Technology Research Industry Update December 7, 2017 - GBH Insights
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Technology Research Industry Update December 7, 2017 Thoughts on FANG Stocks Heading into 2018; Healthy Secular Trends Front and Center Daniel Ives, Head of Technology Research | 917.210.3220 | daniel.ives@gbhinsights.com While FANG stocks have been standout performers in 2017 we have seen a rotation out of these core names over the last week with some tech investors locking in gains for the year, as well as lingering worries around growth/competition causing some concern on the Street as we head into 2018. Overall, we continue to be very bullish on secular tech themes heading into 2018 around streaming/content, e-commerce growth, online ad growth, and the transformational cloud shift among enterprises. While the regulatory environment, corporate tax changes, and the macro backdrop create both opportunities and challenges for these FANG names as well as the rest of the tech sector, we believe the underlying fundamentals, spending environment, and consumer/enterprise landscape looks very healthy heading into 2018 with some potential speed bumps ahead to keep an eye out for. Below we discuss our thoughts on each of these FANG names going into year-end/2018 and lay out the growth catalysts and biggest potential risks for each of these tech stalwarts as we look into our crystal ball. While we are maintaining our Highly Attractive ratings and positive views on FANG stocks into 2018, we are raising our price targets on Amazon from $1,270 to $1,375 and Alphabet from $1,100 to $1,190 to reflect our increased confidence on these underlying fundamental stories over the coming year. Facebook (Highly Attractive, $210 Price Target) • Healthy MAU growth front and center. While there continues to be evolution around Facebook’s ad growth model and monetization strategy, it appears the company is executing extremely well in the field (e.g. engagement, MAU growth, ad growth) and all key metrics look healthy heading into 4Q and 2018 based on our recent checks and GBH survey work. We maintain our Highly Attractive rating and $210 price target. • 2 billion users and counting. We estimate Facebook is on a trajectory to have another solid quarter in 4Q on the MAU front and has strong
Technology Research Industry Update December 7, 2017 momentum heading into 2018 on this all-important growth driver for the business. With MAUs currently north of 2 billion total users, Facebook will continue to grow its massive global installed base in our opinion while importantly monetizing users especially on the Instagram side of the house, which remains the “core 1-2 punch” that underlies our bullish thesis on the name. • Instagram growth and monetization are the keys going forward. We note that Instagram already announced 800 million MAUs in September (vs. 700 million in April) as this platform remains a “golden jewel” in Facebook’s platform in our opinion with healthy monetization and ad growth set to play out in 2018 based on our forecasts. With this platform on pace to be over 1 billion MAUs by 1H2018 based on our estimates, we view this an underappreciated asset by the Street that could be a major growth catalyst for Facebook over the next 12 to 18 months on the advertising front. • Investing for future growth. Facebook must invest in newer growth initiatives in our opinion to further expand its drivers around ad growth rates, AR, mobile platform expansion, video, consumer engagement, and Instagram/Messenger monetization into 2018 and beyond. This is an integral part of Facebook’s strategy that we expect to play out over the coming years despite worries on the Street around a stepped up investment profile for the coming year. • Biggest risk/concern heading into 2018: Facebook recently gave a FY18 outlook that is anticipated to be an “investment year” with forecasted total expense growth of 45%-60%. While the term “investment year” are never two words investors want to hear, we do believe this is a prudent strategy despite causing some agita for bulls on the name. The company is citing this significant increase in spending primarily to the hiring of more employees to work on security/safety along with payments Facebook is making for shows in its recently unveiled Watch tab as video remains a major “wild card” product initiative in our opinion. To this point, this higher investment profile could be a lingering cloud over Facebook’s shares in the Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 2
Technology Research Industry Update December 7, 2017 near term until investors can get further comfort that these investments are fueling the next phase of the company’s growth story for 2018 and beyond with margin improvement hopefully set to kick in for 2019. Amazon (AMZN-Highly Attractive, $1,350 Price Target) • Iron grip on e-commerce spending. Amazon was the clear star of Cyber Monday as we forecast the company is on pace to capture between 45-50% of all holiday online sales this year (vs 38% in 2016). While Walmart has done a commendable job beefing up its e-commerce strategy through organic (partner push, inventory expansion, offline driving online sales) and acquisitive means (Jet.com), Amazon continues to have an “iron grip” on the e-commerce market heading into 2018 despite a clear bullseye on its back from retailers around the world including Bentonville. To reflect our increased confidence in Amazon’s underlying core growth drivers into 2018, we are raising our price target from $1,270 to $1,350 while maintaining our Highly Attractive rating. • Prime membership growth is Amazon’s key asset. Bezos has built a Prime membership of over 85 million strong which is poised to increase spending another 20%+ this year and likely beat 4Q estimates handily and is on a stronger than expected organic growth pace for 2018 in our opinion. Prime growth remains the key jewel for Amazon going forward as cross- selling around Whole Foods customers and putting up more walls/barriers around its growing Prime customer base is a major ingredient in Amazon’s ability to fend off competition. International growth on Prime will also be another catalyst that we expect to play out in 2018 and should help further drive better than expected e-commerce retail growth in the year ahead. • Driving the Amazon flywheel effect. While near-term there is a major focus on significant investments around fulfillment, Prime, Echo/Alexa, AWS, and integrating the Whole Foods acquisition into the fold which could Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 3
