As expected, I could not get to everything that I wanted to this week. I will tuck AMD and Block earnings reviews into earnings articles for next week.

Q3 revenue guidance beat by 1.5%, while its 53.5% GPM guide missed 54.0% estimates.

Block trades for 17x 2024 earnings. EPS is expected to grow by 95% this year and by 28% next year. It is currently inflected to positive GAAP EPS as well.

This was really bad. Intel bulls are pretty much relying on this morphing into a Taiwan Semi competitor through government subsidies and factory build-outs. That is a long road and meanwhile the existing core business is not in good shape. If you can’t deliver strong data center revenue growth in this environment, you probably never will. They need a new core.

“Our Q2 financial performance was disappointing, even as we hit key product and process technology milestones. Second-half trends are more challenging than we previously expected.”

CEO Pat Gelsinger

Following downward profit revisions, INTC trades for 80x 2024 earnings. Earnings are expected to meaningfully fall this year, and then rise from $0.26 to $1.56 next year. I’d imagine those $1.56 estimates will see downward revisions in the coming weeks.

Here, I’ll introduce Cloudflare’s product suite and niche. This will be partially review for consistent readers and for those who are well-versed in its product suite:

In essence, Cloudflare makes the internet faster and more secure. They have a massive global Content Delivery Network (CDN) to move traffic closer to the end user, which cuts web latency. They actively assist clients in optimizing traffic speed and consistency as well. It also has a suite of security tools to protect customers from Distributed Denial of Service (DDoS) attacks. This form of hacking aims to inundate and overwhelm networks with traffic. NET doesn’t sell physical firewall hardware, but instead a virtual, cloud-native “Magic Firewall” to supplant these hardware needs. It offers web application firewalls too for app-level security, while Magic Firewall is for network-level security. Magic WAN is Magic Firewall’s partner in crime. Magic WAN connects networks while Magic Firewall protects them. The closest cybersecurity competitor in public markets is Zscaler.

Workers Platform is its server-less (so fully managed by Cloudflare) product suite for developers to build, maintain, secure and deploy applications. This allows for caching of content and apps across Cloudflare’s global network for faster delivery. Its newer Workers AI product allows developers to access models and infuse GenAI tools (like sentiment analysis) into Cloudflare-hosted apps and networks. Workers AI pairs seamlessly with its “Vectorize.” Vectorize offers a style of data querying that allows for visualization of patterns. Another key example of Cloudflare’s GenAI tools is its R2 product. This allows cloud workloads and data to be freely moved among public clouds with no tax. Key in a multi-cloud world. This is popular for model building and implementation as models are voracious users of data and data is routinely hosted in many clouds.

Cloudflare Access is its Zero Trust Network Access (ZTNA) program. This directly competes with Zscaler. Zero trust means that a user or device must be constantly verified (or never trusted). Cloudflare does this in a seamless manner so as to minimize user friction. It considers device type, location, usage patterns (or signatures) and other contextual clues to better authorize permission requests. This way, it knows when to block those requests or when to require more information. It then deploys a minimal privilege approach to ensure only the necessary permissions are granted to workers. Nothing more, nothing less. Zero Trust ensures an adversary can’t breach the most vulnerable part of a tech stack and move freely throughout it thereafter.

Secure Access Service Edge (SASE) platform is a term for how Cloudflare conjoins web performance and security use cases. This drives vendor consolidation, controls costs and augments performance. Cloudflare One is its overarching product bundle subscription combining its suite.

Cloud Access Security Broker (CASB) is a security tool to provide firms with a birds-eye-view of application usage. It hosts and secures client data and uncovers suspicious activity or deviations in typical usage patterns to flag threats. It plugs into NET’s Secure Web Gateway (SWG), which is essentially a digital security guard ensuring protection from a firm’s secure network and assets and the open internet. It ties closely to NET’s data loss prevention (DLP) tool and URL filtering tool.

