VCS Agency - Lunar Capital

Apple Doesn’t Fall Too Far from the Tree

In 1998, Compaq Research introduced the first “Personal Jukebox.” Although the device was bulky and could only store the equivalent of one CD, it represented a significant advancement in portable music technology. Recognizing its potential, Apple procured exclusive rights to affordable 5GB disc drives developed by Toshiba, which were capable of storing up to 1,000 songs. Apple subsequently redesigned the media player with a sleek and user-friendly interface and launched the iPod in 2001.

Apple is known for observing market trends before developing its own products. The company waits to see which products become popular and, if there is potential for further growth, it creates its own versions with Apple’s distinctive design and sells them to the market.

In the realm of generative AI, Apple has taken a unique approach compared to other major technology companies like Alphabet, Amazon, Meta, and Microsoft. Unlike these firms, Apple has not significantly increased its capital expenditure on building data centres.

Instead, Apple opted for its more patient strategy, aiming to develop an AI of the highest quality. Initially, this method presented some challenges for Apple, such as delays and bugs in the AI features on its devices. Now, in cases where Apple’s AI is unable to generate responses for users, it utilizes ChatGPT to provide the necessary responses.

Apple’s strength lies in its highly valuable consumer distribution platform, designed to create a seamless experience for users centred around the iPhone. In Q4 2024, Apple’s products and services generated a revenue of $124 billion, with an operating income of $42 billion. This robust distribution to a highly valuable customer base is a key strength and could position Apple as one of the significant beneficiaries in the AI race.

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Disclosures
Lunar Capital (Pty) Ltd is a registered Financial Services Provider. FSP (46567)
Read our full Disclosure statement: https://lunarcapital.co.za/disclosures/
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The Lunar BCI Worldwide Flexible Fund Fact Sheet can be read here.
This stocktake is prepared for the clients of Lunar Capital (Pty) Ltd. This stocktake does not constitute financial advice and is generated for information purposes only.

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Net Flicks on Flicks on Flicks

Weekly Stocktake / By VCS Agency

Three years ago, Netflix’s stock price experienced a significant decline of more than 70% from its peak reached at the end of 2021. This decrease was driven by the loss of subscribers for the first time in Netflix’s history. Analysts also argued that Netflix was unable to maintain its market leadership and effectively counter the competition. Concurrently, inflation in the United States was rising to levels not seen for decades.

However, last week, Netflix achieved new stock price highs, with the stock closing at $977 on Friday. Netflix ended the week with price-to-earnings ratio of just over 49 and a market capitalization of $417 billion.

Netflix saw an increase in their number of subscribers by nearly 20 million in Q4 2024, reaching just over 300 million subscribers worldwide. Revenue for Netflix rose by 16% to $10.24 billion, while operating profit grew by 52% to $2.3 billion. The significant rise in profitability was attributed to operational leverage. Netflix managed to expand its subscriber base without a proportional increase in operating costs. The below graph shows the change in profitability for Netflix over the last two years.

Why is there so much positivity behind Netflix’s business?

Netflix is uniquely positioned to concentrate their efforts exclusively on streaming, unlike competitors in the entertainment sector who balance their newer streaming initiatives with their currently-profitable legacy assets.

Other competitors, such as YouTube (a subsidiary of Alphabet) and Amazon Prime, have primary businesses in areas such as search and e-commerce that demand extensive company resources in terms of effort and capital. Consequently, these companies may not place a high enough priority on their streaming business, potentially resulting in a loss of market share.

Netflix also has an extensive lineup of new shows and movies scheduled for release this year, as part of its strategy to further expand its revenue base. The company has also introduced advertising packages in numerous markets and plans to scale these efforts throughout the year. Following the success of live events such as the Jake Paul vs. Mike Tyson fight, Netflix is exploring opportunities to develop its live events segment, focusing on occasional events rather than expensive, year-long sports leagues.

However, despite their recent successes, Netflix faces significant competition, increasing costs, and shifting consumer preferences. A few missteps could considerably impact the company’s performance.

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TSMC: Manufacturing Artificial Intelligence

Weekly Stocktake / By VCS Agency

Good day everyone, I trust you all had a pleasant break during the festive period. Taiwan Semiconductor Manufacturing Company (TSMC) commenced the year by announcing their results for Q4 2024.

