Category: Investing Analysis

Tech stocks have taken a pummeling this month so far. If you’re a long-term holder of tech stocks and are feeling the pinch, you’re not alone.

Some of the tech stocks that I have a vested interest in have nosedived too.

For some of the companies that I have a stake in, the chart below shows how far off their recent highs their share prices are as of 14 May 2021.

It’s clear that the companies above have experienced sharp falls in their share prices from recent highs. The most prominent is Teladoc, which provides telehealth-consultation services – its share price has fallen by more than 50% from its peak.

But as a long-term investor, I am prepared to hold through these drawdowns. As long as I think that the stock can appreciate meaningfully over the longer term, I would not want to sell.  

To me, what’s more important is that the stocks are cheap in relation to their long-term fundamental growth potential – which I think is the case.

In fact, with the recent drop in tech stock prices, many of our portfolio companies now trade at what I think is “value” territory.

Valuations

The table below shows the recent revenue growth of the same 12 stocks in the earlier chart.

Although the share prices of the companies listed above have fallen through the roof, their businesses have actually been growing rapidly.

Revenue growth for the most recently reported quarter was between 26% (Tencent) and 369% (Zoom). Although market participants are expecting a growth-deceleration going forward as comparisons start to become more difficult in the latter part of 2021, the recent revenue-growth numbers do speak to the solid execution of the aforementioned companies.

Even with the difficult comparisons going forward, many of these companies are still expecting double digit growth for this fiscal year.

Moreover, given the tailwinds in many of the industries that these companies operate in, I expect most, if not all of them, to continue to compound revenue at upwards of 20% per year for years.

After the recent tech sell-off, these stocks are also trading at much more palatable valuations. The chart below shows the price-to-sales ratios of the 12 companies.

The trailing price-to-sales ratios of the 12 companies have declined, as share prices have fallen while revenue has grown.

The current multiples look attractive to me, given the tailwinds behind the companies listed above. I won’t go into too much detail here on why I think these multiples make sense now but you can have a look at an article I wrote on price-to-sales valuations to get a better idea of my thought process.

What matters

Volatility is part and parcel of investing.

Rather than worry about drawdowns, I prefer to monitor a company’s fundamentals to see if it can recover. Based on what I’ve seen so far, the companies that I have a vested interest in (the 12 companies listed above are not exhaustive) may have seen their share prices fall, but their business fundamentals remain solid.

Even when they were at their recent highs, I felt that these stocks would be worth much more in a decade’s time. Today, as prices have fallen from their peaks, they can provide even more long-term upside potential.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Mercado Libre, Tesla Inc, Tencent Holdings, Zoom Video Communications, Wix.com, Afterpay, Shopify, MongoDB Inc, Sea Ltd, Okta Ltd, The Trade Desk and Teladoc Health Inc. Holdings are subject to change at any time.

Earlier this week, Singapore Press Holdings Limited (SGX: T39) announced a proposal to spin off its media business. The media business involves the publishing of newspapers, magazines, and books and one of the key newspapers is The Straits Times.

I’m not an SPH shareholder. But if I was, I’d be infuriated with SPH’s plan.

Unlike normal spin-offs or sales, SPH shareholders will not get a stake in the media business that is spun off, nor will SPH get cash from the deal. Even worse, SPH is proposing to “donate” cash and shares to the new entity. That’s adding insult to injury for SPH shareholders.

While true that SPH’s media business has been on the decline, its media arm was still profitable up to FY2020 (financial year ended 31 August 2020) and recorded only its first full-year loss that year. More importantly, the media business holds valuable assets that could be sold off instead of “given away” for free.

In its investor presentation on its proposal, SPH said that its net asset value will drop to S$3.36 billion from S$3.60 billion after the restructuring. 

Effectively, SPH will be “giving away” S$238 million for free to this spun-off entity and shareholders will get nothing in return. This includes S$80 million in cash, S$20 million in SPH REIT units (23.4 million units), and S$10 million in SPH shares (6.9 million shares) that SPH is proposing to “donate” to the new spin-off.

In fact, of the S$238 million that SPH will lose in net asset value, S$237 million are in the form of tangible assets recorded on the books. Some of the assets that the company wants to “give away” include the SPH Print Center and SPH News Center that still have 13 years and 10 years remaining on their leases, respectively. These are valuable tangible assets that could be sold.

Let’s not forget that The Straits Times and all its other media brands hold intangible brand value that is not reflected on SPH’s balance sheet too. I would assume that a strategic buyer would have to pay a premium over tangible assets to acquire SPH’s media business.

And although the media business made losses in FY2020 and the first half of FY2021, proper management and the right strategies could potentially salvage the business by enhancing its digital revenue streams further. This is best showcased by other major foreign news outlets such as The Washington Post which Jeff Bezos turned around with a digital strategy after acquiring it in 2013.

Yes, I understand that The Straits Times is an important national newspaper that needs to be tightly regulated. But this restructuring deal is completely unfair to SPH shareholders.

Even though SPH is marketing the restructuring as a good thing as it is removing “dead weight” from the business, I’m not sold. And judging by the sell-off after the announcement – a 15% decline in SPH’s share price on the day after the proposal was released – it seems market participants aren’t either. The reality is that SPH’s media business can be sold, instead of given away.

Giving away money and shares for free is just rubbing salt in the wound for SPH shareholders, some of whom are retail investors who have stuck by the company for years. 

If I was a shareholder of SPH, I’d definitely be voting against the restructuring deal.

---

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have no vested interest in any companies mentioned. Holdings are subject to change at any time.

It was a busy week of earnings. All members of FAAMG (Facebook, Alphabet/Google, Amazon, Microsoft, and Apple) released their results for the first quarter of 2021 within a few days of each other. I rounded up some of the key figures and management quotes. 

For those who want the short version, all five companies reported stellar growth – despite coming off massive revenue bases – and seem well-positioned for growth. And here’s the long version.

Alphabet Inc (NASDAQ: GOOG)

The parent company of search giant, Google kicked things off with another impressive set of results. Revenue jumped 34% to US$41.2 billion, driven by broad-based growth from its advertising businesses, other services, and Google Cloud. 

