Salesforce is the 3rd largest enterprise software firm on the planet. It provides a broad suite of products to help clients optimize customer interactions, sales and marketing. The overarching niche is called Customer Resource Management (CRM). Salesforce offers a variety of cloud services to its customers. There’s a sales cloud, which perfects consumer touch-points. There’s a commerce and marketing cloud to build online storefronts and augment promotional activity. There’s a service cloud to handle customer issues and inquiries. There’s also a platform cloud, which includes Slack.

Most recently, it debuted its data cloud. This is an aggregated analysts service to ingest, organize & glean insight from 1st party data. It conjoins siloed data and “unlocks” previously disparate sources for client value creation. It’s similar to what Snowflake does, but more for managing customer relationships. MuleSoft and Tableau are both key pieces of this data cloud. MuleSoft integrates apps and data to enable management of these products within Salesforce. Tableau is a data visualization tool to create automated progress reports and suggestions to leverage findings. Finally, it offers industry-specific clouds for sectors like healthcare. These are customized to meet specific regulatory and operational needs. All of these clouds and products make up the firm’s subscription & support revenue, which represents 93% of its total business. Professional services make up the rest.

Separately, Salesforce offers a product called Einstein One. This is a full set of AI tools, including outcome prediction, chat bots, image recognition, sentiment analytics and more. It’s considered a general-purpose AI platform infused into all Salesforce products. Most recently, through an OpenAI partnership, it debuted Einstein GPT. Einstein existed before the GenAI wave, but is now getting an upgrade thanks to it. Einstein GPT allows Salesforce clients to plug into language models (including OpenAI, Anthropic and Cohere) to make workflows more productive, intuitive, conversational and automated. It features a low code tool set to reduce the barrier for non-experts to build applications; it also boasts expert-level tools to build more complex apps. That’s Salesforce in a nutshell.  Now, the quarterly results.

Key assumptions in its guidance include:

Salesforce trades for about 21x this year’s earnings. Estimates should be stable following this report and EPS is expected to grow by 19% Y/Y.

Just like last quarter, the intersection of the Salesforce data cloud and its work in AI was the key theme. As Benioff explains (and so do we frequently in this newsletter), models are racing towards commoditization. They all pull from large swaths of the exact same public data. So what makes them unique? Infusing a client’s unique and relevant training data into these models. Salesforce has 250 petabytes of client data that’s ripe for model seasoning; it also has a data cloud that allows customers to tear down data lake and data warehouse (structured and unstructured data) siloes to utilize all of it in a cohesive, categorized manner. That’s how to get the most out of the AI strategy: by having a superior data foundation, which Salesforce is pushing hard to facilitate.

The Salesforce Zero Copy Partner Network blazes a more direct trail between the Data Cloud and other large databases. It allows customers to openly query and use data across these sources to avoid constant data copying and higher storage/processing costs. Partners include all three hyperscalers, Snowflake, Databricks and IBM. 

As an aside, many have asked if I think GenAI is cannibalizing software spend. I think that’s possible to some extent… but if it is, I also think that will be short-lived. All of the amazing consumer apps and interfaces that will come from GenAI require a large foundational infrastructure to first be in place. That’s why we’re seeing such massive CapEx numbers from the hyperscalers. That’s why hardware is enjoying all of the GenAI fun today. That will not last forever. The foundation will be laid, quality companies that can build solid use cases will begin to monetize at scale, and this narrative will dissipate. That’s how I see things.

Salesforce is best-in-breed in terms of its ability to consolidate vendor point solutions and cut expenses for its customers. That strength was again apparent this quarter. Half of its 50 largest deals and 6 of its 10 largest deals included 6+ cloud products. Industry-specific clouds were also in 5 of its largest deals, including Paychex. This customer went with its financial service industry cloud and the data cloud to more proactively pursue customer renewals.

FedEx went with the data cloud for its ability to “generate expansive savings” and foster a “more efficient and profitable FedEx.” Products making this happen include automated “next best action for seller” suggestions, its Einstein virtual assistant, opportunity scoring, lead generation and more. Air India also purchased its data cloud service to help conjoin its loyalty, reservation and other siloed data warehouses. It’s also using Einstein to automate case summaries for customer service interactions to free up employee time.