Browser Isolation is Net’s managed service for providing users with a purely secluded environment to search and scrape the web. This will be an increasingly important tool for its GenAI inference products that are now building steam. That’s where Cloudflare expects to realize the bulk of GenAI’s potential financial value. Models are trained once and periodically updated with new data. After that, the value of those models lies in their ability to connect dots and drive insights (or inferences). That’s where Cloudflare presides. It provides a managed cloud platform to do all of that app and model work in a secure and compliant fashion.

“Today, we have inference-tuned GPUs live in 167 cities worldwide, making us, we believe, the most global cloud inference solution. Inference requests powered by Cloudflare AI increased more than 700% quarter-over-quarter.”

Founder/CEO Matthew Prince

Cloudflare beat revenue estimates by 1.6% & beat its guidance by 1.8%. Its 38.1% 3-year revenue compounded annual growth rate (CAGR) compares to 40% last quarter and 40.9% two quarters ago.

Within the strong EBIT leverage Y/Y, sales & marketing delivered 400 bps of expansion despite ramping hiring, R&D delivered 100 bps of expansion and G&A delivered 200 bps of expansion. Headcount rose 15% Y/Y. From a CapEx point of view, network CapEx remained at a modest 6% of revenue. Still, investment timing will lead to that rising to 11% of revenue for the full year. Just like public cloud providers, NET feels the need to build more capacity to meet demand (on a much smaller scale).

Third quarter guidance was a slight miss on revenue & a slight beat on EBIT. This implies a Q4 guide that is solidly ahead of expectations.

“We remain prudent in our outlook for 2024.”

CFO Thomas Seifert

Net trades for 110x 2024 earnings. EPS is expected to grow by 44% Y/Y this year and by 13% Y/Y next year. Here’s how its current EBITDA multiple compares to historical norms:

Cloudflare has long held the reputation of building best-in-class products. But that’s not the only thing that matters. Marrying great products with a surgically precise, timely and effective go-to-market is imperative for financial success. 

A few quarters ago, Founder/CEO Matthew Prince ripped into his team’s underperformance, slashed slacking talent and vowed to improve. And to his credit, they’ve done just that in short order. This quarter, its go-to-market morphed from what was a growth bottleneck, into what is now credited for its ability to overcome stubborn macro headwinds. The company delivered another quarter of 10%+ Y/Y sales productivity gains. Close rates improved and the sales cycle shrank, despite continued budget scrutiny and general macro anxiety. Prince did acknowledge that its great products are helping drive this progress, but added that they “still have to fight for every deal as the buying environment remains challenging. Investments in go-to-market improvements are showing dividends.” This was “not an easy quarter.” Cloudflare simply overcame obstacles.

With this newfound efficiency and upgraded sales cadence, Cloudflare is accelerating the pace of sales manager and account executive acquisition. Hiring for both of those positions rose over 100% Q/Q, and that trend should continue throughout 2024. Still, EBIT margin will significantly expand (based on the guide) and it will look for other operating efficiencies to support that. 

As a relevant aside, Asia Pacific growth accelerated considerably to 29% Y/Y. This, to the team, is direct evidence of a “number of go-to-market initiatives delivering early returns.”

Cloudflare signed two large deals with Australian tech companies during the quarter. Both were expansions and both included SWG, CASB, DLP, Magic WAN & Firewall, browser isolation, the Workers Platform etc. One of those customers, which started as a free user a few years ago, will now spend nearly $9 million annually on the platform, while the other picked NET over 3 direct competitors for superior solutions, performance and roadmap. NET drove considerable vendor consolidation for both, which means lower customer costs, superior customer outcomes and lower churn.

Channel partners helped a Fortune 500 financial service firm find Cloudflare for its “leading DDOS” product. The customer was struggling with security vulnerabilities, and NET’s tools were onboarded in just 10 days.

Interestingly, it also signed an expansion with a high profile AI company. The firm was already using its R2 product to store unstructured data in the cloud, but now will use NET’s GenAI inference tools as part of the Workers AI platform. The customer was struggling with bloated costs with a hyperscale and poor performance. Cloudflare’s “inference-tuned” GPU and cloud infrastructure have delivered a 40% cost improvement for this company to season models and build high performance compute (HPC) apps. There’s another $5 million customer “expressing interest in NET’s AI products.”

