Ten Investable Things that We Think Will Happen in 2020
SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai
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January 3, 2020
Ten Investable Things that We Think Will Happen in 2020
It’s prediction time again! 2019 was a tough year, but we still managed to get as much right as we got wrong. Our three best? Yes, growth tech outperformed the broader market – by a lot; Yes, the smart speaker installed base nearly doubled while smartphone volumes fell; and Yes, fintech and healthcare are the new battle grounds for internet giants. Our worst? Cloud capex rebounded in 2H19 but fell short of our 30% growth prediction; Waymo did not announce new commercial market (although GM did back off on a 2020 launch, as predicted); and Our top long picks underperformed our top shorts, all failing to top the S&P500. As for the rest, we were a tad too aggressive on MSFT’s gains vs. AMZN in the cloud; TMUS has announced aggressive 5G plans, but its merger with S is not done yet; The EU is rattling its saber again but launched no major new investigations for FB, AMZN and AAPL; and NFLX came up 5M subs short of our predicted number at the launch of Disney+.
- Smartphone volumes will disappoint. Forecasters are projecting a reversal of the 3-year decline in smartphone volumes, driving rallies in stocks like AAPL, SWKS, and MU. We don’t see it. The new flagship models are uninspiring and 5G deployment is still too limited to spur an immediate upgrade cycle. Look for device sales to miss expectations, driving disappointment in phone makers, flash memory, radio chips and other component suppliers, at least until the real 5G phones hit in 4Q20.
- Hyperscale datacenter spending will accelerate. The 1H19 swoon in datacenter investment, after nearly 50% growth in 2018, looks done, as the big hyperscale platforms (GOOGL, MSFT, AMZN, FB, BABA, etc.) revived to double digit spending growth at the end of the year. Still, forecasts are curiously modest – up just mid-single-digits – for 2020. We expect substantially higher spending against very easy compares to juice performance of data center suppliers, like NVDA, XLNX, and AVGO.
- SaaS winners and losers will separate as market consolidates. We remain very bullish on SaaS. The best players are defying consensus forecasts for sharp deceleration, as analysts underestimate the huge amount of runway left. Valuations may seem steep based on pessimistic projections and conservative terminal value assumptions, but we see significant further upside for the leaders. Meanwhile, the market remains very fragmented, but with obvious candidates to drive consolidation – MSFT, CRM, GOOGL, ADBE, WDAY, etc. We expect M&A to pick up in 2020 and for the winners to show obvious separation from the losers. We like many names – AYX, NOW, ZEN and OKTA are in our model portfolio, and 10-15 other well positioned companies could be candidates.
- GOOGL will get aggressive on multiple fronts. GOOGL has a reputation for dithering – developing fantastic new tech but taking forever to bring products to market. We think the company may be turning a new leaf. Well respected Sundar Pichai is taking control from founder and CEO Larry Page in 2020, while aggressive former Oracle executive Thomas Kurian starts his 2nd year as head of Google Cloud. For 2020, we expect big moves in multiple directions: enterprise software, financial services, healthcare, autonomous ride hailing, AI personal assistants and the connected home. Look for 3-4 deals at least as big as the $2.1B Fitbit acquisition and for 3-4 major new commercial business launches, which could include new markets for Waymo, banking products, a new health monitoring solution, and major new enterprise cloud applications and services.
- FinTech will hurt traditional banks/payments processors. AAPL and AMZN already launched credit cards. Checking accounts are likely next, with GOOGL expected to join the fray. PYPL could partner to expand its threatened online payments franchise, while FB is a wildcard. Big moves here will portend future moves to consumer lending and other financial products. Meanwhile, SQ, PYPL, and SHOP lead a move to absorb merchant payments into broader point-of-sale solutions. We expect upside from all three, while the newly consolidated merchant acquirer players could badly disappoint.
- New streamers will struggle with trial conversion as NFLX surprises. AAPL and to a lesser extent DIS, used free trials to grab early audiences, but we expect the enthusiasm to cool in 2H20 as trials end and viewers must be converted to paid subs for still thin content libraries. T’s HBO MAX must cut through the confusion around its multiple offerings and ties to Pay TV subscriptions – early conversions could disappoint. Meanwhile, NFLX’s deep library and international momentum (its rivals are largely US only) have been discounted by investors. We expect significant upside vs. expectations.