Google Advertising was up 32% from a year ago to US$44.7 billion, as Youtube ad revenue grew by around 50% to US$6.0 billion. 

Google Cloud revenue grew 46% to US$4.0 billion and operating losses in the segment narrowed to just US$974 million from US$1.7 billion, demonstrating improving operating leverage.

The tech behemoth is now sitting on US$135 billion in cash and marketable securities. It announced that it would be using US$50 billion to buy back shares in the future. At its current market cap, that would reduce the share count by around 3%.

Sundar Pichai, CEO of Alphabet and Google, said that with the economy rebounding, the company’s product releases are returning to a regular cadence.

For example, Google Maps will be releasing Indoor Live View, which helps users navigate airports, transit stations, and malls using augmented reality. Google News Showcase, which Google is investing US$1 billion in, is also showing some momentum as it added more than 170 publications across 12 countries during the first quarter of 2021.

Management also believes that Google Cloud will eventually become profitable with increasing scale. Ruth Porat, CFO of Alphabet and Google, shared the following during Alphabet’s latest earnings call:

“As for Google Cloud, our approach to building the business has not changed. We remain focused on revenue growth, and we will continue to invest aggressively in products and our go-to-market organization given the opportunity we see. The operating results in Q1 in part reflect some notable items in the quarter, first, the lapping of the unusually high allowances for credit losses recorded in the first quarter of 2020 as I already mentioned; and second, lower depreciation expense due to the change in estimated useful lives, although the dollar benefit will diminish throughout the course of the year across segments. As we have noted previously, operating results should benefit from increased scale over time; however, at this point, we do remain focused on continuing to invest to build the Cloud organization for long-term performance.”

Apple Inc (NASDAQ: AAPL)

The most valuable company in the world reported a whopping 54% increase in revenue to US$89.6 billion compared to a year ago.

There was broad-based growth across Apple’s suite of hardware products of the iPhone, Mac, iPad, and other devices. iPhone sales grew 66% to US$47.9 billion, driven by the strong popularity of the new iPhone 12 series. iPad and Macs continue to see strength as work and study from home have become commonplace globally. Mac sales were up 70% to US$9.1 billion while iPad sales were up 79% to US$7.8 billion. Services revenue also grew, albeit at a slower pace than hardware sales, at 26% to US$16.9 billion.

Apple is now sitting on US$82.6 billion in net cash (total cash & investments minus total debt) after generating US$56.9 billion in free cash flow in the six months ended 31 March 2021.

Despite the run-up in Apple’s share price over the last 12 months, the company’s CFO, Luca Maestri, still feels that buybacks are a good way to allocate some of the company’s excess capital. He said in the latest earnings conference call:

“We continue to believe there is great value in our stock and maintain our target of reaching a net cash neutral position over time. Given the confidence we have in our business today and into the future, our board has authorized an additional 90 billion for share repurchases. We’re also raising our dividend by 7% to $0.22 per share, and we continue to plan for annual increases in the dividend going forward.”

Microsoft Corporation (NASDAQ: MSFT)

The tech giant reported another outstanding set of results, continuing its strong run from 2020. Revenue was up 19% to US$41.7 billion, operating income surged 31% to US$17.0 billion, and non-GAAP diluted earnings per share spiked 39% to US$1.95.

Microsoft saw broad-based growth across almost all of its products. Its Office Commercial and Office Consumer products, together with their respective cloud services, gew up 14% and 5%, respectively. In terms of revenue growth, Linkedin rose 25%, Windows OEM was up 10%, Xbox content grew 34%, and cloud computing services provider Azure spiked by 50%. 

As usual, Microsoft CEO Satya Nadella spent a good chunk of time at the company’s latest earnings conference call discussing Azure. He said:

“As the world’s COGS become more digital, computing will become more ubiquitous and decentralized. We are building Azure to address organizations’ needs in a multi-cloud, multi-edge world.

We have more data centre regions than any other provider, including new regions in China, Indonesia, Malaysia, as well as the United States.

Azure has always been hybrid by design, and we are accelerating our innovation to meet customers where they are. Azure Arc extends the Azure control plane across on-premises, multi-cloud, and the edge, and we’re going further with Arc-enabled machine learning and Arc-enabled Kubernetes.”

He also added that Microsoft is positioned to meet the data analytics demands of its clients. He explained:

“ The next-generation analytics service, Azure Synapse, accelerates time to insight by bringing together data integration, enterprise data warehousing, and big data analytics into one unified service. No other provider offers the limitless scale, price-performance, and deep integrations of Synapse. With Spark integration, for example, organizations can handle large-scale data processing workloads. With Azure Machine Learning, they can build advanced AI models. With Power BI, anyone in the organization can access insights. 

We are seeing adoption from thousands of customers, including AB InBev, Dentsu, and Swiss Re. Queries performed using Synapse have increased 105 per cent over the last quarter alone. 

We are leading in hyper scale SQL and non-SQL databases to support the increasing volume, variety, and velocity of data. Customers continue to choose Azure for their relational database workloads, with SQL Server on Azure VMs uses up 129 per cent year over year. And Cosmos DB is the database of choice for cloud-native app development – at any scale. Transaction volume increased 170 percent year over year.”

Facebook Inc (NASDAQ: FB)

It was nothing short of an amazing quarter for Facebook. Revenue was up 48% to US$26.2 billio, with advertising revenue jumping 46% to US$25.4 billion. Facebook enjoyed a 30% increase in the average price per ad, and a 12% hike in the number of ads shown.

With monthly active users growing more slowly and ad load reaching optimum levels, Facebook said that ad prices will be its primary driver of growth for the rest of 2021.

The company also lowered its 2021 capital expense outlook from US$21-23 billion to US$19-21 billion.

COO Sheryl Sandberg spent some time in the latest earnings conference call addressing the impact to Facebook’s business stemming from changes to Apple’s privacy policy which lets users opt out of tracking. She said:

“Yes, there are challenges coming to personalized advertising and we’ve been pretty open about that. We’re doing a huge amount of work to prepare. We’re working with our customers to implement Apple’s API and our own Aggregated Events Measurement API to mitigate the impact of the iOS14 changes. We’re rebuilding meaningful elements of our ad tech so that our system continues to perform when we have access to less data in the future. And we’re part of long-term collaborations with industry bodies like the W3C on initiatives like privacy enhancing technologies that provide personalized experiences while limiting access to people’s information.