The themes of these wins were Cloudflare driving vendor consolidation and becoming a true connectivity platform. Secondly, many included usage of its Workers Platform for developers. Total developers using this rose 20% Q/Q to 2.4 million. Workers AI, a subsection of the Workers Platform for GenAI and HPC workloads, saw developer usage rise 67% Q/Q on a smaller base.

“We see sustained momentum with large customers, significant public sector progress and continued high prioritization by our customers.” 

CFO Thomas Seifert

Prince cited a Stack Overflow survey that ranked Cloudflare 4th in what platforms developers are using. The top three were the three hyperscalers, which makes coming in 4th place very impressive to me. Furthermore, it ranked 2nd in platforms that developers are most excited to use. Developers build the workflows and apps that consumers and enterprises know and love. Creating a platform that they actually want to build on matters a lot. It motivates usage, traffic and growth for Cloudflare.

This was an excellent quarter from an excellent company. Continued rapid, margin accretive growth, successful product expansion, a flawlessly executed go-to-market pivot and more high profile customer wins.

The only thing I don’t like is its stock’s valuation. This is very high on my wish list of firms to buy if Mr. Market continues to sharply sell-off. It is still too expensive for me, but I remain deeply impressed with this firm and team. There’s nothing negative to pick at here, despite a volatile operating environment. 

Mercado Libre is an e-commerce, logistics and payments giant in Latin America with a quickly broadening product offering.

Note that Meli made a series of changes to reporting disclosures starting last quarter. First, Mercado Pago Interest Income and Expense was moved from below the EBIT line to above it. For its shipping business (Mercado Envios) it changed its position from an agent to a principal. Previously, it netted shipping costs out of gross revenue. Now, it reports revenue as gross revenue and puts shipping expenses in cost of revenue line. Finally, it removed peer-to-peer volume from total payment volume (TPV). All of this means higher net revenue and margin dilution as a result. Q/Q and Y/Y margin comps reflect this.

Logistics net costs as a percent of volume rose 50 bps Q/Q due to some Mexican capacity constraints and investments in its Meli+ loyalty program to enhance best-in-class service. Still, it did drive total cost leverage thanks to productivity gains in fulfillment centers where capacity was not an issue. Leverage was enjoyed across G&A, R&D and S&M. Overall Brazilian margins rose Y/Y when excluding accounting change; Argentina’s margin fell Y/Y, but margin pressure eased due to improving demand, lower fintech funding costs and shipping disinflation. Mexico margin fell Y/Y due to higher credit provisions related to credit card growth, higher shipping costs related to its Hot Sale event and capacity constraints. Overall, net income margin set an 8 year record, with net profit rising 103% Y/Y. Finally, it debuted a new FCF financial disclosure. It generated $678M in FCF vs. $145M Y/Y.

MELI trades for likely 45-50x 2024 EPS depending on where estimates land. EPS is expected to compound at a 40%+ clip for the next two years.

Here’s how its current EV/EBITDA multiple compares to historical norms:

Meli’s entire business is rocking and rolling – commerce included. Unique buyers rose 19% Y/Y and items sold rose 29% Y/Y, which are both the fastest rate of growth since early 2021. Overall FXN GMV growth was also stable in Mexico Q/Q and accelerated across all other core markets. In Brazil, its largest market, FXN GMV growth set a 3 year record. Customers are flocking to the platform, raising engagement levels and are not churning. Not only does this mean fabulous segment growth this quarter, but it gives Meli a larger base to cross-sell its rapidly growing suite of solutions across financial services, entertainment and more. It’s a somewhat similar idea to Apple selling more iPhones allowing it to cross-sell several more services to juice lifetime value and margin.

Argentina GMV growth of 252% Y/Y FXN was 0% when accounting for its wildly elevated inflation rate. Still, this is an improvement Q/Q and Meli does think consumption trends on a per-unit basis are improving. Furthermore, while macro there might suck today, there are reasons to believe it could look very good eventually. The new government continues to slash regulation, promote private business and push to make Argentina an easier place to operate. That should be a large tailwind at some point. Not yet.