- VZ and T will raise capex forecasts, 5G subs will disappoint. The US wireless duopoly is banking on a failure for the TMUS/S merger, downplaying the investment needs for competitive 5G nets. This will prove costly in 2020, as the deal goes through, TMUS gets aggressive and DISH cuts deals with internet platforms to push a low-price alternative service. VZ likely needs to buy new spectrum rights to offer broader 5G coverage in lower frequency bands. T needs to raise cash against its strained balance sheet to fund faster deployment. We expect TMUS and DISH to significantly outperform VZ and T.
- Digital ad spending will grow more than 15% YoY as traditional ad spending falls. 2020 is an election year and an Olympic year. Usually, that is a huge boon to ad spending, and analysts are building that into growth projections for linear TV names like CBS, NWSA, CMCSA, and DIS. We are skeptical that the cyclically strong spending will be more than a small boost to linear TV and expect disappointment for traditional media investments. Rather, we see upside to digital ad sales, with GOOGL and FB leading the charge, and TWTR, SNAP and a few other benefitting.
- The smart home will finally gain major traction. The CHIP alliance begun by AAPL, GOOGL, AMZN and the Zigbee organization will be a major kickstart for smart home development, enabling ALEXA, Google Assistant and SIRI support out of the box and compatibility with device standards from all three. Expect the internet behemoths to get aggressive on full-line integrated home solutions with voice controls front and center and expanded lists of supported products and skills.
- Our best picks for the year. Long: GOOGL – it lagged rivals in 2019 but is poised for a big year; NTNX – the business model transition is almost over and growth will sharply accelerate against easy compares; XLNX – The 5G buildout rolls on and datacenter investment will accelerate well beyond expectations. Short: DIS – DIS has a great long-term story, but 2020 brings hard compares, soft linear TV, and a challenge to convert DIS+ trial viewers to paid subs; SWKS – weak smartphone volumes, enough said; VZ – Shares have rallied, but we see the millimeter wave strategy as fatally flawed.
The Year that Was
2019 was a hard year for many institutional investors. With the S&P 500 up 28.7% for the year and the tech components of that index up 47.9%, the benchmarks were very hard to clear. Our 15-stock model portfolio, heavy in SaaS, 5G, streaming media, e-commerce, fintech and security, beat the broader market but missed the tech benchmark despite rising 29.3%. This can be tied directly to our skepticism on smartphones, the semiconductor cycle and payments processors – stocks in all three areas boomed in 2019 – and to our faith in a few stocks (NFLX, NTNX, IBM) that stumbled during the year, despite what we still believe are excellent longer term prospects. In this context, it is no shock that our annual predictions, published a year ago, were a mixed bag (Exhibit 1).
Our report card for 2019:
- Growth tech recovers and outperforms the broader market – The year began with growth tech in a year end swoon with many pronouncing an end to the bull market. We went the other direction and predicted outperformance vs. the broader market. Bingo – tech beat the market average by 17.7%, with growthy names leading the way. We give ourselves an A
- AWS and GCP moves up the SW stack via M&A, Azure gains 500bp of share – Both AMZN and GOOGL did do multiple deals to move up the stack, but the largest one was GOOGL’s $2.6B deal for Looker so, perhaps, less of a splash than we had anticipated. Azure picked up 350bp of share vs AWS through 3Q19 – close but no cigar. We were directionally correct on all counts, but perhaps a tad too aggressive – give us a B
- Cloud CAPEX tops expectations with 30%+ growth – We were WAY too aggressive here. Actual spending was up 11% through 3Q after picking up nicely in the most recent quarter. This is better than the naysayers who called for spending down for the full year, but even with a strong 4Q, it won’t hit our 30% bogey. We’ll take a C.
- Merged TMUS/S announces aggressive 5G plans – T-Mobile did announce aggressive 5G roll out plans, but the deal isn’t done yet. Strong testimony from Dish Network’s Charlie Ergen showing his confidence that it can compete in 5G may have swung the tide. There is a strong chance that a positive January ruling will seal the deal. This one is a B for us.