TSMC is widely regarded as one of the most crucial companies globally. While Nvidia and Apple design semiconductors for AI and phones, respectively; TSMC is the company that manufactures the semiconductors. Today, over 90% of the world’s most advanced chips are produced at TSMC’s manufacturing facilities in Taiwan.

Semiconductor designers choose TSMC for their chip production for several reasons:

Economies of Scale: Given TSMC’s existing scale, they can accelerate chip production much faster than other companies.

Supply Chain Resilience: TSMC has the capability to stockpile critical materials during shortages, ensuring a reliable supply chain.

Business Model: TSMC specializes solely in semiconductor manufacturing, unlike competitors such as Intel and Samsung who also design chips. This specialization instils confidence with their clients that TSMC is not competing with them.

Operational Excellence: TSMC’s operational expertise enables them to produce semiconductors with fewer defects, compared to their competitors. This proficiency allows TSMC to increase their margins while reducing costs for their customers.

TSMC’s revenue for the quarter was $26.9 billion, an increase of 37% compared to the previous year. This growth in revenue was primarily due to strong performance in the High Performance Computing segment and the Smartphone segment. These segments represented 53% and 35% of TSMC’s Q4 2024 revenue, respectively. As a result of the increased production scale for high-performance computing chips, TSMC’s income from operations rose by 63% year over year to $13.2 billion, indicating an operating margin of just under 50%.

Due to increasing geopolitical tensions, the United States has been encouraging TSMC to build facilities in the US by offering grants and loans. TSMC has built a factory in Phoenix, Arizona and has already started producing semiconductors from this facility. Additionally, the US has issued executive orders restricting companies from selling advanced semiconductors and semiconductor equipment to China, as both countries strive for technological leadership. Despite these measures, semiconductor designers continue to choose TSMC due to a lack of viable alternatives.

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Quarterly Investment & Performance Review – 31 December 2024

Quarterly Performance / By VCS Agency

Sabir provides an update of the Funds’ performance and how Lunar Capital plans to invest in the current market climate

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Sweet and Sour Lululemon

Weekly Stocktake / By VCS Agency

The premium athleisure brand Lululemon has gone through a rough patch this year. Last week the company released their third quarter 2024 results, sending the stock just under 16% higher on the day. However, year to date, the stock is down 14%, compared to the S&P 500 index, which is up just under 28%.

The two main issues Lululemon recently faced are:

Earlier this year, Lululemon released a selection of leggings that did not meet customer preferences. The range lacked sufficient colour options and had incorrect size quantities, resulting in missed sales in key locations such as the US.
Another challenge that Lululemon encounters is the highly competitive market in which they operate. If customers are dissatisfied with the products, they can easily switch to other brands. Given the premium pricing of Lululemon items, customers tend to be particularly discerning and may readily choose alternatives.

During the earnings call, Lululemon stated that they will focus more on their existing customers in the US, rather than significantly expanding the total number of stores to gain new customers. Of the total revenue of $2.4 billion in Q3 2024, America accounted for 79% of the revenue. One of the strategies Lululemon is implementing is increasing the percentage of new products to total products in their stores as a way of encouraging current customers to spend more at their stores. The next few quarters will indicate the success of this strategy.

Despite some challenges in the US market, Lululemon’s international segment has shown significant growth. The segment in China grew by 39% to $318 million, while revenue from regions outside the Americas and China increased by 27% to $308 million.

Internally, the company maintains healthy margins. The gross margin for Q3 2024 was 58.5%, an improvement from 57% in the same quarter of the previous year. Furthermore, Lululemon’s operating margin for this quarter was 20.5%, compared to 15.3% in the same period last year.

Lululemon primarily sells through its stores, giving it greater control over its brand. This strategy allows for quicker adjustments. However, challenges remain, and only time will tell if they regain customer favour.

This is the last Stocktake of the year. Have a great festive season and travel safely. The Weekly Stocktake with Danyaal will resume in January.

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CrowdStruck

Weekly Stocktake / By VCS Agency

On July 19th, a faulty update, from cybersecurity firm CrowdStrike, caused a global outage on Windows devices, leading to major IT disruptions worldwide. Businesses and governments faced operational issues, with losses estimated in the billions. CrowdStrike’s share price dropped by over 40% after the incident.

