clients had fallen below 3.4 million and quarterly revenue to $400M — both the lowest since 2019\. The pandemic-era gains had fully evaporated. Stitch Fix turned into a money-losing, declining business. The stock traded under $4, down over 96% from its 2021 peak. ![](https://substackcdn.com/image/fetch/$s_!QQPR!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fda5bca90-c51d-4174-8c05-8c9df039fc7d_1200x742.png "Chart") By the time Lake returned, the Stitch Fix has less customers than it had when COVID started ![](https://substackcdn.com/image/fetch/$s_!e5bx!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5e5b0d18-f7dd-43d2-bcb7-f3800b309287_2048x1058.png) Revenue reversed to 2019 levels, with growth rate and profit margin going negative The earnings call marking Lake’s return is one of the most memorable I’ve listened to. She acknowledged the decline in her opening remarks: > \[...\] We haven’t met recent expectations. Driving towards an ambitious vision has resulted in a loss of focus. We must now more than ever deliver on the client experience, bring focus in our marketing efforts and drive results for our shareholders. Lake was quite open when asked where Stitch Fix “lost its focus”: > \[...\] As we thought about expanding the business in a very ambitious way, we took a marketing approach that probably tried to bring people into a variety of different customer segments. And very notably, we spent marketing dollars trying to bring people into a Freestyle-first experience as an example. So that’s a place where not only did we find that that marketing of freestyle first wasn’t as effective as what we had done historically in Fixes. But it also actually made it harder for us to be able to be acquiring people into the Fix channel. > > \[...\] Another one is around inventory. We definitely built up an inventory in anticipation of a Freestyle customer that was a different set of inventory than Fixes and also more unknown, it was a customer we hadn’t served before. It was a channel we hadn’t served before. And so, there was more risk in the inventory. The word *focus* — which Lake said more than thirty times on the call — was *doing a lot of work*[*1*](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com#footnote-1). These examples point to a bigger story: a decade of machinery, built and tuned around the Fix, repurposed to chase Freestyle — hurting the Fix business in the process. *Loss of focus* was a generous way to describe what had happened during the previous seventeen months. Stitch Fix didn’t get distracted; it was dismantling the elements that made it unique and successful in the first place. ## **Unstitching Stitch Fix** [Part 1 of this series](https://94040.substack.com/i/203379944/capital-efficient-growth?ref=mbi-deepdives.com) told the early success story of Stitch Fix: accepting a limited-size market allowed the company to build a differentiated business that – unlike its peers – was profitable and made efficient use of capital. All parts of its operation – the software infrastructure, fulfillment centers, marketing channels, algorithms, and human stylists – were optimized around the Fix concept. None of them alone was the moat; the way they were stitched together created a unique offering. The algorithm had blind spots, but the stylists learned to work around them. The algorithm and stylists worked around inventory gaps. The warehouse was designed to efficiently pack 5-item boxes, where clothes weren’t folded (since the customer was going to try them on first). Fix customers were motivated to provide item-level feedback – on style, cut, quality, and pricing – thus feeding the algorithm far more data than any retailer ever collected. Marketing was optimized for the type of customers who found those mystery Fix boxes delightful. The way each part was optimized around the others’ strengths and limits was the moat: competitors may have copied different components, but couldn’t replicate the integration. That moat is why Stitch Fix made money while its box-subscription peers burned cash. It’s also why the business rapidly came apart once the equilibrium was broken. --- The story of “Fix Preview” provides a great illustration: Originally, a Fix was a mystery box. Customers didn’t know its content until it arrived. In 2020, the company started[2](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com#footnote-2) sending its UK customers an email with the content of an upcoming Fix, allowing them to make modifications. Encouraged by improved keep rates and order values, the company rolled out Fix Previews in the US during 2021. It backfired, however, when Stitch Fix failed to recognize its own limitations and stretched the feature too far: in many cases the preview was generated by the algorithm, with no human stylist in the loop. The customer was effectively doing the stylist’s job, which was an opportunity for Stitch Fix to save on styling costs. This led to some frustrating experiences – from a [2022 Vice article](https://www.vice.com/en/article/stitch-fix-stylists-are-unheard-overworked-and-at-the-mercy-of-robots/?ref=mbi-deepdives.com): > \[...\] According to stylists, the algorithm often just picks up on keywords in these \[customer feedback\] sentences without understanding context. If you tell the system that you don’t want jeans, you may very well end up with multiple pairs of jeans in your Fix Preview. > > “And sometimes our clients don’t know that the algorithm is picking stuff,” a stylist told Motherboard. “They’ll respond, like, ‘Why did you send me this stuff?’” > > “The algorithm was not trained well enough to take into account seasonality or where people live. It would just start pulling out like, a bunch of sweaters for someone who lives in Texas, or like 10 pairs of pants, or like 10 of the exact same shirt, or like 10 backpacks,” \[...\] Fix Previews violated the delicate balance: with the stylists removed, customers were directly exposed to algorithm shortcomings and inventory gaps[3](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com#footnote-3). And they blamed their stylists. These complaints didn’t alarm management — there are always customers with grievances, and nothing was showing up in the numbers. Keep rates and order values held. When Lake returned, however, she reported what those metrics had been hiding: > Although at the highest level Fix Preview has demonstrated a positive impact on AOVs, digging into the data, we see a more nuanced story. There absolutely are clients who significantly benefit from Fix Preview. But there are also clients for whom showing a preview actually increases cancellation. Oops. This is textbook [survivorship bias](https://en.wikipedia.org/wiki/Survivorship%5Fbias?ref=mbi-deepdives.com) — just like Wald’s bomber planes, which which shot down and never made the stats – customers who canceled weren’t accounted for by the key metrics Stitch Fix was monitoring. You can’t measure the keep rate or the value of an order that didn’t go through. But the damage was real – algorithm-generated previews were repelling customers, even if the dashboards weren’t showing it. ![](https://substackcdn.com/image/fetch/$s_!y8Ca!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff634ef32-b7c5-494f-8785-2d3e55345e42_2048x1526.png) Just like the planes that never returned to base, prospective customers who never completed their order weren’t showing up in the metrics. There’s an interesting analogy. Customers were stuck with an algorithm too rigid to understand what they wanted; management was running Stitch Fix on metrics with the same flaw — confident, context-blind. Both these cases needed a human in the loop to catch the miss. The stylists[4](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com#footnote-4). It didn’t end there. --- The stylists’ job, it turned out, was more than correcting the algorithm’s picks. “Shopping is inherently a personal and human activity,” [Lake wrote in 2018](https://hbr.org/2018/05/stitch-fixs-ceo-on-selling-personal-style-to-the-mass-market?ref=mbi-deepdives.com), insisting that data science must be combined with human stylists; she explained: > For example, when a client writes in with a very specific request, such as “I need a dress for an outdoor wedding in July,” our stylists immediately know what dress options might work for that event. In addition, our clients often share intimate details of a pregnancy, a major weight loss, or a new job opportunity—all occasions whose importance a machine can’t fully understand. But our stylists know exactly how special such life moments are and can go above and beyond to curate the right look, connect with the clients, and improvise when needed. That creates incredible brand loyalty. This didn’t show up in a metric, but played a critical role for Stitch Fix. Things changed the same month Spaulding became CEO. In August 2021, stylists were required to switch to 20-hour weeks, dropping the flexible arrangements — between shifts, after bedtime – that let Stitch Fix rent the judgment of people it could never have hired full-time. Hundreds of experienced stylists opted, instead, to take $1,000 and walk away. For those who stayed, a new points system roughly doubled the expected pace. Stylists were measured on efficiency – required to style a Fix within five to fifteen minutes[5](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com#footnote-5) – and on keep rates. These incentives may have looked good on paper, but turned out to be perverse. In the old days, a stylist might spend fifteen or twenty unmeasured minutes drilling down into a client’s previous notes and browsing her Pinterest board and Facebook profile, trying to “crack” the right style. This large upfront effort offered the potential reward of winning over a loyal customer. The new system penalized exactly that: the efficiency hit was immediate, while the potential keep-rate payoff was months away. Hard clients — new, picky, style still unclear — became a losing trade. The system taught stylists to harvest the existing base of established and predictable clients, and let new clients churn. This was a one-two punch: the company was acquiring fewer customers, due to the abrupt marketing changes ([see Part 2](https://94040.substack.com/i/204579299/betting-the-company?ref=mbi-deepdives.com)); the customers it did acquire were monetized at lower rates due to the degraded service. ## **Post Mortem** Despite these issues, Lake was optimistic that Stitch Fix could recover by returning to its roots: > \[...\] In terms of what the customer is looking for, I think that’s really differentiated about our channel relative to others, it’s not necessarily price. It’s not necessarily finding the brand that you love. It is actually around fit \[...\] It’s about style. It’s about finding things that you love. And in some cases, find things that you love that are surprising to you. And that’s something that really only our channel can deliver on. > > \[...\] Stitch Fix is one that really makes shopping more tenable and makes it easier. It helps people to look their best without spending a lot of effort to do it. And those are really differentiating qualities in our customer that we can build the right assortment to be able to deliver on. > > \[...\] I think just really being able to focus on the things that we already know that we are able to deliver on that we have a business that’s 10-plus-years-old, that has a history of profitability delivering on this business to be able to focus back on the things that we know and know that we can deliver is kind of the core thesis. That thesis didn’t hold. The decline persisted, bottoming at 2.3 million active customers and $340M of quarterly revenue. Over three years later, Stitch Fix still hasn’t returned to profitability. The stock has been flat for almost four years. In reality, Stitch Fix’s “differentiating qualities” were already broken. The Fix moat was gone, in a way that wasn’t easily reversed. [As we’ve seen before](https://94040.substack.com/i/193651447/business-traps?ref=mbi-deepdives.com), saying “*I no longer want the cheese*” doesn’t get the mouse out of the trap. --- It’s tempting to conclude that Stitch Fix’s biggest mistake was violating the very aspect [Ben Thompson had liked about it](https://stratechery.com/2017/stitch-fix-and-the-senate/?ref=mbi-deepdives.com) when it went public in 2017: > Stitch Fix is a more important company than it may seem at first glance: it proves there is a way to build a venture capital-backed company that is not an aggregator, but still a generator of outsized returns. The keys, though, are positive unit economics from the get-go, and careful attention to profitability. The reason this matters is that these sorts of companies are by far the more likely to be built: Google and Facebook are dominating digital advertising, Amazon is dominating undifferentiated e-commerce \[...\] To compete with any of them is an incredibly difficult proposition; better to build a real differentiated business from the get-go, and that is exactly what Stitch Fix did. The COVID e-commerce euphoria pushed Stitch Fix to pursue an aggregator dream – transforming into a personalized apparel marketplace and disrupting all of shopping – which indeed turned out to be “an incredibly difficult proposition.” Stitch Fix abandoned its humble-yet-safe territory, flew too close to the sun, and crashed. *Right?* While this is largely true, the actual moral of the story is – like many things in today’s article – much more nuanced. --- I like [this story from former Amazon executive Dan Rose](https://colossus.com/episode/rose-how-stunning-founders-operate/?ref=mbi-deepdives.com), about how Jeff Bezos asked Steve Kessel – who was running Amazon’s media e-commerce business – to lead the Kindle initiative: > He said to Steve one day, “Steve, I need you to come over and run this digital business and get this digital book platform started so that we don’t get iPoded out of books.” > > And Steve said, “Great, I’ll take one of my best people. We’ll put them on it, and we’ll get a team going, and it will be great.” > > \[...\] And Jeff goes, “No, Steve, let me make this clear. > > “As of today, you’re fired from your job. > > “Your new job is to kill your old business. > > “I want you to put the physical books business out of business by building a digital product that’s so “good that people don’t buy physical books anymore. > > “If you run both, you’ll never be motivated to do that.” Bezos understood The Innovator’s Dilemma very well. In his 1995 HBR[6](https://94040.substack.com/p/what-happened-to-stitch-fix-part-e1a?ref=mbi-deepdives.com#footnote-6) article about Disruption, Harvard professor Clayton Christensen concluded that *responsibility for building a disruptive-technology business* *must be placed in an independent organization.* Unfortunately for Stitch Fix, even though Katrina Lake attended Harvard Business School, she didn’t follow Christensen’s advice; she handed Elizabeth Spaulding the responsibility for building Freestyle – meant to be a disruptive new business – and at the same time, the responsibility of overseeing the core Fix business. That’s the most catastrophic part of the story: yes, Freestyle was too ambitious, and failed. But had it been built in a separate organization – akin to Meta’s Reality Labs, or Amazon’s Fire Phone – it wouldn’t have been as consequential. Money would have been lost, but the Fix side of the house wouldn’t have been damaged. In that parallel universe Stitch Fix may have been able to bounce back after COVID, and to remain a profitable, growing business today. --- The most incredible thing, though, is that Christensen’s recommendation followed research showing that managers prioritize their existing core business, depriving the potentially disruptive new business of resources needed for it to succeed. An independent organization is, he concluded, the only solution. Which is why Bezos detached Kessel from Amazon’s existing physical books e-commerce business. He wanted a manager fully devoted to building the new digital books business. But the opposite happened at Stitch Fix: having both Freestyle and Fix under her supervision, Elizabeth Spaulding prioritized the new and uncertain business over the existing successful one. So eager was Stitch Fix to disrupt itself that it didn’t notice it was tearing down the Fix business. There aren’t many stories like this. I think that even the late Prof. Christensen would have been surprised. Imagine Bezos telling Kessel “*your new job is to kill your old business*,” but leaving him in charge of the old business too. The intention, surely, was for him to build a new business so good that it renders the old one obsolete. But there’s a shortcut, the kind that a rigid and unsophisticated algorithm might come up with: just directly kill the old business. That, tragically, is what happened to Stitch Fix. --- For more posts like this, I recommend you subscribe to [**Matan’s Blog**](https://94040.substack.com/?ref=mbi-deepdives.com). ### Meta On the Offense! URL: https://www.mbi-deepdives.com/meta-on-the-offense/ Last updated: 2026-07-10T14:39:05.000Z _This post is for paying subscribers only._ ### The Salience of Data URL: https://www.mbi-deepdives.com/data/ Last updated: 2026-07-09T14:46:02.000Z _This post is for paying subscribers only._ ### Why Consumer AI Appears to be Lagging Enterprise URL: https://www.mbi-deepdives.com/consumer-vs-enterprise-ai/ Last updated: 2026-07-08T13:57:03.000Z _This post is for paying subscribers only._ ### "It's not a lie if you believe it" URL: https://www.mbi-deepdives.com/its-not-a-lie-if-you-believe-it/ Last updated: 2026-07-07T14:08:32.000Z _This post is for paying subscribers only._ ### "Never Sell" Episode: Scuttleslops, OpenAI Valuation, Ryan Specialty URL: https://www.mbi-deepdives.com/never-sell-16/ Last updated: 2026-06-29T13:41:38.000Z **Programming Note**: As [mentioned](https://www.mbi-deepdives.com/scheduling-and-disclosure-update/) earlier, MBI Deep Dives will be off for the next week and I will resume the cadence of posting daily on Tuesday next week (July 07, 2026). --- For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode yesterday. Scuttleblurb recently introduced a new feature “Scuttleslops” and we took this opportunity to discuss the initial reactions as well as AI’s growing role in content creation. We also discussed what you need to underwrite to achieve a \~10% IRR if you were to take a stake in OpenAI at their latest funding round valuation. Then we took a hard turn from AI related discussion to…insurance brokers, especially Ryan Specialty. You can listen to the conversation here: [Spotify](https://open.spotify.com/episode/2nk9ViDeBz0nbp79438EIW?si=s7q2RexwTkewbJb1my8C6g&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/scuttleslops-openai-valuation-ryan-specialty/id1786912203?i=1000774614060&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=AqZCnS9oyrg&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Recommended Read URL: https://www.mbi-deepdives.com/recommended-read/ Last updated: 2026-06-28T14:50:04.000Z Instead of writing my personal musings on this Sunday, I would actually suggest you read these two pieces that expanded my understanding of the world: “[**How funerals keep Africa poor**](https://davidoks.blog/p/how-funerals-keep-africa-poor?ref=mbi-deepdives.com)**”,** and “[**Why kinship societies kill their old**](https://davidoks.blog/p/why-kinship-societies-kill-their?ref=mbi-deepdives.com)**”.** They are both quite thought provoking and illuminating in a way that is hard to appreciate about the reality of living in a scarcity society. I highly recommend these pieces! ### The Shape of Compute Curve URL: https://www.mbi-deepdives.com/the-shape-of-compute-curve/ Last updated: 2026-06-27T14:57:56.000Z In a recent podcast, Lambda (one of the neoclouds) CTO Stephen Balaban expressed almost bit of a disdain for the critics who wondered whether the hyperscalers or neoclouds are “gaming” the GPU accounting by assuming higher useful lives of the GPUs than warranted. From the [podcast](https://www.youtube.com/watch?v=0NttU4CbyVs&ref=mbi-deepdives.com): > Matt Turck: You’re running an H100 at a higher rate because why? Because the demand for compute is so rabid that people will take any? Or the technical depreciation of the product is slower than people thought? What drives that? > > Stephen Balaban: Well, what’s driving it, I mean, certainly it’s the demand being high increases the price that you’re able to get in the market. There’s no question about that fundamental law. Again, going back to what people didn’t understand about this market. There were people who were saying, “Oh, well, there’s a five-year lifetime, or three-year lifetime,” I even heard some people say three-year lifetime for these GPUs. Completely false. You know, we have GPUs that we commissioned, and we’re one of the earliest neoclouds, in fact, we’re probably the only neocloud that actually has GPUs in our fleet that are fully depreciated from an accounting perspective. Most people are adapting around a six-year accounting depreciation schedule. But that’s not the usable life. The usable life is longer than the accounting depreciation schedule, and what really matters is the economic usable life. And so what we’re starting to see is that the people who were the naysayers—”oh, this is going to be, you’re going to throw these GPUs out in five years”—are completely wrong. They’re completely wrong and they’ve been wrong the entire time. Given the rental rate even for the older GPUs stayed much higher than most people expected a couple of years ago, I can understand why Balaban is so dismissive of the critics. Nonetheless, I do wonder whether he’s giving too much credit to themselves. Ultimately, whether GPUs have longer useful life or not may depend a lot on whether the demand side of the equation can keep finding compelling and economically useful things to do with such GPUs. If Claude Code or Codex were not a thing in 2026, the demand for GPUs would be lot more sober and the rental rate for older GPUs would be lot lower than it is today. Do the compute sellers have clear idea whether such new capabilities or use cases will keep showing up in a couple of years? Or how confident can you be that the current use cases can carry the day even if novel use cases don’t show up in a year or two? You see this whole depreciation debate is much more of a technological question than a boring accounting question and I suspect it’s nearly impossible to have a very high conviction **long-term** view on this topic from the outside. If compute buyers keep finding use cases that far exceed the cost for compute, demand will outweigh supply and compute prices can remain high to the extent that hyperscalers depreciating the GPUs at a 4-5 year timeframe may end up underreporting their earnings power in the next few years. Of course, the opposite could also happen if compute customers struggle to find valuable use cases with their compute. To be precise, not only the investors, but I think even compute sellers are not in a great position to have high conviction view about long-term depreciation schedule for the GPUs. Compute buyers, on the other hand, probably have a marginally better idea given they’re the ones who will have to extract value from these compute but even in this case, I don’t think they quite know the shape of the demand curve with high conviction in 3-5 years. One additional complexity here is that the depreciation of these GPUs may vary a lot in different hyperscalers/neoclouds. While traditional CPU is much more standardized and likely have less variability in depreciation curve among different providers, the use cases in GPUs are still somewhat nascent and different providers can end up with vastly different actual useful lives of these GPUs. For example, this [blog](https://www.aravolta.com/blog/gpu-depreciation-curve?ref=mbi-deepdives.com) points out several factors that can swing the depreciation rate of such GPUs and based on telemetry data, they found the following: “The fleet's effective depreciation curve **varied by 30–45%** across different end-customers, *even though the GPUs were identical model*” ![](https://substackcdn.com/image/fetch/$s_!u_GO!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff9da176d-c6de-4275-9820-5f3181a268cc_1287x517.png) Source:[ Aravolta Blog](https://www.aravolta.com/blog/gpu-depreciation-curve?ref=mbi-deepdives.com) Speaking of the shape of compute curve, John Arnold, who sits at Meta’s board, had a bit of a provocative tweet a couple of weeks ago: > Most of the SpaceX neocloud analysis changes dramatically if you understand that there's a backwardated curve for compute today. > > — John Arnold (@johnarnold) [June 15, 2026](https://x.com/johnarnold/status/2066500154564452391?ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) For the uninitiated, a market is backwardated when the spot price sits **above** forward prices i.e. the thing is scarce and expensive right now, and the curve slopes down because everyone expects it cheaper later. Saying compute is backwardated means a unit of GPU capacity rents at a steep premium today because of the power/chip/packaging crunch, while the forward curve is lower because the market expects supply to catch up and performance-per-dollar to keep improving. But wait a minute…if that’s what one of the board of directors thinks the shape of the curve for compute to be, why is Mark Zuckerberg buying compute hand over fist **today**? While that may seem contradictory at first glance, I think there may be less tension between these positions than one may think. Backwardation is a statement about the price of **renting** compute, and about the risk to a compute **merchant**, but not about the value of compute to a compute **consumer** who turns it into something else. Meta isn’t obviously earning the rental rate on its GPUs and it earns ad dollars, engagement, and model capability with the compute capacity it is building/renting. So, while the curve tells you merchant economics may deteriorate especially if the price falls faster than expected; it says almost nothing about whether a compute consumer should build for its own use. Again, one customer’s failure to utilize compute may not also mean disaster for the entire compute market either. When xAI failed to utilize their compute capacity, they could sell it to Anthropic and Google because those compute buyers can get presumably value from the compute capacity higher than what they’re paying for such capacity. Meta may be forced to do the same if their ambition in staying closer to the frontier model falls apart. Of course, the true disaster in compute prices will happen only when other potential buyers (OpenAI/Anthropic/Google) either run out of ideas to utilize such capacity or already have enough capacity to serve their users or build the next model. While these scenarios feel very unlikely today, I am not sure you can be **VERY** confident about the shape of the curve in a 3-5 year timeframe. Arnold made his money in trading energy and at one point, he was actually the youngest Billionaire in the US. In Arnold's own native language: “convenience yield**”** can also play a huge role in determining whether a compute buyer such as Meta should buy compute today or wait for prices to come down. A curve inverts into backwardation precisely when holding the physical thing **now** commands a premium. The only question is whether **your** private convenience yield beats that premium. "Wait and accumulate later" only works if the returns to compute aren't time-sensitive. AI, especially in consumer land, is potentially a winner-take-most race, and ceding two years of ad gains, model quality, and engagement to Google and OpenAI to save on input cost is likely a catastrophic trade. The savings can be completely dwarfed by the returns forgone. Of course, it also doesn’t help that power, land, interconnects, and GPU allocations have multi-year lead times. If you wait, you will just start the queue late. It is also worth [recalling](https://mebfaber.com/2022/01/26/e386-john-arnold/?ref=mbi-deepdives.com) how Arnold made his name. In 2006, Amaranth’s star trader Brian Hunter sat on a massive, highly leveraged position in natural gas [calendar spreads](https://en.wikipedia.org/wiki/Calendar%5Fspread?ref=mbi-deepdives.com). The 2005 hurricanes had made him a hero, and by 2006 he was running a book so large that Amaranth reportedly controlled something like 70% of the open interest in certain contracts. Arnold’s read was different. I dredge this up because it is perhaps the same muscle at work when he’s looking at the compute market today. Hunter bet a scarcity spread would persist; Arnold bet that supply and seasonality would reassert themselves and the curve would mean-revert and indeed, it did. I guess it’s the same instinct sitting behind a throwaway line about compute being backwardated: a man who got rich fading one-sided positioning in an energy curve, now staring at a market where the entire crowd leans the same way on “demand outstrips supply forever.” The only problem here is I think the question about shape of demand-supply curve here is much more of a technological one than it perhaps ever was for natural gas in 2000s and answering that question may be above Arnold’s (or anyone’s) paygrade sitting in mid-2026! --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### The ASIC-GPU Standoff URL: https://www.mbi-deepdives.com/the-asic-gpu-standoff/ Last updated: 2026-06-26T15:10:17.000Z My friend Liberty recently [highlighted](https://www.libertyrpf.com/p/645-how-chinas-ai-punches-above-its?ref=mbi-deepdives.com) an interesting [paper](https://arxiv.org/pdf/2606.15870?ref=mbi-deepdives.com) from Google that goes through the evolution of TPUs. The objection to domain-specific silicon which might sound quite persuasive is the one about obsolescence: a chip may take two to three years to design, fabricate, and deploy, and AI moves fast enough that whatever you tuned it for has usually moved on by the time it lands in a data center; you may end up optimizing for a workload that no longer exists while a GPU runs whatever the labs may cook up next quarter. So, Google’s bet on TPU was somewhat contrarian but thankfully, that bet has been on the right side of history so far. From the paper (emphasis mine): > Skeptics initially warned that an ASIC might be too tailored to existing DNN (Deep Neural Network) models, quickly becoming outdated given AI’s rapid pace. That proved not to be the case. **The founding principles of TPU v2 demonstrated remarkable longevity, with later generations increasing component speed and size by riding technological breakthroughs without altering the underlying design. Not all accelerators can make this claim**. ![](https://substackcdn.com/image/fetch/$s_!Vmx1!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F469ea9f1-5b3b-4e9f-8b34-a49360ca0d2a_1119x1009.png) The paper quipped that TPU’s success has “launched a thousand chips”. Indeed, the latest ASIC that grabbed a lot of attention is OpenAI’s [Jalapeño chip,](https://openai.com/index/openai-broadcom-jalapeno-inference-chip/?ref=mbi-deepdives.com) its first in-house inference chip, built with Broadcom and Celestica. Unlike most press releases, this one is worth reading carefully. Here are some key excerpts (emphasis mine): > OpenAI designed the chip **from scratch** around its deep understanding of LLM fundamentals, informed by its roadmap of models, kernels, serving systems, and product needs, with partners Broadcom and Celestica, helping industrialize the platform through chip implementation, board, rack system integration, high-performance networking, and scalable production systems. **Jalapeño is designed with flexibility to work with all LLMs guided by OpenAI’s insights into the inference needs of current and future AI models across the industry.** Engineering samples of the Jalapeño chip are running ML workloads in the lab at production target frequency and power, including GPT‑5.3‑Codex‑Spark. > > While OpenAI is still measuring final performance, early testing shows that **Jalapeño will deliver performance per watt substantially better than current state-of-the-art**. A detailed technical report on performance will be presented in the coming months. The architecture reduces data movement and balances compute, memory, and networking resources to achieve **realized utilization much closer to theoretical peak performance**. > > Jalapeño was co-developed **from initial design to manufacturing tape-out in just nine months**, and the custom AI accelerator program represents what we believe to be the fastest ASIC development cycle ever achieved in high-performance advanced semiconductors. That speed reflects deep software-hardware co-development with OpenAI’s engineering teams, Broadcom’s silicon implementation expertise, and the use of OpenAI models to accelerate parts of the design and optimization process. > > Jalapeño is **the first step in a multi-generation compute platform designed for initial deployment by the end of 2026 and expanding in the years ahead**, combining OpenAI-designed accelerators with Broadcom silicon implementation, networking, and connectivity technologies; and Celestica’s board, rack, and system expertise. Going through that press release is a good reminder how damn useful owning the model layer can be. There may be capability overhang as the models are likely to be far more capable than what most people use it for, but the very researchers developing these models should be in the best seat to extract the highest capabilities out of these frontier models. Of course, such fast paced LLM-optimized chip design does raise question around the depth of moat around Nvidia’s CUDA. I myself wondered [**last year**](https://www.mbi-deepdives.com/how-would-we-know-if-market-were-agi-pilled/) that this question will inevitably be raised: > A good chunk of Nvidia’s moat comes from CUDA (Compute Unified Device Architecture) which is a parallel computing platform and programming model that has created immense developer lock-in. CUDA exists to bridge the gap between human programmers and the complex architecture of the GPU. As AI systems become capable over time, AI should not require human-friendly abstraction layers, SDKs, or documentation. It could theoretically look at any piece of hardware i.e. an Nvidia GPU, a Google TPU, or a novel architecture it just designed and write perfectly optimized machine code for it. If humans are increasingly out of the loop, shouldn’t the friction that keeps developers locked into CUDA also materially diminish over time? Jensen Huang was actually directly asked about this a couple of months ago during his [podcast](https://www.dwarkesh.com/p/jensen-huang?ref=mbi-deepdives.com) with Dwarkesh: > **Dwarkesh:** > > Can all the hyperscalers write these custom kernels for themselves? Nvidia still has great price performance, so they might still prefer to use Nvidia. But then the question is, does it just become a question of who is offering the best specs, the best flops and memory bandwidth for a given dollar. Whereas historically Nvidia has just had, and still has, the best margins in all of AI across hardware and software, +70%, because of this CUDA moat. And the question is, can you sustain those margins if for most of your customers, they can actually afford to build, instead of the CUDA moat? > > **Jensen Huang** > > The number of engineers we have assigned to these AI labs is insane, working with them, optimizing their stack. The reason for that is because nobody knows our architecture better than we do. These architectures are not as general purpose as a CPU. A CPU is kind of like a Cadillac. It’s a nice cruiser. It never goes too fast. Everybody drives it pretty well. It’s got cruise control, and everything’s easy. But in a lot of ways, Nvidia’s GPUs, accelerators, are like F1 racers. I could imagine everybody’s able to drive it at a hundred miles an hour, but it takes quite a bit of expertise to be able to push it to the limit. We use a ton of AI to create the kernels that we have. Huang likes to call Nvidia an “extreme co-design company,” and that’s where much of the magic comes from, but it stops being a uniquely Nvidia trick once a customer controls most layers and points its own models at optimizing across them. Even though CUDA moat may be diminishing in the age of increasingly more and more capable frontier models, Nvidia’s moat is likely to be fine in the near term given their control [across the supply chain](https://www.mbi-deepdives.com/nvda-moat-pichai-comp/), but long-term questions cannot quite be resolved. Speaking of supply chain, Rihard Jarc recently shared an interesting interview of a Google employee who has hinted at the possibility of hyperscalers building a more direct relationship with TSMC. Maybe TSMC’s CEO won’t need to utter “[customers’ customers](https://www.mbi-deepdives.com/tsm1q26/)” for too long in their earnings calls! Some key points from Rihard’s [post](https://x.com/RihardJarc/status/2069781596362719533?ref=mbi-deepdives.com): > Interview with a Google employee explaining that the value when it comes to ASIC design from companies like AVGO, Mediatek, and MRVL is in their TSMC allocation, not the co-design anymore: > > 1\. When it comes to co-design of chips, he thinks the real value of companies like AVGO, Mediatek, and MRVL lies in their TSMC allocation and memory allocation, which they got sooner than everyone else. In the whole process, he sees platform verification and then manufacturing as key. > > 2\. If you could flip a switch and completely reset the TSM allocation, he thinks the hyperscalers would move 100% to internal co-design and skip the co-designers for that part. There is still value in AVGO‘s IP for memory, or in MRVL’s interconnects, but for co-design specifically, he thinks it comes down to TSMC and the memory supply chain allocation. > > 3\. In the future, he thinks hyperscalers will move to direct TSMC relationships. Huang is, of course, acutely aware of how his top customers are all deeply incentivized to design their own chips and it’s hard to bet on such well-capitalized customers **NEVER** getting there. This is perhaps why Nvidia itself is also on their own journey of building open-weight models. Any time there is a monopoly formed in some parts of the AI value chain is not good news for the rest of the value chain. If Anthropic or OpenAI ends up with a monopoly or stable duopoly without a viable open-weight alternative (assuming China open-weight models get eventually banned in the US), you can see the pressure the likes of Nvidia and 3P hyperscalers might feel eventually to extract margin from OpenAI/Anthropic. With Meta sending not-so-reassuring signals about their approach to open-weight AI models, Nvidia is trying to [lead](https://www.wired.com/story/nvidia-investing-26-billion-open-source-models/?ref=mbi-deepdives.com) the open-weight models in the West. The equation is simple: everyone wants fragmentated customer base for whatever they’re selling and the moment your customer base becomes too concentrated, it’s hard to sit idle and pray/hope that such customers will forever pay your margins. In some sense, much of the AI value chain increasingly feels like this below meme from “The Office” and it’s not easy to know how all of these debates will largely settle in 3-5 years. ![](https://substackcdn.com/image/fetch/$s_!_0wx!,w_1456,c_limit,f_auto,q_auto:good,fl_lossy/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe5479aa9-9ac0-48da-8695-da4301966744_480x400.gif) --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Scale Without Sluggishness URL: https://www.mbi-deepdives.com/scale-without-sluggishness/ Last updated: 2026-06-25T14:36:50.000Z _This post is for paying subscribers only._ ### Scheduling and Disclosure Update URL: https://www.mbi-deepdives.com/scheduling-and-disclosure-update/ Last updated: 2026-06-24T13:51:31.000Z A few things I wanted to share: what’s coming up, a break I’m taking next week, and a change to my portfolio disclosure. **What I’m working on** I’m currently working on DoorDash, which I expect to publish sometime next month. After that, I plan to turn to Pool Corp, and then spend some time on memory companies, Micron in particular. A quick word on cadence. Between the Deep Dives and the daily pieces, I expect each Deep Dive to take a little longer than a month to finish from here on. Some of that is simply the daily workload. But some of it reflects a view I’ve been forming for a while: six years in, the library of Deep Dives has grown large enough that I increasingly think the daily pieces are becoming the core of what MBI Deep Dives offers. In the early years, every new Deep Dive was almost entirely net-new for readers; today, an incremental one may not carry the same weight it once did. That said, there’s no shortage of businesses I still want to understand more deeply, so Deep Dives will remain an integral part of the work for the foreseeable future. **A break next week** I’m taking a week off, starting Tuesday, June 30\. I’ll publish daily as usual through Monday, June 29, and I’ll be back to the regular daily cadence on July 7. **A change to my portfolio disclosure** This one needs a bit of context. I started MBI Deep Dives almost six years ago, after my work authorization in the US expired. I moved to Canada in early 2021 and incorporated the business there. I later moved back to the US but kept the company in Canada. This year, after receiving my Green Card, I spoke with a couple of tax professionals about moving the business to the US to simplify my tax reporting now that I’m a permanent resident here. I’ve since begun that process, mainly moving over the investments I’ve held through the Canadian entity. It has turned out to be more complicated than I expected, and I’ll need to make a trip back to Canada to sort out some of the details. As part of this, I sold my entire Canadian-held portfolio yesterday. Because that was roughly 85% of my total holdings (the rest is in the US), I think the right thing to do is to pause the portfolio disclosure for a few weeks, until I’m able to move the assets over. Once I can, I intend to largely buy back the positions I sold though where I land will, of course, depend on where those stocks are trading by then. Frankly speaking, this whole process has been a real headache. But I’d rather deal with the distraction now, over the coming week, so I can get back to focusing fully on investing afterward. Thank you, as always, for your understanding and for reading. --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Spotify Model Update URL: https://www.mbi-deepdives.com/spot-model-update/ Last updated: 2026-06-23T15:03:58.000Z _This post is for paying subscribers only._ ### Some Notes from Spotify's 2026 Investor Day URL: https://www.mbi-deepdives.com/spot-2026/ Last updated: 2026-06-22T14:49:32.000Z _This post is for paying subscribers only._ ### On Father’s Day URL: https://www.mbi-deepdives.com/fathers-day-26/ Last updated: 2026-06-21T15:18:19.000Z **Programming Note**: As a reminder, every Sunday, I write pieces that are predominantly based on personal experiences which may or may not be loosely connected with investing. If you are reading MBI Deep Dives everyday, I think it would be rather useful for my readers to understand my personal lens a bit better since that presumably affects (at least in some capacity) the way I analyze businesses as well. --- I actually forgot about today being Father’s day until my wife reminded me last night. While growing up in Bangladesh, Father’s day or Mother’s day just wasn’t a thing we used to celebrate. However, that started to change the moment Facebook became popular in Bangladesh and even all of our parents started using Facebook by mid to late 2010s. Every Father’s and Mother’s day, my Facebook feed is typically flooded with my friends uploading photos with their respective parent and caption it with emotions that you hardly ever get to express to your parent. In Bangladesh, you don’t quite say to your parent how much you love them (and vice versa). Of course, once it became a trend, your parents **almost** expect you to upload a photo and explain with captions how much they mean to you. Nonetheless, I still quite enjoy scrolling through my Facebook feed on these special days. I don’t have the data, but I do sense lot more people post on Mother’s day than they do on Father’s day. Even the static pictures often say a lot more than we think. The photos on Mother’s day imbues a sense of warmth and love whereas father’s day photos hint more towards a sense of admiration and respect. While admiration or respect have positive connotations, I cannot help but feeling a sense of distance many kids may feel about their fathers. Who knows maybe it’s just me as I do have a difficult relationship with my father. I will spare my father from being litigated in front of thousands of people on Father’s day and I am indeed still appreciative of the toil it must have taken to provide for the family. Now that I myself am a father of a 18-month old son, I do wonder a lot about the far more prevalence of kids having difficult relationships with their father than their mother. It’s hard to generalize the source of such tension in these relationships, but if I am forced to generalize, I think fathers tend to be lot more prescriptive about the world of tomorrow and can be particularly prone to want to engineer their children’s lives. Mothers, on the other hand, tend to be **relatively** more comfortable in playing the [role of shepherd](https://www.caryacademy.org/news-stories/letting-our-children-be-who-they-are-meant-to-be/?ref=mbi-deepdives.com). I have always thought one of the mistakes of parenting is the desire to be a precise director of their children’s lives. For myriad reasons, fathers can suffer from the illusion of knowledge that they know where the world is going and how the children should steer themselves to fit in that world. Of course, the truth is few of us have any clue whatsoever what the world will look like when our kids will go out there to make a dent in the world in a couple of decades (or sooner/later depending on your context). One thing that is perhaps far more useful than many of us appreciate is simply stories of our ancestors. I don’t need my father to impart his illusion of knowledge in how to navigate the world of tomorrow, rather I would love to know the stories of the past how he or my forefathers responded to the challenges in their own times. My sneaky suspicion is that the way I may be prone to responding to life’s challenges can be eerily similar to how my ancestors did in their own times even though details around such circumstances are likely to be completely different to each other. If your ancestors had a gambling problem, you should think twice before taking margin loans or loading up on options today. If my forefathers had difficulty in forming fruitful partnership in running a business, I should think long and hard before partnering with someone else. Unfortunately, as they say, “past is a foreign country”. In most cases, the stories we tell our children end up being too embellished to be useful for them. Perhaps you don’t want your children to picture their great grandparents or grandparents as alcoholic or someone with gambling habit. People perhaps would rather want to propagate the stories of greatness in their lineage even if they’re largely apocryphal in nature. On this father’s day, I am promising myself to tell my son in the years ahead mostly stories about what happened in my life **so far** and restrict myself as much as possible from prognosticating where my life, his life, or the world at large is heading. As a father, I want the past to be more familiar to my son and would like him to know that the future is perhaps **more foreign to me than it is to him**. Perhaps everyone reading this piece has already read Kahlil Gibran’s seminal [poem](https://poets.org/poem/children-1?ref=mbi-deepdives.com) on Children. I first read it when I was a freshman in college and I promised myself to remember these words when I become a father one day: > Your children are not your children. > They are the sons and daughters of Life’s longing for itself. > They come through you but not from you, > And though they are with you yet they belong not to you. > > You may give them your love but not your thoughts, > For they have their own thoughts. > You may house their bodies but not their souls, > For their souls dwell in the house of tomorrow, which you cannot visit, not even in your dreams. > You may strive to be like them, but seek not to make them like you. > For life goes not backward nor tarries with yesterday. There is a profound saying that *“we do not inherit the earth from our ancestors; we borrow it from our children”*. To borrow implies a return…a passing of the torch. My son doesn't need me to pave a road over the grass or tell him exactly where the trail ends. He just needs to know where he came from. Perhaps my only job is to hand him the keys with a steady hand, and the confidence that he is hopefully equipped to navigate the foreign country of tomorrow on his own terms. Happy Father’s Day! ![](https://substackcdn.com/image/fetch/$s_!hB58!,w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb4baa0fc-3a7a-4236-97e6-3d607b1f70d2_1542x2047.jpeg) --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Airbnb's Fintech Opportunity URL: https://www.mbi-deepdives.com/abnb-fintech/ Last updated: 2026-06-20T15:24:30.000Z _This post is for paying subscribers only._ ### Shopify at the E-com OS Layer URL: https://www.mbi-deepdives.com/shopify-os/ Last updated: 2026-06-19T15:11:44.000Z _This post is for paying subscribers only._ ### What's Embedded in OpenAI's Stock Price? URL: https://www.mbi-deepdives.com/openai/ Last updated: 2026-06-18T15:17:45.000Z _This post is for paying subscribers only._ ### Airbnb's Incentives URL: https://www.mbi-deepdives.com/airbnbs-incentives/ Last updated: 2026-06-17T14:37:19.000Z _This post is for paying subscribers only._ ### Owning the Hill URL: https://www.mbi-deepdives.com/owning-the-hill/ Last updated: 2026-06-16T14:59:09.000Z _This post is for paying subscribers only._ ### Meta's Myriad Questions URL: https://www.mbi-deepdives.com/metas-myriad-questions/ Last updated: 2026-06-15T16:12:17.000Z _This post is for paying subscribers only._ ### The Geography of Time URL: https://www.mbi-deepdives.com/the-geography-of-time/ Last updated: 2026-06-14T16:30:05.000Z _This post is for paying subscribers only._ ### Adobe's Continued Deceleration URL: https://www.mbi-deepdives.com/adbe2q26/ Last updated: 2026-06-13T14:58:47.000Z _This post is for paying subscribers only._ ### FICO: Capital Allocation, Management Incentives, and Valuation URL: https://www.mbi-deepdives.com/fico4/ Last updated: 2026-06-12T15:21:09.000Z _This post is for paying subscribers only._ ### Automation's Asymptote: Part 2 URL: https://www.mbi-deepdives.com/automations-asymptote-part-2/ Last updated: 2026-06-11T15:01:52.000Z _This post is for paying subscribers only._ ### Automation's Asymptote URL: https://www.mbi-deepdives.com/automations-asymptote/ Last updated: 2026-06-10T15:14:13.000Z Anthropic [launched](https://www.anthropic.com/news/claude-fable-5-mythos-5?ref=mbi-deepdives.com) “Claude Fable 5” yesterday which is the much anticipated “Mythos-class” model. Anthropic was already leading in most benchmark with its Opus 4.8 model, but Fable 5 created a bit more distance from its competitors. Anthropic’s pace of model release even when its setting the bar at the frontier does give some credence to the notion of “recursive self improvement” of building models. Staring at the benchmark chart may make you wonder whether we are indeed at the cusp of automating a good chunk of white collar work. ![Benchmark table showing Claude Fable and Mythos compared to other leading models](https://substackcdn.com/image/fetch/$s_!1ch4!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F496d6462-1acc-4306-aa5c-b5fa9b6bb502_2600x2870.webp "Benchmark table showing Claude Fable and Mythos compared to other leading models") Source: Anthropic Even OpenAI recently explicitly laid out an audacious [vision](https://openai.com/index/built-to-benefit-everyone-our-plan/?ref=mbi-deepdives.com): “*Our internal belief is that by *March of 2028* we may have a *significant fraction of our research* being done by AI systems in tandem with our own researchers*.” When trillion+ dollars are expected to be deployed on an annual basis to build and serve these models, you perhaps do need these eyebrows raising goals in not-so-distant future. Nonetheless, as the model capabilities are increasing over time, it is perhaps reasonable to feel increasing discomfort due to fear of automation. During my break, I read this very thoughtful piece: “[After Automation](https://every.to/p/after-automation?ref=mbi-deepdives.com)” by Every’s Dan Shipper who made the case that you can be simultaneously AI-pilled and yet not fear the impending automation doom. He also appeared on Lenny’s [podcast](https://www.lennysnewsletter.com/p/the-ai-paradox-dan-shipper?ref=mbi-deepdives.com) to discuss the piece. I have read and listened to both and frankly speaking, I found it to be one of the best articulations tackling this topic. So, I recommend you take the time and either read the full piece or listen to the podcast. I do want to highlight a few bits from Shipper’s piece that I found to be quite compelling. One of the highlights from his piece is a discussion on in-house benchmark that Shipper came up with and how the score on that benchmark evolved: > “We built an in-house benchmark called the Senior Engineer benchmark. It is, as its name implies, designed to test how good frontier models are at senior engineer–level coding tasks like a major refactor. > > The Senior Engineer benchmark gives a coding agent a vibe coded production codebase that has gone sideways. It’s from a real codebase for [Proof](https://proofeditor.ai/?ref=mbi-deepdives.com) that I vibe coded and subsequently needed a senior engineer to fix. > > The agent gets the codebase as it was before it was fixed and is the kind of instructions you’d give a senior engineer: “This is vibe coded slop; please rewrite it from first principles.” > > This is a good benchmark because it tests the ability for a coding agent to examine many different, unrelated problems and then sees whether it has enough autonomy, conceptual clarity, and courage to perform a working rewrite. (I also have two rewrites from human senior engineers, who used AI, that I use to compare and grade the model output.) > > Coding agents find this task hard. Not only does the agent need to find the root of the problem, it needs to keep the problem in mind over many turns without getting distracted by existing code. It also needs to be comfortable deleting large portions of the codebase—which agents are trained to avoid. > > Most coding agents can identify the shape of the rewrite, but when it comes to execution, they patch over the problem instead of fixing it. > > Until [GPT-5.5](https://every.to/vibe-check/gpt-5-5?ref=mbi-deepdives.com). > > GPT-5.5 scored a 62/100 on its best run—about 30 points above Opus 4.7.[(6)](https://every.to/p/after-automation?ref=mbi-deepdives.com#marginalia-cite-6) > > GPT-5.5’s result felt like the model has crossed a line: not autocomplete, not assistant, not tool, but something uncomfortably close to a human. A human senior engineer scores in the high 80s or low 90s on the benchmark, so another 30 points and it’ll be at human senior engineer level. That is how benchmark numbers work on the imagination: They turn a strange, qualitative change into a clean number that tells a powerful—scary—story. (Next stop: chart psychosis.) > > My guess is that the models will hit the 80s and 90s on this benchmark within the next year. But it is important to understand what the score contains in order to tell us what it means. In this case, the 62 isn’t just a measure of the model itself.” It turns out even Shipper underestimated the pace of improvement as he revealed yesterday that Fable 5 scored 91 on this benchmark! To his credit, Shipper never intended to be married to a particular timeline of when the benchmark will be saturated by the models. He, in fact, laid out why the score itself reveals far less than what most people may think. Again, from his piece: > The prompt for the Senior Engineer benchmark is generic, but it is a frame. And if we varied it, we would see the model perform at a different level. > > For example, the prompt asks for a “structural rewrite from first principles,” it says the problem is likely in the “document collaboration” part of the code, and it asks the coding agent to find and hold to “invariants.” > > If we removed those particulars, the score would go down. If we replaced the prompt entirely with one asking the model to “solve all of the errors that keep popping up,” the model’s score would be close to zero. It would go straight to identifying and resolving the issues one by one, instead of taking a step back to consider a rewrite.[(8)](https://every.to/p/after-automation?ref=mbi-deepdives.com#marginalia-cite-8) > > I can also trivially raise the model’s score. If I ask it to delete a lot of code and give it exact filenames that should be pared down, or if I ask it to check the results of its work to make sure the app is fully functional before it says it’s done, it will be better at the task. > > …Once the current Senior Engineer benchmark saturates, we’ll change the frame to zero it out again. > > The next benchmark will not ask only, “Can you rewrite the app?” It will ask: Can you decide when a rewrite is needed, choose the scope, preserve the right invariants, manage the migration, and judge whether the result is any good? > > As senior engineers use AI to solve these problems, the models will get better at solving them on their own. > > We will all momentarily freak out. It looks like the model can now decide whether to do a rewrite! They can do everything a senior engineer can do! > > And then a new edge will appear that was not obvious before, we will zero our benchmarks, demand will stimulate, and the process will repeat Shipper framed the dynamic as [Zeno’s paradox](https://en.wikipedia.org/wiki/Zeno%27s%5Fparadoxes?ref=mbi-deepdives.com): humanity is the tortoise with a fifty-yard head start, the model is Achilles, and every time the model reaches where we stood, we have moved because saturating a benchmark immediately prompts us to redraw it. Progress inside any fixed “frame” is exponential, but progress against the moving frontier of what humans actually value behaves like an asymptote. Shipper makes more of a philosophical point here, but it does ring true to me: > “The panic that AI generates when we observe it doing something new keeps coming back to this: We set a frame, watch the models climb it, and then confuse the frame—or whatever climbs it—with the thing itself. > > When we look at a benchmark and compare it to human abilities, we confuse the frame for the framer. The score tells us how well the model operates inside a frame we supplied; it does not tell us that the model has become us. > > That is the category error underneath the panic. We point to the latest edge we drew and say: This is us. Then, when the model climbs it, it feels like it has caught us. But it has caught the frame, not the framer. > > The mistake is wanting something concrete to hold on to. We want to say: Intelligence is this benchmark, but the moment something is concrete enough to point at, it is concrete enough to climb. > > Frames are necessary; they let us get traction on the world. But they are frozen, partial, and therefore optimizable. > > Framers are different. The framer is the one still in contact with what the frame has to discard—the whole situation as it appears to them, moment to moment. > > What is this “whole situation”? The moment you start to say what “the whole situation” contains, you have already begun another frame. You can’t say what “it” is, but it exists because you exist.” I do wonder, however, that it can be simultaneously true that humans remain in this loop and that the economics of being in the loop can deteriorate. If reviewing AI-generated pull requests becomes the core of the engineering job, the supply of people who can do that job adequately may expand faster than the demand for it, especially when the models themselves are being trained, release by release, on exactly the review-and-framing behavior we perform. To what extent most people can retain or improve their economic worth in a world where AI models continue to climb the hill is perhaps an open question. --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](#/portal/signup) --- **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### FICO: The Contestable Monopoly? URL: https://www.mbi-deepdives.com/fico3/ Last updated: 2026-06-09T12:41:14.000Z _This post is for paying subscribers only._ ### Veeva 1Q'26: Strong Present, Patient Future URL: https://www.mbi-deepdives.com/veev1q26/ Last updated: 2026-06-09T12:38:37.000Z _This post is for paying subscribers only._ ### Airbnb's Soul Search Beyond Homes URL: https://www.mbi-deepdives.com/abnb_soul/ Last updated: 2026-05-21T14:17:48.000Z _This post is for paying subscribers only._ ### FICO: Deconstructing the Monopoly Margins URL: https://www.mbi-deepdives.com/fico2/ Last updated: 2026-05-20T15:01:03.000Z _This post is for paying subscribers only._ ### Floor & Decor's Cyclical Malaise vs Structural Moat URL: https://www.mbi-deepdives.com/fnd_cycle/ Last updated: 2026-05-19T14:00:41.000Z _This post is for paying subscribers only._ ### The Honeymoon Phase of Capacity URL: https://www.mbi-deepdives.com/honeymoon/ Last updated: 2026-05-18T14:25:01.000Z _This post is for paying subscribers only._ ### The Best Yardstick URL: https://www.mbi-deepdives.com/yardstick/ Last updated: 2026-05-17T15:33:10.000Z _This post is for paying subscribers only._ ### Figma 1Q'26: "Not Dead" URL: https://www.mbi-deepdives.com/fig1q26/ Last updated: 2026-05-16T14:01:46.000Z _This post is for paying subscribers only._ ### FICO: Pricing the Standard URL: https://www.mbi-deepdives.com/fico1/ Last updated: 2026-05-15T13:53:00.000Z _This post is for paying subscribers only._ ### Constellation Software 1Q’26: Leaning In Amidst the SaaSpocalypse URL: https://www.mbi-deepdives.com/csu1q26/ Last updated: 2026-05-14T13:07:31.000Z _This post is for paying subscribers only._ ### Roblox 1Q'26: Age Check Hangover, But Aiming to Go Beyond the Blocks URL: https://www.mbi-deepdives.com/rblx1q26/ Last updated: 2026-05-11T14:45:29.000Z _This post is for paying subscribers only._ ### "MBI" Skill for Claude and Codex URL: https://www.mbi-deepdives.com/mbi_skill/ Last updated: 2026-05-10T13:36:57.000Z _This post is for paying subscribers only._ ### Digital Advertising Industry Snapshot 1Q'26 URL: https://www.mbi-deepdives.com/digital_ad_1q26/ Last updated: 2026-05-09T13:29:13.000Z _This post is for paying subscribers only._ ### Airbnb 1Q'26: Growth Acceleration Despite War Headwind URL: https://www.mbi-deepdives.com/abnb1q26/ Last updated: 2026-05-08T15:09:40.000Z _This post is for paying subscribers only._ ### Insurance Brokers 1Q'26 Update URL: https://www.mbi-deepdives.com/insurance-brokers1q26/ Last updated: 2026-05-07T14:32:34.000Z _This post is for paying subscribers only._ ### Shopify 1Q'26: Impressive, But Still Not Enough to Justify Valuation URL: https://www.mbi-deepdives.com/shop1q26/ Last updated: 2026-05-06T14:31:17.000Z _This post is for paying subscribers only._ ### Floor & Decor 1Q'26: Persistent Macro Challenges, but Pro Growth Encouraging URL: https://www.mbi-deepdives.com/fnd1q26/ Last updated: 2026-05-05T15:03:52.000Z _This post is for paying subscribers only._ ### "Never Sell" Episode: Big Tech earnings, S&P and Moody’s, AI URL: https://www.mbi-deepdives.com/never_sell_15/ Last updated: 2026-05-04T13:19:34.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode yesterday. While I have already covered big tech's earnings over the last few days ([Meta](https://www.mbi-deepdives.com/meta1q26/), [Alphabet](https://www.mbi-deepdives.com/goog1q26/), [Amazon](https://www.mbi-deepdives.com/amzn1q26/), and [Microsoft](https://www.mbi-deepdives.com/msft3q26/)), we expanded on how IT budget reallocation towards AI may not lead to any sustained long-term advantage for the enterprises. I also touched on why I find the recent circular financing deals between Anthropic and hyperscalers particularly questionable. Finally, Scuttleblurb had a more in-depth discussion on AI risk for S&P and Moody's. You can listen to the conversation here: [Spotify](https://open.spotify.com/episode/62vkIPlUJQ8PlU9MNixn1P?si=d040038265b24faf&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/big-tech-earnings-s-p-and-moodys-ai/id1786912203?i=1000765932750&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=31G92cfh77g&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. --- *Subscribers get the daily journal and five+ years of Deep Dives, i.e. full-length analyses with financial models on* [***65+***](https://www.mbi-deepdives.com/models/) *companies. The daily is just how I think out loud between the Deep Dives!* [Subscribe](https://www.mbi-deepdives.com/msft3q26/#/portal/signup) ### Microsoft FY 3Q'26: Multi-Model Mirage, Copilot Momentum URL: https://www.mbi-deepdives.com/msft3q26/ Last updated: 2026-05-03T15:17:28.000Z _This post is for paying subscribers only._ ### Amazon 1Q'26: Rosy Near-term but "Cloudy" Long-term URL: https://www.mbi-deepdives.com/amzn1q26/ Last updated: 2026-05-02T16:19:01.000Z _This post is for paying subscribers only._ ### Alphabet 1Q'26: Stratospheric Heights in Performance and Expectations URL: https://www.mbi-deepdives.com/goog1q26/ Last updated: 2026-05-01T15:26:57.000Z _This post is for paying subscribers only._ ### Meta 1Q'26: Nothing to Complain About URL: https://www.mbi-deepdives.com/meta1q26/ Last updated: 2026-04-30T19:36:10.000Z _This post is for paying subscribers only._ ### Spotify 1Q'26: Recalibrating Expectations URL: https://www.mbi-deepdives.com/spot1q26/ Last updated: 2026-04-29T15:01:41.000Z _This post is for paying subscribers only._ ### Roblox: Aggregating the Attention of Next Generation URL: https://www.mbi-deepdives.com/rblx/ Last updated: 2026-04-28T13:47:19.000Z _This post is for paying subscribers only._ ### Personal Day URL: https://www.mbi-deepdives.com/personal-day/ Last updated: 2026-04-27T13:14:31.000Z I’m taking a personal day today, but wanted to share a couple of quick updates. I was working on a Deep Dive on Roblox this month and it will go out tomorrow. After that, I’ll be working on Deep Dives on FICO and DoorDash over the next couple of months. One change: while I’ve typically published each Deep Dive as a single \~50–60 minute read, going forward I’ll be breaking them into three or four separate posts. Roblox will still come out as one piece, but FICO and DoorDash will each be published as a series over the course of the month. I think it is not only easier for readers to digest relatively shorter posts but also helpful for me to dig deeper in questions where I may want to spend more time. Thank you. [Subscribe](#/portal/signup) ### A (Largely) Functional World: Part 2 URL: https://www.mbi-deepdives.com/functional2/ Last updated: 2026-04-26T15:07:06.000Z _This post is for paying subscribers only._ ### The Era of Tokenmaxxing URL: https://www.mbi-deepdives.com/tokenmaxxing/ Last updated: 2026-04-25T14:59:48.000Z _This post is for paying subscribers only._ ### Pricing "The Compute Theory of Everything", Texas Instruments Hitting Inflection Point URL: https://www.mbi-deepdives.com/txn1q26/ Last updated: 2026-04-24T14:22:57.000Z _This post is for paying subscribers only._ ### Tesla's Terafab Dream URL: https://www.mbi-deepdives.com/terafab/ Last updated: 2026-04-23T13:44:40.000Z _This post is for paying subscribers only._ ### Danaher 1Q'26 Update URL: https://www.mbi-deepdives.com/dhr1q26/ Last updated: 2026-04-22T14:36:45.000Z _This post is for paying subscribers only._ ### Meta's Heterogeneous Fleet URL: https://www.mbi-deepdives.com/mtia2/ Last updated: 2026-04-21T17:35:43.000Z _This post is for paying subscribers only._ ### Token Cost Conundrums URL: https://www.mbi-deepdives.com/token-cost/ Last updated: 2026-04-20T14:29:53.000Z _This post is for paying subscribers only._ ### The Counterintuitive Truths URL: https://www.mbi-deepdives.com/counterintuitive/ Last updated: 2026-04-19T16:07:30.000Z _This post is for paying subscribers only._ ### Huang Isn't Planning to Wake Up a Loser URL: https://www.mbi-deepdives.com/not-a-loser/ Last updated: 2026-04-18T15:30:09.000Z _This post is for paying subscribers only._ ### TSMC 1Q'26 Update URL: https://www.mbi-deepdives.com/tsm1q26/ Last updated: 2026-04-17T14:37:35.000Z _This post is for paying subscribers only._ ### ASML 1Q'26 Update URL: https://www.mbi-deepdives.com/asml1q26/ Last updated: 2026-04-16T14:42:04.000Z _This post is for paying subscribers only._ ### AI Economics in the East: Part 2 URL: https://www.mbi-deepdives.com/ai-economics-in-the-east-part-2/ Last updated: 2026-04-15T14:47:27.000Z _This post is for paying subscribers only._ ### Frontier AI's Economic Engine URL: https://www.mbi-deepdives.com/frontier-ais-economic-engine/ Last updated: 2026-04-14T14:54:55.000Z _This post is for paying subscribers only._ ### AI Economics in the East URL: https://www.mbi-deepdives.com/ai-economics-in-the-east/ Last updated: 2026-04-13T15:07:24.000Z _This post is for paying subscribers only._ ### Too Cheap to Meter, Too High to Measure URL: https://www.mbi-deepdives.com/too-cheap/ Last updated: 2026-04-12T15:23:15.000Z _This post is for paying subscribers only._ ### Meta Strikes Back! URL: https://www.mbi-deepdives.com/meta-strikes-back/ Last updated: 2026-04-11T14:58:20.000Z _This post is for paying subscribers only._ ### Jassy's Defense URL: https://www.mbi-deepdives.com/jassys-defense/ Last updated: 2026-04-10T14:58:29.000Z _This post is for paying subscribers only._ ### The Jagged Intelligence of Humans URL: https://www.mbi-deepdives.com/jagged/ Last updated: 2026-04-09T16:16:43.000Z _This post is for paying subscribers only._ ### Man and Machine URL: https://www.mbi-deepdives.com/man-and-machine/ Last updated: 2026-04-08T14:41:08.000Z _This post is for paying subscribers only._ ### The Fat-Tailed Economics of AI URL: https://www.mbi-deepdives.com/fat-tail-ai/ Last updated: 2026-04-07T17:55:39.000Z _This post is for paying subscribers only._ ### "Serious" Era of Software Investing URL: https://www.mbi-deepdives.com/serious-saas/ Last updated: 2026-04-06T14:22:31.000Z _This post is for paying subscribers only._ ### A (Largely) Functioning World! URL: https://www.mbi-deepdives.com/functioning-world/ Last updated: 2026-04-05T15:26:30.000Z _This post is for paying subscribers only._ ### "Founder Mode" Complacency URL: https://www.mbi-deepdives.com/founder-mode-complacency/ Last updated: 2026-04-04T15:46:18.000Z _This post is for paying subscribers only._ ### "Never Sell" Episode: AI Doom, Veeva, Research and Writing URL: https://www.mbi-deepdives.com/never-sell-14/ Last updated: 2026-04-03T13:54:49.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode covering investors’ increasing fascination around AI doom scenarios, why we think Veeva is likely to be more insulated from AI disruption, and the value of approaching investment research more as a judge rather than as a lawyer defending the thesis or a stock. You can listen to it here: [Spotify](https://open.spotify.com/episode/2c39nOdsEBLBS1tjAtb3Aj?si=5eeeb81017af4230&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/ai-doom-veeva-research-and-writing/id1786912203?i=1000758940048&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=PfCIPBrUdeI&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) During the conversation, we mentioned this piece “[Infinite midwit](https://www.experimental-history.com/p/infinite-midwit?ref=mbi-deepdives.com)” which I really enjoyed reading. While I recommend you read the entire piece, I highlighted the following excerpts while reading it myself: > It’s cool that AI can fold proteins, create websites, fact-check journal articles, etc. but it can’t write anything that I am interested in reading. The problem isn’t that it hallucinates or makes mistakes. It’s that everything it writes vaguely sucks. I drag my eyes across the words and I feel nothing. That’s not quite right, actually—I feel like, “I would like this to be over as soon as possible.” > > …the faster you go, the sooner you hit the wall. I have found myself facing all of those limitations at one time or another, and as soon as I overcame them, I was immediately stymied by some other obstacle. I think all of us suffer from this *bottleneck blindness*: we assume our *current* bottleneck is our *only* bottleneck. When you’re strapped for cash, you think *all* of your problems are cash problems. But once you’ve got some money in you pocket, you realize that what you really need is *time.* Free up some time, and you discover that you’re actually lacking *motivation*. Acquire some motivation, and you realize what you’re missing is *ideas*. Then you need *direction*, then you need *discipline*, then you need *buy-in*, and so on, forever. > > As Montaigne [put it back in 1580](https://www.gutenberg.org/cache/epub/3600/pg3600-images.html?ref=mbi-deepdives.com), “though we could become learned by other men’s learning, a man can never be wise but by his own wisdom”. What does it look like to have all the learning ever created, but no wisdom of your own? I hope the conversation, as well as the aforementioned piece, is a good food for thought for your Friday. As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 67 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) ### Unprecedented Lock-in URL: https://www.mbi-deepdives.com/unprecedented-lock-in/ Last updated: 2026-04-02T14:37:06.000Z _This post is for paying subscribers only._ ### Social Media's Defense URL: https://www.mbi-deepdives.com/social-medias-defense/ Last updated: 2026-04-01T14:27:22.000Z _This post is for paying subscribers only._ ### The Pendulum Between Intelligence and Knowledge URL: https://www.mbi-deepdives.com/pendulum/ Last updated: 2026-03-31T18:56:48.000Z _This post is for paying subscribers only._ ### Energy's Moment URL: https://www.mbi-deepdives.com/energy/ Last updated: 2026-03-30T14:21:59.000Z _This post is for paying subscribers only._ ### Thoughts on Last Week URL: https://www.mbi-deepdives.com/last-week/ Last updated: 2026-03-28T15:58:42.000Z _This post is for paying subscribers only._ ### Digital Engagement's Fat Tail Risk? URL: https://www.mbi-deepdives.com/fat_tail/ Last updated: 2026-03-27T14:55:47.000Z _This post is for paying subscribers only._ ### Follow-up on Floor & Decor URL: https://www.mbi-deepdives.com/fnd3/ Last updated: 2026-03-26T17:04:18.000Z _This post is for paying subscribers only._ ### Meta's Agentic AI Ambitions URL: https://www.mbi-deepdives.com/metas-agentic-ai-ambitions/ Last updated: 2026-03-25T15:17:09.000Z _This post is for paying subscribers only._ ### Scuttleblurb on Ryan Specialty URL: https://www.mbi-deepdives.com/scuttleblurb-ryan/ Last updated: 2026-03-24T13:56:16.000Z _This post is for paying subscribers only._ ### Why I am buying Floor & Decor URL: https://www.mbi-deepdives.com/fnd2/ Last updated: 2026-03-23T22:09:02.000Z _This post is for paying subscribers only._ ### Ryan Specialty: The Unconflicted Middleman URL: https://www.mbi-deepdives.com/ryan/ Last updated: 2026-03-20T14:03:43.000Z _This post is for paying subscribers only._ ### Nadella's Flip-Flop URL: https://www.mbi-deepdives.com/nadellas-flip-flop/ Last updated: 2026-03-19T14:44:22.000Z _This post is for paying subscribers only._ ### Survival of the Fastest URL: https://www.mbi-deepdives.com/nvda_gtc26/ Last updated: 2026-03-18T14:44:47.000Z _This post is for paying subscribers only._ ### OpenAI's Dilemma URL: https://www.mbi-deepdives.com/openai-dilemma/ Last updated: 2026-03-17T15:14:05.000Z _This post is for paying subscribers only._ ### The Neocloud Trojan Horse URL: https://www.mbi-deepdives.com/neocloud/ Last updated: 2026-03-16T14:43:17.000Z _This post is for paying subscribers only._ ### Veeva Model Update URL: https://www.mbi-deepdives.com/veev26/ Last updated: 2026-03-15T17:42:13.000Z _This post is for paying subscribers only._ ### Meta at the AI Crossroads URL: https://www.mbi-deepdives.com/meta-at-the-ai-crossroads/ Last updated: 2026-03-14T14:54:06.000Z _This post is for paying subscribers only._ ### Editing Adobe URL: https://www.mbi-deepdives.com/editing-adobe/ Last updated: 2026-03-13T14:34:28.000Z _This post is for paying subscribers only._ ### Meta's Chip Resilience URL: https://www.mbi-deepdives.com/mtia/ Last updated: 2026-03-12T13:25:37.000Z _This post is for paying subscribers only._ ### Follow-up on "AWS: Pre and Post-ChatGPT" URL: https://www.mbi-deepdives.com/aws2/ Last updated: 2026-03-11T17:52:29.000Z _This post is for paying subscribers only._ ### Constellation Software 4Q'25 Update URL: https://www.mbi-deepdives.com/csu4q25/ Last updated: 2026-03-10T14:39:48.000Z _This post is for paying subscribers only._ ### Nvidia's Burgeoning Moats, Pichai's Comp URL: https://www.mbi-deepdives.com/nvda-moat-pichai-comp/ Last updated: 2026-03-09T14:28:14.000Z _This post is for paying subscribers only._ ### Notes from MS Conference: Meta, and Microsoft URL: https://www.mbi-deepdives.com/meta-msft/ Last updated: 2026-03-08T15:01:30.000Z _This post is for paying subscribers only._ ### AWS: Pre and Post-ChatGPT URL: https://www.mbi-deepdives.com/aws/ Last updated: 2026-03-07T18:19:37.000Z _This post is for paying subscribers only._ ### Why AI Is Unlikely to Kill OTAs URL: https://www.mbi-deepdives.com/ai-vs-ota/ Last updated: 2026-03-07T04:50:06.000Z _This post is for paying subscribers only._ ### Veeva FY4Q'26 Update URL: https://www.mbi-deepdives.com/veevafy4q26/ Last updated: 2026-03-05T15:04:47.000Z _This post is for paying subscribers only._ ### Never Sell: MBI Interviews Asianometry URL: https://www.mbi-deepdives.com/asianometry/ Last updated: 2026-03-04T13:55:04.000Z For this month’s "Never Sell" podcast, I had the privilege of speaking with [**Asianometry**](https://www.youtube.com/@Asianometry?ref=mbi-deepdives.com). If you have any interest in semiconductors, you have probably come across his exceptionally useful YouTube videos before. I myself spent countless hours watching several of his [playlists](https://www.youtube.com/@Asianometry/playlists?ref=mbi-deepdives.com) related to semiconductors over the last 3-4 years. As you can imagine, we discussed chips at length, and went through the semiconductor value chain. You can listen to it here: [Spotify](https://open.spotify.com/episode/7am5pHqErmwC0T0XhNcwCD?ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/mbi-interviews-asianometry/id1786912203?i=1000752956818&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=rAhXJ1MOGgU&t=29s&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 66 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) ### Frontier AI Economics URL: https://www.mbi-deepdives.com/frontier-ai-economics/ Last updated: 2026-03-03T13:37:44.000Z _This post is for paying subscribers only._ ### How Elephants May Die URL: https://www.mbi-deepdives.com/how-elephants-may-die/ Last updated: 2026-03-02T19:18:49.000Z _This post is for paying subscribers only._ ### Hardcoding Habits URL: https://www.mbi-deepdives.com/hardcoding-habits/ Last updated: 2026-03-01T15:52:33.000Z _This post is for paying subscribers only._ ### Meta’s AI Advantage is "In the Water" URL: https://www.mbi-deepdives.com/metas-ai-advantage/ Last updated: 2026-03-01T03:33:23.000Z _This post is for paying subscribers only._ ### Digital Advertising Industry Snapshot 4Q'25 URL: https://www.mbi-deepdives.com/digital-advertising-industry-snapshot-4q25/ Last updated: 2026-02-27T15:35:42.000Z _This post is for paying subscribers only._ ### The Nvidia Math URL: https://www.mbi-deepdives.com/the-nvidia-math/ Last updated: 2026-02-26T19:35:21.000Z _This post is for paying subscribers only._ ### CoStar's Obfuscation, and AI vulnerabilities URL: https://www.mbi-deepdives.com/csgp4q25/ Last updated: 2026-02-25T21:03:59.000Z _This post is for paying subscribers only._ ### Scuttleblurb on Veeva URL: https://www.mbi-deepdives.com/scuttleblurb-veeva/ Last updated: 2026-02-24T14:56:48.000Z _This post is for paying subscribers only._ ### Alphabet: From Search to AI to "AGI" URL: https://www.mbi-deepdives.com/goog2026/ Last updated: 2026-02-23T19:26:03.000Z _This post is for paying subscribers only._ ### The Long-term Reality of Hyperscalers: The Good, The Bad, and The Ugly Scenarios URL: https://www.mbi-deepdives.com/hyperscalers/ Last updated: 2026-02-22T15:46:21.000Z _This post is for paying subscribers only._ ### Walmart’s Trillion-Dollar Mojo URL: https://www.mbi-deepdives.com/wmt4q25/ Last updated: 2026-02-21T17:05:23.000Z _This post is for paying subscribers only._ ### Figma 4Q'25 Update URL: https://www.mbi-deepdives.com/fig4q25/ Last updated: 2026-02-20T16:03:07.000Z _This post is for paying subscribers only._ ### Booking vs Airbnb's 4Q'25, Booking's Response to Existential Question URL: https://www.mbi-deepdives.com/bkng4q25/ Last updated: 2026-02-19T15:29:04.000Z _This post is for paying subscribers only._ ### Some Portfolio Changes URL: https://www.mbi-deepdives.com/some-portfolio-changes-2/ Last updated: 2026-02-20T21:10:39.000Z _This post is for paying subscribers only._ ### Lipstick on Frontier AI "Pigs" URL: https://www.mbi-deepdives.com/lipstick-on-frontier-ai-pigs/ Last updated: 2026-02-17T19:37:11.000Z _This post is for paying subscribers only._ ### Airbnb 4Q'25 Update URL: https://www.mbi-deepdives.com/abnb4q25/ Last updated: 2026-02-13T16:31:14.000Z _This post is for paying subscribers only._ ### Shopify's Miraculous Momentum URL: https://www.mbi-deepdives.com/shop4q25/ Last updated: 2026-02-12T15:06:28.000Z _This post is for paying subscribers only._ ### Spotify's Teachable Moments URL: https://www.mbi-deepdives.com/spot4q25/ Last updated: 2026-02-11T15:50:45.000Z _This post is for paying subscribers only._ ### Zuckerberg's Lens URL: https://www.mbi-deepdives.com/zuckerbergs-lens/ Last updated: 2026-02-10T15:21:39.000Z _This post is for paying subscribers only._ ### Amazon: 2026 Update URL: https://www.mbi-deepdives.com/amazon-2026-update/ Last updated: 2026-02-09T17:36:31.000Z _This post is for paying subscribers only._ ### Never Sell: Episode 13-Big Tech Earnings URL: https://www.mbi-deepdives.com/never-sell-13/ Last updated: 2026-02-08T13:38:03.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode on Big Tech earnings. One of the key topics that I highlighted is why I think the street is likely mismodeling Meta. We also touched on Microsoft and Amazon’s current predicament. You can listen to it here: [Spotify](https://open.spotify.com/episode/4U80uTFWsUBT99wmnV0O2J?si=rDu8kj0fRtuXvpgG8GhzjQ&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/big-tech-earnings/id1786912203?i=1000748706224&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=Al5R2bRgJE8&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. I will publish my annual model update on Amazon tomorrow. --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 66 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) ### Some thoughts from last week URL: https://www.mbi-deepdives.com/some-thoughts-from-last-week/ Last updated: 2026-03-04T15:39:24.000Z _This post is for paying subscribers only._ ### Amazon 4Q'25 Update URL: https://www.mbi-deepdives.com/amzn4q25/ Last updated: 2026-02-06T15:30:34.000Z _This post is for paying subscribers only._ ### Alphabet 4Q'25 Update URL: https://www.mbi-deepdives.com/goog4q25/ Last updated: 2026-02-05T17:55:05.000Z _This post is for paying subscribers only._ ### Insurance Brokers 4Q'25 Update URL: https://www.mbi-deepdives.com/insurance-brokers-4q25-update/ Last updated: 2026-02-04T15:33:03.000Z _This post is for paying subscribers only._ ### The Fog of AV Economics URL: https://www.mbi-deepdives.com/the-fog-of-av-economics/ Last updated: 2026-02-03T15:21:59.000Z _This post is for paying subscribers only._ ### Betting Big on Meta URL: https://www.mbi-deepdives.com/meta2026/ Last updated: 2026-02-02T15:56:33.000Z _This post is for paying subscribers only._ ### Trillion Dollar Club URL: https://www.mbi-deepdives.com/trillion-dollar-club/ Last updated: 2026-01-31T14:01:14.000Z A couple of weeks ago, I recorded a podcast with my friend [Liberty](https://www.libertyrpf.com/?ref=mbi-deepdives.com) to discuss all the companies in “trillion dollar club”. Enjoy! --- From [**Liberty’s Highlights**](http://Trillion Dollar Club): “At nearly two hours, this one is massive, but you know what they say: *Too much of a good thing can be wonderful!* My friend [MBI](https://www.mbi-deepdives.com/) and I sat down to do something that sounds simple but turned out to be a seminar. In 2018, Apple became the first $1T company. Fast forward to now, and we’re living in the era of the **Trillion Dollar Club**, a small group of companies that collectively represent an almost comical amount of market cap (**Nvidia**, **Apple**, **Google**, **Microsoft**, **Amazon**, **TSMC**, **Meta**, **Broadcom**, and **Tesla**). We went through all of them one by one and shared our honest thoughts, bouncing between the big picture and small details that may turn out to be crucial. If the market is a card game, we wanted to figure out which hands we like best. ♥️♦️♣️♠️ We touch on many interesting ideas that help us better understand the forces at play for Big Tech these days. Early on, we dive into the “compute theory of everything.” MBI found this [1998 Hans Moravec paper](https://jetpress.org/volume1/moravec.htm?ref=mbi-deepdives.com) with a sentence so good that he repeats it to himself like a mantra on his daily walks! 🚶‍♂️ (*gotta get those 10k steps!* 👣) Among many other things, we discuss: - Jensen’s “circular financing” strategy, and why it might actually be brilliant 🔄 - East Coast vs. West Coast investing philosophy. - Why the job of the analyst is getting *harder*, not easier. - How academic papers create trillions in value (cat paper, “Attention is All You Need,” Chinchilla). - Apple as “Switzerland,” and their risky bet that we’re at the hardware end-state 📱 - Whether Google has the best hand but keeps getting in its own way, and DeepMind as Google’s “reverse takeover” and saving grace - Why Microsoft seemed to have everything and somehow ended up in the doghouse 💾 - TSMC as the true choke point, the bottom of the inverted pyramid, and why MBI is Zen about geopolitical risk 🧘‍♂️ - Meta’s confusing inability to reach the frontier despite checking every box, and what are the necessary ingredients for a frontier AI lab? 🧑‍🍳🍜 - Tesla as the ultimate “West Coast philosophy” stock and Musk’s loss of interest in EVs. - Broadcom’s IP blocks + custom ASIC enablement + networking… with the risk of hyperscaler disintermediation. - Amazon’s retail business being underestimated and Walmart as a sneakily smart company 🛒 - A tribute to Buffett and Munger, where our emotions come out a bit. - Which CEOs are overrated and underrated? 👍👎 We close with the hardest question: if you could own only one of these companies for the next 20 years, which would it be? We both landed on the same answer. Listen to the end to find out why 🎧 ## **🎧 Listen on Spotify** If you prefer to listen on **Spotify**, here’s the feed: - [Liberty’s Highlights podcast feed on Spotify](https://open.spotify.com/episode/1Mqr4tQf8YaELoVj6lYFso?ref=mbi-deepdives.com) ## **🎧 Listen on Apple Podcasts** Here’s the podcast feed on **Apple Podcasts**: - [Liberty’s Highlights podcast on Apple](https://podcasts.apple.com/ca/podcast/trillion-dollar-club-with-mostly-borrowed-ideas-mbi/id1616884594?i=1000747362769&ref=mbi-deepdives.com) ## **📺 Watch on YouTube** ### Microsoft in the "Dance Floor" URL: https://www.mbi-deepdives.com/msft_dance/ Last updated: 2026-01-30T15:35:51.000Z _This post is for paying subscribers only._ ### Meta 4Q'25 Update URL: https://www.mbi-deepdives.com/meta4q25/ Last updated: 2026-01-29T19:28:00.000Z _This post is for paying subscribers only._ ### Texas Instruments 4Q'25 Update URL: https://www.mbi-deepdives.com/txn4q25/ Last updated: 2026-01-28T15:32:28.000Z _This post is for paying subscribers only._ ### A "Sneaky" Bull Case for Tesla's Operating Performance? URL: https://www.mbi-deepdives.com/tsla_sneaky_bull_case/ Last updated: 2026-01-27T15:54:01.000Z _This post is for paying subscribers only._ ### Figma: The Design OS at the AI Crossroads URL: https://www.mbi-deepdives.com/fig/ Last updated: 2026-01-26T14:07:13.000Z _This post is for paying subscribers only._ ### The Social Media Ban Wagon URL: https://www.mbi-deepdives.com/the-social-media-ban-wagon/ Last updated: 2026-01-25T15:52:31.000Z _This post is for paying subscribers only._ ### Some charts that caught my attention URL: https://www.mbi-deepdives.com/some-charts-that-caught-my-attention/ Last updated: 2026-01-24T16:04:56.000Z _This post is for paying subscribers only._ ### The Bull Case for AI Content on UGC Platforms URL: https://www.mbi-deepdives.com/bull_case_ai_ugc/ Last updated: 2026-01-23T21:49:11.000Z _This post is for paying subscribers only._ ### The Case for Giving Employees More Agency in Compensation URL: https://www.mbi-deepdives.com/agency_sbc/ Last updated: 2026-01-22T20:49:47.000Z _This post is for paying subscribers only._ ### The Great SaaS Debate URL: https://www.mbi-deepdives.com/the-great-saas-debate/ Last updated: 2026-01-21T15:39:21.000Z _This post is for paying subscribers only._ ### The Slow Singularity URL: https://www.mbi-deepdives.com/the-slow-singularity/ Last updated: 2026-01-20T14:59:33.000Z _This post is for paying subscribers only._ ### Incentives > Intelligence: The Real Barrier(s) to Agentic AI URL: https://www.mbi-deepdives.com/incentives-intelligence/ Last updated: 2026-01-19T15:14:57.000Z _This post is for paying subscribers only._ ### The Misunderstood Utility of Search Ads URL: https://www.mbi-deepdives.com/search-ads/ Last updated: 2026-01-18T16:11:28.000Z _This post is for paying subscribers only._ ### TSMC's Green Signal URL: https://www.mbi-deepdives.com/tsmcs-green-signal/ Last updated: 2026-01-16T13:24:45.000Z _This post is for paying subscribers only._ ### Airbnb: Inbound Headwinds, AI Moat Question, and a CTO Shakeup URL: https://www.mbi-deepdives.com/abnb_cto_ai_headwind/ Last updated: 2026-01-16T11:46:32.000Z _This post is for paying subscribers only._ ### "File over App", Veeva at JPM Healthcare Conference URL: https://www.mbi-deepdives.com/file-over-app-veeva/ Last updated: 2026-01-14T23:00:09.000Z _This post is for paying subscribers only._ ### The Ecosystem Advantage: Part 2 URL: https://www.mbi-deepdives.com/the-ecosystem-advantage-part-2/ Last updated: 2026-01-13T15:35:21.000Z _This post is for paying subscribers only._ ### China's Rise in Innovation Ladder and Questions for ASML URL: https://www.mbi-deepdives.com/chinas-rise-in-innovation-ladder-and-questions-for-asml/ Last updated: 2026-01-12T14:48:36.000Z _This post is for paying subscribers only._ ### Software in Crosshairs: Part 2 URL: https://www.mbi-deepdives.com/software-in-crosshairs-part-2/ Last updated: 2026-01-11T15:47:28.000Z _This post is for paying subscribers only._ ### "The Compute Theory of Everything" URL: https://www.mbi-deepdives.com/the-compute-theory-of-everything/ Last updated: 2026-01-10T16:03:46.000Z _This post is for paying subscribers only._ ### Climbing the Scaling Wall URL: https://www.mbi-deepdives.com/climbing-the-scaling-wall/ Last updated: 2026-01-09T15:30:57.000Z _This post is for paying subscribers only._ ### CoStar's Outlook URL: https://www.mbi-deepdives.com/costars-outlook/ Last updated: 2026-01-08T15:31:58.000Z _This post is for paying subscribers only._ ### Scaling Law Skepticism URL: https://www.mbi-deepdives.com/scaling-law-skepticism/ Last updated: 2026-01-07T15:28:38.000Z _This post is for paying subscribers only._ ### Alphabet's Alpha Bet URL: https://www.mbi-deepdives.com/alphabets-alpha-bet/ Last updated: 2026-01-06T15:40:00.000Z _This post is for paying subscribers only._ ### Software in Crosshairs URL: https://www.mbi-deepdives.com/software-in-crosshairs/ Last updated: 2026-01-05T14:56:34.000Z _This post is for paying subscribers only._ ### The Pursuit of Better Explanations URL: https://www.mbi-deepdives.com/the-pursuit-of-better-explanations/ Last updated: 2026-01-04T16:03:28.000Z A couple of weeks ago, Instagram algorithm showed this reel to me about James Cameron. It’s a two part series ([part 1](https://www.instagram.com/reel/DSvHiU8kT5b/?igsh=YzAyMDM1MGJkZA%3D%3D&ref=mbi-deepdives.com), [part 2](https://www.instagram.com/reel/DSvH1Tcke0y/?igsh=YzAyMDM1MGJkZA%3D%3D&ref=mbi-deepdives.com)) which in aggregate will take you four and half minutes to watch. I recommend you watch the videos, but in case you don’t, this is how the part 1 starts: > “James Cameron is the most interesting person on earth and it is because he is absolutely insane. When he was younger, he had no idea what he wanted to do with his life and he was working as a truck driver and a janitor. But that all changed when one day he went and saw Star Wars, of all things. You see, he went and saw Star Wars and he said, "I want to get into movies.” Then in near the end of part-2, the reel provides a good gist of Cameron’s non-exhaustive accomplishments: > “Just to recap, he is a self-taught painter. He is a self-taught director. Self-taught illustrator. He is a self-taught screenwriter. He is practically a self-taught marine biologist. First director to ever have a film that made over $1 billion. First director to have a movie that earned over $2 billion as well. He currently holds three of the top 4 highest-grossing movies of all time. Maybe he's gonna get a fourth one." I want to emphasize again: this is a non-exhaustive list. If you’re curious, I recommend you spend the four and half minutes to watch the videos. During my daily 10k-step walk, I cannot tell you how many times my mind kept going back to thinking about this particular reel in the last few days and as you can see, I feel compelled to write about it even though none of this is really quite related with investing. But hey, it’s Sunday which I may use as an excuse to share some of these random musings with my readers. The question that I kept wondering how on earth Cameron had such deep reservoir of curiosity in such wide ranging fields! It is one thing to have child like curiosity but a different thing altogether to be so deeply proficient at it. A couple of years ago, I tried to read David Deutsch’s book “[The Beginning of Infinity](https://www.amazon.com/Beginning-Infinity-Explanations-Transform-World/dp/0143121359?ref=mbi-deepdives.com)”. I found it a bit dense but after listening to Deutsch in a couple of podcasts, I found his ideas more accessible through that medium. In fact, I find many of his ideas quite captivating that resonate well with how I perceive the world. As I kept thinking about these reels on James Cameron, I wondered how Deutsch would explain Cameron’s insatiable pursuit to new problems. So, like any normal person would do in 2026, I asked both ChatGPT and Gemini Deutsch’s epistemological explanations for Cameron’s accomplishments. I had some back and forth for quite a while, so let me share some key excerpts below from Gemini’s responses: > “According to Deutsch, the difference between Cameron and the “average” person is not biological hardware (e.g., a “genius” brain vs. a normal brain), but rather the software (ideas) they use to process reality. > > Deutsch argues that **all humans are Universal Explainers**. > > The human brain is a universal computer. If a brain can understand one complex domain (like the grammar of a native language), it possesses the computational capacity to understand *any* domain that can be understood (physics, engineering, directing). There is no such thing as a "math brain" or an "art brain." > > Cameron’s ability to jump from screenwriting to deep-sea engineering to optical physics is not a biological miracle; it is the standard function of a human mind that has not arbitrarily limited itself. He treats "physics" and "storytelling" not as separate identities, but as different applications of the same universal explanatory capacity. > > The majority of people operate under the **"Bucket Theory of the Mind,"** believing that knowledge is a fluid held by authorities (teachers) that must be poured into them. If they want to learn engineering, they wait to be taught. > > Deutsch thinks knowledge is created *only* through **Conjecture and Criticism** (Karl Popper’s epistemology). We learn by guessing a solution to a problem and then criticizing/testing it to correct errors. Cameron is a radical practitioner of this method. He did not go to film school to "receive" knowledge. He went to the USC library to solve specific problems (e.g., *"How does an optical printer work?"*). He would form a conjecture (a design for a camera), build it, fail, and correct the error. Because he was actively creating knowledge to solve a problem he cared about, his learning was exponential compared to a passive student. > > Deutsch argues that **coercion** (forcing someone to learn against their will) destroys the capacity for creative thought. To solve difficult problems, the mind must be free to follow its interest. Deutsch calls this the **"Fun Criterion"**—not frivolous entertainment, but the deep, conflict-free engagement with a problem. > > Cameron dropped out of college because he found it coercive and limiting. He only learned physics because he *needed* it to build submersibles, making the learning functional and deeply integrated. The majority of people learn to pass tests (coercion), which results in shallow knowledge that is quickly forgotten. > > Deutsch warns of **"Anti-Rational Memes"**—cultural ideas that survive by disabling critical thinking (e.g., "You aren't qualified," "Trust the experts," "Stay in your lane"). Most people are infected by the meme of **Credentialism**. They believe they are *not allowed* to do engineering without a degree. This is a "bad philosophy" that acts as a self-imposed prison. > > Cameron operates on Deutsch’s **Principle of Optimism**: *“Anything that is not forbidden by laws of physics is achievable, given the right knowledge.”* When told a camera couldn't film at 11,000 meters depth, the majority would accept the impossibility. Cameron viewed it merely as a lack of knowledge, which he then created. He respects the authority of the *problem*, not the authority of the *experts*. > > Epistemologically, James Cameron is what a human looks like when their natural **Universality** is not suppressed by **static, anti-rational memes**. He is not a specialist; he is a general-purpose problem solver who treats ignorance not as a permanent state, but as a temporary lack of explanation.” Just chatting with ChatGPT/Gemini is a daily reminder that education has permanently and radically changed even if much of the world (especially educational institutions) hasn’t quite woken up to that reality. I am not sure I quite believe there will be millions of Einsteins or James Camerons in the data center, but it does seem highly likely that AI may embolden many more Homo Sapiens than ever before to accelerate their pursuit of knowledge and solve problems. Sure, there will be some LLM-induced psychosis along the way, but I will be surprised if the world doesn’t have more Camerons and Einsteins hopping from one problem to another in the pursuit of better explanations of the universe! [Subscribe](#/portal/signup) ### The Battle for Attention URL: https://www.mbi-deepdives.com/the-battle-for-attention/ Last updated: 2026-01-07T13:19:48.000Z _This post is for paying subscribers only._ ### 2025 Annual Letter URL: https://www.mbi-deepdives.com/2025/ Last updated: 2026-01-01T01:42:04.000Z _This post is for paying subscribers only._ ### One Year of Parenting! URL: https://www.mbi-deepdives.com/one-year-of-parenting/ Last updated: 2025-12-25T03:31:25.000Z When the world was celebrating Christmas last year, we welcomed our son Nile to the world! “Oh, a Christmas baby!!”— we kept hearing from the doctors and nurses in the hospital. I didn’t grow up celebrating Christmas, but who knew my greatest cause for celebration would arrive on the Christmas day! Looking back at the past year, Nile has been a constant source of unbridled joy for us. We are perhaps among the luckiest parents since I feel like we got almost all of the upsides and none of the downsides of having a new born at home. After the first eight weeks, Nile started sleeping mostly throughout the night. My personal sleep quality was basically unaffected after those first eight weeks. Not sure many parents of a new born can say that, so perhaps I owe a lot to Nile! We did have plenty of help though. My in-laws flew from Bangladesh to stay with us for six months. My mother-in-law has essentially become a personal hero of mine. She has always been a homemaker throughout her life, but just observing how relentless she has been day-in-day-out is simply awe inspiring. She wakes up before the sun rises, says her prayer, prepares food for all of us, and then looks after Nile once she’s done. It’s a crazy amount of workload for a 60-year old, but she insists carrying out the responsibility with such rigor and precision that I can tell she enjoys having these responsibilities. In some sense, having a job with a very clear expectation of what you are supposed to accomplish today and then going to bed knowing you have done everything you were supposed to do on that day can be oddly satisfying. It’s not for everyone, of course, especially since many people I assume could be put off by the mundane nature of the work. Frankly speaking, observing my mother-in-law was partly a contributor for me to think of publishing something everyday. I myself noticed that whenever I published my monthly Deep Dive, I felt a sense of accomplishment. It actually made me think it would be nice to chase that feeling everyday! Eventually, we did hire a nanny for Nile. Since I work from home, my presence at home perhaps has no obvious charm (sigh!) to Nile at this point. But my wife gets to enjoy work from home only half the time and goes to office for work for the other half. Nile doesn’t seem to wonder where his mom is throughout the day, but whenever my wife comes home from work, his body curls up and makes almost this automatic reflex with hands stretched outward to signal as if “can you please hold me, woman?” It’s a real treat for me to watch this ordeal. My wife’s face lights up like I have never seen before when she holds Nile after coming from work. I quipped to my wife the other day, would you please love me 20% of how much you love Nile? She asked me back, “how much do you love me if Nile is the scale?” I sheepishly had to mention “20%!” and then pointed out there’s a reason I only want 20% from her; you see, I am a fair and reasonable person! While Nile acts like he wants to remain attached to his mother whenever he sees her, I noticed he is much more willing to copy what I do. The little guy is already learning to mostly borrow from his Dad! Nile would play with me for almost an hour at night before going to bed. He audibly smiles and tries to copy my hand gestures which he then shows to his grandparents the next day! But looking at how he closely observes me made me wish I actually was way cooler than I am (Sorry, Nile!). It also made me realize if my son is looking at me so intently, there is a certain weight I feel in showing my best version to him as much as possible. Almost a decade ago, my manager at my old job in Bangladesh once mentioned to me that our lives are basically like “balance sheets”. Just as a company’s balance sheet contains almost everything that has happened since its inception, whatever happened with our ancestors and whatever our ancestors did, our genes contain all the remnants of the past. However, just like the recent history has obviously much more influence to a company’s balance sheet than what happened 50 years ago, our parents can have similar effect on us. Nonetheless, human beings are lot more complicated than “balance sheets” and I do see myself more as a “[shepherd and not an engineer](https://www.instagram.com/reel/DMQAcgBI2fe/?ref=mbi-deepdives.com)” for Nile. But since we both grow from the “same vine”, I want to be a good shepherd (great song!) I recently came across this [quote](https://www.goodreads.com/quotes/10442-people-say-that-what-we-re-all-seeking-is-a-meaning?ref=mbi-deepdives.com) by Joseph Campbell while listening to a podcast: > “People say that what we’re all seeking is a meaning for life. I don’t think that’s what we’re really seeking. **I think that what we’re seeking is an experience of being alive**, so that our life experiences on the purely physical plane will have resonances with our own innermost being and reality, so that we actually feel the rapture of being alive.” There is hardly anything that made me feel alive more than looking at Nile smile! That may seem rather banal way to feel the rupture of being alive, but I personally sense it is indeed the deepest source of feeling alive. If we could only feel alive by climbing the Mount Everest or being Billionaires, the essence of life would be obviously beyond most of our reach. But mother nature has, fortunately, kept it far simpler than that. It doesn’t require us to keep accomplishing ever crazier adventures to feel alive; perhaps all most of us need is to just stare at our own offspring! Merry Christmas, everyone! I will be taking some time off between December 25th and December 30th to keep staring at Nile for an uncomfortably long period. I hope to publish my annual letter on the 31st and then take another couple of days off in the new year before starting to publish everyday in 2026 from January 3rd! [Subscribe](#/portal/signup) ![](https://substackcdn.com/image/fetch/$s_!PSYs!,w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7a85e784-7626-4ffd-874c-e6abc69faba8_745x1207.png) ### The Ecosystem Advantage URL: https://www.mbi-deepdives.com/the-ecosystem-advantage/ Last updated: 2025-12-23T20:02:16.000Z _This post is for paying subscribers only._ ### Veeva's Opportunity in Clinical Software URL: https://www.mbi-deepdives.com/veeva-clinical/ Last updated: 2025-12-22T15:47:31.000Z _This post is for paying subscribers only._ ### Sam Altman's Explanation URL: https://www.mbi-deepdives.com/sam-altmans-explanation/ Last updated: 2025-12-21T16:05:43.000Z _This post is for paying subscribers only._ ### Veeva Update URL: https://www.mbi-deepdives.com/veeva-update/ Last updated: 2025-12-20T18:28:40.000Z _This post is for paying subscribers only._ ### Why I am not writing a Deep Dive this month URL: https://www.mbi-deepdives.com/why-i-am-not-writing-a-deep-dive-this-month/ Last updated: 2025-12-19T13:56:56.000Z I was working on this month’s Deep Dive on Nvidia. I was excited to finally study the largest company in the world with focus and patience it deserves, but after spending the last three weeks on the business, I have decided to give up on writing the Deep Dive. I still feel too much gaps in knowledge to be comfortable writing a Deep Dive on the company. While this is unfortunate and I apologize to you for the inconvenience, I think it can be instructive to understand how I came to realize this. I listened to all the Acquired series on Nvidia (Part [1](https://www.acquired.fm/episodes/nvidia-the-gpu-company-1993-2006?ref=mbi-deepdives.com), [2](https://www.acquired.fm/episodes/nvidia-the-machine-learning-company-2006-2022?ref=mbi-deepdives.com), [3](https://www.acquired.fm/episodes/nvidia-the-dawn-of-the-ai-era?ref=mbi-deepdives.com), [interview](https://www.acquired.fm/episodes/jensen-huang?ref=mbi-deepdives.com) with Jensen Huang). Huang’s very recent [interview](https://www.youtube.com/watch?v=3hptKYix4X8&t=3376s&ref=mbi-deepdives.com) with Joe Rogan was also helpful to appreciate some of the near death moments Nvidia faced. I was particularly touched by Huang’s upbringing and I came away quite appreciative of his innate ability to evolve and adapt to almost any situation Huang (and Nvidia) may find themselves in. I listened to a bunch of episodes ([here](https://joincolossus.com/episode/376-jensen-huang-founder-of-nvidia/?ref=mbi-deepdives.com), and [here](https://joincolossus.com/episode/403-how-jensen-works/?ref=mbi-deepdives.com)) on Founders podcast to get to know Nvidia and Huang’s story better. After having a reasonable grasp on the history, I started going through their SEC filings. I read Huang’s all the shareholder letters. There are too many good bits to quote, but let me share a couple that stood out. > “Foreseeing the importance of **energy efficiency, we set out half a decade ago to build high-end parallel and mobile processors**. These groundbreaking initiatives sought to address **two of our fundamental convictions: that power will limit the number of computers in large data centers,** and that energy efficiency will define our experience with mobile devices” > > “There is already well over 1 exabyte of images and videos in the cloud, more than 100,000 times the books in the Library of Congress. Hundreds of millions of photos are uploaded daily. And the amount of data created will rise 50-fold this decade, according to IDC. **Our GPUs can make a real contribution to processing this deluge — enabling computers to learn how to help us search a world filled with images. It is an opportunity that could potentially require millions of our GPUs**. Here’s a quiz: when do you think Huang wrote these sentences in his shareholder letters? The first quote was taken from **2011** shareholder letter, and the latter from **2013**. This was my reaction after reading these quotes... ![Lisan Al Ghaib Meme - Lisan al ghaib - Discover & Share GIFs](https://substackcdn.com/image/fetch/$s_!EeMt!,w_1456,c_limit,f_auto,q_auto:good,fl_lossy/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F99a0d6f0-c76f-4707-a734-f1a075a3eb41_220x180.gif "Lisan Al Ghaib Meme - Lisan al ghaib - Discover & Share GIFs") I built a shell excel model for the company and the way their revenue and earnings ramped up, it is fair to say I have never seen anything like it. I wanted to see what some analysts were saying about Nvidia before some of these eyepopping numbers showed up in their financials. I read a bunch of them, and I was pleasantly surprised how Scuttleblurb’s 2021 series on Nvidia (Part [1](https://www.scuttleblurb.com/nvda1/?ref=mbi-deepdives.com) and Part [2](https://www.scuttleblurb.com/nvda2/?ref=mbi-deepdives.com)) touched on so many key areas that became part of the conversation in the next few years (The Bitter Lesson, Jevon’s Paradox, competition from ASICs, detailed explanation of CUDA moat etc.). I let Scuttleblurb know how much I enjoyed reading his pieces, and fortunately, he took paywall off his Nvidia pieces later. So, you can all go and read it yourself. I also want to highlight this [piece](https://www.fabricatedknowledge.com/p/gpt-3-and-the-writing-on-the-wall?ref=mbi-deepdives.com) by Fabricated Knowledge back in 2020 who was admirably early in outlining the “future”. To get a sense of the current competitive landscape of Nvidia, I went through a bunch of work done by Semianalysis (see their work on [AMD](https://newsletter.semianalysis.com/p/amd-advancing-ai-mi350x-and-mi400-ualoe72-mi500-ual256?utm%5Fsource=publication-search), [TPU](https://newsletter.semianalysis.com/p/tpuv7-google-takes-a-swing-at-the?ref=mbi-deepdives.com), [Trainium](https://newsletter.semianalysis.com/p/aws-trainium3-deep-dive-a-potential?ref=mbi-deepdives.com), for example). Gavin Baker’s recent [podcast](https://joincolossus.com/episode/nvidia-v-google-the-economics-of-ai/?ref=mbi-deepdives.com) on ILtB was also helpful in understanding the rivalry between Google and Nvidia. I probably mentioned only \~30% of the content I went through during my research process, but you can sense there is a deluge of content on Nvidia. After consuming a good chunk of it and feeling reasonably good about my understanding, I started writing the Deep Dive myself. After making 20% progress on writing the Deep Dive, I only started appreciating the gaps of my knowledge when I got to more meaty parts of the Deep Dive. Frankly speaking, if I didn’t try to write a Deep Dive, it would have been lot easier to convince myself that I understand the business reasonably well. But writing is a forcing function in making you realize your gaps in understanding. AI didn’t quite help because AI’s answers were only making it more apparent to me that the gaps may be wider than I appreciated. It also didn’t help that there is some news flow about Nvidia that is happening on a daily basis which further eroded my confidence in my ability to write a Deep Dive that can maintain its relevance even a year form now. So, after writing a Deep Dive every month since September 2020, I came to this unfortunate decision to pause writing the Deep Dive for this month. However, since I have an “okay-ish” foundation of knowledge on Nvidia now, it will be marginally easier for me to follow the company going forward. I would like to follow and cover their quarterly earnings, and major events such as GTC more closely for a couple of years before making another attempt of writing a Deep Dive on the company. While everyone is talking about semis, the whole experience was a stark reminder that the technical nature of the industry remains quite challenging for not only to get up to speed but to keep up with the industry. I am not giving up on covering semis in the future, but just appreciating the patience it will require to get there. It’s not ideal, and I wish I had a better update for you. Thank you for your understanding. **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Digital Advertising's "Bitter Lesson" Moment URL: https://www.mbi-deepdives.com/digital-advertisings-bitter-lesson-moment/ Last updated: 2025-12-18T13:48:48.000Z _This post is for paying subscribers only._ ### The Reality of Meta's Reality Labs URL: https://www.mbi-deepdives.com/the-reality-of-metas-reality-labs/ Last updated: 2025-12-17T15:46:19.000Z _This post is for paying subscribers only._ ### CoStar and Zillow's Google Risk URL: https://www.mbi-deepdives.com/costar-and-zillows-google-risk/ Last updated: 2025-12-16T17:40:54.000Z _This post is for paying subscribers only._ ### Adobe and Airbnb URL: https://www.mbi-deepdives.com/adobe-and-airbnb/ Last updated: 2025-12-15T15:20:31.000Z _This post is for paying subscribers only._ ### Booking on the Offense URL: https://www.mbi-deepdives.com/booking-on-the-offense/ Last updated: 2025-12-14T15:39:30.000Z _This post is for paying subscribers only._ ### Synopsys' Pricing Evolution in Design IP URL: https://www.mbi-deepdives.com/snps_ip_pricing/ Last updated: 2025-12-14T01:40:01.000Z _This post is for paying subscribers only._ ### Lululemon's Succession URL: https://www.mbi-deepdives.com/lululemons-succession/ Last updated: 2025-12-12T14:59:17.000Z _This post is for paying subscribers only._ ### Adobe and Figma's Divergent Path URL: https://www.mbi-deepdives.com/adobe-and-figmas-divergent-path/ Last updated: 2025-12-11T15:23:34.000Z _This post is for paying subscribers only._ ### The "Edge AI" Bear Case URL: https://www.mbi-deepdives.com/the-edge-ai-bear-case/ Last updated: 2025-12-10T14:58:47.000Z _This post is for paying subscribers only._ ### Waymo's Surge URL: https://www.mbi-deepdives.com/waymos-surge/ Last updated: 2025-12-09T15:02:14.000Z _This post is for paying subscribers only._ ### Music's AI Mess: Part 2 URL: https://www.mbi-deepdives.com/musics-ai-mess-part-2/ Last updated: 2025-12-08T15:26:53.000Z _This post is for paying subscribers only._ ### Dollar Store Earnings 3Q'25 URL: https://www.mbi-deepdives.com/dg-dltr3q25/ Last updated: 2025-12-07T16:02:02.000Z _This post is for paying subscribers only._ ### My experience on Airbnb Experience: Part 2 URL: https://www.mbi-deepdives.com/abnb_experience2/ Last updated: 2025-12-06T16:51:13.000Z _This post is for paying subscribers only._ ### Reader's feedback on "The Great Abstraction" URL: https://www.mbi-deepdives.com/feedback-great-abstraction/ Last updated: 2025-12-05T14:07:11.000Z _This post is for paying subscribers only._ ### Understanding AWS Graviton Playbook URL: https://www.mbi-deepdives.com/aws-graviton/ Last updated: 2025-12-04T15:06:26.000Z _This post is for paying subscribers only._ ### The Great Abstraction? URL: https://www.mbi-deepdives.com/the-great-abstraction/ Last updated: 2025-12-03T15:20:33.000Z _This post is for paying subscribers only._ ### Why is AWS partnering with GCP? URL: https://www.mbi-deepdives.com/aws-gcp/ Last updated: 2025-12-02T14:23:27.000Z _This post is for paying subscribers only._ ### Behind the scenes: Airbnb vs Booking URL: https://www.mbi-deepdives.com/abnb_bkng/ Last updated: 2025-12-01T15:17:59.000Z _This post is for paying subscribers only._ ### Never Sell: Episode 12-Serial Acquirer ROIC, Fiserv Debacle and Management Credibility, Wise and Stablecoins URL: https://www.mbi-deepdives.com/never-sell-episode-12-serial-acquirer-roic-fiserv-debacle-and-management-credibility-wise-and-stablecoins/ Last updated: 2025-11-30T13:35:37.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode. You can listen to it here: [Spotify](https://open.spotify.com/episode/7MklmTYaWLXuaWFfCE7YtS?si=771012c38a5f49af&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/serial-acquirer-roic-fiserv-debacle-and-management/id1786912203?i=1000738939144&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=enYRlJfgqGU&t=10s&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) Some of the relevant posts that we touched on this episode: 1. [What exactly is CSU’s ROIC?](https://www.mbi-deepdives.com/what-exactly-is-csus-roic/) 2. [Fiserv’s October Massacre](https://www.scuttleblurb.com/scuttlebit-fi1/?ref=mbi-deepdives.com) 3. [Wise is probably going to be fine](https://www.scuttleblurb.com/scuttlebit-wise1/?ref=mbi-deepdives.com) 4. [The Depreciation Battleground](https://www.mbi-deepdives.com/the-depreciation-battleground/) As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 65 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) ### The Depreciation Battleground URL: https://www.mbi-deepdives.com/the-depreciation-battleground/ Last updated: 2025-11-29T22:34:59.000Z _This post is for paying subscribers only._ ### Anthropic's focused bet, Portfolio Change URL: https://www.mbi-deepdives.com/anthropics-focused-bet-portfolio-change/ Last updated: 2025-11-26T15:26:47.000Z _This post is for paying subscribers only._ ### Solving the "DoorDash Problem" URL: https://www.mbi-deepdives.com/solving-the-doordash-problem/ Last updated: 2025-11-25T14:44:14.000Z _This post is for paying subscribers only._ ### Booking: The shareholder friendly OTA king URL: https://www.mbi-deepdives.com/bkng/ Last updated: 2025-11-24T14:58:50.000Z _This post is for paying subscribers only._ ### The limits to our imagined vision of the future URL: https://www.mbi-deepdives.com/the-limits-to-our-imagined-vision-of-the-future/ Last updated: 2025-11-23T16:57:48.000Z ***A programming note***: I hope to publish my Deep Dive on Booking Holdings tomorrow. Since this is my first year of publishing daily at MBI Deep Dives, I am still thinking about some vacation policy. I will let you know once I finalize something, but for now, I would like to take Thursday and Friday off during Thanksgiving next week. I would also take the last week of the year off. My son, who is a Christmas baby, will be turning one this year; so I think I will have my hands full during that time! --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 64 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) --- Earlier this year, I read this [piece](https://www.noemamag.com/finding-awe-amid-everday-splendor/?ref=mbi-deepdives.com) “Finding Awe Amid Everyday Splendor” which made the point that seeking “brief moments of awe is as good for your mind and body as anything you might do.” The writer of the piece interviewed Dacher Keltner (the author of the book “[Awe](https://www.amazon.com/Awe-Science-Everyday-Wonder-Transform/dp/1984879685?ref=mbi-deepdives.com)”) while strolling through Point Reyes beach. The first time I went to Point Reyes North Beach was in October 2024 and I remember telling my wife how the vastness of the sea in that foggy October afternoon in a nearly secluded beach added a surreal element to our life events! It almost felt like we were saying good byes to our past selves before entering a new phase in our life: parenthood! Then when I read that piece about “awe”, it rekindled a deep desire to go back to that beach once again. So, I have been thinking about going back for a while, but finally, after publishing my “daily dose” on Friday last week, I started driving for Point Reyes North Beach! ![](https://substackcdn.com/image/fetch/$s_!eIPR!,w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5f132312-4381-490d-94e7-1f073ae82431_1440x1800.jpeg) It took me three and half hours to get there. This time, it was lot sunnier. With a clear sky and constant sound of crashing waves, I found the beach even more secluded this time. I took a stroll for half an hour around the beach and then started driving back to my home for another three hours! 0:00 /0:49 1× Admittedly, I was less awestruck about Point Reyes North Beach the second time around, but I actually conjured lot more awe while driving to and from the beach itself because during the entire 7-hour trip, I was **finally** listening to Acquired’s three Nvidia episodes (part [1](https://www.acquired.fm/episodes/nvidia-the-gpu-company-1993-2006?ref=mbi-deepdives.com), [2](https://www.acquired.fm/episodes/nvidia-the-machine-learning-company-2006-2022?ref=mbi-deepdives.com), and [3](https://www.acquired.fm/episodes/nvidia-the-dawn-of-the-ai-era?ref=mbi-deepdives.com)). It was a bit **surreal** to listen to these episodes knowing what we know today: Nvidia is the largest market cap company in the world! While listening to the episodes, there are a few things that really stood out to me. Jensen Huang was born in Taiwan and his family later moved to Thailand. At age Nine, his family sent him to a boarding school in the US to chase the American dream. While the school seemed affordable, his family’s knowledge about the school was clearly quite…limited! From the podcast: > “It turns out that the reason that this school, OBI (Oneida Baptist Institute) was so cheap was it’s actually not a prep school. It’s a reform school. This is a school for troubled kids. It’s a reform school. Jensen’s roommate, when he shows up as a 9-year-old, is a 17-year-old kid who had just gotten out of prison and was recovering from 7 stab wounds that he got in a knife fight.” Many people may laugh or even raise eyebrow at such callousness of Huang’s parents, but as an immigrant father, I can confirm feeling a bit sentimental when my son’s American passport arrived. I almost felt like I did something “very important” for my son. The other thing that really stood out from the series was a particular Marc Andreessen quote. I googled it and found the quote in a Forbes [piece](https://www.forbes.com/sites/aarontilley/2016/11/30/nvidia-deep-learning-ai-intel/?ref=mbi-deepdives.com) from Nov 30, 2016\. Here’s the quote from Marc Andreessen: > “We’ve been investing in a lot of startups applying deep learning to many areas, and every single one effectively comes in building on Nvidia’s platform,” says Marc Andreessen of venture capital firm Andreessen Horowitz. “It’s like when people were all building on Windows in the ‘90s or all building on the iPhone in the late 2000s. > > “For fun,” adds Andreessen, “our firm has an internal game of what public companies we’d invest in if we were a hedge fund. We’d put all our money into Nvidia.” Oh, he would have so much more fun if he (or any of us) actually did that! The stock compounded at a cool **62% CAGR** **AFTER** that Forbes piece was published. A few days ago, I was lamenting to a couple of investor friends that how hard investing may be evolving to be, especially in tech given how seeds of the major value unlock in recent years came from “academic papers” 7-8 years ago (think “Attention is all you need”). Isn’t it going to be increasingly more difficult to understand these inflection points? Admittedly, listening to the Nvidia series was a good reminder that indeed “attention is all you need”! You don’t have to take any prominent VCs (or anyone) words as gospel obviously since just like anyone else, they can often be wrong but in retrospect, there was enough “easter eggs” out there for a good student of the market to **at least start paying attention** to what’s going on in Nvidia. ![chart](https://substackcdn.com/image/fetch/$s_!J-9P!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8803dced-37d3-4b7b-b7ec-85e67ecf1437_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://app.koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) Of course, investing is never going to be so easy that just by paying “attention” you will magically sense the future! When Acquired published its Part 1 of Nvidia series in March 2022, its Enterprise Value (EV) was \~$700 Billion. A month later when they published part 2, Nvidia’s EV dropped to $500 Billion. It was interesting how the bull-bear cases that Acquired discussed in April 2022 still remains relevant to this day even though the company is today almost \~10x larger. Notice the below excerpt from part 2, for example: > “Google is sort of counter positioned against NVIDIA here, where they’re saying, we want to differentiate Google Cloud with this offering that depending on your workload, it might be much cheaper for you to use TPUs with us than for you to use NVIDIA hardware with us or anyone else. They’re probably willing to eat margin on that in order to grow Google Cloud’s share in the cloud market. It’s kind of the Android strategy, but runs in the data center.” In fact, while listening to episode 2 of Nvidia series, I didn’t know when they published it since I was driving. But it became clear that it was definitely before ChatGPT as they were kind of struggling a bit to justify what could explain Nvidia’s $500 Billion valuation. By the time, Acquired released their part 3 of Nvidia series in September 2023, the world became obsessed with ChatGPT and Nvidia’s EV reached $1 Trillion. ![chart](https://substackcdn.com/image/fetch/$s_!M_JO!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd926b1c2-294a-4a92-ae21-3d3b87cd3256_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://app.koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) When I got back home, it was wild to see the earnings revisions of Nvidia’s in recent years. In January 2023, Nvidia’s consensus operating income or EBIT estimates for FY’26 was just $20 Billion. Today, estimate for FY’26 shot to $135 Billion!! You bet I found “awe” looking at this chart! ![chart](https://substackcdn.com/image/fetch/$s_!msnY!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Feb6b322b-8f33-43d7-8c3e-761ae82c2837_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://app.koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) One of the easiest way to be humble in market is to imagine time traveling and wonder if you could possibly foresee now that you know how in reality it actually turned out. More often than not, I quickly come to the realization how investing would still be very, very difficult even if I knew some (but not all) key data points beforehand. Even if I were following Nvidia like a zealot for the last 10 years and became infatuated with ChatGPT right after it came out in November 2022, the harsh reality is I might still have been quite tentative about investing my money in Nvidia. Investing is inherently forward looking, but I find time traveling in the past is quite underappreciated. Because we don’t know the future, all our debates are understandably centered around how any of these will pan out, but if we just go back even a couple of years, it should be crystal clear that how our imagined vision of the future likely stands on a foundation of sands! I hope that should make it apparent that the distribution of outcomes is likely always wider than we like to imagine! **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Meta's biggest competitor(s) URL: https://www.mbi-deepdives.com/metas-biggest-competitor-s/ Last updated: 2025-11-22T15:21:44.000Z _This post is for paying subscribers only._ ### Walmart and Target CY 3Q'25 Earnings URL: https://www.mbi-deepdives.com/walmart-and-target-cy-3q25-earnings/ Last updated: 2025-11-21T14:57:29.000Z _This post is for paying subscribers only._ ### The corporations of the future URL: https://www.mbi-deepdives.com/the-corporations-of-the-future/ Last updated: 2025-11-20T13:39:54.000Z _This post is for paying subscribers only._ ### Some Portfolio Changes URL: https://www.mbi-deepdives.com/some-portfolio-changes/ Last updated: 2025-11-19T17:15:39.000Z _This post is for paying subscribers only._ ### Messaging Opportunity and Group Chat Dynamics URL: https://www.mbi-deepdives.com/messaging-opportunity-and-group-chat-dynamics/ Last updated: 2025-11-18T15:04:28.000Z _This post is for paying subscribers only._ ### The appeal of conversational commerce URL: https://www.mbi-deepdives.com/the-appeal-of-conversational-commerce/ Last updated: 2025-11-17T14:17:21.000Z _This post is for paying subscribers only._ ### On the eve of Gemini 3.0 URL: https://www.mbi-deepdives.com/gemini3/ Last updated: 2025-11-16T14:48:48.000Z _This post is for paying subscribers only._ ### The Great Concentration of Productivity URL: https://www.mbi-deepdives.com/the-great-concentration-of-productivity/ Last updated: 2025-11-15T14:43:47.000Z _This post is for paying subscribers only._ ### Meta's GEM URL: https://www.mbi-deepdives.com/metas-gem/ Last updated: 2025-11-14T14:44:16.000Z _This post is for paying subscribers only._ ### Nadella's truth URL: https://www.mbi-deepdives.com/nadellas-truth/ Last updated: 2025-11-13T14:22:06.000Z _This post is for paying subscribers only._ ### Why I may have underestimated the potential for Airbnb Experiences URL: https://www.mbi-deepdives.com/why-i-may-have-underestimated-the-potential-for-airbnb-experiences/ Last updated: 2025-11-12T20:47:23.000Z _This post is for paying subscribers only._ ### What exactly is CSU's ROIC? URL: https://www.mbi-deepdives.com/what-exactly-is-csus-roic/ Last updated: 2025-11-12T13:42:45.000Z _This post is for paying subscribers only._ ### Constellation Software 3Q'25 URL: https://www.mbi-deepdives.com/csu3q25/ Last updated: 2025-11-11T14:58:14.000Z _This post is for paying subscribers only._ ### How would we know if market were "AGI" pilled? URL: https://www.mbi-deepdives.com/how-would-we-know-if-market-were-agi-pilled/ Last updated: 2025-11-09T14:43:12.000Z _This post is for paying subscribers only._ ### Digital Advertising Industry Snapshot, Portfolio Change URL: https://www.mbi-deepdives.com/digital-advertising-industry-snapshot-portfolio-change/ Last updated: 2025-11-08T15:21:29.000Z _This post is for paying subscribers only._ ### Airbnb 3Q'25 Update URL: https://www.mbi-deepdives.com/abnb3q25/ Last updated: 2025-11-07T15:05:15.000Z _This post is for paying subscribers only._ ### Corpay 3Q'25 Update, Portfolio Change URL: https://www.mbi-deepdives.com/corpay-3q25-update-portfolio-change/ Last updated: 2025-11-06T14:34:10.000Z _This post is for paying subscribers only._ ### Shopify 3Q'25 Update URL: https://www.mbi-deepdives.com/shop3q25/ Last updated: 2025-11-05T15:07:48.000Z _This post is for paying subscribers only._ ### Insurance Brokers 3Q'25 Update URL: https://www.mbi-deepdives.com/insurance-brokers-3q25-update/ Last updated: 2025-11-04T14:03:40.000Z _This post is for paying subscribers only._ ### Never Sell: Episode 11-The Big Tech Capex Debate, Amazon Retail, Align’s Pricing Challenge URL: https://www.mbi-deepdives.com/never-sell-ep11/ Last updated: 2025-11-03T12:50:52.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode. You can listen to it here: [Spotify](https://open.spotify.com/episode/5NyeYMWe09WzUTxB82vJer?si=bf59aa2e555f4c9e&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/the-big-tech-capex-debate-amazon-retail-aligns/id1786912203?i=1000734933500&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=LQa6HvR5D5s&ref=mbi-deepdives.com), [RSS feed](https://rss.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com) Unlike yours truly, Scuttleblurb rarely talks about big tech in public, so I really enjoyed discussing and thinking through the thorny capex debate. David (Scuttleblurb) is one of the sharpest analysts I know, and the primary reason I was pestering him for the last couple of years to launch a podcast with me is I need a good excuse to discuss stocks with him. It's one of those things that I frankly do not quite care much if anyone else listens to these conversations (I know many of you do), but it's certainly something I personally look forward to every month. Maybe one day I will be able to convince David to do it more than once a month! As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 64 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) ### The Great Decoupling of Labor and Capital URL: https://www.mbi-deepdives.com/the-great-decoupling-of-labor-and-capital/ Last updated: 2025-11-02T15:43:23.000Z _This post is for paying subscribers only._ ### Alphabet 3Q'25 Update URL: https://www.mbi-deepdives.com/goog3q25/ Last updated: 2025-11-01T14:31:25.000Z _This post is for paying subscribers only._ ### Amazon 3Q'25 Update URL: https://www.mbi-deepdives.com/amzn3q25/ Last updated: 2025-10-31T12:45:56.000Z _This post is for paying subscribers only._ ### Meta 3Q'25 Update URL: https://www.mbi-deepdives.com/meta-3q25-update/ Last updated: 2025-10-30T14:59:05.000Z _This post is for paying subscribers only._ ### CoStar 3Q'25 Update URL: https://www.mbi-deepdives.com/csgp3q25/ Last updated: 2025-10-29T14:20:22.000Z _This post is for paying subscribers only._ ### Amazon marketplace trends URL: https://www.mbi-deepdives.com/amazon-marketplace-trends/ Last updated: 2025-10-28T13:23:54.000Z _This post is for paying subscribers only._ ### Music's AI mess URL: https://www.mbi-deepdives.com/musics-ai-mess/ Last updated: 2025-10-27T14:25:20.000Z _This post is for paying subscribers only._ ### Amazon's robot army URL: https://www.mbi-deepdives.com/amazons-robot-army/ Last updated: 2025-10-26T13:27:08.000Z _This post is for paying subscribers only._ ### The coming debt deluge? URL: https://www.mbi-deepdives.com/the-coming-debt-deluge/ Last updated: 2025-10-25T14:36:30.000Z _This post is for paying subscribers only._ ### Instacart: "Webvan done right" URL: https://www.mbi-deepdives.com/cart/ Last updated: 2025-10-24T13:30:19.000Z _This post is for paying subscribers only._ ### Airbnb's bet on anti-trend URL: https://www.mbi-deepdives.com/airbnbs-bet-on-anti-trend/ Last updated: 2025-10-23T16:01:39.000Z _This post is for paying subscribers only._ ### Texas Instruments 3Q'25 Update URL: https://www.mbi-deepdives.com/txn3q25/ Last updated: 2025-10-22T13:20:23.000Z _This post is for paying subscribers only._ ### Danaher 3Q'25 Update URL: https://www.mbi-deepdives.com/dhr3q25/ Last updated: 2025-10-21T14:46:32.000Z _This post is for paying subscribers only._ ### ChatGPT's value capture problem URL: https://www.mbi-deepdives.com/chatgpts-value-capture-problem/ Last updated: 2025-10-20T13:43:09.000Z _This post is for paying subscribers only._ ### TSMC's Margins URL: https://www.mbi-deepdives.com/tsmcs-margins/ Last updated: 2025-10-19T14:19:04.000Z _This post is for paying subscribers only._ ### Why I bought some puts URL: https://www.mbi-deepdives.com/why-i-bought-some-puts/ Last updated: 2025-10-18T13:21:31.000Z _This post is for paying subscribers only._ ### Sartorius 3Q'25 Update URL: https://www.mbi-deepdives.com/sartorius-3q25-update/ Last updated: 2025-10-17T14:32:09.000Z _This post is for paying subscribers only._ ### ASML's China question URL: https://www.mbi-deepdives.com/asmls-china-question/ Last updated: 2025-10-16T14:59:45.000Z _This post is for paying subscribers only._ ### Why I don't worry (as much) about big tech's depreciation schedule URL: https://www.mbi-deepdives.com/why-i-dont-worry-as-much-about-big-techs-depreciation-schedule/ Last updated: 2025-10-15T14:07:56.000Z _This post is for paying subscribers only._ ### Gartner may not be "AI loser" URL: https://www.mbi-deepdives.com/gartner-may-not-be-ai-loser/ Last updated: 2025-10-14T13:11:56.000Z _This post is for paying subscribers only._ ### AI diffusion URL: https://www.mbi-deepdives.com/ai-diffusion/ Last updated: 2025-10-13T13:02:51.000Z _This post is for paying subscribers only._ ### Rare earth shenanigans URL: https://www.mbi-deepdives.com/rare-earth-shenanigans/ Last updated: 2025-10-12T13:12:38.000Z _This post is for paying subscribers only._ ### Less is more? URL: https://www.mbi-deepdives.com/less-is-more/ Last updated: 2025-10-11T14:32:56.000Z _This post is for paying subscribers only._ ### The Cat Paper URL: https://www.mbi-deepdives.com/the-cat-paper/ Last updated: 2025-10-10T13:35:20.000Z _This post is for paying subscribers only._ ### First impression of ChatGPT Agent, and apps on ChatGPT URL: https://www.mbi-deepdives.com/first-impression-of-chatgpt-agent-and-apps-on-chatgpt/ Last updated: 2025-10-09T13:35:30.000Z _This post is for paying subscribers only._ ### Meta's monetization game URL: https://www.mbi-deepdives.com/metas-monetization-game/ Last updated: 2025-10-08T13:22:52.000Z _This post is for paying subscribers only._ ### Airbnb's mix shift URL: https://www.mbi-deepdives.com/airbnbs-mix-shift/ Last updated: 2025-10-07T14:18:45.000Z _This post is for paying subscribers only._ ### GDP's absurdity URL: https://www.mbi-deepdives.com/gdps-absurdity/ Last updated: 2025-10-06T13:39:44.000Z _This post is for paying subscribers only._ ### Thoughts on Alpha School URL: https://www.mbi-deepdives.com/thoughts-on-alpha-school/ Last updated: 2025-10-05T14:34:01.000Z _This post is for paying subscribers only._ ### OpenAI's admirable pace of iterations URL: https://www.mbi-deepdives.com/openais-admirable-pace-of-iterations/ Last updated: 2025-10-04T15:20:36.000Z _This post is for paying subscribers only._ ### First impression of Meta Ray-Ban Display, Taking a big swing at Airbnb URL: https://www.mbi-deepdives.com/first-impression-of-meta-ray-ban-display-taking-a-big-swing-at-airbnb/ Last updated: 2025-10-03T14:01:52.000Z _This post is for paying subscribers only._ ### Constellation's Succession URL: https://www.mbi-deepdives.com/constellations-succession/ Last updated: 2025-10-02T13:20:21.000Z _This post is for paying subscribers only._ ### Airbnb Model Update URL: https://www.mbi-deepdives.com/airbnb-model-update/ Last updated: 2025-10-02T01:59:36.000Z _This post is for paying subscribers only._ ### Expanding the scope of digital advertising URL: https://www.mbi-deepdives.com/expanding-the-scope-of-digital-advertising/ Last updated: 2025-09-30T15:49:39.000Z _This post is for paying subscribers only._ ### Never Sell: Episode 10-Lululemon, Align, LLMs and Newsletters, Portfolio Holdings, Right for the Right Reasons URL: https://www.mbi-deepdives.com/never-sell-episode-10-lululemon-align-llms-and-newsletters-portfolio-holdings-right-for-the-right-reasons/ Last updated: 2025-09-29T12:53:16.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode. You can listen to it here: [Spotify](https://open.spotify.com/episode/698Qic75tIlmcqYoV7RqzX?si=f3msNmUuSveyXLwVWsmJVw&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/lululemon-align-llms-and-newsletters-portfolio/id1786912203?i=1000728947337&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=XC6EP4QRX3o&ref=mbi-deepdives.com), [RSS feed](https://feeds.buzzsprout.com/2435713.rss?utm%5Fsource=substack&utm%5Fmedium=email) As the title suggests, we tried to cover a bunch of topics, but I wanted to highlight our discussion on Lululemon. Lululemon has been a big loser for me in 2025 and through my introspection, this episode may be some source of vicarious learnings for you. As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. [Subscribe](#/portal/signup) ### Reader Response to "AI Overinvestment" URL: https://www.mbi-deepdives.com/reader-response-to-ai-overinvestment/ Last updated: 2025-12-05T14:10:05.000Z A couple of days ago, I wrote a piece titled “[**What if there’s an overinvestment in AI?**](https://www.mbi-deepdives.com/what-if-theres-an-overinvestment-in-ai/)**”** I received some thoughtful emails in response to that piece. One reader named Craig Melillotook the time to share a more detailed thoughts which he granted me the permission to share with all of you. I am copying his email below which I think adds to my aforementioned piece (slightly edited; emphasis mine): --- “This is/was a great exercise. I am sure you are not alone in attempting this (I know that I am and have). I think the four incumbent hyperscale spenders (AMZN, META, GOOG, MSFT) are in somewhat of a “tails I win, heads you lose” situation given their AI spend to date is discretionary and it is not damaging the balance sheet. Some capacity will get utilized immediately, and some capacity will get utilized eventually. The attached revenues might not be what investors hope for, but it doesn’t kill them and IRR is likely >0%. In your scenario, NVDA would be in for a really tough time, which likely means in the short term, at least for stock prices, that everyone would be in for a tough time (especially ORCL, neo clouds, power supply chain). Open AI is its own case, and the $500B post-money from this past month plus a $20-25B exit rate annualized revenue will keep private shareholders trapped. Maybe the bubble popping solves inflation, enables rate cuts, and strengthens the dollar. I am not exactly going out on a limb with this next statement, but I see three potential “events” that could act as rubber meeting the road event that pours some water on the fire: 1. Scaling laws asymptote and there’s a realization that digital God isn’t around the corner which removes the biggest totem that public markets and CEO’s both have in terms of giving permission to chase the dream. How does this manifest? More respected skeptics speak on it, and the frontier models level off. 1. I think Dwarkesh Patel made a really good [point](https://www.dwarkesh.com/p/timelines-june-2025?ref=mbi-deepdives.com) a few months ago when he said that **the more time that goes by without achieving AGI, the less likely it becomes that we get there at all**. If we assume that we do not get AGI within 3 years, then how much incremental value does a general purpose model that “just” provides longer context windows, memory, and faster response times actually provide if tomorrow’s small models are good enough (and what is the willingness to pay?). Training frontier zero-revenue models on chips that become obsolete for training purposes every 18 months is not sustainable. Ben Thompson made the point that early on in his career, he initially underappreciated society’s collective demand for better technology for the sake of better technology (maybe I am making that same mistake), but in this instance the cost of the incremental improvement is quite literally measured in the tens of billions of dollars (and you don’t know the return ahead of time, so it’s another leap of faith after the previous leap of faith did not deliver). Also, the predominant use case of today’s models are “free to me” inference, so the enterprise NEEDS to adopt this stuff, and if you listen to Accenture’s call yesterday, basically the large enterprise is nowhere near ready for it. Obviously GPT5 is much more accurate than GPT4 due to better reasoning, but if enterprise use cases are going to be grounded in domain specific data, then hallucinations should be lower in those cases lessening the demand for improvements in reasoning that are intended to reduce hallucinations. So how many bites at the apple will OAI get to train the next frontier model if they cannot live up to their own promises? 2. Any one of the cloud companies stops saying “demand exceeds supply” or implies that they have sufficient capacity to meet demand (implies AI demand decel, not growth decline) 1. If it takes 18-24 months to stand up an AI datacenter, then we really only have like 12-18 months of AI data center investment online since the hyper scalers actively committed to going pedal to the medal on investing in 2024\. So, it makes sense that collective demand exceeds supply. But if collective supply goes up by 2-3x over the next 18-36 months, will there be a smooth 1:1 balance with demand? i.e. can AI tokens continue to growth exponentially for the current base? Maybe, but what is the willingness to spend in the face of excess supply? We don’t know, but if MSFT doesn’t want to build training infrastructure, then we know someone will say “we’re good”. 