TMT Model Portfolio Update: What next?

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Artur Pylak

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March 10, 2016

TMT Model Portfolio Update: What next?

January was hard on high-multiple TMT stocks, and thus, our model long portfolio, which underperformed the tech elements of the S&P 500 by -690 bp since our last update. In particular, the market reaction to signs of deceleration in demand for some SaaS app companies, led by a 54% sell-off in DATA, was a considerable burden, accounting for our underperformance and then some. We continue to believe that 2016 will see the same leadership from the FANGs and MSFT that we saw in 2015, although the performance of these names has been mixed YTD. TWTR, a notably poor performer in 2015, started 2016 badly, but may have finally found its bottom, a boon to our portfolio going forward, if so. Our short model portfolio, launched in late Dec., significantly underperformed. The announced takeout of IM, was the biggest hit, with a rally in linear TV related names also painful. Despite the weakness in both portfolios, we remain confident that our themes – the enterprise cloud over traditional IT, streaming video and mobile ads over linear TV, e-commerce over brick-and-mortar and wholesale distribution, big internet platforms over niche specialists, and growing wireless competition – will play out over 2016 and beyond.

  • Market meltdown hit growth stocks hard – Fears of a global recession weighed heavily on high multiple names during the January market sell off. TMT companies with better than 10% TTM sales growth have underperformed the S&P500 tech components by 690bp YTD. The disproportionate sell-off may be without basis. With the exception of the 2001 internet bubble, growth tech has performed well during recessions, and in this case, the driving factors – Chinese economic uncertainty, EU political turmoil and the collapse of oil prices – are orthogonal to the cloud revolution fueling the growth of high-multiple TMT. Arguably, with significant cost savings at the core of the cloud value proposition, we would expect demand for these companies to be particularly resilient.
  • Your SaaS is grass – A deceleration in DATA’s license signings during 4Q15 surprised investors, who hammered it and everything that looked like it. Subsequent strong reports from other prominent SaaS companies, including CRM and WDAY, belied concerns that DATA’s problem was market wide, but even these stalwarts remain down more than 10% YTD. Our model portfolio, which holds both DATA and WDAY, has suffered accordingly, with the 2 SaaS names contributing 352 bp of absolute decline. Looking forward, we believe that the superior value proposition of SaaS applications will sustain growth for the group, and see the idiosyncratic slowdown in DATA’s license growth as most likely temporary.
  • FANG + M – We were expecting strong quarters from the big 5 cloud operators – FB, GOOGL, and MSFT cooperated, their shares held back only by the overall market conditions. NFLX tripped up early in earnings season, with perceived weakness in US subs sending the stock down 30% before gaining traction to trace back 10% in February. AMZN delivered strong sales but disappointed on earnings, contributing to a 15.9% drop since our last portfolio update in December. Together NFLX and AMZN are responsible for 164 bp of the decline in our model portfolio. Both stocks have begun to recover from their January sell-offs, and we believe will show considerable strength over the remainder of 2016.
  • TWTR being TWTR – TWTR dropped another 25% since our last update, with reaction to a plan to pay employee retention bonuses whacking much of the recovery from its post-earnings low and hitting our model portfolio by 166 bp. While the sentiment is obviously hugely negative, we remain positive on the company’s long term prospects. Its combination of an active critical mass of news makers, a unique real time distribution focused infrastructure, deep interest graphs, advertiser friendly native formats and reach to nearly 900M monthly visitors, make it a resilient and highly valuable platform, despite its struggle to deliver growth in registered users.
  • Media puts off the inevitable – Media stocks have been on a February tear after mixed results for 4Q15. A narrative of stalled cord cutting and resilient TV ad spending has emerged, but we are very skeptical. The big cable operators (CMCSA, TWC) may have added pay TV subs in 4Q, but smaller MSOs, Satellite and telcos lost them, and the decline in overall pay TV subs actually accelerated. Meanwhile, unexpectedly aggressive primary election season spending, debate viewership, and fantasy sports ads have propped up the scatter market, despite the continued decline in core TV viewership. The long view on linear TV remains unequivocally ugly and we believe the sector is overvalued.
  • Cheap stocks may not really be cheap – Traditional IT names delivered mixed results against tepid expectations, but low multiple stocks are no haven when they also facing the existential threat of a generational sea change. We are also skeptical that AAPL and its suppliers can meet optimistic projections in a mature premium smartphone market, particularly in the face of potential recession.
  • Long model portfolio performance weak – For the 9 weeks since our last update, our large cap long model portfolio underperformed the tech elements of the S&P 500 by -690 bp, driven by the sharp drop in DATA, and underperformance by TWTR, NOK, NFLX and AMZN. The portfolio performed particularly badly through the SaaS meltdown, down 16.9% through February 5th, but has thrived since then, outperforming its benchmark by 150 bp. We are removing DIS, which has languished under concerns that the ESPN cash cow is at risk despite delivering strong 4Q15 results on the spectacular success of Star Wars ep. 7. In its place, we are adding NOW, off 34% YTD after issuing guidance slightly below the 2016 consensus.
  • Short model portfolio off to a poor start – Tianjin Tianhai’s Feb 18 bid for IM sent its shares up 20% and negated a massive miss just a week later. Meanwhile, the market turmoil turned investors toward seemingly safe names like T, NLSN, CBS, ARW and even ORCL, badly hitting our short portfolio in its inaugural quarter. Since inception, the portfolio is up 3.3% vs. a -3.1% decline in the tech components of the S&P 500. Still, we believe that our basic themes, threatening cybersecurity, OTA, linear TV, traditional data center spending, and telecom pricing, will play out. We are removing IM and AKAM, which surprised on unexpected strength in a new business, and adding IBM and CHTR.

