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October 30, 2014 – TMT: Portfolio Update – Dreams, Comebacks, Skeptics and the Death Watch Redux

Written October 30th, 2014 by

 

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TMT: Portfolio Update – Dreams, Comebacks, Skeptics and the Death Watch Redux

Last quarter, we created a framework to assess TMT stocks, juxtaposing near-term cash flow expectations (5-year consensus cash flows) with long term expectations (post 5 year cash flows implied by residual value). Arrayed on these axes, companies fall into 4 distinct quadrants 1) High near-term/High long-term “Dream Stocks”, 2) High/Low “Skepticism Stocks”, 3)Low/High “Comeback Stocks”, and 4) Low/Low “Death Stocks”. We extended this analysis to all US-traded TMT stocks with market cap above $3B, yielding a universe of 180 names, updating it to account for recent changes in valuation. As with the original analysis, the stocks largely fall into intuitively sensible quadrants. We believe the categorization has clear implications for investment – Dream Stocks are easily forgiven for short term transgressions, Skepticism Stocks are chronically “undervalued”, Comeback Stocks must justify their valuations or rerate, and Death Stocks have potential to surprise but could be value traps.

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Quick Thoughts: TWTR 3Q14 – It’s Always Something

Written October 27th, 2014 by

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-        TWTR posted 3Q14 results that either met or beat consensus for every reported metric, including 23% growth in users, 14% growth in timeline views, and 114% growth in revenue

-        Nonetheless, shares traded off 10%+ after hours, leading reporters to speculate the cause – 4Q sales guidance? Views per user? Whisper numbers? Decelerating QoQ MAU growth?

-        The worst number in the report was a 7% sequential jump in stock based compensation expense, which wiped away the benefit of record EBITDA margins, and then some.

-        4Q compares are relatively easy on MAUs, engagement and sales. 4Q guidance could be a low ball –3Q sales were 6% above the high end of guidance. Perhaps TWTR will answer the skeptics.

In its fourth quarter of reporting earnings as a public company, Twitter once again reported generally strong results that were either in line or beat consensus. Top line revenue was a clear beat at $361M against the $352 expected by consensus, growing 114% YoY. EBITDA came in at $68M, well above the consensus target of $54M, on operating margins that were, again, well above analyst expectations. EPS was on target at a penny, but save for some extraordinary expenses including forex and increased interest expense on a convertible note offering, it would have been $0.02.

Monthly Active Users (MAUs), 284M, were up 13M from last quarter and 52M from last year, representing YoY growth of 23%, in line or ahead of analyst projections that had been quoted in the press. Timeline views by logged in users reached 180.6B, up from 158.8B last year, growing at 14%. The company had phenomenal success monetizing mobile, with the category now representing 85% of revenue, up from 70% last quarter. The “data licensing & other” category was up 171% to $41M driven by MoPub. Its international user monetization more than doubled in value as the company now has a presence in 60 countries, and is aggressively targeting certain growth markets. BAM! The stock is trading down more than 10% after hours. What happened?

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Quick Thoughts: MSFT – Not Your Father’s Microsoft

Written October 23rd, 2014 by

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-          MSFT’s 1QFY15 were stellar – 11% YoY organic sales growth, strength in both devices/consumer and commercial businesses, and a solid EPS beat.

-          MSFT is killing it in the cloud – commercial sales up 128% YoY, likely to a $5B+ annual run rate. Commercial Windows and Server both delivered double digit growth

-          Consumer was a surprise. Xbox sales doubled YoY. Surface Pro 3 is selling at 2X the pace of Pro 2. Office 365 up 25% QoQ. Even Nokia was surprisingly strong.

-          Margins are down, but the fruits of MSFT’s significant restructuring are yet to be felt. 2015 should yield significant earnings acceleration.

Microsoft delivered another extraordinary quarter under CEO Satya Nadella showing the “mobile-first and cloud-first” strategy articulated in July is working. Top line revenue was up 25% to $23.2B, and backing out Nokia, the organic growth was a still impressive 11%. The top line figure handily beat consensus expectations of $22.0B and the bottom line was a solid beat of $0.54 in EPS against $0.49 expected. The company’s restructuring expenses also came in at the lower end of guidance with some $1.14B in write offs related to the Nokia handset business. With other traditional enterprise IT players struggling to adapt their businesses for new cloud and mobile opportunities, Microsoft has shown it’s successfully making the transition.

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October 21, 2014 – Sensors: What’s in YOUR Smartphone?

Written October 21st, 2014 by

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Sensors: What’s in YOUR Smartphone?

In the growing functionality of high end devices, the spread of basic smartphones, and the emergence of new device types – wearables, etc. – sensors are a $60.4B market that is growing at a 9.2% CAGR. We categorize them into 5 groups – physical, optical, radio, electrical and chemical – each serving specific applications and requiring particular design and manufacturing disciplines. As such, competition amongst sensor manufacturers stays within these silos. For sensor functions already well embedded into portable devices, suppliers are challenged to minimize cost, footprint and power draw, often integrating multiple functions of a type into a single solution. Emerging functions, such as gesture control or biometric ID, have drawn approaches using different sensor types, although economics and performance will eventually drive standardization. New devices are a growth market for existing sensor types, but may also create opportunity for new sensor components suited to specific applications. While we are bullish on new portable device opportunities for sensor components, we note that many longstanding sensor products are commoditized, particularly within well established traditional end markets, such as automotive and industrial automation.