3. We see one/some of the negative margin AI model wrappers run out of funding and there’s reluctance for VC’s to step in (this is the least likely one given sovereign money will be there as long as the first two events don’t happen). You point out that if you were in Zuck’s shoes then you would continue to invest too, and I agree that it is the right move. **Everyone in the value chain is acting rationally and in their own best interest given everything they currently know: scaling laws have more or less held up keeping the dream for “digital God” alive, demand for tokens/AI inference capacity exceeds CURRENT supply, and all competitors are choosing NOT to cooperate**. I have a short take on each, and figured I would share. - **META** – META is competing for consumer screen time directly with LLM’s as well as traditional competitors YouTube and TikTok. They need to make the product “AI native” to retain/grow mindshare. I don’t know if they will get a model that will act as “the draw” to the app for consumers, but they need a model that will drastically improve the recommendation engine, enable pro-grade multi-media content creation for users and advertisers, and then be good enough to act as an LLM destination for people that don’t want to leave the app. This is putting the augmented reality dream to the side for now, because I’m sure there is a lot synergistic spend for RL in here. - I think Meta will prove to be the most difficult company in terms of disaggregating “AI revenue” versus “non-AI revenue”, as they may already be generating AI revenue via ad creation tools, improved targeting, - **GOOG** – they are doing as well as you could hope with balancing monetization and disrupting oneself. YouTube will likely only increase in value and perhaps search has a much higher floor than the worst case fears. OpenAI may need to launch an ad supported model to keep the dollars flowing, and this could potentially steal from Google’s ad revenue (and ignite some ‘search is dead’ fears for a little). But Google Cloud, YT, and Gemini are crushing it. - **MSFT/ORCL/OpenAI** – the only one you could argue who is not acting rational is MSFT, unless they firmly believe we will not see the digital God dream (in which case, then they are acting rational and are optimizing for future inference demand that needs to be available when enterprise clients ultimately need it). MSFT is pretty much telling us that the incremental value of training frontier models will have diminishing returns. **We want to applaud Oracle as “the winner” but they’re winning because MSFT is allowing it**, and because OpenAI doesn’t have an existing business that prints $100B+ of operating cash flow per year to fund the spend. Maybe MSFT is wrong, and this will be the most obvious fumble ever, but they have skin in the game, but they were early to OpenAI so there’s a track record of seeing around the corner a bit with Satya. I don’t think they have an innovator’s dilemma even as/if OAI says they want to takeover the workplace application market. the G Suite is essentially free, and it MSFT has done quite well with its coexistence. Oracle has no other path to fast track itself into the hyperscaler conversation. Ellison is 81 and in it for glory, so he figures why not attach myself to a potential anchor customer in OAI (and now TikTok) that can maybe do $100B+ per year with me. I suspect there will be a lot of collateralized, non-recourse debt in their Stargate arrangement. - **OAI/NVDA** \- OAI wants to be everything yesterday, but they only have one product (though it’s a general/world model), and they don’t have the organic cash flow to get there. So how do they solve it? They sell the dream to anyone and everyone who will listen to raise the money. The backers (NVDA/ORCL) need to adopt the same approach, and their leaders have no problem doing so. 18 months ago, Altman tried to say he would manufacture chips and TSMC laughed at him because they can’t afford to waste their time. Today, Altman has aligned himself with two owner operators in Huang and Ellison who have long histories of selling the dream. Since there is a hype market for it, it feels dumb for people to push back on it in the moment. NVDA also needs as many customers as possible to apply pressure to MSFT/AMZN/GOOG who are developing their own chips internally. To the extent NVDA can keep the market tight for GPU’s it means competitors are running fast and providing less leash for the ASIC customers to experiment with pushing internal chip efforts, and it forces the HPC’s to keep buying. This is also why Huang is so keen on keeping the chips flowing to China (and Singapore).” --- I thought this was very well grounded discussion. The only people I disagree strongly with are people at the both extremes: “AGI is just around the corner” and “this is the most obvious bubble in the history of mankind”. Of course, there are gazillions of scenarios between these two extremes and navigating these scenarios remains the key challenge for the next few years. Thank you, Craig for sharing your thoughts with me and allowing me to publish it on MBI Deep Dives. --- *In addition to “Daily Dose” (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 63 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Buying Constellation Software amidst its consternation! URL: https://www.mbi-deepdives.com/buying-constellation-software-amidst-its-consternation/ Last updated: 2025-09-27T14:57:27.000Z _This post is for paying subscribers only._ ### What if there's an overinvestment in AI? URL: https://www.mbi-deepdives.com/what-if-theres-an-overinvestment-in-ai/ Last updated: 2025-09-26T14:27:59.000Z _This post is for paying subscribers only._ ### ASML: The Machine that Builds the "Machine God(s)" URL: https://www.mbi-deepdives.com/asml/ Last updated: 2025-09-25T12:49:58.000Z _This post is for paying subscribers only._ ### Nvidia and OpenAI's Gambit URL: https://www.mbi-deepdives.com/nvidia-and-openais-gambit/ Last updated: 2025-09-24T13:55:01.000Z _This post is for paying subscribers only._ ### Airbnb's Evolution URL: https://www.mbi-deepdives.com/airbnbs-evolution/ Last updated: 2025-09-23T15:04:52.000Z _This post is for paying subscribers only._ ### The resilience of consumer spending in the US URL: https://www.mbi-deepdives.com/the-resilience-of-consumer-spending-in-the-us/ Last updated: 2025-09-22T13:59:37.000Z _This post is for paying subscribers only._ ### My Experience on Airbnb Experience URL: https://www.mbi-deepdives.com/my-experience-on-airbnb-experience/ Last updated: 2025-09-21T13:53:39.000Z _This post is for paying subscribers only._ ### The Data Center Story: Part 2, Portfolio Change URL: https://www.mbi-deepdives.com/the-data-center-story-part-2-portfolio-change/ Last updated: 2025-09-20T13:28:56.000Z _This post is for paying subscribers only._ ### The Data Center Story: Part 1 URL: https://www.mbi-deepdives.com/the-data-center-story-part-1/ Last updated: 2025-09-19T14:30:22.000Z _This post is for paying subscribers only._ ### Thoughts on Meta Connect 2025 URL: https://www.mbi-deepdives.com/thoughts-on-meta-connect-2025/ Last updated: 2025-09-18T13:32:16.000Z _This post is for paying subscribers only._ ### Amazon's "unfair" advantage in advertising URL: https://www.mbi-deepdives.com/amazons-unfair-advantage-in-advertising/ Last updated: 2025-09-17T14:18:20.000Z _This post is for paying subscribers only._ ### How people use ChatGPT and its implications, Portfolio Change URL: https://www.mbi-deepdives.com/how-people-use-chatgpt-and-its-implications-portfolio-change/ Last updated: 2025-09-16T13:49:11.000Z _This post is for paying subscribers only._ ### Why we need Intel foundry spin-off, funded by a mag7 consortium URL: https://www.mbi-deepdives.com/why-we-need-intel-foundry-spin-off-funded-by-a-mag7-consortium/ Last updated: 2025-09-15T13:45:35.000Z _This post is for paying subscribers only._ ### Texas Instruments' data center and robotics opportunity URL: https://www.mbi-deepdives.com/texas-instruments-data-center-and-robotics-opportunity/ Last updated: 2025-09-14T14:19:12.000Z _This post is for paying subscribers only._ ### Airbnb's untapped monetization lever(s) URL: https://www.mbi-deepdives.com/airbnbs-untapped-monetization-lever-s/ Last updated: 2025-09-13T14:11:38.000Z _This post is for paying subscribers only._ ### Notes and thoughts on Meta and Microsoft discussion at GS Communicopia URL: https://www.mbi-deepdives.com/notes-and-thoughts-on-meta-and-microsoft-discussion-at-gs-communicopia/ Last updated: 2025-09-12T14:26:58.000Z _This post is for paying subscribers only._ ### Why Synopsys Sank URL: https://www.mbi-deepdives.com/why-synopsys-sank/ Last updated: 2025-09-12T14:37:54.000Z _This post is for paying subscribers only._ ### More Alphabet! URL: https://www.mbi-deepdives.com/more-alphabet/ Last updated: 2025-11-25T00:03:04.000Z _This post is for paying subscribers only._ ### "Innoveracy", Finding Awe URL: https://www.mbi-deepdives.com/innoveracy-finding-awe/ Last updated: 2025-09-13T12:07:07.000Z _This post is for paying subscribers only._ ### The Appeal of Cash URL: https://www.mbi-deepdives.com/the-appeal-of-cash/ Last updated: 2025-09-08T14:52:19.000Z _This post is for paying subscribers only._ ### Google's evolving TPU strategy URL: https://www.mbi-deepdives.com/googles-evolving-tpu-strategy/ Last updated: 2025-09-07T15:07:10.000Z _This post is for paying subscribers only._ ### Texas Instruments and Analog Devices at Citi TMT Conference URL: https://www.mbi-deepdives.com/texas-instruments-and-analog-devices-at-citi-tmt-conference/ Last updated: 2025-09-06T14:04:15.000Z _This post is for paying subscribers only._ ### Lululemon 2Q'25 Update URL: https://www.mbi-deepdives.com/lulu2q25/ Last updated: 2025-09-05T13:18:35.000Z _This post is for paying subscribers only._ ### Technology vs Platform Shift, Portfolio Change URL: https://www.mbi-deepdives.com/technology-vs-platform-shift-portfolio-change/ Last updated: 2025-09-04T13:04:33.000Z _This post is for paying subscribers only._ ### Why I bought more Alphabet! URL: https://www.mbi-deepdives.com/why-i-bought-more-alphabet/ Last updated: 2025-09-03T14:16:21.000Z _This post is for paying subscribers only._ ### The Changing Healthcare Landscape URL: https://www.mbi-deepdives.com/the-changing-healthcare-landscape/ Last updated: 2025-09-02T15:21:35.000Z Last month, JP Morgan published a very interesting healthcare [piece](https://assets.jpmprivatebank.com/content/dam/jpm-pb-aem/global/en/documents/eotm/sick-as-a-dog.pdf?utm%5Fsource=theideafarm.com&utm%5Fmedium=newsletter&utm%5Fcampaign=american-unexceptionalism&%5Fbhlid=2ab9c84cacf055c431022caf2e0a04b8c31df0ec) titled “Sick as a Dog” which I read yesterday. They also published a podcast on this [piece](https://open.spotify.com/episode/4ow2QrKViGBL8wC2AN9hCG?si=390df70cc0ce4382&ref=mbi-deepdives.com), but I think you would enjoy reading the piece instead. I would like to highlight some interesting points from the piece. One of the startling data points for me was healthcare pretty much matched technology sector’s return from 1989 to 2019 period with dramatically lower volatility (15% vs 24%). Imagine how much the world has changed thanks to technology during this period and yet, if you put your money in healthcare, you would not only have a much better sleep but also enjoyed just as good a return as tech investors. Well, even if you did that, your sound sleep has been abruptly disrupted since 2019\. While tech’s run has continued unabated, healthcare sector has been limping around since then. ![](https://substackcdn.com/image/fetch/$s_!vcWr!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F026850f7-0ef6-49b3-baeb-1e906ebd1326_1165x394.png) Another topic that surprised me is the data related to patent thickets, an idea which I originally came across from this Lina Khan’s [tweet](https://x.com/linamkhan/status/1870185009958510795?ref=mbi-deepdives.com). Patent thicket happens when so many overlapping patents exist in one area that it becomes hard to make or sell something new without running into legal trouble. While I did know the idea, I didn’t know “*almost 75% of all patents granted and all patent applications were filed *after* FDA approval*”. From the report: > Multiple overlapping patents for a given drug are known as “patent thickets”, and typically must all expire or be settled with manufacturers before generic and biosimilar drugs can be sold. Regardless of a patent’s strength or validity, patent thickets can deter competition by raising the perceived litigation cost of entry. A 2024 JAMA article analyzed patent thickets for the 10 brand name drugs with the highest US sales. The authors found that patents filed after FDA approval, most of which were unrelated to each drug’s active ingredient, can substantially lengthen the effective period of patent protection and delay the impact of generic and biosimilar drugs. For the ten small molecule and biologic drugs in the JAMA analysis, almost 75% of all patents granted and all patent applications were filed after FDA approval > > Patent reform has the potential to substantially impact US drug prices. While the US has the highest generic drug utilization rate in the world at 90% by volume, generic drug consumption represents just 17.5% of total drug spending. The remaining 10% of all drug prescriptions account for the other 82.5% of drug spending. These figures are remarkable; in other words, the issue is not that patients aren’t using generic drugs; it’s that the branded drug market remains heavily impacted by increasingly “creative” patent thickets that may exceed the original goal of protecting intellectual property investments in pharmaceuticals. ![](https://substackcdn.com/image/fetch/$s_!mUKC!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F85e921db-325d-401d-8a14-286de1c5eecc_873x310.png) I knew biotech investors have suffered a lot in the last few years, but it still shocked me to know that “*since 2018, half of all biotech IPOs have lost 80%+ of their value, and only 20% had positive holding period returns*.” ![](https://substackcdn.com/image/fetch/$s_!5Ixk!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2e4e34e1-ec1d-46fa-a33f-2bcaa09182dd_943x640.png) There are some interesting issues raised near the end of the report. Aging population driving healthcare spending has been a secular thesis among most healthcare investors, but we may have hit some sort of ceilings on healthcare spending. From the report: > “…personal consumption spending on healthcare as a share of GDP rose from 5% in 1976 to 11% by 2008 but has flatlined since 2008; the same trend is true for national health expenditures. > > The cost of Medicare and Medicaid entitlements relative to non-defense discretionary spending shown in the last chart is continuing to rise. I believe we’re getting closer to an informal national referendum to narrow this gap, rather than taking steps to keep increasing it. ![](https://substackcdn.com/image/fetch/$s_!sTEO!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F97508fda-8d53-4f08-8c23-5cc47c24f7c0_721x985.png) Healthcare is obviously a very heated political topic in the US. I will admit that some of the healthcare related debates have been bit of a cultural shock to me when I moved to the US in 2017\. While growing up in Bangladesh, I have basically never known anyone with health insurance. All of our healthcare related spending were out-of-pocket expenses. If you couldn’t afford private healthcare, you could go to government hospitals which are always overflowing with patients. Therefore, your access to proper healthcare was pretty much directly tied to your wealth. To my surprise, most of the western countries, including the US has largely eliminated your need to be wealthy to access proper healthcare, and yet, it remained such a thorny political topic. People seem to deeply underappreciate how close almost all the western countries are to the “utopia” of equality when it comes to access to quality healthcare. The reality is it is nearly impossible for private health insurance companies to be popular because most people do not consume healthcare and vastly “overpay” to subsidize the chronically ill, old, and poor people of the society in the West. If you look at these [numbers](https://www.healthsystemtracker.org/chart-collection/health-expenditures-vary-across-population/?ref=mbi-deepdives.com#Share%20of%20total%20population%20and%20total%20health%20spending,%20by%20age%20group,%202021) below, it should be clear why health insurance companies will always structurally have hard time gaining any popularity anytime soon: > In 2021, 5% of the population accounted for nearly half of all health spending…At the other end of the spectrum, the 50% of the population with lowest total health spending accounted for only 3% of all health spending…Roughly 14% of the population had $0 in health expenditures in 2021. I suspect the reason nationalized healthcare seems to be more popular is it abstracts away the way it is funded and many people feel like they are accessing healthcare for “free”. Of course, there is no free lunch. If someone asked me “what’s the conspiracy theory you think is true”, I am not sure I have a good answer today. But when I look at how skewed the data is in healthcare spending, sometimes I wonder if the western governments will be highly incentivized in the future to make it socially popular (or even desirable) for the chronically ill and/or very old people to choose assisted suicides. Take a look at the age distribution and spending mix of healthcare in the US below. Considering the fertility rate, the population mix will be increasingly dominated by older and older population for the next few decades. Given the broader social consensus around uniform access to healthcare in most western countries, these trends can lead to pretty uncomfortable political conundrums. To be clear, I personally do not want a broader social consensus to form to make it more desirable to choose assisted suicides, but frankly speaking, societies do have history of taking nearly unfathomable or cruel policies to solve an anticipated problem (e.g. one child policy in China). Perhaps we do need AGI to usher us in an accelerating growth to make these pesky problems go away! ![](https://substackcdn.com/image/fetch/$s_!_b2x!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9cfcf52c-d0ce-494f-a374-5d3760235a30_1621x727.png) --- *In addition to "Daily Dose" (yes, *DAILY*) like this, MBI Deep Dives publishes one Deep Dive on a publicly listed company every month. You can find all the 62 Deep Dives* [*here*](https://www.mbi-deepdives.com/models/)*.* [Subscribe](#/portal/signup) --- **Current Portfolio:** Please note that these are **NOT** my recommendation to buy/sell these securities, but just disclosure from my end so that you can assess potential biases that I may have because of my own personal portfolio holdings. Always consider my write-up my personal investing journal and never forget my objectives, risk tolerance, and constraints may have no resemblance to yours. My current portfolio is disclosed below: ![](https://substackcdn.com/image/fetch/$s_!_wAv!,w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F27dd7f4b-24ba-4c84-925a-a911031c4be5_1102x595.png) *\*Based on closing prices as of August 30, 2025 (time-weighted YTD: +6.7%); Since inception (August 24, 2018) time-weighted annualized return +17.3%* **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### MBI turns five! URL: https://www.mbi-deepdives.com/mbi-turns-five/ Last updated: 2025-09-13T12:07:29.000Z On this day five years ago, I decided to start an independent research service. I had a simple idea: just one Deep Dive on a publicly listed company every month. It may seem there are a plethora of Substacks or independent research services today, but even five years ago, there was only a handful of decent analysts publishing their work at a regular frequency online. Even the ones who did, very few actually did long form write-ups on publicly listed companies. Over time, I realized why there weren’t as many decent analysts publishing their work online. The reality is if you are any good, you would inevitably get picked up by the industry. Market is usually efficient enough that good analysts are spotted fairly quickly. So, the only way any decent analyst can remain “online” for a long time is through their sheer commitment to stay independent. I have no doubt that the likes of [Ben Thompson](https://stratechery.com/?ref=mbi-deepdives.com) or [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) needed to make conscious, firm decision to stay the course. Admittedly, I was, at times, in two minds. Every year since starting MBI Deep Dives, I did receive interest from my own subscribers every once in a while whether I would be interested in going back to buy-side. In **some** cases, I did engage in and entertained these conversations. But over time, I realized I have increasingly become, for better or worse, “unemployable”. I have simply fallen in love with the work I do at MBI Deep Dives, and it is perhaps going to be pretty much impossible to replicate this feeling anywhere else. Of course, the joys of working for yourself also exposes one to the vagaries of capitalism itself much more directly. My initial bet with MBI Deep Dives was very few people actually have the focus, interest, and discipline to do a proper Deep Dives every month and only a handful will do so online. So, if I can accomplish that and do a good job at it, it is highly likely to have a market for that. Indeed, that bet was correct! However, once “Deep Research” came to the scene, my business model increasingly seemed anachronistic to me. Although the raw numbers didn’t quite show any noticeable sign of tension, I couldn’t quite be at ease while thinking about the future of MBI Deep Dives in three to five years! I could see multiple tensions brewing over time. In a pre-AI world, you could read a Deep Dive and easily appreciate the effort that went behind producing such a piece. Deep Research completely abstracts away or/and cheapens these efforts in the eyes of readers. If I came across MBI Deep Dives and saw this guy meticulously published Deep Dive after Deep Dive every month in the last 60 months, frankly speaking I would be impressed at the persistence and discipline. AI, however, likely already has or is going to rewire these perceptions in a profound way for all written content. Remember how I thought only a handful of people could be focused, disciplined, and interested enough to do these Deep Dives regularly? Well, after Deep Research, that number certainly, theoretically, shot up to tens of thousands (if not more). As someone whose job is to analyze businesses, it didn’t take me too long to infer “Houston, we have a problem!” While AI was posing these uncomfortable questions, the actual process of analyzing businesses didn’t quite get a lot simpler overnight. To understand, absorb, digest a new company and write my own thoughts on a business, I still needed to do almost all the work that I was doing earlier. Nonetheless, I decided to take a deeper look at my work and what I could do to tweak my business model a bit. One of the things I always try to focus on is to take a closer look at what I am **already** doing in my day-to-day life and whether any of it would be useful to other people. One thing that jumped out to me was I am an infovore who prodigiously devours content and I suspect I have developed a pretty decent taste on content published online. Moreover, thanks to studying different businesses over the years, I myself have a lot of my own thoughts and inferences while consuming content everyday. So, I thought what if I write **everyday**? Admittedly, it was a jarring thought. Publishing something everyday requires a level of self-discipline and productivity that I wasn’t sure I quite had it. After some self-introspection, I decided to lean into my fear and gave it a shot. Voila, MBI Deep Dives went from monthly to daily! How do I work these days? I wake up somewhere between 4 to 5 am. I basically get three uninterrupted hours to myself before my son wakes up. So, I intend to publish my daily post within three hours before my son wakes up. I usually have a pretty good idea what I intend to write the night before, and typically have a brief outline before going to bed. I do the actual writing after waking up. After publishing my daily post, I spent about an hour or so with my son. Then I focus on the monthly Deep Dives for the rest of the morning and afternoon. I tend to have pretty early dinner these days and post-dinner, I spend some time creating an outline for the post next day. Actually, \~80% of the idea of daily posts comes during my daily walk. As I try to hit 10k steps every day, these are usually great fodder for gathering my thoughts circling in my head. It’s been two months since I made these adjustments. I surprised myself how easily I adapted to this schedule. I don’t think I have ever been as cognitively active as I had been in the last couple of months. The rigid deadline of publishing something everyday turned out to be a great way to stay deeply intellectually engaged. And it doesn’t hurt that the “market” responded; MBI revenues last month reached new all-time highs with lowest ever monthly churn in the last five years! I don’t quite think Deep Dives are any less important today than it was five years ago. I want to do this job because investing is my lens to understand the world. To understand the world, I still need to dive deep, ponder, and wrestle with my thoughts before writing down my understanding and assessment of a business. But I do feel I needed to wake up to the market reality. I believe this will happen to a broad swath of knowledge economy jobs; as you can see, I don’t quite think AI is quite the wholesale replacement for the work most of us do, but we may need to take a deeper look to tweak some things to keep our work economically relevant in the post-AI world. As far as success or failure goes, I remind myself the following by Viktor Frankl: “*Don't aim at success. The more you aim at it and make it a target, the more you are going to miss it. For success, like happiness, cannot be pursued; *it must ensue**” Indeed, it must ensue! One of my core beliefs is mere survival online over a very long period of time will be rewarded in many positive, unexpected ways. Here’s to the next five (and hopefully many, many more)! Thank you so much for your support! [Subscribe](#/portal/signup) ![](https://substackcdn.com/image/fetch/$s_!S1fj!,w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F331e718b-12e5-4451-9a8e-f45d512f1fa9_3072x4080.jpeg) ### The ROI Question URL: https://www.mbi-deepdives.com/the-roi-question/ Last updated: 2025-08-31T13:37:24.000Z _This post is for paying subscribers only._ ### Google's "first mistake" URL: https://www.mbi-deepdives.com/googles-first-mistake/ Last updated: 2025-08-30T13:54:55.000Z _This post is for paying subscribers only._ ### Dollar General 2Q'25, Microsoft's Cybersecurity business URL: https://www.mbi-deepdives.com/dollar-general-2q25-microsofts-cybersecurity-business/ Last updated: 2025-08-29T15:41:23.000Z _This post is for paying subscribers only._ ### Meta's (lack of) Agency URL: https://www.mbi-deepdives.com/metas-lack-of-agency/ Last updated: 2025-08-28T14:34:21.000Z _This post is for paying subscribers only._ ### Amazon's Ambition in Groceries: Part 2 URL: https://www.mbi-deepdives.com/groceries_2/ Last updated: 2025-08-27T14:22:39.000Z _This post is for paying subscribers only._ ### The Promise and Pitfall of Agentic Commerce URL: https://www.mbi-deepdives.com/the-promise-and-pitfall-of-agentic-commerce/ Last updated: 2025-08-26T14:44:11.000Z _This post is for paying subscribers only._ ### Never Sell: Episode 9-Global Payments, AI and Software, OpenAI and Anthropic Bubble? URL: https://www.mbi-deepdives.com/never-sell-episode-9-global-payments-ai-and-software-openai-and-anthropic-bubble/ Last updated: 2025-08-25T13:09:18.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I published a new episode today. You can listen to it here: [Spotify](https://open.spotify.com/episode/1AJCzOLHeQrmETVfeaPJvP?si=377a485024be404b&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell-episode-9-global-payments-ai-and-software/id1786912203?i=1000723428464&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=iDR-CN-hBis&ref=mbi-deepdives.com), [RSS feed](https://feeds.buzzsprout.com/2435713.rss?utm%5Fsource=substack&utm%5Fmedium=email) As a reminder, if you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our future episodes. ### Challenges for Self driving Semi, ADI 3Q'25 Earnings URL: https://www.mbi-deepdives.com/challenges-for-self-driving-semi-adi-3q25-earnings/ Last updated: 2025-08-24T14:45:54.000Z _This post is for paying subscribers only._ ### Airbnb's unique demand driver URL: https://www.mbi-deepdives.com/airbnbs-unique-demand-driver/ Last updated: 2025-08-23T15:03:16.000Z _This post is for paying subscribers only._ ### Walmart and Target Earnings URL: https://www.mbi-deepdives.com/walmart-and-target-earnings/ Last updated: 2025-08-22T14:24:21.000Z _This post is for paying subscribers only._ ### Constraints, and challenges of value capture in the AI race URL: https://www.mbi-deepdives.com/constraints-and-challenges-of-value-capture-in-the-ai-race/ Last updated: 2025-08-21T14:21:57.000Z _This post is for paying subscribers only._ ### Union Pacific: Chasing the Transcontinental Dream URL: https://www.mbi-deepdives.com/unp/ Last updated: 2025-08-20T12:15:53.000Z _This post is for paying subscribers only._ ### Global Payments, Tax Shenanigans URL: https://www.mbi-deepdives.com/global-payments-tax-shenanigans/ Last updated: 2025-08-19T13:36:42.000Z _This post is for paying subscribers only._ ### Market Bubble Talk, Frozen Housing Market Implications URL: https://www.mbi-deepdives.com/market-bubble-talk-frozen-housing-market-implications/ Last updated: 2025-08-18T14:22:38.000Z _This post is for paying subscribers only._ ### Amazon's Ambition in Groceries: Part 1 URL: https://www.mbi-deepdives.com/groceries_1/ Last updated: 2025-08-17T14:54:23.000Z _This post is for paying subscribers only._ ### Tyler Technologies, Portfolio Change URL: https://www.mbi-deepdives.com/tyler-technologies-portfolio-change/ Last updated: 2025-08-16T14:12:07.000Z _This post is for paying subscribers only._ ### Cursor's Conundrum URL: https://www.mbi-deepdives.com/cursors-conundrum/ Last updated: 2025-08-15T14:11:01.000Z _This post is for paying subscribers only._ ### Beyond the "Search" Box URL: https://www.mbi-deepdives.com/beyond-the-search-box/ Last updated: 2025-08-14T13:22:51.000Z _This post is for paying subscribers only._ ### Maravai 2Q'25 Update URL: https://www.mbi-deepdives.com/mrvi2q25/ Last updated: 2025-08-13T14:06:30.000Z _This post is for paying subscribers only._ ### Golden age of Digital Ads, LLM P&L URL: https://www.mbi-deepdives.com/golden-age-of-digital-ads-llm-p-l/ Last updated: 2025-08-12T13:08:03.000Z _This post is for paying subscribers only._ ### ChatGPT's Edge, Tech Talent Retention URL: https://www.mbi-deepdives.com/chatgpts-edge-tech-talent-retention/ Last updated: 2025-08-11T13:34:37.000Z _This post is for paying subscribers only._ ### CoStar Multifamily vs Zillow Rentals URL: https://www.mbi-deepdives.com/costar-multifamily-vs-zillow-rentals/ Last updated: 2025-08-10T14:39:55.000Z _This post is for paying subscribers only._ ### Shopify's Surprise, XPEL 2Q'25 URL: https://www.mbi-deepdives.com/shopifys-surprise-xpel-2q25/ Last updated: 2025-08-09T15:00:31.000Z _This post is for paying subscribers only._ ### Digital Advertising Snapshot, Corpay 2Q'25, Portfolio Change URL: https://www.mbi-deepdives.com/digital-advertising-snapshot-corpay-2q25-portfolio-change/ Last updated: 2025-08-08T13:23:30.000Z _This post is for paying subscribers only._ ### Airbnb 2Q'25 Update URL: https://www.mbi-deepdives.com/abnb2q25/ Last updated: 2025-08-07T15:34:51.000Z _This post is for paying subscribers only._ ### Novelty bias and future of software engineering, Social's growing share in ad dollars URL: https://www.mbi-deepdives.com/novelty-bias-and-future-of-software-engineering-socials-growing-share-in-ad-dollars/ Last updated: 2025-08-06T13:23:59.000Z _This post is for paying subscribers only._ ### The "humorless" and timeless machine of Booking Holdings, Portfolio Change URL: https://www.mbi-deepdives.com/the-humorless-and-timeless-machine-of-booking-holdings-portfolio-change/ Last updated: 2025-08-05T14:17:23.000Z _This post is for paying subscribers only._ ### Some notes from Big Tech 10-Qs URL: https://www.mbi-deepdives.com/2q2510q/ Last updated: 2025-08-04T22:59:11.000Z _This post is for paying subscribers only._ ### Never Sell: Episode 8 - AI, Meta, Process, Pods, Writing URL: https://www.mbi-deepdives.com/never-sell-episode-8-ai-meta-process-pods-writing/ Last updated: 2025-08-03T13:21:29.000Z For the “Never Sell” podcast, [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I recorded an “AMA” episode. You can listen to it here: [Spotify](https://open.spotify.com/show/3Fdub8zkhm4xwN1ZcDbv1j?ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell/id1786912203?ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/@scuttleblurb?ref=mbi-deepdives.com), [RSS feed](https://feeds.buzzsprout.com/2435713.rss?utm%5Fsource=substack&utm%5Fmedium=email) Thank you for asking thoughtful questions. If you have any questions for either MBI Deep Dives or Scuttleblurb, please feel free to email us the questions which we may try to respond/discuss in our podcast. ### Microsoft FY2025 Update URL: https://www.mbi-deepdives.com/msft2025/ Last updated: 2025-08-05T15:49:20.000Z _This post is for paying subscribers only._ ### Amazon 2Q'25, Portfolio Change URL: https://www.mbi-deepdives.com/amzn2q25/ Last updated: 2025-08-01T14:50:22.000Z _This post is for paying subscribers only._ ### Meta 2Q'25, CoStar suing Zillow, Portfolio Change URL: https://www.mbi-deepdives.com/meta2q25/ Last updated: 2025-07-31T12:54:09.000Z _This post is for paying subscribers only._ ### Video on NotebookLM, Amazon's response to WSJ, Brown & Brown 2Q'25 URL: https://www.mbi-deepdives.com/07-30-2025/ Last updated: 2025-07-30T15:00:06.000Z _This post is for paying subscribers only._ ### Meta Ray-Ban, Ads in AI Chats URL: https://www.mbi-deepdives.com/07-29-2025/ Last updated: 2025-07-29T13:52:39.000Z _This post is for paying subscribers only._ ### Google's response, Lululemon Community URL: https://www.mbi-deepdives.com/07-28-2025/ Last updated: 2025-07-28T15:07:31.000Z _This post is for paying subscribers only._ ### Insurance Brokers, Portfolio Change URL: https://www.mbi-deepdives.com/07-27-2025/ Last updated: 2025-07-27T14:45:05.000Z _This post is for paying subscribers only._ ### CoStar 2Q'25 Update URL: https://www.mbi-deepdives.com/csgp2q25/ Last updated: 2025-07-26T14:10:59.000Z _This post is for paying subscribers only._ ### Texas Instruments 2Q'25 Update URL: https://www.mbi-deepdives.com/txn2q25/ Last updated: 2025-07-25T14:23:05.000Z _This post is for paying subscribers only._ ### Alphabet 2Q'25, Corpay M&A, Portfolio Changes URL: https://www.mbi-deepdives.com/goog2q25/ Last updated: 2025-07-24T14:53:40.000Z _This post is for paying subscribers only._ ### Danaher 2Q'25 Update URL: https://www.mbi-deepdives.com/dhr2q25/ Last updated: 2025-07-23T13:28:53.000Z _This post is for paying subscribers only._ ### Tariff conundrums, AI capex boom, Edge computing fallacy, AI ARR chicanery URL: https://www.mbi-deepdives.com/07-22-2025/ Last updated: 2025-07-22T15:26:54.000Z _This post is for paying subscribers only._ ### Cognex: Agents of Automation URL: https://www.mbi-deepdives.com/cgnx/ Last updated: 2025-07-21T14:13:53.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 20, 2025) URL: https://www.mbi-deepdives.com/07-20-2025/ Last updated: 2025-07-20T22:16:03.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 19, 2025) URL: https://www.mbi-deepdives.com/07-19-2025/ Last updated: 2025-07-20T22:16:27.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 18, 2025) URL: https://www.mbi-deepdives.com/07-18-2025/ Last updated: 2025-07-20T22:16:58.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 17, 2025) URL: https://www.mbi-deepdives.com/07-17-2025/ Last updated: 2025-07-20T22:17:22.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 16, 2025) URL: https://www.mbi-deepdives.com/07-16-2025/ Last updated: 2025-07-20T22:17:44.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 15, 2025) URL: https://www.mbi-deepdives.com/07-15-2025/ Last updated: 2025-07-20T22:18:16.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 14, 2025) URL: https://www.mbi-deepdives.com/07-14-2025/ Last updated: 2025-07-20T22:18:36.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 13, 2025) URL: https://www.mbi-deepdives.com/07-13-2025/ Last updated: 2025-07-20T22:19:17.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 12, 2025) URL: https://www.mbi-deepdives.com/07-12-2025/ Last updated: 2025-07-20T22:19:47.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 11, 2025) URL: https://www.mbi-deepdives.com/07-11-2025/ Last updated: 2025-07-20T22:20:17.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 10, 2025) URL: https://www.mbi-deepdives.com/07-10-2025/ Last updated: 2025-07-20T22:20:40.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 09, 2025) URL: https://www.mbi-deepdives.com/07-09-2025/ Last updated: 2025-07-20T22:21:09.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 08, 2025) URL: https://www.mbi-deepdives.com/07-08-2025/ Last updated: 2025-07-20T22:21:59.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 07, 2025) URL: https://www.mbi-deepdives.com/07-07-2025/ Last updated: 2025-07-20T22:22:23.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 06, 2025) URL: https://www.mbi-deepdives.com/07-06-2025/ Last updated: 2025-07-20T22:22:51.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 05, 2025) URL: https://www.mbi-deepdives.com/07-05-2025/ Last updated: 2025-07-20T22:23:23.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 04, 2025) URL: https://www.mbi-deepdives.com/07-04-2025/ Last updated: 2025-07-20T22:24:05.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 03, 2025) URL: https://www.mbi-deepdives.com/07-03-2025/ Last updated: 2025-07-20T22:24:40.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 02, 2025) URL: https://www.mbi-deepdives.com/07-02-2025/ Last updated: 2025-07-20T22:25:18.000Z _This post is for paying subscribers only._ ### MBI Daily Dose (July 01, 2025) URL: https://www.mbi-deepdives.com/07-01-2025/ Last updated: 2025-07-20T22:26:03.000Z _This post is for paying subscribers only._ ### From Monthly to Daily URL: https://www.mbi-deepdives.com/from-monthly-to-daily/ Last updated: 2025-06-30T14:45:51.000Z I have decided to make some changes to **MBI Deep Dives**. Before I get to the changes, here is a quick update on next month’s Deep Dive: I am currently studying **Cognex (CGNX)** and expect to publish the Deep Dive by **July 25**. For this month’s *Never Sell* podcast episode, David Kim from [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I discussed **APi Group** ([Spotify](https://open.spotify.com/episode/32t5RFZd9Jys3Zf05etxOP?si=a6923f09fd9548cd&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell-episode-7-api-group/id1786912203?i=1000715131730&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=YC%5F2bsLphH4&ref=mbi-deepdives.com), [RSS Feed](https://feeds.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com)). So, about the changes. Starting tomorrow, I will send **one email every day** (yes, including weekends). I will call it **“MBI Daily Dose.”** Each Daily Dose will cover interesting content I come across that day. If you are currently in our WhatsApp Community, the format will be largely familiar. However, I am going to archive the WhatsApp Community because, unfortunately, it is not a great solution for what I am trying to do. With a member limit of 1,024 on WhatsApp, it cannot scale over time. While I used to disclose and discuss any changes to my portfolio in the last section of the monthly Deep Dives, I will now share my portfolio (and any changes) in the Daily Dose emails. This will allow me to communicate more quickly whenever something changes on my end. I will, of course, still publish my Deep Dives. These changes are additive to your experience in MBI Deep Dives. The point of these changes is to move closer to what I keep repeating about MBI Deep Dives: **it is my investing journal.** My objective is to share this journal in its fullest sense. The Daily Dose brings me closer to that ideal end state by allowing me to chronicle, every day, what I am reading and listening to and, perhaps, share a few thoughts while reflecting on it. Of course, my content diet will be largely biased toward companies I already own or would like to own eventually. The modus operandi at MBI Deep Dives has always been to ask myself whether I would find it useful if someone else did the same. While I cannot speak for anyone else, I am confident that I would find a "Daily Dose" email very useful. Even before AI arrived, the search cost of finding interesting and useful content had already become unwieldy, so I believe MBI Deep Dives can add value here since such search cost may materially increase over time. As an "infovore**"**, I do not consider it extra work (or "work"); I would devour content every day anyway! You do not have to do anything on your end and there is no change in price; just expect an email to show up everyday sometime between 9 am-12 pm PT everyday from tomorrow. Thank you for your support! [Subscribe](#/portal/signup) ### APi: Safety-as-a-"Subscription" in a Fragmented Market URL: https://www.mbi-deepdives.com/apg/ Last updated: 2025-06-24T15:17:38.000Z _This post is for paying subscribers only._ ### Lululemon 1Q'25 Update URL: https://www.mbi-deepdives.com/lulu1q25/ Last updated: 2025-06-06T00:13:35.000Z *Disclosure: I own January 2026 $165 Call Options* While the quarter looks mostly okay, Lulu’s guide is the primary culprit for the stock to be down 20%+ after-hours today. Before we get into that, let me recap the quarter first and then I will share some highlights from the call. [Subscribe](#/portal/signup) **Sales by Region** Lulu is again back to LSD growth in the US; what makes it more disappointing is they actually had a somewhat easier comparison since 1Q’24 growth was just 2%. Canada, despite a low double digit growth in 1Q’24, again had higher growth than the US this quarter. China and Rest of the World (RoW) maintained healthy growth rates but growth has materially decelerated. However, due to the timing of Chinese New Year, Lulu’s China growth was impacted by four points. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6fc7dd66-2e56-40f0-ba7d-5a58aea327c6_1236x811.png) Given US is still the majority of the business (albeit declining in overall mix; US as % of overall mix has been trending downward for a while: 68% in 1Q’22, 66% in 1Q’23, 61% in 1Q’24, and 57% in 1Q’25), the main focus is still around the anemic growth in the US. What explains the struggle in the US? Management mostly blamed “macro uncertainty” and “consumer confidence” as the key reasons which led to traffic decline in stores. They mentioned conversion remains mostly consistent and average order value actually increased YoY. While most management teams typically like to shift the blame to macro, I wonder if the real challenge here is the broader athleisure segment which definitely took plenty of share in overall apparel industry in the last few years post-Covid and now may be ceding some of the shares. The reason I suspect this may be at least partly the case is **Athleta’s persistent struggle as well which posted 1Q’25 revenue that was \~15% lower than what they did in 1Q’22\. In contrast, Lulu’s revenue in the US was actually +24% during that same period.** In fact, Lulu management highlighted that they believe they continue to take share in the US: > When I look at our performance vs the market, **we gained market share** in the premium activewear. We had strong performance gains vs our peers in this segment of the market where we compete…We're definitely not happy where the growth is in the U. S. But relative to the market and our performance vs others, we are pleased that we're putting on share Of course, we cannot track some of the key competitors such as Alo or Vuori since they aren’t public companies. Moreover, if the broader Athleisure segment is under pressure, we may see increased promotional activity or increased markdown in the US. Lulu management did confirm that they suspect the back half of the year is likely to experience that: > from a competitive perspective, there's nothing we're seeing globally on a price promotional play other than in the U.S., where I would say we continue to monitor that closely because we do see ongoing promotional activity across the market, across the competitors as we've seen the certain consumer the more cautious. > > We know that to lever other pulls and we continue to monitor it and quite frankly, **anticipating a bit of a spike in the back half if the macro headwinds continue**. But we are a full price business, and we'll lead with innovation and our core assortment, we'll continue to play that. But we are seeing and do anticipate probably a dynamic competitive market. in the U.S. Lulu’s markdown so far is **down 10 bps** compared to last year, but they expect it to increase over the course of the year by 10-20 bps YoY. Management thinks traffic is the leading indicator when it comes to markdown and given the declining trend in traffic in the US (traffic hasn’t improved in QTD as well), they assume overall markdown will rise in 2025 vs 2024. Lack of newness was mentioned as the key reason for last year’s lackluster growth in the US, but they seem to have corrected the newness mix and plan to rollout some of the recently launched styles over the course of the year (which was launched in just limited number of stores so far): > In terms of the composition of our merchandise mix, we are back at our newness percentages…I think the way the guest is reacting and responding within that newness, she is reacting very positively to the new core or intended core silhouette styles that she has not seen before… Align no line, the Daydrift, to Be Calm to name just a few, and there's a number of those. > > Those as a percentage of our newness mix, we are increasing in the back half so that we're reacting to what the guest is responding to, and as a result, we are shifting some of the seasonal colors, patterns and graphics in the remaining core to maintain that sort of ratio that we're seeing. But as I look to the back half, the percentage of newness remains strong above historical as we lean into a little bit of these areas where the guest has really responded well, and we weren't at full store distribution. One good thing, however, is that management mentioned unaided brand awareness in the US increased from mid-30s in 4Q’24 to 40% in 1Q’25\. Of course, we are not seeing such positivity in the financials yet, but this unaided brand awareness is critical for Lulu to eventually get back to healthy growth rates in their US business. **Operating Margin** In both the Americas and in China, Lulu’s operating margin improved YoY. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fde5b28d8-ca6f-4bff-ad55-5f453e238363_940x288.png) I will discuss tariff more in the outlook section, but Lulu thinks they can absorb some of these increased costs and likely pass some to consumers given the “elasticity” of their consumer base: > We have an industry leading operating margin. This allows us to continue investing across our strategic road map to enable long term growth while managing any increased cost associated with tariffs. > > our premium positioning in the performance athletic apparel category yields different elasticity for our products relative to fashion oriented brands. **Sales by Gender** All three segments grew at largely similar rates in 1Q’25 ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fac43abe3-3a34-410f-a5c4-7a2516e274b4_1228x262.png) **Inventory** In 4Q’24 call, Lulu guided inventory to grow at high-teens as they chase the newness mix but inventory actually grew by 23%. However, management indicated this was mostly due to FX and tariff; when considering inventory in terms of units, it increased by 16% which was more in line with the guide. > When looking at inventory, we expect units to increase in the low double digits in Q2, with dollar inventories up in the low 20s and due in large part to the impact of higher tariff rates and foreign exchange. We expect a similar dynamic in inventory growth for the remainder of the year. **Capital Allocation** Lulu maintained their buyback intensity throughout last quarter. They bought back $430 mn shares at $316/share (vs $332 Mn in 4Q’24 and $297 Mn in 1Q’24). As a result, Lulu’s shares outstanding declined by 4.3% YoY in 1Q’25\. Management’s buyback activity at the face of headwinds faced by business does seem to project confidence about the long-term health of the business. Given they still have $1.3 Billion cash on balance sheet and the stock price reaction to this earnings, I expect them to remain quite active in buying back shares. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1f634259-74b6-48a5-b320-ff72119c36e5_964x387.png) **Outlook** For 2025, topline guide remains unchanged $11.15-11.3 Bn, implying \~5-7% YoY growth. If you exclude the 53rd week impact, this implies \~7-8% growth. However, they lowered the EPS guide for 2025 from $14.95-15.15 to $14.58 to $14.78 (vs $14.64 in 2024). Why was EPS guided lower despite keeping the topline guide? > For the full year, we now expect gross margin to decrease approximately 110 basis points versus 2024\. Relative to our prior guidance for a 60 basis point decrease, we expect the additional 50 basis points of deleverage to be driven predominantly by increased tariffs, offset somewhat by our enterprise-wide efforts to mitigate these costs and slightly higher markdowns. When looking specifically at tariffs, the assumptions we've made regarding rates include 30% incremental tariffs on China and an incremental 10% on the remaining countries where we source. > > From a mitigation standpoint, as Calvin said, we've looked across the enterprise and have identified several levers which will help offset much of the impact of these higher rates. Based on our implementation strategies, we expect our mitigation efforts to be most impactful in the second half of the year. > > Turning to SG&A for the full year. We expect deleverage of approximately 50 basis points versus 2024, relatively in line with our prior guidance, driven by FX headwinds and ongoing investments into our Power 3x 2 road map, including investments in marketing and brand building aimed at increasing our awareness and acquiring new guests, investments to support our international growth and market expansion and continued investment in technology. > > Looking at operating margin for the full year 2025, we now expect a decrease of approximately 160 basis points versus 2024 So, basically additional \~50 bps pressure in the gross margin due to tariffs than what was communicated in 4Q’24 call; tariff was already assumed to be \~20 bps headwind during 4Q’24 call, but of course that was before the broad based tariff that Trump later imposed. They do expect to raise price a little in some assortments to minimize this impact but nonetheless will take some margin hit. > When we think about the tariff impact to mitigation actions, I'd highlight, one would be pricing. We are planning to take strategic price increases looking item by item across our assortment as we typically do, and it will be price increases on a small portion of our assortment, and they will be modest in nature. > > And then on the sourcing side, we are also pursuing some efficiency actions there, some of which will impact the second half of this year, and then we are also focused on that into '26 as well. **Final Words** I bought Lulu in April 2024; so I clearly underestimated the challenges Lulu has been facing in the US. While it is possible that Lulu has been gaining share, there is lot of noise in verifying such claim given I don’t have data related to Alo/Vuori etc. In any case, gaining share is no panacea if the segment itself is facing headwind. The reality is without persistent MSD-HSD growth in the US, Lulu will find it very difficult to get back mid-20s P/E multiple (or higher). It current trades at \~17x P/E (based on high end of their current 2025 EPS guide). I have mentioned last quarter that I don’t intend to add to my position unless Lulu trades at \~10x NTM EBIT which is basically another 20% down from current price in after-hours. Given that I think Lulu will likely still manage to grow at MSD+ rate over the next 3-5 years even in the scenario that US remains stuck in LSD growth, it is sufficiently attractive for me to start adding if the stock experiences 20% drawdown from here. Thank you for reading. ### June 2025 Update URL: https://www.mbi-deepdives.com/june-2025-update/ Last updated: 2025-06-03T13:22:19.000Z Just a few quick updates for this month: I am going to publish my Deep Dive on **APi Group (APG)** by 26th of this month. For this month's "Never Sell" podcast episode, David Kim from [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I discussed Booking and Airbnb. I even had some product ideas for Brian Chesky; it was a fun conversation! ([Spotify](https://open.spotify.com/episode/3lm2F5UaiddZ38eJDbAc6D?si=4fefd357c37449e9&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell-episode-6-airbnb-and-booking/id1786912203?i=1000710964051&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=--M8CxJh%5F70&ref=mbi-deepdives.com), [RSS Feed](https://feeds.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com)). Finally, for new subscribers, I would like to let you know that you can access the full library of Deep Dives, including excel models, [here](https://www.mbi-deepdives.com/models/). I also encourage you to join the [WhatsApp community](https://chat.whatsapp.com/DYCGwtHfIteDKua1JHkAso?ref=mbi-deepdives.com) where I share interesting tidbits on the companies I follow almost everyday. Thank you for your support! [Subscribe](#/portal/signup) ### Perimeter: Private-Equity GP Economics in Public Markets URL: https://www.mbi-deepdives.com/prm/ Last updated: 2025-05-21T14:28:59.000Z _This post is for paying subscribers only._ ### May 2025 Update URL: https://www.mbi-deepdives.com/may-2025-update/ Last updated: 2025-05-02T15:32:41.000Z Some quick updates for this month: I am going to publish my Deep Dive on **Perimeter Solutions (PRM)** by 25th of this month. Given that this is a busy earnings season, I wanted to study a small cap company instead of undertaking a large cap company this month. For this month's "Never Sell" podcast episode, David Kim from [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I discussed Cadence and Synopsys. ([Spotify](https://open.spotify.com/episode/2FF3stedGzyN3vJe3avYbo?ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell-episode-5-cadence-and-synopsys/id1786912203?i=1000705553510&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=LBnNCv%5F2BEw&ref=mbi-deepdives.com), [RSS Feed](https://feeds.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com)). Speaking of earnings season, I have covered [Alphabet](https://www.mbi-deepdives.com/goog1q25/), [Meta](https://www.mbi-deepdives.com/meta1q25/), and [Amazon](https://www.mbi-deepdives.com/amzn1q25/) this quarter. You can read some notes from Meta's follow-up call [here](https://x.com/borrowed%5Fideas/status/1917983681282752652?ref=mbi-deepdives.com). As a reminder, I encourage you to be part of the [WhatsApp community](https://chat.whatsapp.com/DYCGwtHfIteDKua1JHkAso?ref=mbi-deepdives.com) where I share more updates frequently. While I typically haven't covered Microsoft's quarters in the past (I did do a Deep Dive in [April 2023](https://www.mbi-deepdives.com/msft/)), I intend to start covering their quarterly earnings as well from next quarter. One of the big tech companies I have never covered at all in MBI Deep Dives is Nvidia. I hope to do a Deep Dive on Nvidia later this year. These big tech companies are clearly the most important companies, and without following them closely, it will increasingly create wider gaps in understanding the broader economy and the world. Therefore, I expect myself to be diligent in filling these gaps over time. Finally, for new subscribers, I would like to let you know that you can access the full library of Deep Dives, including excel models, [here](https://www.mbi-deepdives.com/models/). Thank you for your support! [Subscribe](#/portal/signup) ### Amazon 1Q'25 Update URL: https://www.mbi-deepdives.com/amzn1q25/ Last updated: 2025-05-02T00:12:02.000Z *Disclosure: I own shares of Amazon* Amazon has another pretty decent quarter. Here are my highlights from today’s call. [Subscribe](#/portal/signup) **Revenue** Overall revenue grew by 10% (FX neutral). While Amazon’s 3P business usually grows faster than 1P, both 1P and 3P retail business grew at similar rate in 1Q’25\. Ads revenue continued its momentum at 19% growth YoY which was higher than both Google and Meta. After growing at \~19% YoY for the last three consecutive quarters, AWS growth decelerated this quarter to 17%. I’ll discuss more about AWS later, but let’s talk more about Amazon ex-AWS first. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F384b31e0-0ad8-4235-be09-9ee4279583b9_1579x226.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** Amazon recorded “one time charges related to some historical customer returns has not yet been resolved and some costs to receive inventory that was pulled forward into Q1 ahead of anticipated tariffs” Excluding this impact, North America and international segment’s margin would be 7.2% and 3.7% respectively. Given that 1Q’24 operating margins for North America and international segment were 5.8% and 2.8% respectively, the margin expansion continues to be an ongoing theme. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F355564aa-ea1d-465a-a148-ff44ac07207f_1120x673.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Of course, tariffs were a big talking point in the call. I thought it was interesting that Amazon was somewhat forceful in reminding investors that the value proposition that Amazon retail provides to customers and how they may be much more resilient than they’re given credit for (perhaps compared to other retailers such as Walmart or Costco): > …We haven't seen any attenuation of demand yet, To some extent, **we've seen some heightened buying in certain categories** that may indicate stocking up in advance of any potential tariff impact. We also have not seen the average selling price of retail items appreciably go up yet. Some of this reflects some forward buying we did in our first party selling, and some of that reflects some advanced inbounding our third party sellers have done But a fair amount of this is that most sellers just haven't changed pricing yet. Again, this could change depending on where tariffs settle. **Amazon is not uniquely susceptible to tariffs**. > > As it relates to China, **retailers who aren't buying directly from China are typically buying from companies who themselves are buying from China**. Marking these items up, rebranding, and selling to US consumers. These retailers are buying the product at a higher price than Chinese sellers selling directly to US consumers in our marketplace. So t**he total tariff will be higher for these retailers than for China direct sellers**. It's also sometimes easy to forget what Amazon sells. We're not mostly selling high average selling price items, though we certainly sell a bunch. In the first quarter, **our everyday essentials grew more than twice as fast as the rest of our business, and represented one out of every three units sold** in the US on Amazon. Even if you exclude Whole Foods Market and Amazon Fresh, Amazon is one of the largest grocers in the US with over 100 billion dollars in gross sales last year. People are buying a lot of their everyday essentials at Amazon. We also have extremely large selection. > > …Finally, when there are uncertain environments, customers tend to choose the provider they trust most. Given our really broad selection, low pricing, and speedy delivery, we have emerged from these uncertain areas with **more relative market segment share than we started** and better set up for the future. I'm optimistic this could happen again. **Fulfillment+ Shipping** If you look at worldwide paid unit growth vs shipping+ fulfillment cost growth, you would notice that the latter used to consistently outpace the former pretty much all the time since 2015 until 3Q'22\. Since then, unit growth has largely been faster than shipping+ fulfillment costs, indicating operating leverage in their logistics footprint. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F26a1f6f0-2eb2-40fe-ad7a-09e0cc59f2c9_1168x526.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Advertising** As mentioned before, Amazon ads grew the fastest among the top three digital advertising players. Given Amazon ads are perhaps more of a competitor to Google than Meta, I think it’s interesting to track how Amazon is gaining share here. Amazon ads incremental revenue as a percentage of Google advertising incremental revenue increased from 33% in 1Q’24 to 40% in 1Q’25. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe3a7b31b-be76-460c-8547-0dd534c104c3_877x511.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AWS** Okay, now let’s talk about AWS. AWS added $481 Mn incremental revenue QoQ which was slightly disappointing to me. Current backlog stands at $189 Bn, which is +20% YoY. Weighted average remaining life of this backlog is 4.1 years. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6b40f7ea-4be2-448e-a51b-bc1e453ee867_1042x538.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Let’s take a quick look at hyperscalers growth. Azure, Google Cloud, and AWS revenue grew by 35%, 28%, and 17% respectively. OpenAI clearly is adding bit of a torque to Azure’s growth here. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa61b1af8-dd55-41e4-a258-f5ed70ca378b_1402x775.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. Back in 2020, Google Cloud was only about a quarter of the size of AWS, but now it’s two-fifth of AWS revenue. We don’t know exactly how much of this is GCP, but we can be pretty confident that GCP is leading this catch-up with AWS. Google Cloud hasn’t made much progress this quarter relative to AWS. While revenue as a percentage of AWS increased by 36 bps QoQ, opex as a percentage of AWS actually increased by 258 bps which isn’t quite indicative of efficiency from Google’s perspective. However, Google tends to look worse in this comparison in Q1 and gradually improves over the course of the year. I will be curious to track if that continues to be the case in 2025. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff165ecd2-2af5-4d94-b64f-2e11a83dad2e_1050x637.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2c877a13-ce07-4be6-8d05-59cab13e9fbf_1102x658.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) While AWS topline growth was slightly disappointing, they did post their highest ever operating margin of \~40% this quarter. I am mostly used to seeing AWS operating margins hovering around \~25-30%, but for the last five consecutive quarters, AWS is posting 35%+ operating margin. What’s interesting about such margins this quarter is AWS actually decreased useful life of servers last quarter which was a headwind this quarter. Moreover, when you consider their “multi-billion” AI revenue run-rate growing at triple digit which is presumably lower margin segment today, it is mighty impressive that they are posting \~40% operating margins! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe4d83389-0712-4966-906f-0310e0422ca6_1600x120.png) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8100a861-4284-434d-9d8e-6bcfdef8330b_1194x646.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Couple of quotes on AWS from the call: > Our AI business has a **multibillion dollar annual revenue run rate**, continues to grow **triple digit** YoY, and is still in its very early days. While there is good reason for the high optimism about AI, I conclude my AWS comments with a reminder that there is still so much on premises infrastructure yet to be moved to the cloud. Infrastructure modernization is much less sexy to talk about than AI but fundamental to any company's technology and invention capabilities, developer productivity, speed, and cost structure. And **for companies to realize the full potential of AI, they're going to need their infrastructure and data in the cloud**. > > …**as fast as we actually put the capacity in, it's being consumed. So, you know, I think we could be helping more customers and driving more revenue for the business if we had more capacity…**I expect that, you know, there are other parts of the supply chain that that are a little bit jammed up as well, you know, motherboards and some other componentry, some of that is just because there is so much demand right now. But I do believe that the supply chain issues and the capacity issues will continue get better as the year proceeds. **Opex+Capex** Just like other big tech, Amazon’s capital intensity continues to increase as well. Capex as a percentage of revenue was \~16% in 1Q’25 (vs \~10% in 1Q’24). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8627fad8-6a02-45f2-8474-6503e8d82b10_1453x316.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** Amazon’s guidance for 2Q’25 is below. Please note consensus 2Q’25 revenue and EBIT before the call were $161 Bn and $17.7 Billion respectively. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fda40c2e5-b0ae-4c6a-b418-e6f0ed28b49d_1044x237.png) Source: Company Filings **Closing Words** I agree with Jassy’s characterization that even in a deteriorating tariff scenario, my best guess would be Amazon retail would fare okay and may even gain share. Of course, they can still be hurt if consumer spending goes down in a recession scenario, but I feel comfortable about Amazon retail’s competitive position which is more important to me as a long-term shareholder than guessing how tariff will affect this year’s EPS. On AWS side, while the margins are quite eye popping, I expected to see them grow faster, especially in light of the increasing capex spending. These things can be lumpy and as Jassy mentioned in the call, it isn’t a question about demand. I intend to stay invested, and if I decide to deploy some capital over the next month, Amazon would be on top of my list. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Meta 1Q'25 Update URL: https://www.mbi-deepdives.com/meta1q25/ Last updated: 2025-05-01T03:00:58.000Z *Disclosure: I own shares of Meta Platforms* > Our goal is to make it that any business can basically tell us what objective they're trying to achieve, like selling something or getting a new customer and how much they're willing to pay for each result and then we just do the rest…if we deliver on this vision, then over the coming years, I think that the increased productivity from AI will make advertising **a meaningfully larger share of global GDP than it is today**. > > \-Mark Zuckerberg (1Q’25 Earnings Call) Digital advertising has surpassed the days of “[Mad Men](https://en.wikipedia.org/wiki/Mad%5FMen?ref=mbi-deepdives.com)” a while ago and thanks to AI, it seems even better positioned to unlock new markets and more opportunities. Meta is, of course, one of the companies leading this march. Here are my highlights from today’s call. [Subscribe](#/portal/signup) **Users** Daily Active People (DAP) across its Family of Apps (FOA) accelerated to 80 mn QoQ in 1Q’25\. I wonder when Zuckerberg starts to get concerned about the fertility crisis as well since Meta may run out of people to sign up for their products in a few years! (only half-kidding) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F97d6e77c-ad77-4ab3-8a41-494a963c04ac_1825x93.png) **Ad revenue by Geography** You can take a look at the table below and tell these numbers are quite impressive, but let me contextualize how impressive they are, especially in light of Google’s numbers. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffe7e9c5a-8994-4617-a566-5a9b38b46dfd_1933x337.png) Google advertising’s incremental revenue was $5.2 Bn in 1Q’25 YoY (of which Google Search added $4.5 Bn). Meta’s Family of Apps (FOA) ad business generated $5.8 Bn incremental revenue! FOA’s growth has now surpassed Google’s even from pre-ATT days. Imagine facing an existential crisis and then come out stronger than ever before…a true sign of antifragility! ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fcc25689b-baef-40ae-82d3-e4ae0a5cd2a2_706x145.png) **Ad Impression and Avg. Price Per Ad** I know a lot has been said about Google’s paid click growth of just 2% in 1Q’25\. Meta’s ad impression growth was 5% YoY. On one hand, I think it makes Google’s number look more okay than many might think. On the other hand, Meta just seems to have more unmonetized impressions they can unleash if they ever feel too saturated. For example, Threads is just starting to monetize with 350 Mn MAUs. In the call, they also mentioned “tens of billions of views of status posts on WhatsApp each day”. I know they don’t monetize these via ads, but never say never. I wouldn’t be surprised if they eventually decide to monetize these; I’m obviously not suggesting anything in the near term but think long term i.e. 5-10 years and I sense it gives us more margin of safety in growth runway at Meta (vs Google). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5ca88659-3f2c-4b98-b26f-266f3741b50e_1060x496.png) This call also again **drove the point home** how AI is such a big deal in digital advertising and why even if impression growth stalls, we may have decent runway just by improving monetization of current impressions: > In just the last quarter, we are testing a new ads recommendation model for reels, which has already **increased conversion rates by 5%**. And we're seeing 30% more advertisers are using AI creative tools in the last quarter as well. > > we continue to see **conversions grow at a faster rate than ad impressions** in Q1, so reflecting **increased conversion rates** and ads ranking and modeling improvements are a big driver of overall performance gains. > > we continue to evolve our ads platform to drive results that are optimized for each business' objectives and the way they measure value. One example of this is our incremental attribution feature, which enables advertisers to optimize for driving incremental conversions or conversions we believe would not have occurred without an ad being shown. We're seeing strong results in testing so far, with advertisers using incremental attribution in tests, **seeing an average 46% lift in incremental conversions** compared to their business as usual approach. We expect to make this available to all advertisers in the coming weeks. **Segment Reporting** Overall 1Q’25 revenue was +16.3% YoY (\~**19%** on constant currency). FOA’s “other revenue” was +34% YoY which was driven by business messaging and Meta verified subscriptions (I don’t think Meta called out “verified subscriptions” as growth driver until this quarter. Of course, it’s probably meaningless given the scale of ads business) FOA continued to post >50% operating margins. For Reality Labs, another quarter of $4 Billion losses! More embarrassingly, revenue **declined** YoY! I know Meta is re-allocating a lot of expenses to AR glasses. I wonder if Meta is very close to admitting “defeat” in VR and scaling down their investments substantially by the end of 2026 if AI advancements don’t lead to sustained acceleration in VR in the next few quarters. AR likely deserves continued investments, so I don’t expect the Reality Losses to reverse course anytime soon even if they scale down investments in VR. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8984d12f-17a7-401d-b19c-d4cfe0b3c438_2098x549.png) **AI** Some quotes from the call all of which are good evidence for ROI on Meta’s AI investments: > In the last 6 months, improvements to our recommendation systems have led to a **7% increase in time spent on Facebook, a 6% increase on Instagram and 35% on Threads.** > > Over the long term, as AI unlocks more productivity in the economy, I also expect that **people will spend more of their time on entertainment and culture**, which will create an even larger opportunity to create more engaging experiences across all of these apps. > > We began testing using Llama in Threads recommendation systems at the end of last year given the app's text-based content and have already seen a **4% lift in time spent from the first launch**. It remains early here, but a big focus this year will be on exploring how we can deploy this for other content types, including photos and videos > > we shared on the **Q3 2024 call that improvements to our AI-driven feed and video recommendations drove a roughly 8% lift in time spent on Facebook and and a 6% lift on Instagram over the first 9 months of last year. Since then, we've been able to deliver similar gains in just 6 months' time, with improvements to our AI recommendations, delivering 7% and 6% time spent gains on Facebook and Instagram, respectively.** **Meta AI** Meta AI monthly actives reached 1Billion (vs 700 million in 4Q’24 and 500 million in 3Q’24). While by this metric Meta AI looks better than even ChatGPT, I wouldn’t be surprised if number of conversations on Meta AI is not even 20% of ChatGPT gets today. What are the top use cases? > The top use case right now for Meta AI from a query perspective is really around information gathering as people are using it to search for and understand and analyze information followed by social interactions from, ranging from casual chatting to more in-depth discussion or debate. We also see people use it for writing assistance, interacting with visual content, seeking help. And we see Meta -- people engage with Meta AI from several different entry points. WhatsApp continues to see the strongest Meta AI usage across our Family of Apps. Most of that, WhatsApp engagement is in one-on-one threads, followed by Facebook, which is the second largest driver of Meta AI engagement, where we're seeing strong engagement from our feed deep dives integration that lets people ask Meta AI questions about the content that's recommended to them. How is Meta AI different from all the other chat bots out there? > I'm not sure that people are going to use multiple agents for the same exact things, but I'd imagine that something that is more focused on kind of enterprise productivity might be different from something that is somewhat more optimized for personal productivity and that might be somewhat different from something that is optimized for entertainment and social connectivity. So then there were different experiences. One of the trends that I think we're starting to see now is personalization across these. Right now if the experience is unpersonalized then you can kind of just go to different apps and get reasonably similar answers to different questions. > > But once an AI starts getting to know you and what you care about in context and can build up memory from the conversations that you've had with it over time, I think that will start to become somewhat more of a differentiator. While ChatGPT is certainly a productivity amplifier, it also very much satisfies a lot consumer use cases as well. And like Zuck said, it can definitely know me well and personalize the responses over time. I’m not super convinced yet that I will use different chat bots based on different query types. Given OpenAI is still figuring out how to monetize free users and doesn’t have as prodigious cash flows as Google/Meta does, I wonder if the fight for the next 500 million users will be more closely fought than the first 500 million users was. In this call, Meta did indicate that they will lean to their usual playbook of ad based model to monetize Meta AI: > Our focus for this year is deepening the experience in making AI the leading personal AI with an emphasis on personalization, voice conversations and entertainment. I think that we're all going to have an AI that we talk to throughout the day, while we're browsing content on our phones, and eventually, as we're going through our days with glasses. And I think that this is going to be one of the most important and valuable services that has ever been created. In addition to building Meta AI into our apps, we just released our first Meta AI stand-alone app. It is personalized. So you can talk to it about interests that you've shown, while browsing reels or different content across our apps. And we built a social feed into it. So you can discover entertaining ways that others are using Meta AI. And initial feedback on the app has been good so far…**I think that there will be a large opportunity to show product recommendations or ads as well as a premium service for people who want to unlock more compute for additional functionality or intelligence**. But I expect that we're going to be largely focused on scaling and deepening engagement for at least the next year before we'll really be ready to start building out the business here. **Facebook, and Instagram** > In the first quarter, we saw strong growth in video consumption across both Facebook and Instagram, particularly in the U.S., where **video time spent grew double digits year-over-year.** **Messaging** Some good color on messaging opportunity: > …there are now **as many messages sent each day on Instagram as they are on Messenger** > > …business messaging should be the next pillar of our business. In countries like Thailand and Vietnam, where there is a low cost of labor, we see many businesses conduct commerce through our messaging apps. **There's actually so much business through messaging that those countries are both in our top 10 or 11 by revenue, even though they're ranked in the 30s in global GDP**. This phenomenon hasn't yet spread to developed countries because the cost of labor is too high to make this a profitable model before AI, but AI should solve this. **Threads** Threads Monthly Active Users (MAU) over time: 3Q’23: 100 Million 4Q’23: 130 Million 1Q’24: 150 Million 2Q’24: 200 Million 3Q’24: 275 Million 4Q’24: 320 Million 1Q’25: 350 Million MAU growth has decelerated a bit here. **AR** > Ray-Ban Meta AI glasses have **tripled** in sales in the last year. > > We're seeing very strong traction with Ray-Ban Meta AI glasses, **with over 4x as many monthly actives as a year ago, and the number of people using voice commands is growing even faster as people use it to answer questions and control their glasses.** **Capital Allocation** Interesting to see Meta was much more aggressive in 1Q’25 in buying back shares (vs last quarter). They haven’t filed 10-Q yet, but I will be curious to see the prices at which they bought back these shares given both the upside and downside volatility the stock experienced in the quarter. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd98708eb-beb7-4389-b027-d36aad43c559_2088x316.png) **Capex and Opex** Looking at this table below, I wondered in which year Meta’s (and other big tech) depreciation expense may surpass their employee compensation expense! At the pace big tech is spending on capex, maybe it’s not as nonsensical as it may seem at first glance. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0d7c7b01-a223-417c-96df-0e2ca78f6762_2091x105.png) **Regulation** > The European Commission recently announced its decision that our subscription for no ads model is not compliant with the DMA. Based on feedback from the European Commission in connection with the DMA, we expect we will need to make some modifications to our model, which could result in a materially worse user experience for European users, and a significant impact to our European business and revenue as early as the third quarter of 2025\. We will appeal the commission's DMA decision, but any modifications to our model may be imposed before or during the appeal process. Meta later clarified that it would affect 16% of their overall revenue. There is not much merit to EU’s logic and it is clearly hostile to US tech companies as many EU companies do exactly what Meta has done. I would expect current US admin to not look the other way if US big tech is treated such a way by EU or anyone else in the world. **Outlook** Meta guided 2Q’25 revenue $42.5 Bn to $45.5 Bn (1% FX tailwind). Consensus is $43.8 Bn. They also guided opex range down a bit from $114-119 Bn to $113-118 Bn. However, capex guide was increased: > We anticipate our full year 2025 capital expenditures, including principal payments on finance leases will be in the range of $64 billion to $72 billion, increased from our prior outlook of $60 billion to $65 billion. This updated outlook reflects additional data center investments to support our AI efforts as well as an increase in the expected cost of infrastructure hardware. The majority of our CapEx in 2025 will continue to be directed to our core business. **Closing Words** Overall, this was a super impressive quarter and the guidance is reassuring even in the volatile tariff environment. The takeaway is pretty clear: Meta is very well positioned in navigating and riding along the secular theme of AI. It’s not just Meta of course; when I looked at Microsoft’s numbers tonight, perhaps the real surprise to me is the volatility that the big tech stocks routinely experience every now and then despite having such rock solid underlying business, growth, profitability, and balance sheets. Meta trades at below 25x NTM P/E even after \~5% AH rally, so the valuation is quite reasonable as well. I intend to stay invested. Having said that, I am somewhat disappointed at Meta’s recent missteps in Llama and Zuck’s somewhat [disingenuous](https://x.com/modestproposal1/status/1917593373705150892?ref=mbi-deepdives.com) explanation later. I don’t think Meta necessarily needs to have the best model for the stock to do well for long-term shareholders, but it does make me think whether the company may be losing their usual execution muscle a bit. I will cover **Amazon’s** earnings **tomorrow**. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Synopsys: Harnessing Complexity URL: https://www.mbi-deepdives.com/snps/ Last updated: 2025-04-25T12:44:37.000Z _This post is for paying subscribers only._ ### Alphabet 1Q'25 Update URL: https://www.mbi-deepdives.com/goog1q25/ Last updated: 2025-04-25T01:45:12.000Z *Disclosure: I own shares of Alphabet* While Google continues to fend off concerns related to long-term future of search, Alphabet’s business keeps chugging along. Here’s my highlights from today's earnings. [Subscribe](#/portal/signup) **Revenue** On an FX adjusted basis, Alphabet increased its revenue by 14% in 1Q’25 (\~200 bps headwind from FX). For the **11th** consecutive quarters, Google network’s revenue went down. Just when regulators are lambasting Google for their network business in court, it keeps dwindling to oblivion. If Google just spins it off to get rid of the legal hassle, that’s probably an even worse news for the open web. Eric Seufert today made a [compelling](https://stratechery.com/2025/an-interview-with-eric-seufert-about-digital-advertising-during-political-uncertainty/?ref=mbi-deepdives.com) case to publishers: *“be careful what you wish for”*. Both Search and YouTube ads grew by 10% YoY. To appreciate YouTube’s momentum, we may increasingly have to rely on “Subscription, platform, and devices” revenue (formerly known as “Google other” segment). More on this later. Google Cloud is now at almost $50 Billion revenue run-rate, growing at an incredible \~28% YoY in 1Q’25. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5824a569-f125-441b-8af5-d22241661707_1768x364.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Take a look at growth rates by segment over the last 13 quarters. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffa079e84-e9f4-494e-9274-9b28eb2d8419_1603x313.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **EBIT** Google continues to post pretty unbelievable margins. Both Google Services and Google Cloud posted their highest ever operating margins. Google Services had another mind-boggling \~70% incremental margin quarter. It’s easy to forget but almost everyone expected the opposite to unfold since ChatGPT came to the scene. With monetization headwind from AI and rising cost per query, it certainly surprised me how much Google was able to expand its margins. For context, Google posted \~30% operating margin in 4Q’22 when ChatGPT was released. They just posted \~42% operating margin for Google Services. Couple of things helped expand margins: a) the persistent decline of Google network business which has the highest TAC rate and likely one of the lowest margin business for Google Services; and b) the increase of depreciation schedule over the last few years. Google, of course, also enhanced its focus on “durably reengineering the cost base”. The fact that sales & marketing expense was down 4% in 1Q’25 is a good evidence to that approach. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff4d055d0-b130-4c96-803d-dbd0ea5ddb3f_1687x468.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ## **Search** Some interesting quotes on Search from the call; I will include my comments/notes in the parentheses: > …AI Overviews is going very well with over **1.5 Billion users** per month and we are excited by the early positive reaction to AI mode. > > …We released Gemini 2.5 Pro last month, receiving extremely positive feedback from both developers and consumers. 2.5 Pro is state of the art on a wide range of benchmarks and debuted **at number one on the chatbot arena by a significant margin**. (**Note**: it definitely feels Google got its mojo back in model development. It’s TBD whether it is noticeable enough for consumers to care as OpenAI seems to be still better in productizing the model. My guess is it may matter if Google consistently continues to lead and actually ends up increasing the lead over time. Other than that, models may remain mostly commodity and they will have to just capitalize on their existing distribution to compete against OpenAI and others) > > …On average AI mode queries are **twice as long as traditional search queries**. We're getting really positive feedback from early users about its design, fast response time and ability to understand complex nuanced questions. We also continue to see significant growth in multimodal queries. Circle to Search is now available on more than 250 million devices (**Note**: mentioned to be 200 million last quarter) with usage increasing nearly **40% this quarter**. And monthly visual searches with Lens have increased by 5 Billion since October. > > …with the launch of AI Overviews, the volume of commercial queries has increased. Q1 marked our largest expansion to date for AI overviews, both in terms of launching to new users and providing responses for more questions. > > …For AI overviews overall, we continue to see **monetization at approximately the same rate**. (**Note**: this was also mentioned in last quarter, so not a new info) > > …In Q1, the number of people shopping on Lens grew by over 10% and the majority of Lens queries are **incremental**. > > …Thanks to dozens of AI part improvements launched in 2024, businesses using DemandGen now see an average 26% YoY increase in conversions per dollar spent for goals like purchases and leads. And when using DemandGen with product feed, on average, they see more than double the conversion per dollar spent year over year. > > …We are continuing to make a lot of progress there in terms of people using coding suggestions. I think the last time I had said the number was like 25% of code that's checked in. It involves people accepting AI solutions. **That number is well over 30% now.** > > …Search and Gemini obviously will be **two distinct efforts**, right? I think there are obviously some areas of overlap, but they're also you know, like expose very, very different use cases. And so, for example, in Gemini, we see people iteratively coding and going much deeper on a coding workflow, as an example. So I think **both will be around**. Within Search, would think of AI overviews scaling up and working for our entire user base, but an AI mode is the tip of the tree for us pushing forward on an AI forward experience. There will be things which we discover there which will make sense in the context of AI overviews, so I think will flow through to our user base. But you almost want to think of what are the most advanced 1 million people using Search for, the most advanced 10 million people, and then how do 1 billion people use Search for. And we want to innovate and so I think this allows us to do that. But the **true north star through all of this is user feedback, user satisfaction, user experience**. From personal perspective, LLM feels like a mix of productivity and search tool. So, the surface area of long-term potential does feel pretty wide. I think it makes sense for now to approach these from multiple angle to gauge what resonates with the users the most. ### **YouTube** > “YouTube now has over 1 Billion monthly active podcast users. YouTube Music and Premium reached over 125,000,000 subscribers, including trials globally.” I wish Google stopped including the trials in their subscriber numbers. Just report the paying subscriber number! ### Subscriptions, Platforms, and Devices Google announced they not have 270 million subscribers! Back in 1Q’22, both YouTube ads and the then “Google other” (now “subscription, platforms, and devices) segment had \~$6.8 Billion revenue. Three years later, this segment just reported \~$1.5 Billion more revenue than YouTube ads in 1Q’25\. Google mentioned this growth is primarily driven by YouTube and Google One subscriptions. If Google can maintain its recent momentum in releasing SOTA models, I think Google One can be a pretty large business for them. Their [offering](https://x.com/borrowed%5Fideas/status/1911436715111419991/history?ref=mbi-deepdives.com) is quite compelling! Search’s long-term future can be hard to decisively answer, and while Google may be too dependent on search advertising revenue, I think they have plenty of defense to remain relevant for a long time: > All 15 of our products with a half a billion users now use Gemini models. Android and Pixel are two examples of how we are putting the best AI in people's hands, making it super easy to use AI for a wide range of tasks just by using their camera, voice or taking a screenshot. ### **Google Cloud** Google Cloud more than doubled its revenue in just three years as it grew from $5.8 Billion in 1Q’22 to $12.3 Billion in 1Q’25\. Just as Google cloud grew its revenue by 28%, one interesting thing that I noticed is when AWS had \~$12 Billion quarterly revenue in 4Q’20, they also grew revenue by 28%. Two years ago, I [mentioned](https://www.mbi-deepdives.com/goog/) that Google Cloud’s revenue tends to mirror AWS revenue four years apart, but I was skeptical that it would continue. So far, Google cloud is largely still keeping pace with AWS four years apart. I will discuss more on Cloud when Amazon posts later this week. Management reiterated that demand-supply is still not in an equilibrium: > …we're in a tight demand-supply environment and given that revenues are correlated with the timing of deployment of new capacity, we could see variability in cloud revenue growth rates depending on capacity deployment each quarter. > > …We expect relatively higher capacity deployment towards the end of twenty twenty five. ### **Capital Allocation** In 1Q’25, Google returned 92% of their FCF to shareholders through buyback and dividend. Share count declined by 46 bps QoQ. They also increased dividend by 5% going forward. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fec0e3393-dd95-4500-a9b5-822f90a918a2_679x628.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ### **Capex and Opex** Management re-iterated that they expect capex to be $75 Billion in 2025\. My sense is no matter what happens in the economy, we will see $75 Billion capex this year, and the real impact of economic situation will sway their capex plan in 2026. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0f104c90-a3ff-47dd-aa45-9a67dac301cd_1605x238.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ### **Outlook** Google doesn’t provide guidance, but did remind the headwind from “APAC based retailers” and the tsunami of depreciation expense that’s coming: > With regard to Q2, we're only a few weeks in, so it's really too early to comment. I mean, we're obviously not immune to the macro environment, but we wouldn't want to speculate about potential impacts beyond noting that the changes to the de minimis exemption will obviously cause a slight headwind to our ads business in 2025 primarily from APAC based retailers. > > We had about a 31% year over year growth in depreciation this quarter and it will be higher as we go throughout the year. So think about that kind of as a headwind that we have to manage against. ### **Valuation** Since [3Q'22](https://mbideepdives.substack.com/p/goog3q22?utm%5Fsource=publication-search), I share the following valuation framework every quarter. The Services business seems to be currently priced at \~15x LTM EBIT, (a segment that has grown EBIT by 14.1% CAGR over the last three years) and Google Cloud at \~5x run-rate revenue. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1f635f0b-8de5-443f-a5ef-065f1da87491_1840x379.png) I will publish my Deep Dive on **Synopsys** tomorrow, and will cover the other big tech earnings next week. Thank you for reading. **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Portfolio Discussion URL: https://www.mbi-deepdives.com/portfolio-discussion/ Last updated: 2025-04-08T00:32:57.000Z _This post is for paying subscribers only._ ### Back to Google! URL: https://www.mbi-deepdives.com/googl/ Last updated: 2025-04-05T02:07:08.000Z There's a popular meme on Twitter that goes like this: *"I'm starting to be a real believer in AI. Will be a megatrend like no one is really imagining right now. I'm sure lots of ramps and drops along the way though"* Like any good meme, there is indeed an ounce of truth to it. Maybe not an ounce; I actually think there is likely to be a lot of truth to it. However, as former Bernstein Internet Analyst [Corry Wang](https://x.com/corry%5Fwang?ref=mbi-deepdives.com) (who is incidentally currently at Google AI Strategy team) [put it](https://x.com/corry%5Fwang/status/1300635628460220418?ref=mbi-deepdives.com) : *"There is a misguided obsession in many tech circles around predicting the future of technology. In contrast, I would posit that predicting the future is actually pretty easy - the hard part is making any money on it."* Indeed, a couple of years ago, it was somewhat easy to foresee that the narrative around the future of search would likely continue to sour. It did, but the details have been somewhat more difficult to be right about. For example, since the rise of GenAI and chat bots, one common concern has been a potential double whammy for incumbents such as Google i.e. GenAI queries are harder to monetize and at the same time, the cost to serve such queries would be materially higher than traditional search queries. I doubt anyone was expecting Google's operating margin would go **higher** from 30.6% in 2021 to 32.1% in 2024\. I myself thought Google Services operating margin in 2021 might be "peak margin" for Google as they would have to navigate much higher cost to serve queries and lower monetization phenomenon (admittedly, part of this margin expansion was due to extending depreciation schedule, but even if you adjust that, 2021 and 2024 Google Services operating margin would be somewhat similar). What actually happened was Google reduced cost to serve these GenAI queries by 90% in 18 months through " hardware, engineering and technical breakthroughs" (3Q'24 call). Moreover, Google has stumbled onto new query markets e.g. in 4Q'24 call, they mentioned how lens is used for 20 billion visual search queries, majority of which are **incremental**. How about monetization of these GenAI queries? It's less reassuring so far, but in 1Q'24 call Google management mentioned *"based on our testing so far, I'm comfortable and confident that we'll be able to manage the monetization transition here well as well."* This isn't a Deep (or even shallow) Dive on Google, so I'm not going to focus much on numbers or try to address/discuss all the Google related concerns (read this [piece](https://www.mbi-deepdives.com/goog/) if you're more interested in numbers; I may also do an update later in the year). Look, when I [sold](https://x.com/borrowed%5Fideas/status/1732083595874009587?ref=mbi-deepdives.com) Google in December 2023, I did mention I expect search to go through a significant transformation in the next 10-15 years. It's always dangerous to change your mind on something in two years that you expect to play out over much longer period. I still have plenty of sympathies for search related concerns. And even from personal perspective, while it is true that Google did lose my query share mostly to OpenAI, Google hardly lost any of my monetizable query share. However, if you want to disrupt Google, you always were going to disrupt the non-monetizable queries first and then work your way to monetizable queries later. So, I am certainly not claiming Google to be out of the woods yet. My appreciation of the risk is certainly why I made Google only a 3% position so far with an average cost of $150\. I will pay close attention to price and broader developments in AI before sizing it up more. However, I do want to mention a couple of things to give you a sense what prompted to change my mind. Let me be very frank. When I sold Google in 2023, I hardly knew much about semiconductors and I knew even less about TPUs. As I gained a bit more [understanding](https://www.mbi-deepdives.com/models/) over the last 15 months, I started appreciating there are certainly scenarios in which Google's deep infrastructure advantage and breadth of existing relationship with users can mask almost all of their weaknesses. I have been following big tech since 2018-19 fairly closely and it never became easier to predict how the narratives will shift just in 2-3 years down the line. Just imagine trying to predict the narrative around Meta today back in 2022 (or "Apple 2021 narrative" back in 2018). I certainly do not rule out the possibility that search can chug along just fine, and thanks to Google's almost end to end control over their infrastructure (unfortunately, they still do have dependency on TSMC for fabricating TPUs), Google's narrative can change materially especially in the post-regulatory clarity era. I am not super confident in predicting how the big debates will be settled in AI, but it does seem there is a distinct scenario in which Google can potentially be materially ahead of everyone else in 5 years. Outlining the exact path is hard to do, but I have come to the view that while the search related debates consume all the airtime, most investors are potentially missing or underappreciating a scenario in which Google may just topple everyone else by leveraging their infrastructure advantage. But isn't Google pretty bad at productizing their AI advancements? They have already deployed quite impressive models and capabilities, but if they're bad at productizing it, will this infrastructure advantage matter at all? While I was pondering about the point about infrastructure advantage for almost a year now, the recent Sharp Tech podcast [episode](https://open.spotify.com/episode/7dkl5Eshi4HV2USY4UleEp?si=dac0253f554540d0&ref=mbi-deepdives.com) really drove the point home and also reminded me why Google may be able to succeed **despite** its weakness in productizing model capabilities. A listener of the pod sent the following musing for Ben and Andrew: *"When exactly was Google good at building new products? The answer is never. Google has always sucked at building new products. Consider the epic failures of Google Buzz, Wave and Plus or G chat, and Google Hangouts.* *Google was only ever successful at innovating and building one of the following three things:* *•Google search* *•A critical infrastructure required and custom tailored for Google search.* *•Products where search-like characteristics, huge scale, and a data flywheel turned out to be critical for success.* *Google pioneered amazing concepts such as map reduce, batch processing, zero trust security, containers, software defined networking to name a few. However, it sucked when it came to wrapping them as general purpose infrastructure products. This goes back to the famous 2011* [*Stevey's platform rant*](https://gist.github.com/chitchcock/1281611?ref=mbi-deepdives.com)*.* *Stevey's platform rant predicted so well why Google Cloud Provider was destined to lag behind AWS. This is also why despite employing a phenomenal collection of talent with security researchers and engineers, Google could never have built a product like Wiz for external use. All of this is to say, I don't think there's anything new going on. Maybe this is just Google being Google, the awkward nerd that gains his advantage by staying up in the data center all night figuring out how to stack 20 times more servers compared to Inktomi who occupied the cage next door. Of course, OpenAI has the better polished product. That was never Google's advantage. And if that's what what it takes to win an AI, then well, Google is just not going to win. Not now and not ever in its history.* *The only hope is if it turns out AI models aren't a commodity. Search engines were considered a commodity back in the Inktomi, Alta Vista days very much like LLMs today. Google's only hope is if just like in the early 2000s, *it turns out the consensus is wrong and there is a sustainable long-term advantage to be gained by better infrastructure engineering.**" But is this a good time to buy Google when majority of the revenue is largely dependent on advertising revenue given the recently introduced tariffs may even cause a global recession? Tariffs are certainly a risk, but let me offer some brief thoughts on them. Let me provide a historical analogy that I think can have some resemblance to today. Imagine we are in late 2001 to early 2002\. Tech bubble just crashed and people just experienced 9/11\. I bet 9/11 consumed almost all of our attention (and rightly so), and perhaps more and more people started laughing at people who thought internet would revolutionize everything. In my mind, these tariffs (if they remain unchanged) are like 9/11 i.e. incredibly impactful for the world and will certainly affect us in ways we may not be realizing today, just as 9/11 did. But from purely long-term market perspective, 9/11 wasn't the main story that mattered; what mattered was the internet. Today's "internet" is "Generative AI". In a decade (likely lot sooner), it is much more likely than not that Gen AI will be dominant driver of the market, and while tariffs may be impactful in the meantime, they are mostly going to be adapted and absorbed by different stakeholders in the value chain. Google, Meta, Amazon have all been down 30% from their highs. I have started deploying my capital to all of them today (3% Google at $150, and adding more to my existing Amazon and Meta positions: 1% Amazon at $168, 1% Meta at $500). I am keeping an eye on Microsoft as well, but haven't pulled the trigger yet. I expect myself to buy more if stocks keep going down. There is a very good probability that people may "forget" about AI amidst the tariff tantrum, but I am of the opinion that might lead to a compelling opportunity to steer my portfolio to the future of the world even more. [Subscribe](#/portal/signup) ### April, 2025 Update URL: https://www.mbi-deepdives.com/april-2025-update-2/ Last updated: 2025-04-01T14:28:52.000Z Just a couple of quick updates for this month: I am going to publish my Deep Dive on **Synopsys** by 28th of this month. I know I mentioned before that I would cover ASML this month, but I am shifting ASML to next month as I wanted to study an EDA tools company first. For this month's "Never Sell" podcast episode, David Kim from [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I discussed Adobe. ([Spotify](https://open.spotify.com/episode/2TnWaXDtZZwnYWHUVPdCe0?ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell-episode-4-adobe/id1786912203?i=1000701577625&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=qXzTX5ive1A&ref=mbi-deepdives.com), [RSS Feed](https://feeds.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com)). I have also uploaded an updated Adobe model for the paying subscribers at the end of this post. Finally, for new subscribers, I would like to let you know that you can access the full library of Deep Dives, including excel models, [here](https://www.mbi-deepdives.com/models/). Thank you for your support! [Subscribe](#/portal/signup) --- **ADBE Updated Model:** [ADBE Mar 29, 2025ADBE Mar 29, 2025.xlsx2 MBdownload-circle](https://www.mbi-deepdives.com/content/files/2025/04/ADBE-Mar-29--2025.xlsx "Download") ### Lululemon 4Q'24 Update URL: https://www.mbi-deepdives.com/lulu4q24/ Last updated: 2025-03-28T00:30:36.000Z *Disclosure: I own January 2026 $165 Call Options* Since its IPO back in 2007, Lululemon always posted double-digit revenue growth every single year. While there was plenty of skepticism throughout 2024, they managed to eke out double digit growth last year. But 2025 topline guidance of 5-7% implies the era of persistent double digit growth regardless of the economy is likely behind us! Here are my highlights from the quarter. [Subscribe](#/portal/signup) **Sales Growth by Region** After three quarters of anemic growth in the US, Lulu managed to post MSD growth in the US in 4Q’24\. Canada was double digit. China remains on a different growth stratosphere and even Rest of the World (RoW) segment’s growth was \~30% last quarter. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc971f881-11c8-4f0a-9710-32a1e0282c08_1158x564.png) Lulu’s struggle in the US was mostly due to lack of its newness last year which they have largely corrected now: > “Looking at quarter one, **we have increased our level of newness on par with the past.** We believe this increase along with a robust pipeline of innovation will enable us to meet the expectations of our guests and I'm excited about what the product teams are bringing to market this spring throughout the year. We started the year strong with the launch of several new innovations. > > **Initial response has been very strong and we've been selling out across several sizes and colors**. The teams are chasing into it now and we have several additions planned for later this year. Based on this response and performance, **we believe Daydrift become a new core franchise**.” While Lulu talked about increased newness, they guided for LSD-MSD revenue growth in the Americas; to be more specific, they expect US to be closer to the lower end of the range and Canada to be on the higher end. Why such lackluster growth despite the increased newness? > we started this year with several compelling new product launches, but we also believe the dynamic macro environment has contributed to a more cautious consumer. In fact, based on a survey we conducted earlier this month in conjunction with Ipsos, **consumers are spending less due to increased concerns about inflation and the economy**. **This is manifesting itself into slower traffic across the industry in The U. S.** **in Q1 which we are experiencing in our business as well**. However, we see guests who visit us responding to the newness and innovations we brought into our assortment. We believe this is a positive indication as we continue to flow new product engage with our guests through unique and compelling activations and launch brand campaigns. We are controlling what we can control and we expect to see modest growth in U. S. Revenue for the full year of 2025. Later, they clarified it’s mostly a US thing and they haven’t seen similar traffic trend in other regions: > “So in terms of traffic, I would say the notable trend we saw was that shift in The U. S. Nothing materially different in terms of either Canada or the international markets. I would call out just the difference in Lunar New Year timing, a shift in the timing this year. Have a little bit of a headwind on Q1 in terms of our China trend and overall international. And then in terms of U. S. Regional, we aren't seeing any meaningful differences regionally” Lulu emphasized that their new guest acquisition is still strong and when guests arrive at the store, their conversion and average order size has increased; so it’s the decline in traffic itself that warranted the caution for the guide. In their guide, they assume Q1 traffic trend to continue which means they don’t expect improvement or further deterioration in traffic trend from here. Their guide for other regions remains healthy: China \~25-30% and RoW at \~20%. Also, if you look at the comps for the US, Q2 and Q3 were pretty weak last year, so if traffic improves later in the year, that can boost their US revenue growth. But at their current size, it is quite clear they cannot be insulated from broader macro trend. Lulu emphasized the long-term opportunity is still there given low unaided awareness across the world: > our unaided brand awareness in France, Germany and Japan is in single digits In China Mainland, it's in mid to high teens In The UK and Australia, it's in the 20s And in The U. S, unaided brand awareness is in the 30s. **Margin** In 4Q’24, Lulu’s operating margin was more or less flat YoY in Americas but China and RoW margins were comfortably up. I would highlight RoW’s margin progression throughout the year. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F19808bf0-7574-4151-bf1a-434cd94d3f69_865x267.png) Lulu’s gross margin in 2024 was 59.2% and and operating margin was 24.3%, both at or near all-time high for the company. Given the lower revenue growth in Americas, it is impressive that they were able to improve margins for the overall company, mostly thanks to operating margin expansion of 250 bps in China and 460 bps in RoW. I would highlight though that Lulu’s spending on advertising as % of sales increased from 4.1% in 2022 to 4.5% in 2023 to 5.1% in 2024\. Such increased spending may be indicative of higher competitive intensity. As a side note, in my recent visit to LA, I would guesstimate the number of people I noticed wearing Alo and Lulu was almost 50-50\. Despite the competitive intensity, Lulu’s product gross margin did improve by 40 bps in 2024 in Americas, but the higher SG&A led to 50 bps decline in operating margin last year. After hearing Lulu’s plan to more community activation planned throughout this year, I think Lulu will keep their marketing spending intensity and mostly look for other areas to maintain/improve operating margins. **Sales by Gender** Women’s segment returned to double digit growth in 4Q’24\. Both men and other segment also grew at low to high teen despite tough comps. I am somewhat disappointed that Lulu couldn’t make much inroads in shoes, especially in light of Nike’s woes. They are still trying to test out products here, but given that they haven’t been mentioning anything about shoes during the call tells me these experiments haven’t quite gone well. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffcc3ed76-d2d7-4545-b695-78ce53e43bb3_1159x255.png) **Inventory** Even though Lulu guided inventory to increase by low double digits, it grew by 9%. They, however, guided for high-teen inventory growth for Q1 as they chase the newness. Tariff is assumed to be 20 bps headwind this year. **Capital Allocation** Lulu maintained their buyback intensity throughout last quarter. As you can see below, their buyback intensity varies materially over time which implies their activity is somewhat indicative of management’s opinion on the stock. Their actions suggest management continues to think the stock is quite attractive as they repurchased $332 million last quarter. They still have $2 Bn cash on the balance sheet, and given the stock price today and how cash generative this business is (they generated $3.2 Bn cumulative FCF in last two years), I expect buyback activity to continue unabated for the coming months. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F67817faa-e6cb-497e-a26d-dd6a8f3fb89d_496x592.png) Thanks to these buybacks, Lulu’s shares outstanding declined by 3.7% YoY in 4Q’24. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F14cf470a-a6e4-48eb-ae07-a42bfb9c6c3a_949x391.png) **Outlook** I have already somewhat touched on the outlook, but here’s a more granular breakdown: For 2025, topline guide is $11.15-11.3 Bn, implying \~5-7% YoY growth. If you exclude the 53rd week impact, this implies \~7-8% growth. FX is assumed to 100 bps headwind. Gross margin is expected to be down 60 bps, driven by deleverage on fixed cost, FX, and tariff impact. Operating margin is expected to be down \~100 bps, but half of the decline is driven by FX headwind). EPS guide for 2025 is $14.95-15.15 vs $14.64 in 2024, implying only 2-3.5% growth. Please note FX is assumed to be $0.3-0.35 drag this year. **Final Words** After last year’s uninspiring growth in the US, I came to 2025 hoping Lulu’s US business will pick up the pace this year as they introduce more newness to their products. Unfortunately, with potential macro softness it appears we may be set for longer wait for the US business to get back to MSD-HSD growth. In my [interview](https://open.spotify.com/episode/0MOQhtHLwYOUQ8QaCmnoHl?si=13e51b6e18044c79&ref=mbi-deepdives.com) with Speedwell early this year, I mentioned how I worry about recession for a company such as Lululemon which sells consumer discretionary products. Given Lululemon’s size, they cannot be immune from macro headwinds anymore. A recession also makes the job of differentiating broader macro headwinds and the impact from higher competitive intensity very difficult, especially given many of Lulu’s competitors are not public (Alo, Vuori, Gymshark etc.). As a result, admittedly my enthusiasm for the stock has abated a bit in the current macro environment. So, I won’t be adding to my position here unless the stock trades at 10x NTM EBIT. Thank you for reading. ### Illumina: A "Monopoly" in a Knife Fight URL: https://www.mbi-deepdives.com/ilmn/ Last updated: 2025-03-25T03:18:28.000Z _This post is for paying subscribers only._ ### March, 2025 Update URL: https://www.mbi-deepdives.com/march-2025-update-2/ Last updated: 2025-03-03T18:13:11.000Z A few quick updates for this month: I am going to publish my Deep Dive on **Illumina** by 25th of this month. I'm frequently asked about the tools I use in my research process. In my recent podcast, David Kim from [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) and I tackle that question. Moreover, we dive into what's driving our excitement (and a hint of trepidation) about Deep Research. ([Spotify](https://open.spotify.com/episode/3lT4pp31ESH7aFMCMfhDFY?si=bfb64b3897994749&ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell-episode-3-deep-research/id1786912203?i=1000695541831&ref=mbi-deepdives.com), [YouTube](https://www.youtube.com/watch?v=cAi9HJU3BkY&ref=mbi-deepdives.com), [RSS Feed](https://feeds.buzzsprout.com/2435713.rss?ref=mbi-deepdives.com&utm%5Fsource=substack&utm%5Fmedium=email)) I have received quite a few emails letting me know that many of you were not able to join my WhatsApp community. As it turns out, WhatsApp allows only 1,024 members in a community. Since we have reached that limit, I have decided to open a new community. Please do **NOT** join this community if you are already a member of my previous WhatsApp community since I will post the same content in both communities. Click this [link](https://chat.whatsapp.com/DYCGwtHfIteDKua1JHkAso?ref=mbi-deepdives.com) to join. Just to give you an idea in terms of what to expect from the WhatsApp community: I mostly post interesting articles that I come across. I also post my earnings recap for companies that I personally own (usually for companies that tend to have lower weight in the portfolio; for larger positions, I usually do full recap on the website). Moreover, I have recently started posting interesting excerpts from expert network transcripts from AlphaSense (you can get a free trial [here](https://www.alpha-sense.com/mbi/?ref=mbi-deepdives.com)). Overall, this community allows me to share my process of learning and studying companies that I follow closely. If you may be interested in that, I encourage you to join the community. Finally, for new subscribers, I would like to let you know that you can access the full library of Deep Dives [here](https://www.mbi-deepdives.com/models/). Thank you for your support! [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* [ ](https://www.mbi-deepdives.com/meta4q24/) ### Amazon: 2025 Update URL: https://www.mbi-deepdives.com/amzn2025/ Last updated: 2025-02-21T21:24:27.000Z _This post is for paying subscribers only._ ### Meta Platforms: 2025 Update URL: https://www.mbi-deepdives.com/meta2025/ Last updated: 2025-02-14T13:24:34.000Z _This post is for paying subscribers only._ ### Amazon 4Q'24 Update URL: https://www.mbi-deepdives.com/amzn4q24/ Last updated: 2025-02-07T17:11:22.000Z *Disclosure: I own shares of Amazon* I know Amazon stock went down by \~4% after-hours, but I actually liked the quarter. Here are my highlights from today’s call. [Subscribe](#/portal/signup) **Revenue** Amazon faced \~900 Mn FX headwind in 4Q’24 which was \~700 mn higher than assumed. For the third consecutive quarters, AWS grew 19% YoY. Ads grew by +18% YoY, and revenues in other segments increased by mostly High Single Digit (HSD) rate. I’ll discuss more about AWS later, but let’s talk more about Amazon ex-AWS first. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9cbe255c-c5d8-435f-bc69-98e2813d171b_1344x229.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** Despite North America segment being more than 2.5x the size of International segment, it grew by 10% whereas international revenue increased by 9% (both FXN). For the 8th consecutive quarters, both North America and international segment experienced YoY operating margin expansion. Amazon reported its highest operating margin in North America segment at least since 2013\. Moreover, please note that they currently expense majority of their costs associated with development of the satellite network which will be capitalized when services reach commercial viability. Therefore, the “actual” retail margin is almost certainly even higher. While most investors are usually more excited by AWS’ prospects and infatuated by their lofty margins, I may be in the minority in being more optimistic about Amazon retail’s long-term profitability. AWS has a couple of pretty capable competitors and thanks to Nvidia being the key bottleneck, the industry value chain may not evolve in a favorable way for AWS. But when I think about Amazon retail’s long-term future, the gap between Amazon and the competitors may keep growing. More on this below. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff460fa1a-3bcf-4e22-8c08-2eef6b3461c7_1120x682.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Fulfillment+ Shipping** If you look at worldwide paid unit growth vs shipping+ fulfillment cost growth, you would notice that the latter used to consistently outpace the former pretty much all the time since 2015 until 3Q'22\. Since then, unit growth has largely been faster than shipping+ fulfillment costs, indicating operating leverage in their logistics footprint. The gap between the two has, in fact, widened in 4Q’24. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F334dc981-1849-45b9-988e-dcc7f396b12a_1167x550.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Amazon continues to indicate that they are far from done in optimizing their logistics footprint as well as improving speed of delivery. Some key quotes on this topic below: > 2024 also marks **the second year in a row where we've lowered our global cost to serve on a per unit basis**. > > We expanded the number of **same-day delivery sites by** **more than 60% in 2024**, which now serve more than 140 metro areas. And overall, we delivered over 9 billion units the same or next day around the world. Our relentless pursuit of better selection, price and delivery speed is driving **accelerated growth in Prime membership.** > > …I'll also tell you that this group of, call it, **a half a dozen or so new initiatives** is not close to the end of what we think is possible with respect to being able to **use robotics to improve the productivity cost to serve and safety in our fulfillment network**. And we have kind of the next wave that we're starting to work on now. But I think this will be a **many-year effort** as we continue to tune different parts of our fulfillment network where we can use robotics. And we actually don't think there are that many things that we can't improve the experience with robotics. > > …**we have not yet seen diminishing returns** and being able to continue to improve the speed of delivery…if you look at what we're doing with **Prime Air, the promise there is for a number of items that we'll be able to deliver items to customers inside an hour**. And I think when you're ordering everyday essentials where you need something more quickly, it's a big deal. And you see it, it's had a big impact on our everyday essentials. It's had a big impact on our pharmacy business **Advertising** Now that we have the earnings of major digital advertising players, I have updated my industry dashboard. Since I started tracking this in 4Q’20, Meta has its highest ever market share while Google posted its lowest ever share in 4Q’24\. Amazon’s market share also kept growing both YoY and QoQ. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2025/02/image.png) **AWS** Okay, now let’s talk about AWS. AWS added \~$1.3 Billion incremental revenue QoQ which was the second highest incremental growth QoQ ever. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F698d4c90-76a8-4844-baea-4b1bb32bdf81_1035x535.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Let’s take a quick look at hyperscalers growth. Azure, Google Cloud, and AWS revenue grew by 31%, 30%, and 19% respectively. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9406f771-8266-4c30-b4d7-155b0618d818_1398x784.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); \*Google Cloud includes Google Workspace, so not quite apple-to-apple and in reality, GCP tends to grow faster than Google Cloud One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. Back in 2020, Google Cloud was only about a quarter of the size of AWS, but now it’s two-fifth of AWS revenue. We don’t know exactly how much of this is GCP, but we can be pretty confident that GCP is leading this catch-up with AWS. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7b8aa1f6-cc6d-45c4-aa83-fd64a2f89fe9_1051x639.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc56d95bc-efbc-47ec-9188-0e36f1dc2ce4_1102x669.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) AWS had 36.9% operating in 4Q’24, with incremental operating margin being 76%! Please note that their decision to increase server useful life expanded AWS operating margin by 200 bps. As you may know, I have been wondering about big tech’s [deteriorating earnings quality](https://www.mbi-deepdives.com/big-tech-earnings-quality/), Amazon had some interesting comments related to useful life of some PP&E for 2025: > …in Q4, we completed a useful life study for our servers and network equipment and observed an increased pace of technology development, particularly in the area of artificial intelligence and machine learning. As a result, **we're decreasing the useful life for a subset of our servers and networking equipment from 6 years to 5 years**, beginning in January 2025\. We anticipate **this will decrease full year 2025 operating income by approximately $700 million.** > > In addition, **we also early retired a subset of our servers and network equipment**. We recorded a **Q4 2024 expense of approximately $920 million from accelerated depreciation and related charges and expect this will also decrease full year 2025 operating income by approximately $600 million**. Both of these server and network equipment useful life changes primarily impact our AWS segment. > > Lastly, **we also completed a useful life study for certain types of heavy equipment used in our fulfillment centers and are increasing the useful life from 10 years to 13 years beginning in January 2025\. We anticipate this will increase full year 2025 operating income by approximately $900 million**. So, the net impact appears to be a decline of operating income of $400 million in 2025 which doesn’t seem to be a big deal. but given the ever increasing size of capex (more on capex later), this can gradually become more important 3-4 years down the line. It would be interesting to see how Microsoft, Google, and Meta respond the following year. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff5457996-b228-4daa-b0bf-e135f0260e09_1537x123.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F12ab16c8-5225-4d5b-b75e-aabe320ce316_1197x655.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Lots of interesting comments on AWS during today’s call: > AWS is a reasonably large business by most standards, and though **we expect growth will be lumpy over the next few years** as enterprise adoption cycles, capacity considerations and technology advancements impact timing, it's hard to overstate how optimistic we are about what lies ahead for AWS' customers and business. > > Trainium2 just launched at our AWS re:Invent Conference in December. And EC2 instances with these chips are **typically 30% to 40% more price performant than other current GPU-powered instances available**. That's very compelling at scale. > > We're already hard at work on Trainium3, which we expect to **preview late in '25 and defining Trainium4 thereafter**. Building outstanding performant chips that deliver leading price performance has become a core strength of AWS', starting with our Nitro and Graviton chips in our core business and now extending to Trainium and AI and something unique to AWS relative to other competing cloud providers. > > …we also just launched Amazon's own family of frontier models in Bedrock called Nova. These models compare favorably in intelligence against the leading models in the world but offer lower latency, lower price, about **75% lower than other models in Bedrock, and are integrated with key Bedrock features like fine-tuning, model distillation, knowledge bases of RAG and agentic capabilities**. Amazon mentioned they could have grown faster, if not for certain constraints: > It is hard to complain when you have a multibillion-dollar annualized revenue run rate business in AI, like we do, and it's growing triple-digit percentage year-over-year. It's hard to complain. However, **it is true that we could be growing faster, if not for some of the constraints on capacity.** > > And they (constraints) come in the form of, I would say, **chips from our third-party partners, come a little bit slower than before** with a lot of midstream changes that take a little bit of time to get the hardware actually yielding the percentage healthy and high-quality servers we expect. It comes with our own big new launch of our own hardware and our own chips and Trainium2, which we just went to general availability at re:Invent, but **the majority of the volume is coming in really over the next couple of quarters**, the next few months. It comes in the form of **power constraints** where I think the world is still constrained on power from where I think we all believe we could serve customers if we were unconstrained. **There are some components in the supply chain, like motherboards too, that are a little bit short in supply for various types of servers**. So I think the team has done a really good job scrapping and providing capacity for our customers they can grow. We're still growing at a pretty reasonable clip, as I mentioned earlier, but **I do think we could be growing faster if we were unconstrained. I predict those constraints really start to relax in the second half of '25.** Like Microsoft, Amazon seems to be betting that frontier models may be commodity and hence, they want to offer broadest selection of models to their customers: > I think if you run a business like AWS and you have a core belief like we do, that **virtually all the big generative AI apps are going to use multiple model types, and different customers are going to use different models for different types of workloads.** > > You're going to provide **as many leading frontier models as possible** for customers to choose from. That's what we've done with services like **Amazon Bedrock**. And it's why we moved so quickly to make sure that DeepSeek was available both in Bedrock and in SageMaker faster than you saw from others. And we already have customers starting to experiment with that. Amazon also made the case for “[Jevon’s paradox](https://en.wikipedia.org/wiki/Jevons%5Fparadox?ref=mbi-deepdives.com)”: > I think what's -- one of the interesting things over the last couple of weeks is sometimes people make the assumptions that **if you're able to decrease the cost of any type of technology component, in this case, we're really talking about inference, that somehow it's going to lead to less total spend in technology. And we just -- we have never seen that to be the case.** We did the same thing in the cloud where we launched AWS in 2006, where we offered S3 object storage for $0.15 a gigabyte and compute for $0.10 an hour, which, of course, is much lower now many years later. People thought that people would spend a lot less money on infrastructure technology. And what happens is companies will spend a lot less per unit of infrastructure, and that is very, very useful for their businesses. But then they get excited about what else they could build that they always thought was cost prohibitive before, and they usually end up spending a lot more in total on technology once you make the per unit cost less. > > And I think that is very much what's going to happen here in AI, which is **the cost of inference will substantially come down**. What you heard in the last couple of weeks that DeepSeek is a piece of it. But everybody is working on this. I believe the cost of inference will meaningfully come down. I think it will make it much easier for companies to be able to infuse other applications with inference and with generative AI. > > And I think it's going to -- if you run a business like we do, where we want to make it as easy as possible for customers to be successful building customer experiences on top of our various infrastructure services, **the cost of inference coming down is going to be very positive for customers and for our business**. > > …at the stage we're in right now, AI is still early stage. I**t does come originally with lower margins and a heavy investment load as we've talked about**. And in the short term, over time, that should have -- **be a headwind on margins**. But over the long term, we feel the **margins will be comparable in non-AI business** as well. While Amazon’s explanation may be compelling, here’s a counter perspective from [@akramsrazor](https://x.com/akramsrazor/status/1887649655842086976?ref=mbi-deepdives.com) (slightly edited for clarity): > “Reminder that in 1999 server revenue was $58.5 billion on just under 4 million units. The dollar number was not passed till 2017 despite units 3x.Not that these numbers even matter as much when you consider the $ number on anything is a moving target, but it shows how deflationary certain breakthroughs were in computing. Also when everyone talks about capex related infra stocks, the assumption seems to be that arms race of training foundation models goes on for forever for every giant. That's obviously a bad assumption. And who knows where inference ASICs/GPU ASPs ends up with multiple players battling it out for this compute.” **Opex+Capex** Amazon spent $26.3 Billion in capex in 4Q’24 and indicated 2025 capex will likely be annualized figure of that number i.e. $105 Billion. Where they going to spend all these capex? > Similar to 2024, **the majority of the spend will be to support the growing need for technology infrastructure**. This primarily relates to AWS, including to support demand for our AI services as well as tech infrastructure to support our North America and international segments. AWS hinted that the higher capex is basically harbinger of revenue growth in coming years: > **The vast majority of that CapEx spend is on AI for AWS. It's the way that AWS business works and the way the cash cycle works is that the faster we grow, the more CapEx we end up spending because we have to procure data center and hardware and chips and networking gear ahead of when we're able to monetize it.** > > **We don't procure it unless we see significant signals of demand**. And so when AWS is expanding its CapEx, particularly in what we think is one of these once-in-a-lifetime type of business opportunities like AI represents, I think it's actually quite a good sign, medium to long term, for the AWS business. And I actually think that spending this capital to pursue this opportunity, which from our perspective, we think virtually every application that we know of today is going to be reinvented with AI inside of it and with inference being a core building block, just like compute and storage and database. > > If you believe that plus altogether new experiences that we've only dreamed about are going to actually be available to us with AI, AI represents, for sure, the biggest opportunity since cloud and **probably the biggest technology shift and opportunity in business since the Internet**. And so I think that both our business, our customers and shareholders will be happy medium to long term that we're pursuing the capital opportunity and the business opportunity in AI. Amazon also indicated they’re going to increasingly focus on logistics and fulfillment in rural areas which is not quite music to your ears if you’re Dollar Store shareholders: > We also have CapEx that we're spending this year in our Stores business, really with an aim towards trying to continue to improve the delivery speed and our cost to serve. And so you'll see us expanding the number of same-day facilities from where we are right now. **You'll also see us expand the number of delivery stations that we have in rural areas. We can get items to people who live in rural areas much more quickly, and then a pretty significant investment as well on robotics and automation so we can take our cost to serve down and continue to improve our productivity.** ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe6dc0459-1dea-4276-a8b1-bcf4ac2fafa8_2002x289.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** Amazon’s guidance for 1Q’25 is below. Please note consensus 1Q’25 revenue and EBIT before the call were $158.3 Billion and $18.2 Billion respectively. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F17c9253b-906d-4795-80d7-f21369b43429_1072x279.png) Source: Company Filings **Closing Words** This was another strong quarter by Amazon. There’s hardly anything to complain about as an Amazon shareholder. Since we will have more disclosure in the 10-K to work with, I will publish my annual update on Amazon a couple of weeks from now. I will share more thoughts on the valuation then. Please feel free to share with your friends and network. Thank you for reading. **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Alphabet 4Q'24 Update URL: https://www.mbi-deepdives.com/goog4q24/ Last updated: 2025-02-05T13:44:01.000Z Alphabet had bit of a mixed earnings call. While there were some encouraging data points related to the future of search, their tone in the near-term outlook clamped down on the enthusiasm a bit. Here’s my highlights from the earnings. [Subscribe](#/portal/signup) **Revenue** Alphabet maintained their low double digit revenue growth. For the **10th** consecutive quarters, Google network’s revenue went down. Cloud revenue growth decelerated from 35.0% YoY in 3Q’24 to 30.1% in 4Q’24\. I will note, however, that Google usually discloses every quarter that GCP grew at higher rate than overall Cloud, but in this call, they mentioned “GCP grew at a rate that was **much higher** than cloud overall”. Therefore, the deceleration may have been mostly driven by the rest of cloud e.g. Google Workspace. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8eb36736-dd40-43fa-8eb5-2766bc89057a_1669x358.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Google mentioned all of their advertising revenue was impacted by tough comp in 4Q’23, especially because of “APAC-based retailers”. While a year ago most investors were concerned about “APAC based retailers” driven tough comps for Meta, they weren’t even mentioned once during Meta’s 4Q’24 call and it was Google which highlighted tough comp here. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fea95fea8-2ca2-4f15-9b72-77332f7a7a77_1503x238.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) If you look at how Meta’s Family of Apps (FOA), Google Search, and YouTube ads fared over the last three years, it is abundantly clear that Meta is well past the dark days of ATT and continues to gain share. I will update my digital advertising market share dashboard once Amazon posts earnings this week. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7754251b-8cfd-4360-aa7c-bf0a65fac903_606x147.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **EBIT** Google maintained strong profitability across the board. Google Services posted 39% operating margin and high 70s incremental operating margin. Google Cloud also posted its highest ever margin. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fcfd65782-de82-4025-a517-b02270b69272_1503x465.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ## **Search** Some interesting quotes on Search from the call: > AI overviews are now available in more than 100 countries. They continue to drive **higher satisfaction and Search usage**. Meanwhile, Circle to Search is now available on over 200 million Android devices. > > We have 7 products and platforms with over 2 billion users and all are using Gemini. That includes Search where Gemini is powering our AI overviews. **People use Search more with AI overviews and usage growth increases over time as people learn that they can ask new types of questions. This behavior is even more pronounced with younger users** who really appreciate the speed and efficiency of this new format. > > We are also pleased to see how **Circle to Search is driving additional search use** and opening up even more types of questions. This feature results are popular among younger users. **Those who have tried Circle to Search before now use it to start more than 10% of their searches.** As AI continues to **expand the universe of queries** that people can ask, 2025 is going to be one of the biggest years for Search innovation yet. > > We've already started testing Gemini 2.0 in AI overviews and plan to roll it out more broadly later in the year. All these are quite encouraging, but one that stood out to me was the below quote: > **Google is already present in over half of Journeys where a new brand product or retailer are discovered**. By offering new ways for people to search, we're expanding commercial opportunities for our advertisers. Shoppers can now take a photo of a product and using Lens quickly find information about the product, reviews similar products and where they can get it for a great price. **Lens is used for over 20 billion visual search queries every month and the majority of these searches are incremental.** In 3Q’24, Google shared the same data that lens is being used 20 billion times per month and highlighted that 1 in 4 query had commercial intent. So in this call, Google is basically confirming not only a significant percentage of these queries are monetizable, they are also **incremental**. Sundar later reiterated that the opportunity space is “far from zero-sum” > I think the opportunity space expands. I think there's plenty of it, feels very **far from a zero-sum game**. There's plenty of room, I think, for many new types of use cases to flourish. And I think for us, **we have a clear sense of additional use cases**. We can start to tackle for our users in Google Search. And all the early work with AIO view shows that users will react positively to that. > > …**We are continuing to see growth in Search on a year-on-year basis in terms of overall usage**. Of course, within that, AI overviews has seen stronger growth. Moreover, AI Overviews are monetizing “at approximately the same rate”": > we recently launched the ads within AI overviews on mobile in the U.S., which builds on our previous rollout of ads above and below. And as I talked about before, for the AI Overviews, overall, **we actually see monetization at approximately the same rate**, which I think really gives us a strong base on which we can innovate even more. ### **YouTube** While Netflix and Spotify keep hitting new highs, it’s interesting that YouTube likely remains their closest long-term competitor: > …data shows YouTube continues to be #1 in streaming watch time in the U.S. **with our share of streaming now at a record high**. > > …We are now **the most frequently used service for consuming podcast in the U.S.** according to a recent Edison report. This success reflects our long-term approach of investing in emerging trends from mobile to the living room. While election wasn’t even mentioned in Meta’s call, Google highlighted the impact of election for YouTube’s results in 4Q’24 which makes me think YouTube will face tough comp in 4Q’25: > The 14% growth in YouTube advertising revenues was driven by **strong spend on U.S. election advertising with combined spend from both parties almost doubling from what we saw in the 2020 elections**. YouTube is making rapid progress in shorts monetization: > In 2024, the monetization rate of short relative to in-stream viewing **increased by more than 30 percentage points in the U.S., and we expect to make additional progress in 2025**. ### **Google Cloud** Some interesting data points on Google Cloud: > Google data centers deliver nearly **4x more computing power per unit of electricity compared to just 5 years ago…Cloud customers consume more than 8x the compute capacity for training and inferencing compared to 18 months ago.** > > Last year, we closed several strategic deals over $1 billion, and **the number of deals over $250 million doubled from the prior year** > > In Q4, we saw strong uptake of Trillium, our sixth-generation TPU, which **delivers 4x better training performance and 3x greater inference throughput compared to the previous generation.** While some worry about “AI bubble” especially given the capex spree by big tech, Google, like Microsoft, is currently capacity constrained in Q4: > we do see and have been seeing very strong demand for our AI products in the fourth quarter in 2024\. And **we exited the year with more demand than we had available capacity.** Google highlighted their end-to-end stack in infrastructure will be a competitive advantage in the AI race: > part of the reason we have taken the end-to-end stack approach is so that we can definitely drive a **strong differentiation in end-to-end optimizing and not only on a cost but on a latency basis, on a performance basis…I think our full stack approach and our TPU efforts all play give a meaningful advantage. And we plan -- you already see that. I know you asked about the cost, but it's effectively captured when we price outside, we pass on the differentiation.** I will discuss more on Cloud when Amazon posts later this week. DeepSeek predictably came up, and Google management highlighted their models far well vs DeepSeek. Moreover, Google likes how things are trending more towards inferences: > both our 2.0 Flash models, our 2.0 Flash thinking models, they are **some of the most efficient models out there, including comparing to DeepSeek**'s V3 and R1\. And I think a lot of it is our strength of the full stack development end to end optimization, **our obsession with cost per query**. All of that, I think, sets as well for the workloads had both to serve billions of users across our products and on the cloud side. > > A couple of things I would say are if you look at the trajectory over the past 3 years, **the proportion of the spend towards inference compared to training has been increasing, which is good because, obviously, inferences to support businesses with good ROIC**. And so I think that trend is good. > > I think the reasoning models, if anything, accelerates that trend because it's obviously scaling upon inference dimension as well. And so I think -- look, I think part of the reason we are so excited about the AI opportunity is**, we know we can drive extraordinary use cases because the cost of actually using it is going to keep coming down, which will make more use cases feasible.** ### **AI** Some more quotes on impact of AI across different businesses in Google: > Last quarter, we introduced a reinvented Google shopping experience, rebuilt from the ground up with AI. This December saw roughly **13% more daily active users in Google shopping in the U.S., compared to the same period in 2023**. > > …we believe that AI will revolutionize every part of the marketing value chain…Based on the Nielsen meta analysis of marketing mix models, on average, Google AI-powered video campaigns on YouTube delivered **17% higher return on advertising spend than manual campaigns**. ### **Google Other** Google Other or what is currently categorized as “subscriptions, platforms, and devices” have been trending well: > Google One's performance has been outstanding and is **one of our fastest-growing subscription products** in terms of subscribers and revenue growth. > > We continue to have significant growth in our subscription products, primarily due to increase in the number of paid subscribers across YouTube TV, YouTube Music Premium and Google One. With regards to platform, we saw a slight increase in the growth rate in play, primarily due to a strong increase in the number of buyers. ### **Other Bets** > Waymo, which made tremendous progress last year, safely serving more than **4 million passenger trips. It's now averaging over 150,000 trips each week** and growing. Looking ahead, Waymo will be expanding its network and operations partnerships to open up new markets, including **Austin and Atlanta this year, and Miami next year.** And in the coming weeks, Waymo vehicles will arrive in **Tokyo for their first international road trip.** We are also developing the sixth-generation Waymo driver, which will **significantly lower hardware costs**. ### **Capital Allocation** In 4Q’24, Google returned 72% of their FCF to shareholders through buyback and dividend. Share count declined by 57 bps QoQ. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Feb4a4cb5-0846-4e03-a33a-fa949fbe531b_669x601.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ### **Capex and Opex** Google’s capex increased by 63% YoY in 2024\. Management guided it to increase to $75 Billion in 2025 i.e. +43% YoY. They understandably are not interested in being capacity constrained. Let’s see in a year whether $75 Billion capex solves it. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb7318e60-2c58-461e-89a4-3b53e5373d5f_1500x247.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ### **Outlook** Google doesn’t provide guidance, but did mention the below during the call which all sounded somewhat defensive to me: > “in terms of revenue, I'll highlight two items that will have meaningful impact on Q1 revenue across the company. The first is the impact of foreign exchange rates. At the current spot rates, we expect a larger headwind to our revenues from the strengthening of the U.S. dollar relative to key currencies in Q1 versus Q4 2024\. Second is the impact of leap year… These are understandable heads up, but after mentioning tough comp due to “APAC based retailers” to explain 4Q’24 growth numbers, Google somewhat cautioned about tough comp on advertising for entire 2025: > As for our segments, Google Services, **advertising revenue in 2025 will be impacted by lapping the strength we experienced in the financial service vertical throughout 2024**. And in Cloud, given that revenues are correlated with the timing of deployment of new capacity, we could see variability in cloud revenue growth rates depending on when new capacity comes online during 2025. As explained in my recent [piece](https://www.mbi-deepdives.com/big-tech-earnings-quality/) on Big Tech’s deteriorating earnings quality, Google also cautioned about increased “pressure on the P&L” due to “higher depreciation”: > the increase in our investment in CapEx over the past few years will increase **pressure on the P&L, primarily in the form of higher depreciation**. In 2024, we saw **28% year-over-year growth in depreciation** as we put more technical infrastructure assets into service. Given the increase in CapEx investments over the past few years, **we expect the growth rate in depreciation to accelerate in 2025**. ### **Valuation** Since [3Q'22](https://mbideepdives.substack.com/p/goog3q22?utm%5Fsource=publication-search), I share the following valuation framework every quarter. Given I created this table in 2022 which was a very different market than what we have today from sentiment perspective, you can argue this is overly conservative. I’m going to keep it consistent. But I acknowledge the reality that Google not only trades at the lowest NTM P/E multiple among Mag-7 stocks. It appears market is largely valuing the Service operating income at 18x and the cloud business at \~10x revenue. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F719d3c02-7ef7-458f-87f6-4ac625176eee_1839x382.png) Source: MBI Deep Dives Interestingly, there has been a noticeable multiple differential between Meta and Google these days. ![chart](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1adf3e03-c5b2-40d5-baf5-d12ee1931268_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://app.koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) I will cover earnings of **Amazon** this week. Thank you for reading. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### February, 2025 Update URL: https://www.mbi-deepdives.com/feb2025/ Last updated: 2025-02-03T15:59:04.000Z Few quick updates for this month: 1. In February, I will do my annual, more detailed updates on Meta Platforms, and Amazon. I expect to publish my update on Meta by the end of next week, and hope to publish Amazon update the week after that. In the meantime, I will also cover Alphabet and Amazon earnings this week. 2. Let me give you a schedule for the next couple of Deep Dives: Illumina in March, and ASML in April this year. 3. Over the last couple of weeks, I did two podcasts: one with [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com) on XPEL ([Spotify](https://substack.com/redirect/3732c519-ad73-4639-80b9-47ef926b9b1a?j=eyJ1IjoiOXgwejUifQ.QLatekrDQ1JxAFwqYZIS7Eu9DEeYbRkK73W9whI8srw&ref=mbi-deepdives.com), [Apple](https://substack.com/redirect/22afe24c-6828-448c-a603-9969db25c134?j=eyJ1IjoiOXgwejUifQ.QLatekrDQ1JxAFwqYZIS7Eu9DEeYbRkK73W9whI8srw&ref=mbi-deepdives.com), [RSS feed](https://substack.com/redirect/1d442b7a-19f1-421e-ada3-d376ff23c153?j=eyJ1IjoiOXgwejUifQ.QLatekrDQ1JxAFwqYZIS7Eu9DEeYbRkK73W9whI8srw&ref=mbi-deepdives.com)), and the other one with [Speedwell](https://www.speedwellmemos.com/?ref=mbi-deepdives.com) on Spotify and Lululemon ([Spotify](https://t.co/sjrimy2rfH?ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/interview-spotify-case-study-and-learning-from/id1699073398?i=1000685007125&ref=mbi-deepdives.com)). 4. Since I have updated my [portfolio](https://www.mbi-deepdives.com/portfolio/) last week (disclosed on the last day of every month), I do want to disclose that I have started a new position in Maravai LifeSciences (MRVI) **today** which was my [Deep Dive](https://www.mbi-deepdives.com/mrvi/) in December last year. In my Deep Dive, I mentioned I would be looking to be a shareholder if the stock comes down to $4-4.2 price range, but I started this position at slightly higher prices than what I considered to be more compelling entry price because a) while the upside can be debated, the downside is likely to be limited from current prices (elaborated in the Deep Dive), and b) I am unwilling to let my cash balance exceed 20% and would rather swing at opportunities at slightly lower IRR than letting my cash balance grow over time. While cash provides optionality in period of volatility, too much of it can be a drag for the overall portfolio return; therefore, I try to maintain a ceiling of 20% cash for my portfolio. 