Ten Investible Things that We Think Will Happen in 2018
SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai
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January 2, 2018
Ten Investible Things that We Think Will Happen in 2018
In a strong year for tech, our 2017 predictions fared well. Our big clunker was expecting big consolidation in SaaS – the deals were small, as MSFT, CRM, ORCL and others digested their previous acquisitions. We gave ourselves a C (Incomplete), as we still expect an industry roll up to play out and SaaS names performed well without the spur of M&A. Meanwhile calls for the rise of AI-as-a-Service, virtual assistants, atypical cloud partnerships and robo-taxis, and for the fall of linear TV and net neutrality earned straight As. Changing security paradigms and renewed smartphone competition moved in the right direction, but less decisively than we had predicted – solid Bs. Our top longs for 2017 – XLNX, CRM and TMUS – were carried by CRM (+45%), while XLNX (+17%) and TMUS (+9%) trailed the S&P tech components benchmark (+36%). Our shorts? CBS (-7%), EXPE (+7%) and ORCL (+24%) all missed the benchmark. The picks for 2018 – Long GOOGL, KEYS, and ZEN; Short AAPL, T, and AVGO.
- GOOGL launches commercial robocab service – We recently wrote of Waymo’s significant lead in autonomous driving (http://www.ssrllc.com/publication/googl-waymo-is-worth-75b-right-now/). In 2017, it began offering rides to subscribers in a Phoenix suburb with a driver ready to take the wheel. In 2018, it will put the engineer in the back seat, and expand service to all of metro Phoenix. By year end, we expect Waymo to pull the engineer entirely, to expand service to more subscribers, and to announce service introductions for new markets. No other company will offer truly driverless service in 2018.
- AAPL misses FY18 iPhone shipment estimates – Analysts have already begun walking back their projections of an iPhone “Supercycle” for FY18. Still, the street consensus for 12% unit growth is optimistic in a global premium smartphone market that is growing in low single digits at best. Early signals suggest a modest reception for the three new models, with the only potential saving grace in China. Given the higher price points and resurgent Chinese brands, we don’t think it will be enough.
- US carrier CAPEX will rise 8% YoY – For most of the past few years, US carriers have talked down capex for 5G, claiming that the buildout could be funded from reductions in spending on LTE. We are skeptical that T and VZ, facing pricing and share pressures, would yield the competitive high ground to an aggressive TMUS. Recent signs, including spending plans from S, suggest that they won’t. Look for capital spending to surprise to the upside (http://www.ssrllc.com/publication/5g-rising-global-carrier-competition-to-drive-capex/). We like TMUS and KEYS as prime beneficiaries.
- Net neutrality repeal will have little effect – The FCC’s reversal of net neutrality evoked tremendous passion from partisans on both sides of the debate, but the point is moot. MSOs and carriers might be free to exert market power against internet services, but we do not expect them to move aggressively. Elections in 2018 could shift the congressional balance, and the potential of a new administration in 2020 makes the potential for backlash too great. Moreover, we believe 5G is a looming threat to residential broadband. We believe moves will be limited to consumer popular offerings, like zero-rating for popular streaming services.
- US TV viewership and ad sales will be down again – 2018 is an Olympic and election year – typically a recipe for TV ad growth. After a tough 2017, media companies and their investors are looking for a cyclical rebound. We are highly skeptical – the shift to digital is powerful and permanent. Look for disappointments across the board in ratings for both broadcast and cable, and for linear TV ad revenues industry wide. May’s upfronts will be the first major damage, with disappointment looming.
- QCOM will fight off AVGO and settle with AAPL – AVGO’s recipe for QCOM, of cutting royalty rates and raising chip prices is poorly considered. QCOM’s IPR position is far stronger than AVGO supposes and taking price on chips just opens the door for reeling competitors like MediaTek to get back in the game. QCOM will fight back – hard. Expect attacks on AVGO’s quality of earnings, on regulatory issues, and on the risk inherent in this strategy. A 20-30% jump in the bid could get a deal done, but AVGO can’t afford it in such an acrimonious deal. In the wake, we think QCOM will find room for agreement with AAPL – preserving its royalty paradigm and removing the major element of uncertainty for its stock.
