FAANG? I choose FAAAM, fam.
Many of you are familiar with the term FAANG, although a recent poll I ran on Facebook did suggest that many readers think it is a type of tooth.
It’s not a tooth
It stands for Facebook, Amazon, Apple, Netflix and Google (although the listed holding company of Google is called Alphabet these days). Coined a few years ago, the term is often applied loosely as a proxy for the big tech wave that has swept across the US stock market.
Within this group, I am not bullish on Netflix. I have written previously about my views that it is a media company masquerading as a tech company. I own shares in Disney instead, which has a century-old brand and a far more palatable valuation.
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Let’s also get Tesla out of the way, since that’s the word on everyone’s lips. The company barely makes a profit and that’s before it faces stiff competition from established manufacturers. No matter how advanced the cars are, I don’t see Tesla as a tech platform like the other companies are. There’s no T in my portfolio.
My holdings include Facebook, Amazon, Apple, Alphabet and Microsoft. Welcome to FAAAM, fam. Let’s take a look at the results of these companies that were released in the past week.
What does it mean to beat estimates?
Before we delve into specifics, I need to touch on the concept of “beating estimates” or “beating consensus” or even “beating the street” – in this case, Wall Street.
Equity analysts earn a living by valuing companies and predicting their future results. Institutional investors buy this research and use it to make decisions. Analysts submit their forecasts to companies like Bloomberg which then publish a consensus estimate. This is basically the average of the forecasts in the market.
“Beating consensus” (or any of the other terms) means that the company posted revenue or profits (depending on the context) that were higher than the average forecasts. Within that average, some analysts would naturally be closer to the actual result than others. Analysts who are consistently more accurate than others become highly prized commodities and earn a lot of money.
Right, let’s get stuck in on FAAAM.
Lay of the tech land
Apple is the most valuable company in this group (and in the world, as of this week). Facebook has the smallest market cap.
From a sales perspective, Amazon dominates. The nature of Amazon’s business (primarily online retail) means that operating margin is the lowest in the group.
Interestingly, this leaves Apple and Microsoft as the most profitable companies on an operating profit level. Amazon, Alphabet and Facebook generated similar operating profit in the last quarter, although the trends are completely different. This was Amazon’s best-ever quarter but was a highly disappointing performance for Alphabet, for example.
Due to the different business models and level of market maturity, I think Price / Operating Profit is a sensible way to compare the current market valuations of these companies. On this basis, Facebook looks particularly cheap since it was so robust this quarter, while Amazon is pricing in substantial future growth.
There’s been a lot of political noise around Facebook and advertisers boycotting the platform. The results prove that the noise was exactly that – noise.
Revenue at $18.7bn was up 10% vs. the comparable quarter and is a respectable result when competitors are seeing a decrease in ad revenue. The boycott advertisers were easily replaced by small businesses, as Facebook achieved 10% growth even through the boycott period. Best of all, it’s very unlikely that these boycotters can avoid advertising on Facebook forever.
US and Canada still contribute around half of group revenue despite contributing less than 10% of total users, giving a sense of how critical those markets are for these tech giants. ARPU (Average Revenue Per User) is much higher in these markets than elsewhere in the world.
There are 2.7bn active monthly users on Facebook alone. The group (which includes WhatsApp and Instagram) has 3.1bn unique users and 180 million businesses using the various tools. 9 million actively advertise, which suggests a 5% conversion rate of business pages into paying users.
Facebook has clearly had to spend money to make money this year. Marketing and sales spend is up considerably as a percentage of revenue, resulting in a drop in operating margin to 32%. Operating margin has previously been well above 40%, so that’s something that investors need to watch carefully.
Operating income of $5.9bn and free cash flow of around $5.5bn (ignoring the once-off FTC settlement of $5bn) means there is plenty of room for Facebook to invest in the future and maintain substantial profitability.
The world’s largest social media platform is well on its way to becoming a full-blown eCommerce platform, with products like Facebook Pay in the pipeline. They’ve also acknowledged the importance of gaming, something I’m very bullish on. Facebook is perfectly placed to play in that space.
Facebook’s share price closed 9.7% up for the week.
Amazon
Amazon absolutely shot the lights out this quarter.
Let’s start with revenue. The consensus of $81.2bn looked like an up-and-coming tennis player who drew Djokovic in the first round, such was the extent of the beating it received. Amazon reported revenue of $88.9bn. The difference of $7.7bn for the quarter is more than the annual revenue of most of the largest retailers in Africa. Let that sink in. Amazon is absolutely enormous.
North American sales grew 43% and international sales grew 38%, so things are looking good across the board. Importantly, the international arm of the business finally swung into an operating profit, contributing to the Q2 profit of $5.2bn (the largest in the company’s history).
This is despite spending $4bn in Coronavirus-related costs.
Online grocery sales were up 300% year on year. Subscription revenue (mainly Amazon Prime) is now over $6bn and grew 29%. These statistics are worth chewing on for a moment.
Amazon Web Services (AWS), which contributes around 12% of group revenue, grew 29%. This remains a solid result for the market leader in cloud computing but is the first time AWS growth has dipped below 30%. Growth in cloud computing is clearly still there, but companies are under enormous pressure and spending on IT as a whole seems to have slowed. Microsoft is seeing similar trends in its Azure business.
Having said that, AWS remains well placed to benefit from growth in videoconferencing, gaming and entertainment. Zoom, Electronic Arts and Netflix all run on AWS. In a gold rush, it pays to sell shovels.
