TMT: Model Portfolio Update – NOW WITH SHORTS!

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak


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December 21, 2015

TMT: Model Portfolio Update – NOW WITH SHORTS!

We have strong conviction on the near-term opportunities created by paradigmatic changes across the TMT landscape – i.e. Web scale cloud data centers, streaming on-demand media, native digital advertising, increasingly fast and efficient mobile commerce, falling competitive barriers in wireless service, and the huge, but maturing smartphone market. We have explored these opportunities in detail with our research and have use them as guiding tenets to our model portfolio stock selections. Our large cap portfolio underperformed the tech components of the S&P500 by 10bp over the last 3 months, but has outperformed by 1972bp over the past year, and has beaten the benchmark in 9 of the last 12 quarters. This quarter, in addition to updating our portfolio of longs, we are introducing its inverse – a 15 stock short portfolio intended to identify companies that are particularly vulnerable to the structural changes that we believe are playing out across TMT. We have selected the stocks based on our thematic research, focusing on names with valuations or expectations inconsistent with threats that they face.

  • The public cloud is eating private IT investment. The cost and performance advantages of web-scale cloud data centers are vast, capturing enterprise IT spending more rapidly than most in the industry had believed possible. This is a huge opportunity for the few platforms (AMZN, MSFT, GOOG) with the capability to lead, and for SaaS vendors able to exploit the advantages. This dynamic create a wealth of short opportunities amongst companies dependent on private data center investment and poorly positioned for the public cloud. Many traditional IT suppliers have been battered, but some still have unrealistic embedded expectations for a reversal in trend. We are also fear that cybersecurity investors may underestimating the impact of the transition to the cloud on future spending for private security solutions. Longer term, we are concerned that SaaS application vendors that run atop sub-scale infrastructure – e.g. CRM – will begin to face cost issues not currently reflected in expectations.
  • More shoes to drop for media stocks. The media group rallied off its sharp August drop, as the anticipation of election/Olympic ad spending, and the sports betting fueled 4Q spot market bump, have TV execs talking up their opportunities. The bigger picture remains grim – pay TV subs are declining and audiences are shrinking, greatly improved streaming alternatives are proliferating, and ad spending continues a hard shift toward digital. We look for another step down in media valuations for 2016, with companies skewed to ad sales the most vulnerable. In this, we also see trouble for agencies.
  • AMZN’s roadkill. AMZN is set to inflict a lot more pain on traditional retailers in 2016, looming as a major threat to B2B wholesalers as well. ( The AMZN effect has already hung on many large retail stocks in 2015, but we believe the contrast in results for the holiday season will be stark. Meanwhile, the highly fragmented B2B distribution market appears ripe for AMZN’s disruption, with electronics, office products, medical supplies, and general industrial markets the most vulnerable. Longer term, we are concerned that the substantial beneficial effect of AMZN on shipping companies could reverse, as investments to move fulfillment centers closer to customers and to engage alternative local delivery solutions are deployed more widely.
  • It’s not your father’s wireless industry. Buying habits for wireless customers are changing. In a world where voice calling is waning as data usage skyrockets, blanket coverage is no longer a deciding factor for many users. TMUS offers fast and available data in the places that matter, with consumer friendly policies and prices much lower than the traditional VZ/T duopoply. This is bad news for the leaders, who are slowly bleeding market share while ARPUs drop, and can do little to stop the pain. Eventually, this will pressure cash flows and dividend yields. Meanwhile, S remains a damaged brand trying to remain solvent until new network technologies allow them to exploit their spectrum holdings.
  • Smartphones hitting the wall. The market for premium smartphones is mature – now driven, almost entirely, by the ebbs and flows of replacement ( There is still growth at the low end, but prices and margins there will be tight. New markets for smartphone-related technologies – IoT, wearables, automotive, etc. – are still too small to make up for weakness looming in high-end portable devices for most players. We are removing ARMH from our model portfolio for this reason.
  • Big beats small in the cloud. Most of the major paradigm shifts playing out in 2016 – SaaS/IaaS, streaming content/digital ads, B2C/B2B e-commerce, etc. – will greatly favor large, well established players like AMZN, GOOG, MSFT, FB, NFLX, etc. to the detriment of smaller, would be rivals. Niche positions will be increasingly difficult to defend, as scale economies, technical expertise and reach to both consumers and business customers begin to play against them.
  • Our inaugural shorts. We identified specific stocks vulnerable to these paradigmatic changes. We then screened them, looking for high valuations, and unrealistic sales/margin expectations, and for names that are not already widely shorted. For stocks threatened by the enterprise shift to the public cloud, we included JNPR, CSCO, FTNT, EQIX, and ORCL. We remain concerned for 2016 TV ad spending in the face of positive spin, and have included CBS, IPG and NSLN expected disappointments. For the moment we are not including traditional retail and non-TMT wholesale companies as possible shorts against AMZN’s growing e-commerce momentum, but do include IM and ARW. Our take on telecom yields T for the list, and our negative view on mobile devices prompts AVGO. The ugly list of subscale cloud businesses is fairly picked over, but PCLN remains unscathed despite similar long-term threats and travel middleman SABR may be vulnerable as well. We see AKAM as vulnerable as internet traffic continues to consolidate to huge players that are looking to disintermediate independent CDNs.
  • The long portfolio has had excellent performance. Our large cap model portfolio is up 22.3% year to date, outperforming the S&P500 by 2420bp and its tech components by 1972bp during that time. It has beat the tech benchmark 9 out of the past 12 quarters, despite not holding AAPL for most of 2014. This quarter we trailed the S&P 500 tech components by 10bp, with poor performance by WDC, TWTR and QCOM offsetting gains by AMZN, NFLX and MSFT. We are replacing WDC with its rival STX on fears of a difficult integration with SNDK. We are also removing ARMH, given our more bearish stance on devices, adding NOK, which we believe can show unexpected synergy from its combination with ALU against pessimistic consensus forecasts.