It’s also on us to keep making the case that personalized advertising is good for people and businesses, and to better explain how it works so that people realize that personalized ads are privacy-protective.

Small businesses don’t have to understand the alphabet soup of acronyms they’ll need to comply with, but they do need to have confidence that they can still use our tools to reach the people who want to buy what they’re selling in a privacy-safe way. We’re confident they can, and that they can continue to get great results as digital advertising evolves.”

The other thing that caught my attention is Facebook’s recent success with Oculus (the company’s AR/VR platform) and the company’s focus on doubling down on AR/VR technology. Facebook CEO Mark Zuckerberg said,

“I believe that augmented and virtual reality are going to enable a deeper sense of presence and social connection than any existing platform, and they’re going to be an important part of how we’ll interact with computers in the future. So we’re going to keep investing heavily in building out the best experiences here, and this accounts for a major part of our overall R&D budget growth.”

He added,

“One interesting trend is that we’re seeing the app ecosystem broaden out beyond games into other categories as well. The most used apps are social, which fits our original theory for why we wanted to build this platform in the first place. We’re also seeing productivity and even fitness apps. For example, we launched a tool so people can subscribe to services like FitXR to do boxing and dancing in VR just like they would for biking on Peloton.

We introduced App Lab so developers can ship early versions of their apps directly to consumers without having to go through the Oculus Store. Between App Lab and streaming from PCs, we’re pioneering a much more open model of app store than what’s currently available on phones today.

Over time, I expect augmented and virtual reality to unlock a massive amount of value both in people’s lives and the economy overall. There’s still a long way to go here, and most of our investments to make this work are ahead of us. But I think the feedback we’re getting from our products is giving us more confidence that our prediction for the future here will happen and that we’re focusing on the right areas.”

Amazon.com Inc (NASDAQ: AMZN)

The e-commerce and cloud computing juggernaut rounded things off on Friday morning (Singapore time) by announcing a spectacular set of results.

Net sales was up 44% to US$108.5 billion. As a result, operating income was up by 122% to US$8.9 billion, and diluted earning per share up 213% to US$15.79. Revenue from AWS – the company’s cloud computing services provider -grew 32% to US$13.5 billion and us now a US$54 billion sales run rate business. Amazon has also breached the 200 million paid Prime members mark worldwide. The company’s business outside of North America reported its 4th consecutive quarter of profitability and generated more than a billion dollars in profit for the first time.

Amazon’s high margin third-party seller services and subscription services businesses increased revenue by 60% and 34% respectively. Brian Olsavsky, CFO of Amazon, sees more growth for AWS even in a post-pandemic world. He shared the following in Amazon’s latest earnings conference call:

“During COVID, we’ve seen many enterprises decide that they no longer want to manage their own technology infrastructure. They see that partnering with AWS and moving to the cloud gives them better cost, better capability and better speed of innovation. We expect this trend to continue as we move into the post pandemic recovery. There’s significant momentum around the world, including broad and deep engagement across major industries.

---

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Facebook, Amazon, Alphabet, Microsoft and Apple. Holdings are subject to change at any time.

Coinbase is the talk of Wallstreet. It will begin trading on the NASDAQ through a direct listing tonight. Coinbase allows users to buy and sell crypto assets such as Bitcoin and Ethereum and its business has been on a tear of late. Revenue doubled in 2020 and then surged over 900% in the first quarter of 2021. 

Its shares have recently traded privately at a company-valuation of close to US$100 billion, making it even more valuable than traditional stock exchanges like NASDAQ Inc (NASDAQ: NDAQ) and Intercontinental Exchange Inc (NYSE: ICE), which is the parent company of the New York Stock Exchange.

Coinbase’s high valuation and strong business performance come as interest in cryptocurrencies spiked in 2020 and early 2021.

With the hype around Coinbase, I decided to take a quick look at its prospectus and note down some reasons for and against investing in it. Here’s my list.

Reasons to invest

Rocketing recent growth: Coinbase’s business has catapulted recently with the surge in demand and interest in crypto assets. Investors use recent growth as a proxy for what is to come in the future. 

Profitable business: Unlike most tech companies seeking to go public, Coinbase is already a profitable business. In fact, it is very profitable. In 2020, Coinbase generated US$322.3 million in net income from US$1.3 billion in revenue, giving it an impressive net income margin of 24.8%. In the first quarter of 2021, Coinbase announced that it made between US$730 million to US$800 million in net income from US$1.8 billion in revenue.

Operating leverage: Coinbase can improve its margins further with operating leverage. As demonstrated in the first quarter of 2021 , its net income margin improved to around 41%, compared to 24.8% for the whole of 2020. If Coinbase’s take rates remain steady, its margin can improve due to the low marginal cost for servicing each additional transaction.

Big addressable market(?): Crypto bulls will argue that Bitcoin and other crypto-assets will become must-own financial instruments. Coinbase has gone as far as to say: “Our objective is to bring crypto-based financial services to anyone with a smartphone, a population of approximately 3.5 billion people today.” For perspective, Coinbase had 56 million users at the end of March 2021.

Secure platform and trusted brand:  With a crypto-exchange playing the role of custodian of crypto-assets, users need to trust that the platform is secure and reliable. Coinbase CEO, Brian Armstrong explained in his Founder letter: “Trust is critical when it comes to storing money. From the early days, we decided to focus on compliance, reaching out to regulators proactively to be an educational resource, and pursuing licenses even before they were needed. We invested heavily in cybersecurity, built novel key storage mechanisms, and obtained a cybercrime insurance policy. We even developed ways for customers to custody their own cryptocurrency safely, so they didn’t need to trust us at all. Most importantly, we built a culture that doesn’t take shortcuts or try to make a quick buck.” While building security is expensive and a gruelling task, it should put Coinbase in a good position to win costumers looking to start their crypto journey.

Network effect and scale provide liquidity: As one of the biggest crypto exchanges in the world, Coinbase boasts scale and can hence provide better liquidity which gives users better prices on their trades.

