Quick Thoughts: AAPL Quiets its Critics, FB Revs Up Growth, and QCOM Stumbles a Bit
– AAPL’s 4.6% YoY sales growth came as a shock, as Chinese demand for the iPhone blew past even the most optimistic forecasts, and drove an unexpected GM pop to 39.3%.
– FB delivered 71% sales growth to crush consensus EPS by 42%. Users and engagement are up nicely, but ad monetization is the big story – we see a lot more runway ahead.
– QCOM missed the top line but beat EPS on opex controls and a better tax rate. Decelerating sales of 3G/4G devices in the quarter will fuel fears that saturation may limit future growth.
– This is a sigh of relief for AAPL bulls, more good news for FB, and new fuel for QCOM haters. We are not convinced that AAPL is back on the growth train nor that QCOM must stumble further.
The Apple bulls must be feeling their mojo. For weeks the story has been that the company would report sales down YoY for the first time in eons. Analysts were somber, downplaying the importance of the seasonally weak March quarter and beating the drums for the big screen iPhone 6 that everyone is expecting for the fall. China Mobile, originally held out as Apple’s ace-in-the-hole in its first quarter supporting the iPhone, seemed a bleak hope after the world’s largest carrier reported just 1.3M 4G phones sold in February. It turns out that all of the sturm und drang was entirely unnecessary.
Boom. Apple’s 2QFY14 sales were $2B ahead of the consensus estimate of $43.6B, delivering 4.6% YoY growth. EPS was an even better story, with stunning 39.3% gross margins 160bp above expectations driving a 14% earnings beat. The drivers? China and the iPhone. Sales in greater China were up 12% YoY to $9.3B while iPhone units were 6M higher than market expectations. It would seem that the Chinese, who celebrate their biggest gift giving season in the first quarter, bought a LOT of iPhones during the quarter. Who cares if iPad sales were down, when the much higher margin iPhone is there to more than pick up the slack. That mix shift also drove that gross margins pop. What’s not to like?
In the long haul, I’m not sure that this giddy surprise changes much. 4.6% sales growth is a lot better than the 0% sales growth that everybody expected, but the year ago quarter was a substantial miss and an easy compare, particularly when you factor in that China Mobile and Japan’s NTT DoCoMo were not selling the iPhone in 2013. The compares will get much more difficult starting in September, and with high end smartphone saturation setting in (see QCOM’s results for evidence) and increasing rivalry (see the anecdotal stories on Samsung G5 sales), it may be difficult to keep up the 4.6% sales growth or the 39%+ gross margins.
Facebook investors are also in a good mood tonight. Zuckerberg and company posted 71% YoY sales growth for 1Q14, continuing the accelerating trajectory off of the 63% growth delivered in 4Q13. Advertising revenues, the true lifeblood of Facebook, were up an even more impressive 82%, a testament to the advertising community paradigm shift toward social/mobile online media that we wrote about at length in our recent piece on the company (http://live.ssrllc.com/2014/03/march-26-2014-facebook-dream-until-your-dreams-come-true/). All of that revenue meant leverage to the bottom line, and Facebook blew out EPS, beating consensus by 46% and nearly tripling its year ago compare.
Inside the numbers was all good. MAUs and DAUs were up 15% and 21% respectively, a real indicator of growing engagement of the ever larger universe of Facebook users. Average revenue per user (ARPU) is up nearly 50% YoY to a $7.80 annualized pace. Facebook is finding new users and serving them more ads at increasing prices. Going forward, with the rise of video ads and other high CPM new formats, I expect Facebook’s ad pricing to be a considerable driver of future sales growth and profitability.
In contrast to Apple, I see lots of runway for Facebook to keep on keeping on with revenue growth. Breaking the monolithic Facebook app into multiple, more focused experiences will allow better user experiences, offer a broader inventory of advertising slots and deliver a far better context for advertising that is likely to command better prices. Meanwhile, the sea change shift as online takes ever larger slices of advertising budgets is a substantial and sustainable tailwind for Facebook, and a positive read across for other companies feeding from the same stream. Of course the read across for other media, and in particular TV, is just the opposite, and I am very interested to see the reception to the coming upfront presentations by the big networks, who will undoubtedly be looking for another round of CPM increases despite dismal ratings.
In a day marked by a parade of tech earnings beats, Qualcomm was the day’s miss, delivering lower than expected top line sending the stock down over 500 basis points in after hours despite also increasing its dividend and buyback program. EPS beat expectations coming in at $1.31 per share, topping the consensus $1.22 figure after getting some lift from a lower than expected tax rate. Revenues came in at $6.37B falling in the lower range of a wide guidance given last quarter of $6.1B-$6.7B. Consensus was looking for about $6.5B. The top line miss was largely due to softness in the QTL licensing business, which brought in about $2.1B on weaker than expected global device sales of $66.5B. Guidance originally called for device sales as high as $72.5B, but Chinese volumes were much lower than expected as carrier rollouts of LTE networks were delayed. The QCT chip business fared better, delivering revenue above expectations at $4.2B and shipments of 188M chipsets. Revenue was also higher, boosting the division’s operating margins to 17%.
And so Steven Mollenkopf’s first earnings call as CEO of Qualcomm was largely spent explaining the company’s activities in China, first as a substantial part of his prepared remarks and then in analyst questions, eight of which went on to probe more about China. China of course is a mixed bag for Qualcomm as it stands to become the company’s largest revenue and profit center assuming licensees honor agreements this time around. 60 of the company’s 100 single-mode OFDMA licensees are in China. With the company’s 10Q filing came the disclosure of a Wells notice on March 13 from the SEC’s LA regional office alleging Qualcomm violated provisions of the FCPA in China. The company promptly filed a “Wells submission” on April 4 to defend itself and argue that enforcement action is unnecessary. While we don’t know what the outcome of the Wells notice will be, but it could portend to some legal troubles down the road. Aside from having US authorities investigate Qualcomm’s business dealings in China, the Chinese government’s National Development and Reform Commission (NDRC) has been in process of investigating the company with respect to Anti-Monopoly Law since November.
Despite looming threats of adverse regulatory action, the company’s China softness this quarter was largely due to a delayed transition to LTE. Revenue potential for Qualcomm in China is massive given an aggressive LTE rollout by carriers in the country. China Mobile, alone, plans to rollout 500,000 LTE base stations by the end of year to serve its 781M subscribers. By comparison Verizon, the largest US LTE operator, likely has fewer than 100,000 LTE base stations deployed for its 100M subs. While China Mobile’s initial sales of 4G phones have been widely viewed as slow, the potential is obviously huge. Most of the phones will likely be at the lowest price points, but those phones will still carry royalties for Qualcomm and many of them will contain Qualcomm chipsets designed for the low tier. This business is truly incremental for the company and should drive a reacceleration of growth as the Chinese carriers proceed with the network rollouts.
These results will clearly feed the Qualcomm bears, who believe that the company will not be able to collect its royalties in China and that it will be unsuccessful in establishing a leading position in low end 3G and 4G chipsets against Asian rivals MediaTek and Spreadstrum. I obviously disagree, and view the inevitable weakness that will come out of these results as a buying opportunity. Time will tell who is right.
For our full research notes, please visit our published research site.