The SSR TMT Heat Map

The Dark Side

Our large cap model portfolio consists of 15 equally weighted stocks chosen to reflect our underlying thesis of dramatic generational shifts to the TMT landscape catalyzed by breakthrough innovations in cloud data processing, mobile device platforms, and wireless communications. The biggest opportunities today are in public cloud hosting, SaaS applications, streaming media, digital advertising platforms, e-commerce (both B2C and B2B), and lower cost wireless data. These big themes feature unusual economies of scale and skill that are pushing toward a greater concentration of value in the next era of competition, to the great benefit of leaders that made their bones years ago.

On the other hand, smartphone demand, the first big wave of the sea change, is facing an abrupt maturity. IoT, wearables, autonomous cars, drones, virtual/augmented reality, telemedicine, and bank-less financial services will be big markets someday, but they won’t be in 2016. The big opportunities have serious negative implications for incumbents in the traditional businesses being displaced – enterprise IT venders including supposedly insulated categories like security, linear TV networks and their advertising partners, brick-and-mortar retailers of all ilk, the fragmented wholesale distribution industry, and the wireless telephone duopoly could all take unexpected pain in the coming year. Ditto for the companies too small, too limited or too late to compete with the behemoths now rolling up most of the value created by the cloud era.

TMT is a target rich environment for short sellers. To that end, we have selected 15 stocks that should feel the negative effects of paradigm change in 2016, favoring names carrying a valuation premium vs. similarly positioned companies, those with consensus estimates embedding an expected upward inflection in growth and/or margins, and those that are not already heavily shorted. Included are CSCO and JNPR, whose expensive core products are unnecessary for the growing data traffic entrusted to the big cloud operations. ORCL will suffer badly as its enterprise customers shift their emphasis to SaaS applications and IaaS hosting where expensive licenses and maintenance agreements won’t play. We expect IT managers to begin to realize that their best security solution is to move sensitive data to AWS or Azure – too bad for companies like FTNT. EQIX leases space for enterprises to locate their data processing equipment – we think there will be much less need as companies move to the cloud.

Media execs are talking up 2016 – election/Olympic years are always good times for TV advertising, and the scatter market has been pretty good in the last couple of months. We think valuations and expectations are generally out of line – we added CBS, IPG and NSLN to the portfolio. We are leaving most retailers and wholesalers out of the portfolio out of deference to our colleagues that cover them, but include tech distributers ARW and IM to represent the crew. We expect falling share and ARPUs to plague T. We see soft demand for AVGO as it copes with integrating BRCM. SABR’s hold on travel reservation data may not be as tight as it believes. Finally, we add two stocks that were previously in our long portfolio. PCLN is one of few consumer internet stories not yet broken, but the risk is there. AKAM will be increasingly redundant as the big guys consolidate traffic and integrate into their own CDNs.