SSR TMT Heatmap

When Life Gives You Lemons

2016 started with a stiff slap in the face, as TMT stocks took a disproportionate blow from the China and oil fueled market sell off. In particular, the high growth, high multiple stocks that have driven TMT performance over 2015, and that make up the bulk of our large cap long model portfolio, de-rated amidst the fears of a global recession. While the market reaction makes intuitive sense, history suggests that these types of companies can be considerable outperformers during economic crises. Moreover, the leading TMT names – i.e. FB, AMZN, NFLX and GOOGL (FANG) – have little exposure to the presumptive catalysts of this possible crisis.

4Q15 earnings were decidedly mixed. We had expected the FANGs plus MSFT to lead the way. FB, GOOGL, and MSFT cooperated with unambiguously strong numbers, but only FB has beaten the broader market YTD. NFLX sold off on lower than expected US sub numbers – although international subs, sales and earnings were all upside surprises. AMZN blew out the top-line, but missed on profits, with little explanation and no forward guidance from management. In both cases, we see the perceived weaknesses as isolated aberrations rather than indicators of troubling long term trends.

A sharp deceleration in new license sales by our model portfolio constituent DATA precipitated a near 50% plunge in that stock that dragged down most of the SaaS application sector. Subsequent strong earnings from other SaaS names, like CRM and WDAY, points to DATA specific problems, such as rising rivalry in analytics or order lumpiness, although the whole group remains relatively depressed. We believe the group is oversold, including DATA, and are adding to our model portfolio’s exposure with the addition of NOW in place of the post Star Wars DIS.

We believe DIS is threatened by a real erosion of the whole linear TV business model, although you wouldn’t know it from the recent performance of other leading media stocks. 4Q15 TV ad sales were buoyed by the unusually strong campaign spending, by the very high ratings for candidate debates, and by big growth in ad sales to fantasy sports betting companies. However, the audience for scheduled programming continues to weaken, and the decline in Pay TV subscribers is accelerating, particularly if you do not include OTT services like SlingTV. Expectations for 6-8% TV ad sales growth seem aggressive.