I think the most encouraging customer win during the quarter, aside from Autodesk, was a CrowdStrike expansion. The endpoint and cloud security disruptor added Salesforce’s data, marketing, commerce and revenue clouds during the quarter – along with MuleSoft. It was already a Slack and Einstein One user. CrowdStrike is broadly viewed as among or the best-in-breed for pretty much all of its  products. It sets the innovation curve in cyber security. Why does this matter for Salesforce? Some of CRM’s products are viewed as somewhat dated. With that in mind, it’s nice to see a leader in a high tech sector standardizing on Salesforce’s platform. CrowdStrike has already enjoyed a 30% project delivery pace boost with the new Salesforce tools.

A few quarters ago, Salesforce disbanded its M&A team, proclaiming that it had all of the assets it needed. During this past quarter, rumors swirled that it was considering a purchase of Informatica. That led some to believe it was struggling a bit to find longer term organic growth. They were asked about this on the call. Benioff committed to making sure any large-scale M&A was accretive to customers rather than dilutive. I’m candidly not sure what he means by that. Maybe he meant earnings instead. He also said they’ll remain selective; any and all M&A within its “framework” seems to be back on the table.

“As we go forward, we know that we need to slightly adjust that so that we can continue to deliver you these amazing financial metrics… we know we can continue to deliver cash flow and margin numbers at this level. We're also going to have to continue to keep our eye on the M&A framework.”

Founder/CEO Marc Benioff

In the fourth quarter, Salesforce cited shrinking sales cycles and an improving buyer appetite. Benioff said the demand environment took a “complete 180.” That 180 seems to have been short-lived, which can be seen in the 3% Y/Y billings growth. This quarter, things negatively reverted back to what they have seen over the past 2 years. The sales cycle again elongated, deal size compressed and budget scrutiny again rose. That’s frankly not great to hear from one of the world’s largest sellers of enterprise software.

The team also discussed some “go-to-market changes” implemented to improve processes, which apparently hurt its billings activity as well. 

“As we entered the post-pandemic reality, companies had acquired so much software and looked to actually rationalize it, ingest it, integrate it, install it, update it. I mean it's just a massive amount of software that was put in. And so every enterprise software company kind of has adjusted during end of this post-pandemic environment.

Founder/CEO Marc Benioff

The quarter was fine aside from the billings number. And again, billings weakness only becomes concerning when it’s a multi-quarter trend. 

Salesforce had been spoiling people with solid top line results and material upward margin surprises for several quarters in a row. That did not repeat, as the EBIT margin was simply reiterated this quarter. To me, that item, the negative buying environment commentary and the small subscription revenue guidance reduction were the three negatives to pick at. We can’t call this quarter good, but I also don’t think we can call it terrible either. It’s not like maintaining an EBIT margin guide is the end of the world. Far from it.

While the short term punishment does make sense, I don’t see this as a quarter to fret for the long term Salesforce bull. The misses were all quite small. The lack of margin raise is to invest in more growth; stable revenue attrition shows that competition and bad products aren’t the root causes of weakness. And it still raised its full year earnings outlook to a level that puts it at a 21x p/e. That’s historically quite cheap for this company. It’s actually looking interesting to me here, but the large enterprise software exposure that I already have will likely keep me away.

Cava beat revenue estimates by 4.4%. Its 51.3% 2-year revenue CAGR compares to 52.2% Q/Q and 53.3% 2 quarters ago. Note the same store sales (SSS) comp was extremely tough, with Q1 2023 SSS growth of 28.4% Y/Y. Same store sales growth includes 3.5% Y/Y price growth and -1.2% Y/Y traffic growth (excluding the positive impact of holiday timing).

The restaurant-level margin decline was actually better than expected. The company has been telegraphing heavier labor investments (8% Y/Y wage growth) and store expansion investments as weighing on this margin line throughout 2024. It did get some help from food input costs this quarter, but sees that help vanishing for the rest of the year – largely due to its debuting of a steak dish. G&A as a percent of revenue was 13.1% of sales vs. 14.3% Y/Y. Less performance based stock compensation helped leverage here while more investments in growth offset the leverage a bit.