We hope that the short portfolio performs as well as the long. This quarter’s 10bp miss vs. the tech components of the S&P500 was the first in a while – we are up 1972bp over the past year. Looking ahead, we are swapping WDC for its rival STX on fears of the SDSK integration, and removing ARMH in recognition of smartphone maturity, in favor of NOK and its potential synergies with ALU.

The Sun Also Sets

We believe that the TMT sector remakes itself in broad 25-30 year generational cycles. The past 8 years or so have been the start of such an era, catalyzed by groundbreaking innovations in web-scale data processing, in mobile friendly device platforms, and in fast wireless networks. These innovations, in concert, are creating waves of opportunities for new products and services that exploit the capabilities of the underlying technologies. This dynamic thus yields inevitable and irreversible changes to the status quo within the TMT landscape, but also to the many markets in the economy that depend upon it. The early winners in this era are already well known, Apple, Google, and Facebook chief amongst them, having ridden the explosive growth of smartphones and social networks to headlines and huge market capitalization.

We are now transitioning to a second wave of change. This time, most of the world already has a smartphone in their pocket and a social networking account or two. The question is now – what can they do with them? For the moment, the answer is consume media, find information, buy things, and communicate, and the companies that enable those things have the mojo. In parallel, enterprises are finding that web scale cloud computing platforms have profound cost and performance advantages over the private data centers of the previous era, and the exodus has begun. All of this change favors scale, experience and sophisticated skills, concentrating the value created by the massive opportunities to a relative few winners. Our large cap model portfolio leans heavily on these companies – Google, Amazon, Facebook, Microsoft, and Netflix are all constituents (Exhibit 1).

Exh 1: The SSR Large Cap TMT Model Portfolio

Of course, in a market with a few big winners, there are many losers. To that end, we are launching our large cap short model portfolio, highlighting stocks that we would not only avoid, but would actively bet against. Our process is straightforward. From our thematic research, originally slanted toward detailing the investment case for long ideas and considering the potential risks, we have identified categories of companies poised to suffer as a result. Within those categories, we looked for specific companies whose valuations and/or expectations ran counter to the threatening narratives, hoping to find poorly positioned companies that were not already widely shorted.

Public Cloud Roadkill

We have written extensively about the substantial cost and performance advantages of web-scale cloud data centers, calling out Amazon’s AWS, Microsoft’s Azure and, perhaps, Google’s GCE as having achieved critical scale and experience that will allow them to consolidate further market share in the potentially $T long-term market for cloud hosting (Exhibit 2-4). We also favor Software-as-a-Service (SaaS) application companies that are committed to exploiting these advantaged platforms with best-in-class applications that ride atop them. To that end, we have included Amazon, Microsoft, Google, Adobe, Workday, and Tableau in our long model portfolio, and all have been contributors to outperformance in 2015.

Exh 2: Worldwide Data Center Hardware, Software, and Operation Spending, 2013-2019

Exh 3: Worldwide Cloud Infrastructure Services Forecast, 2010-2020 CAGR: 42.6%

Exh 4: Indexed Revenue Growth, AWS versus Traditional IT 1Q14-3Q15

The flipside of this is the damage done to traditional IT companies. With the obvious advantages of SaaS applications and cloud hosting showing the way forward, enterprise CIOs are scaling back investment in their internal data operations and weighing plans to transition away from their legacy systems. Demand for new data center gear, infrastructure software and packaged applications has been decelerating into declines for several years. Companies promising investors reacceleration and margin expansion in this environment are bucking a serious, serious trend. Investors who believe them will likely get what they deserve.

Exh 5: Key Operating and Valuation Metrics – CSCO

Cisco’s revenues were up over the past two quarters, but the demand for its core products – routers and switches – was down. Consensus isn’t expecting much for January, but sees a substantial reacceleration over the course of calendar 2016, along with margin expansion (Exhibit 5). The valuation is rich compared with other data center suppliers. There is a perception that networking equipment is relatively immune to the shift to the cloud, but with traffic moving to players, like Amazon and Microsoft, that lever commodity switch fabrics and proprietary networking software overlays, internal enterprise networks will be less congested. Moreover, network security, generally considered the Cisco trump card, is rapidly becoming an important factor driving enterprise IT to migrate to the cloud more quickly.