- The EU acts against FB, AAPL and AMZN – the EU competition committee looked due for a shakeup, with the head of the committee, Margarethe Vestager at the end of her term and facing election opposition at home. However, Vestager beat her challengers and in September was named for an unprecedented second term as Competition Committee chair. This uncertainty seems to have delayed investigations underway on FB, AAPL and AMZN. These companies are still in the hot seat, but the hammer didn’t fall in 2019. We give ourselves a generous B.
- AI speaker installed base nearly doubles, smartphone revenues decline – This was unequivocally true. The AI speaker installed base was up 87% YoY at the end of 3Q. Smartphone units were down YoY for each of the first three quarters of the year, while ASPS slid. We’ll take the A.
- NFLX tops 165M subs before DIS launches its competing service – Close but no cigar here. Disney+ launched on November 12. As of the end of September, Netflix had just over 158M global subs, and while it undoubtedly added new ones between the end of the quarter and November 12,
Exh 1: SSR TMT 2019 Predictions Scorecard
we suspect we missed the mark by a few million. We are still bullish on NFLX and will take a B on this one and move on.
- Waymo announces new markets, GM/Cruise pushes its launch to 2020 – So GM/Cruise has put off its commercial service launch indefinitely. Google’s Waymo made progress. It is now offering most rides in its Arizona trial without safety drivers behind the wheel and appears to be ramping for major testing in Los Angeles. Still, not a peep on expanding its Phoenix commercial service into new markets. We suspect the company is feeling less pressure as its would-be rivals keep running into new problems, but progress is definitely slower than we anticipated. Give us a C.
- Financial services and healthcare are the new battlegrounds for Internet giants – Apple and Amazon each launched major credit card programs in 2019. Google is reportedly in talks with potential banking partners to offer a range of consumer financial services on its platform. Facebook announced its plans for a cryptocurrency to facilitate cross border transactions. On the healthcare side, Amazon launched its employee healthcare solution for its Seattle-based employees and appears to be angling toward quick expansion. Apple has inked multiple deals to employ its Apple Watch in medical research and announced significant enhancements to the health-related data collection and tracking across all of its devices. Google has been very aggressive, recently agreeing to buy FitBit for $2.1B and providing AI-driven analytics for many research and clinical applications. This one is an A+.
- Our Best Picks for 2019: LONG – NFLX, NTNX and TMUS; SHORT – ORCL, BKNG, and DBX – Our stock picks for 2019 were poor, particularly given the strong overall tech market. On the long side, we picked NFLX only to be blindsided by the sloppy 2Q report – the stock is barely back to where it begun the year after a recent rally. We also picked NTNX, still underwater by 25% YTD after confusion about its business model transition spooked investors. Finally, TMUS wasn’t as bad, but still lagged the broader market after the anti-trust suit from 13 state attorneys general dragged on into the new year. On the short side, we picked BKNG, ORCL and DBX. DBX was a hot mess, off almost 15% YTD, while BKNG (+19.3%) and ORCL (+19.2%) lagged the S&P500 (+28.7%) by a little and the tech components of the index (+47.9%) by a lot. We deserve a C-.
Onward and Upward
2019 is behind us and we have new predictions. We start the new year with a lot of uncertainty. Elections in the US are hard to call, with the potential for radical change from the already unpredictable course that we have been following. New tech is being hyped – 5G wireless, wearables, AR/VR, smart homes, hybrid clouds, solid state storage, self-driving, mobile payments, touchless checkout, health monitoring tech, medical AI, telemedicine, drone deliveries, industrial IoT, streaming everything, and so on. Skeptics, uncomfortable with tech valuations, are calling for corrections if not full on recessions. Where do we go from here? Our best thoughts:
Prediction 1 – Smartphone volumes will disappoint
We are believers in 5G. Technically, the new wireless standard is a major step up from 4G LTE, offering dramatic increases in system capacity, a magnitude reduction in latency, and new flexibility to carriers
Exh 2: Global Smartphone unit shipments growth has declined, 2010 – 2019E
Exh 3: Analysts expect 2020 Smartphone unit sales to rebound, without 5G
Exh 4: Summary of 5G service launches and suggested timelines in key markets
looking to carve out differentiated services. Still, we believe the market is jumping the gun (Smartphones: The Market is Mature, Now What?). Smartphone king Apple has seen its stock rally more than 50% in anticipation of an iPhone upcycle, carrying chip stocks (smartphones are 25% of global chip sales) along in the tide.
