July 10-14, 2023

Weekly Update

Let’s get right into the news for this week!

Tesla

There was quite a bit of Tesla news so let’s take it one by one.

First, in the latest avalanche of car companies adopting Tesla’s charging standard, Mercedes just announced its EVs will have access to Tesla’s superchargers by next year.

Second, Tesla is looking to break ground any day now on its latest Gigafactory in Monterrey, Mexico. The company is actively trying to diversify its supply chain and it is miles ahead (pun intended) of competitors. After the Mexico plant, the company will be able to easily service North America, South America, Europe, and Asia.

A Mexican government official announced that the company’s permits would get approved very soon. Tesla has already secured the land and once the final permits are approved, then the company will likely break ground in the next couple of weeks.

Third, Dojo, Tesla’s supercomputer, is ramping up this month. This will hopefully supercharge the company’s progress in full-self driving and in the long run, I wouldn’t be surprised to see Tesla let other companies use some of its functionality. Tesla is notoriously generous with its technological advancements. The thing that is hard to replicate is the sheer amount of data that the company has from its FSD beta users.

Fourth, there have been some reports that Tesla is laying off assembly workers in the Shanghai plant. While on the surface this seems worrying, implying that demand is falling off, the reality is a little more nuanced. At the factory, Tesla has three main assembly lines and this particular line is the least automated. Further, the company’s battery supplier, CATL, is opening a large facility right next to GigaShanghai, reducing the need for these workers. Tesla is still keeping the two main assembly lines open but with the opening of the CATL facility, it makes economic sense to move towards more automation.

And finally, fifth, as briefly mentioned last week, all 16 Chinese car manufacturers signed a vow to play nice with each other and not continue to lower prices. However, just five days later, the Chinese Association of Automobile Manufacturers rescinded the pricing coalition. I am curious to see how the government will react but it’s strange to see such a quick reversal. Anyway, I guess there will be no effect for Tesla.

MercadoLibre

On Monday, MercadoLibre was down about 6% because of an analyst downgrade, highlighting increased competition because of a recent e-commerce regulation in Brazil. The new law removes the 60% import tax but keeps the 17% value-added tax. This means that cross-border companies like Shopee or Shein can offer lower prices since they aren’t impacted by the import tax anymore. This doesn’t really directly affect MELI’s business since most of it isn’t cross-border, meaning that they ship the products right from Brazil. Obviously it affects MELI considering the increased competition that this rule will likely catalyze.

This is a very interesting regulation because it puts a lot of pressure on Brazilian merchants. It’s quite difficult to compete with China and the government is effectively siding strongly with the consumers instead of small businesses. Lots of Brazilian merchants will be upset by this but consumers will get lower prices from Chinese manufacturers. In fact, this regulation is great for Shopee as it competes in lower-priced items. For MercadoLibre, Brazil makes up about half of revenues and sub-$50 items probably make up about 25% of revenue, after subtracting out the off-platform payment revenues.

One thing the analyst report doesn’t bring up is that this doesn’t affect the convenience of ordering items. Shopee and Shein still have to ship products from China to Brazil and it’s pretty difficult to do that in one or two days. MercadoLibre still has the logistics advantage and that isn’t something to be underrated as we’ve seen with Amazon in the US.

This is definitely something to keep an eye on and frankly, it’s a surprising move by the Brazilian government. Competition is great for consumers and it will keep MELI sharp. I’m eager to see what the company’s management team says about this on the next earnings call.

Datadog

The latest Gartner Magic Quadrant for Application Performance Monitoring and Observability is out and Datadog is still a leader. However, the company’s position is a little bit less favorable than last year. In the 2022 report, the company was neck-and-neck with Dynatrace but this year, it looks like Dynatrace has pulled ahead and New Relic is now in the mix. Further, there is increased competition in general from Splunk, Honeycomb, and even ServiceNow, which has recently made a push into the space.