5. Finally, in case you're not already a member of WhatsApp community, I encourage you to [join](https://chat.whatsapp.com/HKJLqkvhIkQBgtBdEIf5jV?ref=mbi-deepdives.com) since I do share more earnings coverage, as well as interesting pieces that I come across, on WhatsApp. For new subscribers, let me also highlight that you can access the full library of 55 Deep Dives [here](https://www.mbi-deepdives.com/models/). Thank you for your support! [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Meta 4Q'24 Update URL: https://www.mbi-deepdives.com/meta4q24/ Last updated: 2025-01-30T16:42:26.000Z *Disclosure: I own shares of Meta Platforms* > “This is going to be a really big year. I know it always feels like every year is a big year, but more than usual, it feels like the trajectory for most of our long-term initiatives is going to be a lot clearer by the end of this year.” > \-Mark Zuckerberg in Meta’s 4Q’24 Call In recent weeks, Meta stock has mostly been one-way street: up! That continued to be the case after-hours post 4Q’24 earnings. [Subscribe](#/portal/signup) Here are my highlights from today’s call. **Users** Daily Active People (DAP) across its Family of Apps (FOA) accelerated to 60 mn QoQ in 4Q’24\. It’s kind of mind boggling that Meta added 1 Billion DAP since 1Q’20. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb9bd84aa-2fa5-42c8-81d7-a4f95d53e0b6_1842x105.png) **Ad revenue by Geography** I remember many investors were worried about “tough comps” this time last year which is understandable when you look at the comps. Despite growing ad revenue by 24% in 4Q’23, Meta still managed to increase revenue by 21% in 4Q’24. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3c36927a-7652-40f1-a04a-8a81637aba65_1942x328.png) **Ad Impression and Avg. Price Per Ad** Overall impression grew by 6% YoY and avg. price per ad grew by 14% YoY. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9638fa54-eec0-41f5-84b6-7b6e48529caf_910x498.png) While many prefer revenue growth driven through impressions, Meta mentioned they think they will have opportunity to drive revenue growth across both pricing and impression growth: > “we generally expect that we are going to be able to deliver ongoing ad performance improvements through a lot of the ongoing work that we're doing across our monetization road map and that will have the sort of effect of benefiting pricing overall…Overall, we are seeing healthy cost per action trends for advertisers for whatever is the action that they are optimizing for. And we believe we'll continue to get better at driving conversions for advertisers. And when we do, that will have the effect of continuing to lift CPMs over time because we're delivering more conversions per impression served, resulting in higher value impressions.” Later in the call, Meta expanded further on how they are working on improving monetization: > In the second half of 2024, we introduced an innovative new machine learning system in partnership with NVIDIA called Andromeda. This more efficient system enabled a 10,000x increase in the complexity of models we use for ads retrieval, which is the part of the ranking process **where we narrow down a pool of tens of millions of ads to the few thousand we consider showing someone**. The increase in model complexity is enabling us to run far more sophisticated prediction models to **better personalize which ads we show someone. This has driven an 8% increase in the quality of ads that people see on objectives we've tested**. Andromeda's ability to efficiently process larger volumes of ads also positions us well for the future as advertisers use our generative AI tools to create and test more ads. > > Adoption of Advantage+ shopping campaigns continues to scale with revenues surpassing a **$20 billion annual run rate and growing 70% year-over-year in Q4**. Given the strong performance and interest we're seeing in Advantage+ shopping and our other end-to-end solutions, we're testing a new streamlined campaign creation flow. > > …**More than 4 million advertisers are now using at least one of our generative AI ad creative tools, up from 1 million six months ago**. There has been significant early adoption of our first video generation tool that we rolled out in October, image animation with hundreds of thousands of advertisers already using it monthly. **Segment Reporting** Overall 4Q’24 revenue was +21.2% YoY; on a 2-yr and 3-yr CAGR basis, Meta’s topline increased by 22.3% and 12.8% respectively. FOA’s 4Q’24 operating margin of **\~60% (!!)** was \~550 bps higher than previous peak margin. Incremental margin at FOA was 88% last quarter! As you know, inside Meta, “there are two wolves”: one with eyepopping profitability and the other with mind numbing mounting losses quarter after quarter. Reality Labs managed to report $5 Billion losses in 4Q’24\. It’s almost hard to fathom that these two segments are within the same company! There was also no indication in the call that losses at Reality Labs have either peaked or close to be peaking. So, I guess we’ll have to keep watching this bleeding in almost suspended disbelief. To put it in context, since breaking out Reality Labs as a separate segment, Meta has reported a cumulative **$60 Billion losses** in the last 17 quarters in Reality Labs. Given there has been some recent optimism around Meta’s AR glasses, we are probably looking at **tens of billions** of continued investments **every year**. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9ef6ad41-d9a7-45fa-b73d-e94a29908e09_1938x535.png) Let’s look at some interesting comments from the earnings call: **AI, AI, AI** > “I expect that this is going to be the year when a highly intelligent and personalized AI assistant reaches more than 1 billion people, and I expect Meta AI to be that leading AI assistant. Meta AI is already used by more people than any other assistant. And **once a service reaches that kind of scale, it usually develops a durable long-term advantage**. > > …I also expect that 2025 will be the year when it becomes possible to build an AI engineering agent that has coding and problem-solving abilities of around a good mid-level engineer. And **this is going to be a profound milestone and potentially one of the most important innovations in history, like as well as over time, potentially a very large market, whichever company builds this first, I think it's going to have a meaningful advantage in deploying it to advance their AI research and shape the field**. So that's another reason why I think that this year is going to set the course for the future. Meta AI monthly actives reached 700 million (vs 500 million in 3Q’24). The following bit is also an indication how Meta AI can drive incremental growth over time but don’t expect much monetization of Meta AI anytime soon as they’re still mostly focused on delivering the consumer experience first: > We're now introducing updates that will enable Meta AI to deliver more personalized and relevant responses **by remembering certain details from people's prior queries and considering what they engage with on Facebook and Instagram to develop better intuition for their interest and preferences**. **Llama** Some very bold predictions and ambitions on Llama: > I think **this will very well be the year when Llama and open-source become the most advanced and widely used AI models as well**. Llama 4 is making great progress in training, Llama 4 Mini is doing with pretraining and our reasoning models and larger model are looking good too. **Our goal with Llama 3 was to make open source competitive with closed models. And our goal for Llama 4 is to lead.** Llama 4 will be natively multimodal. It's an omni model, and it will have agentic capabilities. Recent developments around DeepSeek only emboldened Meta’s strategy to double down on open source: > I also just think in light of some of the recent news, the new competitor DeepSeek from China, I think it also just puts -- it's one of the things that we're talking about is there's going to be an open source standard globally. And I think for our kind of national advantage, it's important that it's an American standard. So we take that seriously, and we want to build the AI system that people around the world are using and I think that if anything, some of the recent news has only strengthened our conviction that this is the right thing for us to be focused on. **Facebook, and Instagram** > In Q4, global video time grew at **double-digit percentages** year-over-year on Instagram, and we're seeing particular strength in the U.S. on Facebook, where video time spent was also up double-digit rates year-over-year. We see continued opportunities to drive video growth in 2025 through ongoing optimizations to our ranking systems. > > In the U.S., we recently launched a new destination in reels that consists of content your friends have left a note on or liked. **We're seeing very positive early results**, and we'll look to expand this globally in the coming months. **WhatsApp** One thing I would like to highlight is FOA’s “other revenue” which is mostly revenue from WhatsApp grew at 55%, 68%, and 50% CAGR over 1-yr, 2-yr, and 3-yr respectively. While it’s only \~$2 Billion run-rate business, it’s an interesting area to watch given the growing importance of business messaging in the next 5-10 years. So, it’s pretty goo that WhatsApp has continued to gain momentum in the US: > I expect WhatsApp to continue gaining share and making progress towards becoming the **leading messaging platform in the U.S.** like it is in a lot of the rest of the world. **WhatsApp now has more than 100 million monthly actives in the U.S**. **Threads** Threads Monthly Active Users (MAU) over time: 3Q’23: 100 Million 4Q’23: 130 Million 1Q’24: 150 Million 2Q’24: 200 Million 3Q’24: 275 Million 4Q’24: 320 Million MAU growth has decelerated a bit here, but momentum is still intact. **AR/VR** > “This will be a defining year that determines if we're on a path towards many hundreds of millions and eventually billions of AI glasses and glasses being the next computing platform like we've been talking about for some time or if this is just going to be a longer grind. > The number of people using Quest and Horizon has been steadily growing. And this is a year when a number of the long-term investments that we've been working on that will make the Metaverse more visually stunning and inspiring will really start to land. So I think we're going to know a lot more about Horizon's trajectory by the end of this year. I have noticed some people interpreted this as “make-or-break” year for Meta’s AR/VR investments. I don’t think Meta meant anything drastic changes here, but in case glasses adoption continues to accelerate, it is likely that they’ll double down here with more aggressive investments. If not, they will still very much persist in their investments but perhaps at a more measured pace. However, VR investments do seem to be increasingly bit of a suspect. I doubt “stunning visual” at Metaverse will be any real breakthrough for engagements. However, like Zuck, I too am quite optimistic about the glasses. It seems much easier bet that the people will upgrade to smart glasses in the next 10-15 years: > It's kind of hard for me to imagine that a decade or more from now, all the glasses aren't going to basically be AI glasses as well as a lot of people who don't wear glasses today, finding that to be a useful thing. So I'm incredibly optimistic about this. **Capital Allocation** Meta didn’t repurchase any shares which I applaud. The stock isn’t nearly as attractive as it was over the last couple of years and given the size of investments Meta is planning, it makes sense to not hurriedly return cash to shareholders. There is perhaps a scenario in which Meta’s FCF can be severely pressured (imagine a recession in a year or two, for example) but still would like to be committed to their investments to not fall behind compared to its competitors. To exacerbate my concerns around earnings quality (see my recent [piece](https://www.mbi-deepdives.com/big-tech-earnings-quality/) on this topic) even further, Meta changed its depreciation schedule for certain servers and network assets from 5 to 5.5 years. Interestingly, Meta did mention in 3Q’24 follow-up call that they had “no current plans to extend the useful lives in our servers”. I will do more work on this when I publish more detailed annual update on Meta in couple of weeks. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F332eb4ea-2204-4d1e-b25d-d7548eb5ab3c_2008x316.png) **Capex and Opex** Given Meta is going to spend $60-65 Billion on capex in 2025, this topic deserves detailed notes. First, some interesting commentary on Meta’s custom chips MTIA: > …we're pursuing cost efficiencies by deploying our custom MTIA silicon in areas where **we can achieve a lower cost of compute by optimizing the chip to our unique workloads**. **In 2024, we started deploying MTIA to our ranking and recommendation influence workloads for ads and organic content. We expect to further ramp adoption of MTIA for these use cases throughout 2025, before extending our custom silicon efforts to training workloads for ranking and recommendations next year**. > > we expect that **we are continuing to purchase third-party silicon from leading providers in the industry. And we are certainly committed to those long-standing partnerships, but we're also very invested in developing our own custom silicon for unique workloads, where off-the-shelf silicon isn't necessarily optimal and specifically because we're able to optimize the full stack to achieve greater compute efficiency and performance per cost and power** because our workloads might require a different mix of memory versus network, bandwidth versus compute and so we can optimize that really to the specific needs of our different types of workloads. Meta was quite willing to credit DeepSeek to inject some novel advancements which may or may not affect long-term capex intensity: > …on the DeepSeek question. I think **there's a number of novel things that they did that I think we're still digesting**. And there are a number of things that they have advances that we will hope to implement in our systems. > > …I don't know -- it's probably too early to really have a strong opinion on what this means for the trajectory around infrastructure and CapEx and things like that. There are a bunch of trends that are happening here all at once. > > There's already sort of a debate around how much of the compute infrastructure that we're using is going to go towards pre-training versus as you get more of these reasoning time models or reasoning models where you get more of the intelligence by putting more of the compute into inference, whether just will mix shift how we use our compute infrastructure towards that. **That was already something that I think a lot of the -- the other labs and ourselves were starting to think more about and already seemed pretty likely even before this, that -- like of all the compute that we're using, that the largest pieces aren't necessarily going to go towards pre-training. But that doesn't mean that you need less compute because one of the new properties that's emerged is the ability to apply more compute at inference time in order to generate a higher level of intelligence and a higher quality of service, which means that as a company that has a strong business model to support this, I think that's generally an advantage that we're now going to be able to provide a higher quality of service than others who don't necessarily have the business model to support it on a sustainable basis.** > > …I continue to think that investing very heavily in CapEx and infra is going to be a strategic advantage over time. **It's possible that we'll learn otherwise at some point, but I just think it's way too early to call that. And at this point, I would bet that the ability to build out that kind of infrastructure is going to be a major advantage for both the quality of the service and being able to serve the scale that we want to**. Meta’s 2024 opex turned out to be $95 Billion (vs guide of $96-98 Billion in 3Q’24). 2025 opex guide is $114-119 Billion. So, while opex increased by \~$7 Billion in 2024, it is expected to grow by \~$20 Billion in 2025. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1b9789cf-ac18-4204-be42-2bee61ee294c_2010x106.png) **Outlook** Meta guided 1Q’25 revenue growth to be +11% to +18% on a constant currency basis. Consensus was closer to the high end of the guide. **Closing Words** Near the end of the call, Zuck tried to inject some caution: > I guess my note of caution or just my kind of periodic reminder…the actual business opportunity for Meta AI and AI studio and business agents and people interacting with these AIs remains outside of '25 for the most part. And **I think that's an important thing for for us to communicate and for people to internalize as you're thinking about our prospects here**. But nonetheless, we've run a process like this many times. We built a product. We make it good. We scale it to be large. We build out the business around it. That's what we do. I'm very optimistic, but it's going to take some time. While the animal spirits are running high in this market and Meta is one of the prime beneficiaries of that, it is indeed good to remember the exceedingly high bar Meta is going to face this year. To put this in context, Meta will have to grow its incremental revenue by $30 Billion to grow its operating profit by \~15% in 2025\. Bulls might say they did grow revenue by $30 Billion this year and they can do it again, and bears may see the impending wall that Meta may hit at some point as their business is gradually becoming more and more fixed cost heavy (more PP&E) which will make it harder for them to be agile in case they hit an idiosyncratic or macro-wide rough patch. Meta is well positioned for the long-term, but better to not expect the path towards long-term a linear one. As alluded earlier, I will expand more on my thoughts on Meta in a couple of weeks on my annual update on Meta. Notes from follow-up call [here](https://x.com/borrowed%5Fideas/status/1885005302065697275?ref=mbi-deepdives.com). I will cover **Google** and **Amazon’s** earnings **next week**. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Big Tech's Deteriorating Earnings Quality URL: https://www.mbi-deepdives.com/big-tech-earnings-quality/ Last updated: 2025-01-26T20:08:33.000Z *Disclosure: I own shares of Meta Platforms, and Amazon* Almost one and half years ago, I wrote about “[The Curious Case of Big Tech](https://www.mbi-deepdives.com/the-curious-case-of-big-tech/)”, in which I highlighted that much of the big tech was actually “deep value” investments back in 2013\. In fact, I also mentioned *“Meta, and Amazon are *currently trading at* *lower* OCF multiple than they were trading back in 2013*”. Both Meta and Amazon have comfortably outperformed both S&P 500 and Nasdaq 100 since then (not claiming any causal relationship, of course). ![chart](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8c7f2412-c92d-495b-b1db-a9bca0489c43_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://app.koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) [Subscribe](#/portal/signup) However, as the title of this piece suggests, I have a slightly different tune today. I am increasingly concerned about Big Tech’s deteriorating earnings quality. While some people started murmuring about this topic a few quarters ago, I would like to show through this write-up that big tech shareholders (including me) should perhaps indeed be **at least** slightly concerned. Moreover, as almost all the big tech are going to continue to invest in their capex hand over fist in the short to medium term, this concern may accentuate even further. To make my case, I am going to focus on three companies within Big Tech: Microsoft, Meta Platforms, and Alphabet. Apple and Nvidia aren’t quite capex heavy, so this may not be a concern relevant for them. While it is very much relevant for Amazon, Amazon’s capex numbers are slightly convoluted given their retail AND cloud operations as well as the nature of my exercise (to be explained later). Even though Amazon won’t be under my scanner in this exercise, it was Amazon which essentially sowed the seed of deteriorating earnings quality in big tech back in 2020\. In 4Q’19 earnings call, Amazon announced to increase the useful life for their servers from **three to four years**: > …*there's enough trend now to show that the useful life is exceeding four years. We have been – for our servers and we had been depreciating them over three years. So, we are going to start depreciating them on a *four year* basis."* (Amazon 4Q'19 Call) This led to similar adjustments at Microsoft, Alphabet, and Meta a year later as they all decided to extend the useful life for their servers to four years. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0937daca-6ec8-46a0-b9d7-a382d15e1dc8_579x431.jpeg) Two years later, Amazon did it again. The useful lives for their servers were extended from **four years to five years**, and for their networking equipment from **five years to six years**. This time they tried to provide bit more justification why this isn’t just “accounting change” out of thin air, but rather a careful assessment of the reality: > As a practice, we monitor and review the useful lives of our depreciable assets on a regular basis to make sure that our financial statements reflect our best estimate of how long the assets are going to be used in operations…**Although we're calling out an accounting change here, this really reflects a tremendous team effort by AWS to make our server and network equipment last longer**. We've been operating at scale for over 15 years, and we continue to refine our software to run more efficiently on the hardware. This then lowers stress on the hardware and extends the useful life, both for the assets that we use to support AWS' external customers as well as those used to support our own internal Amazon businesses. (4Q’21 Call) That sounds reasonable…except miraculously Alphabet, Microsoft, and Meta again came to the same conclusion just **a year later**. Basically, it’s the same meme I mentioned above. Microsoft extended the depreciable useful life for server and network equipment assets in cloud infrastructure **from 4 to 6 years.** So did Alphabet. Meta, however, extended the useful life to five years. Given how quickly they all followed Amazon’s changes, it makes me wonder why they weren’t proactively carefully assessing the useful lives of their assets in the first place. Or if you’re cynical, you may think they may not have robust rationales anyway; they’re just doing it because a big tech peer gave them the “signal” that it can be done. Of course, higher useful life leads to lower depreciation expense which leads to higher operating profit. While shareholders all love ever increasing higher profits, it may be prudent to ask difficult questions to big tech management or ask them to provide a more detailed reporting on how they came to these re-assessments so quickly after years of “inefficiently” managing their servers and networking equipment. Of course, not all big tech shareholders readily assume that something nefarious is going on here. Some understandably wonder whether the mix of PP&E itself may have contributed to lower depreciation rate in recent years. For example, land is not depreciated at all, and buildings are usually depreciated at 25-30 year period. So overall depreciation rate would go down if such mix shift occurs. However, we don’t quite see that in their financials. Let me show you Microsoft, Meta, and Alphabet’s more granular PP&E to substantiate this point. Let’s start with Microsoft. **Microsoft** Microsoft’s gross PP&E increased from $22 Billion in FY’2013 to $212 Billion in FY’2024\. While the gross PP&E basically 10xed in the last 11 years, computer equipment and software was consistently \~40-45% of their gross PP&E. However, thanks to the changed depreciation schedule mentioned above, **overall depreciation rate as a percentage of net PP&E declined from \~30-34% during FY’2014-2020 to just \~15% in FY’2024.** While one can perhaps legitimately claim that some of these computer equipment’s useful life may have been extended thanks to more innovative engineering and efficient management, that is perhaps equally (if not more) counterbalanced by increasing mix of GPUs in their PP&E. This is not controversial to say that the useful life of these GPUs are lot lower compared to when this cycle of extending useful life started anyway. Here’s Rohit Krishnan in a recent [piece](https://www.strangeloopcanon.com/p/what-would-a-world-with-agi-look?hide%5Fintro%5Fpopup=true&ref=mbi-deepdives.com): “*The actual service life of H100 GPUs in datacenters is relatively short, ranging from 1-3 years when running at high utilization rates of 60-70%.”* Ben Thompson in his recent [interview](https://stratechery.com/2025/an-interview-with-daniel-gross-and-nat-friedman-about-models-margins-and-moats/?ref=mbi-deepdives.com) with Nat Friedman and Daniel Gross made the same point: *“you have a data center, which is I think a 30-year depreciation, and then the GPUs are I think accounted for in a five-year depreciation, but actually are unusable after about 36 months. So, you already have a problem there in terms of your accounting for the GPUs”* Given this context, these companies perhaps should face difficult time in maintaining their historical depreciation rate, yet we are seeing the **opposite**. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2be5eebc-ed0d-4437-8eea-3c1f120fd843_1453x583.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Let’s look at Meta now. **Meta** Meta made some changes in how they classify certain PP&E items in 2021\. To make it more apple to apple, I have created a line item myself titled, “sub-total Servers and Network Assets”. In Meta’s case, we do see a somewhat noticeable mix shift within PP&E for servers and network assets as it declined from \~45-60% in 2013-2018 period to \~38-42% in the last five years. Like Microsoft, Meta’s depreciation rate as a percentage of beginning net PP&E declined from \~25-30% during 2013-2018 period to \~14-15% in the last two years. Unlike Microsoft, however, Meta’s incremental depreciation rate was somewhat consistent over the last decade. In Meta’s case, there was indeed some mix shift in PP&E, but given Meta’s ever increasing GPUs (Zuckerberg mentioned they expect to have [1.3 million GPUs](https://www.facebook.com/zuck/posts/pfbid0219ude255AKkmk4JAueXZeZ9zpjNYio2tBkd7bNmCaRbJ6iJaVVjypUgDg78CNdq5l) which clearly indicates these GPUs will be a significant part of their PP&E), the question remains just as valid whether we perhaps should expect to see depreciation rate to increase, instead of being down or steady going forward. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8a3efc0c-5e51-4359-bb45-f9149f7242b9_1407x886.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Now let’s look at perhaps the most interesting one: Alphabet. **Alphabet** Of these three companies, Alphabet is likely the worst “offender” in this exercise. “Information technology assets” has largely been steady in their PP&E mix over the last 10 years. When Alphabet’s net PP&E doubled from $42 Billion in 2017 to $85 Billion in 2020, their depreciation expense also doubled. So far, so good. However, **while their net PP&E increased by a whopping $50 Billion in 2023 compared to 2020, their annual depreciation expense has actually declined by $1 Billion during the same period**. Those changes in useful lives certainly came in pretty handy for Alphabet. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd4847c90-2725-4f25-a027-83477e9d830e_1330x580.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); the cells colored yellow indicates that Alphabet later re-stated its depreciation expenses in 2021-22 period It almost doesn’t pass the smell test when I noticed Meta and Google reported almost the same depreciation expense in 2023 even though Meta’s net PP&E as % of Google’s was only \~70% in 2023\. Given their network assets in the PP&E mix are kind of similar, I’m not sure why such discrepancy exists. Perhaps Google is much better than Meta in managing their assets! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F63f09817-3e56-4840-9d65-7ae1cfa889ff_1108x592.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) While many may consider it “analysis paralysis” on accounting shenanigans, there may be important implications for these companies. Even though changes in depreciation schedule doesn’t have any impact on cash flow, since all these big tech companies are investing heavily in their capex, investors understandably pay more attention to their earnings these days than free cash flow in valuing these companies. If somewhat questionable depreciation schedule leads to higher reported profit and higher reported ROIC, investors can go a bit astray in assessing their fundamentals. This can become especially more important as the size of their PP&E grows which is almost certainly going to be the case in the short-to-medium term. Thank you for reading. I will cover Google, Meta, and Amazon's earnings in the next couple of weeks. [Subscribe](#/portal/signup) ### IDEXX: Leading the Humanization of Pet Care Through Diagnostics URL: https://www.mbi-deepdives.com/idxx/ Last updated: 2025-01-23T13:23:49.000Z _This post is for paying subscribers only._ ### 2024 Annual Letter URL: https://www.mbi-deepdives.com/2024/ Last updated: 2025-08-04T17:00:57.000Z _This post is for paying subscribers only._ ### Some updated thoughts on AppFolio URL: https://www.mbi-deepdives.com/appf3/ Last updated: 2024-12-23T14:34:00.000Z _This post is for paying subscribers only._ ### Maravai: A Cornerstone in mRNA and Biologics Innovation URL: https://www.mbi-deepdives.com/mrvi/ Last updated: 2024-12-20T23:39:00.000Z _This post is for paying subscribers only._ ### Lululemon 3Q'24 Update URL: https://www.mbi-deepdives.com/lulu3q24/ Last updated: 2024-12-11T17:56:40.000Z *Disclosure: I own January 2026 $165 LULU Call Options* While the overall market continues to hit All-time High almost every other day, Lulu has been battling the skeptics for much of this year. There is still a long way to go, but with the stock now up almost 50% over the last three months, Mr. Market has likely started acknowledging that the bear narratives perhaps went a bit too far. Glancing through the numbers for 3Q’24 may seem eerily similar to 2Q’24, but management’s tone was much more upbeat tonight. Lulu’s CEO Calvin McDonald started the call with an apparent dig at Alo (which ran 30% discount on all products during this Black Friday) while assuaging investors that the current quarter is trending well so far: > We are pleased with our business over the extended Thanksgiving weekend and the traffic trends we saw across both our store and e-commerce channels. In fact, on Black Friday, **we had the most visits ever to our Shop app and e-commerce site.** **Unlike others in this space, we do not run sale events across our entire store.** We leveraged the increased traffic over this period to clear through product we are not taking forward and to feature full-price style. While some competitors such as Alo notched up the promotional intensity, Lulu remained disciplined. McDonald later explained: > ..We are happy with **how the guests responded to both with full price sales driven by some of our key franchises** > > ..From a year-over-year perspective, I don't think the overall market is any more intense. There's pockets where certain brands and retailers are more promotional and where others are less. I think it obviously depends on the momentum in their business coming in of how they've chosen to play that. > > But when I look at the premium athletic space, **we've continued to play a non-promotional markdown only reg price business unlike others within this space** and pleased to see the results to kick off the holiday and the way the guest responds to our product. [Subscribe](#/portal/signup) **Sales Growth by Region** For the two consecutive quarters, US revenue was flat. US traffic was positive in e-com but slightly lower in stores than last year’s. Given Lulu’s bear thesis mostly revolves around alleged saturation in the US, Lulu won’t be able to kill this bear thesis until US revenue/comp starts growing. Remember, despite the roaring rally in the last three months, the stock is still down \~33% from its peak. Canada remains a bright spot in North America. Lulu closed their Mexico franchise and instead added 15 company operated stores in Mexico. While every other brand seems to be struggling in China, Lulu seems to be operating on a different gear there. I have shared more about their China strategy on my [WhatsApp community](https://chat.whatsapp.com/HKJLqkvhIkQBgtBdEIf5jV?ref=mbi-deepdives.com) a couple of months ago, so I won’t elaborate much here. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F49f12872-2268-4357-871b-533d293977d1_847x859.png) Source: Company Filings While Lulu’s US trajectory remains an issue, management mentioned that guest retention remains high and their membership program reached now 24 million in North America. If you take LTM revenue of \~$9.5 Billion in North America and assume \~80% of this revenue was derived from Lulu’s “members”, it implies each member spent \~$300 on Lulu in the last 12 months. This is **average** number, but it is likely that top 10% of Lulu’s customers perhaps spend multiple thousands of dollars per year. This should give you a good idea about the nature of the cult Lulu is for its core customers. Given the high retention of these members, I’m only half joking when I say Lulu is perhaps almost like a “subscription” for many of these core customers. Of course, these customers are not going to buy the same color every year which is why newness is an important driver for Lulu. Unfortunately, they have faltered on this for the last few quarters and management reiterated that by Q1, they expect to reach their historical level of newness: > We continue to see good response to newness from our guests, and **we're on plan to hit that historical number by quarter 1**. And when I look at our guests, I'm happy with the absolute growth number. Our retention with our guests remains very strong, and the opportunity remains, as I've spoken to in the past revenue per guest related to newness. Beyond North America and China, Rest of The World (RoW) also continues to grow at a rapid pace. Lulu plans to open company-operated stores in Italy in 2025; they have also decided to enter Denmark, Belgium, Turkey and the Czech Republic under a franchise model. I wish there were more questions why Lulu decided to opt for franchise model in these markets, but there wasn’t much discussion on this during Q&A. But the fact that Lulu is just entering market such as Italy (fourth largest GDP in Europe and 10th in the world) makes me optimistic that there is ample growth runway left in RoW. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F51951927-03a0-455f-991f-85711d68e0ff_1159x264.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Lulu’s sqft growth gained a bit more momentum in the last quarter; adding 15 stores in Mexico certainly helped. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc01b815f-6466-4215-b367-44529ed46feb_880x453.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Margin** Lulu’s operating margins in North America and China segment may look pretty elevated, but management hinted that there’s more margin to be gained in China in due time: > it's not a region where we're looking right now to optimize operating margin, really focused on driving our long-term trend, but certainly see opportunity there over the longer term. Lulu’s Gross Margin (GM) was ahead of their expectation which was driven by +50 bps increase in product margin, lower inventory provision offset by higher freight costs. Markdown was flat YoY; there was also 20 bps deleverage of fixed costs and 10 bps positive FX impact. SG&A, on the other hand, had 20 bps negative impact from FX. 3Q’24 operating margin was still highest in the last 10 years. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F591c0a80-6a13-4354-9901-c714d41720c4_1411x799.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F91d304aa-a9c2-4456-a282-b649dbd7985c_1198x673.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Sales by Gender** After MSD growth in women’s category in 2Q’24, it has picked up in 3Q. Lulu also seems to be planning to focus more on “play category” which I think is a good idea: > In quarter 3, in women's, **we saw strength in short skirts and leggings and seasonal colors**…We built upon our success this past spring in Golf by focusing on another play category, tennis, when we dropped our Lululemon tennis club collection during the U.S. opened in New York this quarter. > > Based on the strong guest response we continue to see an opportunity to grow our play activities and intend to evolve our strategy from a seasonal approach to one where we introduced newness into these collections consistently throughout the year. Lulu’s accessories business (other category) continues to defy the tough comp and maintained its HSD growth despite facing mid-20s comp from last year. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F45c41a50-b327-43c1-9960-187db255b34e_1081x258.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Inventory** Even though Lulu guided inventory to increase by mid-teens, it only grew by 8%. They, however, guided for mid-teen inventory growth for Q4 as they chase the seasonal newness. There was a question about potential impact of tariff. It sounds to be quite manageable: > we have very limited exposure in China, we sourced approximately **3% of goods from China**. So exposure there is relatively small. **Our sourcing from Mexico is less than half of percentage, and we don't source anything from Canada.** So also a very small exposure there as well. So I would expect those are probably under some of the competitive landscape. **Capital Allocation** I am so, so impressed by Lulu management’s capital allocation in the recent few quarters. As the market warmed up to Alo/Vuori bear thesis, management decided to be quite aggressive in buying back the stock. When the stock was trading below $300 in July-August, they really ramped up their buyback activity. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb4727f97-da96-4064-9c28-2228fe4deadf_487x520.png) Source: Company Filings, MBI Deep Dives I was curious to see whether management chose to be similarly aggressive in the past. Indeed, I had to go back to 2018-19 when Lulu was similarly aggressive in buying back stocks as the stock was trading at $120-160/share. The stock did 2.5-3x since then, so these buybacks turned out to be quite accretive for remaining shareholders. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffa798572-548c-4662-b41f-c359d896abab_489x406.png) Source: Company Filings, MBI Deep Dives The current aggressive buybacks already started proving to be fruitful as Lulu’s shares outstanding declined by 3.1% YoY in 3Q’24. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb655c220-f5b0-4e2f-9018-d6fa8b21279c_954x393.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** Even though Lulu comfortably beat topline in 3Q, they guided rather conservatively for 4Q. They increased the mid-point of annual guidance after taking it down by 3% last quarter: > Starting with full year 2024, we now expect revenue to be in the range of $10.452 billion to $10.487 million. This range represents growth of 9% relative to 2023…For the full year, we now expect gross margin to increase approximately 10 to 20 basis points versus our adjusted gross margin in 2023\. We continue to expect markdowns to be relatively flat with last year…When looking at operating margin for the full year 2024, we continue to expect a decrease of 10 to 20 basis points versus adjusted operating margin in 2023, which expanded 110 basis points versus 2022. **Final Words** Lulu remains a very important holding in my portfolio. I am encouraged to see growth momentum continuing in international markets, but for Lulu to get out of the woods, we will have to wait for the US growth to return. I am optimistic that we will see such return to growth in the US in 2025 which may help evaporate the clouds on Lulu’s business. More reading on Lululemon: [here](https://www.mbi-deepdives.com/lulu/), [here](https://www.mbi-deepdives.com/apr2024/), and [here](https://www.mbi-deepdives.com/tsm/) (see section 5) Thank you for reading. ### December, 2024 Update URL: https://www.mbi-deepdives.com/dec24/ Last updated: 2024-12-02T15:30:10.000Z Some quick updates for this month. I am currently working on **Maravai Lifesciences (Ticker: MRVI),** and I expect to publish my Deep Dive later this month. I plan on covering earnings of Dollar General and Lululemon this week. Since DG has become somewhat unimportant holdings for me at this point, I will share my notes and brief thoughts on DG's earnings in our WhatsApp community; join the [community](https://chat.whatsapp.com/HKJLqkvhIkQBgtBdEIf5jV?ref=mbi-deepdives.com) if you haven't already. I will, however, cover Lululemon earnings in detail on the website. As I do after every month, I have disclosed my updated portfolio [here](https://www.mbi-deepdives.com/portfolio/). After receiving some feedback, I have now included a more granular breakdown of the portfolio on the "Portfolio" tab of the website itself. While this disclosure is not new since I have disclosed this at the end of my monthly Deep Dives, it is more convenient for readers to quickly see the current overall portfolio. For new subscribers, let me highlight that you can access all the past 53 Deep Dives, including excel models, [**here**](https://www.mbi-deepdives.com/models/). Thank you for your support. [Subscribe](#/portal/signup) ### Oracle: Ellison's Voyage to Software and Beyond URL: https://www.mbi-deepdives.com/orcl/ Last updated: 2025-01-23T06:19:21.000Z _This post is for paying subscribers only._ ### November, 2024 Update URL: https://www.mbi-deepdives.com/november-2024-update-2/ Last updated: 2024-11-04T15:28:12.000Z Some quick updates for this month. I am currently working on **Oracle Corporation (Ticker: ORCL),** and I expect to publish my Deep Dive on Oracle by November 26th. While I mentioned earlier that I would work on a couple more semiconductor companies this year, I am shifting it to next year. So far, I have published a [Primer](https://www.mbi-deepdives.com/semiconductors-to-see-a-world-in-a-grain-of-sand/) on semis, and Deep Dives on [Texas Instruments](https://www.mbi-deepdives.com/txn/) and [TSMC ](https://www.mbi-deepdives.com/tsm/)this year. Next year, I hope to cover at least two more companies from semiconductor industry. For new subscribers, let me highlight that you can access all the past 52 Deep Dives, including excel models, [**here**](https://www.mbi-deepdives.com/models/). I also disclose my [portfolio](https://www.mbi-deepdives.com/portfolio/) on a monthly basis. Thank you for your support. [Subscribe](#/portal/signup) ### Amazon 3Q'24 Update URL: https://www.mbi-deepdives.com/amzn3q24/ Last updated: 2024-11-01T01:10:23.000Z *Disclosure: I own Jan 2025 $55 call options of Amazon* Like clockwork, Amazon has posted another impressive quarter. Every part of the business seems to be trending well, and moving in the right direction. Here are my highlights from today’s call. [Subscribe](#/portal/signup) **Revenue** Except 1P, every segment of the business is growing at double digit rate. Both AWS and advertising grew at 19% YoY. I’ll discuss more about AWS later, but let’s talk more about Amazon ex-AWS first. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6f2d9767-984d-49b4-bd2d-bbe29ba798e6_1501x232.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** North America and international sales grew +9% and +12% respectively. Both North America and international segment posted their seventh consecutive YoY operating margin improvement. Amazon’s operating margin improvement is well telegraphed and understood by investors, but still nice to see them execute so well here. Lower cost to serve, greater contribution from advertising, improved selection, faster delivery speeds driving consumer demand are some of the things mentioned by management for retail business’ continued improvement. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F54d097a3-d8be-435f-9419-a8cab4158186_852x94.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Some key quotes on retail business below: > Prime remains a core contributor to this growth. Year-over-year paid membership growth **accelerated in Q3 from both the U.S. and globally**. > > When you look at the split between revenue growth and unit growth, you do see some impact of the lower ASP products that we're selling as well as **some of the trade down that consumers are doing**. But we take that as a real positive, seeing the growth in everyday essential categories, which are really predicated on speed. > > So you have to have fast delivery to be able to sell the those products to customers. And when you do, it results in a **stickier consumer relationship, higher orders, building larger baskets, which help our ship economics, and repeat orders are stronger**. So those are all positive signs, and **we'll take any short-term degradation in ASP because what we're focused on primarily is free cash flow here.** > > …**it's easy to lower prices but it's much harder to be able to afford to lower prices**. And the same thing is probably true about lower ASP items. It's pretty easy to choose to supply them but **it's much harder to be able to afford to economically supply them.** And so one of the reasons that we have been so maniacal about cost to serve over the last few years is that as we're able to take our cost to serve down, it just opens up the aperture for more items, particularly lower ASP items that we're able to supply in an economic way. Given how focused Amazon seems to be in serving lower ASP items, you gotta wonder about the long-term questions that may pose for Dollar stores, especially in urban/semi-urban areas. **Fulfillment+ Shipping** If you look at worldwide paid unit growth vs shipping+ fulfillment cost growth, you would notice that the latter used to consistently outpace the former pretty much all the time since 2015 until 3Q'22\. Since then, unit growth is faster (was at par in 3Q’23) than shipping+ fulfillment costs, indicating operating leverage in their logistics footprint. That theme continued in 3Q’24 which makes me confident that Amazon retail remains very much on track. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2aef1bc6-b66a-4aff-90c3-ed0a5a619da4_1108x469.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) The good news is there is likely more upside left here. Their regionalization efforts in logistics is continuing to reap benefits for the company that will likely keep improve customer experience and margins even more over time: > First, we continue to believe there are **more gains on top of what we've captured thus far in outbound regionalizatio**n and getting more items closer to end consumers. As such, we're in the process of significantly changing the way we inbound items into our fulfillment network and subsequently spread them to our regional fulfillment nodes. > > In the last few months, we've made hundreds of changes to our U.S. inbound network and opened more than 15 inbound buildings. While still relatively early in this re-architecture, **we've already improved our ability to spread inventory across our fulfillment centers by 25% YoY**, allowing us to have more of the requisite items in fulfillment centers closest to the customer so we can compile shipments and ship to customers even more quickly. As we scale and optimize this new design, we expect these changes will **further improve inventory placement, offer faster delivery time, save transportation costs, and enable us to increase units shipped per box.** > > Second, we continue to roll out same-day delivery facilities, which is **not only the fastest way to get products to customers but also one of our lowest cost ways to deliver**. Over 40 million customers this past quarter have had their orders delivered for free with same-day delivery, **an increase of more than 25% year-over-year**. And third, we continue to innovate in robotics to speed delivery, lower cost to serve, and further improve safety in our fulfillment network. > > We recently launched our 12th-generation fulfillment center design with the first building launching in Shreveport, Louisiana. This is the first facility that incorporates our newest robotics inventions to simplify stowing, picking, packing, and shipping processes. **Thus far, this new design reduces fulfillment processing time by up to 25%, increases the number of items we can offer for same-day or next-day delivery and is expected to drive a 25% improvement in our cost to serve during peak within this next generation facility.** Though we believe we have more expansive automation and robotics than other retail peers, **it's still early days in how much automation we expect in our fulfillment network.** > > we really do believe that **AI is going to be a big piece of what we do in our robotics network**. We had a number of efforts going on there. We just hired a number of people from an incredibly strong robotics AI organization. And I think that will be a very central part of what we do moving forward, too **Advertising** > …Sponsored Products, we're seeing **meaningful growth on a very large base**, and we see further opportunity in driving **even better performance for advertisers by further improving the relevancy of the ads** we show and by providing additional optimization controls. At the same time, some of our newer offerings are in their very early days. We're just entering our first broadcast season for Prime Video advertising, following a very strong showing at upfronts. And we're continuing to support brands of all sizes with our generative AI-powered creative tools across display, video and audio, including our video generator that uses a single product image to curate custom AI-generated videos. While we're generating a lot of advertising revenue today, **there remains considerable upside**. **AWS** Okay, now let’s talk about AWS. AWS added \~$1.2 Bn incremental revenue QoQ. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe5a7a6fd-223c-4f7a-a057-bd5b0888a2fe_1018x532.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Let’s take a quick look at hyperscalers growth. While both Azure and Google Cloud accelerated in 3Q, AWS growth remained steady at 19%, same as 2Q’24\. Do keep in mind AWS’ large base though now that it has annualized run-rate of $110 Billion revenue. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fbd3b5750-e291-4e67-99f3-03872afd0880_1399x796.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); \*Google Cloud includes Google Workspace, so not quite apple-to-apple and in reality, GCP tends to grow faster than Google Cloud One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. Back in 2020, Google Cloud was only about a quarter of the size of AWS, but now it’s almost two-fifth of AWS revenue. We don’t know exactly how much of this is GCP, but we can be pretty confident that GCP is leading this catch-up with AWS. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0c783133-871e-41bb-8524-9e7e7dc9b8fa_1000x616.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0cc3fd1a-0b8a-43ab-b600-b0ed35f09ace_1077x664.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Like Google and Meta, AWS also kept posting almost “obscene” incremental operating margins of \~80% in 3Q’24\. AWS, in fact, posted its highest ever operating margin of 38.1% in 3Q’24\. What’s driving these incredible operating margins? > …continued focus on cost control, including a measured pace of hiring, a focus on driving efficiencies in our infrastructure, and reducing costs across the business. Additionally, we increased the estimated useful life of our servers starting in 2024, **which contributed approximately 200 basis points** to the AWS margin increase year-over-year in Q3\. As we said in the past, we expect the AWS operating margins to fluctuate, driven in part by the level of investments we're making at any point in time. I know investors don’t love these margin expansion from extending useful lives of servers, but it’s extremely unlikely that they’re making these numbers up without supporting evidence for doing so. So, I don’t quite frown on this practice. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F189d29bb-1114-4b30-8e4b-428a19bec78f_1465x115.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe28a1dfe-0b0d-4a5d-ae4b-69ce4d0077e0_1192x649.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) The following quote from Andy Jassy on AWS was quite insightful: > I think **one of the least understood parts about AWS, over time, is that it is a massive logistics challenge**. If you think about, we have 35 or so regions around the world, which is an area of the world where we have multiple data centers, and then probably about 130 availability zone through data centers, and then we have thousands of SKUs we have to land in all those facilities. > > And **if you land too little of them, you end up with shortages, which end up in outages for customers. So most don't end up with too little, they end up with too much.** **And if you end up with too much, the economics are woefully inefficient. And I think you can see from our economics that we've done a pretty good job over time at managing those types of logistics and capacity.** And it's meant that we've had to develop very sophisticated models in anticipating how much capacity we need, where, in which SKUs and units. > > And so I think that the AI space is, for sure, earlier stage, more fluid and dynamic than our non-AI part of AWS. But it's also true that **people aren't showing up for 30,000 chips in a day. They're planning in advance. So we have very significant demand signals giving us an idea about how much we need. And I think that one of the differences if you were able to get inside of the economics of the different types of providers here is how well they manage that utilization and that capacity. It has a very direct impact on what kind of margins you have over time and what kind of capital efficiency you also have over time.** > > And so I think you're right…that **there are some similarities in the early days here of AI, where the offerings are new and people are very excited about it. It's moving very quickly and the margins are lower than what I think they will be over time. The same was true with AWS. If you looked at our margins around the time you were citing, in 2010, they were pretty different than they are now. I think as the market matures over time, there are going to be very healthy margins here in the generative AI space.** **Opex+Capex** Just like other big tech, Amazon's capital intensity has also gone up materially with their increased scale. In 1H’24, they spent $30.5 Bn in capex, \~$22 Billion in Q3, and guided another \~$23 Billion for Q4\. Back in 2018-19, capex as % of sales used to be \~5-6%. Capital intensity has almost tripled as it reached 14.2% of sales in 3Q’24. What are they spending these capex on? > The majority of the spend is to support the growing need for technology infrastructure. This primarily relates to AWS as we invest to support demand for our AI services while also including technology infrastructure to support our North America and international segments. > > Additionally, we're continuing to invest in our fulfillment and transportation network to support the growth of the business, improve delivery speeds and lower our cost to serve. This includes investments in same-day delivery facilities, in our inbound network and as well in robotics and automation. Management emphasized that this may be “once-in-a-lifetime” opportunity, so they would rather be aggressive in their investments: > so the thing to remember about the AWS business is the cash life cycle is such that **the faster we grow demand, the faster we have to invest capital in data centers and networking gear and hardware**. And of course, in the hardware of AI, the accelerators or the chips are more expensive than the CPU hardware. And s**o we invest in all of that upfront in advance of when we can monetize it with customers using the resources.** > > But of course, a lot of these assets are many-year useful life assets. Data centers, for instance, are useful assets for 20 to 30 years. And so I think we've proven over time that we can drive enough operating income and free cash flow to make this very successful return on invested capital business. And we expect the same thing will happen here with generative AI. **It is a really unusually large, maybe once-in-a-lifetime type of opportunity. And I think our customers, the business, and our shareholders will feel good about this long term that we're aggressively pursuing it.** For opex, Amazon has started to find its efficiency religion. They mentioned office staff is down slightly YoY (and flat from 2023 end). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F61396f60-e86c-4cf1-8ce4-f2045e695f4f_2109x256.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Other Bets** Nothing on Kuiper in this call, but Amazon continues to show optimism around Alexa although I’m not sure such optimism around Alexa is shared by many: > We've about 0.5 billion devices out there with a couple of hundred million active endpoints. And when we first were pursuing Alexa, we had this vision of it being the world's best personal assistant and people thought that was kind of a crazy idea. > > And I think if you look at what's happened in generative AI over the last couple of years**, I think you're kind of missing the boat if you don't believe that's going to happen.** It absolutely is going to happen. So **we have a really broad footprint where we believe if we rearchitect the brains of Alexa with next-generation foundational models, which we're in the process of doing, we have an opportunity to be the leader in that space.** **Outlook** Amazon’s guidance for 4Q’24 is below. Please note consensus 4Q’24 revenue and EBIT before the call were $186.3 Billion and $17.3 Billion respectively. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff99bc97c-7960-4e90-ab44-0c5266194a6d_1054x220.png) Source: Company Filings **Closing Words** Amazon seems to be in a pretty strong place in both of its core business: retail and cloud. Both of them are staggeringly large markets with sizable profit pool across the value chain and Amazon remains in a prime position to capture attractive economics. I intend to remain invested at current price. For more in-depth valuation discussion of Amazon, see my analysis [**here**](https://www.mbi-deepdives.com/amzn2024/) (February, 2024). Please feel free to share with your friends and network. Thank you for reading. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Meta 3Q'24 Update URL: https://www.mbi-deepdives.com/meta3q24/ Last updated: 2024-10-31T16:13:42.000Z *Disclosure: I own shares of Meta Platforms* Meta’s earnings was fine. But there is almost a certain sense of exhaustion in terms of reaction to Big Tech earnings this quarter so far. Here are my highlights from today’s call. [Subscribe](#/portal/signup) **Users** Daily Active People (DAP) across its Family of Apps (FOA) decelerated to 20 mn QoQ in 3Q’24. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffe8fca7f-15bd-4b68-bb79-f18631413602_1879x81.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Ad revenue by Geography** Even though easy comp ended in 1Q’24 and 3Q’24 faced a fairly difficult comp, Meta posted quite strong YoY growth rates across regions in 3Q’24. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F09318ee2-7298-4a86-85e7-ea0a7d4c1699_1978x361.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Meta’s Family of Apps (FOA) ads revenue growth is comfortably ahead of both Google Search and YouTube ads in each of the last 1-yr, 2-yr, and 3-yr timeframe. Given the growth levers Meta have today, I reckon they will grow noticeably faster compared to both Google Search and YouTube ads in the next couple of years. More on the growth levers later. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F781e9966-d829-4397-be94-958345517f10_514x157.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Ad Impression and Avg. Price Per Ad** Overall impression grew by 7% and avg. price per ad grew by 11% YoY. Interestingly, Asia Pacific had the slowest growth in 3Q’24, mostly because it was lapping a period of stronger demand from China-based advertisers. I remember how much airtime these “China-based advertisers” were getting last year from the analysts, and how they may have “inflated” Meta’s ad revenue. Today, this felt almost a trivial point. Meta’s ad infrastructure is going through some consequential changes which I suspect will keep improving monetization at all the FOA properties over multiple quarters going forward. Some interesting quotes from the call: > Pricing growth was driven by increased advertiser demand, in part due to improved ad performance. > > …Similar to organic content ranking, we are finding opportunities to achieve meaningful ads performance gains by adopting new approaches to modeling. For example, we recently deployed new learning and modeling techniques that enable our ad systems to consider the sequence of actions a person takes before and after seeing an ad. Previously, our ad system could only aggregate those actions together without mapping the sequence. This new approach allows our systems to better anticipate how audiences will respond to specific ads. Since we adopted the new models in the first half of this year, **we've already seen a 2% to 4% increase in conversions** based on testing within selected segments. > > In Q3, we introduced changes to our ad ranking and optimization models to take more of the cross-publisher journey into account, which we expect to **increase the Meta attributed conversions** that advertisers see in their third-party analytics tools. > > we care a lot about **conversion growth, which…continues to grow faster than impression growth**. And are we seeing healthy cost per action or cost per conversion trends. And as long as we continue to get better at driving conversions for advertisers that should have the effect of lifting CPMs over time, **because we're** **delivering more conversions per impression served and that will result in higher value impressions.** ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3f561e84-ee6e-4564-9218-b52d08b30923_877x504.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Segment Reporting** Overall 3Q’24 revenue was +18.9% YoY; on a 2-yr and 3-yr CAGR basis, Meta’s topline increased by 21.0% and 11.8% respectively. FOA’s 3Q’24 operating margin of 54.0% was slightly below its peak operating margin of 54.4% in 4Q’20\. Incremental margin at FOA remains super impressive at 67.2% in 3Q’24. Here’s a funny stat. Meta added $12.9 Billion incremental quarterly revenue in 3Q’24 vs 3Q’22\. Their incremental operating income at FOA increased by $12.4 Billion during this time. So, basically they were able to grow their revenue at effectively 100% margin. The magic of zero marginal cost runs deep into Meta’s business. The less magical segment: Reality Labs (RL) continues to bleed. But an optimistic would say the silver lining here is QoQ losses here declined. Does this mean we are very close to peak RL losses? Meta was asked this question, but didn’t answer definitively. My guess is they may provide more clarity on this next quarter. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6aee5bd8-2ad5-48eb-bec7-1d5b980b1af3_1836x540.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Let’s look at some interesting comments from the earnings call: **AI, AI, AI** Lots of good data points how AI is helping Meta’s core products: > Meta AI now has more than **500 million monthly actives**, improvements to our AI-driven feed and video recommendations have led to an **8% increase in time spent on Facebook and a 6% increase on Instagram this year alone**. More than 1 million advertisers used our Gen AI tools to create more than 15 million ads in the last month. And we estimate that **businesses using image generation are seeing a 7% increase in conversions and we believe that there's a lot more upside here**. Meta’s new approach to content ranking will likely act as tangible lever of growth in terms of time spent and surfacing more relevant content for the users, but it’s going to be probably a multi-year journey: > Previously, we operated separate ranking and recommendation systems for each of our products because we found that performance did not scale if we expanded the model size and compute power beyond a certain point. However, inspired by the scaling laws we were observing with our large language models, last year, we developed **new ranking model architectures capable of learning more effectively from significantly larger data sets.** > > To start, we have been deploying these new architectures to our Facebook ranking video ranking models, which has enabled us to deliver **more relevant** recommendations and unlock meaningful gains in launch time. Now we're exploring whether these new models can unlock **similar improvements to recommendations on other services**. After that, we will look to introduce **cross-surface data to these models, so our systems can learn from what is interesting to someone on one surface of our apps and use it to improve their recommendations on another**. This will take time to execute and there are other explorations that we will pursue in parallel. > > However, over time, we are optimistic that this will unlock more relevant recommendations while also leading to higher engineering efficiency as we operate a smaller number of recommendations. **Llama** Meta again explained how their “open” approach is going to benefit them in the long run: > There's sort of the quality flavor and the efficiency flavor. There are a lot of researchers and independent developers who do work and because Llama is available, they do the work on Llama and they make improvements and then they publish it and it becomes -- **it's very easy for us to then incorporate that both back into Llama and into our Meta products** like Meta AI or AI Studio or Business AIs > > Perhaps more importantly, is just **the efficiency and cost**. I mean this stuff is obviously very expensive. When someone figures out a way to run this better if that -- **if they can run it 20% more effectively, then that will save us a huge amount of money**. And that was sort of the experience that we had with open compute and part of why we are leaning so much into open source here in the first place, is that **we found counterintuitively with open compute that by publishing and sharing the architectures and designs that we had for our compute, the industry standardized around it a bit more. We got some suggestions also that helped us save costs and that just ended up being really valuable for us.** > > Here, one of the big costs is chips -- a lot of the infrastructure there. **What we're seeing is that as Llama gets adopted more, you're seeing folks like NVIDIA and AMD optimize their chips more to run Llama specifically well, which clearly benefits us**. So it benefits everyone who's using Llama, but it makes our products better, right, rather than if we were just on an island building a model that no one was kind of standardizing around the industry. So that's some of what we're seeing around Llama and why I think it's good business for us to do this in an open way. One thing that really stood out to me was Meta mentioned they are helping the public sector to adopt Llama across the US govt which assuages my concerns related to potential unfriendly regulations to open source approach that are being lobbied strongly by some of the companies pursuing closed approach models: > This quarter, we released Llama 3.2, including the leading small models that run on device and open source multimodal models. We are working with enterprises to make it easier to use. And now we're also working with the public sector to adopt **Llama across the U.S. government.** Llama 4 (the smaller one) is coming early next year: > The Llama 3 models have been something of an **inflection point** in the industry. But I'm even more excited about Llama 4, which is now well into its development. We're training the Llama 4 models on a cluster that is bigger than 100,000 H100s or bigger than anything that I've seen reported for what others are doing. I expect that the smaller Llama 4 models will be ready first, and they'll be ready -- we expect **sometime early next year**. > > It seems pretty clear to me that open source will be the most cost-effective, customizable, trustworthy performance and easiest to use option that is available to developers. **Facebook, and Instagram** > On Facebook, we continue to see **positive trends with the young adults, especially in the U.S.** > > In the third quarter, we continue to see **daily usage grow year-over-year across Facebook and Instagram, both globally and in the U.S**. On Facebook, we're seeing strong results from the global rollout of our unified video player in June. > > Since introducing the new experience and prediction systems that power it, we've seen a **10% increase in time spent within the Facebook video player**. This month, we've entered the next phase of Facebook's video product evolution. Starting in the U.S. and Canada, we are updating the stand-alone video tab to a full screen viewing experience, which will allow people to seamlessly watch videos in a more immersive experience. We expect to complete this global rollout in early 2025. > > Within Facebook, video engagement **continues to shift to short form following the unification of our video player**, and we expect this to continue with the transition of the video tab to a full screen format. This is resulting in an organic video impressions growing more quickly than overall video time on Facebook, which **provides more opportunities to serve ads**. > > Across both Facebook and Instagram, we're also continuing our broader work to optimize **when and where we should show ads within a person's session. This is enabling us to drive revenue and conversion growth without increasing the number of ads.** As you can see, there are a number of growth levers Meta is working on. Each of these levers will probably only add a couple of points of growth, but in aggregate they can really add up over time. **WhatsApp** > For WhatsApp, the U.S. remains one of our fastest-growing countries, and we just passed a milestone of **2 billion calls made globally every day**. > > The other element of revenue on WhatsApp, I would say, is **paid messaging that continues to grow at a strong pace again this quarter**. It remains -- in fact, the **primary driver of growth** in our Family of Apps other revenue line, which was up 48% in Q3, and we're seeing generally a strong increase in the volume of paid conversations driven both by growth in the number of businesses adopting paid messaging as well as in the conversational volume per business. **Threads** Threads Monthly Active Users over time: 3Q’23: 100 Million 4Q’23: 130 Million 1Q’24: 150 Million 2Q’24: 200 Million 3Q’24: 275 Million They are seeing 1 million sign-ups per day. Engagement is growing as well. In Q3, they saw strong user growth in the U.S., Taiwan and Japan. Threads monetization is unlikely to happen in 2025\. But Threads is another “margin of safety” in Meta’s growth trajectory. Given how MAU keeps accelerating every quarter, it is likely they may reach the coveted 1 Billion MAUs sometime in 2026 after which I think Meta will start monetizing Threads. Once this ad inventory becomes available, that’s gotta be bit of a tailwind for Meta sometime in 2026-27. **AR/VR** Meta mentioned their newly launched limited edition Meta Ray-Ban glasses sold out almost immediately and currently “trading” online for over $1,000\. Good signs! VR got very limited attention in the call. Quest 3 will probably do really well during the holiday season, but if this doesn’t lead to better engagement and retention post-Christmas, I suspect Meta may get its “efficiency” religion in VR and re-allocate some resources to move faster so that they can launch “Orion” before Apple gets there. **Capital Allocation** Meta generated $15.5 Billion FCF and returned $10 Billion cash to shareholders via dividend and buyback. They also completed a debt offering of $10.5 billion in Q3. LTM SBC per employee is now at $226k. Mr. Zuckerberg is clearly quite generous with his employees! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6409fc2d-0882-48b5-b402-a2087e9719de_1879x307.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex and Opex** Opex guide for 2024 was narrowed to $96-98 Billion (vs 96-99 Billion) Capex guide range was **again** tightened to $38-40 Billion (from $37-40 Bn in 2Q’24, $35-40 Bn in 1Q’24, and $30-37 in 4Q’23). However, in the first 9 months, they only spent \~$24 Billion. So Meta is going to \~$15 Billion in capex in Q4: > We continue to expect **significant capital expenditure growth in 2025**. Given this, along with the back-end weighted nature of our 2024 CapEx, we expect a significant acceleration in infrastructure expense growth next year as we recognize higher growth in depreciation and operating expenses of our expanded infrastructure fleet. Consensus capex estimate is still $47 Billion. I suspect it’s going to be closer to $50 Billion capex in 2025. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdcaa2a69-7743-49c4-b911-6e74cf03883c_1885x103.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** 4Q’24 topline guide is $45-48 Bn. Mid-point YoY growth is \~15.9% (vs consensus estimates of $46.2 Billion) **Closing Words** At the end of his prepared remarks, Zuckerberg said the following: > This may be the most dynamic moment that I've seen in our industry, and I am focused on making sure that we build some awesome things and make the most of the opportunities ahead. For a change, Meta seems quite well positioned during a potentially seismic shift in the tech landscape. Meta still needs to execute well, but nothing really happens in a straight line. Notes from the follow-up call [here](https://x.com/borrowed%5Fideas/status/1852000815239827865?ref=mbi-deepdives.com). For more in-depth analysis on Meta Platforms, you can read my analysis [**here**](https://www.mbi-deepdives.com/meta2024/) (February, 2024). I will cover **Amazon’s** earnings **tomorrow**. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Alphabet 3Q'24 Update URL: https://www.mbi-deepdives.com/goog3q24/ Last updated: 2024-10-30T03:09:11.000Z Alphabet had a pretty impressive quarter! Here’s my highlights from the earnings. [Subscribe](#/portal/signup) **Revenue** Let’s start with not-so-good news. For the 9th consecutive quarters, Google Network revenue kept declining. Everything else is good news. Despite all the disruption narrative, Search keeps humming along. YouTube is doing okay. But the highlight from last quarter was Google Cloud. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F799e48be-f8d1-4a3f-a944-97c6b9adf644_2005x361.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Google Cloud grew **35% YoY,** **highest** in the last 8 quarters. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F64bb80b7-b5eb-4c8e-9c4d-391cf7bd79b6_1833x235.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **EBIT** Not only did Google Cloud grow at faster pace at a larger scale, they did so at much higher profitability than ever before. After turning profitable in 1Q’23, Google Cloud posted 17.1% operating margin in 3Q’24\. The narrative that Google cannot reliably make money anywhere other than search should be put to rest. After posting its highest ever margin in 2Q’24, Google Services business reached a new margin peak again in 3Q’24\. Thanks to five consecutive quarters of **\>70% incremental operating margin (!!)**, operating margin for Google Services was 40.3% in 3Q’24! Given the qualitative narrative around search in the age of AI, I’m not sure too many people (certainly not me) would predict that Google Service business would keep reaching new heights in terms of operating margin every passing quarter! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd4a5c736-b3f5-446d-b6b4-ed6770f40631_1936x469.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Search** Speaking of search, let me share some interesting quotes on Search from the call: > since we first began testing AI overviews, we have lowered machine cost per query significantly. **In 18 months, we reduced cost by more than 90% for these queries** through hardware, engineering and technical breakthroughs while doubling the size of our custom Gemini model. > > In search, recent advancements, including AI overviews, Circle to Search and new features in lens are transforming the user experience, expanding what people can search for and how they search for it. This leads to users coming to search **more often for more of their information needs driving additional search queries**. Just this week, AI overview started rolling out to more than 100 new countries and territories. **It will now reach more than 1 billion users on a monthly basis.** We are seeing strong engagement, which is **increasing overall search usage and user satisfaction**. People are asking longer and more complex questions and exploring a wide range of websites. What's particularly exciting is that **this growth actually increases over time as people learn that Google can answer more of their questions**. The integration of ads within AI overviews is also performing well, helping people connect with businesses as they search. > > Circle to Search is now available on over 150 million Android devices (**MBI note**: 2Q’24 data was 100 million, so 50 million incremental here over a quarter) with people using it to shop, translate text and learn more about the world around them. **1/3 of the people who have tried circle to search now use it weekly a testament to its helpfulness in potential.** Meanwhile, **lens is now used for over 20 billion visual searches per month.** Lens is **one of the fastest-growing query types** we see on search because of its ability to answer complex multimodal questions and help in product discovery and shopping. For all these AI features, it's just the beginning, and you will see a rapid pace of innovation and progress here. > > AI really supercharges search…with Circle to Search, where we see **higher engagement from users aged 18 to 24**. AI is expanding our ability to understand intend and connect it to our advertisers. This allows us to connect highly relevant users with the most helpful ad and deliver business impact to our customers. > > every month lens is used for almost 20 billion visual searches with **1 in 4 of these searches having commercial intent**. > > …As you remember, we've already been running ads above and below AI overviews. We're now seeing that **people find ads directly within AI overview is helpful** because they can quickly connect with relevant businesses, products and services to take the next step at the exact moment they need. As I've said before, we believe AI will revolutionize every part of the marketing value chain. > > …people are using a lot of buzz words like answer engines and all that stuff. I mean **Google started answering questions about 10 years ago in our search product with featured snippets.** So look, I think, ultimately, you are serving users. User expectations are constantly evolving. And and we work hard to stay a step ahead, anticipate and stay a step ahead. And this is why we've kind of really brought multimodality on the input side and the output side in search pretty natively. Just a lot of very positive data points for Google’s search business. I know management is supposed to highlight the positives, but it’s definitely not getting easier to depict the Search bear case given what Google shared today. You can argue we are still in the early days, but Google Search’s operating performance has so far been much better than most bears would have predicted by mid-2023. **YouTube** In the last 12 months, YouTube's combined ad and subscription revenue has surpassed $50 billion for the first time. Of all the channels uploading to YouTube each month, 70% are uploading shorts. 70 billion YouTube shorts are watched every day. Monetization gap on shorts has continued to narrow. Moreover, Google DeepMind is going to launch its most capable model for video generation which will help creators produce shorts later this year. **Google Cloud** Sundar Pichai had a very good quote on how customers are using Google Cloud products which is worth reading in full: > Customers are using our products in 5 different ways. First, our AI infrastructure. which we differentiate with leading performance driven by storage, compute and software advances as well as leading reliability and a leading number of accelerators. Using a combination of our TPUs and GPUs, LG AI research reduced inference processing time for its multimodal model by more than 50% and operating costs by 72%. > > Second, our enterprise AI platform, Vertex is used to build and customize the best foundation models from Google and the industry. **Gemini API calls have grown nearly 14x in a 6-month period**. When Snap was looking to power more innovative experiences within their “My AI” chatbot, they chose Gemini's strong multimodal capabilities. Since then, Snap all over **2.5x as much engagement** with “My AI” in the United States. > > Third, customers use our AI platform together with our data platform, big query, because we analyze multimodal data no matter where it is stored with ultra low latency access to Gemini. This enables accurate real-time decision-making for customers like Hiscox, one of the flagship syndicates in Lloyd's of London, which reduced the time it took to quote complex risks **from days to minutes**. These types of customer outcomes, which combine AI with data science have led to **80% growth in big query ML operations over a 6-month period**. > > Fourth, our AI-powered cybersecurity solutions Google threat intelligence and security operations are helping customers like BBVA and Deloitte, prevent deduct and respond to cybersecurity threats much faster. We have seen customer adoption of our Mandan power threat deduction **increased 4x over the last 6 quarters**. > > Fifth, in Q3, we broadened our applications portfolio with the introduction of our new customer engagement suite. It's designed to improve the customer experience online and in mobile apps as well as in call centers, retail stores and more. A great example is Volkswagen of America, who is using this technology to power its new IBW virtual assistant. In addition, the employee agents we delivered through Gemini for Google Workspace are getting superb reviews. **75% of daily users say it improves the quality of their work.** I will discuss more on Cloud when Amazon posts next week. **AI** > all **7 of our products** and platforms with **more than 2 billion monthly users** use Gemini models, that includes the latest product to surpass the 2 billion user milestone Google Maps. Beyond Google's own platforms, following strong demand, we are making Gemini even more broadly available to developers. > > We're also using AI internally to improve our coding processes, which is boosting productivity and efficiency. Today, **more than 1/4 of all new code at Google is generated by AI, then reviewed and accepted by engineers.** **Other Bets** > Waymo is now a clear technical leader within the autonomous vehicle industry and creating a growing commercial opportunity. Over the years, Waymo has been infusing cutting edge AI into its work. Now each week, **Waymo is driving more than 1 million fully autonomous miles and serves over 150,000 paid rights.** > > Wing, our drone delivery company recently passed the 1-year university of scale in its partnership with Walmart in the Dallas-Fort Worth area, now **operating in 11 stores and serving 26 different cities and towns.** **Capital Allocation** Google returned capital to shareholders through buyback and dividend almost equivalent to FCF they generated last quarter. Share count declined by 74 bps QoQ. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc9f56f63-8a3c-4311-832a-a77112ff3c54_675x574.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex and Opex** Some good context around Google’s capex: > as you saw in the quarter, we invested $13 billion in CapEx across the company. And as you think about it, it really is divided into 2 categories. One is our technical infrastructure, and that's the majority of that $13 billion. And the other one goes into areas such as facilities, the bets and other areas across the company. Within TI, we have investments in servers, which includes both TPUs and GPUs. And then the second categories are data centers and networking equipment. This quarter, approximately **60% of that investments in technical infrastructure went towards servers and about 40% towards data center and networking equipment**. And as you think about them, we offer both GPUs and TPUs, both internally and to our customers. So we have choices and options based on what our customer needs and what our internal needs are. And as you think about the next quarter and going into next year, as I mentioned in my prepared remarks, we will be investing in Q4 at approximately **the same level of what we've invested in Q3**, approximately $13 billion. And as we think into 2025, we do see an increase coming in 2025, and we will provide more color on that on the Q4 call, **likely not the same percent step-up that we saw between '23 and '24, but additional increase.** For context, Google’s capex is expected to increase by \~55% in 2024 vs 2023, and the consensus estimates imply capex to be $54 Billion in 2025 vs $50-52 Billion in 2024\. So, of course nobody is remotely expecting “same percent step up” but my gut says the fact that they even mentioned it perhaps implies the “additional increase” is probably not just a couple of billions of capex increase in 2025, but rather $8-10 Billion increase. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F065d9ebe-d495-46f9-a07d-060080e87f88_1831x234.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** Google doesn’t provide guidance, but did mention the below during the call: > As we think about the remainder of 2024, there are a couple of dynamics to consider. In terms of revenue, Year-on-year growth in advertising revenue will continue to be impacted by the increase in strength in advertising revenue in the second half of 2023, in part from APAC-based retailers, and there will be a headwind to year-over-year growth in subscription platforms and devices revenue in the fourth quarter due to the pull forward of our Made by Google launches into the third quarter this year. **Valuation** Since [3Q'22](https://www.mbi-deepdives.com/goog3q22/), I share the following valuation framework every quarter. Given I created this table in 2022 which was a very different market than what we have today from sentiment perspective, you can argue this is overly conservative. I’m going to keep it consistent. But I acknowledge the reality that Google not only trades at the lowest NTM P/E multiple among Mag-7 stocks, its multiple is also below S&P 500. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa8e76552-63ba-4ab7-b4fe-9b8618f42299_1831x382.png) Source: MBI Deep Dives Finally, I do want to mention that Google shareholders should be proud to own a company that was the epicenter of AI research for the last decade or so which led to couple of its employees win the Nobel Prize! When I read the news first, I wished I owned Google! There is hardly any doubt that AI is going to have profound impact on our lives, and on society, and no matter which way the stock goes in the next 10-15 years, History will likely remember Google quite positively. I will cover earnings of **Amazon and Meta** this week. Thank you for reading. **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Why I am buying AppFolio URL: https://www.mbi-deepdives.com/appf2/ Last updated: 2024-12-23T14:51:24.000Z _This post is for paying subscribers only._ ### UMG: The Sound of Music URL: https://www.mbi-deepdives.com/umg/ Last updated: 2025-01-23T06:20:29.000Z _This post is for paying subscribers only._ ### October, 2024 Update URL: https://www.mbi-deepdives.com/october-update-3/ Last updated: 2024-10-02T14:32:08.000Z Just a very quick update for this month. I am currently working on **Universal Music Group (UMG),** and I expect to publish my Deep Dive on UMG by October 25th. Following UMG, I hope to work on **Oracle** Deep Dive next month. For new subscribers, I would like to highlight that you can access all the past Deep Dives, including excel models, [here](https://www.mbi-deepdives.com/models/). You can also follow MBI Deep Dives on [WhatsApp](https://chat.whatsapp.com/HKJLqkvhIkQBgtBdEIf5jV?ref=mbi-deepdives.com). Thank you for your support. [Subscribe](#/portal/signup) ### Veeva: Durable Vertical Cloud Platform URL: https://www.mbi-deepdives.com/veev/ Last updated: 2024-09-25T18:42:24.000Z _This post is for paying subscribers only._ ### Some more thoughts on Dollar General URL: https://www.mbi-deepdives.com/dg_sept2024/ Last updated: 2024-09-10T14:30:14.000Z After Dollar General’s (DG) disastrous earnings couple of weeks ago, I was quite concerned about their prospects in the near-term. However, a week later after digesting through Dollar Tree (DLTR) as well as DG management’s explanation in the Goldman Sachs Retailing Conference, I have updated some of my thoughts about DG…in the positive direction. Nonetheless, I have decided to abide by my decision **not** to inject more capital to DG, but to increase my notional exposure to DG via long-dated call options. As a result, I now no longer own any share of DG but do own January 2026 $45 Calls for which I have paid $36.8 per share. To be more specific, I still have similar $ exposure to DG as I did before, but doubled the notional exposure now thanks to these call options. Before I discuss what prompted me to be willing to increase my notional exposure to DG, let me start with the acknowledgement that there are indeed plenty of question marks on DG. When a stock is down \~67% from its peak, it should not be surprising that there are some concerning developments for the business. ![chart](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa9f2ecad-63fc-4c12-90a0-f97c2fd7542e_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://app.koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) There are two distinct vector of concerns: **a) Walmart (WMT)**: while WMT and DG have co-existed and thrived for decades, after WMT’s **14 consecutive quarters** of faster Same Store Sales (SSS) growth- it is certainly a fair question to wonder whether something structurally has changed. . ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F61e048e4-07a2-44ed-9434-8305f2276730_1804x142.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) As Alex Morris from “[The Science Of Hitting](https://thescienceofhitting.com/p/the-dollar-store-downturn?ref=mbi-deepdives.com)” (TSOH) discussed today, I agree that it is clear WMT has been outexecuting DG in the last three years or so, but the impact of WMT may largely have been confined to the marginal trip and not necessarily a structural question on the DG business model. From TSOH: > I think we need to answer a fundamental question: **what value does DG provide to its customers**? The primary answer, especially in the \~16,000 stores located in small towns (population of less than 20,000), is convenience. **As a reminder, the majority of their products cost under $5, with an average transaction value around $16\. (To put that into context, free delivery through Walmart+ is only available on $35+ orders.)** The mix is also heavily weighted to consumables, which account for >80% of DG’s revenues. > > Put differently, I think most Dollar General customers walk in the store to pick up a handful of products, with the need for (consumption of) those products likely to be in the **immediate future**. Given this context, I’m not quite losing my sleep over DG’s **consumables** business…yet! The value proposition of convenience of DG stores is likely to remain relevant for many years to come, something that can be easily underappreciated by people living in the urban areas with plenty of retail alternatives to choose from. Moreover, DG management reiterated that they primarily gain share from drug stores and grocery stores and there is likely healthy amount of share left by those stores, so I don’t think DG needs to necessarily win a food fight against WMT in the near to medium term to get back to \~3%+ SSS trend in consumables next year. From DG management: > What we have noticed over the years is that our share gains have been coming no surprise, and we've been very vocal about it from drug first and the grocery sector second. Normally, what you find from those 2 cohorts of retailers is a middle to upper middle and even lower and upper income demographic. And that, on a quarterly basis has been for, gosh, probably the last 10 years, that customer, at least in my mind, has been up for grabs, right?…So when I look at Q2, while our core customer was very stable, $30,000 and under, what we saw different from Q1 to Q2 was that while we gained share in that middle income cohort, we gained it at half the rate we did in Q1\. And it was obvious to us through the data where the other half went and it went to mass. And I think we called out the guys in Bentonville, took a little bit larger piece of that. b) **Amazon/Temu**: As earlier discussed in my [earnings update](https://www.mbi-deepdives.com/dg2q24/), I do have plenty of sympathy for structural concerns when it comes to non-consumables business. After 10 consecutive quarters of decline in LTM non-consumable sales, it is difficult not to see some impact of Amazon and Temu here. There are some [data](https://www.earnestanalytics.com/insights/all-posts/temu-takes-share-of-wallet-from-dollar-general-dollar-tree-customers?ref=mbi-deepdives.com) out there that also seem to substantiate such impact. This is indeed a real concern and unless the trend reverses, it may act as an insurmountable barrier to get back to DG’s long-term operating margin of \~8-9% (vs current \~5%). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fccb76dc5-3b6f-46a5-879d-386347dc4527_1942x162.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) One counter argument to this concern is although declining non-consumables certainly pressured gross margins in recent quarters compared to what we have seen in 2020-21 period, gross margin still looks pretty similar to pre-pandemic era. Given DG reported 8.3% operating margin both in 2018 and 2019 despite reporting somewhat similar gross margin to recent quarters, the mix shift from non-consumables to consumables may be more manageable than many suspect. The key difference between 2018-19 and now, of course, is SSS. While DG is guiding SSS to be 1.3% (mid-point) in 2024, they reported >3% SSS in 2018-19 period. Therefore, SSS remains the most important KPI for the stock. So, the question is can this KPI go in the right direction? ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F246ee6c1-4d0a-4cc3-9cb6-5afa7205bb15_2127x103.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) DG’s SSS increased by only 0.2% in 2023 and is expected to grow by +1.3% in 2024\. Therefore, my first observation here is DG will be up against some pretty soft comp next year. Moreover, given Family Dollar (FDO)’s continued struggle, it is highly likely that we will see an acceleration of store closure to shut down the underperforming stores. As a [reminder](https://www.mbi-deepdives.com/dg/), almost half of FDO stores is within 5 miles of DG store; therefore, DG should be a beneficiary of such a strategy by FDO and should help DG lift SSS a bit next year or two. Perhaps more importantly, it is the macro commentary by DG (and DLTR) management that makes me think DG is a very, very compelling bet especially in my personal portfolio context (more on this later). Here’s what DG management said at GS conference last week: > as we look at the quarter, what we saw was a pretty drastic slowdown in change. And it happened suddenly, I would say, mid-quarter-ish if you will. And what led us to start looking even deeper at, is this macro? Is this something internal? Is it a combination? We started to take a look at a couple of different factors. > > One being, is it broad-based? And with 20,000 stores, it's an advantage, right, because you're coast to coast. And **if it's something macro, normally, you start to see that across the country and it was definitely that. It happened across every region, every division that we had almost the same amount**. > > Second thing was we looked at was well, **is it happening in your new stores?** Well, again, we're advantage there with opening as many new stores as we've done. And **sure enough, our new store base all sort of ships went down in the harbor at the same time as well**. So those are great leading indicators. > > And then lastly, what we noticed was an even tighter core consumer at the very last week of each of the months in Q2\. While that's always a tighter week of the month for our core consumer, it was by far, though, the weakest in each of the -- when you look at each of the 4 weeks of each of the period. So, that led us to believe it's more macro in nature. While we still have a lot to do in our back-to-basics work, I would tell you that we believe that the macro effect of what we're seeing in our core customer is starting to take effect on her. > > …our core customer normally works her 30 to 40 hour a week job but also has a secondary job that she normally works 15 to 25 hours in. What she told us in Q2 was that is going away or has gone away. > > …it looks like the economy is slowing at a pretty decent cliff, at least what we're seeing here from the customer base. And **that natural progression that we see as she moves, that middle income, all roads lead through Bentonville and usually go to Walmart first**, right? And then -- and here's the key. The key is, the trade down in there is this, the customer says, I'm trading in because I'm fleeing, I'm looking for value, right? > > And I think you heard other retailers talk about that. **The next shoe to drop normally is not I'm seeking value, but I must have value. I've got to make ends meet, where our core customer is today. And then when that happens, that usually then that customer trades into Dollar General**. Given how the stock has traded in the recent months, investors seem to be deeply unwilling to give much credence to management’s explanation, and while I have not been a fan of Todd Vasos (CEO of DG), I happen to find the explanation more reasonable than market likes to think today. Not only DLTR has echoed similar concerns, dollar stores’ history also encourage me to be a bit more optimistic here. I have been discussing some of these aspects with Alex Morris over the last week, and he already aptly explained the historical context in his [write-up](https://thescienceofhitting.com/p/the-dollar-store-downturn?ref=mbi-deepdives.com) today. Let me quote from his piece: > In February 2008, Dollar Tree reported [its Q4 2007 results](https://www.sec.gov/Archives/edgar/data/935703/000093570308000004/ex99%5F1.htm?ref=mbi-deepdives.com). Reported comps declined \~1%, a notable change in trend from prior periods. As CEO Bob Sasser noted at the time, the results reflected “continuing pressure on the consumer from a generally challenging economic environment”. Mr. Market wasn’t too pleased with that explanation: the stock, which had traded up to \~$15 per share in mid-2007, was down >50% by early 2008 (split adjusted). > > [But then the results started to improve](https://www.nytimes.com/2009/05/02/business/02dollar.html?ref=mbi-deepdives.com). As you can see below, despite facing intensified macro pressures during the heart of the financial crisis, DLTR started reporting mid-single digit comps. > > …The stock, which bottomed well below $10 per share in early 2008, was trading at \~$25 in early 2011\. (As an aside, it’s interesting to note that DG’s comp trajectory during this period was quite similar: some weakness [in late 2007 and early 2008](https://investor.dollargeneral.com/websites/dollargeneral/English/310010/us-sec-filing.html?secFilingId=97952e49-89d3-4269-97de-6e701ce37252&shortDesc=Securities%20Registration%20Statement&format=convpdf&ref=mbi-deepdives.com) followed by stellar results for full year 2008 / 2009.) > > …At the time, I’d be willing to bet that analysts and investors questioned whether that answer fully explained what was going on, particularly given that a notable competitor like Walmart [was still reporting solid results](https://www.sec.gov/Archives/edgar/data/104169/000119312508033081/dex991.htm?ref=mbi-deepdives.com): “We had a very strong underlying operating performance, exceeding our expectations for the quarter… The price leadership strategy we put in place at the beginning of the year was exactly the right strategy… **Price leadership and improved customer service made the difference**.” To the extent DG management is right about macro potentially deteriorating from here, almost all of my portfolio holdings will likely take at least a temporary hit. Most DG investors prefer exposure to dollar stores precisely because of their countercyclicality. Given the recent missteps, this exposure has unfortunately come at a heavy price. I do suspect, however, that it is much more likely than ever that we may be on the cusp of some much needed countercyclical exposure such as DG. Consensus estimates for 2025 and 2026 operating margins are 5.0% and 5.3% respectively. If DG comes back to 3%+ SSS for the next couple of years, it is very much conceivable to me that actual operating margin may turn out to be \~150-200 bps higher (which would still be \~150-200 bps lower than DG’s long-term operating margins). If we do see return to \~6.5-7% operating margin and multiple re-rates to \~15-16x P/E, the stock can almost double in a couple of years. I don’t think any of my portfolio holdings will double in a couple of years if we face a recession during this time. As a result, despite my concerns about DG, I have decided to ensure that I have appropriate notional exposure to DG. At the same time, I do feel a strong aversion not to inject more capital to water my weeds which is why it still just remains a \~3% position. Thank you for reading. **Further reading**: My [Deep Dive](https://www.mbi-deepdives.com/dg/) on DG (August, 2023) [Subscribe](#/portal/signup) ### September, 2024 Update URL: https://www.mbi-deepdives.com/september-2024-update-2/ Last updated: 2024-09-04T01:06:48.000Z First things first, I am currently working on **Veeva Systems** (Ticker: **VEEV**) which I expect to publish by 25th of this month. Exactly four years ago, I launched MBI Deep Dives to, frankly speaking, help pay off my student loan. Not only did it help completely pay off my loans, it has ended up becoming my full-time livelihood. I have published [**50 Deep Dives**](https://www.mbi-deepdives.com/models/) over the last four years and I hope to continue to write one Deep Dive every month for many years to come. I also would like to let you know that I have started a [**WhatsApp Community**](https://chat.whatsapp.com/HKJLqkvhIkQBgtBdEIf5jV?ref=mbi-deepdives.com)**.** I expect to share more regular updates and thoughts on the companies I cover via this channel. For example, Dollar General, Analog Devices, and Texas Instruments will appear on different sell-side conferences this week. Publishing a post on the website about these sell-side conferences seems to be an overkill, and I'm hoping this channel will be a bridge to share bits and pieces from different earnings calls, conferences, or interesting articles that I read. Thank you for your continued support. I appreciate it very much. [Subscribe](#/portal/signup) ### Lululemon 2Q'24 Update URL: https://www.mbi-deepdives.com/lulu2q24/ Last updated: 2024-09-01T14:44:31.000Z *Disclosure: I own January 2026 $165 LULU Call Options* It is far from common for a stock to be up 4% after missing the revenue guide for the quarter **and** slashing the full-year revenue guide. That’s exactly what happened with Lululemon today which should tell you the kind of sentiment going into the earnings! Here are my highlights from tonight’s call. [Subscribe](#/portal/signup) **Sales Growth by Region** The crux of the bear thesis on Lulu usually circles around their US business. After growing sales +2% YoY in 1Q’24, it was **flat** in 2Q’24\. So, I don’t quite expect bears to bow out unless and until Lulu’s US business dispels their concerns. We are clearly not there yet. More on the US business later, but looking at Canada which is Lulu’s most mature market, I continue to be optimistic that the brand hasn’t peaked in the US. While China revenue grew by +37% YoY this quarter, skeptics might think the deceleration from last quarter (+52% YoY) is also a bit concerning. A good counterargument is the Chinese New Year was in Q1 this year which lifted the growth last quarter. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3b3da6ea-cb6d-4e55-b3a3-a5ae241034fe_1165x472.png) Source: Company Filings Management mentioned in the US *“traffic was up across both channels and Google search queries remain positive”,* andreiterated \~5% sqft growth per annum in Americas through 2026\. They also reminded that comps for the US will be easier next year; my guess is if Lulu can deliver HSD to LDD growth next year in the US, much of the bear concerns will likely evaporate. While the comps will be easy, the big question remains whether the macro will be supportive of such growth trajectory next year. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F03a4ba78-6415-414c-aa08-f6e35910cbf5_987x282.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) After four quarters of YoY decelerating sqft growth trend, 2Q’24 quarter saw a slight uptick. Although this is nice to see, please note Digital was \~38% of the revenue. So, unlike most physical retailers, Lulu story is not necessarily hinged on sqft growth. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F538def64-a8ba-4e92-869a-e20ebea0e162_1243x631.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Margin** Another popular bear case circles around Lulu’s margins which many suspect Lulu over-earned during the pandemic and now that consumer is weak and Lulu is facing intensifying competition from the likes of Alo/Vuori, Lulu will be compelled to defend its turf by sacrificing margins. So far, we don’t see this thesis playing out in the numbers. Americas margins was flat YoY, China was +229 bps YoY, and Rest of the World (RoW) posted +334 bps YoY operating margin **improvement**. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3419f6af-385b-44c4-ac82-185225ecfffd_603x261.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Lulu’s gross margins used to be in the low 50s during 2014-17 period. Lulu posted **its highest ever gross margin in 2Q’24**. Similarly, Lulu also posted **its highest ever 2Q operating margin this year**. For a retailer that’s experiencing some hiccups in the topline and typically have material fixed cost, it is quite impressive that Lulu has been able to pull this off. While I understand the appeal of that bear thesis on margin contraction, there is **so far** scant evidence on this point. We’ll see if that materially changes going forward. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F55d35b1a-f92f-444f-8e0d-113fc0d09feb_1407x790.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb3e31fc6-5444-4f8a-80cf-d5c841c7d6a7_1197x673.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Sales by Gender** One area that can embolden bears is the mediocre results in women’s segment which has come down to a meagre MSD growth in 2Q’24\. Men’s and accessories/others continue to chug along just fine, but women’s segment (\~62% of overall sales) is clearly bit of a headache at this point. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6e5996fc-0b05-47bb-9e26-9b86a44634f1_1074x259.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) So what’s going on with women’s segment? Here are some quotes from the call discussing this segment: > While we continue to see growth in our men's business, we have experienced a slowdown in women's. We have improved our in-stocks in smaller sizes through Q2 and are entering Q3 better positioned. As we've analyzed our women's business in more detail, **we have determined the most significant factor was a product plan that introduced less newness across core and seasonal styles**. By newness, I'm referring to the seasonal updates we bring into the assortment, typically expressed as color, print, patterns and silhouettes. > > I'm not referring to our pipeline of innovation, which remains full…As we have learned more, it's become clear to us that this **reduced newness, which is below our historical levels and stems from earlier product decisions has impacted conversion rates given the fewer new options available to our female guests. While this reduction was seen across our women's assortment, it had a more pronounced impact in bottoms and in our online channel**. The newness that we had performed well, we simply did not have enough to inspire her to purchase. > > …Guest was coming in traffic was positive across all channels and the opportunity was in conversion. > > So I see that as an opportunity that they were there with intent to spend, and there was a noticeable reduction in those historical levels of newness. So those were the product decisions that we made earlier and the new teams in action. And as I alluded to the chase, but definitely, I think majority is within our control. > > …For 2025, we are fast-tracking several new styles within performance shorts, tops and track suits. **We are optimistic that we will begin to see the benefits of these strategies over the upcoming quarters and return to our historical levels of newness no later than spring 2025**. It is *really, really* disappointing to see management score such an own goal. For the two consecutive quarters, we are hearing about this lower conversion rates. I think much of this problem emanates from not what they did this quarter, but due to their poor preparation over the course of last few quarters. I should note about the recent debacle related to Breezethrough which Lulu pulled away after noticing design complaints from their customers. Management mentioned it had immaterial impact on revenue or inventory and since customers really liked the fabric (but not the design), they’ll reintroduce the fabric with a different design in 2025 (or later). The problems management has outlined here made me wonder whether management fell asleep at the wheel here. I harbor mostly positive opinions about Calvin McDonald (just see pre and post Calvin era growth trajectory until this year), but I don’t think McDonald can afford to have any more mishap without attracting activist shareholders. The good thing is McDonald will have the power of Lulu brand to give him some time to course correct; despite management’s recent spotty ability to serve their core customers, Lulu continues to acquire new customers: > In terms of the guest profile, nothing meaningful in that we continue to grow our new guest base and continue to do it across the demographics that we have been growing. **Inventory** Inventory declined by 14% YoY and LULU expects it to increase by mid-teens in Q3 and slightly higher in Q4. **Capital Allocation** While management will get probably a “D” grade from me in terms of operational execution in the last couple of quarters, I am at least pleased to see that as the stock kept going down, they increased their buybacks. While Lulu mentioned they repurchased $1.2 Bn YTD, their 10-Q shows they bought back $889 Mn until Q2 which implies they bought back another $311 Mn so far this quarter. Assuming $260/share, it means they repurchased 1.2 mn shares in August i.e. \~1% shares. (**MBI Note**: updated this section after going through the 10-Q) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4a1330f0-0bb4-4566-9b76-2fa2d7361e8c_1195x220.png) Source: Company Filings ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffd07a2b8-d638-4827-aad2-35c2ca1e7643_1185x214.jpeg) Source: Company Filings Thanks to these buybacks, LULU’s shares outstanding has gone down by \~2% in 2Q’24. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8e29c6e7-2049-44eb-9cd6-b93deb61f0f5_963x439.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** As mentioned earlier, Lulu guided down for the full-year. 2024 revenue outlook is now $10.375-10.475 Bn (down 3% from prior guide). The reason for guiding down was macro uncertainty. Management mentioned in Q2, May was more in line with Q1 trend, then it deteriorated in June, but July was slightly above June. Some more colors around the guide below: > …we are assuming that revenue trends in the second half of the year remained fairly consistent with Q2, when excluding the 53rd week and the impact of a shorter holiday shopping season in Q4 > > …For the full year, we now expect gross margin to be approximately 20 basis points below our adjusted gross margin in 2023, due prominently to deleverage on fixed costs associated with lower forecasted sales and an increase in freight costs relative to our prior estimates. We continue to expect markdowns to be relatively flat with last year. Turning now to SG&A for the full year. We now expect it to be approximately flat versus 2023\. When looking at operating margin for the full year 2024, we now expect a decrease of 10 to 20 basis points versus adjusted operating margin in 2023, which expanded 110 basis points versus 2022. **Final Words** As mentioned earlier, unless and until Lulu starts posting healthy topline growth in the US, it will likely prove difficult for the stock to take a decisive upward trajectory. Over the long run, I do think international growth will be a material driver for the stock, but in the next 12-18 months, Lulu’s fate will likely hinge on the trajectory of their US business. I have no plan to add/trim following this quarter. More reading on Lululemon: [here](https://www.mbi-deepdives.com/lulu/), [here](https://www.mbi-deepdives.com/apr2024/), and [here](https://www.mbi-deepdives.com/tsm/) (see section 5) Thank you for reading. [Subscribe](#/portal/signup) ### Dollar General 2Q'24 Update URL: https://www.mbi-deepdives.com/dg2q24/ Last updated: 2024-08-29T17:33:17.000Z *Disclosure: I own shares of Dollar General* I first wrote my Deep Dive on Dollar General back in [August 2023](https://www.mbi-deepdives.com/dg/). While I wasn't initially excited about owning a piece of the company despite the stock being down 40% from peak then, I changed my mind when the stock went down another \~25% following 2Q'23 earnings. After today's dismal earnings, the stock went down almost another 30% since 2Q'23 earnings. If you're counting, the stock is now down \~67% from its peak in October, 2022\. From listening to today's call, I think it is likely that I underestimated the depth of challenges Dollar General was heading towards. Here are some highlights from today’s call. [Subscribe](#/portal/signup) Let's start with DG's assessment on the **low-end consumers** which is DG's core customer base: > From a monthly cadence perspective, same store sales growth was strongest in June before turning negative in July**. Notably the three softest comp sales weeks of the quarter were the last week of each of the calendar months.** This pattern suggests that our customers are less able to stretch their budgets through the end of the month. With that in mind, as well as our continued softness in discretionary sales and our own customer data and survey work, we believe the softer than anticipated sales performance in Q2 is at least partially attributable to a core customer that is less confident of their financial position. > I want to provide some additional context around what we're seeing and hearing from our customers. The majority of them state that they feel worse off financially than they were six months ago. As higher prices, softer employment levels and increased borrowing costs have negatively impacted low income consumer sentiment. As a result, our core customers who contributes approximately 60% of our overall sales comes predominantly from households earning less than $35,000 annually. Inflation has continued to negatively impact these households with **more than 60% claiming they have had to sacrifice on purchasing basic necessities due to the higher cost of those items**. > In addition to paying more for expenses such as rent, utilities and health care, more of our customers report that they are not resorting to using credit cards for basic household needs and **approximately 30% have at least one credit card that has reached its limit**. And in our latest survey, **25% of our customers surveyed noted they anticipated missing a bill payment in the next six months**. While middle and higher income households are seeking value as well, they don't claim to feel the same level of pressure as low income households. > As customers have felt more pressure on their spending, we have also seen corresponding elevation in the promotional environment beyond what we have anticipated coming into the year. > ...we are increasing our investment in markdown activity in an effort to support our customers, further drive customer traffic and improve sales. While some of these data are helpful in gauging the challenges low end consumers face today, it would be **more** helpful if we could get a time-series data (e.g. what % of consumers claimed they had to sacrifice purchasing basic necessity last year vs today?). My guess is the broader point management is trying to drive would still stand but we could glean more insight in terms of the trend. But wait a minute; isn't DG supposed to benefit in tough economic environment as middle-class customers tend to **trade-down** during such period. DG management had a good explanation why we are not seeing that...yet: > First of all...it takes a few quarters to come out of that, meaning our core customer. What we also see is **it takes a quarter or more for the trade-in to come in at a higher rate**. Now, in saying that, **what we've noticed is a trade-in has been slower to come in to the channel than what we had anticipated and/or have seen in the past**. I believe that's – there's a couple reasons why. I think the main reason and I believe this is true because it appears in every piece of data that we have is that the job market is still pretty decent, right. It's not as robust as it was. But also, unemployment hasn't spiked greatly, if you will, in the last quarter or so. **Normally it takes that jolt to get the trade-in to come in at a heavier clip**, if you will. > Now, the middle and the upper middle income are still looking for value. So I don't want you to believe that they're not. But usually to get them to trade in at a higher rate usually takes something a little bit more substantial than we've even seen to occur. I'm not suggesting I want to see that happen to that customer, but we stand ready and willing to certain her when that happens. **The other thing that we've noticed is that more and more online activity comes from that cohort. Our core customer continues her online journey pretty much the way she was. It's pretty static, if you will. But we've noticed that middle to upper middle continues to rely on online a little bit more. And so as that occurs, I believe the trade-in slows a little bit on that side**. So it's incumbent upon us to take a look at how we offset that piece as well. **Same Store Sales (SSS)** After a more encouraging SSS of +2.4% 1Q'24, SSS decelerated to just +0.5% in 2Q'24\. Traffic remains positive at +1% YoY (vs +4% YoY in 1Q'24) which was offset by transaction amount -0.5% YoY. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/08/image-3.png) SSS increase was driven entirely by consumable category and was partially offset by declines in non-consumables (home, seasonal and apparel categories). After non-consumables grew faster than consumables during 2020, it was almost 12 consecutive quarters of sales decline YoY in non-consumables (excluding 4Q’22)!! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/08/image-2.png) There are potentially important implications for such persistent decline in non-consumables. LTM non-consumable sales peaked in 1Q'21 at \~$8.2 Bn. In 2Q'24, LTM non-consumables **declined by \~$1 Bn** since then; in the meantime LTM SG&A **increased by $2.4 Bn** since then. Before the pandemic, non-consumable sales and DG's overall SG&A almost mirrored each other in 2019\. During the pandemic, thanks to the stimulus money, non-consumables soared and while the initial slowdown in non-consumables was interpreted as just Covid hangover, the relentless decline quarter after quarter should make everyone wonder whether something has structurally shifted in the post-pandemic period. It is not just Temu, but even Amazon's one-day shipping promises may have structurally damaged DG's non-consumable business. While they can still hold onto their core customers through consumables business, e-commerce may be taking bites on DG's attractive profit pool of non-consumables. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/08/image-10.png) **Shrink** Shrink was 21 bps headwind in Q2 which was in line with DG's expectations and they expect it will turn to a tailwind as they move into Q4 and then much more substantial of a tailwind into 2025\. **Gross Margin** Speaking of profit pool, DG's gross margin declined by 112 bps YoY, attributable to increased markdowns, increased inventory damages, a greater proportion of sales coming from the consumables category and increased shrink. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/08/image-4.png) **Operating margin** Again, since non-consumables is higher gross margin segment, the decline of this segment is a persistent headwind to margins. And since thanks to inflation, labor costs are increasing. As a result, DG is finding itself in a pretty tough spot. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/08/image-5.png) **Inventory** Inventories stood $7 Bn in 2Q’24, -7% YoY and a decline of 11% on a per store basis. Non-consumables inventory was -13% YoY and -17% on per store basis. **Outlook** In light of the tough environment DG has seen in the recent months, DG has **lowered its annual EPS guide by almost 20%**: > we now expect net sales growth in the range of approximately 4.7% to 5.3% and same store sales growth in the range of approximately 1% to 1.6% (**MBI Note**: from earlier guide of 6-6.7% sales growth and SSS of 2-2.7%) > Turning to gross margin, we expect additional pressure as a result of the increased promotional markdown activity that Todd noted as well as increased sales mix pressure due to the customers' need to prioritize their spending on the consumables category > Within SG&A, we are seeing an elevated rate of maintenance expense particularly with HVAC units and coolers in the summer months. We're taking steps in the back half of the year to be more proactive in addressing these opportunities in order to provide a more consistent customer experience across our store footprint while also supporting ongoing sales growth. As a result, we expect incremental pressure from the increased repairs and maintenance expense to continue within SG&A in the back half of the year. > Finally, we are also seeing pressure from wage rate inflation closer to **approximately 4% this year**, which is higher than was contemplated in our initial guidance for the year. With all of this in mind, we are updating our EPS guidance and now expect to deliver EPS in the range of approximately $5.50 to $6.20\. (**MBI Note**: from earlier guide of $6.8-7.55, so EPS is revised down by almost 20%) > ...this guidance really assumes more of a macro neutral to slight softening of that consumer. So the low end of the guidance takes that into consideration. > So on that lower end range, we're looking at a comp similar to the comp that we had in the second quarter whereas the higher end of the range would assume that there's some acceleration. **Final Words** This really has been a brutal quarter for DG and as a result, it is not a surprise that the stock is taking a beating. Given the context of relentless decline in non-consumable sales and the implications for margin, it is unfortunately difficult to add to the stock despite the stock being down \~30% today. And if the trend in non-consumables is more secular in nature than a short-term challenge, DG's operating margins from yesteryears may prove to be incredibly difficult to get back to. Therefore, I do not plan to add further capital to DG; I will, however, stay invested as I think the stock can still prove to be a potential hedge if the softness in low-end consumer ends up spreading to middle class in the coming quarters. **Further reading**: My [Deep Dive](https://www.mbi-deepdives.com/dg/) on DG (August, 2023) Thank you for reading. I will cover Lululemon's earnings tonight. ### EssilorLuxottica: From Eyecare To Eyewear To Smart Glasses URL: https://www.mbi-deepdives.com/esloy/ Last updated: 2024-08-24T13:52:40.000Z _This post is for paying subscribers only._ ### August, 2024 Update URL: https://www.mbi-deepdives.com/aug24/ Last updated: 2024-08-02T14:47:57.000Z Just a few quick updates for this month: 1. While I said last month that I would like to cover another healthcare company in August, I have changed my mind and would rather do a Deep Dive on **EssilorLuxottica**. Considering they may be an interesting piece of the value chain in AR glasses, I would like to have a deeper understanding of the overall industry. I expect to publish the Deep Dive by 25th of this month. 2. If you missed my earnings updates so far this quarter, you can read them here: [Alphabet](https://www.mbi-deepdives.com/alphabet-2q24-update/), [Amazon](https://www.mbi-deepdives.com/amzn2q24/), and [Meta](https://www.mbi-deepdives.com/meta2q24/). I would also encourage you to go through this [thread](https://x.com/borrowed%5Fideas/status/1819028328260817376?ref=mbi-deepdives.com) on Meta's follow-up call. 3. While I didn't publish these on the website, I have tweeted about earnings on some of the other companies that I own: [Bioprocessing](https://x.com/borrowed%5Fideas/status/1816607877454577743?ref=mbi-deepdives.com) (Danaher and Sartorius), [CoStar](https://x.com/borrowed%5Fideas/status/1816637699614474467?ref=mbi-deepdives.com), [Texas Instruments](https://x.com/borrowed%5Fideas/status/1816846592709919223?ref=mbi-deepdives.com), [Insurance Brokers](https://x.com/borrowed%5Fideas/status/1816870881597243628?ref=mbi-deepdives.com) (AON and BRO), and [Sherwin Williams](https://x.com/borrowed%5Fideas/status/1817248634330927150?ref=mbi-deepdives.com). While Lululemon didn't have earnings yet, the stock continued to its downward trajectory on which I have shared some thoughts [here](https://x.com/borrowed%5Fideas/status/1816655490849603815?ref=mbi-deepdives.com). 4. Last month, I also appeared on the podcast: Liberty's Highlights to discuss semiconductors. You can find the podcast [here](https://www.libertyrpf.com/p/semiconductors-industry-going-deep?ref=mbi-deepdives.com). 5. For the new readers, you can access all the past 49 Deep Dives, including excel models, [here](https://www.mbi-deepdives.com/models/). Thank you for supporting MBI Deep Dives. I appreciate it very much. [Subscribe](#/portal/signup) ### Amazon 2Q'24 Update URL: https://www.mbi-deepdives.com/amzn2q24/ Last updated: 2024-08-02T03:02:53.000Z *Disclosure: I own Jan 2025 $55 call options of Amazon* Now that all the big tech reported their quarters, we now have better context to how their quarters went. So, while I will mostly discuss Amazon's earnings in this update, I will briefly touch on some broader themes as well. [Subscribe](#/portal/signup) **Revenue** While Amazon’s 1P business (online and physical stores) continues to limp forward, the rest of the business kept their growth momentum. Advertising decelerated from \~24% YoY in 1Q’24 to \~20% in 2Q’24\. AWS, on the other hand, slightly accelerated from \~17% YoY in 1Q’24 to \~19% YoY in 2Q’24 (FXN). I’ll discuss more about AWS later, but let’s talk more about Amazon ex-AWS first. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa3ad560e-2d1c-49a9-84f8-3eef4d05a68d_1555x226.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** For the second consecutive quarters, North America (NA) operating margins went down QoQ. However, there are more nuances to this headline number as NA store margins actually improved QoQ (management didn’t quantify exact improvement): > If we look at profitability of the core North America stores business, **we actually improved our margin again quarter-over-quarter in Q2**. The overall North America segment operating margin **decreased slightly due to increased Q2 spend in some of our investment areas, including Kuiper, where we're starting to manufacture satellites will launch in the space in Q4.** Some other key quotes on retail business below: > “we're seeing lower average selling prices or ASPs right now because customers continue to **trade down on price** when they can on more **discretionary higher ticket items** > > our seller fees are a **little lower than expected** given the behavior changes we've seen from our latest fee changes. While some of these issues compress short-term revenue, we generally like these trends. While consumers are being careful on price, **our North American unit growth is meaningfully outpacing our sales growth**, as our continued work on selection, low prices and delivery is resonating. > > **On seller fees, lowering apparel fees has spurred substantial year-over-year unit growth in apparel** and the incentive we've given sellers to send their items to multiple Amazon inbound facilities so they can save money where they save us effort and money **is getting more traction than we'd even hoped**. > > These cost improvements won't happen in 1 quarter or 1 fell swoop. They take technology and process innovation with a lot of outstanding execution, **but we see a path to continuing to lower our cost to serve”** As you can see below, international margins also deteriorated QoQ. Since Amazon typically have a step up in SBC during Q2, all the segment margin was affected by it this quarter. There wasn’t any other explanation other than the usual which goes like this: “some countries are tracking just as well as the US whereas the emerging countries where Amazon is ramping up is lowering the overall margins” ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F10391da0-e695-4420-8fb9-02770ea7fada_1116x669.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Fulfillment+ Shipping** If you look at worldwide paid unit growth vs shipping+ fulfillment cost growth, you would notice that the latter used to consistently outpace the former pretty much all the time since 2015 until 3Q'22\. Since then, unit growth is faster (was at par in 3Q’23) than shipping+ fulfillment costs, indicating operating leverage in their logistics footprint. That theme continued in 2Q’24 which makes me confident that Amazon retail remains largely on track even if headline margin numbers may give a different impression. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff9c31226-0cc8-4307-ae44-7e4f00c2ae6d_1105x469.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Amazon management also reiterated that there’s more upside left here: > …the first one that you've seen play out over the last year or so has been the regionalization of the U.S. network. And I think one thing to remember about that is that while it had even bigger impact than maybe we theorized when we first architected it, **we're still not done fully honing it**. There's a lot of ways that we continue to optimize that U.S. regionalization that we think will continue to bear lower cost to serve. > > But at the same time, **we found a number of other areas where we believe we can take our cost down while also improving the customer experience**. One of the great things about regionalization was **it not only took our costs served down, but it meaningfully changed the speed with which we're able to get items to customers**. And so we have a number of those other opportunities. > > …as we're able to take cost to serve down, it means that **we're able to afford to have more selection** that we're able to offer to customers. And there are a lot of lower ASP items there, average selling price items, that we don't stock because they're not economic to stock with our current cost to serve. But as we work hard to make progress like we are on lowering our cost to serve, **that allows us to add more selection**. And we see this time in and time out that we -- when we add more selection, customers actually consider us for more of their purchases and spend more with us down the line. **Advertising** For the second consecutive quarters, Meta grew at the fastest pace among all the digital advertising companies. After looking at other companies’ results, Meta’s 2Q’24 numbers (and even the 3Q guide) appear to be even **more** impressive. While Meta has \~30% market share in digital ads (Note: see definition of "digital ads), it has taken >40% incremental ad dollars in the last 6 consecutive quarters. Meta’s incremental share could potentially be higher as Meta’s CFO Susan Li made this interesting comment on the follow-up call: > Our compute needs outstrip our available data center capacity right now. Given the focus that we have on accelerating our GenAI efforts, the new capacity that we've been bringing online is really going more towards GenAI than towards other workloads. We've also had to do a little bit of shifting capacity around to free up capacity for GenAI training. And altogether, **we expect that that will result in some foregone revenue growth from ads and organic content ranking improvements that we would have otherwise made**, but that has been factored into our Q3 outlook. And **we generally expect this to be to be a near term dynamic until we start bringing additional data center capacity online next year, which will meet our capacity needs.** *(*Note*: quite a few subscribers suggested me to include TTD in this table; while I wanted to do that, TTD hasn't reported their Q2 yet, so I will update it once they do)* ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6d2e61d3-2950-43cb-8c79-4b5638345507_979x820.png) Amazon ads is now $50 Bn LTM revenue business, and there are still plenty of avenues for growth left: > Sponsored ads drive the majority of our advertising revenue today, and we see further opportunity there. Even with this growth, it's important to realize we're **at the very beginning of what's possible in our video advertising**. **AWS** Okay, now let’s talk about AWS. AWS added $1.2 Bn incremental revenue QoQ. The current backlog is $156.6 Bn, growing 19% YoY. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd7989aa8-8200-4509-882d-41723f888f69_1024x550.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Let’s take a quick look at hyperscalers growth. While Azure’s growth has decelerated a bit, AWS and Google Cloud slightly accelerated. Many people seem to care about these 1-2 points of growth acceleration/deceleration; I don’t quite think it matters nearly as much as the attention it gets. It’s hard to complain about these growth rates anyway even if it were 1-2 points lower/higher. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0f74e3da-3b42-479a-a5d5-1b08bf1f7ec3_1393x790.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. Google Cloud’s both revenue and opex as % of AWS went in the right direction in 2Q’24 although opex improvement perhaps could have been better. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3b5c68cc-ca42-4b30-a327-045c5bca3151_892x579.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7abcba9c-3a3d-41f9-9978-a07aed8cc08b_912x574.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Google Cloud's opex trajectory is likely less of a concern because AWS posted another quarter of eye-watering margins**,** so it’s hard to keep pace with them. AWS incremental operating margin was **96%** in 2Q’24!!Enjoy while it lasts though as we may not see these margins for too long given the massive capex ramp up we are seeing now (and likely will continue to see next year): > AWS operating margin **includes an approximately 200 basis point favorable impact from the change in the estimated useful life of our servers that we instituted in Q1**. > > we expect AWS operating margins to **fluctuate over time, driven in part by the level of investments we're making at any point in time**. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa5b6704d-fc62-4882-96e0-2776ce4d8371_1401x117.png) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4a1768b2-a9e6-4b5a-8889-1531829eefd1_1201x658.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) During Q&A, I found Jassy’s answer to Eric Sheridan’s question really interesting. Just read the whole exchange: ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1170d974-3b3f-40f8-909f-d4dd756b9531_1857x1074.png) Some other interesting tidbits on AWS from the call: > We're continuing to see 3 macro trends drive AWS growth. First, companies have **completed the significant majority of their cost optimization** efforts and are focused again on new efforts. Second, companies are spending their energy again on **modernizing their infrastructure and moving from on-premise infrastructure to the cloud**…And third, Builders and companies of all sizes are excited about leveraging AI. **Our AI business continues to grow dramatically with a multibillion-dollar revenue run rate despite it being such early days**. > > At the heart of this strategy is a firmly held belief which we've had since the beginning of AWS that there is not 1 tool to rule the world. People don't want just 1 database option or 1 analytics choice or 1 container type. **Developers and companies not only reject it, but are suspicious of it.** They want multiple options for flexibility and to use the best tool for each job to be done. > > The same is true in AI. You saw this several years ago when some companies tried to argue that TensorFlow will be the only machine learning framework that mattered and then PyTorch and others overtook it. The same 1 model or 1 chip approach dominated the earliest moments of the generative AI boom, but we have a lot of data that suggests this is not what customers want here either, and our AWS team is determined to deliver choice and options for customers. **Opex+Capex** I would caution readers from getting too excited about Amazon's higher gross margins in 1Q'24 since the cost of sales for AWS is actually reported within R&D (or as they say "Technology & Content"). As a result, we don't really know for sure what Amazon's gross margin is. However, looking at its cost of sales as % of revenue and AWS reported operating margin, it is perhaps safe to assume that its gross margin is indeed improving (but just wanted to remind that the lack of hard data as evidence). Just like other big tech, Amazon's capital intensity has also gone up materially with their increased scale. In 1H’24, they spent $30.5 Bn in capex and expects 2H’24 capex to be higher. What are they spending these capex on? > The majority of the spend will be to support the growing need for AWS infrastructure as we continue to see strong demand in both generative AI and our non-generative AI workloads. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fee77135a-24fb-4647-942a-a6c468961cb1_2023x259.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Other Bets** There are some interesting tidbits on Kuiper in this call. While they haven’t disclosed any number yet (and I suspect Amazon’s total investments on Kuiper may surprise its shareholders if it were disclosed), at least we are starting to get some details: > …for Project Kuiper, our low earth orbit satellite constellation, **we're accelerating satellite manufacturing** in our facility in Kirkland, Washington. > > We've announced a distribution agreement with Vrio who distributes DIRECTV Latin America and Sky Brazil **to offer Project Kuiper satellite broadband network to residential customers across 7 countries in South America** and we continue to field significant demand for the service from enterprise and government entities. **We expect to start shipping production satellites late this year and continue to believe this could be a very large business for us.** > > our Kuiper team is working on how **to figure out how to help the 400 million to 500 million households around the world who don't have broadband connectivity get that connectivity and allow them to do a lot of the things we take for granted today with broadband connectivity.** **Outlook** Amazon’s guidance for 3Q’24 is below. Please note consensus 3Q’24 revenue and EBIT before the call were $158.3 Bn and $15.2 Bn respectively. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6c5a5b75-b47f-4ecf-bbe5-d29580096551_1057x220.png) Source: Company Filings **Closing Words** While the stock went down by \~8% after-hours, this was a fine quarter. Sure, the guidance may be a little soft, but it may likely be because of broader consumer weakness in general. I will stay invested, and may think about adding more to my position at $160 (or below) if it gets there. For more in-depth valuation discussion of Amazon, see my analysis [**here**](https://www.mbi-deepdives.com/amzn2024/) (February, 2024). Please feel free to share with your friends and network. Thank you for reading. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Meta 2Q'24 Update URL: https://www.mbi-deepdives.com/meta2q24/ Last updated: 2024-08-01T02:26:16.000Z *Disclosure: I own shares of Meta Platforms* While the meme of *“nobody uses Facebook”* sort of evolved to *“only old people use Facebook”*, Meta reminded us that it’s just another urban myth: > “…The growth we're seeing here in the U.S. has especially been a bright spot. **WhatsApp now serves more than 100 million monthly actives in the U.S.**, and we're seeing **good year-over-year growth across Facebook, Instagram, and Threads** as well, both in the U.S. and globally. I'm particularly pleased with the progress that we're making **with young adults on Facebook**. The numbers we're seeing, especially in the U.S., really go against the public narrative around who's using the app. A couple of years ago, we started focusing our apps more on 18 to 29 year olds, and it's good to see that those efforts are driving good results. Here are my highlights from today’s call. [Subscribe](#/portal/signup) **Users** After adding 50 mn in two consecutive quarters, Daily Active People (DAP) across its Family of Apps (FOA) decelerated to 30 mn QoQ in 2Q’24\. Still pretty impressive given their scale. I have already mentioned how Young Adults are driving growth on Facebook. What are they doing on Facebook? Posting on Marketplace and Group. > We've seen healthy growth in young adult app usage in the U.S. and Canada for the past several quarters. And we've seen that products like Groups and Marketplace have seen particular traction with young adults. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb7e547d0-b7c8-4ab8-b367-4271e32aa5cd_1798x91.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Ad revenue by Geography** Even though easy comp ended in 1Q’24, Meta continued to post quite strong YoY growth rates in 2Q’24. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fabb951eb-ca29-4cf1-8bbd-32a0d4e560f4_1897x370.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Looking at Family of Apps (FOA) ads revenue growth, YouTube’s number looks a bit perplexing. YouTube’s ads have materially underperformed both Search ads and FOA ads over the last one, two, and three-year period despite being \~18-20% of the size of Search ads and Meta FOA. Of course, as I have [mentioned](https://www.mbi-deepdives.com/alphabet-2q24-update/) earlier, it’s hard to infer any conclusion about YouTube ads with high conviction given we don’t know how much of the revenue simply shifted from ads to subscription segment. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F890a267f-2a80-4676-91e6-f99e98fd7cbf_517x145.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Ad Impression and Avg. Price Per Ad** We got ad impression and ad price related disclosure by geography since 1Q’24. Overall impression grew by \~10% and avg. price per ad grew by \~10% YoY. Interestingly, the strongest ad price growth was in RoW segment (which includes Africa, Middle East, and LATAM) which incidentally also had the highest revenue growth. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F55da25fc-ef76-44ae-b146-15847bb61f1c_796x496.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Segment Reporting** Overall 2Q’24 revenue was +22.1% YoY; on a 2-yr and 3-yr CAGR basis, Meta’s topline increased by 16.4% and 10.3% respectively. FOA had another near \~50% operating margin quarter and Reality Labs (RL) continues to bleed. Like [Google Services](https://www.mbi-deepdives.com/alphabet-2q24-update/) , Meta continues to post truly incredible incremental operating margins. FOA had 89% incremental operating margin whereas overall Meta posted 77% incremental margins in 2Q’24!! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdd0b552b-43f8-4c32-bb5a-b2a2f42a2ca8_1753x544.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Let’s look at some interesting comments from the earnings call: **AI, AI, AI** Zuck has recently been talking about moving to a unified recommendation/AI system. What stood out to me is such a shift is leading to higher engagement and it seems there is still upside left as Meta completes this transition over time: > In this quarter, we rolled out our full screen video player and unified video recommendation service across Facebook, bringing reels, longer videos, and live into a single experience. And **this has allowed us to extend our unified AI systems, which had already increased engagement on Facebook Reels more than our initial move from CPUs to GPUs did**. Over time, I'd like to see us move towards **a single unified recommendation system that powers all of the content, including things like People You May Know across all of our services. We're not there yet. There's still upside** and we're making good progress here. Of course, advertisers remain the key early beneficiaries of Meta’s AI investments: > …today, advertisers still need to develop creative themselves. And in the coming years, AI will be able to generate creative for advertisers as well, and we'll also be able to personalize it as people see it. > > Over the long term, **advertisers will basically just be able to tell us a business objective and a budget, and we're going to go do the rest for them.** We're going to get there incrementally over time, but **I think this is going to be a very big deal.** > > …We've seen promising early results since introducing our first generative AI ad features, image expansion, background generation, and text generation, **with more than 1 million advertisers using at least one of these solutions in the past month**. Zuck expects Meta AI to be the most used AI assistant by the end of the year. Admittedly, the only time I typically use Meta AI is when I am wearing my [Meta Ray-Ban smart glasses](https://x.com/borrowed%5Fideas/status/1725282443526082886?ref=mbi-deepdives.com) (mostly while I’m driving/walking). It turns out India is driving the strong adoption of Meta AI which is not surprising given the Indian userbase on WhatsApp and their understandable lack of willingness to pay $20/month to access closed models: > People have used **Meta AI for billions of queries** since we first introduced it. We're seeing particularly **promising signs on WhatsApp in terms of retention and engagement, which has coincided with India becoming our largest market for Meta AI usage.** Usage or adoption is one thing, but how is Meta going to make money here? Zuck essentially says “trust me; we have seen this before and we know what we are doing here.” > before we're really talking about monetization of any of those things by themselves, I mean, I don't think that anyone should be surprised that I would expect that, **that will be years, right?** I think that, like what we've seen with Reels. It's what we sell with all these things. **But I think for those who have followed our business for a long time, you can also get a pretty good sense of when things are going to work years in advance.** **And I think that the people who bet on those early indicators tend to do pretty well,** which is why I wanted to share in my comments the early indicator that we had on Meta AI, which is, I mean, look, it's early. > > Last quarter, I think it just started rolling it out a week or 2 before our earnings call. This time, we're a few months later. And what we can say is I think we are on track to achieve our goal of being the most used AI assistant by the end of this year. And **I think that's a pretty big deal**. Is that the only thing we want to do? No. I mean, we obviously want to kind of grow that and grow the engagement on that to be a lot deeper, and then we'll focus on monetizing it over time. > > But the early signals on this are good, and I think that, that's kind of all that we could reasonably have insight into at this point. But **I do think that part of what's so fundamental about AI is it's going to end up affecting almost every product that we have in some way. It will improve the existing ones and will make a whole lot of new ones possible.