Unfortunately, the networks aren’t ready – only a few geographic markets have any 5G at all and those that do have extremely spotty coverage. At the same time, only a handful of 5G phones are available, mostly at $1,000 plus price points. Apple will not even deliver a 5G capable iPhone until 4Q. As expected, user reviews from South Korea and other early markets are less than enthusiastic, citing disappointment in the actual benefit of higher connection speeds and in the inconsistent availability. In this context, market forecasts for 5G phones to be 10% of total global unit volume and a third of premium smartphone device sales appear farfetched. At the very least, 2020 5G device volumes are likely to be backend loaded, leaving 1H20 sales very likely to disappoint (Exhibit 2, 3).
This has implications for the entire smartphone value chain. Mobile phones account for more than 25% of all semiconductor sales by volume, by far the largest end market for chips. Weak 5G device volumes would obviously affect demand for mobile specific components, like displays, SoC processors, modems, RF, power converters and other parts, but would also drag sales of more generic chips, like flash memory, and thus, have impact on contract fabs, capital equipment, and other businesses related to chip making. At the same time, the chip sector rallied furiously in 2019, in anticipation of a 5G driven cyclical upturn in 2020. We believe the enthusiasm is a year too early (Exhibit 4).
Prediction 2 – Hyperscale datacenter spending will accelerate
In contrast to our pessimism for smartphones, we are bullish on datacenter investment. As more enterprise computing shifts into the cloud and as the leading consumer internet franchises grow their dominance, datacenter spending is concentrating into a small number of hyperscale operators, led by Google, Amazon, Microsoft, Facebook, Alibaba, and a few others. In this context, demand for datacenter components – CPUs, GPUs, FPGAs, disc drives, interfaces, switches, etc. – has been a roller coaster. CAPEX by the top operators was up nearly 50% YoY in 2018, as many played catch up and then some against extraordinary growth in demand for capacity. 2019 started with a bit of a hangover and spending against beefy compares turned down YoY before shifting back to growth in 3Q and, presumably, 4Q.
Industry analysts, like Gartner, are taking a cautious approach to datacenter capex going forward (Semiconductor Forecasts: Too Bullish on Smartphones, Too Bearish on the Cloud). Server chip volumes, a proxy for datacenter spending, are expected to vacillate over the next few years but never rise higher than the 2018 level. 2022 volumes are projected below the relative down year of 2019. Given the public cloud hosting market continues to deliver better than 40% annual sales growth with falling prices, and the robust health of the big consumer internet franchise services – e.g. Google Search, Amazon e-commerce, Facebook social media and the lot – we believe the pessimism is quite misplaced.
Look for strong 2020 datacenter component demand to drive upside for component makers like Nvidia, Xilinx, Broadcom, Western Digital and Seagate. Even Intel, which is suffering from a mix shift away from its CPUs in hyperscale datacenters and resurgent competition from AMD, could benefit. Longer term, we see AI processors and high-speed communications components as the best, and most underappreciated, opportunity in the datacenter market.
Exh 5: Consensus growth estimates for hyperscale capex in 2020 are pessimistic
Prediction 3 – SaaS winners and losers will separate as market consolidates
SaaS applications stocks were strong in 1H19 but hit a wall come summer (Exhibit 6). The 63 SaaS names with market caps in excess of $1B were up a collective 33.9% for 2019, ahead of the broader market but well behind the tech index. Despite average sales growth of 29.3% and clear long-term leverage to margins, these stocks carry a real stigma to many investors who see them as overvalued on traditional metrics (Exhibit 7, 8). We have written about the failure of standard valuation techniques, in particular discounted cash flows, to cope with high growth rate tech stocks. (Model Portfolio: What is Value in Tech?) Typically, analysts posit out 5 years of explicit free cash flows, often applying a healthy deceleration to current growth rates, before slapping a “market multiple” to calculate a terminal value from the fifth-year number. Given that the terminal value may be as much as 80% of the total DCF present value, the use of a generic multiple to calculate it is highly questionable. If today’s high-flyers were slapped with a market multiple on current earnings, all would have been BADLY undervalued by analysts 5 years ago.
