Quick Thoughts: The Week That Was and the Days Ahead

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

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January 27, 2020

Quick Thoughts: The Week That Was and the Days Ahead

  • NFLX’s strong 4Q19 results are a strong counter to the popular bear case that new US competition would hurt sub growth. We believe naysayers underestimate the importance of its content depth, scale economies, and international positioning.
  • IBM may have finally turned the corner to sustainable growth, with cloud and RHT more than offsetting legacy declines. Likely management change could be a further catalyst soon.
  • INTC has long-term problems (e.g. threats to the x86 processor architecture, process development missteps) but analysts are overly pessimistic on datacenter spending. INTC can beat 2020 expectations and the read across for other datacenter suppliers (e.g. NVDA, XLNX, AMD, X, WDC, etc.) is very positive.
  • Tuesday: We are very bullish for XLNX, one of our top picks for 2020. Strong datacenter demand and accelerating 5G rollouts should drive a strong quarter. AAPL manages the street better than anyone – expectations for 5% YoY growth are doable vs. an easy compare, and management is always confident on the call
  • Wednesday: We see MSFT upside. Multiple reports suggest Azure share gains vs. AWS, while INTC results suggest PC upside. FB could post another blow out – it has long term issues, but the digital ad market is VERY strong. NOW should easily top a consensus that continues to expect a sharp deceleration that is not coming anytime soon.
  • Thursday: AMZN is a TOUGH call. Overall retail numbers have been soft, but part of that is AMZN’s success. MSFT and GOOGL are gaining share vs. AWS, but the overall market remains very strong, and AMZN has generated big margins. We love it long term, but there may be better risk reward elsewhere for this quarter.

The talking heads on CNBC seem to love trash talking Netflix. For a few months the narrative has been either “Disney is coming!” or “Netflix is spending too much money on content and burning too much cash!” We are not concerned. Disney+ has arrived and Netflix posted a 1.2M subscriber upside surprise on 31% revenue growth. While we are confident of Disney’s long-term success in streaming, the current catalog is painfully thin of content after you watch the 8 hours of “The Mandalorian”. The Marvel series don’t start coming until 2H2020 – that’s a long time to rely on multiple viewings of Baby Yoda. HBO Max, due in March, will offer an attractive roster of content but will mostly be converting the 34M US households that already subscribe through their Pay TV operators. Comcast’s Peacock will be free, and if Disney+ is thin, Apple TV Plus is anorexic. Netflix is buying more content than all these competitors combined for its 167M

Exh 1: NFLX subscriber base continues to expand with strong momentum, 4Q19

Exh 2: NFLX historical projected vs. actual subscriber addition trend, 1Q16 – 4Q19

paying subscribers, and its good content, based on the astounding success of the company during award season (Exhibit 1, 2).

Moreover, all this only effects Netflix in the US. Nearly 2 thirds of Netflix subs and, essentially, all the growth, is coming from international markets. It is that steady 30%+ growth that is driving Netflix’s cash burn. Spending this year is not really for 2020 but for a year or two ahead, when there will be many more paying subs to justify it. When Netflix’s growth eventually slows down, and undoubtedly it will, the cash burn will turn to substantial cash flow and the massive content library will be an uncrossable moat protecting it from pesky interlopers. Sure, Disney and HBO will probably be there too, but they will be looking up at Netflix. 4Q earnings? Right on track.

Meanwhile, IBM seems to have snuck up on people. For a couple of years, Big Blue has been on the precipice of growth, flirting with it for a quarter before stumbling back. This quarter feels like the real thing. Cloud businesses (this seems a lot more reasonable than those “strategic imperatives” that somehow included things that were neither strategic nor imperative) grew 21%, while the acquired Red Hat business reaccelerated to 24% growth. Not counting divestitures and adjusting for FX, those two businesses carried the company to solid 3% YoY topline growth. We see more of the same in coming quarters and a likely upside pop once Ginny Rometty finally retires later this year (Exhibit 3).

Exh 3: IBM Quarterly Sales Growth, Recent Past and Consensus Expectations

Finally, Intel delivered an upside surprise on Thursday, powered by 19% YoY growth in datacenter sales in the face of analysts who were collectively expecting them to grow just 5.4%. This is where we tell you that we told you so. One of our 10 predictions for 2020 that we published less than a month ago (Ten Investable Things We Think Will Happen in 2020) forecast datacenter spending far ahead of expectations (Exhibit 4). This seems a good start. In the long run, we don’t love Intel. Its x86 processor architecture is tired and the cloud operators are emphasizing AI services that run on GPUs, FPGAs or ASICS instead. Intel was very late with its process upgrade to 10nm, allowing rival AMD to throw down poster dunks all year long. Still, spending in a big important category is up big and Intel will benefit from that all year long. By the way, so should other datacenter suppliers, such as Nvidia and Xilinx, both of which are in our model portfolio – just sayin’.

Turning to this week’s busy earnings schedule. Tuesday night brings us Xilinx and Apple. We are bulled up on Xilinx, which is one of our tip picks for 2020. Not only will it benefit from the same wave of datacenter spending that boosted Intel, but it will also get serious upside from accelerating global 5G network deployment. Add in automotive sales, which have been erratic but generally strong, and Xilinx has the cut of a winner. Turning to Apple, we’ve been at this too long to call a short on Apple just ahead of earnings. The expectations are do-able, and we expect them to be able to do it, then ooze their characteristic confidence on the call. Still, we think the rest of 2020 might be tough for 2019’s best Dow stock.

Exh 4: Consensus growth estimates for hyperscale capex in 2020 are pessimistic

Analysts are calling for a 5G powered super cycle this year, even though Apple won’t even have a 5G iPhone until the end of September and history that says that new mobile standards don’t take off in their first year.

On Wednesday, Microsoft gets its turn to flex. Things are going right for Nadella and company. Multiple reports suggest Azure is taking even more enterprise share from AWS – note that Microsoft has been nearly doubling Amazon’s growth in this market over the past few years. Add in an upside surprise from Intel’s PC chip numbers, and this smells like another solid beat for the kids for Kirkland. Staying with software, Service Now will be the first major SaaS company to report this year and there is no reason to believe that it will fall off of its extraordinary growth trajectory now, even though that is exactly what consensus has been incorrectly predicting for the company in each of the last 8 quarters. Consensus is wrong again this time, expect a major beat. Then there is Facebook. Mark Zuckerberg has a lot to worry about – world governments would like nothing more than to take his company down a notch or twenty. We don’t really get the company’s long-term plans either – see our piece last week vis a vis “The Metaverse” and virtual reality. Nonetheless, the shift to digital ads is powerful and Facebook is the greatest beneficiary. Expectations for 23% sales growth are a big step down from the 29% growth posted last quarter with no reason for immediate pessimism. It is definitely worth a trade.

Finally, Amazon. Jeff Bezos really doesn’t care if he beats expectations or not. Surprises could come for any reason and in any direction. The conference call will be nearly devoid of explanation. Still, over many years, it has generally been a good decision to trust Bezos to deliver shareholder value, but it has been a very nervous ride. In that context, this quarter, to be reported on Thursday, seems particularly difficult to call. AWS is starting to feel the breath of Microsoft Azure catching up from behind and Google Cloud Platform is suddenly relevant, but the overall cloud hosting market remains vibrant. Prominent retailers have preannounced ugly quarters but its hard to say if this is because of Amazon or because of market weakness. All of this is to say that we are happy holding the stock as an investment – it remains a part of our model portfolio – but we would be a bit cautious in trading it ahead of earnings.


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