The following memo was shared amongst our investment research team.
Quibi’s shutdown offers a few valuable lessons for investors.
- A great founding team does not eliminate the need for a unique insight about the problem and market. We previously talked about how Quibi’s founding notion — that there are “in between moments” where consumers would want short TV-like experiences — was flawed. Those moments were already more than filled with content from social networks. Perhaps Quibi’s management team had a response to that reality, or perhaps no one wanted to challenge an A+ management team of Jeffrey Katzenberg and Meg Whitman, who are still an A+ team despite this failure. Bad markets and bad ideas don’t work, even with more than capable management and especially when management can’t adapt to market feedback.
- Most startup ideas change. This also includes ideas that are funded with hundreds of millions of dollars upfront. Quibi raised $1.75 billion before launch to develop content and technology. To challenge Netflix and YouTube requires tremendous resources when attacking them with professional-grade content, so it’s understandable why the company raised the money it did. Instead of developing some rough product or prototype and testing it with customers, the company’s resources encouraged the team to deliver on a finished vision of a product. One might argue that you can only try to compete against Netflix and YouTube with a finished version of a product rather than a minimum viable version. If the unchallenged vision for Quibi happened to be correct, the return would have been extraordinary. But so often in the world of startups, founder visions to get punched in the face by the market before a great product comes out. Nearly $2 billion in financing gave Quibi the opportunity to try the initial idea, but it didn’t give the company the flexibility to adapt to market response. The well was dry after so many resources went into the initial idea.
- Large funding rounds decrease the margin for error, not increase it. Every subsequent fundraise, even for companies who raise in a more traditional trajectory, comes with incremental expectations from investors at the next level. For Quibi, the trajectory was to go public. The public markets would have been the most appropriate venue to raise several billion more dollars to fund continued investment into content. To go public, the company would have needed to gain millions of subscribers with fast growth and low churn. The magnitude of Quibi’s financing locked the company into a vision and milestones with minimal flexibility. The unfortunate result was failure.
- Money is never a guarantee of product-market fit. Companies that raise mega-rounds often gain an aura of being unstoppable, but money doesn’t equate to success. Happy customers that can’t live without your product and tell all their friends about it equates to success. This is true of all companies, whether seed stage or mega-cap public tech.
The non-consensus opportunity. Innovation in the entertainment space may slow after Quibi’s failure, as investors often pull back from areas where significant money was lost. But this creates a non-consensus opportunity. Just as Pets.com and GM’s EV1 weren’t representative of ultimate eCommerce and electric vehicle demand in the early 2000s, I don’t think Quibi’s failure is a true representation of consumer demand for new forms of entertainment today in the 2020s. The insight may have been flawed, but the battle for consumer attention never ends.
Estimating iPhone demand throughout the year has stages, with each building on the previous. The first stage is the pre-orders, in which we track two factors: intent-to-buy, along with iPhone delivery lead times. This week, we found positive indications on both of these fronts. Our iPhone intent-to-buy survey suggests greater interest in the latest iPhones, compared to a typical year. Additionally, we continue to see delivery lead times extend slightly, suggesting demand is outpacing production. Historically, this has been a positive signal for sales. We continue to estimate the company will sell 217m iPhone units in FY21 (compared to 187m in FY20) and iPhone revenue will grow 15% y/y (compared to 1% in FY20).
We surveyed a range of 478 to 961 people through a Twitter poll on October 16. The sample is likely skewed toward consumers that are more tech-savvy, which means our survey likely captured users who are: 1) more likely to upgrade when a new iPhone is launched, 2) care more about 5G speeds, and 3) have newer phones.
Question 1: Do you plan on upgrading your iPhone in the next six months?
About 45% of respondents said they plan to upgrade their iPhone in the next six months. As a point of reference, a typical upgrade cycle sees between 17%-22% of the iPhone base upgrading. We view the 45% intent-to-buy as encouraging for iPhone demand, given a tech-savvy cohort would likely see between 30%-40% upgrade intention.
Question 2: Is 5G a significant factor in your upgrade decision?
