TMT: 3Q 2015 Earnings Preview

sagawa

2Q15 gave powerful evidence to the tectonic plate shifts remaking the TMT landscape. Those change vectors will drive 3Q15 earnings as well, creating significant investment opportunities and risks. Specifically: 1) The deterioration of the linear TV model continues, fueling growth for NFLX and GOOG and yielding painful admissions from traditional media execs. 2) TWTR, with a permanent CEO, splashy new product features, and planned job cuts, may be setting itself up to move out of the dog house. 3) The enterprise cloud is moving FAST. AMZN’s AWS and MSFT’s Azure are putting up huge growth and introducing new IT-friendly services – good for them and BAD for traditional IT vendors. 4) AMZN is killing it in e-commerce – its growth will hurt everyone else. 5) TMUS should continue its hot streak, taking phone subs from everyone and growing revenues and margins. 6) AAPL has one last easy compare and a stagnant worldwide market for high-end smartphones – a beat won’t mean much for the share price.

TV swoons.  Fall TV ratings have been very poor. Spot prices for primetime advertising are down. Pay TV sub declines have been accelerating. Video streaming services have been growing viewing hours and revenues at high double digit pace. There is nothing to suggest that any of this is likely to reverse, and history suggests that these changes are more likely to accelerate than not. Of course, heading into the seasonally strong Holiday quarter with 2016 election spending ready to begin in earnest, media and cable executives may be inclined to spin weak 3Q results toward optimistic 4Q guidance, but we are very skeptical. Meanwhile, we expect NFLX and GOOG to continue their 2Q15 excellence.

Jack is back. What to make of TWTR? Shares shot up in early Oct. with the CEO announcement, followed by the launch of Moments, a planned expansion of the 140 character limit, an extension of the Buy button to new partners representing 100K merchants, and a team-up w/ GOOG on the AMP program to accelerate the loading of web pages. Then, reports of possible layoffs killed most of those gains. We expect management to make a strong case that all of this is bullish – 61% sales growth in 2Q on strong ad monetization should continue in 2H; Moments, improved on-boarding and a planned ad blitz should revive MAU growth; and pruning TWTR’s bloated employee roles should move it more quickly to profit. If @Jack can get that MAU needle to move, this stock has a LOT of upside to come.

Clouds are gathering. In 2Q, AMZN grew its AWS cloud business 81% YoY, and just announced a raft of new features to make it easier and more attractive for traditional enterprises to move their computing onto AWS. MSFT, while still much smaller in the hosting business, topped that with 96% growth for Azure. SaaS vendors, like CRM, WDAY, DATA, N, NOW, SPLK, and others, continue to post strong double digit sales growth. Meanwhile, business at traditional data center equipment and software companies is sad, and EMC’s take-out by Dell aside, we believe managements have not offered credible plans for long term survival, much less success, in a cloud dominated future. We expect more of this in 3Q15, and favor MSFT, AMZN and the SaaS names.

Who can challenge AMZN? In 2Q15, AMZN grew its e-tail business 26% YoY despite considerable FX headwinds, with a recent study showing 44% of mobile shoppers starting with AMZN vs. 21% for all other retail apps and sites combined. In contrast, the top 10 US retail chains grew an average of 1.8%, with WMT showing dead flat sales. Indeed, WMT’s touted e-commerce efforts, less than 1/10th the size of the merchandize sold through AMZN, decelerated to just 16% growth in the quarter. A recent survey showed 44% of US online shoppers go directly to AMZN, with just 21% starting on any other retailer’s site or app. We expect this widening gulf to be clear in 3Q15 earnings.

TMUS is harvesting subs. In 2Q15, VZ, T and S all saw ARPU erosion, weak post-paid phone subscriber numbers and declining wireless revenues. T-Mobile added 2.1M post-paid subscriptions and grew its wireless revenues by 11%. This is a classic Clay Christensen “Disruptive Innovation” case of an upstart attacking from the bottom and winning. Nothing has happened that will stall this momentum.

One last hurrah for AAPL. Consensus projects 22.4% topline growth for AAPL in its 4QFY15 with an abrupt stall to 3.1% growth in the December Q. AAPL announced that first weekend sales for its iPhone 6S models were 13M, topping last year’s sales by 2.5M units. However, 4QFY14 sales did NOT include China, suggesting that there may be little or no growth on an apples-to-apples basis. We believe that FY15 iPhone sales have pulled substantial upgrade sales forward and that demand for the 6S models may suffer as a result. If so, consensus revenue expectations for FY16 may be too high. Despite the likelihood of topline disappointment, we note that margins for the iPhone 6 and for the Apple Watch are likely higher than expectations, leaving room for earnings to fare better than sales.

Top picks for 3Q15. Paradigm change is creating upside opportunities for a number of large cap stocks in the TMT universe. We believe that TWTR, TMUS, AMZN, GOOG, MSFT, and NFLX are likely to deliver combinations of financial results, guidance and management commentary to drive their shares higher through 3Q15 earnings season. In contrast, we are particularly concerned for IBM, CSCO, VMW, HPQ, FOXA, VIA, SNI and T.

Please see our published research page for the full note.

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