“Our strong balance sheet and ability to self-fund growth put us in a position of strength to continue gaining market share.” – CEO Brett Schulman

Cava trades for 210x this year’s earnings. Earnings are expected to compound at a 2-year clip of 37%, making this one of the most expensive names in its sector and the market. Many are betting on forward earnings estimates being far too low. They’ve been right so far. They need to continue being right for this to continue working, in my opinion.

Cava has already opened up 5 new stores quarter-to-date (QTD) following 14 openings last quarter. It recently entered Chicago, where long lines and a passionate fan reception are leading it to re-think how many locations can work in that important market. New stores are all outperforming internal expectations and could boost its year 2 target of $2.3 million in average unit volume (AUV) in the near future.

After two years of testing, the firm’s sun-dried tomato steak is being rolled out across the nation. The company sees this adding momentum to its dinner demand, with dinner already making up 46% of its total sales. It also expects this to provide a tailwind for same store sales, as red meat has been missing from its menu since it removed meatballs last year. This encompasses Cava’s obsessive approach to new menu items. It tests, tests and tests some more across a few markets until it’s absolutely sure the dish will work.

As we spelled out in the deep dive, Cava recently wrapped up an intense vertical integration of its entire tech stack. With this now largely in the rear-view, it’s turning its attention to better leveraging first party data. It thinks its first party data, like for everyone else, can drive more optimal customer touchpoints and better, more personal relationships. It’s now rolling out its new rewards points program, which, in early testing, has been shown to directly raise order frequency.

“We believe we are on the precipice of a decade long data transformation.” – CEO Brett Schulman

The company’s connected kitchen initiative is its way of using all of this data, with the help of GenAI partners, to “drive quality, consistency, accuracy and speed of service.” This pilot program will begin testing this year. Finally, its new labor deployment program, which balances hours across peak demand, is delivering better employee experiences in 30 test stores.

Jeff Gaul was named as the company’s new Chief Development Officer. He was most recently Nike’s Global Store Development VP and a Senior VP of Store Development at Sephora.

This is a fantastic company with a fantastic team putting up fantastic results. I have wanted to own this for quite some time, but just cannot get comfortable with the multiple or anything remotely close to its current multiple. I think it’s just too expensive; that doesn’t change the fact that shareholders should be enjoying this strong run. Congrats to you. I hope to own this at some point in the future.

SentinelOne directly competes with CrowdStrike, Microsoft Defender and Palo Alto in endpoint security. It specializes in small-and-medium-sized business (SMB) clients and is now expanding up-market. While CrowdStrike’s overarching platform is called Falcon, SentinelOne’s comparable suite is called the “Singularity Platform.” The core use cases of the Singularity Platform are in endpoint security (like endpoint detection and response (EDR)). Like CrowdStrike, it offers highly autonomous services and a slick, lightweight, single agent to drive interoperability. This, in turn, means overarching coverage and superior breach protection vs. legacy incumbents.

Also similar to CrowdStrike, SentinelOne boasts a complementary data analytics platform (which it calls the Singularity Data Lake). This lake can ingest structured data logs from identity, case management, threat intelligence and so much more. With this capability, SentinelOne can collect data once and utilize it throughout all client use cases with that single agent. Less data siloing means its platform’s models and algorithms can be more effectively seasoned to drive better efficacy. The use cases beyond solely endpoint security mean that it can recycle this data repeatedly with little incremental cost. 

Just like CrowdStrike (noticing a theme?), it’s also actively expanding into cloud security and some identity use cases too. Important cloud security acronyms:

It has an “opportunity to be FCF positive on a full year basis.” That, however, will depend on how the environment shakes out and how aggressive it wants to get with growth spending.

Reiterated path to positive EBIT this year. Already FCF positive compared to guidance of turning FCF positive by the end of this year.

PurpleAI is SentinelOne’s overarching GenAI platform layer to uplevel its product offering. It’s quite similar to CrowdStrike’s Charlotte AI, in that it can actively detect anomalies, help orchestrate remediations and fix issues with a human analyst’s permission. All of this pushes beginner-level security analysts to much higher levels of capability. This matters a lot in our budget-and-talent-constrained world.