- MSFT/GOOGL make big moves vs. AWS – The enterprise exodus to the public cloud will continue apace, but the growth will shift toward traditional businesses, where MSFT and IBM have real advantage. Look for both to be surprise share gainers against market leader AMZN in a strong market environment. Google Cloud Platform will also prosper beyond expectations, as its partnership with CRM bears fruit, sparking M&A rumors, and GOOGL’s AI chops gain further currency.
- AMZN’s GMV will catch WMT by 4Q18 – No tears for AMZN. We believe that its gross merchandise volume (GMV), including the full value of 3rd party sales conducted through its site, topped $325B for 2017 and could beat $450B for 2018, as a full year’s push in grocery and a likely entry to pharmacy spur extraordinary growth. By 4Q, this should put AMZN neck and neck with WMT, which is expected to do nearly $500B in annual sales but will show far less growth, and thus, a less skewed final quarter. At some point this year, investors, analysts and the media will pick up this thread.
- IBM will deliver full year sales growth – 22 quarters of pain will come to an end this year. While investors have come to understand that a good chunk of management’s “strategic imperatives” were neither strategic nor imperative, we think that the cynicism is now overdone. IBM is well positioned to take cloud hosting business as the demand now tilts toward its traditional enterprise customers. Watson is real – management overpromised on the timing, but IBM’s AI capabilities are no joke. Blockchain is becoming a vital issue for many enterprises, and IBM is better versed in the tech than any of its peers. IBM’s assets – technology, platform, consulting resources, business relationships – are unique. Once IBM turns to back growth in 1H08, we expect it to be able to sustain it.
- Our best picks for the year – Longs: GOOGL, KEYS and ZEN. GOOGL’s dominant digital ad biz will drive growth, but self-driving and enterprise will boost future expectations. KEYS will be an early cycle winner in 5G. ZEN would be an excellent customer service platform tuck-in for any of the big software names. Shorts: AAPL, T and AVGO. A disappointing iPhone “Supercycle” would be enough to take down AAPL a notch. T, in limbo while the DoJ fights its TWX deal, will cope with falling ARPUs and capex pressures. AVGO could take a big hit if its play for QCOM comes up empty.
How did we do Last Year? Our 2017 predictions earned 6 As, 3 Bs and a C (incomplete). We were spot on in calling for AI-as-a-Service. GOOGL, MSFT, and even IBM went hard on launching AI hardware platforms and software tools as points of differentiation vs. hosting leader AMZN, which invested heavily to respond – including hiring AI superstar Alex Smola to lead its efforts. CRM’s partnership with GOOGL answered our call for big new cloud tie ups, with AMZN and MSFT also signing sizeable deals with new customers. AI assistant powered home speakers were the product category of the holiday season, in line with our expectations for momentum behind AI as a UI. GOOGL’s Waymo proved us right by joining Uber in offering commercial rides in its driverless cars and announcing truly driverless service for 2018. The linear TV narrative did break in 2017, as predicted, with DIS’s aggressive move to buy studio assets from FOX to fuel its streaming ambitions a key moment. The Trump FCC nixing Net Neutrality was a lay-up.
We gave ourselves a B for our call for a bold paradigm shift in data security – the shift to cloud-based AI tools is happening, but quietly. Smartphone competition did heat up in 2017, mostly in China, and our top picks – XLNX, CRM and TMUS long, and ORCL, CBS and EXPE short – were pretty good. We had one major fail – MSFT, CRM, GOOGL, AMZN, ORCL and company did not go on a SaaS buying spree, instead taking the pause that refreshes. Nonetheless, SaaS names had a banner year and we still see an industry roll up in the future.
Exh 1: The 2017 Predictions Scorecard
2017 was an eventful year. Amidst the political turmoil and existential hand-wringing, TMT stocks drove the market ever higher. Our large cap model portfolio, chock-a-block full of growthy Cloud/AI Era names, performed well, beating the S&P 500 by 1918bp and the tech components of that index by 189bp. Our predictions, published a year ago today, fared pretty well too – we graded ourselves at 6 As, 3 Bs, and a C (incomplete). Feel free to grade us differently.
