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Quick Thoughts: TWTR 2Q14 – How Tweet it Is!

Written July 29th, 2014 by

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-          TWTR crushed expectations on every important metric, in particular delivering 24% growth in monthly average users, reversing a deceleration that had previously spooked investors

-          Sales growth accelerated to 124% YoY, with ad $/MAU up 85% despite a disadvantageous mix shift toward non-US users. Guidance was well above consensus, portending sharp upward revisions.

-          Future user growth should see further acceleration with a redesigned app to improve user experience and more aggressive marketing to support it on the way.

-          TWTR is very well positioned to exploit ad industry paradigm shift to digital – on and off the TWTR site. Huge scale economies will drive margins much further and faster than expectations.

The naysayers will put this all on the World Cup. Yes, monthly average users were up 24% YoY and 6.3% QoQ, beating even the highest hopes of Wall Street analysts during 2Q14, but, hey, the last two weeks of June saw the start of the globe’s biggest sporting event. Indeed, during the final on July 14, Twitter bragged that its users had set a new record, hitting nearly 619,000 tweets per minute at the peak. Surely some of these new, football-crazed, MAUs will stop using the service now that the tournament is in the history books.

Well, maybe not. First of all, those World Cup users undoubtedly stayed on board for the finals, which occurred a full two weeks into 3Q14, and probably brought even more users to the app as the knockout rounds progressed, so there is no reason to expect any drop off for September. Second, the month long event gave those users a full immersion in Twitter’s compelling use case. Surely many of them will stick around for the club football season and to keep up with any other interesting topics they may have discovered along the way. Finally, a World Cup bump bought Twitter time to fix its cumbersome mobile app and to put together a serious marketing push for the Christmas season. There are more than 100M smartphone users world-wide that have the app but don’t regularly use it. Fix it so they can easily get started using it and explain the use case with a memorable ad campaign, and I’d bet the user number can move even faster than it did this quarter.

Meanwhile, Twitter blew the doors off on monetization. Total revenues were up 124% YoY. On a global basis, monthly ad revenue per user was $1.02, up nearly 85% YoY, with total ad revenues up 129% after factoring in that strong user growth. Even while investors were collectively kvelling about the sluggish MAU growth in the last few quarters, Twitter has established itself as an ad selling juggernaut – its interest graph offers unique and valuable targeting data, its new rich media advertising formats have proven effective in delivering messages to their audience, and its MoPub network opens the door to leveraging that expertise and data to sell mobile ads across the entire internet. At this point, the mobile ad game looks like a three horse race – Google, Facebook and Twitter – and with the $1T global ad industry in the midst of a significant paradigm shift that will emphasize digital over traditional media formats, the company is in an enviable position.

Twitter is trading up big after hours and will likely keep most of those gains as investors metabolize these numbers and as analysts eat crow with their big upward revisions. After this blow out, the September quarter is set up – the new guidance is substantially above consensus, but only a modest step up on a sequential basis. Meanwhile, I expect a newly revamped app to hit the market in 4Q, along with the company’s first concerted advertising program to explain the use case and get users on board. There really is no alternative to Twitter for distributing and discovering real time information, and I think the use case is FAR more universal than the market currently believes. I think that there may be more days like this one ahead for Twitter investors.

SSR Index of Current-Quarter Healthcare Demand Growth: Final 2Q14 Estimates

Written July 28th, 2014 by

We expect 4.1% (nominal) y/y growth in US health services demand during 2Q14, the product of 2.6% growth in demand intensity and 1.5% growth in price. Following the BEA’s nearly unprecedented downward revision of its 1Q14 demand estimate, our projection of intensity is sharply lower than our initial 2Q14 estimate

The surprise demand spike reported by BEA for 1Q14 has been completely revised away in the agency’s final reported figures. We speculated recently that BEA had erred in using its judgmental trend to call for an immediate ACA-driven uptick in services consumption. Final reported numbers – which rely on more rigorous survey data than the preliminary numbers – showed that our final 1Q14 estimate was a mere 10bp off, and that there was actually a sequential dip in consumption from 4Q13. In short, whether because of late enrollment, plan features or other reasons, the ACA does not appear to have materially impacted demand in the first 3 months of 2014

