MAGA Has Replaced The FAANGs
August 16, 2018
- The Financial Times says the new tech leaders are MAGA not FAANGs.
- Microsoft is turning into a services company, producing lots of cash flow.
- Apple is also turning into a services company, and is insanely cheap.
- Amazon.com continues to fire on all cylinder and throw off cash flow.
With the recent blowups of Facebook and Netflix, the Financial Times said the stock market’s technology leaders are no longer the FAANGs, but have been realigned as MAGA.
While that’s a clever play on President Trump’s Make America Great Again, it actually stands for Microsoft (MSFT), Apple (AAPL), Google (GOOGL) and Amazon.com (AMZN).
Facebook (FB), the "F" in FAANG, gets kicked out after missing revenue expectations in July on slower user growth, then forecasting revenue growth rates would continue to fall. You may remember this as the day Facebook's stock fell 20%.
Netflix (NFLX), the “N” in FAANG, hardly deserves to be wrapped into the same acronym as the other tech leaders, said the Financial Times, after its shortfall in subscriber growth last quarter.
I have to say I agree, especially, with Microsoft adding $280 billion of stock market value in the last year alone, nearly double Netflix’s entire market cap, according to the FT.
The Microsoft story is all about Chief Executive Satya Nadella's skill in transitioning the software giant into a services company. He's turning its Office software suite into a subscription-based platform and moving the rest of the company into cloud-based technology.
Azure, the company’s cloud-computing business, has replaced Windows as its key enterprise offering, according to Atlantic Equities analyst James Cordwell. In June, Cordwell forecast Azure will produce more than $100 billion in revenue over the next decade.
Research firm Canalys said Azure is growing faster than everyone else, although Amazon Web Services is currently bigger. Canalys ranks Google’s cloud services in third place.
For the fiscal fourth quarter ended June 30, Microsoft reported Azure’s revenues surged 89%. Meanwhile revenues jumped 13% to $9.67 billion at the company’s core productivity and business processes segment, which includes the Office 365 software suite. The company is also having a renaissance with its hardware. The Surface tablet saw sales increase 25% over last year. In addition, the company increased its research and development budget 13% in fiscal 2018.
Mr. Softie is sitting on a ton of cash, $134 billion, to pay dividends and buy back stock. Currently, it has 7.7 billion shares outstanding. Both ValueLine and MarketSmith predict it will buy back 500 million shares over the next 18 months, reducing that to 7.2 billion, which will boost earnings per share.
With a reduced share count and Value Line's forward price-to-earnings ratio of 26 on next year's earnings of $6.00, its reoccurring revenue from the majority of the business gets you to a share price of $156, 39% above Thursday's $112.
Apple is also all about the services business.
As shown by the latest editions of the iPhone and iPad, as well, as the dearth of new innovative products, CEO Tim Cook is not a visionary like Apple founder Steve Jobs. But with the cellphone market well saturated, Cook is smart enough to realize the company needs to move in a new direction. So, he’s radically changing the business from hardware to services, which is where the cash flow is. Apple services include the App Store, Apple Care, Apple Pay, iTunes and cloud services.
For the fiscal third quarter ended June 30, Apple reported revenue grew 17%, its fourth consecutive quarter of double-digit revenue growth. Earnings per share surged 40% year over year even as the number of iPhones shipped stayed flat at 41.3 million. Revenue in the high margin services business leapt 28% to $9.55 billion.
When earnings were released, Luca Maestri, Apple’s CFO, said, “We returned almost $25 billion to investors through our capital return program during the quarter, including $20 billion in share repurchases.”
Services is a high margin business. As that part of the company grows there will be more cash to distribute to investors. Apple predicts gross margins of 38.5% for the next quarter. But as the company keeps growing the services business, I predict it can boost gross margins to 40%.
With services revenue currently at $9.55 billion a quarter, that gives us a conservative estimate of $40 billion for the next four quarters. If we boost that services revenue forecast to $50 billion a year from now, at 40% gross margin that's $20 billion that can be returned to shareholders.
Apple is paying a dividend yield of just 1.4%. Now, that $20 billion in gross margin floating around is just 2% of Apple's record-breaking $1 trillion market cap.
When we view it that way we think there is enormous room for the dividend to grow and for the board to return more of the current profits to the shareholders for their loyalty.
