Quick Thoughts: AMZN, and MSFT and GOOGL – OH MY! Tech’s Big Day

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

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October 30, 2017

Quick Thoughts: AMZN, and MSFT and GOOGL – OH MY! Tech’s Big Day

  • Digital ads – 23% growth for GOOGL is a read across for FB and clear evidence that minor controversies haven’t scared off advertisers, TV ad budgets are the next target
  • Streaming video – YouTube streaming 100M hours/day to TV sets; AMZN sees Video as driving Prime conversion and will step up investment; NFLX #s were also strong
  • E-commerce – AMZN is dominant – GMV is growing faster than sales and challenging WMT in total volume; GOOGL positioned as white knight for traditional retailers
  • Enterprise Cloud – Office365 (~25%) and Azure (90%) growth positions MSFT to lead the enterprise cloud; GOOGL (~70%) and AMZN (42%) also delivering strong cloud growth

A few weeks ago, we published lengthy report (http://www.ssrllc.com/publication/the-cloudai-era-a-perspective-on-the-next-decade-of-tmt-investing-2/) detailing our perspective on the on ongoing paradigm shift toward a Cloud/AI Era that we expect to define the technology sector, disrupt much of the rest of the economy, and change the way in which people work and live with information. At the core of that piece, we lay out our case for the dominance of Alphabet, Amazon, and Microsoft from their cloud-based platforms, using massive data assets and market leading AI capabilities to capture much of the value created by emerging paradigmatic services. On Thursday, all three companies reported their 3QCY17 earnings and emphatically supported our thesis.

We see four major levers for monetization of the Cloud/AI paradigm today – Digital Advertising, Streaming Video, E-Commerce and Enterprise Cloud software/services – with other opportunities, such as autonomous transportation, AI assistants as a UI, fraud-free financial services, augmented reality glasses, or a health care revolution, growing more relevant for the future. Reviewing the Amazon, Alphabet and Microsoft results shows three companies that are dominating the current levers, while positioning themselves for the new opportunities.

Amazon got the biggest share price boost from its report, with investors enjoying a 10th consecutive quarter of profits. AWS, Amazon’s leading commercial cloud hosting service, is the primary driver of this profitability and delivered solid growth at a steady 42% pace. The core business for Amazon is still online retail, and it delivered upside growth in both revenues and, more importantly, gross merchandise volume. Adding in all the 3rd party sales on its platform shows Amazon handling more than 43% of all online sales, and positions it within shouting distance of America’s #1 retailer Walmart for total sales of any kind. In the process, Amazon has signed a lot of new Prime customers – how many? Management isn’t saying, but we believe the total now exceeds 90 million. These customers buy more and often pass on comparison shopping through other channels. To this end, Amazon has used its Prime Video streaming service as a loss leader to pull in new Prime members. Management is pleased at this symbiosis, even if it doesn’t provide any details to track it. Amazon is also laying in the weeds, lurking as a threat to all the retail and wholesale categories that it doesn’t already dominate. Drug store stocks cratered on Friday, after rumors of Amazon’s possible entry to drug distribution. History suggests that these threats are real. Meanwhile, steady margins are a salve for investor nerves and this quarter was soothing indeed.

Microsoft has put up a string of solid reports under dynamic CEO Satya Nadella. The company has deftly pivoted away from its PC-dominated past to establish its bona fides as the clear leader in enterprise cloud and AI. AWS may have double its share in the hosting market, but as demand shifts toward more traditional businesses, Microsoft’s Azure has real advantages. Azure revenues were up 90% in the quarter, closing ground on AWS with its 42% growth. Meanwhile, the cloud-based Office 365 now has more commercial users than its PC application counterpart. The results seem to confirm that cloud users are worth more to Microsoft than its traditional users, even before the company ups the ante by applying its AI chops to the growing usage data to offer new insights to the organizations that use its applications. 3QCY17 results also benefited from a more stable PC market, which has been helpful to other companies in the value chain as well. All this, and strong margins as well – Nadella has Microsoft really clicking. It is not just a future promised based on its powerful position with enterprises, its strong cloud platform and its #2 spot on the list of AI scientific talent, it is a growth story now.

Alphabet investors are a bit more worried. Antitrust and privacy attention brings some risk – we wrote about it last week (http://www.ssrllc.com/publication/tmt-worrying-about-the-government/). The digital ad business has also had some bad press, with some advertisers pulling campaigns after finding their spots tied to objectionable content and congressional scrutiny for the company’s possible role in enabling the distribution of propagandistic “fake news”. None of this had any effect on 3Q17 results. Global ad sales were up 23% – astounding for a company that already has a 33% share of global digital ad spending. Management called out success in monetizing YouTube, perhaps an indicator that digital platforms are finally making inroads to the previously sacrosanct TV budget for major advertising. This is probably a good read across for Google’s advertising archrival, Facebook.

Only 10% of Alphabet’s current revenues come from non-ad sources, another sticking point for GOOGL skeptics. Within that chunk come sales from the Google Play Store, device sales (e.g. Pixel Phones, Chromebooks, Nest Thermostats, Google Home AI speakers, and the lot), and from Google Cloud Platform. This last bit is intriguing, for while GCP is small relative to market leader AWS, it is growing more quickly (although not as quickly as #2 Microsoft). We see more than enough opportunity for GCP to prosper in what should be a market worth $100’s of billions over the next decade – it has a clear lead in AI technology and an extremely high-performance infrastructure. A recent partnership with Cisco may show a way forward for GCP to get more enterprises to consider its platform. We would not be surprised to see more of these deals, or even a major acquisition (CRM?) that could further enhance its enterprise presence. We also note that Google CEO Sunder Pichai was enthusiastic about the company’s opportunities in e-commerce, perhaps signaling a redoubling of effort in an area where Alphabet’s progress has been disappointing. The recent tie-up with Walmart for local delivery and integration to the Google Assistant AI, could be a sign. Finally, the Waymo autonomous car business is ready to begin shuttling real customers in Phoenix.

Thursday’s results showed us that Microsoft, Amazon and Alphabet have not yet been grabbed by the tractor beam of regression to the mean and hinted at the miles of runway stretching out ahead. We believe that these companies have already built sustainable advantages that are too powerful for would-be competitors to uproot them. Without government intervention – the big wild card in this equation (http://www.ssrllc.com/publication/tmt-worrying-about-the-government/) – we believe Alphabet, Amazon and Microsoft, in some order, will be the most valuable companies in the world a decade from now.

Exh 1: Top Tech Earnings Summary

Exh 2: Top Tech Valuation Summary

Exh 3: SSR TMT Heatmap

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