This year’s predictions build on last year’s. A year ago, we expected to see companies offering test rides to customers in self-driving cars – albeit, self-driving cars with a driver ready to take control on immediate notice. This year, we expect GOOGL’s Waymo to pull the driver entirely and announce a commercial on-demand autonomous robo-cab service. Last year, we predicted more competition in smartphones, this year, we are predicting AAPL to whiff on consensus iPhone shipment expectations, as the anticipated “Supercycle” fails to materialize. A year ago, we believed that the Trump FCC would eliminate the Net Neutrality restrictions. That happened, but for 2018, we believe the carriers and MSOs will too cowed by possible future political pressures to do much more than offer consumer-popular zero-rating bundles. In 2017, we predicted that the linear TV narrative would break and in 2018 we are calling for TV ratings and ad sales to materially disappoint. 12 months ago, we called for the rise of AI-as-a-Service. Now we call for MSFT and GOOGL to use AaaS as impetus to make material share gains vs. AWS.
We are also making predictions in fresh directions. After a decade of holding CAPEX in check, we believe US carriers will open their wallets to fund 5G buildouts, materially surprising investors who have been trained to expect tight discipline. We also think that a AVGO/QCOM combo is a terrible idea for both companies, and expect QCOM successfully fight off the hostile move, likely trashing AVGO’s planned strategy (cutting royalties, raising chip prices and trimming R&D) as value destroying and attacking the quality of earnings underpinning AVGO stock. In the aftermath, we think an AAPL licensing deal could get the stock moving.
By 4Q18, we think AMZN’s gross merchandize volume will be neck and neck with WMT, shocking many observers who forget that 3rd party sales (reported only as commission payments) are growing much faster (and more profitably) than AMZN’s revenues. Aggressive moves in grocery and an entry to pharma will help. We also see good things for IBM after 23 consecutive quarters of falling sales. Big Blue’s cloud businesses are finally enough of the pie to deliver overall revenue growth in 2018.
Finally, our top picks for the year. On the long side, we start with GOOGL – strong digital ad sales will be supported by positive news flow from its underappreciated autonomous driving and enterprise cloud businesses will turn sentiment positive. KEYS will be an early cycle winner as global 5G spending picks up faster than many expect. ZEN is a high-growth SaaS customer service specialist that will be an M&A candidate once industry consolidation begins. On the short side, it is hard to bet against AAPL, but we think talk of an iPhone “Supercycle” has expectations way too high – the iPhone X backlash seems to have already begun. T had a nice little run in 4Q, but we don’t see a lot of good things going on – the TMX deal is in jeopardy and competition is eroding the cozy oligopoly at the top of the wireless market. Finally, we expect AVGO to fail in its play for QCOM, exposing aggressive M&A accounting and poor organic growth in the process.
1 – GOOGL launches commercial robocab service
In 2017, we predicted that Google’s Waymo self-driving initiative would join Uber in offering limited commercial trials of autonomous taxi service with engineers behind the wheel and ready to take control if needed. This happened. We also suggested that fully autonomous trials, without emergency drivers, would be ready to go by the end of the year, with Asia viewed as the most hospitable venue. Right idea, wrong place. Waymo is ready to go in Arizona (Exhibit 2).
Exh 2: Summary of Autonomous Car Leaders
We recently wrote of Waymo’s potential dominance in self-driving (http://www.ssrllc.com/publication/googl-waymo-is-worth-75b-right-now/). While Google had been content to operate sub rosa until now, we believe 2018 will be Waymo’s coming out party. Limited service geofenced to Chandler Arizona will be expanded to the full Phoenix metro area over the course of 2018 as the engineers move from the front seat to the backseat. By year end, the Waymo employees will be out of the cars, and the operation will fully commercial as a subscription transportation service. Plans will be revealed to extend to new markets – testing is already underway in Austin TX, Kirkland WA and Mountain View CA (Exhibit 3).
