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Takeaway: A couple of ugly, a couple with accel, all Shorts

MCHP | King Julian Sees All, Likes To Buy Crap Semis

  • Confusing short-term signals as orders re-accelerated in October after the September quarter cleanout of inventory, although some of the October strength might be excess shipment ahead of the feared increase in tariffs from 10% to 25%.
  • On the long-term side, no one asked about the lawsuit or the risk that Steve might have to recuse himself from the CEO role. The company is fixing MSCC operationally but the ongoing evidence of excess inventory (over 8 months for high-reliability products) only buttresses our view that real growth for MSCC was even worse organically than the feeble numbers we had scrubbed to. In other words, the point of buying MSCC…is to hurry up and buy another semi company. Steve even noted that his strategy is to buy underperforming semiconductor assets, which is a fine strategy, but does not come with a premium or high performance analog multiple.
  • If there is a risk to our Short thesis it probably comes from the s-t signals with maybe a very brief trade into year-end before it collapses in February.

ADT | How Soon Before They Retire The Current CEO

  • The revenue beat came from M&A, as we previewed.
  • The company couldn’t answer why they are buying a fire and safety company (Red Hawk) other than the claim that it has favorable financials (sounds desperate). Generally speaking, the CEO's answers to multiple strategy related questions were super weak and light on calories, including (implied & direct) how to compete with DiY crossing into professional monitoring, is the strategy customer acquisition or FCF, why shift revenue mix towards lower margin businesses, and most important, why are you raising churn guidance for 4Q.
  • The cash outlay to acquire subscribers jumped big time but the cadence of incremental recurring revenue was right in-line with previous quarters.
  • The company raised the churn outlook for 4Q18.
  • LTM FCF (GAAP + non-GAAP) went down sequentially.
  • Adding Red Hawk to numbers will be the main show for the next 2 quarters. Otherwise, it’s more of the same.

ALRM | ~60x Trailing FCF and 9x EV/ARR For Mixed Software Line is Where You Cover? No, It’s Where You Press

  • ALRM delivered $74MM in SaaS revenue for 3Q18 versus Street at $72MM. Nicely done. Remember that SaaS revenue isn’t pure SaaS in this instance and involves the resale of physical assets as well as resale of cellular service.
  • The not-so-shocking part here is that SaaS revenue was up another ~$3MM sequentially, just like last Q, and the Q before that, and the Q before that, and the Q before that. So the management team is good at sandbagging, but the business hasn’t really changed.
  • Our view is that in the short term, ALRM customers are scared of all the changes happening. The entrance into their world of technology players threatens to commoditize their offering. In the near term, they are leaning more on ALRM to defend their positions which accelerates the short term transition from monitored to interactive monitoring, and thus favors ALRM. This isn’t a shock. But the long term also doesn’t change for ALRM’s customer base: there is almost no use case for a central monitoring service if everything is in software. What will be the long-term cost of mostly software-based monitoring service? DiY crossovers are putting it at ~$10 per month. How is ALRM going to charge their customers $5.50, going to $7 with video, when the customer itself will charge $10 to residential subscribers? More importantly, ALRM’s customers will see their business models challenged and many of them will fail because these companies have super heavy customer acquisition models relative to new entrants and they can’t afford to lower monthly service ARPU. The entire structure of the business is changing. For the better. And ALRM is stuck as the coolest, best, technology weapon serving the buggy whip makers. In this case we think people who are Long ALRM are racing in their sports cars towards a brick wall, as the 2016 8MM interactive subs quickly reaches some saturation point by 2019 with the larger addressable end market flat or falling in this time.

AVLR | Temporary Acceleration Point

  • AVLR is benefitting from the sales re-org in mid-2017, which should help y/y recurring revenue capture for the next 3 quarters in addition to the recently announced 3Q18.
  • AVLR will have points of acceleration from some increments of large enterprise customers, at a much higher per company ARPU than the mid-tier (but also a much longer sales cycle).
  • We noticed slowing Sales & Marketing headcount adds recently, which should have been a sign that incremental efficiencies were on the horizon, and AVLR proved it in 3Q18 with ~$2MM of incremental OPEX against $6MM of incremental revenue. The combination of faster topline growth and slower OPEX growth will begin the process of healing what has been, up to now, a wildly inefficient model.
  • The rest of the hair is still there. The recent lawsuit points to an innovation problem inside the company; the M&A path points to the same problem as most of the key functionality of the software has been acquired over time. The employee disaffection is real and makes us think the December lock-up expiration will be met with jubilatory selling. The lack of addressable market points is real in most ways: AVLR is selling an expensive version of something that is available at cheaper price points with better pricing transparency, and into a market that has a mixed opportunity set of open and closed doors.
  • So we aren’t willing to give this a premium by any stretch. Mid-20%s growth rate in the next few quarters will sunset by mid-2019 on a comps basis and sag to below 20% growth. A middle of the road EV/2019 revenue multiple of ~6x gets us sub $30 per share, basically around our original price target when we put the Short on at $44. You would have to use some pretty aggressive FCF multiples just to get to our current price target, so there is no salvation from that corner.
  • Bottom line: when we put the Short on, we figured the stock would actually be up a bit on 3Q18 results at which point the improved run-rate would be in the stock and the comparison of best case growth to obnoxious valuation would be poor and cause a collapse from mid-high $40s to the mid-$20s levels. The market is smarter than we are and already began scrubbing the valuation, so we are well along the curve with no change to our view. Why? The accel last night was 100% circumscribed within the range of our understanding as y/y comping the sales re-org + some interesting M&A that closed in May (which wasn't so small on a transactions basis). But the boost is not about a better solution incrementally opening up an accelerating market opportunity. It is a comps issue which then reverses in 2H19 and poof you have a long term sub-20% grower. To maintain over 20% growth by then will require some chunkier M&A. So if there isn't that much downside from here, we shrug, and also say, we aren't believers in the upside either. Our advice would be, short the pops. Oh, there is one right now! Go for it.

What-To-Do When Your 4 Shorts Are Up On EPS:

ADT results were garbage + the CEO had no answers and will get replaced; MCHP is becoming an acquirer of garbage and that isn’t worth much but we accept the s-t order signals create some confusion; AVLR accel is 100% within our expectations, we think this business is sadly much more mature than understood and without a dynamic innovation curve. While a lot of the downside got expressed recently we think pops are shortable; ALRM is the Short for the ‘patient person’ and reminds us of a good passage from the good book “A truthful witness for a time that will come. Even if it tarries, wait for it still;” Habakuk ch.2,v3 (one of the books of the Bible, in The Twelve Prophets).

Please call or e-mail with any questions.

Ami Joseph

Managing Director




Yosef Vaitsblit