After reading the report, there were three main concerns regarding Datadog that the Gartner analysts brought up:

Ok, so the three issues are price spiraling out of control, too many products, and the outage communication. Nothing new in terms of information. Number 1 has been the biggest knock against Datadog all along if you talk to customers. However, people continue to use the product because it’s so good. Further, I think customers are clearly optimizing some of that spend and we’re seeing that in the Datadog numbers. Number 2 isn’t a problem in my mind – it’s just a function of the company innovating and offering more functionality. Everything is transparent about the product details and pricing. Number 3 is a little worrying but I trust management and this is the first time anything like this has happened.

I do think Dynatrace has done a really good job and they are much stronger competition than I initially gave them credit for. The company’s new Grail product has had really good feedback and makes me a little nervous about Datadog’s competitive position quite frankly.

All in all, I think Gartner’s report didn’t offer anything new in terms of risks but it’s good to get a sense of the narrative around all of the companies in the space. I do think the space is a little too crowded nowadays so I am certainly keeping Datadog on a shorter leash (pun intended once again).

Cloudflare

On Wednesday, network security stocks were down because of Microsoft’s new product, Entra. The namesake has two products, Internet Access and Private Access, just like Zscaler’s ZIA and ZPA. So Microsoft is more directly competing with Zscaler but also with Cloudflare now. To be clear, Zero Trust makes up a relatively small part of Cloudflare’s business but it is something to watch out for. I would be a little more nervous as a Zscaler investor but this will likely be a situation where a lot of companies will still opt for the best-of-breed option as we’ve seen with something like Crowdstrike.

As IT budgets get optimized, there will likely be some companies that just opt to use Microsoft for everything as they can get a bundled discount. This is something to monitor and if it affects the numbers at some point, it may be a signal that the moats in this industry aren’t as deep as previously imagined. For now, I’m not super worried.

Some Thoughts

As I look at new companies every day, I’ve been thinking more and more about the few factors that really matter. Ultimately you’re looking for high growth in free cash flow per share so following the evidence of strong revenue growth and margins is important. But the financials are an output of the quality of the business. If the business has a ton of competition, a terrible product and no leadership, it’s not very likely that the financials will be amazing.

Getting straight to the point, I think the quality of leadership and the singularity of the company are the two most important factors. Leadership is pretty straight forward but there are a few aspects. One, I prefer founders because they eat, sleep, and breathe their own business. Two, skin-in-the-game matters so I like seeing high insider ownership. Three, a CEO that is just playing on a different level than everyone is such an advantage. Four, a CEO that is willing to make long-term investments and is always thinking a couple moves ahead is another great advantage. I could go on and on but a business is merely a collection of people and processes. If a company is healthy, it likely means there is strong leadership.

As a counterpoint, what about Buffett talking about how he prefers businesses that an idiot can run because one day, an idiot will end up running it? Well, one of his main criteria is still looking at management so he clearly cares about it. Further, I tend to invest in companies who don’t necessarily have the deepest moats right now but are building them at furious paces. In this part of a business's life cycle, management is much more important.

The second criteria is what I will call singularity – basically, the company is far-and-away the leader in the space. When you think of the category, you think of the company. Tesla and EVs, Airbnb and house sharing, Axon and public safety, Amazon and e-commerce. It’s sort of like the cognitive referent idea or how companies become verbs but I think it’s a little different. Sometimes, the companies aren’t yet big enough to become verbs in the culture but they are well on their way. That’s the ideal investment for me – companies that are in the early stages of becoming a verb in their respective industry. The Trade Desk is one I’ve seen become a verb in real time. It’s not easy to become a verb but it’s typically a testament to the quality of the product. If there is a product that is just so much better than anything else out there, people buy that product and it becomes so ingrained that it self-reinforces the business. The best people want to work there and the profits roll in, enabling the company to increase its lead even further and so on. This is the ideal investment where you can just sit back and let the company hauls in the profits while you sleep soundly. Finding this sort of investment is rare and oftentimes, the near-term prices can be quite expensive but that’s what we are after. Buying the best businesses can be a little vague so one framing is that we are trying to find the verbs before they become verbs.

If you have any companies that fit this bill, always feel free to send them on over :)