Microsoft and Amazon – Chalk and Cheese

Microsoft has the bit between its teeth while Amazon flounders.

• Microsoft and Amazon reported results on 23^rd October leaving me in no doubt that a strong preference for Microsoft over Amazon is the right way to go.

Microsoft Q1 15A

• Microsoft reported excellent results with Q1 15A revenues and EPS of $23.2bn / $0.54 compared to consensus at $22.0bn / $0.48.
• The combination of the stability in the PC market and hardware shipments being ahead of expectations, underpinned the outperformance.
• Cloud, Office 365, Surface and Lumia all had an excellent quarter and this is expected to continue into fiscal Q2 15E.
• Phone hardware is expected to decline this quarter but this is more due to the rationalisation of the non-smartphone business which I am expecting to be wound down over the next few quarters.
• This performance is also gratifying as it comes in the midst of the biggest shakeup Microsoft has been through in the last 20 years.
• Focus has not been lost and I am comfortable that the businesses should continue to perform despite the internal upheaval.
• The key now is to bring all of the disparate pieces of the Microsoft ecosystem together.
• When they are all integrated and they all know about each other, then Microsoft can offer a full and complete offering for both Digital Life and Digital Work.
• This is the panacea that will return Microsoft to steady growth but there still remains a mountain to climb.
• In the meantime the fundamentals are steady and the stock looks likely to continue its steady performance.

Amazon Q3 14A

• Amazon reported bad Q3 14A results as growth continues to come at the expense of profitability.
• Q3 14A revenues and EPS were $20.6bn and LOSS$0.95 compared to consensus at $20.9bn and LOSS$0.75.
• Included in the figures was a $170m write-down of unsold Fire phone inventory.
• This looks like a $200 write off per device implying that Amazon had made commitments for somewhere around 1m units.
• It looks like Amazon has shipped something in the region of 35,000 devices to date.
• This comes as no surprise (see here) and I continue to believe that Amazon is conducting an expensive series of random experiments rather than having a real strategy to build an ecosystem.
• Guidance for Q4 14E was also very disappointing with revenues of $27.3bn-$30.3bn expected and net loss of $570m to a net profit of $470m is expected.
• This compares unfavourably to forecasts of $30.9bn and a net profit of $461m.
• Erratic ecosystem strategy aside, the fundamental problem with Amazon is that it makes no money.
• Investors have been waiting a long time for scale to start working in its favour and for the company to start earning some money but it never seems to happen.
• Worst of all, at 126x 2014E PER and 69.4x 2015E PER the shares are already pricing in improvements that never seem to materialise.
• The correct valuation for a company that will never make a net profit for shareholders is 1x book value.
• In Amazon’s case this is $10.3bn which is far below the current market capitalisation of $146bn.
• It is an extreme statement to say that Amazon will never make any money for shareholders but it is clear that until it does, one should steer clear.
• Google, Microsoft and Apple are far better places to be.