CrowdStrike has addressed the issue and claimed to have implemented more robust internal processes to ensure the proper functioning of their updates and products. The company has also engaged extensively with its customers to reaffirm the quality of its products in terms of protection, ease of use, and cost-effectiveness at scale. Post-outage, CrowdStrike’s customer retention rate was 97%, slightly lower than the 97.5% reported in the same quarter last year. The company attributed this decline primarily to the outage.

Despite the outage, CrowdStrike’s revenue for the third quarter of the 2025 financial year reached $1.01 billion, marking a 29% increase compared to the same quarter in the previous year. Their annual recurring revenue was $4.02 billion, reflecting a 27% increase year over year. CrowdStrike noted that customers are seeking to consolidate service providers. Currently, 66% of customers use 5 or more security modules on CrowdStrike’s security platform, Falcon. The platform allows customers to manage their cybersecurity from a single platform.

With ongoing geopolitical tensions globally and ever-increasing connectivity, cybersecurity has become crucial for governments and organisations. Cybersecurity firms have benefitted from this trend as more organisations seek to protect themselves from online threats. Despite the July outage, CrowdStrike’s stock has risen by over 40% year-to-date. Although still about 11% from its peak.

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Nvidia: Friend or Foe

Weekly Stocktake / By VCS Agency

Nvidia designs state-of-the-art Graphics Processing Units (GPUs) which are among the most advanced available in the market. Their GPUs are essential for handling and processing extensive workflows required for training and operating Artificial Intelligence (AI) applications. Nvidia’s latest Blackwell chip is priced at approximately $35,000 each. These chips are primarily sold to Big Tech companies such as Google, Amazon, Microsoft, Meta, and other AI providers with the financial capacity to procure them.

Competitors like Intel and AMD have been attempting to challenge Nvidia’s dominance in the GPU market. Nvidia’s revenue for the recent quarter was $35.1 billion, an increase of 94% year over year. This growth was mainly driven by their data centre segment, which accounted for 87 percent of Nvidia’s revenue this quarter. In comparison, AMD’s data centre revenue was $3.5 billion for the quarter.

Nvidia’s customers are significantly increasing their demand for Nvidia’s chips. They are all expanding their capacity and raising their capital expenditure to build platforms for training and running models. Nvidia’s customers are determined not to fall behind in the AI industry. As it currently stands, over the next five years, Big Tech companies plan to invest over $1 trillion in AI.

The Big Tech companies are increasingly dissatisfied with the costs and “single point of failure” risk associated with Nvidia’s products. Consequently, many companies are developing their chips to reduce their dependence on Nvidia’s technology. Amazon, for instance, is planning to integrate its suite of products with Nvidia’s offerings. Unlike Nvidia’s versatile chips, Amazon’s products are designed for specific tasks, which can help lower the expenses of running certain AI applications.

Nvidia continues to hold a significant share of the market. Their operating margin for the quarter was 62%, highlighting the premium their customers are still willing to pay for their products.

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What’s Up Walt

Weekly Stocktake / By VCS Agency

The Walt Disney Company holds a diverse portfolio of brands and assets. These include Disney, Marvel, Star Wars, Pixar, 21st Century Fox, sports broadcaster ESPN, and Disney Experiences. Since the onset of the pandemic, Disney has faced challenges in maintaining its previous level of success. The segments have not always done well simultaneously.

Disney’s multiple business segments that drive the revenue for the company:

Experiences – includes their theme parks and Disney cruises.
Entertainment – includes their streaming platforms, linear tv assets, and box office hits .
Sports – includes their ESPN assets.

During the Covid pandemic, Disney’s streaming service, which was in its early stages, contributed to the company’s growth. The strategy was to leverage its extensive catalogue of creative and entertainment Intellectual Property (IP) to attract more users to its brand and transition users from its traditional linear television business to a more streaming-focused model.

Its Direct-to-consumer business (DTC) which includes Disney+ and Hulu, currently have just under 175 million paying subscribers globally. Average revenue per user (ARPU) per month in the United States for Disney+ is $7.70, compared to Netflix, which has an ARPU of $17.06. Netflix’s streaming service also boasts 282 million subscribers globally, over one hundred million more than Disney’s streaming platform.