** Zuck was pushed near the end of the call about these new potential opportunities coming out of Meta AI. > when I was talking before about we have the initial usage trends around Meta AI but there's a lot more that we want to add, things like commerce and **you can just go vertical by vertical and build out specific functionality to make it useful in all these different areas** are eventually, I think, what we're going to need to do to make this just as -- to fulfill the potential around just being the ideal AI assistant for people. Then there is business piece of AI, especially on messaging: > “We're still in alpha testing with more and more businesses. The feedback we're getting is positive so far. **Over time, I think that just like every business has a website, a social media presence and an e-mail address, in the future, I think that every business is also going to have an AI agent that their customers can interact with**…our goal is to make it easy for every small business, eventually every business, to pull all of their content and catalog into an AI agent that drives sales and saves them money. When this is working at scale, I think that this is going to **dramatically accelerate our business messaging revenue**.” For what it’s worth, FOA’s other revenue increased by 73% YoY in 2Q’24 (was +85% YoY in 1Q’24), driven by business messaging revenue growth from WhatsApp business platform. So we clearly have early signs of potential for business messaging even without AI coming into play. **Llama** If you haven’t read it already, I encourage you to read Zuck’s [letter](https://about.fb.com/news/2024/07/open-source-ai-is-the-path-forward/?ref=mbi-deepdives.com) when Meta launched Llama 3 model. A lot of the points from that letter were repeated which I’m not going to mention and I would rather encourage you to read the letter instead. During the call, Zuck also hinted at the ever increasing and kind of mindboggling cost increases for building the next models: > The amount of compute needed to train **Llama 4 will likely be almost 10x more than what we used to train Llama 3**. And future models will continue to grow beyond that. It's hard to predict how this trend -- how this will trend multiple generations out into the future. But at this point, **I'd rather risk building capacity before it is needed rather than too late, given the long lead times for spinning up new infra projects**. And as we scale these investments, we're, of course, going to remain committed to operational efficiency across the company. To be clear, Meta does seem to have ample capacity to build Llama 4\. Llama 3 was trained on \~16k H100s, and Meta expects to have \~600k equivalent H100 capacity by the end of 2024\. If Llama 5 is 10x more than Llama 4, of course that changes the equation dramatically (speaking in hypotheticals, so not a prediction). Just like Google, Meta seems also committed to not face the scenario of under capacity. Perhaps I’m suffering from bit of PTSD in 2022, but it does remind me of the 2021 era hiring spree which almost every big tech did except Apple. Ironically, Apple remains largely absent in the capex spree here as well, and yet remains the consensus AI winner given their end-to-end control and primacy of their devices in our lives. We will see whether ROI on these capex will be much better than the terrible return we have seen on the opex in 2021. Meta, however, reminded the investors about the fungible nature of the capex which somewhat allays my concerns a bit: > …we're continuing to build our AI infrastructure with **fungibility in mind** so that we can flex capacity where we think it will be put to best use. The infrastructure that we build for gen AI training can also be used for gen AI inference. We can also use it for ranking and recommendations by making certain modifications like adding general compute and storage. And we're also employing a strategy of staging our data center sites at various phases of development, which allows us to flex up to meet more demand and less lead time if needed while limiting how much spend we're committing to in the outer years. While Meta takes ROI-based approach for their core AI work, their investments in GenAI products are understandably more speculative/experimental in nature: > On our core AI work, we continue to take a very ROI-based approach to our investment here. **We're still seeing strong returns as improvements to both engagement and ad performance have translated into revenue gains**, and it makes sense for us to continue investing here. > > Gen AI is where we're much earlier, as Mark just mentioned in his comments. We don't expect our gen AI products to be a meaningful driver of revenue in '24\. But we do expect that they're going to open up new revenue opportunities over time that will enable us to generate a solid return off of our investment while we're also open sourcing subsequent generations of Llama. **Reels** > On Instagram, Reels engagement continues to grow as we make ongoing enhancements to our recommendation systems. Part of this work has been focused on increasing the share of original posts within recommendations so people can discover the best of Instagram, including content from emerging creators. Now, **more than half of recommendations in the U.S. come from original posts**. **Threads** Threads Monthly Active Users over time: 3Q’23: 100 Mn 4Q’23: 130 Mn 1Q’24: 150 Mn 2Q’24: 200 Mn Just as you expect an app that benefits from network effects, growth here is accelerating. Zuck seems committed to grow Threads to reach 1 Bn userbase and he appears to be under no hurry to monetize it. When X/Twitter is perhaps wondering whether they can make the next quarterly interest payments, Threads is focused on just growing the userbase with zero ads. While fintwit is barely active on Threads, let’s not underestimate how lopsided this game may prove to be over the next 2-3 years as Meta may continue to leverage its FOA apps to drive adoption and engagement on Threads. > …a lot of other companies that ship something and start selling it and making revenue from it immediately. So I think that's something that our investors and folks thinking about analyzing the business, if needed, to always grapple with is all these new products, we ship them and then there's a multiyear time horizon between scaling them and then scaling them into not just consumer experiences but very large businesses. > > But the thing that I think is just super exciting about Threads is that we've been building this company for 20 years, and **there are just not that many opportunities that come around to grow 1 billion-person app.** I mean, there are, I don't know, maybe a dozen of them in the world or something, right? I mean, there are certainly more of them outside the company than inside the company, but we do pretty well and **being able to add another 1 to the portfolio if we execute really well on this is just really exciting to have that potential.** **AR/VR** Meta mentioned both Meta Quest and Ray-Ban Meta Smart glasses are selling better than they expected. On AR glasses: > Demand is still outpacing our ability to build them, but I'm hopeful that we'll be able to meet that demand soon. > > Ray-Ban Meta smart glasses are showing very promising traction with the early signals that we are seeing across **demand, usage and retention**, increasing our confidence in the long-run potential of AR glasses. Please note 2Q’24 RL sales are largely driven by Quest headsets and it’s not clear how the revenue is recognized by Meta in AR glass sales for which they have a partnership with EssilorLuxottica. **Capital Allocation** Meta returned \~70% of their FCF via dividend and buyback. Net cash balance remains \~$40 Bn, and diluted shares outstanding decline by 57 bps QoQ. LTM SBC per employee for the first time exceeded $200k per employee Despite the buybacks, shares outstanding decreased by only 0.2% QoQ, thanks to Meta’s quite generous SBC program which is currently nearing \~$200k/employee. Meta makes even Google look pretty conservative on SBC as Google’s LTM SBC per employee is “only” $125k. To be clear, I would rather let Meta keep an exceptionally high bar for talent and pay people more than the hiring spree they went on during 2021-22\. After all, these comp packages are likely important source of competitive advantage of big tech as most of these talents get priced out from much of the Silicon Valley startups/smaller companies. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F497d9be2-28d4-4fd1-a356-eaf53d6f243c_1797x310.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Opex Guide** I will stop sharing the below graph after this quarter. While Meta used to decrease their opex guide gradually over the course of the year, clearly this is likely just Dave Wehner phenomenon, and Susan Li doesn’t seem to have any such approach. She appears to mostly stick to her initial opex guide. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fcc24b1ab-88c8-482a-9b5a-2d4fe3d02be1_1209x582.png) Source: Company Filings, MBI Deep Dives **Capex** Capex guide range was **again** increased to $37-40 Bn (from $35-40 Bn in 1Q’24, and $30-37 in 4Q’23). More importantly, Meta mentioned *“we currently expect *significant* capital expenditures growth in 2025”* What does “significant” mean? Meta didn’t clarify further, but my guess is a number closer to $50 Bn. **Outlook** 3Q’24 topline guide is $38.5-41 Bn (\~2% FX headwind). Mid-point YoY growth is \~16.4% (vs consensus estimates of 14.7%) **Closing Words** After 1Q'24 call, Meta’s stock went down by almost 20% as the market was quite jittery about increased capex. This time the stock went up by +7% (and almost \~30% from 1Q’24 post-earnings low). Why the diametrically opposite reaction despite the fact that Meta is signaling another year of massive capex increases? My best guess is investors are increasingly appreciating Meta’s avenue of opportunities on capitalizing on GenAI, especially the fungibility of capex and hence the risk to the upside is perhaps more likely than to the downside from these investments. For more in-depth analysis on Meta Platforms, you can read my analysis [**here**](https://www.mbi-deepdives.com/meta2024/) (February, 2024). I will cover **Amazon’s** earnings **tomorrow**. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Alphabet 2Q'24 Update URL: https://www.mbi-deepdives.com/alphabet-2q24-update/ Last updated: 2024-07-24T19:12:43.000Z Yesterday’s Google’s earnings may have been bit of “meh” at first glance, but there were nuggets in the call that may have important implications for the broader market. Here’s my highlights from the earnings. [Subscribe](#/portal/signup) **Revenue** Network segment continues to struggle, but the rest of the businesses continue to grow at healthy double digit rate. Search revenue growth surpassed YouTube ads revenue growth last quarter. For the first time, Cloud posted >$10 Bn quarter while maintaining high 20s growth YoY. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F78639dec-6e32-4b7d-90bc-b2eb0005ff5e_1903x358.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **EBIT** Google Services business posted its highest ever margin. Thanks to four consecutive quarters of **\>70% incremental operating margin (!!)**, operating margin for Google Services was 40.1% in 2Q’24! Google Cloud posted its first ever double digit operating margin quarter. TAC continues to tick lower as % of ad revenue. Overall company operating margin expanded from 29.3% in 2Q’23 to 32.4% in 2Q’24. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff48248e4-c6c5-4179-8cb8-799d9cc32ac6_1723x459.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Search** Some interesting comments on Search from the call: > We are pleased to see the **positive trends** from our testing continue as we roll out AI Overviews, including **increases in Search usage and increased user satisfaction** with the results. > > …we see even **higher engagement from younger users aged 18 to 24** when they use Search with AI Overviews. > > …we are seeing that ads appearing either above or below AI Overviews continue to provide valuable options for people to take action and connect with businesses. > > …**AI expands the types of queries we are able to address** and opens a powerful new ways to Search. Visual search via Lens is one. Soon, you'll be able to ask questions by taking a video with Lens. And already, we have seen that AI Overviews in Lens leads to an increase in overall visual search usage. Another example is **Circle to Search, which is available today on more than 100 million Android devices**. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F484c4eb3-4858-4fc6-909f-0f502a305e88_922x544.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **YouTube** YouTube’s ad revenue missed the consensus numbers by \~3%. After \~21% growth in Q1, the pace of deceleration was a bit surprising. Management explained the reason for such deceleration: > YouTube was lapping negative year-on-year growth in Q1 last year. And then also Q1 benefited from the extra from leap year. And so what you're also seeing here is with YouTube, we were anniversary-ing the ramp in APAC-based retailers that began in the second quarter last year and foreign exchange headwinds as well that we noted. And so there are some timing issues going on. YouTube’s numbers might have spooked investors about broader digital ads industry (Meta, Snap, Pinterest etc.), but Eric Seufert [hypothesized](https://x.com/eric%5Fseufert/status/1816129617868284252?ref=mbi-deepdives.com) that *“broader CTV CPM compression instigated by the influx of inventory from Amazon Prime Video”* also likely contributed to YouTube’s deceleration. Of course, it’s always hard to conclude anything about YouTube ads **definitively** given the subscription side of YouTube. It’s really high time Google started disclosing overall YouTube revenue instead of just ad revenue. If more and more users switched from ads to subscription, that’s far from bad news. However, subscription growth also experienced sequential decline YoY: > we continue to have significant growth in our subscriptions business, which drives the majority of revenue growth in this line. However, there was a sequential decline in the year-on-year growth rate as we anniversaried the impact of a price increase for YouTube TV in the second quarter last year Some more interesting comments on YouTube: > …Views on CTV have increased more than 130% in the last 3 years. According to Nielsen, YouTube is the #1 most watched streaming platform on TV screens in the U.S. for the 17th consecutive month. Zooming out, **when you look not just at streaming but at all media companies and their combined TV viewership, YouTube is the second most watched after Disney**. And this growth is happening in multiple verticals, including sports, which has seen CTV watch time on YouTube grow 30% year-over-year. > > …we continue to see an improvement in Shorts monetization, particularly in the U.S. We're also seeing a very encouraging contribution from brand advertising on Shorts, which we launched on the product in Q4 last year. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9f180c46-d2e8-40bd-bd64-d2e642b490c8_916x544.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Google Cloud** While Google Cloud revenue growth accelerated to 28.8% in 2Q’24, management mentioned GCP continued to outpace overall Cloud growth. Not sure we will see such persistence of growth at such revenue level/size in too many secular growth industries! > We are the **only cloud provider to offer grounding with Google Search**, and we are expanding grounding capabilities with Moody's, MSCI, ZoomInfo and more. I had to ask Perplexity about grounding; if you are in the same boat, see [here](https://www.perplexity.ai/search/google-said-this-in-the-earnin-nwoyip9lSXeWl90aOEOV4w?ref=mbi-deepdives.com) for explanation. I will discuss more on Cloud when Amazon posts next week. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fbe922325-39bc-49e9-a39d-c8fd59419918_924x547.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AI** > **At 2 million tokens, we offer the longest context window of any large-scale foundation model to date**, which powers developer use cases that no other model can handle. Gemini is making Google's own products better. All 6 of our products with more than 2 billion monthly users now use Gemini. Google seems to indicate that while GenAI is contributing positively to their own products, model capabilities are converging for the enterprise customers and the full range of potential of multimodal models are yet to be fully explored: > …I think **there is a time curve in terms of taking the underlying technology and translating it into meaningful solutions** across the board, both on the consumer and the enterprise side. Definitely, on the consumer side, I'm pleased…in terms of how for a product like Search, which is used at that scale over many decades, how we've been able to introduce it in a way that **it's additive** and enhances overall experience and this **positively contributing** there. > > …I think across our consumer products, we've been able -- I think we are seeing progress on the organic side. Obviously, monetization is something that we would have to earn on top of it. **The enterprise side, I think we are at a stage where definitely there are a lot of models. I think roughly, the models are all kind of converging towards a set of base capabilities**. But I think where the next wave is working to build solutions on top of it. And I think there are pockets, be it coding, be it in customer service, et cetera, where we are seeing some of those use cases are seeing traction, but I still think there is hard work there to completely unlock those. > > …we are all building multimodal models. At least Gemini has been natively multimodal from the ground up. But **most of the use cases today that have been unlocked have been around the tech side. So in terms of getting real generative audio, video experience is working well. I think there is still -- it's going to take some time.** **Waymo** Google seems quite encouraged at the pace of adoption of Waymo and has decided to make a multi-year investment of $5 Bn. > Waymo served **more than 2 million trips to date and driven more than 20 million fully autonomous miles on public roads. Waymo is now delivering well over 50,000 weekly paid public rides**, primarily in San Francisco and Phoenix. **Capital Allocation** Google paid its first dividend last quarter. They returned capital to shareholders through buyback and dividend more than FCF they generated last quarter. As a result, net cash balance decreased from $95 Bn in 1Q’24 to $87 Bn in 2Q’24\. If they keep this pace, they may get closer to a balance sheet with zero net cash in the next 3-5 years. There’s been quite a few **rumors** flying around Google’s potential acquisitions (Hubspot and Wiz are recent examples neither of which apparently likely to consummate as per media reporting); so they may get there soon if they use cash to do large deals. Despite buying back $15.7 Bn shares, share count only declined by 13 bps QoQ which is of course disappointing. It is not 100% clear why that’s the case; Google issued 32 mn RSUs in 2Q’24 vs 33 mn in 1Q’24 and bought back 111 mn shares in 2Q’24 vs 92 mn in 1Q’24\. My best guess is they also issued some contingent shares from some earlier acquisitions (Mandiant maybe?) in 2Q’24. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F924ff830-c1df-4a9d-ab26-0c4cc1344d1d_673x576.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex and Opex** Sundar Pichai had a very interesting answer to Ross Sandler’s question on whether hyperscalers are overbuilding capacity. It’s clear that Google is indeed trying to overbuild capacity since the risk of underinvesting is far greater. This answer may have more implications not only for the hyperscalers but also many semiconductor companies as well. See the Q&A below: ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0c82c65b-b478-427d-8fe8-ae965fc96113_2017x553.png) Source: Tikr Google seems quite aware that the impending depreciation expenses from this potential overinvesting need to be managed to continue to grow earnings: > Our leadership team remains focused on our efforts to moderate the pace of expense growth in order to **create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure**. Given that reality, don’t expect big tech hiring to ramp up anytime soon. Although Google’s headcount declined QoQ for the second consecutive quarter, Google did say headcount will have a “slight” increase in 3Q as they will hire new graduates. Overall capex is expected to be \~$12 Bn or above for each of the quarters in 2024. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3f79d9ae-555f-48c4-8daf-9262cb7cf007_1723x246.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Valuation** Since [3Q'22](https://mbideepdives.substack.com/p/goog3q22?utm%5Fsource=publication-search), I share the following valuation framework every quarter. As a matter of fact, the stock was also at $176 post 1Q earnings when I [mentioned](https://mbideepdives.substack.com/p/alphabet-1q24-update?utm%5Fsource=publication-search) that “For the first time since 3Q’22, each of the following scenario indicates upside to be limited”. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/07/image-2.png) Source: MBI Deep Dives Google’s valuation is far from unreasonable, neither is it very expensive. But is it compelling? The answer appears to be no in my opinion. I will cover earnings of **Amazon and Meta** next week. Thank you for reading. **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Sartorius Stedim: A Pure-play Pick-and-Shovel in Biotech URL: https://www.mbi-deepdives.com/dim/ Last updated: 2024-08-23T15:08:20.000Z _This post is for paying subscribers only._ ### Why I am buying CoStar Group URL: https://www.mbi-deepdives.com/csgp2/ Last updated: 2024-07-10T17:30:48.000Z I have started a \~3% position in CoStar (CSGP) at $71/share and would like to increase the position to \~5% if the stock goes down to \~$60. I wrote a [**Deep Dive**](https://www.mbi-deepdives.com/csgp/) on CSGP back in January 2024, so I would suggest reading my Deep Dive for a more comprehensive discussion on the company. I will mostly highlight a couple of points in this piece. While many like to depict CoStar as “Bloomberg for CRE” (Commercial Real Estate), I liked the way Brown Advisory [described](https://x.com/StockCompil/status/1810681563543118033?ref=mbi-deepdives.com) it, *“it’s like Bloomberg, if FactSet did not exist”*. While that is perhaps an apt description of CSGP’s offerings and its competitive advantages within CRE market, CoStar suite and information services are only \~45% of their revenue today. \~45% of their revenue comes from online marketplaces (LoopNet, and Multifamily), and the rest \~10% comes from the nascent residential segment and other marketplaces and services. One of the things that I really like about CSGP is while CoStar’s information & analytics segment is more procyclical, online marketplace segment is a bit countercyclical which subdues the overall cyclicality of the company. From my Deep Dive: *“Looking at the dire situation in commercial office space during post-Covid era, an understandable concern that one might have is whether CoStar is also going to feel indirect pain of their CRE customers. Given CoStar’s revenue declined by 1% during GFC and their almost entire business was information & analytics back then, we can sense their vulnerability in this segment in a potential, secularly challenged environment for office space. Nonetheless, it is perhaps also somewhat impressive that even during GFC, their revenue declined by only \~1%. It likely indicates that unless their customer is going out of business (bankruptcy may just mean restructuring the capital structure and not necessarily shutting down the business), CoStar’s CRE information business is likely to remain (and was) resilient in the last 2-3 years.* *What’s different from GFC now is \~55% of CoStar’s revenue comes from online marketplaces such as LoopNet, Apartments.com etc. During boom economic period, PMCs may have very little vacancies in a low unemployment environment. For example, during 2021-22 period rental vacancies came down to almost 30-year low. In such environment, you simply don’t have much need to sign up for an annual advertising subscription product of CoStar. On the other hand, when vacancies rise during recession, you not only feel the need to advertise your rentals but also feel tempted to upgrade to a different tier to fill up your rentals. Given the low vacancy rate in 2021-22, CoStar’s multifamily segment revenue only grew by \~13% and 10% in 2021 and 2022 respectively whereas it was consistently growing at >20% before that. It started growing at >20% in 2023 as rental vacancies started to rise again in recent quarters*. *Such countercyclical dynamic makes it much more likely that even in a “GFC” scenario, CoStar’s revenue may continue to increase.”* I also recently read Speedwell Research’s Deep Dive on [CSGP](https://speedwellresearch.com/companies/?ref=mbi-deepdives.com) and came away with more confidence that even though CoStar suite and information service business may be procyclical, even this segment is very unlikely to be too volatile. From Speedwell: *“In 3Q08, Andy noted that firms that had been with them for more than 3 years had a 95% renewal rate versus those who were with them for less than 3 years having 70%. This difference was explained by a larger number of new firms and brokers that entered the market during the frothiest years of the real estate boom. For those that stayed in business, as CFO Brian Radecki points out below, *no matter how bad the industry was, their product was still in need**.” Andy Florance, however, is not the kind of CEO who would be content with \~70% retention rate. So, CSGP incentivized salespeople based on usage of their product, not just on new users/seats even though CoStar products are not priced based on usage. They correctly figured out that one way to increase retention is to increase usage of the product. So, salespeople were highly incentivized to make sure their customers are using the product regularly to build habit using CoStar products. By 3Q10, retention of customers who had been with CSGP for less than 5 years increased from 74% to 87%. Today, their overall retention rate is \~90% (\~95% for customers with CSGP for >5 years). So, even their procyclical part of the business may do just fine even during recessions. CSGP is one of those rare companies that grew its revenues double digit for each of the last 51 quarters. CSGP guided for $5 Bn revenue in 2027 even though consensus estimates today is $4.5 Bn in 2027\. Led by its founder Andy Florance, CSGP has been a public company since 1998\. As a result, we have track record of their past long-term guidance and how they fared afterwards. Back in 2012, CSGP had \~$350 Mn revenue. In early 2013, CSGP guided $800 mn annualized revenue in 2016\. Their actual revenue (not annualized) in 2016 was $840 Mn. In early 2014, CSGP guided $1 Bn annualized revenue in 2018\. Their actual revenue (not annualized) was $1.2 Bn. So, at least looking at historical precedence, it does not seem CSGP comes up with their long-term revenue guide out of thin air. CSGP also guided for $2 Bn EBITDA (\~40% EBITDA margin) in 2027\. Let’s go back to GFC again. From Speedwell: *“…despite the worst economic crisis since the great depression, CoStar not only pulled through unscathed, but actually hit their ambitious U.S. EBITDA margin target of 30% by the end of 2008—a quarter early. In 3Q08, their U.S. business hit a 33% EBITDA margin, showing the leverage in the model.”* Having said that, I do acknowledge that it is more likely that CSGP will hit 2027 revenue target than their EBITDA target; Florance is not the type of CEO who would necessarily optimize for near-term profit targets. They are currently in the middle of a massive bet in US residential segment. Just as they spent \~$1 Bn on advertising after acquiring Apartments.com, they are going for the same playbook in residential segment with Homes.com. Today, apartments.com/multifamily segment is their largest revenue driver of the overall company (an incredible feat given it was only launched just \~10 years ago). Replicating success of multifamily will not be easy given the entrenched incumbents here (i.e. Zillow to be specific), but if anyone can disrupt these perennially barely profitable/unprofitable incumbents, it is Andy Florance’s CoStar. The good thing is I don’t think we are quite paying much for CSGP potentially hitting it big with Homes.com. At current $25 Bn EV (with \~$4 Bn net cash on balance sheet), the company is currently trading at \~20x NTM EV/EBITDA multiple (ignoring residential losses which really mask the profitability of the core business). This is capex light business, so EBITDA can be considered a reasonable proxy for FCF here. Paying \~20x multiple for a founder led, highly competitively advantaged business growing at LDD rate for the next 3-5 years seems quite reasonable to me, especially when a major optionality is largely uncaptured in current valuation. Thank you for reading. **Recommended Content** 1. MBI's [Deep Dive](https://www.mbi-deepdives.com/csgp/) on CSGP 2. Speedwell's [Deep Dive](https://speedwellresearch.com/companies/?ref=mbi-deepdives.com) on CSGP ### Buying Puts on QQQ URL: https://www.mbi-deepdives.com/qqq/ Last updated: 2024-07-06T14:23:00.000Z I posted on X and Threads yesterday why I started buying some puts on QQQ. Since not all of my readers may be on X and Threads, let me share my thoughts with you as well. I have also edited a bit and expanded on a couple of points after receiving some feedback on X. **$440 QQQ Puts for January 2026** The current bull market has finally persuaded me to start buying some insurance for the eventual rainy days. While it’s just **\~1%** of my portfolio, it is an acknowledgement of the little upside that I see today. Let me put some of my thoughts into words. Why $440 Puts? Since I paid \~$20 for these puts, I will breakeven at $420\. For each $20 decline from $420, these options would be worth one double in $20 intervals. +100% at $400, +200% at $380, +300% at $360…you get the idea. Anything above $440 would make the options worth **zero**. The reason I am not buying puts for ATM (At-the-Money) options is it’s psychologically not challenging to go through \~10-20% drawdowns. Having experienced 2022 drawdown, I know that it starts to become unpleasant experience when the drawdown extends beyond 20%. Food starts to taste bland at >30% drawdown. At >40% drawdown, you almost start suffering from apathy which is NOT good because ideally you want to remain excited to deploy capital at depressed prices. So, I have decided to give myself some **psychological reprieve** if we end up experiencing >20% drawdown. So, in case QQQ goes down \~30% and my portfolio does the same (TBD), this \~1% put options would increase to become \~5% of my portfolio which I can potentially deploy at more attractive prices. \~5% may not seem much, but near the bottom, every inch of cash deployment counts. Now, why might QQQ go down \~20-30% (or more)? Time for some blunt truth. I (neither does **almost** anyone) have no clue. It might be because inflation scare will come back, maybe deficit and/or stagflation concerns, AI investments can become earnings headwinds for mag7, or something much more catastrophic such as China invading Taiwan or some **real** regulatory challenge for Big Tech in the US/EU. Very few people (if any) could have accurately predicted Covid, stimulus driven demand, HSD inflation, supposedly taming of the said inflation etc. **consecutively**. But one thing is certain today: the multiples at the index level is now trading at nosebleed level. QQQ currently trades at \~32x LTM EV/EBIT multiple (LTM=Last Twelve Months; NTM=Next Twelve Months). For context, it bottomed at \~18x LTM EV/EBIT both in 2020 and 2022 drawdowns and at \~15x during 2018 drawdown. These are all the drawdowns I experienced first-hand since I started investing in the US in August, 2018\. If we go beyond that, QQQ consistently traded below \~20x between 2016 and 2018\. QQQ currently basically trades at 2021 peak LTM EV/EBIT multiple, and we got to go back to during 2000 tech bubble to find multiples higher than this. Given this context, I think not much needs to go wrong for these options to be a worthwhile bet. I, however, do not want to have puts regardless of the market environment. My general framework is to have puts whenever QQQ trades at above >30x LTM EV/EBIT multiple (historically, it happened very rarely). So, if we go to 2026 and QQQ still trades at >30x LTM EV/EBIT and we don't have a compelling reason to think earnings is depressed for one-off reasons (think something like Covid), I will maintain \~1% puts in my portfolio. To put it differently, I am okay with losing \~1% of my portfolio per year to protect my downside a bit when index trades at a nosebleed valuation. If it trades at \~20x multiple, I will not have puts in that case. ![chart](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/07/data-src-image-deea199c-2866-4235-8587-7f26fc2eca5a.png) Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)); \*KoyFin has QQQ valuation multiple data since 2016. Wait, shouldn’t we look at NTM? The reason I’m not looking at NTM numbers here is LTM numbers are facts whereas NTM is opinion. Having gone through 2020-2024 cycle, I have very little confidence on anyone’s ability to forecast NTM numbers with high accuracy. Moreover, data quality is a huge concern for me as analysts account for SBC for some companies (mostly big tech) in NTM numbers whereas for most other companies, they don’t. I wanted to avoid the black box of NTM numbers for index and decided to stick to LTM numbers. It’s a time series comparison anyway, so this isn’t a strong limitation. Why not buying puts for SOXX? I think there are credible (although unlikely) scenarios where mag7 ex-NVDA would engage in an uneconomic GPU war with each other which might (temporarily?) wreck the economics of mag7 ex-NVDA more than SOXX constituents. Although I think it is more likely than not that both SOXX and QQQ would go up/down simultaneously, I wanted to keep it simple by buying puts for QQQ instead of getting too cute with SOXX. Isn't a static put options expiry a bit more risky than having a more dynamic expiry dates i.e. instead of buying Jan 2026 options, shouldn't I have multiple puts in multiple expiry dates? Perhaps, and I may still do it. To be very precise, these puts are 0.8% of my portfolio now and they're roughly \~18 months in duration. Since I am okay with setting aside \~1% on puts **per year,** I can potentially add \~0.3-0.4% more of these puts in my portfolio. I will perhaps do that if QQQ has another \~10-20% rally in the next 6-12 months, so I have some additional capacity left here. Some people wonder whether there is upside risk to QQQ as bears may all just give up simultaneously. In some sense, I think it has already happened in last 2.5 months? Of course, it can always continue moving higher which is why I have some tiny capacity left. ![chart](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/07/data-src-image-a5fc4284-f5bc-4075-af0a-425fa5f33b3f.png) Figure: Performance of selected stocks and indexes since April 19, 2024; Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) Why Jan 2026? Timing is the most challenging aspect of options and there aren’t, unfortunately, compelling answers. Index is unlikely to go down \~30-40% in 3 months (unless China invades Taiwan of course), so I wanted to give it “enough” time for the index to go down and minimize my timing risk a bit. Also 12 months is probably enough time if market decides to get nervous about the new administration’s regulations, plans for spending etc. Shouldn't we just raise some cash if QQQ is overvalued, especially in a world with \~5% yield on cash? I do have \~6% cash right now and I expect myself to save at least \~10% of my current portfolio in the next 12 months. So, while it may make a lot of sense for someone else depending on their personal context, it makes more sense to me to add an instrument that provides some torque in the upside if index does go down. Okay, that’s the rough sketch. If these options expire worthless, I am probably not terribly unhappy since it likely means 99% of my portfolio may do just fine. If it becomes worth multiple of what I paid for these put options, I will feel psychologically lot better to have owned at least some insurance for the rainy days. Ultimately, investing is, more often than not, a psychological sport. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* [ ](https://www.mbi-deepdives.com/lulu1q24/) ### July, 2024 Update URL: https://www.mbi-deepdives.com/jul2024/ Last updated: 2024-07-02T13:55:54.000Z Just a very short update for this month. I will publish a Deep Dive on **Sartorius Stedim Biotech** by 25th of this month. After studying [IQVIA](https://www.mbi-deepdives.com/iqv/) last month, I am enjoying working on some healthcare companies and may choose to do a couple more this year to keep extending my learning curve here. For the new readers, I would like to highlight that you can access all the past 48 Deep Dives [**here**](https://www.mbi-deepdives.com/models/). You can also see my portfolio [**here**](https://www.mbi-deepdives.com/portfolio/) (updated on the last day of every month). Thank you so much for your support. [Subscribe](#/portal/signup) ### IQVIA Deep Dive URL: https://www.mbi-deepdives.com/iqv/ Last updated: 2024-06-21T17:06:18.000Z _This post is for paying subscribers only._ ### Lululemon 1Q'24 Update URL: https://www.mbi-deepdives.com/lulu1q24/ Last updated: 2024-06-06T02:53:09.000Z *Disclosure: I own January 2026 $165 LULU Call Options* Lululemon was facing some really thorny questions from Mr. Market ever since 4Q’23 earnings. Today’s earnings should help calm some nerves. Here are my highlights from tonight’s call. **Sales Growth by Region** At first glance, one may find confirmation to plenty of concerns for LULU. US sales, which was \~61% of overall sales this quarter, grew by only 2%. Growth momentum in international markets, especially in China helped mask the weakness in the US. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F31a696da-6a94-4ee2-9eab-fd1e6ac0a3e4_1107x1002.png) Source: Company Filings Looking at Canada’s continued double-digit growth momentum assuage my concerns related to maturity of the US business as Canada is LULU’s most mature market. There are quite a few factors at play here. US business had much tougher comp than Canada this quarter (1Q’23 US business grew by \~20% vs Canada’s \~3%). The “[Everywhere Belt](https://shop.lululemon.com/p/bags/Everywhere-Belt-Bag/%5F/prod8900747?sz=ONESIZE&ref=mbi-deepdives.com)” bag was much more popular in the US last year than it was in Canada. I will discuss a few other reasons for US weakness later. Let me focus a bit more on international opportunity, which was \~21% of LULU’s revenue in 2023\. Interestingly, while Nike is \~3x the size of LULU’s North America business, Nike’s China business is \~8x the size of LULU’s, hinting at the large runway available for LULU to further penetrate the market. LULU’s China business grew by \~67% in 2023, and yet China revenue grew by 52% FXN in 1Q’24. LULU management expects international to eventually contribute 50% of overall revenue. That may seem overly ambitious, but looking at China growth momentum and low penetration it doesn’t seem inconceivable to me. Moreover, LULU doesn’t even operate in potentially large markets such as India yet (although they may enter [soon](https://economictimes.indiatimes.com/industry/cons-products/fashion-/-cosmetics-/-jewellery/yoga-pants-inventor-lululemon-athletica-plans-to-enter-india/articleshow/109791990.cms?from=mdr&ref=mbi-deepdives.com)). Admittedly, India for LULU may be more of a 2030s story than 2020s story, but in the fulness of time, \~50-50 revenue mix between North America and International seems plausible to me. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1d3d5e37-3fb9-4e44-95ef-61aa9bc1a1c8_901x289.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Margin** What’s perhaps even more interesting is LULU’s margins in China are quite incredible. In 1Q’24, they reported \~39% operating margin in China (vs \~35% in Americas). Operating margins in Rest of the World (RoW) have also improved by \~400 bps YoY. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9c164a95-7660-4c40-81c0-442b2e2644a8_432x259.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) LULU’s overall gross margin was 57.7%, \~20 bps improvement YoY which was driven by 120 bps increase overall product margin (lower product costs, lower air freight costs and lower inventory provisions) but was offset somewhat by a 50 bps increase in markdowns. LULU expects inventory markdown to increase YoY in Q2 as well (but less than in Q1) but annual markdown is still expected to be flat YoY, implying lower markdown in the back half of the year **Sales by Gender** While LULU’s men’s business maintained its robust mid-teen growth, women’s segment reported <10% revenue growth for the first time since 2Q’20 (which was marred by Covid anyway). As discussed earlier, “others” category which includes bags had a particularly tough comp (1Q’23 grew by 54%). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6d302f02-f721-45b1-8364-4b35004fc4bc_987x258.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Why did women’s segment perform poorly? From today’s call: > When looking at women's, we did not maximize the business in the U.S., which was the result of several missed opportunities, **including a color palette and our core assortment, particularly in leggings that was too narrow**. Where we had color guests responded well, we just needed more as they are looking for additional choices. And we are also out of stock in some of our smaller sizes. > > …The 1 color and newness we did have, she responded incredibly well to, but she was looking for more, and our palette that we chose was just more limited than what she was looking for as well as because of the success in Q4, we came into the year with some missed opportunity across our size profile, particularly our smaller sizes. **All of this is within our control**. All of this, the teams have been chasing and **we expect much of that to be addressed in the second half of this year** as well as a lot of the newness and innovation, we did have planned for this year and our women's business was scheduled more for mid to back half of the year. The pain in women’s segment seems mostly self-inflicted to me and something that can be corrected over the course of the year. Lack of product assortment was also an issue in “other” category: > In the accessories business, we know that we're cycling over the success of the Everywhere Belt Bag which is incredible. It really validates and shows what's possible for our brand in accessories, in particular, in bags. And although that bag continues to perform well, not quite to the levels of last year, but the team has introduced a number of new styles of bags that the guests responded incredibly well to. > > We just didn't have the depth of inventory to satisfy the demand that could have offset some of the headwind of the Everywhere Belt Bag success last year. That is something we can control. We know the newness is resonating and the guest is moving beyond just an Everywhere Belt Bag, and we have opportunity and the teams have been chasing into that and expect to be in a better in-stock position in the back half, **the 2-tone bag is a good example of that sold out almost immediately. We were able to chase bring some in, offer it as an Essentials member early access, it again sold and did incredibly well, and we continue to chase into that**. To put LULU’s success in perspective, they did $549 mn revenue in “other” category in 2021 which then more than doubled by 2023 to reach $1.2 Bn. I know competition is the hot topic for LULU; but frankly speaking, I’m not sure whether they were even able to match LULU’s momentum in their “other” category, let alone men’s and women’s category over the last 2-3 years! Perhaps thanks to such outsized success, things had to be a bit rocky in 2024\. I do, however, expect LULU’s management to be better prepared with product assortments than they were in the first half of the year. Management did mention a number of new products to be launched in second half of the year, so we will have better clarity on this issue in a couple of quarters. **Membership** LULU now has 20 mn members in North America (vs 17 mn in 4Q’23). LULU continues to acquire new customers, but it would be bit more helpful if they provided more color on guest retention numbers. In 2019, for example, they mentioned they had [92%](https://x.com/borrowed%5Fideas/status/1791826965756035510?ref=mbi-deepdives.com) guest retention for high value guests. **Inventory** Inventory declined by 15% YoY and LULU expects it to decrease mid-teens in Q2 as well before starting to increase in line with revenue in the second half of the year. **Competition** Has the intensity of competition gone up recently? From the call: > There remains competitors in this space that use promo as a means to drive demand for their product. We've seen that increase over the last few years. > > But **I wouldn't say in this quarter, it's either gone deeper or pulled back**. **It's sort of the same, which I would say is a heightened level from a few years ago, but nothing dramatic in the quarter.** **Capital Allocation** It’s not everyday you see a company increasing the buyback intensity as stock price goes down, so it’s good to see LULU execute that. As the stock went down, they increased buyback intensity from \~117k shares in February to \~186k in March to \~448k in April. We know the stock did even worse in May, and thankfully management mentioned they bought back another $230 Mn (so another \~650-700k shares in my estimates) in May. Moreover, they raised buyback authorization by $1 Bn and have $1.9 Bn cash on balance sheet. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4a1330f0-0bb4-4566-9b76-2fa2d7361e8c_1195x220.png) Source: Company Filings Thanks to these buybacks, LULU’s shares outstanding has been going down by \~1% YoY each quarter. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1bf4e5a9-8ff2-4586-b514-9f3d8a8b58f3_706x421.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** LULU maintained their topline and operating margin guidance. EPS guide was slightly increased 14-14.2 to 14.27-14.47 (without assuming future buybacks). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5642f373-aa54-43d3-9edc-b7020e085b48_1128x261.png) Source: Company Filings **Final Words** Overall, this quarter highlighted that there are indeed some issues for LULU’s product assortments, especially for women’s segment in the US, but it does appear to be largely self-inflicted. The rest of the business seems to be largely continuing its momentum. If LULU manages to address the concerns for women’s segment in the US, I’m still optimistic that they may be able to do better than their high-end of revenue guidance for 2024, and that’s likely not priced in despite the \~10% rise in the stock price After-hours! More reading on Lululemon: [here](https://www.mbi-deepdives.com/lulu/), [here](https://www.mbi-deepdives.com/apr2024/), and [here](https://www.mbi-deepdives.com/tsm/) (see section 5) Thank you for reading. [Subscribe](#/portal/signup) ### June, 2024 Update URL: https://www.mbi-deepdives.com/jun24/ Last updated: 2024-06-03T19:08:23.000Z We are getting close to the half-year mark for this year. Let me take this opportunity to briefly share some thoughts with you: 1. First things first, after spending the last three months on studying semiconductors, I will spend the next couple of months on healthcare industry. I will publish this month's Deep Dive on **IQVIA Holdings** (Ticker: IQV) by 25th of this month. In the following month, I plan on doing a Deep Dive on **Sartorius Stedim Biotech** (Ticker: DIM). 2. One of the things that I have been thinking about is how challenging it has become to figure out the long-term implications of the current Capex bonanza of Mega Cap Tech companies. While it may be tempting to bucket all of these capex in a monolithic fashion, I suspect that is likely to prove to be too simplistic. Google, Microsoft, Meta, Amazon have sufficiently different strategies around AI that they will not necessarily succeed or fail **simultaneously**. The funny thing is when I started investing in the US back in 2018, I remember feeling a bit overwhelmed while studying some of the Big Tech companies and I imagined things will probably feel easier after studying/following these companies for a few years. Six years later, while it doesn't feel as overwhelming, the reality remains it still is quite difficult to figure out how the moats are going to evolve in the future in the big tech land. I don't have all the answers yet and the broader landscape remains quite fluid. While perhaps most of us have been actively thinking about these questions, unfortunately "Magnificent Seven" has been incorporated into our investing lexicon over the last couple of years. I encourage investors to not think about all the capex in uniform terms, rather appreciate the potential for dispersion in future returns due to AI. 3. In my 2021 [Annual Letter](https://www.mbi-deepdives.com/2021/), I wrote the following: > ...because of the business model of MBI Deep Dives, it can be challenging to choose certain companies for deep dives. For example, I am nervous to take a shot at semiconductor companies (crypto is also another area of apprehension) since I suspect one month may not be enough to understand the complexity of the whole industry. Now that I have done [Ethereum](https://www.mbi-deepdives.com/eth/) Deep Dive, a [Primer](https://www.mbi-deepdives.com/semiconductors-to-see-a-world-in-a-grain-of-sand/) on Semiconductor, and two Deep Dives on semiconductor companies ([Texas Instruments](https://www.mbi-deepdives.com/txn/), and [TSMC](https://www.mbi-deepdives.com/tsm/)), you can see I have tried to address this "weakness" of MBI Deep Dives as I grew more confident about tackling more technically challenging companies over time. Part of the reason for covering semiconductors is simply due to my somewhat recent realization that it is getting quite difficult to follow some of the mega cap tech companies I own without understanding semiconductors itself. I do want to reiterate that I am still on the very early stage of my semiconductors journey and you can expect me to cover two to three semiconductor companies every year at least for the next five years (if not more) regardless of what's going to happen to the stock prices of semiconductor companies during these years. One of the things I have become quite comfortable over time is to trust the market to provide volatility no matter how great a company/industry is. Even if AI is the mega theme for the next 10-20 years like the internet was back in late 90s to early 2000s, I am almost unreasonably confident that Mr. Market will provide us **ample** volatility along the way which is why my only focus is to study the companies closely, and not necessarily catch the "current" wave. I am starting to do the same with healthcare industry as well. Like semiconductors, I am likely to cover 2-3 companies from healthcare sector per year going forward. As a generalist, my goal is to keep studying companies across wide range of industries. 1. One of the questions I received a couple of times is whether I have incorporated Gen-AI in my research workflows. It's early days, so I'm not sure whether my current behavior will stick for years to come. Let me mention a couple of tools I have been using frequently over the last few months. I have started using [Cubby](https://cubby.nyc/?ref=mbi-deepdives.com) to manage all the highlights from annual reports, earnings transcripts, blogs, podcast etc. in one place while working on a Deep Dive. The biggest benefit from having all of my highlights in one place is that it is searchable, so it is lot more convenient to find the source of a particular quote or excerpts quickly. If you want to try it out, you can use the code "**MBI**" (disclosure: I have no financial interest in this recommendation). I have also been using Perplexity for mostly two types of things: a) to understand complex topics which was quite handy while studying semiconductors. Asking follow-up questions and requesting it to simplify the jargons certainly helped while going through jargon filled world of semiconductors, and b) uploading earnings transcripts and asking questions about the recent earnings call. While I still read earnings transcripts in full for my largest holdings, for smaller positions I have resorted to this method to stay updated. As someone running one-person investment research service, I appreciate this efficiency/productivity gain. 2. Finally, last month, I went to Omaha to attend Berkshire's AGM. One of the best things about attending this meeting is the opportunity to meet some of my subscribers. As I work from home writing Deep Dives, my work can feel a little amorphous at times; so I enjoy the fact that it feels a lot more tangible when I meet some of you. Thank you for supporting my work. I appreciate it very much! [Subscribe](#/portal/signup) ### Dollar General 1Q'24 Update URL: https://www.mbi-deepdives.com/dg1q24/ Last updated: 2024-05-30T19:09:10.000Z *Disclosure: I own shares of Dollar General* *“Dollar General (DG)’s stock had an interesting reaction to today’s earnings. First it went up by \~6% in pre-market, but then ended the day 5% down.”* I actually wrote that in last quarter’s update and surprisingly, this event more or less repeated this quarter as well. Stock initially went up \~8%, but currently trading \~7% down. Here are some highlights from today’s call. **Same Store Sales (SSS)** After three consecutive quarters of tepid SSS growth, DG returned to a more healthy SSS growth of 2.4% in 1Q’24\. Like 4Q’23, SSS was again driven by +4% customer traffic growth. This was offset by a decline in avg. transaction amount which was driven by fewer items per basket. DG’s traffic experienced negative growth in 2020, 2021, 2022, and in 1H’2023\. Since then, traffic returned to positive trend which is an encouraging sign. Moreover, DG continues to experience trade downs: > like we saw in Q4, what we're seeing is that the next cohort and the one above that, so let's call it middle- to upper-middle income and then in some of the upper-income strata, we're seeing the trade down still come in. So we feel good that we're getting new customers in. We can see it in our data, and that we're retaining at a high level those core customers of ours in that lower income strata ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7b16ddcd-e24a-4829-a5dd-de674039d04f_1036x691.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) SSS increase was driven entirely by consumable category and was partially offset by declines in non-consumables (home, seasonal and apparel categories). After non-consumables grew faster than consumables during 2020, it was almost 10 consecutive quarters of sales decline YoY in non-consumables (excluding 4Q’22)!! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fce1f1c8e-6ee9-4d9a-9077-b832456f47d1_1894x117.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) DG says non-consumables category is under pressure as consumers exhibit more cautious behavior in their discretionary spending. I wonder if the rise of Temu may have contributed to their struggle in selling discretionary items. **Gross Margin** Since non-consumable segment is relatively higher margin segment, the mix shift has hurt DG’s overall gross margin. Gross margin declined by 145 bps YoY. Apart from mix shift, higher than expected shrink and markdowns contributed to the gross margin pressure: > “Shrink continues to be our most significant headwind and was 59 basis points worse in the first quarter compared to prior year. > > With regards to markdowns, we're seeing promotional levels more similar to 2019 levels, as we anticipated coming into the year.” ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdb57ae28-ad3b-47a3-a8c5-1bccf0e92849_1140x679.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Shrink** To combat shrink, DG converted 12,000 stores (\~60% of total stores) away from self-checkout so far this year. Going forward, DG plans to have self-checkout options available in a limited number of stores, most of which are higher-volume and low shrink locations. DG management seems a bit cagey when it comes to talking about shrink. While at one point CEO said *“what we're seeing on the shrink front right now is what we thought we would”,* CFO clearly indicated otherwise during the call: > …shrink is currently trending worse than we initially expected coming into the year, and we now expect this headwind to be greater in 2024 than what was originally contemplated in the financial guidance we provided on our earnings call in March. We're taking aggressive and decisive action to mitigate this challenge, and we're expecting to see improvement later in the back half of 2024 than we had previously anticipated and more significantly, into 2025. Once self-checkout options become very limited, it’s quite likely that we will see shrink to bottom sometime by this year. **Operating margin** While DG’s operating margin bottomed in 3Q’23 and it came back to close to \~6% in 4Q’23, it has gone slightly in the wrong direction this quarter. SG&A as % of sales increased 97 bps YoY driven by retail labor, depreciation and amortization, incentive compensation, and repairs and maintenance. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F001f6385-5a30-4680-95f5-861fb7343815_1155x684.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Inventory** Inventories stood $6.9 Bn in 1Q’24, -5.5% YoY and a decline of 9.5% on a per store basis. Non-consumables inventory was -19.1% YoY and -22.5% on per store basis. **Store expansion** DG has slightly changed its store expansion cadence. While they initially guided 800 new store openings this year, they lowered the number to 730\. They now expect to remodel 1,620 stores this year compared to previous expectation of 1,500 remodels. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F74814b4b-a585-4d47-b5d9-743262bb83a0_649x390.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** DG’s outlook for 2024 remains the same: > we're reiterating our financial guidance for 2024 and continue to expect net sales growth in a range of approximately 6% to 6.7%, same-store sales growth in a range of 2% to 2.7%, and EPS in a range of $6.80 to $7.55\. This guidance continues to assume an estimated negative impact to EPS of approximately $0.50 due to higher incentive compensation expense and an effective tax rate in a range of approximately 22.5% to 23.5%. Although they don’t typically guide by quarter, DG provided some more color on 2Q’24\. 2Q’24 SSS guide is low 2% range and EPS guide is $1.7-1.85. **Final Words** While traffic and SSS trend remain quite encouraging, it’s disappointing to see operating margin trend in the wrong direction. Looking at consensus estimates, market clearly doesn’t expect DG to go back to its earlier \~8-9% operating margin days. As a shareholder, I disagree with market’s pessimism here, but I’m wary that the longer it takes DG to go back to its \~8% operating margin days, the more unlikely it will be for them to return and sustain such margin. As a result, I am drawing a hard line. If DG fails to post operating margin of >6.5% by 2025, I am unlikely to remain a shareholder. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff2fadeb1-286d-426c-8949-b1d79767f614_813x478.png) Source: Tikr, MBI Deep Dives **Further reading**: My [Deep Dive](https://www.mbi-deepdives.com/dg/) on DG (August, 2023) Thank you for reading. I will cover Lululemon's earnings next week. ### TSMC: The Most Mission-Critical Company on Earth URL: https://www.mbi-deepdives.com/tsm/ Last updated: 2024-10-17T14:18:34.000Z _This post is for paying subscribers only._ ### May, 2024 Update URL: https://www.mbi-deepdives.com/may2024/ Last updated: 2024-05-12T14:15:00.000Z This month's Deep Dive will be on **TSMC** which I'm hoping to publish sometime in the last week of this month. Following TSMC, I will spend some time out of semis for a few months and then come back to semis later in the year. I also wanted to share some brief notes on why I have started buying Aon today. **Why I am buying Aon** I bought a \~3% position in Aon (Ticker: AON) at $282/share and am open to increase exposure if stock continues to go down. I first covered the insurance brokers in June 2023 when I did a [Deep Dive](https://www.mbi-deepdives.com/bro/) on Brown & Brown (Ticker: BRO). After owning BRO and following other insurance brokers for almost a year, I have only appreciated the simplicity of the business even more. These businesses are just as exciting as watching paint dry, but quite a few publicly listed insurance brokers have been able to keep compounding for their shareholders for decades and it’s much more likely than not that it may continue to be the case. Aon is primarily an insurance broker that sells insurance on behalf of the carriers and gets paid largely a fixed percentage of commission on the insurance premium. I love the broker business model because a) they are capital light with \~30% operating margin and \~30% ROIC, b) there is no insurance underwriting risk and c) business is largely immune from inflation over the long-term. However, the business is not quite immune from typical P&C cycle and revenue growth will be affected depending on where we are in the P&C cycle but for long-term shareholders, we need not fret too much over the cycle as long as we get to buy the stock at reasonable price and let the economics of the business prevail over the course of the entire cycle. Unlike BRO, Aon primarily serves the Fortune 500 i.e. large corporate customers across 120 countries. Its revenue mix in 2023 was as follows: Commercial Risk Solutions (53%), Reinsurance Solutions (19%), Health Solutions (18%), and Retirement Solutions (11%). Revenue in terms of geographical mix in 2023 was as follows: US 44%, Americas ex US 9%, UK 14%, EMEA 21%, and APAC 12%. Aon is quite a competitively advantaged business for serving its core customers: large corporates. Its more or less a duopoly with Marsh & McLennan (Ticker: MMC) in that segment. There’s a somewhat of a struggling third player here: Willis Towers Watson (Ticker: WTW) which Aon wanted to acquire back in 2020 but DOJ deemed the deal to to be anti-competitive. Going through DOJ’s [complaint](https://www.justice.gov/atr/case-document/file/1425181/dl?ref=mbi-deepdives.com) of the deal gives you a pretty good picture of the competitive dynamics in this industry. Some key excerpts from DOJ's complaint below: > *“Aon and WTW are the second- and third-largest insurance brokers in the world. Together, Aon, WTW, and Marsh McLennan (“Marsh”) tower above other firms—so much so that they are often referred to as the “Big Three.” The Big Three dominate competition for insurance broking for the largest companies in the United States, *almost all of which are customers of at least one of them.* The Big Three compete with each other directly on price, service, and the development of innovative solutions to the challenges these customers face. *Other broking firms do not offer large customers the same quality and combination of services* that the Big Three currently deliver: extensive global networks of offices, sophisticated data and analytics, a breadth of knowledge across multiple types of employee benefits and risk management strategies, strong reputations, and depth of personnel with specialized expertise. With respect to these qualities, the Big Three distinguish themselves from other firms.* > *High levels of concentration exist because customers view Aon and WTW—along with Marsh— as offering key advantages over other firms. First, through a mix of broad data, deep experience, knowledge, and institutional resources that outstrip smaller insurance brokers, Aon and WTW can customize their products to fit a particular client’s unique needs. Second, Aon and WTW offer, and have deep talent across, the full range of commercial risk and employee benefits products and services, *allowing them to provide advice and insights that would not be possible for a smaller firm with a narrower scope*. Third, Aon and WTW have extensive global networks of offices that facilitate the provision of seamless worldwide service for multinational customers. Finally, as crucial sources of business for insurance carriers, Aon and WTW are able to secure carriers’ attention on behalf of their customers more easily and promptly than could any individual customer (or smaller insurance broker).* > *Among large customers in the United States, *Aon and WTW have a combined market share of at least 40%* for broking property damage risk, third-party liability (or “casualty”) risk, and financial risk, which together account for the majority of most large customers’ commercial risk insurance expenditures.* > **Past attempts have shown that successful entry is difficult*. For example, several years ago a number of employees from one of the Big Three attempted to start their own commercial risk broking firm with a focus on serving large customers. Despite having deep experience in the industry and existing relationships with many potential customers, this new venture failed to take much business from Aon, WTW, and Marsh. Similarly, *at least one major direct-to-consumer provider spent several years attempting to expand into the private multicarrier retiree exchange market, but has since abandoned that effort due to a lack of success*. This direct-to-consumer provider’s foray into private multicarrier retiree exchanges was hampered by, among other things, its lack of reputation and experience with large employers that Aon and WTW have handled for years*.” Although WTW deal didn’t go through, it didn’t quite change the reality of the competitive dynamics in this industry. WTW is still there as an independent company but AON and MMC may gradually prove to be the “the Big Two”. There’s not much of an impetus for intense price competition among the “Big Two”, so it is probably fair to assume stability in the commission structure of their core business. How about disintermediation risk? MMC has been around for 150 years. Insurance broking is a really old business model as customers, especially large sophisticated corporate customers have always intuitively understood the inherent conflict of interest of buying non-standardized insurance products directly from the carriers. As a result, the middlemen i.e. brokers have played a key role in the insurance industry for more than a century in the US. That seems unlikely to change going forward. One interesting thing that AON is currently trying to do is acquire its way to middle market insurance. They recently completed an acquisition of NFP for $13.4 Bn (\~15x EBITDA). Success in middle market is far from guaranteed as it’s effectively a different market from large corporates. However, in case AON attains compelling economics from this deal, AON may end up being lot more acquisitive in middle market as well. If not, they may just contain themselves within large corporates. This is bit of an unknown to me, but even if Aon's foray into middle market insurance turns out to be wrong, it is unlikely to be a major setback. AON has organically grown its topline at \~MSD rate in the last 5-10 years and should continue to grow at nominal GDP+ 0-2% organic growth rate for years to come (again, growth can be affected by P&C cycle but this should hold true over the course of the cycle). Given the stock currently trades at \~18x P/E and they typically enjoy some margin expansion each year, we can get to LDD IRR with reasonable assumptions: \~5% organic revenue growth+ \~0-1% margin expansion+ \~5-6% earnings yield. If they manage to deploy capital at attractive ROIC by acquiring smaller middle market insurance brokers, IRR can be notched up a bit. In the most recent quarter, AON’s organic growth lagged its peers which led to decline in AON’s multiples compared to MMC’s. Over the last 10 years, AON hardly ever traded below MMC and S&P 500 NTM EV/EBITDA multiples, but today they trade at 1-turn and 2-turn below S&P 500 and MMC NTM EV/EBITDA multiple respectively. I consider the stock to be good value. ![chart](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/05/data-src-image-e64a379f-42ab-4ce1-aaad-a213e83d61c7.png) Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) Finally, I am writing this from Omaha. Feel free to say hello if we stumble into each other in the streets of Omaha for the next few days! Thank you for your support. [Subscribe](#/portal/signup) ### Amazon 1Q'24 Update URL: https://www.mbi-deepdives.com/amzn1q24/ Last updated: 2024-05-01T02:17:48.000Z *Disclosure: I own Jan 2025 $55 call options of Amazon* Now that Meta, Alphabet, Microsoft, and Amazon all reported their quarters, we now have better context to how their quarters went. So, while I will mostly discuss Amazon's earnings in this update, I will briefly touch on some broader themes as well. [Subscribe](#/portal/signup) **Revenue** Overall revenue was slightly below the high end of Amazon's guidance. However, once you adjust for the FX (\~$700 mn adjustment), revenue was actually higher than high end of Amazon's guide last quarter. It's interesting to note that while all of their businesses basically overcame the pandemic hangover, Amazon's 1P business (online +physical stores) is barely growing on 3-yr CAGR basis. Apart from 1P which is also likely their least profitable segment, every single segment of their business is growing at a healthy rate. Both AWS and 3P are now >$100 Bn run-rate business and yet growing at high teen rates YoY. While most people are focused on Gen AI's implications for AWS, it's interesting to see how this technology can be a boon for Amazon's 3P business as well: > We've recently launched a new generative AI tool that enables sellers to simply provide a URL to their own website, and we automatically create high-quality product detail pages on Amazon. Already, over 100,000 of our selling partners have used one or more of our gen AI tools ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-20.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** While North America's margin slightly went down QoQ, it was still +5.8% in 1Q'24 vs +1.2% in 1Q'23\. International segment's operating margin improvement was even more impressive as it went from -4.3% in 1Q'23 to +2.8% in 1Q'24\. Ads was an "**important contributor**": > Advertising remains an important contributor to profitability in North America and international segments. We see many opportunities to grow our offerings, both in the areas that are driving growth today like sponsored products and in areas that are newer, like streaming TV ads. While North America's operating margin got pretty close to pre-pandemic level, Amazon reminded that it should not be seen as a ceiling since advertising used to be much less of a contributor back then. With ads ramping up, these segments should be more profitable: > We look back to before the pandemic, and we say, first, **we can achieve those operating margins even without the impact of advertising**. And we're not quite there yet. But we're not limiting ourselves to that. We're looking for ways to, again, turn over every rock, look at every process and everything that we do on the logistics side and see **how can we get our cost structure down** and how can we get speed up and selection up. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-21.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Fulfillment+ Shipping** Speaking of logistics, here are some highlights from on this topic from today's call: > In this past Q1, we delivered to Prime members at our fastest speeds ever. In March, **across our top 60 largest U.S. metro areas, nearly 60% of Prime members orders arrived the same or next day. And globally, in cities like Toronto, London, and Tokyo, about 3 out of 4 items were delivered the same or next day**.. > As we further optimize our network, **we've seen an increase in the number of units delivered per box, an important driver for reducing our cost**. When we're able to consolidate more units into a box, it results in fewer boxes and deliveries, a better customer experience, reduces our cost to serve, and lowers our carbon impact.. If you look at worldwide paid unit growth vs shipping+ fulfillment cost growth, you would notice that the latter used to consistently outpace the former pretty much all the time since 2015 until 3Q'22\. Since then, unit growth is faster (was at par in 3Q’23) than shipping+ fulfillment costs, indicating operating leverage in their logistics footprint. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-30.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Advertising** For the first time in a long time, Amazon didn't grow its advertising revenue the fastest among the big three (Google, Meta, and Amazon). To be fair, Amazon didn't have as much of an easy comp as Meta did, so would discourage anyone from inferring much from this data. While Meta has \~30% market share in digital ads (Note: see definition of "digital ads), it has taken >40% incremental ad dollars in the last 5 quarters. It will be interesting to observe how the next 5 quarters play out given their easy comp is now behind them. If Meta AI leads to some share in the bottom of the ad funnel thanks to high intent data from user chats, Meta's high incremental market share may persist even beyond their easy comp duration. *(*Note*: quite a few subscribers suggested me to include TTD in this table; while I wanted to do that, TTD hasn't reported their Q1 yet, so I will update it once they do)* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/05/image.png) **AWS** Okay, now let’s talk about AWS. This was Amazon's best Q1 ever. If you notice last few years, historically incremental QoQ revenue in Q1 is generally the lowest. If that remains the case in 2024, this may prove to be a pretty robust growth year for AWS after digesting through last several quarters of "optimization" from their customers. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-22.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Amazon believes they continue to enjoy the highest absolute growth over their competitors (hard to validate since others don’t disclose exact numbers): > It's useful to remember that year-over-year percentages are only relevant **relative to the total base from which you start. And given our much larger infrastructure cloud computing base, at this growth rate, we see more absolute dollar growth again quarter-over-quarter in AWS than we can see elsewhere.** ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-23.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); \*Google Cloud includes Google Workspace, so not quite apple-to-apple and in reality, GCP likely grew faster than Google Cloud One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. While Google Cloud’s revenue somehow managed to maintain its gradual momentum against AWS, opex trajectory went to the opposite direction. That may be less of a fault by Google Cloud and more of a credit to AWS. But do remember that given Google Workspace is likely higher margin segment within Google Cloud, GCP's economics is likely considerably worse than AWS and may have plenty of catch up to do in the future. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-26.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-27.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Nonetheless, the reason I was saying Google Cloud's opex trajectory is likely less of a fault on their part is **AWS opex actually declined YoY while their revenue increased by \~$3.7 Bn, which led to an eye-watering operating margin of \~38%.** Don't get used to such margins though as AWS expects to ramp up their capex materially going forward which will lead to higher depreciation and lower margin initially but will get to normalized margin once the utilization improves: > We expect the combination of AWS' reaccelerating growth and high demand for gen AI to meaningfully increase YoY capital expenditures in 2024, which given the way the AWS business model works is a positive sign of the future growth. **The more demand AWS has, the more we have to procure new data centers, power and hardware. And as a reminder, we spend most of the capital upfront. But as you've seen over the last several years, we make that up in operating margin and free cash flow down the road as demand steadies out. And we don't spend the capital without very clear signals that we can monetize it this way**. > ...in Q1, we had $14 billion of CapEx. **We expect that to be the low quarter for the year**...And we continue to see strong CapEx performance in our stores business. Most of that will be related to modest capital or capacity increases in addition to our same-day fulfillment network and some Amazon Logistics upgrades to the fleet. **But for the most part, what you'll see is really going to be on the AWS side**. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-25.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-24.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Some other interesting tidbits on AWS from the call: > ...companies have largely completed the lion's share of their cost optimization and turned their attention to newer initiatives. Before the pandemic, companies were marching to modernize their infrastructure, moving from on-premises infrastructure to the cloud to save money, innovated at a more rapid rate, and to drive more developer productivity. The pandemic and uncertain economy that followed distracted from that momentum, **but it's picking up again**. Companies are pursuing this relatively low-hanging fruit in modernizing their infrastructure. > ...We see considerable momentum on the AI front where we've accumulated a **multibillion-dollar revenue run rate** already. > today, we announced the general availability of Amazon Q, the most capable generative AI-powered assistant for software development and leveraging company's internal data. > ...I think the thing that people sometimes don't realize is that while we're in the stage that so many companies are spending money training models, once you get those models into production, which not that many companies have, but **when you think about how many generative AI applications will be out there over time, most will end up being in production when you see the significant run rates. You spend much more in inference than you do in training because you train only periodically, but you're spinning out predictions and inferences all the time**. > ...**we see both training and inference being really big drivers on top of AWS.** And then you layer on top of that the fact that so many companies, their models and these generative AI applications are going to have their most sensitive assets and data. And it's going to matter a lot to them what kind of security they get around those applications. And yes, if you just pay attention to what's been happening over the last year or 2, **not all the providers have the same track record**. And we have a meaningful edge on the AWS side so that as companies are now getting into the phase of seriously experimenting and then actually deploying these applications to production, people want to run their generative AI on top of AWS. **Opex+Capex** I would caution readers from getting too excited about Amazon's higher gross margins in 1Q'24 since the cost of sales for AWS is actually reported within R&D (or as they say "Technology & Content"). As a result, we don't really know for sure what Amazon's gross margin is. However, looking at its cost of sales as % of revenue and AWS reported operating margin, it is perhaps safe to assume that its gross margin is indeed improving (but just wanted to remind that the lack of hard data as evidence). Just like other big tech, Amazon's capital intensity has also gone up materially with their increased scale. However, given much of the current capex cycle is driven by AWS which has a pretty high visibility to attractive ROIC, I very much applaud this capex. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-28.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Other Bets** What I like less and less is complete lack of disclosure or even paltry discussion on Amazon's "other bets" (i.e. Alexa, Kuiper et al) in their earnings call. **Outlook** Amazon’s guidance for 2Q’24 is below: ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-32.png) Source: Amazon Press Release One thing Amazon highlighted in the call while discussing the guide is they are seeing Europe to fare worse than the US in the current quarter: > As part of our guidance considerations, we also continue to keep an eye on consumer spending and macro level trends, specifically in Europe, where it appears to be a bit weaker relative to the U.S. For more in-depth valuation discussion of Amazon, see my analysis [here](https://www.mbi-deepdives.com/amzn2024/) (February, 2024). Please feel free to share with your friends and network. Thank you for reading. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* [ ](https://www.mbi-deepdives.com/meta1q24/) ### Alphabet 1Q'24 Update URL: https://www.mbi-deepdives.com/goog1q24/ Last updated: 2024-04-26T03:05:17.000Z "...*it took Google more than 15 years to reach $100 billion in annual revenue. In just the last 6 years, we have gone from $100 billion to more than $300 billion in annual revenue*" Despite following Big Tech closely for the last 5 years, this sentence from today's call still somewhat surprised me! The scale and the height of success of Google **truly boggles** my mind. Over the last year or so, Google has had its fair share of skeptics, including yours truly. While the stock price used to embed some tension and debate about Search's future, following after-hours (AH) rally, as I will show, it appears that the stock is finally priced as "AI winner". Here’s my highlights from today’s earnings. [Subscribe](#/portal/signup) **Revenue** For the second consecutive quarters, every important segments i.e. Search, YouTube, Cloud accelerated their topline growth. Overall revenue growth was +15% YoY (+16% FX Neutral) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-5.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Amidst the bearish narrative around Search, Google Search's topline growth of 14.4% was quite impressive. But to appreciate Search's resiliency, I would like to highlight something else. If it were a trivia question which of these three businesses (Meta's Family of Apps' or FOA Ads, Google Search, and YouTube Ads) generated highest topline growth over the last three years, my guess is most people would get it wrong. While many may think growth in Meta's FOA has been extraordinary, **Search actually outpaced FOA and YouTube ads** over the last 3-year period. Meta's FOA just appeared more impressive this quarter primarily due to easier comps. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-15.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ***EBIT*** Google Services business posted 39.6% operating margin which was very close to its all-time high reported margin in this segment back in 3Q'21\. When Search related bearish narrative gained momentum last year or so, I too started entertaining the possibility that we may have seen peak margin for Google Service segment back in 3Q'21\. **With >70% incremental operating margin in the Services segment for three consecutive quarters**, Google seems poised to post record margins sooner rather than later. For the second consecutive quarters, Google Cloud posted +9.4% operating margin. Moreover, TAC as % of Ad revenue was the lowest as far as my eyes could see in the last 5 years (may be the lowest ever, but not 100% sure about it). Sluggish revenue from Network business (which is higher TAC) perhaps made this metric look lot better (maybe higher Android smartphone share too? Not sure though). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-16.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Search** Some interesting comments on Search from the call: > based on our testing, we are encouraged that **we are seeing an increase in search usage among people who use the new AI overviews as well as increased user satisfaction** with the results. > since introducing SGE about a year ago, **machine costs associated with SGE responses have decreased 80%** from when first introduced in Labs driven by hardware, engineering, and technical breakthroughs > Overall, I think with generative AI in Search, with our AI overviews, I think we will **expand the type of queries we can serve our users**. We can answer more complex questions as well as, in general, that all seems to carry over across query categories. Obviously, it's still early, and we are going to be measured and put user experience at the front, but we are positive about what this transition means Almost near the end of the call, Pichai reminded all the skepticism that was hurled at Google and yet how they have prevailed and expect to thrive going forward: > ...if you were to step back at this moment, there were a lot of questions last year, and we always felt confident and comfortable that we would be able to improve the user experience. People question whether these things would be costly to serve, and we are very, very confident we can manage the cost of how to serve these queries. People worried about latency. When I look at the progress we have made in latency and efficiency, we feel comfortable. There are questions about monetization. And based on our testing so far, I'm comfortable and confident that we'll be able to manage the monetization transition here well as well. It will play out over time, but I feel we are well positioned. And more importantly, when I look at the innovation that's ahead and the way the teams are working hard on it, I am very excited about the future ahead. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-10.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **YouTube** > viewers are watching over **1 billion hours** of YouTube content on TVs daily. > And on subscriptions, which are increasingly important for YouTube, we announced that in Q1, **YouTube surpassed 100 million Music and Premium subscribers globally, including trials**. And **YouTube TV now has more than 8 million paid subscribers**. > In 2023, more people created content on YouTube than ever before, and **the number of channels uploading Shorts year-on-year grew 50%.** > In the U.S., the monetization rate of Shorts relative to in-stream viewing has more than **doubled** in the past 12 months, including a **10- point sequential improvement** in the first quarter alone. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-9.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Advertising Infrastructure** > Advertisers using PMax asset generation are **63% more likely** to publish a campaign with good or excellent ad strength. And those who improve their PMX ad strength to excellent see **6% more conversions** on average. > We're also driving improved results for businesses opting into Automatically Created Assets (ACA), which are supercharged with gen AI. Those adopting ACA see, on average, **5% more conversions** at a similar cost per conversion in Search and Performance Max campaigns. **Google Cloud** Cloud revenue growth again accelerated. Interestingly, Google expects YouTube overall (ads+ subscriptions) and Google Cloud will have combined $100 Bn revenue run-rate by the end of 2024 which implies pretty sustained growth momentum throughout the year. I will discuss more on Cloud when Amazon posts next week. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-8.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Google Other** Google One (subscription service that provides additional storage for Google Drive, Gmail, and Google Photos) now has \~100 million paid subscribers. **AI** Contrary to popular perception, Pichai outlined how AI can be gamechanger for Google: > I think **for the first time**, we can work on AI in a **horizontal way and it impacts the entire breadth of the company, be it Search, be it YouTube, be it Cloud, be it Waymo and so on.** And we see a rapid pace of innovation in that underlying. **So it's a very leveraged way to do it**, and I see that as a real opportunity ahead. **In terms of the challenges, I think it's been a mindset shift, which we've been driving across the company** to make sure that we are embracing this opportunity but being very efficient in how we are approaching it **Capital Allocation** Google mostly utilized all of its FCF to buyback shares, declining shares outstanding by 0.6% QoQ. For the first time, they have declared cash dividend of $0.20/share. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-11.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex and Opex** Google spent $12 Bn capex in Q1 and indicated capex will be around $12 Bn or above for each of the three remaining quarters. So, call it \~$50 Bn capex in 2024 (vs \~$32 Bn in 2023) compared to Meta's $35-40 Bn in 2024\. Google reminded how committed they always have been with their infrastructure (and frankly in my opinion it is perhaps an underrated moat): > We have the best infrastructure for the AI era. Building world-leading infrastructure is in our DNA, starting in our earliest days when we had to design purpose-built hardware to power Search. Our data centers are some of the most high-performing, secure, reliable, and efficient in the world. They've been purpose-built for training cutting-edge AI models and designed to achieve unprecedented improvements in efficiency. We have developed new AI models and algorithms that are more than 100x more efficient than they were 18 months ago. Our custom TPUs, now in their fifth generation, are powering the next generation of ambitious AI projects. Gemini was trained on and is served using TPUs. We are committed to making the investments required to keep us at the leading edge in technical infrastructure. You can see that from the increases in our capital expenditures. This will fuel growth in Cloud, help us push the frontiers of AI models and enable innovation across our services, especially in Search. Google’s headcount declined QoQ, but capex as % of revenue increased to 14.9% in 1Q’24 which was highest since 3Q’19\. Google seems to be balancing between headcount and emboldening their infrastructure investments. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-12.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** Google doesn’t provide guidance, but management did seem to hint at tougher comp ahead: > Looking ahead, two points to call out: first, results in our advertising business in Q1 continued to reflect strength in spend from APAC-based retailers, a trend that began in the second quarter of 2023 and continued through Q1, which means we will begin lapping that impact in the second quarter; second, the YouTube acceleration in revenue growth in Q1 reflects, in part, lapping the negative year-on-year growth we experienced in the first quarter of 2023. > > ...Q1 results reflect the benefit of leap year > > Looking ahead, **we remain focused on our efforts to moderate the pace of expense growth in order to create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure**. We believe these efforts will enable us to deliver full year 2024 Alphabet operating margin expansion relative to 2023. **Valuation** Since [3Q'22](https://www.mbi-deepdives.com/goog3q22/), I share the following valuation framework every quarter. For the first time since then, each of the following scenario indicates upside to be limited. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-17.png) Source: MBI Deep Dives Market is likely valuing Google Service segment at \~20x LTM EBIT and the Cloud business at \~8-10x revenue multiple. I think it's fair to say despite plenty of bearish narrative around Google, it's hard to find figment of that in the financials. Management seems rather confident that early numbers indicate GenAI is not really a threat to Search economics. As a result, investors seem to be finally willing to embrace Google as one of the winners of "tomorrow". ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-18.png) Source: MBI Deep Dives While almost all big tech seem to be cruising along today, what matters for long-term investors is where each of these businesses will stand 5-10 years from now. I have mentioned this before, but would like to reiterate that understanding, assessing, and predicting competitive dynamics, moats, and durability of such moats for big tech remains quite a challenging task. I will cover earnings of **Amazon** next week. Thank you for reading. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Meta 1Q'24 Update URL: https://www.mbi-deepdives.com/meta1q24/ Last updated: 2024-04-25T18:03:32.000Z *Disclosure: I own shares of Meta Platforms* If you have been following Meta for some time, you probably are accustomed with after-hours (AH) volatility by now. While Meta was -20% at one point AH today, it does seem a bit overdone. Of all the post-earnings drop that I have experienced following Meta since 2018, this one probably made me nervous the **least**. Here are my highlights from tonight’s call. **Users** This was another typical quarter for Meta adding \~50 mn Daily Active People (DAP) across its Family of Apps (FOA). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fded181b9-14ab-4ea0-b1bd-79fcd8a4b0e7_2005x127.png) **Ad revenue by Geography** While ad revenue growth YoY continued at a brisk pace, this was the last quarter with easy comps and hence, 2-yr CAGR is likely better reflective of underlying trend. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe0665fdd-9632-4e0f-9a1a-345ffdc8981c_1809x339.png) **Ad Impression and Avg. Price Per Ad** We got ad impression and ad price related disclosure by geography for the first time this quarter. Overall impression grew by \~20% and avg. price per ad grew by \~6% YoY. Interestingly, the strongest ad price growth was in RoW segment (which includes Africa, Middle East, and LATAM) which incidentally also had the highest revenue growth. Meta mentioned in the call that they grew conversions at a faster rate than impressions over the course of this quarter, making the ads more performant. Moreover, campaigns using Advantage+ audience targeting saw on average a 28% decrease in cost per click or per objective compared to using regular targeting. Ad revenue from Advantage+ shopping and Advantage+ campaigns has more than **doubled** since last year. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F15594ffd-f25d-4fc7-9483-2e9da8d35a25_708x493.png) . Meta didn’t quantify China revenue, but did mention that they “are lapping periods of increasingly strong demand over the course of 2024 given the recovery of China-based advertisers in 2023 from their prior pandemic-driven headwinds.” Ad revenue from North America was 43.4% of overall revenue which was the lowest in Meta’s history, indicating the increasingly global nature of Meta’s business as APAC and RoW segment ramps up and contributes more to revenue. In 1Q’21, these two regions in aggregate contributed 28.2% of Meta’s ad revenue but in 1Q’24, they were 33.3% of ad revenue. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F74e9ab07-7150-411e-88f1-fb57ca6b0c8d_2017x160.png) **Segment Reporting** Overall 1Q’24 revenue was +27.3% YoY; on a 2-yr and 3-yr CAGR basis, Meta’s topline increased by 14.3% and 11.7% respectively. FOA’s other revenue increased by 85% YoY, driven by business messaging revenue growth from WhatsApp business platform. Zuck called out business messaging to be “the biggest clear opportunity…it's not like next quarter or the quarter after that scaling thing, but it's not like a 5-year opportunity either.” I expect this momentum in business messaging to continue for years to come. FOA had another near \~50% operating margin quarter and Reality Labs (RL) had another quarter of continued bleeding. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7404b8ef-0be2-4ce9-a9c4-fc0ece2484db_1618x511.png) Last [quarter](https://www.mbi-deepdives.com/meta4q23/), I mentioned: *“I know some Meta bulls are tempted to look at FOA and try to imagine some SOTP by assigning Reality Labs valuation of zero...I would mostly just pay attention to Meta’s consolidated numbers.”* Zuck more or less made the same case as the two segments increasingly become intertwined: > one strategy dynamic that I've been reflecting on is that an increasing amount of our reality labs work is going towards serving our AI efforts. We currently report on our financials as a family of apps and Reality Labs were 2 completely separate businesses. **But strategically, I think of them as fundamentally the same business with the vision of Reality Labs to build the next generation of computing platforms in large part to where we can build the best apps and experiences on top of them**. **Over time, we'll need to find better ways to articulate the value that's generated here across both segments. So it doesn't just seem like our hardware costs increase as our glasses ecosystem scales, but all the value flows to a different segment.** Let’s look at some interesting comments from the earnings call: **Meta AI** Meta AI was the key focus on this call. Meta says the initial feedback is “very positive”: > The initial rollout of Meta AI is going well. Tens of millions of people have already tried it. **The feedback is very positive**. And when I first checked in with our teams, the majority of feedback we were getting was people asking us to release Meta AI for them wherever they are. This has emboldened Meta to continue to invest more aggressively: > Overall, I view the results our teams have achieved here as another key milestone in showing that we have the talent, data and ability to scale infrastructure to build the world's leading AI models and services. And this leads me to believe that we should **invest significantly more over the coming years** to build even more advanced models and the largest scale AI services in the world. Zuck reminded investors that while it may be somewhat painful to go through, they have pretty compelling track record in building features and using their unparalleled distribution to monetize these features. While some investors may wonder whether this is more akin to RL investments or Reels/Stories investment phases, I think it’s exceptionally likely to be the latter. Meta AI is not a speculative/unproven ideas on which Meta is aggressively investing; business messaging, and high intent data from chat bots and hence getting more ad dollars from bottom of the ad funnel is likely to be an **once a decade** opportunity for Meta. It makes perfect sense to me that they would go after this rather quite aggressively: > As we're scaling CapEx and energy expenses for AI, we'll continue focusing on operating the rest of our company efficiently. But realistically, even with shifting many of our existing resources to focus on AI, we'll still **grow our investment envelope meaningfully before we make much revenue from some of these new products**. I think it's worth calling that out that **we've historically seen a lot of volatility in our stock during this phase of our product playbook, where we're investing in scaling a new products but aren't yet monetizing it. We saw this with Reels, Stories, as newsfeed transition to mobile and more. And I also expect to see a multiyear investment cycle before we fully scaled Meta AI, business AIs and more into the profitable services I expect as well.** > > Historically, investing to build these new scaled experiences in our apps has been a very good long-term investment for us and for investors who have stuck with us. And the initial signs are quite positive here, too. > > On the upside, once our new AI services reach scale, **we have a strong track record of monetizing them effectively. There are several ways to build a massive business here**, including scaling business messaging, introducing ads or paid content into AI interactions and enabling people to pay to use bigger AI models and access more compute. **And on top of those, AI is already helping us improve app engagement**, which naturally leads to seeing more ads and improving ads directly to deliver more value. > > So if the technology and products evolve in the way that we hope, each of those will unlock massive amounts of value for people and business for us over time. The point about increased engagement is really crucial here. If there is \~10% higher engagement on Meta’s apps thanks to better recommendation system, simplistically assuming that may result in \~$10-15 Bn revenue opportunity. If you assume FOA’s \~50% operating margin for these incremental ad dollars thanks to higher engagement/time spent, ROIC on these capex is going to be pretty compelling! And Meta already has good evidence that this is the right path to take: > We're seeing good progress on some of these efforts already. Right now, **about 30% of the posts on Facebook feed are delivered by our AI recommendation system. That's up 2x over the last couple of years. And for the first time ever, more than 50% of the content that people see on Instagram is now AI recommended**. > > AI has also been a huge part of how we create value for advertisers by showing people more relevant ads. And if you look at our 2 end-to-end AI-powered tools, Advantage Plus shopping and Advantage Plus campaigns, **revenue flowing through those has more than doubled since last year**. > > …historically, each of our recommendation products, including Reels, in-feed recommendations etc. has had their own AI model. And recently, we've been developing a new model architecture with the aim for it to power multiple recommendations products. We started partially validating this model last year by using it to power Facebook Reels. **And we saw meaningful performance gains, 8% to 10% increases in watch time as a result of deploying this**. This year, **we're actually planning to extend the singular model architecture to recommend content across not just Facebook Reels, but also Facebook's video tab as well. So while it's still too early to share specific results, we're optimistic that the new model architecture will unlock increasingly relevant video recommendations over time**. And if it's successful, we'll explore using it to power other recommendations > > …with Meta AI, I think that **we are on our path to having Meta AI be the most used and best AI assistant in the world, which I think is going to be enormously valuable**. So all of that basically encourages me to make sure that we're investing to stay at the leading edge of this. **Reels** > Video also continues to grow across our platform, and it now represents more than **60% of time on both Facebook and Instagram**. Reels remains the primary driver of that growth. **WhatsApp** > …we're seeing **healthy growth in the US**…where the number of daily actives and message sends in the U.S. keeps gaining momentum **Threads** Threads now has 150 Mn MAU (vs 130 Mn in 4Q’23 and 100 mn in 3Q’23) **AR/VR** > The Ray-Ban Meta glasses that we built with Essilor Luxottica continue to do well and are **sold out** in many styles and colors. > > …As the ecosystem grows, I think there will be sufficient diversity in how people use mixed reality that there will be demand for more designs than we'll be able to build for example, a work-focused headset…Now to be clear, I think that our first-party Quest devices will continue to be the most popular headsets as we see today, and we'll continue focusing on advancing the state-of-the-art tech and making it accessible to everyone. But I also think that opening our ecosystem and opening our operating system will help the overall mixed reality ecosystem grow even faster. I have noticed Zuck put more emphasis on Meta Ray-Ban Glasses than VR headsets during this call. I have both Quest and the glasses and I think the adoption of glasses may inflect sooner than many may think. I myself have noticed after wearing the glasses, I have taken more photos/videos given how friction free it is which then get posted on social media. In the long-term, the biggest risk for Meta is lack of engaging content on its platforms, so the more it can unlock the velocity/quality of content, the better it is for Meta’s FOA platform. **Capital Allocation** Meta bought back \~$15 Bn last quarter (\~120% of FCF). Moreover, it also paid $1.2 Bn dividend. Despite the buybacks, shares outstanding decreased by only 0.2% QoQ, thanks to Meta’s **quite** **generous SBC program** which is currently nearing \~$200k/employee. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa435d261-06d8-421c-b98d-ff874231b9e9_1720x304.png) **Opex Guide** Anyone following Meta perhaps knows by now that Meta tends to decrease their opex guide as the year progresses. But last [quarter](https://www.mbi-deepdives.com/meta4q23/), I did wonder whether this was mostly Dave Wehner-thing and now that we have a new CFO (Susan Li), she may have a different approach. She indeed has bit of a different approach as Meta guided for $96-99 Bn opex (vs $94-99 Bn) for 2024. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F631bb344-633f-4622-8032-d5f58de69e21_1225x577.png) **Capex** Capex guide range was increased from $30-37 Bn to f $35-40 Bn in 2024\. As you can imagine, all the AI infrastructure related investments do not come cheap. Expect capex ramp up to continue: > “While we are not providing guidance for years beyond 2024, we expect CapEx will continue to increase next year as we invest aggressively to support our ambitious AI research and product development efforts.” As mentioned earlier, this is a fundamentally different opex/capex plan for Meta compared to what they have done/are doing with RL. I consider these investments to be lot less speculative. If there is a terrible adoption rate of “Meta AI” and declining engagement by users, Meta can scale back the level of investments and just keep iterating based on what works. It is way less risky capital deployment than AR/VR investments in my opinion. **Regulation** While it does seem increasingly unlikely that the regulators can cause real pain to Meta, it remains a wild card: > we continue to monitor an active regulatory landscape, including the increasing legal and regulatory headwinds in the EU and the U.S. that could significantly impact our business and our financial results. > > We also have a jury trial scheduled for June in a suit brought by the state of Texas regarding our use of facial recognition technology, which could ultimately result in a material loss. **Outlook** 2Q’24 topline guide is $36.5-39 Bn (\~1% FX headwind). Mid-point YoY growth is \~19% (vs consensus estimates of \~20%) **Closing Words** When I [shared](https://www.mbi-deepdives.com/meta2024/) my updated model on Meta, I did mention I sold \~10% of Meta shares I had after last quarter. As I deem market’s reaction to be rather excessively negative today, I would be willing to buy those shares back at \~$400 which would value the company at \~14-15x 2025 (consensus) EBIT. Given Meta’s significant weight in my [portfolio](https://www.mbi-deepdives.com/portfolio/), I am not going to chase the stock if it doesn’t come to $400 or below. For more in-depth analysis on Meta Platforms, you can read my analysis [**here**](https://www.mbi-deepdives.com/meta2024/) (February, 2024). Notes from follow-up call are [here](https://twitter.com/borrowed%5Fideas/status/1783489441090478403?ref=mbi-deepdives.com) I will cover **Alphabet’s** earnings **tomorrow**. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Texas Instruments: Leading the Analog Chips Industry URL: https://www.mbi-deepdives.com/txn/ Last updated: 2024-04-22T23:14:16.000Z _This post is for paying subscribers only._ ### April 2024 Update URL: https://www.mbi-deepdives.com/apr2024/ Last updated: 2024-04-02T17:14:16.000Z First things first, this month's Deep Dive on **Texas Instruments** will be published by April 25th. Thank you for all the great feedback on my Semiconductor [Primer](https://www.mbi-deepdives.com/semiconductors-to-see-a-world-in-a-grain-of-sand/) last month; I'm glad that many of you found it useful to get up to speed on the industry. Although I rarely explain my investment activities in these monthly updates, I will share some thoughts on why I have started buying Lululemon today. Before I explain my rationale to start buying Lululemon (Ticker: LULU), let's go down the memory lane first. I first published my [Deep Dive](https://www.mbi-deepdives.com/lulu/) on the company in November 2020\. I would suggest you read the Deep Dive for more comprehensive and detailed analysis, especially to grasp LULU's competitive advantages. I thought the valuation was a bit rich back then, but later I changed my mind in [June 2021](https://www.mbi-deepdives.com/lulu2/) and started buying the stock at $335/share. However, I later sold the stock at \~$385 in [May 2022](https://www.mbi-deepdives.com/adyey/) (see Section 6) and mentioned this for my rationale to sell LULU to increase my exposure in some of my other portfolio holdings: *"While LULU’s long-term future is likely to be bright, I thought IRR in some of my other portfolio holdings are potentially much higher."* Indeed, while my portfolio nearly doubled since May 2022, LULU has been basically flat since then. Moreover, the stock is down \~25% YTD and is actually flat since August 2020\. Today, I think I am in the opposite situation of May 2022; my guess is LULU is likely to outperform much of my current portfolio holdings in the next 3-5 years and hence took a \~4% position at $380/share (and open to increase my exposure depending on how stock price and/or fundamentals move going forward). This isn't a Deep Dive, so I will be rather brief and highlight just a couple of points on why I like LULU today. Perhaps nothing encapsulates how LULU has somewhat quietly graduated from a fashion cult brand to a scaled, mainstream brand than looking at some of its numbers in comparison with Nike (Ticker: NKE). During 2013-2018 period, LULU's revenue and gross profit was consistently Mid to high single digit as % of Nike's revenue and gross profit. Since LULU has higher operating margin than NKE, operating profit was low double digit to mid-teen as % of NKE's operating profit. Then something changed in 2020! LULU has been on a tear for the last four years since the pandemic. Last year, LULU was almost \~20% of NKE's sales, \~25% of NKE's Gross Profit, and a whopping \~37% of NKE's EBIT. Given their financial years are different from each other, this isn't quite apple-to-apple, but even when we look at the last three years aggregate numbers, it still sort of depicts similar picture. During 2021-2023, NKE generated \~$64 Bn aggregate gross profit. LULU posted $13.7 Bn or 21.5% of NKE's. During this period, NKE generated \~$20 Bn aggregate operating profit whereas LULU posted $5.3 Bn or \~27% of NKE's. You may find this surprising but LULU generated these numbers by spending **\~10% of what NKE spends on advertising**! I'm not going to delve deep into why/how LULU can pull off such a thing and I encourage you to read my initial [Deep Dive](https://www.mbi-deepdives.com/lulu/) where I did explore exactly that. LULU's performance in the last 3-4 years is nothing short of staggering and looking at a massive, global brand such as NKE for comparison really highlights their height of success. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-1.png) Source: Tikr, MBI Deep Dives What surprises me is that despite such a staggering success especially compared to NKE, LULU actually trades at **lower** NTM EV/EBIT multiple today. In fact, it is hardly an anomaly. Historically, NKE often traded at higher multiples than LULU, implying that investors have nurtured a persistent skepticism about LULU's durability and brand power, especially compared to brands such as NKE. Let me explain why I don't share such skepticism and I, in fact, believe LULU should trade at higher multiple than NKE. ![chart](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/data-src-image-ea79ac18-a8ae-4167-9f95-a3a8c1009036.png) Source: KoyFin (MBI Deep Dives readers get 20% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) Back in 2020, [Gavin Baker](https://twitter.com/GavinSBaker?ref=mbi-deepdives.com) wrote a really insightful [piece](https://gavin-baker.medium.com/why-category-leading-brick-and-mortar-retailers-are-likely-the-biggest-long-term-covid-d70b8dfadc20?ref=mbi-deepdives.com) titled *"Why category leading brick and mortar retailers are likely the biggest long term Covid beneficiaries."* Let me share some relevant excerpts here: *"Many of the perceived Covid winners such as e-commerce, videogame and streaming media companies have simply been pulled a few years forward into a future that was inevitable. Their destiny did not change. The future for those businesses simply accelerated whereas the future for category leading “brick and mortar” retailers has changed dramatically as a result of Covid, more so than for any other business of which I can think.* *Said another way, long term steady state FCF will likely be the at the same level for many e-commerce, videogame and streaming media companies as it would have been before Covid. This is not to say that Covid did not increase their value; it did but primarily by pulling their financials forward a few years which obviously matters in a DCF. *Whereas long term steady state FCF will likely be significantly higher for category leading brick and mortar retailers who had reasonably strong e-commerce businesses coming into Covid. Especially so for those category leading retailers who operate in inflationary categories where inventory turns are less important than they are in deflationary categories where e-commerce only companies have structural cost advantages due to faster inventory turns.** *The future was always going to be omnichannel. Pundits have been prematurely predicting this for many years, but it is finally happening.* *Brick and mortar stores have tremendous online value in addition to enabling true omnichannel commerce. Nothing matters more for an e-commerce company than marketing efficiency expressed either as gross margin $ payback period or the ratio of CAC to LTV. Brick and mortar stores significantly lower online CAC by improving marketing efficiency (higher click through rates, higher quality scores for ads). Consumers are more likely to trust a brand they have seen in the real world. Ironic in a world where “CAC is the new rent” that one of the best ways to lower your online rent, i.e. CAC, is to pay rent offline for physical stores. Brick and mortar stores also enable BOPIS (buy online pickup in store) and the in-store return of items purchased online, which consumers value. Economically, BOPIS will always be cheaper than same day delivery and large numbers of consumers are highly cost sensitive*." While Baker didn't mention LULU in his piece, there are hardly better companies that fit and proved this thesis. Like many e-commerce companies, LULU, who already had a pretty decent omnichannel offering to their customers even before the pandemic, had a meteoric growth (\~42%) in 2021\. I'm not sure there are too many e-commerce companies which managed to then grow at \~30% in 2022 and \~20% in 2023\. Remember, this used to be mid-teen to low 20s topline grower before the pandemic. LULU's vertical integration (and hence control over the brand) and direct relationship with its customers by executing a seamless omnichannel experience likely perhaps created a durable change in competitive dynamics. Every person I discuss LULU with (the stock) never forgets to mention the threat from up and coming brands such as Alo, Vuori etc. but I think they fundamentally underestimate and underappreciate that LULU's brand has likely found an escape velocity in the last few years. While those up and coming brands can enjoy some success in their niche, it may require a shocking mismanagement from LULU's management to fumble the structural CAC advantage they now currently enjoy. To be clear, LULU used to be terribly managed business in much of the 2010s; even that wasn't enough to deteriorate the brand too much, implying the strength of the brand in the first place. The current management, led by Calvin McDonald, really deserves some high praise for what they accomplished in the last few years (despite their hiccup with Mirror acquisition). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2024/04/image-2.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Now that the stock trades at \~18-19x EBIT, we don't have to underwrite heroic assumptions to get to pretty decent returns. LULU's current operating margin is \~23% which seems already quite optimized, so margin upside is rather limited or non-existent. But I think it's quite likely that their topline continues to grow at HSD to low double digits in the next 3-5 years, mirroring the potential IRR from current stock price (assuming no multiple compression/expansion which is likely a fair assumption). The stock recently has gone down \~25% YTD as the management guided low double digit topline growth in 2024; investors were perhaps getting too accustomed to \~20% growth in the last few years. After such a meteoric growth in 2021-23, it is not surprising to me at all that LULU may need bit of a digestion period to grow at a more sustainable pace. HSD to low double digit topline growth seems very much achievable for the next 3-5 years and therefore, I started a new position in the stock. Speaking of new position, I also bought XPEL yesterday. I haven't published a Deep Dive on XPEL yet and I may not publish anything on XPEL in 2024 (highly likely I will do so in 2025). If you're interested in understanding more about XPEL, I suggest you read yesterday's piece by [Scuttleblurb](https://scuttleblurb.substack.com/p/xpel-xpel-inc?ref=mbi-deepdives.com). Thanks for reading. I will come back with the TXN Deep Dive later this month. [Subscribe](#/portal/signup) ### Semiconductors: "To see a World in a Grain of Sand" URL: https://www.mbi-deepdives.com/semiconductors-to-see-a-world-in-a-grain-of-sand/ Last updated: 2024-03-25T13:30:31.000Z _This post is for paying subscribers only._ ### Dollar General 4Q'23 Update URL: https://www.mbi-deepdives.com/dg4q23/ Last updated: 2024-03-14T20:38:28.000Z *Disclosure: I own shares of Dollar General* Dollar General (DG)’s stock had an interesting reaction to today’s earnings. First it went up by \~6% in pre-market, but then ended the day 5% down. Despite the somewhat bizarre stock price reaction throughout the day, I think the worst days are likely behind DG. Here are some highlights from today’s call. [Subscribe](#/portal/signup) **Same Store Sales (SSS)** After two quarters of negative SSS growth, DG returned to positive SSS (+0.7%) in 4Q’23 which helped eke out +0.2% SSS growth for FY’23\. More importantly, SSS was driven by +4% customer traffic growth which sequentially improved each month of the quarter (and traffic improvement is persisting in current quarter as well). This was offset by a decline in avg. transaction amount, primarily driven by fewer items per basket. Improving customer traffic trend is quite encouraging as I was always more worried about traffic vs transaction amount growth. Interestingly, DG mentioned they’re seeing some trade down which made me wonder whether the overall consumer may be weaker than it generally appears or it is more of a reflection of DG’s operational improvement that lured some of those customers back: “*what we're starting to see is -- and gives us confidence is that for the first time in many quarters, we're starting to see the trade down come back in. And we hadn't seen that for a few quarters.*” SSS increase was driven entirely by consumable category and was partially offset by declines in the home, seasonal and apparel categories. So, customers seem to be more cautious in their discretionary expenditures. More importantly, after four consecutive quarters DG has finally posted a better SSS comp than Family Dollar (FDO) which is their closest competitor. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd8211bce-a512-4bce-b2bb-161d35c7614e_1230x808.png) **Gross Margin** While gross margin declined by 138 bps YoY, it continued to fare much better compared to FDO. Why did DG’s gross margin fall? > This decrease was primarily attributable to increases in shrink and markdowns, lower inventory markups and a greater proportion of sales coming from the consumables category. These were partially offset by decreases in LIFO and transportation costs. Notably, year-over-year shrink headwinds continued to build during the year, increasing more than 100 basis points for both the fourth quarter and full year. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2d358527-9cff-404f-ae32-20fc39491aaa_1123x733.png) **Operating margin** It appears operating margin has bottomed for DG in 3Q’23 and it came back to close to \~6% in 4Q’23\. There is still a long way to go back to \~8-10% operating margin that DG used to post during much of the 2017-2022 period. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8b25d95d-b464-4de4-a788-5863e803b35b_1126x747.png) **Inventory** Inventories stood $7 Bn in 2023, +3.5% YoY but a decline of 1.1% on a per store basis. Non-consumables inventory was -17% YoY and -21% on per store basis. There’s still plenty of room for improvement here as inventory turnover came down to 3.9x in 2023 (vs 4.2x in 2022 and 4.4x in 2019). **Store expansion** DG guided 800 new stores expansion (Including 30 popshelf and 15 stores in Mexico) in 2024 which will be the lowest since 2015. In 2024, DG will also remodel 1500 stores (vs 2,007 stores in 2023) and relocate 85 stores (vs 129 stores in 2023). DG also mentioned they now have fresh produce in 5,400 stores and will target additional 1,500 stores for fresh produce in 2024. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2deea2bd-ced9-481c-9470-15250657c57a_631x379.png) **Outlook** Here’s DG’s outlook for 2024: > we expect the following for 2024: net sales growth in the range of approximately 6% to 6.7%, same-store sales growth in the range of 2% to 2.7% and an EPS in the range of $6.80 to $7.55\. We currently anticipate an estimated negative impact to EPS of approximately $0.50 due to higher incentive compensation expense. Our EPS guidance assumes an effective tax rate in the range of 22.5% to 23.5%. I’m encouraged to see a return of somewhat healthy SSS growth outlook for 2024\. As you can see below, except for pandemic induced demand in 2020, SSS was consistently hovering around \~2.5%+ during the pre-pandemic period. Following last year’s operational haphazardness which led to management changes, there was certainly a question mark whether DG’s model is indeed broken. If DG returns to it’s \~3% SSS growth, the next beast they need to slay to calm investors is operating margin. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5222a5cb-2836-4a85-8ba4-a09480939e74_997x541.png) 2024 outlook still implies an operating margin closer to \~6% which is long way from DG’s operating margins during the pre-pandemic period. Of course, I don’t expect DG to return to such operating margin level quickly, but a somewhat consistent improvement throughout 2024 should lead us to a clearer pathway to get closer to \~8% operating margin sometime in 2025-26. When DG was trading near $100 in September 2023, the primary question investors needed to get comfortable with to invest in DG is whether DG’s retail model is durable. As DG is about to embark on their 85th year of operation with store locations within 5 miles of approximately 75% of the U.S. population, I was always confident that the answer to that question is highly likely to be yes as their core value proposition of convenience has lasted the test of time. Now that the stock price is at $150, we need to answer an additional question: when (if ever) can DG go back to its historical operating margin? I’m optimistic that over time, DG can get closer to the historical average operating margin. Admittedly, it is a slightly harder question than the first one, but I’m happy to be patient here. **Further reading**: My [Deep Dive](https://www.mbi-deepdives.com/dg/) on DG (August, 2023) Thank you for reading. ### March, 2024 Update URL: https://www.mbi-deepdives.com/mar24/ Last updated: 2024-03-01T15:21:01.000Z After publishing my Deep Dive on [AppFolio](https://www.mbi-deepdives.com/appf/), I have started studying the semiconductor industry. It didn't take me too long to understand that this is one of the more challenging areas for a generalist like me to get up to speed quickly. As a result, I have decided to take this month just to study the overall industry-the basics, the historical background of the industry, and the overall semiconductor value chain. Given that context, instead of publishing a Deep Dive on a company, I would like to publish a **Primer on Semiconductor** later this month (tentative date: March 26, 2024) . Even with ten days of study, I can already sense that generalists like me cannot hide away from semiconductor for too long. While in the past one could perhaps own many of the big tech companies without understanding semiconductor, it does seem that those days are perhaps already behind us. Following the Primer, I would like to do a couple of company Deep Dives on Semiconductor industry. They are most likely going to be **Texas Instruments** (April, 2024), and **TSM** (May, 2024). I plan on doing a few non-tech Deep Dives after that and then eventually come back to semiconductor again in the latter half of the year when I would like to cover **Nvidia** and **AMD**. Even beyond 2024, I expect myself to cover 2-4 companies per year from semiconductor industry in the next 3-5 years. If you are a new subscriber, I just want to highlight that you can access all the past 44 Deep Dives, including their financial models, [**here**](https://www.mbi-deepdives.com/models/)**.** Thanks to your support, I can afford to take the time to study anything I want. I appreciate it so very much! [Subscribe](#/portal/signup) ### AppFolio: Moving Up Market in Property Management Software URL: https://www.mbi-deepdives.com/appf/ Last updated: 2024-12-23T15:03:03.000Z _This post is for paying subscribers only._ ### Spotify 4Q'23 Update URL: https://www.mbi-deepdives.com/spot4q23/ Last updated: 2024-02-07T03:55:59.000Z While not exactly Meta-like twists and turns, Spotify’s rise from the ashes of late 2022 perhaps slipped through many investors’ mind. The stock was at \~$70 in December, 2022\. Today, it closed at $232. Before I get to my highlights from today’s call, let me first mention that I am no longer a shareholder of Spotify as I sold my shares today at $243\. I will briefly discuss my rationale after discussing the highlights from the call. [Subscribe](#/portal/signup) ![chart](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd3e2a86a-dbfc-43b6-9d4b-fb3031a71414_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 15% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) **Users** This was another strong quarter in both premium subscribers and Monthly Active Users (MAU). Spotify’s MAU momentum over the last 5-6 quarters truly defied my expectations. However, premium subscriber as % of MAU declined from \~44% in 4Q’21 to \~39% in 4Q’23\. Spotify again reiterated that they continue to believe that a strong top of the funnel will eventually lead to upgrade to premium subscription, but considering premium mix as % of MAU has declined for six consecutive quarters may hint that Rest of the World (RoW) from where much of the MAU growth is coming from is a structurally different market; premium penetration in RoW may be structurally lower compared to other regions. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F72bf1d40-158a-493e-a99c-3714f75c8708_1812x157.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Netflix vs Spotify** This is something I track every quarter. Netflix has almost entirely eliminated the gap with Spotify in terms of subscriber growth that persisted for the last 12 quarters. I should mention that definition of subscriber of NFLX and SPOT is not apple-to-apple, so I would caution not to infer more than what this data can tell us. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F602dc015-e108-4bfe-8e76-b6daf9889183_838x544.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Revenue** 4Q’23 enjoyed the full benefit of price increases which helped drive 16.7% growth in premium subscription revenue. While overall reported revenue growth was 16.0%, it was +20% FXN, which was \~300 bps QoQ acceleration. Please note that FXN revenue growth in 3Q’23 also had 300 bps QoQ acceleration. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F96cccdaf-ebfe-4502-956d-c6b05ce8e4df_1519x240.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Podcast** Spotify has been shifting its podcast strategy for the last few quarters; they have clarified their changing strategy during this call: > …we're in a very different position than we were just a few years ago in podcasting because today, Spotify is, in many cases, the #1 podcasting player already. > > …so exclusivity makes sense when you're the smaller playing trying to gain scale. When you're the bigger player, the additional value of the exclusivity is far smaller than it is about being aligned. > > …while exclusivities were net positive on the side, it's not driving as much as the opportunity that we see on the ad side. And so by broadening distribution, we think we can accomplish a number of different goals. Most notable among them, we are going to be more aligned with the creator. The creator obviously wants to be on many different platforms and wants to have as big of an audience as possible. Although Spotify guided last quarter that podcast may reach breakeven for 2024, they were already close to breakeven in 4Q’23 and now guided for full-year profitability on podcasting in 2024. **Audiobook** Some interesting details on recently launched audiobook segment: > Data shows that our entry into this market has dramatically accelerated its overall growth. **In Q4, we became the #2 provider of audio books behind Audible**, which is notable given how entrenched the legacy players are. > > …the biggest surprise has been the type of titles that resonate with consumers. These are not the normal titles that traditionally does well, that do well on Spotify, and that's pleasing to see because **that means we're bringing a whole new audience to audio books**, the format, which is great to see. **Apple** While many had high hopes that EU’s clamp down on iOS ecosystem may lead to some reprieve for a company such as Spotify, we now know Apple seems to be one step ahead of the regulators to kill those hopes. The deadline to be compliant with Digital Markets Act (DMA) in March 07, so EU regulators may still outmaneuver Apple’s tactics. If they do, Spotify did outline the benefits that may accrue to them: > …a la carte purchases, things like superfan things like purchasing of audio books, top-up things **that could be quite meaningful for Spotify's revenues is a significant hindrance today because Apple insists on taking a 30% cut, which in many cases, exceeds even our own cuts that we're able to take inside of the app**. So some of these more innovative things that we would like to do, we are currently restricted in doing on the iOS ecosystem, which limits some of that more innovative things that we would like to do. **Gross margin (GM)** Overall reported GM was +26.7%. Music GM was +29.1% (same as 3Q’23). GM in ads was 11.6% (vs 8.3% in 3Q’23). Expect GM improvement to continue in 2024: > As you look into 2024, we expect to see a continued improvement in our gross margin trends and a continued improvement in our operating income trends as well. > > when you think about the improvements and gross margin moving to 2024, marketplace will be a key contributor, again, along with the podcasting flip and some of the other costs of revenue. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F797bddb2-d3e7-4e11-a00b-6fde8267dd33_874x522.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Opex** Spotify had EUR 143 Mn charges for “efficiency” actions aka mostly layoffs. Excluding this charge, Spotify posted EUR 68 Mn operating profit which was more than double of 3Q’23 operating profit. SBC went down from EUR 100 mn in 4Q’22 to EUR 34 Mn 4Q’23!! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9eb565a3-708a-40a5-ae27-806804833f1f_1813x190.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook for 1Q'24** Perhaps even more importantly, Spotify surprised with \~5% operating margin guide in 1Q’24\. Moreover, they indicated that both gross and operating margin will likely keep improving throughout the year. That is going to be quite the turnaround from 2022 when they posted -5.5% operating margin. Basically, Spotify is now expected to improve operating margins by more than 1,000 bps (no typo) in just two short years. Perhaps rising interest rates and/or a threat of recession isn’t necessarily a bad thing if that’s what it takes for some of these tech companies to wake up and run the business properly. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0a1c6ff9-cc7d-409a-8c40-45011c35c9d7_1276x447.png) Source: Company Filings **Why I sold Spotify** I first [bought](https://www.mbi-deepdives.com/spot/) Spotify in December, 2021 at \~$240\. By the end of 2022, I identified buying Spotify as a [mistake](https://www.mbi-deepdives.com/2022/) mostly due to my naivete around their ads business. However, while I was admitting my mistake on the ads business, especially podcast business to myself, bears were essentially doubting whether Spotify is even a real business when the stock was trading at below $100\. Since I strongly disagreed with such sentiment, I averaged down and my average cost was $115\. Unfortunately, I found it quite hard to hold onto my shares in Spotify and started trimming from $140 and sold whatever I had left today. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7a90f0f0-08fd-4cd3-89ae-2c7010d1fa03_1087x667.png) Source: MBI Deep Dives Why was it much harder to hold Spotify? As I was introspecting about it, I could find at least four reasons: a) It is simply hard to hold onto unprofitable companies. When profits are just figment of your imagination i.e. forecasts in the future instead of reality of today, I suspect it is psychologically more challenging to hold onto such stocks, especially for a company that hardly ever made money despite being founded in 2006\. b) While many bears assume Spotify’s core music business as just a commoditized and easily substitutable product, actual users vote differently by having much higher engagement and lower churn compared to other music streaming alternatives. However, as it’s often the case for most bull/bear cases, there is a point/valuation at which bears (or bulls) argument can start to make a bit more sense. For example, while I consider it unlikely that Amazon or Google will snatch any noticeable percentage of subscribers away from Spotify, I also don’t think it is likely that Amazon or Google will ever leave this business. I don’t agree with bears when they say Google/Amazon/Apple want to subsidize losses here and make money through other parts of their respective ecosystem, there is, however, some ounce of truth that their presence is a hindrance for Spotify’s long-term ability to exercise pricing power. By 2030, we will almost certainly reach saturation across the world in music streaming and hence the ability to raise price may become the primary driver of revenue growth in music streaming. The broader point I am trying to drive here is Spotify’s moats, although not as fragile as bears may think, are not quite as strong as most of my portfolio holdings. c) In retrospect, while $140 may have been too early for me to trim, I didn’t quite envision how quickly they were able to dial up their efficiency button. However, at $240, the stock has somewhat steep expectation embedded in. After today’s earnings, I updated some of my numbers, and I could get to EUR 3-3.5 Bn EBIT (assuming \~8-10% EBIT margin) in 2030 (vs EUR 3.4 Bn **Gross Profit** in 2023). If you take EUR 3.2 Bn EBIT in 2030, I would still need to assume \~25x EBIT multiple in 2030 to get to \~9-10% IRR. \~25x EBIT may be okay for a business that has pretty robust moats with continued pathway for growth. I wasn’t confident Spotify will fit that description in 2030. d) Finally, I think I was a bit jumpy in selling Spotify because of what I own in my portfolio. With a significant exposure in tech and a fresh memory of what that led to in 2022 made me perhaps too eager to lighten my exposure to tech as these stocks just kept rallying. And most of the time when I was looking for trimming my exposure to tech, Spotify seemed a better candidate than other tech companies I own in my [portfolio](https://www.mbi-deepdives.com/portfolio/). Since I sold the stock, I am closing my coverage of Spotify for now, but if there is significant upside/downside volatility from here, I may come back to infer the right lessons in the future. While I have you here, I would like to let you know I am currently working on AppFolio (ticker: **APPF**) for this month’s Deep Dive. I hope to publish by 22nd of this month. Thank you for reading. [Subscribe](#/portal/signup) ### Amazon: Model Update (2024) URL: https://www.mbi-deepdives.com/amzn2024/ Last updated: 2024-02-06T18:11:57.000Z _This post is for paying subscribers only._ ### Meta Platforms: Model Update URL: https://www.mbi-deepdives.com/meta2024/ Last updated: 2024-02-05T16:53:06.000Z *Disclosure: I own shares of Meta Platforms* So I took this weekend to update my models on Meta and Amazon. I just wanted to leave some brisk thoughts on these updated models. I will start with Meta today and will share my thoughts on Amazon tomorrow. You can find the updated model on Meta [here](https://www.mbi-deepdives.com/models/) which I encourage you to download to play around with your own narrative as you see fit. Let’s start with the frustrating bit: Reality Labs (RL). # **Reality Labs (RL)** **Revenue Model** Since I just mentioned this is going to be brisk, I am going to assume you have read/followed my [earlier piece](https://www.mbi-deepdives.com/meta2023/) on Meta in which I went to a much greater length in explaining the thought process behind the structure of the model. For Reality Labs model, I have segmented revenue build in two categories: a) Virtual Reality (VR), and b) Augmented Reality (AR). Of course, it is nearly impossible to model Reality Labs revenues long-term given how speculative this segment still is and how spotty the adoption has been so far, so take these numbers with a grain of salt. With Quest launch in late 2023, buzz from Apple Vision Pro, and Meta’s expected launch of [Quest 3 Lite](https://www.uploadvr.com/chinese-analyst-quest-3-lite/?ref=mbi-deepdives.com) in 1H’24, I am modeling an uptick in hardware sales units for VR in 2024 and 2025\. Beyond that is just a pure guessing game. AR glasses is also just as hard to forecast. As Meta mentioned in 4Q’23 call, the new Meta Ray-Ban Smart glasses have been selling well, have seen higher retention than the last version, and with multi-modal AI assistant expected to be active on these glasses soon, I have modeled some momentum in the next couple of years in unit sales. AR glasses are the primary form factor through which Meta wants to put a dent on the dominance of smartphones, and there is an expectation that we may get to see a more tangible glimpses of such consumer ready AR glasses in 2027\. My model assumes lower price per unit than what you see in retail price because I am implying Luxxottica keeps \~50% of the hardware revenue. While there is perhaps a 90% probability of this being “garbage-in-garbage-out” revenue model, it’s the thinking process that counts which we will need to update as we get closer to understanding the adoption rate of such hardware among consumers. Don’t pay too much attention to the revenue/gross profit numbers because I am not modeling Reality Labs to reach anywhere close to profitability even by 2030. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fcd50b566-bbdd-48bb-baf2-a5ce90f39bd8_909x942.png) Source: Company Filings, MBI Deep Dives **RL Opex** Looking at Reality Labs numbers is really not for the faint hearted. While things may change in the future, so far this meme probably depicts the reality of Reality Labs aptly! ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdc3e5a8d-6ea0-46fe-aeba-9b6cdda7b8a9_830x500.jpeg) It was disappointing to see Meta mentioning once again that losses will increase **“meaningfully”** in 2024 despite losing \~$16 Bn in 2023\. What does “meaningfully” mean for 2024? I suspect the answer is closer to $20 Bn. Given how Meta has navigated RL in the last few years, I no longer feel comfortable in assuming RL losses will peak anytime soon. I have modeled continued increase in losses until 2028 when the losses are assumed to have peaked. Nonetheless, even 2030 losses is modeled to be \~$20 Bn. Am I being too pessimistic? Meta bulls would probably think so, but wouldn’t investors be somewhat incredulous as well if someone told them in 2019 that Meta is going to spend $60 Bn aggregate opex against aggregate revenue of mere $8 Bn in 2019-2023 period. I bet you would think that’s overly pessimistic, and yet that’s what Meta spent over the last 5 years with continued guidance for more losses in RL. Looking at these numbers, I have come to the sobering conclusion that there is perhaps less than 1% probability for Meta to generate \~10% IRR on their investments in RL. The only way it may make sense to invest as aggressively as they did/do is to assume the bet on RL is far from “other bets”, and it is very much a core bet that is required to protect and even grow Family of Apps (FOA) business for decades to come once they truly can control their destiny on the next platform shift. Anytime you read how Meta has “pivoted” from Metaverse to AI, remember these losses! As shareholders, it is perhaps not unfair to expect some guidance from management when we can expect RL losses to peak. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F71f750e2-d6ea-4c7e-84eb-56fc1be3cdb6_906x381.png) Source: Company Filings, MBI Deep Dives # Family of Apps (FOA) Users: This is all self-explanatory. Just take a peek at the numbers and assumptions going forward. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3f6733b9-e5eb-4711-aa07-ab1022f162f3_1345x690.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **FOA revenue model** As FOA has regained much of the signal losses from ATT, Meta’s monetization has improved a lot. Since the economy is expected to fare fine and thanks to the continued rollout of Advantage+ and Shop Ads (which quickly became $2 Bn run-rate business after launching just in the US in 2Q’23), I am modeling ARPU momentum to continue in 2024\. Beyond 2024, I am modeling closer to MSD type ARPU growth in 2025-2028 in the US and then reach closer to nominal GDP growth by 2030\. International ARPU growth is modeled to outpace North America. Other revenue, which is largely revenue from WhatsApp business platform, is modeled to grow ARPU at a rapid pace throughout this decade. Because we are still in the early stage of WhatsApp Business monetization, despite such seemingly aggressive assumption, I end up with only \~$1.4 ARPU (worldwide) in 2030\. There is perhaps a non-negligible probability that this number may be substantially higher than I am modeling, especially if SMBs utilize WhatsApp and AI assistants to chat with customers for customer service, repeat purchases etc. It’s hard to underwrite these numbers with higher conviction until the numbers continue to show up quarter after quarter since WhatsApp monetization has been dreamed by investors for a number of years without seeing a lot of tangible evidence to it in financials. Recent numbers hint that it may be changing, but I will wait before underwriting even more optimistic scenarios. I should note that my numbers are slightly conservative than street estimates and likely more conservative than buy-side estimates. I am perhaps a bit more concerned about the tough comp in 2H’24, but it is possible that I may be underestimating the multiple tailwinds (Shop ads, Advantage+, ever improving ad infra post-ATT etc.) especially if the economy continues to grow at a healthy pace. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9c68c9c2-4581-4497-bbdd-f70f1371278a_1297x535.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **FOA Opex** My Opex model below is also self-explanatory. What I would like to highlight is I do suspect most investors are too eager to model the low end of the opex guide for 2024 ($94-99 Bn) whereas I wonder whether the [prior trend](https://www.mbi-deepdives.com/meta4q23/) of guiding higher opex and then lowering opex almost every quarter throughout the year still holds under Susan Li as reliably as did under David Wehner. If RL losses are indeed going to be \~$20 Bn in 2024, I think there’s a decent probability of total opex to reach closer to $99 Bn rather than $94 Bn. While consensus opex estimates seem to be \~$98 Bn, I have been hearing estimates closer to $94 Bn from some of my buy-side friends which I find to be a tad bit aggressive. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7c281648-e7d6-4c94-932f-d43c983415fd_1296x846.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **MBI vs Consensus** Thanks to slightly higher opex and lower revenue than consensus estimates, my operating profit lags the street estimates for this year and continues to trail behind street estimates in out years as well. What if I am closer to the reality than sell/buy-side estimates for Meta in 2024 (and beyond)? While missing estimates may be a terrible news for many investors, I am not sure it should necessarily concern “actual” shareholders of the business since estimates is just one side of the equation, we also need to take a look at valuation multiples. Ultimately, in the near-term (\~1 year), it’s the entry and exit multiple that **often** play a larger role in your return (note: what we have seen in Meta’s stock in the last 12-18 months is highly unusual; it’s **not** the norm), and forecasting multiple expansion/contraction within the next year or so is usually above anyone’s paygrade. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F02409118-1b6f-4ede-a71c-ac351fb676a3_924x498.png) Source: Tikr, MBI Deep Dives **Capex** Before I touch on implied valuation multiples, let me quickly note that I am also modeling capex closer to the high end of Meta’s capex guidance for 2024 (guide: $30-37 Bn). Beyond 2024, I am modeling capex to be persistently above $30 Bn as it may be likely that we are closer to either beginning or mid cycle of AI-related infrastructure investments than to the end of it. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa5744ec6-e4ea-42bd-87da-eab653644682_1297x70.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Valuation** To generate \~10% IRR (remember, I’m doing reverse DCF to figure out what I need to believe to generate \~10% IRR), I need to assume \~20x terminal FCF multiple. Please note even the terminal FCF number **includes \~$20 Bn losses from RL segment**. While that may seem to be a draconian assumption and I tend to agree, Meta management has made my job increasingly difficult by continuing to increase losses “meaningfully” year after year without giving even a hint at how far we may be from RL losses peaking. Since there is every chance of AR/VR being a protracted race between Apple and Meta (and who knows who else if this is indeed the future of computing), it is hard to have high conviction on how the losses will evolve in RL. Nonetheless, capitalizing $20 Bn losses with \~20x multiple is effectively implying RL to be worth negative $400 Bn which obviously just sounds wrong, so perhaps bulls can make a rather convincing argument that the “real” terminal multiple is 2-4 turn lower than what you see here. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F36b5d71a-f508-4428-acd2-93cdd3e65eb4_885x300.png) Source: MBI Deep Dives # Closing Words Times have changed a bit; Mark Zuckerberg is now being widely lauded by investors for subscribing to the efficiency religion in operating the company and somehow growing the company faster despite laying off a quarter of the company. If you are not a new reader here, you may be aware that I rate Zuckerberg very highly. Yet, looking back in the last 7-8 years in big tech land, it may be sobering to see Zuckerberg’s company was worth so close to other big tech companies in 2016-17 period, and today those companies are worth $500 Bn to $2 Tn more than Meta is today. Even Nvidia joined this trillion dollar club almost out of nowhere and is even worth more than what Meta is today despite the +400% rally since October, 2022\. If Zuckerberg wants to position Meta near the top in this big tech club by 2030-35, he will have to allocate capital **much more prudently** than he did in the last 5-7 years. ![chart](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff262c9ea-6541-4318-8af5-0862bfca0265_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 15% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) Facebook turned 20 years yesterday; what a Harvard undergrad started as dorm room project turned into a more than a trillion dollar company. It is not lost on me what a downright remarkable achievement this is, but as a shareholder, I hope he continues to have a very high bar for himself for the next couple of decades. I have exercised my January 2025 $50 call options on Friday last week and converted the options to stocks. I did sell 10% of what I received after exercising the options and plan to keep the rest 90% for the time being since despite the dizzying rally in recent months, the stock still seems reasonably valued. I will upload an updated Amazon model and share my thoughts by **tomorrow**. ### Amazon 4Q'23 Update URL: https://www.mbi-deepdives.com/amzn4q23/ Last updated: 2024-02-02T15:45:11.000Z *Disclosure: I own Jan 2025 $55 Call Options of Amazon* While many investors remain obsessed with quarterly topline growth of AWS, the real story continues to be North America’s sustained margin recovery. Here’s my highlights from yesterday’s earnings. [Subscribe](#/portal/signup) **Revenue** 1P revenue grew HSD and Amazon’s revenue ex 1P increased by high-teens last quarter. Since I continue to rate Amazon retail to be relatively overlooked driver for Amazon, let me start with margin discussions on retail. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa735e452-dd7b-4d66-9b28-3718719c3821_1164x259.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** North America’s operating margin bottomed at -2.3% 1Q’22 and has since then increased by more than 800 bps to reach 6.1% in 4Q’23, just shy of the pre-pandemic high of 6.4% in 1Q’19. International margin bottomed at -8.9% in 3Q’22 and also experienced massive margin improvement to reach -1.0% in 4Q’23 although here margin deteriorated a bit QoQ. Amazon tried to reassure that things are on track in international segment: > The International segment represents more than 20 countries of varying degrees of growth. In our largest established countries like the U.K., Germany and Japan, relatively strong revenue growth contributed to the year-over-year improvement in profitability. Additionally, we saw good progress in our emerging countries as they continue to expand their customer offerings while seeking to invest wisely. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd0225eca-5756-49aa-a902-4641a4f4b601_1117x678.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Fulfillment+ Shipping** Shipping+ fulfillment costs, and paid units both increased by \~12% in 4Q’23. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa7fb8169-0dd0-4975-95b9-d4ab05c91380_1372x594.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Shipping+ fulfillment cost as % of GMV continued to go in right direction. As % of estimated GMV, shipping+ fulfillment costs were 21.8% in 4Q’23 (vs 26.1% in 1Q’22). We are now lot closer to pre-pandemic level, but Amazon may still have a plenty of runway left for further improvement if you eye at 2016 when this number used to be below 17%. Again, let me contextualize why this is a huge deal for Amazon and its shareholders. I estimate Amazon’s GMV was \~$800 Bn in 2023 (defined as online sales+ (3P sales/25%). So every 100 bps improvement would add \~$8 Bn to Amazon’s bottom line. For the full-year, shipping+ fulfillment cost as % of GMV was 22.7%. If it were \~400 bps lower i.e. 18.7%, it would add \~$32 Bn to Amazon’s total operating profit which would almost double its actual reported profit of \~$37 Bn!! Of course, we cannot expect it to magically happen by next couple of quarters or even years, but this is indeed the most important thesis for Amazon in my opinion that will likely play over multiple years. To understand the valuation implications more clearly, I encourage you to play with my earlier shared Amazon model [**here**](https://www.mbi-deepdives.com/models/). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4bbb4c9f-482d-4971-a785-8a686e3d48d6_1473x748.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) During the call, management reiterated margin upside potential for retail in 2024: > we're seeing a reduction in some of the inflationary factors that hit us especially hard in 2021 and 2022, things like transportation services, fuel and others. So not totally out of the woods there but coming down, and we still see some more upside Jassy also shared quite a few encouraging data points which also made it tangible how hard it will be to compete against Amazon’s logistics: > In 2023, Amazon delivered to Prime members at the fastest speeds ever, with more than **7 billion items arriving same or next day, including more than 4 billion in the U.S. and more than 2 billion in Europe**. In the U.S., this result is the combination of two things. One is the benefit of regionalization where we rearchitected the network to store items closer to customers. The other is the expansion of same-day facilities where in the U.S. in the fourth quarter, **we increased the number of items delivered the same day or overnight by more than 65% year-over-year**. > > …In 2023, **for the first time since 2018, we reduced our cost to serve on a per unit basis globally**. **In the U.S. alone, cost to serve was down by more than $0.45 per unit compared to the prior year.** Lowering cost to serve allows us not only to invest in speed improvements but also afford adding more selection at lower average selling prices, or ASPs, and profitably. We have a saying that **it's not hard to lower prices, it's hard to be able to afford lowering prices. The same is true with adding selection. It's not hard to add lower ASP selection, it's hard to be able to afford offering lower ASP selection and still like the economics.** Like improving speed, adding selection puts us in the consideration set for more purchases. **Shopping Assistant** Amazon launched “Rufus” which is their shopping assistant. It increasingly seems clear to me that query share will continued to be fragmented in GenAI dominated apps and almost every consumer tech company understands and smells this opportunity. It remains to be seen how well this opportunity will be capitalized, but the near certainty of fragmentation of query shares, and the uncertainty around how all these eventually settle is what unsettled me enough to sell Google shares. We’ll see how that ages over time. Here’s more color from management what the assistant can do: > we launched Rufus, an expert shopping assistant trained on our product and customer data that represents a significant customer experience improvement for discovery. Rufus lets customers ask shopping journey questions, like what is the best golf ball to use for better spin control or which are the best cold weather rain jackets, and get thoughtful explanations for what matters and recommendations on products. You can carry on a conversation with Rufus on other related or unrelated questions and retains context coherently. You can sift through our rich product pages by asking Rufus questions on any product features and it will return answers quickly. We're at the start of what Rufus will do with further personalization and expansion coming, but we're excited about how it will make discovery even easier on Amazon. **AWS** AWS is now almost \~$100 Bn annualized revenue business. After five quarters of hiatus, AWS again added more than a billion QoQ revenue which Amazon claimed to be higher than other hyperscalers: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F31215264-b5b4-4663-94c9-f82b0b5a00fb_1027x535.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Now that we have all the hyperscalers reports, here’s their revenue growth trajectory: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd5e2f805-311c-4aac-8730-c8875551aa73_1185x759.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); \*Google Cloud includes Google Workpace, so not quite apple-to-apple and in reality, GCP likely grew faster than Google Cloud We knew GCP had a good quarter, but it does appear to be even better when you benchmark against AWS numbers. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F95875dc5-c174-4c0c-8f72-3fc9c2f73c4f_895x576.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4dd90376-515f-4912-9b9e-54597cb485bb_880x579.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Back to AWS. AWS incremental operating margin continued to be >60% and overall operating margin hovers around \~30%. The incremental margins across the big tech I covered clearly exhibited a ton of efficiency last couple of quarters! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa65c93b1-88e1-4e0d-94b3-5036a27ccc02_1321x118.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa565909b-8c17-4daa-b206-db3941e0c8ee_1264x658.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Some encouraging comments on AWS growth from the call: > Similar to what we shared last quarter, we **continue to see the diminishing impact of cost optimizations**. And as these optimizations slow down, we're seeing more companies turning their attention to newer initiatives and reaccelerating existing migrations. > > …We expect **accelerating** trends to continue into 2024. **Opex+Capex** Looking at cost structure, it’s tempting to see a lot more headroom for further efficiency, especially in sales & marketing. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2ab22a35-f107-4399-ae8b-c5ea42d2a4d7_2094x295.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) If 2023 was the “year of efficiency” in big tech land, 2024 may prove to be “year of capex”. Like Google and Meta, Amazon too indicated capex to increase due to their investments in AWS related infrastructure although they haven’t quantified the increase: > As we look forward to 2024, we anticipate CapEx to increase year-over-year primarily driven by increased infrastructure CapEx to support growth of our AWS business, including additional investments in generative AI and large language models. **Other Bets** We got an update on Kuiper: > In October, we had a major milestone in our journey to commercialize Project Kuiper, which is our low Earth orbit satellite initiative that aims to provide broadband connectivity to the 400 million to 500 million households who don't have it today. > > …We're on track to launch our first production satellite in the first half of 2024 and started beta testing in the second half of the year. **Outlook** Amazon’s guidance for 1Q’24 is below (please note they increased useful life from 5 to 6 years): ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6d386e33-e7cd-413e-952d-4e8b8d7c5c4d_1063x250.png) Source: Company Filings **Closing words** While there is a lot of positive you can take away from this report, I do want to reiterate that a lot of this is already priced into the stock. Amazon trades at \~35x NTM EV/EBIT multiple, so market clearly is paying dearly for the impending growth and margin expansion. We are, unfortunately, currently in a market in which we should perhaps lower our expected return. Please feel free to share with your friends and network. I will cover Spotify's earnings next week. Thank you for reading. [Subscribe](#/portal/signup) ### Meta 4Q'23 Update URL: https://www.mbi-deepdives.com/meta4q23/ Last updated: 2024-02-02T06:21:11.000Z *Disclosure: I own shares and 2025 January $50 Call Options of Meta* By 3Q’23 earnings, almost everyone understood Meta’s turnaround; the layoffs were behind us, topline growth was accelerating, and thanks to Meta’s “efficiency”, margins were expanding. Yet, the stock has gone up another **\~60%** since 3Q’23 earnings (including AH earnings reaction today). Despite being one of the big tech companies, the stock’s volatility in both directions has been nothing short of dizzying for investors. From \~75% drawdown in 2022 to \~+400% from the bottom in just 15 months, there was never quite a dull moment for Meta’s shareholders! Here are my highlights from tonight’s call. [Subscribe](#/portal/signup) **Users** Take a look at the Facebook’s DAU or MAU number for the last time because Meta will stop reporting them from next quarter. Investors usually assume the worst when any important KPI gets deprecated by the company. Thankfully, along with Family “Daily Active People” (DAP), Meta will report YoY changes in ad impressions and average price per ad by **region**. I suspect a granular region level data may prove to be more helpful for investors to gauge Family of App’s (FOA) health than what the deprecated data was providing us. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Faf753da2-e2df-4b4d-8f4f-6cdd1bca8701_1804x510.png) **Engagement** DAU/MAU engagement improved QoQ in every single region. Overall DAU/MAU ratio has been inching up for the last **eight** consecutive quarters. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fbbace8f7-4c27-4926-bdcb-d9bd6737ec11_1798x544.png) **ARPU** While ARPU exhibited considerable strength, please note the material weakness in YoY comparison and hence, 2-yr CAGR is likely better reflective of long-term trend. As you can see below, we have one more quarter of easy comp ahead of us after which growth may start to mirror closer to long-term trends. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9c1f76ee-8e99-44d0-95ae-1820861bd493_1654x181.png) Annual ARPU (calculated as ad revenue divided by FB MAU) in North America reached \~$220 in 2023 which is a staggering number. While that can also make investors nervous wondering how much larger it can possibly be, it does seem Meta’s ad infra continues to get better which is essential for further runway for ARPU: > Our approach to optimizing ad levels in our apps has become increasingly sophisticated over the years as we've **developed a better understanding of the optimal place, time and person to show an ad, which has enabled us to adopt a more dynamic approach to serving ads**. We expect to continue that work going forward, while services with relatively lower levels of monetization like video and messaging will serve as additional growth opportunities **Ad revenue** Number of ad impression grew by 21% YoY whereas average price per ad increased by 2% YoY, driven by “advertiser demand and currency tailwinds, which were partially offset by strong impression growth, particularly from lower-monetizing services and regions” . ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F611c9bfe-dff6-4c8f-80a9-3178c4c5686e_1113x553.png) China-based advertisers was 10% overall revenue for Meta in 2023 and contributed 5 percentage point of growth. After last quarter, investors started worrying about sustainability of this growth. While the stock price trajectory since then makes me think such concern has largely dissipated, I suspect it can come back at a moment’s notice anytime we start to see softness from these China-based advertisers. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1a0ccdb9-b4cf-4c29-bde8-4ca963865f52_1638x576.png) **Segment Reporting** Overall 4Q’23 revenue was +25% YoY(+22% FXN) whereas total expenses was -8% YoY. On a 2-yr CAGR basis, Meta’s topline increased by 9.1% in 4Q’23\. For context, Google Search revenue grew by 5.3% and Google advertising increased by 3.4% during the same time! FOA posted **\~80%** incremental operating margin in 4Q’23 vs 4Q’21 (just as it did for 3Q’23 vs 3Q’21). For the second consecutive quarters, FOA had >50% operating margin. This is damn impressive of course, but let me change gear a little. Looking at such margins, it reminded me about Zuck’s appearance at Senate hearing yesterday. While the hearing is bit of a circus, I cannot help but think a business with >50% operating margin **can, should, and must** do more than what Meta does today to protect their users from harm’s way. While this may depress near-term margins, it may be of paramount importance for long-term health of the business; in fact, it may further entrench these big tech’s moats even if it leads to lower margins in the near term. To be clear, unlike most people, I am [far from convinced](https://www.oii.ox.ac.uk/news-events/no-evidence-linking-facebook-adoption-and-negative-well-being-oxford-study/?ref=mbi-deepdives.com) that usage of social media is harming today’s teens, but I do think Meta may need to do more as society’s (and regulators) expectation from big tech [evolves](https://www.wsj.com/business/retail/amazon-could-soon-be-on-hook-for-safety-of-third-party-products-it-sells-and-ships-be58b697?ref=mbi-deepdives.com) as they get bigger and bigger. The increasing presence of [scammy ads](https://twitter.com/friedoystercult/status/1752518443071340856?ref=mbi-deepdives.com) has also been disappointing and concerning to see. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F021177c4-7542-42bf-a55d-81426243b616_1510x486.png) Okay, back to financials now. Other revenue, which includes “business messaging” from WhatsApp, stood out to me for its pace of growth. Although it’s a small base for now, it increased by 82% YoY (2-yr CAGR 47%) and will be interesting to see if the momentum persists in 2024. Reality Labs remains largely a cause of concern for investors. While it exceeded $1 Bn revenue for the first time, thanks to Quest 3 and Quest 2 sales during Christmas season, losses have no sign of peaking. In fact, Meta mentioned again for 2024, *“for Reality Labs, we expect operating losses to *increase meaningfully* year-over-year due to our ongoing product development efforts in AR/VR and our investments to further scale our ecosystem.”* I know some Meta bulls are tempted to look at FOA and try to imagine some SOTP by assigning Reality Labs valuation of zero. I strongly discourage you to do that as I think it should be clear by now that despite what you may have read about Meta “pivoting from Metaverse to AI”, that is pure fiction. Meta remains fully committed to AR/VR and with Apple’s entry to this space, it is fair to say Meta is going to compete and keep pace against a company that has >3x revenue with deep and entrenched benefits from Apple’s control of incumbent mobile computing. Only way I can see Meta to scale back materially is if Apple itself decides to exit the market if Vision Pro is a massive flop. That wouldn’t be my base case and I expect this to be protracted race between these two companies. In short, I would mostly just pay attention to Meta’s consolidated numbers. Let’s look at some interesting comments from the earnings call: **Reels** > We're seeing sustained growth in Reels and video overall as daily watch time across all video types **grew over 25% year-over-year in Q4** driven by ongoing ranking improvements. **Shop Ads** > Shops ads, we talked about the **$2 billion annual run rate in Q4** after we just **opened availability to all U.S. advertisers in Q2.** > > …eligible Shopify businesses can now onboard to shops on Facebook and Instagram very seamlessly. And we're making it easier for advertisers to turn their existing ads into shops ads. And we'll continue to **focus on deepening integrations with partners and leveraging AI to make shops ads even more performant**. **WhatsApp** WhatsApp Channels now has 500 Mn MAU. > WhatsApp is also doing very well. And the most exciting new trend here is that it is **succeeding more broadly in the United States**, where there's a real appetite for a private, secure and cross-platform messaging app that everyone can use. And given the strategic importance of the U.S. and its **outsized importance for revenue**, this is just a huge opportunity. **Threads** Threads now has 130 Mn MAU (vs 100 mn in 3Q’23). **Open Source** For the second consecutive quarters, Zuck tried to explain to investors why Meta is taking the open source route: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4b1fb682-a8af-44f2-99db-304ce223c429_1080x765.jpeg) One other thing that stood out to me from Zuck’s prepared remarks is Meta’s access to data regardless of how the GenAI related lawsuits will settle: > Now the next key part of our playbook is learning from unique data and feedback loops in our products. When people think about data, they typically think about the corpus that you might use to train a model upfront. And on Facebook and Instagram, there are hundreds of billions of publicly shared images and tens of billions of public videos, which we estimate is **greater than the common crawl data set**. And people share large numbers of public text posts and comments across our services as well. **AR/VR** > “our focus for this year is going to be on growing the mobile version of Horizon as well as the VR one.” I [love](https://twitter.com/borrowed%5Fideas/status/1725282443526082886?ref=mbi-deepdives.com) my Ray-Ban Meta smart glasses, and it seems even Meta was surprised by the demand: > Ray-Ban Meta smart glasses are also off to a **very strong start both in sales and engagement.** Our partner, EssilorLuxottica is already planning on making more than we both expected **due to high demand**. Engagement and retention are also **significantly higher** than the first version of the glasses. **Capital Allocation** Meta bought back $6.3 Bn last quarter ($20 Bn for the full year). What was perhaps bit of a surprise was Meta has initiated a dividend of $0.5/share. While headcount was down 22% YoY, Meta started hiring again as headcount increased by \~1k QoQ. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff4e6fee8-4549-4a26-b00d-0a406e6d34c4_1810x354.png) **Opex Guide** Meta kept opex guide unchanged: $94-99 Bn. Given historical trends, investors typically expect Meta to either lower the opex guide over time or be closer to the low end of the guide. I wonder if this assumption remains relevant under Susan Li. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa3a0ed14-c84d-4ac3-a018-02598dcb624d_1224x583.png) **Capex** Capex guide range was increased from $30-35 Bn to $30-37 Bn in 2024 > We expect growth will be driven by investments in servers, including both AI and non-AI hardware, and data centers as we ramp up construction on sites with our previously announced new data center architecture. Given how well their capex ramp turned out when it was quite controversial among investors, Zuck seemed emboldened by that experience which is quite understandable: > I recently shared that by the end of this year, we'll have about 350,000 H100s and including other GPUs, that will be around 600,000, H100 equivalents of compute. We're well positioned now **because of the lessons that we learned from Reels**. We initially underbuilt our GPU clusters for Reels. And when we were going through that, **I decided that we should build enough capacity to support both Reels and another Reels-sized AI service that we expected to emerge so we wouldn't be in that situation again**. > > And at the time, the decision was somewhat controversial, and we faced a lot of questions about CapEx spending, but I'm really glad that we did this. Now going forward, we think that training and operating future models will be even more compute-intensive. We don't have a clear expectation for exactly how much this will be yet, but **the trend has been that state-of-the-art large language models have been trained on roughly 10x the amount of compute each year**. > > And our training clusters are only part of our overall infrastructure, and the rest obviously isn't growing as quickly. But overall, we're playing to win here, and I expect us to continue investing aggressively in this area. In order to build the most advanced clusters, we're also designing novel data centers and designing our own custom silicon specialized for our workloads. In case you think Zuck has become atheist to the “efficiency” religion, he did have some reassuring words: > …we're in a place now where the business is performing well. And I think the obvious question would be, okay, well, given that, should we just invest a lot more in things? > > And the biggest thing that's holding me back from doing that is that at this point, I feel like **I've really come around to thinking that we operate better as a leaner company.** > > Even beyond 2024, my operating assumption is that we will also try to keep it relatively minimal because I think that -- until we reach a point where we're just really underwater on our ability to execute, **I kind of want to keep things lean because I think that's the right thing for us to do culturally**. > > …a big part of why I wanted to improve our profitability is to give ourselves the ability to go through what is a **somewhat unpredictable and volatile period over the next 5 or 10 years. There are different risk factors that are geopolitical or regulatory or different things, but also the technology landscape is somewhat unknown**. And we want the ability to be able to surge investment on things, like building out larger training clusters or just making different investments where that's necessary. > > …being a leaner company is helping us execute better and faster, and we will continue to carry these values forward as a ***permanent*** part of how we operate. **Regulation** Hard to know what to infer from the dizzying number of regulatory worries: > FTC is seeking to substantially modify our existing consent order and impose additional restrictions on our ability to operate. We are contesting this matter, but if we are unsuccessful, it would have an adverse impact on our business. **Outlook** 1Q’24 topline guide is $34.5-37 Bn (+25% YoY at mid-point). **Closing Words** So, what now? The stock has become \~5x in the last 16 months. Is there really much money left on the table here? The reality is I have been listening/reading “the easy money has been made on Meta” since it went from $90 to $150\. Having resisted such proclamations, I too have **finally** started to echo that easy money is likely indeed over. Frankly speaking, I do not see “easy money” anywhere in my portfolio or companies in my watchlist, and it is far from clear to me that Meta is any more “difficult money” than my other [portfolio holdings](https://www.mbi-deepdives.com/portfolio/). I will share more thoughts on how I am thinking about it in my monthly deep dives. My investment in Meta has been by far the most tumultuous one in my career even though it worked out more than fine **so far**. David Poppe’s (Giverny Capital Asset Management) recent letter had this interesting bit that really resonated with me which is perhaps also quite apt on my investment in Meta since 2018: > "The stock market is peculiar in its ability to deliver a satisfactory result over time in a manner that feels unsatisfying. It’s perhaps like a restaurant with amazing food and awful service. Or a slot machine in reverse: you mostly win and over time your wealth increases. But every so often you suffer a debilitating loss that causes real financial pain. On top of this, the losses generate headlines and the gains are often received skeptically" For more in-depth analysis on Meta Platforms, you can read my analysis [**here**](https://www.mbi-deepdives.com/meta2023/) (March, 2023). I will cover **Amazon** earnings **tomorrow**. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) ### Alphabet 4Q'23 Update URL: https://www.mbi-deepdives.com/goog4q23/ Last updated: 2024-01-31T02:58:10.000Z While I have [sold](https://twitter.com/borrowed%5Fideas/status/1732083595874009587?ref=mbi-deepdives.com) my shares in Alphabet last month, I remain a very curious observer. Here’s my highlights from today’s earnings. [Subscribe](#/portal/signup) **Revenue** While almost every single revenue segment grew by double digits, Google Network was down \~2% YoY and \~10% from 4Q’21\. The Network business may not be terribly important given it’s a relatively lower margin segment compared to Search, but it may be indicative of the general direction of where the open web is heading. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff8160733-6d54-4e32-9c84-afd03a5b1ebe_1693x358.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) As I have mentioned [before](https://www.mbi-deepdives.com/goog/), Google’s reliance on non-Google properties has declined consistently since its IPO 20 years ago; this trend has likely accelerated and likely will continue to do so in the age of GenAI. Is that bad news for Google? On one hand, you can argue that open web’s role has been diminished for years without making much of a dent on Google’s health. On the other hand, Dan Taylor, VP of Global Ads for Google, was quoted saying this on a WSJ [piece](https://www.wsj.com/articles/why-google-plays-down-its-ad-tech-business-but-is-determined-to-keep-it-11667292084?ref=mbi-deepdives.com) published in 2022: “*Without websites to be searchable and discoverable content, people would have less need for search engines like ours. In that way our interests are really aligned with supporting publishers through ads*.” It remains an open question in my mind to what extent Google can be insulated if open web becomes increasingly crippled. It would be clearly a terrible news if Google didn't own YouTube; perhaps Google’s YouTube acquisition will prove to be an even better masterstroke than it already is regarded in 5 years time! ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1b645189-3f6c-4468-a373-f17479e33aaf_1330x916.png) Image Source: [WSJ](https://www.wsj.com/articles/why-google-plays-down-its-ad-tech-business-but-is-determined-to-keep-it-11667292084?ref=mbi-deepdives.com) **EBIT** Google Services business maintained its mid-30s operating margin profile. The real surprise was Google Cloud which accelerated margin from just 3.2% in 3Q’23 to 9.4% in 4Q’23\. In just 16 quarters, Google Cloud’s margin improved from **negative 62% to +9.4%**!! ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F24dbc79c-e35d-43f2-acca-a7ffaa6c1618_949x544.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Google’s incremental margin also remained quite healthy at 54% in 4Q’23\. While corporate costs appear inflated, please note it includes restructuring costs of $1.2 Bn in 4Q’23 and $3.9 Bn in 2023. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc039ed64-fd48-4232-999c-3df6ed9ad3f4_1518x418.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Search** Search revenue growth YoY continued to accelerate. While GenAI bear case remains top of mind concern for Search among Google observers, the business seems to be cruising along so far. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1dc1b6d2-c44f-4ee1-8c1c-c58ade546551_822x508.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Some interesting comments on Search from the call: > We are already experimenting with Gemini in Search, where it's making our Search Generative Experience, or SGE, faster for users. We have seen a **40% reduction in latency** in English in the U.S. > We had particular **strength in retail in APAC**, a trend that began in the second quarter of 2023 and **continued through the end of the year**. **YouTube** Like Search, YouTube ads growth also accelerated this quarter. YouTube shorts is now viewed 70 Bn times daily (note, it’s the same data they shared [last quarter](https://mbideepdives.substack.com/p/alphabet-3q23-update?ref=mbi-deepdives.com)). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F094c61e6-2f13-4362-855a-773fe6da1af0_826x513.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Google Cloud** After disappointing investors last quarter, Google Cloud beat expectations (which was \~22%) this quarter. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8f6db618-8a0d-4b20-a441-3546024326f2_823x514.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) As I [noted](https://www.mbi-deepdives.com/goog/) before, Google Cloud’s revenue historically lagged AWS revenue by four years. Looking at how AWS performed in 2020-22 period, I think it is fair to assume Google Cloud will almost certainly **not** be able to maintain this historical trend in 2024-26 period. 2023 was also the first time Google Cloud’s incremental revenue $ growth was lower than it was the year before. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fde91f02c-80ea-4716-ad24-5c30319e75da_645x214.png) Source: Company Filings, MBI Deep Dives Some interesting comments on Google Cloud from the call: > Vertex AI has seen strong adoption with the API request increasing **nearly 6x from H1 to H2 last year.** > > …the cost optimizations in many parts are something we have **mostly worked through** **Google Other** Google Other is now categorized as “Google subscriptions, platforms, and devices”. Subscription revenue (YouTube Premium and Music, YouTube TV and Google One) is now $15 Bn revenue business, which has been \~5x since 2019. While this is quite impressive, please note the primary driver for subscription business is YouTube Premium and Music, both of which are likely lower gross margin business. Some interesting comments from the call: > Google One is growing very well, and we are just about to cross **100 million subscribers**. > > Play had solid growth again in the fourth quarter driven primarily by an **increase in the number of buyers**. In devices, we continue to make **sizable investments with increased emphasis on our Pixel family, particularly with AI-powered innovation** while driving further efficiencies across the portfolio. **Capital Allocation** Google posted $7.9 Bn FCF last quarter and bought back $16 Bn shares. Please note Google made a $10.5 Bn tax payment in October last year which affected their FCF for the quarter. Overall, they generated $69 Bn FCF in 2023 and repurchased $62 Bn shares. They still have $98 Bn net cash on balance sheet. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc8be5e26-2ac1-4af0-8936-d047f1daa738_649x499.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex and Opex** Google’s headcount was largely flat QoQ, but capex as % of revenue increased to 12.8% in 4Q’23 which was higher since 1Q’22\. This increased capex was “driven overwhelmingly by investment in technical infrastructure with the largest component for servers followed by data centers”. Google also indicated that 2024 capex will be “**notably larger**” than it was in 2023 which was \~$32 Bn. Management didn’t quite hint or clarify what is meant by “notably larger”, but I would guess around $40-44 Bn: > The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be **notably larger** than in 2023. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F169b7998-33c5-481d-8f02-71cdb655d081_1510x240.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** Google doesn’t provide guidance, but management did seem to hint at tougher comp ahead: > As we enter 2024 with advertising revenues of **more than $100 billion higher than 2019**, we remain focused on sustaining healthy growth on this larger base. While topline may face a tougher second half ahead of Google (and other big tech), Google can perhaps navigate that and grow earnings through a better operating discipline: > As we have repeatedly stressed, we remain committed to our framework to durably reengineer our cost base as we invest to support our growth priorities. Key contributors to **moderating our expense growth** include: first, product and process prioritization to ensure we have the right resources behind our most important opportunities and to reallocate resources where we can; second, organizational efficiency and structure. We're focused on **removing layers to simplify execution and drive velocity**. **Valuation** I share the following valuation framework every quarter. Market seems to be valuing Google Service business at \~15x EBIT and the Cloud business at \~8-10x revenue multiple. While Cloud or other segments can provide some downside protection for shareholders, Alphabet remains essentially a bet on Search and its ability to protect, sustain, and grow Search. That reality is unlikely to change anytime soon. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9db3f162-7596-4c0f-9f65-58728463d2cf_1824x376.png) Source: MBI Deep Dives I will cover earnings of **Meta Platforms** and **Amazon** on Thursday this week. Thank you for reading. [Subscribe](#/portal/signup) ### CoStar: The Art of Creating, Capturing, and Protecting Value URL: https://www.mbi-deepdives.com/csgp/ Last updated: 2024-01-23T15:31:22.000Z _This post is for paying subscribers only._ ### January, 2024 Update URL: https://www.mbi-deepdives.com/january-2024-update/ Last updated: 2024-01-04T16:51:07.000Z [Subscribe](#/portal/signup) Happy New year. Just a few quick updates to start 2024: 1. My next Deep Dive is on **CoStar Group** (Ticker: **CSGP**) which I hope to publish by January 23rd. Following CSGP, I plan on studying **AppFolio** (Ticker: **APPF**) in February. 2. Someone asked me about the mix of subscribers at MBI Deep Dives. I meant to include this chart on my [**Annual Letter**](https://www.mbi-deepdives.com/2023/), but forgot about it later. Approximately half of MBI Deep Dives subscribers is professional investors, and the other half is individual investors. ![Image](https://pbs.twimg.com/media/GCh7th_aQAAA9Ik?format=jpg&name=large) 1. Over the last few months, I have heard a specific feedback from a number of subscribers about navigation on my website. Some suggested whether I could make it easier for new subscribers to follow my portfolio changes in the past. For example, I published a Deep Dive on Adyen in May 2022, but only started buying the stock in August 2023\. For new readers, it was hard to figure out earlier why I changed my mind and which post to go to in order to understand the rationale for changing my mind on Adyen. The "[**Portfolio**](https://www.mbi-deepdives.com/portfolio/)" tab on the website will help you navigate that more easily now. This will allow you to also see my portfolio's evolution over time. 2. One other feedback that I have heard from multiple subscribers is many readers would like to receive more updated opinions on the companies that I have covered in the past. One of the features about my investing process at MBI Deep Dives is I am leaning more towards breadth than depth since as a generalist, a better breadth than specialists is how we mostly can add value. While I do keep my eyes on companies that I have covered in the past, it may impede the speed at which I increase my breadth if I go back to updating past coverage too frequently. But I do want to acknowledge that I would like to toggle between new and past coverage a bit more frequently than I have done so far. While there is no change in my process for 2024 and you can expect just 12 new Deep Dives in 2024, I plan on making some changes from 2025\. From 2025, I will do 11 new Deep Dives every year and choose to **update** coverage of **three** companies that I did since 2020\. I will see how it goes and perhaps in 2028-30, I may lean to update 6 companies and do 10 new Deep Dives per year. While these are not yet certain, I just want to convey to my readers how I am thinking about it. 3. Finally, if you are a new subscriber, I just want to highlight that you can access all the past 42 Deep Dives, including their financial models, [**here**](https://www.mbi-deepdives.com/models/). Thank you so much for your support. ### 2023 Annual Letter URL: https://www.mbi-deepdives.com/2023/ Last updated: 2025-08-04T17:02:11.000Z _This post is for paying subscribers only._ ### Floor & Decor: A Special Specialty Retailer URL: https://www.mbi-deepdives.com/fnd/ Last updated: 2023-12-29T13:42:39.000Z _This post is for paying subscribers only._ ### Dollar General 3Q'23 Update URL: https://www.mbi-deepdives.com/dg3q23/ Last updated: 2023-12-08T19:17:36.000Z *Disclosure: I own shares of Dollar General* While Dollar General’s (DG) stock rallied +30% over the last two months (still down \~15% pre-2Q’23 earnings though), the business is not quite out of the woods yet. Here are some highlights from today’s call. [Subscribe](#/portal/signup) **Same Store Sales (SSS)** For the two consecutive quarters, SSS is negative for DG whereas Family Dollar (FDO), DG’s primary competitor, maintained its LSD-MSD SSS growth during the same time. Thankfully, management mentioned traffic finally turned positive this quarter; so the SSS decline was driven by average ticket: > …customer traffic was positive in Q3\. After starting the quarter slightly negative, traffic turned positive in the middle period and improved sequentially each period of the quarter. > > ...Customer traffic and same-store sales continue to improve in November. (MBI Note: DG’s third quarter ended on November 3rd and hence sequential improvement in November is not reflected) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F478c32b4-9cea-46bb-bbfe-3a9a49167af9_1369x871.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Gross Margin** Only consumables segment grew YoY and since consumables is relatively lower margin segment compared to other segments, gross margin declined \~147 bps YoY. Management also mentioned increase in shrink, lower inventory markups and increased markdowns for gross margin decline (partially offset by decreases in LIFO and transportation costs): > Shrink is actually 100 basis point headwind for us. And then as we moved into Q3, it's actually running just a little bit higher than that. And so certainly a pressure near term for us, something that we're looking to hopefully- we're mitigating along the way, and it'll show up in the financial results later in 2024. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F6030befa-1a90-43c9-a54a-aa706ab692f0_1354x868.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Operating margin** While FDO seem to be gaining traffic share and somewhat narrowed the gap in gross margins, it continued to struggle to generate profits. Both discount retailers struggled last quarter; DG posted their lowest ever quarterly operating margins in the last decade (possibly longer, but I looked at data since 2013 and their lowest operating margin quarter before this quarter was +6.9%). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F25688b41-302d-4f6f-94b0-9b4f5560c52a_1378x876.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) “New” management made some changes (TBD whether these lead to margin improvement over time): > …we have made the decision to redeploy labor hours away from **smart teams** and instead more directly to our store teams and a greater emphasis on customer service and store-level inventory management activities. (Note: Smart teams used to be prior management’s idea which is basically groups of employees that move between multiple stores to organize excess inventory.) **Inventory** Inventory was +3% YoY and -1.8% on per store basis. Non-consumables inventory was -15% YoY and -19% on per store basis. Management expects they have opportunity to take out a “meaningful number of SKUs” to further rationalize inventories (currently they have \~11-12k total SKUs per store) **Store expansion** DG guided 800 new stores expansion in 2024 which will be the lowest since 2015. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2d75448d-4792-4877-b9ac-9827f9eb791f_885x460.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) While management thinks slightly slower expansion is more prudent given macro and current context of DG, they remain optimistic about store expansion plans: > we monitor the following 5 metrics of our new store portfolio, including performance against pro forma sales expectations; new store productivity compared to the mature store base; cannibalization, which overall has remained consistent and predictable; cash payback, **which we continue to expect in 2 years or less**; and new store returns, **which we expect to be approximately 18% on average in 2024.** > > I want to note that our expectations for new store returns, while still very strong, are **down modestly from our historical target of 20%-plus**. > > We are placing a **heavier emphasis on rural stores in 2024 with more than 80% of our new stores planned in rural communities** where we believe we can have the most significant and positive impact for our customers The costs of opening new stores is also likely exerting pressure on DG to open stores slower than in recent years: > the initial opening of our 8,500 square foot store has increased more than 30% since we began rolling out the larger format in 2022\. Additionally, nonresidential construction costs have increased significantly since pre-COVID. **Outlook** 2023 Outlook is unchanged from what DG shared couple of months ago. 2023 EPS guidance is $7.35 (mid-point) which implies the stock is currently trading at \~18x P/E. For investors to make decent money in DG, the real debate is whether they can increase their operating margin from \~6.5% (9M’23) to \~8.5% (historical average) over the next couple of years. That debate remains far from settled. **Further reading**: My [Deep Dive](https://www.mbi-deepdives.com/dg/) on DG (August, 2023) Thank you for reading. [Subscribe](#/portal/signup) ### December, 2023 Update URL: https://www.mbi-deepdives.com/december-update-2/ Last updated: 2023-12-04T14:49:27.000Z While it's been a couple of days since the sad news of Charlie Munger passing away, there is certainly a sense of void percolating around. What has consistently amazed me about both Buffett and Munger is not their almost unbelievable track record in investing, but their ability to do much of it in front of the public eye for nearly six decades! Investors with better track record may eventually come along, but I am not sure there will ever be investors who would be able to do so for similar duration **and** let **anyone** leverage their investing prowess by owning a publicly traded stock. Of course, investing track record is hardly the only reason to admire Charlie Munger. I shared my biggest takeaway from Munger's life a couple of days ago: "Munger met Buffett at the age of 35\. How many people actually meet their best friends after 30s? Munger met Li Lu when he was nearly 80 years old. How many people actually form deep intellectual partnerships at such an age? If there's anything I want to learn from his life, it is to live life with intense curiosity and be open to the idea that the best years may be ahead of me. Such belief, even if it proves to be wrong, is deeply optimistic and may lead to more fun and interesting life." Rest In Peace, Charlie Munger. --- Some quick updates for this month: I am currently working on Floor & Decor (Ticker: FND). I hope to publish my Deep Dive before Christmas, but as my family just moved from New York to California, we are still going through all the challenges that come with [moving](https://twitter.com/borrowed%5Fideas/status/1730609526699888729?ref=mbi-deepdives.com) from one coast to another. I would still expect to publish the Deep Dive before Christmas. I will cover Dollar General's earnings this week. I will also do my annual poll among the subscribers, so you will likely receive a short survey link in a couple of weeks. If you are a new reader/subscriber, I would like to highlight that you can access all the past 41 Deep Dives [**here**](https://www.mbi-deepdives.com/models/). Thank you for your support! [Subscribe](#/portal/signup) ### FleetCor: Far from Fleeting URL: https://www.mbi-deepdives.com/flt/ Last updated: 2023-11-20T14:20:09.000Z _This post is for paying subscribers only._ ### November Update URL: https://www.mbi-deepdives.com/november-update-2/ Last updated: 2023-11-02T13:51:18.000Z Some quick updates for this month: 1. I will publish a Deep Dive on FleetCor (Ticker: FLT) by November 22nd. In December, my final Deep Dive in 2023 will be on Floor & Decor (Ticker: FND). 2. Now that all the key digital advertisers reported their earnings this quarter, here are some key takeaways from 3Q'23 digital ads market: a) Alphabet's share in digital ads was lowest since 4Q'20 b) Meta's share troughed in 3Q'22; it kept gaining share since then and exceeded 30% market share in digital ads again. c) While Alphabet and Meta's duopoly continues, Amazon keeps taking share. ![Image](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F76159142-55f0-4f67-9975-c68cc2c82210_1586x563.png "Image") 1. I have also just updated the below chart following Shopify’s earnings today. I usually track this data and mention it on Amazon’s earnings update. But since Shopify reported later than Amazon this time, I am just posting it now: ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/11/image-4.png) 1. If you are a new reader/subscriber, I would like to highlight that you can access all the past 40 Deep Dives [**here**](https://www.mbi-deepdives.com/models/). 2. Finally, a personal update. I am moving from Ithaca, New York to Sacramento, California by the end of this month as my wife is planning to start a new job. My wife and I plan on driving for about a week to move our lives one coast to another. While I tend to be weather agnostic person, my wife does crave the sunshine. I wouldn’t be surprised if she gets sick of sunshine by this time next year! I am happy to meet any reader if you live around the area. Thank you so much for your support. [Subscribe](#/portal/signup) ### Amazon 3Q'23 Update URL: https://www.mbi-deepdives.com/amzn3q23/ Last updated: 2023-10-27T01:41:32.000Z *Disclosure: I own Jan 2025 $55 call options of Amazon* Imagine opening Amazon’s 3Q’23 earnings report 5 years from now and what do you think you might hope you paid more attention to? It’s very unlikely to be AWS topline growth rate this (**or any**) quarter. If I have to guess, it’s the shipping+ fulfillment costs related developments that you would find **more consequential** 5 years from now. I’ll explain why but let’s first take a look at some numbers quickly before going back to that discussion. [Subscribe](#/portal/signup) **Revenue** 3P revenue grew by almost +20%, ads +25%, subscription mid-teen, and 1P MSD+. AWS, which was the key focus for many, grew by \~12%. More on AWS later; let’s start more segment level discussion with Amazon, ex AWS. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8c10941d-a643-48f6-9e76-eecc0817b5c2_1502x234.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon ex-AWS** This chart is a good indication that the real story is not AWS topline growth, rather the pace of improvement or margin expansion in Amazon “Retail” (defined as everything ex AWS). The crux of this story lies in shipping and fulfillment related costs. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5df1a165-1610-4454-b1e0-af07fc5f2ad4_894x620.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Fulfillment+ Shipping** Amazon re-architected their fulfillment network which is paying a lot of dividends: > Our move earlier this year from a single national fulfillment network in the U.S. to eight distinct regions represented one of the most significant changes to our fulfillment network in our history. This change has gone **more smoothly and made more impact than we optimistically expected**. As delivery speed improved (as an Amazon retail customer living in upstate NY, I experienced the pace of improvement personally), it has unlocked new demand: > we know how important speed of delivery is to customer satisfaction and buying behavior. A good example is **the significant growth we're seeing in consumables and everyday essentials**. When customers are getting items as quickly and conveniently as they are now from Amazon, they're going to consider us more frequently for more of their shopping needs. As we've shared the last few quarters, we've reevaluated every part of our fulfillment network over the last year. What’s more encouraging is Amazon sounds optimistic that they can keep improving here. The difference between Amazon’s integrated logistics experience vs other alternatives will likely keep widening: > …don't think we fully realize all the benefits yet and we continue to make steady improvements in fine-tuning the placement algorithms to enable even more in-region fulfillment and to further increase consolidation into fewer shipments…**We have a long way before being out of ideas to improve cost and speed**. How does this manifest in numbers? If you look at worldwide paid unit growth vs shipping+ fulfillment cost growth, you would notice that the latter have consistently outpaced the former pretty much all the time since 2015 until a year ago. Since then, unit growth is faster (was at par in 3Q’23) than shipping+ fulfillment costs, indicating some leverage in their logistics footprint. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd2a34478-185d-4b6c-b8e0-d7c14fae18e4_1258x606.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Why is this a much bigger deal? In 1Q’22, shipping+ fulfillment costs as % of GMV peaked at 26.1%. Since then, this number has been coming down almost every quarter to reach 22.7% in 3Q’23. If we give some credence to Amazon management’s claims that there is ample room for cost improvement here, naturally a question comes to mind about the extent of this potential improvement. Back in 2016, this number used to be \~17-18%, so almost \~500-600 bps lower from current level. I estimate Amazon will have \~$800 Bn GMV this year (defined as online sales+ (3P sales/25%)). So every 100 bps improvement leads to \~$8 Bn profit to Amazon at 2023 estimated GMV level. Now, I don’t quite expect this to happen anytime soon. Amazon didn’t have 1-day shipping program in 2016, and their international presence was minimal back then compared to today which has important implications here since those countries are at different cost trajectory than more established markets (recently launched countries would have a much higher shipping+ fulfillment expenses as % of GMV compared to Amazon US). On the other hand, Amazon’s further investments in robotics may be an added tailwind to cost curves that didn’t exist back then: > We have a very substantial investment of additional robotics initiatives. I would say many of which are **coming to fruition in 2024 and 2025 that we think will make a further additional impact on the cost and productivity and safety and our fulfillment service** If you look forward to 5-10 years when much of Amazon’s retail will be near maturity, this number can very likely go back to high teen level. There’s an enormous operational leverage embedded in building these logistics and fulfillment network and as GMV increases over time, **every 100 bps improvement will have a quite consequential lift to bottom line**. Frankly speaking, I pay much closer attention to this than AWS topline growth on a quarterly basis. To understand the valuation implications more clearly, I encourage you to play with my earlier shared Amazon model [**here**](https://mbideepdives.substack.com/p/models?ref=mbi-deepdives.com). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7bd61ede-417e-462e-8c9e-f1b14dcb2445_1481x755.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AWS** Okay, now let’s talk about AWS. While 12% YoY growth doesn’t sound exciting, QoQ incremental revenue in 3Q’23 was highest in the last five quarters. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F35db7359-749f-4403-8d1d-9cc754b7e9bb_1003x604.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Of course, 12% sort of pales in comparison with Azure or Google Cloud’s growth number, Amazon believes they continue to enjoy the highest absolute growth over their competitors (hard to validate since others don’t disclose exact numbers). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9ddf8070-73c4-4b5d-9b16-271a277b9d52_1167x754.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); \*Google Cloud includes Google Workpace, so not quite apple-to-apple and in reality, GCP grew faster than Google Cloud One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. While Google Cloud’s revenue somehow managed to maintain its gradual momentum against AWS, opex trajectory really went haywire for Google Cloud. While that’s disappointing for Google, important to remember it’s just a quarter. So we may need a couple of quarters to assess whether this trend is rather sticky. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2bf4e0a7-3334-4897-88f2-146f7ab3554f_894x578.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F927f981c-33aa-4991-9c1c-d0bce73d8e38_861x587.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Back to AWS. AWS incremental operating margin finally turned around. Operating margin returned to \~30%. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3d25bca1-e6a6-41cd-a17f-ca51942cda30_1228x124.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffe5f4028-c9b8-4f80-968c-d02697035f58_1269x664.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) While management reiterated margin can fluctuate a bit, the reason cited for margin expansion this quarter was “increased leverage on headcount costs”. Management mentioned optimization is starting to “attenuate”. They used the word “attenuate” **6 times** during the call. They also highlighted that some optimization is actually good for both customers and Amazon: > AWS' year-over-year growth rate continued to stabilize in Q3\. And while **we still saw elevated cost optimization relative to a year ago, it's continued to attenuate** as more companies transition to deploying net new workloads. > …while optimization still remain a headwind, we've seen the rate of new cost optimization slowdown in AWS, and we are encouraged by the strength of our customer pipeline…When we look at the fundamentals of the business, we believe we are in good position to drive future growth as the rates of cost optimization slow down. > You also see a lot of customers **who are moving from the hourly on demand rates for significant portions of their workloads to 1- to 3-year commitments, which we call savings plans**. So those are just good examples of some of the cost optimization that customers are making in less certain economies **where it's really good for customers short and long term, and I think it's also good for us**. Amazon seemed to be really eager to assuage the concerns on AWS being a potential laggard on Gen AI: > we're seeing the pace and volume of closed deals pick up, and we're encouraged by the strong last couple of months of new deals signed. For perspective, **we signed several new deals in September with an effective date in October that won't show up in any GAAP reported number for Q3, but the collection of which is higher than our total reported deal volume for all of Q3.** > …In these early days of generative AI, companies are still learning which models they want to use, which models they use for what purposes and which model sizes they should use to get the latency and cost characteristics they desire. In our opinion, **the only certainty is that there will continue to be a high rate of change**. > …Our generative AI business is growing very, very quickly, as I mentioned earlier. And almost by any measure, it's a pretty significant business for us already. **Opex+Capex** Amazon’s cost structure is starting to show some sign of efficiency. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc1593ba1-386c-4fac-9ade-c0aa8522d02f_2021x291.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Other Bets** Amazon hasn’t given up on Alexa yet: > We continue to be convicted that the vision of being the world's best personal assistant is a compelling and viable one and that Alexa has a good chance to be one of the long-term winners in this arena. **Outlook** Amazon’s guidance for 4Q’23 is below: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8bd353ac-e662-4bd9-86c3-7cda93f20fba_1055x236.png) Please feel free to share with your friends and network. Thank you for reading. [Subscribe](#/portal/signup) ### Meta 3Q'23 Update URL: https://www.mbi-deepdives.com/meta3q23/ Last updated: 2023-10-26T13:10:03.000Z *Disclosure: I own shares and 2025 January $50 Call Options of Meta* Meta had a terrific third quarter which makes the after-hours reaction (down \~3%) tad bit surprising, but perhaps understandable given the wider range of scenarios for advertising going forward. Here are my highlights from tonight’s call. [Subscribe](#/portal/signup) **Users** Since 4Q’19, Meta added 880 Mn Daily Active Users/People (DAU/DAP) to its Family of Apps (FOA) properties. Given Snap currently has 406 mn DAU, this means Meta added **two** “Snap” (and then some) in less than four years!! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F031c9b9f-3f6e-4ea2-b296-e771ef7a9f3c_1712x522.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Engagement** DAU/MAU engagement looks steady across all regions. Overall DAU/MAU ratio has been inching up for the last **seven** consecutive quarters. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7bce0e38-3ac9-4523-837c-6b97f1973dac_1712x552.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **ARPU** While ARPU exhibited considerable strength, please note the material weakness in YoY comparison and hence, 2-yr CAGR is likely better reflective of long-term trend. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Faa5f4450-63af-4a80-a5db-2f0219b242b0_1545x185.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Ad revenue** Number of ad impression grew by 31% YoY whereas average price per ad declined by 6% YoY, driven by higher impression growth in APAC and RoW as well as lower monetizing surfaces (i.e. Reels). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F20215bbb-48c7-454a-8dea-1117f213d8d0_1016x552.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Largest contributor to YoY growth: online commerce, CPG, and gaming respectively. Again, Meta highlighted strong demand Chinese advertisers: > spend from Chinese advertisers **further accelerated** for us in Q3\. We have benefited from strong investments from a few of our larger clients. We've also seen generally broader-based strength from other China advertisers, and we believe factors such as lower shipping costs and easing regulations on the gaming industry have served as tailwinds here. But **I think there has been a broader story of improved growth across all advertiser regions in Q3, and even excluding China, advertisers revenue growth has accelerated nicely**. But is the strong demand from Chinese advertisers sustainable? Meta mentioned even though they enjoyed long-term robust demand from these advertisers, they can be a bit volatile: > you kind of alluded to whether there's – the sustainability of the China advertising revenue. And even though we've seen particularly strong growth this year, I would say that **there has been a longer-term trend of overall growth with this segment dating back to past years** and also periods of volatility in the past, like in the last 2 years, we've seen periods with higher shipping costs with lockdowns, with regulation weighing on demand. So **we recognize there's the potential for volatility in the future as well and especially given that there are so many macro factors at play that are quite hard to predict** I also wanted to highlight the growing contribution from APAC and RoW region. During 2019-20, these two regions used to contribute \~26-28% of Meta’s ad revenue; in each of the last three quarters, these regions were >32% of total ad revenue. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fbff1783a-ddba-4825-9438-32fe5e45ea5a_1430x554.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Segment Reporting** Overall revenue was +23% YoY(+21% FXN) Total expenses -7% YoY, FOA expense -9% YoY While easy comp can be thought of as one of the rationales for such growth, I think Meta’s resilience can be understood in comparison with Google. On a 2-yr CAGR basis, Google Search revenue grew by 7.7% and Google advertising increased by 6% whereas Meta’s advertising business grew by 9.1% CAGR. Considering ATT and all the things that happened over the last two years, this has been an incredible turnaround for Zuck and Co. Even more impressive is FOA’s **\~81%** (no typo) incremental operating margin in 3Q’23 vs 3Q’21\. After **eight** quarters, FOA returned to >50% operating margin. Admittedly, I myself started thinking in 2022 that we may never see >50% operating margin in FOA again. Glad to be proved wrong. Reality Labs (RL) continue to hemorrhage losses, but losses are almost flat QoQ. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F99bd2480-20ed-4957-98e6-c7be4d96409e_1423x493.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Reels** Reels has been a massive success: +40% increase in time spent on IG since launch; Monetization milestone reached earlier than expected as it is now net neutral to revenue. Reels is expected to be modest tailwind to revenue in 2024. **Business Messaging** 600 mn conversations happen everyday between people and businesses on Meta’s platforms. \>60% of people on WhatsApp in India message a business app account. Click-to-messaging ads doubled YoY in India. Business messaging revenue is included in FOA’s “other revenue” which was +53% YoY largely driven by Business Messaging growth on WhatsApp. > We're seeing sustained momentum with click-to-message ads. Click-to-WhatsApp ad revenue continues to grow very quickly in particular and is already at a multibillion-dollar annual run rate. We're progressing on our work to enable further down-the-funnel conversions. And longer term, we're excited about the potential of AI to help businesses message with customers more efficiently at scale. **Threads** Threads now has 100 Mn MAU. **Chat Bots** Meta thinks chat bots engagement should be incremental: > this is a new use case that **doesn't take away from people interacting with people**. If anything, it should – we're designing these to make it so that they can help facilitate and encourage interactions between people and make things more fun by making it so you can drop in some of these AIs into group chats and things like that just to make the experiences more engaging. So this should be **incremental and create additional engagement.** **AI** Recommendation system increased time spent on FB and IG by 7% and 6% respectively in 2023\. AI tools for advertisers are also driving results with Advantage+ shopping campaigns with a $10 billion run rate. If you assume similar monetization for this incremental engagement, you can start to see that all those capex may be worthwhile. Perhaps that’s why Meta wants to lean onto hiring for more AI-related projects: > **AI will be our biggest investment area in 2024, both in engineering and compute resources**. But I want to avoid allocating a lot of new headcount. So we're going to **continue deprioritizing a number of non-AI projects** across the company to shift people towards working on AI instead. > we have a **sizable hiring backlog right now** since part of our layoffs earlier this year included teams swapping out certain skill sets for being able to hire others. And we're still going to be hiring those roles into 2024\. So that means that even though we're planning to grow headcount at a much slower rate going forward, the actual rate next year may **temporarily be faster** as we work through this hiring backlog. Meta believes what they’re doing on AI is quite unique: > here's some analogy (note: chat bots) is like what OpenAI is doing with ChatGPT, but that's pretty different from what we're trying to do. Maybe the Meta AI part of what we're doing overlaps with the type of work that they're doing, but the AI characters piece, **there's a consumer part of that, there's a business part, there's a creators part. I'm just not sure that anyone else is doing this**. > I think for the Feed apps, I think that over time, **more of the content that people consume is going to be either generated or edited by AI.** Some of it will be creators will now have all these tools to make content more easily and more fun. And I think over time, **maybe we'll even get to the point where we can just generate content directly for people based on what they might be interested in**. I think that, that could be really compelling. **Llama and Open Source** Llama 2 was downloaded more than 30 mn times last month. What’s the point of making all these work open source? > our CapEx expenses are a big driver of our costs, **so any aid in innovating on efficiency is sort of a big thing there**. > While at the same time, a lot of the secret sauce that goes into our product has specific product logic on top of the model, and we're also able to further train the models with data that we have internally. So I think it's a good balance of **improving the quality of what we do and improving the economics around it and improving recruiting while still enabling us to build a leading product**. **Metaverse** Can FOA ever be benefitted through RL’s work? > Reality Labs is working to build the future of online interactions. And we do expect **you'll see some interesting ways that translate into work with the Family of Apps in the near term**. > …Longer term, obviously, we think there's a lot of value from operating our Family of Apps experiences on top of a new computing platform that we helped develop, for example, **having glasses on that enable you to have our Meta AI assistant with you at all times. And as glasses scale, they'll make it increasingly easy to capture compelling content from a first person point of view** while you're staying in the moment or the activity that you're doing and sharing that content should enrich our content ecosystems even further. > the smart glasses that we just rolled out, we sort of thought were a precursor to eventually getting to displays and holograms for augmented reality, and I think we will eventually get there still. **It's not that far off**. But I think that now the ability to deliver AI through smart glasses may end up being a killer use case for that even before you get to the kind of augmented reality type of use cases. Meta sounded pleased with Quest 3 and Smart Glasses initial reception from people, but didn’t disclose any numbers. **Efficiency** > As part of our 2024 budget, we plan to selectively allocate incremental headcount toward 4 key company priorities: **AI, infrastructure, Reality Labs and monetization as well as toward our regulatory and compliance needs**. Of those areas, we expect AI to be the largest area of increased investment as we further invest in generative AI across our core products, internal tooling and research efforts. We aim to offset some of this growth by continuing our efficiency focus and **reducing planned hiring in other areas across the company in 2024**. > The net effect of our efforts to close out our 2023 hiring underruns and our efficiency-focused 2024 budgeting process is that we expect to end next year with reported in-seat headcount **meaningfully higher than our current headcount but to grow at a slower rate beyond that**. **Capital Allocation** Like Google, Meta too was quite reticent in buying back stocks last quarter. For the second consecutive quarters, shares outstanding actually increased. Why is Meta not buying back shares? Google alluded to pending tax payments. Meta hinted the same but while Google’s amount was $10 Bn, Meta didn’t specify any amount but my guess is tax is playing a role here. In 1Q’20, Meta’s LTM SBC per employee was \~$120k (vs Google at $100k). Now Google is at \~$120k but Meta is at \~$177k! I wonder whether last few years poor stock price performance forced Meta to be a bit generous (among other things, likely not the only reason). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc19f91d5-00fd-4776-b96d-e5d041939206_1710x385.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Opex Guide** Meta narrowed their opex guide range from $88-91 Bn to $87-89 Bn for 2023\. They also provided 2024 expense guide: $94-99 Bn (street was more or less expecting $96-102 Bn, so this guide was better than expected). FOA “will be a larger source of payroll expense growth than Reality Labs in 2024”. Even though Meta is guiding 2024 expense, it seems some of it will depend on what they see in topline: > How the expense and revenue outlook come together? Obviously, that's -- **as we get more information on the revenue outlook for next year, that will influence that**. Going forward, Meta will provide next year’s opex and capex guide in 4Q call instead of 3Q call. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdeff6b7e-3a94-45b8-b5a5-da827d05d545_1228x616.png) Source: Company Filings, MBI Deep Dives **Capex** Speaking of capex, 2023 capex range was narrowed: $27-30 Bn to $27-28 Bn (initial capex guide was $30-33 Bn) 2024 capex guide is $30-35 Bn which was also largely lower than what most people were expecting. **Regulation** Regulation, while ironically a moat for Meta, also remains a key worry for me as a shareholder. Meta touched on these concerns and it sounds like we may get an update on EU soon: > …we continue to monitor the active regulatory landscape, including the increasing legal and **regulatory headwinds in the EU and the U.S. that could significantly impact our business and our financial results. Of note, the FTC is seeking to substantially modify our existing consent order and impose additional restrictions on our ability to operate. We are contesting this matter, but if we are unsuccessful, it would have an adverse impact on our business**. > We're continuing to engage with the DPC and other regulatory authorities on our proposed consent model, but **we're committed to making this move as soon as possible, and we will provide an update when we have it**. **Outlook** 4Q’23 topline guide is $36.5-40 Bn (+2% FX tailwind). The range is wider than usual for following reasons: > coming into Q4, **we've been seeing continued strong advertiser demand in key segments**, including online commerce and gaming. But having said that, we are also **seeing more volatility at the start of the quarter**. That's in part why we widened our guidance range to capture that uncertainty. And so for instance, while we don't have material direct revenue exposure to Israel and the Middle East, **we have observed softer ad spend in the beginning of the fourth quarter, correlating with the start of the conflict, which is captured in our Q4 revenue outlook**. **Closing Words** I will perhaps always vividly remember Meta’s 3Q’22 earnings, a period that truly instilled in my heart, mind, and brain that anything is possible in the market (see below tweet by [Alex](https://twitter.com/TSOH%5FInvesting?ref=mbi-deepdives.com)). As it looks like we are amidst another period of volatility in the market, it is good to remember that. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1f6a191b-5e03-452b-a4bc-4c7dfc9e65a1_904x379.png) More commentary on follow-up call and 10-Q is [**here**](https://www.threads.net/@mostly.borrowed.ideas/post/Cy3NIk9Aymq?ref=mbi-deepdives.com) For more in-depth analysis on Meta Platforms, you can read my analysis [**here**](https://www.mbi-deepdives.com/meta2023/) (March, 2023). I will cover **Amazon** earnings tomorrow. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends. [Subscribe](#/portal/signup) ### Alphabet 3Q'23 Update URL: https://www.mbi-deepdives.com/goog3q23/ Last updated: 2023-10-25T00:59:10.000Z *Disclosure: I am long shares and Jan 2025 $50 Call Options of Alphabet* While Google Service segment did just fine, Google Cloud’s pace of deceleration in topline was a bit disappointing. Here are my highlights from Alphabet’s call tonight. [Subscribe](#/portal/signup) **Revenue** After four consecutive quarters of single digit growth, Google returned to double digit growth this quarter. Both Search and YouTube grew by double digit, but Google cloud’s topline growth came down from \~28% last quarter to 22.5% this quarter. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F71975730-94ba-4e56-84ed-ddb9cf849113_2025x381.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **EBIT** Google Services maintained mid-30s EBIT margin, but after posting QoQ margin expansion for the last 6 quarters, Google Cloud’s margin declined from 4.9% in 2Q’23 to 3.2% in 3Q’23. If you compare Google’s current quarter’s result to the respective pre-Covid results, Google’s 3Q’23 overall revenue increased by 89% compared to 3Q’19 revenue, but EBIT increased by 133% during the same time. Despite the hiring spree post-pandemic, Google’s incremental margins have been quite strong. One thing I would like to highlight here is TAC as % of ad revenue came down to 21.2% which was the **lowest** since Google started disclosing Google Advertising revenue separately in 4Q’18. Given Pixel’s relative success recently, it would not surprise me if this number continues to go down: > Pixel is the fastest-growing smartphone brand in our top markets and the **only one that grew in units sold year-over-year** ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fef4d9e60-9b35-4de8-8050-b5e1d723b109_1835x416.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Search** Google will launch “next generation series of models” in 2024: > we are developing Gemini in a way that it is going to be available at various sizes and capabilities, and we'll be using it immediately across all our products internally as well as bringing it out to both developers and cloud customers through Vertex. So I view it as a journey and each generation is going to be better than the other, and we are definitely investing and the early results are very promising. When asked about whether the future of query is decentralized via many different applications/bots, Google reminded that it was always a possibility that they were and remain focused to defy: > if you zoom back and take an information view of the world, there's always been many different ways to get it. And part of our work we do in making Search be world-class and give users what they're looking for so that we can get it as much of that intent as possible. So I don't see that changing. > With mobile, there were more ways people could get information, but we worked out to make Search work better in the mobile world. And similarly, a view with AI, there'll be many ways people get information, but it also offers us an opportunity in Search and in Assistant to take it to the next level and answer use cases, which we couldn't have done before and expand the diverse set of needs where we are sourced. So that's how I see the opportunity ahead **YouTube** Google disclosed YouTube shorts is now viewed 70 Bn times daily (prior disclosures: 4Q’22: 50 Bn, 1Q’22: 30 Bn) For comparison, Reels was viewed 200 Bn in 2Q’23 (prior disclosure in 3Q’22: 140 Bn) Reels is clearly ahead of Shorts and that gap doesn’t seem to be closing over time. Google Other revenue was +21% YoY, led by YouTube subscription revenues. YouTube’s non-ad revenue is almost certainly growing faster than ad revenues. **Google Cloud** Google Workspace now has 10 mn paying customers (prior disclosures: 1Q’23: 9 mn, 1Q’20: 6 Mn, 1Q’19: 5 Mn) From Q2 to Q3, the number of active generative AI projects on Vertex AI grew by 7x Google Cloud’s topline growth was especially disappointing given the context of Azure, with a higher base, posting +28% YoY growth **Other** Some interesting comments on other/other bets: > We also shared that Chromebooks will now get regular automatic updates for 10 years, more than any other operating system. > …In Other Bets, Waymo is onboarding more riders to its commercial ride-hailing service as it gradually adds over 100,000 people from its San Francisco waitlist. Austin will follow as its next ride hail city. Wing and Walmart announced a new partnership to provide drone delivery service in the Dallas-Fort Worth area. **Capital Allocation** Google utilized \~70% of their FCF in buyback which led to 53 bps decline QoQ in diluted shares outstanding. They still have $106 Bn net cash on balance sheet. Google management sort of hinted why they didn’t utilize all of their FCF to buyback shares in the last couple of quarters: > our cash balance and free cash flow in the second and third quarters benefited from the deferral of certain tax payments to the fourth quarter of 2023. > …On October 16, 2023, we made an estimated tax payment to the IRS of $10.5 billion that will be reflected in our fourth quarter operating cash flow. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3775f032-4f12-44f6-8f4c-6897ec5cf7dc_672x474.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex and Opex** Google started hiring again although at a much subdued pace. They hinted that they expect topline to grow faster than total opex growth. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fadcbc50c-183c-4f0c-86ee-be1bb9951fa8_1840x251.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** > First, cost of sales in the fourth quarter will reflect both higher hardware costs given Pixel family launches as well as increased YouTube as previously noted. > Second, as usual, we expect sales and marketing expenses to be more heavily weighted to the end of the year, in part to support product launches and the holiday season. > …Finally, our reported CapEx in Q3 was $8 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers, data centers, reflecting a meaningful increase in our investments in AI compute. The growth in reported cash CapEx in Q3 is somewhat muted due to the timing of supplier payments which can cause variability from quarter-to-quarter. We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024. **Valuation** I share this back-of-the-envelope valuation table on Google every quarter to have a quick gut check. While Google seems more or less fairly or reasonably valued today, its long-term future will be very reliant on the durability and sustainability of Search profits. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9726d38d-c8f4-40cc-8b20-412a4e906520_1834x386.png) Source: MBI Deep Dives You can read my more in-depth analysis on Google [**here**](https://www.mbi-deepdives.com/goog/) (March, 2023). I will cover Meta’s earnings tomorrow. Thank you for reading. [Subscribe](#/portal/signup) ### Spotify 3Q'23 Update URL: https://www.mbi-deepdives.com/spot3q23/ Last updated: 2023-10-24T17:15:49.000Z *Disclosure: I own shares of Spotify* --- > We walked into 2023 thinking we would do just over 20 million in net subscriber adds for the full year, but we're actually on track to deliver 30 million, which is a significant beat from where we thought we would be. I’ve been following Spotify for almost two years now and this was perhaps their best quarter. Not surprised that the stock is +10%. Here are my notes from today’s earnings. [Subscribe](#/portal/signup) **Users** Despite price increases for the individual subscription plan first time in the US, Spotify did not lose subscribers on net in North America: > when you think about a price increase, there's really the 2 components you're always going to be focused on. One is anything that elevates churn. And then two, anything that impacts the gross intake in any way. And so what was great was the **churn was right in line with expectations**. And we talked about in the past **when we've raised prices that churn had never been that material, and it was similar to this go around**. And then I guess even just as importantly, **we outperformed on the gross intake side**, which is one of the reasons why we outperformed on overall subs ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fba73115e-2d1d-41dc-97c1-0e4802223f0b_1674x161.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Premium Mix** Premium as % of MAU went down over the last 4-5 years as Rest of the World (RoW) region in the MAU mix went from 13% in 1Q’19 to 31% in 3Q’23\. RoW MAU basically 4xed in less than four years. While MAU is generally considered a pretty good funnel to transition to premium subscription, the relationship appears to be a bit weak for RoW so far. **Netflix vs Spotify** This is something I track every quarter. After significantly lagging Spotify for a while, Netflix is not narrowing the gap at a pretty fast clip. I should mention that definition of subscriber of NFLX and SPOT is not apple-to-apple, so I would caution not to infer more than what this data can tell us. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F74100ad4-45d5-4790-868b-a91fa004c3ad_793x527.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Revenue** While overall reported revenue was +10.6% YoY, it was actually +17% YoY. FXN which was \~300 bps QoQ acceleration. Ads was even better with +24% YoY FXN growth. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F211d720d-8465-43da-803b-46dd15c6e92d_1447x238.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Ads as % of revenue kept going up gradually. It was 13.3% of revenue in 3Q’23 (vs 12.7% in 2Q’23). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F26718e9e-5896-44f8-aea8-22749471804d_742x554.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Gross margin (GM)** Overall reported GM was +26.4% (\~40 bps higher than guided) > As you look into 2024, we expect to see a continued improvement in our gross margin trends and a continued improvement in our operating income trends as well. Music GM was +29.1%. Marketplace continues to be a tailwind to margins: > we're offering more and more products to people on the marketplace side, which is seeing better and better results relative to all the other marketing spend that labels and artists teams are encountering, which, of course, is a great testament for – meaning more and more artists will keep on investing with us there. Moreover, ads segment GM was +8.3%, higher than past 6 quarters. Expect more margin improvement here: > we've seen the improvements in the podcasting business, and we talked about how that's been a drag on our gross margins, and **we expect it to soon reach breakeven** and then **become something that's actually additive to gross profit**. So we're on track on the podcasting side there, and that should continue to be helpful into 2024\. **Same with the music side in terms of incremental gross margins there as well**. Will the launch of audiobooks pour cold water to GM expectations in 2024? While Spotify didn’t share much details about margin structure on audiobooks, they specifically outlined 2024 GM to be higher than 2023: > When you think about the audiobooks side of it, there's obviously some investment anytime you launch a new business. But again, as I said earlier, we feel really good about continuing to have a nice progression in gross margins into 2024. > …we are expecting gross margins to be improved in 2024. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fadd24425-f473-491b-9d89-4701e053016d_867x516.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Opex** Despite lots of efficiency promises in the past, it does seem the efficiency train is finally here. > the new part of the Spotify modus operandi is our focus on efficiencies…you should expect us to continue to look for more improvements going forward because that's just our modus operandi. > …our expectations are now that we will consistently be in the black moving forward… we've hit an inflection point with respect to profitability of the business. The numbers look very encouraging. In 3Q’22, Spotify spent €432 Mn in S&M and added 23 Mn MAU and 7 mn subscribers in that quarter. In contrast, they spent 18% YoY lower in S&M to drive basically similar outcome. G&A was also down 19% YoY. R&D was -4% YoY. You can finally smell some “efficiency” here. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F895cc708-2942-41cf-a76a-48a7c2ab4bb2_1747x194.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AI** GenAI should be pretty neat in lowering cost of ad creatives and creating new demands: > what generative AI has the promise to do is, of course, to allow for that creative **cost to come down. But not only that, but it allows you to scale that creative in unimaginable ways**. So you can translate whatever creative you had lots of different languages. You can use the same voice actor, but instead of producing 1 or 2 ads, you can have 1,000 or 10,000 or even 100,000 ads that are individually created to each user that gets to hear this. **Outlook for 4Q'23** While Spotify faces competition from perhaps the most potent set of competitors in the world (Google, Amazon, and Apple), it has surprised (including me) how it reaccelerated its user growth at scale. Spotify reminded 2023 will be their highest year for net MAU add: > 2023 should finish with the highest net additions for MAUs and the second largest for subscribers in company history, but actually the largest if you exclude the impact of Russia 4Q’23 topline is expected to +20% YoY FXN. Impressive quarter, but probably need a couple of those to truly convince investors that things are different now. The stock doubled this year so far, so perhaps many investors already updated their views on Spotify. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fea9bc6ed-911e-49e3-a4a0-76b1d64e4160_1271x435.png) Source: Company Filings You can read my Spotify Deep Dive (December, 2021) [**here**](https://www.mbi-deepdives.com/spot/) I will cover Alphabet’s earnings tonight! [Subscribe](#/portal/signup) ### Enphase Energy: A Solar Roller Coaster URL: https://www.mbi-deepdives.com/enph/ Last updated: 2023-10-23T11:29:10.000Z _This post is for paying subscribers only._ ### Forward Cap and MBI Discuss Tesla URL: https://www.mbi-deepdives.com/forward-cap-and-mbi-discuss-tesla/ Last updated: 2023-10-05T15:36:37.000Z --- One of the joys of writing about publicly listed companies at a very accessible price point is the interaction with other intelligent and curious readers. I routinely learn a lot from these interactions and MBI Deep Dives is a better product because of these interactions. After I published my [**Deep Dive on Tesla**](https://www.mbi-deepdives.com/tsla/), [Forward Cap](https://twitter.com/forwardcap?ref=mbi-deepdives.com) diligently read my work and sent me his thoughts. I enjoy Forward Cap's work and I encourage you to read his work on his [Substack](https://autoinsights.substack.com/?ref=mbi-deepdives.com). I suggested him that we make our interactions public which he agreed. **Full disclosure**: as of this writing, Forward Cap owns shares of Tesla and I have no exposure to Tesla. [Subscribe](#/portal/signup) --- **Forward Cap**: Hey – finally got around to reading your deep dive. Great work!! I always love reading a fresh perspective and you have a lot of interesting datapoints, insights, and opinions. Wanted to share some of my feedback: Your S/X deliveries are off (99k act vs 22k in your model) so the ASP in the article is showing $110k vs $76k actual (lower when deducting reg credits which are also 0 in your model for 2018-19). **MBI**: You are right. I linked the cells incorrectly on S/X deliveries for 2018\. I have corrected it now on my model and on my write-up. (For regulatory credits, I do not see related disclosure on my database and hence it was zero.) **Forward Cap:** I like the comparison to the auto industry from 100 years ago, as there are a lot of parallels, specifically with respect to difficult competitive dynamics which are very real here. However, one thing that is much different this time around that’s critical to my thesis is the legacy business/innovator dilemmas that are materially dragging competitor efforts. Between conflicting interests for management, employees, shareholders, unions, dealers, and more – it’s a very difficult uphill battle for incumbent OEMs. **MBI:** I don’t disagree. I am not eager to bet on the ICE incumbents to transition to EV. It’s a tall ask for them. However, I am not super confident that **none** of them will be able to do it. My lack of confidence comes not from deep knowledge about their initiatives, rather the opposite. I certainly didn’t have time to carefully assess each of the incumbents EV initiatives. I do broadly agree with your thesis that the supermajority of them will likely find it too challenging to transition to EV successfully. However, perhaps a couple of them will be able to do it. We are still way too early in EV to form rigid opinions. We may be in the “1920s” and “Toyota” and “Volkswagen” haven’t even been founded yet. The whole discussion on what happened a century ago was to set the context for lack of predictability and a sense of humility required for a long duration bet. **Forward Cap**: You do a good job of highlighting the structural advantages that Tesla has over incumbent OEMs with respect to the DTC distribution vs third party dealers, but I think that often gets mistaken as the only reason why bulls feel that Tesla is differentiated. Both from a margin and pace of innovation perspective, there are several other reasons why Tesla can innovate more quickly and save on costs relative to legacy competitors: - Innovative manufacturing methods that reduce complexity and costs ([see quotes from competitors here](https://x.com/forwardcap/status/1480948169592786946?s=20&ref=mbi-deepdives.com)). There is a lot to unpack here, but fundamentally Tesla is building factories and assembly lines from the ground up and willing to take on additional risk to innovate, whereas there are too many legacy facilities/assets and conflicted parties that would allow this at a legacy OEM. Obviously, Tesla’s ability to dedicate 100% of their effort to developing more efficient manufacturing methods also helps, whereas legacy OEMs are still mostly spending resources on ICE. I highly recommend the Munroe Live YouTube channel to learn more on this, as he/his firm are industry veterans with mountains of knowledge. - Internally developed software, not just FSD, which is an increasingly important aspect of the auto industry. Jim Farley does an excellent job explaining [here](https://x.com/WholeMarsBlog/status/1665626706957438977?s=20&ref=mbi-deepdives.com). In addition to cost and time savings, this allows Tesla to fully capture all of their data, which uniquely positions them for FSD, insurance, understanding vehicle diagnostics/useful parts, and other software-driven applications. - Ability to attract top talent across the org ([more detail here](https://x.com/forwardcap/status/1525835837392490496?s=20&ref=mbi-deepdives.com)). Tesla is really the only automaker competing with big tech for talent and there’s a litany of reasons for this: ability to live in SF or Austin, equity upside (not common at competitors), less bureaucracy/ability to work on smaller teams, ability to work on more internal software and technology, and more. Tesla can also get more out of its workforce because they are not unionized. - Localized production. While geopolitical tensions in China present a risk to Tesla, they are the only foreign automaker to ever operate there independently (i.e. without a JV structure). They are diversifying through their factories in California, Austin, Berlin, Mexico, and eventually other areas which all helps further localize production. This helps them save on costs (i.e. tariffs) and time from production to delivery, which helps drive their industry-leading Days of Inventory. - Economies of scale and first mover advantage. Tesla's lead in EV volumes, specifically domestically and less relevant in China because of BYD, allows them to be more competitive on pricing as a result of lower fixed overhead relative to sales, greater negotiating leverage when sourcing batteries and other key components, etc. Additionally, as a first mover, Tesla’s brand is synonymous with EVs and consumers are proven to check out Tesla specs when considering an EV purchase. This is a big reason why they have been able to scale to a $100B+ revenue business without advertising yet, though I hope they do soon. - Ability to share key manufacturing methods, proprietary technology, and top talent with SpaceX. This happens quite often and is underrated, as there’s more relevant overlap than meets the eye. **Forward Cap:** Great discussion on BYD and I like that you elaborate on them because they are definitely under-discussed. It’s incredible what they’ve accomplished, especially given their presence in mostly just one country, and representative of the much more competitive nature of the Chinese market. BYD has definitely had a negative impact on Tesla’s pricing strategy in China. With that said, I think the article focuses too much on BYD’s volumes and not enough on the differences in market segments (there are pictures but no commentary). A lot of BYD’s volume comes from significantly lower priced vehicles so the volume isn’t exactly apples-to-apples. For example, their top selling cars are the Song starting at 169,800 Yuan and Yuan Plus starting at 135,800 Yan vs Model 3 starting at 259,00 Yuan and Model Y at 263,900\. As a result, BYD has and will likely maintain a much lower share of industry profits. **MBI:** Yes, given I alluded BYD as the “GM” in today’s EV race, I probably should have expanded even more. I guess I was a bit too self-conscious about the length of the Deep Dive as it was \~15k words already. Anyways, I do think volume is quite/likely the most important element here. If you think EVs not just as “hardware” sales but a potential revenue stream of “FSD, insurance, parts sales” etc., protecting gross margin on hardware may prove to be shortsighted. I think Tesla understands that and they seem quite eager to pursue volume instead of protecting automotive’s gross margins; their recent pricing strategy hints at such an approach. It is to BYD’s credit that they could produce low cost EVs that they could sell and the overall profit pool on LTV basis may be quite compelling despite the initial lower gross margin. Tesla clearly has a willingness to produce even cheaper EVs in the long term (which is critical for mass adoption). BYD is likely to be a major exporter to all other regions (except US?) in the next 3-5 years and therefore, BYD and Tesla seem quite destined to be fierce competitors. **Forward Cap:** I agree that China geopolitical risk is a major risk for Tesla. Elon has made it pretty clear in recent interviews that he thinks China will invade Taiwan and tensions will escalate. Pretty wild. **MBI:** Yes, even if China doesn’t end up invading Taiwan, I would argue China could still make Tesla’s life difficult if BYD doesn’t get greenlight to operate in the US. The last thing I expect from China is to allow an American company to dominate one of the largest industry’s profit pools when their own homegrown companies are anathema in the US. I know Apple is still there, but admittedly I’m just as equally concerned about their long-term viability there. **Forward Cap:** I love and agree with this quote “The range of outcome for FSD is really perhaps the widest of anything I have come across in studying businesses over the last decade!” With the trend in ASPs and gross margins this year, the bull case is becoming increasingly dependent on FSD. Not what I envisioned prior to this year. **MBI**: It took me a while to understand FSD’s accounting implications in the financial statements and once I did, I realized it really is perhaps a make-or-break thesis for Tesla shareholders. Elon was indeed right. If FSD “works” eventually, things are likely to turn out to be fine for the shareholders. On the model: **Forward Cap:** Overall, you have very reasonable assumptions. Not far off my volume estimates in 2030 for example. \- I think they’ll gain a bit more operating leverage than you give credit for, but I also think (hope) they will start advertising, so SG&A leverage won’t be as strong as we’ve seen historically. \- You properly show how much value FSD can add without a robotaxi/licensing scenario, though still likely conservative on the GAAP recognition % over time as that is based on available feature set which is expanding. \- The 2% p.a. increase in FDSO is aggressive in my opinion since that has really slowed down recently. For example, FDSO is only 0.1% higher as of Q2 2023 than Q4 2022. **MBI**: To be clear, I was just trying to figure out embedded assumptions in current stock price. I agree that looking at history, one can argue I could have been a bit more generous in giving Tesla credit for further operating leverage. Perhaps I have been burned too many times assuming such operating leverage which very rarely plays out. More seriously, I do think more advertising would be required if competition with BYD heats up across the world. I am not sure Tesla cars would be able to maintain the same inherent appeal to potential customers without doing so. Selling cars to “early adopters” vs “early majority” could be a different ball game. Similarly, I do expect Tesla will have to be more generous in doling out SBC and other benefits. The upside for employees joining at <$100 Bn market cap vs \~$1 Tn market cap is different. It is, however, possible that Elon Musk would be far more conservative in hiring than any other big tech. We will see and I agree that my dilution assumptions could prove to be aggressive. **Forward Cap**: I think it’s likely that non-core revenue streams today will play a much larger role in the latter part of the decade. They have a very large opportunity in Energy for example and are just now beginning to leverage excess battery capacity towards energy as growth in vehicle business slows, which gives them nice optionality. A few other examples: insurance, long-haul transportation (Semi), battery manufacturing, FSD licensing, Optimus, Dojo. All massive opportunities that are adjacent to current areas of focus. With a company as innovative as Tesla, some things are obviously very hard to predict that far into the future, which is where the market is assigning a lot of its value, but nearly impossible to model today so obviously tough to include in any analysis. I’ve always been the biggest Tesla bull I know and looking back at my models from 5+ years ago it’s insane how much even I under-estimated it. Of course, that’s not predictive of future results, but I think they’ve maintained the same culture that got them to where they are today. **MBI**: While I did incorporate some of these opportunities (Energy directly and insurance indirectly in the services segment), I agree that opportunities such as FSD licensing, Optimus etc. are not adequately captured in my model. Valuing optionality for big tech is just incredibly hard and interestingly, almost no other shareholders of other big tech give credit to the companies for such optionality. Google and Meta both are valued based on consolidated numbers despite having large other bets losses (especially for Meta). Similarly, even though Apple is getting into AR/VR and had been working on Car for last 10 years, investors were rarely willing to give these companies any credit for such “investments” until and unless these investments turn into something more tangible. It is possible that Tesla’s shareholder base would act differently here; however, looking at last year's drawdown also gives me pause on that theory. To read my Deep Dive on Tesla, click [**here**](https://www.mbi-deepdives.com/tsla/). Thank you for reading. [Subscribe](#/portal/signup) ### Tesla: A Bet on Dominance in Potentially Compelling Megatrend(s) URL: https://www.mbi-deepdives.com/tsla/ Last updated: 2024-04-08T23:32:18.000Z _This post is for paying subscribers only._ ### September Update URL: https://www.mbi-deepdives.com/sep-email/ Last updated: 2023-09-01T14:24:06.000Z Exactly **three years** ago, I launched MBI Deep Dives in September, 2020\. Thanks to your support, I have been able to keep at it for the past thirty six months writing [**Deep Dives**](https://www.mbi-deepdives.com/models/) every single month. I have never had as much fun as I have had "working" for MBI Deep Dives. I want to keep doing what I am doing for decades, so we are still hopefully in the very early days. Thank you for allowing me to pursue what has been genuinely fun and intellectually stimulating experience for me. [Subscribe](#/portal/signup) Some quick updates for this month: 1. Speaking of fun, I am indeed enjoying studying **Tesla** very much. Tesla is not only just a controversial stock but also perhaps one of the more complicated ones I have studied so far. I hope to publish the Deep Dive sometime during the final week of September. 2. I recently appeared on my friend Liberty's [**podcast**](https://www.libertyrpf.com/p/meta-platforms-and-mark-zuckerberg?ref=mbi-deepdives.com#details) to discuss Meta Platforms. We explored what are likely misunderstood aspects about the company as well as some risks and opportunities ahead of the company. Give it a listen if you are curious. 3. Following Tesla, I plan on covering **Enphase Energy**. I haven't decided on the schedule for the rest of the year yet, but I will let you know once I do. 4. I have received a number of feedback on last month's Deep Dive: [**Dollar General (DG)**](https://www.mbi-deepdives.com/dg/). A few readers let me know that I may have underappreciated the inherent complexities associated with increasing new stores from \~1k/year to 1.5k-2k/year. The constraint is not necessarily capital, rather labor, real estate etc. During my due diligence of DG, I spoke with a couple of shareholders and in fact, they did mention this when I shared my criticism of DG's capital allocation. I, unfortunately, forgot to mention this counterpoint on my Deep Dive. While I do think this is a very fair counterpoint to my criticism, I still think DG management should have been a bit more proactive in penetrating their TAM a bit more quickly since 2015; perhaps not by increasing new stores by 2k/year, but more like 1.2-1.5k/year if they indeed believe the US market opportunity is closer to 30k stores. Another reader mentioned a pretty neat point on why they think DG's historical Same Store Sales (SSS) growth may not be quite indicative of the end-state same store sales growth: *"a dirty trick for retailers same store sales growth is that store roll out is also a tailwind to SSS growth. If it takes 5 years for a store to fully mature, the SSS benefit is counted after year 1 as a tailwind to the group. The implication is that the underwhelming same store sales figures are actually worse if we were to look at the mature subset of long-standing stores (a better proxy for terminal SSS)"* I have also received a couple of emails/messages requesting me to comment on yesterday's large drop on DG's prices. While I'll try to not make it a habit to comment on short term stock price movements on every stock that I have covered, let me address a couple of points here. One of my primary concerns about DG was declining Same Store traffic trend that started in 2020\. Family Dollar (FDO), the closest comp, had the same issue but they turned to positive traffic in the last two quarters whereas DG's traffic remains negative. The traffic comp should be "easy" by now since it declined for three consecutive years. Therefore, it is indeed a bit concerning that traffic trend hasn't turned around yet, especially when the closest competitor's did. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/09/image.png) There has been another [narrative](https://twitter.com/yipitdata/status/1697338854645105136?ref=mbi-deepdives.com) that is increasingly gaining momentum across US retail is the rise of Temu and how much it is potentially affecting other retailers in the US. It is perhaps too early to comment on Temu, but I think it is unlikely that it is the primary reason for DG's recent weakness. If Temu were such a force, I would assume it would show up in FDO's number as well. In fact, one could argue that given FDO over-indexes on more urban regions than DG, delivering low priced items to FDO-adjacent regions would be more convenient than DG-adjacent regions. \~80% of DG's stores are in towns with fewer than 20,000 people. Transaction amount per customer trip to a DG store is \~$15\. I don't see how delivering such low value products to towns with <20k people can make compelling economic sense. Therefore, even if Temu threat were real, I would be lot less worried about DG than most other retailers in the US. Finally, I do think following DG's drop in stock price yesterday, DG's risk-reward is slowly becoming more attractive than I considered them before. I am not a shareholder yet, but I am watching DG with interest. As I have mentioned before, questions are always evolving depending on changes in stock prices and the business fundamentals. Every now and then, the questions just *seem* easier to answer. 5\. I have provided more details on my back-of-the-envelope math on Adyen [here](https://www.threads.net/@mostly.borrowed.ideas/post/CwRGssvsFqq?ref=mbi-deepdives.com). While that thread primarily speaks about the numbers, I encourage you to read my [**Deep Dive**](https://www.mbi-deepdives.com/adyey/) to understand the broader narrative. Moreover, if you want to get up to speed on some of the recent developments on payments industry, especially Adyen, Stripe, and PayPal, I encourage you to listen to this [Stratechery](https://stratechery.com/2023/an-interview-with-lisa-ellis-about-payments/?ref=mbi-deepdives.com) podcast. Thank you again for your support! [Subscribe](#/portal/signup) ### The Curious Case of Big Tech URL: https://www.mbi-deepdives.com/the-curious-case-of-big-tech/ Last updated: 2025-01-26T16:50:08.000Z **Disclosure*: Nearly 60% of my personal portfolio is invested in Meta, Amazon, and Alphabet* --- *“Most people overestimate what they can achieve in a year and underestimate what they can achieve in ten years.”* While most market participants want to focus on what happens next quarter or the next year, it is often revealing to look back and see what has been achieved over ten years! What I am about to discuss is something I have discussed with some fellow investor friends over the past month or so, and I have noticed how frequently some of these data startled them. So, I thought about writing a brief note to share this with my readers. In the beginning of 2013, Big Tech’s (defined as Apple, Microsoft, Alphabet, Amazon, and Meta) market cap were: Apple: $500 Bn Microsoft: $225 Bn Alphabet: $232 Bn Amazon: $114 Bn Meta: $58 Bn In aggregate, Big Tech was worth $1.1 Tn at the end of 2012\. **Over the last ten years (2013-2022), Big Tech collectively generated $2.3 Tn Operating Cash Flow (OCF), slightly more than double their aggregate market cap ten years ago**! To say it differently, Big Tech was a form of deep value investing that was deeply underappreciated even though they are all widely followed companies at that time! Believe it or not, back then 10-year treasury was yielding below 2%! Perhaps this is what people call “generational opportunity”! [Subscribe](#/portal/signup) What is perhaps even more strange is that this underappreciation was not quite specific to one or two companies, but to the **entire group**. No company was, however, as underestimated as Meta Platforms (formerly known as Facebook) generating $271 Bn OCF in 2013-2022, which was **470%** of their market cap in 2012! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/08/image-9.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Skeptics may point out these companies tendency to dole out SBC and the higher capital intensity over the years which necessitate more and more to focus on FCF. As I will show you later, the skeptics may have a point, but the numbers still point out how attractive Big Tech was in retrospect! Amazon is an anomaly here as they relentlessly deploy all of their operating cash flow. Nonetheless, Big Tech generated $1.3 Tn “true” Free Cash Flow (FCF), which is defined as Operating Cash Flow-Capex-Stock-based Compensation (SBC). Again, **this “true” FCF was \~$160 Bn higher than their aggregated market cap in 2012**. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/08/image-7.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Clearly, investors deeply underestimated Big Tech ten years ago, but did things change five years ago? From OCF perspective, it appears they were still quite underappreciated in the beginning of 2018 even though the depth of underappreciation dwindled a bit. All five companies generated \~40-50% of their 2017 year end Market cap in 2018-2022 aggregate operating cash flows. It is certainly quite conceivable that by 2027, perhaps all of them would generate OCF more than their 2017 market caps! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/08/image-8.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) The narrative, however, gets complicated when it comes to “true” FCF. While Amazon remained true to its color by redeploying their entire OCF, Meta and Alphabet seemed to have followed a similar, but unexpected trajectory. What benefitted Apple and Microsoft (to a large extent) is their primary source of cash machines remained somewhat capital light. As a relatively late entrant, Alphabet ramped up their investments in Cloud. Alphabet was also transitioning to be “AI-first” company which likely required significant human and financial capital investments. Similarly, gone are the days of capital light social media businesses! With everyone’s feeds now being intensely personalized with ongoing shift from text to images to videos, Meta required to grow up to that reality (ATT only worsened the situation). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/08/image-4.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) These somewhat divergent paths are reflected in their returns since 2018\. Investors were surprised to understand the capital intensity of Alphabet and Meta’s core businesses whereas they likely grew a bit tired of Amazon’s relentlessness and started entertaining healthy amount of skepticism about their ROI on recent investments. ![chart](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0ac3665c-abd4-4c2d-a230-894b953342cc_2400x1240.png "chart") Source: KoyFin (MBI Deep Dives readers get 15% discount; just click [****here**](https://koyfin.com/?via=abdullah&ref=mbi-deepdives.com)) The real question, however, is whether this was just an investment cycle required for them to grow to the new reality further extending their moats. **This question will take time to answer** as given the recent Generative AI enthusiasm, the investment cycle is not quite over yet. While nobody quite expects that the capital intensity will return to the level of 2012-2017 period, it is certainly conceivable that investors extrapolating recent capex bonanza till eternity may turn out to be a key source of alpha for long-term investors. Why do I say that? Meta, and Amazon are **currently trading at** **lower** OCF multiple than they were trading back in 2013\. The set up remains quite attractive if the persistence of capital intensity (not just in absolute dollars but as % of their revenues or OCF) turns out to be overstated. Apple and Microsoft, on the other hand, went from “impending terminal businesses” to durable cash gushers in investors mind. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/08/image-3.png) Source: MBI Deep Dives Despite lower multiples, we perhaps cannot expect similar returns from some of these stocks due to important changes in initial conditions. At the end of 2012, Instagram may not have generated its first dollar of revenue yet. AWS “IPO” happened in 2015, so you can imagine Google Cloud or Azure did not even enter investors consciousness back then. LinkedIn was still an independent company and Big Tech were still allowed to acquire companies and could use their massive distribution to scale those businesses. Apple was considered a “hardware business” destined to lose their profit pool to cheaper phones over time. Many of those optionalities could not possibly be modeled back then and the reality is the world has never seen such **a dominant group of global companies** **in the history of capitalism** which led to this deep underappreciation for such a long time which arguably somewhat still persists. But it also introduces questions: what are the current set of optionalities for Big Tech today that are hard to model and hence value appropriately? For Alphabet, the first word that comes to my mind is Waymo. For Apple and Meta, it is AR/VR. Amazon has a whole host of “other bets” that are barely disclosed (Kuiper, Alexa to name a couple). It can also be hard to pinpoint how much Microsoft is the key beneficiary of Generative AI. It may understandably seem to investors that these “optionalities” are far less lucrative than their former versions. Hindsight is 20-20 and perhaps impossible to imagine today how preposterous it would seem to claim in 2012 AWS revenue would be $80 Bn in 2022! Nonetheless, I too broadly agree that these set of optionalities are likely to be much more underwhelming than the last ten years, but companies trading at similar or lower valuation multiples somewhat relieve us from making those bold predictions anyway with the caveat that we need to assume managers/operators of these businesses will act rationally if these optionalities prove to be value destructive. It is a nuanced point; in all likelihood, AR/VR is worth "negative" for Meta *today;* to create value for today's shareholders, AR/VR doesn't have to start a new "smartphone" revolution, but just have to be a real, not an imaginary, business. And if the real business proves to be reasonably attractive, that is quite certainly far from being priced in the stock. I can do these for Alphabet and Amazon as well, but you hopefully get the idea. While all of these may seem quite long-term questions, I am of the opinion that these are the kind of questions, along with durability of their core businesses, are really the **questions that matter**. To substantiate this point, I will leave you with an excerpt from Edward Chancellor’s book “[Capital Returns](https://www.amazon.com/Capital-Returns-Investing-Through-Managers/dp/1137571640?ref=mbi-deepdives.com)”: > While the case for long-term investment has tended to centre around simple mathematical advantages such as reduced (frictional) costs and fewer decisions leading (hopefully) to fewer mistakes, **the real advantage to this approach, in our opinion, comes from asking more valuable questions**. > > The short-term investor asks questions in the hope of gleaning clues to near-term outcomes: relating typically to operating margins, earnings per share and revenue trends over the next quarter, for example. Such information is relevant for the briefest period and only has value if it is correct, incremental, and overwhelms other pieces of information. Even when accurate, the value of the information is likely to be modest, say, a few percentage points in performance. In order to build a viable, economically important track record, the short-term investor may need to perform this trick many thousands of times in a career and/or employ large amounts of financial leverage to exploit marginal opportunities. > > And let’s face it, the competition for such investment snippets is ferocious…Can there really be much of value to say about industry developments over such limited time frames? Of course not. Even so, we would hate to discourage such research as, from time to time, what the short-term guys are selling can turn out to be wonderful long-term investments. > > ...**The longer one owns the shares, however, the more important the firm’s underlying economics will be to performance results. Long-term investors therefore seek answers with shelf life.** What is relevant today may need to be relevant in ten years’ time if the investor is to continue owning the shares. Information with a long shelf life is far more valuable than advance knowledge of next quarter’s earnings. Thank you for reading! For more detailed analysis of Big Tech, click here: [Meta](https://www.mbi-deepdives.com/meta2023/), [Amazon](https://www.mbi-deepdives.com/tag/amzn/), [Alphabet](https://www.mbi-deepdives.com/goog/), [Microsoft](https://www.mbi-deepdives.com/msft/). [Subscribe](#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Dollar General: Rural America's Retailer URL: https://www.mbi-deepdives.com/dg/ Last updated: 2023-08-24T14:26:35.000Z _This post is for paying subscribers only._ ### Amazon 2Q'23 Earnings Update URL: https://www.mbi-deepdives.com/amzn2q23/ Last updated: 2023-10-26T20:17:52.000Z **Disclosure: I own shares, and Jan 2025 $55 call options of Amazon** This was perhaps the best Amazon earnings call from my recent memory, especially on Amazon Retail. Not surprising that the stock was +8% in after hours. Here are my highlights from tonight’s call. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Revenue** 3P, subscription, and AWS grew by mid to high teen while ad segment increased by 20%+ The mix-shift from product to services in Amazon continues as services mix increased from \~40% in 2018 to \~60% in 2023. Let’s start more segment level discussion with AWS. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa41a3018-4ffa-4da1-9d3d-d14cc8b9d545_2154x304.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AWS** After experiencing its first QoQ revenue decline in 1Q’23, AWS added $786 Mn revenue QoQ in 2Q’23\. The 12% YoY growth reflects the tough comp of 2Q’22; since cost optimization mostly started in the latter half of last year, 3Q’23 and 4Q’23 may prove to be easier comp for AWS. More on this later. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa56e069b-6e9d-4ca4-aa84-397bbfcc6978_1418x718.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Azure vs Google Cloud vs AWS** Now that we have all the hyperscalers earnings report this quarter, here’s how their growth stacks against each other. As Jassy reminded during the call, don’t ignore the base effect while thinking about % growth: “…*AWS has almost doubled the revenue of any other provider.*” ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9da45cdc-a38e-4782-b904-cf8ffa7c4b39_1654x994.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink); \*Google Cloud includes Google Workpace, so not quite apple-to-apple and in reality, GCP grew faster than Google Cloud One thing I would like to track is Google Cloud’s operating performance trajectory against AWS. While Google Cloud’s revenue continues to build its gradual momentum against AWS, opex trajectory went slightly in the wrong direction. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2314464c-09eb-49f8-81a5-cd93cc4c6476_1210x766.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0334596e-f5eb-46df-ba7b-a8233233f976_1222x762.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) As I have mentioned in Google [update](https://www.mbi-deepdives.com/goog/) early this year, Google Cloud’s revenue closely tracks AWS revenue trajectory just four years apart! ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa8c64ce5-6ee0-449c-a66c-dd4aa2757073_936x330.png) Source: Company Filings, MBI Deep Dives Okay, back to AWS. AWS incremental operating margin continued to struggle this quarter as well. At least, operating margin was slightly up, so hopefully AWS operating margin already bottomed in 1Q’23. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffdd080a9-1269-498d-9568-dfd54e4f9065_1556x164.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F085cd893-607b-47a1-bfa9-0dfa06dfd907_1738x898.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Amazon thinks AWS is pretty well positioned for Generative AI (I’m skipping more details as much of it was mentioned in earlier quarters as well): > Remember, the core of AI is data. **People want to bring generative AI models to the data, not the other way around. AWS not only has the broadest array of storage, database, analytics and data management services for customers, it also has more customers and data store than anybody else**. It seems highly likely that the cost optimization headwinds may be behind us: > What we're seeing in the quarter is that **those cost optimizations, while still going on, are moderating and many maybe behind us in some of our large customers. And now we're seeing more progression into new workloads, new business.** So those balanced out in Q2\. We're not going to give segment guidance for Q3\. **But what I would add is that we saw Q2 trends continue into July. So generally feel the business has stabilized, and we're looking forward to the back end of the year** **Amazon ex-AWS** Personally, the highlight from this call was Amazon Retail. Just see the material margin momentum in North America segment from 1.2% operating margin last quarter to 3.9% this quarter. International segment is also on the right direction: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1e611a80-6c6e-4097-91b2-d5c2f5de8e1b_1262x810.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Management also re-iterated that margins can not only go back to pre-Covid level but do even better: > I continue to believe what I said last quarter…which is I do believe that **we'll get back to margins like what we had pre COVID. And I don't think that's the end of what's possible for us there.** **Shopify vs Amazon** One metric I like to track is Shopify vs Amazon GMV trajectory. Shopify has so far been able to keep up with Amazon. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F93fe95a3-cffa-429f-a5a4-8e6b8804d7a8_1472x888.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Amazon Business is currently at $35 Bn** gross sales run-rate. Jassy thinks it can be $100 Bn+ business over time. **Fulfillment+ Shipping** The primary reason I thought this earnings call was excellent is I am much more optimistic about shipping and fulfillment cost as % of GMV may come down over time. For the fourth consecutive quarters, shipping and fulfillment costs are growing slower than unit growth. 3P units were 60% of overall mix (highest ever) and Amazon saw “good growth in the number of sellers and the unit sold per seller.” In 2017, Amazon’s shipping and fulfillment expenses as % GMV was estimated to be \~19% which consistently crept upwards every year to exceed \~25% in 2022\. This has started to come down this year; I estimate this number was 24.7% in 1H’22 but declined by 190 bps YoY to 22.8% in 1H’23. If long-term shipping and fulfillment expenses is actually closer to \~20% (or lower), the valuation implications are quite intriguing. I encourage you to play with these assumptions in my [Amazon model](https://www.mbi-deepdives.com/models/). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F16c6db77-6fdc-4f1c-af45-9d19095927f1_1674x770.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) But is such cost structure possible for Amazon Retail? Isn’t same day shipping going to make life difficult for Amazon to attain such cost structure? This calls makes me optimistic about these questions: > Central to our efforts has been the decision **to transition our stores' fulfillment and transportation network** **from 1 national network in the United States to a series of 8 separate regions serving smaller geographic areas. We keep a broad selection of inventory in each region, making it faster and less expensive to get those products to customers.** > > Regionalization is working and has delivered **a 20% reduction in number of touches for our delivered package, a 19% reduction in miles traveled to deliver packages to customers and more than a 1,000 basis point increase in deliveries fulfilled within region, which is now at 76%.** This is a lot of progress. Sometimes I hear people make the argument that Amazon is chasing faster speed while driving its costs higher and where it doesn't matter much to customers. **This argument is incorrect. There are 2 things to note. First, customers care a lot about faster delivery. We have a lot of data that shows when we make faster delivery promises on a detail page, customers purchase more often, not just a little higher, meaningfully higher. It's also true that when customers know they can get their items really quickly, it changes their consideration of using us for future purchases, too.** > > Second, **when shipments come from fulfillment centers that are closer to customers, they travel shorter distances, which cost less in transportation, get there faster and is better for the environment. There's a lot of goodness in that equation.** This ability to have shipments closer to customers is the result of a lot of work and invention on the regionalization side, placement logic and local in-stock algorithms. It's also driven by our development and expansion of same-day fulfillment facilities, which is our fastest fulfillment mechanism and one of our least expensive, too. > > Our same-day facilities are located in the largest metro areas around the U.S. so our top moving 100,000 SKUs but also cover millions of other SKUs from nearby fulfillment centers that inject selection into these same-day facilities and **have a design that streamlines getting items from order to being ready for delivery in as little as 11 minutes. The experience has been so positive for customers in our business that we're planning to double the number of these facilities. We believe that we are far from the law of diminishing returns and improving speed for customers.** > > In this last quarter, **across the top 60 largest U.S. metro areas, more than half of Prime members' orders arrived at the same day or next day. So far this year, we've delivered more than 1.8 billion units to U.S. Prime members the same or next day, nearly 4x what we delivered at those speeds by this point in 2019.** **Opex+Capex** The way Amazon has increased SBC intensity is not really a good look. SBC as % of revenue used to be <3% in 2018-2021, but crept up to \~4% in 2022 and was >5% in 2Q’23\. Diluted shares outstanding was +2.7% YoY, not an acceptable dilution for \~$1.5 Tn company. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F209d127c-6c51-43e9-8592-1d0cd89e0590_2516x382.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Amazon’s LTM Capex+ finance leases was $54 Bn, down from $61 Bn; guidance for 2023 is slightly more than $50 Bn (vs $59 Bn in 2022). Much of the capex is going to AWS: > On the how much generative AI may impact the capital expense spend, included in that number **is a pretty significant amount of capital expense in the AWS business** for large language models and for generative AI. And we have quite a bit of demand right now. And so it's -- like in AWS in general, **one of the interesting things in AWS, and this has been true from the very earliest days, which is the more demand that you have, the more capital you need to spend because you invest in data centers and hardware upfront and then you monetize that over a long period of time.** > > So I would like to have the challenge of having to spend a lot more in capital in generative AI because **it will mean that customers are having success and they're having success on top of our services** and -- but I think that, that's our best estimate right now on that capital expense and we'll update it if we find it's different. **Other Bets** Apart from SBC, another not so great spot is Amazon’s continued reluctance to share “other bets” details with shareholders. I suspect I may care about this detail more than most Amazon shareholders. Let me explain why. Before Meta disclosed Reality Labs (RL) expenses, many investors/analysts were underwriting \~$5 Bn loss estimates/year for RL. But when they started disclosing, we got to know investors materially underestimated the expenses. My primary concern is something similar may be happening here at Amazon as well. While minority shareholders don’t quite have a strong say in how Amazon will allocate their capital (probably nobody has enough % of ownership in Amazon to have material influence even if there is no dual class share structure), at the very least we can make a much more informed decision in valuing Amazon. **Outlook** Amazon’s guidance for 3Q’23 is below: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa3b6760e-fdcb-4741-8b97-46db2327316d_1310x270.png) Thank you for reading. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Meta 2Q'23 Earnings Update URL: https://www.mbi-deepdives.com/meta2q23/ Last updated: 2023-10-25T21:23:35.000Z *Disclosure: I own shares, and Jan 2025 $50 call options of Meta* While the stock is up +6-7% after hours, I found some mixed signals on this call to keep both bulls and bears interested. In any case, I have never found Meta’s earnings calls monotonous! Here are my highlights from tonight’s call. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Users** Facebook exceeded 3 Bn MAU for the first time, and MAP is now approaching 4 Bn. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F38baec2b-18ba-4164-aed8-eda71bd7f385_2210x646.png) **Engagement** DAU/MAU engagement looks steady across all regions. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F405ce54c-a230-4338-927f-edb12fa9ca44_2212x726.png) **ARPU** While ARPU exhibited considerable strength, please note the material weakness in YoY comparison. One interesting thing is Europe, APAC, and RoW had higher ARPU in 2Q’23 than they had in 4Q’22 which is a holiday season! ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1b130009-796b-476d-acdb-c215bab671c1_1832x258.png) **Ad revenue** For the second consecutive quarters, number of ad impression growth and change in average price per ad is moving in the same direction; it’s the derivative that matters! Lower price is driven by higher impression growth in APAC and RoW as well as lower monetizing surfaces (i.e. Reels). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F527287ac-04f1-429e-9848-156f49c23650_1282x734.png) ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0d2d9ece-6192-4040-aa24-b3039630ed34_1832x700.png) **Segment Reporting** Topline grew by 11% (1% FX headwind). Reality Labs (RL) revenue declined by 39% YoY and lost $3.7 Bn this quarter. 2023 RL losses are still expected to exceed 2023 losses which will be higher than 2022’s. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8d54c69b-6dbd-421b-aa03-c597e88dafb0_1658x636.png) **Facebook** AI-recommended content led 7% increase in overall time spent on Facebook. **Reels** In 3Q’22 call, Meta mentioned there are 140 Bn Reels played across Facebook and Instagram each day. That number exceeded 200 Bn last quarter. 75% of Meta’s advertisers are now using Reels. Annual revenue run rate from Reels exceeded $10 Bn in 2Q’23 which was $3 Bn last fall. TikTok [reportedly](https://www.wsj.com/articles/tiktok-struggling-with-slowing-digital-advertising-industry-lowers-ad-revenue-outlook-11668139787?ref=mbi-deepdives.com) generated $10 Bn revenue in 2022; it is perhaps not aggressive to think that Reels may exceed TikTok revenue by next year. Meta is routinely under the wrath of investors (often by its own shareholders), but I have to take a moment and applaud what they achieved here. Admittedly, I was a bit nervous about rise of TikTok and whether Meta will be able to rearchitect FOA properties to build a compelling alternative. They clearly have exceeded my expectations. However, increased time spent will not grow revenue linearly: > we continue to expect time on Reels will monetize at a lower rate than Stories and feed for the foreseeable future since people scroll more slowly through video content. **WhatsApp** WhatsApp Business now has 200 mn users who will “be able to create click to WhatsApp ads for Facebook and Instagram without needing a Facebook account. This is a pretty big unlock, particularly in countries where WhatsApp is often the first step to bring a business online.” > The number of businesses using our paid messaging products has doubled year-over-year. > > click-to-WhatsApp ads revenue continues to grow very quickly at over 80% year-over-year. **Threads** Zuck mentioned the initial reaction to Threads exceeded their expectation and their main focus is on retention now. Don’t model Threads monetization too soon; Meta indicated they want to reach “hundreds of millions” users before thinking about monetization. Zuck hopes Threads might be the 5th big app of Meta’s FOA properties: > I do think it has been sort of this weird anomalous thing in the tech industry that there hasn't been an app for public discussions like this that has reached 1 billion people. As expected, there was a lot of discussion on AI. **AI for Advertisers** > **Almost all our advertisers are using at least one of our AI-driven products**. We've also deployed Meta Lattice, a new model architecture that learns to predict ads performance across a variety of data sets and optimization goals. And we introduced AI Sandbox, a testing playground for generative AI-powered tools like automatic text variation, background generation and image outcropping. One thing that stood out to me was why Meta thinks “AI agent” may finally launch messaging monetization spigot: > You can imagine a world on this where over time, every business has as an AI agent that basically people can message and interact with. > > it should alleviate one of the biggest issues that we're currently having around messaging monetization is that in order for a person to interact with a business, it's quite human labor-intensive for a person to be on the other side of that interaction, which is one of the reasons why we've seen this take off in some countries where the cost of labor is relatively low. > > But you can imagine in a world where every business has an AI agent, that we can see the kind of success that we're seeing in Thailand or Vietnam with business messaging could kind of spread everywhere. My brother runs an SMB which often deals with this issue; they receive far more messages (at times in a very short window if they have a discount offer going on) that any human(s) can deal with. Meta’s rationale makes intuitive sense and it can indeed be gamechanger if the “AI agent” is well executed. **AI for Consumers** On a consumer level, Meta’s plans are also quite expansive, but there will be more clarity and product launches later this year: > We are also building a number of new products ourselves using Llama that will work across our services. I'm going to share more details on that later this year. But you can imagine lots of ways that AI can help people connect and express themselves in our apps. **Creative tools that make it easier and more fun to share content, agents that act as assistance, coaches that can help you interact with businesses and creators and more.** And these new products will improve everything that we do across both mobile apps and the metaverse, helping people create worlds and the avatars and objects that inhabit them as well. If Snap’s “My AI’ [learnings](https://newsroom.snap.com/en-GB/early-insights-on-my-ai?ref=mbi-deepdives.com) is any indication, this can get quite interesting; if this takes off, I expect Meta to take some digital ads market share from Google. **Llama and Open Source** Why open source? > Llama is an open source project, which is a little bit different from building out a developer platform, although there will be an ecosystem around this. What we've seen around open source work that we've done, which we've done a lot of in our core infrastructure work, design of servers and data centers and basic infrastructure as well as in AI. And I pointed out some of these in my remarks upfront, like PyTorch and just a bunch of other models that we've released recently. > > One of the things that we've seen is that when you release these projects publicly and open source, there tend to be a few categories of innovations that the community makes. So on the 1 hand, I think it's just good to get the community standardized on the work that we're doing. That helps with recruiting because a lot of the best people want to come and work at the place that is building the things that everyone else uses. It makes sense that people are used to these tools from wherever else they're working. They can come here and build here. In case Llama indeed becomes the industry standard, Meta made sure their main competitors won’t use the model for free. Anyone with more than 700 mn users will have to pay fees to Meta to use and build on top of Llama: > one of the things that you might have noticed is in addition to making this open through the open source license, we did include a term that for the largest companies, **specifically ones that are going to have public cloud offerings, that they don't just get a free license to use this. They'll need to come and make a business arrangement with us.** > > And our intent there is we want everyone to be using this. We want this to be open. But **if you're someone like Microsoft or Amazon or Google and you're going to basically be reselling these services, that's something that we think we should get some portion of the revenue for. So those are the deals that we intend to be making, and we've started doing that a little bit. I don't think that, that's going to be a large amount of revenue in the near term. But over the long term, hopefully, that can be something.** Zuck is also aware that the conversation around AI safety is evolving and he kept the door open to not make everything open source in case there is real danger but also reminded that the companies who are in the business of **selling** their model may have vested interest in touting AI’s danger to make things “closed” source: > by open sourcing Llama now… we intentionally did not go out there and say we're going to open source every single thing in the future because we do want to have the space to be able to look at how the safety landscape evolves. And if we think that we do cross some kind of critical threshold in the future, it may not be the right thing to open source it in the future. But for our business model at least, since we're not selling access to this stuff, it's a lot easier for us to share this with the community because it just makes our products better and other people, and that, I think, is a really healthy dynamic for the industry. **Metaverse** Quest 3 is going to be launched during this year’s Connect. > Quest 3 is going to be the first mainstream accessible device that we expect many millions of people will get to experience this technology with. The metaverse content and software vision continues coming together as well. We recently announced that Roblox is coming to Quest with an open beta on App Lab. Quite a few push back from the analysts on Meta’s Metaverse spending. Meta tried to defend: > a lot of the investment that's driving the growth here is around conducting the fundamental R&D to solve hard technology problems…A lot of it is around clearing technical hurdles that will make subsequent devices smaller, cost less, weigh less, et cetera. I guess the question that looms large on my mind is whether this is a capital question or a limitation of Physics. Is throwing more money at the problem going to lead to solve the technical challenges in AR glass? For a moment, Zuck seemed to acknowledge how things are not going according to their plan here: > …I'd say the signals that we're getting from the market are it's certainly not getting adopted a lot faster than we expected so **that's sort of the somewhat sobering signal**. Zuck is aware that investors are not quite fond of this bet: > At a deep level, **I understand the discomfort that a lot of investors have with it** because it's just outside of the model of, I think, **even most long-term investors how you would think about this. And look, I mean, I can't guarantee you that I'm going to be right about this bet.** I do think that this is the direction that the world is going in. There are 1 billion or 2 billion people who have glasses today. I think in the future, they're all going to be smart glasses. Zuck reminded how the owners of the current mobile computing platforms made life difficult for Meta. Even though Meta is quite successful despite playing by the platforms’ rules, Zuck probably feels deeply uncomfortable in playing by their ever changing, arbitrary rules: > we've been quite successful at building large-scale social experiences within the constraints of platforms that often our competitors are defining. I think we're going to be able to do even better work. And there's a lot of things that I would like to see us build that we just can't because of the ways that we're constrained by the competitors who build these platforms. My guess is if Quest 3 is not successful (like selling less than 5 mn units in 6 quarters after launch), Meta may scale back on VR but will keep trying to solve AR glass. But there seems to be bit of **emotions** involved here, so it is not a very high confidence “guess”. > I know from an investor standpoint, most people aren't investing on quite as long of a time horizon as we are here, so I kind of get that, a lot of investors might want to see us spending less here in the near term. My view is that we are leading in these areas. I believe that they're going to be big over time. I think we've shown that we can deliver good business results in the near term while investing ambitiously in the long term. So I'm planning on continuing to do that, and I do continue to believe that over time, we will be happy that we did that. **Efficiency** Zuck praised how a small team basically launched Threads and how that chimes well with Year of Efficiency. Zuck re-emphasized on the efficiency theme even though the worst seems to be behind them: > Over the next few months, we're going to start planning for 2024\. And I'm going to be focused on continuing to run the company as lean as possible for these cultural reasons, even though our financial results have improved. I expect that we're still going to hire in key areas, but newly budgeted headcount growth is going to be relatively low. However, the efficiency messaging has bit of a mixed signal. While headcount growth may be limited, expect payroll expenses to go up (AI folks are highly sought after) and Metaverse losses will keep piling up (they did mention that in 1Q’23 as well, so not a new message in this call though): > we anticipate growth in payroll expenses as **we evolve our workforce composition toward higher-cost technical roles**. Finally, for Reality Labs, **we expect operating losses to increase meaningfully year-over-year due to our ongoing product development efforts in AR, VR** and our investments to further scale our ecosystem. **Capital Allocation** Meta mentioned they would like to be near net cash neutral over time which I am very glad to hear. Surprisingly, they hardly did much share buyback this quarter, and I’m not sure I understand why (analysts didn’t ask anything on this). Like many investors, I often complained about Meta’s buyback decisions in the past. While there are certainly valid criticisms to make Meta’s buyback decisions in 2021-22 period, in retrospect I think I have misunderstood Meta’s broader buyback policy. When it comes to buyback, there are two lenses to look at it: Return **Of** Capital, and Return **On** Capital. Supermajority of investors, including me in the past, seem obsessed with return on capital when it comes to buyback. But the data seems pretty evident: big tech mostly doesn’t think deeply about return on capital in their buyback decision; they just want to mostly return the capital back to shareholders i.e. return of capital. Let me share some data to put this in context. From 1Q’20 to 2Q’23, both Google and Microsoft generated \~$208 Bn FCF (yes, same). Microsoft returned 76% of that in the form of dividend and buyback while Google returned 82% of FCF during this time in just buybacks. Meta, on the other hand, generated $98 Bn FCF from 1Q’20-2Q’23 and they bought back $99 Bn shares. Seeing in this light, we can see a clear theme in how big tech allocates capital to buyback. And if you really want big tech to focus on return **on** capital, be careful what you wish for. Let’s be honest: would we really want big tech to accumulate cash on their balance sheet in 2020-21 in the chance that we were on the bubble and they could buyback shares when stock craters? Again, this is not a defense of Meta’s ill-timed buybacks in 2021, rather a general explanation of how I think big tech thinks about buyback. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fac593eed-29d8-4ae6-a672-c8c713380e60_2208x496.png) **Opex Guide** Meta increased their opex guide range from $86-90 Bn to $88-91 Bn. Historically, they usually trim their opex guide over the course of the year, but they had a legal-related expense which probably contributed to the increased range. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Feec0d3de-f081-4bb4-ab57-f59e7398bc20_1662x824.png) **Capex** Perhaps surprisingly, Meta lowered capex guide for this year, but it’s mostly just shifted to 2024: > …The other major budget point that we're working through is what the right level of AI CapEx is to support our road map. **Since we don't know how quickly our new AI products will grow, we may not have a clear handle on this until later in the year**. > > **We expect capital expenditures to be in the range of $27 billion to $30 billion, lowered from our prior estimate of $30 billion to $33 billion. The reduced forecast is due to both cost savings, particularly on non-AI servers as well as shifts in CapEx into 2024 from delays in projects and equipment deliveries rather than a reduction in overall investment plans.