The strength of the TV linked stocks (CBS, NLSN, and IPG), along with the announced take-out of IM by a Chinese buyer, contributed to poor performance of our short model portfolio during its inaugural period. Since Dec. 20, the short portfolio gained 330 bp, while the tech components of the S&P were down -310 bp. We are changing out two constituents, IM and AKAM (which surprised on strong sales from a secondary business), and replacing them with IBM and CHTR.

Our long portfolio performance underperformed the benchmark by -690 bp, with that difference attributable to DATA, NFLX and AMZN. February brought considerable relief for the growth names that make up most of our portfolio after the indiscriminate selling in January, momentum that we expect to continue going forward. As noted above, we are removing DIS in favor of NOW.

Sell Now, Ask Questions Later

The January downdraft was hard on TMT stocks, and on the high growth cloud-focused names that had led the market in 2015 in particular. The TMT components of the S&P 500 have underperformed the broader index by 160bp, while Facebook, Amazon, Netflix, and Google, the so called “FANGs” as dubbed by CNBC’s Jim Cramer, underperformed by more than 800bp (Exhibit 1). We see this as a considerable overreaction, particularly given the proximate causes of the sell-off.

Exh 1: FANG + M Indexed Performance YTD

Many of the cloud-based businesses that had been the backbone of the 2015 rally have little to no exposure to China and its presumed stalling economy. Internet-based services, like Alphabet, Facebook, Amazon, Netflix, and Twitter, have been badly disadvantaged by government censorship, regulation and strong indigenous competitors. A weakening Chinese market would be of little consequence to any of them. Similarly, American wireless carriers, tower owners, and pay TV MSOs are limited by their infrastructures, none of which extend far out of the US and certainly not to China. Component suppliers may ship a fair amount of product to China, but much of that is exported in turn, leaving most of the exposure to FX rather than Chinese demand.

In our model portfolio, we see just three companies with significant China concerns (Exhibit 2-3). Qualcomm is in the midst of negotiating new royalty agreements with most Chinese OEMs, including asking for payment of unpaid back royalties. This will be more difficult in a struggling economy. Moreover, much of the recent growth for Qualcomm’s chip business has derived from Chinese domestic smartphone demand, which should be expected to slow. The Walt Disney Company has obvious exposure to Chinese demand in its studio and consumer products businesses, and is building a multi-billion-dollar theme park near Shanghai. Finally, Nokia generated 8% of its sales from China in 2015, most of that coming from a substantial order for 4G equipment from China Mobile. Given that this installation is nearly complete, a drop in Nokia’s Chinese business for 2016 has been widely anticipated and would be unrelated to the economy as a whole.

Exh 2: SSR TMT LONGs China Exposure

Exh 3: SSR TMT SHORTs China Exposure

It is also hard to see how petroleum prices and slowing industrial production will have more than a tangential impact on the TMT sector. These industries are not significant end markets for most TMT companies and the secondary impact on enterprise IT spending should be modest. If anything, lower energy costs are a benefit for cloud-based businesses where data center electricity use has been a growing element of expenses.

Exh 4: Indexed USD FX versus Major Currencies

The strong dollar has an obvious effect, but one that TMT companies have already been addressing for two years. Over that time, and despite hedging strategies, leading companies have reported 5-10% YoY FX headwinds to their top line growth. A further move in the dollar caused by Fed interest rate hikes and risk from global economic weakness could extend this burden. However, for generally high margin and strong cash flow businesses, the impact is easily absorbed, as it was during 2015, particularly when the biggest risk is from the Chinese Yuan (Exhibit 4).