Independent of our quarterly growth rate models, we handicap the odds of a trend break, i.e. a significant acceleration or deceleration in demand. The trend-break model indicates that sequential acceleration in demand intensity during 2Q14 (from 1Q14) is only slightly more likely than a deceleration (66%); i.e., quarter on quarter movement is very nearly a toss-up

Pricing growth remains anemic, although we expect observed y/y price dynamics to improve substantially this quarter as sequester-related cuts to Medicare reimbursement annualize out of the base period observations. In spite of this (mathematical) improvement in government pricing, commercial pricing is weakening

We continue to believe intensity of demand will grow as ACA enrollment gains play through and as employment improves. However, consistent with our observations throughout 2014, and with the BEA’s about face on the impact of the ACA in 1Q14, the timing of demand growth remains unclear. We still favor healthcare sub-sectors that are: 1) positively levered to gains in US per-capita intensity; and 2) have stable pricing, such as Non-Rx Consumables (e.g. BDX, BCR, COV, CFN, OMI)

For our full research notes, please visit our published research site

SWK – Business Momentum to Continue

Written July 28th, 2014 by

“We have a history of, if we can’t fix something in 18 to 24 months, we usually do something else with it. And we don’t fall in love with anything that isn’t earning its cost of capital.” – Stanley Black & Decker CEO John Lundgren

When we wrote about SWK in early April, we noted its indirect leverage to various housing and construction markets. With these markets hardly busting down the doors in 2014 year to date, it is all the more impressive that Stanley was able to post the strong Q2 that it did.

The company has shown a clear ability to control costs, and this has contributed to strong operating leverage – in the Industrial segment, notably, a 3% increase in volume translated into a 22% increase in operating margin. SWK management sees momentum in this segment continuing in Q3.

With the polar vortex winter cutting into the outdoor products selling season, CDIY volumes were flat but margins rose to a post Black & Decker merger high. The company gained share in Europe and expects mid single digit volume growth to resume in the second half of the year.

The Security segment importantly saw sequential improvement. It was noted on the conference call that the vertical security solutions are gaining traction in North America and COO Jim Loree indicated “we have some wins on the horizon that I think will be eye-opening in size.” This system is still a quarter or two (or three) away from being implemented in Europe, where attrition rates continue to moderate in the wake of the Niscayah acquisition from Securitas. Significantly, it was noted that Spain and Italy (representing 10% of European Security sales) are the main drags on performance there, with the company’s other 12 markets in the region seeing a turnaround.

The above quote from CEO John Lundgren likely also encouraged investors. The Security division has been a distraction from and a drag on a group of otherwise strong, cash generative businesses with stable return profiles and improving market shares.

All in all, this is still an inexpensive company with a very healthy stable of brands in the CDIY segment, exposure to the still strong OEM atuo market in the Industrial & Automotive Repair segment, and an improving story in the Security segment. It seems that in the latter segment, the trends will remain on a positive trajectory, and if some markets scuffle, the company has not ruled out cutting their losses. Acceleration in the housing and construction markets could provide an additional tailwind. The company felt comfortable raising their full year EPS range – the previous high end of $5.50 a share is now the lower bound with $5.60 the top end. We think SWK now has considerable business momentum and would expect the company wide margin improvements seen in Q2 to continue in Q3 as Security incrementally improves and the other segments benefit from operating leverage given the demonstrated commitment to cost control. Our valuation model has SWK fairly valued at over $120 per share, representing more than 33% upside from current levels.

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Lyondell Numbers and Very Weak NGLs Bode Well for Westlake

Written July 25th, 2014 by

Lyondell reported very strong earnings this morning, beating consensus estimates by more than 10%.  The strength of their US olefins and polyolefins business was notable, given that the company has experienced a meaningful delay in restarting its La Porte (Tx) ethylene facility following substantial expansion work, as well as other operating constraints in the quarter.  Other businesses at LYB were strong, but in aggregate not much different to Q1 2014 and the approximate 37% sequential quarterly earnings improvement was focused in the US operations – and helped by a 4% lower share count.  The gains in the US for LYB were largely a function of the natural gas and NGL price movement down from the Q1 weather driven spike.