** Looking ahead, while we continue to refine our plans as we progress throughout the year, we currently expect total capital expenditures to grow in 2024, driven by our investments across both data centers and servers, particularly in support of our AI work. > > ..**we are mindful of our intention to reduce the capital intensity of these investments over time.** **Regulation** The following bit (especially the bold line) stood out to me and to my utter surprise, there was not a single question asked on this point during the call; this remains a pivotal risk for Meta’s business in the long term as the philosophy of “surveillance capitalism” becomes more mainstream: > With respect to EU-U.S. data transfers, we saw a positive development with the European Commission's adoption of a final adequacy decision, which allows us to continue to provide our services in Europe. This is good news, though broadly speaking, **we continue to see increasing legal and regulatory headwinds in the EU and the U.S. that could significantly impact our business and our financial results**. **Outlook** Meta guided $32-34.5 Bn for 3Q’22 (expectation was $31.2 Bn); +20% YoY growth on the high-end. +3% FX tailwind expected in 3Q’23 and 3Q’22 was -4.5% topline quarter, so YoY comparison is a lot easier. Nonetheless, the guide clearly indicates Meta’s relative strength today. **Closing Words** Overall, Meta is at an intriguing place today: on one hand, there are exciting opportunities on the near to mid term horizon (Reels, Messaging, and even AI can have material impact in relatively quick time), but on the other hand, Meta’s long-term bet on Metaverse continues to stand on quite fragile foundation. Bears should marvel a little bit at Meta’s strength and continued ability to adapt at its core business, and bulls should wait a little bit before going euphoric due to near-term wins. More thoughts from the follow-up call, 10-Q, and current valuation **[here](https://twitter.com/borrowed%5Fideas/status/1684542652241395713?ref=mbi-deepdives.com)** I will cover Amazon next week. Thank you for reading. If you are not a subscriber yet, please consider subscribing and sharing it with your friends: [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Alphabet 2Q'23 Earnings Update URL: https://www.mbi-deepdives.com/goog2q23/ Last updated: 2023-10-24T22:15:42.000Z *Disclosure: I own shares, and Jan 2025 $50 call options of Alphabet* > “With 15 products that each serve half billion people and 6 that serve over 2 billion each, we have so many opportunities to deliver on our mission.” > > \-Sundar Pichai (2Q’23 Earnings Call) Here are my highlights from Alphabet’s call tonight. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Revenue** Topline grew +9% FXN. While Google Services revenue growth was flat in 1Q’23, it was 5.5% YoY in 2Q’23, with growth re-accelerating in every component of Google Services. Despite cost optimization efforts by customers, Google Cloud maintained its momentum with \~28% YoY growth (same as it was in 1Q’23). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fcef53831-0ebb-4f0a-a321-389c2cc1f4fd_2176x484.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **EBIT** Google Services maintained mid-30s EBIT margin. But note the following: > Costs associated with the Brain Team, which were previously included in Google Services, are now reported as part of Alphabet's unallocated corporate costs. So, on an apple-to-apple basis, Google Services margin would be slightly lower this quarter than reported (say, \~$500 Mn opex for Google Brain). Google Cloud improved its margin to MSD. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc993015c-af6c-49cd-a9d4-830a8e74b2a9_2084x546.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Search** Google launched “Search Generative Experience” or SGE" in May. Sundar sounds excited on initial feedback: > The feedback has been very positive. We've just **improved our efficiency pretty dramatically** since the product launch. **The latency has improved significantly**. We are keeping a very high bar, but I would say **we are ahead on all the metrics in terms of how we look at it internally**. Google is currently building Gemini, a multimodal Large Language Model, which Google believes will make the user experience even better. How about monetization? If one thing we can be relatively confident about, it is Gen AI will have material impact on how advertisers work with Google’s ad products. Some excerpts on this point below: > Ads will continue to play an important role in this new search experience. Many of these new queries are inherently commercial in nature. We have more than 20 years of experience serving ads relevant to users' commercial queries, and SGE enhances our ability to do this even better. We are testing and evolving placements and formats and giving advertisers tools to take advantage of generative AI. > > It's worth reiterating that while generative AI is now supercharging new and existing ads products with tons of potential ahead, AI has been at the core of our ads business for years. In fact, today, **nearly 80% of advertisers already use at least one AI-powered search ads product.** > > …later this year, **Automatically Created Assets, which are already generating headlines and descriptions for search ads, will start using generative AI to create assets that are even more relevant to customer queries**. > > To…**drive consideration in the mid funnel, we're launching 2 new AI part ad solutions, demand gen and video view campaigns, and both will include (YouTube) shorts inventory.** **YouTube** YouTube’s +4% YoY ad revenue in 2Q’23 (vs -2.6% in 1Q’23) driven by growth in brand, followed by direct response, reflecting further stabilization in advertiser spend. Shorts is now watched by 2 Bn people every month (vs 1.5 Bn in 2Q’22) “Google Other” revenue was bit of a surprise with +24% growth in 2Q’23 (vs +8.8% in 1Q’23). This was largely driven by strong growth in YouTube subscriptions revenues (also, Google Play growth turned positive this quarter). While 70% gen AI unicorns are Google Cloud customers, and more than 750k Workspace users have access to new features such as Duet AI in preview. Google thinks upsell opportunities exist on their 9 mn installed base of Google Workspace customers. Google indicated optimization still is continuing: > we saw a continued moderation in the rate of consumption growth as consumers optimize their spend **Headcount** The recent layoff hit the headcount number last quarter. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4acb954a-11c5-4b0f-9a6d-819fa7b7bb4a_1162x630.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capital Allocation** Google utilized \~70% of their FCF in buyback which led to 46 bps decline QoQ in diluted shares outstanding. They still have $105 Bn net cash on balance sheet. If they don’t want to deplete the net cash balance, at least utilize 100% FCF to buyback shares. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F599629e5-614e-4892-933c-03eb2f0b5830_942x594.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex** Google mentioned earlier that 2023 capex to be modestly higher than 2022\. But so far after 1H, capex in 2023 stands at $13 Bn (vs $16.6 Bn in 1H’22). But Google reiterated their capex guidance which means we probably should expect \~$20 Bn capex in 2H’23\. And the capex train will continue in 2024 as well. Here’s how Ruth explained this capex cadence: > as it relates to CapEx, in Q2, **the largest component was for servers, which included a meaningful increase in our investments in AI compute**. The sequential step up in the second quarter was lower than anticipated for 2 reasons. First, with respect to office facilities, we continue to moderate the pace of fit-outs and ground-up construction to reflect the slower expected pace of headcount growth. Second, there were delays in certain data center construction projects. **We expect elevated levels of investment in our technical infrastructure increasing through the back half of 2023 and continuing to grow in 2024.** **The primary driver is to support the opportunities we see in AI across Alphabet, including investments in GPUs and proprietary TPUs as well as data center capacity.** With all that said, we remain committed to durably reengineering our cost base in order to help create capacity for these investments in support of long-term, sustainable financial value. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb77ad275-cd01-46d2-9329-1ffe908552ed_1144x618.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Valuation** I share this back-of-the-envelope valuation table on Google every quarter to have a quick gut check. When Google was trading at $100 or below, investors mostly needed to be confident about relevance of Google search in 5-10 years. Today, we also need to underwrite both sustainability and growth in Google Services business (led by Google Search, but YouTube will also have to play its role). ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9fbb84ca-5928-4026-a0e4-e2186bf6a93b_2492x500.png) Source: MBI Deep Dives I will cover Meta’s earnings tomorrow! Thank you for reading. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Spotify 2Q'23 Earnings Update URL: https://www.mbi-deepdives.com/spot2q23/ Last updated: 2023-07-25T16:56:14.000Z *Disclosure: I own shares of Spotify* Spotify stock has been one of the “winners” in 2023\. A week ago, its YTD was +130%. With Generative AI, price increases, and potential margin improvement speculations, the stock crumbled after today’s earnings as it mostly appears to be very much “work-in-progress” story, and there’s not quite inflection point in sight, yet! Here are my highlights from today’s earnings. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Users** Spotify does seem to be hitting on the next gear when it comes to adding users. While Premium net add is quite robust, it is the total MAU (including ad-based segment) that added a record 36 mn users in the last quarter. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7d9e1775-20b2-4925-a998-35d02c713294_2058x210.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Premium Mix** North America and Europe continue to lead Premium subscriber net add growth with 3 mn and 4 mn respectively. Rest of the World (ROW) still seems quite sluggish in converting to premium product; hence, premium as % of total MAU continues to go down. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffaf180ed-144f-4079-ae57-9b6821dd160b_1826x1056.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Netflix vs Spotify** I mention this chart every quarter; it is evident that Spotify’s subscriber growth is reaccelerating. The difference between Spotify and Netflix’s net subscriber adds has narrowed a little since Netflix also accelerated in the last quarter. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F12fa8d7b-68c5-43ae-a12f-abc9b64b0b19_1074x691.png) Source: Company Filings, MBI Deep Dives; Note: definition of subscriber is not apple-to-apple between Spotify and Netflix, so limitations apply. **Revenue** On **constant currency** basis, topline was +14%, Premium segment revenue was +14% and ad revenue +15%. ARPU continues to decline for three consecutive quarters. Podcast ad revenue was +30% while music related ad revenue grew by mid single digit %. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff90c6e47-5f83-4d44-b1c4-f26332b13f14_1796x348.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **ARPU** The recent price increases will probably put an end to QoQ ARPU decline for the next two-three quarters: > Yesterday, we announced broad price increases across more than 50 markets, including most of Europe and North America…And while this won't impact revenue per user much up until the end of Q3, we expect it to have a meaningful impact on Q4 and beyond. The price increases are the most significant in Spotify’s history. Here’s how much price is being increased for different products in the US: Student +20%, Individual +10%, Duo +15%, Family +6% **Gross margin (GM)** Reported GM was 24.1% and adjusted GM was 25.5%. What are these adjustments? > In the quarter, **we took steps to shrink our real estate footprint and rationalize certain areas of our podcasting business. We also exited our Soundtrap marketplace business**. We expect all of these moves to have a positive impact on our rate of profitability on a go-forward basis. However, they did result in roughly **EUR 135 million of net charges in the quarter with EUR 44 million flowing through gross margin and EUR 91 million flowing through our operating expense.** About EUR 25 million of these charges were cash related. Over the last 14 quarters, Premium segment’s GM remains somewhat static at 28%. Analysts asked whether Spotify will enjoy better margin for incremental price increases from the labels. Spotify was pretty tight lipped on that. Ad segment’s margin was positive again, but still miles to go to be considered respectable. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0bbad671-8cbc-4946-b3a5-746fef4be133_1124x674.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AI’s Impact** There were some comments on AI’s impact, but the following bit stood out to me: > if you think about advertisers today, the cost of generating new advertisements on Spotify is quite a big thing, especially on audio ads. By using Generative AI and our tools here, **I think you're going to be able to see that we can significantly reduce the cost that it takes for advertisers to develop new ad formats**. And that obviously means that you as an advertiser instead of having 1 ad, you can imagine having thousands and tested across the Spotify networks. **Things that you could easily do today using text, but you haven't been able to do over video or in audio**. **Opex** With 91 mn one-off charges this quarter, total opex trend may appear worse than it is. Nonetheless, Spotify probably needs to try harder to find efficiency in opex structure. Even if we adjust the one-off charges, total opex would be 120% of gross profit. Clearly, more “efficiency” is required. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fa5949d3c-ec1a-4030-994d-ba6f153b29f5_1800x276.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook for 3Q'23** In 3Q’22, Spotify added 7 mn premium subscribers, but is now guiding 4 mn for 3Q’23\. Why? > Our data would suggest that historical price increases have had minimal impact on growth, but given the breadth of this change and the significant outperformance in the first half of the year, **there is some conservatism baked into our outlook for Q3**. We do expect our net adds through Q3 of this year to be higher than the same point last year, roughly 30% better. Moreover, 600 bps FX headwind is assumed in guide. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F525f144e-37a0-45ed-9974-fb24c201fb7f_1452x502.png) Source: Company Filings You can read my Spotify Deep Dive (December, 2021) [**here**](https://www.mbi-deepdives.com/spot/) I will cover Alphabet’s earnings tonight! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### CSX: The Old School "Monopoly" URL: https://www.mbi-deepdives.com/csx/ Last updated: 2023-07-24T11:28:37.000Z _This post is for paying subscribers only._ ### Meta's Achilles Heel(s) URL: https://www.mbi-deepdives.com/metabear/ Last updated: 2023-07-13T19:21:45.000Z *Disclosure: I own shares and January 2025 $50 Call Options of Meta* [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) First some caveats: while we have all probably read Charlie Munger’s quote *“I never allow myself to hold an opinion on anything that I don't* ***know the other side's*** *argument better than they do”*, the reality is this is exceptionally uncommon and challenging. In fact, when investors mention risks about a company they like, they often deliberately choose strawman arguments from the other side and advertently or inadvertently ignore steelman arguments. I will try to avoid strawman bear cases (and boy there are many), and only outline the bear cases that indeed concern me as a shareholder. Since I am writing about the bear cases, they are known unknown, but obviously there can be unknown unknowns that I may not even be aware but can certainly affect Meta in the long run. Before we get into those long-term concerns, let me start where I have left off in last week’s post: [Meta’s Moat](https://www.mbi-deepdives.com/metamoat/). I have received quite a few insightful constructive feedback. One of the counterarguments was since the business of social media had dramatically changed over the last decade, it is less useful to track where newer social companies are today at similar scale vs where Meta was a decade ago. While I did mention that “the business of social media likely changed forever”, I could have done a better job outlining where things stand today between Meta vs other social companies. For the purpose of this piece, I will primarily focus on Snap to continue the conversation from the last week’s piece. Let’s start with ARPU. Back in [October 2014](https://www.axios.com/2017/12/15/a-timeline-of-snaps-advertising-from-launch-to-ipo-1513300279?ref=mbi-deepdives.com), Snap launched its ads, so it was just \~4% of Meta’s ARPU (see how it is calculated below) in 2015\. But then it quickly ramped up to 12% of Meta’s ARPU in 2016 and reached 22% in 2020\. Then the progress stopped in the last couple of years. Zuckerberg and Spiegel initially had somewhat opposite tones when it comes to [ATT](https://www.singular.net/glossary/app-tracking-transparency/?ref=mbi-deepdives.com#:~:text=App%20tracking%20transparency%20%28ATT%29%20is,by%20companies%20other%20than%20Apple.); Spiegel almost [welcomed](https://9to5mac.com/2021/05/21/snap-ceo-happy-to-pay-app-store-commission/?ref=mbi-deepdives.com) Apple’s ATT but it is ATT that may have played a significant role in stalling their ARPU momentum against Meta. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc4d3da8a-29ab-43b4-9502-73e731ae6aa7_1476x146.png) Meta’s ARPU is calculated based on the company’s reported advertising revenue divided by last four quarterly average of Facebook’s DAU. Please note Facebook’s DAU includes Messenger but doesn’t consider DAU that uses **only** IG **or** WhatsApp **and** not Facebook. Source: MBI Deep Dives, Company Filings Some may wonder whether user mix differentials between these two companies had contributed to the stalling of progress in ARPU. Not really; in fact, while Snap’s ARPU quickly ramped to \~8-9% of Meta’s by mid-2016, it hasn’t been able to gain much ARPU momentum in North America (NA) since then and in recent quarters, it started going in the wrong direction. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff6a5e2f1-7eed-40bc-bb2b-ea95baf8e0ac_1384x812.png) Facebook NA ARPU is calculated based on company disclosed Facebook DAU (not MAU) to make it apple-to-apple with Snap; Source: MBI Deep Dives, Company Filings What somewhat surprised me is that Snap’s ARPU as % of Meta’s ARPU is actually higher in geographies ex-North America. There are interesting implications here which is relevant with my first bear concern about Meta (to be discussed shortly). Let’s look at Opex now. To make it more apple-to-apple, we need to make some adjustments. Since we want to compare Snap to Meta’s FOA business, I have excluded Reality Labs (RL) related opex. Since RL expenses were disclosed from 2019, I have made some assumptions for RL opex in 2015-2018\. I also excluded restructuring expenses for both Meta’s FOA segment and Snap in 2022 as well as Meta’s large legal bills in 2019\. To be fair, Snap also invests in AR but since they don’t quite disclose it separately (and it seems very much part of the core business), I took Snap’s total opex base (ex restructuring) for calculating their Opex per DAU (Note: Snap IPO-ed in 2017 which distorted that year’s number, so I would ignore it). What we see is on a per DAU basis, Snap spent almost half of Meta in the last three years and yet only generated approx. one-fifth of Meta’s ARPU. Without ARPU momentum, Snap’s ability to invest on its own business through the Income Statement will be limited. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F668bc245-705e-49ee-b9be-2ffcf8aa4d5a_1536x182.png) 2015-2018 RL Opex is estimated but 2019-2022 RL opex is disclosed by company. Source: MBI Deep Dives, Company Filings ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb3d997d3-456c-467a-97d0-5efde370ff79_1538x174.png) Snap IPO-ed in 2017 which led to the increase in Opex in 2017; Source: MBI Deep Dives For Meta’s moat, I highlighted two primary moats that are relevant today: a) ability to attract and price talent, and b) regulatory capture are the primary moats of Meta. As ATT and heightened data privacy concerns wrecked havoc in digital advertising (ex Google Search), Snap’s ARPU momentum lost its venom which is presenting Meta a great opportunity to widen the gap from their competitors. What perhaps shocked me is Snap’s SBC per average employee vs Meta’s: ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5d418ea5-c6db-4665-877b-135e0bb2a9d2_1328x782.png) Source: MBI Deep Dives, Company Filings, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) It's a double whammy for a company such as Snap. They need to invest in the next big thing (AR, AI, paying creators for content, ever increasing moderation requirement etc.) while dealing with ATT, GDPR etc. which directly affect ARPU momentum. The way they could have potentially escaped it if their users grew fast so that they enjoy some cost leverage, but despite Facebook’s DAU being 2x Snap’s DAU, Facebook surpassed Snap’s incremental DAU growth YoY for the last couple of quarters. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ff5f198b0-7b6b-4d2e-b018-0bb699871ec4_1092x628.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) While some readers took an issue with whether execution moat is actually sustainable over the long run (management can change or even the existing management can lose direction for variety of reasons etc.), it is perhaps **far less controversial** to say that Snap (or anyone else) would have to execute out of their skins and hope that Meta loses its way a bit to close the competitive gap with Meta. Therefore, you don’t necessarily need to believe whether Meta has execution moat or not, rather I would invert it: you need to assume Meta would be somewhat incompetent exactly when Snap (or anyone else) would execute extremely well. Of course, it may not have to be binary, but given [power laws](https://twitter.com/borrowed%5Fideas/status/1528494526339420161?ref=mbi-deepdives.com) in consumer internet, it may be harder to generate consistent and durable profit for sub-scaled players. But this piece is not about Snap vs Meta and despite what the stock prices can make shareholders feel these days, not everything is puppies and kittens for Meta. My steelman bear cases are two fold: a) Meta’s persistent dependency on North America, and b) the evolution from “social media” to “media social” and social interactions online. Before I elaborate on my bear cases, let me quickly mention the driver of Meta’s revenue today: a) number of DAU or MAU, and b) the time spent on Meta’s platforms. While much of the bear concerns revolve around users leaving the platform that can be potentially accelerated due to reverse network effects, I think it is the “time spent” function that’s lot more credible bear case. Within the time spent function, Meta’s revenue is driven by: a) the volume or number of ad impressions, and b) the effectiveness of ads which affects price per ad. My first “Achilles heel” for Meta revolves around effectiveness of ads while the second one is about volume of ads or number of ad impressions. ### **Meta’s persistent dependency on North America** At first glance, it may sound like a strange bear concern, so allow me to explain. Back in 2009, 36% of Facebook DAU was based in North America (NA) which contributed two-third of the company’s overall revenue. 4 years later in 2013, NA users became 20% of the DAU and 47% of the revenue. As Meta grew its tentacles all over the world, NA DAU became only 10% of overall DAU in 2022\. Surprisingly, NA’s revenue contribution remain almost half of the company’s revenue. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd98c3a96-0eeb-4fe4-b938-76b79da3bdf3_1158x660.png) \*2009-2012 data is only for US, not NA. Source: Company Filings, MBI Deep Dives So, why is this a concern? Two reasons. First, I suspect while there is a massive difference among regions in terms of ARPU, the cost to serve the users may not have much difference. Meta’s ARPU in NA is \~3x Europe, \~11x Asia Pacific, and \~15x Rest of the World. How about the costs? Back in 2012 10-K (first 10-k after IPO), Meta had an interesting paragraph which they didn’t repeat anytime in their annual filings since 2012: > User geography also has some impact on our costs, though in general new users in Asia and Rest of World **do not require material incremental infrastructure investments** because we are able to utilize existing infrastructure such as our data centers in the United States to make our products available to these users. In addition, user growth by geography does not necessarily affect our overall headcount requirements or headcount-related expenses since we are generally able to support users in all geographies from our existing facilities. I imagine they stopped publishing this paragraph because it may be not true anymore. A [2018 blogpost](https://about.fb.com/news/2018/07/hard-questions-content-reviewers/?ref=mbi-deepdives.com) by the company indicated that Facebook’s “safety and security” team employs 30k people (most of them are contract labor and hence not part of company’s headcount). Such moderation requirement certainly didn’t exist in 2012, and since moderating content requires you to understand local context and nuances, I imagine much of this workforce is region specific. Moreover, if political will to control citizens data within their borders gain critical momentum, data infrastructure costs can also become more region specific. With US leading ARPU momentum that the other regions are finding hard to keep up with, there likely is a massive margin differential across regions. Any weakness in the North America business may make life challenging for Meta, and there seems to be one company which has vested interest in making Meta’s life difficult in North America: **Apple** (Well, their feud is global in nature, but the center of the feud and the potential implications for Meta is most acutely felt in North America since this region is much more mature than others and hence growth primarily depends on effective monetization of MAU.) Mark Zuckerberg is fighting against Apple to keep his company’s economics: > "A guy who rises to the top of a big corporation and owns none of it is much more interested in control than he is in economics. It is just the nature of humanity. A guy who owns his business is already used to control. He never has to fight for control. What he has to fight for is economics” > > \-John Malone iPhone is dominant in North America and if iPhone’s market share among teens is any indication, Apple’s dominance in the US is expected to only increase over time. Apple’s continued and persistent dominance in the US can be bad news for Meta. From 2017-2022, Meta’s MAU in the NA increased by \~2% CAGR whereas ARPU grew by \~20% CAGR during the same time. It is safe to assume Meta’s MAU growth in NA will not exceed \~2% in the next 5-10 years; therefore, the crux of the question around NA’s growth sustainability hinges upon ARPU question. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F66349a47-6037-46a1-8f6e-150304595f80_960x702.png) Source: [WSJ](https://www.wsj.com/articles/why-apples-imessage-is-winning-teens-dread-the-green-text-bubble-11641618009?ref=mbi-deepdives.com) The three largest beneficiaries of the current mobile computing are Apple, Google, and Meta (in that order). Apple reportedly receives [\~$20 Bn](https://macdailynews.com/2023/02/21/google-pays-apple-20-billion-annually-to-be-safaris-default-search-engine/?ref=mbi-deepdives.com) (and it keeps growing) per year from Google which more or less goes directly to Apple’s bottom line. That makes their relationship a bit more symbiotic; despite all the speculation about Apple entering search market, it would not surprise me if the relationship remains in the current equilibrium for the next 3-5 years (but hard to know beyond that). But it is Meta’s rise that must be so damn annoying to Tim Cook (and most likely would be to Steve Jobs too if he were alive) since Apple receives peanuts from Meta. Given Apple doesn’t take a cut of advertising from developers, there’s no direct payment flowing from Meta to Apple, but some may argue rise of social media is what made smartphones much more intriguing to own and hence, Apple and Meta too have symbiotic relationship. I am quite confident that Apple feels they catalyzed smartphone revolution, hosts the wealthiest billion on their platform, and hence **deserves** some share of Meta’s economics. Evan Spiegel [validates](https://9to5mac.com/2021/05/21/snap-ceo-happy-to-pay-app-store-commission/?ref=mbi-deepdives.com) such perception: > We really feel like Snapchat wouldn’t exist without the iPhone and without the amazing platform that Apple has created. A recent [post](https://post.news/@/noam/2RTRvTNNxSCQb3yNjqa0DPfr1Yk?ref=mbi-deepdives.com) on Meta’s near acquisition of Waze (Google ultimately acquired Waze) made me realize if Apple were run by Mark Zuckerberg, he would probably be angry too that Apple doesn’t receive much in return from Meta even though Meta’s majority of revenue (and likely supermajority of profits) is generated on their phones: > Facebook was the natural fit from the product perspective — they feared dependency on the mobile platforms and wanted to own their location stack, both for their upcoming phone and their apps. We spent a lot of time together mapping out potential integration, but Facebook kept running up against the problem of “What if we help you, you become a huge platform, and then Google comes along and acquires you? We would not be able to compete with them financially.” **This was on the heels of the Spotify US launch where Facebook believed they had “built Spotify's business” but did not extract any value from it.** > > \-Noam Bardin (former CEO of Waze) Guess what, Spotify wasn’t anywhere close to making any profit when Zuckerberg felt they had “built Spotify’s business” and lamented that they didn’t get much in return from Spotify. Imagine how Zuckerberg would have felt if a company that runs its products on his platform and generated almost half of Meta’s operating profit but he couldn’t extract much value from that company. Zuckerberg would probably do exactly what Cook had done if Zuckerberg’s role were reversed. Tim Cook and Mark Zuckerberg are, hence, at odds on the question of economics. Zuckerberg wants to maintain status quo, and Cook is constantly looking for tweaking the status quo to get his hands on Meta’s economics. Apple [suggested](https://www.wsj.com/articles/inside-the-apple-vs-facebook-privacy-fight-11660317376?ref=mbi-deepdives.com) Meta pay 30% to Apple for “Facebook boosts”, but Meta declined. Finally, Apple resorted to privacy narrative and wrecked havoc in entire digital advertising ecosystem by introducing ATT. While this may sound like past news to readers, the underlying feud is very much alive and may not be totally solved anytime soon. If ATT turns out to be a boon for Meta and entrenches its moat against sub-scaled players, I cannot imagine Apple thinking the job here is done for them. Given how incentives are stacked, **Tim Cook would actually prefer Google to keep and grow their share in digital ad market at the expense of Meta** since Apple keeps a healthy economics from Google. Our base case likely should be that this is a protracted cat and mouse game between Meta and Apple. Eric Seufert’s [work](https://twitter.com/eric%5Fseufert/status/1671529775880454151?ref=mbi-deepdives.com) indicates (also see this [tweet](https://twitter.com/ErocsJohns/status/1671534568887689216?ref=mbi-deepdives.com)) Apple may continue to make life difficult for digital advertisers until they realize it may be easier to come to a deal with Apple than constantly living life on the edge. Zuckerberg probably feels by giving into Apple’s demands, he makes his business fragile over the long-run (think decades, not years) and would rather endure through the pain but maintain his company’s economics. But make no mistake; if Meta is ever forced to make a deal with Apple because Apple nukes the signal to keep destroying digital ad infrastructure, Meta will get a pretty bad deal from Apple. It’s not just ad infra that can be influenced by Apple’s whims, Apple has every incentive to [help](https://twitter.com/borrowed%5Fideas/status/1532480292103020559?ref=mbi-deepdives.com) Meta’s competitors (harder to negotiate against a monopoly than with a company in a fragmented industry). This is why 2022 was so scary for Meta and its shareholders; when Apple was coming after their ability to monetize users time spent effectively, TikTok was encroaching and threatening Meta’s ability to keep users engaged on their platforms. While the TikTok threat seems well addressed at this point by Meta ([data points](https://twitter.com/borrowed%5Fideas/status/1651407199485165568?ref=mbi-deepdives.com) about Reels popularity as well as political onslaught on TikTok for its ties with CCP makes this threat a bit tame albeit not fully neutralized), Apple’s shadow still looms large over Meta’s future. The fact that they are also the main competitors in AR/VR makes it even more likely that both companies have incentives to see the other stumble on protecting their cash gushing machines they both currently have. Meta’s ability to hurt Apple, however, is quite limited today; Apple’s is probably not. What can Meta do to reduce its dependency on North America? US GDP as % of global GDP (ex China) is \~30%. Therefore, Meta’s best bet is probably North America’s revenue contribution to decline to \~30-35% of overall revenue over time. There are two ways Meta can reduce dependency: a) the bad way: Apple can do it for them by continuously making it challenging to build effective ad infra. and b) the good way: Meta finds other opportunities to monetize its userbase by directly integrating the whole sales funnel within their properties. One of the reasons I think international growth hasn’t quite kept pace is Meta’s lack of significant monetization of WhatsApp. Back in 2014, Meta acquired WhatsApp for $4 Bn cash, 184 mn shares of Facebook (now Meta), and 46 mn RSUs which would imply \~$70 Bn acquisition cost for WhatsApp in today’s price i.e. \~10% of Meta’s Enterprise Value (EV) today. Meta disclosed in 3Q’22 [call](https://twitter.com/borrowed%5Fideas/status/1585444319955066880?ref=mbi-deepdives.com) that click-to-messaging revenue run rate was $1.5 Bn on WhatsApp (growing \~80% YoY) which makes WhatsApp’s contribution to be a measly \~1% of Meta’s overall revenue today. While bulls believe all sorts of ways Meta can monetize WhatsApp going forward and imagine Meta can turn WhatsApp into a “super app” in many important countries especially India and Brazil, Meta has rather been uncharacteristically slow in ratcheting up monetization. That, however, seems to be changing in recent years; WhatsApp business MAU [increased](https://techcrunch.com/2023/06/27/whatsapp-business-crosses-200m-maus-introduces-personlized-messages-feature/?ref=mbi-deepdives.com) from 50 mn in 2020 to 200 mn in 2023\. Meta may be on the verge of a massive monetization spigot in WhatsApp which will largely propel its revenue growth outside NA going forward. Analyzing WhatsApp itself would require a separate piece; thankfully, Invariant did a [good job](https://invariant.substack.com/p/whatsapp-metas-next-growth-engine?ref=mbi-deepdives.com) following management’s narrative around WhatsApp which paints an optimistic picture for WhatsApp’s future. My opinion on WhatsApp is largely going to be hinged upon their growth momentum; the problem is Meta may not consistently disclose it which will make it difficult to evaluate monetization progress. ### **From “Social Media” to “Media Social”** I don’t remember who coined this term on twitter, but it definitely left an impression on my mind that Meta’s business had gradually evolved from “Social Media” to “Media Social”. In the “Social Media” business, you primarily consume content/media from your **social** connections whereas in the current “Media Social” stage, it is the “Media” that’s the center and the Meta’s attitude towards the source of the “Media” is increasingly becoming agnostic i.e. all Meta cares about is to entertain you which may or may not come from your social connections. When WSJ published "[The Facebook Files](https://www.wsj.com/articles/the-facebook-files-11631713039?ref=mbi-deepdives.com)" a couple of years ago, this particular slide caught my attention. In many ways, Meta has been "lucky" in facing competition from Snapchat and TikTok. Let me explain. ![Image](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7963a764-3187-4501-b987-696d86c78e11_2470x1360.jpeg "Image") Source: [WSJ](https://www.wsj.com/articles/the-facebook-files-11631713039?ref=mbi-deepdives.com) Meta launched "News Feed" in 2006\. Despite vociferous criticism from the users at the time, Feed (as it's later renamed) has been the most scaled profitable "real estate" in social networking industry. Meta doesn't disclose this, but it is highly likely that content posted for Feed per user per month has been on a secular decline. As people become more self-aware of their digital presence, social broadcast is unlikely to experience a renaissance anytime soon, if ever. With diminishing content production over time, users would not have compelling rationale to come back to Meta's properties. Imagine if there were no "Stories", Young Adults (18-29 yr olds) would probably produce far less content. If there were no TikTok, there might not have been any "Reels" (maybe eventually though). Meta would have to clutter your feed in some other ways which could be far less compelling than Reels. Meta, ironically, needed moderate competition to refresh their social networking apps to help them transition from social broadcast to more social entertainment apps in which in 5 years people may mostly consume algorithmic content on Feed and discuss/share them on DM. Meta's competitors currently face the double whammy of monetizing their users and rising CAC in a post-ATT non-ZIRP world. While Meta is relatively better positioned in those dimensions, there are credible risks about the transition from social broadcast to entertainment. Feed currently has \~25% ad load and given how many ads you can watch while scrolling during a typical \~60-minute session per day, Meta may have to increase time spent materially to keep ad impressions growing. When “Stories” came to the scene and took time away from Feed, it wasn’t as concerning since Stories took very little time to navigate and allows Meta to throw you plenty of ads as you browse through your friends’ Stories. For Reels, this time is different. Meta indicated the structural challenges related to Reels in the 1Q’23 call: > There are **structural supply constraints** with the Reels format as people view a Reel for a longer time than a piece of Feed or Stories content, which results in **fewer opportunities to serve ads in between posts**. That will make it likely more challenging to close the monetization efficiency gap than it was with Stories. > > …we're working down the headwind to revenue from the growth of Reels cannibalizing some time that is spent on our more mature ad surfaces, Feed and Stories. And basically, we have been balancing the 2 factors here, which is the degree **to which Reels is driving incremental engagement on the platform versus the lower monetization efficiency of Reels relative to the Feed and Stories engagement that it cannibalizes.** And ultimately, the overall economics of Reels is really going to be determined by the combination of those 2 things. > > so while **we're on track to Reels becoming neutral to revenue by end of year or early next year**, I do think it's important to call out that Reels is structurally different from Feed and Stories. And so **we don't have line of sight of getting Reels to monetization parity per time with Feed or Stories anytime soon because of those structural differences.** It is very much possible such structural changes may mean the best days of profitability of "Feed" is behind us. To substantiate this point, let’s imagine a DAU spent \~50 minutes on Meta’s Family of Apps (FOA) properties in 2019\. The following table outlines why even with the assumption of increased time spent over time, the structural challenges may be a strong headwind for ad impression growth for Meta. Without growing ad loads, impressions, and limited room for DAU/MAU growth, revenue growth will be largely dependent on price per ad which relies on targeting and the quality of ad attribution. If you remember the bear case discussed above, Apple may make things difficult for Meta in their journey to enhancing ad targeting and attribution infrastructure. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdc1f7887-396c-4b3c-9a41-ebe335d8d0c3_1436x608.png) Source: MBI Deep Dives Meta doesn't seem to be oblivious to such glaring risks; monetizing messaging and perhaps shopping will need to pull the lever for Meta this decade both of which have been in the investor conversation for the last 4-5 years but never quite materialized to the extent investors hoped. Rihard Jarc [shared](https://twitter.com/RihardJarc/status/1671905328588308481?ref=mbi-deepdives.com) an insightful expert network interview which outlined why Meta’s shopping efforts failed so far and why that might still change. While I encourage to read the full [thread](https://twitter.com/RihardJarc/status/1671905328588308481?ref=mbi-deepdives.com), the following bit stood out to me: ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F57d14d9e-0678-4bfc-9853-574dc0f93b4e_2070x1144.png) Source: Rihard Jarc (Twitter) As a shareholder, when I look forward, I do think Meta will have to make shopping and messaging to work in a meaningful way for it to be **somewhat** immune from “Apple” risk (i.e. they may not be fully immune from Apple risk; just that they will be hurt less). Once you assess the level of pain Apple can inflict upon Meta, it probably starts making a bit more sense why Meta is so incredibly eager to control the next computing platform. Of the big tech companies, Meta is one of the easier companies to hypothesize bear cases today. 10 years ago, it was actually Apple which was easier to hypothesize bear cases e.g. it’s a hardware company and hardware companies don’t make the kind of margins Apple does; Apple will lose market share to Samsung, Google, Microsoft etc. I try to be a diligent student of big tech companies and the more I studied history, the more it reminded me to be mindful of how hard it is to predict the evolution of moats. As you can probably tell, I have decent amount of sympathies for bear cases about Meta. But Meta’s management’s overall historical track record as well as some potential wild cards still keeps me a shareholder today. Reality Labs which is still likely assigned a steep negative value today by investors is one such wild card, but the other wild card that I am starting to ponder a bit more on is AI chat bots. Snap recently shared their [early insights](https://newsroom.snap.com/en-GB/early-insights-on-my-ai?ref=mbi-deepdives.com) on their chat bot called “My AI”. The whole report is very, very interesting and can have potentially uncomfortable implications for Google Search (disclosure: long). Meta has three separate messaging properties (Messenger, WhatsApp, and IG DM) consisting \~4 Bn MAUs; all three will likely be [swarmed](https://twitter.com/alex193a/status/1665825192398995469?ref=mbi-deepdives.com) with AI chat bots by the end of this year. While we are way too early here (Meta hasn’t even launched anything), the landscape can shift quickly in digital advertising. If chat bots can truly take off on messaging properties, Meta, which generates less than half of Google Service’s revenues, may end up gaining material market share from Google. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fce75c4db-48fa-4b84-87c5-68feb2c74c03_1092x1186.png) Source: [Snap](http://m/en-GB/early-insights-on-my-ai?ref=mbi-deepdives.com) Even if the bear cases for Meta play out, it is unlikely to be a terminally ill business and hence, the question of valuation is quite relevant. Meta currently trades at \~17x NTM EV/EBIT, but if you assign RL a valuation of zero (debatable; can be negative), it trades at \~12-13x NTM EV/EBIT, a significant discount from both S&P 500 Index (\~18x) and Nasdaq 100 (\~23x) most of whose constituents add back SBC (so actual discount is likely even higher). As I have mentioned before, I always consider valuation in terms of questions. The response to those questions is not binary but a probability weighted answers. Most people consider probability to be an inherently quantitative concept with objective and precise answer, but for fundamental active investors (especially with concentrated portfolio) dealing with probability is primarily qualitative in nature. Because it is probability, I do and will routinely assess and update it as fundamentals and valuations change. Thank you for reading. For more detailed valuation work on Meta, read this [post](https://www.mbi-deepdives.com/meta2023/). [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ***Disclaimer:*** *All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Brown & Brown: A Decentralized, Boring, Money Making Machine URL: https://www.mbi-deepdives.com/bro/ Last updated: 2023-06-23T12:48:04.000Z _This post is for paying subscribers only._ ### Meta's Moat URL: https://www.mbi-deepdives.com/metamoat/ Last updated: 2023-06-19T12:37:12.000Z **It's not "network effects".** *Disclosure: I own Meta’s shares and January 2025 $50 Call Options* [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) During the weekend, I [asked](https://twitter.com/borrowed%5Fideas/status/1670192933092433920?ref=mbi-deepdives.com) my twitter followers: What do you think Facebook's DAU to MAU ratio was in 2009? The number that got the highest votes was \~80% even though I mentioned the most recent number was \~68%. I asked this question a couple of friends in real life too and they too picked the \~80% number. I asked why they picked this number. Their explanation was, “well, Facebook used to be really cool back then. Everyone was using it and we were certainly oversharing stuffs that would make us cringe today. If DAU to MAU is \~68% now, it must have been higher back then.” I suspect most of my twitter followers had similar rationale in mind. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd32897b3-fb21-4c97-8351-1aff031d820b_822x598.png) The actual number was 48%. While the DAU/MAU has hardly changed since 2016, the ratio rapidly increased from 48% in 2009 to 66% in 2016\. As a result, while Facebook’s MAU increased by 10.7x in 2022 vs 2009, its DAU became 15x during the same time. What did most of the respondents to the poll miss? Smartphone penetration. Global smartphone shipments [increased](https://www.statista.com/statistics/271491/worldwide-shipments-of-smartphones-since-2009/?ref=mbi-deepdives.com) from 173.5 Mn in 2009 to 1.2 Bn in 2022\. Ironically, while transition to mobile was widely believed to potentially “kill” Facebook, Facebook turned out to be perhaps one of the largest beneficiaries (along with Apple and Google of course). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fed2291c8-d2a6-450f-978c-f57470573d81_942x556.png) Source: Company Filings, MBI Deep Dives As I was discussing some of these aspects with a couple of friends, they mentioned why the expansion of DAU/MAU ratio isn’t surprising since thanks to network effects, the product is supposed to become stickier. That makes intuitive sense, but did it also happen in some of the other social apps such as Snap, Twitter, Reddit or Pinterest? Unfortunately, we don’t know the answer since Snap and Twitter don’t disclose MAU, and Pinterest doesn’t report DAU. One of the things I think many people often misunderstand about network effects is people tend to think it only needs to be solved **once** as if once you get the flywheel going, you could just sit back and let the network grow on its own. While many investors can be susceptible to thinking in such simplistic terms, that’s not how it works in reality. Here’s a [quote](https://marker.medium.com/the-untold-history-of-facebooks-most-controversial-growth-tool-2ea3bfeaaa66?ref=mbi-deepdives.com) from Zuckerberg reminiscing Facebook’s challenges in growing their network in “early” years: > “Growth had plateaued around 90 million people, I remember people saying it’s not clear if it was ever going to get past a 100 million at that time. We basically hit a wall and we needed to focus on that.” (**MBI note**: Myspace at its peak had 75.9 Mn users) The reality is that network effects need to cross several chasms to keep growing and those chasms don’t get solved on their own; people running the business need to take ingenious approaches to tackle the growth challenges. What complicates this even further is there are competing networks (i.e. other social apps) which makes **speed** a paramount importance, but at the same time, your tech infrastructure needs to be ready to facilitate such speed and retain the userbase after acquiring them. In other words, the moat derived from network effects can be short lived and what needs to follow after the initial spark is just relentless and near flawless execution by the people running the business. But what does “execution” exactly mean? And of course, growing users is not much of a promised land either; you need to know how to monetize your users and you need to learn how to do it profitably. Having interacted with many investors following social networking industry over the last few years, I suspect most investors deeply underestimate how much everyone else in this industry fell behind on the “execution” department. Instead of making qualitative statements, I intend to show this point quantitatively to contextualize what I am talking about. One of the things that made me dig deep into this is I myself started wondering why Meta posted 34% operating margin in 2009 but today’s crop of social networking companies are either unprofitable or barely profitable even at similar scale. Daniel Ek, Spotify’s CEO, [indicated](https://twitter.com/borrowed%5Fideas/status/1659655525762473995?ref=mbi-deepdives.com) in a recent podcast the sea change in unit economics that likely occurred since Facebook’s IPO: ![Image](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb040c972-9722-4aed-bf53-ea1a29be39d4_1290x434.png "Image") Source: Acquired [Podcast](https://open.spotify.com/episode/671O5v5twrIfApPuyBdJTv?si=3e1bba54ce144729&nd=1&ref=mbi-deepdives.com) Here’s what I am going to do: I will show the unit economics of Meta (then Facebook; they also had just “Facebook” website/app back then) in 2009-11 and then show the unit economics of Snap, Pinterest, and Twitter in 2019-2021 period. Snap, Pinterest, and Twitter **somewhat** resemble Meta in terms of userbase 10 years apart and this exercise is indeed quite revealing to gauge what exactly is Meta’s moats against today’s **and** future set of competitors in their social networking business. I will briefly comment on TikTok later. **Meta vs Snap** Seven years after Facebook, Snap was founded in 2011\. In 2019, Snap had 155% of what Facebook’s DAU was in 2009\. But by 2021, Snap came down to 69% of Facebook’s DAU in 2011. Interestingly, while Snap’s Cost of revenue was \~3x higher than Meta’s 10 years ago, their Gross Profit (GP) is largely similar, thanks to much better monetization of the users by Snap and Facebook’s relatively primitive monetization/ad infrastructure back then by today’s standard. It’s the below the gross profit line where things start to diverge dramatically. **On a per DAU basis**, Snap’s R&D was \~6-8x, S&M \~2.5-3x, and G&A \~3-5x of what Meta had 10 years ago at similar scale! Snap had almost double the employees Meta had and while neither company doesn’t exactly disclose salary related expenses, Opex (R&D+S&M+G&A) per average employee for Snap was $644k in 2021 vs Meta’s $493k in 2011. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd9124db6-fa1e-4484-bb1e-b1bff03d7e2f_1734x600.png) \*Avg. MAU or DAU is calculated based on average of the four quarterly reported user date; Source: Company Filings, MBI Deep Dives One of the things that always somewhat surprised me about Snap is how so many people seem to rave about Evan Spiegel’s [leaked](https://wikileaks.org/sony/emails/emailid/139920?ref=mbi-deepdives.com) email **from 2014**. When I first read it a couple of years ago, I was happy to ignore his macro prognostics but was alarmed to see his deeply flawed understanding of the elephant i.e. Facebook in the industry he is building his own business (see the below excerpt). Some of my friends tell me I’m being harsh on Spiegel since he was just 23 at that time. Unfortunately, capitalism doesn’t have any grace period related to age; in any case, when Google came after with all its might after Facebook by launching Google+ in 2011, Zuckerberg was just 27 years old. I know ZIRP world made it easy to forget, but capitalism tends to be sink or swim if you don’t know what you are doing. Ironically, even though Spiegel had a lot to say about Fed and interest rates, his company may be one of the largest beneficiaries of such environment as Snap IPO-ed in March 2017 at $24 Bn valuation despite the fact that they reported **negative 11.7%** gross margin and **negative 128.7% operating margin** (no typo here) in 2016. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5dadee6f-8f9a-402b-824d-031e59a84777_2194x688.png) Source: Excerpt from Evan Spiegel’s [leaked](https://wikileaks.org/sony/emails/emailid/139920?ref=mbi-deepdives.com) email **Meta vs Pinterest** Pinterest was founded in 2008\. Similar to Snap, Pinterest had slightly better GP than Meta at similar scale although their path to slightly better GP per MAU was different to Snap’s. Both their ARPU and Cost of revenue was more or less similar to what Meta had 10 years ago. People likely spend less time on Pinterest than they used to on Facebook back then, so perhaps that’s why they have similar ARPU even with Facebook’s basic ad infrastructure during 2009-2011 period. Since Pinterest IPO-ed in 2019, I am going to ignore 2019 vs 2009 comparison. **On a per MAU basis**, Pinterest’s R&D was \~3-5x, S&M \~2.5-3x, and G&A \~2-3.5x of what Meta had 10 years ago at similar scale! What’s interesting is Pinterest actually had similar number of employees to what Meta had back then. So why exactly Pinterest’s cost structure was still so wildly different? There may be multiple factors at play. But average salary per employee almost certainly increased over time which may be the primary reason for such divergence. Again, as I have [discussed](https://www.mbi-deepdives.com/sbc/) before, there are only a handful of companies in Silicon Valley which **built** de-facto monopoly, and the primary “raw materials” to sustain their monopoly (using the word very loosely; FTC lawyers are encouraged to ignore my phrasings) is their pool of human capital. As you can expect, with their “monopoly” profits, they basically call shot in pricing the labor market and you have to play along even if you don’t have monopoly yourself. To say it differently, everyone in Tech at Silicon Valley or Seattle are rich thanks to a handful of monopolies regardless of whether they work at any of the monopolies themselves. If there were no monopolies in Silicon Valley/Seattle, labor market would likely go through a sea change to reflect the reality of the economics of many of the younger tech companies that were started close to GFC era. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F087c75a3-b654-4432-b7cf-7ac1e3ea8ac0_1734x586.png) Source: Company Filings, MBI Deep Dives **Meta vs Twitter** While Facebook was started in 2004, it became open to general public in 2006, the same year Twitter was founded. Therefore, these two companies are bit of a contemporary but their fates have diverged materially. Mark Zuckerberg had an apt quote about Twitter that gets repeated every now and then: > “Twitter is such as mess — it’s as if they drove a clown car into a gold mine and fell in.” Despite being a contemporary, Twitter’s mDAU or “monetizable DAU” in 2019 (Twitter stopped disclosing DAU or MAU and used to report mDAU) was similar to what Facebook had in 2009\. By 2021, Twitter’s mDAU was less than half of Facebook’s in 2011. Twitter’s ARPU in 2019-21 was actually \~3-4x of Facebook’s 10 years ago which led to GP per DAU to be \~2.5-4x of Facebook’s. Anything below GP line, again, is just a sorry state of affairs. **On a per DAU basis**, Twitter’s R&D was \~7-9x, S&M \~6-7x, and G&A \~4-7x of what Meta had 10 years ago at somewhat similar scale (perhaps these numbers are slightly overstated since I’m using mDAU as DAU for Twitter)! It is perhaps no surprise that Elon Musk got tempted to buy and right size the cost structure a bit, but it seems he had done that at the expense of ARPU so far, so the jury is still out there whether Twitter is in a better position pre or post acquisition by Musk. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F1eb724ba-9a87-4989-a3c5-5c63c795a3e0_1726x588.png) \*Ignored Twitter’s litigation expense for 2021 Opex and EBIT calculation; Source: Company Filings, MBI Deep Dives The two other companies that are mostly talked about in social networking industry but yet to be public are Reddit and of course, TikTok (which isn’t necessarily “social”, but they are certainly Meta’s perhaps most potent competition). Reddit, another contemporary of Meta as it was founded in **2005**, likely generated [$350 Mn](https://www.theinformation.com/articles/reddits-ad-revenue-expected-to-double-to-at-least-350-million-this-year?ref=mbi-deepdives.com) revenue in 2021 which is basically **a day’s revenue of Meta today**. TikTok, on the other hand, [generated](https://fortune.com/2023/04/06/tiktok-ban-china-bytedance-increased-ad-spending/?ref=mbi-deepdives.com) $10 Bn revenue in 2022 which would put them closest to Meta in terms of revenue. If WSJ’s [reporting](https://www.wsj.com/articles/tiktok-parent-bytedance-sees-losses-swell-in-push-for-growth-11665071238?ref=mbi-deepdives.com) is true that ByteDance, the owner of TikTok, posted $7.15 Bn losses in 2021, TikTok almost certainly had a pretty deep loss in 2021\. Anecdotally speaking, TikTok pays a hefty premium to lure talent away from Big Tech; but even such premium wasn’t enough to convince a couple of my acquaintances to join TikTok since they were not confident that TikTok would be around in the US in 2-3 years. Therefore, while I don’t expect TikTok’s cost structure to resemble some of the public companies discussed here, it is still likely nowhere close to Meta’s unit economics. What is my broad takeaway from digging into these numbers? While it is tempting to blame management of one company or another (and they likely do deserve some criticisms), we probably should take a step back and wonder why is every single Meta’s competitors being managed so poorly? Why were they all spending money like drunken sailors without any clear sight to compelling economics in the near future? I’m sure low interest rates and investors willingness to look past losses for the elusive economics at scale played their parts too, but I think the primary reason is the business of social media likely changed forever. On the surface level, social networking seems like an amazing business: once you manage to create network effects, the nodes of the network grow and the network just feeds on itself. Since your users generate all the content at zero marginal cost, and your job is basically to just aggregate demand to sell the network’s attention to advertisers vs paying for content in the legacy media business, this sounds like a great business model . Operating margin for such business was understandably expected to be at least \~30% and potentially much more (Meta’s highest ever operating margin was 52.3% in 2010 which likely contributed to such inflated expectations). Why isn’t that happening at all? I already wrote about “raw material” inflation which may not reverse anytime soon. AI may help lowering the demand for software engineers in the medium to long-term, but even then as long as Big Tech have the profits, it shouldn’t be hard for them to maintain a persistent and increasing “inflation” for the talented pool of human capital. Attracting talent at reasonable cost itself would be a difficult challenge, but as societies around the world demand more data privacy, security, and moderations in these companies, it is creating the **unintended benefit** to the incumbent such as Meta (think ATT, GDPR etc.). **So, today these two things: a) ability to attract and price talent, and b) regulatory capture are the primary moats of Meta.** But even beyond that, perhaps yet another challenge for these companies is their competitor is Meta. Tech may seem inherently a [red queen’s race](https://en.wikipedia.org/wiki/Red%5FQueen%27s%5Frace?ref=mbi-deepdives.com), but it may become more difficult to keep pace for everyone else if the company that is way ahead is also run by an operator who is so paranoid about durability of his business that he ends up running faster than everyone else. I would even argue most moats in tech are essentially “execution” moats (maybe also why Buffett mostly avoids them), and except maybe one or two, none of the tech companies can just sell products/services without perennially participating in the red queen’s race. When Michael Nathanson asked the below question to Mark Zuckerberg in 2Q’22 earnings call, admittedly I found Zuckerberg’s response a bit lacking and thought the real answer that he’s not saying is Meta’s moats are evaporating. Not sure if it’s just the stock price that’s influencing me here, but I do think he indeed pointed out the moat Meta likely capitalized the most in its history (the network effects moat expired some time ago) and it’s their **execution**: > **Michael Nathanson** > > Mark, I think going to one of the earlier questions about your advantages at Facebook. The previous moat, we would argue, was just the social graph of billions of people, families and friends. Do you think what you're building now with AI and from digital, how all those content is even a better moat, is a better business than the one you had before, which was a pretty high barrier to entry, just given the social effects of the network you built? (**MBI**: *if it were so high barrier to entry, how could Snap, Pinterest, TikTok enter and gain massive userbase over time? It was always a very weak moat, yet there is almost no profit left for others to eat)* > > **Mark Zuckerberg** > > In terms of building sustainable competitive advantages, in terms of the social graph, right, which you cited from before, people have been able to get that from phones for more than a decade now, right? S**o I don't really think that's been the thing for us. I think it's we're a serious technology company. We invest a lot in building infrastructure. And culturally, we focus on moving and learning faster than everyone else. And I think that those are sustainable advantages.** > > And so certainly, I think that the AI technology infrastructure that we're building, **I think it can compound and be better than others in the industry and that will be an advantage and make the product better over time**. But I think at the end of the day, what that really comes down to is just **I try to push the company to be one that learns faster and just keeps iterating and moving faster than we did in the past and than others in the industry do**. And I think if we can do that well, then we'll continue to succeed. > > **But I think the moment that we stop doing that, then we'll basically fall behind**. It's a very competitive field and we need to keep on pushing ahead. But I think the reason why we have succeeded and seen so good results with Facebook, Instagram and the other social apps is **because we basically focus pretty relentlessly on just pushing to constantly improve them.** Just as it didn’t satisfy me back then, Zuckerberg’s response may not feel convincing to many because it feels a bit fluffy and not the usual kind of moat we talk about. But if you look at Meta’s financials since 2009 and study carefully not only against other social companies but also other big tech, it is hard not to infer their execution has been almost unparalleled. Here’s what I [wrote](https://www.mbi-deepdives.com/meta2023/) back in March this year: “While investors have perennially wondered about the ghost of Myspace, FOA (Family of Apps) continued to reach new and unforeseen heights in the social media industry. A **19-year old** Mark Zuckerberg co-founded Facebook (currently Meta) in 2004 and it is hard not to be awestruck by what he did in less than couple of decades. Let me contextualize Zuckerberg's height of success with Facebook (now Meta). 17 years after being founded, Meta reached $95 Bn Gross Profit in 2021\. To reach similar Gross Profit, Alphabet, Amazon, Apple, and Microsoft took 22, 24, 42, and 45 years respectively. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F201d8296-2c54-4819-a2e0-c2872e7e90df_1056x207.png) Source: Company Filings, MBI Deep Dives How about **GAAP** Operating Profit? Meta posted $45 Bn operating profit (**including** \~$10 Bn losses in Reality Labs) in 2021\. To reach similar operating profit, Alphabet, Apple, and Microsoft took 22, 36, and 44 years respectively. To post such operating profit, only Microsoft required lower invested capital than Meta, so Meta was able to reach such profitability with incredible margins **and** ROIC. Perhaps the AGI will beat Zuckerberg's record by reaching $45 Bn operating profit faster. While Meta may have gotten a bit derailed in 2022, it would be unfair to not acknowledge, appreciate, and applaud what Zuckerberg and his team did in 2004-2021.” ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F56cbe1c5-c86b-4759-88f5-8d6372a717e1_1799x209.png) \*Invested Capital is calculated as total assets-cash and short-term investments-current liabilities; Source: Company Filings, MBI Deep Dives If “execution” is the moat, what is the driver of such moats? It’s the people who have to execute the plan, and it’s the CEO who need to design the plan and recruit the right people to get the job done. Of course, investing is inherently about the future, and what Meta did in 2004-2021 can prove to be just relics of history. But it is historical track record that is the bedrock to form our qualitative insights for the long-term. I do admit Meta’s capital allocation in 2021-22 period was far from anything to be proud of (and Zuckerberg would probably not disagree either); I do want to point out that for most tech companies, capital allocation doesn’t start based on what FCF you generate, so I’m not just alluding to Meta’s ill-timed buybacks in 2021\. It essentially starts at Gross Profit level; how much a tech company spends in R&D, S&M, and G&A are deeply integral to capital allocation framework. From this perspective, Zuckerberg made some very suboptimal decisions and committed mistakes by over hiring which he later needed to correct through a massive and painful series of layoffs. Overhiring is a mistake committed by many CEOs in 2021-22 period, but that’s not a defense for Meta or Zuckerberg because if “execution” is the primary moat, you better be switched on when everyone else is off. At the end of the day, the real question about Meta’s “execution” moat is which “Zuckerberg” reflects closer to reality today going forward: is it 2004-21 Zuckerberg? or is 2021-22 one? Investors generally dislike personality based moats as they can be excruciatingly hard to assess/evaluate/track, and these personalities often tend to test your patience, but if you look at tech history and perhaps the most outlier successes, such personality driven (and not necessarily business driven moats), are not a rarity. Even before the 2022-23 drama, I have always thought the Facebook or Meta’s long-term bull case revolves around Zuckerberg (see my [2020 thread](https://twitter.com/borrowed%5Fideas/status/1253165456850145281?ref=mbi-deepdives.com)). Imagine if someone told you in 2015 that by 2023, the most popular social formats would be “Stories” and “Short form videos”, both of which would be invented (and hence enjoy a material leg up) by Meta’s two closest competitors at the time, you would probably be worried whether Meta would remain relevant in just 8 years. When Meta was transitioning hard to mobile, operating margin fell from 47.3% in 2011 to 10.6% in 2012\. Transitioning to Stories and Reels also required Meta to be willing to give up valuable surfaces or time spent on their apps to materially lower monetized features which create near-term earnings pressure. This is the kind of decisions which are not quite hard to take by a founder but can be quite tricky to pursue for hired management. The social media of 2030-35 would probably be very, very different than what it is today. Any careful analysis of today’s business fundamentals may become obsolete and hence, your ability to be long-term owner of this business may be largely dependent on your opinion about the quality of management as the people running the business would likely need to go through a couple of format/feature shifts every decade or so (maybe OS too every 2-3 decades). Considering almost constant negative press coverage and the difficulty of forecasting/underwriting social media businesses for 5-10 years, the stock may persistently trade at below market multiples. Despite +134% YTD, the stock still trades at \~17x NTM EV/EBIT which is \~8-10 turn lower compared to Nasdaq 100 (when you include SBC in EBIT calculation) and \~3-4 turn lower than S&P 500 (again, similar SBC adjustments to QQQ). To the extent my opinion about Meta’s management is correct is what will likely drive shareholders’ long-term return. **P.S.** I know any piece on Meta’s moat may seem incomplete without any discussion on Metaverse or AR/VR segment. It is simply too early to form any rigid opinion there, but for curious readers, I encourage you to read this Benedict Evans piece which I thought was perhaps the most thoughtful [piece](https://www.ben-evans.com/benedictevans/2023/6/15/vision-pro?ref=mbi-deepdives.com) on Vision Pro/Quest post WWDC. You can also read a bit more detailed analysis on Meta [**here**](https://www.mbi-deepdives.com/meta2023/)(March, 2023) [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ***Disclaimer:*** *All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Adobe 2Q'23 Update URL: https://www.mbi-deepdives.com/adbe2q23/ Last updated: 2023-11-26T13:44:25.000Z *Disclosure: I am long shares of Adobe* First things first, while as of this writing I do own Adobe shares, I have gradually trimmed half of my Adobe holdings for the last couple of weeks. By the time I will publish my Deep Dive next week, it is likely that I may not own any Adobe shares. Before I explain my thought process on selling Adobe, let me quickly recap Adobe's latest earnings. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Revenue** Digital Media net new ARR $470 Mn ($50 mn higher than guide) Digital Media segment revenue $3.5 Bn (guide $3.45-3.47 Bn) Digital Experience $1.22 Bn (guide $1.21-1.23 Bn) Total revenue $4.8 Bn (guide $4.75-4.78 Bn) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-5.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Gross Margin** Digital Media gross margin remains steady at \~96%, but Digital Experience posted its highest ever gross margin of 67.3% in 2Q'23\. Overall gross margin expanded by 41 bps YoY to 88.1% last quarter. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-1.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Cost Structure** 2Q'23 GAAP operating margin was 33.7%, down from 34.9% in 2Q'22\. SBC as % of revenue increased from 8.0% in 2Q'22 to 9.0% in 2Q'23\. Working capital benefits and SBC make FCF look better than it is. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-2.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capital Allocation** Buyback pace has slowed down as Adobe only utilized 50% of their FCF to buyback shares which is noticeably lower compared to the last three quarters. Share count went down by only 0.2% QoQ. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-3.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Guidance** Digital Media net new ARR increased from $1.7 Bn to $1.75 Bn in 2023. GAAP EPS range was increased from $10.85-11.15 to $11.15-11.25 for 2023. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-4.png) Source: Adobe Press Release **Why I am selling Adobe** When I published my Deep Dive on Adobe in [August 2022](https://www.mbi-deepdives.com/adbe/), I was cautious about their ongoing and likely intensifying competitive onslaught from Figma and Canva. Moreover, I mentioned I was reluctant to pay premium multiples for Adobe vs Microsoft which is likely the greatest software business in the world today. While Adobe may offer potentially higher growth, I considered the moat and durability unlikely to be as strong as Microsoft to deserve the premium multiples. Adobe was trading at $450/share or in the low 20s NTM EV/EBIT multiple (not really, but more on this later). For context, 10-year treasury was trading at \~2.8% yield back then. Just one month after publishing my Deep Dive, Adobe announced to acquire Figma for an eye-popping valuation which the market absolutely hated and the stock tanked by 40%. While I [agreed](https://www.mbi-deepdives.com/net/) the price paid for Figma is likely to be excessive, I inferred such acquisition would lead to more pricing power for Adobe over time and given the massive drawdown, the valuation concerns were more than taken care of. To me it seemed market almost forgot Adobe still remains an excellent business and despite the valuation concerns, the fact remains they were about to take a likely potent long-term competitor under their own umbrella. Moreover, the more Adobe stock was falling, the lower Figma's price tag would be since the deal was priced as $10 Bn cash+26.5 mn shares+6 mn RSUs. With Adobe stock at $275, Figma would cost \~$19 Bn to Adobe. The odds seemed good to me . I [changed](https://www.mbi-deepdives.com/net/) my mind and took a decent sized position in the stock at an average cost of $315/share. Okay, so where do we stand today? For starters, 10-year is now yielding 3.7%. But that's hardly my only concern. Let's take a look at Microsoft and Adobe valuation multiples again. At first glance it may seem they are both trading at similar multiples, but there is important nuance that's missed in this graph. Not sure how many investors miss this nuance, but I certainly did. While reporting consensus EBIT estimates, analysts consider SBC in their EBIT calculation for Microsoft whereas for Adobe, consensus EBIT adds back SBC. Basically, Microsoft's number is GAAP whereas Adobe's number is non-GAAP which make this whole graph an apple-to-oranges comparison (unfortunately, **EVERY** data provider does this; I'm not taking a dig at KoyFin. You may wonder why such discrepancy exists. For some reason, big tech's NTM EBIT estimates includes SBC impact but except for those handful of tech companies, everyone else just ignores SBC from NTM EBIT estimates. I guess SBC only matters for Big Tech shareholders). Analysts estimate Adobe's NTM EBIT (non-GAAP) to be $8.7 Bn. Adobe's 1H'23 SBC was $849 Mn (vs $674 Mn in 1H'22). Let's double the 1H'23 number to assume NTM SBC to be $1.7 Bn which would make NTM GAAP EBIT to be $7 Bn. After making the numbers more apple-to-apple, Adobe actually currently trades at \~31x NTM EV/EBIT multiple (ignoring AH rally), almost \~5 turn higher than Microsoft. Even if these estimates are revised upwards a little, the multiple isn't going to change much. How about the rest of the concerns? ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-6.png) With Adobe stock at $510/share, Figma deal is currently priced at \~$26 Bn. If you thought $20 Bn was expensive, well the price may end up being a lot higher thanks to +50% rally over the last month. Perhaps more importantly, will the deal even close? If Microsoft and Activision saga are any indication, the regulatory bodies across the Atlantic will likely fight tooth and nail to stop this deal and I would argue the probability that the deal will go through is likely declining. Adobe bulls think failure to consummate this deal may even be a boon for Adobe as they will be stopped from paying ZIRP like valuation multiples amidst a mid single digit Fed rate world. I am not sure I see it this way. So far, Figma raised $333 Mn over seven funding rounds. If the deal with Adobe doesn't go through, Figma will receive $1 Bn breakup fee. So, effectively Adobe shareholders will pay \~3x money that Figma raised over its entire life to receive exactly 0% ownership of Figma. To put it differently, Adobe shareholders will be giving $1 Bn charity to Figma to potentially compete much more directly with Adobe in the medium term. So, in a sense, today, when I am looking at Adobe, all my concerns deteriorated over time. 10-year yield increased by \~100 bps, stock trades at more expensive multiple, and the competitive concerns from Canva and Figma are very much alive. But what about AI? Isn't this potentially a big boon for Adobe? I suspect if I am wrong about selling Adobe today (I will consider my decision to be wrong if Adobe generates >10% IRR over the next 5-7 year period), it may be because I am underestimating AI's potential for strengthening Adobe's moat. Adobe seems to be taking a bit [conservative approach](https://twitter.com/borrowed%5Fideas/status/1646509218722205696?ref=mbi-deepdives.com) in mitigating some of the legal concerns that may end up affecting much of the leading AI companies today, and they also have a much clearer path to [monetize](https://twitter.com/jiggycapital/status/1661814238589976580?ref=mbi-deepdives.com) their AI capabilities. I mostly agree with bulls that Adobe will likely beat earnings estimates in the next few quarters and I am certainly not expecting any quick doom for Adobe. But I am not as confident as Mr. Market that AI is an unalloyed positive for Adobe in the long-term. Take the below graph for example which Adobe shared on their last Analyst Day. Majority of their net new ARR in Creative Cloud comes from single apps, a likely material percentage of which I assume come from consumer+ SMB segment. If AI is truly as revolutionary tech as the consensus thinks it to be, I wonder if Google and Meta will make Adobe's life difficult in the consumer+ SMB segment. Given the pace at which Meta, Google, or Microsoft (thanks to OpenAI) are moving in AI, it would not shock me if they completely end up disrupting consumer creativity software industry. Kevin Kwok wrote in his piece tiled "[How to Eat an Elephant, One Atomic Concept at a Time](https://kwokchain.com/2021/02/05/atomic-concepts/?ref=mbi-deepdives.com)": > Even more striking, many of the dominant video platforms—like Youtube—are purely distribution focused. **They don’t even have any editing capabilities**. Instead, companies like Adobe end up being large beneficiaries of this need. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/06/image-7.png) Source: Adobe Analyst Day, October 2022 Color me surprised if YouTube and Meta's family of apps business don't end up incorporating significantly better editing tools leveraging their state-of-the-art AI research centers in five years. One counterargument could be thanks to AI tools, if the number of people interested in editing tools or art increase substantially, the market may be large enough to accommodate both big tech and Adobe. That may not be a bad argument, but the fact that Adobe today is $220 Bn EV perhaps doesn't provide much margin of safety if Adobe becomes a consistent market share donors to accommodate other players over time. Moreover, Adobe's AI related capabilities are very unlikely to insulate itself from competitive pressure of Canva and potentially Figma. On top of that, I am not sure I have the skillset to assess where Midjourney or [RunwayML](https://runwayml.com/?ref=mbi-deepdives.com) end up in 5 years both of which are more born and operated in "native" AI environment. Adobe's distribution will continue to be a massive moat, but it may not be unassailable moat. As I often mention on my valuation related discussions, I think of valuation in terms of questions the stock price asks me and my job is to assess my confidence or comfort level in answering the questions. At current valuation, I consider the questions posed by Adobe's stock price are increasingly discomforting. While market seems to have labeled Adobe an "AI" stock, the long-term returns will ultimately be decided not by today's labels, but the company's ability to maintain its competitive moats and profits/FCF in the long run. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Disclaimer:* All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Tyler Technologies: Selling Software to the Government URL: https://www.mbi-deepdives.com/tyl/ Last updated: 2023-05-25T11:43:56.000Z _This post is for paying subscribers only._ ### Amazon 1Q'23 Earnings Update URL: https://www.mbi-deepdives.com/amzn1q23/ Last updated: 2023-04-28T02:19:08.000Z *Disclosure: I own shares, and Jan 2025 call options of Amazon* An Analyst asked a legitimate question to Amazon management: *“Does the company ever think about breaking out all the big investments so that we have more clarity on the retail margin structure?”* Andy Jassy provided a word salad in response. As a shareholder, I am not opposed to investing in Alexa, Kuiper etc. But the lack of disclosure to its **owners** is increasingly distasteful. Here are my notes from today’s earnings call. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Revenue** Overall revenue was +9.4% (+11% FXN) While the low margin 1P segment is flat for last two years, everything else is doing just fine. Let me spend more time on dissecting AWS which remains a key focus for investors. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F3e1be03e-ea75-4325-881f-35e0b2cffcc1_1886x312.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AWS** For the first time in its history, AWS QoQ sales declined. Please note that 1Q QoQ has consistently been the weakest since 2016. Since AWS mentioned last quarter that they exited January at mid-teens growth, this wasn’t quite a surprise. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fc4864f9f-5138-43c1-8fbf-287bc7a6dacd_1360x678.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) What, however, spooked investors a bit was the exit growth rate in April: > customers continue to evaluate ways to optimize their cloud spending in response to these tough economic conditions in the first quarter. And we are seeing these optimizations continue into the second quarter with **April revenue growth rates about** **500 basis points lower than what we saw in Q1**. One thing to note here is 2Q’22 was a very strong quarter, so even if AWS posts 11-12% YoY growth in 2Q’23, we’ll see \~$550-750 Mn QoQ incremental revenue. AWS’ numbers now makes Azure’s numbers look even more impressive than it already was! With AWS having higher exposure to startups (vs Azure’s large enterprises) as well as higher % of revenue coming from IaaS rather than PaaS for AWS (vs Azure) means AWS will be more cyclical than Azure. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd551e3f9-67d9-421f-aaf2-321b85569907_1560x884.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) It’s not just Azure; Google Cloud’s numbers also look pretty good now. One caveat is Google Cloud includes Google Workspace, and Alphabet doesn’t disclose GCP numbers. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F58d34599-b6b7-4c5a-8a18-b2a6ab72f468_1206x754.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4e5fd965-363e-4d0f-b8cf-79ab2ea39d10_1222x750.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) AWS cost structure may also require some further right sizing. 1Q’22 EBIT margin was 35.3% (highest ever), but in 1Q’23, it came down to just 24.0%. Incremental operating margin is now negative for two consecutive quarters. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9f2131f8-aed9-4d38-8b7f-4fc872960cd3_1608x180.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F68f30695-0234-4465-bbb6-6f5173f1ee0e_1736x894.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) As expected, there are plenty of generative AI related talking points which I’m not including here. Amazon remains quite upbeat about cloud’s momentum: > few folks appreciate how much new cloud business will happen over the next several years from the pending deluge of machine learning that's coming. **Amazon ex-AWS** While headline figures still don’t seem encouraging, I am personally quite glad about the progress made at retail. Both North America and International segment’s margins are going in the right direction. North America was profitable in 1Q’23 but still far cry from \~5-6% operating margins seen in 2018 and in 2020. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb7da024f-3159-4001-97ea-5154b4630537_1196x730.png) While Amazon retail is dealing with whole host of issues, the operating margin history in North America is perhaps a strong indication that plenty of undisclosed “other bets” are jammed in this segment. If I were a large shareholder of Amazon, I would push Amazon to disclose and quantify such bets. I believe most Amazon shareholders are quite conducive to bold, aggressive bets, but not disclosing the bets is not doing anyone any favor. On International, Amazon reminded us the nuances embedded in margin trajectory there: > I will remind you that, again, that international is an **aggregation of established countries which are already profitable and who look a bit like North America**, perhaps at an earlier stage of development and working their way to parity on profitability. We have forward-loaded Prime benefits in a lot of these countries that are ahead of the curve that we saw in North America. > > We have a large emerging business. **In the last 5 years, we've added more than 10 new countries.** What we're seeing is if you looked back to North America long ago, it took 9 years for us to reach breakeven profitability in the United States. We see a similar curve in a lot of countries overseas. There's, in fact, additional challenges that we usually have to deal with, things like lack of payment methods, lack of the established infrastructure for -- especially for transportation and infrastructure for the Internet and everything else One indication that retail business is progressing well is that for the third consecutive quarters world-wide paid units growth YoY surpassed shipping+ fulfillment cost growth YoY. In fact, the gap is widening, indicating Amazon’s efficiency in dealing with shipping and fulfillment related cost. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffbfcf01d-e6a1-4129-8e21-b9cdf518571f_1530x776.png) **Advertising** Amazon continues to buck the broader advertising trend and even mentioned “*We have a lot of upside still in advertising*”: > On the advertising side, we're continuing to buck wider advertising trends and deliver robust growth. I think there are a few reasons for it. First, even in difficult economies, most people still shop. And with the largest e-commerce shopping venue, we have a lot of customers that companies seek to reach. That, coupled with our very substantial investment in machine learning to make sure customers see relevant ads when they're looking for various items, have meant that these advertisements have performed unusually well for brands, which makes them want to advertise in Amazon. > > It's also worth noting that **we're still very early in our efforts** to find a way to thoughtfully place ads in our broader video, live sports, audio and grocery properties. **We have a lot of upside still in advertising**. **Alexa** There was a question about Alexa’s long-term viability; Amazon still seems confident that they can make it work, especially in light of generative AI. That sounds plausible, but I guess Alexa has a couple of years left to figure out a viable business model before facing severe cut: > I think when people often ask us about Alexa, what we often share is that **if we were just building a smart speaker, it would be a much smaller investment**. But we have a vision, which we have conviction about that **we want to build the world's best personal assistant**. And to do that, it's difficult. It's across a lot of domains and it's a very broad surface area. However, **if you think about the advent of large language models and generative AI, it makes the underlying models that much more effective such that I think it really accelerates the possibility of building that world's best personal assistant**. > > And I think we start from a pretty good spot **with Alexa because we have a couple of hundred million endpoints being used across entertainment and shopping and smart home and information and a lot of involvement from third-party ecosystem partners**. And we've had a large language model underneath it, but we're building 1 that's much larger and much more generalized and capable. And I think that's going to really rapidly accelerate our vision of becoming the world's best personal assistant. **I think there's a significant business model underneath it**. **Opex+Capex** There was $470 Mn employee severance charge in 1Q’23\. But the overall cost structure still seems quite bloated. Capex for 2023 will be lower than it was in 2022\. While analysts asked for more specifics, Amazon didn’t quite outline any specific number for 2023 capex. > For the full year 2023, we expect capital investments to be lower than our $59 billion investment level in 2022, primarily driven by an expected year-over-year decrease in fulfillment network investments. We're continuing to invest in infrastructure to support AWS customer needs, including investments to support large language models and generative AI. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F2e060642-dd12-4d23-8760-2b2e5d9d78ae_2414x350.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Outlook** 2Q’23 topline is expected to be $127-133 Bn, \~5-10% YoY growth. Operating income is expected to be between $2.0-$5.5 Bn (vs $3.3 Bn in 2Q’22) Thank you for reading! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Meta 1Q'23 Earnings Update URL: https://www.mbi-deepdives.com/meta1q23/ Last updated: 2023-04-27T12:55:24.000Z *Disclosure: I own shares, and Jan 2025 call options of Meta* > “There are two major technological waves driving our road map: a huge AI wave today, and a building metaverse wave for the future.” > > Mark Zuckerberg (1Q’23 Earnings Call) Here are my notes from tonight’s earnings. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Users** When Facebook’s DAU declined in 4Q’21 and MAU declined in 2Q’22 for the first time in its history, some feared (hoped?) for Facebook’s gradual decline to irrelevance. Facebook added 37 mn DAU (now >2 Bn) and 26 mn MAU last quarter. \~3 Bn people now use one of Meta’s apps daily. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F98522b3a-a359-4458-8674-0a6fada5aa2d_2092x692.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Engagement** US & Canada Facebook DAU reached 200 mn. DAU/MAU trends continue to be strong across regions. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F8d892fc7-c4dd-4400-80a6-ff117ed75767_2094x726.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **ARPU** ARPU was positive across regions too. Rest of the World (RoW) continues to lead ARPU growth, followed by US & Canada. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9327dfaa-1f82-4f59-a2d1-5a3d541d68d3_1720x236.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Ad revenue** In 1Q’23, number of ad impressions was +26% YoY while average price per ad was -17% due to strong impression in lower monetizing services such as Reels and in lower ARPU regions as well as FX. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Faa21c63b-5ea6-46c0-97a8-c1c3ecd8f0eb_2090x724.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Segment Reporting** In 1Q’23, overall revenue was +6% FXN while FOA was +7% FXN After two quarters of \~mid-30s FOA operating margin, now it is back to \~40%. Ex-restructuring, FOA operating margins would be 42.9% in 1Q’23. Overall restructuring cost was $1.1 Bn in 1Q’23\. RL losses $4 Bn (+1 Bn YoY). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fe9dada69-4baa-4c1a-8b14-89c35947b10d_1552x620.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Reels** In 3Q’22, Meta mentioned 1 Bn Reels was shared via DMs on IG **everyday.** That number is **2 Bn** now. While the battle is not over with TikTok, my hats off to Meta for building such a compelling product and scaling it so quickly. They just aren’t as fragile as many so intently seem to believe. Reels seems to be driving incremental engagement: > “Since we launched Reels, AI recommendations have driven a more than 24% increase in time spent on Instagram.” Reels monetization trend is also positive while Advantage+ is doing its magic: > Reels monetization efficiency is up over 30% on Instagram and over 40% on Facebook quarter-over-quarter. Daily revenue from Advantage+ shopping campaigns is up 7x in the last 6 months. While Reels is driving incremental time spent, important to remember the nuances in this format and not get carried away what incremental minutes may mean for revenue in the long run: > There are **structural supply constraints** with the Reels format as people view a Reel for a longer time than a piece of Feed or Stories content, which results in **fewer opportunities to serve ads in between posts**. That will make it likely more challenging to close the monetization efficiency gap than it was with Stories. > > …we're working down the headwind to revenue from the growth of Reels cannibalizing some time that is spent on our more mature ad surfaces, Feed and Stories. And basically, we have been balancing the 2 factors here, which is the degree **to which Reels is driving incremental engagement on the platform versus the lower monetization efficiency of Reels relative to the Feed and Stories engagement that it cannibalizes.** And ultimately, the overall economics of Reels is really going to be determined by the combination of those 2 things. > > so while **we're on track to Reels becoming neutral to revenue by end of year or early next year**, I do think it's important to call out that Reels is structurally different from Feed and Stories. And so **we don't have line of sight of getting Reels to monetization parity per time with Feed or Stories anytime soon because of those structural differences.** **Messaging** Number of businesses using paid messaging on WhatsApp grew +40% QoQ. > click-to-message ads continue to grow and bring incremental demand onto our platform. **This format is mostly used by smaller advertisers today in Southeast Asia and Latin America, and one of the exciting opportunities ahead is to expand adoption to larger advertisers in more markets** by investing in increased automation and reporting to help businesses more easily manage messages and measure results at scale. Expect AI agents to be available on Meta’s messaging apps over time. While Messaging has been perennially undermonetized, I wonder whether generative AI will be big unlock for monetization. Meta is very well positioned here with two separate >1 Bn MAU messaging apps: > I think that there is an **opportunity to introduce AI agents to billions of people in ways that will be useful and meaningful**. We're exploring chat experiences in WhatsApp and Messenger, visual creation tools for posts and Facebook and Instagram and ads, overtime video and multimodal experiences as well. I expect that these tools will be valuable for everyone from regular people to creators to businesses. For example, **I expect that a lot of interest in AI agents for business messaging and customer support** will come once we nail that experience. Now over time, this will extend to our work on the Metaverse too, where people will much more easily be able to create avatars, objects, worlds and code to tie all them together. > > I also think that there's going to be a very interesting convergence between some of the AI agents in messaging and business messaging, where right now, we see a lot of the places where business messaging is most successful are places where a lot of businesses can afford to basically have people answering a lot of questions for people and engaging with them in chat. And obviously, **once you light up the ability for tens of millions of small businesses to have AI agents acting on their behalf, you'll have way more businesses that can afford to have someone engaging in chat with customers.** So I think that, that could be a pretty big opportunity, too. > > We've introduced new features like **in-thread payments and other commerce tools. So we think that there's a big opportunity here. We're trying to make every part of the experience for advertisers, easier, better and more performance**. **AI** Meta is making a bet on open ecosystem for LLM-based products: > Right now, most of the companies that are training large language models have business models that lead them to a closed approach to development. And I think that there's an important opportunity in the industry to help create an open ecosystem. And if we can help be a part of this, then much of the industry, I think, will standardize on using these open tools and help improve them further. So **this will make it easier for other companies to integrate with our products and platforms as we enable more integrations**, and that will help our product to stay at the leading edge as well. > > …I think to some degree, we're just playing a different game on the infrastructure than companies like Google or Microsoft or Amazon, and that creates different incentives for us. So overall, I think that, that's going to lead us to do more work in terms of open sourcing some of the lower-level models and tools. But of course, a lot of the product work itself is going to be specific and integrated with the things that we do. So it's not that everything we do is going to be open. Obviously, a bunch of this needs to be developed in a way that creates unique value for our products. But I think in terms of the basic models, I would expect us to be pushing and helping to build out an open ecosystem here, which I think is something that's going to be important. **Metaverse** Meta called out the nonsense in several Media that are propagating Meta is shying away from “Metaverse”: > A narrative has developed that we're somehow moving away from focusing on the Metaverse vision. So **I just want to say upfront that,** **that's not accurate**. We've been focusing on both AI and the Metaverse for years now, and we will continue to focus on both. The 2 areas are also related. Breakthrough in computer vision was what enabled us to ship the first stand-alone VR device. Mixed reality is built on a stack of AI technologies for understanding the physical world and blending it with digital objects. Being able to procedurally generate worlds will be important for delivering compelling experiences at scale. And our vision for AR glasses involves an AI-centric operating system that we think will be the basis for the next generation of computing. Since last year, number of apps with \~$25 Mn revenue has doubled on Quest store. More than half of Quest daily actives now spend more than an hour using their device. But Meta didn’t mention how many daily actives Quest has. **Efficiency** There’s a growing narrative that Meta may have cut to the bone to appease the Street. Meta doesn’t think so: > A lot of this efficiency work that we've been undertaking and especially this year, **is driven not sort of by solely financial imperative, but really with the focus of increasing operational efficiency**. And that really includes more carefully scrutinizing road maps, winding down projects that are no longer at the top of our priority list, reprioritizing investments. That's really a muscle that, I think, we have spent a lot of time building over the last half year, and I expect that we will be carrying that discipline into the way that we assess our product road maps going forward. > > …The goals of our efficiency work are to make us a stronger technology company that builds better products faster and to improve our financial performance to give us the space in a difficult environment to execute our ambitious long-term vision. **When we started this work last year, our business wasn't performing as well as I wanted. But now we're increasingly doing this work from a position of strength. Even as our financial position improves, I continue to believe that slowing hiring, flattening our management structure, increasing the percent of our company that is technical and more rigorously prioritizing projects will improve the speed and quality of our work**. I also believe that a stronger financial position will enable us to weather a volatile environment while remaining focused on our longer-term priorities. There was a question on recent media report on 1-2% headcount growth going forward. Meta indicated headcount growth will likely exceed 1-2% from the base of post-layoff headcount at least in 2024. **Regulation** Some uncertainty remains around EU-US privacy framework, but one interesting data point was only \~10% revenue comes from EU countries. I honestly expected more questions around data privacy regulation as I do think it is a long-term risk to the business. **Capital Allocation** Meta continues to buyback in excess of FCF which is great to see given the depressed stock price. Share count declined by 1.7% QoQ and 5.3% YoY. Meta still has \~$28 Bn net cash on balance sheet. CFO Susan Li even indicated a better optimized capital structure over time: > As we look forward, I also expect that we will modestly evolve our capital structure over time to improve our overall cost of capital. We expect to do so through periodically accessing the debt markets to diversify our funding sources while **still maintaining a positive or neutral net cash balance over time**. 1Q’23 headcount reflects November layoff but doesn’t reflect the March layoff yet as they are being done in April-May. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0275d050-e438-4217-8aeb-317f8ed3eff0_2094x456.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Opex Guide** After guiding \~$100 Bn Opex for 2023 initially, Meta’s opex guide range has come down by $6-15 Bn. Given last few years trend, it is likely to be closer to $86 Bn (including $3-5 Bn restructuring costs). While thankfully Meta omitted the word “**significantly**”, Reality Labs losses is still expected to increase in 2023. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F970ae19f-3871-4c34-a7d5-3c47095b5096_1644x822.png) Source: Company Filings, MBI Deep Dives **Capex guide** Capex guide is unchanged at $30-33 Bn. I became a little excited after reading the following quote by Zuck and thought capex ramp up is mostly behind us after 2023: > A couple of years ago, I asked our infra teams to put together ambitious plans to build out **enough capacity to support not only our existing products but also enough buffer capacity for major new products as well. And this has been the main driver of our increased CapEx spending over the past couple of years. Now at this point, we are no longer behind in building out our AI infrastructure. And to the contrary, we now have the capacity to do leading work in this space at scale**. But as Susan later explained, capex is likely hinged on how transformative generative AI related investments going to be: > …you can really think about our CapEx investment as having 3 broad buckets. The first, we've talked about before, non-AI compute needs. We do have ongoing general compute and storage needs to support the existing business, but this is an area where we've become much more efficient in terms of capital intensity and are very much focused on continuing to do so over time. > > The second area is in our core AI investments, which is really most of our AI investment today, and that's supporting the building of the discovery engine, ranking unconnected organic content, ranking ads, and we're focused on measuring the return of those investments and making sure that we feel good about the ROI of our spend there, and that really will drive our future plans in terms of that core AI spend. > > And then the third bucket is really around CapEx investments now to support gen AI. And this is an emerging opportunity for us. We're still in the beginning stages of understanding the various applications and possible use cases. And I do think this may represent a significant investment opportunity for us that is earlier on the return curve relative to some of the other AI work that we've done. And it's a little too early to say how this is going to impact our overall capital intensity in the near term. **Outlook** 2Q’23 topline guide is $29.5-32 Bn, \~7% YoY at mid-point (vs consensus of $29.5 Bn) assuming 1% FX headwind Since from 2Q’22-4Q’22 Meta reported negative topline growth, the comps get easier from here. While the mudslinging between Meta bulls and bears continues, it is perhaps a good moment to reflect for everyone involved in this stock about the last 12 months of craziness in one of the most widely followed stocks in the world. Some more thoughts from the follow-up call can be found **[here](https://twitter.com/borrowed%5Fideas/status/1651570464337063944?ref=mbi-deepdives.com)** For a more detailed analysis on Meta, you can read **[here](https://www.mbi-deepdives.com/meta2023/)** (no paywall). I will cover **Amazon** earnings tomorrow! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Alphabet 1Q'23 Earnings Update URL: https://www.mbi-deepdives.com/goog1q23/ Last updated: 2023-04-26T10:34:10.000Z *Disclosure: I own shares, and Jan 2025 call options of Alphabet* Google Search is still growing, but YouTube ads was down YoY for three consecutive quarters now. Thankfully, Google Cloud maintained the momentum with +28% topline growth. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fd9a0b459-c7b0-4655-ac55-a7fb9b3be556_2056x490.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) The big news in this quarter is Google Cloud became profitable for the first time. But there are some caveats. This profitability came after some adjustment in internal cost allocation methodologies. Google recasted Google Cloud’s last four quarter’s EBIT (from 1Q’22). They also changed estimates for useful life of servers and network equipment which was almost $1 Bn benefit some of which likely flows through Cloud segment. Corporate costs included $2.6 Bn restructuring charges (severance+ office related) and costs related to DeepMind (used to be other bets before). Google Services margin is likely to have a tailwind from 2Q’23 as Google Research related costs will move from Google Services to Google DeepMind within Alphabet's unallocated corporate costs. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F5f88a51b-427a-4f9e-a7b5-c25711132520_1968x548.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) It’s really bit of a shame that after acquiring DeepMind in [2014](https://techcrunch.com/2014/01/26/google-deepmind/?ref=mbi-deepdives.com), it took them almost a decade to integrate and pool the intellectual horsepower together. In fact, DeepMind [tried](https://www.wsj.com/articles/google-unit-deepmind-triedand-failedto-win-ai-autonomy-from-parent-11621592951?ref=mbi-deepdives.com) to seek an “independent legal structure” even after being acquired. If not for competition from OpenAI+ Microsoft, I wonder if this integration would ever happen. **Search** Since there has been media reports about Samsung potentially choosing Bing over Google for default search position on their phones, there was a question related to that: > we've always been in a competitive environment for these deals. And while I can't comment on the specifics of any of our partnership agreements, what has served us well is always, first of all, building the best product possible, focused on giving value to users. And when we work with our partners, we work hard to create a win-win experience, and **ultimately, partners end up choosing us because that's what their users want.** And that's always been what's helped Search be widely distributed. So I think it all starts with continuing to innovate and improve Search and making sure we are leading there. So I think we've always approached it very robustly over the many, many years, and I'm comfortable that we'll continue to be able to do so. While Satya Nadella indicated gross margin for Search may have peaked for forever, Sundar Pichai sounds a little more optimistic that costs can be managed: > costs of compute has always been a consideration for us. And if anything, I think it's something we have developed extensive experience over many, many years. And so for us, it's a nature of habit to constantly drive efficiencies in hardware, software and models across our fleet. **And so this is not new. If anything, the sharper the technology curve is, we get excited by it because I think we have built world-class capabilities in taking that and then driving down cost sequentially and then deploying it at scale across the world.** So I think we'll take all that into account in terms of how we drive innovation here. As expected, AI was frequently mentioned, but very little useful info was given in the call in terms of timeline and specifics of product rollout. AI-driven tools, however, have been driving ad performance: > Advertisers who use PMax are, on average, achieving over 18% more conversions at a similar CPA. This is up 5 points in just 14 months, thanks to advances in the AI underlying bidding, creatives, search query matching and new formats like YouTube Shorts. **Google Cloud** > Over the past 3 years, GCP's annual deal volume has grown nearly 500%, with large deals over $250 million growing more than 300%. Nearly 60% of the world's 1,000 largest companies are Google Cloud customers Google Workspace now has 9 mn paying customers. The last time they disclosed paying customers number (6 mn) was back in 2020\. While some seem to think Google Workspace as a threat to Microsoft 365, it doesn’t seem Google Workspace has much of a bite. It just kept growing \~1 mn paying customers per year since 2015\. For context, Microsoft has \~400 mn Office 365 paid seats in commercial segment. While Alphabet never disclosed how many paid seats per paying customer Google Workspace has, it is hard to imagine Microsoft losing sleep over Google’s 1 mn/year incremental growth. It would definitely cause headache if Google Workspace started adding paying customers at an accelerating rate. Some other interesting quotes on GCP: > We are the only cloud provider to announce availability of NVIDIA's new L4 Tensor Core GPU with the launch of our G2 VMs, which are purpose-built for large inference AI workloads, such as generative AI. > > Growth in GCP remained strong across geographies, industries and products. > > in Q1, we continued to see slower growth of consumption as customers optimized GCP costs reflecting the macro backdrop, which remains uncertain. **YouTube** The number of channels that uploaded to Shorts daily grew over 80% in 2022\. No updated data on daily shorts watched per day, so I wonder whether Shorts may have peaked for the time being. Some interesting quotes/data on YouTube: > our creator ecosystem and multi-format strategy will be key drivers of YouTube's long-term growth. And to support this growth, we're focused on, number one, Shorts; number two, engagement on CTV; number three, investing in our subscription offerings; and number four, a longer-term effort to make YouTube more shoppable. > > …In one of our largest marketing mix modeling studies to date, YouTube ROI is 40% higher than linear TV and 34% higher than all other online video, according to a customer analysis from January 2020 to March 2022 of Nielsen Compass ROI benchmarks across 16 countries and 19 billion of total media spend measured. This proves YouTube's ability to drive effectiveness at scale. **Capital Allocation** Alphabet continues to utilize almost all of their FCF in buying back shares which come out to be \~1% share per quarter. They also have \~$100 Bn net cash on balance sheet. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F96783392-e3d0-4baf-9f0b-a35ad840c7a6_948x554.png) Source: Company Filings, MBI Deep Dives **Headcount** While headcount grew by 477 in 1Q’23, the recent layoff will be reflected from 2Q’23\. Google talked about “durably reengineer our cost base” which likely means they would like to match topline and expense growth. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F41e19a8d-828c-4d9b-9b60-2d6590b8cee1_1172x656.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capex** While street (including me) was expecting capex to be mostly flat YoY, CFO guided 2023 capex to “modestly higher than in 2022.” > CapEx this year will include a meaningful increase in technical infrastructure versus a decline in office facilities. We expect the pace of investment in both data center construction and servers to step up in the second quarter and continue to increase throughout the year. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fcc0a214f-4a0b-4133-bdd9-0e951a4214d0_1018x612.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Valuation** While Alphabet’s valuation remains undemanding, the long-term questions related to Google Search and evolution of Search economics will decide whether it is mispriced stock or a potential value trap. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb4d5cb1c-4375-4f6b-a181-e93b4e169bbc_2498x498.png) Source: MBI Deep Dives You can read my more detailed analysis (including valuation) on Alphabet [here](https://www.mbi-deepdives.com/goog/) I will cover Meta’s earnings tomorrow. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Spotify 1Q'23 Earnings Update URL: https://www.mbi-deepdives.com/spot1q23/ Last updated: 2023-10-24T10:50:36.000Z *Disclosure: I own shares of Spotify* Over the last 6 months, Spotify stock has doubled. The business, however, remains largely work-in-progress with users accelerating but operating efficiency yet to reflect in the financials. Here are my notes from today’s earnings. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Users** Spotify experienced its largest two MAU growth (mn) quarters in its history for two consecutive quarters. Management mentioned they’re seeing an acceleration in MAU retention, higher DAU/MAU, and lower churn. MAU was 15 mn ahead of guidance! > “retention is higher, the DAU over MAU is higher than before, and the actual engagement is higher. And that's across music, but it's certainly true on podcasting as well. And we've seen a healthy trend sort of up to the right on podcasting for now many, many, many quarters. And we're seeing how both podcast and music is acting in great symbiosis together to drive an overall healthier user funnel on Spotify. > > …The strength was broad-based, and we had record Q1 net additions across nearly all age demographics in both developed and developing regions.” ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fbc4a0da7-aafa-4266-978b-eb17fd3b5c13_2278x232.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Premium Mix** Premium as % of MAU went down over the last 4-5 years as Rest of the World (RoW) region in the MAU mix went from 13% in 1Q’19 to 28% in 1Q’23\. RoW MAU basically doubled in two years and it usually takes time to convert MAU to premium. Spotify thinks recent MAU momentum usually bodes well for future premium subscriber growth. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F64c094f5-6acc-4378-ae93-469428b38d11_1430x1086.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Netflix vs Spotify** This is something I track every quarter. The divergence between Netflix and Spotify premium subscriber trend continues to widen every quarter. I should mention that definition of subscriber of NFLX and SPOT is not apple-to-apple, so I would caution not to infer more than what this data can tell us. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb31db038-b1c0-493d-91ef-c12e909770dc_960x632.png) Source: Company Filings, MBI Deep Dives **Revenue** While user growth kept surprising for two quarters, ARPU has been negative for two consecutive quarters. Spotify admitted the recent acceleration of subscribers may be marginally helped by being a lower cost provider (vs competitors most of whom raised price recently) The primary driver for negative QoQ ARPU growth was higher mix of family/duo plans. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F0975cb16-ff21-4eeb-8acf-52f6c8aa2ad1_1582x318.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) While ads growth is higher than premium segment, things aren’t quite moving as fast as investors would like. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Ffcfd52f7-683c-4876-8c66-85f772ea5964_914x720.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Gross margin (GM)** Spotify guided 24.9% GM this quarter, so the actual GM came out \~30 bps higher. Ad’s GM was -3% in 1Q’23 (vs -1.4% in 1Q’22). Building a negative gross margin segment when the primary investor concern about Spotify’s music business is GM is what you call “fate loves irony”. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F7950e6ed-860c-4074-81ed-3a64f30c9048_1080x598.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Content Cost** The primary culprit for negative gross margin in ads is, of course, the podcast related investments which Spotify has vowed to take a much closer look: > we're going to be very diligent in how we invest in future content deals. And the ones that aren't performing, obviously, we won't renew. And the ones that are performing, we will obviously look at those on a case-by-case basis on the relative value. And I would say 2 things here. One, we have very sophisticated tools for measuring impact on the platform where we talked about this at the Investor Day, where we do understand the relative impact on lifetime value in our subscribers and so on and so forth. I think that helps us paying a fair price or understanding what a fair price would be. But then the second part also, because we are now the largest podcasting platform, that means we have a great opportunity to amortize across a larger base. So relative to someone that's smaller, we should be in a better position should we want to renew a deal because we obviously can amortize that against a larger base of users. **Opex** Spotify had €41 mn severance related charge in opex (€44 mn overall, but even if we subtract one-off charges, opex as % of gross profit would be 115%. That’s obviously not sustainable. R&D as % of gross profit increased from mid-30s in 2021 to above 50% in the last three consecutive quarters. Spotify needs to gain leverage on its cost base. With AI in the horizon, I wonder if any material leverage may be hard to come by anytime soon. ![](https://substackcdn.com/image/fetch/w_2400,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F467ffc08-0d2d-46c9-963d-3bbe98d9b904_1962x192.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **AI** Speaking of AI, it does seem Spotify is likely to be beneficiary as music content creation process can get materially easier thanks to AI: > …to caution everyone, this is very early days, and it's an incredibly fast developing space. As I mentioned before, I don't think I've ever seen anything like it in technology, how fast innovation and progress is happening in all the really both cool and scary things that people are doing with AI at the moment. But I think it's important. > > I guess on the risk side would be not just for Spotify, but I think for our -- the entire creative ecosystem is obviously the question around copyrights and who owns what copyrights and what the fairway would be to attribute value when you're doing things in name and likeness situations or inspired \[ by a certain \] artist, et cetera. I think the whole industry is trying to figure that out and trying to figure out training -- and I would definitely put that on the risk account because there's a lot of uncertainty, I think, for the entire ecosystem. > > But on the positive side, to flip on that for a moment because I don't think that's been as highlighted as part of the story. One, I think this could be potentially huge for creativity on the positive side. I go in and talk a little bit more in detail about this on our -- for the record podcasts. > > If you really think about it, with now these conversational interfaces, it will allow people that perhaps don't know anything about how to play a music or even know these complex music production software tools to now create just using their voice, instruct the AI to make something to sound a little bit more upbeat, make something sound a little bit more like add some into the mix when you're creating a drum pattern or something like it. And that has the chance, I think, to meaningfully augment that creative journey that many artists to do. And you could even imagine someone just humming something and then the AI helping you out by creating a backdrop that you then can add it and alter, which is the music sort of software environment that many producers and music creators are doing. **And that should lead to more music. And that more music, obviously, we think it's great culturally, but it also benefits Spotify because the more creators we have on our service the better it is and the more opportunity we have to growing the engagement and growing the revenue.** So that would be on the upside, which a lot of people aren't talking about. And then, of course, there's entirely new potential products that perhaps can happen where you can have users creating their own music and perhaps Spotify could be a conduit of that, but I think it's way too early to speculate on those types of things at present moment. . **Outlook for 2Q'23** In Q2, Spotify is assuming 300 bps FX headwind; FXN topline growth is expected to be 14%. They do expect a steady ramp in gross margins throughout 2023 as well as sequential improvements in our operating loss. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F815a9818-8afc-4a28-9e67-4775bc594ec1_1456x494.png) Source: Company Filings You can read my Spotify Deep Dive (December, 2021) **[here](https://www.mbi-deepdives.com/spot/)** I will cover Alphabet’s earnings tonight! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Microsoft: The Quintessential Technology Company URL: https://www.mbi-deepdives.com/msft/ Last updated: 2025-04-07T17:28:58.000Z _This post is for paying subscribers only._ ### Readers' Feedback, and A Simpler Amazon Model URL: https://www.mbi-deepdives.com/feedback_amzn/ Last updated: 2023-04-02T19:23:38.000Z _This post is for paying subscribers only._ ### Amazon Update (amended) URL: https://www.mbi-deepdives.com/amzn2023/ Last updated: 2023-03-30T15:55:00.000Z _This post is for paying subscribers only._ ### Amazon Update URL: https://www.mbi-deepdives.com/amzn/ Last updated: 2023-03-25T12:04:52.000Z _This post is for paying subscribers only._ ### Adobe 1Q'23 Update URL: https://www.mbi-deepdives.com/adbe1q23/ Last updated: 2023-03-16T00:29:26.000Z *Disclosure: I am long shares of Adobe* In 2001 and 2002, Adobe's topline went down 3% and 5% respectively. In 2009, revenue went down by 18%! Thanks to shift to subscription and a continued secular momentum in digital content, Adobe will perhaps prove to be a quite resilient business in the much anticipated slowdown of 2023\. Not only they had an impressive Q1, they also raised guidance for 2023. Here are my highlights from the quarter. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Revenue** Topline grew +9% or +13% FXN. Net New Creative Cloud and Document Cloud ARR were $307 Mn and $103 Mn respectively. Overall, Digital Media net new ARR was $410 Mn (vs guidance of $375 Mn). 2Q guidance for Digital Media new new ARR is $420 Mn. [RPO](https://flgpartners.com/the-remaining-performance-obligation-rpo-saas-metric/?ref=mbi-deepdives.com#:~:text=A%20company's%20Remaining%20Performance%20Obligation,a%20contract%20with%20a%20customer.) exiting the quarter was $15.21 billion, which is +10% YoY or +13% FXN. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fb8ba0138-9bb4-4bf9-bbbb-90b8c664b115_1952x412.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Analysts kept asking why Adobe’s business is proving to be very resilient. Here’s what Adobe said: > When I take a step back and I think about what is driving that differential performance in this environment, I think **our products are mission-critical** to our customers. **We are on the critical path of them generating revenue. But as the world goes digital and those investments are prioritized, not only do we help companies drive top line growth, but we help them with the underlying productivity gains that go with that. It is why customers in this environment are prioritizing around things that we sell to enable their success. It addresses top line performance as well as underlying profitability of our customers.** So being on the critical path, being mission critical to customers, we think this is the type of environment where the power of Adobe and the performance of the company gets to shine. **What’s driving Adobe’s growth?** > In terms of **primary growth driver, it is and always has been new user acquisition.** **It is by far the biggest contributor**, and a lot of the PLG work that we've done over the last year or 1.5 years is contributing to not just top of funnel, but also conversion of that top of funnel. > > **In terms of upsell and migration, we've been investing for a decade or more in education**, and we have a very efficient channel now where students that graduate effectively upgrade and migrate into full priced offerings. **That drove a very strong Creative Cloud individual all apps quarter for us.** > > Retention, we've been doing a lot of work in retention through PLG, but we've also been driving a lot of utilization of Adobe Express as part of the Creative Cloud business. All of that combined makes for **a very strong retention rate**. > > New businesses, we talked about **Substance and Frame having outsized growth.** And of course, the pricing and packaging work that we've been doing and all along continues to contribute to that, both for CC and Acrobat CCDC as a whole. So looking ahead, all of these drivers and these levers are intact, and we have lots of opportunities going forward as well. **Gross Margin** Digital Media continues to post almost unparalleled gross margin i.e. >95%. Digital Experience’s gross margin seems stuck at mid-60s. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F57c2d4f4-1eb0-43c2-912e-0dcda8e8ea0a_1088x636.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Cost Structure** Thanks to those sky high gross margin and strong market position, Adobe posted \~34% GAAP Operating Margin. SBC as % of revenue remains in the High Single Digit (HSD) level. ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F4c235872-1419-4dbc-837a-65033398fddf_1978x276.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Capital Allocation** Adobe utilized 88% of its FCF in buying back shares, reducing share count by 1.3% QoQ (and -3.2% YoY). ![](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F99421fb2-8ec3-4f30-abca-4f335ccf1d18_1978x172.png) Source: MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) **Figma** Speaking of capital allocation, Adobe still sounds optimistic about Figma acquisition closing by 2023: > From the outset, **we have been well prepared for all potential scenarios while realistic about the regulatory environment**. We have completed the discovery phase of the U.S. DOJ second request and are prepared for next steps, whether that is an approval or a challenge. **Adobe remains confident in the facts underlying the case. And based on current process timing, we believe the transaction continues to be on track for a close by the end of 2023.** **Figma-Adobe Opportunities** Adobe is certainly paying an eye-popping price for Figma, so they reminded why they think Figma-Adobe integration makes sense for both companies: > we believe that **we can just fundamentally accelerate what they're doing today in product design. We have a global footprint.** We are working with a lot of our -- with enterprise customers across the globe, and the feedback that we're getting from these enterprise customers is a lot of excitement about the kind of things we can do by bringing these 2 companies together to just accelerate and make them more productive in terms of what they want to accomplish and just accelerate everything that they're doing. > > The second thing is around **taking workflows between Photoshop and Illustrator and Figma and really just operationalizing them in a way that we can bring real-time collaboration capabilities based on the Figma platform** to these -- to the core disciplines like illustration and video editing and photography and 3D design and more. > > And the third is really around the evolution with **FigJam, bringing that into the core for productivity use cases. So taking FigJam and integrating it more deeply with things like Acrobat and starting to just recognize that creativity is starting to be the foundation of how new productivity applications need to present themselves.** And that whole motion of enabling productivity workers to express themselves creatively is where the market is going with the rise of the creator economy. And so we see -- we just see a ton of opportunities to integrate the products. **Generative AI** A big question mark on the terminal value of Adobe is how Generative AI will affect the Creative Cloud business. Adobe makes the case that it is net positive: > **Creating an image is just the start. It's not the end. And Adobe is the only player that has a full end-to-end workflow,** not just within the products and the tools that we have in the digital media business, but also everything that Anil is doing around the content workflow and the content supply chain out to the point of distribution. And in fact, because of this, we're seeing other gentech companies wanting to partner with us more and more, and so **we feel like we're in a really advantaged position where we're going to come out with our own model and we're going to be partnering with others to make sure that because of our distribution and the place we play in the market, we can bring a lot of this value to actual fruition.** > > …We think that, again, **if you can start to imagine yourself as creative by using a text prompt, we can take you through that full journey and onboard you into other Adobe offerings. It's also great for retention.** We've always seen the more value that gets used in our core offerings, the better the retention rates and the better the LTV. And we think there's upsell opportunity. We do think these are distinct new packages that we can bring to market and upsell people to. **Guidance** Digital Media net new ARR guidance for full year was increased from $1.65 Bn to $1.7 Bn. GAAP EPS guide was also raised from $10.75-$11.05 to $10.85-$11.15. For a more in-depth analysis on Adobe’s business, see my Deep Dive on [Adobe](https://mbideepdives.substack.com/p/adbe?ref=mbi-deepdives.com) [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Alphabet Update URL: https://www.mbi-deepdives.com/goog/ Last updated: 2023-03-11T12:16:46.000Z _This post is for paying subscribers only._ ### Meta Needs A Decade Of Efficiency URL: https://www.mbi-deepdives.com/meta2023/ Last updated: 2023-03-02T22:42:12.000Z *Disclosure: I own January 2025 Call Options and Shares of Meta Platforms* *This is *Part-1* of my four-part series on Big Tech. Part-two, three, and four will be on *Alphabet, Amazon, and Microsoft* respectively. While this post is made public, the rest of the series will be behind paywall.* [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) --- Mark Zuckerberg announced 2023 to be the "Year of Efficiency". Following the spending decadence in 2021-22, I think what Meta needs is a decade, not a year, of efficiency. The **primary objective** of this update is to understand what shareholders like myself need to **believe** to generate \~10% IRR **without** using a lofty exit multiple e.g. \~10-12x in 2030\. (I'll comment on what may be appropriate exit multiple as well.) But first of all, I want to discuss the 2022 Opex. I was curious how exactly Meta managed to spend \~$88 Bn in 2022 when it spent only \~$20 Bn in 2017\. I know they show their spending by line items in the Income Statement, but I wanted to approach the Opex differently to gain a better sense of their spending. That's **Section 1.** In **Section 2**, I will explore whether there is a path for Reality Labs to be a real business even in 2030. In **Section 3**, I will move to a more hopeful direction if you are a Meta shareholder: Family of Apps. In **Section 4**, I will show you some valuation math in which I'll explore what we need to believe to make \~10% IRR using 12x terminal FCF multiple. Finally, in **Section 5**, I will leave some concluding remarks on Meta Platforms. ## Section 1: Making sense of \~$88 Bn expense in 2022 Instead of looking at operating expense line items such as cost of revenue, R&D, S&M, G&A, I tried to estimate opex by infrastructure cost, headcount costs, and other reported expenses to get a sense of the overall spending structure for Meta. Let's start with the infrastructure cost. Snap on its recent investor day disclosed the following interesting graph: ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-135.png) Source: Snapchat 2023 Investor Day While Meta never disclosed their infrastructure costs, Snap's disclosure could be a good starting point to estimate Meta's infra costs. Since Snap uses public cloud whereas Meta uses their own infrastructure to run their properties, one may think Meta is likely to have lower infra cost per DAU, but of course there are more nuances. Meta has four major apps: Facebook, Instagram, Messenger, and WhatsApp compared to Snap's one major app: Snapchat. Facebook and Instagram usage likely to cost materially more than Messenger and WhatsApp and because of the potential cost efficiency of using their own infra vs public cloud, I assumed Meta's infra cost per Daily Active People (DAP) to be 2x of Snap's reported number in 2020\. But since Reels was launched in August 2020 and subsequently became an increasing percentage of total time spent on Meta's properties, I assumed 2.5x and 2.8x of Snap's reported infra cost per DAU in 2021 and 2022 respectively for Meta. With such assumption, I estimate that Meta's infra costs (includes depreciation) increased from $13.5 Bn in 2020 to $17.3 Bn in 2021 and $18.4 Bn in 2022. I then estimated Meta's cost of revenue for Reality Labs (mostly VR hardware), content related costs (mostly licensing music and/or video content etc.) to calculate opex excluding cost of revenue in the last three years. Since I wanted to gain a better understanding of total compensation paid to employees, I looked for any other cost items explicitly reported by Meta. From their 10-K, I could find their advertising expense, restructuring expense in 2022, and lease costs. Once I took into account all these expenses, I was left with $33 Bn, $44 Bn, and $55 Bn opex in 2020, 2021, and 2022 respectively. If I assume all of that as compensation paid to employees, that would imply \~$692k per average headcount in 2022\. That doesn't sound right because we know Meta discloses their Stock Based Compensation (SBC) number which came out to be \~$151k per average headcount in 2022\. Data from [levels.fyi](https://www.levels.fyi/?compare=Lockheed%20Martin,Square,Cisco&track=Software%20Engineer&ref=mbi-deepdives.com) suggest software engineers, for example, at Meta get paid more in cash (base+ bonus) than in stocks for E3-E6 levels whereas E7-E8 employees make significantly more in stock than in cash. Although an organization this big is likely to follow pyramid structure in headcount (significantly higher number of employees in E3-E6 than E7-E8), at the senior level total comp is so skewed to stock that it is unlikely cash comp per headcount is order of magnitude higher than average SBC per headcount. However, I looked at some data for international offices at Meta and it seems employees in international offices get paid more in cash and less in stocks compared to employees in the US offices. While there are clearly some puts and takes here, I assumed cash to be 2x of SBC per overhead. If that's the case, total comp per overhead at Meta was \~$454K in 2022\. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-145.png) Source: levels.fyi Of course, it's not just cash and stocks; every big tech has their famed perks and benefits. We all know about that, but it was still quite something to go through some of the benefits Meta/Facebook allegedly have for their employees, as per levels.fyi ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-146.png) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-147.png) Source: levels.fyi Levels.fyi estimates that all these benefits are valued at $27,459/year. If we plug that, we can calculate that employee related costs totaled $38 Bn in 2022, leaving $16.6 Bn unallocated opex in this exercise. I also want to explicitly mention that as a shareholder, I want Meta to remain one of the highest paying employers, if not the highest, among the tech companies because it is indeed one of the key competitive advantages of Meta (as it is for other big tech vs the startups or SMID cap tech companies; more on this [here](https://www.mbi-deepdives.com/sbc/)). On my "wish list", I do not want lower total comp per headcount but I certainly would love to see more discretion in the number of hiring. Meta's employees increased from \~25k in 2017 to \~86k in 2022 and it is the pace of hiring that led to some angst among shareholders, including me. The recent layoff (and potentially more) shows Meta is finally working on addressing this. Let's go back to the unallocated opex. What exactly is this $16.6 Bn opex which is $210k per average headcount? It could be office furniture, travel expenses, tech gadgets given to employees, Meta's own software bills etc. Whatever it is, if you are looking for efficiencies, this would probably be a good place to start. If Meta could run their entire company with $20 Bn opex in 2017 (they had chairs, laptops, and software bills in 2017 too), I am sure there are plenty of inefficiency in this bucket. Speaking of inefficiencies, Reality Labs perhaps takes the cake, and it is indeed potentially a significant drag for shareholders going forward. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-8.png) Source: Company Filings, MBI Deep Dives ## Section 2: Is there a path for Reality Labs to be a real business in 2030? Meta disclosed segment wise revenue and EBIT numbers from 2019 even though it doesn't disclose more granular breakdown of operating expenses in Reality Labs. Let's start with the revenue and gross profit build for Reality Labs. If my model appears a bit unrealistic for Metaverse skeptics out there, please stick around for the expenses modeled to generate these projected revenues to understand what I'm doing here. **Revenue and Gross profit Build** Within Reality Labs, I have segmented revenue in broadly two categories: Virtual Reality (VR), and Augmented Reality (AR). Then within each of these categories, I assumed three sources of revenue: Hardware sales, software revenue, and advertising revenue. Let's start with VR. Since Meta is yet to launch any major AR product and unlikely to do so until 2025, I attributed all of Reality Labs revenue to VR till 2024\. Meta's VR has, broadly speaking, two types of hardware: relatively lower priced consumer hardware (e.g. Quest 2), and higher priced enterprise hardware (e.g. Quest Pro). Their initial plan was to keep launching a new version of either consumer or enterprise segment in alternate years, but there seems to be some [indication](https://mixed-news.com/en/meta-cardiff-headset-cancelled/?ref=mbi-deepdives.com) that they may choose not to pursue such a path. Because the Enterprise version was just launched this year and even the future versions are likely to cost at least \~2x (likely higher) the price of consumer ones, there will be a natural tailwind to Average Sales Price (ASP) per unit. The quantity is perhaps anyone's guess. Since Quest 3 is going to be launched later this year, I imagine Quest 2 sales will dwindle for much of the year and sales will only pick up after Quest 3 is launched. I assumed continued decline in units sold, but ASP is modeled to increase by $100 due to Quest Pro and Quest 3's higher price point compared to Quest 2 which was the best sellers in 2021-22\. Beyond 2023, let's **assume** VR will keep gaining steady momentum and units sold will increase by 1 mn incrementally each year till 2030 which will mean 11 mn units sold in 2030\. With $900 ASP, it implies $9.9 Bn revenue from hardware sales in 2030. The software revenue is basically assumed to be something similar to Apple's App Store model in which Meta keeps 30% of whatever that gets sold in Quest Platform. Let's assume each VR device holder will replace the hardware on an average every two years and the install base of the Meta's VR hardware will be the sum of the last two year's units sold. For software revenue, I assumed the install base of Quest will have one paid app installed on their hardware. If one such app costs $20/month or $240/year, Meta keeps $72/year from that revenue. if \~21 mn install base pays for one app on an average, it leads to \~$1.5 Bn revenue in 2030. The other potential revenue source is advertising. Meta owned apps such as Horizon are likely to monetize via advertising. It's likely Meta may have multiple apps on their platform which they may try to monetize via advertising. Let's say 30% of the install base will be Monthly Active Users (MAU) of one Meta owned app. Assuming $30 ARPU/year, this implies $180 mn revenue in 2030; so it may be rather inconsequential. For cost of revenue, I assumed Meta to be gross margin breakeven in VR, thanks to Quest Pro and Quest 3, both of which are unlikely to be negative gross margin products. As Meta gains more scale in hardware, gross margin is modeled to exceed 45% by 2030\. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-2.png) Source: MBI Deep Dives Now, let's talk about AR. There were media [reports](https://www.theverge.com/23022611/meta-facebook-nazare-ar-glasses-roadmap-2024?ref=mbi-deepdives.com) last year that indicated Meta is planning to launch first generation AR device by 2024 and was also already working on a lighter, more advanced design for 2026, followed by a third version in 2028\. However, on a recent Ask Me Anything (AMA) session on Instagram, Meta's CTO Boz was asked: "Do you think AR glasses will be delayed by macroeconomic state?" Boz played down macroeconomic influences on AR launch and highlighted technological limitations. Since this AMA happened on February 2nd this year, that doesn't sound like an optimistic news for a 2024 launch. 0:00 / 1× Source: Instagram [AMA](https://www.instagram.com/stories/highlights/17889286679717554/?ref=mbi-deepdives.com) by Meta's CTO Meta's CTO was also asked: "What tech breakthroughs are needed in order for AR to achieve critical mass? Timeline?". On the question of timeline, he just used one word: "Tough". 0:00 / 1× Source: Instagram [AMA](https://www.instagram.com/stories/highlights/17889286679717554/?ref=mbi-deepdives.com) by Meta's CTO Given the sentiment shared by Boz, I assume Meta may not launch AR device until late 2025\. Zuckerberg repeatedly mentioned before he thinks AR devices (**not** VR) are the potential replacement for smartphones. It's hard to say how much it will cost, but given the mass target market and potential use cases, I'm going to assume a $500 price point and a faster adoption curve compared to VR. While I assumed Meta will sell 11 mn VR devices in 2030, I assumed 24 mn AR devices will be sold in 2030\. Let me be very clear: the range of estimates is very, very wide here. iPhone unit sales exceeded 100 mn five years after its launch. So, if Meta's AR launch is anywhere nearly as successful as the iPhone (perhaps the most successful product launch in this century so far), these estimates will look laughable. On the other hand, if the technological limitations prove to be too hard, the devices may turn out to be "meh" to mass consumers or at the extreme, Meta may not be able to figure out at all how to build a cost effective AR device that can appeal to the mass consumers. Forecasting is almost always dangerous, but if you are in the investing business, you are always underwriting some estimates/forecasts for the future regardless of the difficulty of forecasting. I encourage readers not to take these estimates seriously and insist on only following the thought process. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-156.png) Source: [Global Data](https://www.globaldata.com/data-insights/technology--media-and-telecom/annual-sales-of-apples-iphone/?ref=mbi-deepdives.com) At $500 price point and 24 mn unit sales in 2030, I estimate $12 Bn sales of AR hardware. Similar to assumptions made in VR segment, I estimate the install base will have on an average one paid app installed paying $240/year which means Meta keeps \~30% of that as their net revenue. Advertising assumptions are also similar to the VR segment (and also assumed to be inconsequential). On a consolidated basis, Reality Labs is modeled to generate $26.5 Bn revenue in 2030 which at first glance may seem like a wild success story. I wish we could eat revenue; let's move onto expenses! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-158.png) Source: MBI Deep Dives Reality Labs' Income Statement is not for the faint hearted. Reality Labs reported $2.2 Bn revenue and $13.7 Bn losses, implying \~$16 Bn operating expenses in 2022 (Again, Meta (then Facebook) spent $20 Bn in opex in 2017\. Sigh!). As explained earlier, I estimated $2.2 Bn for cost of revenue, leaving the rest for R&D, S&M, and G&A. R&D is where most of the money is spent so far, especially since Meta is effectively inventing a lot of the technology required for AR & VR products. From the rest of the Opex in Reality Labs, I assumed $10 Bn was spent on R&D, and $1.55 Bn was spent on both S&M and G&A. Boz [mentioned](https://tech.facebook.com/reality-labs/2022/12/boz-look-back-2023-look-ahead/?ref=mbi-deepdives.com) half of the R&D goes to AR and the rest to VR, wearable, and software/content (e.g. Horizon). Given the pressure to launch a viable product to the consumer, I assume R&D intensity is unlikely to go down despite the recent layoff and efficiency talk and assumed $1 Bn increase in R&D expense compared to 2022\. Beyond 2023, I assumed R&D to increase $500 mn incrementally each year till 2030\. My R&D estimates can be a bit of a Rorschach test. On one hand, the incremental increase seems quite tame and conservative compared to history. On the other hand, Meta is clearly making a huge effort to make a technological breakthrough here; will they need to keep up the intensity once the fundamental problems are solved? And if no breakthrough is possible with $10 Bn R&D spending, I'm not sure 2-3x of that spending will solve the problem either. Zuckerberg [mentioned](https://stratechery.com/2022/an-interview-with-meta-ceo-mark-zuckerberg-and-microsoft-ceo-satya-nadella-about-partnering-in-the-metaverse/?ref=mbi-deepdives.com) he thinks Meta needs to be 2-3 years early compared to Apple to make sure they are ahead of the competition. It is very much possible that he may be ahead by 5-7 years and being too early can sometimes be equivalent to being wrong. Even if Meta makes those technological breakthroughs after spending tens of billions, it may be their competitors who will be the prime beneficiary of those R&D dollars by quickly imitating Meta's success. For all the talk of Meta being a fast follower of all the cool features other social media companies invent, the tables will perhaps be turned against Meta in the Metaverse! ![](https://media.tenor.com/CXfDcqtHBfoAAAAC/the-office-michael-scott.gif) One question shareholders routinely wonder is whether Meta can just shut down Reality Labs if nothing seems to pan out. While nothing is impossible, I consider it to be **extremely unlikely**. This goes to the crux of the difficulty of building a hardware startup as opposed to software. When Meta works on a standalone app but fails to gain traction from users, it can basically shut down swiftly without too much noise. But manufacturing hardware at scale requires collaboration with multiple stakeholders whose planning relies on your commitment. Think about Qualcomm or Corning who may be partnering with Meta for the AR/VR hardware value chain and you'll probably appreciate how challenging it can be for Meta to unilaterally take a decision without creating much repercussion in the future. How can Qualcomm/Corning trust or rely on Meta the next time they think of building hardware? The complexity of the supply chain in hardware will make it much more difficult to make a swift decision. The other issue is when you are trying to build the next computing platform, you need third-party developers to build on your platform. But why should anyone build on your platform as opposed to building on the current computing platform? Again, the company pursuing the next computing platform may require an unusual display of capital commitment to show their seriousness (perhaps Amazon's Alexa is a similar victim to such commitment requirement?). I am not smart enough to know what the correct R&D spending should be today or 5-10 years from now at Reality Labs. If Meta spends the way I have modeled here, despite the splashy $26.5 Bn revenue in 2030 it will incur $115 Bn aggregate losses in 2023-2030\. If we add the last four years reported losses, aggregated loss from 2019-2030 will be $150 Bn. This model assumes Reality Labs losses will peak in 2026-27 and start going down afterwards but still incurring $9 Bn losses even in 2030 which may imply breakeven another 3-5 years away even from 2030\. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-3.png) Source: Company Filings, MBI Deep Dives While it is easy to be a bear on Reality Labs, let's imagine the bull case that Meta will eventually have its "iPhone" moment. In just 7 years after the launch of the iPhone, Apple's FCF increased from $8.5 Bn in 2008 to $70 Bn in 2015\. In 2022, Apple generated $111 Bn FCF and made a cumulative $782 Bn FCF in 2008-2022\. Let's imagine once Meta finds its "iPhone" moment, Reality Labs will post the exact same FCF every year following that "iPhone" moment. What would IRR from Reality Labs Investments be in such a case? ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-159.png) Figure: Apple FCF from 2008 to 2022; Source: Tikr One of the major assumptions to this IRR question is investment required on Reality Labs before it finds its "iPhone" moment. I have created a scenario analysis which ranges from $150 Bn-$500 Bn investment required to get such a moment. Please note we cannot just sum up the aggregate losses to calculate the investment required. **We have to take into account the cost of capital**. If cost of capital is 7% for Meta and "iPhone" moment arrives in 2035, $13.7 Bn losses in 2022 is equivalent to $33 Bn in 2035 (multiply 13.7 Bn by 1.07^13). Therefore, assuming 2036 to be the starting point for "iPhone" moment (as Apple was in 2008) for the stream of FCFs, $350 Bn may be a more realistic investment amount to consider. Given that assumption, even an "iPhone" moment would lead to just \~15% IRR. Two big takeaways from this are: **time is of the essence**, and the longer Reality Labs is away from being a real business, the harder it is for Meta to generate a decent IRR even in the **stretched bull case** scenario. (*Please note: I took Apple's 2022 FCF and multiplied it by 10x to calculate the terminal value of Reality Labs which is $1.1 Tn. Why 10x? If Meta could truly disrupt iPhone, iPhone may have a maximum another trillion FCF left to return to shareholders. And if Meta could disrupt Apple in 2035, we also need to entertain the possibility of someone else doing the same to Meta at some point. Again, focus on thought process and not on inconsequential quibbles)* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-162.png) Source: MBI Deep Dives Of course, hardly anyone believes Reality Labs is worth any positive value. The business that's perhaps worth all of Meta's market cap (and then some) is Family of Apps. Let's move onto a potentially more optimistic direction for Meta shareholders now. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ## Section 3 Family of Apps: Defying the question of durability Family of Apps (FOA) primarily consists of Facebook, Instagram, Messenger, and WhatsApp. While investors have perennially wondered about the ghost of MySpace, FOA continued to reach new and unforeseen heights in the social media industry. A **19-year old** Mark Zuckerberg co-founded Facebook (currently Meta) in 2004 and it is hard not to be awestruck by what he did in less than couple of decades. Let me contextualize Zuckerberg's height of success with Facebook (now Meta). 17 years after being founded, Meta reached $95 Bn Gross Profit in 2021\. To reach similar Gross Profit, Alphabet, Amazon, Apple, and Microsoft took 22, 24, 42, and 45 years respectively. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-171.png) Source: Company Filings, MBI Deep Dives How about **GAAP** Operating Profit? Meta posted $45 Bn operating profit (**including** \~$10 Bn losses in Reality Labs) in 2021\. To reach similar operating profit, Alphabet, Apple, and Microsoft took 22, 36, and 44 years respectively. To post such operating profit, only Microsoft required lower invested capital than Meta, so Meta was able to reach such profitability with incredible margins **and** ROIC. Perhaps the AGI will beat Zuckerberg's record by reaching $45 Bn operating profit faster. While Meta may have gotten a bit derailed in 2022, it would be unfair to not acknowledge, appreciate, and applaud what Zuckerberg and his team did in 2004-2021. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-172.png) \*Invested Capital is calculated as total assets-cash and short-term investments-current liabilities; Source: Company Filings, MBI Deep Dives Okay, let's look at FOA business now. I'll start with users. The [model is available](https://www.mbi-deepdives.com/models/) to paid subscribers, so please feel free to change the assumptions as you see fit, but let me quickly summarize my assumptions for Daily Active Users (DAU) at Facebook (including Messenger) going forward. Except for Rest of the World (RoW), I have assumed a material deceleration for net new DAU add for Facebook in 2023-2030 vs 2017-2022 period (not I'm comparing next 8 years numbers vs last 6 years, so even for RoW, the net add per year is expected to decelerate). [Last year](https://www.mbi-deepdives.com/meta/), I was much more pessimistic about user trends in the long-term following the rapid rise of TikTok. While the TikTok threat is far from fully neutralized, Meta seems quite well positioned following the increasing popularity of Reels (more on this later). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-173.png) Source: Company Filings; MBI Deep Dives With \~3.7 Bn Monthly Active People (MAP) across its Family of Apps, Meta is, of course, highly penetrated in almost all markets (ex-China) and hence user growth is naturally expected to decelerate. It is interesting, however, that in the last 12 months Meta added more users than Pinterest and Snapchat even in North America. > Monthly Active User (MAU) growth in \*North America\* over the last 12 months > > Facebook: +4M > Snapchat\*: +3M > Pinterest: 0 > > Size of MAU in NA: > > Facebook: 266M > Snapchat\*: 100M > Pinterest: 95M > > \*Snap doesn't disclose MAU; it only reports DAU; Facebook's DAU was also +4 mn YoY in 2022 > > — Mostly Borrowed Ideas (@borrowed\_ideas) [February 6, 2023](https://twitter.com/borrowed%5Fideas/status/1622713601969602561?ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) It can be a bit confounding that Meta not only kept adding new users in North America despite the almost constant negative coverage of their products in legacy media post-2016 election but the company also kept reporting engagement (e.g. DAU/MAU) metric that remains highest in North America compared to other regions in the world. In some sense, many North American Facebook users made a conscious decision to stay on the platform even if they may strongly disapprove of the owner of the platform, indicating the stickiness of these users. Even if Meta had been facing increasing [difficulty](https://s.wsj.net/public/resources/documents/teens-young-adults-on-ig-and-facebook.pdf?ref=mbi-deepdives.com) in attracting "Young Adults" to its properties, especially Facebook, its agility in incorporating features such as Stories and Reels ensured the existing users aren't leaving the platform en masse. This isn't a Deep Dive on Meta, so I cannot go into the intricate details on TikTok vs Meta, but let me touch on a popular bear case briefly. Bears mention how TikTok eroded the competitive advantage of network effects that Meta enjoyed since TikTok's famed algo doesn't even rely on network effects. While there is truth to that, I do think CAC is much higher for businesses that don't have much of a network effect. With 3.7 Bn MAP on its platform, if Meta can just copy features from other apps, CAC will increase even higher. Ultimately, Meta's Family of Apps business is in the digital distribution business. It has aggregated essentially the entire world (ex-China) and enjoys enormous CAC advantage over anyone who is going to threaten their business. And the CAC math is even more challenging in the post-ATT world when monetization of your user base is a big question mark for all the sub-scaled networks. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-163.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Speaking of monetization, two things are simultaneously likely to be true: a) Meta's advertising attribution may never be as good as it was pre-[ATT](https://www.adjust.com/glossary/apptrackingtransparency-att/?ref=mbi-deepdives.com), and b) ATT itself will be competitive advantage against sub-scaled social media players (Twitter, Snap, Pinterest, and even TikTok) who were struggling even in the pre-ATT world to catch up with Meta's advertising infrastructure. Reels is currently a headwind for Meta (>20% of time spent) for monetization and as they expect to reach parity with feed or stories by 2024, I expect it to be a natural tailwind for the business in 2023 and 2024 compared to 2022\. Moreover, FX itself was \~$6 Bn headwind in 2022\. I'm modeling $5 Bn and $7 Bn advertising revenue growth respectively in the next two years. If FX headwind evaporates (or becomes tailwind) and Reels monetization momentum picks up, my model may be implying not much of a growth at all from 2021 to 2024\. Moreover, Meta's investment improving ad attribution (e.g. [Advantage+](https://www.ft.com/content/fc95a0f7-5e4e-4616-9b17-7b72daee6c60?ref=mbi-deepdives.com)), >$10 Bn direct-to-messaging business run-rate, and massive capex investments in the last two years (discussed later) is also likely to yield some benefit which, if it improves attribution infra, can be a material tailwind to price per ad and consequently revenue growth. Speedwell [discussed](https://speedwellresearch.com/2023/01/17/meta-platforms-deep-dive/?ref=mbi-deepdives.com) this eloquently: > ...as targeting improves, (ad) inventory opens up, which first depresses prices, as auctions are less competitive. This lowers prices, which makes it even more attractive to advertisers, and more sellers allocate more ad budget to Facebook. Then the advertisers bid up the cost of impressions again and (hopefully) Meta releases new ad targeting improvements which start the cycle again, growing revenues with each iteration while maintaining happy advertisers. However, given the size of Meta's advertising business, the macro factors may outweigh all these potential tailwinds in the next couple of years. Therefore, some conservatism may be prudent. Beyond 2024, I do expect the earlier mentioned tailwinds, along with stabilizing or hopefully improving macro environment, are likely to lead to faster growth. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-164.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) Let's talk about margins now. First, I want to touch on whether Meta may opt to share revenue with Reels creators which will obviously have profound gross margin implications. In 3Q'22 call, Meta mentioned there are 140 billion Reels played across Facebook and Instagram each day. While they didn't disclose this number in 4Q'22, let's assume the number increased to 150 Bn per day in 4Q'22\. In 4Q'22 call, Alphabet disclosed that YouTube Shorts was watched 50 Bn times per day i.e. one-third of Reels watched per day. Of course, the market leader in short-form video is TikTok which is a private company and hence doesn't provide much disclosure. Several media/analyst reports seem to indicate that people spend \~90 minutes per day on TikTok. In September 2021, TikTok [disclosed](https://newsroom.tiktok.com/en-us/1-billion-people-on-tiktok?ref=mbi-deepdives.com) that they had reached 1 Bn MAU. Let’s assume that today they have 1 Bn DAU, and people on TikTok watch 3 videos per minute. That would lead to 270 Bn videos per day. If we add it all up, market share in short-form video in terms of daily views among these companies is as follows: TikTok 57%, Meta 32%, and YouTube 11%. YouTube, being the distant third player in this market, is doing the “right” thing. They’re causing a headache for the leaders in this space with a disruptive revenue sharing model. They can afford to do that because YouTube’s core value proposition for Alphabet is to support Google’s broader moat and not necessarily to build compelling economics on a standalone basis. The question is whether Meta should follow YouTube. The answer should be, at least temporarily, no. Let me explain. Reels was launched in \~50 countries in August 2020 and YouTube Shorts (beta) was launched the following month. Shorts was then globally released in July 2021\. It’s perhaps too early to figure out what the end state looks like. But here’s how I’m currently thinking about this. At scale, aggregating demand is much more important than aggregating supply. If you have 100 Mn users and 1 Mn content creators, it is more important to increase users to 200 Mn than to increase content creators to 2 Mn. At some point, your marginal content creators bring very little or negligible value to the overall network. But your network value keeps increasing non-linearly with more and more users. Given Instagram MAU is already \~2 Bn, they have aggregated massive demand. The suppliers have no alternative but to supply content for the platform, especially because the marginal cost to post is close to zero. But the opportunity cost for a content creator not being active on a platform where there is 2 Bn MAU is significantly higher than zero. TikTok and Meta as current market leaders have strong incentive not to follow the third player here. **By following YouTube, they’ll destroy economics and gain effectively almost nothing. If everyone goes for the revenue share model, we are back to the drawing board of aggregating demand.** Imagine if short-form video is a $100 Bn gross revenue market in 5-10 years and YouTube eventually gains 30% market share, it will keep only somewhere between $8-16 Bn. If Meta keeps even 20% market share (down from 32% now) in short-form video views, it will make $20 Bn (assuming similar monetization effectiveness across the board). Hence, it may make more sense to let YouTube gain market share than to follow their economic model. There is another interesting dynamic that may arise due to YouTube’s decision to opt for a revenue share model. Such a decision will effectively cap the number of players to three. TikTok has the largest audience for short-form video, Meta has a superior ad infra to help creators monetize their following, and YouTube has a compelling revenue share model to incentivize creators. How can the 4th, 5th…100th short-form video players entice the market? Those up-and-coming players are yet to aggregate demand, won’t have good ad infra thanks to ATT, and will therefore be forced to play along with YouTube’s overly generous economic model. Given this scenario, Meta should primarily focus on gaining market share in short-form video **net revenue $** and should not lose sleep over the allure of time spent and gross revenue market share. What if TikTok opts for a revenue sharing model? In that case, Meta may indeed have to opt for revenue sharing as well. I don't consider it likely that TikTok will pursue such a monetization plan as ByteDance (TikTok's parent company) [allegedly](https://www.wsj.com/articles/tiktok-parent-bytedance-sees-losses-swell-in-push-for-growth-11665071238?ref=mbi-deepdives.com) posted only \~56% gross margin in 2021; it seems very unlikely that they are in a position to be generous with the content creators. While many understandably feel content creators deserve direct payment for their work from the platforms themselves, that mostly sounds like a moral plea and the economic rationale to do so seems quite fragile. While FOA enjoyed \~87% gross margin in 2017, it is fair to say we may never see such margin ever going forward. Since content has shifted from text to images to video, there is a double whammy for Meta here: just as its monetization has been going through a headwind from ATT, its cost of revenue was increasing due to rising computing intensity to serve increasingly video dominated feed/surface on the app. Now that Reels itself will go through a multi-year journey in a post-ATT world and Reels is likely to gain share in overall time spent on the platform, gross margin may shrink further from 2022 level. There can also be potential headwinds from tougher negotiation from music labels to license their music to be used in Reels. I modeled \~150 bps gross margin compression over time from 2023. I'll touch on R&D and capex together in the next section. On S&M and G&A, there's no compelling reason why Meta won't enjoy some scale benefit over time. In any case, for 2030 I modeled S&M and G&A as % of sales closer to where it was in the 2017-18 period. If this plays out as modeled, FOA operating margins will gradually increase from \~41% in 2022 to \~47% in 2030 (vs peak margins of \~52% in 2017). Moreover, while FOA added \~$15 Bn incremental revenue each year in 2018-2020 and a whopping $30 Bn in 2021 before posting declining revenue in 2022, I didn't model $15 Bn incremental revenue growth for FOA in any of the next 8 years. **If Meta can find its efficiency religion just in FOA business, it may generate an aggregate \~$550 Bn operating profit in 2023-2030\. Meta's current Enterprise Value is \~$425 Bn.** Perhaps the two biggest threats to FOA are: a) regulatory whims specifically directed at FOA business (Europe seems particularly intent on enacting regulations that can affect Meta's business), and b) perhaps more importantly: TikTok. I expect TikTok to make a concerted effort in integrating more and more social features to create network effects to lower the CAC burden. It remains to be seen how successful they will be in such efforts but TikTok remains a key risk for FOA's path to continued domination. Then there are, of course, owners of current mobile computing platform i.e. Apple. While it appears the worst is behind Meta when it comes to ATT, it is always possible there may be more tricks in Apple's bags waiting to be revealed over time, creating a persistent overhang on Meta's core business. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-4.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) ## Section 4: Valuation/Model Assumptions Since I already discussed the estimates for FOA and Reality Labs, the one major assumption I want to focus on in this section is capital expenditures or capex. First, some history on Meta's capex. If you look at the past, Meta went through a couple of capex cycle: a) 2010-2012 period highlights their shift to mobile and capex as % of sales peaked at 24% and then gradually declined to 14% in 2016, b) Meta started shifting more from text to images and videos which made the business more capital intensive given the increasing computing/storage intensity. During the more recent capex cycle (2018-ongoing), revenue growth maintained a healthy clip in 2018-2021\. Therefore, while absolute capex dollars increased from \~$7 Bn in 2017 to \~$19 Bn in 2021, capex as % of sales continued to decline. However, in 2022, Meta experienced its first ever revenue decline while simultaneously increasing capex from $19 Bn in 2021 to $31 Bn in 2022\. Moreover, they guided capex $30-33 Bn in 2023 as they make more investments in AI, advertising infra, and expect Reels to be an increasingly greater percentage of time spent on the platform. The street estimates $30-33 Bn ongoing capex as far as 2027 (estimates not available beyond 2027). What the maintenance capex is for Meta in the long-term is one of the key question on valuation and I think the long-term maintenance capex is potentially $5-10 Bn lower than what the street may think. Let me explain why. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-183.png) Source: Company Filings, MBI Deep Dives, Tikr ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-182.png) Source: Company Filings, MBI Deep Dives Meta’s Gross PP&E increased by \~$86 Bn in 2022 compared to its 2017 balance. But \~$28 Bn of it is quite discretionary and remnants of the bygone era (Buildings and equipment increased by $23 Bn and $5 Bn respectively during this period). As we enter a very different era for Meta, it is fair to say we are unlikely to see $30 Bn incremental spending on building and office equipment in the next 10 years (let alone 5 years). The much less discretionary expenses are servers and network assets which Meta continues to ramp up to cater to the increasing computing intensity of users consumption. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image.png) Source: Company Filings, MBI Deep Dives, [Daloopa](https://daloopa.com/?utm%5Fsource=MBI&utm%5Fmedium=Organic&utm%5Fcampaign=SourceLink) In 2022, Meta had \~$34 Bn servers and network assets which translated to $9.4 per MAP (Monthly Active People). If Meta adds another \~1.2 Bn MAP in the next 8 years (vs \~1.4 Bn add in last 5 years) and we keep the assumption that server/network asset per MAP will keep going up (see below), Meta may have \~$87 Bn servers and network assets in 2030\. It’s fair to say Meta’s capex is likely to be closer to maintenance capex in 2030, so I’ll focus on that to understand the long-term capex intensity of this business. While Meta used to amortize these assets over 4 years, in the 2022 10-K they increased the useful life to "four to five years". I am optimistic that they’ll realize similar benefits as Amazon, Alphabet, and Microsoft did and will learn to lengthen the useful life to 5-6 years. Assuming 5 years useful life, depreciation for these assets is \~$17 Bn per year ($87 Bn\*20%). If Meta becomes prudent in keeping their discretionary expenditure in check, depreciation for the rest of PP&E could easily be \~$3-5 Bn. So, we may be looking at $20-25 Bn maintenance capex once the current capex cycle normalizes. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-1.png) Source: Company Filings, MBI Deep Dives A natural question may arise on whether the computing cost intensity will be even higher than I assumed. I modeled almost doubling of computing cost intensity per user in 2030 (vs 2022). Could it be a 150% increase? 200%? While I don't think anyone really knows the correct answer here, that seems unlikely to me. Not only computing cost may just get a lot cheaper, but also there may be some interesting implication if computing intensity is indeed materially higher than modeled here. ARPU for Rest of the World (RoW) i.e. ex North America, Europe, APAC was just **$13** in 2022\. Therefore, if computing intensity keeps rising materially faster, it may be financially unfeasible for companies to serve those users. In such a case, it may even be possible that Meta may not make certain features such as Reels available (or may limit usage or provide max time limit) in these cost prohibitive countries. It is more likely that we are closer to the end of this current capex cycle (than in the middle) and capex may possibly peak in 2023 and may start towards more long-term maintenance capex over time. Of course, companies do investment through balance sheet (capex) AND income statement (mostly R&D). It's perhaps more relevant to look at both R&D and capex together to get a sense of investment made by the company. The sum of capex and R&D was \~$34 Bn even in 2020 which increased to $43 Bn in 2021 and $67 Bn in 2022, so it effectively doubled in just two years. Analysts can understandably feel nervous about lowering capex estimates when it simply has never gone down in Meta's history. However, looking at the past to extrapolate the future may prove to be wrong once this capex cycle normalizes. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-5.png) Source: Company Filings, MBI Deep Dives Looking at other big tech (admittedly there are some notable exclusions here), it is hard not to infer that Mark Zuckerberg wants to go above and beyond to compete with other big tech even though other big tech's Enterprise Value (EV) are 2.5x-5x larger than Meta. Of course, just spending on capex and R&D doesn't mean much; what matters is the efficiency of the spend. If Metaverse proves to be nothing, all of your billions of capex+R&D spent on Reality Labs (mostly R&D) may not be worth much either. Therefore, I would caution in inferring too much from the table below, but it does underscore that Meta's spending on R&D and capex is already staggering and assuming ever increasing spending going forward implies a depth of ineptitude in the management team at the helm. Time will tell whether my capex and R&D assumptions are in the right ballpark. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-180.png) Source: MBI Deep Dives One concern investors may have is since I am assuming $115 Bn losses in 2023-2030 period for Reality Labs and mostly maintaining the current capex+R&D spent, what does ROIC look like in such a scenario? Meta's ROIC dropped precipitously from mid 20s in 2018-2021 to mid-teen in 2022 and despite my Reality Labs losses and capex+R&D assumptions, ROIC may still revert back to the 20s over time. As we all know, the longer it goes, the more likely it is that shareholders return will get closer and closer to ROIC. While return in a particular year may be volatile based on numerous factors, long-term (think decades, not years) return will certainly have close resemblance to company's ROIC. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-168.png) ROIC= NOPAT/average invested capital. Invested capital is calculated as total assets-cash-current liabilities; Source: Company Filings, MBI Deep Dives **Valuation:** If these assumptions prove to be ball-park right, I need to assume just 12x terminal FCF (fully burdened for SBC in terminal year which is why 2030 FCF dropped vs 2029; in the interim years, dilution is modeled and no SBC is deducted) multiple to generate 10% IRR. Since this is consolidated FCF, it **includes $9 Bn losses assumed** for Reality Labs in 2030\. What it means is **I am capitalizing the losses of Reality Labs by exit multiple** which bulls might think it to be a bit draconian assumption. **I tend to agree**, but it is hard to do SOTP until and unless we know the kind of milestones Meta may have internally to decide how they want to manage their investments in Reality Labs. However, the closer Reality Labs gets to be a real business and gets closer to breakeven, investors may rethink their valuation approach and may want to value FOA and Reality Labs using SOTP. In such case, 12x consolidated terminal FCF would prove to be **quite** conservative assumption. If terminal consolidated FCF is 18x, IRR would be \~15%; at 25x, IRR would improve to be \~19% (again, remember I'm still capitalizing Reality Labs losses here since these are all consolidated numbers; therefore, the higher the multiple, Reality Labs is valued even more negatively which is a bit nonsensical. So, in reality you may not need to assume 25x FCF multiple to generate \~20% IRR here). I also assumed Meta's net cash to decrease from \~$31 Bn in 2022 to \~$2 Bn in 2030 as Meta started issuing debts recently and expressed its interest in accessing debt market more over time. All the FCF is assumed to be used to buyback stocks while stock price is modeled to increase at IRR rate over the projected period. Similarly, to keep things consistent, SBC was assumed to be issued at the same stock price the shares are implied to be repurchased each year. As usual, I strongly recommend you [download](https://www.mbi-deepdives.com/models/) the model, play with the assumptions to fit your narrative, and decide for yourself what you think. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/03/image-9.png) Source: MBI Deep Dives ## Section 5: Final words If you notice my assumptions carefully, I am not modeling Meta to be extremely fit overnight (that can only happen in spreadsheets, but not in reality). I am, however, indeed expecting Meta to recognize the lack of discipline shown in the last 12-18 months. While media reports may make it seem like Meta has been a hot mess for quite some time (most companies indeed are), the numbers tell us it was one of the most wonderfully scaled businesses in the history of capitalism up until 2021\. Should we put more weight on 2022 or should we consider the 2004-2021 period a better reflection of how Mark Zuckerberg wants to run this company? The next couple of years may give us a more clear answer. The best companies are not efficiently run for any particular year; efficiency is usually their modus operandi. It is perhaps very likely that following the "Year of Efficiency", Zuckerberg may prefer such a year much more than what he and Meta experienced in 2022\. "The Year of Efficiency" needs to last a decade for Meta to be the kind of company Zuckerberg likely wishes Meta to be. Even though some investors think Zuckerberg may simply choose to not care about shareholders, I do not think that is a viable option for him. His employees are paid in stocks and if their stocks continue to dwindle when other big tech reaches new heights, he will have hard time attracting top talent. Personally, I am willing to give a a lot of rope for once in a generation founders such as Zuckerberg. Of course, that rope's length is **not** infinite. One final thing I would like to highlight in this update is how incredibly challenging it can be to assess the moat even for some of the most widely followed companies such as Big Tech. The following chart is a humble reminder to me (and also for readers) that sentiment can change rapidly in unforeseen ways in the Big Tech land. 10 years ago, Apple and Microsoft were in the doghouse in investors' books and it was Meta (then Facebook) and Alphabet (then Google) that were enjoying the favorable sentiment from the street. Today, the situation has been completely reversed. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-181.png) Source: KoyFin It is quite challenging, for example, to predict with high conviction how generative AI may shape the tech landscape. Meta has been one of the most aggressive investors (through capex and R&D) in that space and if AI indeed becomes the defining force 5-10 years from now in protecting moats, Meta may find itself one of the strongest companies in the world in 2030\. We are, however, almost certainly not paying for such rosy picture to unfold. Thank you for reading. I will publish my update on **Alphabet** in a couple of weeks. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Autodesk 4Q'FY23 Update URL: https://www.mbi-deepdives.com/adsk4q23/ Last updated: 2023-02-24T02:35:57.000Z *Disclosure: I am long shares of Autodesk* [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) Autodesk met their high end of the topline guidance. While topline grew at High Single Digit (HSD) rate YoY, it was +12% FXN. Subscription revenue, which is \~92% of revenue, was +14% FXN. While Media &Entertainment (M&E) segment was down 10%, it won the largest ever EBA in 4Q last year which included significant upfront revenue. Excluding upfront revenue, M&E grew 4%. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-136.png) Net revenue retention remains at 100-110% (FXN). Autodesk typically discloses their subscriber numbers in 4Q. Volume remains the primary driver as it continues to grow at solid double digit rate. Price has been a muted factor over last couple of years, but I suspect it's more due to mix shift. Autodesk management mentioned that over time they want to drive 10-15% topline growth from largely equal contribution from volume, price mix, and ASP. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-142.png) GAAP operating margin increased by 1 percentage point, but Autodesk management continues to have an unhealthy obsession with non-GAAP margins as well as Rule of 40/45\. As a shareholder, it does concern me that the management team keeps touting metrics that have no real meaning. CFO thinks this rule of 40 is "hallmark of the most valuable companies in the world". Nope. While Rule of 40/45 (sum of Non-GAAP operating margin+ Topline) can have relevance for cash burning companies, it essentially has zero relevance for mature public market software companies. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-138.png) Thankfully for minority shareholders, management did mention that they expect SBC as % of revenue to come down to 10% over time. Autodesk repurchased 5.5 mn shares for $1.1\. Bn at an average price of $198/share in 2022 which reduced shares outstanding by 4 mn (-2% YoY). Buyback was 54% of FCF. They also spent $350 Mn to retire debt in 2022. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-139.png) FY'24 topline guidance assumes 7-9% growth, but +12% on constant currency and excluding Russia impact. Management mentioned 3Q and 4Q activity was consistent across quarters. Analysts seem a bit skeptical about the guide because it's essentially not incorporating much of a slowdown in business despite the macro environment. Back in 2009, Autodesk's revenue went down by 26%. One could perhaps infer a couple of things: a) this recession, if it comes to fruition, may just be a very benign one; and b) Autodesk's business, following the switch to subscription in 2017, may be somewhat immune from the general cyclicality of the economy. Management seems to think the trends in 4Q would basically continue throughout this year. If that doesn't happen, the topline guide, in fact, may prove to be optimistic. Non-GAAP operating margin guide is similar to this year which may be impressive given FX headwind. Long term (FY'26) Non-GAAP operating margin targets are 38-40% (\~2-5 percentage points higher than FY'23). Cash tax rate will be 31% in FY'24 vs 25% this year: > Our cash tax rate will return to a more normalized level of approximately 31% in fiscal '24, up from 25% in fiscal '23\. We accrued significant tax assets as a result of the operating losses we generated during our business model transition. Growing profitability and more recently, rising effective tax rates across the globe, have accelerated the consumption of those tax attributes. Absent changes in tax policy, we expect our cash tax rate to remain in a range around 31% for the foreseeable future. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-140.png) Why is FY'24 FCF guide only $1.2 Bn (Mid-point) vs $2 Bn in FY'23? > Change in deferred revenue increased fiscal '23 free cash flow by $790 million, but will reduce fiscal '24 free cash flow by approximately $300 million. The switch to annual billings for multiyear customers and a smaller multiyear renewal cohort are the key drivers of this $1.1 billion swing. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-141.png) Thank you for reading. I will publish my valuation update on **Meta Platforms** later next week. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Fastenal: Compounding Nuts and Bolts URL: https://www.mbi-deepdives.com/fast/ Last updated: 2023-02-21T23:09:41.000Z _This post is for paying subscribers only._ ### Shopify 4Q'22 Earnings Update URL: https://www.mbi-deepdives.com/shop4q22/ Last updated: 2023-02-16T02:26:40.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) > "If you look at our 7 years since IPO, we were profitable 5 out of the 7." \-Harley Finkelstein (4Q'22 Call) Except that's not true! Shopify was profitable only 2 out of 7 years since IPO. Perhaps he was adding back SBC? You can add back SBC if you want, but you cannot add back SBC and then define it as "profitable". Let's look at my other highlights from the call. **GMV** GMV grew +13% YoY (+17% FXN) vs US retail growth of +6%. Tough comps, and 3-yr growth shows pretty robust 43% CAGR. At $197 Bn GMV in 2022, Shopify has \~10% penetration in the US e-commerce market. During Black Friday, 52 mn (+12% YoY) consumers bought from brands powered by Shopify. Off-line GMV was +25% YoY in 4Q'22; +40% in FY'22. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-113.png) Source: Company Press Release, MBI Deep Dives, [Daloopa](Daloopa.com/mbi) **Amazon vs Shopify** One metric that I like to track is how Shopify's GMV growth $ fares against estimated Amazon's GMV add. After some significant momentum in 3Q'21-2Q'22, this number came down to closer to 2019-1H'21 level. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-112.png) \*Amazon GMV estimated as online sales+ physical store sales+(3P sales/25%); Source: Source: Company Press Release, MBI Deep Dives, [Daloopa](Daloopa.com/mbi) **Take rates** While take rates for merchant solutions increased from 1.5% in 1Q'19 to 2.2% in 4Q'22, overall take rates remains largely static over the same period. Shopify recently raised prices for its monthly subscription plans by 33%; while it went into effect immediately for new merchants but will take effect on April 23 for existing merchants. In the US, there were 4 mn new business applications on an average per year during 2015-2020\. In 2021 and 2022, that number has been 5 mn/year which is a good sign for Shopify. > Contribution from our Plus merchants to total MRR increased year-over-year to 33% from 29% in Q4 of 2021 as larger volume brands join the platform and thousands of additional retail locations began using Point-of-Sale Pro. > For 2022, our MRR per merchant remained relatively consistent with 2021, excluding those on our free and paid trials. We expect to see some incremental benefit to MRR in 2023 from the pricing changes we announced last month. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-114.png) Source: Company Press Release, MBI Deep Dives, [Daloopa](Daloopa.com/mbi) **Payment penetration** Shopify Payments continues to march forward as penetration increased from 41% in 1Q'19 to 56% in 4Q'22. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-115.png) Source: Company Press Release, MBI Deep Dives, [Daloopa](Daloopa.com/mbi) **Shop App** Lots of interesting details about Shop App; Shopify clearly has larger ambitions about this in the long-term: > Since we introduced the Shop App in early 2020, it has grown from an accelerated checkout and order tracking utility to become an important driver of many of our merchants business performances. Shop gives merchants new ways to stay connected with their buyers like in-app offers and notifications when their favorite products are back in stock. In a nutshell, Shop enables a Shopify merchant on their first day to have a storefront in a native mobile app. That's very powerful. > **In 2022, we shipped dozens of enhancements to Shop, including discounts and expanded search function, personalized shopping experiences and embedding Shop Cash, our loyalty program that is currently in early access. With tens of millions using the app every month, we're able to match the right merchants to the right buyers, creating personalized shopping feeds for the buyer segment and a new customer acquisition tool for merchants.** > Shop is still in its early days, but it's one of the ways we're investing to help merchants win over the long term. A key feature of the Shop App is Shop Pay, our accelerated checkout feature that continues to commerce better for merchants and buyers alike. **With well over 100 million buyers opted into Shop Pay, our accelerated checkout facilitated $11 billion in GMV in Q4 and a cumulative $77 billion at year-end since its launch in 2017.** **International** One area where Shopify may outpace Amazon over time is international markets. 45% of its merchants now based outside of North America generating 27% of revenue. Shopify Payments is now available in 22 countries; Point-of-Sale in 14 countries, Shipping in 7 countries, and Shopify Capital in 4 countries. Shopify advanced $400 mn (+21%) capital to merchants in 4Q'22. Interesting stat about cross border transactions: > In 2022, **Shopify enabled approximately $28 billion in cross-border sales, capitalizing on the surge of international interest, with nearly 28% of all traffic to Shopify stores coming from buyers outside of the merchant's home country.** **New Products** Shopify discussed a few new products that they have recently launched: Commerce Components by Shopify or CCS, and Shopify Tax. > To kick off the year, we made a major announcement that we were launching our **enterprise retail solution**, Commerce Components by Shopify or CCS. > **Shopify signed business partnership agreements with Accenture, Deloitte, Ernst & Young and KPMG to enable greater opportunities for larger brands to adopt Shopify** > Also in Q4, we launched **Shopify Tax**, a new product offered to U.S.-based merchants that takes a stress out of sales by simplifying tax compliance. **Early data shows that merchant adoption has ramped quickly**, speaking to the trust that merchants have in Shopify. As we work to sell their toughest problems, our merchants are eager to utilize more of our products. **SFN** > > Over the past 6 months, we have made significant strides in integrating Deliverr into SFN. We're creating one unified network that enables data-driven inventory distribution and access to our logistics services. Compared to Q4 of 2021, we've seen a 40% increase in orders per merchant, while Deliverr has achieved over 50% growth in units fulfilled and more than doubled its services outside of fulfillment, services like freight, B2B, parcels and returns. **Gross Margin** Merchant Solution's gross margin continues to decline, primarily due to Payments and Deliverr both of which are likely lower margin business than overall reported margin. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-120.png) Source: Company Press Release, MBI Deep Dives, [Daloopa](Daloopa.com/mbi) **Cost structure** Shopify had one impairment charge of $84 Mn. it would still be unprofitable even if we adjust for that. Adjusting one-off expenses, 4Q'22 opex was flat compared to 3Q'22\. Interestingly, Shopify went through a process of benchmarking comp for their employees and decided to pay higher comp, primarily in R&D. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-117.png) Source: Company Press Release, MBI Deep Dives, [Daloopa](Daloopa.com/mbi) **Outlook** > ...expect Q1 revenue to grow in the high teens on a year-over-year basis. We expect Q1 gross margin to be slightly higher than our gross margin for Q4 of 2022. > We believe that our Q1 operating expenses will be up in the low single-digit percentage versus our Q4 2022 operating expenses when excluding the onetime charges that we had in Q4\. Stock-based compensation for Q1 is expected to be in line with Q4 of 2022\. Finally, we expect that capital expenditures for Q1 will be in line with what we spent for the full year of 2022. SFN will be "*headwind to gross margin and a significant contributor to operating expenses in 2023\. This impact on year-over-year comparability will be most prominent in the first half of 2023 given that the Deliverr acquisition closed in July 2022."* No update on Buy with Prime. **Valuation** I have recently sold my shares of Shopify. The last time I showed this valuation exercise, its EV was $30 Bn and you could make the case that despite Buy With Prime and SFN execution related risks, the risk-reward was likely to be quite favorable. At $60 Bn EV today, it seems risk-reward is likely to be quite unfavorable. For context, if we assume 18% GMV CAGR in 2022-2030 (vs \~12% YoY growth in 2022) and increase take rate 100 bps (vs 26 bps increase over last 5 years), 50% gross margin, 15% S&M, 15% R&D, and 5% G&A, we get to $3.5 Bn GAAP EBIT (\~13% margin). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-118.png) Source: MBI Deep Dives You need to multiply that EBIT by 40x to get to \~10% IRR. At 20x, you get \~1% IRR. Of course, there are some optionality such as Shop App which, if it becomes massively successful, can change the math materially. At this prices, you probably need to start getting comfortable with valuing the optionality and hope the company defies the risk of Buy With Prime. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-119.png) Source: MBI Deep Dives Thank you for reading! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### IAC 4Q'22 Earnings Update URL: https://www.mbi-deepdives.com/iac4q22/ Last updated: 2023-02-15T00:07:05.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares of IAC* > The world was priced for perfection, digital companies broadly focused on growth at all costs, and “basic” was a tacit insult. Not anymore! IAC's theme for 2023 is "**Back to Basics**: clear objectives, relentless prioritization, focus on profitability and return on investment." Here's my highlights from today's call and the latest shareholder letter. **ANGI** Lots of interesting new data points disclosed this quarter, but ANGI is doing another pivot which is admittedly a bit exhausting to anyone who's following this company for a while. It's been around for almost two decades and still needs plenty of adjustments to be "Adjusted EBITDA" profitable. So, what's the latest pivot? > "In Q4, we began to focus heavily on high-volume, repeatable, lower average-order-value jobs, and we will exit the more complex services entirely in 2023." ANGI is going to focus on its legacy ads and leads business (customers pay SPs i.e. Service Professionals), and high-volume fixed pricing projects (customers pay to ANGI and ANGI pays to SPs after taking a cut). Ads and leads had \~13% adjusted EBITDA margin in 2022 and everything else was unprofitable. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-103.png) Ads and leads business seemed to have hit a trough in 1Q'22 and since then, both topline and margins are growing again. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-104.png) ANGI's foray into fixed pricing service business didn't pan out well. As they are leaving the complex jobs, they expect things to improve a lot and last two quarters trajectory does seem a bit encouraging. Also, services is switching to net revenue reporting from next quarter. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-105.png) Unit economics of the service business is finally going in the right direction. While ANGI's take rate was only 5.2% in 2022, it increased to 11.3% in 4Q'22\. Again, it does seem leaving the complex job market can lead to a more healthy unit economics. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-106.png) > There's the reality that a lot of service professionals have to try out our platform, and it doesn't work for everybody. That's been true forever and will be true forever. > > But the service professionals that it does work for, which is about **1 in 4 reached the 1-year milestone**, those service professionals that it does work for stay for a very long time. **They stay on average 4.5 years, and they now comprise 60% of the service professionals on our platform.** CEO Joey Levin indicated the retention could improve from 25% to 35%, but at a 20-year business, it's probably hard to improve that number materially. ANGI is targeting $60-100 mn Adjusted EBITDA in 2023\. Given that SBC will be $40-50 mn this, it will actually be barely profitable. Well, let's hope that the business can operate 2-3 consecutive years without another pivot. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-107.png) Management thinks that beyond 2023 ANGI can be a double digit grower with room for margin expansion: > **we do expect gross profit to grow mid-single digits across the overall Angi business this year** really due to even if total revenue is flat, favorable mix between Ads and Leads and Services > **On the long-term revenue growth and margins, we think this is -- should be a double-digit revenue grower**. Again, 2023 is going to be choppy because we're removing some empty calories and changing a bunch of things in the business. > > But kind of after 2023, a double-digit revenue growth is absolutely achievable with expanding margins. **Dotdash Meredith** > Aggregate traffic volumes across the portfolio is **still down circa 5% to 6%** mainly driven by real weakness in a number of the historical Dotdash sites that just had large booms during the pandemic and Omicron, Investopedia, The Spruce, others. > overall, for the year, we -- **both traffic and revenues aim to get to flat at some point in the second quarter, see growth in the second half and drive to growth for the full year.** > > Growth and profitability will come from a couple of things: cost actions we've taken, including a reorganization that we have actioned recently; and then also just scale on high-margin digital revenues. Of course, there was a question about ChatGPT. But it's a valid question as an analyst provided context to the opportunity/threat posed by chat bots : > *On one hand, you could potentially produce content much more efficiently in the future. On the other hand, SEO traffic might be negatively impacted.* IAC, as you can imagine, thinks it is more of an opportunity than threat: > Every new technology is a threat and an opportunity, and we certainly think about them in both ways. > There's a big difference if you want to **draw the line between commodity content and differentiated content. And I think that commodity content, which I'll call kind of text-based content, has been threatened or significantly removed but -- from the search engines for a long time.** It exists on the search engines and SEO, but generally, they hold on to that traffic count. **So something like greater than 50% of traffic doesn't leave Google anymore.** > The format of that may change on the search engine itself, **but we're not counting on that kind of traffic and haven't relied on that kind of traffic from the search engines for a long time.** And you could argue in that context, again, that brand is even more important. Voice is even more important. **Care** > Care delivered a solid year of 10% revenue growth, despite slowing consumer demand and lapping challenging Enterprise comparables driven by robust corporate demand for back-up care during the pandemic. **Vivian** > Vivian, a leading health-care jobs marketplace focused on simplifying the hiring process for health care professionals, agencies and hospitals, more than doubled revenue in 2022. There was no question asked about Care, Vivian, or Turo. **Capital Allocation** After buying back $23 mn, $64 mn, and $24 mn in the last three quarters respectively, IAC repurchased just $1 mn shares in 4Q'22 even though stock traded at much lower level in 4Q than any other time in 2022. I wonder whether IAC is getting close to do a deal and hence, not utilizing the cash for buyback. IAC hasn't hinted at anything concrete, so just speculation on my part. **Valuation** If you add IAC's ANGI and MGM stake, that's worth $44/share. IAC bought Meredith for $2.7 Bn in 2021; let's assume the whole DotDash Meredith business is worth that today (\~10x 2023 adjusted EBITDA), that's another $31/share. If we assume \~$1 Bn corporate costs ($12/share), ANGI+ MGM+ Dotdash Meredith -Corporate costs =$63 per share while the stock is trading at $54/share. Of course, I have assumed Turo, Care, and Vivian etc. to be worth zero. Well, the valuation math can change if chat bots make Dotdash Meredith to be worth zero. We are almost always taking a risk (knowingly or unknowingly) even when it may seem it's difficult to lose money from such and such cheap valuation. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-108.png) I will cover Shopify tomorrow. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Amazon 4Q'22 Earnings Update URL: https://www.mbi-deepdives.com/amzn4q22/ Last updated: 2023-02-03T13:49:55.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares, and Jan 2025 call options of Amazon* > ..it's important to remember that over the last few years, we took a fulfillment center footprint that we've built over 25 years and doubled it in just a couple of years. And then we, at the same time, built out a transportation network for last mile roughly the size of UPS in a couple of years \-Andy Jassy (4Q'22 Earnings Call) Here's my highlights from the call. **Revenue** Overall topline was +8.6% YoY despite 360 bps FX headwind In Q4, sellers was 59% of overall unit sales. AWS was understandably a major focus on this call, so let me spend more time there. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-25.png) **AWS** AWS continued its rapid deceleration from 40% in 4Q'21 to 37% in 1Q'22, 33% in 2Q'22, 28% in 3Q'22, and 20% in 4Q'22. What perhaps surprised (shocked?) investors is the following quote: > Starting back in the middle of the third quarter of 2022, we saw our year-over-year growth rates slow as enterprises of all sizes evaluated ways to optimize their cloud spending in response to the tough macroeconomic conditions. As expected, these optimization efforts continued into the fourth quarter. > we expect these optimization efforts will continue to be a headwind to AWS growth in at least the next couple of quarters. **So far in the first month of the year, AWS year-over-year revenue growth is in the mid-teens**. That said, stepping back, our new customer pipeline remains healthy and robust, and there are many customers continuing to put plans in place to migrate to the cloud and commit to AWS over the long term. If AWS ends 1Q'23 at \~15% YoY growth, we will see AWS reporting its first ever QoQ revenue decline. Okay, how about beyond the couple of quarters? > In the AWS growth rate, I'm not sure I can forecast for you with any level of certainty what is going to happen beyond this quarter. You kind of -- **this is a bit uncharted territories economically.** ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-21.png) AWS sales declining QoQ wasn't certainly on my bingo card, but one of the core value propositions of cloud (vs on-prem) is the ability to scale up or down based on demand. So, some cyclical component is natural, but I personally expected secular to beat cyclical nature of cloud in 2023. AWS isn't trying to optimize for the quarter though: > the way that we've built all our businesses, but AWS in this particular instance, is that **we're going to help our customers find a way to spend less money. We are not focused on trying to optimize in any one quarter or any one year,** **we're trying to build a set of relationships in business that outlast all of us**. And so if it's good for our customers to find a way to be more cost effective in an uncertain economy, our team is going to spend a lot of cycles doing that. It's deeply annoying that Google Cloud and Azure don't report their cloud specific numbers. Sounds like Amazon is a bit annoyed too: > we're the only ones that really break out our cloud numbers in a more specific way. So it's always a little bit hard to answer your question about what we see. But we, to our best estimations, when we look at the absolute dollar growth year-over-year, we still have significantly more absolute dollar growth than anybody else we see in this space. Just as Amazon made forecasting errors in e-commerce demand and overbuilt warehouses/FCs, it does seem their cost structure in AWS also needs some right sizing. Their incremental opex YoY **exceeded** incremental revenue in 4Q'22. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-23.png) AWS reported 35.3% operating margin in 1Q'22 whereas in 4Q'22, it came down to 24.3%! The last time they reported such low margin was back in 2Q'17\. Andy Jassy has big shoes to fill in. And it's fair to say now he's had a rough start. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-24.png) Amazon, ex AWS margins are also in the wrong direction. While Amazon reported $2.7 Bn operating income in 4Q'22, there was $2.7 Bn one-off charges. Excluding those, operating income would be $5.4 Bn in 4Q'22. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-26.png) Amazon added **$281 Bn revenue in 2022 vs 2018**, and yet none of the operating cost line items shows any operating leverage (cost of sales is mostly mix shift from product to service sales). They even managed to increase marketing cost from \~5% in 2018 as % of revenue to \~8% in 2022. Capex intensity almost doubled over the last 5 years. That's "probably" okay; I say "probably" because they don't disclose how much they're spending on other bets and we don't have much of a clue about economics of any of their other bets. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-22.png) **Prime Video** Amazon asserts they do rigorous ROI analysis on their spending on content (probably take it with a grain of salt): > The Rings of Power, the most watched Amazon original series in every region of the world, **reaching over 100 million viewers and driving more Prime sign-ups worldwide during its launch window than any previous Prime Video content.** > We also finished our inaugural season as the exclusive home of Thursday Night Football, reaching the youngest median age audience of any NFL broadcast package **since 2013 and increasing viewership by 11% from last year among hard-to-reach 18- to 34-year-olds.** > **In aggregate, we invested approximately $7 billion in 2022 across Amazon Originals**, live sports and licensed third-party video content included with Prime. **That's up from about $5 billion in 2021.** As a reminder, these digital video content costs are included in cost of sales on our income statement. **We regularly evaluate the return on the spend and continue to be encouraged by what we see, as video has proven to be a strong driver of Prime member engagement and new Prime member acquisition.** **Amazon International** International remains a challenging segment for Amazon, but Jassy shared some encouraging stats, but I would love to hear how they're doing in India: > if you look at the compounded annual growth rate from 2019 to '21, **in the U.K., it was over 30%; in Germany, it was 26%; in Japan, it was 21%**. And the fact that we haven't given back that growth, and these are all net of FX, but if you look at even the last couple of quarters where we're continuing to grow and we haven't given back some of that growth, a meaningful amount of market segment share has shifted to our global established e-commerce territories, and we're excited about that. Andy Jassy, in his first call with the analysts, also depicted how Amazon is thinking strategically on their big bets: > when we think about big areas to invest in, we ask ourselves a few questions. We ask, if we were successful, could it really be big and move the needle at Amazon, which is a high bar at a place like Amazon? Do we think it's being well served today? Do we have a differentiated approach? And do we have some competence in those areas? And if we don't, can we acquire them quickly? And if we like the answers to those questions, we will invest. > when we look at the answers to those 4 questions, we are very enthusiastic about our investments in streaming entertainment devices, our low Earth orbit satellite and Kuiper, health care and a few other things. And I think that do I think every one of our new investments will be successful? History would say that, that would be a long shot. However, it only takes one or two of them becoming the fourth pillar for Amazon for us to be a very different company over time. This was perhaps Amazon's the most underwhelming quarter in the last four years of my Amazon coverage. [Tip Jar](https://mbideepdivescom.outpost.pub/donate?ref=mbi-deepdives.com) (feel free to dip your toes in the tip jar if you find these updates useful; thank you so much in advance) I'll cover Shopify and IAC in a couple of weeks. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Alphabet 4Q'22 Earnings Update URL: https://www.mbi-deepdives.com/goog4q22/ Last updated: 2023-02-03T01:36:59.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares, and Jan 2025 call options of Alphabet* > More than 6 years ago, I first spoke about Google being an AI-first company \-Sundar Pichai (4Q'22 Earnings Call) Given the hype of AI and speculation of AI being potentially Achilles heel of Google Search and its profitability, AI was predictably a huge focus on this call. Here's my highlights from tonight's call. **Revenue** 4Q'22 revenue was +1% YoY but +7% FXN, so material FX headwind in every revenue line item FY 2022 search revenue +9.1%; click +10%, CPC -1% > Clicks were up 10% in 2022, reflecting a number of factors, including increased engagement, primarily on mobile devices and improvements in ad formats. YouTube Ads down \~8% YoY ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-9.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Operating Income** Google Services operating margin was again in the low 30s. Cloud margin improved by \~362 bps QoQ. At this pace of QoQ improvement, we may see Cloud reaching profitability in Q3/Q4 this year. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-20.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Google Cloud** One thing I like to track is how Google Cloud is progressing against AWS. Last quarter's performance is quite encouraging (or probably AWS was just worse? more on this on Amazon's coverage later) Note Google will increase estimated useful life to 6 years which will lower depreciation expense by $3.4 Bn in 2023\. It almost seems like all hyperscalers+Meta are in competition who can extend useful life of servers. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-11.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-12.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Other Bets** Other bets losses are continuing in the wrong direction. Hopefully this macro environment is finally going to put a brake on this. Also, DeepMind, which was reportedly profitable in 2020, will be part of "Corporate cost" from next quarter which means other bets losses can deteriorate even more. > DeepMind, previously reported within Other Bets, will be reported as part of Alphabet's corporate costs, reflecting its increasing collaboration with Google Services, Google Cloud, and Other Bets. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-19.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **AI** So about AI...Sundar basically painted a picture that intends to show how AI is underpinning almost all of their product portfolio. let me just highlight bits and pieces from Sundar's prepared remarks: > We have been preparing for this moment since early last year, and you're going to see a lot from us in the coming few months across 3 big areas of opportunity: **first, large models. We published extensively about LaMDA and the industry's largest, most sophisticated model plus extensive work at DeepMind. In the coming weeks and months, we'll make these language models available, starting with LaMDA so that people can engage directly with them. This will help us continue to get feedback, test and safely improve them.** > These models are particularly amazing for composing, constructing and summarizing. They will become even more useful for people as they provide up-to-date more factual information. And **in Search, language models like BERT and MUM have improved searches for 4 years now, enabling significant ranking improvements and multimodal search like Google Nets. Very soon, people will be able to interact directly with our newest, most powerful language models as a companion to Search in experimental and innovative ways.** Stay tuned. > Second, we'll provide new tools and APIs for developers, creators and partners. **This will empower them to innovate and build their own applications and discover new possibilities with AI on top of our language, multimodal and other AI models.** > > Third, our AI is a powerful enabler for businesses and organizations of all sizes, and we have much more to come here. > There's a few flavors of this. **Google Cloud is making our technological leadership in AI available to customers via our Cloud AI platform**, including infrastructure and tools for developers and data scientists like Vertex AI. **We also offer specific AI solutions for sectors like manufacturing, life sciences and retail and will continue to roll out more. Workspace users benefit from AI-powered features like Smart Canvas for collaboration and Smart Compose for creation. And we are working to bring large language models to Gmail and Docs. We'll also make available other helpful generative capabilities from design and more.** > And for our advertising partners, Philipp will discuss in detail how **AI is powering dramatic campaign improvements and value-adding features for them.** Of course, in addition to all this, AI also continues to improve Google's other products dramatically. And we'll continue our work with others outside Google, including joint research collaborations to develop AI responsibly and to apply AI to tackle society's greatest challenges and opportunities. > For example, DeepMind's protein database of all 200 million proteins known to science have now been used by 1 million biologists around the world. We continue to invest in AI across the board, and AI and DeepMind are integral to a bright AI-first future. Over the past few years, DeepMind has been increasingly working across groups within Google and the other And to reflect that progress, we'll be making a financial reporting change that Ruth will share more about in her comments. **We are just at the beginning of our AI journey and the best is yet to come.** **Margins** A few questions on margin impact of AI, but while nothing specific was given, general message seems to be that AI is already incorporated in many of Google's products. It's not clear how much impact there will be incrementally. Google indicated it will take time to execute on cost rationalization which will be more clearly seen in 2024 rather than 2023. **YouTube** Shorts is now averaging 50 Bn daily views (30 Bn in 1Q'22) YouTube Music and Premium surpassing 80 million subscribers, including trials. **Pixel** > we gained share in every market we operate in this year. **Buyback** Google used almost its entire FCF to buyback shares which led to 1.1% QoQ decline in diluted shares outstanding; YoY shares down 3.7%. They still have \~$100 Bn net cash on Balance Sheet. They probably should repurchase shares a bit more aggressively given the stock price. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-13.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Headcount** Google laid off 12k which will be mostly reflected in 1Q'23\. Severance charge $1.9-2.3 Bn. Avg. Opex per overhead $334k. LTM SBC per overhead \~$110k, which is lower than Meta's \~$150k. Meta makes even Google look stingy! Of course, ultimate $ value of SBC depends on stock price and Google's stock has handily beaten Meta over the last 1,3,5 years. So most Meta employees may have ended up making less than Google employees. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-14.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Capex** 2023 capex will be in line with 2022 "with an increase in technical infrastructure versus a decline in office facilities." ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-17.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Valuation** Google's valuation remains somewhat undemanding. As they say, “in the long run, **everything is a toaster**”, and if we assume we have reached "the long run" for Google and use \~12x LTM EBIT multiple, and throw a shabby \~5x revenue multiple for its cloud business, we still get pretty close to Google's current market cap. Of course, there's a theory on Search business economics imploding in the world of AI. That's a topic for another day (likely sometime later this month)! [Tip Jar](https://mbideepdivescom.outpost.pub/donate?ref=mbi-deepdives.com) *(feel free to dip your toes on the Tip Jar if you find these recaps helpful)* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-18.png) Source: MBI Deep Dives I'll cover Amazon's earnings tomorrow morning. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Meta 4Q'22 Earnings Update URL: https://www.mbi-deepdives.com/meta4q22/ Last updated: 2023-02-06T21:37:09.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares, and Jan 2025 call options of Meta* What a difference three months makes! Meta stock almost doubled from late October to today! 2023 is suddenly the "Year of Efficiency"! Zuck's tone was markedly different tonight. Here's my highlights from tonight's earnings call. **Users** Facebook DAU reached 2 Bn. But isn't it dying in the US? Snapchat grew its DAU by 3 mn YoY in North America in 4Q'22\. During the same time, Facebook's DAU in **North America** increased by 4 mn. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-28.png) Source: Meta Press Release, MBI Deep Dives ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-2.png) Source: Meta Press Release, MBI Deep Dives **Engagement** DAU/MAU increased incrementally QoQ and YoY across all regions. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-3.png) Source: Meta Press Release, MBI Deep Dives **Ad revenues** In 4Q'22, Ad impression was +23% YoY, avg price/ad was -22%. Impression growth was driven by APAC and RoW. Ad price decline was due to impression growth in lower monetizing surfaces and regions, lower advertiser demand and FX. Growth was negative in online commerce and CPG but YoY decline in commerce slowed vs 3Q. Largest positive contributor was travel and healthcare (both smaller verticals for Meta). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-4.png) Source: Meta Press Release, MBI Deep Dives **Segment reporting** FOA revenue as well as total revenue was down \~4% (+2% FXN). Admittedly, it's bit shocking to see flat RL 2-yr CAGR growth despite launching Quest Pro this year. That should tell you how it's doing. That's not a S-curve, is it? FOA's operating margin is down \~20 percentage points over last 2 years. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-5.png) **Opex** If we look more closely, Meta's Gross Margin deteriorated by 530 bps QoQ and 706 bps YoY. This used to be \~87% gross margin business in 2017! What's going on? > cost of revenue increased 31%, driven mostly by a write-down of certain data center assets Plus, Meta likely sells RL products at negative gross margin. If we assume -10% GM for RL, FOA's GM was \~76% in 4Q'22\. I'll keep a close eye on FOA's GM going forward. Despite that write-down, it's perhaps fair to say the days of 87% gross margin may never come back! Discovery engine's AI-recommended content and Reels are just fundamentally lower gross margin business than text/photo based feeds. FYI, WSJ [reported](https://www.wsj.com/articles/tiktok-parent-bytedance-sees-losses-swell-in-push-for-growth-11665071238?ref=mbi-deepdives.com) ByteDance's 2021 gross margin was 56%. There was also $4.3 bn restructuring costs in Q4 (and another $1 Bn expected in 2023) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-6.png) **Reels and AI** Speaking of Reels, >40% advertisers are using Reels now. Meta is seeing progress in both Direct Response (DR) and brand ads within Reels. By the end of 2023, recommended content will be \~30-40% of feed. Zuck's prepared remarks on Reels and AI is worth reading in full (emphasis mine): > The 2 major technological waves driving our road map are AI today, and over the longer term, the metaverse. So first, let's talk about our AI discovery engine. Facebook and Instagram are shifting from being organized solely around people and accounts you follow to increasingly showing more relevant content recommended by our AI systems. And this covers every content format, which is something that makes our services unique. But we're especially focused on short-form video since Reels is growing so quickly. And I'm really proud of our progress here. **The Reels plays across Facebook and Instagram have more than doubled over the last year, while the social component of people resharing Reels has grown even faster and has more than doubled on both apps in just the last 6 months.** > The next bottleneck that we're focused on to continue growing Reels is improving monetization efficiency or the revenue that's generated per minute of Reels watched. Currently, the monetization efficiency of Reels is much less than Feed. **So the more that Reels grows, even though it adds engagement to the system overall, it takes some time away from Feed, and we actually lose money.** > But people want to see more Reels though. So the key to unlocking that is improving our monetization efficiencies that way we can show more Reels without losing increasing amounts of money. W**e're making progress here, and our monetization efficiency on Facebook has doubled in the past 6 months.** > **In terms of the revenue headwind, we're still on track to be roughly neutral by the end of this year or maybe early next year**. And then after that, we should be able to profitably grow Reels while keeping up with the demand that we see. > In our broader ads business, we're continuing to invest in AI, and we're seeing our efforts pay off here. **In the last quarter, advertisers saw over 20% more conversions than in the year before.** And combined with the decline in cost per acquisition, this has resulted in higher returns on ad spend. > AI, it's the foundation of our discovery engine and our ads business. And we also think that it's going to enable many new products and additional transformations in our apps. Generative AI is an extremely exciting new area with so many different applications. And **one of my goals for Meta is to build on our research to become a leader in generative AI in addition to our leading work in recommendation AI.** **Click-to-messaging ads** click-to-message ads is now the $10 billion run rate. Shop ads (still on beta) has a revenue run rate in the hundreds of millions of dollars. **Capital Allocation** Meta bought back $6.8 Bn last quarter, \~130% of FCF. Diluted shares outstanding is down 5.7% YoY. The recent \~11k layoff is not reflected in 4Q'22 headcount. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-7.png) [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Opex+Capex guide** Meta clearly has an Opex problem which they're trying to address now. First of all, as expected, opex outlook came down from last quarter's guide. If we see last few years, full-year expense guide given in Q1 (next quarter) call is usually more spot on. So, opex guide may go down further. Capex guide for 2023 is lowered from $34-37 Bn to $30-33 Bn. > The reduced outlook reflects our updated plans for lower data center construction spend in 2023 as we shift to a new data center architecture that is more cost efficient and can support both AI and non-AI workloads. The key question is, of course, the long-term maintenance capex. Susan made some encouraging remarks: > In terms of longer-run capital intensity, we certainly expect that the lower CapEx outlook will have some incremental benefit to CapEx as a percent of revenue, and that's still really something that we are focused on over the longer term. The current surge in CapEx is really due to the building out of AI infrastructure, which we really began last year and are continuing into this year. We'll be measuring the ROI of these AI investments, and their returns will continue to inform our future spend. **Our intention is still to bring CapEx as a percent of revenue down**, but capital intensity in the nearest term is really going to depend, in part, on the revenue outlook and our needs to further build AI capacity for future demand. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/02/image-8.png) **Metaverse** > There are now over 200 apps on our VR devices that have made more than $1 million in revenue. We're also continuing to make progress with the avatars. We just launched Avatars on WhatsApp last quarter, and more than 100 million people have already created avatars in the app. And of those, about 1 in 5 are using their avatar as their WhatsApp profile photo. I thought that, that was an interesting example of how the Family of Apps and Metaverse visions come together because even though most of our Reality Labs investment is going towards future computing platforms -- glasses, headsets and the software to run them -- as the technology develops, most people are going to experience the Metaverse for the first time on phones and then start building up their digital identities across our apps. > even though none of the signals that I've seen so far suggests that we should shift the Reality Lab strategy long term, we are constantly adjusting the specifics of how we adjust -- of how we execute this. So I think that we'll certainly look at that as part of the ongoing efficiency work. Don't get your hopes up; base case still is 2023 losses will increase from $13.7 Bn RL losses in 2022. > On Reality Labs, we still expect our full year Reality Labs losses to increase in 2023, and we're going to continue to invest meaningfully in this area given the significant long-term opportunities that we see. **1Q'23 guide** 1Q'23 topline is expected to be $26-28.5 Bn (2% FX headwind) which implies -7% to +2% YoY Meta remains a tricky ship. It is far from dead as the stock was telling you at $90, but the underlying currents indeed went through a rapid change over the last few quarters. The following quote by Zuck perfectly encapsulates this from today's call: > for the first 18 years, I think we grew at 20%, 30% compound or a lot more every year, right? And then obviously, that changed very dramatically in 2022, where our revenue was negative for the growth for the first time in the company's history. So that was a pretty big step down. **And we don't anticipate that, that's going to continue, but I also don't think it's going to necessarily go back to the way it was before.** So I do think this is a pretty rapid phase change there that I think just forced us to basically take a step back and say, okay, **we can't just treat everything like it's hyper growth.**.. I'm actually fairly optimistic that there are a pretty good road map of things that we can do that will just make us more efficient and actually better able to build the things that we want. > Not all of them will help save money, right? So for example, focusing on AI tools to help improve engineer productivity, it's not necessarily going to reduce costs. **Although over the long term, maybe it will make it so we can have fewer -- we just hire less, right, and stay a smaller company for longer.** But I do think things like reducing layers of management just make it so information flows better through the company and so you can make faster decisions. And I think, ultimately, that will help us not only make better products, but I think it will help us attract and retain the best people who want to work in a faster-moving environment. > And so that honestly was a little bit surprising, right, that as we started digging into this **that the company would actually start to feel better to me**. And I don't know how long that will -- like how long the road map is, if things that we can continue to do where that will be the case. But I do think we have a good amount of things like that. So that's why I'm really focused on this now. **And I do want to continue to emphasize the dual goals here of making the company a better technology company and increasing our profitability.** They're both important, but **I think it's also really important to focus on the first one of just making it a better company because that way, even if we outperform our business goals this year, I just want to communicate, especially the people inside the company that we're going to stick with this**, because I think it's just going to make us a better company over the long term. So I think that's it for now. By no means, Meta is out of the woods yet! But Meta will probably become a better run company for all the pain it went through in last 18 months. We'll see! [Tip Jar](https://mbideepdivescom.outpost.pub/donate?ref=mbi-deepdives.com) (just experimenting with a new tool; no pressure!) I will cover Google and Amazon earnings tomorrow! More thoughts on Meta [**here**](https://twitter.com/borrowed%5Fideas/status/1621190757385224193?ref=mbi-deepdives.com). [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Spotify 4Q'22 Earnings Update URL: https://www.mbi-deepdives.com/spot4q22/ Last updated: 2023-01-31T20:56:26.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares of Spotify* > we're in a better position competitively than we've been in many, many years. For throughout the existence of Spotify, we have always heard of competitors, and it was always the sort of big scary wolf, whether it was Apple or Amazon in the past, et cetera. Now it's perhaps YouTube and TikTok, etc \-Daniel Ek (4Q'22 earnings call) **Users** MAU experienced acceleration in growth with highest ever net add of 33 mn QoQ, \~10 mn ahead of guidance. Premium subscribers as % of MAU continues to decline as much of the MAU growth is coming from Rest of the World (RoW) where appetite for premium is weaker. YoY churn was consistent and didn't have any uptick. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-68.png) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-78.png) Source: MBI Deep Dives, Press Release, Daloopa **Premium Mix** Good to see some acceleration in Premium segment in Europe with \~4 mn net add. Other geographies added \~2 mn each. > given the outperformance in MAU this year, that's always a good harbinger for sub growth in the future. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-69.png) Source: MBI Deep Dives, Press Release, Daloopa **Netflix vs Spotify** This is something I track every quarter. Spotify clearly is yet to exhibit signs of growth exhaustion, especially since growth accelerated in last quarter. I should mention that definition of subscriber of NFLX and SPOT is not apple-to-apple, so I would caution not to infer more than what this data can tell us. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-70.png) Source: MBI Deep Dives, Press Release, Daloopa **Revenue** After growing 5 consecutive quarters at >20%, Premium revenue increased below 20% last quarter. ARPU also slightly declined QoQ after increasing for 6 consecutive quarters. Ads momentum also slowed considerably. Ads as % of total revenue was 14.2% in 4Q'22 (vs 14.7% in 4Q'21). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-81.png) Source: MBI Deep Dives, Press Release, Daloopa ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-72.png) Source: MBI Deep Dives, Press Release, Daloopa **Price increase?** > in 2022, we increased our price point in more than 40 markets around the world. So it's definitely something that we're doing, and we're looking at it as a balanced portfolio approach where in some markets, we're selectively increasing prices because we're in a more mature place. In some markets, we're mostly focused on growth. **Gross margin (GM)** After reporting almost breakeven gross margin for ad-supported segment in the first 3 quarters, Q4 GM for ad segment improved to \~5%, thanks to lower podcast spend. Both Music GM and overall GM improved by \~60 bps QoQ. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-73.png) Source: MBI Deep Dives, Press Release, Daloopa Spotify expects Q1 GM to be the low point for '23 and then to improve throughout the year: > Q1 will be the low point in terms of gross margin for the year, with gross margin improving throughout 2023\. So that's still the plan. When we look at Q1, in particular, sort of our core margin, when we look at sort of music and podcasting is improving. Some of the investments we made in the back half of the year are still slightly impacting Q1. Marketplace revenue was >200 mn (>30% YoY) in 2022 which must have helped GM; management reiterated \~30% consolidated GM in 5 years and *"podcast reaching breakeven within several years".* **Opex** Just like most tech companies, Spotify's opex continued to move in the wrong direction. As they're grappling with their investments in podcast and other areas, opex as % of revenue increased from mid-20s in 2021 to \~30-33% in last three quarters. Rapid pace of hiring as well as a steep \~€400k opex per employee (salary is probably \~60-70% of Opex, so \~€250-300k per employee) was the reason for opex bloat. Spotify laid off \~6% of workforce recently. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-86.png) Source: MBI Deep Dives, Press Release, Daloopa SBC as % of gross profit used to be MSD-HSD in 2019-2021, but increased to mid-teen level in 2022\. As I [discussed](https://www.mbi-deepdives.com/sbc/) before, SBC as % of revenue can be misleading during period of massive stock price volatility. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-83.png) Source: MBI Deep Dives, Press Release, Daloopa So, I looked into how many stocks/options Spotify granted to its employees. Number of shares+options that Spotify granted to its employees in 2022 was almost equivalent to the total of **2019-2021**! Of the 10.2 mn grant, 7.8 mn was options with exercise price of \~$152, \~40% higher than current price. If all the grants could be exercised, that's \~5% dilution (vs \~1.5% in 2021). At least, Spotify is smart enough to issue mostly options, not just RSUs. As of 3Q'22, Spotify had 3 mn RSU outstanding with \~$152 avg grant price and 15 mn options outstanding with \~$174 exercise price. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-77.png) \*full-year data is not available yet; until 3Q'22; Source: MBI Deep Dives, SEC Filings **Outlook for 1Q'23** ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-85.png) Source: Press Release You can read my Spotify Deep Dive (December, 2021) [**here**](https://www.mbi-deepdives.com/spot/) I will cover Meta's earnings tomorrow! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Management Compensation and Incentives at Big Tech URL: https://www.mbi-deepdives.com/incentives/ Last updated: 2023-02-07T14:26:57.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Note**: I appeared on Liberty's Highlights [podcast](https://www.libertyrpf.com/p/big-tech-compensation-going-deep?ref=mbi-deepdives.com#details) to discuss this topic. It may be better to listen to the podcast since it is done after writing this post below, so I could add more context to it, especially after further discussion and feedback from readers. --- I was recently reviewing management incentives at Apple, Microsoft, Alphabet/Google, Amazon, and Meta in their 2022 proxy statements. My best to worst ranking purely on incentive structure below: **Best: Apple** In 2011, AAPL granted time-based restricted Stock Units (RSUs) to Tim Cook with no performance condition i.e. as long as Cook remains CEO, he would receive the RSUs in two installments: 2016 and 2021\. See original 2011 grant here: ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-60.png) Cook requested in 2013 to insert performance condition: he would get those RSUs only if Apple outperformed two-third of S&P 500\. If Apple were bottom-third among S&P 500 companies, Cook would receive zero RSUs. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-61.png) Apple was in the 97th percentile in 2018-2021 period. Such a gutsy move by a CEO to align his compensation with the stock performance when probably much of the Wall Street in 2011-13 expected Apple to be terminally ill by 2021\. No wonder someone in Omaha liked this stock. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-62.png) Current incentive program (2021-2023) is also tracked with relative Total Shareholder Return (TSR), with more upside for the executives than the prior one. If AAPL beats 85% of S&P 500 companies, management will receive 200% of target RSUs. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-63.png) Next is **Google/Alphabet** A bit similar to AAPL, but slightly more favorable to the management than AAPL's. If Google beats 75% of S&P 500 companies (**Edit**: **S&P 100** companies, not 500), management will receive 200% of target Performance Stock Units (PSUs). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-64.png) #3 is **Microsoft** I don't like their long-term equity incentive plan. Strange to see no profitability or ROIC metric for such a company. "LinkedIn session", seriously? No wonder it's filled with cringe posts. For MSFT, Relative TSR is only a modifier. Only 25% downside for management RSUs even if stock goes absolutely nowhere. This incentive structure overly incentivizes for topline growth and doesn't save shareholders from value destructive acquisitions or capital allocations. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-65.png) [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) Microsoft is, at least, better than **Amazon**. Andy Jassy receives time-based RSUs with no performance condition attached. It is similar to what Cook received originally in 2011\. Jassy's RSUs were granted at $166.7/share (split-adjusted). AMZN has no relative TSR even as a modifier. So even if AMZN is $100/share in 2030, Jassy's total RSUs will be worth \~$122 Mn. That would be pretty good payday for a stock down \~40% 10 years after the grant date. Not good. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-66.png) The worst incentive structure "award" goes to **Meta Platforms** Perhaps this is one of the many reasons why they aren't part of the Big Tech anymore. It's comical that the then CFO Dave Wehner was, in fact, awarded for 2H'21 performance when he was essentially lighting cash on fire by buying back stocks at $330. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-67.png) Similar to AMZN, all their long-term RSUs have nothing to do with relative TSR. As long as they survive in their roles, they will be duly rewarded for their survival. Not cool. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-59.png) Source: Meta's Proxy Statement (2022) Peter Thiel used to be Chairman of the Compensation Committee in 2021\. After he left the board, Peggy Alford (EVP of Global Sales at Paypal) has become the new Chair. Given PYPL's own [incentive shortcomings](https://www.mbi-deepdives.com/pypl/), I'm not optimistic we'll see much change here. Charlie Munger once said: “Well, I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little further.” I'll leave it there. Thank you for reading. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Speedwell and MBI discuss Meta Platforms URL: https://www.mbi-deepdives.com/mbi-speedwell-meta/ Last updated: 2023-01-24T12:12:13.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) Last week, [Speedwell Research](https://speedwellresearch.com/?ref=mbi-deepdives.com), an independent investment research service, published their Deep Dive on Meta Platforms. They were kind enough to send me a copy of their work. After reading their work, we exchanged a few emails/tweets discussing their report. I enjoyed this interaction enough to think I would like to keep our exchanges on Meta as a separate post on my website. Click [**here**](https://speedwellresearch.com/2023/01/17/meta-platforms-deep-dive/?ref=mbi-deepdives.com) to read Speedwell's work on Meta Hope you enjoy our exchanges on probably one of the most hotly debated companies in the market! (slightly edited for clarity) --- ## My initial email to Speedwell First of all, thank you for sharing your work on Meta with me. I skipped your 16-page PM summary and took my whole Saturday to read your 166-page report (a “book” would perhaps be more appropriate). As a shareholder of Meta, I feel it was time very well spent. Despite following the company for almost 5 years, I learned new things from your work. Appreciate your (and your team’s) thorough, diligent, and unjaundiced work on a company that certainly elicits strong emotion among investors. Let me share some of my thoughts after reading your work. **“Enemy of the State”**: I chuckled a bit when I saw Mark Zuckerberg jovially mentioned himself as “Founder, Master and Commander, Enemy of the State” on the “About” page of “Thefacebook”. Although it is more of a testament to the teen hubris, it is ironic how prescient that would be in terms of popular perception in the West. **“Radical Transparency”**: I knew Zuckerberg’s penchant for radical transparency and how he erred on the “Beacon” fiasco, but I think people generally underestimate how principled Zuckerberg seems to be. Just today, I read [this](https://sarharibhakti.substack.com/p/unpacking-crowdtangles-breakup-with?utm%5Fsource=post-email-title&publication%5Fid=2997&post%5Fid=97838465&isFreemail=true&utm%5Fmedium=email) interview of a former Meta executive who touched on Meta’s culture of radical transparency: *“When this period of the history of Silicon Valley is written, there will be at least one story about how radical Facebook’s internal culture of openness and transparency was, especially compared to the incredibly siloed & secretive cultures of Snap, Apple, and others. The openness at Facebook made it a fascinating place to work & helped it attract brilliant people. I think it made it a better company by fostering collaboration. But that openness also made it vulnerable and had some material downsides for the company.”* Scaling culture is perhaps one of the most challenging things founders need to do, especially for a large company such as Meta. With \~80k employees today, I do wonder whether it is time for Meta’s culture to evolve a bit. It is hard to change culture overnight, so perhaps they may need to learn to live with radical transparency. **Infrastructure as a moat**: I never spent much time on why/how Friendster failed. I probably wouldn’t have guessed their poor infra investments were a dominant factor. It also perhaps provides much more context to Meta’s massive proprietary investment in data centers and infrastructure in general, and not be overly reliant on public cloud to a run a business used by the whole world. Companies who are going in the opposite direction may run the risk of becoming “Friendster” of the future. Zuckerberg’s formative experiences probably informed him deeply to make these infra related investments. To quote from your piece: *“Far from a trivial factor, page load time was hindering Friendster and, retrospectively, was one of the larger factors that led to their eventual irrelevance. Users were complaining of page load times of up to 40 seconds, with 20 seconds being not unusual. Such a poor user experience was driving users away.* *Zuckerberg was far more methodical than his social networking peers, controlling Facebook’s growth until their servers were ready to handle the demand”* **The relentless death march of Meta’s new standalone apps**: Camera, Poke, Slingshot, Paper, LifeStage, Riff, Threads, Hobbi, Notify, Tuned, SoundBits, Audiohub, Venue, Collab, CatchUp, Moments, Mentions, Lasso…perhaps there is some truth to the urban legend: Meta cannot innovate! I knew a few of these attempts, but it was sobering to read how every single attempt by Meta to create the next big app failed miserably. The lone success is Messenger which didn’t even start as a standalone app. If I remember correctly, it was initially part of Facebook app, but they eventually forced you to download the Messenger app to access your DMs. Reading their persistent failure, I was reminded of what Nikita Bier said on a podcast. He mentioned Meta has a very academic and scientific approach to growth, and it is incredible how much they have perfected the scaling game. But Meta struggles with creating that initial spark organically (I’m paraphrasing and writing from memory). Nikita’s subsequent success with “Gas” only further substantiated this speculation in my mind that Meta has a suboptimal approach to new standalone apps. It would be so much easier to fend off bear concerns of legacy apps (Facebook, Instagram) if Meta could just organically build a couple of other standalone apps organically and then let its “scientific” scaling game to take care of the rest. **A strategic error?** While you did not allude to this, I wondered whether Meta’s decision to downgrade content from social graph to make space for content by recommendation engine beyond social graph in **both** Instagram **and** Facebook is a strategic mistake. Perhaps it would be better to maintain the supremacy of social graph on Facebook and use Instagram to capitalize on algorithmic content. I agree with you that there is very little true competition on social graph. I would go one step further: it is relatively easier for Meta to encroach into TikTok’s territory i.e. short-form video than anyone else to build a global, scaled social graph. Facebook and Instagram may be the only globally scaled social graph available for decades to come. Social graphs are likely to be more durable than anticipated and they are almost certainly more FCF generative businesses than apps purely optimizing for time spent which is inherently more competitive, fickle, and lower margin business. **A flawed mental model?** Speaking of time spent, I suspect some investors are making a lot of erroneous assumptions about short-form video’s advertising dollar potential. Based on your data, I can see people spend less than half of the time on Instagram than they do on YouTube, but Instagram generated probably double the revenue of YouTube last year. Ad inventories/impressions, measurement, and attribution are all important variables that can get lost by investors who may think time spent as some form of panacea. In a post-ATT world, TikTok’s road ahead to scale their advertising infra will be fraught with challenges some seem to underestimate. That’s why I feel TikTok may be under pressure to attempt to build a social graph, the success of which is fairly uncertain. I share your skepticism on the scalability of TikTok’s current ad infra to make it to the big league (emphasis mine): *“Whereas a Facebook advertiser could grab some existing content from their product list page and turn that into an ad, a TikTok advertiser will have to find people to act in a video as well as make it worth watching so it doesn’t get skipped (*if you do this well enough though, you don’t even need to pay for advertising as the algorithm can share your video with millions if its popular*).”* The bold sentence makes me think short-form videos will **create** massive value for many businesses, but it may be a herculean task to **capture** that value by Meta and TikTok consistently. **Live and die by ROAS**: One of my key takeaways from your piece is how Meta’s superior relative standing in terms of advertising infra among current set of competitors will not save it from the woes of the post-ATT world. Your case is convincing and now I think that my prior understanding on Meta’s relative standing being the dominant factor is flawed. Some key quotes from your piece: *“Whereas TikTok and Snapchat had some momentum with direct response, ATT was a formidable step back for them and it is questionable whether they will ever be able to close the AdTech gap in terms of targeting and measurement relative to Meta. However, while *Meta might be in a better position relative to other platforms, but they are still net in a much worse position than pre-ATT.** *Even though they may be relatively stronger than alternatives, it doesn’t matter because advertisers look at total return on ad spend, not relative return on ad spend (lose less money advertising with us will never be a great selling point).* *...If a business cannot get an adequate return on ad spend, they usually can’t go elsewhere: it is just potential economic activity that is destroyed.”* **Sorry, RoW:** I am not sure I agree with your capex assumptions. Even in your optimistic scenario, you assumed 18% capex as % of revenue. I am going to make the case that it is, in fact, the pessimistic (albeit not improbable) scenario. Meta’s Gross PP&E increased by \~$60 Bn in 2021 compared to its 2017 balance. But \~$30 Bn of it is quite discretionary and remnants of the bygone era (e.g. beautiful buildings, expensive office equipment etc.). As we enter a very different era for Meta, it is fair to say we are unlikely to see $30 Bn incremental spending on building and office equipment in the next 10-15 years (let alone 5 years). The much less discretionary expenses are servers and network assets which Meta continues to ramp up to cater to the increasing computing intensity of users consumption. In 2021, Meta had \~$26 Bn servers and network assets which translate to $7.2 per MAU. If Meta adds another \~500-600 mn MAU in this decade and we keep the assumption that server/network asset per MAU will keep going up (see below), we may reach \~$70 Bn servers and network assets in 2030\. It’s fair to say Meta’s capex is likely to be closer to maintenance capex in 2030, so I’ll focus on that to understand the long-term capex intensity of this business. While Meta currently amortizes these assets over 4 years, I am optimistic that they’ll realize similar benefits as Amazon and Microsoft did and will learn to lengthen the useful life to 5 years. Assuming 5 years useful life, depreciation for these assets is \~$14 Bn per year. If Meta becomes prudent in keeping their discretionary expenditure in check, depreciation for the rest of PP&E could easily be \~$3-5 Bn. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-47.png) So, we may be looking at <$20 Bn maintenance capex. If \~$20 Bn is the maintenance capex, that leads to capex as % of sales of \~17% **\*today\*.** Therefore, even if we assume zero topline growth for Meta for this entire decade, Meta may still keep the terminal maintenance capex to be below 18% which you assumed. And if the topline grows, maintenance capex as % of sales will be much lower than 18%. That’s why I said, your best case scenario of 18% capex as % of sales is my worst case scenario. A natural question may arise on whether the computing cost intensity will be even higher than I assumed. I assumed \~130% increase of computing cost intensity per user in 2030 (vs 2021). Could it be 200% increase? 300%? That seems unlikely to me. Not only computing cost may just get lot cheaper, but also there may be some interesting implication if computing intensity is indeed materially higher than modeled here. ARPU for Rest of the World (RoW) i.e. ex North America, Europe, APAC was just **$12** in 2021\. Therefore, if computing intensity keeps rising materially faster, it may be financially unfeasible for companies to serve those users. In such case, it may even be possible that Meta may not make certain features such as Reels available on these cost prohibitive countries. Again, thank you for the very thoughtful work. --- **P.S.** I also meant to include the following paragraph from Speedwell's piece (but later forgot) which I thought was fantastic to highlight why an effective and improving ad infra leads to a virtuous cycle of revenue growth for companies such as Meta: > ...as targeting improves, (ad) inventory opens up, which first depresses prices, as auctions are less competitive. This lowers prices, which makes it even more attractive to advertisers, and more sellers allocate more ad budget to Facebook. Then the advertisers bid up the cost of impressions again and (hopefully) Meta releases new ad targeting improvements which start the cycle again, growing revenues with each iteration while maintaining happy advertisers. --- ## Speedwell's response > 1/ A big thank you to [@borrowed\_ideas](https://twitter.com/borrowed%5Fideas?ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) for taking the time to read the entire report + provide such thoughtful feedback! Not easy to get through 160pgs in one day! > > Cool to hear even someone covering the company for >5yrs learned some stuff :) > > Some thoughts on his thoughts below [https://t.co/cNfSLOY1sm](https://t.co/cNfSLOY1sm?ref=mbi-deepdives.com) > > — Speedwell Research (@Speedwell\_LLC) [January 23, 2023](https://twitter.com/Speedwell%5FLLC/status/1617549086038843392?ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) **Here's the rest of that thread:** We think the “infrastructure as a moat” concept was probably more material pre-public cloud (Snapchat is run on AWS and Tiktok was on Alicloud prior to US data concerns). The need for more content moderation (Meta has 40k moderators and highly advanced AI that can prevent a majority of unsavory content from ever being posted) and keeping up with a dizzying number of regulations could be a new sort of moat though. Perhaps the content recommendation engine also becomes a competitive advantage, but it is curious they need to spend so much to improve recommendations whereas Tiktok hasn’t seemed to need to. Agree on the potential for more recommended content to mess up their core “socializing job”. In theory, they could just revert the algo back if it wasn’t working/they saw another threat. In 2018 they deprioritized FB video in the feed because they felt it was displacing “meaningful” social interactions (created FB Watch tab). However, Reels is an admittance this sentiment was wrong and suggestive that FB tended to overvalue social graph content if anything. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2023/01/image-48.png) Interesting point re: potential for capex intensity in RoW to increase beyond ARPU. The mitigating factor could be lower data consumption (FB Lite), but their ROI there could be worse. (To the extent a social network benefits from RoW, you can spin this as a competitive advantage) The whole maintenance vs growth capex discussion for us is convoluted by the fact that ATT (and Google's future privacy actions) has (and potentially will further) degrade advertiser ROAS & attribution. So whether they are restoring lost signal or “improving” is debatable. Since the server/AI spend is to get around the privacy actions and be able to do more with less, if they can’t get beyond their prior targeting capabilities then it could all be considered maintenance. That’s probably too draconian of a reading and we think it is likely that this spend does yield incremental AI improvements as we are starting to see with their suite of Advantage Plus tools as well as with Reels recommendations. Your $20bn maintenance capex figure seems reasonable to us. Thanks again [@borrowed\_ideas](https://twitter.com/borrowed%5Fideas?ref=mbi-deepdives.com). It was fun to trade notes! Also, some (only partially thought through) questions we’re chewing on having read your response: How does influencer leverage change when more content is recommended? Is “reach” devalued and does “endorsement” become more meaningful? (Maybe less views w/ higher conversions?) What does the prominence of Amazon Shops mean for Instagram Shops? (And more perplexingly, why did Instagram enable that ability to add links to Stories just recently–what changed?) What if AI eventually generates the content (as is all the range in SV with OpenAI and generative AI) Why pay for ads if you can make compelling content that gets shared for free? Does this mean de facto that ads will be more intrusive as only those who can’t make good content pay for ads? [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) --- ## My follow-up to Speedwell **Irrelevance of infra moat in the age of Public Cloud**: That is a very good rule of thumb. But there can be some very good exceptions and I suspect a global, scaled, hyper-personalized, and extremely compute intensive services such as Meta/TikTok is one of those exceptions. Let me [quote](https://stratechery.com/2022/three-trends-follow-up-the-question-of-cool-tiktok-and-the-sinicization-of-the-internet/?ref=mbi-deepdives.com) Ben Thompson to make this point: *“The problem for Snap is that to the extent that AI capabilities become critical not only for content but also advertising the greater the burden their reliance on cloud providers will become. To put it another way, while I am generally a huge advocate of using public clouds — the flexibility, scalability, and engineering focus it enables is almost always worth the higher cost — there may be an exception for companies that are extremely AI-dependent, and there is a strong argument that this is exactly where “social networks” (I put that in quotes because the entire point is that reality is moving beyond social networks) are headed.”* Also note that if Meta does a really good job at managing their infra investments as well as Public Cloud, they’ll save the margins Public Clouds will be making on serving TikTok. WSJ reported TikTok’s Gross Margin was \~56% in 2021\. Assuming that’s true, there are probably multiple potential rationales of such Gross Margin: a) the platform’s monetization is far from fine-tuned, and they are far from monetizing the time spent to translate to advertising dollars. Margin will improve as monetization improves but cost of revenue grows at a lot slower pace, b) short-form video is a materially lower gross margin business compared to text and image based feeds and even terminal economics is no where close to high 80s Gross Margin that Meta enjoyed a few years back, and c) it is expensive and inefficient to build such a globally scaled platform on public cloud who are obviously happy to make money hand over fist over your usage. My guess is all three rationales are in play in varying degrees here and while the infra as a moat has certainly narrowed over the last two decades thanks to public cloud, it is not fully eliminated. **Content moderation/regulation as a moat**: This is also a good rule of thumb, and as a shareholder, while I would love to have this moat, I suspect it is not much of a barrier for startups. Would regulators really go after “Clubhouse” (just an example) if we find terrible content are being posted on that platform? I doubt it. Regulators are more likely to put a blind eye on up-and-coming social apps as they probably know any draconian regulation would simply lead to death for those new apps. Meta, on the other hand, makes \~40-50% operating margin on Family of Apps (FOA) and is almost indiscriminately hated by both sides of the political aisle. There’s a lot more to gain by regulators, politicians, and media companies by reporting unsavory details about Meta. A dying “Clubhouse”? Not so much. But let’s focus a little more on TikTok since they’re probably going to be in the same bucket as Meta these days. They too are increasingly universally hated by regulators, politicians, and other media companies. Can they beef up their moderating team as much as Meta? They probably wouldn’t be able to if they were under pressure from their shareholders to make money. However, it does seem they have the license from their shareholders to not necessarily focus on profitability. Ah, the joys of being a private company! If this “joy” proves to be short-lived (likely scenario), in such case, I agree that this would indeed be a moat by Meta against TikTok. **Is Reels a retreat from “Meaningful Social Interaction” (MSI)?** You mentioned *“in 2018 they deprioritized FB video in the feed because they felt it was displacing “meaningful” social interactions (created FB Watch tab). However, Reels is an admittance this sentiment was wrong and suggestive that FB tended to overvalue social graph content if anything.”* I don’t necessarily think Reels is a massive retreat from MSI. While “FB Watch” was mostly about passive consumption, Reels is a more eclectic mix of passive consumption and MSI. In 3Q’22, Meta mentioned 1 Bn Reels was shared via DMs on IG **\*everyday\***. Clearly, Reels leads to more sharing and interactions among friends/followers than “Watch” did. In fact, such trend is perhaps one of the key reasons Zuckerberg wants to heavily lean onto short-form video after some initial skepticism. Having said that, as mentioned in my earlier comments, I do have mixed feelings about the mix of content from social graph and recommendation engine based algorithmic content. I wonder whether they should favor the mix of content from social graph heavily in either Facebook or Instagram to maintain their value proposition of social graph strongly. I’m not too worried since this seems to be, as Bezos would say, a “two-way door” decision. Meta will eventually end up where the data says they should end up. You left some thought provoking questions at the end that I need to mull over more to organize my thoughts. I suspect I may not have much of an answer to a couple of questions. In any case, I enjoyed this back and forth with you, and hope to follow your work closely going forward. --- Thank you for reading! ### Hilton: Scaling Hotels in Asset-light Way By Monetizing Brand URL: https://www.mbi-deepdives.com/hlt/ Last updated: 2023-02-21T15:27:22.000Z _This post is for paying subscribers only._ ### 2022 Annual Letter URL: https://www.mbi-deepdives.com/2022/ Last updated: 2023-12-29T13:54:52.000Z _This post is for paying subscribers only._ ### Sherwin-Williams: Painting the Wonder of Compounding Decade After Decade URL: https://www.mbi-deepdives.com/shw/ Last updated: 2023-07-25T12:01:18.000Z _This post is for paying subscribers only._ ### Adobe 4Q'22 Update URL: https://www.mbi-deepdives.com/adbe4q22/ Last updated: 2022-12-16T02:44:17.000Z *Disclaimer: I own shares of Adobe* [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *"It is the golden age of design. Everybody would like to express themselves."* **Shantanu Narayen,** CEO of Adobe While the days of 20%+ topline growth is clearly behind us, Adobe remains the juggernaut in creativity software industry. Digital Media, Digital Experience, and overall revenue in 4Q'22 increased +13%, +16%, and +14% YoY respectively (all FXN). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-86.png) Source: MBI Deep Dives, Daloopa More encouragingly, Creative Cloud just had the best net new ARR quarter. While we typically see an untick in net new ARR in Document Cloud in Q4, there wasn't any this time. Why? *"it's important to remember that some portion of this is also -- the Acrobat business is also represented in the creative business. So the Acrobat growth number is probably a bit understated in this point."* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-85.png) Source: MBI Deep Dives, Daloopa I'm not sure I have ever seen any company reporting 96% gross margin before, but Digital Media's gross margin remains steady at \~95-96% despite the FX headwind. Digital Experience's gross margin increased by 55 bps YoY to 66.0%, and overall company's gross margin was 87.4% last quarter. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-82.png) Source: MBI Deep Dives, Daloopa With such skyhigh gross margin, it is not a surprise that a scaled company such as Adobe is \~33-35% GAAP EBIT margin business. Thanks to net working capital benefit and SBC, FCF is consistently materially higher than operating margin. There's not much sign of SBC leverage, but as I explained [here](https://www.mbi-deepdives.com/sbc/), you shouldn't expect SBC as % of revenue to go down anytime soon. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-83.png) Source: MBI Deep Dives, Daloopa Adobe has ramped up its buyback activity this year, declining \~3% shares outstanding. \~89% of last year's FCF was used to repurchase its shares. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-84.png) Source: MBI Deep Dives, Daloopa On the product side, Adobe Express, which is a direct competitor of Canva, remains a major focus for the company: > Express' unparalleled collection of stock images, videos, fonts, design assets and templates and its unique integration of AI Magic from Photoshop, Premiere Pro and Acrobat enable us to deliver the best of Adobe to customers of every skill level. Q4 continued to see exciting growth with millions of monthly active users, greater than 40% quarter-over-quarter visitor growth in the U.S. and an NPS greater than 50. > Our primary focus has been and continues to be right now around usage, repeat usage and utilization. We are seeing, though, while that's our primary focus, we are seeing a lot of really interesting data coming in suggesting that we -- that the upgrade has are -- while still early and not our primary focus are working. For example, in many higher ed institutions where we've started to deploy Adobe Express, we're starting to see not just the increase in terms of usage of Express, but we're also starting to see increase in demand for Adobe Creative Cloud flagship applications Regulatory review on Figma acquisition is going "as expected". > Overall, the regulatory process is proceeding as expected. The transaction is being reviewed globally, including by the Department of Justice and the Competition and Markets Authority in the U.K. We are currently engaged in the DOJ's second request process. We expect that the transaction will also be reviewed in the EU. While RPO may seem to be rapidly decelerating, there is \~3% FX headwind. Even FXN, there is definitely signs of pressure on growth. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-87.png) Source: MBI Deep Dives, Daloopa Adobe, however, is seeing retention to be better than pre-pandemic: > I think we also shared that we're seeing usage of products continues to stay very strong as we bring in these new audiences. And we're starting -- and we're seeing retention continue to tick up and improve. And in fact, retention now is better than it was pre-pandemic as an example. So we continue to bring in new users. We continue to retain those new users and we see organic opportunities to move them up and upgrade them. Adobe re-iterated its guidance for 2023 shared on Analyst Day in late October. If they can indeed grow revenue by 13% in 2023 which increasingly seems to be consensus recession year, it will be quite the feat compared to last recessions. In 2001 and 2002, Adobe's topline went down 3% and 5% respectively. In 2009, revenue went down by 18%! Switching to subscription business model has indeed worked wonder for Adobe. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-88.png) Source: Adobe Press Release ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/12/image-89.png) Source: Adobe Press Release [Adobe Deep Dive](https://www.mbi-deepdives.com/adbe/) (August, 2022) As promised, I will publish my Deep Dive on Sherwin Williams on December 20th! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Some thoughts on SBC URL: https://www.mbi-deepdives.com/sbc/ Last updated: 2023-01-06T10:52:42.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) I have received quite a few messages and emails on Stock Based Compensation (SBC) over the last few weeks. Two things prompted me to write a separate post on SBC: a) it is a much more efficient way to respond to messages/emails on this topic, and b) there still seems to be widespread confusion on SBC. While this isn't going to be a primer on SBC, it will hopefully address most of the questions many of you have. First of all, a caveat: I am not an accountant or tech industry insider. Most of my understanding on SBC is self-taught through profuse browsing on the internet and talking to other investors and industry insiders. Therefore, if you think I am wrong, I will appreciate your input. So, let's get into the topic now. **SBC number on Income Statement/Cash Flow Statement is almost always wrong** After the Restricted Stock Unit ([RSU](https://www.investopedia.com/terms/r/restricted-stock-unit.asp?ref=mbi-deepdives.com)) or Performance Stock Unit ([PSU](https://us.etrade.com/knowledge/library/stock-plans/understanding-restricted-performance-stock?ref=mbi-deepdives.com#:~:text=Performance%20Stock%20Unit%20%28PSU%29,measured%20against%20the%20defined%20goals.)), which are the most common form of SBC, are granted to employees and Named Executive Officers (NEO), the value of such grant is recognized in Income Statement. It is important to understand how the value is calculated. RSUs typically have a vesting schedule and the fair value is calculated on **the initial grant date** under a straight line schedule (or accelerated amortization schedule). For example, let's say you received RSUs of a company whose stock was trading at $100/share on January 1st, 2021\. The company granted you $100k worth of shares on that day i.e. 1,000 shares (100\*1000=$100k). If the vesting schedule is recognized in a straight line over four years, you will receive 250 shares of the company after each year of employment for the next four years. *No matter what happens to the stock price afterwards, the company will recognize $25k SBC in each of the next four years. Therefore, the SBC number you see in Income Statement/Cash Flow is based on the estimates of cost on the initial grant date.* Now let's say, after your year 1 of vesting, you received 250 shares and you sold them immediately. You are about to receive the next 250 shares after year 2, but the stock had 90% drawdown and is trading at $10/share today (it was trading at $100/share on the grant date). If I ask you what's this 250 shares worth today, you'll obviously say $2,500 (250\*10=$2,500), but under GAAP, income statement will recognize $25,000, a whopping 10x more than what it actually is worth. Of course, this works the other way too. If you receive $100K worth of shares today from this company, you will receive 10,000 shares ($100k divided by current stock price of $10). If the stock becomes 10x in a couple of years, GAAP will recognize $25k expense per year whereas the actual cost of these shares will become $250,000. *The big takeaway is GAAP does an awful job of depicting reality in the period of extreme volatility.* Extreme volatility is far too common for individual stocks, especially for tech stocks in the post-Covid period (at first, extreme upside volatility in 2020-21 and then extreme downside volatility in 2022). However, for steady stocks, GAAP may do a good enough job of informing the actual economic cost of these grants. This is exactly why I used to disagree with many investors who want to just subtract SBC from FCF each year because the SBC we are seeing on Income Statement/Cash Flow can be severely underestimated or overestimated depending on what's going on in the stock prices after the grant. In other words, the actual economic cost of SBC was underestimated in 2020-21 and highly likely to be overestimated in 2022-2023\. Don't be angry why companies' SBC as % of revenue isn't going down in 2022-23 when the SBC that you see on Income Statement may be pretty overestimated. **Look at dilution, right? Sure, but it too is far from perfect.** Since the limitation of SBC numbers we see on financial statements is understood by many investors, many just prefer to look at dilution each year. Unfortunately, this approach too has limitations. While this is helpful, I suspect many investors tend to infer too much information from a specific year's dilution than there actually is. If a company diluted its shareholders by 0.5% or 1% this year, it may not necessarily mean that it is the company's intended strategy to dilute shareholders by 1% or less. It may just mean they are lucky because stock is trading at sky high multiples and they can pay pretty good comp to their employees without diluting shareholders too much. I have shared this table before in my [Datadog Deep Dive](https://www.mbi-deepdives.com/ddog/), but some of you asked for the formula. Please see the formula shown for cell B3\. A caveat: I'm ignoring options in this calculation and assuming all SBCs as RSU. There are also other limitations of this table. As I just elaborated to you, the SBC $ number itself can be very unreliable, and therefore, SBC as % of revenue can also be flawed. This is just a good gut check on what sort of dilution is being implied in different multiples and SBC as % of revenue. If you want to calculate dilution, unfortunately **there's no easy way other than going through notes to financial statements for each company**. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-89.png) Figure: Shareholder dilution in different EV/S and SBC as % of revenue scenarios; Red indicates dilution >2% and green indicates <=2% dilution; Source: MBI Deep Dives A big question for investors or anyone among tech stakeholders is which one is a relatively fixed number: is it the number of shares offered to employees or the dollar amount of SBC per headcount? I think the answer is likely to prove to be much closer to the latter i.e. relatively fixed dollar amount per headcount but there are nuances to it. I'll explain later with an example. If you do assume management will continue to pay employees a fixed $ amount of stock every year, GAAP accounting is, in fact, lot closer to reality over the long term than modeling dilution which can be more volatile depending on stock price in any particular year. I know it sounds like a recursive function because it is indeed one. (**Note**: I received feedback fromsomeone who prefers to remain anonymous based on which I edited this section later after publishing this post) **An example of SBC** I was discussing SBC with an industry insider recently and here's a rough estimate of how a typical comp is initially structured and how it evolves over time for an employee. Here's an **illustrative example** for an L5 engineer at Google. The initial offer is $200k base, $450K stock (vested over 4 years), and 15% bonus on base. Therefore, year 1 total comp is $342.5K ($200K+($450K/4)+(15%\*$200K). This employee usually gets a stock refresher after year 1 which is typically \~25% of year 1 stock grant i.e. \~$28K ($112.5K\*25%). Therefore year 2 total comp is $341K, and so on. Of course, the actual total comp is dependent on stock price. But none of the tech companies basically thinks about the stock component of the total comp in terms of number of shares, but mostly from the point of view of dollar amount. If they indeed want to dilute the shareholders less, they will have to lower the total comp offered to their employees. Some pressure on tech comp is already underway as annual refreshers, which apparently used to be more or less prevalent, is lately being mostly doled out to top performers. Therefore, total opex per headcount may have peaked at least for 2-3 years, if not longer. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-95.png) Figure: Illustrative Total Comp example (not actual) While tech comp may have peaked for the next few years, I am not super optimistic that tech comp will drastically go down anytime soon. In fact, when you look at big tech opex per headcount compared to other tech companies in Silicon Valley, it is hard not to see the material competitive advantage big tech enjoys today in recruiting which may be strengthened during the downturn. Therefore, even though we are likely to see some layoffs here and there by big tech, I will be somewhat surprised if opex per headcount goes down materially in big tech. The reality in Silicon Valley is while the number of "monopolies" are only a handful, today's "monopolies" make sure the cost of "raw materials" to make the next monopoly remains exorbitantly high. It is also perhaps not the best idea for these "monopolies" to show obscene margins when they are being litigated left and right by FTC and EU regulators. (Please note: \~50% of Apple's employees are related to retail who are obviously not highly paid and hence on an apple-to-apple basis, their opex per headcount may be closer to Google; Amazon has too many warehouse employees to make these comparisons meaningful and hence not shown). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-96.png) Source: MBI Deep Dives, Tikr, KoyFin While many tech/software investors are annoyed and even angry at the exorbitant comp packages of Silicon Valley employees, I do not think management of these tech companies are being willfully negligent. I encourage investors to think about how exactly they plan on recruiting engineers and sales people to work on enterprise software companies without being competitive against comp offered by the big tech. **My mistake on SBC (most software investors are perhaps still committing it)** Whether investors admit it or not, in my experience the majority of software/tech investors had a somewhat flawed mental model. I am not criticizing anyone because I made a lot of these mistakes myself. A very common approach followed by investors is just model dilution in interim years and multiply the terminal FCF/share number by a reasonable exit multiple (FCF being Operating Cash Flow-Capex). As I said, I myself followed this approach until June this year. You will see the difference in my earlier and current approach if you [download](https://www.mbi-deepdives.com/models/) any model before and after June 2022\. After a long chat with a couple of followers of mine on twitter and thinking it through, I did come to the conclusion that such an approach does create a mismatch between stock (share count) and flow (SBC) variables which can have profound impact on valuation. In the terminal year, this mismatch can be better approached by deducting SBC from FCF and multiplying the result by a reasonable exit multiple (what is reasonable depends on many variables outside the scope of this piece). On the other hand, if you choose to subtract SBC in interim years as well as in the terminal year, you don't need to model dilution either in interim or terminal year. Given SBC for most of the software companies is a significant contributor to FCF (often >50%), I do think you would materially overestimate the valuation of these companies if you don't deduct SBC from FCF in the terminal year, an error I think many software investors may still be committing. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclaimer: I own Google, Meta, Amazon, Autodesk, and Adobe shares.* *All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Autodesk 3Q'FY 2023 Earnings Update URL: https://www.mbi-deepdives.com/adsk3q23/ Last updated: 2022-11-23T04:18:03.000Z *Disclosure: I own shares of Autodesk* Autodesk had bit of a mixed quarter. While they typically beat the high end of their guidance, Q3 topline was near the low end of the guidance. Moreover, guidance appears to be weak too as Q4 implied topline growth is HSD i.e. \~7-9%. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-74.png) Source: MBI Deep Dives, Company Press Release Q3 had 1-point FX headwind and Q4 is assumed to have 3-point headwind. So, on FXN basis, topline growth may continue to be double digit. However, Autodesk did see *"modest deceleration in our new business, particularly in Europe during Q3, that does have a slight follow-on impact to revenue in Q4."* Net revenue retention continues to be \~100-110% range. However, Autodesk is seeing less demand for multiyear upfront billings and more demand for annual contracts than they expected. Customers are likely being more conscious about their cashflows in a soft macro environment. Autodesk was transitioning to annual billings anyway, but the macro is likely to make the transition quicker than anticipated. > On the customer side, what they've historically had a discount of anywhere from 10% to 5% to have a multiyear contract that's invoiced and collected upfront, and that discount goes away. And we think based on the feedback that we've been getting from our customers that they want to have multiyear contracts with annual billings. Some interesting quotes from the call: > Across construction, we added almost 1,000 new logos with Autodesk Build's monthly active users growing more than 60% quarter-over-quarter and becoming Autodesk's largest construction products. > we announced Fusion, Forma and Flow, our 3 industry clouds, which will connect data, teams and workflows in the cloud on our trusted platform > Fusion, Forma and Flow connect data, teams and workflows in the cloud on our trusted platform, making Autodesk rapidly scalable and extensible into adjacent verticals from architectural and engineering to construction and operations, from product engineering to product data management and product manufacturing. Don't expect these announcements to lead to anything material anytime soon. Fusion took almost a decade to be where it is today; Andrew Anagnost, CEO of Autodesk, seemed to think it'll take \~5 years for Forma to mature and even longer for it to totally replace what the customers are doing. Speaking of Fusion 360, subscriber number continues to chug along but at a slower pace which is expected given the macro environment. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-79.png) Source: MBI Deep Dives, Company Press Release More caution about macro: > Channel partners remain optimistic, but with hints of caution. Usage rates continue to grow modestly in the U.S. and APAC, excluding China, but are flat in Europe, excluding Russia. Labor shortage is still the primary concern, but demand softness is appearing on the low end: > one thing continues to pressure the industry more than the demand, and it is the labor shortages and the capacity to execute. Construction companies still have a backlog of business. They're still struggling to execute through the business that they have to. > If anything what we're seeing is softness in the low end of our business, which is what you would expect in a climate like this. LT growth as well with LT renewal rates have seen some pressure. That's where we're seeing things. The collections percentages, the collections renewal rates, these have remained steady throughout the year and throughout the quarter. **Cost structure** GAAP EBIT margin expanded from \~17% in 3Q'FY22 to \~20% in 3Q'FY23\. Non-GAAP margin similarly expanded from \~32% to \~36% in the same time. Management **reiterated** non-GAAP margin guidance to \~38-40% sometime in FY'23-26 window. It is **disappointing** to see management focus on such **meaningless** number; you can always congratulate yourself just by issuing more SBC to hit your non-GAAP operating margin guidance. More on this later. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-75.png) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-76.png) Source: MBI Deep Dives, Company Press Release **Capital allocation** Autodesk so far bought back 4.4 mn shares this year with avg. cost of $200/share. Diluted shares outstanding decreased by 2.2% YoY. Frustratingly, they keep mentioning buying back stock primarily to offset dilution from SBC and don't think it as capital return strategy. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-77.png) Source: MBI Deep Dives, Company Press Release Speaking of SBC, this has become quite the hot topic recently and Autodesk is also under the scanner. While I do criticize the management to focus on meaningless metric such as non-GAAP operating margin, Autodesk hasn't been egregious in Silicon Valley standard. Although SBC has no sign of cost leverage, off the top of my head I cannot think of any tech company (at least the ones I studied) which experienced any SBC leverage over their cost base. From \~10-11% to \~12-13% of sales is perhaps nothing to be too critical about. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-78.png) Source: MBI Deep Dives, Company Press Release Moreover, by and large, I doubt any management in tech thinks about stock as a currency that needs to be intelligently used based on the price of stock. More realistically, most tech companies have a target comp in mind and a target mix of cash and stock. If your target stock comp is $1000 and the stock is trading at $100, you get 10 shares. On the other hand, if stock starts trading at $10, the employee will receive 100 shares with target comp remaining relatively fixed. The reason any company cannot just simply decide that they don't want to pay or want to pay less in stock is talent has been incredibly sought after in the last few years. I randomly picked four companies in tech in various stages/sub-sectors to see how Autodesk fares against them in terms of total comp and as you can see, Autodesk certainly doesn't stand out. Autodesk, in fact, has been more conservative than many younger software companies. But that is the talent market Autodesk had to operate in. As investors, we cannot simply daydream about low SBC or total comp because these companies need to hire people to run the business. Autodesk also was relatively more prudent in hiring cadence. Number of employees increased by 13.9% and 9.6% in last two years respectively. I do want to point out that it appears to me extremely likely that tech comp will go through a prolonged stagnation. Not many businesses can possibly afford to hire even recent college graduates with these eye popping comp packages. It is very, very difficult to build highly profitable businesses when opex per headcount is \~4-6x US GDP per capita. Now that big tech is on the retreat from the talent market (remains to be seen how long that lasts though), it is possible the talent war will cool off. This will also give us more hint just how human capital intensive these businesses need to be (lots of theories out there, but we will have much clearer answers in 2-3 years). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-80.png) Source: MBI Deep Dives, Company Press Release **Outlook** Coming back to Autodesk, CFO perhaps intentionally set a cautious tone for FY'2024 as well citing FX, transition to annual billings etc.: > We'll have about a 5-point-or-so incremental FX headwind. That's because of the continued strengthening of the U.S. dollar and then another point of incremental headwind from exiting Russia. > That's going to make it tough for us to grow revenue beyond double digits. On margin, the revenue headwind creates margin growth headwinds, which likely means limited progress on reported margins in fiscal '24\. Put another way, margins will look better at constant exchange rates. And then on free cash flow, FactSet consensus right now is a range of $1.2 billion to $1.7 billion. There's a couple of important things to consider. > The first is the rate at which our customers transition to annual billings. And the second is the overall macroeconomic environment. We continue to be focused on executing on that transition as fast as possible because while the change is good for us, and it's good for our customers, from a financial standpoint, we really want the noise behind us. So remember, the faster that we move the multiyear based annual billings, the greater the free cash flow headwind we'll see in fiscal '24\. On macro, we will, as usual, give our fiscal '24 guidance based on the macro conditions that we see as we exit fiscal '23. For my readers in the US, Happy Thanksgiving! Autodesk's earlier earnings threads: [FY 1Q'22](https://twitter.com/borrowed%5Fideas/status/1398098719271182337?ref=mbi-deepdives.com), [2Q'22](https://twitter.com/borrowed%5Fideas/status/1430705775165456385?ref=mbi-deepdives.com), [3Q'22](https://twitter.com/borrowed%5Fideas/status/1463358812102955008?ref=mbi-deepdives.com), [4Q'22](https://twitter.com/borrowed%5Fideas/status/1497242017667203078?ref=mbi-deepdives.com), [1Q'23](https://twitter.com/borrowed%5Fideas/status/1529991868372733961?ref=mbi-deepdives.com), [2Q'23](https://www.mbi-deepdives.com/adsk2q23/) ### Datadog: Leading the Cloud Infrastructure Dogfight URL: https://www.mbi-deepdives.com/ddog/ Last updated: 2025-03-10T17:31:49.000Z _This post is for paying subscribers only._ ### IAC 3Q'22 Earnings Update URL: https://www.mbi-deepdives.com/iac3q22/ Last updated: 2022-11-09T19:37:25.000Z *Disclosure: I own shares of IAC* [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) > Perceptions of both IAC and Angi have swung from extreme confidence to extreme skepticism. We could all challenge the rationality of the extremes, but the general shift in sentiment has been warranted: Joey Levin Here are my highlights from the recent shareholder letter and earnings call. **Angi** As Levin became 4th CEO in the last 5 years, he started with admission of past mistakes. He seems to be aware that good letters aren't going to cut it anymore; only way to get out of the hole is to execute on the business, just as he did with Vimeo and Mindspark. > Not only did we burn capital, but we spread it too thin and lost focus on some fundamentals. > Skepticism is warranted here given our recent results, but I want to be unequivocally clear that I don’t share it. > When I became CEO of Mindspark in 2009, the first business I ran for IAC, the business had just dropped to nearly breakeven in its most recent quarter, after delivering profits for years. The trends were bad, but we had nine figures of annual revenue and a bright and committed team and rightly believed we had enough clay to work with. When I went to be CEO of Vimeo, we had a similar story. I acknowledge that being Angi’s fourth CEO in five years is not confidence-inspiring but I take on the role of Angi CEO with a head start, having served as Chairman through the challenges of the past few years, not dissimilar to the situations at Mindspark and Vimeo. Following the brand changes, Angi is still missing $100 mn annual profit from traffic coming from search engines. Levin is more focused on balancing growth AND profitability: > I think we have to deliver for 2023, and I think we have to deliver more profit for 2023, and I think we're totally capable of doing that. **Dotdash Meredith** > In hindsight, we timed that acquisition poorly: both Dotdash and Meredith have experienced headwinds throughout the year, with soft traffic compared to extraordinary pandemic audiences and an unexpectedly weak digital advertising market. Three reasons for softness for this business: **a) Ad market:** "*Premium and programmatic advertising across a broad range of industries represent roughly 65% of Dotdash Meredith’s Digital revenue...Advertisers responded to inflation and changing consumer spending patterns by materially scaling back spend, in some cases by more than 25% vs. first half 2022 and prior year levels."* **b) Integration execution:** "*Dotdash had acquired and integrated nine properties previously, but the scale of the Meredith acquisition was at a different level."* **c) One-Time Costs:** **"*Through September, we have recorded $60 million in charges deriving from restructuring costs, real estate impairments, severance and other activities. All of these are non-recurring and relate to the 2022 fiscal year"* While there have been integration challenges, by and large it still seems plausible that over time these challenges can be rectified: *"In prior acquisitions, Dotdash has seen migrated sites initially decline in traffic following a migration, before visits stabilize and then grow at about the six-month mark, as shown in the table below:* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-31.png) *The following table summarizes the performance of migrated Meredith sites to date, detailing months since migration, performance against the benchmarks above, and the relative size for each site:* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-32.png) IAC guides flat revenue for Digital ads segment in 1H'23 and then growth in the latter half with the caveat of macro: > we believe we can get to flat Digital revenue in the first half of next year without a material improvement in the advertising market, and flip to growth for full-year 2023, **provided the economy and market do not substantially soften**. Adjusted EBITDA guide for 2022 down from $300 mn to $240-250 Mn, primarily driven by declining digital ad revenue as Print and expenses outlook remain similar. How about $450 Mn EBITDA guide in 2023? > "I think realistically, we're probably 1 to 1.5 maybe years behind schedule." **Care** > We’ve also executed reasonably well at Care, repositioning a challenged company and growing revenue over 70% since acquisition, with increased profits. **Bluecrew** IAC sold Bluecrew to EmployBridge, "the country’s largest light industrial staffing company", for $50 Mn cash and equity to become a minority shareholder with a board seat at EmployBridge. Bluecrew had gross margins in the teens, so IAC probably felt it needed better to scale build a more sustainable business. Selling Bluecrew will almost eliminate LTM $26 Mn loss from adjusted EBITDA. **Vivian** > Vivian Health, our leading healthcare-jobs marketplace, continues to take share, growing revenue 77% in the third quarter. **Valuation** Joey made the following pitch on IAC's valuation: ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/11/image-33.png) An analyst asked why the disconnect between the SOTP (Sum Of The Parts) valuation and how the market is pricing IAC? This is what Joey said: > the primary source of the disconnect is execution. And then the other source of the disconnect is, as is the case in any sum of the parts, what people are focused on is the ability to access the parts, and there's probably a perceived time or gap between now and ability to access the parts. That's something I've talked about a lot, that doesn't really worry me and everything that we have. We maintain that optionality. That option has value. The value of that option doesn't really decline. And so we don't feel real pressure to exercise those options. But the thing that we have done in realizing value on those things over time is we have certainly demonstrated an ability and willingness to exercise those options in tax-efficient ways. > Right now, that's not a high priority focus for us. The focus for us is execution against all of our businesses. And then those options will become available or more exercisable over time. And that usually shrinks the discount. While IAC started disclosing monthly metrics post-pandemic, those won't be disclosed monthly after December 2021 and will go back normal cadence of quarterly disclosure. I will publish my Deep Dive on Datadog in a couple of weeks. You can explore all the past 26 Deep Dives published so far **[here](https://www.mbi-deepdives.com/models/)**. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Amazon 3Q'22 Earnings Update URL: https://www.mbi-deepdives.com/amzn3q22/ Last updated: 2022-10-28T11:20:24.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares of Amazon* > When faced with an uncertain economy or some kind of discontinuous event, customers tend to double down on companies that they believe have the best customer experience and that take care of them the best As Bezos said, *long-term* shareholders and customers interests are aligned. We'll see. Here are my highlights from 3Q'22. **Revenue** Topline had 460 bps FX headwind (vs guidance assumed 390 bps). Unlike in most companies, FX impact is higher for topline than bottom-line for Amazon. > FX is a bigger issue for us on our revenue growth in dollars than it is on our income. It actually has a slight favorability due to the investments we're making internationally. 2,3,4-yr CAGR still look pretty healthy across most segments. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-109.png) Source: Amazon Press Release, MBI Deep Dives **Retail** 3P seller unit mix 58% in 3Q'22 (vs 56% in 3Q'21) While Retail growth may look unimpressive at first glance, it looks much better in comparison with Shopify last quarter although Amazon's numbers probably got extra boost because of Prime Day. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-105.png) \*Amazon GMV estimated as online sales+ physical store sales+(3P sales/25%); Source: Amazon Press Release, MBI Deep Dives **Prime** Prime day drove 400 bps growth YoY in 3Q'22 (Prime Day was in 2Q last year). Rings of Power and NFL's TNF drove Prime subscriber growth: > "The Rings of Power attracted more than 25 million global viewers on its first day. And in the first 2 months since its launch, Rings of Power has driven more Prime sign-ups globally than any other Amazon Original." > NFL's Thursday Night Football also premiered in September, averaging more than 15 million viewers during its first broadcast, and driving the 3 biggest hours of U.S. Prime sign-ups in the history of Amazon. **AWS** AWS run-rate $82 Bn. Backlog $104 Bn (+57% YoY) Although AWS grew +28% YoY FXN, 3Q'22 ended with mid-20s growth, indicating some slowdown in cloud. The last time AWS saw high 20s growth in 2Q'20-4Q'20, it was able to reaccelerate later. It seems a bit tough to do that again in the next few quarters given the macro situation. > With the ongoing macroeconomic uncertainties, we've seen an uptick in AWS customers focused on controlling costs. And we're proactively working to help customers' cost optimize, just as we've done throughout AWS' history, especially in periods of economic uncertainty. The breadth and depth of our service offerings enable us to help them do things like move storage to lower-priced tiers options and shift workloads to our Graviton chips. > Graviton3 processors delivered 40% better price performance than comparable x86-based instances. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-108.png) Source: Amazon Press Release, MBI Deep Dives Even though growth is likely to decelerate, value proposition of shifting to cloud may become clearer during economic downturn: > I would say this is one that real valuable points about cloud computing is that it's turning fixed cost into variable for many of our customers, and we help them save money either through alternative services or Graviton3 chips. There's many ways that we have to help them lower their spending and still get great cost performance ratios. Financial Services, mortgage business, crypto are down which have affected AWS growth. Now that we have AWS results, it makes Google Cloud look a bit better, especially given the hiring ramp-up Google did for GCP over the last few quarters. It makes me optimistic that by 2024, GCP may make some serious improvement in margins. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-107.png) Source: Amazon Press Release, MBI Deep Dives ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-106.png) Source: Amazon Press Release, MBI Deep Dives Speaking of margins, AWS EBIT margin went down to 26.3% in 3Q'22\. Why? > I'd say what's happening lately is, yes, the stock-based comp. There's -- we have seen inflation in our wages this year and particularly on our check employees is heavily concentrated in AWS. So that's one element of it. We're also seeing energy costs that are materially higher than they had than pre-pandemic electricity and the impact of natural gas pricing. **So those prices up more than 2x over the last couple of years and contribute to about 200 basis point degradation** versus 2 years ago. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-110.png) Source: Amazon Press Release, MBI Deep Dives Ex-AWS, rest of Amazon posted -2.7% EBIT margin (2Q'22 was -2.4%). Amazon did take some non-recurring charges this quarter by closing Amazon Care, Fabric.com, and Amazon Explorer. Some more explanations here: > On international, international is always a mix of profitability in more established countries of Europe and Japan, offset by emerging countries and investments in Prime benefits. I think the biggest issue quarter-over-quarter, the increase in losses versus Q2 was tied to some additional operating costs in Europe. **We've seen higher fuel costs there**, just even more certain in the United States. **And Prime Day is always a bit of -- has lesser profitability because there's just a lot of deals. And it's a bit of margin from Prime Day in both North America and international.** > So we also had a big -- a big part of that is **device sales. And again, we sell a lot of devices during our Prime Day events. We don't make money on the device**. We make money on the use of the device. So that always can end up hurting profitability in the quarter. Of course, we can always find "reasonable explanations", but let me ask some tough questions. Before I ask the questions, let me give some data. Net Service Sales as % of Total revenue went from \~30% in 2016 to \~53% in 2022\. Service is higher gross margin business than product sales. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-112.png) Source: Amazon Press Release, MBI Deep Dives Now let's look at Amazon's cost structure from 1Q'16-3Q'22\. Please note in 2016, Amazon's average quarterly topline in first three quarters was \~$30 Bn compared to \~$120 Bn in 2022\. What's surprising is apart from cost of sales (which was just a benefit for mix shift to service), **every single cost line item deteriorated over time**. One would imagine adding $90 Bn topline would lead to at least some scale benefits, but well, not at Amazon! 3P and advertising are likely to be pretty high margin segments. Clearly, there are some "Metaverse" hidden in this income statement. I am curious whether investors will be able to force Amazon to disclose its "other bets" losses. Let's see whether investors do have any voice on a company without the dual class shareholder structure. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-113.png) Source: Amazon Press Release, MBI Deep Dives Unlike Meta, Amazon, however, is quite adept at communicating with shareholders. Amazon sounded like an adult when it reminded that they cut about 1/3 of their budget from what they originally thought for 2022\. While that sounds good, also as a reminder, this is their capex+ leases spend over the years: 2015: $9.0 Bn 2016: $13.5 Bn 2017: $14.6 Bn 2018: $22.9 Bn 2019: $23.6 Bn 2020: $54.3 Bn 2021: $68.1 Bn 2022\*: \~$60 Bn \*not including leases I'll be very curious about their 2023 capex outlook, especially ex-AWS. **Outlook** 4Q topline guide $140-148 Bn, implying \~2-8% YoY growth (assumes 460 bps FX headwind) This has been a draining week. Take care, everyone! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Shopify 3Q'22 Earnings Update URL: https://www.mbi-deepdives.com/shop3q22/ Last updated: 2022-10-27T17:33:57.000Z *Disclosure: I own shares of Shopify* By and large, things are in the right direction for Shopify. Here are my highlights from the latest earnings. **GMV** GMV grew 11% YoY, \~15% FXN. 2-yr CAGR and 3-yr CAGR were \~22% and 46% (52% FXN) respectively which lets you peek beyond the tough comp. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-104.png) Amount in USD Bn; Source: Shopify Press Release, MBI Deep Dives **Take rates** Shopify posted its highest ever take rates in the last quarter, primarily driven by Merchant solutions. Most Shopify plans are fixed plans, so take rates are probably not the best metric for subscription solutions. However, Shopify Plus pricing is $2,000/month or 0.25% of GMV whichever is higher with the maximum price being $40,000/month. Shopify Plus merchants were 33% of MRR in 3Q'22 (vs 28% in 3Q'21). It is the Merchant Solutions that can and will grow commensurately with GMV. As Shopify builds more and more products for Merchants to address their problems, the attach rates is likely to go higher. Take rates for Merchant solutions increased from 1.5% in 1Q'19 to 2.1% in 3Q'21\. Deliverr added 8 bps to the take rate. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-95.png) Source: MBI Deep Dives, Shopify Press Release **Payment penetration** The primary driver of Merchant Solutions take rates is Shopify's payment penetration. Payment penetration keeps going higher every quarter and went from 40.9% in 1Q'19 to 54.1% in 3Q'22 (vs 49.2% in 3Q'21). I am going to keep a close eye on this metric to gauge whether "Buy with Prime" is making any inroads with Shopify Merchants. Since it's very early days with "Buy with Prime", there's not much signal here yet, but expect it be under the scanner in 2023-2024 when "Buy with Prime" is rolled out more widely. Despite the public rhetoric, I expect Shopify to be quite protective of this revenue source since Merchant solutions is now \~72% of total revenue, majority of which is driven by payments. Shopify is simply not in a position to let Amazon "steal" this revenue from them. > "we were talking to Amazon about how we **implement this in the right way**." ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-96.png) Source: MBI Deep Dives, Shopify Press Release **Gross Margin** As merchant solutions, which is lower gross margin, grow much faster than higher margin subscription solutions revenue, overall gross margin continue to go down over time (+typical FX caveat). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-97.png) Source: MBI Deep Dives, Shopify Press Release **Offline Retail** Shopify maintained its recent ramp up beyond online retail infrastructure; 8 new merchants with >20 locations (one with 175 locations) became Point-of-Sale (POS) customers. Shopify Plus merchants were 35% of POS sales in 3Q'22 (vs 14% in 3Q'21). Offline GMV grew 35% YoY (41% FXN) > Since the beginning of 2021, over half of the rapid adoption of point-of-sale Pro is being driven by new SMB retailers coming to Shopify to get their start as a new omnichannel business. Additionally, over 1/3 are from established offline retailers who are entirely new to e-commerce or selling only on point of sale. **Social Commerce** > While still very nascent, GMV through native checkout integrations on key partner services such as Facebook, Instagram and Google, more than tripled from Q3 last year. **Product** Shopify's product initiatives make me optimistic that over time, they can expand Merchant Solutions take rates, which as I will explain later, may be essential for shareholders to make money. *Shopify Collabs* > Another marketing tool that we launched in early access in mid-August is Shopify Collabs, which brings brands and creators together. It has generated approximately **50 million organic impressions across social channels in less than 2 months.** Collabs allows creators to monetize their talents by discovering and partnering with independent brands and sharing their favorite products with their followers. This gives merchants yet another new channel to grow their brand reach and find new customers. *Shopify Markets* > We're also investing in our merchants' ability to grow by helping them go global. Shopify Markets, which launched in Q1 allows merchants to identify, set up, launch, optimize and manage their international markets from a single storefront. **To date, more than 175,000 merchants across the world have used markets to help launch their international businesses**. > By reducing the barriers to international selling, **U.S. merchants utilizing Markets now sell into an average of 14 additional countries.** Shopify Markets Pro, which debuted in mid-September in early access, is our cross-border solution built on top of Markets. By combining global use features with markets capabilities such as the Translate and Adapt app, **Markets Pro makes it easier for merchants to accelerate their global expansion to over 150 countries** overnight without increasing their operational costs, risks or complexity. > **International retailers** outside of North America continued to grow our overall merchant mix, **comprising 45% of all merchants in Q3** and demonstrating the continued success of our investments. *Shopify Capital* > At the end of August of this year, capital broke another record. We've provided cumulative funding of $4 billion since inception to our merchants. *SFN* > In Q3, we completed the rollout of Shop Promise to all SFN merchants. Shop Promise is a consumer-facing badge indicating fast and reliable delivery across Shopify's online store and other popular direct-to-consumer channels. Shop Promise has already significantly boosted sales as participating merchants increased buyer conversion by up to 9% during the initial rollout. > In September alone, SFN saw over 2/3 of domestic packages delivered within 2 business days, an exponential increase from less than 2% predicted delivery before SFN's software update in early 2022\. All new SFN merchants are now automatically qualified to display the Shop Promise badge out of the box. We are confident that Shop Promise's impact on merchant value will continue to increase as it evolves and matures. And we believe that SFN has the opportunity to become the de facto fulfillment solution for independent merchants in the consumer packaged goods and apparel categories. > We're already increasing the number of SFN orders with predicted delivery of 2 days or less, from -- to over 65%. And so we're on track to hit over 75% by the end of the year. **Cost structure** Like other tech companies, Shopify's cost structure skyrocketed from 2021\. R&D as % of sales went from \~18-20% in 2021 to \~30% last quarter. S&M went down as % of revenue sequentially QoQ. Shopify had \~$97 Mn one-off expenses (including $30 Mn severance expense) last quarter. Excluding this, G&A would be 12% of revenue in 3Q'22. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-98.png) Source: MBI Deep Dives, Shopify Press Release **New comp structure** > As part of opting into this new compensation system, employees received a single total compensation number and had the choice to allocate their pay between cash and newly granted equity in the form of restricted stock units and/or stock options. In addition, previously granted unvested equity was canceled, and the new quarterly equity grants will vest monthly. > Employees will be able to change their allocation between cash and equity each quarter as their personal preferences change. We link Flex Comp tightly to our mission and long-term vision of building a 100-year company. **So for those employees who elected extra equity above the default settings, they were given an additional 5% bonus on that equity amount.** **Outlook** Shopify expects merchant solutions to grow more than double that of Subscription solutions in 2022\. Gross profit dollar growth will continue trail revenue growth. Operating expense growth YoY in Q4 will sequentially decelerate from Q3. > From an adjusted operating loss perspective, we continue to expect a loss for the full year. For Q4, based on our updated outlook, we now expect an adjusted operating loss dollar amount that will be fairly comparable to the adjusted operating loss in Q3\. Finally, the full year estimates of stock-based compensation and related payroll taxes, CapEx and amortization of acquired intangibles are now $575 million, $125 million and $55 million, respectively. **Valuation** Shopify is down almost \~80% from its All-Time High (ATH). However, you still need to assume \~15% GMV CAGR (2021-2030), \~13% GAAP EBIT margin, and 25x terminal EV/EBIT multiple to make \~10% IRR. Here's a scenario analysis (keeping other variables such as EBIT margin constant): ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-99.png) *IRR calculated from Enterprise Value of $30 Bn over 8 years. 1% annual dilution assumed. Red indicates IRR below 10% and Green indicates IRR above 10%* **How to get to \~13% GAAP EBIT Margin?** If take rates expand by \~100 bps over the next 8 years, Shopify should not find it difficult to manage its cost structure to reach \~12-15% EBIT margin in 2030\. Of course, as we have seen with Amazon, they may not post such margin even in 2030 if they can manage to grow GMV and gross profit at \~20% or higher with attractive ROIC. Therefore, ROIC may be more important driver than terminal margins in this case. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-102.png) Source: MBI Deep Dives Speaking of Amazon, I will cover their earnings tonight. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Meta 3Q'22 Earnings Update URL: https://www.mbi-deepdives.com/meta3q22/ Last updated: 2022-10-27T01:17:17.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares of Meta* > "...I think that those who are patient and invest with us will end up being rewarded." > > Mark Zuckerberg From October 26, 2015 to today (after-hours), the stock is flat. The "reward" remains elusive. Here are my highlights from 3Q'22. **Users** DAU/MAU all look pretty healthy. Number of ad impressions +17% YoY, price per ad -18%. Pricing was affected by stronger impression growth in APAC and RoW, FX, and lower demand from advertisers. Interestingly, fastest user growth for WhatsApp is in North America now; global DAU crossed 2 Bn. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-86.png) Source: Meta Press Release, MBI Deep Dives ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-87.png) Source: Meta Press Release, MBI Deep Dives **Ad Revenue** Ad revenue decelerated across the globe; FX Neutral looks a bit better since there was 6% FX headwind. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-88.png) Source: Meta Press Release, MBI Deep Dives **Segment Reporting** Reality Labs (RL) losses continue to climb up but revenue went down almost 50% as Quest 2 units sold fell YoY. Family of Apps (FOA) went from 50-55% EBIT margin business to mid 30s this quarter. FXN, it would probably be low to mid-40s. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-89.png) Source: Meta Press Release, MBI Deep Dives If you look at more granular breakdown, two things stand out: 1. R&D went from \~20% as % of revenue in 1Q'19-4Q'21 to \~30-33% in the last two quarters. With RL, Meta is spending a lot on R&D which obviously have negligible contribution on topline. 2. G&A also went from 5-8% to \~10-12%. It's not as noticeable as R&D ramp up and likely to go back in MSD-HSD range once topline growth returns. R&D, however, may prove to be quite sticky for a while. Also, capex as % of sales went from mid teens to \~34% this quarter. Social networking is not a capital light business anymore! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-92.png) Source: Meta Press Release, MBI Deep Dives **Capital Allocation** Meta generated a meagre $173 Mn FCF, so used its balance sheet to buyback $6 Bn shares which led to \~1% decline in diluted shares outstanding QoQ. Headcount growth slowed QoQ, but still growing fast on YoY basis. Headcount at the end of 2023 will be similar to 3Q'22. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-90.png) Source: Meta Press Release, MBI Deep Dives **Expense and Capex Guide** Expense guide $96-101 Bn for next year (vs \~$86 Bn in 2022). Capex guide is $34-39 Bn (vs $32 Bn in 2022). My guess is the stock would do just fine (and might be up) if both these numbers were closer to (or lower than) 2022. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-91.png) Source: Meta Press Release, MBI Deep Dives Why is the expense and capex guide going up despite all the headwinds Meta faces? On expense guide: > One thing I'd point out first is just next year's guide includes an estimated $2 billion in 2023 expenses that are onetime charges as part of our office facilities consolidation as we continue to rationalize our real estate footprint. We also expect a little over half of our expense dollar growth in 2023 to come from OpEx, with the rest coming from cost of revenue. Cost of revenue will go up primarily via higher expected contribution from RL sales i.e. Quest hardware sales (which is higher cost of revenue). Higher depreciation too given capex ramp up in recent years. Even though headcount will be largely fixed, some opex growth will come from full-year salaries that were only paid for partial year for new hires this year. So if Meta wanted to lower expense next year (vs this year), they would have to fire people which they are trying to avoid. Moreover, RL losses will increase "meaningfully" next year. YTD losses in RL is already $9.4 Bn (vs $10 Bn for full year 2021). I shudder to think what "meaningfully" even means; if full-year losses is \~$12 Bn this year, is it $18 Bn in 2023? How about Capex? Mostly AI and data centers. > Before turning to our CapEx outlook, I'd like to provide some context on our infrastructure investment approach. We are currently going through an investment cycle, which is being driven -- which is primarily driven by 2 large areas of investment. First, we are significantly expanding our AI capacity. These investments are driving substantially all of our capital expenditure growth in 2023\. There is some increased capital intensity that comes with moving more of our infrastructure to AI. It requires more expensive servers and networking equipment, and we are building new data centers specifically equipped to support next-generation AI hardware. We expect these investments to provide us a technology advantage and unlock meaningful improvements across many of our key initiatives, including Feed, Reels and Ads. We are carefully evaluating the return we achieved from these investments, which will inform the scale of our AI investment beyond 2023. > Second, we are making ongoing investments in our data center footprint. In recent years, we have stepped up our investment in bringing more data center capacity online. And that work is ongoing in 2023\. We believe the additional data center capacity will provide us greater flexibility with the types of servers we purchase and allow us to use them for longer, which we expect to generate greater cost efficiencies over time. These investments, along with revenue headwinds, are contributing to higher capital expenditures as a percentage of revenue in 2022 and 2023 than we expect over the long term. Some of the capex investments seem to bring some results: > In the Q2 call, we had shared that a single AI advancement in scaling our recommendations models had led to a 15% watch time gain for Facebook Reels, and that gain has continued to grow. And we expect that there will be additional Watch time improvements coming from that work. **Reels** While understandably a lot of attention has been given to expenses and capex, there are plenty of positives in FOA business. Reels is played 50% more vs 6 months ago; 1 Bn Reels were shared per day via DMs on IG. Reels run-rate is now $3 Bn (vs $1 Bn last quarter). Reels is currently $500 Mn revenue headwind given the lower monetization, but expect to reach revenue neutral position in 12-18 months. Aggregate time spent on Instagram and Facebook both are up year-over-year and in both the U.S. and globally. Reels is proving to be incremental. **Click to messaging ads** Click to messaging ads is $9 Bn run-rate business. This is mostly Messenger; WhatsApp passed $1.5 Bn run-rate, growing 80% YoY. **Outlook** > Turning now to the outlook. We expect fourth quarter total revenue to be in the range of $30 billion to $32.5 billion. Our guidance assumes foreign currency will be an approximately 7% headwind to year-over-year total revenue growth in the fourth quarter based on current exchange rates. Near the end of the call, Zuck commented the following on his effort around Metaverse: > I think it's some of the most historic work that we're doing that I think people are going to look back on decades from now and talk about the importance of the work that was done here. That group of people may or may not include shareholders! I will cover Shopify and Amazon tomorrow. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Spotify 3Q'22 Earnings Update URL: https://www.mbi-deepdives.com/spot3q22/ Last updated: 2022-10-26T12:00:12.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares of Spotify* > "...I suspect many of you think Spotify is a great product, yet at the same time, you may also think that we're a bad business or at least a business with bad margins for the foreseeable future." > > Daniel Ek Unfortunately, the skeptics are yet to be proved wrong as Spotify missed their gross margin guidance this quarter. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-70.png) Source: Spotify Press Release Here are some highlights from 3Q'22. While Premium subscribers is likely to exceed 200 mn next quarter (\~2x over last 15 quarters), MAU is growing even faster, mostly driven by RoW. ARPU for premium is up QoQ for the last 6 consecutive quarters. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-72.png) Source: Spotify, MBI Deep Dives (ARPU is calculated based on current quarter premium revenue\*4 divided by trailing four quarters average premium subscribers) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-71.png) Source: Spotify, MBI Deep Dives *(calculated based on disclosure of Overall Premium Subscriber number and the mix of Premium Subscriber by geography)* One metric that I like to keep track is subs add of Netflix and Spotify. While Netflix was a massive beneficiary of Covid, Spotify added more premium subs on TTM basis for the last 7 quarters, and the difference continues to widen over time! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-73.png) Source: Spotify and Netflix Press Release, MBI Deep Dives **Will Spotify raise price for premium?** A price increase in the US seems imminent. > in the last 2 years, we've actually done more than 46 price increases in markets around the world. > And again, in specific, mostly to the U.S.-based price increases, it is one of the things that we would like to do, and this is a conversation we will have in light of these recent developments with our label partners. **Negotiation with labels on incremental price increases** I hope Ek goes really hard on getting a better deal from the labels for marginal price increases. And if he doesn't get it, I would support focusing on taking market share than just following Apple on price increases. > again, any price increases that we choose to do should be net-net a win-win for both parties. So that's definitely part of any conversations when we're talking about pricing with our label partners, as you could imagine, even in the past and in the context of the 46 price increases we've already made **Platinum tier/HiFi update** Unfortunately, no updates yet. Spotify was asked, but they avoided the question. **Competition from TikTok** Ek mentioned in the markets TikTok already has its music streaming product (Resso), it hasn't been able to take market share from Spotify. > "When they've taken share-they haven't taken share from us. It's been from others." **Ads** Spotify's ads business is facing headwinds as well; revenue growth decelerated from 30% in the last two quarters to 20% this quarter. But since ads remains a small portion of the overall business, management thinks the headwinds will be manageable. EMEA is softer than North America. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-74.png) Source: Spotify Press Release, MBI Deep Dives ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-75.png) Source: Spotify Press Release, MBI Deep Dives Number of advertisers and podcast related data seem encouraging. > the number of advertisers that are participating in SPAN, that continues to move up > "We've seen podcast MAU as a percent of our total MAU continue to increase. It was up again in Q3\. And then podcast consumption per podcast MAU is also up year-on-year" **Gross margin** Of course, gross margin is the real challenge with Spotify. So, what happened last quarter? Gross margin for Premium went down by 100 bps YoY, but the gross margin for ads declined from 10.8% in 3Q'21 to 1.8% in 3Q'22\. The irony of getting into ads to improve overall margin is turning out to be a bit comical. Spotify thinks it is still possible, but needs more time to build the whole ad ecosystem/infrastructure. Detailed explanation on gross margin miss is below: > Turning to gross margin. Gross margin of 24.7% was below guidance by 50 basis points. There are 3 factors that contributed to the results and in order of significance. First, the expected renewal of a large publishing contract outside the U.S. resulted in an accrual adjustment this quarter. The adjustment reflected revised estimates spanning the previous 9 quarters. And while the amounts were immaterial in any single quarter, taken together, they added up to a material impact in Q3. More explanation on this accrual was given later in the call: > As many of you know, often times, we have relationships with our royalty partners. And some of the times, those contracts expire. And as we are negotiating new contracts, we estimate as best we can what we think the expenses we need to incur during that period of time. Normally, and in most cases, we're always very conservative. In most cases, it results in us actually getting a slight benefit when we actually settle the contract. In this case, it was a very modest impact. The reason it mattered in this quarter is because the contracts have been expired for over 2 years. And so it was 9 quarters worth of small little adjustments over 9 quarters that we had to take in this quarter. What were other two reasons for gross margin miss? > And second, like many, we did experience some impact to the top line advertising growth from the macro slowdown, and this shortfall had a modest impact on margin. And third, currency fluctuations, mainly the continued strength in the U.S. dollar, had a small impact on cost of revenue. Historically, currency has had a big impact on operating expense and a somewhat minimal impact on cost of revenue. However, given the significant strength of the dollar, it has started to impact gross margin as well **LTV/CAC** > "the lifetime value of a user, is the primary tool we use to inform our business decisions and judge whether our strategy and investments are working and achieving better outcomes." If it were indeed the primary tool to inform Spotify's business decisions, I think Spotify should disclose and report the LTV calculation for its shareholders. Spotify is optimistic that CAC will come down during the downturn: > "We will make new investments with 2 criteria in mind. First, it must be accretive to margin over the investment period given this new hurdle rate. And second, over the long term, that investment must strengthen our value proposition to users and creators alike. This said, new opportunities will likely emerge in downturns. As an example, we may find that our customer acquisition cost goes down as the cost of advertising typically declines in a softer market. This would then offer us a clear opportunity to grow our market share even in a challenging economy because we can acquire users at lower cost relative to LTV." **Expense growth** > Growth in the quarter was slightly lower than forecast on a currency-neutral basis > Currency continues to be a big impact, adding $85 million to operating expenses or just over 14 percentage points of year-over-year growth. > I think you can expect that dynamic of revenue growth and expense growth to flip from where it's been over the past couple of years and start to see that focus shift in sort of how we manage the business. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-76.png) Source: Spotify Press Release **Outlook** Gross margin outlook is negative too. Detailed explanation here: > Our gross margin outlook for Q4 is 24.5%. We recognize this is likely a bit below what many of you have been expecting based on our commentary, exiting our Q1 results for a gross margin of around 25% for the balance of the year. The variance between these figures is primarily a result of 3 factors. > > One, including the softening macro environment over the course of the year, which is reflected in the current advertising slowdown, we also see another quarter of negative currency exposure. And last Q4 includes a restructuring charge at our podcasting business, which should lead to improved productivity at select studios on a go-forward basis. All in, we anticipate approximately 70 basis points of impact from these 3 items with the impact spread roughly evenly across each. Overall, while Spotify's premium and MAU user growth look very encouraging, the stock seems unlikely to get out of the penalty box, especially in the current environment unless and until they make noticeable and persistent improvement in gross margin. You can read my Spotify Deep Dive (December, 2021) [**here**](https://www.mbi-deepdives.com/spot/) I will cover Meta's earnings tomorrow! [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Alphabet 3Q'22 Earnings Update URL: https://www.mbi-deepdives.com/goog3q22/ Last updated: 2022-10-26T10:15:59.000Z [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) *Disclosure: I own shares of Alphabet* > "There's no question we're operating in an uncertain environment" Summertime is over, and winter is almost here. Here are some of my highlights from 3Q'22. First things first, there was 5% FX headwind, so FXN revenue was +11%. YouTube ads and Google Network revenue declined YoY. Cloud continued its growth momentum. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-67.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives While Google Services EBIT declined by 17.5% YoY, given FX is a larger headwind for EBIT, EBIT declined by \~7-8% YoY FXN. Google Cloud's margin was -10.2% which was its highest ever. Cloud is likely to be a nice tailwind for margin in 2023. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-79.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives **Search** Google is optimistic about Search's performance during the economic downturn: > In challenging times like these, advertisers are carefully evaluating the effectiveness of their budgets. Search tends to do relatively well in such an environment, given its strong measurability and focus on delivering ROI. It's also well suited to quickly adjust to changes in consumer behavior. And when Search is coupled with our automation products across bidding, creatives, targeting or Performance Max, it can drive performance even further. > We are also making visual search more natural than ever before. People now use Google Lens to answer more than 8 billion questions every month using just a photo or an image. **YouTube** While YouTube ads declined YoY, YouTube non-advertising revenue increased YoY driven by Music Premium and YouTube TV. Revenue sharing on Shorts will arrive early next year. YouTube Shorts are watched by 1.5 billion users every month which lead to >30 billion daily views. Google mentioned the exact same numbers in Q1 and Q2\. Does that mean Shorts DAU/MAU is not growing? At least, Shorts monetization is here: > As of September, ads on Shorts have officially launched via video action, app and Performance Max campaigns. > video action campaigns with product feeds saw an over 70% increase in conversions on Shorts versus those without. Shorts viewership as % of total YouTube watch time is increasing: > We continued to experience a slight headwind to revenues as Shorts viewership grew as a percentage of total YouTube watch time. And as I alluded to earlier, the initial progress on Shorts monetization has been encouraging. YouTube TV is putting up some big numbers: > Nielsen reported that YouTube was the leader in streaming TV viewership in the U.S. in September for the first time. > Eyeballs keep moving away from traditional TV. On average, global viewers are watching 700 million-plus hours of YouTube content on TV daily. YouTube paid creators, artists and media companies over $50 billion in the last 3 years! Play revenues declined YoY: > Play revenues were lower due to a number of factors, including a decline in user engagement and gaming from the elevated levels seen earlier in the pandemic. Among other factors, this shift in user behavior also created downward pressure on our advertising revenues, with lower revenues from ad promo spend on YouTube Network and Play Ads in Search and other. More advertisers pulled back in Q3\. Some sectors that pulled back within financial services (for example): insurance, loan, mortgage and crypto subcategories. **Cloud** > Google Workspace is now used by more than 8 million businesses and organizations worldwide. (earlier disclosure: 5 mn in Feb'19, 6 mn in Apr'20) Cloud may not be immune from macro softness: > in some cases, certain customers are taking longer to decide, and some have committed to deals with shorter terms or smaller deal sizes, which we attribute to a more challenging macro environment. **Other Bets** > Waymo announced that Los Angeles will be its third ride-hailing city, joining Phoenix and San Francisco. Waymo will begin by mapping several neighborhoods in LA as it prepares to serve people there. Wing just surpassed 300,000 commercial deliveries. It's servicing new areas in Australia and announced its first drone delivery trials in Ireland. **Buyback** One disappointing aspect from the earnings was non-aggressive buyback cadence (below 100% FCF). One would imagine this is the time to use the $100 Bn net cash to put it to some good use. Despite $15 Bn buybacks, diluted shares outstanding was down 1.1% QoQ. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-84.png) Source: Alphabet Press Release, MBI Deep Dives That's probably not surprising when you see the headcount (+12.8k QoQ, excluding Mandiant acquisition \~10k QoQ). I hope you are sitting, because I'm going to say something astonishing: Number of headcount **added** by Google in the last 14 quarters (2Q'19-3Q'22) = Meta's **total employees** as of 2Q'22 ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-80.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives Google management, however, promised that Q4 headcount add will be less than half of Q3, and 2023 will exhibit more cost discipline in terms of headcount add. **Capex** Capex YTD $23.8 Bn (vs $24.6 Bn for full year of 2021) > servers really has been the largest driver of the investment dollars. The technical infrastructure team has consistently focused on levers to improve utilization and efficiency and they continue to do so. **Outlook** Google expects even larger FX headwind in Q4 > In the fourth quarter, the very strong revenue performance last year will continue to create tough comps that will weigh on the year-on-year growth rates of advertising revenues. **Valuation** It is hard to argue Google's valuation is expensive. The core Google Service business is trading at \~12x LTM EBIT if we value Google Cloud at 5x run-rate revenue. But let's hope they don't add a "Meta" in the next 3-4 years in their headcount. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-82.png) Source: MBI Deep Dives I will post my thoughts on Spotify earnings later tonight. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) ### Adobe Update URL: https://www.mbi-deepdives.com/adbe2/ Last updated: 2023-02-08T23:03:12.000Z **Disclosure: I own shares of Adobe** Adobe just had its Annual Creativity Conference: MAX as well as its Analyst Day. I wanted to write an update based on more data points that were disclosed on the Analyst day. If you are not up to speed on the business, I encourage you to read my [Adobe Deep Dive](https://www.mbi-deepdives.com/adbe/) published in August, 2022\. On this update, I will mostly talk about interesting things we got to know from the Analyst day and then talk about quantitative implications for the stock. I will break this update in four segments: a) Digital Media (Creative Cloud, Document Cloud, and Figma) b) Digital Experience, c) Capital Allocation, and d) Valuation/Model Assumptions. ## Digital Media *Creative Cloud* One of the interesting disclosures on the Analyst Day was the mix between single apps and all apps. Adobe expects to add $1.4 Bn net new ARR for Creative Cloud in 2022\. Of this net new ARR, \~55% of it will come from single apps and the rest from all apps. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-46.png) Source: Adobe Analyst Day, October 2022 In January 2020 Analyst Day, Adobe disclosed single apps and all apps ARR mix. In 2016, all apps used to contribute \~80% of ARR and then in 2019, \~67% of Creative Cloud ARR came from all apps. Given majority of the growth is coming from single apps these days, overall revenue is likely to be more balanced between single and all apps. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-45.png) Source: Adobe Analyst Day, January 2020 Adobe's strategy is clear. They want to have as large install base as they possibly can. Even if a subscriber is in the Adobe ecosystem through a single app, over time Adobe gets ample opportunities to upsell on these subscribers: > We are prioritizing user acquisition growth and longer-term ARR over short-term maximization New subscription explained \~65-70% of new new ARR in Creative Cloud and the rest came from upsell. Moreover, supermajority of net new ARR came from Adobe's flagship products (Photoshop, Illustrator, Lightroom, Premiere etc.). While in the short to medium term, subscription growth can continue to carry the growth momentum, Creative Cloud's long-term future growth is likely to depend on Adobe's upselling capabilities as well as success of some of its emerging products ([Adobe Express](https://www.adobe.com/express/?ref=mbi-deepdives.com), Stock, Frame.io, Substance etc.). Given the rise of single app users, future ARPU growth may primarily come from upselling and Adobe may not be under pressure to use its pricing lever anytime soon to meet its desired growth. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-50.png) Source: Adobe Analyst Day, October 2022 Speaking of Emerging products, let me talk about [Adobe Express](https://www.adobe.com/express/?ref=mbi-deepdives.com). Now that Figma is being acquired by Adobe, Canva is probably the largest threat for Adobe going forward, especially for creator/communicator segment. Founded in 2012, Canva launched its first product in 2013 and now has \~[100 mn](https://petapixel.com/2022/10/12/canva-passes-100-million-monthly-active-users-nearly-4x-that-of-adobe/?ref=mbi-deepdives.com) Monthly Active Users (MAU). In contrast, Adobe Express was launched in December 2021, so it is still pretty early days. It does appear they are willing to be a bit disruptive to compete effectively against Canva who has a decided lead in this segment. Adobe recently [announced](https://blog.adobe.com/en/publish/2022/10/17/adobe-express-reaches-over-43-million-students-teachers-globally-top-creativity-tool-for-education?ref=mbi-deepdives.com) that Adobe Express reached over 43 million students and teachers globally for free. From the Analyst Day: > We've removed all barriers to adoption. It's free to get started. It doesn't require a desktop download. It's 100% web and mobile. It doesn't have a learning curve and sign up to publish and have your first success is a matter of minutes. So this fundamentally has changed and enabled us to bring new customers into the franchise. > And the quality of our templates, the size of our stock library, over 175 million images, the integration of our fonts, over 20,000 fonts, workflows with our flagship applications. These are the things that differentiate us. And the team has been super busy since launch. We've now had over 100 releases in the last 10 months. We have a strong NPS. While today Emerging products don't quite drive much of the growth for Creative Cloud primarily due to low base compared to the size of its flagship products, the growth momentum in Adobe Stock, Substance, and Frame.io look quite encouraging. Adobe Stock's Book of Business (BoB), which is defined as annualized subscription value of SaaS, Managed Service, Term, and subscription services offerings, will exceed $500 Mn this year, growing at \~60% CAGR from 2015-2022\. Substance's ARR grew at \~80% CAGR in 2019-2022, and Frame.io's ARR also increased by >50% YoY in September, 2022\. The growth numbers shown in the below graph highlights Adobe's ability to scale these products after acquiring them (the starting time indicates when it was acquired). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-48.png) Source: Adobe Analyst Day, October 2022 A long-term potential area of concern for Adobe is the rise of Generative AI that really has captured everyone's attention in recent months. While it is perhaps too early to shut down these concerns for good, Adobe doesn't seem to be oblivious to what may turn out to be a generational trend. Adobe thinks Generative AI will make their existing products more productive. Here's an excerpt from discussions related to Generative AI: > For those of you who are not familiar with it, generative AI can conjure up an image from a simple text description. So imagine a world where you can ask Sensei in Photoshop to add an object to scene simply by describing what you want or ask Sensei to give you alternative ideas based on what you've already built. > > Imagine if you can combine Gentech with Lightroom, so you can ask Sensei and Lightroom to transform night in today to alter a sunny photograph into a beautiful sunset, move shadows by moving the light or changing the weather. Imagine what you could do in Adobe Express, if you could combine generative technology with our massive font library, you'll be able to create completely new and highly stylized fonts on the fly in a way that makes you and your brand stand out. It's not just all talk; Adobe showed its capabilities in the conference: > This is wild. Dall-E-like transformer model integrated into Photoshop. [$ADBE](https://twitter.com/search?q=%24ADBE&src=ctag&ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) [pic.twitter.com/PEQLnGmPkB](https://t.co/PEQLnGmPkB?ref=mbi-deepdives.com) > > — Marcelo P. Lima (@MarceloPLima) [October 18, 2022](https://twitter.com/MarceloPLima/status/1582386804249874432?ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) It is not clear to me how the technology itself is going to be differentiator for the startups focusing on Generative AI. While I don't think playing field has been decided yet, the distribution advantage that incumbents have and the ability to integrate AI capabilities to existing products may prove to be a big hurdle for the startups in the medium to long-term. A [quote ](https://a16z.com/2015/11/05/distribution-v-innovation/?ref=mbi-deepdives.com)by Alex Rampell that I always come back to whenever I assess disruption risk faced by incumbents: > **The battle between every startup and incumbent comes down to whether the startup gets distribution before the incumbent gets innovation.* *Document Cloud* I will keep this section really short. Two things stood out to me for Document Cloud: a) Adobe Sign had >50% YoY growth in SMB which indicates Adobe's momentum in the lower end of the market, and b) "product-led growth motions for the Acrobat business represents over 60% of new paid Acrobat subs in this year" *Figma* Figma acquisition obviously captured much of the attention of the broader tech world as well as shareholders, and it remains a hotly debated topic among many investors. Following the acquisition announcement, one concern from Figma users I came across on Reddit/Hacker News/Twitter was whether Figma may face similar fate as Macromedia for which Adobe diluted its shareholder \~20% in 2005 but eventually most of the Macromedia assets struggled under Adobe's umbrella. Adobe made it a point to highlight its success in scaling some of the recent acquisitions (as discussed earlier). Here are a few quotes on Figma that stood out to me from the Analyst Day: > As a reminder, Figma has 2 core products. The first is FigJam for brainstorming and ideation and the second is Figma Design for interactive product design. **Both products are nice adjacencies to our TAM.** > **2/3 of our users are non-designers** and a substantial portion of those are developers. And as we think about the entire product journey of starting with ideation, brainstorming, diagramming, in FigJam and going to Figma with design, next step of that is design to code. How do designers and engineers collaborate better. As we focus more on developers, I think you'll see a lot more coming in there. > as we look at Figma, **we actually see that 5% of the files created in ft are slides and presentations**. And so we think there's enormous opportunity. Like you said earlier, **creativity is the new productivity** > Figma is this incredibly rare company **that has achieved escape velocity as it relates to product design and targeting an area that was an unsolved problem** > I think we will have the ability to take **what Figma has with FigJam, what Adobe has with Adobe Acrobat, what we have with Express and create a brand-new platform that enables people to be both creative and productive**. ## Digital Experience Adobe shared interesting data points and anecdotes on its Digital Experience segment. While I am far less enthusiastic about Digital Experience segment compared to Digital Media, I came out slightly more optimistic about this business but also managed to stumble on to new concerns as well. Let's start with the good stuff. Adobe mentioned two of its large customers in this segment who scaled their relationship with Adobe massively over time. One telco company grew its Book of Business (BoB) from $4.5 Mn in 2016 to $45 Mn in 2022\. Even more impressively, a healthcare company scaled from $3.7 Mn of BoB in 2019 to $48 Mn in 2022\. While they are obviously cherry picked, data across the customer cohort shows impressive momentum. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-49.png) Source: Adobe Analyst Day, October 2022 Total customers grew from 2,000 in 2012 to 11,500 in 2022\. Only 10% of these customers have over 4 Adobe Digital Experience products (# of customers with 4+ products growing 26% YoY). Avg BoB is $2.5 Mn for customers with 4+ products. Adobe highlighted many of its enterprise customers' willingness to partner with platform solution rather than point solutions: > the other big thing that we are seeing is as they look at the multiple point providers they have had or they've been looking at in this space of customer experience, digital marketing, we have, one, it's leading to fragmentation. Two, that's just concerned about the viability of some of these providers. And so they're looking to a strategic digital partner, a partner like Adobe, who can really help them be the long-term partner of choice. Customer Data Platform or CDP is also another bright spot for Adobe. Adobe Experience Platform (AEP)'s BoB increased from $70 Mn in 2020 to $450 Mn in 2022. > In 2020, our book of business for Adobe Experience and the 3 apps that we have constructed natively on this, which is the CDP, the real-time customer data platform, Adobe Journey Optimizer and the customer journey analytics. That AEP and apps was a $70 million book of business in 2020, and we estimate that exiting this year, it'll be at $450 million in growing. What was, however, surprising to me is how Adobe's Digital Experience BoB for its top 25 and top 100 customers almost doubled over the last three years and yet its revenue increased by only \~60% in the same period. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-54.png) Source: Adobe Analyst Day, October 2022 If we assume BoB as equivalent of revenues (for simplicity's sake; I know they are not the same), based on the data above we can figure out the performance of long tail customers for Digital Experience. As you can see below, while Adobe's top 25 customers grew its BoB by \~25% CAGR, its customers beyond the top 1000 grew its revenue by only \~8% CAGR over the last 3 years. Since number of customers itself has certainly grown over this period, actual revenue or BoB per customer in the long tail may be flat or declining. It is possible Adobe's Digital Experience platform may not be a good fit or may be lot harder to scale over time unless you are a large enterprise customer. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-56.png) Estimated in USD Mn based on Adobe's disclosure on Investor Day As usual, there wasn't much discussion on profitability of Digital Experience segment apart from the comment from management that Digital Experience segment contributed to recent margin expansion experienced by overall Adobe. > we're on pace to deliver approximately 5 points of margin expansion over the last 3 years. And that margin performance includes delivering significant improvement in the margin of our digital experience business. ## Capital Allocation Adobe emphasized its strategy of share buybacks following its splurge on Figma: > While the transaction is pending, we will be opportunistic regarding share repurchase. And you saw that in the current quarter with our $1.75 billion share repurchase executed. And at a minimum, we'll repurchase enough shares to remain dilution-neutral, but we'll always look to be opportunistic in this environment. > As a growth company, we think the most efficient mechanism to return cash to shareholders is through share repurchase. Our goal is going to be to meaningfully reduce the share count over time following the closing of the Figma acquisition. Although this isn't anything material, I was a bit disappointed to still see concept such as "Rule of 40" (whether your Non-GAAP operating margin+ topline growth exceeds 40%) being mentioned by Adobe CFO. While "Rule of 40" may be helpful for companies burning cash, it has almost no use or meaning for a 40-year old public software company. For example, I estimate Digital Media's GAAP operating margin to be \~50% (so non-GAAP would be even higher). For such mature margin business, if Digital Media's topline declines by 10% next year, it would still be "Rule of 40" business. Is there anyone (including management) who would be glad that Adobe remains a "Rule of 40" business in such a case? Adobe is hardly the exception here as most tech companies mention these metrics even though they don't quite make sense from first principles perspective. Ultimately, shareholders mostly care about increasing **FCF per share** over the long term, and most new-age metrics don't quite pass the smell test. ## Valuation/Model assumptions If you haven't read any of my Deep Dives before, I strongly encourage you to read my piece on “[approach to valuation](https://www.mbi-deepdives.com/my-valuation-approach/)”. Please read it at least once so that you understand what I am trying to do here. I follow an “expectations investing” or reverse DCF approach as I try to figure out what I need to assume to generate a decent IRR from an investment which in this case is \~9-10%. Then I glance through the model and ask myself how comfortable I am with these assumptions. As always, I encourage you to [download](https://www.mbi-deepdives.com/models/) the model and build your own narrative and forecast as you see fit to come to your own conclusion. None of us have the crystal ball to forecast 5-10 years down the line, but it’s always helpful to figure out what we need to assume to generate a decent return. *Revenue Model* I have updated my Adobe model based on management's guidance and made few other changes which I'll explain here. I encourage you to download the updated model [here](https://www.mbi-deepdives.com/models/) and play around the assumptions to fit your narrative. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) One of the variables that I kept fixed while building this model to generate \~9-10% IRR is terminal FCF multiple which I assumed to be 14-15x. Hence, these are not necessarily my estimates or forecasts, rather what I need to assume to underwrite \~9-10% IRR at 14-15x terminal FCF multiple. Even though the acquisition is pending, I have incorporated and modeled Figma into this updated model. Let's start with Figma. While Figma's numbers are not publicly disclosed, Adobe management shared enough data points to allow me to build a shell model for now. Adobe mentioned Figma is expected to add \~$200 Mn ARR (Annualized Recurring Revenue) in 2022 and will exceed $400 Mn ARR this year. I assumed ARR in 2022 to be $420 Mn, $220 Mn in 2021, and made some reasonable assumptions going back to 2017 when they generated first dollar of sales. Of course, for a growing company, ARR is higher than revenue. I made an assumption that Revenue to ARR ratio to be \~80%. Adobe mentioned Figma's gross margin to be \~90% this year and Figma will be operating cash flow positive. Since a high growth subscription business such as Figma's operating cash flow is likely to have material net working capital benefit, I assumed its non-GAAP operating margin to be slightly negative (something like -5%) in 2022 and then made some assumptions in the rest of the income statement to get there. One other data point that I had was Figma currently has \~850 employees and I assumed the average Stock-Based Compensation (SBC) per employee to be $150k. My estimates assigned larger cost in R&D as Adobe mentioned Figma to be largely product led company and its sales motion is yet to be supercharged. In terms of projections, I estimate ARR $ growth to be \~$250 Mn/year for the next two years as Figma becomes part of Adobe and gets digested to broader Adobe ecosystem in a soft macro environment. But over time, I expect ARR growth momentum to pick up from here as I expect Adobe to help Figma scale faster. Based on these assumptions, I estimate Figma's 2030 revenue to be \~$3 Bn. In the terminal year (i.e. 2030), I assumed R&D, S&M, and G&A as % of revenue to be 35%, 35%, and 12% respectively. While many startups can be product led companies in the early stage, S&M costs almost always end up being the largest cost line item if you are building anything to sell to enterprise customers. I expect Adobe to be a great help here for Figma as Figma scales the business for the rest of this decade. Overall, I estimate GAAP operating margin to be \~34% in 2030 and assuming SBC as % of revenue to be \~20%, non-GAAP operating margin to be \~54% which closely matches with Adobe's broader Digital Media margin. As per these estimates, Figma may post \~$1 Bn operating profit in 2030\. Assuming 30x multiple on that, we get to \~$30 Bn valuation for Figma in 2030, implying \~6% IRR for Adobe. While that may not be excellent use of capital from strictly financial sense, Adobe shareholders would probably be pretty worried if Figma were acquired by Microsoft (hypothetical example). Therefore, the strategic value of Figma may have played an important role in Adobe's decision to pursue Figma. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-57.png) Source: MBI Deep Dives Before I discuss all the segments at Adobe, let me clarify a few things first. While Adobe management guided $19.1-$19.3 Bn revenue for 2023, my model incorporates Figma's estimated revenue of $538 Mn in 2023\. Excluding Figma, I'm at the high end of management guidance. Two things need to keep in mind for the guidance: a) FX is a \~4% headwind going into 2023\. Therefore, although management's mid-point guidance implies \~9% topline growth, on a constant currency basis it's \~13%; b) management did take soft macro environment into account while giving the guidance. \~13% topline growth despite macro headwinds indicates the overall resilience of Adobe's subscription model. In 2009, Adobe experienced 18% decline in topline when it still had perpetual licensing model. There may be, however, potentially a lag between the impact of macro softness and the impact on Adobe's topline, so we may still not be quite out of the woods yet. Let's talk about Digital Media and Digital Experience now. While Digital Media grew at 23% CAGR in the last 4 years (2017-2021), I modeled High-Single-Digit (HSD) CAGR for 2022-2030\. This implies Mid-Single-Digit (MSD) CAGR for number of subscribers in 2022-2030 vs estimated \~20% CAGR in the last 4 years. Moreover, pricing power is also assumed to be muted. It is perhaps more likely that this model may turn out to be a bit conservative. While Adobe added estimated \~15 mn subscribers in 2017-2022, I am modeling another \~19 mn in the next 8 years. This growth is likely driven by single apps and by 2030, single app may become majority of the Creative Cloud subscriber mix. Given the rise of single apps subscriber, ARPU growth is likely to be relatively subdued. However, the implied all apps subscriber numbers appears to be quite conservative (vs historical) and it is possible further upside may be there on subscriber growth in this segment. While all apps subscription price was raised in 2018 and then in March this year, I assumed a more linear increase going forward (although it is more likely that it may happen in every 2-3 years but the end result may be somewhat similar). For its Digital Experience business, I assumed Low Double Digit (LDD) CAGR going forward (vs high teens in the last 4-5 years). It is perhaps likely that Adobe will continue to do some bolt-on acquisitions in this segment. Please note I set aside $16 Bn for acquisitions in 2023-2030 (excluding Figma) which is likely to be mostly utilized to do bolt-on acquisitions in Digital Experience. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-64.png) Source: ADBE SEC Filings, MBI Deep Dives *Cost structure* As discussed in my Deep Dive, while Adobe reports gross margin by segment, it does not report segment wise operating margin. After publishing my Deep Dive, I heard from a couple of Adobe shareholders who were more sanguine about Digital Experience's profitability than I was. While I assumed Digital Experience to be operating at loss, it may be lot closer to breakeven than I assumed. Therefore, I made some changes in the model. Digital Media is estimated to be \~50% operating margin business and margin upside is perhaps limited from here. Digital Experience, on the other hand, is expected to increase its margin from near break even in 2021 to \~20% in 2030\. Even if you think such margin expansion may not materialize, it is not a significant driver of Adobe's value anyway. If you assume \~10% operating margin for Digital Experience instead of \~20% in 2030, it decreases the overall operating profit by \~5%. Ultimately, the success or failure of Adobe largely hinges on maintaining its dominance on Digital Media. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-60.png) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-62.png) Source: Adobe SEC Filings, MBI Deep Dives *Valuation* To generate \~9-10% IRR in this model, I had to use \~14x FCF multiple which implies \~15x P/E multiple. To be clear, FCF multiple is lower compared to P/E since as a subscription business, Adobe enjoys networking capital benefit. Also note that, I have deducted SBC in the terminal year to keep it consistent with stock variable (share count) and flow variable (FCF) which is why you notice a drop in FCF in the terminal year. As you can see below in share count for 2023, the jump in share count is explained by Figma acquisition. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/10/image-63.png) Source: MBI Deep Dives What's the upside case from here? If Adobe manages to grow its topline 300 bps faster (will probably need to be driven by Digital Media), keep the margins as modeled, and assume \~20-25x terminal FCF multiple, Adobe can be mid-to-high teen IRR from current prices. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) I will cover earnings of Google, Amazon, Meta, Spotify, Shopify, and IAC in the next couple of weeks. Subscribers can also access all the [Deep Dives](https://www.mbi-deepdives.com/models/) published so far: Uber, Etsy, Lululemon, Angi, Ansys, Autodesk, Copart, Shopify, Otis, CrowdStrike, Roku, Boeing, Square, Trupanion, RH, Spotify, Pinterest, Twilio, Constellation Software, Ethereum, Adyen, PayPal, Danaher, Adobe, Cloudflare, and Airbnb. Thank you for reading! ### Airbnb: From Cereal Boxes to "Seven-Star" Travel Experience URL: https://www.mbi-deepdives.com/abnb/ Last updated: 2024-09-29T15:41:25.000Z _This post is for paying subscribers only._ ### Cloudflare: Helping to Build a Better Internet URL: https://www.mbi-deepdives.com/net/ Last updated: 2022-11-21T17:59:13.000Z _This post is for paying subscribers only._ ### Autodesk 2Q'FY 2023 Earnings Update URL: https://www.mbi-deepdives.com/adsk2q23/ Last updated: 2022-08-25T00:31:39.000Z *Disclosure: I own shares of Autodesk* *"End market demand remained strong during the quarter, resulting in robust new business activity. Renewal rates were again excellent."* This was a solid quarter for Autodesk. Let's dig in. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Topline** Autodesk beat the high end of topline guidance which, historically speaking, is pretty much the norm. Topline growth continues to hover around mid-teen. Guide for 3Q and full-year also implies mid-teen topline growth. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-81.png) Source: Autodesk, and MBI Deep Dives Fusion 360's subscribers reached 205k in 2Q'23 (vs 189k and 198k in 4Q'22 and 1Q'23 respectively). It also had its first million-dollar contract last quarter. Direct revenue (higher margin business) grew +18% and now 34% of overall revenue. Net revenue retention +100-110%. Billings increased +17% YoY. The transition from multi-year to annual billings is expected to start in FY'24. One of the benefits of introducing "Flex pricing" may not be just converting non-compliant users, but also lowering the barrier for existing subscribers to dabble into other products of Autodesk: *"One of the growth vectors for Flex that I'm particularly excited about is in the long tail of our business. Because what Flex allows you to do, if you're in a smaller company, say you're in a 5-person company and you want to occasionally use Revit for some of the projects you bid on, but the vast majority of your projects are AutoCAD or you want to engage in structural simulation for a particular product, the Flex model lets people dabble. It lets people engage with advanced functionality and advanced capabilities on a pay-per-use basis. And they don't have to commit to an annual subscription or a multiyear subscription to get some of these capabilities."* Autodesk Build saw +45% MAU QoQ. Why is bidding activity important? *"So when you see an increase in bid activity on BuildingConnected, what you're actually seeing is an increase in the book of business of projects that will actually get executed downstream, right? So this is a good predictor of ongoing activity as you close a bid, you actually then move into execution with that particular subcontractor and some of the things associated with that."* Autodesk keeps hearing from its customers that labor market is tight: *"The biggest challenge we hear from these customers is hiring, frankly. We were hearing last year a lot of conversations about, oh boy, fixed bid contracts and inflationary pressures and all these things. As I've said previously, they bake these things now into their business bids and they're able to capture those costs in their contracts. But what they're struggling with is hiring."* **Profitability** Autodesk posted its highest GAAP operating margin in the last quarter at least in the last 10 years. Operating Cash Flow (OCF) Margin and FCF margins are a bit more volatile due to working capital dynamics. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-84.png) Source: Autodesk, and MBI Deep Dives Autodesk has the highest R&D budget among its peer group, but doesn't have the highest headcount in R&D. Why? *"Part of that is because of where we concentrate on R&D and what kind of talent we're pursuing. We're pursuing a lot of cloud talent, a lot of cloud-native talent, full staff development talent that allows us to build out the core cloud capabilities and continue to expand them. That talent resides in certain places, and it has certain costs associated with it and we think that's the right strategy."* **Capital Allocation** Autodesk bought back 1.4 mn shares at $182/share. Weighted avg. share count, however, declined by only 1.8% in last 12 months given most of the buybacks is just offsetting SBC. While buyback amount slowed down compared to 1Q, Autodesk did repurchase shares in excess of FCF it generated in 2Q. I wish they used their \~$1.5 Bn cash balance more aggressively in buyback. Don't expect capital return to be major theme though as management reiterated plan to be opportunistic in acquiring companies and buybacks continue to be thought of as primarily to offset SBC. *"We've proactively used our strong liquidity to repurchase 3.5 million shares in the first half of this year, front-loading the offset of next year's dilution."* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-85.png) Source: Autodesk, and MBI Deep Dives Given how entrenched Autodesk's moats are in AEC and AutoCAD, a bit more leverage in balance sheet probably would be accretive to shareholders especially if used for buybacks. To be fair, Autodesk did issue $1 Bn debt at 2.4% in October, 2021; so management deserves some credit there. **Outlook** ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-86.png) Source: Autodesk Press Release As I discussed after Q1, Autodesk trades at \~23x FY'23 FCF, but half of that FCF is SBC and NWC benefit, so \~45-50x after burdening for SBC and ignoring NWC benefit. If they can maintain mid-teen topline growth with expanding margins (so high-teen GAAP EBIT growth), the stock should work in the long-term. You can read my Deep Dive on Autodesk [**here**](https://www.mbi-deepdives.com/adsk/). Autodesk's earnings threads: [FY 1Q'22](https://twitter.com/borrowed%5Fideas/status/1398098719271182337?ref=mbi-deepdives.com), [2Q'22](https://twitter.com/borrowed%5Fideas/status/1430705775165456385?ref=mbi-deepdives.com), [3Q'22](https://twitter.com/borrowed%5Fideas/status/1463358812102955008?ref=mbi-deepdives.com), [4Q'22](https://twitter.com/borrowed%5Fideas/status/1497242017667203078?ref=mbi-deepdives.com), [1Q'23](https://twitter.com/borrowed%5Fideas/status/1529991868372733961?ref=mbi-deepdives.com) ### Adobe: A Software Giant from the 80s URL: https://www.mbi-deepdives.com/adbe/ Last updated: 2024-10-04T14:02:50.000Z _This post is for paying subscribers only._ ### IAC 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/iac2q22/ Last updated: 2022-08-10T17:26:28.000Z Disclosure: I own shares of IAC *"We want our shareholders to feel their capital is safe with us...that it’s our responsibility to help that capital grow healthily by building businesses and creating opportunities our shareholders may not have the chance to access on their own."* IAC is seeing a *"notable disparity in behavior between consumers and businesses"* Let's dig into the businesses IAC owns one by one. [Subscribe](https://www.mbi-deepdives.com/#/portal/signup) **Dotdash Meredith** *"We had hoped to have nearly all the Meredith properties migrated by this point, but we’ll finish in Q3 and the benefits will show up more in 2023 than 2022."* *"We're not moving as fast as we'd like, and I don't think we have the support from the ad market that we expected"* Rapid pullback in ad spend among retail, CPG Pro-forma Digital is down 7% which is half self-inflicted (migration of Meredith properties) and half macro *"our comps at Dotdash Meredith do get easier in the fourth quarter, the -- especially at the Meredith properties, which were quite slow at the end of last year, probably due to distraction due to the acquisition"* Still expects $300 Mn Adj. EBITDA this year, but ruled out $450 Mn Adj. EBITDA next year considering the macro and advertising market. During Q&A, management mentioned they may get there 6-12 months later. **ANGI** *"After a challenging two years, we are starting to see the light at the end of the tunnel, and we’re reasonably confident it’s not another train approaching head-on."* It almost feels like a bit of deja vu reading that line as I feel like we have been told something along those lines a few times. So, what new problems ANGI encountered recently? *"we've had some pretty significant operational challenges in Roofing. Those have been primarily around pricing"* Revenue for Roofing was $14 Mn in 2Q'22, but came down to just $9 Mn in July (vs $11 Mn last yr) As housing is cooling down a little, demand for ads and leads from Pros is trending up mid to high single digit. Angi Key members \~300k now (vs \~200k in 4Q'21) 2H'22 EBITDA will be higher for ANGI than 1H'22 as they start focusing more on profitability vs growth. **Care** Consumer business has been decelerating fast (from 30% in April to 18% in June), but the trend will be clearer over the course of back-to-school season Enterprise business has seen corporate customers defer procurement decisions. **Other** "Bluecrew worker-shifts requested by its client base in June was flat year-over year following strong growth earlier in the year and now declining in July, led by Retail, Warehousing and Logistics customers, while Vivian’s healthcare job volumes continue to grow steadily." Not much discussion on Turo (or potential IPO of Turo). **Buyback** IAC, for the first time since 2018, repurchased 735k shares ($59 Mn) at an avg price of $80.38 in 2Q'22 *"we believe the embedded value of the portfolio represents a compelling opportunity to buy in the stock. Fortunately, we haven’t emptied our wallet yet. IAC has $1.2 billion of cash and no debt at the parent level, and now’s a good time to have capital, conviction, and a long-term view."* **Valuation** IAC is a collection of challenged businesses these days, but SOTP remains compelling which perhaps explains why they're buying back stock for the first time since 2018. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-27.png) Source: MBI Deep Dives I'll publish Adobe Deep Dive on August 22nd, and cover Autodesk's earnings on August 24th. You can browse through IAC's earlier earnings here: [Earnings Call 4Q'20](https://twitter.com/borrowed%5Fideas/status/1357493089582080000?ref=mbi-deepdives.com), [1Q'21 ](https://twitter.com/borrowed%5Fideas/status/1391037300621070338?ref=mbi-deepdives.com), [2Q'21](https://twitter.com/borrowed%5Fideas/status/1423441401036083204?ref=mbi-deepdives.com), [3Q'21](https://twitter.com/borrowed%5Fideas/status/1456768314441707522?ref=mbi-deepdives.com), [4Q'21](https://twitter.com/borrowed%5Fideas/status/1494751170275029000?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1524073136089665541?ref=mbi-deepdives.com) ### Block 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/sq2q22/ Last updated: 2022-08-05T02:00:15.000Z *Disclosure: I own shares of Block/Square* "...we recognize the importance of exercising discipline with our investments as we enter a period of potential uncertainty." Unfortunately, total opex continues to exceed gross profit, and given the focus on non-GAAP opex, actual opex may remain ignored. Let's dig in segment by segment. **Square Seller** Square seller GP, excluding APT grew 16% YoY, but 3-year CAGR was +40%. Gross Margin was slightly below mid-40s. Mid-market sellers continue to dominate GPV. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-2.png) Source: Block, MBI Deep Dives ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image.png) Source: Block Shareholder Letter Square for Restaurants gained quite the momentum: *"Through the first half of the year, GTVs from Square for Restaurants sellers more than doubled year-over-year, with these sellers using an average of 4 monetized products during the second quarter."* *"...40% of Square GPV comes from a range of services verticals in 2021\. The remaining 60% is across some of those discretionary areas like food and beverage, retail and other smaller but growing verticals"* APT is also being integrated for Square Sellers: *"Within our Square ecosystem, in May, we announced the in-person integration of Afterpay for Square sellers in the U.S. and Australia, adding to the online capabilities we announced earlier this year with more products to come."* **Cash App** Cash App Gross Profit was +29% in 2Q'22 YoY, but +15% excluding AfterPay (APT). 3-year CAGR of +82% reflects how much the business has grown. Gross margin, excluding Bitcoin (BTC) hovers around \~80%. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-1.png) Source: Block, MBI Deep Dives APT is finally being integrated: *"We're rolling out a new Discover tab to the main navigation, making it easier for customers to find and use brands and products that can save on with Boost and paying with installments with Afterpay."* *"You can find it within Cash App by looking for the magnifying glass at the bottom of your navigation. We intend this to be a place where you can find everything related to what you might want within Cash App, be it sending money to people like your friends or buying products or services for merchants around your -- across the Internet. So that is a big part of our focus and a big aspect of what we believe is important about this acquisition."* Cash App had highest ever quarterly inflows in 2Q'22; overall inflows increased both QoQ and YoY Monthly actives was 47 Mn in June (vs 44 mn in Dec'21) which is +18% YoY; weekly and daily actives are growing faster. Inflows per active averaged $1,048 in 2Q'22, which was relatively stable qoq but -11% YoY primarily due to government disbursements last year. Cash App Borrow (first credit product) had 1 mn monthly actives. Avg loan size is <$200 with avg tenor is 1 month. Loss rates is <3% which is similar to Square loans for sellers. Unit economics is profitable. Given the macro backdrop, Block remains cautious: *"While we've seen strength so far, we are also being mindful of the environment. This is a short duration product where we determine eligibility based on unique data signals, which we believe enables us to pivot quickly. As with the rest of our business, we are tracking trends in real-time to monitor any changes, and we intend on acting conservatively with each of our credit products as the macro environment evolves."* **AfterPay** GMV was $5.3 Bn, +13% YoY or 65% 3-year CAGR. (FX headwind 5%). Revenue +6% YoY. Losses as % of GMV 1.02% (vs 1.17% in 1Q’22). 90-95% of installments paid on time. Growth in Australia held up better, but slowed more in North America. **Outlook** Based on the trends so far, SQ expects the following in July: Gross Profit +35% YoY. Excluding APT, +22% YoY CashApp GP +32% YoY Square Seller GP +14% YoY, GPV +18% YoY BNPL +12%, GP +1% Block has reduced its expense outlook: *"While gross profit trends have been healthy through July, we recognize the importance of exercising discipline with our investments as we enter a period of potential uncertainty. As a result, we are reducing our planned investments for the full year 2022 by $250 million. We pulled back on experimental and less efficient go-to-market spend, adjusted risk loss estimates based on more current trends and slowed the pace of hiring. In total, we have now reduced our non-GAAP operating expense plan by a total of $450 million since the start of the year, which is 20% of what we initially guided for the step-up in 2022."* *"For 2022, we now expect to increase overall non-GAAP operating expenses by $1.85 billion compared to 2021, roughly 10% less than what we shared last quarter. Within this, we now expect Afterpay's operating expense base to be approximately $750 million this year. And excluding Afterpay, we expect to grow overall non-GAAP operating expenses by 30% year-over-year or $1.1 billion."* It seems SQ's GP may grow in tandem with non-GAAP opex this year, but talking about non-GAAP opex today seemed a bit tone-deaf to me. Shareholders will find it hard to make money if non-GAAP opex is all what SQ focuses on! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/08/image-3.png) Source: MBI Deep Dives You can read my Deep Dive on Block/Square [here](https://www.mbi-deepdives.com/sq/). Earlier quarterly recaps on SQ are here: [3Q'21](https://twitter.com/borrowed%5Fideas/status/1456430452152094724?ref=mbi-deepdives.com), [4Q'21](https://twitter.com/borrowed%5Fideas/status/1497054180975910913?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1522388157488062475?ref=mbi-deepdives.com) I will cover IAC and ANGI next week. ### Amazon 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/amzn2q22/ Last updated: 2022-08-06T13:39:15.000Z *Disclosure: I own shares of Amazon* Amazon may be the first and the last \~$1.5 Tn market cap company to report negative Trailing Twelve Months (TTM) FCF (-$23.5 Bn to be exact). It is quite incredible how Amazon management gained credibility and earned trust to ride through two of the most secular growth markets for multiple decades: e-commerce and cloud. Competitors must envy Amazon for its lack of burden of posting profits! **Segment-wise reporting** For the second consecutive quarters, 1P posted negative growth. Revenue mix continues to lean to services as 1P declined from \~60% in 2018 to \~45% in 2022\. AWS maintains >30% growth momentum even in this scale. \~320 bps FX headwind, so revenue growth was +10% FX neutral ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-29.png) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-30.png) One metric I like to keep track in e-commerce is Amazon vs Shopify GMV. Shopify again seems impressive in the context of overall reality in e-commerce this year. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-32.png) **Operating Margin** For the fourth consecutive quarter, Amazon, ex AWS posted negative operating margin. AWS margins fell from 35% in 1Q'22 to 29% in 2Q'22\. Why? ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-31.png) *"The margin rate is going to fluctuate in this business. It's going to be always a factor of new investment and things like the sales force and new regions and infrastructure capacity, offset by infrastructure efficiency gains that we see, pricing issues as we extend contracts. We've seen really good progress with our customer base, longer and longer commitments, really committing to the cloud, some of that comes with credits to help them make their conversion to the cloud. And you said that the revenue pattern can be -- and the margin on that revenue can fluctuate quite a bit quarter-to-quarter."* AWS backlog was +65% YoY in 2Q'22 (vs 68% YoY in 1Q'22). Weighted avg remaining life of long-term commitments in 2Q'22 was 3.9 years (vs 3.8 years in 1Q'22) AWS run-rate is $79 Bn and still growing like weed. When AWS had $4.6 Bn revenue in 2014, Bezos wrote in his letter, *"I believe AWS is market-size unconstrained."* I remember that sentence every quarter I look at AWS numbers! **Retail** *"we're not seeing some of the pressures that other people are seeing right now. Our macroeconomic issues are principally on inflation, and we've been pretty transparent on that."* **3P** *"Third-party sellers represented 57% of all units sold on Amazon in Q2, the highest percentage ever."* *"So on the seller fee, again, we added that fee grudgingly in May to compensate for some of the inflationary pressures we're seeing. I don't want to give you the idea that either of those fee increases came close to covering our costs. You can see from our operating results, some of it's internal related, but a lot of it's external factors that there -- we are not passing through that at 100% to external groups. And it's -- we've got to work our way out of the condition we're in. And we're making good progress in Q2 and expect to keep pressing on that in the second half of the year. But we saw strength in the seller results in Q2, as we mentioned on the percentage mix. So I think sellers are -- sellers business remains strong and an integral part of our customer offering."* **Advertising** Unlike David Wehner who blamed macroeconomy for soft advertising, Amazon sounds pretty optimistic on ads: *"...you're probably wondering again about softness -- potential for softness in that or macroeconomic factors. Right now, we still see strong advertising growth. Again, it's got to be a positive both for the customer and for the brand. I think our advantage is that we have highly efficient advertising. People are advertising at the point where customers have their credit cards out and are ready to make a purchase. It's also very measurable. And when people are looking -- if companies are looking to potentially streamline or optimize their advertising spend, we think our products compete very well in that regard, in addition to maybe longer-term things like brand building and brings new selection to bear in front of customers."* This sounds intriguing but not smart enough to know whether this is material: *“AWS and Amazon Ads launched Amazon Marketing Cloud (AMC) Insights on AWS. The new solution helps advertisers and agencies easily use AWS services when running Amazon Ads campaigns to analyze and generate reporting from the Amazon Marketing Cloud API, reducing their development time from weeks to hours. With a few clicks, AMC users can monitor ongoing ad campaign performance across reach, frequency, geography, audience, and device type to better understand how to maximize ad spend.”* **International markets** *"..In our established international locations, U.K., Germany, Japan, over time, we've continued to improve the profitability"* *"In our emerging locations, there's a healthy amount of investment we've done to drive expansion, and we expect to continue to do that given the strong competition across many of these markets."* **Prime** *"Prime member membership and retention is still strong. I think that change has been above our expectations positively."* **Expenses** inflationary costs, fulfillment network productivity and fixed cost deleverage added $4 Bn incremental cost in 2Q'22 (as expected) vs $6 Bn in 1Q'22. *"There are 2 main drivers when talking about fixed cost leverage. First is the unfavorable comparison to very high holiday-level utilization rates that we saw in the first half of 2021; and second is the normal step down in volumes off of our Q4 peak that we saw in the first half of 2022.* *On the first point, we expect this challenging year-over-year comp will have ended in Q2\. On the second point, we expect fixed cost leverage to improve in the second half of the year as we continue to grow into our capacity. We have also taken steps to slow future network capacity additions."* **Capex** In 2021, Amazon spent $60 Bn in capex. 2022 capex will be slightly higher, but the composition of capex will change to more investment in technology infrastructure (50% in '22 vs 40% in '21). **Alexa** *“Amazon now has over 1 million registered developers, brands, and device makers building with Alexa.”* **Drone Delivery** *“Amazon announced that later this year, Amazon customers in Lockeford, California, and College Station, Texas, will be among the first to receive Prime Air drone deliveries in the U.S. Customers will have the option to receive free and fast drone delivery on thousands of everyday items”* **Guidance** 3Q'22 topline guidance $125-130 Bn, +13-17%. Pretty impressive guide, but please note Prime Day was in 2Q last year but was in 3Q this year, so slightly easier comp in 3Q'22 Expects to see $1.5 Bn sequential cost improvement in fulfillment which will be offset by more investment in AWS and Prime content Operating income guidance for 3Q'22 is $0-3.5 Bn (vs $4.9 Bn in 3Q'21) **Valuation** I do this back-of-the-envelope exercise every quarter to see what's embedded. If Amazon can post this EBIT, terminal EBIT multiple required to generate \~10% IRR is <14x (excluding impact from interim cash). For context, META, despite terminal value concerns, currently trades at \~14-15x NTM EV/EBIT. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-33.png) You can browse Amazon's earlier earnings quarters here: [2Q'20](https://twitter.com/borrowed%5Fideas/status/1289339307765846016?ref=mbi-deepdives.com), [3Q'20](https://twitter.com/borrowed%5Fideas/status/1321979259473268736?ref=mbi-deepdives.com), [4Q'20](https://twitter.com/borrowed%5Fideas/status/1356781099976908800?ref=mbi-deepdives.com), [1Q'21](https://twitter.com/borrowed%5Fideas/status/1387942079905533953?ref=mbi-deepdives.com), [2Q'21](https://twitter.com/borrowed%5Fideas/status/1420921521086865411?ref=mbi-deepdives.com), [3Q'21](https://twitter.com/borrowed%5Fideas/status/1453898032005668887?ref=mbi-deepdives.com), [4Q'21](https://twitter.com/borrowed%5Fideas/status/1489426008864342019?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1519840996497969155?ref=mbi-deepdives.com) I will cover Block (formerly known as Square) next week! ### Meta 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/meta2q22/ Last updated: 2022-07-28T01:46:29.000Z *Disclosure: I own shares of Meta* *“…we seem to have entered an economic downturn that will have a broad impact on the digital advertising business. And it's always hard to predict how deep or how long these cycles will be, but I'd say that the situation seems worse than it did a quarter ago.”* **Users** While Meta globally had +8 Mn DAU QoQ, MAU was flat QoQ (as guided) which was driven by Europe (-11 Mn MAU QoQ) because of the loss of Russian users. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-22.png) ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-24.png) DAU/MAU improved across the regions QoQ, so better engagement. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-23.png) **Revenue** Ad revenue growth continues to be anemic in North America and Europe. \# of ad impressions +15% whereas avg. price per ad -14% Overall revenue declined 1% YoY, but +3% FX neutral ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-25.png) **Segment Reporting** FOA margins continue to slide from mid-50s in 4Q'20 to high 30s in 2Q'22\. RL remains a money losing behemoth (and it could have been worse)! *“cost of revenue decreased 4% as growth in core infrastructure investments and content-related costs were more than offset by a reduction in Reality Labs loss reserves as a result of the announced price increase of Quest 2.”* ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-26.png) **Buyback** Meta repurchased $5 Bn shares, lowest in the last 4 quarters. While it's higher than FCF they generated, buyback as % of FCF was lower than last 3 quarters. As much as I hate looking at the scaling back of buybacks after \~60% drawdown, I sympathize. Meta's business is in tough spot. The stock will work with or without the buybacks if they can turn around FOA business (and vice versa). Dividend or buyback yield, unfortunately, cannot save shareholders. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-28.png) **Expense Guide** Despite the planned slowdown in hiring, headcount growth will be substantial YoY next few quarters but will decline over time. *“Now this is a period that demands more intensity, and I expect us to get more done with fewer resources.”* Expense guide is predictably going downward. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-27.png) Zuck repeatedly called out the significance of AI in the call. *“…there are 2 major technological waves that we're riding in our business. The first wave of driving our business today is AI, and then the second longer-term wave is the emergence of the metaverse.”* **Reels** Lots of interesting data and quotes on Reels. *“Right now, about 15% of content in a person's Facebook feed and a little more than that of their Instagram feed is recommended by our AI, from people, groups or accounts that you don't follow. And we expect these numbers to more than double by the end of next year. As our AI finds additional content that people will find interesting, that increases engagement and the quality of our feeds. And since we're already efficient in monetizing most of these formats, this should increase our business opportunity over that period as well.”* *“I shared last quarter that Reels already made up 20% of the time that people spend on Instagram. This quarter, we saw a more than 30% increase in the time that people spent engaging with Reels across Facebook and Instagram. AI advances are driving a lot of these improvements. And 1 example is that after launching a new large AI model for recommendations, we saw a 15% increase in watch time in the Reels video player on Facebook alone.”* *“In Instagram, for example, we see that Reels makes up more than half of content reshared into messages. So our strategy isn't about public versus social content and interaction. It's really about enabling a flywheel that compounds both.”* *“Reels doesn't yet monetize at the same rate as Feed or Stories. So in the near term, the faster that Reels grows, the more revenue that actually displaces from higher monetizing surfaces. Now in theory, we could mitigate the short-term headwind by pushing less hard on growing Reels, but that would be worse for our products and business longer term since we're confident that Reels will grow engagement overall and quality and will eventually monetize closer to Feed.”* *“We've now crossed a $1 billion annual revenue ru*n rate for Reels ads, and Reels also has a higher revenue run rate than Stories did at identical times post launch.” *“Reels is additive to time spent. But obviously, it does have a cannibalistic impact as well but the net impact is positive.”* While Stories ads was launched in 2018, it only reached parity on monetization this year. **Click to messaging ads** It is multibillion dollar business growing double digit; it’s the fastest ad format business for Meta. 40% advertisers already use this format. **Transition** This was Sheryl’s last call, but she'll sit at Meta's board. Dave Wehner is taking a new role within Meta: Chief Strategy Officer. New CFO is Susan Li who was VP of Finance at Meta. **Outlook** Revenue guide is $26-28.5 Bn (mid-point is -6% YoY; since FX headwind is assumed to be 6%, guide is essentially flat). Capex $30-34 Bn (prior $29-34 Bn) To me, it’s a very disappointing guide given Q3 was supposed to be easy comp as we are lapping ATT next quarter. Meta mostly blamed macro and resultant softness in advertising market for this. Stock probably would be down lot more if it were already not in the gutter. **What is Meta's competitive advantage?** *“…culturally, we focus on moving and learning faster than everyone else. And I think that those are sustainable advantages.”* As a long-term shareholder, I do think Meta left a lot to be desired in the last few quarters in terms of *"moving and learning faster than everyone else".* I certainly hope they'll operate with much more intensity in the next few quarters. I will cover Amazon tomorrow. Browse earlier quarters of Meta here: [2Q'20](https://twitter.com/borrowed%5Fideas/status/1289013558114738176?ref=mbi-deepdives.com), [3Q'20](https://twitter.com/borrowed%5Fideas/status/1322017012391026688?ref=mbi-deepdives.com), [4Q'20](https://twitter.com/borrowed%5Fideas/status/1354613235652190209?ref=mbi-deepdives.com), [1Q'21](https://twitter.com/borrowed%5Fideas/status/1387602289783934977?ref=mbi-deepdives.com), [2Q'21](https://twitter.com/borrowed%5Fideas/status/1420572586585563137?ref=mbi-deepdives.com), [3Q'21](https://twitter.com/borrowed%5Fideas/status/1452825084666732548?ref=mbi-deepdives.com), [4Q'21](https://twitter.com/borrowed%5Fideas/status/1489073001891090432?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1519475976937299969?ref=mbi-deepdives.com)) ### Shopify 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/shop2q22/ Last updated: 2022-07-27T18:37:32.000Z *Disclosure: I own shares of Shopify* “2022 will be different, more of a transition year in which e-commerce is largely reset to the pre-COVID trend line and is now pressured by persistent high inflation.” Let's dive into this "transition year"! While Shopify still maintains >50% GMV and topline CAGR over 3-yr and 5-yr period, growth has come down to a lackluster level, given the reality of current e-commerce trends. Take rates continues to be on the right direction. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-17.png) Source: Shopify, MBI Deep Dives Shopify expects take rates to keep increasing going forward as merchants use more and more of their products. **Revenue Mix** Merchant Solutions was 71.7% of overall revenue in 2Q'22 vs 70.1% in 2Q'21. While total revenue was impacted by 1.5% for FX, FX headwind for Merchant Solutions was 2%. **Shop Pay** Shop Pay penetration was 53.1% of GMV in 2Q’22 vs 48.0% in 2Q’21\. Although Shop Pay penetration has accelerated in recent quarters, we need to track this metric closely once "Buy With Prime" enters the market with its full force. **Shopify Plus** Shopify Plus as % of total MRR was 31% in 2Q’22 vs 26% in 2Q’21 *“In May, we introduced localized subscription pricing plans over 200 countries to better reflect this country's purchasing power and lower the financial barrier to access Shopify.”* Why Shopify Plus has been successful: *“I think some people have missed this often, but the reason that I think Plus has been successful is not just because it is the best place for existing brands to either go direct to consumer for the first time or scale or modernize their retail operations. I mentioned some big household names on -- in my opening remarks. But it's also because we have an unfair advantage that Shopify is where people go to start businesses and those that are successful, and in some cases, very successful. They migrate up to Plus and stay with us indefinitely.”* **GMV through Social** *“While still a relatively small percentage of overall GMV, GMV through key partner services, including our native checkout integrations on Facebook, Google and Instagram, grew 5x over Q2 last year.”* Last time, they mentioned 4x YoY growth, so things are picking up on social commerce. Shopify also recently partnered with Twitter and YouTube. *“shoppers can round out a great shopping experience in YouTube by quickly checking out with Shop Pay"* **Gross margin** Gross margin declined by 484 bps YoY. Why? *“…adjusted gross profit was affected by a greater mix of our lower-margin Merchant Solutions revenue, lower margins in Shopify Payments due to merchant and card mix shifts and increased investments in our cloud infrastructure.”* **S&M question marks?** Shopify laid off 10% of its workforce yesterday. It's easy to understand why once you take a look at how much the S&M efficiency went down in the last two quarters. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-18.png) Source: Shopify, MBI Deep Dives; *Return on S&M is calculated as following: (Revenue Yr 1-Revenue Yr 0)/Sales & Marketing expense* **Shopify Audiences** As the tectonic shift following [ATT](https://www.macworld.com/article/344420/app-tracking-transparency-privacy-ad-tracking-iphone-ipad-how-to-change-settings.html?ref=mbi-deepdives.com) continues, Shopify launched Shopify Audiences. Here's how it works: *“Shopify Audiences is a tool that helps merchants find new customers. It's essentially a 3-step process. A Shopify Plus merchant selects the product they want to sell more of. Machine learning algorithms build an audience of high-intent buyers tailored for that product, and the audience list is directly and securely exported to the merchant's ad network of choice, which we are launching first with Facebook and Instagram.* *Merchants are finding that audiences makes a real difference. They are seeing a meaningful increase in conversion rates and return on ad spend. For example, early access merchant, BlenderBottle, has seen its return on ad spend increasing as high as 6x. Another fast-growing merchant, L'AMARUE, saw a 48% uptick in its click-through rates, a 2.5x return on ad spend on its targeted campaign, and 73% of revenue from paid acquisition attributed to Shopify Audiences. All this, plus a 26% decline in customer acquisition costs. Audiences is off to a very promising start, and we're excited to see what it will do for merchants, especially ahead of the holiday selling season.”* **Logistics** Three challenges in logistics: Freight, Distribution, and Delivery. Shopify expanded on each of these three steps and its plans: *Freight* *“Let's start with freight. Inbounding inventory from suppliers is incredibly difficult for independent merchants to handle on their own. Today, merchants who manufacture abroad have to work with upwards of 10 vendors to receive inventory from suppliers, ship across the ocean and receive it at ports. Even if a merchant centralizes this through a freight forwarder, many of the processes are manual and fractured, designed for big businesses with large volumes and consistent demand.* *To help with this, SFN has launched a pilot program with Flexport so merchants can more easily and cost effectively inbound freight. It enables merchants to ship inventory at the pallet level versus container level, and have just-in-time access to prebook containers that deliver goods directly to an SFN hub. This prevents tying up our merchants' excess capital and inventory and allows them to remain nimble to changing buyer trends. Early pilot runs have shown that SFN merchants can expect service from origin ports up to 50% faster, with cost per pallet much less expensive than average.”* *Distribution* *“Through Deliverr, we are accelerating the simplification of the distribution phase. Using software and machine learning, these SFN hubs, leveraging Deliverr's capabilities, will unpack, scan and inspect all inventory, then compare against metadata in Shopify's back office throughout the goods to merchants' various distribution channels as well as forward position inventory into SFN's spoke direct-to-consumer fulfillment centers based on expected buyer demand. With this software-based approach, Deliverr is helping us expand 2-day delivery across SFN.* *Deliverr already fulfills more than 1 million orders per month, and its asset-light, technology-driven service is trusted by thousands of merchants across the U.S.”* *Delivery* *“Affordable and timely fulfillment has been nearly impossible for independent businesses to do on their own, but it is important. Just getting buyers' confidence that an order will arrive when promised, even if it's 3 or 4 days, is enough to increase conversion.* *By leveraging Deliverr software in SFN hubs and SFN's spoke partner warehouses all equipped with Six River Systems technology, we can forward position merchants inventory to support timely fulfillment with a minimal inventory commitment for merchants.* *We've also continued our early access to Shop Promise, which lets merchants offer 2-day delivery promises across online storefronts and channels like Google, Facebook and Instagram. Deliverr data suggests that as Shop Promise reaches scale, many merchants will be able to increase average conversion rates by more than 30%.”* Ryan Petersen tweeted this: > Flexport's fulfillment partnerships are coming together, including getting featured in Shopify's earnings call today. [https://t.co/SeMDCYWEZN](https://t.co/SeMDCYWEZN?ref=mbi-deepdives.com) [pic.twitter.com/K9TTZllIiZ](https://t.co/K9TTZllIiZ?ref=mbi-deepdives.com) > > — Ryan Petersen (@typesfast) [July 27, 2022](https://twitter.com/typesfast/status/1552344029270007811?ref%5Fsrc=twsrc%5Etfw&ref=mbi-deepdives.com) **Outlook** GMV growth will outperform broader retail market Merchant solutions revenue as % of GMV will increase i.e. higher take rates. \# of new merchants joining Shopify in 2H’22 will be higher than 1H’22. Because of larger of Merchant solution and Deliverr acquisition, Gross profit will trail revenue growth. Expects operating losses in 2H’22 even after excluding severance costs; Q3 losses to be higher than Q2 but “Q4 losses to be significantly smaller than Q3” once expense significantly decelerates **Valuation** Despite \~80% drawdown, Shopify's valuation remains largely dependent on the story you tell yourself about the potential it can reach over the long-term. Here is one such story: ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-20.png) Source: MBI Deep Dives You can read my Shopify Deep Dive [here](https://www.mbi-deepdives.com/shop/). Shopify's previous quarterly earnings recap: [4Q'21](https://twitter.com/borrowed%5Fideas/status/1494334562482065418?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1522260369225494532?ref=mbi-deepdives.com) I will cover Meta's earnings in the evening. ### Spotify 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/spot2q22/ Last updated: 2022-07-27T15:19:05.000Z *Disclosure: I own shares of Spotify* *“…we believe the Spotify machine is what differentiates us from other tech platforms. It leverages one consumer experience, powered by 3 revenue-generating business models: subscriptions, ads and marketplace.”* After falling into the abyss, the "machine" mostly delivered this quarter which led to +15% pop today! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-9.png) Source: Spotify From 100 mn Premium subscribers in 1Q'19, Spotify is set to double the subscriber base by the end of this year. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-10.png) Source: Spotify, MBI Deep Dives *(calculated based on disclosure of Overall Premium Subscriber number and the mix of Premium Subscriber by geography)* While Premium subs and MAU numbers exceeded guidance, Gross Margin fell below expectation mostly because of one-off adjustment for stopping manufacturing of "Car thing" and positive net royalty accruals in prior period. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-11.png) Source: Spotify, MBI Deep Dives (ARPU is calculated based on current quarter premium revenue\*4 divided by trailing four quarters average premium subscribers) One comparison I like to keep track is subs add of Netflix and Spotify. While Netflix was a massive beneficiary of Covid, Spotify added more premium subs on TTM basis for the last 7 quarters, and the difference is growing! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-12.png) Source: Spotify, Netflix, MBI Deep Dives A big help for Spotify is its lower churn: *“…churn was in line with expectations and down on a year-over-year basis.”* Spotify thinks it has pricing power, but given the macro uncertainty in the near term, it sounds like they are unlikely to exert pricing power soon. **Advertising Business** Ad segment maintained \~30% YoY growth momentum. Given 2Q'21's base, that's pretty good! ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-13.png) Source: Spotify, MBI Deep Dives Music ad CPM was up double digit and impression was up Mid-Single Digit (MSD) One analyst asked whether advertising budget for audio is more experimental. Here's what Daniel Ek said in response: *“if you think about it broader and not just around podcasting, but think about audio more as a category, one of the very unique things about audio and the properties around audio is really how differentiated it is from all the other media that's out there. So to take that into consideration, there is no other media format that can reach consumers in the car. The car is a massive use case, and particularly in North America. Radio usage is going down. Digital consumption of content is going up. It's quite obvious that audio ads is going to be a very dominant driver for reaching people lest they're in the car.* *Similarly, when you think about -- as people are walking around outside, more and more of us with our headphones and earbuds in, there's a huge opportunity in local advertising, too. I believe that audio is the primary beneficiary of that.* *…And so we are seeing, despite a very higher uncertain macro environments, advertisers take up to the format really, really well. And I think that's a testament to -- that the product is actually working. And we've talked about this before. But the retention of the advertisers that we have is also going up, and that clearly shows that the format is working for them.”* Ad inventory is going to be a big tailwind: *“a lot of our inventory just isn't available to advertisers just yet. So we're expanding the amount of inventory that's available. That's going to be by far the single biggest contributor to the growth of the ad business.”* **Expenses** FX movement added 1,000 bps higher growth in expenses. Wow. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-14.png) Source: Spotify **Outlook** Spotify is not seeing any material impact from economic slowdown on users/sub growth yet but preparing for worse anyway. They reduced hiring by 25% and *“instituted a double-down weekly revenue monitoring”.* Premium subs and MAU outlook +6 Mn and +17 Mn respectively QoQ Expected ARPU growth MSD Gross Margin 25.2% Benefit of hiring slowdown will be realized in 2023 Expect FX headwind to be material in Q3 as well. Expect to see impact of initiatives such as audiobooks in 2023\. Audiobooks may have positive impact on gross margin. To read my Spotify deep dive, including a downloadable excel model, go [here](https://www.mbi-deepdives.com/spot/) To browse through Spotify's earlier quarters, follow these links: [4Q'21](https://twitter.com/borrowed%5Fideas/status/1489218113627467778?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1519343467029225473?ref=mbi-deepdives.com), [Investor Day'22](https://twitter.com/borrowed%5Fideas/status/1534569729670660098?ref=mbi-deepdives.com) I will send my thoughts on Shopify's quarter in a few hours! ### Alphabet 2Q'22 Earnings Update URL: https://www.mbi-deepdives.com/goog2q22/ Last updated: 2022-11-22T19:37:56.000Z *Disclosure: I own shares of Alphabet* 2022 is the year of tough comps, along with macro uncertainty. The word "uncertainty" was emphasized by CFO Ruth Porat because *"the data are complicated"*. Let's look at some simple data from the most recent quarter first. While YoY quarter numbers doesn't seem impressive at first glance, in the context of 2-yr and 3-yr CAGR, Google's numbers are pretty darn impressive. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-4.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives Operating income was flat YoY as incremental operating margin went in the wrong direction after some massive jump in last year. Again, some contexts here: there was 3.7% FX headwind to topline this quarter (expect even larger FX headwind in Q3), but FX had greater impact on operating income since expense base is more weighted to USD. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-5.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives [TAC](https://www.investopedia.com/terms/t/traffic-acquisition-cost-tac.asp?ref=mbi-deepdives.com)'s run-rate is now \~$50 Bn/year. While bears talk about Apple's potential rival search product, color me skeptical given this growing "free money" they get to keep. Some interesting quotes from the call: **Search** *“People are using Google to do visual searches more than 8 billion times per month.”* *“Merchants will soon be able to submit 3D images of their products to appear directly on Google Search. So customers can try before they buy.”* *“Searches for places to visit in summer were up 2x globally year-over-year, while searches for last-minute hotel deals were up 50%.”* **YouTube** *“YouTube Shorts are watched by over 1.5 billion signed-in users every month with more than 30 billion daily views. In Q2, YouTube TV surpassed 5 million subscribers, including trials.”* FYI, Google mentioned the same number i.e. >30 Bn daily views for YouTube shorts in [Q1](https://twitter.com/borrowed%5Fideas/status/1519111739324968963?ref=mbi-deepdives.com) as well. As per Google commissioned study, for CPG companies YouTube CTV effectiveness turned out to be 3.1x greater than TV. *“…we have seen pullbacks in spend by some advertisers that, in fact, was the biggest factor in the quarter-on-quarter change, the sequential decline in the growth rate. And we're -- that we do view that as rather idiosyncratic as I said, some of it is supply chain, some of its inventory.”* *“ATT impact, in fact, remained relatively constant.”* **Android** *“…Android remains the world's most popular operating system with more than 3 billion monthly active devices worldwide. Last year alone, consumers activated 1 billion Android phones.”* **Cloud** Some softness in cloud momentum, but long-term story remains intact *“…you do see a varying mix of -- some customers impacted in terms of their ability to spend, some customers just slightly taking longer times. And maybe in some cases, thinking about the term for which they're booking and so on. I don't necessarily view it as a longer-term trend as much as working through the macro uncertainty everyone is dealing with.”* **Buyback** In the last 10 quarters, Google repurchased more than 100% of its quarter's FCF only twice: 1Q'20 and 2Q'22\. Google clearly likes to be a bit opportunistic in buyback which is great to see. Despite the buyback enthusiasm, diluted shares outstanding is going down very gradually (-2.3% YTD). Why? ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-6.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives When you look at headcount, you'll get your answer. After adding \~4-5k employees/quarter in 2Q'19-2Q'21, Google ramped up massively in the last quarter. Now that "roaring 20s" isn't quite happening, Google has decided to slowdown hiring. But the impact of such slowdown will only be realized in 2023. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/2022/07/image-7.png) Source: Alphabet Filings, Press Releases, MBI Deep Dives Given the potential for opex optimization, the stock remains valued at undemanding assumptions. Assuming 12.5x LTM EBIT for Google Services segment i.e. pretty close to "commodity multiple", 5x Google Cloud's run-rate revenue, deducting LTM corporate costs at 12.5x, and adding $110 Bn net cash gets you to current market cap. Sure, *"advertising is cyclical"*, but EPS growth may be far less cyclical! I will cover Shopify, Spotify, and Meta tomorrow. You can browse Google's previous quarters here: [2Q'20](https://twitter.com/borrowed%5Fideas/status/1289041099961638914?ref=mbi-deepdives.com), [3Q'20](https://twitter.com/borrowed%5Fideas/status/1322155716401111040?ref=mbi-deepdives.com), [4Q'20](https://twitter.com/borrowed%5Fideas/status/1356981947055149060?ref=mbi-deepdives.com), [1Q'21](https://twitter.com/borrowed%5Fideas/status/1387228149541376007?ref=mbi-deepdives.com), [2Q'21](https://twitter.com/borrowed%5Fideas/status/1420197641657503744?ref=mbi-deepdives.com), [3Q'21](https://twitter.com/borrowed%5Fideas/status/1453158229840736262?ref=mbi-deepdives.com), [4Q'21](https://twitter.com/borrowed%5Fideas/status/1488711685468733440?ref=mbi-deepdives.com), [1Q'22](https://twitter.com/borrowed%5Fideas/status/1519111723856375810?ref=mbi-deepdives.com) ### Start Here URL: https://www.mbi-deepdives.com/start-here/ Last updated: 2025-08-01T20:11:33.000Z I publish one in-depth research on a publicly listed company every month. Subscribers can not only access the full library of content but also download detailed financial models, all of which can be found [here](https://mbi-deepdives.com/models/?ref=mbi-deepdives.com). From August 2022, you can also listen to the [audio](https://www.mbi-deepdives.com/audio/) version of the Deep Dives. Anyone can access these sample deep dives to understand what a typical Deep Dive looks like: [Adobe](https://www.mbi-deepdives.com/adbe/), [Roku](https://mbi-deepdives.com/roku/?ref=mbi-deepdives.com), [Airbnb](https://www.mbi-deepdives.com/abnb/), [Sherwin Williams](https://www.mbi-deepdives.com/shw/), [Meta](https://www.mbi-deepdives.com/meta2023/). Subscribers also receive an email **everyday** on companies I follow or/and content I find interesting. I disclose my [portfolio holdings](https://www.mbi-deepdives.com/portfolio/) everyday in my daily email so that you are well aware of any potential conflict of interest. Please note that these are NOT my recommendation to buy/sell these securities, but just disclosure from my end so that you can assess potential biases that I may have because of my own personal portfolio holdings. Always consider my write-up as my personal investing journal and never forget my objectives, risk tolerance, and constraints may have no resemblance to yours. MBI Deep Dives is **NOT** a stock picking service, rather an investment research service. I, along with David Kim from [Scuttleblurb](https://www.scuttleblurb.com/?ref=mbi-deepdives.com), launched a podcast in December 2024\. We are doing one episode per month. You can listen to the episodes here: [Spotify](https://open.spotify.com/show/3Fdub8zkhm4xwN1ZcDbv1j?ref=mbi-deepdives.com), [Apple](https://podcasts.apple.com/us/podcast/never-sell/id1786912203?ref=mbi-deepdives.com), [RSS feed](https://feeds.buzzsprout.com/2435713.rss?utm%5Fsource=substack&utm%5Fmedium=email) You may also consider reading MBI’s [research process](https://mbideepdives.substack.com/p/my-research-process?ref=mbi-deepdives.com), and [approach to valuation](https://mbideepdives.substack.com/p/my-valuation-approach?ref=mbi-deepdives.com). ### Danaher: A compounding machine over four decades URL: https://www.mbi-deepdives.com/dhr/ Last updated: 2024-01-31T23:21:09.000Z _This post is for paying subscribers only._ ### PayPal: Beyond the Button URL: https://www.mbi-deepdives.com/pypl/ Last updated: 2024-01-31T23:22:03.000Z _This post is for paying subscribers only._ ### Adyen: The “Navy SEAL” Team of Payments URL: https://www.mbi-deepdives.com/adyey/ Last updated: 2024-01-31T23:08:51.000Z _This post is for paying subscribers only._ ### Ethereum: A Literature Review URL: https://www.mbi-deepdives.com/eth/ Last updated: 2024-01-31T23:23:22.000Z _This post is for paying subscribers only._ ### CSI: Software Santa eating the VMS market URL: https://www.mbi-deepdives.com/csu/ Last updated: 2024-03-07T15:51:55.000Z _This post is for paying subscribers only._ ### What’s embedded in Meta’s stock price? URL: https://www.mbi-deepdives.com/meta/ Last updated: 2022-07-26T13:04:09.000Z **Disclosure: I am long META/FB shares** **[Subscribe](#/portal/signup)* to receive future posts in your inbox* Let me cut to the chase here. This isn’t one of my typical deep dives. While in a typical deep dive, I dive into both numbers and narrative to understand what’s embedded in stock price, I will primarily focus on the numbers in this piece. Numbers will, of course, also highlight some of the embedded narrative. I believe the major narratives related to Meta are widely discussed and understood but the numbers often get lost in translation. *Before I explain the model, please remember, the projections in the model are NOT what I forecast or think will happen. It is my attempt to figure out what’s embedded in the stock price today. However, what’s embedded in stock price does NOT follow scientific approach, and many investors will have different ways to figure out the embedded assumptions in the stock. This is simply my personal attempt. For 2022, I modeled in a way so that the topline closely resembles the consensus estimates. However, from 2023 and beyond, I consciously avoided to take into account of consensus estimates out there as I think street estimates are lot less useful two years (or more) out.* If you are reading my deep dive for the first time, I strongly encourage you to read my piece on “[approach to valuation](https://www.mbi-deepdives.com/my-valuation-approach/)”. Please read it at least once so that you understand what I am trying to do here. I follow an “expectations investing” or reverse DCF approach as I try to figure out what I need to assume to generate a decent IRR from an investment which in this case is \~8%. Then I glance through the model and ask myself how comfortable I am with these assumptions. As always, I encourage you to [download](https://www.mbi-deepdives.com/models/) the model and build your own narrative and forecast as you see fit to come to your own conclusion. None of us have the crystal ball to forecast 5-10 years down the line, but it’s always helpful to figure out what we need to assume to generate a decent return. **The Meta Model** In 2021, Meta has segmented its business in two categories: a) Family of Apps (FOA), and b) Reality Labs (RL). FOA consists of revenue from Facebook, Instagram, Messenger, WhatsApp, and other services. RL derives revenue from AR/VR related hardware, software, and content. Almost 99% of FOA revenue comes from advertising. Let’s simplify the ad business a little before getting into the numbers. Advertising revenue is driven by number of ads and Cost per thousand impression(CPM). Number of ads and CPM are driven by metrics such as Daily Active Users (DAU) or Monthly Active Users (MAU), and the effectiveness of the ad. The effectiveness of the ads can be understood by better conversion, and Return on Ads dollar spent (ROAS). While Meta discloses DAU/MAU numbers consistently, other metrics are not publicly disclosed and hence the two metrics I’ll focus on is DAU/MAU and Average Revenue Per User (ARPU). Whenever I’ll mention DAU/MAU, it will indicate to Facebook’s numbers (the core blue app), and will NOT include Instagram and WhatsApp’s numbers. However, Meta also discloses Daily Active People (DAP), and Monthly Active People (MAP) publicly which include users from all its FOA related apps. So, what do we see? Facebook had 1.9 Bn DAU and 2.9 Bn MAU in 2021, implying two-third of DAU being active on a monthly basis. While the global DAU/MAU relationship has remained stable over the last five years, there are interesting nuances by geography. What I found particularly counterintuitive is Facebook has the highest DAU/MAU ratio in US & Canada. However, unfortunately the DAU/MAU ratio has been consistently slipping over the last five years in US & Canada. DAU has been stable over the last two years in this region, and I have modeled it to steadily decline from here for the next few years and in the out years, the decline is assumed to accelerate. I have modeled similar dynamic in Europe as well even though Europe’s DAU performed better than US & Canada historically. For Asia Pacific, and Rest of the World, my model assumes low-single digit growth in DAU. For MAU, I used the DAU/MAU ratio to project the MAU in future years. Here too I assumed a steady decline in DAU/MAU ratio in the next 10 years for all the regions. The DAU/MAU trend essentially implies Meta will be a share donor to TikTok, Snapchat, and perhaps yet-to-be invented social apps in the future. One potential risk here is when network effects unravel in the opposite direction, it can be just as dramatic and it may not be as linear deceleration as modeled here. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-1024x518.png) Let’s talk about ARPU now. Please note for FOA ARPU, I have used Facebook’s MAU since Meta does not disclose MAP by geography. Therefore, there is a slight mismatch between numerator and denominator when it comes to calculating ARPU (nothing too material though) i.e. the numerator takes into account of revenue from Facebook, Instagram, WhatsApp, and Messenger whereas the denominator is just Facebook’s MAU. Monetization in the US market had been incredibly strong over the last five years despite the lukewarm DAU/MAU trend. If we look at other regions ARPU as % of US & Canada ARPU, interestingly monetization in other regions remained somewhat constant as % of US & Canada ARPU. I have assumed zero growth in ARPU from 2023-2030 in the US and Europe, and only a very low single digit growth in Asia Pacific and Rest of the World. The numbers here perhaps imply Apple’s ATT restrictions will be a permanent headwind and Meta’s attempt to solve it will largely fail. One could also argue that if DAU/MAU really starts falling, it may be challenging for Meta to retain similar ad budgets from its advertisers and hence even keeping the current ARPU may be difficult. However, what the ARPU also implies is Reels and WhatsApp monetization plans may not also work out as well as Meta expects. Overall, as per this model, following this year revenue growth in FOA will be almost non-existent for the rest of this decade. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-1-1024x443.png) How about RL or the metaverse bet? This is basically a venture bet, I’m sure we all understand how difficult it is to put numbers behind venture bets. Whether the bet is successful or a failure, one thing is certain whatever model we build today for RL will prove to be wrong. With that caveat in mind, let’s dig into it. Meta started disclosing RL’s numbers in 2021 and we only have last three years’ numbers; therefore, 2017 and 2018 numbers are estimated. I estimated 2% of Facebook’s MAUs to be RL’s MAU in 2030 which comes out to be \~70-75 Mn. Because RL revenue consists of hardware (which itself drives supermajority of revenue; a Quest 2 costs $299/$399 each today), software, and content, ARPU is significantly higher compared to FOA. As a result, ARPU in 2030 turns out to be $682\. I’m sure many of you are rolling your eyes looking at \~$50 Bn revenue in RL segment in 2030\. In 2010, Meta reported \~$2 Bn revenue which is RL’s revenue today. In 2021, Meta reported \~$118 Bn revenue. I know, I know you cannot build Facebook every decade which is perhaps once in a generation company. In any case, even if you think \~$50 Bn is preposterous number, bear with me, and let me come back to this point again later. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-2-1024x119.png) **Cost structure**: To understand Meta’s cost structure in a more granular level, I have tried to segregate into FOA and RL’s costs. Please note that Meta does not report segment level costs, but do report segment level operating income. Therefore, I tried to make assumptions in a way that get us close to the reported actual operating income (loss) for each segment. Because RL used to have negligible contribution to overall Meta in 2017, I considered 2017 as a guide for FOA costs in later years. While projecting FOA costs, I modeled a slight benefit of scale when seen from 2021 cost structure, but if you notice the historical cost structure, I did not assume much scale benefit at all. For RL, again, this is anyone’s guess what the eventual economics will look like. Meta is currently incurring heavy losses which I rationalize over the years to reach 40% gross margin in 2028, and a breakeven EBIT in 2028\. In 2030, RL’s gross margin and EBIT margin are assumed to be 50% and 10% respectively. Theoretically, the hardware component will be low margin and software/content revenue is likely to be higher margin. As more advanced version of VR headsets arrive and sophisticated AR glasses are launched, hardware may not suffer commodity like margin, but this is perhaps impossible to predict, given a lot depends on upcoming competition from other big tech and beyond. Of $682, if we assume hardware is $400 and is sold at \~25% gross margin and the rest software/content revenue is sold at \~80% gross margin, the overall gross margin per user is \~50%. For the rest of the cost structure within RL, I assumed gradual improvement that one can expect to see once the topline scales a bit. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-3-1024x750.png) Going back to the earlier point on RL’s topline projection, whether you believe $50 Bn topline is possible matters perhaps lot less when you see it through the cost structure perspective. In this model, I have assumed RL to burn $90 Bn cash from 2017-2027 which is likely to be the highest cash burn in the history of capitalism for a “venture bet”. For all these cash burns, I assumed \~$5 Bn EBIT in 2030\. I believe it is difficult to consider these assumptions aggressive unless of course, Zuck just decides to keep incinerating cash even if RL’s topline shows no sign-up momentum. **Capex**: Meta has been in a heavy-capex cycle for quite some time, as indicated by Capex to depreciation ratio which has been consistently above 2.0x. Of course, this cannot continue for forever, and capex to depreciation ratio is expected to be 1.1x-1.2x in the long-term (the 10-20% premium is expected to incorporate future inflation as you upgrade your infrastructure in the future). I didn’t assume Meta would get there in two-three years, but in five years. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-4-1024x117.png) **Buyback and share dilution**: While Meta mostly focused on offsetting dilution in the past, in 2021 they changed gears materially by repurchasing \~5% of diluted outstanding shares. Going forward, I assumed 100% of FCF to be deployed in buying back shares from the market. Meta still has \~$48 Bn cash in balance sheet which is assumed to be *unutilized* for buybacks and can be deployed for future acquisitions if Lina Khan ever decides to give them a pass (don’t count on it). For stock-based compensation, I assumed similar stock issuance as Meta did in the last couple of years. It is possible Meta may decide to dole more shares to its employees this year given the hit stock recently took, but such decisions are unlikely to be floor for stock issuances in the future. \~20-30 mn extra stock issuances in one-off year do not have material impact on the valuation. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-5-1024x162.png) **Valuation**: After taking all that into account, I needed to use 8x FCF multiple in 2030 to get \~8% IRR. Please note #of shares is assumed to decrease by \~45% by 2030\. Again, I strongly recommend you to [download](https://www.mbi-deepdives.com/models/) the model and play with the assumptions you deem appropriate. You don’t have to agree with any of my assumptions. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2022/03/image-6-1024x278.png) **Final words:** When Zuck decided to go big on his bet on Metaverse in November last year, I became more cautious since the range of outcomes for Meta widened because of such material increase in expenses on an inherently uncertain bet. As stock price plummeted since then and I also got more opportunity to learn more about VR’s potential, I decided to do this exercise to figure out what’s really embedded in today’s stock price. Based on these numbers discussed in this write-up, I think Meta appears to be a fat pitch to me (but please note even fat pitches do have risks as I alluded here), and hence I decided to increase my weight in META from \~7% to \~12% over the last week. I will publish my deep dive (both narrative and numbers; not just numbers) on ***Constellation Software*** on Monday next week (21 March, 2022). Thanks for reading. [Subscribe](#/portal/signup) to receive the deep dives in your inbox. The companies covered so far are: Uber, Etsy, Lululemon, Angi, Ansys, Autodesk, Copart, Shopify, Otis, CrowdStrike, Roku, Boeing, Square, Trupanion, RH, Spotify, Pinterest, and Twilio **Disclaimer*: All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* ### Twilio: Communication API platform for the developers, by the developers URL: https://www.mbi-deepdives.com/twlo/ Last updated: 2024-01-31T23:26:50.000Z _This post is for paying subscribers only._ ### Pinterest: Building the taste graph URL: https://www.mbi-deepdives.com/pins/ Last updated: 2024-01-31T23:27:22.000Z _This post is for paying subscribers only._ ### 2021 Annual Letter URL: https://www.mbi-deepdives.com/2021/ Last updated: 2023-02-25T11:54:01.000Z _This post is for paying subscribers only._ ### Spotify: Play the Audio URL: https://www.mbi-deepdives.com/spot/ Last updated: 2024-01-31T23:28:21.000Z _This post is for paying subscribers only._ ### RH: Climbing the elusive luxury mountain URL: https://www.mbi-deepdives.com/rh/ Last updated: 2024-01-31T23:29:21.000Z _This post is for paying subscribers only._ ### Trupanion: Ensuring humanization of pets via insurance URL: https://www.mbi-deepdives.com/trup/ Last updated: 2024-01-31T23:31:19.000Z _This post is for paying subscribers only._ ### Why I sold Etsy URL: https://www.mbi-deepdives.com/etsy/ Last updated: 2022-07-26T13:05:22.000Z **[Subscribe](#/portal/signup)* to receive future posts in your inbox* I first bought Etsy in September 2020 at $111/share and continued to add to my position later to make it my largest holding (\~15% of portfolio) at an average cost of $128/share. Following my first purchase, I [published](https://www.mbi-deepdives.com/etsy-a-handmade-giant-in-the-passion-economy/) a deep dive on Etsy in October 2020 and wrote multiple [twitter threads](https://www.mbi-deepdives.com/twitter-threads/) as I kept following the company closely. I now believe I had materially overestimated the strength of the marketplace and in my original deep dive, I got the unit economics of an active buyer simply wrong. I sold my entire position on Etsy yesterday at $214/share. I am not short Etsy (in fact, I have not shorted any stock ever) and this is NOT a recommendation to either sell or short Etsy. I am merely sharing my thoughts on the company, and you can, of course, come to very different conclusions than I did. Since my original deep dive (and all twitter threads) remains open for anyone to read, I have decided not to keep my current thoughts on Etsy behind paywall. On this update, I will explain a) why I started second guessing my earlier work on Etsy, b) how I currently think about active buyers and the marketplace, and c) walk you through my modeling assumptions and show you my work to elaborate why I am uncomfortable remaining a shareholder of Etsy. *Why I started second guessing my earlier work on Etsy* In my original deep dive, I used the cohort data published in Etsy’s 10-K to work on the unit economics. Since the deep dive was published in October last year, I had the 2019 10-K in hand, and hence utilized the following cohort data (see page 9 of 2019 10-K). Let me explain how I originally interpreted the below graph using the 2016 buyer cohort as an example. Before you read my interpretation, I encourage you to read the below statement +graph first and come up with your own interpretation. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2021/10/image-1024x547.png) Here’s what I thought: I assumed the “2016 active buyers” as anyone who bought anything on Etsy either for the first time or reactivated after a lapse of 12 months or more in 2016\. Let’s assume, for the sake of simplicity, “2016 active buyers” consisted of 100 buyers. In 2017, \~45% of these “2016 active buyers” i.e. 45 buyers shopped again at Etsy. In 2018, \~40% of “2016 active buyers” i.e. 40 buyers shopped at Etsy, and in 2019, \~37.9% of “2016 active buyers” i.e. \~38 buyers (see the yellow lined statement above) found something to buy at Etsy. The original interpretation was that even though there is a material (\~55%) buyer churn in year 2, the ones who stick in year 2 turn out to be very sticky buyers as an overwhelming majority of them continued to shop at Etsy for four consecutive years. Recently, I wrote a twitter [thread](https://twitter.com/borrowed%5Fideas/status/1440793933915639812?ref=mbi-deepdives.com) to respond to bear concerns on Etsy and expressed skepticism on the strength of the bear case. However, following the thread, I had multiple exchanges with a few people which led me to ask Etsy’s Investor Relations (IR) for some clarification on the interpretation of the aforementioned chart. I have exchanged multiple emails over the last week with IR and received multiple confirmations of what Etsy intended to mean. So, what is the correct interpretation? Let’s continue with our “2016 active buyers” example which is again assumed to be 100 buyers. Of these 100 buyers, \~45% i.e. 45 buyers shopped again in 2017\. In 2018, however, 40% of “2016 active buyers” *who also bought in 2017* i.e. only 18 buyers shopped at Etsy again. In 2019, only 7 of the “2016 active buyers” shopped at Etsy for four consecutive years. I have shown below the incorrect (my previous interpretation) and correct interpretation of the cohort data below. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2021/10/image-1.png) Essentially, the graph applies ONLY to “consecutive buyers” i.e. if “2016 active buyer” shopped in 2017 (year 2) but didn’t shop in 2018 (year 3), the buyer is NOT included at all in this graph even if he/she shopped again in 2019\. I will be very surprised if any of my readers was able to infer this “correct” interpretation by reading/looking at the graph on their own. I have looked at many cohort/retention data published by publicly listed companies, but I cannot recall any company which defines it the way Etsy does. In fact, considering I myself run subscription-based research service, Stripe reports subscriber cohort level data by month and Stripe too defines the way I originally interpreted Etsy’s data. Given that tech companies seem to define some of these very common metrics not in a standardized manner, I am probably not the first analyst to misinterpret a metric. I, however, was confounded by the following statement from the paragraph shared earlier: *“36.2% of active sellers and 37.9% of active buyers as of December 31, 2016 continued to be active sellers and active buyers through their fourth year on the platform”* In my mind, there is really one possible interpretation of this sentence and hence, I asked for clarification again. This time IR confirmed that this particular sentence is not indicating to the graph shared right below that statement. While the graph only applies to “consecutive buyers”, the statement applies for both consecutive and non-consecutive buyers i.e. 37.9% of “2016 active buyers” indeed shopped at Etsy in 2019, but it includes buyers who shopped each of the 2016-2019 years AND buyers who may not have bought anything at Etsy in 2017 and/or 2018 but did buy in 2019\. If this feels confusing, it is because it is indeed confusing. What I find curious is even though IR mentioned that the statement and the chart are not related and hence should be considered separately, the data from the graph seems to align really well with the aforementioned statement in each of the 10-Ks in the last five years. For what it’s worth, Etsy’s IR seemed to understand how this is all confusing and mentioned to me that *“we're looking to revamp how we present cohorts. We inherited this view and decided to keep it consistent for comparison.”* So what does this all mean? First of all, it means my previous analysis on unit economics of an active buyer is, in no uncertain terms, wrong. I also inferred that I needed to re-think how to think about “active buyers” and consequently the marketplace based on this new understanding. *How I currently think about active buyers, and the strength of the marketplace* Before I explain how I think about active buyers now, I would like to highlight all of my work is based on publicly available information. I just started re-thinking my work after I got to understand the correct interpretation of retention data mentioned in Etsy’s 10-K. Active buyers can be categorized in three separate segments: a) new buyers, b) re-activated buyers, and c) consistent buyers. Let me define each of these segments and explain the numbers mentioned in the table below. **New Buyers** A “new buyer” is someone who buys something from Etsy for the first time in his/her life. Etsy started disclosing “new buyer” data from 2018, so we have company reported data from 2018-2020\. From 2013-2017, the data that you see below are my own assumptions. While I obviously don’t know how close to the reality my assumptions are, I believe I am not off the chart by miles. **Re-activated buyers** A “re-activated buyer” is someone who, for example, bought something from Etsy in 2020 but did not buy anything in 2019 (or the Last Twelve Months/LTM). This buyer bought at least one item from Etsy at some point in their lives (could be 2008 or 2018). In 2020 10-K (see page 73), Etsy mentioned *“The Etsy marketplace saw an influx of 60.7 million new buyers and reactivated buyers during the year, the latter being those who haven’t purchased in a year or more.”* Since we know there were 38 mn new buyers in 2020, we can easily calculate that there were 22.7 mn re-activated buyers in 2020\. Etsy did not mention or report “re-activated buyer” data before 2020, so I had to assume the data for 2013-2019 period. The reason I used T-2 years to calculate re-activated buyers as a % of T-2 Active buyers is if a buyer in T-1 year shops in year T, he/she cannot be considered for re-activated buyer pool for year T. Only the buyers who shopped any time before or in T-2 years can be in the pool of potential re-activated buyers. Again, I do not know how correct I am with my assumptions, but I believe these should be around the ballpark for most years. **Consistent buyers** A “consistent buyer” is someone who has bought something from Etsy for the last *two* consecutive years. This is a term I myself came up with; Etsy does not report/mention/define any active buyer category like this. Ultimately, if you are not a “new buyer” and not a “re-activated buyer”, you are a consistent buyer. To drive this point home, let me give examples. If a buyer bought something in 2017 but didn’t buy anything in 2018 and yet bought something in 2019, he/she is re-activated buyer, not consistent buyer. A “2018 consistent buyer” is someone who bought something in both 2017 and 2018, but if this same buyer did not buy anything in 2019 and then chose to buy in 2020, he/she is considered “re-activated buyer” in 2020\. As a result, consistent buyer churns all the time, goes to re-activated buyer bucket, and then has the potential to go to “consistent buyer” bucket. Since Etsy reports its total active buyers and we either know or assumed new buyers and re-activated buyers number, we can easily calculate “consistent buyers” (Active buyers- new buyers- reactivated buyers). ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2021/10/image-2-1024x608.png) Now that we understand different buyer categories, let me explain “Implied LTM Churn”. This data is also not reported by Etsy. In T-1 year, each of the three buyer-categories has a chance to either become or remain a “consistent buyer” in year T. Therefore, if they do not become part of “consistent buyer” in year T, it implies he/she has churned from the marketplace. Consequently, I calculated “Implied LTM Churn” as “T-1 Active Buyer – Consistent Buyer in year T”. Churn rate or churn % is calculated as Implied LTM Churn divided by T-1 Active Buyer. If this still seems confusing, I strongly encourage to [download](https://www.mbi-deepdives.com/models/) the excel model and spend some time on “Buyer” worksheet. What do we see from this data? We see that churn is consistently greater than 50% in each of the last 8 years, even during Covid-19\. While re-activated buyers were typically 30-35% prior to pandemic, clearly Covid-19 had incentivized many of the churned buyers to come back to the marketplace. What it essentially depicts is Etsy’s marketplace appears to be weaker than I thought earlier. Even though number of sellers increased by almost 200% in the last 5 years, it does not seem to have a noticeable impact in the churn. Buyer loyalty seems weak and when you triangulate with the “correct” interpretation I explained earlier, it seems a very small group of buyers come back to Etsy every year and the rest are promiscuous in their shopping habits to the extent that they may not even remember Etsy for year(s). Of course, the fact remains Etsy is a capital-light high margin business. So what does all this mean for valuation? Let’s get to the modeling assumptions and valuation discussion then. ***Valuation/Model assumptions***: If you are reading my work for the first time, I encourage you to read my piece on “[approach to valuation](https://www.mbi-deepdives.com/my-valuation-approach/)”. I follow an “expectations investing” or reverse DCF approach and try to figure out what I need to assume to generate a decent IRR from an investment (in this case \~7%). Then I glance through the model and ask myself how comfortable I am with these assumptions. As always, I encourage subscribers to [download](https://www.mbi-deepdives.com/models/) the model and build your own narrative and forecast as you see fit to come to your own conclusion. Let’s start from where we have left off in the earlier section. Let’s drill down further in Active buyers. As I have just explained the historical numbers (please see color code shared earlier), I’ll primarily focus on my thoughts behind the projections to figure out the expectations embedded in the current stock price. Considering the year 2021 is almost complete and we have fairly narrow range of outcomes, let’s mostly ignore that year as well. For new buyers, at first glance, it may appear I am conservative in my estimates. But think about the definition of “new buyer”, someone who is buying from Etsy for the *first* time. If I add all the new buyers from 2013-2030, we get to \~250 Mn people. If we keep adding 15-20 mn “new buyers” each year in the next 10 years, we will simply run out of people in the US. But Etsy bulls (and my former self) would argue and point out the international opportunities for Etsy. The problem is even though “international GMS” was 36% of overall GMS in 2020, we don’t have a good idea how many “international buyers” are truly “international” since as per Etsy’s definition of “international GMS”, if either buyer or seller is from outside the US, it is considered “international GMS”. Therefore, if a New Yorker orders jewellery from UK, it is part of “international GMS”. It is possible that Etsy may become a big marketplace in multiple countries and may surprise me by continuing to add >10 mn new buyers throughout this decade. For re-activated buyers, I assumed 35% of 2020 active buyers will become re-activated buyers in 2022 and then increase it by 100 bps every year till 2030\. Please note that barring 2020, there was never a time when Etsy was able to re-activate more than 36% of its T-2 active buyers. Therefore, this assumption appears somewhat aggressive to me. Consistent buyer is basically just the opposite side of churn. If you do not churn, you become consistent buyer and if you do churn, you go back to the potential pool of re-activated buyers in future years. Again, if you see closely, when we assume Etsy will manage to convert 50% of T-1 active buyers as consistent buyers in each of the next 10 years, it means we are assuming something Etsy was not able to do anytime in the past (based on my assumptions). This too does not appear a conservative assumption to me. Total Active Buyers is just sum of these three buyer categories. Now that we have total active buyers, let’s talk about Gross Merchandise Sales (GMS) per active buyer. Before 2019, Etsy’s GMS/active buyer was consistently growing at low single digit rate. Josh Silverman, after becoming CEO in May 2017, turned the ship around and started to show impressive result as GMS/Active buyer grew at 7.7% in 2019 and thanks to the pandemic, 2020 was off the charts. Now let’s look at the future. I basically had to assume GMS/active buyer will grow consistently at 10% from 2022-2030 to reach \~$30 Bn GMS in 2030. Ultimately, if my number of active buyer projections are in the ball-park, Etsy shareholders need to believe that frequency of purchase by active buyers will materially increase. As it happens to be the case, [In Practise](https://inpractise.com/?ref=mbi-deepdives.com) recently interviewed a former Etsy employee and asked this exact [question](https://twitter.com/%5Finpractise/status/1436734402298531846?ref=mbi-deepdives.com), “*Do you think Etsy can improve the frequency and repeat buying over time, or is there a limit…?*” The response did not drive much confidence: *“…Can it be done? Nothing’s impossible. Did we ever see success in moving that metric? No.*” ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2021/10/image-3-1024x285.png) Let me now mention what other changes I made in my Etsy model. I kept gross margin assumptions the same and I kept the operating leverage I modeled for G&A and R&D. However, considering Etsy consistently experienced 50-60% buyer churn every year, I now think Etsy may not enjoy much scale benefit in Sales & Marketing (S&M). As a result, my S&M assumptions (29% of sales) in out years are now more conservative compared to the model I shared earlier. Given decreased margin assumptions, I also had less cash to deploy buybacks in my current model. As you navigate my model, please don’t fixate on my estimates vs consensus on any particular year and rather focus on the long-term assumptions embedded in the model. To generate \~7% IRR, I needed to assume 32x terminal FCF multiple. What I would like to highlight here is it is not that I was uncomfortable with any one particular driver/assumption on my model; In fact, my discomfort *compounded* as I felt most of the GMS driver assumptions are aggressive and on top of that, I need to assume 32x FCF multiple to generate \~7% IRR. For context, if we look at eBay, a marketplace which also had its moment in 2000s but had difficulty growing in 2010s, is currently trading below 20x FCF multiple. ![](https://storage.ghost.io/c/57/41/5741a57f-8779-47c3-a5a5-48acb195f4db/content/images/wp-content/uploads/2021/10/image-4-1024x292.png) While I made a good return on Etsy, it appears in hindsight that this was based on incorrect assumptions/analysis. Had I understood the cohort data and active buyers the way I currently do, I would have sold my position earlier, or may not have initiated a position in the first place. As they say, better be lucky than right. Can my newfound skepticism for Etsy turn out to be largely unfounded? I certainly cannot rule it out. If I could be wrong once, I can certainly be wrong again. Etsy’s “House of Brands” strategy can turn out to be spectacular if Depop/Elo7 goes on to define their categories. This may all make me look foolish in a few months/years and if it does, I will learn something from that exercise. I strongly encourage you to do your own work, play with the model if you want, and then please come to your own conclusion. I am currently dropping coverage of Etsy, but as I alluded earlier, if Etsy continues to post soaring operating results, I will re-assess in a year or two to see what I got wrong. Even though I am not a shareholder anymore, my wife already let me know that she will continue to shop at Etsy. Therefore, my household is likely going to be a “consistent buyer”. Given that I had been busy with Etsy, this month’s deep dive on Trupanion will be slightly delayed and it will be published on October 18th (Monday) instead of October 15th (Friday). Please [subscribe](#/portal/signup) to receive it in your inbox. Thank you for your support! Follow-up thread based on further feedback from readers can be found [here](https://twitter.com/borrowed%5Fideas/status/1446825657577656322?ref=mbi-deepdives.com). *Disclaimer: All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a recommendation to buy or sell securities discussed. Please do your own work before investing your money.* _Includes the latest 500 public posts. Use `/sitemap.xml` for the complete archive of public content._