Cisco’s longtime rival, Juniper, sits in the same boat with even higher expectations and a higher forward P/E (Exhibit 6). The valuation suggests a bit of longer term skepticism, with an implied terminal value that is just 60% of EV, but projections for both accelerating sales and growing margins in the next couple of years belie unjustified optimism. The short interest is a higher percentage of shares than Cisco, but still very low relative to other old-line IT equipment names. Now, Juniper is facing allegations that unauthorized code in the security firewalls integrated into its routers could have allowed networks to have been breached by foreign governments.

Exh 6: Key Operating and Valuation Metrics – JNPR

In fact, both Cisco and Juniper have been floated as backdoors for hackers into supposedly secure systems, highlighting one of the major challenges for data security. Enterprises have focused on encrypting everything and erecting perimeter defenses to detect and defend against intruders, but the perimeters are wide, and heterogenous and once breached, the entire system integrity can be compromised. This calls into question the efficacy of most security software solutions and raises the benefits of working with cloud services with much more secure operations. In this, we see substantial risk for the high flying data security sub-sector, and add specialist Fortinet to Cisco and Juniper on our short list. Fortinet is growing at a 30%+ clip, but after a 3Q miss which chopped 30% off its value, expectations of 25% growth with margin expansion in 2016 seem aggressive and the valuation is still very, very high (Exhibit 7).

Exh 7: Key Operating and Valuation Metrics – FTNT

Oracle, in the midst of a losing streak where it has missed 4 of its last 6 quarters, loves to tout its progress in the cloud (Exhibit 8). Supposedly, enterprises are flocking to the company’s cloud offerings, including an IaaS service intended to compete with AWS and Azure, justifying expectations for sales to return to growth and for margins to expand. However, Oracle’s chest beating on the cloud does not match the perspectives of its putative rivals, who don’t see Oracle competing successfully. Moreover, recent reports suggest that the company has given significant incentives to its rapacious salesforce to push “cloud” components in renewal deals and has gotten aggressive with customers in usage audits (used to determine appropriate fee levels) and demanded cloud agreements to settle disputes. With new contract signings in an unending tailspin, and the animosity that many of its customers have toward it, we see Oracle as a particularly apt short.

The shares of IT real estate play Equinix are up more than a third this year, as investors tie its data center outsourcing business to the cloud (Exhibit 9). We are not so optimistic. While the company’s well-located shared facilities are attractive relative to typical internal enterprise data centers and many businesses have moved some of their computing and storage operations in to take advantage, we see it as a temporary first step on the way to real public cloud solutions. As such, we see analyst projections of accelerating revenues and even faster earnings growth as problematic. The company is a popular short, with 8% of the float, but we believe that it is ripe for disappointment.

Exh 8: Key Operating and Valuation Metrics – ORCL

Exh 9: Key Operating and Valuation Metrics – EQIX

The War on TV

We have written often of the existential threats to linear television. In 2015, these threats became more real for investors. In August, Disney CEO Bob Iger revealed that his company’s ESPN network had seen declining subscription numbers from its Pay TV distributors, sending the entire sector into a tailspin. Across the board Pay TV sub statistics were down, at a pace that seems to be slowly accelerating (Exhibit 10). Industry audience measurement favorite Nielsen published its first report showing that US TV viewing had begun to decline – even though there is ample evidence that the audience had peaked a few years earlier (Exhibit 11). Sales of TV ads during the May upfronts were very soft. Fall TV ratings have been poor. Meanwhile, ad spending with Google, Facebook and even Twitter has continued to boom.

Exh 10: US Multichannel Video Customers, Q107-Q315

Exh 11: Monthly TV Viewing Time, US Q4

Still, media stocks have rallied off of those 3Q worries. CBS CEO Les Moonves is pounding the table, touting a resurgent scatter market for 4Q ads and the promise of 2016 as an Olympic/election year. Historically, the quadrennial Presidential elections have been worth 4-6% in additional ad sales, so there is precedent for Moonves’ optimism. Nonetheless, the underlying TV advertising demand is waning with the shrinking primetime audiences, cord cutting and increasing confidence of digital ads as an alternative. CBS revenues have been down for the past two years, but consensus expects them to buck the trend with growth not just in 2016, but also in 2017. Indeed, CBS sits in the dream stock quadrant of our valuation framework, with above average cash flow growth expectations vs. the entire universe of TMT stocks and an implied terminal value well above median (Exhibit 12). Rich company for a stock with a clearly compromised future.

