big day for Amazon (AMZN)–why?

AMZN reported 2Q15 results after the close last night.  They were very good.

Sales were up 20% year-on-year; expenses rose by 17%, three percentage points less.  As a result, the company reported an operating profit of $464 million vs. a loss in the second period of 2014.

More than that, AMZN’s cloud services division, AWS, had revenue growth of 81% yoy and a quintupling of segment profits (basically operating profits less stock option expense) to $391 million.  AWS, broken out as a separate segment for the first time after 1Q15, remained a bit more than a third of the AMZN total.

 

AMZN posted an overall profit of $.19 a share for the quarter, vs. analysts’ expectations of a loss of $.13 a share and a deficit of $.27 per share in the year-ago quarter.

On the announcement, the stock immediately rose by 15% in aftermarket trading.

AMZN opened up by 20% this morning, before drifting down steadily during the day to close +9.8% in a market that was down just more than 1%.

 

Why the strong advance?

I have no good explanation, although I do have some ideas.

1. The obvious factor that changed overnight was the earnings announcement.

It contained a significant positive earnings surprise, one that makes it more likely that the company will earn, say, $1- a share in the current year. It makes the analyst consensus of $2.78 a share for 2016 more believable.   On the other hand, the stock was trading at $482 before the earnings report, or 173x the 2016 consensus.  Looking at the stock price another way, let’s say that at maturity for its businesses (whenever that may be), AMZN shares will be trading at 20x earnings.  To sustain the pre-earnings report price, that would imply a burst of rapid growth that shoots earnings up to around $24 a share.  That would be something like a doubling of earnings each year for the next five or six.

That’s already baked in the cake.  A buyer of the stock at this level must believe that $24 a share in eventual earnings is way too low.

I find it hard to believe that a $.32  per share earnings surprise during one quarter–when expectations were already sky-high=-would be enough to add 20%, or even 10%, to AMZN’s perceived market value.

2.  A second hypothesis…

What if investors are beginning to separate AMZN into two parts, AWS and everything else, and are doing a sum-of-the-parts evaluation.  To me, this sounds a little more plausible.  What would the numbers look like?

Let’s say that in 2016 AWS will comprise half of AMZN’s earnings and AMZN Retail the remainder.  To make the figures easier, let’s say each half earns $1.50 a share next year.

Let’s assume AMZN retail can grow in earnings at 20% a year for a long time, and that we’d be willing to pay 50x current results–a big number for a retail stock–for that future profit stream.  If so, AMZN Retail is worth $75.  To reach a sum-of-the-parts value of $482, AWS must therefore be worth about $400, or close to 270x its 2016 eps.  Ok, while I personally wouldn’t be willing to pay that much for AWS, I can see how someone else might.  However, I still don’t understand why confirmation that a holder at 270x earnings isn’t insane would cause the multiple to expand.  (Also, before I’d be comfortable valuing AWS as a separate company, I’d want to know more about how AMZN apportions revenues and costs among segments to ensure the published numbers don’t flatter AWS.  I’d also think long and hard about the possible effect of stock options.)

3.  The explanation for AMZN’s rocket ship ride that I’m leaning toward, however, is more technical.  Two factors may be involved.  At what Google Finance reports as 21+ million shares, today’s trading volume in AMZN was 7x normal.  The sharp opening spike suggests to me that algorithmic trading computers were at work reacting to the earnings report, not humans.  Humans, I think (?!?), would have a better sense of valuation.  I also suspect that the report and immediate upward move triggered a lot of short covering.

I’m partial to #3 because I think the whole reaction is a little  crazy.

Why is any of this important?  AMZN is a high-profile, large-cap stock with almost two decades of operating history.  There’s got to be a way to make money from the possibility that something like AMZN’s big move will occur with other similar names.

 

 

2Q15 earnings for Intel (INTC): back to waiting mode

the results

After the close last night, INTC reported 2Q15 results.  Revenue came in at $13.2 billion, down 5% year-on-year.  Operating profits were down by 25%.  Net was $2.7 billion, however–off by only 3%.  EPS came in at $.55, flat yoy (due to continuing share repurchases shrinking the total shares outstanding).  That figure beat the analyst consensus of $.51.