Estimates for Westlake, which is essentially a pure play US story, anticipate 24% sequential improvement.  To the best of our knowledge Westlake has not suffered any meaningful operational issues in the second quarter and should benefit from the same raw material cost reductions.  On this basis, perhaps Q2 estimates are conservative for WLK.  In its vinyls business Q2 has seen marginally higher values both for PVC and for the chlor-alkali business.  The company did mention an inventory cost headwind for the second quarter, but this could be more than overcome by higher prices and lower costs.

Even if Q2 is not a meaningful earnings beat, WLK should be quite bullish on Q3.  LYB has talked down the quarter a little based on the continued delays to the restart of the La Porte facility.  But LYB’s problems and delays to the restart of the Williams complex in Louisiana have a silver lining for WLK and for LYB.  NGL pricing generally has weakened over the second quarter, but ethane pricing has collapsed in recent weeks because of over-supply – lack of demand from LYB and Williams being part of the problem.  For LYB and WLK, who both operate ethylene plants in the Mid-West we have the added benefit of a reopening of the spread between Texas and Conway pricing for ethane – see chart.

Both LYB and WLK look expensive based on historic average profitability, but neither looks expensive on current earnings, though LYB trades at a 3x multiple discount to WLK today.   We prefer the focus at WLK, the MLP initiative and the move into Europe and would prefer WLK at the margin to LYB today even with the multiple premium.

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Quick Thoughts: AMZN 2Q14 – Jeff Bezos REALLY Doesn’t Care about You

Written July 24th, 2014 by

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-          AMZN delivered its 4th quarterly loss in two years, well below both guidance and consensus, driven by massive investment in new content, devices, and services, and promised bigger losses next Q.

-          Sales were characteristically strong, up 23% YoY, but opex was up even more at 24%. As usual, management is offering no specific detail on the drivers of either sales or expenses.

-          AMZN is launching a smartphone, a set top box, streaming music, and an e-book subscription service. It is rolling out same day and grocery delivery. It is expanding AWS and int’l operations.

-          AMZN has a big lead in pursuing massive market opportunities. These huge investments will likely prove worthy with time, but Bezos may need to let up to avoid further bleeding in future quarters.

Amazon is a maddening company. It has the inside track on an e-commerce opportunity that addresses tens of TRILLIONS of dollars in global retail and wholesale sales. Against that opportunity, it is building an enormous moat of scale economies and logistic capabilities that may be impossible for future would-be rivals to counter. It is also furiously building scale to sustain its first move advantage in commercial cloud data center hosting, a business that itself targets TRILLIONS of dollars in enterprise IT spending. It is playing a high stakes competitive game and it is winning. So much for the good news.

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July 24, 2014 – TMT: Portfolio Update – Sooner, or Later?

Written July 24th, 2014 by

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TMT: Portfolio Update – Sooner, or Later?

We sorted a universe of 67 large cap TMT stocks based on the 5-year cash flow growth projected by consensus, and the percentage of EV represented by the implied 5th year terminal value. Arrayed on these axes, the companies fall into 4 distinct quartiles: 1) Fast growing, high terminal value “Dream Stocks”, where investors are betting on long-term leadership; 2) Fast growing, low terminal value “Skepticism Stocks”, where investors expect current luster to fade; 3) Slow growing, high terminal value “Comeback Stocks”, where investors believe set-backs are temporary; and 4) Slow growing, low terminal value “Death Watch Stocks”, where investors have little faith in long-term viability. With our firm belief in thematic TMT investing, the majority of our large cap model portfolio is squarely in category 1, where stocks like NFLX, AMZN, and TWTR are expected to grow into their valuations. MSFT and STX are our “Death Watch” representatives – we believe both will deliver substantial future growth not reflected in their valuations. Names like AAPL, INTC and portfolio pick QCOM inhabit quadrant 2 – this quartile can be intriguing IF results and news flow can break the deep investor skepticism over their long-term sustainability. We are most negative about the “Comeback Stocks”, generally erstwhile leaders like IBM and HPQ, where the modest enthusiasm seems misplaced and the risk skewed to the downside. However, we are adding FIS from group 2 to the portfolio, replacing IACI, as we believe mobile payments could drive significant near term upside. In small cap, we are adding RKUS, and FUEL, replacing the recently acquired OPEN and the volatile 3D printing name XONE.

