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

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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

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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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