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Quick Thoughts: AAPL – SURPRISE! AAPL beats! (actually, not a surprise)

Written October 20th, 2014 by

-          AAPL delivered 4QFY14 EPS of $1.42 on sales of $42.1B, handily beating the published consensus, on very strong sales of the iPhone 6 and 6 Plus that had been widely anticipated

-          Sales growth of 12.4% was the best since December 2012. iPhone unit sales of 39.3M were up 16.2% YoY, with ASPs up 4.3% to $6.02. iPhone is 56.2% of AAPL sales, up 340bp YoY.

-          Mac sales had a big quarter, up 18% YoY and 15.7% of total. The iPad franchise, down 14% to 12.6%. of AAPL sales, is deteriorating. iTunes grew 8% YoY, falling to 10.9% of total sales.

-          We expect another big beat in December. Increasing dependence on iPhone raises risks as high end smartphone market saturates. Strong Apple Watch sales needed to sustain growth in 2015.

Having already reported selling 10 million units during the opening weekend sales of the iPhone 6 and iPhone 6 Plus, and ongoing press commentary of the vigorous global demand for Apple’s foray into modern larger screen form factors, it would have been shocking if the company had not blown out the published consensus numbers. In that context, the fairly sleepy after-hours response to the obviously excellent results is not all that surprising.

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Quick Thoughts: GOOG – Moonshots are Expensive

Written October 16th, 2014 by

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-          GOOG missed 3Q14 EPS by 2.8%, failing to deliver an expected QoQ improvement in operating margins. Net sales were in line, with fractionally lower revenues offset by slightly better TAC.

-          Sales saw total paid clicks decelerate to 17% YoY growth, but cost per click was once again flat QoQ and down just 2% YoY, rebutting the popular bear narrative of chronic price deterioration.

-          Sites revenue grew 20% and “Other” revenue – including Play, devices, Docs and Compute Engine – grew 50%. Expenses were up nearly 30% YoY, driven by R&D and SG&A.

-          Modest CAPEX, up less than 6% YoY, may be a sign of future cost improvements, but like many other cloud-era leaders, GOOG is relatively unconcerned with delivering quarterly results.

Google missed its 3Q14 EPS bogie by $0.18, delivering $6.35, when the assembled sell side wanted $6.53. Predictably, in a tough tech tape, Google shares are trading down a bit over 2% after hours, drooping uncomfortably close to the 52 week low of $503. Still, despite the headline, 3Q14 was, more or less, a continuation of the trends set in the last couple of quarters.

Sales were, essentially, in line, up 20% YoY at $16.52B. While this was nominally $50M below the published revenue consensus, most investors care more about Google’s net sales after deducting traffic acquisition costs (TAC), and those were actually just a tick above expectations, since TAC was more than $50M lower than forecast. Inside the sales number, was more give and take. The total paid clicks were up just 17% YoY, decelerating from better than 25% click growth in each of the previous three quarters. Management drew a few questions about decelerating click growth on the conference call and asked investors not to panic, explaining that ad demand is pretty volatile quarter to quarter.

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Quick Thoughts: NFLX – One Strike is Not an Out

Written October 15th, 2014 by

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-          NFLX disappointed investors on sub growth, missing guidance for 3.7M new subs by 19% as a price hike and a relatively weak slate of new programming releases dampened demand

-          The disappointing results were amplified by TWX’s announcement that it would offer HBO as a stand-alone streaming service in 2015 – we expect a significantly higher price point than NFLX

-          While sales disappointed vs. consensus, they were up 89% YoY, an acceleration from 2Q14’s 85% growth, a better indicator of imperfect forecasting than real operating problems

-          We remain confident in NFLX’s long term trajectory and expect substantial further sub growth going forward. We also see significant opportunity for advertising revenues down the line.

This is why many technology CEOs hate to give guidance. After blowing out numbers for the past three quarters, NFLX honcho Reed Hastings offered a 3Q14 target of 3.7M new subscribers, a projection of 33.4% YoY growth in total subs and a slight acceleration against the 33.3% growth the company delivered in 2Q. OOOPS! NFLX only delivered 3.0M new subs in the quarter, missing the total sub number by 1.3%, and BOOM! NFLX stock is down 25% as I write this.

It turns out that when you raise prices by 12.5% on a mass market consumer good, it has a negative impact on demand volume. Who knew? Perhaps Hastings had grown confident in the warm glow of Emmy nominations for NFLX’s “Orange is the New Black” and “House of Cards”, both of which had launched new seasons in the spring amidst fanfare and drove strong sub numbers in the first half of the year. Unfortunately, there were no such publicity-magnet tent-pole shows arriving during 3Q and the impact was apparent in the sub numbers. Still, 33.3% YoY growth in subs and nearly 89% growth in revenues should not be taken as some sort of indicator of doom.