With the talk of global recession, it is important to note that most cloud-based businesses are inherently deflationary, selling lower costs to their customers relative to traditional alternatives. Arguably, this benefit becomes more compelling in a recession. This could be true for the major themes at play in our model portfolio – i.e. e-commerce (Amazon and Alphabet), digital advertising (Alphabet, Facebook, and Twitter), streaming media (Netflix, Alphabet and Amazon), public cloud hosting (Amazon, Microsoft, and Alphabet), and SaaS applications (Microsoft, Adobe, Workday, Tableau, and ServiceNow). Other portfolio constituents are likewise in the business of selling value in wireless services (T-Mobile), integrated SoCs and turnkey reference designs (Qualcomm) and barebones disk drives (Seagate). Competing on the basis of significantly lower all-in costs than alternatives, all of these companies could see recession as an impetus to further share gain, counterintuitively making them relative safe havens.

The idea of growth tech being recession resistant isn’t as crazy as it may seem. Through the 2008 financial crisis and the resulting recession, the top Internet companies significantly outperformed. Apple, Google, Amazon and Netflix all grew sales at a better than 20% CAGR from 2007 to 2010, while growing EPS at a better than 25% pace. By comparison, the S&P 500 averaged a 3.9% annual decline in sales while growing earnings at 3.9% per year over the same time frame. Even Microsoft, at the time derided as something of a tech has-been, put up 6.6% sales growth and 14.5% EPS growth over that period. All five of the stocks turned out to be excellent investments as well, every one handily beating the 11.7% CAGR of the 2008-2010 S&P 500 recovery (Exhibit 5-6).

Exh 5: Select TMT Sales and Earnings Metrics, 2007-10

Exh 6: Select TMT Price Performance, 2007-10

The SaaS Meltdown

Shortly after 4 PM on February 4th, all hell broke loose in the SaaS applications subsector. Within minutes of each other, Tableau Software and LinkedIn each posted results that contained indicators of slowing sales to come. Boom! Both stocks fell more than 40% after hours, pulling down any stock with a SaaS focus down with them.

Tableau had topped expectations on both top and bottom line, but the growth in new orders signed in the quarter decelerated from 57% in September to 31% in December. Management gave little color to the data point, leaving investors to wonder whether it had been due to overall weakness in the SaaS market, the impact of competition from Microsoft in business analytics, or simply a matter of a lumpy order pattern in a company with just $200M in quarterly sales. LinkedIn also beat on sales and EPS, but earned its beat down by issuing soft guidance for 2016 below consensus expectations. Again this could have been a harbinger of broader market weakness or of something specific to LinkedIn, either malignant or benign. Still, with two big SaaS names reporting signs of weakness within a half hour of one another, investors discounted the potential of coincidence and the whole group suffered (Exhibit 7).

On February 24, SaaS pioneer Salesforce.com reported a big beat and strong guidance, starting its stock on the way back up. Workday followed on leap day with a beat of its own, combined with confident management commentary on strong customer gains, forthcoming new product categories and its ability to successfully compete with legacy software players like Oracle and SAP. The next day, Workday was up 15%. Combined with Microsoft’s earlier strong beat and excellent SaaS results, it was a little more obvious that Tableau and LinkedIn had been idiosyncratic results. With the dust now settled, both Salesforce and Workday trade above their pre-February 4 levels, although both are still down YTD due to the broader January bloodletting.

Exh 7: Major SaaS Performance YTD

Certainly, the SaaS sector is crowded. There are 33 SaaS application stocks with caps of more than $1B, competition with SaaS products from increasingly desperate traditional software vendors. Perhaps we were due for a shake-up, but if so, we just got one and we see significant opportunity to shop for winners at attractive prices. The upside for these names is enhanced by the possibility of consolidation, with leaders like Microsoft and Salesforce shopping to extend their SaaS franchises to growing new areas., and by old-line tech players like Oracle, SAP and IBM grasping for new straws. We have held Microsoft, Adobe, Workday and Tableau in our model portfolio and are adding Service Now to take advantage of the moment. Having already taken the 50% haircut in Tableau, we see more potential upside from its excellent product and evident momentum, than further risk. We are also interested in Salesforce, Splunk, ZenDesk, Autodesk and HubSpot, although we do not have room for them in our 15 stock roster.