Reasons not to invest

Revenue impacted by prices of crypto assets: Coinbase acknowledges on its prospectus that the prices of crypto assets can impact demand for buying, selling, and trading them. There was a steep decline in crypto asset prices in 2018 which Coinbase said adversely affected its net revenue and operating results. Should similar price declines in crypto assets occur in the future, Coinbase’s revenue may again fall sharply.

Highly dependent on Bitcoin and Ethereum: Although Coinbase supports the exchange of other cryptoassets, the bulk of its transaction volume and revenue comes from Bitcoin and Ethereum. In 2020, these two cryptocurrencies drove over 56% of Coinbase’s total trading volume on its platform. As such, a sudden fall in transaction volume in these two crypto assets can have a big impact on Coinbase’s revenue.

Competition: Unlike stock exchanges, the barriers to entry to become a crypto exchange is much smaller. Although Coinbase has built up a solid reputation, margins can be easily eroded if more aggressive brokers come up with innovative ways to eat market share. In an article for Fortune, Shaun Tully argues that Coinbase’s high transaction fees will not last. At the moment, Coinbase charges an average fee of around 0.46%. In comparison, stock exchanges such as ICE and NASDAQ each make 0.01% on each dollar of securities traded. Tully writes:

“It can’t last, says Trainer. He predicts that fees for trading cryptocurrencies will follow a similar downward trajectory as those in stocks, possibly all the way to zero. Coinbase’s slice of each transaction is so big, and its profits so gigantic, that rivals can slash what they’re charging and still mint huge profits. “Competitors such as Gemini, Bitstamp, Kraken, Binance, and others will likely lower or zero trading fees to take market share,” he says. “If margins are that good, you invite competition.” That will start a “race to the bottom” similar to the contest for market share that triggered the collapse, then virtual elimination, of stock commissions in 2019. Trainer also expects traditional brokerages to soon offer trading in cryptocurrencies, further pressuring Coinbase’s rich fees.”

High valuation: As mentioned earlier, Coinbase could start trading at a valuation of around US$100 billion. This translates to around 14 and 32 times its annualised first-quarter revenue and net profit, respectively. Although those numbers may not seem that high (compared to other tech firms) at first glance, the possibly volatile nature of Coinbase’s business, and possible impending margin compression, might suggest otherwise.

Final words

If Coinbase’s US$100 billion valuation comes to fruition, it can begin life as a public company as one of the 100 biggest companies in the world, even ahead of established names such as Postal Savings Bank of China (SHA: 601658), Softbank Group Corp (TYO :9984), and Starbucks (NASDAQ: SBUX). 

This is a staggering achievement for a company that was founded only around 10 years ago. This does not mean Coinbase is a good investment going forward though. Investors need to consider the host of factors that could impact its eventual return for shareholders. Hopefully, this list provides a good starting point for investors who are thinking of investing in Coinbase.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Starbucks are subject to change at any time.

Netflix Inc (NASDAQ: NFLX) is ushering in a new era in its business.

The streaming video giant delighted investors in January when it announced in its 2020 fourth-quarter earnings update that after years of burning cash, it is finally close to being self-sustainable

Subscription video on demand (SVOD) as a business had previously been a highly contested topic among investors. Although there is no denying that there is product-market fit, Netflix has burnt through billions in cash to build original content each year, raising questions about the unit economics of the business model. 

But cash-burn may soon be a thing of the pass for the undisputed king of SVOD. 

For 2021, Netflix said that it anticipates free cash flow to be around break-even. It is so confident in its ability to be self-sustaining that it plans on repaying some of its bonds and even toyed with the idea of returning cash to shareholders through share buybacks.

Unsurprisingly, Netflix’s optimism was met with enthusiasm from stock market participants. On the day after the announcement of its fourth-quarter results, Netflix’s share price spiked by more than 10%. 

So, what’s driving Netflix’s change in fortunes?

The short answer is scale and operating leverage.

Since the start of 2018, Netflix’s paid memberships have risen from 111 million to 204 million. In addition, price hikes have made each member more valuable to Netflix. Its average monthly revenue per member has grown from US$9.88 to US$11.02.

Consequently, Netflix’s revenue has increased by 113.7% from US$11.7 billion in 2017 to US$25 billion in 2020.

At sufficient scale, Netflix can fund its original content production entirely from the cash earned from subscriptions.

In early 2020, I wrote an article titled What Investors Don’t Get About Netflix titled. In it, I explained:

“To improve its free cash flow metric, Netflix needs to spend much less as a percentage of its revenue. And I think its entirely possible that this scenario will play out sooner rather than later. The math is simple. 

There is a fixed cost to producing content but the value of the content scales as the user count grows. 

For instance, the content that Netflix is producing today can reach its 167 million global subscribers. But as the number of subscribers grows, the content it is producing will reach a larger subscriber base. Put another way, the fixed amount spent on each movie or series will be spread out across a much larger revenue base as user count grows.

Over time, the amount of cash spent on content will take up a much lower percentage of revenue and, in turn, free cash flow should eventually be positive.”

This scenario seems to be playing out exactly as I wrote. Netflix, now with its 204 million members paying monthly subscriptions, can start to internally fund its content production each year.

And it likely gets better from here…

With Netflix hitting this breakeven milestone in its business, the company will likely start to exhibit extremely strong unit economics moving forward.

Put another way, from 2022 onwards, we are likely to see a high free cash flow margin generated from each net member addition.

How much can Netflix potentially earn? Well, looking at the market opportunity, I believe the company’s annual free cash flow could be in the tens of billions.

With around 1.6 billion television households worldwide and an estimated 45% of those having broadband internet access, Netflix has an addressable market of roughly 720 million households. If we assume that Netflix manages to penetrate just 50% of that market, it will have 360 million members – or around 155 million more than it reported for the fourth quarter of 2020.

Let’s also assume that Netflix has factored in 20 million new members in 2021, which will bring its free cash flow number to break even.

To be conservative, let’s also say the contribution margin of every subsequent member added is 90%. Using average revenue per user of US$11, we can calculate that by the time Netflix hits 360 million subscribers, it could potentially be generating US$16 billion* in free cash flow annually. That’s a hefty sum – bear in mind too that I did not even factor in any price hikes.