The main points, as I see them:

–cloud business was stronger than expected

–PC business was weaker, due presumably to overall GDP softness in emerging markets, especially China, and in the EU

–the overall business is shifting to higher-end, more cutting-edge products.  This is resulting in lower than expected volumes.  Higher prices and margins are offsetting this

–even though INTC is expecting a bounceback during the back half of the year from an unusually weak first six months, it is edging down its full-year forecasts slightly to account for continuing weakness is the PC market

–the 2Q tx rate was a miniscule 9.3%, compared with 28.8% in 1Q.  That’s because INTC has decided that some cash balances earned abroad and held overseas are permanently invested there and is asking the IRS for a refund of taxes previously paid on this money.  Eps would have been around $.47 at the 1Q15 tax rate.

waiting for…

–the Altera (ALTR) acquisition to close and new field programmable gate array-based microprocessor products to emerge

–world GDP to accelerate

–the product balance to shift to non-PC products (the cloud, the internet of things…) to a degree that they, not PCs, define the company

–tablets to become profitable

in the meantime

I’ve been surprised by the weakness in INTC shares over the past six weeks or so, as the extent of softness in the 2Q15 PC market has become apparent.

My picture has been that the stock goes sideways, supported by a discount PE multiple and a 3%+ dividend yield, while the company (successfully) transitions into a post-PC world.  I continue to think that this is not so bad for shareholders during a time like the present when the market in general is likely to go sideways.

The key question, for which I have no strong answer (because I’ve been thinking I still have time to formulate one), is what to do as/when economic activity begins to accelerate.  Clearly, in my mind at least, if overall corporate profits begin to rise quickly, being paid 3% to wait for future developments won’t appear to be such a good deal.  I don’t think the current weakness in INTC shares is the first inkling of this sort of shift.  But it’s something I have to consider.

 

What Amazon (AMZN) said about its web services Thursday night

AMZN shares rose by 15% last Friday, after the company gave its first income statement details about Amazon Web Services (AWS), its cloud business.  In its quarterly reporting from now on, AMZN will break out three business segments:  US sales, International Sales and AWS.

IN the late Thursday earnings release, Jeff Bezos said that AWS is growing fast and “in fact, it’s accelerating.”

the data

operating income

–during calendar 2013, AWS had segment operating income of $673 million, according to the GAAP accounting rules used in financial accounting.  That was 35.3% of AMZN’s total segment income.

—for 2014, AMS had segment operating income of $660 million, or 36.5% of the total

–in 1Q15, AMS had segment income of $265 million, 37.5% of the corporate total

cash flow

–on GAAP principles, AWS had cash flow of $2.4 billion last year.

capital spending

–AWS represents over a third of AMZN’s plant and equipment of $17 billion.  With $4.3 billion in plant additions in 2014, AWS was almost half the company’s total capital spending.  Of the $4.3 billion in new plant, $3 billion was acquired using capital leases–meaning a kind of financing which looks like a loan but which allows AWS to buy the stuff cheaply at the end of the lease.

plant life

–if we divide last year’s depreciation into the average of 2013 and 2014 plant, we get an average plant life of 4 1/2 years.

–return on capital

–last year AWS earned $660 million, using capital of $4.6 billion, meaning a return of 14%.

what to make of this

It’s hard to make a lot out of two years’ data, especially in such a fast-moving and capital-intensive business as AWS’s.

The GAAP numbers look good. Nevertheless, AWS is cash-flow negative, which isn’t troubling if we’re certain that the company will continue to earn a significant return on the capital it is pouring into AWS.  Also, although there’s no way to tell for sure, it seems to me likely that on its IRS books, AWS is losing money.  How so?   …tax breaks for technology investment, including depreciation that’s heavily front-loaded (vs. spread out evenly over the assumed life of the equipment, as GAAP calls for).