That said, not all of the big SaaS names will be winners, and those that are not could deserve a discount terminal value even as the winners have earned a substantial premium. We believe that this year could be the year that investors begin to split the wheat from the chaff. In 2019, the 10 worst performing SaaS names were within 12237bp on average of the top 10. We expect the spread to widen in 2020. At the same time, we have long believed that the SaaS market would consolidate, just as the enterprise application market did 20
Exh 6: YTD Cumulative Performance of SaaS names with >$1B market cap
Exh 7: Consensus forecasts for SaaS Sales growth are overly conservative
Exh 8: Top SaaS companies on average have consistently posted top-line surprises against conservative consensus estimates
years ago. Look for the biggest enterprise software names – Microsoft, Salesforce, Adobe, IBM, Oracle, etc. – to be on the hunt for acquisitions to broaden their application portfolios. Look for smaller SaaS names, led by big names like Workday and Service Now to be shopping as well, and for smaller companies to consider mergers with equal or even smaller players as everyone chases economies of scale.
Prediction 4 – GOOGL will get aggressive on multiple fronts
Alphabet has a well-deserved reputation for struggling to commercialize their prodigious technology assets. More than 10 years and 15 million road miles after launch, its self-driving car initiative is still in trial with commercial service limited to a slice of Phoenix, AZ suburbs. Google Maps is used by nearly everyone but generates no direct revenue to the company. YouTube has more or less stuck to its (admittedly highly valuable) knitting while Netflix led the media industry into a streaming revolution. Apple and then Amazon beat it to the punch with voice recognition and AI-based assistants. Amazon Web Services was in business for a decade before the company that actually invented most of the software tech in a modern datacenter actually decided to get into the hosting market.
Many had hoped that the addition of Wall Street veteran Ruth Porat to the CFO role in 2015 would sharpen Alphabet’s focus on commercialization. So far? Not so much. Still, there are reasons for hope. First, Google’s founders Larry Page and Sergei Brin are stepping away from day-to-day responsibility for the
Exh 9: A snapshot of Alphabet’s most attractive business initiatives
company in favor of well-regarded Sundar Pichai, who has been running the commercial arm of the business successfully for a few years now. Second, the company has begun to look outside of itself for commercial leadership, tapping former Hyundai US head John Krafcik to run Waymo and, importantly, former Oracle executive Thomas Kurian to handle the enterprise cloud business. Third, it has begun to make acquisitions, like Looker and Fitbit, to beef up some of its previously sleepy initiatives. Finally, investors have begun to speak up in frustration at the company, which has underperformed its tech mega cap peers despite a run of excellent sales and earnings results.
We believe that Google will get even more aggressive this year, addressing the needs of multiple promising initiatives (Exhibit 9). Waymo, Google Cloud Platform, Google Assistant, Google Maps, healthcare, financial services, e-commerce, the connected home, wearables and other areas of interest should spur 3-4 major acquisitions at least as big as the $2.1B Fitbit deal and another 3-4 surprising commercial initiatives. Options could be new commercial launches for Waymo, expanded enterprise cloud offerings, consumer banking products, health monitoring and diagnostic solutions, amongst many other possibilities.
Prediction 5 – FinTech will hurt traditional banks/payments processors
The big consumer internet franchises – Google, Apple, Facebook and Amazon (GAFA) – have all been circling the consumer financial services market. Amazon may be the furthest along, already offering multiple credit products, gift card accounts and merchant lending. Apple launched Apple Pay in 2015, sparking growing acceptance for mobile payments, and followed in 2018 with its own credit card, offered jointly with Goldman Sachs. Facebook has announced an intention to develop a cryptocurrency-like payments product to facilitate low cost transfers, particularly across borders. We note that this intention has been strenuously opposed by many world governments. Google has been much quieter in its pursuit of payments, although its Google Pay is widely used by Android device users and for online purchases. However, reports have suggested that the company has been in discussions with potential banking partners to launch deposit accounts on its platform (Digital Consumer Banking: What will GAFA do?).
