TMT Model Portfolio Update: What next?

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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.
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