SentinelOne sees this product “widening the competitive gap” vs. other GenAI assistants functioning as glorified chatbots. It has compelling use cases across every single product in the Singularity Platform, ranging from basic workflows to the most complex investigations. It helps everywhere. Interest at this year’s RSA conference was notable, competitive wins and displacements from this product are ramping, and early users are enjoying 80% faster threat hunting.

If Purple AI is a Costco hot dog, the Singularity Data Lake is mustard (not ketchup, come on now). It can ingest data from a near-endless supply of sources to power an end-to-end view of data analytics. This ingestion is done via “log scale,” which means logarithmically organizing and storing data. This broader data ingestion means better breach protection as SentinelOne’s products are more properly trained on larger sets of relevant insight. Teams can intuitively organize and query data to turbocharge breach remediation and to guide strategic decisions. The service of aggregating data (or “logs”) to help organizations uncover and remediate threats is called Security Information and Event Management (SIEM). This is a highly competitive space, but SentinelOne is enjoying strong momentum. 

“Coupled with Purple AI, the Singularity Data Lake is the preeminent AI SIEM. Enterprises no longer have to be burdened by the cost prohibitive and limited actionability of legacy SIEM.”

Founder/CEO Tomer Weingarten

“With Singularity Data Lake, customers get lower cost and faster [querying] speed.”

Founder/CEO Tomer Weingarten

This product led the company’s growth with 100%+ Y/Y expansion for the quarter. SentinelOne’s purchase of Scalyr in 2021 is an instrumental piece of this current momentum, showing you how it can properly integrate point solutions into its overarching platform to drive vendor consolidation, more holistic/effective coverage and cross-selling. This is becoming an increasingly strong platform play… not just an endpoint security company. In addition to the data suite, its cloud, identity and other non-endpoint products drove a full 40% of its bookings activity. Non-endpoint growth comfortably surpassed endpoint growth as clients lean on this vendor to protect more of their organizations.

Cloud Native Application Protection Platform (CNAPP) is the buzz phrase used to describe a company’s full set of cloud security tools. While SentinelOne had mainly been in CWS, it just finished integrating its PingSafe acquisition to fortify its cloud security presence. This will greatly accelerate its path to product parity with CrowdStrike. PingSafe offers an agent-less suite of cloud tools including Cloud Security & Posture Management (CSPM). CSPM reports vulnerabilities and conducts configuration analysis in any cloud environment. It can flag improper permissions or hygiene. It doesn’t stop breaches in isolation, but does offer needed alerts, which frees other cloud tools like CWS to do so. This acquisition solidifies SentinelOne’s cloud security platform to cohesively join its robust endpoint security platform. CSPM will also bolster vendor consolidation and deliver a combination of cost savings and superior efficacy.

While SentinelOne’s CWS takes an agent-based approach, as we briefly mentioned, PingSafe is agentless. Agent-based requires a direct software installation, while agentless does not. One isn’t objectively better than the other. Agentless is considered cheaper, easier to deploy and easier to scale. It’s perfect for lower-stakes use cases like configuration analysis and is a perfect complement to CWS. Companies just starting out with finite budgets, massive potential scaling needs and a lack of hyper-sensitive data can adopt an agentless approach. Agent-based is considered more comprehensive and has more complete visibility. Industries with tighter regulation, more sensitive assets, a need for real-time EDR and more complex compliance are well served by agent-based. By offering both, SentinelOne can address both markets, thus eliminating the need for disparate point solutions.

To me, SentinelOne and CrowdStrike continue to be the two companies with the most complete cloud security offerings. I view CrowdStrike as a bit ahead of SentinelOne based on things like its Application Security Posture Management (ASPM) offering, but it’s highly likely that SentinelOne will offer this at some point too.  This is a large greenfield opportunity without the need to competitively displace entrenched incumbents.

The worst part of this quarter was the weak net new ARR (NNARR) result of about $38 million. There were two reasons for this. One is macro. It’s still seeing budget uncertainty and tighter buying conditions, just like many other companies in its space.