Taking a Bite Out of FANG

The FANGs – Facebook, Amazon, Netflix and Google (Alphabet) – delivered an average of 83.2% appreciation for 2015, easily leading the S&P 500, which was weighed down by the relatively tepid performance of 2014’s champion Apple. To this august group, we add Microsoft, which was up a not too shabby 22.7% in 2015 on its own, to raise it to a five-some, all, in our humble opinion, poised to dominate the coming cloud era of computing. The open runway for these companies, stretching as far as the eye can see, comprises tens of trillions of dollars of addressable markets. Retail commerce, media/entertainment, advertising, enterprise data center spending, and enterprise applications software, all trillion-dollar-plus end markets are under attack. Moreover, these companies are positioned to go after even more – wholesale distribution, personal financial services, personal transportation, delivery services, even health care delivery – in the not necessarily so distant future.

Investors are skeptical. Strong share price performance in 2015 raises caution that it can be repeated in 2016, particularly amidst fears of global recession. FANG + M are collectively off almost 10% YTD (Exhibit 8). Facebook is the only one in the black, after a serious revenue blowout for 4Q15, but only by 1%. Microsoft and Alphabet posted unambiguous beats on both top and bottom lines, each yielding modest gains post earnings that were insufficient to cover the effect of the overall market conditions.

Exh 8: FANG + M Indexed Performance YTD

Netflix and Amazon were both hit hard – each stock is down more than 16% YTD – on metrics that might have gone unnoticed in the salad days. Netflix beat on both top and bottom lines, and delivered much stronger than expected international subscriber growth, but missed expectations on its US subscriber count (Exhibit 9). Noting that Netflix is absorbing the impact of a price hike, and with big program release dates in 1H16, we are comfortable that US subs will pick up. Meanwhile, we see Netflix as having huge potential for international subscriber growth – they have announced forthcoming entry into 115 new countries – and see substantial future monetization levers available – e.g. ad-driven tiers, pay-per-view, live streaming, commerce, etc.

Exh 9: NetFlix Paid and International Customers

Somehow, consensus had projected Amazon to post a substantial further expansion of its margins. In retrospect, this was almost certainly too aggressive for a company that likes to roll most of its profits back into the company and tends to expense most of its investments. CEO Jeff Bezos had shown a tantalizing glimpse of Amazon’s margin potential in 2015, likely focusing on the need for a healthy stock price to help retain employees, but 4Q15 expectations were just too much. Still, Amazon’s performance on the top line was absolutely remarkable, driving sales up 20%+ in the face of a weak retail environment and fierce FX headwinds (Exhibit 10). While Bezos and company are not going to help us out with guidance or explanations, we believe expectations for the rest of the year are achievable.

Exh 10: Amazon Product Sales and Estimated GMV, 2010-2015

So we are keeping FANG + M as the core of our 15 stock model portfolio, suffering the hit from this quarter’s performance. Of them, we have called out Alphabet and Microsoft as having particular upside, owning to the modesty of their valuations relative to their growth and potential, but we are comfortable with Facebook, Amazon and Netflix as well.

Still Time for the Clowns to Find the Gold

Owning Twitter has been a painful experience. After falling nearly 36% in 2015, Twitter has started 2016 on the same note, trading off another 25% YTD. Some relative momentum in the past few weeks was blunted on Thursday, with the news that the company would issue stock grants and one-time cash bonuses to retain employees. While almost certainly necessary, given the fierce competition for Silicon Valley talent, the story was one more blow to the company’s tortured investors.

Still, we believe the failure narrative around the stock has been seriously overstated and that the resulting meager share price is a major discount to the company’s intrinsic value. The bear case for Twitter starts and ends with MAUs, or Monthly Active Users, a metric of user engagement promoted by Facebook and unfortunately adopted by Twitter management during its debacle of an IPO roadshow. By definition, MAU’s are the registered and logged in users that visit the Twitter site or use its app each month. The growth in the number of MAUs began to decelerate shortly after the IPO and have largely stagnated, particularly in the US. This, according to the narrative, is a harbinger of future revenues hitting a wall head first.