Technology Research Industry Update December 7, 2017 depress margins over the next few quarters, we believe this is “near term pain for long-term gain” as Amazon has a unique window of opportunity to double down on its consumer and enterprise initiatives heading into 2018 and drive significant growth/cash flow for the coming years as Bezos & Co. further diversifies the Amazon franchise globally. • Whole Foods synergies=tailwinds into 2018. Strong customer overlap is a major synergy behind the Whole Foods acquisition and provides another avenue of growth into this key customer demographic to increase Prime membership and cross-sell over the next year in our opinion. We are encouraged by the early go-to-market techniques and cross-selling that Amazon has been deploying in Whole Foods stores, as with Prime members spending roughly 2x more than non-members increasing this customer base represents the holy grail. With Amazon’s underlying goal to increase the average customer purchase/basket size, we believe further integration between Whole Foods inventory (recent price cuts in-line with Amazon’s playbook) and the Amazon e-commerce machine is a great 1-2 punch that should drive increased sales/ramp in Prime members for 2018 and is still underappreciated by the Street in our opinion. We also believe potentially aggressively betting on other consumer areas such as healthcare with the pharmacy segment front and center, despite recent noise, is a smart strategic move as Amazon looks to further spread its tentacles across the consumer landscape globally in 2018 and beyond. • AWS remains a pillar of strength. Our AWS checks this quarter are strong yet again as we are seeing major tailwinds on the company’s all- important cloud business as more enterprises shift to the AWS value proposition heading into 2018. We are modeling AWS growth of 40%+ year over year and believe Amazon has strong momentum as the combination of a secular cloud shift, entrenched leadership position, and recent price cuts are catalyzing customer adds and balanced strength geographically speaking, a dynamic we expect to accelerate into 2018. While this “two horse cloud race” between AWS and Microsoft should disproportionably Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 4
Technology Research Industry Update December 7, 2017 benefit both companies in the field, continuing to stay one ahead of the competition with tech stalwarts such as Dell/EMC, Cisco, Google, Oracle among others going after the same piece of the pie remains a competitive dynamic we will be closely watching over the coming year. • Biggest risk/concern heading into 2018: We believe the biggest risk and investor concern for Amazon and Bezos is emerging competition from every direction of the consumer and enterprise landscape with bears pointing to 2018 as finally the year that competitive pressures puts a dent in the Amazon armor. To this point, while on the retail e-commerce front behemoths like Walmart have significantly stepped up their game, we do not believe this should significantly alter the Amazon growth story for 2018 as well as on the AWS front (Microsoft, other cloud players lurking). However, we do believe the aggressive diversification strategy for Amazon is smart, but does come with inherent risks as going after grocery (Whole Foods) and now likely healthcare/pharmacy in 2018 could cause some speed bumps around margins and near-term execution risks which are something for investors to keep their eye with competition lurking from all directions going after the Amazon consumer and enterprise spending pie. Netflix (NFLX-Highly Attractive, $235 Price Target) • Netflix well positioned for 2018 and beyond. As we head into year- end/2018 we believe Netflix has a number of growth levers which should fuel the company’s next phase of strategic penetration among both US and especially international consumers. While the landscape for original content has become increasingly competitive with new entrants entering the market by the day (e.g. Disney, Comcast, etc.), we believe Netflix remains in a unique position of strength to grow its content and distribution tentacles over the next 12 to 18 months and thus further build out its massive content Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 5
Technology Research Industry Update December 7, 2017 and streaming footprint. We maintain our Highly Attractive rating and $235 price target. • Netflix’s competitive moat. We have confidence in the “Netflix content machine” and its ability to expand original content creation (new releases this quarter-Crown 2, Stranger Things 2) with minimal long-term negative franchise impacts due to Disney canceling its license deal recently despite noise in the market. Our bullish thesis on Netflix is based on our belief that the company’s competitive moat, franchise appeal, ability to increase international streaming customers through 2020, and original content build out will translate into robust profitability and growth as the next phase of this story plays out over the coming year. • Content is king for Netflix in 2018 and beyond. The underlying growth and franchise model at Netflix all revolves around original content build out fueling consumer engagement and subscriber growth. With the appetite for content among media companies reaching a feverish pitch, Netflix will be spending between $7 billion and $8 billion on content in 2018, up roughly $1 billion from its spending trajectory for 2017. On its 3Q earnings call, management said it expects roughly 25% of its content spending to be allocated towards original content in 2017 with a long-term target of 50% by 2020. With more consumer dollars shifting away from traditional cable with cord cutting and towards streaming delivery, we believe Netflix has a long runway of growth and opportunity ahead of itself and clear first mover advantage despite intense competition from larger media players, pure play competitors, and new potential entrants. • International sub ramp up front and center. Netflix has talked about its US domestic penetration potential in the 60M to 90M range with our estimate that by 2019 they break the 60M mark (forecasting 54 million subs Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 6
