August 19, 2014 – Infrastructure as a Service: The Race Won’t Go All the Way to the Bottom

Written August 19th, 2014 by

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Infrastructure as a Service: The Race Won’t Go All the Way to the Bottom

The stakes for public cloud operators (IaaS) are huge. Annual global spending on enterprise data centers – hardware, infrastructure software, staffing, facilities, etc. – is more than $1.2T. We expect most of this will migrate to the cloud over the next 2 decades, due to the compelling economic advantages of web-scale distributed data centers, with cloud operators hosting both SaaS and customized applications. The costs and performance of IaaS are highly levered by scale and technical sophistication, factors that will force all but the biggest and best from the market with time. Currently, the 3 best positioned players – AMZN, MSFT, and GOOG – are engaged in a price war, temporarily sapping industry growth and maybe driving all 3 into losses. However, the real casualties of this war will be smaller IaaS operators, who will be uncompetitive without massive consumer cloud franchises to drive scale and sophistication. Meanwhile, we do not expect a “race to the bottom” amongst AMZN, MSFT and GOOG. Rather, as the market concentrates into their hands, we believe natural points of differentiation for each of them will allow lucrative value added services atop commodity processing and storage services. All three should be profitable long-term, with sales growing into $10s of billions before decade end. However, given a slightly richer data center cost structure and the lack of a high margin core business to cover for any losses, we are concerned that AWS will be a burden to AMZN in the near term, as it works to re-establish the confidence of investors.

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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.

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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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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Quick Thoughts: GOOG 2Q14 – In the Right Place at the Right Time

Written July 17th, 2014 by

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-          The paradigmatic shift of ad dollars drove 22% topline growth for digital advertising leader GOOG. The sales beat overshadowed an EPS miss that was largely due to a higher tax rate.

-          GOOG sites revenue was up 23% and Network revenue was up just 7%, a shift that saw TAC continue downward to a 3-year low of 22.9%. Paid clicks were up a whopping 25%.

-          CPC was down just 6% YoY and stable QoQ, quieting the bears, as advertisers are growing more comfortable with mobile and demand is starting to catch up with inventory.

-          GOOG’s results show an accelerating ad spending shift toward mobile, video and social, a shift that should have long legs and that will benefit on-line rivals like FB and TWTR as well.

For a company with as much going on as Google – 13 acquisitions in Q2, a dominant mobile platform supporting dominant on-line application franchises, 32% share of global digital advertising and on-line video streaming, and an impressive stable of inherently interesting moonshot projects – its earnings conference calls leave a lot to be desired. In the tradition of its rivals Amazon and Apple, Google is “Just the facts, Ma’am” and then maybe not all of those when it comes to answering questions from Wall Street. With little else to go on, the assembled crowd hangs obsessively on Paid Clicks, Cost Per Click (CPC), and Total Acquisition Costs (TAC). Fortunately for Google investors, the story told by those metrics was a good one this quarter, driving a significant top line beat and overshadowing an EPS miss, which can be largely blamed on unexpected taxes across various jurisdictions.

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Quick Thoughts: MSFT – Satya Nadella is no Steve Ballmer

Written July 17th, 2014 by

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-          MSFT will cut 18K jobs, most from the former Nokia device business, a repudiation of Ballmer’s “Devices and Services” strategy and a bold move toward a cloud future

-          Device operations will be pragmatic, targeting the low end and emerging world geographies still open to Windows. Expect hard push for apps on rival platforms.

-          Clear move toward focusing on cloud hosting and application opportunities, where MSFT has substantial advantages. Consumer apps critical for scaling cloud ops.

-          Evolving org from the “milking windows” strategy will be tough, but Nadella’s direction is bold and right. We remain bullish on MSFT as a leader in the cloud era.

After last week’s vague and meandering strategy memo, Microsoft CEO Satya Nadella got specific this morning with a company-wide email to announce job cuts of 18,000 employees, most of whom came to Microsoft in its recent acquisition of Nokia’s mobile device business. This is more than a slap in the face to former CEO Ballmer’s “Devices and Services” strategy and his controversial acquisition of the Nokia business in the months before his retirement. It is also a rejection of the organizational focus on the Windows operating system that marked the last 30 years of Microsoft strategy and acknowledged the ugly truth that the device platform battle has been largely lost to Google and Apple during the bungling of the past decade. Of course Windows is not entirely dead, and Microsoft will do what it can to perpetuate the standard, but Nadella prefers to put his resources against opportunities in the cloud, where it is not too late and where Microsoft has advantage and momentum.

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July 10, 2014 – Apple and Google: On Your Wrist and In Your Car

Written July 10th, 2014 by

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Apple and Google: On Your Wrist and In Your Car

Despite slight recent design shifts toward each other, AAPL and GOOG still have very different world views – a contrast that is clear in their strategies to extend their platforms to new venues, like “wearables” or cars. While it moved to open iPhone hardware to 3rd party developers a bit, AAPL has not published APIs for its widely expected iWatch, , portending a highly proprietary device, perhaps tightly tied to the new HealthKit functionality. Meanwhile, GOOG’s AndroidWear gives OEMs leeway for design differentiation, and includes clean APIs for developers to deliver value-added extensions of their apps, aiming to increase user engagement by delivering notifications in a more immediate context. We are not overly bullish for demand, particularly if health/fitness is the salient use case, and expect total demand to be a modest fraction of the installed base for either platform. In this, we suspect “wearables” may better suit GOOG’s objectives (i.e. more frequent app engagement, broader user data profiles) than AAPL’s (i.e. smartphone share gain, profits from iWatch sales). In automotive, the companies have had to settle for the rough parity of APIs that enable users to interact with either smartphone platform via dashboard touchscreens and vehicle hands free controls. In the home, both companies are jostling for space in the crowded and competitive TV market, while swapping roles for home controls, with AAPL courting 3rd party device makers to adopt its iOS-integrated HomeKit solution and recent GOOG acquisition Nest disrupting traditional solutions with its slick connected devices.

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