Quick Thoughts: Finally a Glimpse of What’s Going On

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

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April 27, 2020

Quick Thoughts: Finally a Glimpse of What’s Going On

  • The first week of TMT earnings reinforced our thoughts about the effect of the pandemic. Datacenter spending is up. Both streaming video and cord cutting are accelerating. Social media ad sales are resilient. 5G rollouts and smartphone sales are on pause. No one knows what will happen in 2H20.
  • XLNX, STX, MLNX, and INTC all reported extremely strong datacenter component sales, as cloud platforms are investing to keep pace with the demand from WFH, streaming, gaming, and social media. The read across for others yet to report, like NVDA, AMD, and WDC, is very positive. IBM’s results were further confirmation of the strength of the cloud.
  • NFLX posted extraordinary sub growth and a programming pipeline into 2021. Disney+ and Hulu are the only rays of hope for the dismal DIS story. HBO Max will arrive a month from now to help T. YouTube viewership is likely up big.
  • T and VZ results cast some doubt on the “safe harbor” narrative for telecom. Wireless churn is up, phone sales are down, advertising is weak, and Pay TV cord cutting is up. Not good signs for the cable industry. Results from ERIC and XLNX suggests that global 5G deployments are slow as well.
  • Pay TV ad sales are down hard, but SNAP results support a more constructive story for digital advertising. SNAP’s big engagement gains are likely to be matched by FB, TWTR, PINS and GOOGL’s YouTube. Ad revenues may not be as bad as the naysayers fear.
  • Next week brings a flood of earnings. On Tuesday GOOGL should report a mixed bag (weak ad spending but huge engagement gains) and AMD should be strong. On Wednesday, we expect good news from FB, MSFT and NOW, but a tough print from QCOM. On Thursday, look for positive results from TWTR and TEAM, okay numbers but post-merger close chest thumping from TMUS, and substantial YoY declines from AAPL.
  • None of these companies has any idea what to expect from 2H20. Any credible guidance should be wide enough to drive a truck through it.

TMT earnings season started about a week later than normal with IBM’s report on Tuesday. Big Blue’s cloud businesses and RedHat were strong while the other businesses were weak as the company slipped back into decline revenues and withdrew its full year guidance. While we are believers in IBM’s long-term staying power and expect a turn to sustainable growth by 2021, the pandemic could hurt a bit more than average for a company with a big consulting business that can’t visit its clients and long sales cycle products

Exh 1: IBM Quarterly Sales Growth, Recent Past and Consensus Expectations

with sales reps looking to close deals by video conference (Exhibit 1). Still, the parts of IBM that we like performed very well, the 5.5% dividend yield is still intact, and we see a lot of promise that the company will rebound from the crisis stronger than it was.

Strong demand for cloud services was a theme that played in earnings all week long. Xilinx beat 1Q expectations on 77% YoY growth in sales into datacenters (offset by a shocking 46% decline in telecom sales). The stock slid on sober guidance – telecom and automotive (poised for a drop) are bigger businesses than the cloud for XLNX. Seagate also cited strong datacenter sales as the driver of its 1Q upside surprise but traded off on indeterminate guidance which fed the investor skepticism about the stock. We are more optimistic than that (Exhibit 2). The same is true for Intel, which also posted a datacenter fueled beat and cautious guidance. 2Q margins will be hit by new product transitions, but we think the rest of the year is likely to be more rewarding than the current consensus thinking. 40% growth out of datacenter networking component maker Mellanox is further evidence to the cloud datacenter boom, a phenomenon that should also buoy results for future parent Nvidia (the deal closes on Monday) and fellow suppliers AMD and Western Digital.

Tuesday’s Netflix results swung the focus to media and video streaming. Netflix posted nearly as many new subscriptions for 1Q20 that it had gained over the entire 2020 and still expects strong sub growth for 2Q. Some investors were put off by comments that pointed out that the big numbers driven by mass home confinement would scale back in 2H20, but this seems silly to us. Management is still expecting over 30M new subs for the year – essentially doubling YoY – and confirmed that, unlike its new rivals, its new

Exh 2: YoY FQ Sales Growth for Cloud Franchises of Leading Vendors, 1Q20

Exh 3: Snapshot of Netflix Subscriber Base Over Last 6 Years, 1Q14 to 1Q20

Exh 4: Snap Global Daily Active Users, 1Q18 to 1Q20

programming pipeline remained ample to deliver new content into 2021 (Exhibit 3). Disney+ had a huge bump in March as the service went wide in Europe just as COVID-19 graduated to pandemic status, but the major new shows that were expected to juice engagement ahead of the holidays – The Mandalorian second season, and the debut of the first Marvel series – are all delayed into 2021. Tough news for a company that is smack in the path of the coronavirus hurricane.