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Quick Thoughts: FB and QCOM 2Q14 – Image is Everything!

Written July 23rd, 2014 by

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-          FB blew past 2Q expectations on every metric. Sales up 60% YoY. Ad sales up 67%. Mobile ad sales up 151%. Operating margins were 59% up from 44% a year ago. EPS beat by 31%.

-          Ad spending is clearly shifting to digital, and FB is executing perfectly. ARPU jumped 41% YoY to $2.24. Upward revisions are inevitable, giving the stock more room to appreciate.

-          QCOM delivered 9% YoY sales growth and 40% EPS growth, topping consensus sales and EPS by 4.4% and 18% respectively, driven by its bellwether chip business.

-          However, investors were spooked by cautious guidance for 4QFY14 earnings and concerns for collecting royalties in China. Total 2014 3G/4G units may be underreported by 15-17%.

Another day, another set of big TMT earnings report. Tonight – Facebook and Qualcomm. Both companies reported big beats. Facebook delivered a serious smack down to both consensus and its year ago compares. Sales grew at a 60%+ annual growth rate with advertising revenues up an astounding 67%. Analysts were expecting $2.81B in revenues and Facebook gave them $2.91B. Consensus EPS was $0.32 and Facebook beat it to the tune of $0.42. Mobile advertising revenues, the basis of the bear case after the 2012 IPO, were up an astounding 151%. No wonder the stock set new highs in after hours trading – bravo.

Qualcomm also delivered a big beat. Sales were 4.4% higher than consensus and up more than 9% YoY at $6.81B. Adjusted EPS was up more than 40% to $1.44, beating consensus projections by more than 18%. However, unlike Facebook, Qualcomm offered its results with a spoonful of harsh medicine. Chinese smartphone manufacturers are not complying with Qualcomm’s licensing terms – it believes calendar year 2014 3G/4G smartphone unit shipments will be under reported by nearly 200 million units, leading to a 6-8% shortfall in royalty payments. While the company will pursue its claims with full aggression, resolution will take time and near term results will suffer for it. 4QFY14 guidance pointed to EPS below the current consensus expectations, and while QCOM has often beaten its own guidance, the Chinese royalty impasse has investors worried. As such, QCOM is trading down big despite the exceptional June quarter results. Ah well.

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Dow – Good Quarter Understates Potential – Particularly If Dow Can Stick To the Path

Written July 23rd, 2014 by

Dow Chemical managed to show growth in Q2 2014 despite a couple of headwinds, some of which were discussed and some were not.  Weaker crop markets and plant closures were discussed but the company also raised a second issue that was not really quantified but could be meaningful.

Dow is spending a great deal of time and money working on divestments and working on new builds in the US and in the Middle East.  We know from DuPont how much it is costing to carve out Performance Chemicals (well over $100m) and these costs are likely to be higher for Dow given the more integrated nature of facilities. This is not the only divestment that the company is talking about and so this is also elevating costs.

Consequently – SG&A and other costs at DOW are likely well above trend today and will come down significantly once these moves are made. The company talks about productivity gains and it is likely that costs are coming down at the operating business level and have scope to come down further – as we have discussed in the past, DOW probably has an overall cost cutting opportunity that would be similar to DuPont. The real operating cost run rate could be as much as $200-250 per year lower than it is today, before any major cost initiative. Unlikely that we would see any of this before the divestments are completed – so before end-2015.

Separately, Dow continues chase gains from divestments and Andrew Liveris made some interesting comments today suggesting that Dow is interested in coming to the negotiating table to talk about further consolidation within Ag.

We have suggested more than once that an open and candid conversation between Dow and DuPont might yield some interesting solutions for both companies:

  • A Morris Trust type transaction involving Dow’s chlorine business and DuPont’s Performance Chemicals business.
  • A JV on Ag.