The second factor is simply execution. SentinelOne has been overhauling its go-to-market approach, with seasoned leaders (like Chief Revenue Officer Michael Cremen) stepping in to sharpen processes. It’s getting more aggressive on expansion and displacement opportunities in a move to bring its selling capabilities up to par with its best-in-class tech suite. In my view, this is where it noticeably lags CrowdStrike, with this issue being far more fixable than having bad tech. It needs to lean more heavily on channel partners like it’s now doing and needs to find new partners to help drive awareness of its offering. There are strong early signs of work here paying off, as its pipeline growth is ramping, bookings activity is improving and its revamped selling approach is resonating. This is leading to its conviction in NNARR accelerating in Q3 and Q4. Still, these rapid changes led to some disruption, which was blamed as the primary factor for the small revenue guidance reduction. This reminds me of Cloudflare a few quarters ago. That company figured things out in a hurry; this one needs to as well.

“We have a line of sight to a stronger new business generation in the second half of the year. Our confidence stems from a strong pipeline, ramping newer products and leading indicators from our go-to-market improvements.”

CFO David Bernhardt

“With better execution, we believe we can mitigate macro factors and deliver higher growth.”

Founder/CEO Tomer Weingarten

While I don’t love hearing “we need to execute better” I do love hearing “yeah macro is bad but we think we can and will overcome that on our own.” They’re not waiting for cyclical tailwinds to blow once more.. they’re not saying macro will prevent them from succeeding this year… they’re mitigating the impact of headwinds. And regardless of saying it needs to execute better, it’s still winning most of its competitive bids, still enjoying strong retention and still guiding to one of the fastest revenue growth rates in its sector for 2024 — while beating its schedule to positive FCF. 

“Our innovation is widening the competitive gap… Our technology comes out on top across every capability, be it endpoint, cloud, data or AI.”

Founder/CEO Tomer Weingarten

SentinelOne rolled out a simplified user interface (UI) called the “Singularity Operations Center.” It thinks this, paired with Purple AI and its work in data analytics, gives it a much better chance to win large contracts from Fortune 500 customers. The new UI unifies alerts, prioritizes them and “delivers a single pane of glass view” within the SentinelOne dashboard. It also boasts a correlation engine to borrow data and insight across threat categories to expedite time to remediation.

A key concern for SentinelOne is how successful it will be as it expands up-market to compete more directly with CrowdStrike for large deals. Things seem to be going fine here. 30% Y/Y $100,000+ ARR customer growth was actually a tad better than Bloomberg estimates, while $1M+ ARR customers ticked higher. ARR per customer also rose by more than 10% Y/Y.

This quarter wasn’t great or terrible. It was “meh.” To me, performance was identical to last quarter: a shellacked stock amid very modest guidance weakness on the top line, and a tiny profit raise. I get why traders punished this print. I don’t think a longer term investor like myself should be overly concerned. This remains one of the fastest growers at scale in public markets, operating leverage remains rapid, its path to profitability was again moved up and its non-endpoint traction is clearly building. As I said in the yesterday’s post, it trades at a massive gross profit multiple discount vs. CRWD and PANW. As long as it keeps showing clear signs of real cash flow and real profit in the near term, that’s a nice setup in my view. This company will likely earn $0.10+ this year as it explosively inflects to profitability. It trades for somewhere around 50x next year’s earnings, with an earnings CAGR from next year to three years from now expected to be near 100%.

Plus/Max subs can expect a full review of Zscaler’s report & MongoDB’s report at some point early next week along with coverage of Uber, Airbnb and Mastercard investor conferences. I simply ran out of hours in the day to thoughtfully review these two prints. Zscaler looked excellent; MongoDB’s guide was underwhelming. Stay tuned for a lot more detail in the near future. 

Fourth Quarter Guidance & Valuation:

Zscaler trades for 56x this fiscal year’s earnings with earnings expected to grow by 70% Y/Y this year and 8% Y/Y next year.

Balance Sheet:

Results:

Trades for 39x forward earnings. Earnings are expected to grow by 50% Y/Y this year & 19% Y/Y next year.

Trades for ~40x EPS with -32% Y/Y EPS growth expected & 25% Y/Y EPS growth next year expected.

Meta released an interesting blog post highlighting its plans for Facebook evolution. Notably, this evolution is happening from a point of strength, with young adult North American daily active users (DAUs) setting a 3 year high last quarter.