The opportunity remains quite large. LatAm e-commerce penetration is lower than in North America, Europe and developed parts of Asia. LatAm population growth is strong, regulatory headwinds are largely favorable, the middle class is growing and the runway remains massive. This growth engine does not look set to slow any time soon.

Meli’s fulfillment network continues to drive service gains and augment the overall utility of its marketplace. This is where it conjoins superior selection with an ability to deliver goods faster than others can. This company reminds me of Amazon in so many ways (minus AWS). Same and next day shipping penetration did fall from 56% to 53% Y/Y, but that was due to higher demand for slower, cheaper shipping and Meli delivery day (pre-set day every week to get all packages). Mexico capacity constraints did hurt a bit, but the bulk of the decline was voluntary from its customers. In efforts to ease the bottleneck, it recently opened a new Texas fulfillment center to field inventory from U.S. sellers for distribution in Mexico. Meli still thinks it’s the fastest courier across key urban areas like Mexico City (and São Paulo). Outside of Mexico, delivery speeds in Brazil and Colombia set new records.

Ads rose to 2.0% of volume vs. 1.9% Q/Q and 1.6% Y/Y, with 51% Y/Y revenue growth. More engaged customers directly feed impression growth and success for the segment. Beyond that, it still has much more work to do on raising ad load without inundating consumers with promotions. Just like everywhere else, the runway here is massive. Ad campaigns are reaching more of its digital real estate and its Mercado Play free streaming platform saw 20% M/M growth.

It’s understandably combining this promising opportunity with material investments in sharpening its targeting and reporting algorithms and better utilizing the data it has at its disposal. Progress here was called good, but we weren’t given specific numbers on return on ad spend (ROAS) gains.

Fintech MAUs rose 37% Y/Y to reach 52 million. Engagement growth was strong, products per user rose, retention with recent cohorts improved and this segment continued to (you guessed it) thrive. Its high yield savings account in Brazil is helping a lot with lofty 46% Y/Y user growth there (its most mature market). Its savings account in Argentina has enjoyed 300% and 200% respective growth in users and assets (despite hyper-inflation) over the last 18 months. 

Broad-based strength has led MELI to introduce this account type to its Mexican customers, which it expects to quickly gain traction. It’s securing needed bank licensing to scale this business and unlock the ability to use more deposits to fund credit. It wants to be the largest bank in Latin America, and aside from Nu, competition is generally easier than in the states.

Meli’s credit portfolio rose 51% Y/Y to reach $4.9 billion. It enjoyed strong growth across all markets and great momentum in upselling existing Brazilian users more credit. Asset quality is stable and underwriting models are improving. Still, the all important net interest margin after losses (NIMAL) material soured Y/Y from 36.8% to 31.1%. This is related to a mix shift of its portfolio away from loans and towards credit cards. Specifically, it issued 1.6 million net credit cards and saw 208% Y/Y FXN TPV growth within the segment. Card spreads are lower, so NIMAL falls; this is entirely as expected and not at all concerning.

For credit cards, it continues to pursue its massive base of existing users for cross-selling. MELI has extensive customer data profiles on these potential customers and thus feels confident that it can underwrite with more precision. Makes sense.

This relates to growth for its Mercado Pago payments suite. Some of the volume happens within Meli’s platform and some occurs at merchant sites. Growth here was 24% Y/Y and 75% FXN. It is gaining traction in serving bigger merchants with its point of sale business as TPV per device rose 10%+ Y/Y. A lot of the growth is now happening off-platform (other sites), which is positive.

This was the best earnings report I’ve covered so far this quarter. Everything was fantastic and all I can do is praise this execution. Declining margins are all related to accounting changes and are a nothing burger. Phenomenal is the word that comes to mind. Enough said.

I shared my review of the financials, slide deck and letter in Thursday night’s article. The call was not until Friday morning, so I will cover that here. I won’t accumulate or trim a holding until I’ve gone through all available investor materials. I was not comfortable adding Friday morning, as I hadn’t yet listened to the important call. Had I done so, this would have been on the add list yesterday.