With Apple steadily increasing dividends and buying back large amounts of stock, it would almost be worth it to own the company strictly as a dividend play. But the stock is insanely undervalued.
Current operating cash flow is $14.5 billion, or $3 a share, on a float of $4.8 billion outstanding shares. By end of 2019 we expect it to be $4.7 billion and by end of 2021 $4.5 billion. Currently, Warren Buffett's Berkshire Hathaway own 252 million shares.
Total free cash flow today is $10 a share and the stock trades at $208. We see free cash flow growing to $21 a share by 2021. According to YCharts, Apple's price-to-earnings ratio on Wednesday is 19. If that contracts to 15 by 2021, and you put a 15 multiple on $21 you get a share price of $315 in 2021. Our target is $300.
Amazon.com is another cash flow story.
The big thing Amazon has going for it is Amazon Prime, its all-purpose value-added service for customers willing to pay an annual fee for free shipping on products ordered. But it's more than just shipping. It's streaming video, music and other Prime-specific deals.
Prime has more than 100 million members worldwide and Amazon recently raised its price to $119 from $99. We don't expect any significant drop-off in subscribers.
Chief Executive Jeff Bezos knows he's providing a valuable service to people. In turn, consumers see the value of what they get year in and out and are willing to pay more for a quality service. Basically, Prime is $10 a month, compared to Netflix, which is $8 a month for just streaming.
In fact, more people adopted Prime on July 16 than any other day in the company's history at $119 a year, according to Venturebeat.com.Subscriptions revenue surged 57% in the second quarter to $3.4 billion.
For the second quarter, total revenues jumped 39% to $52.9 billion. But here's the fireworks: net income soared to $2.5 billion, or $5.07 per diluted share, compared with $197 million, or 40 cents per diluted share, in the year-ago quarter.
Free cash flow increased to $10.4 billion for the trailing twelve months, compared with $9.6 billion for the trailing twelve months ended June 30, 2017.
So, it appears that Prime price increase, which doesn't seem to boost expenses, would be an additional $2 billion dollars in annual free cash that just flows to the bottom line.
Amazon Web Services (AWS), the company’s profit center, reported sales leapt 49% to $6.1 billion, beating analysts consensus estimate of $6 billion.
Prime is offering members discounts at Whole Foods, which Amazon recently bought. Prime members are adopting the supermarket faster than the company anticipated and that could go up even faster. The company predicts third quarter earnings between $1.4 billion and $2.4 billion.
Second-quarter profits increased 13-fold. So, there's a precedent for the company seeing profits rise hundreds percent. Amazon is entering a phase where it's investing less on capital expenditures, so this should increase cash flow and earnings can ramp up.
In 2017, Amazon posted $4.55 in annual earnings per share. This year the estimate is $17.24 a share, nearly a 300% increase. Wall Street is predicting earnings per share of $25.19 in 2019, just a 46% increase, which seems pretty conservative.
The Nasdaq website reports Amazon's p/e ratio as 398 in 2017, contracting to 143 in 2018, and going to 90 in 2019. As earnings ramp up we believe there will be a higher price and lower P/E in the future. So, 90 times earnings of $25 gives us a stock price of $2,250 next year. We think Amazon could earn a conservative $31 a share in 2020 and continuing the 90 multiple that would give us a price of $2,700.
Google, was recently renamed Alphabet, but that obviously throws off the acronym with too many "A"s. Google is the least exciting of the bunch. It's basically an advertising firm with 47% of revenue from the U.S and 53% from outside the U.S. It has free cash flow of about $24 billion.
Google is still the king of what it does. No other company has found a way to compete with them on search. And it's been trying to kill Microsoft's Office by giving away document and email programs for free.
We're don't have a price target on Alphabet, and think the most interesting thing about the companies is its Waymo subsidiary. Waymo is a self-driving car company. Currently, we think Alphabet is an okay stock. It's making some headway with its hardware, cloud and play offerings. Google Pay could become a significant contributor to earnings in the future.
Currently, Waymo isn't making any money. However, if Waymo's technology becomes what Morgan Stanley forecasts, it could become a $140 billion business in about three years. It may offer long-term value depending on how the market evolves for self-driving cars. In which case, Alphabet, or Google, or whatever, would deserve a much higher valuation.
Disclosure: I am long MSFT, AAPL, AMZN.