Checking account-like services are an obvious step for all four (Exhibit 10, 11). Combining deposit accounts with credit cards would help facilitate transactions, provide valuable targeting data and serve as a stepping-stone to other consumer financial products, such as loans, insurance or financial advising. We believe that it is likely that one or more of the GAFA platforms will announce an intention to offer deposit accounts and related services. We also expect them to introduce enhancements to their payments products and promote them aggressively in direct rivalry to the premium cards offered by consumer banks.
On the merchant side, seven payments processing specialists have consolidated to three – Fidelity National (FIS), Fiserv (FISV) and Global Payments (GPN). These names were major outperformers in 2019,
Exh 11: Top products consumers are willing to buy from technology companies
as investors believe market concentration will drive efficiencies and create better pricing discipline (Exhibit 12). We believe this will prove overly optimistic, as competition from two directions begins to squeeze the merchant acquirers in 2020. On one side, point-of-sale (POS) solutions from digital native interlopers that integrate payments processing with back office systems, tie in-store sales to e-commerce, and offer innovative check out experiences for customers are gaining considerable traction with retailers. Companies like Square, PayPal and Shopify are commoditizing payments processing as part of their broader solutions, growing their customer bases at a better than 50% annual pace and moving ever higher up the chain to larger retailers (Exhibit 13).
On the other hand, merchant banks have ammunition to attack from the other side. For example, JP Morgan Chase’s Chase Paymentech unit has begun to offer merchants same day posting for credit card payments, an enormous liquidity benefit for retailers long used to 2 to 3-day settlement. Without their own commercial banking platform, the dedicated merchant acquirers will not be able to match that. Given this and the rising tide of smart POS solutions, we believe the payment processing party will be disappointing in 2020, while the challengers thrive (Digital Payments: Revolution at the Register).
Exh 12: TTM Cumulative Performance for Top Payment Processors
Exh 13: US Digital Wallet Transaction Volume and Growth, Forecast 2018 -2023E
Prediction 6 – New streamers will struggle with trial conversion as NFLX surprises
2019 was a tough year for Netflix. A weak subscriber number in the often disappointing second quarter fueled investor skepticism already high from speculation for a raft of new streaming services from rivals announced for the second half (Exhibit 14). A narrative of impending doom arose, with analysts and media projecting that Disney+, Apple TV, HBO Max, Peacock and other new streaming services would spur consumers to cancel Netflix in favor of these well publicized entrants (End of TV: Media Strains to Adapt to Streaming; Quick Thoughts: DIS and VZ Sitting in a Tree).
We believe this perspective is not well supported by evidence. Nearly two thirds of Netflix’s subs are now outside the US, in markets where the new competitors are not in position to compete. This is also from where all Netflix’s recent growth has come. We also note Netflix’s extraordinary depth of programming. Its content budget exceeds all of its streaming rivals combined, with reserves of well-regarded exclusive programming across nearly every important genre. In contrast, Disney+ launched on November 12 with just two of its original series – The Mandalorian and High School Musical: The Musical: The Series – ready to go. The remainder of the announced exclusive programs – much of it from the Marvel and Star Wars franchises – will see introductions spread over the next two years. Disney+ may have the tentpole content to draw people in, but it lacks the depth to be the primary streaming platform for most households. The same is even more true of the other would-be competition for Netflix.
We believe that the new streamers will struggle to sustain their subscribers, many of whom begin service on free trial, once viewers blow through the headline content – combined The Mandalorian and High School
Exh 14: Historical Quarterly Subscriber Base Trend for Netflix, 2Q12 – 3Q19
Exh 15: Estimated subscriber base of streaming platforms in the US, 4Q19
Musical are only about 12 hours of watching. Amazon may be content to keep its Prime Video as a permanent freebie in combo with its Prime Memberships, but the others almost certainly expect to build bases of paying subscribers. In the long run, the real competition for streaming is linear PayTV, which we believe has begun a long, irreversible decline. Cutting the cable, with its $100/month price tag, frees up a lot of potential household spending for streaming services. There will be room for more winners than just Netflix – we’d bet on Amazon, Disney and HBO – but the expectations for 2020 seem unrealistic (Exhibit 15). We would be long Netflix and cautious on the other media stocks.