In our comparison between LyondellBasell and Dow Chemical, published in April, we suggested that DOW has far more available levers to pull than LYB and in work published in February we come up with an $80 value per share if Dow could get it all right.  The risk is the same as always – every time that Dow has moved to an improving return on capital trend over the last 40+ years something has happened to cause a correction back to a very poor trend.  Some causes have been macro and others have been “own goals”.   It is hard to see that risk today, particularly with the focused message, but it was equally hard every time in the past also.

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Quick Thoughts: AAPL & MSFT June Quarter Results – The Song Remains the Same

Written July 22nd, 2014 by

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-          AAPL’s 3QFY14 was mixed, with sales 1.5% below consensus but EPS 4% above on impressive 39.4% GMs. iPhones were in-line with strong expectations, but iPads were down YoY – again!

-          A revenue miss, 6% growth, the fast erosion of iPad sales, and tepid 4QFY14 guidance might have ordinarily spooked investors, but iPhone 6/iWatch hype has most looking ahead to Dec.

-          MSFT beat topline expectations by 1.7%, with 10% YoY organic growth driven by strong enterprise sales. EPS would have beaten by $0.06 without one-time Nokia and other charges.

-          More Nokia write downs and the costs of the upcoming layoffs will hit future quarters, but a 147% YoY increase in cloud sales, now 11%+ of total, speaks to MSFT’s real growth potential.

With the rise of the mobile/cloud era of computing, the nature of the Apple/Microsoft rivalry has changed dramatically. New rivalries with the likes of Samsung, Google and Amazon Web Services have pushed the traditional “Mac vs. PC” battles to the back burner. Still, with the two erstwhile enemies reporting on the same night, it’s an opportunity to engage in the nostalgia of comparing the two companies again.

Both companies’ results had a little bit of hair on them. Apple crushed its EPS bogie by 5 cents, juicing those earnings with 39.4% gross margins, 140bp higher than analyst expectations and the highest level since 4QFY12. However, and it’s a big however, Apple revenues were $600M below expectations at $37.4B, with disappointments in both iPad and iPhone sales not mitigated by the upside surprise in Mac revenues. Guidance for next quarter was weak, suggesting more of the same in September and pushing all of the chips on the Holiday quarter and the hotly anticipated debuts of the iPhone 6 and the iWatch. Microsoft, on the other hand, handily beat revenue expectations, with $23.4B versus the $23.0B expected, but fell short on earnings, delivering $0.55 in EPS versus the $0.60 consensus due to initial write downs associated with the acquisition of Nokia’s handset business. Absent the Nokia charges and some other one-time items, Microsoft could have beaten by $0.06.

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Quick Thoughts: NFLX 2Q14 – In Line is the New Upside Surprise

Written July 21st, 2014 by

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-          Media reports can’t seem to decide whether NFLX’s 2Q14 beat consensus or not, but it counts as an upside surprise anyway, because new subscriptions beat forecasts handily

-          US net sub adds were 570K, and Int’l was up 1.1M, collectively beating guidance by more than 14%, right after a price increase and in NFLX’s most challenging seasonal quarter.

-          NFLX’s recent Emmy nomination bonanza and European push should help keep the momentum for 2H14, with guidance implying revenues above the current $1.38B consensus

-          Management expects Int’l to lose $42M in 3Q, due to investment in Europe, putting EPS guidance well below consensus. Given the strong sub growth, this shouldn’t be a red flag.

Thomson Reuters says the analyst consensus for Netflix 2Q14 EPS was $1.16. FactSet says it was $1.14. Netflix decided to split the difference, reporting $1.15, and sending the news wire into a whirlwind of conflicting articles. The Wall Street Journal main site reported the miss against the Thomsen numbers, while the same company’s MarketWatch and MoneyBeat reporters went with the beat. Both sources of consensus estimates agree that Netflix revenues of $1.34B were in line with expectations, so perhaps, all together, it’s safest to call the quarter in line. Except, the stock isn’t reacting like the news is quite so “meh” – it was up more than a percent in after hours after trading up 1.75% during the regular session and after having risen more than 40% in just the past 2 months. It seems that Netflix delivered an upside beat, whether Thomson Reuters thinks so or not.

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