We are also skeptical of ad agency IPG’s ability to deliver against similar expectations for accelerating growth and widening margins (Exhibit 13). Trading at a post 2000 bubble high, we believe IPG is very vulnerable to a weaker than expected TV ad market. The ongoing shift in ad budgets toward digital, with programmatic auction sales, also weakens the traditional agency role.

Exh 12: Key Operating and Valuation Metrics – CBS

Exh 13: Key Operating and Valuation Metrics – IPG

Exh 14: Key Operating and Valuation Metrics – NLSN

Nielsen is also vulnerable (Exhibit 14). Long the standard bearer for television ratings, despite a methodology that we believe systematically overestimates active viewing, the company has begun publishing ratings for content streamed online. While TV networks have clamored for these broader ratings in order to make a better case to their advertisers, we remain skeptical of Nielsen’s methods and see a range of competitors well suited to subvert its ambitions online. Shares have been very volatile, with current valuation at a strong 16x forward P/E and a 1.7 PEG ratio. Consensus has built in a reacceleration off of decline sales in 2015 that may be difficult to achieve.

The Amazon Juggernaut

Amazon’s e-commerce business is steamrolling most everything in its way. We recently published a detailed piece ( that describes the considerable advantages that Amazon enjoys over traditional merchants and the momentum that it is achieving as the first (and often only) stop for online and mobile shoppers. This is obviously bad for brick-and-mortar retail, and the impact is apparent in the generally poor results of these companies and their obvious struggles to gain relevance in the digital realm (Exhibit 15). While there are undoubtedly significant short targets amongst the retail group now standing in Amazon’s path, we leave these stocks to our consumer sector colleague, Rob Campagnino.

Exh 15: Retailer e-Commerce GMVs, 2014 and 2015

Exh 16: US Wholesale Trade, 2004-2013

With its Amazon for Business wholesale initiative, we see the company starting to threaten B2B distributers, a highly fragmented $8T/year business (Exhibit 16). Within that group, we see technology distributers as particularly vulnerable. Ingram Micro sells a wide array of computer and related products directly to businesses and value added resellers (Exhibit 17). Sales have been down in 2015, but consensus expects a rebound in 2016 and widening margins, despite the possibility of growing price competition. Shares have risen sharply over the past two years, and now trade at a post bubble high, with short interest at about 3% of the float.

Arrow Electronics competes with Ingram Micro, but also sells further up the value chain, distributing component parts to manufacturers (Exhibit 18). It is trading off of the all-time high that it set in 2Q15 after missing 3Q consensus, and analysts expect it to turn back to growth in 2016. We are skeptical, given a maturing smartphone market and the potential for new competition. Like Ingram, the short interest is modest.

Exh 17: Key Operating and Valuation Metrics – IM

Exh 18: Key Operating and Valuation Metrics – ARW

Smartphone Slowdown

A year ago, smartphone sales were booming on the back of the hugely successful iPhone 6. Today, that success, which we believe pulled forward significant upgrade sales, is a hangover for the entire industry. The smartphone market is nearing saturation (, with the only real growth in penetration available in the lowest price segment (Exhibit 19). Replacement activity is already at a relative high, with no sign of pending innovation that might drive a major acceleration (Exhibit 20). While we see significant future opportunities for services that reach consumers through these devices, the smartphone itself is no longer a growth market for device makers or their component suppliers.

Exh 19: SSR Handset Unit Sales Forecast, 2012-20

Exh 20: Global Phone Replacement Rates, 2011-20

Apple is obviously burdened by this – it is buried deep in the “death watch” quadrant of our valuation framework with gloomy prospects for the near-term and long-term alike. Still, we are not sure that a further collapse in share price, even on a likely 1QFY16 miss, will be forthcoming, given the huge cash flow yield and a likely further return of capital to shareholders. Instead, we are adding Apple supplier Avago to our short list (Exhibit 21).

Unlike most smartphone component suppliers, Avago is trading very near its all time high. Analysts have almost universally cheered the company’s planned acquisition of WiFi chip leader Broadcom, increasing its addressable market and creating opportunities for component integration. With the deal, Avago will have reduced its dependence on smartphones to under a third of revenues, but we are not sure that other sectors – automotive, computing, IoT, etc. – are likely to be significant growth engines either. Against that, current expectations for Avago expect sales acceleration and margin expansion. Short interest here is high – 9% of float – but we believe the potential downside for shares to be significant.

