TMT: Model Portfolio Update – NOW WITH SHORTS!


We have strong conviction on the near-term opportunities created by paradigmatic changes across the TMT landscape – i.e. Web scale cloud data centers, streaming on-demand media, native digital advertising, increasingly fast and efficient mobile commerce, falling competitive barriers in wireless service, and the huge, but maturing smartphone market. We have explored these opportunities in detail with our research and have use them as guiding tenets to our model portfolio stock selections. Our large cap portfolio underperformed the tech components of the S&P500 by 10bp over the last 3 months, but has outperformed by 1972bp over the past year, and has beaten the benchmark in 9 of the last 12 quarters. This quarter, in addition to updating our portfolio of longs, we are introducing its inverse – a 15 stock short portfolio intended to identify companies that are particularly vulnerable to the structural changes that we believe are playing out across TMT. We have selected the stocks based on our thematic research, focusing on names with valuations or expectations inconsistent with threats that they face.

The public cloud is eating private IT investment. The cost and performance advantages of web-scale cloud data centers are vast, capturing enterprise IT spending more rapidly than most in the industry had believed possible. This is a huge opportunity for the few platforms (AMZN, MSFT, GOOG) with the capability to lead, and for SaaS vendors able to exploit the advantages. This dynamic create a wealth of short opportunities amongst companies dependent on private data center investment and poorly positioned for the public cloud. Many traditional IT suppliers have been battered, but some still have unrealistic embedded expectations for a reversal in trend. We are also fear that cybersecurity investors may underestimating the impact of the transition to the cloud on future spending for private security solutions. Longer term, we are concerned that SaaS application vendors that run atop sub-scale infrastructure – e.g. CRM – will begin to face cost issues not currently reflected in expectations.

More shoes to drop for media stocks. The media group rallied off its sharp August drop, as the anticipation of election/Olympic ad spending, and the sports betting fueled 4Q spot market bump, have TV execs talking up their opportunities. The bigger picture remains grim – pay TV subs are declining and audiences are shrinking, greatly improved streaming alternatives are proliferating, and ad spending continues a hard shift toward digital. We look for another step down in media valuations for 2016, with companies skewed to ad sales the most vulnerable. In this, we also see trouble for agencies.

AMZN’s roadkill. AMZN is set to inflict a lot more pain on traditional retailers in 2016, looming as a major threat to B2B wholesalers as well. ( The AMZN effect has already hung on many large retail stocks in 2015, but we believe the contrast in results for the holiday season will be stark. Meanwhile, the highly fragmented B2B distribution market appears ripe for AMZN’s disruption, with electronics, office products, medical supplies, and general industrial markets the most vulnerable. Longer term, we are concerned that the substantial beneficial effect of AMZN on shipping companies could reverse, as investments to move fulfillment centers closer to customers and to engage alternative local delivery solutions are deployed more widely.

It’s not your father’s wireless industry. Buying habits for wireless customers are changing. In a world where voice calling is waning as data usage skyrockets, blanket coverage is no longer a deciding factor for many users. TMUS offers fast and available data in the places that matter, with consumer friendly policies and prices much lower than the traditional VZ/T duopoply. This is bad news for the leaders, who are slowly bleeding market share while ARPUs drop, and can do little to stop the pain. Eventually, this will pressure cash flows and dividend yields. Meanwhile, S remains a damaged brand trying to remain solvent until new network technologies allow them to exploit their spectrum holdings.

Smartphones hitting the wall. The market for premium smartphones is mature – now driven, almost entirely, by the ebbs and flows of replacement ( There is still growth at the low end, but prices and margins there will be tight. New markets for smartphone-related technologies – IoT, wearables, automotive, etc. – are still too small to make up for weakness looming in high-end portable devices for most players. We are removing ARMH from our model portfolio for this reason.

Big beats small in the cloud. Most of the major paradigm shifts playing out in 2016 – SaaS/IaaS, streaming content/digital ads, B2C/B2B e-commerce, etc. – will greatly favor large, well established players like AMZN, GOOG, MSFT, FB, NFLX, etc. to the detriment of smaller, would be rivals. Niche positions will be increasingly difficult to defend, as scale economies, technical expertise and reach to both consumers and business customers begin to play against them.

Our inaugural shorts. We identified specific stocks vulnerable to these paradigmatic changes. We then screened them, looking for high valuations, and unrealistic sales/margin expectations, and for names that are not already widely shorted. For stocks threatened by the enterprise shift to the public cloud, we included JNPR, CSCO, FTNT, EQIX, and ORCL. We remain concerned for 2016 TV ad spending in the face of positive spin, and have included CBS, IPG and NSLN expected disappointments. For the moment we are not including traditional retail and non-TMT wholesale companies as possible shorts against AMZN’s growing e-commerce momentum, but do include IM and ARW. Our take on telecom yields T for the list, and our negative view on mobile devices prompts AVGO. The ugly list of subscale cloud businesses is fairly picked over, but PCLN remains unscathed despite similar long-term threats and travel middleman SABR may be vulnerable as well. We see AKAM as vulnerable as internet traffic continues to consolidate to huge players that are looking to disintermediate independent CDNs.

The long portfolio has had excellent performance. Our large cap model portfolio is up 22.3% year to date, outperforming the S&P500 by 2420bp and its tech components by 1972bp during that time. It has beat the tech benchmark 9 out of the past 12 quarters, despite not holding AAPL for most of 2014. This quarter we trailed the S&P 500 tech components by 10bp, with poor performance by WDC, TWTR and QCOM offsetting gains by AMZN, NFLX and MSFT. We are replacing WDC with its rival STX on fears of a difficult integration with SNDK. We are also removing ARMH, given our more bearish stance on devices, adding NOK, which we believe can show unexpected synergy from its combination with ALU against pessimistic consensus forecasts.

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