Leadership believes that competitors will likely follow suit on its decision to implement a mid single-digit surcharge (basically a rake) on gambling winnings. In the eyes of Founder/CEO Jason Robbins, “if this is our calculus, I would imagine others will come to the same conclusion.” That’s very important, as FanDuel and others following suit would eliminate the market share hit from adding this fee. DKNG would get the EBITDA benefit from the charge, without any revenue headwind. That is the ideal outcome here. We’ll see. 

While DKNG does have some interface, up-time and feature edges, these sports books are essentially commodities. Becoming more expensive would absolutely be a top-line headwind. First, revenue would have to aggressively tank for this move to become a profit headwind. DKNG is essentially shedding 60% of their tax bill, and there is a large cushion of revenue losses that can happen while this is still positive for EBITDA in those 4 states. But? DKNG does not expect a material change in market share, even if no other player follows its lead. And finally, thriving customer acquisition, retention and engagement trends are creating enough upside to fully offset this EBITDA obstacle for 2025. That optimism from DKNG is based on existing customer growth and data… not banking on adding an abnormally large number of new customers in Q3 and Q4.  It likely will add more, based on it being football season and the plans to increase growth spend, but there’s nothing overly aggressive in the 2025 guide.

“This will make a huge difference in our ability to make a reasonable margin and compete with the illegal black market in these 4 states.”

Founder/CEO Jason Robbins

If other vendors don’t implement the surcharge and it proves to be too costly, DKNG will pivot. If another vendor comes up with a better idea on how to address this from now to January 2025, it will take that idea for itself. This is not set in stone in perpetuity.

The bulk of the Q&A was spent grilling Robbins about DKNG’s commentary on strong user trends. Again, this strength is why sales & marketing growth turned positive Y/Y this quarter; they’re opportunistically taking advantage. He indicated that more marketing spend was to play offense amid an environment ripe for customer growth. DraftKings is simply finding more productive places to spend marketing dollars at a compelling payback period. This is related to its own improvements in targeting, more national marketing opportunities thanks to a larger state footprint, and overall industry momentum as well. It’s leaning into this momentum, juicing revenue and accepting an EBITDA headwind, as it knows this will optimize run rate profitability over time. DKNG had a decision to make. Does it protect a 2024 EBITDA guide at the expense of long term value creation, or not. I think they’re making the right decision. The irrational move would be not using your superior balance sheet, scale and brand recognition to pounce on this low hanging fruit. For some supporting data, Robbins reminded us that DKNG delivered 80% Y/Y growth in new customers (excluding JackPocket M&A) while customer acquisition cost fell 40% Y/Y. And furthermore, mature states contributed a lot of that acquisition success, which illustrates how long the runway is for post-legalization growth.

“I don’t see why customer acquisition would slow down going into our busiest time of the year.”

Founder/CEO Jason Robbins

DraftKings has great flexibility in adding to or subtracting from its marketing budget over time. It can pull back if the environment sours in a matter of hours or days with linear TV. It will not get stuck spending too much money. It will forgo that spend if payback periods deteriorate. There is no sign of that happening as we enter a much busier season for sports gambling.

Interestingly, it cited strong user acquisition, retention and engagement as an EBITDA tailwind last quarter, but a headwind this quarter. That’s related to customer growth in Q2 skewing more heavily to “acquisition” rather than retention playing a bigger role in Q1. Newly acquired customers get promotions; that weighs on near term margin. 

“We're seeing absolutely no signs of any weakness in the consumer whatsoever. We see super strong, healthy cohort behavior across the board.”

Founder/CEO Jason Robbins

We learned that internal 2025 revenue expectations were raised a bit due to thriving customer trends.

The $1 billion buyback program will take place over the next 2-3 years.

State momentum for banning offshore gambling books is picking up. The black market is massive, doesn’t pay taxes and is still growing. Tighter regulation would be a massive win for all legal players. We shall see how this unfolds. 

The spike in monthly active users compares to historical seasonal trends of flat Q/Q growth. Encouragingly, only 50% of the growth was via Jackpocket M&A and its user metric beat estimates by a whopping 24% (so 12% organic beat). The rest was just broad-based business strength.