Certainly, if Wall Street’s view has been that AWS is bleeding red GAAP ink, the reality is hugely better.  As time goes on, we’ll be better able to judge how insatiable AWS’s need for capital is–or whether, as one would hope, AWS will turn cash flow positive .  My guess is that before then, AWS will be more than half AMZN’s profits, as well.  So holders will have to figure out whether or not it’s an uptick to hold shares in an internet infrastructure business that happens to retail stuff online, too.

 

 

3Q15 earnings for Microsoft (MSFT)

the report

After the closing bell last Thursday, MSFT reported earnings for its third fiscal quarter (its fiscal year ends in June).  The company had revenue of $21.7 billion for the March period and earnings per share of $.62.  This compares with Wall Street consensus estimates of $.51/share.

Cloud-related businesses were very strong, Windows-related less weak than expected–although the coming launch of Windows 10 at mid-year is already keeping a lid on Windows performance, as potential buyers wait for the newer version.

 

MSFT shares opened Friday trading up by 5%+ from the Thursday close and tacked on another 5% or so be 4pm.

 

Yes, the quarter was good.  And management made it clear, even through its brand of jargon-laden corporate speak, that its move to the cloud can enable a radical expansion of its business, not simply a shifting of revenues from one pocket to another.

the Amazon influence

However, I think the unusually sharp rise in MSFT shares on Friday is more due to Amazon (AMZN) than to MSFT.

AMZN also reported after the close on Thursday.  For the first time, it broke out its Amazon Web Services as a separate business line.  Most Wall Street observers had apparently assumed that AWS, a cloud industry leader, made little or no profit for the company.  I’m not sure why they thought this.  The only thing I can come up with is that AMZN as a whole lost money for the first eight years of its existence as a public company–and analysts argued that AWS would be déjà vu all over again.

Turns out, though, that despite AMZN’s notoriously conservative accounting, the line of business breakout shows AWS making a ton of money.  AMZN shares opened Friday up by 12.5% from Thursday’s close, and drifted higher during the day.

It seems to me that MSFT rose mostly in sympathy with AMZN.

what to do about the stock

The move to the cloud has a bunch of pluses for MSFT:

–the company’s services can be used on many platforms–servers, PCs, smartphones, tablets

–it is launching new multimedia, multi-platform services

–it can provide truncated versions of sophisticated corporate services to small businesses and individuals

–the rental model for services will generate higher income than sales, and

–MSFT can reshape its image from being a PC-centric company of the past to being a cloud-based company of the future.

 

My sense is that Wall Street still views MSFT through PC glasses.  Change in perception represents substantial upside for the stock, in my view.  Still, the outsized upward move in the stock has got to tempt holders–myself included–to take some profits now, with the idea of replacing the stock being sold at lower prices.

ARK Investment Management and its ETFs

ARK

I was listening to Bloomberg Radio (again!?!) earlier this month and heard an interview of Cathie Wood, the CEO/CIO of recently formed ARK Investment Management.  I don’t know Ms. Wood, although we both worked at Jennison Associates, a growth-oriented equity manager with a very strong record, during different time periods.  Just before ARK, she had been CIO of Global Thematic Strategies for twelve years at value investor AllianceBernstein.  (As a portfolio manager I was a big fan of Bernstein’s equity research but I’m not familiar with her Bernstein output.)  She’s been  endorsed by Arthur Laffer of Laffer Curve fame, who sits on her board.

ARK is all about finding and benefiting from “disruptive innovation that will change the world.”

Ms. Wood was promoting two actively managed ETFs that ARK launched at the beginning of the month, one focused on industrial innovation (ARKQ) and another the internet (ARKW).  Two more are in the works, one for genomics (ARKG) and the last (ARKK) an umbrella innovation portfolio which will apparently hold what it considers the best of the other three portfolios.

What really caught my ear in the interview was Ms. Wood’s discussion of the domestic automobile market (summary research available on the ARK website).  Most cars lie around doing nothing during the day.  What happens if either ride-sharing services like Uber or the Google self-driven car, which make more constant use of autos, catch on as substitutes?  According to Ms. Wood, until these innovations reach 2.5% of total miles driven (based on the idea that on a per mile basis ride-sharing costs half what owning a car does), there’s little effect.  But at 5% penetration, the bottom falls out of the new car market.  New car sales get cut in half!

