TMT: 3Q Earnings – The Aftermath

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3Q15 earnings season played out mostly, but not entirely, along the lines that we saw in 2Q and highlighted in our preview note from Oct 13. 1. Linear TV metrics were bad, but perhaps, not as bad as had been feared. Media stocks have rallied, but still must cope with falling ratings, a declining sub base, and ad price pressure. 2. Meanwhile, mobile ads are red hot, driving GOOG, FB and TWTR to upside sales surprises.3. TWTR whiffed on MAUs, the only metric for many investors, but the stock just retraced recent gains. We believe positive catalysts could come soon (http://www.ssrllc.com/publication/twtr-beyond-maus/). 4. The public cloud has major traction, and AMZN and MSFT are dominant. GOOG could make it a 3 horse race, but traditional data center IT players are getting killed and it will only get worse. 5. AMZN is killing it in e-tail, and traditional merchants are feeling the pain. 6. iPhone promotions hit TMUS on the bottom line, but more “Uncarrier” means more market share. T and S were the big losers. 7. AAPL is talking a big game for FY16, but scary stories from the supply chain have investors appropriately concerned. We picked favorite stocks for earning season – collectively AMZN, MSFT, GOOG, NFLX, TMUS and TWTR are up 4.8%. Our shorts – IBM, VMW, CSCO, HPQ, T, SNI, VIAB, and FOXA – were down an average of 0.8%.

Media stocks rallied despite troubling trends. Ratings continue to go down, Pay TV is losing subs, and competition for ad dollars is getting more intense. Still, beats from CBS and DIS pulled the group along, despite clear misses at FOXA, TWX, and VIAB. Happy talk from execs won’t mean much if the negative trends continue, and we think they may accelerate into 2016, even with the cyclical benefit of election and Olympic spending. Meanwhile, NFLX skipped a beat on subs, blaming the transition to chip-based credit cards for unintended churn. 4Q brings attractive new programs – Master of None, Jessica Jones and A Very (Bill) Murray Christmas – and a price hike to drive revenues. Longer term, NFLX has long, long runway with potential new monetization levers – international expansion, VOD, live programming, premium tiers, ad-supported services, etc.

Mobile ads are booming. GOOG grew ad revenues at 14% against an 8% FX headwind, with mobile-centric YouTube leading the way. FB put up another huge quarter, with 40% overall sales growth despite FX. Mobile is up to 78% of total ad revenues from 66% in 2014, a shift that drove 61% growth in ad pricing. TWTR disappointed on MAUs but crushed on sales, with ad revenue up 60%. In 2014, these 3 were responsible for 75% of all mobile ad sales, a percentage that is likely higher in 2015.

TWTR whiffs again on MAUs. TWTR’s first quarter with @Jack at the helm had a familiar ring – a big beat on ad revenues and non-GAAP earnings, but a cruel disappointment on the registered MAU count. We believe that MAU is a poor metric for TWTR’s actual reach (http://www.ssrllc.com/publication/twtr-beyond-maus/) but believe that it will reaccelerate MAUs in coming quarters based on product improvements, traffic from the GOOG search deal, and new investment in marketing. Moreover, we believe TWTR can monetize its unlogged-in visitors, along with its intriguing new platforms – Moments, Vine and Periscope. We see Twitter positioned to have a big 2016.

AMZN and MSFT are pulling away in the public cloud. AMZN’s AWS posted 78% growth and 25% operating margins, earning more revenue than the next four competitors combined. Number 2 MSFT’s Azure grew even faster at 135%, approaching half the size of AWS, and has committed over $15B to building out its cloud footprint. Behind the top two, GOOG has the scale and skill to join the leaders, and recently promoted CEO Sundar Pichai claims to be investing heavily. We believe that the public cloud could become a $1T long run opportunity, dominated by a handful of cost and performance leaders. Moreover, enterprise customers, anticipating a SaaS and public cloud future, are scaling back internal data center investment, slowly starving long time suppliers, like IBM, ORCL, CSCO, HPE, EMC, VMW and others, who are not well positioned for this paradigm shift.

AMZN raising the heat on retailers. While traditional merchants bemoan weak sales, AMZN’s core business is accelerating, with revenues growing 28% in N. America and 24% internationally (ex FX). Including its 3rd party marketplace, annualized sales through AMZN are more than $230B, making it #2 with a bullet amongst US retailers. Meanwhile, AMZN’s sales growth towers over the other top ten US retailers. Industry behemoth WMT posted flat sales, with its well hyped on-line business slowing to just 10% growth and less than $16B in annualized revenue. We expect AMZN’s investments in faster delivery, broader selection, lower costs, and superior customer service to continue to pay off in rapid share gains for the foreseeable future

TMUS harvest share from below. Once again, TMUS collected post-paid subs from its rivals, adding more than a million customers. This was more than double VZ’s gains, while both T and S lost customers. Factoring in ARPU declines, TMUS was the only carrier to grow service revenue in the quarter. While TMUS missed EPS expectations in 3Q on an aggressive cycle of promotions, including the iPhone launch, we expect better bottom line leverage in future quarters as the company continues to drive top line growth. In contrast, we are not comfortable with long term growth and profitability expectations for market leaders VZ and T. (http://www.ssrllc.com/publication/tmus-wireless-aint-what-it-used-to-be/)

AAPL coming to a moment of truth. Tim Cook says there is lots of room for the iPhone to grow. We are not so sure – our work on the global handset market (http://www.ssrllc.com/publication/smartphones-mobile-maturity/) suggests the iPhone 6 pulled a LOT of demand forward. GS put AAPL on its conviction list and forecast 43% upside. Other brokers are reporting weak supply chain orders and soft sales. 1QFY16 will settle a lot of bets.

Pre-earnings picks performed well. On October 13, we listed 6 stocks that we predicted would outperform through earning season. Collectively, AMZN, MSFT, GOOG, NFLX, TMUS and TWTR are up an average of 6.8% since then, 280bp outperformance vs. the S&P500. Our 8 shorts – VMW, IBM, CSCO, T, HPQ, SNI, FOXA and VIAB – were flat, with declines in the tech names exactly offset by gains in the media stocks. Relative to the S&P, these stocks underperformed by 400bp.

Please see our published research page for the full note.

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