Apple / Twitter Results – Show me the money.

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Cash flow is king when growth deserts.

 Apple FQ3 16A. 

• Apple reported difficult FQ2 results but critically, iPhone shipments fell by far less than many had feared, confirming my view that this is the end of a cycle not a secular decline.
• FQ2 16A revenues and EPS were $50.6bn / $1.90 missing consensus of $52.0bn / $2.00.
• iPhone shipments were 51.2m compared to consensus of 51.0m with ASPs of $642 compared to $670 in FQ1 16A.
• A large part of the ASP weakness can be attributed to the strength of the USD which impacted overall revenues by 4% during the quarter.
• iPad shipments were 10.3m slightly better than expected driven by the larger screen iPad Pro.
• Mac shipments were 4m slightly missing expectations as the weakness in the PC market has finally impacted demand for Macs.
• Guidance was also disappointing with FQ3 16E revenues and gross margins expected at $41bn – $43bn / 37.5%-38.0% missing consensus at $47.6bn / 39.2%.
• Apple explained the shortfall as a $2bn inventory adjustment to reflect a more cautious outlook, the impact of the lower iPhone SE ASPs and the weaker outlook for the PC market.
• However, I continue to believe that the issue that Apple faces is simply that the iPhone 6 product cycle has come to an end.
• The iPhone 6 addressed a new segment of the market for the first time and also addressed the biggest complaint of iPhone owners namely the small screen.
• Consequently, there was a lot of pent up demand for the device and many users also switched from Android to iOS.
• This phenomenon is now over and iPhone demand has normalised leaving Apple looking at declines in revenues while its performance is being compared to periods when the cycle was in full swing.
• What concerns me more is gross margins which will suffer in the coming quarter from the lower revenue base and a weaker product mix.
• I highlight gross margins as they are the precursor to cash flow, and with a company that is not growing, cash flow is of paramount importance.
• Apple has $232bn of gross cash meaning that the enterprise value of the company is $372bn (taking into account after hours trading and $70bn of debt).
• This quarter Apple generated free cash flow of $33bn which taking into account the lower guidance, the slowing market and capex should comfortably come in at $120bn over the next 12 months.
• This is a free cash flow yield of 32% to anyone holding the equity today and Apple is clearly moving to return more cash to shareholders.
• With this level of return, I think growth is irrelevant but profitability must remain very strong for this thesis to work.
• I see no real immediate threat to Apple’s profitability and on the basis of cash flow yield, the shares are extremely attractive.

Twitter Q1 16A. 

• Twitter reported bad results as the fundamentals of the company performed more in line with RFM forecasts than the overly optimistic market.
• Q1 16A revenues / adj-EPS were $595m / $0.15 compared to consensus at $608 / $0.10 and RFM at $573m.
• User numbers managed to pick up a little coming in at 310m compared to consensus at 308m but guidance was very weak.
• Q2 16E revenues are expected to be $590m-$610m compared to consensus at $678m and RFM at $576m.
• The culprit was lower demand than expected from branded advertisers, underlining my long held concern that advertisers do not want to spend more on Twitter because its focus remains too narrow.
• Twitter only covers 17% of the Digital Life Pie meaning that users spend the vast majority of their time on devices doing something that is outside of services that Twitter offers.
• This fundamentally limits Twitter’s attraction to advertisers which combined with its flat-lining user growth is why revenues are grinding to a halt.
• To turn this around, Twitter needs to find something to encourage to users to spend more time within its properties and break out of being a news broadcaster.
• If successfully executed, I think this would have the effect of restarting user growth and reigniting advertiser interest which would unlock a period of very rapid, catch-up growth.
• Unfortunately, this requires focused and highly engaged management team which I believe is impossible with a part time CEO.
• Until this is rectified, I think the company will languish with very little or no growth.
• Twitter does not have fantastic cash flow to support its valuation.
• In the last 3 months generated a fairly meagre $103m in free cash flow translating into a yield of just 1% compared to Apple at 32%.
• This why I think Twitter could test $10 per share as the reality of its lack of growth sinks in there is no real cash flow to backstop the valuation of the equity.