Alphabet & Microsoft Q3 2022 – Bad omens

The pandemic bill comes due.

• The technology sector is feeling the pinch as consumers and businesses have less money to spend as a result of everyone paying for the pandemic through rampant inflation and higher interest rates.
• The result is that growth expectations are being reduced and as such, this means that multiples are going to come down.
• This sends a negative signal for the higher-priced end of the technology sector which is also likely to feel the pinch this quarter and next.

Alphabet Q3 2022 – Inflation tax.

• Alphabet reported weaker-than-expected results as consumers are spending less which has meant that advertisers spend less money on marketing their wares to them.
• Q3 2022 revenues-ex TAC / EPS were $57.3bn / $1.06 behind estimates of $58.2bn / $1.25.
• The weakness was felt across all of its advertising products as video advertising on YouTube and revenues from search both missed expectations.
• However, there are two things that are important to remember.
  • First, FX: the US dollar has been very strong so far during H2 2022 and this will have a negative effect on the translation of revenues from other countries back into dollars.
  • Furthermore, most of Google’s expenses are in US dollars which means that there will also be a transaction effect resulting in margin pressure which will have contributed to the EPS weaknesses observed.
  • Second, growth: While revenues were weaker than expected, they were still positive YoY, which is a significant achievement given how strong 2021 was and how different the macroeconomic picture now is.
• Consequently, I do not see real pressure on Google’s business, but unrealistic growth expectations will now come down and with it will go the multiple that the market is paying for Google’s earnings.
• Analysts love straight lines which means that the cuts they make will ultimately go too far meaning that there will come a time again when Google is able to sustainably beat expectations.
• That time is quite far off at the moment, but that time will be the opportunity to get back into Google which is a stock I left on valuation grounds quite some time ago.

Microsoft FQ1 2023 – The price of high expectations

• Microsoft reported good results but weak guidance which was particularly impacted by a fall in PC shipments, the strong US dollar as well as a slowdown in cloud computing.
• Microsoft FQ1 2023 revenues / EPS were $50.1bn / $2.35 ahead of expectations of $49.6bn / $2.29 which is a lot better than many of its large technology peers have managed.
• All attention was paid to the forward-looking statements where the headline was that Azure growth will fall to 37% in FQ2 2023 from 42% in FQ1 2023 before any movements in the US dollar.
• In this market, I think that growth of 37% YoY ranks as excellent performance, but the shares still fell by 7% in after-hours trading.
• This is yet another sign that despite the excellent performance, the shares of Microsoft are overvalued and now there is going to be a re-rating of its multiples by the market.
• Microsoft is also not immune to inflation as it now expects to spend a massive $800m more in energy costs to run and cool its data centres across the world this year.
• Unsurprisingly, a disproportionately high portion of the $800m is coming from Europe where the energy crisis is most acute.
• This will make a great marketing point for Arm where the move to design energy-efficient data centre processors is gathering pace and will only be reinforced by this statement from Microsoft.
• This also has a negative read-across for Amazon whose cloud businesses is more than 3x the size of Microsoft’s implying a $2.4bn increase in expenses over the next 12 months.
• This combined with weakness in PC shipments will put pressure on profitability which is why, like Alphabet, Microsoft is also looking to limit expenses particularly around adding more headcount.
• This makes sense as expenses in software and services businesses are largely headcount based making this the most effective way to control and preserve profitability.
• Revenues are not declining and so cuts are not needed but growth is clearly going to be slower.
• Like Alphabet, estimates for Microsoft are going to come down and the multiple that the market pays will also come down.
• Long gone are the days when one could pay 10x for Microsoft’s earnings but as sentiment sours, one might be able to get back into an excellent business at a much more reasonable price than now.
• I left Microsoft some time ago due to its high valuation and I would welcome the chance to get back in.