Quick Thoughts: A Skittish Market Awaits Big Tech 2Q Earnings

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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July 20, 2020

Quick Thoughts: A Skittish Market Awaits Big Tech 2Q Earnings

  • The pandemic tech rally took a break last week with a lot of high-flyers getting knocked back a peg. Chief amongst these was NFLX which fell 6.5% on Friday despite a strong 2Q report on Thursday night.
  • NFLX added 10.2M subs in 2Q, 2.7M ahead of both guidance and consensus, giving it 26M+ new adds YTD. Nonetheless, cautious guidance for 2.5M net adds in 3Q cued a sell off. We believe this is a considerable overreaction – we see a LOT of further runway for growth and future leverage to the bottom line.
  • Monday will bring IBM. The pandemic came just as Big Blue was turning to sustained growth. We fear 2Q could be a bit more painful than investors expect, as the crisis hits consulting revenues and private datacenter investment. We like the long-term story but would hold off for now.
  • The street is expecting a tough quarter for TXN on Tuesday and we suspect that they’ll get it along with guidance for more of the same in 3Q. We’ll pass. SNAP has a much better story – weakness in linear TV and the FB boycott put it in prime position to beat topline expectations.
  • Wednesday is MSFT. The consensus should be an easy bogie – sales up just 8.2% YoY and EPS up just a penny to $1.38. The pandemic is beneficial for most of MSFT’s businesses – Office 365, Azure, Xbox, even Windows. Look for a comfortable beat.
  • Thursday reports: INTC could surprise on datacenter sales, TWTR should have a great MDAU quarter but soft ad sales (but maybe not as soft as consensus expects), and SWKS will give a glimpse into what we think could be an awful quarter for smartphone sales.
  • VZ will close the week on Friday morning. The street is pessimistic, looking for sales down 7.4% YoY with cord cutting, sub losses and weak ad sales the prime culprits. We don’t see a lot of upside, but cash flow could be a possible bright spot as 5G related capex scales back.

Last week the tech heavy NASDAQ lost more than 250 bp to the S&P 500 as investors took pandemic favorites like ZM, WORK and even AMZN to the woodshed. Those sorts of stocks were generally down 10% or so for the week, capped by the 6.5% selloff of NFLX Friday after its report the night before. Ostensibly, the beating was a response to cautious new subscriber guidance but given the prodigious 2Q beat on the same metric after supposedly disappointing guidance just 3 months ago, we would expect investors to have a bit more faith. All CEOs are flying blind in this crazy virus-fueled maelstrom and it seems hard to fault Reed Hastings for his prudence. Netflix has added more than 26M subscribers so far

Exh 1: Snapshot of NFLX subscriber base over time, 1Q14 – 2Q20

this year, crushing all pre-crisis predictions, growing total subs by 15% over just 6 months. While Hastings is concerned that some of those new viewers have pulled forward growth that would have occurred in 2H20, those new subs are not likely going anywhere and the accelerating cord cutting going on with linear pay TV subs suggests that the accelerated growth is not over (Exhibit 1).

Netflix has big advantages now – new programming ready to go while its rivals struggle with production, massive scale advantages in bidding for films orphaned by closed theater chains, serious buzz for its newest releases and global consumers that now look likely to be cooped up at home for a few months longer than had been previously expected. We see a long runway ahead of Netflix with gobs of potential growth in international markets and numerous other monetization levers to pull – live streams, pay-per-view, ad-supported tiers, game distribution, blah, blah, blah. Cautious guidance is only a problem if you can’t beat it.

Next week will be a busy one for tech investors. IBM will kick things off on Monday. We’ve been accused in the past of being a bit soft on Big Blue as it struggled to turn its topline back to sustainable growth. Things were looking good at the beginning of the year, as beleaguered CEO Ginny Rometty saw a chance to step down on a bright note. Then came COVID. The pandemic is bad for IBM. Consultants can’t camp out at client sites and IT managers are focusing on supporting remote users in the cloud rather than investing in their internal datacenters. We’re on the sidelines for a bit.

Exh 2: Snapshot of Azure Cloud Sales YoY Growth Rates, 4Q16 to 1Q20

Tuesday is Texas Instrument and Snap. TXN plays in a lot of markets, so its numbers could give a good read across for much of the semiconductor market. We expect sales to PC OEMs to be pretty good but automotive and industrial to be pretty bad. Moreover, the company’s biggest rival, Analog Devices, just announced a deal to acquire its second largest rival, Maxim, likely intensifying competition in the future. Still, the street isn’t expecting that much – the sales consensus is for a 20% YoY drop. In contrast, Snap is on fire, growing sales more than 40% YoY in 1Q, as the pandemic fueled new engagement. Consensus expects growth to slow up on weak overall ad spending, but we expect Snap to pick up share from suffering linear TV nets and from Facebook as it copes with a growing ad buyer revolt. Look for a beat.

Wednesday is Microsoft day. Mister Softy is very well suited to the pandemic environment. SaaS applications for work-from-home? Check – Office 365 and Teams are huge beneficiaries. Cloud hosting for enterprises looking for more flexibility? Check -Azure is rapidly gaining ground on market leader AWS. PCs and game consoles for workers and students stuck at home? Check – Windows and Xbox are seeing sales pick up. We believe MSFT will easily top forecasts for 8.2% YoY sales growth and speak confidently of its future prospects (Exhibit 2). The only wildcard is the pandemic’s impact on costs, but that is not specific to Microsoft.

On Thursday Intel ought to ride hyperscale datacenter investment and a revived PC market to a 2Q beat – analysts expect the 23% growth the company posted in 1Q to slow dramatically but we are much more optimistic. Twitter is in an odd place. Engagement is likely

Exh 3: Investors will look for continued acceleration in SNAP engagement

through the roof, both in the number of regular users and the amount of time that they spend on the platform. However, the recession has overall ad spending down and the serious tone of the Twitter-verse these days – all COVID and protest – may be scaring away some spending as well. It is not clear how the street would respond to a big beat on MAUs but a miss on sales. Skyworks will give a snapshot of the smartphone market – we think the street is way too confident of a 5G upcycle (5G: The Heat is Off).

Finally, Verizon closes the week on Friday morning (Exhibit 4). Things look pretty weak. The recession has been driving an acceleration in Pay TV cord cutting, homebound families may be cutting extraneous wireless accounts, roaming fees from foreign visitors are next to nil, and ad sales will be poor. The only saving graces may be low marketing expenses and reduced capex from a less vigorous 5G roll out. We are not inclined to try to call a bottom here.

Exh 4: Summary of Key Earnings Scheduled for This Week

 

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