Quick Thoughts: Another Annoying Google Quarter

Written April 17th, 2014 by

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-          While GOOG’s 1Q14 miss is disappointing, it is not particularly unusual in its history of focusing on the long term. To that end, 19% sales growth is a healthy indicator for the future.

-          Network ad sales grew just 4% as GOOG is capturing more ad dollars on its own sites through programmatic ad buying. TAC is now at a record 3 year low of 23.3%

-          The bottom line miss was exacerbated by a 400bp boost to OPEX, mostly due to unusual legal expenses and costs associated with integrating Nest that will be resolved by next quarter.

-          The miss had GOOG off over 3% after hours. We do not see the results as alarming, and would use weakness as an opportunity to add what we see as the best positioned player in the sector.

Earnings happen. Google, like its archrivals Amazon and Facebook, maintains a blasé attitude toward its short term results. This long-term approach, while ostensibly to be applauded, has an annoying tendency to periodically bite investors in the portfolio. Google’s first quarter report is an example of this habit. The numbers were short on both the top and bottom lines, and the stock tumbled after hours, eventually recovering to just 3.15% down. In its past 4 misses, Motorola’s hardware business was the prime culprit, but this time it seems to be a bit of over exuberance in sales estimates combined unusual items that drove OPEX up 400bp. Legal fees likely stemming from the recent stock split drove G&A up, while Nest’s heavy R&D flowed through the P&L taking the company from a historic R&D rate of 12% of revenue to 14%. Despite this little speed bump, things look more than alright in Mountain View.

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April 15, 2014 – TMT: Don’t Rain on My IPO

Written April 15th, 2014 by

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TMT: Don’t Rain on My IPO

2013 was the biggest year for TMT IPOs since 2007, with 54 companies hitting the market, led by TWTR, but otherwise dominated by enterprise cloud software. 2014 began with a big backlog of 590 venture funded companies in the pipeline, up from 426 a year ago, representative of years of public market angst. 19 IPOs have issued YTD, with several high profile acquisitions as well. This year, the mix includes more consumer names, including 50%+of the IPOs YTD, and with Chinese e-commerce giant Alibaba expected to top FB’s 2012 offering as the biggest debut in history. For investors, we see 2014’s likely IPOs as a mixed bag. To date, intriguing plays like GRUB and OPWR have had strong launches, while riskier issues like KING have foundered. Looking ahead, we are more optimistic for enterprise cloud application plays like Palantir, New Relic and AppDynamics, than for the sub-scale infrastructure plays like Box and platform vulnerable consumer businesses like Dropbox and Evernote. Overall, we are bullish that paradigm shifts in advertising, retail, enterprise IT, entertainment, and telecom are opening huge new addressable markets to new paradigm TMT players, and that most valuations remain reasonable given this growth potential. Given this, strong cash flows and balance sheet liquidity, we believe talk of a new tech bubble is misplaced. On a side note, the IPO market may raise prices and slow the pace of sector M&A. We are adjusting our model portfolio – over the past 4 months, the large cap underperformed by 3200bp, driven by the recent pull back, while the small cap outperformed by 4600bp. FB and DATA are joining the large cap list, replacing CRM and CTXS, while OPWR and GRUB are added to the small cap portfolio, replacing GTAT and TYPE.

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Quick Thoughts: Apple and Samsung’s Nuclear Spring

Written April 4th, 2014 by

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-          As AAPL’s $930M verdict from round 1 inches into the appeals process, round 2 has hit the court room, with AAPL looking for $2B from Samsung for alleged infringement of 5 patents.

-          AAPL’s estimated damages are unreasonable. An estimated 250,000 patents apply to every smartphone – if all IPR holders followed AAPL’s lead, each phone would carry $200K in royalties.

-          Whatever the outcome, this trial will have little impact on competition – injunctions are very unlikely, the products affected are obsolete, and damages will be held up by years of appeals.

-          US patent law is under fire – the Supreme Court heard arguments in a case that could weaken software patentability and Congress is debating tighter patent eligibility.

Apple and Samsung are back in U.S. District Court in San Jose this week as their second patent trial commenced on Tuesday after a jury of six women and four men was selected. The trial is the latest in a legal battle with Google’s Android partners that goes back over four years, when Apple sued Android handset maker HTC for patent infringement in March 2010. While it has since settled with the now financially troubled HTC, Samsung has been in Apple’s crosshairs since April 2011. In its latest dispute with Samsung, Apple is seeking some $33-$40 in damages per phone as well as a sales ban over 5 patents, which could amount to an aggregate $2 billion. The lawsuit covers Samsung models released in 2011-2012, most of which have been retired. As hundreds of thousands of patents make up the IP of a modern smartphone or tablet, Samsung is countersuing for a relatively miniscule $7 million, a contrast intended to make Apple’s demands look outrageous. Though the verdict of the 2012 case stands at $930 million award for Apple, Samsung is still appealing that decision and has yet to pay Apple anything, while the US Patent Office is also reviewing the validity of a key patent in the case. A negative outcome on appeal or an invalidation of the patent could greatly reduce or even eliminate Apple’s claims for damages.  Despite numerous meetings between CEOs of both companies to negotiate a settlement outside of court, the patent war rages on.