However, Twitter’s visitors need not register or log in to effectively use the service. In this way, Twitter is far more like Alphabet’s booming YouTube business than it is like Facebook, which is ONLY useful to its registered, logged in users. If forced to report MAUs, YouTube would undoubtedly fall far, far short of the billion and a half users that view its videos each month, and comparing it to Facebook on that basis would seriously underestimate the long term potential of the platform. We believe that the same thing is true for Twitter.

Exh 11: Number of Monthly Active Users by Property

Twitter has indicated that it has more than 500M unique monthly unlogged user visits. Combined with the 320M MAU’s, they put Twitter close to joining Alphabet and Facebook in that magic 1 billion user club (Exhibit 11). For the first time, Twitter will start advertising to those unlogged visitors, and a successful partnership with Google to include relevant tweets prominently in search results should be bringing a growing stream of those visitors. Twitter also has the potential to monetize its promising video properties Vine and Periscope, both of which have considerable business and cultural momentum.

Not to say monetization has been a problem. Twitter revenues grew 58% in 2015, making it the fastest growing public company with a market cap of better than $10B. With that, Twitter, taking advantage of its ad friendly native formats, has been very innovative in rolling out new products for advertisers. 2015 brought auto-roll video ads and buy buttons, amongst other things. So far this year, Twitter has introduced a customer service solution to help companies reach customers and deal with their issues over the service.

Finally, we believe that Twitter management may finally be guiding this unruly organization toward solutions that will entice users to register and build broader engagement. We believe that a reacceleration of MAU growth is probable and that it would stimulate a huge move up. Moreover, we believe that current share price inevitably will bring acquisition interest. We note that Alphabet, the most obvious buyer, is likely unwilling to make a bid until its anti-trust negotiations with EU authorities end in a long-term agreement. Still, we would not be surprised to see such an agreement in place before year end.

Twitter, with sales of more than $2B, a growth rate of better than 50%, and improving operating margins already delivering non-GAAP profits, trades at just over 5 times trailing sales and a market cap of under $12B. Compare that to Snapchat, which has revenues of about $100M and only 200M MAUs, which was valued at more than $19B in its most recent private financing. We know which one we think is the better deal.

Exh 12: Media Stock Performance YTD

Alert the Media

Media stocks have been on a tear, as investors set aside the narrative of cord cutting, shrinking viewership and slack advertiser demand. The big 8 media names are up an average of 5.1% YTD, whupping the S&P 500 by better than 700 bp. The best returns have come from Scripps, CBS and Time Warner, which are up 17.2%, 10.3%, and 8.2% YTD respectively (Exhibit 12). Each of these names emphasized strong advertising sales during their earnings reports, despite general weakness in ratings, circumstances that we believe tie to extraordinarily aggressive spending by fantasy sports services and by political advertisers. Still, there were weak performers too. The Walt Disney Company is down YTD despite a Star Wars fueled blow out quarter, as more analysts and pundits point to the vulnerability of its ESPN cash cow. Viacom faces the erosion of its youth oriented programing franchises while it copes with its lurid succession and governance issues.

For the most part, media executives are leading investors in a “What, me worry?” chorus, suggesting that ad spending is off to a normal election/Olympic year pattern and that cord cutting is irritating, but minor problem for the industry. Media analysts expect 5 of the 8 names in the group to reaccelerate growth for the year, with ad revenues for the major broadcast nets up 4-8%, in keeping with the normal quadrennial pattern. CBS, Time Warner and Viacom are expected to keep accelerating growth over the next three years, optimism that the obituaries for linear TV are too early indeed.