The outlook for Q3 looks strong, with net sales expected to be 24% – 33% higher vs. the comparable quarter last year. Coronavirus-related spending is expected to be around $2bn, taken into account in the operating profit guidance of $2bn to $5bn.
If the current levels of online spending stick in a post-Corona world, but the health risks start to diminish, Amazon’s profitability is going to be even more ridiculous.
It’s impossible to know yet how the congressional hearings into the big tech companies will pan out, but Jeff Bezos did raise some eyebrows regarding data privacy. The company created 175,000 jobs in a quarter when millions were thrust into unemployment, so lawmakers will need to play a careful balancing act here.
Amazon’s share price closed 3.3% for the week.
Apple
Apple is now the most valuable company in the world.
Off the back of these results, the market cap overtook that of Saudi Aramco, the only company to achieve a $2tn market cap (it dropped considerably since achieving that milestone).
Apple is now valued at nearly $1.85tn, so the magic $2tn mark isn’t far away at all. Unlike the oil company that got there first, I see no reason why it won’t keep rising from there.
Like Amazon, Apple smashed the consensus estimate for revenue ($59.7bn vs. $52.3bn), with revenue growth of 10.9%.
73% of Apple’s revenue depends on a product being physically delivered to a customer, whether this is an iPhone, iPad or Mac. Services revenue of $15.2bn is an important underpin and grew 15%, but the strength of Apple is primarily in its devices.
iPhone sales were $26.4bn or 44% of group sales, but only grew 1.7% vs. the comparable period. Apple’s sales growth therefore came from products like Mac (up 21.6% to $7.1bn), iPad (up 31% to $6.6bn) and Wearables, Home and Accessories (up 17% to $6.5bn) and Services as previously mentioned.
International sales account for 60% of the group, so this result would’ve been negatively impacted by the strength of the USD.
Product gross margin this quarter was 29.7% vs. 30.4% in the comparable quarter, likely reflecting the supply chain issues and associated costs but perhaps also the result of a change in product mix as iPhone sales slowed. Services margin expanded from 64% to 67%.
Operating costs grew 10.4% vs. revenue growth of 10.9%, so operating margin expanded from 21.5% to 21.9%. That’s incredible when you consider the economic context and supply chain challenges behind this result.
From a cash flow perspective, Apple knows no equal. The company generated $16.3bn in this quarter, taking the cash pile to $194bn. Apple could start buying entire countries for fun and would barely notice the difference.
Apple’s share price closed 13.3% up for the week.
Alphabet (Google)
It can’t all be good news.
For the first time in its history, Alphabet suffered a decline in revenue, down 2% to $38.3bn. More importantly, operating income saw a nasty decline from $9.2bn to $6.4bn.
The core Search offering contributes 56% of Alphabet’s revenue. A -9.8% decline in this revenue was the primary cause for the difficult result this quarter. It really puts the Facebook result (+10% revenue) in context and suggests that more companies saw value in social media advertising vs. Google ads over this period.
YouTube did well, up 6% as people stayed home and watched more videos. YouTube contributed 10% of group revenue.
The good news story in the result was in Google Cloud (which includes the GSuite products), up 43.2% to $3bn. Other Revenue (which includes Play Store sales) was up over 25%, thanks to people spending more time entertaining themselves on their mobile phones.
Alphabet has invested in all kinds of new technology, including autonomous driving and healthcare. Has this distracted management from their core businesses?
As a shareholder, I’ll be keeping an eye on how quickly their core ad revenue bounces back. If social media ad spending is more appealing to companies than Google Ads, then Alphabet would do well to focus on protecting its core business.
Alphabet’s share price closed 1.7% down for the week.
Microsoft
The senior citizen in this group grew revenue by 13% to $38bn, slower than the 15% growth achieved in the preceding quarter.
Azure, Microsoft’s competitor to Amazon Web Services, registered 47% growth. Azure is smaller than AWS so a higher growth rate isn’t unexpected, but the trend in growth is similar (preceding quarters saw growth rates around 60%). Unfortunately, Microsoft doesn’t separately disclose revenue for Azure.
As further support for my overall gaming thesis, Xbox content and services grew 65%. It helps when everyone is forced to become an introvert and stay entertained at home.
Leaving aside Azure and Xboc and focusing instead on Microsoft’s core businesses, Microsoft achieved 19% growth rates in its cloud application products for corporates and not much growth elsewhere. Even LinkedIN could only manage 10% growth as ad revenue came under pressure for the company.
Profit was down 15% to $11.2bn, although profit for the full 2020 financial year was up 13%. Increases in new PC shipments and a general economic recovery in coming quarters will be needed to get Microsoft back on track, but I’m not about to bet against this juggernaut.
The most interesting news about Microsoft broke after the earnings announcement, with Microsoft rumoured to be in talks to acquire TikTok. The Chinese parent company wants to sell a controlling stake in order to mitigate the risks of the app being banned in the US and other countries. This could be a strong move for Microsoft into the space currently dominated by the likes of Facebook.
Microsoft’s share price closed 1.6% up for the week.
Conclusion
The tech giants have been incredibly resilient over this difficult period. I’m pleased with my investment in each of them.
There are a host of smaller tech companies that also deserve a look. AMD, for example, released blockbuster earnings with the share price running to record highs.
Even if these share prices come under short term pressure, my view is that no sensible investment portfolio can avoid having a healthy slice of international tech action. It’s not even about having a Rand hedge, it’s about investing in the world’s most exciting and powerful companies.
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