Exh 3: Summary of Disruptors with1M+ Tested Miles
2 – AAPL misses FY18 iPhone shipment estimates
The average sell-side analyst expects Apple to grow sales nearly 20% for its FY18 ending in September. Amongst the drivers for this – price hikes, services, watches, and the like – none are nearly as important as the deeply held belief that the newest iPhones, the 8, 8 Plus and the $1K X, will stimulate a global replacement frenzy, otherwise known as the “Supercycle”. With this supercycle, the narrative is that Apple can increase its iPhone shipments by 12-13% in its FY18 (Exhibit 4).
The evidence so far is not encouraging. The iPhone X debuted at the end of November to mixed reviews and stories of moderate demand, with the combo of modest performance advantages, high price and curious design choices (e.g. The Notch, dropping touch ID, etc.) failing to deliver the expected tour de force that is embedded in the consensus. Just this past week, an Asian brokerage with a rep for close contact with Apple suppliers dropped its March quarter iPhone X unit projections by more than 20%. An industry consultant that measures device activations published its market estimates for the holiday season, touting Apple’s iOS and its 44% share, the exact same share that Apple had earned in 2016 without the benefit of a “supercycle”.
We think that it will only get worse in the spring, when new Android models, like the Samsung Galaxy S9, hit the market armed with Qualcomm’s new Snapdragon 845 System-on-a-Chip and a variety of innovations. In recent years, Apple’s iPhone seasonality – up in the first half of its fiscal year and down in the back half – has become a bit more pronounced, and if shipments in December and March are soft, we wouldn’t expect June and September to make up for it. While higher ASPs might soften the sales hit a little and buttress margins, a unit shortfall would almost certainly mean downside surprises and downward revisions, neither good things for a stock that was up 45% in 2017 on dreams of the supercycle.
Exh 4: Quarterly iPhone Revenue and Unit Sales, 1FQ15 – 4FQ17
3 – US carrier CAPEX will rise 8% YoY
US carriers have kept their capital spending within a narrow band relative to sales over the past decade, holding capex between 16.4% and 16.9% of sales (Exhibit 5 & 6). Management at the market leading VZ/T duopoly have held this discipline despite aggressive moves by T-Mobile that have hit subscriber ARPUs and eroded the cash flows generated from operations. With a transition to 5G wireless network technology just ahead, the carriers have downplayed the need for greater capex to accommodate a new network build-out. Instead, management had insisted, cuts in spending on 4G networks could be enough to offset investment on 5G. In other words, don’t worry, 5G won’t accelerate the falling cash flows and endanger those hefty dividend yields.
We are very skeptical. With the dissolution of merger talk between Sprint and T-Mobile, the two market challengers appear to be redoubling efforts to get in front of 5G, with T-Mobile and its shiny new low band spectrum a threat to use the new network technology as another wedge to cleave off market share from Verizon and AT&T. The market leaders cannot cede the technological high ground. Of late, the two Bell System scions have been much less adamant about holding down capex, and we expect a full capitulation around the corner. This is a matter of competitive game theory (http://www.ssrllc.com/publication/5g-rising-global-carrier-competition-to-drive-capex/).
For investors, this will likely fuel a new round of worry for those dividends. AT&T, with its cash-flow motivated acquisition of Time Warner held up by the DoJ, has the biggest yield to defend but the more precarious competitive position in wireless. Verizon has been talking up an aggressive move to use 5G for fixed wireless residential broadband, and a marketing message squarely focused on network superiority.
Exh 5: US Major Wireless Carrier Capex, 2000-2016
Exh 6: Global Wireless Carrier Capex / Sales Forecast
Both will begin to spend. We are projecting average 8% capital spending growth for the US carriers. We still favor T-Mobile and its aggressive moves on the market leaders, and recently added 5G network testing equipment leader Keysight as an early cycle play on 5G investment.
4 – Net neutrality repeal will have little effect
In mid-December, the FCC voted, on 3-2 partisan basis, to end the Net Neutrality policy enacted by the previous administration. This was treated as Armageddon by Silicon Valley and Hollywood, which launched an armada of Internet memes to illustrate its displeasure. A tweet by viral artist Banksy suggested carriers might begin charging fees – $1.95 per Google Search or $9.95 per Netflix movie. Late night comedian Jimmy Kimmel opined that FCC Chairman Ajit Pai was a “Jackhole” who wanted to line the pockets of big telcos and cable operators at the expense of the public. CNN published a headline “The End of the Internet as We Know It”.