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Quick Thoughts: Amazon lights a Fire under Apple and Google

Written April 2nd, 2014 by

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-          AMZN’s $99 Fire TV is quite differentiated vs. rivals at similar price points (AAPL TV, Roku, etc), slotting in between the bare bones $35 GOOG Chromecast and $400+ Xbox One and PS4.

-          Fire TV is well designed to promote AMZN’s content and e-commerce, leveraging the company’s extraordinary retail clout, and the platform’s best in class performance to drive sales.

-          AMZN notably excludes GOOG’s YouTube from its platform, just as AAPL TV and GOOG Chromecast exclude AMZN Prime Video, evidence of the rivalry developing in the category

-          Rumors of an AAPL/CMCSA tie up are not credible – AMZN should play very well at $99, with the cheap Chromecast and expensive Xbox One and PS4 leading at their respective price points.

Earlier today, Amazon joined the ranks of Apple, Roku, and Google in offering a dedicated TV streaming device. The device boasts impressive specs, though it enters a crowded market of existing streaming devices that include set top boxes, internet enabled TVs and Blu-Ray players, as well as a second generation of internet connected game consoles. All are clamoring to be the primary access point for streaming content in the living room. Moreover, streaming apps and content providers are striking deals to have their content shown on these devices. Netflix and Hulu have made ubiquity across devices a business priority, while TV and cable providers are more cautious in selecting platforms for their apps. Comcast and Apple were rumored to have been in talks recently about enabling cable TV and apps on Apple TV, but negotiations appear to have fallen apart to an impasse over customer control. Today’s announcement also underscores a growing rift between the major consumer platforms: Apple, Google and Amazon.

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March 26, 2014 – Facebook: Dream Until Your Dreams Come True

Written March 26th, 2014 by

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In its first year of trading, FB struggled to transition to mobile, delivering lackluster growth and failing to get back to its $38 IPO price. However, with its 2Q13, the company demonstrated a new ability to monetize its increasingly mobile user base, benefitting from a turning point in the acceptance of mobile, social and online video within the ad community. Moreover, we applaud FB’s strategic shift toward a suite of focused but interrelated apps, all leveraging the company’s powerful social graph. Separating previously bundled functions into distinct apps will deliver cleaner experiences for users and better context for advertisers, while co-opting a larger share of smartphone home screen real estate. WhatsApp can further FB’s ambitions, adding new users, particularly in markets where FB is weak, ideally drawing engagement to its more easily monetized services, but the deals for WhatsApp and Oculus are risky and expensive. Within this period of extraordinary growth, we believe that FB can absorb the considerable dilution from both acquisitions without risk disappointing vs. extremely conservative consensus expectations. While FB’s valuation is a significant hurdle for many investors and greatly sensitive to assumptions about longer term growth, we believe continued performance will keep investor dreams alive for quarters to come.

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Mach 2, 2014 – SaaS: After the Levee Breaks – Competition in Software

Written March 2nd, 2014 by

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Web-scale cloud platforms, leveraging massive consumer applications, have dramatic cost and performance advantages over private data centers, stemming from their scale, scope, superior design, and world-class computer science skills. These advantages, which already allow the top cloud operators to deliver 50-75% lower costs to customers vs. the all-in costs of in-house solutions, are growing wider with time and are rapidly separating AMZN, GOOG and MSFT from smaller would-be rivals. As we have often noted, these dynamics are troubling for traditional data center technology vendors, and are likely to be deflationary for IT budgets in general. Low cost, high performance cloud hosting also greatly lowers the barriers to entry for SaaS application developers – opening the door to innovation and competition in enterprise applications, pressuring SaaS pioneers with older architectures, and posing an existential threat to traditional application vendors. Success in SaaS will come from innovation, execution, and scale economies rather than customer lock-in, and product life-cycles will be shorter than in the last 30 years of the software market.

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Quick Thoughts: Netflix and Comcast – Friends with Benefits

Written February 25th, 2014 by

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- Netflix and Comcast’s multiyear peering deal comes as a surprise, amidst reports that broadband distributers have been hampering streaming performance.

- Comcast’s proposed merger with TWC likely gave it an impetus to be on its best behavior under regulatory scrutiny, skewing deal terms in favor of NFLX

- Peering agreements fall outside of previous agreements on net neutrality, but this deal sets a precedent and will clearly impact future regulatory policy.