Ending thoughts…

Netflix has long been a highly debated company among investors. Although it is normal for a young technology company to be burning money, Netflix is far from a young tech startup. Its streaming service has been around for more than a decade and yet it has been lighting up cash for years, raising doubts about the sustainability and unit economics of its business.

But the early criticism from outsiders is starting to look misplaced. Netflix, despite the competition from Disney Plus, and other content-giants, is still the top dog when it comes to SVOD. Steady member growth and low churn speak to that. It’s early (and steady) investments in producing original content are starting to reap the rewards, driving new memberships and increasing the value of its service to existing members.

Netflix’s co-CEO and co-founder, Reed Hasting, perhaps knew it all along. In Netflix’s 2017 fourth-quarter letter to shareholders, a time when it was still burning billions of dollars each year, the company wrote:

“We are increasing operating margins and expect that in the future, a combination of rising operating profits and slowing growth in original content spend will turn our business FCF positive.” 

Netflix is one of the modern era’s great examples of how long-term investing pays off. The company was willing to endure years of cash burn and even tapped into the high-interest debt market to fund its growth. But these investments will likely more than pay off in the years to come.

To me, Netflix is a poster child of the benefits of long-term investing, and a shining example for any serious long-term investor to learn from.

* Calculated by using 224 million as the breakeven number of members. The equation is (360 million-224 million)*US$11*12*0.9.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Netflix Inc. Holdings are subject to change at any time.

You’ve likely heard about the Gamestop Corp (NYSE: GME) saga. I didn’t want to write a post on it but I realised that there is one glaring misconception among Reddit investors that should be addressed.

Many users within the Wallstreet Bets group in Reddit have mentioned that they want to save Gamestop from short sellers.

It’s as if they believe that pumping up the share price of Gamestop will somehow save or help the company.

I appreciate the noble thought, but the concept that driving a company’s share price higher will help it is not how stocks work.

What’s really going on

The stock price is simply the last traded price of the company’s stock. It is the amount that the latest buyer paid to purchase the stock from the previous stock owner.

Buying and selling shares on the stock exchange does not in any way impact the underlying business fundamentals of the company. The money you are paying to buy Gamestop’s stock actually goes to the person who sold you the stock, and not to Gamestop, the company. 

Likewise, there is a misconception that short sellers are destroying a company by trying to drive a company’s stock price down.

This is not the case. Even if a company’s stock price declines, the fundamentals of the company will not change. A fundamentally solid company with a low stock price may, in some cases, even be a good thing for its long-term shareholders: The company can take advantage of the low stock price by buying back its shares to reduce the outstanding share count.

A great example is Restoration Hardware Holdings (NYSE: RH), which was targetted by short-sellers in 2017 and 2018. Seizing the opportunity presented by a low stock price, Restoration Hardware’s management team used the company’s cash to buy back its shares, resulting in a 59.8% decline in its outstanding share count. This created massive fundamental long-term value for its remaining shareholders. Its stock is now up 1,600% since the start of 2017.

How to really save Gamestop?

If you really want to help Gamestop, you can purchase merchandise directly from Gamestop’s retail stores. This hands money over to Gamestop directly.

Similarly, if Gamestop offers a secondary offering or issues a bond, investors who buy into these offerings will be handing money directly to the company. 

These are the real ways that you can help Gamestop’s business.

The unpopular truth is that just buying Gamestop’s stock on the stock market is not really helping Gamestop at all.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned.

Singapore-listed luxury watch retailer The Hour Glass (SGX: AGS) has frustrated shareholders for a few years now. Its share price peaked at S$0.88 in 2015 and has been bouncing sideways since. Today, Hour Glass’s shares trade at just S$0.80 each.

The curious thing is that Hour Glass’s business fundamentals have actually improved since 2015.

While many traditional brick and mortar retailers have struggled due to the introduction of e-commerce, this luxury watch retailer has bucked the trend.  The reason is that the supply of Swiss luxury watches is tightly controlled. Hour Glass has long-standing relationships with brands such as Rolex and Patek Phillipe, giving it near-exclusive rights in Singapore to sell their highly coveted models.

As such, watch collectors who want to buy first-hand watches in Singapore have little choice but to come to Hour Glass. This has been reflected in its financial statements.

Profit has increased from S$53.5 million in FY2016 (fiscal year ended 31 March 2016) to S$77.5 million in FY2020. Because Hour Glass retains much of its earnings, its net asset value per share has similarly increased from S$0.62 as of March 2016 to S$0.90 as of 30 September 2020.

Hour Glass’s business is also very resilient. A good exhibit is its strong performance from April 2020 to September 2020, a period that included Singapore’s COVID-19 lockdown. In these six months, despite having to close its shops for two months during the circuit breaker we have here in Singapore, Hour Glass still managed to be profitable, generating S$38 million in profit, down just 15% from a year ago.

So what is holding back its share price?

Despite all of this, Hour Glass’s share price is still short of its all-time high price reached way back in 2015. Even the most patient shareholders will likely be getting frustrated by the lacklustre performance of the stock. I was one of these investors, buying its shares in 2014 and holding it till early 2020.

In my view, one of the reasons why its share price has fallen is that there is a lack of cash-reward for investors to buy its shares. 

Although the company has grown its profits substantially over the years, it has not used the cash it earned to reward shareholders. In fact, Hour Glass has only been paying out a very small portion of its earnings as dividends to shareholders, opting instead to retain its cash on its own books.

Retaining cash can be a useful thing for a company that has the option of using the cash to generate high returns on capital. Unfortunately, in Hour Glass’s case, this cash has been left in the bank, generating very little returns to shareholders.

With little capital appreciation and a relatively low dividend yield of just 2.5%, there has not been much reason for investors to hold shares of the watch retailer. 

The solution?

I think there is a solution to this problem: Hour Glass can simply start to reward its shareholders by returning some of its excess capital to them. One way to do this is to pay a higher regular dividend or a fat one-time special dividend.

Returning cash to shareholders as dividends give investors confidence that they will be paid while owning the company’s shares, hence giving investors a reason to pay up for those shares.

Another way for Hour Glass to reward shareholders is to use its spare capital to buy back its shares.