Conceptually, we are fans of net neutrality. For the 60% of American households with no choice for Netflix-capable broadband other than their monopoly cable franchise, it offers the potential for much greater scrutiny for possibly abusive pricing and service decisions of the pipe providers. Still, the rhetoric is out of control.
While telecom carriers and cable MSOs are no longer prohibited from charging households for access to popular websites and apps, they are very unlikely to begin doing so. First, the political air cover is far from permanent and behavior deemed as anti-consumer would likely be badly punished if elections go the other way in 2018 or 2020. Net Neutrality has already become a rallying cry for the anti-Trump set and we believe that carries and MSOs will step lightly to avoid proving the doomsayers right and sealing a vicious backlash in a new administration.
In the longer run, we also see broadband competition on the horizon that would scuttle plans to capture monopoly rents. Yes, we are a bit skeptical of Verizon’s fixed wireless plans, but mostly because we believe fully mobile 5G will become a potent alternative to traditional residential broadband. 20 years ago, telco executives scoffed that cellular could ever be good enough to convince Americans to give up their home phones. Today, less than half of households have fixed line service. We think the same will be true for broadband. The idea that there is an insatiable demand for bandwidth is wrong – reliable 4K quality requires less than 25Mbps per stream, 8K requires about 50Mbps. Higher speed services sell primarily because network sharing and oversubscription often means consumers get less than their promised bandwidth. If a customer is confident that the service can reliably stream a few 8K movies simultaneously, the higher bandwidth capability is superfluous. No one actually needs to download an entire movie in 5 seconds.
We believe that carriers will limit their response to the relaxation of net neutrality to services popular with consumers, such as zero-rated bundles. Zero-rating is the practice of not counting traffic generated by certain services against usage caps, a practice not permitted by strict net neutrality. T-Mobile’s popular Uncarrier initiatives skirt this by offering an entire class of services, such as music streaming, for free without caps, but the new regime would allow carriers to build bundles that favor specific content. We expect this to be sold to the public as “free” access to some services, while others count against the cumulative bandwidth cap. This is far from the “end of the Internet as we know it”.
5 – US TV viewership and ad sales will be down again
2017 was a rough year for linear TV (Exhibit 7). According to Nielsen, viewership was down sharply YoY in every age cohort, with a 15%+ drop for viewers below the age of 34. This is no anomaly – viewership has been dropping for more than 5 years – but the latest figures suggest that the phenomenon is accelerating. This was reflected in falling ad sales – TV pureplay CBS saw revenues drop 6% vs. 2016. Still, the narrative for media investors is surprisingly upbeat for 2018. Magna, one of the two big ad industry analytics firms, is projecting 2.5% growth in TV ad spending for 2018, buoyed by the Winter Olympics, the World Cup and the mid-term elections. We believe that this is optimistic.
While Comcast’s NBC has been upbeat about its Olympics ad sales, the erosion of overall sports audiences has to be a concern. Sluggish NFL ratings have persisted long enough to be a trend, while numbers for other sports have also sagged. Mid-term election battles may be fierce, but most of that spending will flow through local stations rather than the national networks. Moreover, we think ad buyers have grown skeptical of the efficacy of TV ad campaigns in an era of DVRs and multitasking. The May upfronts, where TV networks look to pre-sell future ad inventory and set rate expectations for the year, could be revelatory. We expect unsold inventory and lower CPMs to become part of a gloomy narrative for media stocks.
Exh 7: Media Stock Performance, 2017
Meanwhile, digital ad platforms – notably, and almost exclusively, Google and Facebook – will greatly benefit from TV’s troubles. We note that the collapse of US newspaper advertising – which dropped 60% over 3 years beginning in 2006 – played out more than a decade after circulation peaked in 1992. It obviously takes time for the ad industry to adjust to changing conditions. We think the signs are that adjustment may be playing out for TV, and while we don’t expect a newspaper-like collapse, we believe expectations for industry growth are very optimistic.