Exh 21: Key Operating and Valuation Metrics – AVGO

Telecom Paralysis

For decades, the sole measure of service quality for wireless carriers was coverage. By virtue of their initial 1982 850MHz band spectrum grants, the networks that eventually became Verizon and AT&T had enormous advantage over the rivals that gained their licenses later. Lower spectrum meant much larger cell sizes, which meant much, much lower costs to provide blanket coverage. The market leading duopoly was free to charge significant premiums for their “Can you hear me now?” service maps, while Sprint and T-Mobile struggled for scraps of market share at a discount.

The situation has changed. Voice has been in decline for 6 years, as new generations of users rely far more on their smartphones for data connectivity than for telephone calls (Exhibit 22). The coverage requirement of old has taken back seat to data speeds and availability in the places and times that users most frequently need service. Smaller players, with less congested networks, can concentrate capacity to those hot spots without the ruinous cost implications of competing on rural coverage with disadvantaged spectrum. We think the clear winner here is T-Mobile (, who’s popular “Uncarrier” programs have driven steady share gains at the expense of the other carriers (Exhibit 23). As T-Mobile harvests share from below, AT&T and Verizon are trying to hold the line on pricing, needed to support the cash flows and associated dividend policies that have been the core of their value proposition to investors.

Exh 22: Average Monthly Voice Minutes per Mobile User

Exh 23: Wireless Carrier Market Share – Service Revenue, 1Q09-3Q15

We believe that this is a losing proposition. Already ARPUs are deteriorating, and AT&T, in particular, has suffered real subscriber losses. We believe that this dynamic will only get worse. Moreover, we are not enamored with the company’s acquisition of DirecTV, which we believe is also in a spiral of subscriber losses and margin pressure that will not end well. Against this, consensus still predicts organic growth and substantial cost synergies from the merger. The stock is not widely shorted, probably because of the 5.6% dividend yield, but we believe pressure on cash flow margins in 2016 could yield concern for the long term viability of the dividend policy (Exhibit 24).

Exh 24: Key Operating and Valuation Metrics – T

The Increasingly Private Internet

The original model of the internet – millions of independent nodes and thousands of networks passing traffic to each other across public exchanges – hasn’t been an accurate picture for a long time. Big networks started passing traffic to each other, bypassing the exchanges and muscling out smaller networks. Content providers stopped hosting their own content, and began to rely on other companies to manage their pages on their way to end users. Akamai was the pioneer in a service that became known as a “Content Delivery Network” (CDN), where small servers were placed as close as possible to population centers in order to serve the most popular content with as few internet hops as possible.

Exh 25: North America Peak Internet Traffic, Fixed Access, December 2015

Today, the big names on the internet – Google, Amazon, Facebook, Microsoft, Apple, and a few others – control a huge percentage of the time that users spend online from either computers or mobile devices (Exhibit 25). All of these companies have invested in building CDN capabilities within their own vast internal networks. This works against Akamai, and others, like Limelight, Level 3 and VZ. Apple’s struggles for relevance in streaming media also is a burden to Akamai – the once imminently expected but now indefinitely delayed Apple TV service likely would have run over the CDN. Optimists point to a potential acquisition by Microsoft or Facebook, both playing a bit of catch-up vs. Amazon and Google, but we do not believe that either company would be likely to pay a premium for a short term boost.

From a valuation perspective, Akamai has taken a dive, falling from more than $75 in October to just over $52 today on a combination of a poor 3Q report and the news of Apple’s retreat from over-the-top video streaming (Exhibit 26). However, it is still not cheap, trading at 29 times trailing earnings and 19 times forward estimates that seem aggressive. Consensus expects margin expansion, yet the threat of forward integration and traffic concentration from the biggest internet players portends increasing competitive pressure. In our long-term/short-term valuation framework, Akamai screens as a skepticism stock, with strong five-year cash flow growth expected, but a less than average implied terminal value. We believe that the near-term faith may be overly generous.

Exh 26: Key Operating and Valuation Metrics – AKAM

Is Travel Special?

Streaming music, local business reviews, niche e-commerce sites, group discount clubs, blah, blah, blah. The big boys of the internet have soaked up most of the opportunity, leaving a picked over junkyard of once promising digital players. The big exception has been the travel segment, where a handful of leaders have swallowed up smaller competitors and collectively flexed their advertising muscle to hold Google and its planned travel products at bay. The competitive moat is the relationships that the online travel agencies (OTAs) have with airlines, hotels, and car rental companies, who have traded the supposed tyranny of traditional agencies for new middle-men with direct access to a lot of potential customers. We can’t help but think that this too is a transitory circumstance.

