Big tech has trust issues: latest earnings
In July, the chairman of the United States House Judiciary Subcommittee on Antitrust called Amazon, Facebook, Google and Apple “emperors of the online economy” that “enjoy the power to pick winners and losers, shake down small businesses and enrich themselves while choking off competitors”.
It laid the foundation for what would come next: on October 20th, the U.S. Department of Justice filed an antitrust lawsuit against Google for what it identified as “anticompetitive and exclusionary practices”.
It is with this cloud of scrutiny hanging over them that the four companies released their Q3 earnings results last week Thursday, largely beating market expectations and, in some respects, possibly adding fuel to a simmering antitrust fire.
Amazon heard the quote “never waste a good crisis” and ran with it all the way to the finish line. The pandemic has been a boon for the eCommerce giant and, with second wave lockdowns rolling out in many countries, it may be on track to further entrench its dominance.
- Revenue up 37% to $96.1bn
- Net income up 197% to $6.3bn
- Amazon Web Services revenue up 29%
- 248 500 new jobs created
Interestingly, Amazon’s ‘other’ category, which mostly consists of the company’s advertising business, was up 51% to $5.4bn in revenue. While Amazon’s antitrust scrutiny has revolved around whether it misuses sales data to develop products that compete with its third-party sellers, part of Google’s defense strategy is positioning Amazon, not Bing, as its biggest competitor.
Nearly half of online shopping searches, it notes, begin on Amazon.
In a bout of creative accounting too funny to overlook, Amazon’s measure of COVID-19 costs (which it estimated at $2bn) is less tied to expenditure and more to “productivity” – Amazon CFO Brian Olsavsky said that the largest portion of these costs stem from “continued productivity headwinds” in its warehouses, including enforcing social distancing rules, extended breaks for workers and other steps “to make sure our people are safe and distanced”.
Essentially, they are quantifying social distancing and breaks and writing them off as an expense. After all, “Amazon spends $2bn on COVID-19 protections” is a great headline.
Plus, since COVID-19 costs will (hopefully) not recur into H2 2021, Amazon’s Q3 earnings next year will benefit from a comparable period with $2bn of extra expenses.
While the Trump administration kept Facebook’s biggest competitor TikTok busy with a witch hunt and resolution that didn’t fundamentally change anything, Facebook plodded along and delivered a solid quarter of earnings.
- Revenue up 22% to $21.5bn
- Net income up 29% to $7.85bn
- Monthly active users up 12% to 2.7bn
Facebook credited its growth to the shift to eCommerce.
“We believe the pandemic has contributed to an acceleration in the shift of commerce from offline to online, and we experienced increasing demand for advertising as a result of this acceleration,” Facebook CFO Dave Wehner said. “Considering that online commerce is our largest ad vertical, a change in this trend could serve as a headwind to our 2021 ad revenue growth.”
Although these are good results, the biggest question for Zuckerberg and co. will be: where to from here?
With $55.6bn in cash and cash equivalents on their balance sheet and very little debt, they have room to play around. But will they be allowed to? Big acquisitions are probably off the table.
Regulators say that Facebook’s monopoly power in social networking is due to it snuffing out competitors through strategic acquisitions and copying products. For now, they can pat themselves on the back for a good quarter, but eventually ad revenue will hit a ceiling and TikTok will start monetising effectively. Facebook will need to be prepared for that.
In the famous words of LL Cool J: “Don’t call it a comeback!”
Alphabet (Google’s parent company) roared back this quarter after a tepid and negative Q2 performance.
- Revenue up 14% to $46.2bn
- Net income up 59% to $11.3bn
- YouTube ad revenue up 32% to $5.0bn
It’s a great result, with the potential for sustained growth well into 2021 once airline and hotel advertising and bookings start ticking up again.
However, the big news overshadowing the earnings announcement (and probably many announcements going forward) is the antitrust lawsuit.
In essence, the DOJ’s main issue relates to search advertising contracts Google has with companies like Apple. Google pays Apple between $8bn to $12bn annually in exchange for building Google’s search engine into Apple products. In the case of devices that run Android, Google’s contracts also require vendors to include a bundle of Google apps (Gmail, Maps, YouTube).
“For many years,” the agency said in its 57-page complaint, “Google has used anti-competitive tactics to maintain and extend its monopolies in the markets for general search services, search advertising and general search text advertising — the cornerstones of its empire.”
Google estimates that almost 50% of its search traffic comes from Apple devices. The deal with Apple is clearly a critical part of their business. While the case will probably stretch on for years, one thing is certain: a loss could severely knock the Google empire.
The first thing that jumps out from the earnings result is that iPhone revenues were down 20%. However, it makes sense. In anticipation of the iPhone 12 and other new products launching in October, Apple consumers were probably gun-shy about spending on new products.
Note: Q3 functions as Apple’s Q4 (since their year-end is September).
- Total revenue up 1% to $64.0bn
- Net income down 7% to $12.7bn
- Services revenue up 16% to $14.5bn
Apple’s revenue growth in Services is especially important. The division (which comprises Apple Music, the App Store, iCloud, etc.) is close to 20% of total revenue and, at current growth rates, is on track to match iPhone revenue. Also included in that Services line-item is the fee Google pays to Apple. We can estimate that at about $2bn for the quarter.
Important to note here is that that fee is pure profit (i.e. no costs incurred to earn it) and accounts for roughly 15% to 20% of Apple’s net income. According to the DOJ lawsuit, Apple’s most valuable service is cashing cheques from Google, meaning it has a sizable financial stake in the outcome of this case.
This insight from Benedict Evans perfectly outlines how complex antitrust cases can be to analyse in the age of Big Tech:
“The DOJ says this is Google abusing its search dominance (and consequent cash flows) to shut out competition, but you could equally well argue that this is a case of Apple using its smartphone dominance to squeeze $5-10bn a year out of Google. Is this a search market case or a smartphone OS market case?”
Conclusion – what did the market think?
Share price performances are always skewed by general market sentiment at the time of the announcements, so one must be careful to read too much into a short-term result, but share price performance on the day of results looked like this:
- Alphabet +3.43%
- Amazon -5.45%
- Apple -5.60%
- Facebook -6.31%
There are clearly jitters in the market, other than Alphabet (Google) which enjoyed a positive market reception to the results with much-improved search revenue.