Technology Research Industry Update December 7, 2017 exiting 2017) and mid to high single digit domestic growth sustainable from 2019-2021. The holy grail of incremental growth (and profitability) going forward will be from international customers as we believe Netflix has a TAM of over 700M subs by 2020. With the company spending major resources over the last two years building out a global distribution arm and customer base in over 100 countries, we believe the fruits of this labor will start to be fully realized in 2018 and beyond. With the US market starting to see a normalized growth rate after a period of hyper-growth, we believe Netflix has potential to get between 90M to 100M international subs by 2020 (vs. ~60M today), thus rounding out the long term growth and margin story for the coming years. With the international segment turning the corner on profitability in 2017, we believe this incremental growth will flow to the bottom-line and translate into significant cash flow and EPS growth, a dynamic that we believe is still underappreciated by the Street today. To this point, as international growth ramps along with profitability, we believe the Netflix growth story will transition from purely domestic driven into a global streaming play, original content behemoth, and rising ARPU franchise translating into a higher multiple and significant long term earnings power and speaking to our bull case scenario for shares of Netflix heading into 2018. • Biggest risk/concern heading into 2018: Price elasticity remains a hot button issue for the Street as with Netflix’s recent domestic price increase, coupled by rising competition from the likes of Hulu and Amazon among others (e.g. Apple, HBO GO), there are lingering questions heading into 2018 around customer retention/growth with lower price options and high quality original content elsewhere in the market. While this remains a lingering concern for 2018 as the battle for streaming content will put more pressure on the Netflix machine (e.g. Disney/Fox deal looming), we are not Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 7
Technology Research Industry Update December 7, 2017 overly concerned that this dynamic will alter the company’s growth trajectory in the near-term given the Netflix competitive moat and original content spending trajectory. That said, any speed bumps on the international sub ramp and/or US price increase impact will negatively impact the stock/multiple as the Street is hyper sensitive to any hiccups on these initiatives. Google/Alphabet (GOOGL-Highly Attractive, $1,190 Price Target) • 2018 is a “prove me” year for Google. The main growth drivers and key fuel in the engine for Google/Alphabet into 2018 remain mobile search, YouTube, and overall advertising strength which have clear tailwinds heading into 2018 in our opinion based on recent results and our ad survey tracker work this quarter. To this point, we believe Google has a number of organic growth investments that will start to bear fruit in 2018 as ad growth, mobile impression strength, and a host of other initiatives lay out a compelling growth story for Google in 2018 in our opinion. To reflect our increased confidence in Google’s underlying growth drivers and our recent checks into 2018 especially on mobile ad success, we are raising our price target from $1,100 to $1,190, while maintaining our Highly Attractive rating. • YouTube a major advertising asset. We continue to believe YouTube is the major growth driver on the ad front, as this dominant platform now has north of 1.5 billion users watching on average 60 minutes per day. As Google further monetizes this “golden advertising gem” over the coming 12 to 18 months we believe this will be a major growth catalyst that is under appreciated by investors in our opinion and a key driver of ad growth for 2018 and beyond. • TAC remains the banner on the airplane that everyone is watching. Importantly, Google’s advertising business and trends are showing accelerating growth, as we saw TAC increase sequentially in its last quarter Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 8
Technology Research Industry Update December 7, 2017 with mobile search driving this dynamic. We continue to believe that improving TAC trends into 2018 are a major part of the Google narrative going forward, as mobile advertising impression success holds the key to the advertising kingdom in our opinion. Overall while initiatives around hardware (Pixel), cloud (recent partnership with Cisco), AI, and Other Bets (Nest, Fiber) are all important growth initiatives to expand the company’s growth tentacles on both the consumer and enterprise front for 2018/2019, it all comes down to stellar mobile search and advertising growth with YouTube remaining a key under penetrated asset in the Google product portfolio in our opinion. • Biggest risk/concern heading into 2018: With the competition for mobile ad dollars becoming fiercer it is becoming incrementally important for Google to successfully monetize its search kingdom, YouTube asset, and mobile impression success in 2018 as the coming year could be a huge leap forward (or setback) for the company around monetization of its platform. However, this will not be an easy task as we believe Google has some more wood to chop ahead on its “bread and butter” advertising platform/AI capabilities as mobile remains the gateway to its next phase of growth with an increasingly more crowded and price competitive landscape abound which represents an ongoing risk around the name. Daniel H. Ives 917.210.3220 daniel.ives@gbhinsights.com Copyright © 2017 GBH Insights Page 9
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