Exh 13: US Multichannel Video Customers, Q107-Q415

We are very skeptical. Total linear TV viewing has been falling for 6 years, a fact evident to streaming video providers but masked to traditional media, ad agencies and their customers by Nielsen’s TV-friendly methodology (Exhibit 13). Beneath the boosts from the “must see” candidate debates and the upcoming prime time friendly Rio Olympics, this pattern of shrinking core viewership continues unabated. As for cord cutting, the two biggest cable operators (Comcast and Time Warner Cable) may have added pay TV subs in 4Q, but smaller MSOs, Satellite and telcos lost them, and the decline in overall pay TV subs actually accelerated, Exclude Dish’s over-the-top SlingTV subs, and the cord cutting is a veritable snowball. Viewers in Pay TV households are shifting their attention to streaming alternatives such as NFLX which is responsible for over half of the decline in linear TV viewing.

The 2015 Upfronts were historically weak, and only a $300M+ influx of spending from fantasy sports betting sites and unexpected political spending kept the scatter market healthy during the fall season amidst ratings disappointments everywhere. The fantasy sports boon may soon be over, with new restrictions and lawsuits in many populous states. Political spending will be done in the first week of November, and the next summer Olympics are four years away. As such, the 2016 Upfronts will likely be disappointing and hopes for that 6-8% bump in 2015 linear TV ad sales will prove to be optimistic, with 2017 looming as a major step down. Media stocks may have seriously hit our short portfolio YTD, but we see the dark clouds ahead.

The Model Portfolios

Since our last update on December 21, our large cap long model portfolio underperformed the tech elements of the S&P 500 by 690 bp, driven by the sharp drop in Tableau, and underperformance by Twitter, Nokia, Netflix and Amazon (Exhibit 14). Nearly all portfolio constituents and S&P indices are in negative territory over the period with the exceptions of Qualcomm, Facebook, and Seagate. Qualcomm is rebounding from its lows as it garners design wins for its new Snapdragon 820 chip and has gotten traction negotiating new license agreements with Chinese licensees. Facebook and Seagate meanwhile have been more resilient than their TMT peers and are basically just a little above flat.

Exh 14: The SSR Large Cap TMT Model Portfolio

The portfolio performed particularly badly through the beginning of February and the SaaS meltdown, down 16.8%, but has thrived since then, outperforming its benchmark by 220 bp in the month of February. We are making one adjustment to the portfolio by removing Disney, which has languished under concerns that the ESPN cash cow is at risk despite delivering strong 4Q15 results on the spectacular success of Star Wars Episode. VII. In its place, we are doubling down on high quality SaaS and adding Service Now, off 34% YTD after issuing guidance slightly below the 2016 consensus.

Our inaugural short portfolio backfired and actually delivered positive returns in addition to beating both the broad S&P and tech component indices (Exhibit 15).  The biggest hit was Ingram Micro, which saw a bid from China’s Tianjin Tianhai sending shares up 20% and negating a massive miss just a week later. Meanwhile, the market turmoil turned investors toward seemingly safe names like AT&T, Nielsen, CBS, Arrow and even Oracle, badly hitting our short portfolio in its inaugural quarter. Since inception, the portfolio is up 3.3% vs. a -3.1% decline in the tech components of the S&P 500.

Exh 15: The SSR Large Cap SHORT TMT Model Portfolio

Still, we believe that our basic themes, threatening cybersecurity, OTA, linear TV, traditional data center spending, and telecom pricing, will play out. We are removing Ingram Micro and Akamai, which surprised on unexpected strength in a new business, and adding IBM and Charter. After years of cost cutting and focusing on operations, IBM has failed to grow revenue since 2011. Despite hype around its Watson deep learning system and spending on cloud businesses, IBM faces an uphill battle with subscale cloud assets and exposure to old paradigm businesses. Charter’s pending acquisition of Time Warner Cable will make it the largest pure play cable name, representing 17% of the pay TV market and 21% of broadband, assuming that it can negotiate final approval. While some synergies exist, cable companies are notorious for operating and protecting geographic fiefdoms. We anticipate the pain from cord cutting and downgrades to skinny bundles will further pressure video revenue and margins.

 

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