Growth at Disney for its DTC business has slowed significantly since the peak during the Covid period. Revenue for the quarter for its DTC business increased by 16% to $5.8 billion. A notable development is that Disney’s operating income for their DTC platform was positive at $0.3 billion for the current quarter, an improvement from a peak loss of $1.5 billion in Q4 2022.

Disney’s parks and experiences business had the highest operating income among its segments, reaching $1.7 billion for Q4 2024. The segment performed well following the COVID-19 pandemic due to increased demand. However, with consumers facing financial pressure, the experiences business saw a year-over-year growth of only 1%, totalling $8.2 billion for the the quarter.

Disney’s CEO Bob Iger has stated that the current focus of Disney is to return creative control to their various brands and segments. He asserts that producing quality content for audiences encourages engagement with related content, whether from their streaming platform or their experiences business. It remains to be seen if Disney can effectively compete across all its business segments in the extremely competitive entertainment industry.

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Mercado Libre – Seeking Credit

Weekly Stocktake / By VCS Agency

Mercado Libre (Meli), meaning “Free Market,” is an e-commerce and fintech company operating in Latin America. Revenue is primarily generated from its presence in Brazil, Argentina, and Mexico. Mercado Libre’s vision is to service parts of the market that weren’t traditionally being serviced.

Initially established as a marketplace platform for individuals to sell and trade second-hand items, Meli has evolved into a comprehensive e-commerce and fintech platform. It currently has over sixty million unique active buyers on its e-commerce platform, and over fifty million users on its finance platform.

Meli’s Q3 2024 revenue rose 35% to $5.3 billion, fuelled by more online activity. E-commerce revenue jumped 47% year over year to $3.14 billion, while fintech revenue increased 21% to $2.2 billion. Mercado Libre’s gross profit grew 16%, impacted by higher sales costs and finance expenses.

Meli has been aggressively expanding their fintech business, which has the potential for higher net margins if managed effectively. They have leveraged their e-commerce platform to support this growth. Meli believes that the richness of the data they receive will enhance their understanding of their customers. The percentage of monthly active sellers on their e-commerce platform who have obtained financing through Meli has increased from 9.9% last quarter to 21.8% this quarter.

Operating income for the company was $0.56 billion, down 29% year over year. Meli’s aggressive approach to grow their fintech business has resulted in them taking on a higher provision for bad debts. The risk of servicing markets that haven’t previously been serviced before is that there are a lot of unknown risks that the company takes on.

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Alphabet(ting) on AI

Weekly Stocktake / By VCS Agency

Alphabet Inc., the parent company of Google, generates a substantial amount of cash. The Google Services segment, encompassing Search, YouTube, and other platform subscription services, reported a revenue of $76.5 billion for the most recent quarter. After accounting for all operating expenses, Google Services achieved an operating profit of $30.9 billion, resulting in an operating margin of 40%.

Alphabet has leveraged this profitable segment to reinvest in its products, explore new ventures, and strengthen its balance sheet.

At the beginning of 2023, as interest in generative AI was increasing, Alphabet was among the companies with sufficient resources to invest significantly in developing generative AI infrastructure and offering products to customers.

Google Cloud has maintained its position as the fastest-growing segment for Alphabet over the last few years. Google Cloud’s revenue for the current quarter increased by 35% year-over-year to $11.4 billion. This growth was mainly due to the expansion of Google Cloud Platform (GCP) AI infrastructure, Generative AI solutions, and other GCP products. Additionally, Google Cloud has become profitable due to increased scale of operations. For Q3 2024, Google Cloud generated $1.9 billion in operating profit, compared to $0.3 billion for the same quarter last year.

To support the growth of its cloud business, Alphabet has invested heavily in its infrastructure. Since the beginning of this year, Alphabet has spent $38.3 billion on capital expenditure, compared to $21.2 billion over the same period of time last year. It is estimated that 80% of this year’s capital expenditure has been allocated towards data centres, which are used to compute data and power intensive AI workloads.

After all the spend in capital expenditure, Alphabet still had a cash and cash equivalents on hand worth $93 billion at the end of the current quarter.

Alphabet is expected to see its margins compress on its income statement next year when the depreciation on their capital expenditure reflects for the full year. There are concerns that Alphabet, along with their competitors, have been over-investing in generative AI products, without having a real gauge on what the AI market will look like in the medium-long term future. As it stands, Alphabet plans to continue spending on AI infrastructure, arguing that they do not want to be left behind in the AI race.

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