Quick Thoughts: Google and IBM – Some Surprises are Better than Others
– Despite a lot of moving parts, Google’s 4Q12 was really strong – ex MOT sales up 19.5% YoY, EPS up 20.7%. MOT was a big drag – revs were off $260M vs. 3Q and losses hit EPS by more than $1.
– CPC was UP 2% sequentially, evidence of improving supply/demand balance in ad auctions – one step closer to resolution of unwarranted investor concerns over long term effect of mobile.
– IBM posted a EPS beat, but still saw the top line down 1% YoY. Improving profitability caused by mix shift to software and cost cutting, but margin improvement story can’t go on forever.
– Google and IBM have similar market caps, but very different futures. One is positioned to lead TMT for the next 20 years, the other will struggle to remain relevant.
So begins another January earnings season – Google and IBM have beaten consensus and both were up more than 4% in after hours trading, taking both of their market caps over $230B, tipping both of them past Microsoft and into 2nd and 3rd place amongst the world’s most highly valued TMT companies. That’s about where the similarities end, although both companies did manage to host overly long and boring conference calls that shed relatively little light on their respective operations.
Google has an exciting story to tell, if it chose to make the effort to really tell it. Amidst a variety of distracting adjustments, including the acquisition of Motorola and the subsequent sale of its Motorola Home subsidiary, Google’s legacy business, adjusted for the traffic acquisition costs (TAC) paid to web sites using its external ad network, delivered 19.5% YoY growth. Losses from the Motorola Mobility business that Google kept amounted to a bit more than $1 per share – absent those losses, Google EPS was up 20.7% vs. a year ago. In a tough global economy, and with the perception that the sharp shift of Internet traffic toward mobile devices would be a problem for the company, Google delivered with flying colors.
Journalists, bloggers and analysts will undoubtedly make a big deal out of Google’s “Cost per Click” (CPC) metric, which shows advertising revenue divided by the number of paid clicks. It declined 6% YoY (4% adjusted for currency) and actually rose 2% (1% adjusted) vs. 3Q12, a vindication of sorts against a bear case that extrapolated ad pricing in a free fall due to mobile platforms after the metric turned south a year ago and got worse over the first half of 2012. Of course, CPC is a derived pricing number – Google’s actual ad pricing is set by an elaborate auction process and prices rise and fall with the supply of advertising inventory and the vigor of the advertisers bidding for it. The rapid rise of mobile brought a big increase in the inventory of ads relative to the demand for ads in the midst of a global economic malaise. Shocker! CPC was falling. With a rational, long-term perspective, there doesn’t appear to be a lot of reasons why mobile ads, which can target users based on valuable information, such as location, that is not available on the desktop, should sell at a discount. Of course, SOMEONE is going to complain about the deceleration in the YoY growth of total clicks, but then again, 24% growth against a very difficult compare does not yet seem to be much to worry about.
We have written extensively about Google (see LINK) and believe them to be the best positioned company in all of TMT to profit from the profound paradigm shifts underway in the industry. Specifically, Google invented the modern cloud-based distributed data center and the big-data information management and processing technologies necessary to the task of indexing and searching the Internet, and invaluable for addressing an extraordinarily rich array of opportunities that will emerge. Google is the biggest, fastest, and lowest cost cloud company and its rivals are well behind, relying on open source versions of technologies introduced by Google 2-3 generations ago. With that perspective, quarter to quarter fluctuations in CPC or total clicks lose significance.
On to IBM. Big Blue has been on a long run of margin improvement, generally pleasing investors along the way. In that regard, 4Q12 is more of the same, with revenues down 1% YoY but earnings up 14%, supported by a mix shift toward the intrinsically higher margin software business. Management expresses confidence that it can reach its goal of $20 in EPS for FY15, which would imply nearly 10% annual earnings growth and more or less justify the current 15x trailing multiple. Part of IBM’s confidence derives from faith in its growth initiatives – mobile technology, social business networks, cloud software and security amongst them. I don’t have quite so much faith.
IBM is the poster child for survival in the computer industry, almost alone amongst the industry leaders of the mainframe and mini age to thrive in the PC and server era. With another industry sea change afoot, IBM is looking to a similar game plan to navigate this change. However, this time it’s different, and while I expect IBM’s services business to prosper from a long, slow, but comprehensive shift of enterprise data processing into the public cloud, many of its other businesses, including hardware and software are at real risk from the change. Meanwhile, years of cost cutting for a tech company is a double edge sword – the employees that leave are rarely the ones that should leave and cultures are rarely the better for it. It is also far from clear that IBM is really a credible player in some of the growth arenas that it is targeting.
Circling back, both stocks will likely sustain some momentum from the results that they delivered in 4Q12. Both management teams are clear in their confidence in their plan going forward. Unfortunately, IBM’s plan apparently stops after 2015, while Google’s plan positions it to dominate cloud technology and the opportunities that it will create across the economy over decades. Make mine Google.
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