Share buybacks result in a lower cash balance, but it also reduces the outstanding share count. Remaining investors will end up with a larger stake in the company after the buybacks. This can be hugely rewarding for shareholders, especially when share buybacks are made at depressed prices.

The power of share buybacks

A great example of the power of share buybacks is the story of one of Warren Buffett’s investments, RH, formerly known as Restoration Hardware.

There are many similarities between RH and Hour Glass. Like Hour Glass, RH is a specialist retailer that has generated consistent free cash flow and profits despite the emergence of e-commerce. RH’s share price was also hammered down back in 2017 and 2018 – market participants shorted the company because they were skeptical about the longevity of such a retailer in the face of the emerging threat from online retailers.

The management team of RH were, however, confident of the company’s brand appeal and the strength of its business. Believing that the market was discounting the value of its business, RH began an aggressive share buyback spree. Within three years, RH had used all of its net cash to buyback shares and even borrowed money to acquire more shares. In all, RH reduced its share count by a staggering 59.8%.

This resulted in RH’s remaining shareholders owning close to 2.5 times the stake that they previously had. As a result of the buybacks, the company’s earnings per share skyrocketed and investors started to sit up and take notice. RH’s share price is today up 15-fold since the start of 2017 when the company initiated its share repurchase program.

So what if Hour Glass repurchases its shares?

Hour Glass could do something very similar to RH. It could potentially use a large chunk of its net cash to buy back some of its shares. As of 30 September 2020, Hour Glass had S$136 million in net cash sitting in its coffers. Using just 70% of its net cash to buy shares, at current prices, will result in a 17% decrease in its outstanding shares. In addition, by keeping 30% of its current net cash as reserves, it will still have plenty of firepower for working capital and expansion needs.

Such a buyback plan will not just increase Hour Glass’s earnings per share, but will also increase its book value per share, as Hour Glass is currently trading at an 11% discount to book value. It is also worth noting that Hour Glass trades at just 7.4 times FY2020 earnings.

Share buybacks will, in turn, give Hour Glass the ability to pay a much higher dividend per share in the future (since the total dollar outlay will be lower with a lower share count).

Final thoughts

The importance of good capital allocation decisions should never be underestimated. Even though its business fundamentals have improved, Hour Glass’s reluctance to return capital to shareholders, and its inability to generate good returns on retained earnings, has resulted in an extremely disappointing share price.

I can’t fault market participants for being reluctant to pay any higher for Hour Glass’s shares given the lack of impetus for sound capital allocation and a dividend yield of just 2.5%.

But I think there is a simple solution to the problem. With a resilient business that generates cash year after year, copious amount of excess cash on its books, and a chronically depressed share price, share buybacks seem like a rather easy problem-solver in my view.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently do not have any vested interest in the shares of any companies mentioned in this article. Holdings are subject to change at any time.

A few weeks ago, the world rejoiced to the news that two COVID-19 vaccine trials produced extremely encouraging results.

Pharmaceutical giant Pfizer Inc (NYSE: PFE) and BioNtech (NASDAQ: BNTX) announced that their trial COVID-19 vaccine was 95% effective. In its phase III trial, out of the 170 confirmed cases of COVID-19 among the trial participants, 162 were from the placebo group, while only 8 were in the vaccine group. 

Hot on the heels of Pfizer and BioNtech’s announcement, Moderna (NASDAQ: MRNA), a young front-runner in the development of mRNA-based vaccines, announced that its own investigational COVID-19 vaccine had promising interim results. Out of 95 participants of the trial who got COVID-19, only 5 were from the vaccinated group, suggesting a 94.5% efficacy rate.

Stock markets have reacted sharply to the news. Moderna’s current share price is nearly 60% higher from the day before its vaccine announcement on 16 November 2020, while BioNtech’s share price is up by 24% since its joint announcement with Pfizer on 9 November.

Year-to-date, Moderna and BioNtech’s share prices are up by 621% and 237%, respectively.

US$200 billion opportunity

With the hype surrounding these two companies, I wanted to find out if it was too late to get in on their shares. To do so, I came up with a simple calculation to see how much the two companies could potentially earn from their vaccines.

We are currently being told that for best efficacy, two doses of the vaccines are required. There are 7 billion people in the world and to achieve herd immunity, 70% of the population (5 billion people) needs to be vaccinated.

Based on these figures, the world will need about 10 billion doses. 

The US government has placed an initial order of 100 million doses for US$1.95 billion with Pfizer and BioNTech, with the option to purchase 500 million additional doses.  That works out to US$20 per dose. Moderna has said that it will charge between US$25 and US$37 per dose.

Moderna’s market cap vs its potential profits

We can now answer the question of whether the rally in Moderna and BioNTech’s share prices are justified.

Let’s take a base case scenario that the two front runners will manage to corner 50% of the market opportunity.

If Moderna can supply 25% of the global need for COVID-19 vaccines, it will need to supply 2.5 billion doses. We can also assume that these vaccine doses will be sold over a few years. Moderna CEO Stephane Bancel said that they are on track to produce between 500 million to 1 billion doses in 2021.

For the sake of simplicity, let’s assume that Moderna will sell 500 million doses a year for five years. Based on US$25 per dose, that translates to US$12.5 billion in revenue each year.

Pharmaceutical companies can command extremely high margins, especially for a novel product that is first to the market. Given this, Moderna can possibly earn a gross margin as high as 60%, and a net margin of 40%. This will mean that Moderna could earn an annual net profit of US$5 billion based on my projected revenue figure.

Moderna currently sports a market cap of US$56 billion. Given these assumptions, it trades at around 11 times its potential annual earnings.

How About BioNTech?

BioNtech currently has a market cap of US$27.5 billion. Pfizer has agreed to pay BioNTech US$185 million in a mix of cash and Pfizer shares, and an additional US$563 million for future milestone payments.

In addition, BioNTech stands to earn 50% of the profit brought in from the sale of the vaccines.

Pfizer and BioNTech sold their first batch of vaccine doses to the US government at US$20 per dose. If they can sell a similar number of doses as Moderna and achieve similar margins, BioNTech’s share of the profit will be around US$2 billion.

Based on this scenario, BioNTech trades at 14 times this potential annual earnings.

If the above scenarios materialise, BioNTech and Moderna stand to gain a huge windfall. On top of that, their current valuations, at less than 15 times future earnings each, do not seem too demanding.