Prediction 7 – VZ and T will raise capex forecasts, 5G subs will disappoint
As noted in prediction 1, we believe the market is early on 5G adoption. In the US, the progress of the new standard has been further slowed by the lengthy approval process for T-Mobile’s planned acquisition of Sprint. The combined carrier would wrest spectrum advantage away from Verizon and AT&T, which have historically used their privileged low frequency licenses to maintain a powerful duopoly. Combining T-
Exh 16: Consensus estimates for US Carrier Capex continue to remain pessimistic
Exh 17: Snapshot of US Carrier Capex Spending during 3G and 4G cycles
Mobile’s market momentum and newly acquired national 600MHz band license with Sprint’s huge swath of valuable mid-band spectrum creates the ideal environment for deploying and operating a 5G network. Broad coverage can be assured with the huge cell sizes afforded by the low frequency band, while the higher frequencies (still low enough to penetrate walls and power through rainy conditions) enable ample capacity for strong performance in congested neighborhoods (The Three Phases of 5G: Coverage, Density and Applications).
However, with the ongoing anti-trust suit brought by 13 states in an attempt to thwart the deal, Verizon and AT&T have had the luxury of coasting. Rather than making the considerable expense to re-farm its existing spectrum to free up low band frequencies for a 5G backbone network, Verizon has decided to keep 4G LTE as its default network technology and only deploy 5G in the controversial “millimeter wave” band to increase capacity in hot spots and as a vehicle for fixed wireless residential broadband. This strategy saves considerable CAPEX but cannot deliver the benefits of 5G beyond ultrahigh speeds under very narrow conditions and general relief from congestion. AT&T admits to the need for a national 5G backbone but has not yet allocated the resources needed to implement one. It too is on the ultra-high-speed millimeter wave bandwagon. We are very skeptical (5G: Why TMUS will Win)
We believe that T-Mobile will win its anti-trust case and complete its combination with Sprint during the first quarter. It can then begin deploying 5G in earnest, living up to considerable coverage promises made to secure support from the FCC. Dish Networks, given a sweetheart deal for spectrum, subscribers and wholesale access to the T-Mobile Network as a consequence of gaining federal approval, will also begin its network investment, potentially with the support of high-profile internet platform partners. At the same time, we believe that AT&T and Verizon’s 5G programs will fail to generate the adoption that they have predicted and that many investors expect. The pressure on the duopoly to match T-Mobile’s coverage roll out and to support new services will be strong, forcing both to raise capital spending well above their modest targets (Exhibit 16, 17). This will be bad news for Verizon and AT&T investors, while T-Mobile and Dish are likely to surprise.
Prediction 8 – Digital ad spending will grow better than 15% YoY as traditional ad spending falls
2020 is a US election year and an Olympic year. In the advertising world, this has traditionally meant a huge cyclical upswing in spending, with TV networks the biggest beneficiaries. Analysts and investors are betting that history holds form, expecting that cyclicality to overwhelm the broader trend toward declining spending on TV, print and radio. We are more concerned.
Viewership statistics for linear TV have been deteriorating on an accelerating path for years (Exhibit 18). TV ad revenues turned to decline for the first time in 2017, saw a modest recovery in the cyclically favorable 2018 before dropping even more strongly in 2019. For 2020, we do not think that the even year cyclicality will save media companies for seeing downside to ad revenues, with TV joining print and radio as declining traditional advertising formats.
The slack is being taken up by digital advertising. Ad tech works, helping advertisers to target their messages and to track their effectiveness, increasingly all the way to an actual sale, on venues that continue to show
Exh 18: Advertising dollars will soon follow viewership away from Linear TV
Exh 19: Global digital ad spending is expected to grow >15% in 2020
strong growth in engagement. This is no less true for political advertising, and most of the boon from the raucous Democratic Party nomination process has accrued to digital platforms. Twitter and Snap may have pledged to limit their participation in political advertising, but giants Google and Facebook have not. Privacy and anti-trust investigations be damned, the big dogs will get theirs. We expect US digital ad spending growth to be closer to 20% than the predicted 15% in 2020 as traditional ad spending falls (Exhibit 19). This will primarily benefit Google and Facebook, while the media companies reliant on linear TV will suffer.
