Quick Thoughts: A Busy Day in TMT – A Whole Lotta Shaking Going On
– QCOM delivered on the top line, but missed EPS due to $0.10 of litigation costs. 4Q guidance was cautious, but CEO Jacobs blessed a double digit 5 year CAGR for sales and earnings.
– Meanwhile, CBS handily beat estimates reporting its best 3Q ever – highlighting strong ad sales, success monetizing across channels, the importance of digital, and a shout out to TWTR.
– MSFT was a big gainer on a bullish note – We concur on enterprise strength, and give thumbs up IF Mulally is the pick, but calls to divest consumer businesses are unrealistic and shortsighted.
– TWTR priced at $26 and will start trading tomorrow. 4Q is primed to be big – seasonality, timeline images, and Amplify medias all kicking in – and I see upside to $40.
A lot of TMT news today. QCOM reported FY4Q13 sales upside, EPS downside and typically cautious guidance, but investors took it badly and bid the stock down 4% after hours. I think it’s a bit of an overreaction. The EPS miss is entirely the result of a one-time $0.10/share litigation expense related to a trial loss to RF chip maker Parker Vision. While, the case, which proceeded quickly through the US District Court for the Middle District of Florida, reached judgment on October 24, 2013, Qualcomm booked the litigation expense in the quarter ended September 30, 2013, which is allowable under SEC rules. Without this unexpected charge, Qualcomm would have reported $1.15 in EPS, well ahead of the $1.08 consensus and the $1.02-$1.10 guidance.
It’s also possible that investors were spooked by QCOM’s FY1Q14 guidance. QCOM has a long history of caution, but taken at face value, guidance for EPS down 5-13% YoY, lower product ASPS, 3G/4G device prices down $3, and a chip set mix shift to the low end, are a bit of disappointment relative to consensus. Still, QCOM often beats the high end of its own guidance, and the sober December commentary was combined with a very bullish picture of the long run. CEO Paul Jacobs suggested 5 year annual sales and EPS growth rates in the double digits, and spoke to a sharp deceleration in the growth of expenses. R&D and SG&A is expected to rise at just 5-7% going forward after clocking in at 20% growth over the past three years. This obviously points to margin expansion and strong cash flows, while QCOM continues to ride the growth of its dominant wireless semiconductor and IPR businesses.
CBS posted a strong quarter, more or less meeting the optimistic expectations of the market. The company won the month long staring contest with Time Warner Cable over retransmission fees in major markets including New York and LA, apparently none the worse for wear, with 3Q EPS on target and better than expected 11% YoY revenue growth. CEO Les Moonves and the eye network are monetizing successfully across many platforms, with non-ad revenues up 18% YoY and now on the brink of surpassing advertising. CBS’s push to diversify its revenue streams is particularly important, given the fairly lackluster 4% advertising growth despite the network’s ratings dominance.
We remain concerned with the TV business in general and believe network TV viewing will continue to decline in favor of on-demand, on-line options. CBS’s strong stable of programming has it consistently beating its rivals – it posted the top prime-time ratings last week, despite FOX’s airing of the World Series, with NCIS attracting 19.3M viewers vs. the 19.18 that tuned into the climactic game 6. Still, the fall ratings continue the trend of declining TV audiences, and while CBS reports strong scatter demand through October, the erosion of viewership is ominous. Even though newspaper circulation turned down in the ‘90’s, many in the industry were mistakenly confident as advertising continued to grow through 2006, before freefalling 60% over the next three years. We believe that shrinking audience, combined with ad skipping and 2nd screen distraction, will eventually bite the networks in their ad revenues. At least CBS is planning ahead, and aggressively reducing its dependence on advertising.
Meanwhile, MSFT was up more than 4% on a bullish note from Nomura analyst and longtime software axe Rick Sherlund. His note pegged Ford CEO Alan Mulally as the choice for Steve Ballmer’s replacement, praised MSFT’s dominant but under-appreciated enterprise presence, and echoed Paul Allen’s call to divest consumer businesses like Bing and XBox. I have no insight into the CEO derby, but Alan Mulally seems an excellent choice that is certain to be popular with investors. If anything, I’m even more bullish than Sherlund on MSFT’s cloud business – Azure, Office 365, Dynamics, etc. are positioned to extend the MSFT enterprise strength into the new era. We’ve written about it at length here. However, divesting Bing and XBox may have more downside than upside for MSFT. Bing and XBox Live are important anchor tenants for MSFT’s distributed data processing infrastructure, giving it the scale necessary for Azure to compete with AWS and Google. Moreover, I suspect that these services have borne many of the costs of building out that infrastructure over the years, potentially exaggerating their losses.
In addition, the XBox One is a solid entry in the wide open battle for the living room, one that has the potential to be the most important portal for on-line programming to reach the living room big screen. There are many ways for MSFT to monetize such an asset long term, and it seems very unlikely that MSFT would jettison the opportunity just to juice earnings for the next couple of years. As for Bing, once the infrastructure costs are peeled off, it is not likely that it is all that expensive a business but it is an important asset for the mobile device play. While many question the wisdom of Microsoft’s mobile device initiatives, I see Windows Phone as an important extension of Windows 8 for the enterprise market, and as business customers get more serious about mobile, enterprise demand will stimulate consumer demand as well.
Finally, a couple months after filing its S-1, Twitter is now done with its roadshow and has priced the IPO beyond revised pricing bands made public on Monday. With an offering price of $26 per share with approximately 700M share outstanding after dilution, Twitter has a valuation of $18B. I still believe its value is north of $30B (see “Twitter: Out of the Nest, Into the Sky” and “Twitter: There’s Gold in Then Thar Tweets”) and it should get some lift from short term catalysts. Q4 ad budgets are typically strong because of seasonality and its new Amplify program has attracted broad interest from media and entertainment outlets for its second screen marketing potential. Twitter has also recently innovated its product, adding photos to user timeline entries, enhancing its value to users and advertisers alike. Also, publicity around the Twitter IPO may give it some credence with marketers in their push for holiday sales. Expect a big 4Q13 sales number and clear signs that the company is moving close to profitability to keep the momentum going.
For our full research notes, please visit our published research site.