Can tech keep it up?
It’s been a remarkable 12 months. Not only did the world break and then manage to largely fix itself (although there are still reasons to be worried in many regions), but investors with higher risk appetites were rewarded by exceptional rallies in tech stocks and cryptocurrencies.
The asset classes have closer links than you might think. They are both fueled by a younger generation of investors who have ploughed their “stimmy” (stimulus payments) into the markets. Terms like “meme stocks”, “stonks” and “HODL” have become part of investment folklore.
Navigating this world isn’t straightforward. Zoom is a perfect example - after trading at nearly $570 in late October 2020, it dropped horribly to $337 by the end of 2020 (that’s a drop of over 40%).
Volatility is the name of the game
Speaking of gaming, meteoric growth in gaming and eSports has been a significant theme in the market. Regardless of which gaming and eSports ETF you chose to invest in 12 months ago ($ESPO, $HERO or $NERD), you would be well ahead of the Nasdaq 100 index which is a proxy for the listed tech industry in the US.
Things have cooled off considerably this year. It was inevitable and probably not a bad thing for long-term shareholders either. Year to date, the Nasdaq is up around 9%. That’s hardly a bad result over 4 months, but it feels pedestrian compared to the craziness of 2020.
To justify the valuations in the market, tech companies need to be growing quickly, expanding their margins and generating positive cash flows. Many simply don’t fall into this bucket, driving an overall concern about the risk of further corrections.
However, the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) certainly keep performing. Well, almost all of them. There’s a reasonable case to replace the N with Nvidia rather than Netflix, but more on that later.
Facebook: people are still using it
Well, so much for “nobody uses Facebook anymore” and “Facebook is now irrelevant to younger users” – the company grew daily active users (DAUs) by 8% year-on-year, with 1.88bn DAUs in March 2021.
That’s a lot of “Us” and a great deal of advertising revenue generated as a result, with over $26bn in revenue flowing into Zuckerberg’s corporate bank accounts. With an incredible operating margin of 43%, Facebook had a rather healthy bank balance of $64.2bn by the end of the quarter.
One needs to be careful when interpreting growth rates in these results. The base against which growth is measured is the comparable quarter in 2020, which included the first month or so of global lockdowns. A growth rate in revenue of 46% is impressive even in this context but doesn’t tell the full story.
What is impressive is that Facebook grew revenue in full year 2020 by 22% and expanded its operating margin from 34% to 38%.
The incredible results in the latter part of 2020 have been sustained in 2021, with revenue for this quarter slightly lower than the fourth quarter of 2020 (which would’ve included holiday shopping and associated advertising).
Here’s the real kicker: Facebook only plans to spend around $20bn in capex this year. Keep that number in mind when we get to Netflix.
Amazon: crouching tiger, hidden Netflix numbers
Amazon’s earnings announcement talks about cash flow generation for the first four bullets. They don’t even bother writing about revenue until the seventh bullet. It shows where the focus of the company is these days.
For the record, revenue for the quarter was over $108bn (up 44% vs. the comparable quarter in 2020). Assuming steady sales over the latest quarter, Amazon generated more sales revenue in two months than the entire South African formal retail sector achieves in one year!
In his commentary, Jeff Bezos highlights Prime Video and AWS as the growth stories in the company.
Over 175 million Prime members streamed shows and videos in the past year (out of 200 million in total), which is incredible when you consider that Netflix has around 207 million subscribers. There’s almost an entire Netflix hiding inside Amazon.
AWS achieved growth of 32%, which is still remarkable for the global leader in Cloud, although Microsoft and Google both achieved faster growth in their respective Cloud businesses.
When people question whether Amazon can keep growing, it’s worth noting that the North American region still contributes around 60% of the group’s revenue. The scope in the international business is enormous, posting growth of 60% vs. around 40% in the North American business.
The importance of AWS is clear when one looks at the margins. The rest of Amazon’s business achieved operating margin of 4.9% while AWS achieved nearly 31%.
Amazon may have a lower blended margin than other tech stocks, but $8.1bn in net income is more than enough to keep the lights on.
Apple: the world’s most valuable company for a reason
With revenue of $89.6bn, Apple is second only to Amazon in the sheer size of the top-line. The company has now surpassed Saudi Aramco as not just the most valuable, but also the most profitable business in the world.
There’s a reason why Apple boasts a market cap above $2.2tn. Yes, trillion.
With operating cash flow of $24bn, of which nearly everything was paid out to shareholders, Apple operates a cash flow margin of 27%. Referring to Apple as a cash cow doesn’t even begin to do it justice.
The gross margin for Products is 36% and for Services is 70%. If you ever wondered about the importance of the App Store, now you know.
The iPhone is responsible for 54% of total sales. Services is the next largest contributor at 23%. Mac contributes 10%, while iPad and Wearables, Home and Accessories each contribute nearly 9%.
Is Apple still growing? With sales up 54% and net income up 110%, that isn’t a difficult question to answer.
Netflix: is the wrong N included in FAANG?
The trouble with Netflix is that it isn’t really a platform business.
The Netflix Originals strategy walks, quacks and smells like a content creation duck. Content costs money. Disney has an enormous back-catalogue of characters and brands that it can tap into for its streaming business. Netflix doesn’t.
As a result, Netflix’s free cash flow generation is patchy at best and operating margins are erratic. On revenue of just over $7bn per quarter, Netflix plans to invest $17bn this year in content.
Put differently, Netflix generates similar revenue per year to what Facebook generates per quarter, yet the annual capex numbers between the groups aren’t terribly different. That isn’t good news for Netflix investors and the share price is starting to reflect this, with significant underperformance vs. FAANG peers.
With the NVIDIA share price having doubled over the past year and the company now worth considerably more than Netflix, there’s perhaps an argument to change the N in FAANG and replace it with a gaming stock. That could be a better reflection of where the money is being made in the market.
Google: way ahead of expectations
Like the other FAANG stocks, Google achieved a huge growth rate vs. first quarter 2020 (revenue up 34%) and achieved similar revenues in Q1 2021 to Q4 2020, despite holiday shopping falling within that period.
Revenue of $55bn was converted into over $16bn in operating income, a margin of 30%. Search still contributes 58% of revenue, with YouTube ads now at $6bn and Google Network (AdSense and the like) contributing $6.8bn. Importantly, Cloud now contributes over $4bn and grew 46% off a relatively modest base.
With the ad businesses now generating revenues well above pre-pandemic levels and the losses narrowing considerably in Google Cloud, the company has the luxury of operating an Other Bets division which casually lost $1.1bn in this quarter. It’s quite something to lose the value of a JSE mid-cap in a quarter and chalk it up to a growth strategy.
Microsoft: resilience and innovation
In the age of the oil giants (before 2008), Microsoft was among the top ten most valuable companies globally. It still holds that status; the only company to feature in the list both before the Global Financial Crisis in 2008 / 2009 and after the proliferation of the smartphone.
That kind of resilience can only be admired. It’s not as though the company has stopped growing either, with revenue up 19% and operating income up 31%. For this reason, it deserves a mention among the FAANG companies.
Notably, Microsoft Cloud grew 33%, a faster growth rate than AWS.
With operating income margin of over 40%, Microsoft has shown an incredible ability to adapt and grow. With that in mind, we end this article with quote from CEO Satya Nadella from the latest quarterly results:
“Over a year into the pandemic, digital adoption curves aren’t slowing down. They’re accelerating, and it’s just the beginning.”
Can Big Tech keep it up? There’s no reason right now to believe that it can’t.