This was a very good quarter that increased my confidence in DKNG’s ability to overcome regulatory headwinds. Nothing in here is at all alarming. The user trends are fantastic.  While near term margin expectations have taken a hit from new tax laws, it remains strong and share gains remain positive. DKNG is expected to compound EBITDA and EPS at triple digit clips for the next two years, and is 6 months away from trading at 14x forward EBITDA and 21x forward EPS. The revenue growth engine is in its early stages, along with iCasino regulation and black market conversion. I like this investment case and DKNG will be on my accumulate list if Mr. Market keeps throwing fits. 

Uber and BYD have partnered. Uber will deploy 100,000 electric BYD cars in Europe and LatAm and the two will “develop autonomously capable vehicles” for Uber’s platform too. BYD is broadly seen as a Chinese leader in self-driving cars, and this partnership is something I find encouraging. 

The relationship will allow Uber to plug into best-in-class technology, without the immense costs that would coincide with doing this on its own. This is also a strong nod to the power of Uber’s consumer platform aggregation. It controls the demand and high cost self-driving cars need maximum demand to avoid being cash incinerators. BYD will pursue that through Uber. I expect its Waymo partnership to merely deepen over time and I expect an Amazon Zoox partnership down the road as well. While others may disagree with me, I still think Tesla and Uber will partner on this technology and merge autonomy with steady, maximum demand. Musk has said they’ll try to do this all themselves, but Musk says a lot of things that don’t come to fruition. No car maker will have a monopoly over fleets. Uber’s market share dynamic resembles monopolistic power more than any auto OEM will. Like Visa and Mastercard had to partner with PayPal, I think driverless car players will have to partner with Uber.

Elliott Management offered Starbucks a deal that would allow its CEO to keep his job. They want board representation and tighter governance controls.

Apple used Google chips to train its Apple Intelligence models. Google Cloud landed a new cloud migration deal with Humana.

Disney is cutting more jobs in its TV division. Deadpool & Wolverine delivered Imax its best opening weekend since 2022. It set overall 2024 domestic box office records too.

CrowdStrike’s outage cost Delta $500 million. There will continue to be immense headline risk stemming from this global blunder. I think CRWD will recover over time, but I also think patience is currently warranted.

The Fed Funds rate was kept at 5.25%-5.50%. The Fed continues to reduce the pace of quantitative tightening and continues to gain more confidence in a near future rate cut. The employment cost index (ECI) reading this morning added to that confidence even further.  He also spoke on how 2024 disinflation is much healthier than in 2023, as it has now extended to housing and non-housing services. This is no longer just goods disinflation, which is highly positive.

While Powell cannot tell us that a rate cut is coming in September, he hinted at it several times. Inflation was called somewhat elevated vs. elevated previously; the labor market weakening was explicitly cited with a somewhat lower jobs outlook and markets are now pricing in three cuts for 2024 (100% chance in September; 75% chance in November for a second cut; 74% change in December for a 3rd cut). That can change on a dime amid new data releases.

“We have made no decisions about the September meeting. The broad sense is that the economy is moving closer to the point where it will be appropriate to reduce rates… we just want more good data.”

Jerome Powell

The risks to its dual mandate are now in good balance and it sees the economy as gradually slowing, yet healthy. All of this points to Powell seeing a soft landing as the most likely outcome of this rate hike cycle.

I realize it’s quite popular to pedal macro doom on social media. I happen to think Powell has done a great job in steering monetary policy, as well as expectations through this cycle. I see a soft landing or a mild recession as the only two likely outcomes at this point. And? Easier monetary policy with a still reasonably healthy economy is a good setup for stocks.

The data recently has shown clear renewed disinflation and now some cracks in the still healthy unemployment rate. Markets are now expecting 3-4 rate cuts for the year, with JP Morgan and Citi expecting a 50 bps cut in September. Monetary policy is very likely going to soon get much easier, which should support valuation multiples and eventually profit growth as cuts eventually work their way through the economy. As long as we avoid a severe recession or depression, which looks likely at this point, I think this is a somewhat favorable setup. I continue to be a buyer of my favorite names into material multiple compression, like we got this week.