Prediction 9 – The smart home will finally gain major traction
The smart home hype began at least 20 years ago, always the next big thing and always not ready … yet. After years of infighting over standards and promoting idiosyncratic solutions that only complicated consumer lives rather than delivering the promised benefit, the big internet players seem to have come to a simultaneous epiphany. The smart home will only take off when homeowners and builders are confident that the framework for enabling automation will be consistent across nearly any vendor or solution they might choose, and that investment today will be supported for many years forward (Exhibit 20).
Those conditions may be finally in place. In December, Apple, Google and Amazon announced a joint initiative with the Zigbee Alliance to define a common standard for home networking to be supported by all three consumer internet giants, meaning that devices that work with Amazon’s Alexa should also work with Google Assistant and Siri (Exhibit 21).
Exh 20: Global Smart speaker Installed Base Forecast, 2018 – 2023E
Exh 21: Overview of Zigbee Alliance and CHIP project
Supporting the common standard will be a no brainer for home automation products, so consumers need not worry when sourcing lighting, security, appliances, window treatments, AV, and other elements of a connected home. Moreover, expect future Amazon Echoes, Google Nest Hubs and Apple Hubs to make onboarding new smart home devices fast and nearly foolproof. We project major strategy announcements from all three companies in 2020.
This will be a major spur for adoption of home automation – think Philips Hue lighting, Amazon Ring doorbells, Google Nest thermostats and smoke detectors, Sonos audio, and others. We anticipate acceleration in sales of these sorts of products. It will also be further impetus to employ smart speaker products like the Amazon Echo or Google Nest hub. We expect continued strong growth in these categories. The installed base of smart speakers grew 87% in 2019. Look for a 50% or better boost in 2020.
Our Top Picks
Long: GOOGL – We wrote in prediction 4 that we expect Google to get much more aggressive this year, making acquisitions and launching new business initiatives. We also wrote in prediction 8 that we project digital advertising spend to be better than expectations for 2020. This adds up to a big year for Alphabet just as its founders move to the sidelines in favor of well-regarded CEO Sundar Pichai. NTNX – This is a repeat from last year, when Nutanix went on to blow up after poorly communicating the implications of its shift from hardware and license sales to software subscriptions. We’re doubling down, as we believe strongly in the hybrid cloud opportunity and in Nutanix’s strong position in facilitating IT management across public and private datacenters. Compares will be MUCH easier this year as the 40%+ growth in software subscriptions pushes overall sales growth back into double digit territory. Furthermore, we see major possibilities for an acquisition by an ambitious larger player with designs on the hybrid cloud. Think Google, Microsoft, Cisco, Salesforce and others. XLNX – Xilinx was another disappointment for us in 2019, held back, at least in part, by the weak datacenter spending in the first half. In prediction 2, we called for datacenter spending to reaccelerate and in prediction 7, we see 5G capex ramping up faster than expected. For Xilinx, both would be major upsides. As more mundane chip stocks fly, we see Xilinx as a much better option (Exhibit 22).
Short: DIS – Long-term, we love Disney but 2020 brings some immediate challenges. In 2019, Disney accounted for more than 40% of all movie box office receipts. While the merger with Fox may sustain that, investors will notice the impact of fewer and smaller blockbusters on the release schedule – no Avengers: End Game or Star Wars: Rise of Skywalker this year. In addition, linear TV is still very important to Disney and the weak advertising sales projected in prediction 8 will hurt, as will the growing pains from nurturing its streaming properties. SWKS – We could put Apple here, but we are choosing one of its suppliers instead. Skyworks will suffer if smartphone volumes are disappointing, as we forecast in prediction 1. VZ – Prediction 7 kind of says it all. If Verizon’s 5G sub growth is disappointing and the company must fess up to investors that its previously announced flat capex trajectory is inadequate, the stock will fall.
Exh 22: Summary of Top Picks for 2020