Although 5G has received the lion’s share of media attention, only 29% of respondents said 5G is a significant factor in their decision to upgrade. Factoring in that Twitter respondents likely care more about 5G speeds than the average consumer, we believe it is closer to 15%. In other words, over the next year, we don’t anticipate the average consumer to upgrade because of 5G, which is in line with our 5G thought framework. As a reminder, we believe mid-band 5G, which we consider consumer upgrade 5G because it will provide speeds about 7x faster than 4G, will be widely available in 2022.
Question 3: How old is your current iPhone?
33% of respondents said their iPhone was more than 3 years old. Recently, we wrote about an iPhone tailwind: a larger upgrade pool, aka, the number of iPhones that are three years or older. We estimate the current upgrade pool is about 400m out of just under 1B total installed iPhones (~40%). While this estimate is higher than what our survey indicates, we remain confident in it, as our Twitter sample likely skews toward users with newer iPhones.
Lead times extend
When iPhone 12 went on sale on Oct. 16, we shared our initial field notes on delivery lead times. We have continued to check Apple.com regularly for lead times, and have observed them extending. Reflecting on lead times is not a science, given we don’t know how many phones Apple is able to produce. That said, longer lead times have historically been an indicator of healthy demand and shorter lead times an indicator of softer demand.
Tesla reported its fifth consecutive profitable quarter in the most recent September quarter, driven by strong vehicle deliveries. That said, the Tesla playbook is not as obvious as building EVs. While the foundation of Tesla will be manufacturing, the company’s ability to apply automotive tech in new markets, including battery storage, HVAC, insurance, and trucking logistics, will be a hallmark of its long-term strategy.
A more critical perspective would maintain that the number of initiatives bouncing around the Tesla business model diminishes the credibility of the company. We disagree, and, while not all initiatives will take hold, some will, enabling Tesla to expand its addressable markets and lay the groundwork for increasing its market cap.
September quarter takeaways
- Automotive gross margins this quarter were 23.7%, up from 18.7% in the June quarter. The company’s end game with wider margins is to continue making its vehicles more affordable, a top priority for Elon.
- Tesla reaffirmed its 2020 delivery target of 500k vehicles, implying 181k deliveries in the December quarter. This would mean 62% y/y growth, up from 43% in the June quarter. While this is an aggressive goal, we believe the company has a reasonable chance of reaching it.
- Model Y deliveries in Asia and broader Europe are set to begin in 2021, as expected. Given the Model Y is currently only available in North America and select European countries, meeting their goal would represent an impressive acceleration in deliveries in the December quarter.
- The energy generation and storage segment grew at 44% y/y, compared to 1% in the June quarter. While the segment is still small (~7% of total revenue), we believe it has the potential to be 25% or more of the overall business. The challenge of growing this segment is that the auto segment is experiencing comparable growth rates.
Ambitions beyond auto
The company’s earnings call highlighted how Tesla is leveraging its foundational auto tech and vertical integration to expand into other markets.
Musk began the call by reiterating his vision that Tesla’s core competency will be manufacturing, saying the company continues to bring production processes in-house as much as possible. This should have the effect of lowering production costs, lowering the price of Tesla’s products to consumers, and maintaining a high-quality standard. Vertical integration, which Tesla embraces, is a key factor in manufacturing excellence.
Elon suggested the insurance business could be a material part of Tesla’s overall business long term. The driving data it receives from its vehicles will inform insurance rates, creating a feedback loop that should provide cheaper car insurance to consumers. That said, in the long run, we see the insurance segment representing a measurable, but not a material part of the business.
Tesla’s semi-truck is expected to arrive later next year, although production will take time to ramp, given a semi takes 5x more cells than a car and the company is already cell constrained. An additional headwind to the semi rollout is the rollout of the Megacharging network, which will take a few years to build. We believe Tesla’s long-term vision for its trucking segment is to sell semis, and eventually offer a high-margin logistics and dispatch layer, that would compete with traditional logistics companies like C.H. Robinson.
Musk has been hinting at the HVAC opportunity for more than a year. When asked about a Tesla HVAC system on the earnings call, he replied while “there’s no prototype it would be good to have one.” This is something traditional auto doesn’t do.