Who knows whether this is correct or whether it will happen or not   …but I find this a very interesting idea.

about the ETFs

The top holdings of ARKW are:  athenahealth, Apple, Facebook, Salesforce.com and Twitter.  These comprise just under 25% of the portfolio.

For ARKQ, the top five are:  Google, Autodesk, Tesla, Monsanto and Fanuc.  They make up just over 24% of the portfolio.

Both will likely be high β portfolios.  Both have performed roughly in line with the NASDAQ Composite since their debut.

The perennial question about thematic investors (I consider myself one) is whether the high-level concepts are backed up by meticulous company by company financial research.  This is essential.  In addition, it’s important, to me anyway, that the holdings be arranged so that they’re not all dependent on a single theme–the continuing success of the Apple ecosystem, for instance.

I’m not familiar with Ms. Wood’s work, so I can’t say one way or another (Fanuc and ABB strike me as kind of weird holding for ARKQ, though).  But I think her research is worth reading and her ETFs worth at least monitoring.  For us as investors, the ultimate question will be whether Ms. Wood can outperform an appropriate index.  The NASDAQ Composite would be my initial choice.

 

 

 

 

 

earnings calls: Apple (AAPL) vs. Microsoft (MSFT)

Last night after the market close, AAPL reported earnings per share that beat the consensus of Wall Street analysts–and the stock went down in the after-market.  MSFT, in contrast, reported results that fell short of analysts’ estimates–and the stock went up!

What’s going on?

AAPL gave next-quarter guidance that fell below Wall Street’s projection–but it always does this, so that’s not the reason.  MSFT’s income statement looks better after factoring out the large operating loss generated by Nokia, but I don’t think that’s the reason for the market’s positive response, either.  After all, if you wanted to (I didn’t), you could have gotten a reasonable guess at how much Nokia would subtract from the MSFT total from Nokia’s recent results as a stand-alone company.

I think the market’s response is much more a a conceptual response.

Tim Cook has made it clear that AAPL is a manufacturer of high-end mobile consumer technology.  There’s no “next big thing” on the horizon, however, with only a periodic refresh of the company’s smartphone line due any time soon.  If reports from suppliers are accurate, new offerings will include a phone with a large, Samsung Galaxy-matching screen size, and a(n even larger) tablet/phone.  For Jobs-ites, this departure from Steve’s view that phones should be small enough to operate with one hand may be earth-shaking.  But for the rest of the world, this is only catching up to what Samsung already has on the market.  So a ho-hum Wall Street response is appropriate.

For MSFT, on the other hand, the news is relatively better.  The company seems to have a focus for the first time in a long while.  The fact that Nokia is putting up operating losses at a near-$3 billion annual rate seems to me to justify the downsizing MSFT has recently announced.  The only surprise is that this wasn’t started sooner.

Leaving the X-Box content creation business is probably more symbolic than anything else, but it removes a potential distraction–especially given the continual mess the company has typically made of its game software development efforts.

One, admittedly small, figure what caught my eye was that MSFT has added another 1,000,000 individual/small business users to its Office 365 rolls during the June quarter.  I think this just shows the power of the cloud–easier administration, much lower cost-of-goods expense, and hugely better protection against counterfeiting.

For MSFT, then, the earnings were nice, but the fact that the company’s board is allowing significant changes is nicer.  True, the message may turn out only to be that the company will try harder not to shoot itself in the foot again, but even that’s an uptick.  Hence the positive market response.  Absence of missteps won’t be good enough for long, but it’s ok for now.

a closer look at Intel’s 2Q14

2Q14 results

After the close of Tuesday, Intel (INTC) reported a strong 2Q14.   Revenue came in slightly higher than the company’s upwardly revised guidance from last month.  Earnings per share were $.55 vs. Wall Street analysts’ expectations of $.52 (expectations which were revised upward when INTC announced in mid-June that business was looking up).

