Around the Markets:
Stocks and bond yields were mixed last week as the market awaits a resolution to the debt ceiling in Washington and assesses the outlook for growth, inflation and the overall economy and its impact on monetary policy. According to Bloomberg’s World Interest Rate Probability, the market is now expecting that the Federal Reserve is done hiking rates and will begin rate cuts by September. Economists still believe the Fed will hold rates at an elevated level through 2023.
Past performance is not indicative of future performance. The Index returns above are presented for illustrative purposes only. The index returns presented herein do not represent the results of actual trading in investable assets and securities. Index returns do not consider other expenses you may incur when investing or trading an investment strategy, which include, but are not limited to, advisory/management fees, custodian fees and trading fees/commissions. You cannot invest directly in an index.
Source: Bloomberg
Note: Bond yield change in basis points (1 basis point = 0.01%)
In Case You Missed it: In case you missed any of our latest research, here is a selection of some of the blogs we have recently published. You can find all of our research, including archived versions of older newsletters, on our website. And follow us on Twitter, Instagram and LinkedIn for more content.
- Around the Hill Volume 7 - Is a Debt Ceiling Debacle Really Happening?
- What is Generative AI and Which Companies Are Positioned to Benefit From Its Growth?
- The AI Search Wars - What’s at Stake for Google, Bing and Everyone Else?
Roblox Rises as Results Show Stable Growth, Path to Operating Leverage
Roblox shares rose 7.4% on May 10 after the company reported better-than-expected net bookings and user metrics for the first quarter. Investors may also have been encouraged by the company’s expectation to slow the pace of hiring and improve margins over the next few years.
Our Take:
Roblox’s pledge to slow down expense growth and drive higher margins via operating leverage finally demonstrate that the company is serious about getting more efficient. As peers such as Meta Platforms have focused on cutting costs including layoffs, Roblox has continued to grow headcount and expenses at a rapid clip.
In the first quarter, non-GAAP total operating expenses rose 41.7% year-over-year, nearly double the growth rate of net bookings. But Roblox now expects to slow the pace of investment in headcount and compensation expenses and expects bookings growth to exceed that of compensation beginning in 2024. Roblox also expects the growth rate of infrastructure costs to drop below that of bookings in the second half of 2023 now that its second data center construction is largely complete.
Slowing expense growth while maintaining double-digit bookings expansion will be key for Roblox to unlock improved profitability and meet consensus expectations. Analysts expect Roblox adjusted EBITDA margin to reach 15.2% in 2025 vs. 10.7% in 2023.
Investment Themes
Metaverse, Gaming
Google Brings Generative AI Everywhere at I/O Conference
Google’s annual I/O developer conference was dominated by its rollout of several new generative artificial intelligence tools and new large language models. Google-parent Alphabet’s shares rose 4.1% following the announcements.
Our Take:
A narrative has grown that Google is going to get its lunch eaten by Microsoft and OpenAI with generative AI following Google’s lackluster launch of its Bard chatbot earlier this year. Google’s announcements at I/O demonstrate that it is all-in on generative AI and it can successfully roll out the technology across its product suite, including search and productivity applications.
Google also announced a new large language model, PaLM 2, which improves on multilingual, reasoning and coding capabilities. PaLM 2 is trained on 100 languages and several coding languages so it can assist in coding in Python, JavaScript and others.
Although Google has been slower at commercializing its generative AI tools and technologies than Microsoft and OpenAI, we believe they are well-positioned to expand them across their product suite, drive efficiencies for customers with them and lead to higher cloud sales over time. Google also has the potential to release standalone generative products that can drive incremental revenue.
Nintendo Sees Switch Slowdown Raising Questions of What’s Next
Nintendo’s shares were largely unchanged on May 9 after the company provided an outlook for the fiscal year ending March 2024 that was below analyst estimates. Nintendo expects Switch hardware unit shipments to drop to 15 million in FY24 vs. 18 million in FY23 as the cycle enters the mature stage.
Our Take:
Nintendo’s outlook for a further slowing of Switch hardware unit shipments leaves a lot of questions unanswered as to the future path of Nintendo’s hardware roadmap. Despite Internet rumors of a next-generation console, Nintendo refused to provide any color on future products which we believe disappointed some investors who were looking for signs of the next console.
The Switch is already Nintendo’s best-selling home console, with lifetime unit sales exceeding 125 million vs. the Wii’s 101.6 million. But the Switch is entering its seventh year of sales and Nintendo, on average, releases a new home console roughly every six-to-seven years. With advances in graphics technology and player expectations for game quality, Nintendo may be forced to elaborate more on future hardware plans soon.
The strong release of the Mario movie and the release of the Legend of Zelda: Tears of the Kingdom should provide an uplift to June quarter profit but that may not be enough to offset declining operating profit. Nintendo’s FY24 guidance points to a roughly 10% decline in the metric.
Investment Themes
Gaming
Unity Jumps on Improved Outlook, First Quarter Beat, AI Opportunities
Unity Software’s shares jumped 12.9% on May 11 after the company reported first quarter results that exceeded analyst estimates and raised its guidance for 2023 sales and EBITDA that also exceeded expectations. The company also described its efforts to embed generative AI tools across its product suite to onboard more creators to its real-time 3D software.
