Digital Ecosystems – Easier compares

All about cost-cutting.

• Meta, Google and Microsoft have all painted a rosy picture of recovery but sifting through the details reveals a reality which is much more sanguine although not as bad as many have feared.
• Alphabet, Meta and Microsoft all reported good results with revenue growth recovering more than expected as well as improving profitability.
• In all cases, the improvement in profitability is almost entirely due to the cost cuts that all of them put through in H1 2023 and so have very little to do with the current operating environment.
• Here, YoY growth has recovered with Meta reporting 11% YoY growth, Alphabet 7% and Microsoft 8% YoY all of which beat expectations by a few percentage points.
• At a high level, this reads as a recovery in consumer activity but it is worth remembering that it was Q2 2022 when growth in these companies started to significantly slow which worsened into Q3 2022.
• This means that the YoY comparisons for these companies in Q2 2023 are much easier than they were in Q1 2023 giving one reason to partly explain the recovery.
• Another is inflation.
• Consumers are spending more money, but they do not seem to be buying more products but instead are paying higher prices for the products that they do buy.
• This is a result of the reduction in the value of fiat currency (of which a lot has been printed since 2020) rather than a sudden jump in consumer confidence leading spenders to rush out and buy more products.
• When I take these two factors into consideration, I don’t see a sudden recovery but more a situation that is not ideal but is at least stable.
• This is why almost all of the commentary in these results was about AI and here again, sleight of hand has come in very useful.
• Both Google and Meta Platforms have been using AI in their products for years with differing levels of success (Google – good, Meta Platforms – bad).
• 2023 has seen a meteoric rise in interest in AI and generative AI in particular.
• Generative AI is a relatively new type of AI that uses large models to generate content and investors currently cannot get enough of this type of AI.
• In their conference calls both Google and Meta Platforms were vague enough in their commentary to imply that they are already using generative AI in their commercial products when what they are really using is the same stuff that they have always used.
• In short, they are dressing up an activity they have been doing for years to look like the new technology for the sake of appearances.
• Clearly, they are going to begin using the new technology in commercial products pretty soon but it is going to take a long-time before these products have a material effect on revenues.
• Furthermore, I suspect that expectations of generative AI pricing are probably 12x too high meaning that the current $20 per month that everyone is banking on receiving is likely to end up being closer to $20 per year or less.
• However, for the moment, reality has been booted from the driving seat and there is hay to be made by creating the perception of being a leader in this area which, to be fair, Google, Microsoft and Meta Platforms all are.
• Hence, the real story for value investors at the moment is one of operational improvements and cost cutting which is the main reason why Meta Platforms has performed so well this year.
• Many of the digital ecosystems have been very lax on cost control while growth was abundant and have hired far more people than they really need.
• This is what has created a large amount of surplus capacity that can be easily removed without having any meaningful impact on the performance of the business or its growth.
• Meta has been trading at a substantial discount to both Google and Microsoft but its stellar performance over the last 6 months has removed this discount making all of these companies look pretty expensive.
• I missed Meta as I was waiting for $70 before buying it and I have no inclination to chase it or either of the others from here.