6 – QCOM will fight off AVGO and settle with AAPL
Qualcomm will not be easy prey for Broadcom in its hostile takeover attempt. Having rejected Broadcom’s initial offer and its proposed slate of directors, Qualcomm has several measures to play against the aggressor. First, we expect Qualcomm to move to complete its own acquisition of NXP, having recently gained approval from EU regulators. Activist shareholders are looking to force a higher price, and we suspect Qualcomm management will meet their needs. Adding NXP raises the total price for Broadcom to nearly $140B, including assumed debt.
Assuming Broadcom will launch a proxy fight for control, Qualcomm will take its case to investors, and to the press. Qualcomm will paint its pursuer’s proposed strategy as foolhardy. Unilaterally scuttling Qualcomm’s patent licensing program, established over 25 years of industry negotiations and confirmed through hard fought legal battles in venues across the globe, would destroy the source of most of its profits and cash flows. The idea that the loss could be made up via price increases for chips and cuts in R&D expenses is naïve. Raising prices would cede market share to competitors like MediaTek. Cutting R&D would hamstring the company’s position for future growth from new wireless standards (6G will be coming someday) and from new opportunities (hyperscale datacenter processors). Analyst reports suggesting accretion to AVGO up to a $100/share price rely on the same naïve assumptions about Qualcomm’s business
Qualcomm will also make the case that Broadcom’s offer, although a 37% premium above the share price at the time of the offer, was roughly on par with where the stock had traded just a year prior. The acrimonious patent royalty negotiations with Apple had revived concerns for the long-term viability of Qualcomm’s licensing program, but we, like management, believe that those fears are badly overblown (Exhibit 8). Qualcomm management will make its case to shareholders, that, absent Broadcom’s meddling, it will be able to come to a mutually beneficial agreement with Apple. Moreover, Broadcom’s modus operandi of using write-offs of intangibles to drive non-GAAP profit growth, leaves the quality of its earnings highly suspect. Qualcomm will attack AVGO stock as an inappropriate currency to complete any deal. We think that Broadcom will take a lot of pain in a war that it won’t win.
Exh 8: QCOM Fundamentals under AAPL Settlement
Assuming we are right about Broadcom, Qualcomm would next turn to address its ongoing conflict with Apple. With Broadcom and its tales of cut-rate licensing off the table, and with legal pressure on Apple’s Asian partners to live up to their contracts, we expect the two companies to cut a deal that gives Apple some unique advantage but also preserves the integrity of Qualcomm’s licensing program and avoids triggering most-favored contractual agreements with other licensees. This is much more doable than Qualcomm bears suppose – the company has been in this spot many times and always found a way.
7 – MSFT/GOOGL make big moves vs. AWS
We love Amazon, the stock and the company. It has shown vision and bold leadership in building AWS into the obvious leader in hosting other companies’ computing and storage on its hyperscale datacenters. This business features huge scale economies that clearly advantage the performance and costs for leading IaaS hosts. We expect cloud hosting to continue to grow rapidly toward an ultimate market size that could exceed a trillion dollars (Exhibit 9), and Amazon will be amongst a handful of global players that will likely dominate the industry.
Exh 9: Public Cloud Services Market Revenue and Growth Forecast, 2016 – 2026
That said, it is not a given that AWS will remain the biggest cloud hosting player, much run away with the competition – as many an analyst has surmised. The next ten years of the cloud market will be very different from the first ten years. Hosting demand is increasingly coming from traditional enterprise customers rather than the web-based businesses that dominated the past decade. These companies are looking to manage hybrid environments, combining their own datacenters with resources in the cloud. Microsoft and IBM – each with deep business relationships with almost all the major traditional computing organizations, with long experience with the computing challenges faced by those organizations, and with experts in the field ready to facilitate the move to the cloud – are very well positioned to address this demand.