INTC also revised up its full-year revenue guidance from basically flat year-on-year to +5% growth.  It said that its server business ($3.5 billion of the company’s $13.8 billion total during the quarter) continues to boom, with both unit volumes and unit prices rising.  That’s no surprise.  In addition, however, the PC business ($8.7 billion in 2Q14 sales) appears to have bottomed and to be bouncing back a bit.

The PC development has two aspects.  Corporate customers, who make up about 40% of the PC total, are buying again.  The simplest explanation for this is that their existing laptops and desktops have just gotten too old.  Buying may also be spurred by the fact the Microsoft is ending support for Windows XP, that corporations don’t regard tablets as a viable substitute for laptops, or simply that firms are flush with cash.  In any event, corporates are buying, and will easily continue to do so in increasing amounts into next year.

Consumers, 60% of the total PC market, may also be showing signs of life–although this is more OEM and distributor body language than actual orders.

Remember, too, that INTC’s sales are not to end users.  So it stands to benefit not only from increased final sales but also by manufacturer and distributors purchases to built up bare-bones inventories.

operating leverage

INTC has substantial operating leverage, both from the capital-intensive nature of its manufacturing and its very large R&D and SG&A budgets.  As a result, small changes in revenue can make a disproportionately large impact on the bottom line (in fact, they’re almost pure profit).  At the moment, the revenue changes in INTC’s two main businesses, PCs and servers, are both positive.

tax rate

INTC is saying it  expects its tax rate to remain at 28% for the rest of the year, implying that the growth it is seeing is mostly coming from the developed world, where tax levies are relatively high.

lines of business

As is always the case in securities analysis, the line of business table is where the real work is done.  For INTC, I’ve duplicated the relevant 2Q14 lines below:

PC Client Group :    revs = $8.667 billion, op income = $3.734 billion

Data Center Group :   revenues = $3.709 billion, op income = $1.807 billion

Mobile and Communications Group : revenues = $51 million, op income = ($1.154 billion).

No, that’s not a mistake.  INTC’s tablet and smartphone chip business had revenues of $51 million for the quarter …and an operating loss of $1.2 billion.

INTC is earning operating income of $22 billion – $25 billion a year from its traditional businesses and using a chunk of that to fund the massive losses it is incurring in trying to break into the mobile computing business.

The M&C Group figures need some interpretation.  The revenue figures are net of marketing or other incentives INTC gives to buyers of its mobile chips; the operating loss includes R&D and other expenditures that arguably have an enduring value.

Nevertheless, the line of business table does convey the essence of the INTC story for shareholders wiling to pay $30+ for a share of stock.  INTC is, in effect, two companies:

–one is a mature microprocessor maker earning $2.50 or so a share and growing at maybe +10% a year

–the other is a startup currently bleeding red ink at a $4 billion annual rate.

my take

The fact that INTC is incurring large near-term losses on its M&C Group says two things to me:

–it doesn’t yet have a set of products customers are willing to actually pay for, and

–INTC believes M&C is crucial to its long-term success.

I might be persuaded to pay 15x earnings for the traditional business, if I thought it would have stable-to-rising earnings.  That would mean a target price in the high $30 range.  However, INTC’s actions imply that top management doesn’t believe the business is viable without M&C.  So maybe the right price for the traditional business would be $30.

That leaves the question of the status of M&C still up in the air, though.

On the other hand, if INTC can create a profitable mobile business, that would mean–to pluck numbers out of the air–total INTC near-term earnings could be $3 a share, with a higher growth rate.  Worth $45 a share?  …probably so.

My bottom line:  news of a cyclical upturn in the PC and server businesses probably supports INTC shares for the time being.  Eventual downside to the high $20s (?) if/as it becomes clear the mobile chip business has no hope.  Upside to $40+ on signs that INTC is narrowing its M&C operating losses.

I find it hard to assign probabilities to either outcome.  For the time being I’m content to remain a holder of the stock.