Google & Samsung – Tough at the top

Google Q1 19 – Risky investments.

• Google reported disappointing Q1 19 results as both its size and the fact that it is 50% dependent on fixed internet advertising caused it to underperform expectations.
• Q1 19 ex-TAC revenues / adj-EPS were $29.5bn / $11.90 which were below expectations when compared to consensus at $30.3bn / $13.21.
• This was largely caused by advertising from PCs stagnating as business increasingly moves to mobile and expenses growing more quickly than revenues.
• Google is unlike Facebook in that around 50% of its revenues come from PCs.
• Hence it is normal for Google to underperform when PCs slow down compared to mobile as Facebook’s revenues are 93% derived from mobile.
• Google also underperformed Amazon, but this advertising business is much smaller making it easier for it to grow quickly.
• However, it is worth noting that growth at Amazon’s business also plummeted from 97% YoY in Q4 18 to 36% in Q1 19.
• This business also gets a portion of its sales from fixed, meaning that it was not just Google that took a hit in that area.
• Google’s real problem remains profitability which declined to 23% (EBIT) from 25% one year ago.
• This is a combination of rising traffic acquisition costs which has been going on for some time as well as investments in its fledgeling cloud business.
• This is where the risk for Google lies as there is a significant risk that these investments don’t pay off and the cloud market remains split between Amazon, Microsoft and increasingly Alibaba.
• Google’s growth is looking much more pedestrian from here but its valuation is also not particularly challenging compared to the other digital ecosystems, so I see no reason to sell it now.

Samsung Q1 19 – Perfect storm

• The perfect storm of Huawei competition, broken phones and weakness in the smartphone market prompted Samsung to report very soft results.
• Q1 19 revenues / Net Income were KRW52.4tn / KRW5.0tn below already reduced consensus at KRW53.4tn / KRW5.2tn.
• The operating margin says it all which in Q1 19 came it at 11.9% compared to 25.8% in Q1 18 when everything was going swimmingly.
• In the last 12 months, the smartphone market has stagnated which has hit in the handset business, the memory business and the display business.
• Furthermore, Huawei has continued to close the gap in Samsung in terms of handset volumes meaning that the volume advantage that afforded the handset business double-digit margins is now a distant memory.
• Combine this with falling commodity memory and display prices as the Chinese ramp up aggressively in a bid to gain share, and it is not hard to see where the margin has gone.
• Samsung is pinning a recovery in H2 2019 on 5G ramp up and new models but this is going to be a tough nut to crack.
• Firstly, 5G is proving to be exactly what the laws of physics predicted it would be (see here) and secondly, Samsung is far from alone in ramping up new models to try and drive replacements.
• However, its valuation has come back to much more reasonable levels meaning that most of this bad news has been fully reflected.
• I would consider Samsung if I was looking for a capital parking place.