AI will be another driver, particularly for value-added tools and APIs that will make AI cloud customers stickier and higher margin than those buying traditional computing. AWS is a little late to the party on AI. Google is the top dog here, with more experts than number 2 Microsoft and number three IBM combined. It offers the most sophisticated AI platform and the best regarded APIs in important categories like natural language, translation and image recognition. It has also signed a partnership deal with Salesforce, by which that company’s representatives will bundle Google Cloud Platform services and Google’s enterprise applications (mostly the G-suite productivity apps) for their customers, while Google provides hosting and AI support for Salesforce. We believe that this agreement has the potential to meaningfully increase Google’s position for enterprise hosting.
For 2018, we expect AWS sales growth to slow up a bit – say to 35% or so – while Microsoft Azure (90%+ growth), Google Cloud Platform (70%+) and IBM’s SoftLayer/Watson (40%+) pick up steam. This will help drive upside results and positive news flow for all three companies in 2018. It is possible that quarterly news flow around AWS could prove a short-term negative for Amazon – but there will be good news for Bezos and company as well.
Exh 10: Amazon GMV Estimates and Revenue, 2010 – 2016
8 – AMZN’s GMV will close the gap with WMT
Amazon does not share statistics around the total volume of merchandise sold through its platform. At some point, a rule thumb – that 3rd party sales are roughly equal to Amazon’s own retail sales – gained hold, perhaps based on estimates that about half of the total items sold, regardless of price, came from 3rd parties (Exhibit 10). After subtracting some $30B for 3rd party commissions, another $15B for AWS, and $8B for subscriber fees, consensus expects about $120-125B in Amazon retail sales, and thus, somewhere around $240-250B in Gross Merchandise Volume (GMV) sold for 2017. We think this is low – pricing for 3rd parties listing in the Amazon Marketplace range from 10-25% of sales depending on the amount of services rendered by Amazon. Presuming that the average rate is between 15-20% suggests that 3rd party volumes are more like $150-200B for GMV of $270-$325B.
Moreover, 3rd party commissions grew about 40% in the most recent quarter, more than doubling the growth in Amazon’s own on-line sales (Exhibit 11). At this pace, 3rdparty sales for 2018 might be $250B or more, combining with $140-150B from Amazon’s own sales, to push GMV close to the $400B or even above it. By comparison, Walmart sales are growing at about 2.5% and are projected at just over $500B for 2018. However, the projections for 4Q18 are intriguing. WMT, which reports a January quarter, is projected to do about $138B in that quarter a year from now. By our calculations, Amazon’s GMV should be about $130-135B for its analogous December quarter.
Exh 11: Amazon Quarterly 3rd Party Seller Services Revenue, 1FQ16 – 3FQ17
With another year of grocery under its belt, a possible entry into pharmacy and opportunity galore in B2B, Amazon will be poised to pass the longstanding retail king to become the top seller by volume, of any kind, in the western world. #toobadWalmart
9 – IBM will deliver full year sales growth
We were early to jump on the IBM bandwagon, but the ride has started to get a little less rough of late. 3Q, the 22nd consecutive quarter of YoY revenue declines, surprised to the upside a bit and moved the company to within shooting distance of growth (Exhibit 12). IBM management’s credibility remains strained – many of their “strategic imperatives” have proven neither strategic or imperative. Still, we believe that 23% of the company’s sales come from cloud-focused businesses with clear growth paths, and that the remainder of the company will no longer obscure that growth.
IBM is well positioned in those cloud businesses. With hosting demand growth shifting from web-based businesses to traditional enterprises, IBM’s longstanding position with those customers will serve it well. Many of them will need help bridging their private datacenters to make best use of cloud resources – IBM can provide that help. Many of them are interested in introducing AI-based analytics and other tools to their systems – IBM has Watson and an army of well-trained consultants to lead the process. This will pay off in growth for 2018, growth that we believe will change the failure narrative that has hung on the company through those painful 22 quarters. Consensus expects 1.3% 4Q17 growth – we think they will beat that, and that growth will be sustained in each quarter of 2018. Expect upside surprises, upward revisions and multiple expansion for Big Blue.
Exh 12: IBM Quarterly Sales and Consensus Estimates, Q1 2012 – Q4 2018