But…

… there are risks. 

First of all, not every government may be willing to pay for the vaccines to immunise their country. Governments from first world countries such as the US, UK, Malaysia, and Singapore have shown a willingness to pay for the vaccines for their citizens but other countries may not be so willing or even have the means to do so. If fewer governments bite, my estimate of a market opportunity of 10 billion doses over five years may have been overstated.

Another thing to consider is the threat of new vaccines. Competition could erode margins and lead to a lower market share than I modelled for. Pharmaceutical giants AstraZeneca and Johnson and Johnson, have pledged not to make a profit from their vaccines as long as the world is still in a pandemic. This could force companies like Moderna to lower their prices if vaccines from these companies gain approval in the coming months.

We should also not overlook the fact that the vaccines may be effective enough that patients do not need a booster every few years. In this scenario, it could be possible that after the initial demand for vaccines, and once global herd immunity is achieved, subsequent demand for vaccines will subside and earnings will dry up.

This is a legitimate concern as both BioNTech and Moderna have no other product currently in the market.

Potential tailwinds

But there are some potential tailwinds on the cards. Both Moderna and BioNTech have a healthy pipeline of drugs in development besides their COVID-19 vaccines.

The success of their COVID-19 vaccines also validates the potential of mRNA technology in other use-cases. Experts claim that mRNA-based vaccines could potentially be targeted at numerous diseases that we previously had no vaccines for. Both companies specialise in mRNA technology and could stand to benefit from this breakthrough. Moderna, for example, is working on another mRNA vaccine for CMV, which is already in phase II clinical trial.

Besides vaccines, both companies are also researching drugs that use similar mRNA technologies to treat cancer. Moderna currently has a total pipeline of 20 other drugs while BioNTech boasts a pipeline of 28. If another blockbuster drug reaches the market, they could unlock a different source of profits.

So is it too late to buy now?

Investing in young Biotech companies is risky but can be rewarding. The successful commercialisation of a single drug, as in the case of both Moderna and BioNTech, can lead to a multi-year windfall for the company and, as shown, a large appreciation in its share price.

However, there are also risks to pre-product companies.

Many may start off with a promising novel technology only to stumble at the final hurdle.

In Moderna and BioNTech’s case, they seemed to have successfully navigated the final hurdle to commercialisation by posting excellent phase III results for their COVID-19 vaccines. The market opportunity for them is huge and they are set to bring in copious amounts of cash in the not so far future.

But are investors on the sidelines too late now? With the spike in both the share prices of Moderna and BioNTech, and considering the possibility of competition, it seems that the market has already priced in a substantial amount of the future earnings from both companies’ COVID-19 vaccine.

I believe investors who are still considering investing in these two companies should not focus on the COVID-19 vaccine as this has already been priced into the stock. Instead investors should explore the pipeline of drugs and how Moderna and BioNTech plan to invest their windfall. This will be a greater determinant of the long-term returns of the company’s shares.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. We currently have no vested interest in any companies mentioned. Holdings are subject to change at any time.

Zoom Video Communications Inc (NASDAQ: ZM) has been on a roll this year. The video conferencing software provider has been one of the main benefactors of the COVID-19 pandemic.

In the quarter ended 30 April 2020, Zoom’s revenue increased by a mind-boggling 169% from the corresponding period a year ago. But that wasn’t all. In the very next quarter ended 31 July 2020, Zoom again blew past expectations, reporting a 355% increase in revenue.

Unsurprisingly, investors have reacted sharply to the news, sending Zoom’s stock price up 460% since the turn of the year. As of the time of writing, the company was valued at US$114.8 billion. To put that in perspective, the Singapore stock market’s largest company by market capitalisation, DBS Group Holdings, is only valued at S$61 billion. Zoom was born just nine years ago in 2011 while DBS took 52 years to get to where it is today.

The question now for investors is whether Zoom is overvalued. 

Growth skeptic

In March this year, I preached conservatism when it came to Zoom. The company, then, had a market cap of around US$38 billion. It had just doubled in value and I was concerned that investors were getting too optimistic. 

Looking back, I was way too conservative in my growth projections. Zoom went on to blow past consensus expectations in the two quarters after that, as I had described earlier, far exceeding what some of the biggest bulls had expected.

Zoom has become more than just a company, it has become a verb. Even my non-techy parents use “Zoom” as a synonym for video conferencing.

Since my article, Zoom has more than quintupled in value. After seeing the quick pace of adoption, my blogging partner, Ser Jing, and I decided that Zoom was worthy of a place in our investment fund’s portfolio.

We bought our first tranche of shares at US$254, which was then close to an all-time high and have added more since. Today, Zoom’s shares trade at around US$404.

Believing

I used to be one of the sceptics when it came to Zoom’s valuation but I am now firmly in the opposite camp. In fact, I think that even after the recent run-up in its share price, Zoom can still provide significant value for long-term investors.

Zoom exited the quarter ended 31 July 2020 with an annual revenue run rate of US$2.6 billion. Unlike many high-growth software companies, Zoom boasts not just GAAP profitability, but also a high free cash flow margin. In that quarter, it had a free cash flow margin of 56%. Boosted by record collections during the quarter, Zoom’s cash flow margin is best-in-class for software companies.

Even after accounting for any one-off jump in collections for the quarter, I think Zoom can settle at a free cash flow margin of close to 40% at its steady state.

Given this, and using Zoom’s annual revenue run rate, Zoom currently trades at a normalised price-to-annual free cash flow run rate multiple of 110. By most accounts that seems like a high multiple to pay. But let’s not forget that Zoom has immense business momentum in its favour. The company just grew by a staggering 355% in the last quarter and in its recent Zoomtopia customer and investor day event, the company let slip that usage is up since then.

Can Zoom continue to grow?

Zoom has undoubtedly been one of the benefactors of shelter-in-place measures enacted by governments around the world to combat COVID-19. But even after life returns to normal, I believe Zoom will still be a mainstay for most companies. Video conferencing has become a norm due to the ease and practicality of its use. In fact, many companies have announced that they will permanently adopt work-from-home or hybrid work settings, allowing employees to spend either all or part of their time working from home.

