Microsoft and Facebook – The social trend.

Facebook surprises more than Microsoft.

Microsoft FQ3 2020 – The obvious beat

• Microsoft ticked all the right boxes in its FQ3 2020 earnings report with the exception that it saw weakness from one-time software sales which are typically purchased by small businesses which is where the virus hammer is falling the hardest.
• FQ3 2020 revenues / EPS were $35.0bn / $1.40 which was 1.6% ahead of revenue expectations and 8.3% ahead of EPS forecasts.
• Azure (cloud) revenue growth jumped back up to 57% YoY while its overall revenues attached to the cloud also jumped to 39% YoY.
• Whatever happens from here, this trend is likely to be sustained meaning that cloud revenue growth should continue to be elevated for the next 12 months or so.
• While Windows Surface has some trouble sourcing components, the other parts of the More Personal Computing segment where Xbox and Windows licencing is to be found more than made up the gap.
• The obviousness of Microsoft’s business performance is clear from the guidance which has come in exactly where consensus put it, forecasting FQ4 2020 revenues / EBIT of $36.5bn / $13.0bn compared to forecasts of $36.9bn / $12.9bn.
• Microsoft is not desperately exciting but with the level of uncertainty swirling around in the market, this is exactly what one should be looking for.
• My only concern with Microsoft remains its valuation and how that might be hit should the overall market decide that an all-time high valuation for the S&P500 is too rich during one of the worst recessions seen for 90 years.

Facebook Q1 2020 – Confirms the social trend.

• Facebook reported stronger than expected results as the impact of the pandemic did not hit until March but has also seen revenues stabilise at a level significantly better than Google.
• Q1 2020 revenues / EPS were $17.4bn / $1.71 broadly in line with estimates but it was the commentary around the stabilisation which made the shares jump in after-hours trading.
• Engagement was up across the board with monthly active users (MaU) and daily active users (DaU) returning to 10% and 11% respectively compared to low single digits in recent years.
• This represents new users and previously disengaged users engaging with Facebook as a communication tool during the lockdown.
• I do not expect this growth to be sustained but the absolute level of users should remain slightly elevated once things return to some semblance of normality.
• Very much like Google, Facebook saw normal revenue during January and February which began to grind to a halt in March.
• However, the good news is that unlike Google which is currently experiencing declines of mid-teens in April, Facebook has seen its revenues stabilise at around the same levels as in April 2019.
• The net result is that Facebook is cutting its planned expansion of expenses by $2bn annually but is not halting it entirely.
• This reflects SNAP’s results and confirms a trend where digital advertising is being slashed across the board but is also being tilted much more towards social networking platforms.
• This is how Facebook can feel confident in growing overall expenses in 2020 as opposed to the more conservative approach taken by Google.
• Facebook’s shares jumped 10.5% in after-hours trading reaching $214 putting it close to its all-time high of $224 reached in January.
• This is a great example of the irrationality currently gripping the equity market in general.
• Facebook has said that growth has ground to a halt and margins will be hit in 2020 meaning lower earnings but the shares have returned to levels reached when around 20% growth was expected.
• Consequently, there has been a substantial increase in the PE ratio that the market is prepared to pay for Facebook’s earnings.
• In a recession, the PE ratio of the market usually declines meaningfully as there is lower confidence in earnings growth and the consistency of that growth.
• This is what makes me very nervous about technology companies with valuations towards the top end of the range.
• Amazon and Microsoft both have great tailwinds but their valuations are still a lot higher than those of Facebook and Google leaving them at risk should the PE ratio of the market collapse.
• It is the possibility of this seemingly inevitable collapse that leaves me nervous with regard to having any equity exposure.
• Hence, I would stick with a market-neutral strategy (long-short) or go into the more defensive names like Intel, Samsung, Seagate whose valuations are unlikely to unwind less in the advent of a big correction.
• I am expecting this correction at some point as the Fed cannot support the market with printed money forever.