It’s implementing a few changes to nurture this strong young adult momentum. Some of these changes simply center on making its marketplace, community pages and Facebook Dating more visible for users. As an encouraging aside, Facebook Dating enjoyed 20% Y/Y DAU growth across North America last quarter. That’s a new, encouraging disclosure, with the caveat that growth was likely from a smaller, unknown base. Meta has tried to get into dating in the past with very little success. It’s hard to leverage its massive scale while delivering the level of privacy desired for dating app users. Perhaps it’s figuring this degree of separation out.

It upgraded its Reels and Feed content ranking algorithms in its push to have the “world’s best recommendation technology by 2026.” It also implemented a new GenAI model to sharpen content matching further. It’s infusing GenAI tools right into the discovery process to turn a tasty recipe into a clickable link to do it yourself.

Some other updates from the release included:

Facebook is supposed to be the weakest part of this growth engine. North America is supposed to be one of its two most mature markets within the weakest part of its growth engine. These stats point to the ugliest house on the block still being a shiny mansion. With billions of people already on Facebook, engagement work and progress like we’ve noted here will become all the more important for extending this runway.

I wish I could order a cheeseburger and watch a great movie with the same exact subscription. That is the dream… and Amazon is making it a reality. Amazon is deepening its GrubHub partnership to offer complimentary access to the delivery service for Prime members. They had a one year free trial in place until this point. 

While this news is small in isolation, it serves as a compelling piece of a broader theme. Amazon continues to infuse more product utility into its subscription. That is why Prime has among the best consumer subscription pricing power on the planet. That is why churn for this product is so low. This is more of the same for Amazon. From cell service, to entertainment, to food delivery, to probably satellite internet at some point (Project Kuiper)… the subscription just keeps getting more compelling. 

Nu continues to round out its product suite to areas beyond financial services. This week, “NuViagens” was announced through a partnership with Hopper Technology Solutions. This is essentially an online travel hub and booking service for its Ultravioleta high net worth members. Customers can plan trips and purchase travel/hotel accommodations for a “guaranteed best price.” They get a refund if they can find a better deal. This deepens the travel services from its previous Global Account, which helps with currency exchange.

I very intentionally placed this right after the Amazon section. Why? Because this section works off of the same concept on a smaller scale. Nu is rounding out its products and subscriptions to widen the value gap it provides vs. everyone else. This is what will drive engagement, pricing power, retention and its financial success. That’s also how it can provide lower interest rates than others and a “guaranteed best price here.” Beyond lower relative fixed cost, it does more for its customers, it keeps its customers around longer and so it generates more revenue from these customers with little incremental fixed cost. That paves the way for superior unit economics.

Step one was getting Brazil to embrace Nu’s core products. With 54% of the country on the platform, step two is now giving them everything they want to ensure they never leave and generate more lifetime value. Mexico is the same idea for Nu, just several years behind Brazil.

There’s another idea in here that I want to discuss. Nu isn’t supporting this product… or its telecom product… or its asset heavy insurance product on its own. It’s partnering with quality vendors to let them do the legwork. It’s not building out expensive systems or taking on excess balance sheet risk through diversification. It’s merely opening itself up to far more commission-based, asset-light revenue. This is ideal in my view.

Like we discussed last week, Nu is not a financial services company. Nu is a “make its customer base happier with an easier, more convenient day-to-day” company. Financial services was merely one area in Latin America where improvement was desperately needed. Telecom is another… travel is another… and many of the other consumer apps we know and love in the states are on the table in my view. 

Other perks:

Other Nu news:

PayPal is creating a new advertising platform with the help of new SVP of Ads, Mark Grether. For those unfamiliar with Gether, he was instrumental in building the foundation for Amazon as Director of Advertising in 2020-2021 and also as VP and GM of Uber Advertising until this month. This is a well-deserved promotion from VP to SVP of a Fortune 500 brand.

I find this somewhat exciting. Ads are what have made Amazon’s and Uber’s marketplaces more profitable than anyone thought they could be. And? Ads should be a highly profitable revenue driver for PayPal as well. It already has the digital real estate to enhance ad load across PayPal and Venmo. Now it’s just time to finally take advantage. This dynamic should mean this business is highly accretive to margins like it has been for the other two mentioned giants. 