Social media platform Snap also reported on Tuesday with a big beat. If there was a digital ad slump, Snap didn’t see it, as sales were up 44% YoY. Daily Active Users were up 20%, particularly impressive when you consider that the reported DAUs are an average across all three months of the quarter and not just a measure for the time after social distancing began in earnest (Exhibit 4). Look for another big jump in engagement next quarter. The read across should be positive for other ad supported digital media – Google, Facebook, Twitter, and Pinterest numbers may not be quite as bad as the skeptics worry.

Verizon and AT&T are widely regarded as safe haven stocks that should be resilient to the contagion crisis. 1Q results cracked that reputation a little. Traditional media advertising looks like it is getting hit hard. Pay TV cord cutting has accelerated even with everyone sheltering at home. Phone sales are down, and churn is up. T-Mobile has closed its acquisition of Sprint and has already begun deploying 5G into the ample mid-band spectrum that came in the deal (N.B. one of the few global carriers accelerating its 5G rollout), placing some pressure on the market leading duopoly to keep up. Altogether, a less than ideal situation for Verizon and AT&T shareholders counting on safety. The read-across is bad for smartphone stocks like AAPL, QCOM, QRVO and SWKS and for Pay TV operators like CMCSA and CHTR.

Exh 5: Summary of Outlook of Notable Earnings Scheduled for the Coming Weeks

This week, the pace will not slow down. On Tuesday, GOOGL reports and it has some explaining to do. Management worried investors this past week with the news that it is freezing hiring, cutting marketing spending, and pulling back on some investments. It certainly sounds like its ad sales are weak, but just how weak. We suspect that it is not quite as bad as the market fears. Meanwhile, we expect the conference call to emphasize strong growth in the enterprise business unit, where Google Cloud Platform and GSuite ought to be taking full advantage of the work-from-home phenomenon. YouTube engagement is off the charts, and even if ad sales there are down, the lasting shift away from linear TV is a big long-term plus. AMD also reports on Tuesday. We expect it to follow Intel’s lead and deliver big upside to sales and earnings on the back of a major acceleration in datacenter sales. Since it doesn’t have a costly product transition like Intel, 2Q guidance ought to be considerably less traumatic.

On Wednesday, Facebook should confirm what everyone suspects – global engagement is on fire – and offer real datapoints on the advertising slowdown. Ad sales maybe down, but we believe they won’t be down as much as the bears fear. Microsoft reports at the same time and should crush the top and bottom-line results. Few companies are better set up to prosper from remote work than Mister Softy. Service Now should be okay – probably not closing a lot of new deals in this environment, but usage is likely up considerably. On the downside, Qualcomm will also report on Wednesday. It could be pretty ugly.

Thursday, Apple will fill out the picture on the global smartphone market. With stores closed across Western Europe and North America and joblessness at record levels, it’s hard to see how iPhone sales won’t be down hard. Worldwide recession could make a return to 2019 volumes a long slog, made worse by likely delays in bringing new models to market. Meanwhile, T-Mobile will have an upbeat call in the immediate aftermath of closing the Sprint acquisition. 1Q numbers are likely to be meh, but upbeat commentary can go a long way. Twitter could also be a mixed bag – “Monetizable Daily Active Users” should be up BIG TIME,

but management has called for caution on advertising, noting that engagement on the platform is heavy on COVID-19 news and brands are reticent to be closely associated with it. Still, investors are well aware of the risks from slow ad sales the raft of new users is a good sign for the platform beyond the current crisis. Finally, Atlassian will also report Thursday. Its SaaS project management solution is tailor made for the rush of employees unexpectedly working from home. We expect an unequivocal beat.

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