- We don’t expect this deal to have a major impact on NFLX’s bottom line, but expect NFLX will use the terms for negotiations with other providers

Over the weekend, Netflix and Comcast surprised investors announcing a peering agreement whereby NFLX will pay for unimpeded connections to Comcast broadband subscribers. Over the past several quarters, NFLX streaming customers have been frustrated as Comcast, Verizon and other ISPs have refused to expand the bandwidth of connections between the popular content provider and their distribution networks. As a result, average streaming speeds for NFLX users have declined more than 25% at Comcast and more than 15% at Verizon since February 2013, according to the company. Given the burgeoning popularity of the service – NFLX draws 31.6% of all downstream Internet activity in North America according to Sandvine – the deteriorating performance due to the peering conflict is a significant risk to the company. Comcast’s newly signed agreement settles the problem on its network, and eventually on Time Warner Cable, assuming that the announced merger is allowed to proceed. This deal expands the net neutrality limitations that Comcast agreed to in its 2011 consent decree, and will likely be a precedent for further deals with other streaming providers and between streamers and other ISPs. Given Comcast’s obvious interest in courting approval for its TWC merger with an FCC skeptical of the deal’s possible impact on broadband competition, the terms are likely favorable to Netflix.

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Quick Thoughts: Facebook Buys More Users and Usage

Written February 19th, 2014 by

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-          At $19B in cash, stock and future stock grants, FB is paying more than 10% of its enterprise value for WhatsApp, its 450M monthly active users and 55 employees.

-          Strategically, WhatsApp is a great fit, with extremely strong penetration and engagement in markets where FB is relatively weak, like India and Latin America and a clear monetization path

-          The strategy of separate focused mobile apps is spot on – WhatsApp for messaging, Instagram for photos, Paper for news dissemination – controlling footprint and usage on others’ platforms.

-          This is a VERY bold move, but WhatsApp will deliver real long-term growth and FB may have enough short term business momentum to cover for the almost certain and substantial dilution.

Wow! Mark Zuckerberg is not playing it safe. WhatsApp has been on fire, going from 0 to 450M users in less than 5 years, now serving more messages than all of the Earth’s wireless carrier SMS systems combined. The service is particularly strong in emerging markets – According to The Information, 55% of Indians, 63% of Brazilians, 72% of South Africans and 76% of Mexicans surveyed by Jana Research reported WhatsApp as their most used messaging application, while Facebook didn’t top 6% in any of those markets. No mystery that Facebook would be interested in buying the company, but after seeing Twitter’s big move out of its IPO and having had Snapchat turn down a rumored $3B offer, the real question was whether it was too late to get WhatsApp at a price that Zuckerberg was willing to pay.

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Quick Thoughts: Kabletown Gets Serious

Written February 13th, 2014 by

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-          CMCSA is SERIOUSLY understating the approval challenges for its TWC deal –DOJ and FCC are philosophically opposed, Hollywood and Silicon Valley can offset its political clout

-          Combined, CMCSA/TWC passes 60% of US households, and has 37%+ of broadband and 32% of video subs. Divesting subs to get under 30% share of video isn’t enough of a concession

-          Net neutrality will become the BIG deal hold up – FCC could require common carriage regulation, open the door to real open web TV competition on cable pipes

-          Meanwhile, the deal announcement throws a major monkey wrench into AAPL’s rumored plans to offer TWC access via AppleTV – all industry over-the-top TV plans now go on hold

Comcast definitely has swagger. In the wake of John Malone’s ill-fated $130/share bid for Time Warner Cable, Brian Roberts swoops in with a friendly $158 offer, just a tick below the $160 number TWC had floated as a fair price for its sloppily managed cable TV dominion in slapping down the Malone/Charter Cable bid. Anticipating the inevitable regulatory scrutiny, Comcast immediately offered to peel off roughly 3 million subs to get under the 30% share Maginot line previously established by the FCC as unacceptable concentration in the cable industry, and published a powerpoint document outlining its argument as to why a combination of the country’s number one and number two cable providers would be a boon to consumers and to competition in general.

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February 5, 2014 – Google: King of the Kloud Krewe

Written February 6th, 2014 by

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GOOG dominates the booming digital ad market – we expect Search, YouTube, local, AdSense, and other initiatives to keep the company in front, even with the shift to mobile, social and video, and in the face of able challenges from Facebook and Twitter. However, it is GOOG’s dominion over modern computer science that scaffolds this ad sales machine and that creates wholly new opportunities – in fields as diverse as robots, medical research, augmented reality, commercial hosting and the internet of things. The company has the world’s biggest, cheapest, and most powerful computing platform, and combining that extraordinary infrastructure with its world leading data management, algorithm development and deep learning software expertise puts it in prime position to attack the nearly limitless number of traditional businesses ripe for disruption from the cloud. In this context, GOOG’s seemingly out-of-focus moon-shot investments and acquisitions make perfect sense, even if they may be monetized by subscriptions, service charges, equipment sales, retail commissions, or transaction fees rather than ads. Ultimately, GOOG may be addressing a larger and more lucrative opportunity set than any other TMT player, with assets and skills that will make it difficult to beat as the cloud era plays out.

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