PayPal has the massive customer scale, the unmatched data vault to build customer profiles and the strong consumer engagement needed to make ad impressions valuable. It also has the vast merchant network needed to actually place these ads without 3rd party help. How was this not a focus under old leadership? Good question. I don’t know, but I am relieved to see it as a focus today. This is how you become more profitable, without losing focus on your core offering. It has already launched marketing tools within PayPal Gold and the advanced offers platform. This is a more formal entrance into the advertising space. Maybe a partnership with The Trade Desk could be explored to ensure this goes as smoothly as possible.

As part of this release, John Anderson was also named the SVP and GP of PayPal’s Consumer Group. He will lead the product development for PayPal and Venmo. He was most recently the Head of Product and Payments at Plaid, Head of Product at Oculus and Head of Payments at Meta. The team continues to become more impressive.

The Illinois state government passed a new progressive sports gambling tax as part of its budget. The bill changes the flat 15% tax rate to a progressive tax rate of up to 40%. Vendors will pay 20% on revenue up to $30 million, 25% from $30-$50 million, 30% from $50-$100 million, 35% from $100-$200 million and 40% thereafter.

That is not ideal for large players like DraftKings and Flutter, which are the dominant market share holders in that state and all others. While high tax rates in states like New York are tough to navigate, that rate is flat, which benefits the big boys over everyone else. Inefficiency makes a tough industry even tougher to compete in and leads to weaker players fading away. Illinois legislation penalizes the big boys for their success. So what does this mean for these larger players and potential legislation across other states?

According to Illinois, Draftkings and FanDuel generated about $350 million and $400 million in revenue from that state in 2023, respectively. As DraftKings is the pure-play digital U.S. gambling company, we’ll focus here as the impact on FanDuel will be more diluted by its other businesses. This change will likely mean DKNG’s tax rate roughly doubles from 15% to 30% for a roughly $50-$70 million annual hit to adjusted EBITDA and a similar hit to GAAP EBIT, net income and free cash flow. ~$60 million is 6% of next year’s profits and about 4% of profits the year after. Two additional notes here: one positive and one negative. First, the 6% and 4% hits assume DraftKings has no levers to pull to offset the impact. It assumes it can’t trim promotions, can’t continue to grow its own handle share through more parlays and is hopeless amid this change. This is just not realistic. The true impact will be smaller than $60 million. 

Secondly, and vitally, the fear is Illinois serving as a domino for other states embracing this same taxation approach. It’s not the high tax rate that is the most worrisome, as DKNG and FLUT both do very well in states with high flat tax rates. It’s the progressive taxation structure that has some pundits worried. From the sell-side research I was able to access and research, the general consensus is that Michigan and New Jersey (two states of focus) are only seriously considering a flat tax rate hike rather than going this route. That’s a much easier pill to swallow. Higher tax rates offer a small profit hit, but a larger market share gain opportunity for FLUT and DKNG as the little guys just can’t make things work. According to Morgan Stanley’s analyst, New Jersey should be settled by the end of June. He doesn’t see a risk to any states following the Illinois model. Massachusetts already decided not to. Finally, the analyst made another good point in that the need to raise taxes to help raise funds bodes well for the roughly 80% of states that haven’t legalized iCasino. That’s the real profit driver for both players.

As I discussed in last week’s intro (and as we’ll discuss further in the deep dive this month), regulation is the big risk here. Selfishly, the timing worked out quite well for me. I had just started the new position, and this allowed me to accelerate the build-out of this new stake. I see Illinois as an anomaly and I see this news as leading to tougher comps for a year and then very little impact thereafter.

Bearish Lululemon opinions are as in style as its yoga pants. That will happen to all companies from time to time – even sell-side darlings like this one. Share price has a way of drawing out the Monday Morning Quarterbacks. This week, Morgan Stanley bucked that trend. Its high frequency sales data is pointing to Lulu’s U.S. growth outperforming expectations and potentially creeping back above 10% Y/Y. That would be a positive surprise and could easily be rewarded for a company trading at multi-year lows for profit multiples and with U.S. strength the key investor concern. It sees potential for Q2 guidance outperformance, but notes the added uncertainty surrounding the brand will not vanish overnight from next week’s report. It kept a buy rating on the company and lowered its target from $490 to $404 (tracking share price).