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Quick Thoughts: HPQ – Another 180 Degree Turn, But Still No Strategic Direction

Written October 6th, 2014 by

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-           HPQ’s plan to split in two echoes EBAY’s PayPal spinout, completely repudiating its previous assertion of strategic synergies and capitulating to financial market pressure

-           HP Inc., the PC/Printer business, will be in long term decline, but could be attractive to acquirers looking for scale. Historically, it has been distinctly unsuccessful in entering growth markets.

-           Hewlett Packard Enterprise (HPE) is poorly positioned to compete for cloud services and will face serious deterioration in the demand for its in-house data center solutions going forward

-           More cost cutting or combining with another threatened data center supplier, like EMC, would do nothing to strategically reposition HPE for future success

Is there something in the water in Silicon Valley that is causing CEOs to do things that they had previously said they would never do? First Tim Cook’s Apple announces a phablet; then John Donahoe’s eBay decides to spinout PayPal; and now Meg Whitman’s HP announces a split into two. The moves come in increasing degrees of desperation – Apple finds some growth by finally giving its loyal users the top item on their wish lists, eBay gives Carl Icahn the top item on his personal wish list, and HP tries to make itself less unwieldy in case someone wants to buy a piece or agree to join forces as the ominous threat of the mobile/cloud era rolls in.

The rationale behind HP’s move is classic sum-of-the-parts – break off a business (HP Inc.) that is viewed as detracting from the value of the whole, and, VOILA, the bad stock price mojo follows the spin and the remainder gets a friendly multiple expansion. So HP Inc. gets a ~0.50 P/S ratio and trades at $15-17/share, ostensibly allowing HP Enterprise to break out to ~0.80 P/S and trade at $25-30. Meanwhile, breaking into two eliminates operating synergies and does nothing to address the substantial strategic threats that both of the businesses face.

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October 3, 2014 – Consumer Data: It’s Not Just What You Have, It’s Also Knowing What to Do With It.

Written October 2nd, 2014 by

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As the time that consumers spend on line continues to grow, particularly on mobile devices, the information that various companies are able to collect about their users is also growing. The value of that information – for commercial advertising, commerce, and personalized services – allows those companies to better address markets that are collectively worth $17T. We have built a taxonomy of that information – demographics, interests, actions, locations and connections – and assessed the degrees to which each category might be valuable. We then created a framework to assess various companies with stakes in the flow of consumer data based on their access to data, their ability to collect and analyze the information, and their potential for monetizing it. Not surprisingly, GOOG is far ahead in all regards – the extensive data they are privy to across the taxonomy, their prodigious institutional skills in data collection and analysis, and the levers for monetization that they are able to pull. Amongst the rest – AMZN, FB and TWTR are obvious leaders. AAPL, and NFLX are constrained by their ability/willingness to monetize. Other internet players – YHOO, AOL, YELP, EBAY, etc. – lack scale and depth in the data that they are able to collect and reach in the vehicles used to monetize it. The same is even more true of the incumbents in industries in the path of digital competition, including banks, retailers, media companies, and others.

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Quick Thoughts: EBAY – OK Carl, Just Don’t Tell Us “I Told You So”

Written September 30th, 2014 by

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-          A PayPal spinoff is a sharp shift from EBAY’s “one-stop” merchandizing outsourcing strategy, relegating often asserted synergies between EBAY and PayPal to arm’s-length contracts

-          PayPal is growing but faces growing threats. AAPL is making payments an iOS default utility while fee advantaged card nets and banks are moving to build their own digital services

-          PayPal acquisition speculation will fly – banks (COF, JPM) and online leaders (GOOG, AMZN, BABA) will be rumored, but may not pay a premium for a brand that they likely see as vulnerable

-          EBAY’s strategy to offer digital merchandizing as a service to retail merchants is interesting but risky. Spinning PayPal, assuming agreements can sustain synergies, does little to change that

Carl Icahn is obviously smiling this morning. After months of protesting that the synergies between PayPal and its Marketplace and Enterprise businesses were substantial and integral to its broader strategy, eBay has executed an abrupt about face. With eBay sales now generating less than 30% of PayPal’s revenue, and with PayPal growing at twice the pace of the rest of the company, now may be as good a time as any to execute a separation. PayPal will be spun off to shareholders as a tax-free transaction some time in 2015.

The new tune is that the two separate companies will now be agile and freer to pursue the ample opportunities in their rapidly evolving target markets, and that those substantial synergies can be perpetuated by long-term, arm’s-length, operating agreements. Those synergies flow in both directions. eBay got strong payments franchise with innovative approaches for using integrated payments to enhance the shopping experience across online and physical stores to sell as part of its package of services for merchants. PayPal got advantaged access to eBay’s nearly 150M customers and its thousands of participating merchants. Both businesses benefited from jointly analyzing the consumer data generated by customers using their services. While soon to step down CEO John Donahoe asserts that these benefits can be sustained over the long haul, I’m a bit skeptical.

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