The travel industry continues to poke about for ways to take back the fees paid to the OTAs for their referrals. Often, airlines and hoteliers will reserve special discounts for customers that book directly, and all are willing to make their reservation books available to other 3rd party sellers willing to accept similar or lower fees for their efforts (Exhibit 27). Meanwhile, the leading OTA, Priceline, is projected to grow its revenues at a 13.5% annual pace through 2018, while expanding its operating margins by 380bp to more than 40%. We will take the under. The valuation is rich – 19.5 times those hefty 2016 earnings – even after a 3Q disappointment lopped nearly 15% of the share price, and it is not a popular short (Exhibit 28).

Exh 27: US Online Travel Bookings by Channel, 2015

Exh 28: Key Operating and Valuation Metrics – PCLN

The story is much the same for Sabre, the middle-man’s middle-man (Exhibit 29). Sabre organizes seat inventory data for a variety of airlines and then resells the service to both OTAs and traditional travel agents and corporate travel departments. It has been less successful in brokering other travel services, like hotels and car rentals, but is investing to expand its business there, along with backward integrating toward outsourcing for the airlines themselves. In this, Sabre is much more dependent on the traditional travel channel, which is significantly less data savvy than the OTAs, who can replicate much of Sabre’s services internally, We are concerned that the ongoing shift from travel agent, to OTA and eventually, to direct purchasing will greatly reduce Sabre’s value added. Moreover, we believe the company’s data processing operations will become an increasing cost and performance liability in the world of public cloud platforms.

Consensus expects overall economic recovery and surging air travel to push Sabre revenues to double digit growth over the next three years, after having suffered declining sales over the last three. Margins are projected to expand by 690bp to more than 24% over the same time frame. Shares trade at 22 times projected 2016 earnings, just off an all-time high and have almost doubled over the past two years. Short interest is less than 2.5% of the float.

Exh 29: Key Operating and Valuation Metrics – SABR

Our Model Portfolios

In summary, our inaugural large cap short model portfolio contains 15 stocks, all equally weighted, as shown in the exhibit below (Exhibit 30). Like our large cap long portfolio, we will revisit our selections about once a quarter to track performance and make changes as appropriate.

Exh 30: The SSR Large Cap TMT SHORT Model Portfolio

Our long portfolio performance was a slight disappointment over the past three months. We were up 5.2% for the quarter, well ahead of the S&P500 (+2.6%) but 30bp below the tech components of the index (+5.5%). Over the past year, our performance has been unequivocally good, beating the S&P500 by a resounding 2420bp and the tech components benchmark by 1972bp (Exhibit 31). This quarter was just the third quarterly miss against the tech benchmark in the last 12 quarters, and the only one that was not caused by our failure to own Apple during its strong 2014 run (Exhibit 32).

This quarter, our strongest performers were Amazon, Netflix and Microsoft, each of which appreciated by more than 27%. Our weak performers were Western Digital, Twitter and Qualcomm, each of which declined by double digits. We are maintaining our stake in both Twitter and Qualcomm, as we see strong potential catalysts for each stock that could see them retracing their declines. We are replacing Western Digital with its rival Seagate (Exhibit 33). We believe that Western Digital’s acquisition of Sandisk will be distracting and that the perceived synergies will be harder to achieve than expected. Meanwhile, we continue to expect demand from cloud storage operations to drive a return to growth for the category.

Exh 31: The SSR Large Cap TMT Model Portfolio – Past Performance

Exh 32: SSR TMT Large Cap Portfolio Performance – Relative vs. Benchmarks past 12 quarters

Exh 33: The SSR Large Cap TMT Model Portfolio – Reconstituted

We are also removing Arm Holdings. While we remain long term believers in the potential for ARMs processor design to become standard for a wide range of new applications, the current dependence on smartphones makes the company vulnerable to a what we believe will be a significant disappointment in 2016 device sales vs. expectations. In its place, we are adding Nokia, which will integrate an acquisition of its own in 2016. Here we think that the absorption of ALU into NOK could yield MORE synergies than expected, given ALU’s bloat and redundant products.

APPENDIX 1: SSR’s ST/LT Quadrant Valuation Framework

APPENDIX 2: The Top 185 TMT Companies with Cap over $3B

APPENDIX 3: The SSR Large Cap TMT Portfolio Constituents






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