Our Take:
Unity is seeing strong cost and revenue synergies from its acquisition of ironSource begin to pay off with improving growth trends and profitability. The company now expects, at the midpoint of its outlook, 2023 sales and EBITDA of $2.1 billion and $275 million. The revenue outlook was in-line with analyst views but its outlook for EBITDA exceeded the consensus $243 million. The revised profit outlook in particular is encouraging as Unity attempts to get to a run-rate EBITDA of $1 billion exiting 2024, a goal of which analysts remain skeptical.
Unity is also attempting to grow new revenue streams which will take time but can help it achieve that profit target. Management notably discussed its focus on growing usage-based revenue as opposed to subscription sales, especially as it rolls out more cloud-based products. On paper, this is an encouraging scenario but it may prove cannibalistic to its users, who value the company's predictable pricing model to gain visibility to costs. Unity would like to have more products whose revenue scales with that of its customers.
And Unity couldn't miss the opportunity to discuss its use of generative AI. The company discussed how it plans to roll out its project Barracuda across its product suite - including the Unity Editor, Unity Runtime and Unity Network - to drive deeper usage by customers and potentially win new ones. The company believes that its trove of real-time 3D data will be crucial to training large language models for game developers that others building generative AI products lack.
Investment Themes
Metaverse, Gaming, Artificial Intelligence
EA Slides as Strong FIFA Overshadowed By Conservative Outlook
Electronic Arts’ shares fell 0.5% on May 10 after the company reported better-than-expected fiscal 2023 results but provided a softer outlook for the June quarter. Still, analysts remain positive as the company’s key live services franchises continue to show strength and mobile revenue rebounds.
Our Take:
EA posted strong fiscal 2023 results, with FIFA 23 becoming the highest-selling edition of the franchise in just 6 months. It was boosted heavily by the world cup in December vs. the event’s normal timing in June, meaning it was much closer to launch and helped EA capture greater demand for the event. But other key titles such as Apex Legends showed stabilization while FIFA Mobile grew triple digits.
Still, EA’s guidance for the June quarter was slightly weak, which may point to conservative estimates around the release of Star Wars Jedi: Survivor, the sequel to Star Wars Jedi: Fallen Order. The original title sold over 10 million units and EA said the sequel is pacing strongly against the original.
There remain headwinds in parts of the business such as the non-FIFA mobile games, including the acquired Glu Mobile business. Although management noted that Glu’s profits were growing, the mobile business excluding FIFA appears to have declined 15-20% year-on-year. The core FIFA business also faces difficult year-ago comparables in fiscal 2024 with no world cup this year, but management still expects sales to grow modestly which we see as encouraging.
Investment Themes
Metaverse, Gaming
Senate Hearing Paves the Way Forward for SAFE Banking Reform… Maybe
The U.S. Senate Committee on Banking, Housing and Urban Affairs held a hearing discussing the pending Secure and Fair Enforcement Banking Act (SAFE). Feedback was largely positive and it sets the stage for votes to clear the committee before coming to the Senate floor.
Our Take:
A clean SAFE bill has the best chance of passing but risks still remain that Senate majority leader Chuck Schumer will add social justice reforms such as clearing criminal history to the bill, which in our view would hurt its chances of passing significantly. Still, the clean version of the bill appears to have enough bipartisan support to pass.
The passage of SAFE would not just enable cannabis companies to accept card and other digital payments, but it would significantly unlock banking and financial services for the sector. For example, it would enable listed companies in the U.S. to move from over-the-counter trading on to exchanges, which could significantly increase their potential investor pool, given tighter restrictions on trading OTC securities.
We believe that cannabis reform is a matter of when, not if, but we believe that attacking it with incremental legislation - such as a clean SAFE - rather than all at once - such as including social justice reforms - is the best path forward to increase the odds of reforms getting through congress.
Investment Themes
Cannabis
Chart of the Week
Source: Roundhill Investments, May 9, 2023
As Large Language Models continue to evolve, new pre-training and fine tuning techniques unlock increasingly accurate and sophisticated outputs. LLMs sit at the core of generative artificial intelligence applications. In our chart of the week, you can see the evolution of some of the leading LLMs over time and the number of parameters on which they are trained.
The information contained in this newsletter is for informational purposes only and does not constitute financial, investment, tax or legal advice. The information expressed herein reflects the opinion of Roundhill Investments (“Roundhill”) on the date of production and are subject to change at any time without notice due to various factors, including changing market conditions. Where data is presented that is prepared by third parties, such information will be cited, and these sources have been deemed to be reliable. Roundhill is separate and unaffiliated from any third parties listed herein and is not responsible for their products, services, policies or their content. All investments are subject to varying degrees of risk, including the risk of the loss of capital, and there can be no assurance that the future performance of any specific company, strategy or product referenced directly or indirectly in this newsletter will be profitable, perform equally to any corresponding indicated historical performance level(s), or be suitable for your portfolio. Past performance is not an indicator of future results.