Although Zoom’s growth will understandably slow when the pandemic passes, I believe the company will still see decent growth well into the future as video conferencing becomes even more prevalent for businesses and individuals alike.

Zoom is also barely scratching the surface of its total addressable market. In its IPO prospectus released last year, Zoom stated that it is addressing a US$42 billion communications market, according to independent market researcher International Data Corporation. But I believe the US$42 billion figure understates the increasing number of use cases that video conferencing addresses. The pandemic has demonstrated that video conferencing software can be used for education, telemedicine, fitness classes, and many more purposes than previously imagined. 

Given the momentum in video conferencing, I think it is not beyond Zoom to quadruple its annual revenue and free cash flow run rate in five years to north of US$10 billion and US$4 billion respectively.

Zoom’s current valuation is, hence, just 28 times that projected free cash flow in 2025. More importantly, I don’t see its growth stopping there. Zoom’s CEO, Eric Yuan, and his crew are highly innovative and have already recently released new products such as Zoom Phone and Zoom hardware to expand its addressable market. 

Final words

From a trailing-12-months perspective, Zoom seems immensely overvalued. However, for a company that is growing as fast as Zoom is, the next 12 months will look very different from the last 12, so we certainly shouldn’t be looking backwards to come up with a valuation.

Looking beyond the next 12 months, Zoom’s growth will likely endure as it seeks to win its share of the more than US$42 billion market opportunity ahead of it. Competition remains a threat to Zoom, given that Zoom users can just as easily switch to an alternate software. But I believe that Zoom’s relentless pursuit of customer satisfaction and its superior product gives it a big leg up over its competitors. Zoom boasts a net promoter score of 62, the highest among video conferencing software that I’ve seen. 

Zoom’s branding is also remarkably strong at the moment. Like Google, Zoom has become a verb, which is a fact that shouldn’t be underestimated.

Although there is invariably a chance that Zoom can lose its focus on satisfying customer, and competition can erode growth, the pie is large enough for multiple winners in this space. Given all this, and the momentum behind Zoom, I think that the odds of its success far outweigh the risks. For more on Zoom, you can head here to find an investment thesis for the company that Ser Jing and I have penned for our investment fund.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Zoom Video Communications. Holdings are subject to change at any time.

Tesla recorded another profitable quarter in the second quarter of 2020, marking a fourth consecutive quarter of GAAP (generally accepted accounting principles) profit for the company. It was a welcome change for the previously cash burning and unprofitable electric vehicle pioneer. 

But eagle-eyed investors will have noticed that virtually all of Tesla’s profit and free cash flow generated over the last 12 months was due to the sale of ZEV (Zero Emission Vehicle) credits.

The company booked US$1.05 billion from the sale of regulatory ZEV credits in the 12 months ended 30 June 2020. During the same time period, Tesla recorded US$368 million and US$907 million in net profit and free cash flow, respectively.

So what are regulatory ZEV credits?

To incentivise automobile manufactures to sell ZEVs, some states in the USA have adopted a regulatory credits program, termed the ZEV Program. The ZEV Program is a state law, which currently applies to 12 states in the USA.

This law mandates that a certain percentage of each automobile manufacturer’s annual sales must be made up of zero-emission vehicles, measured by what is termed ZEV credits. ZEV credits can be earned by selling ZEVs such as battery and hydrogen fuel cell electric vehicles or Transitional Zero-Emission Vehicles (TZEV) which include hybrid vehicles.

How Tesla makes money from the ZEV program

In order to avoid penalties, manufacturers who sell in states which impose the ZEV program need to earn a certain number of ZEV credits.

There are two ways to achieve this. Either they sell sufficient ZEVs and TZEVs to chalk up enough credits, or they can buy ZEV credits from manufacturers who have built up excess ZEV credits to sell.

This regulation works beautifully for Tesla. As every vehicle sold by Tesla is a long-range electric vehicle, it generates a lot more ZEV credits than it requires. As such, it can sell excess credits to other automobile companies who need them, earning Tesla extra income at virtually no additional expense.

Can Tesla keep selling ZEV credits?

But how long can this last? Historically, Tesla’s revenue from ZEV sales has increased as more states started imposing the ZEV program.

The ZEV program originated in California in 1990 and has since extended to a total of 12 states in the US. There are a few things to consider here.

First, is the speed of regulatory changes. Tesla can benefit if more states start to impose the ZEV program.

Similarly, Tesla benefits if states that are already imposing the ZEV program increase the credit requirements. For example in California, ZEV targets are expected to rise from 3% of sales to around 8% by 2025.

Another near-term tailwind is that some credits that were bought in the past are due to expire. A recent report by EPA found that some large automakers buy credits in advance to satisfy future requirements. Some of the “banked” credits are set to expire at the end of 2021 if not used. This might result in a rush for ZEV credits in the next few years.

But it won’t last…

However, selling ZEV credits will likely not be a long-term revenue driver for Tesla. Traditional ICE (internal combustion engine) automobile makers are shifting more of their resources towards ZEVs and TZEVs. As their sales mix shifts, they will eventually be able to comply with the ZEV program without having to buy additional ZEV credits.

At Tesla’s analyst briefing for 2020’s second quarter, Chief Financial Officer Zachary Kirkhorn said:

“We don’t manage the business with the assumption that regulatory credits will contribute in a significant way to the future. I do expect regulatory credit revenue to double in 2020 relative to 2019, and it will continue for some period of time. But eventually, the stream of regulatory credits will reduce.”

Tesla can live without this extra income

Tesla is still in the early innings of its grand plan for fully-autonomous vehicles. It also has the ability to keep raising more capital through the sale of its high-flying stock.

Shareholders will also note that Elon Musk said that its autonomous software could be valued as much as US$100,000 per vehicle. With a growing base of Tesla vehicles, which are fitted with autonomous vehicle hardware, Tesla has a ready base of customers to up-sell a much higher margin software product.

In the meantime, the sale of ZEV credits can continue to be a source of cash for the next few years as the company bridges for the next phase of its business. Hopefully for shareholders, by the time the sale of ZEV credits dry up, Tesla’s other businesses will exhibit greater profitability and higher margins to keep the company’s profits and cash flow streaming in.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.