Global Tech: stocks in focus - Facebook, Alphabet, Apple, Amazon



Technology is a sector where 'the winner of most market share' tends to enjoy a disproportionately large share of profits. Alison Porter, portfolio manager within Henderson's Global Technology Team, provides an update on key holdings - Apple, Facebook, Alphabet (formerly Google) and Amazon - following the release of the companies' latest quarterly earnings results, recent company visits and management meetings.

Facebook and Alphabet – online advertising growth

Facebook and Alphabet are long-term holdings in the Henderson Global Technology Strategy and fourth quarter earnings provided further evidence of the trend of advertising dollars moving online. Online advertising still constitutes a relatively small portion of overall advertising (less than 30%). We expect this to increase to above 40% in the next three to five years as advertisers shift spending from print and TV towards online, search and social media. Facebook and Alphabet (via Google) are the key beneficiaries of this trend, having captured more than 80% of the incremental advertising dollars spent online in the fourth quarter of 2015.  In the fourth quarter, Facebook grew its advertising dollars by 66% as the social media company increased its level of video advertising and added advertisements to Instagram.  The Global Technology Team’s recent conversation with Facebook’s management confirmed our view that with Instagram in the early stages of monetisation and the revenue generation model for WhatsApp and Messenger still ahead, there is a long runway of more than 25% revenue growth at Facebook for the foreseeable future. Given the size of the revenue base, investors are anticipating growth to decelerate from the level reported last quarter. 
Alphabet also recently provided investors with further information on its other investments i.e. ‘other bets’, which currently lose money hence highlighting the profitability of Google.  We expect Alphabet’s new chief financial officer to continue to demonstrate renewed capital discipline and additional segment disclosures over the next year, which should improve the valuation of  Alphabet’s other businesses. In addition, we expect YouTube, also owned by Alphabet, to continue to capitalise on its leading online video advertising share with over 1 billion monthly active users. 
Apple – a transitional phase
While we maintain a significant position in Apple (around 7% at end February 2016 versus an index weighting of 11%), this is a reduced weighting compared to last year with the holding sold down in September and further in December 2015. This move was based on concerns about the outlook for near-term iPhone sales and in particular a slowdown in Chinese handset sales. Other products such as the iWatch and the new iPad Pro have seen limited traction. In the first half of 2016, Apple faces challenging sales comparisons but the iPhone 7 launch later in the year should bolster sales. US dollar strength has become increasingly problematic for Apple in emerging markets given the already steep price for the iPhone. We believe that average selling prices for the iPhone have likely peaked, but the company can still grow in the long term by leveraging its eco-system (platform).  
Apple is currently valued by the market as a one product cyclical company, which we believe undervalues the potential long-term value of the user base and eco-system.  During the company’s recent quarterly earnings conference call, Apple revealed it has an installed base of over 1 billion devices and a services business of around $20bn (circa 10% of sales), which is more  profitable than the corporate average. Following meetings with the company, we believe that Apple is becoming more focused on developing this services opportunity and may increase acquisitions to bolster its suite of services and applications, and to drive new growth areas such as Apple TV or an Apple car. The move to diversify away from the iPhone is a long-term transition for the business and acquisitions are a change in strategy, which could limit medium-term share price appreciation. The company, however, maintains its attractive capital return policy with a very healthy balance sheet (described by chief executive officer Tim Cook as “the mother of all balance sheets”) and is committed to returning free cash flow to shareholders.  This will provide downside support to the share price during this transitional phase.
Amazon – ‘customer first’ strategy

Source: iStock/Rene Mansi

Amazon suffered a shortfall in operating profits in the fourth quarter of 2015.  This came following a year when Amazon had more than doubled in value hence investors sold the stock and took profits. A combination of increased promotional spending in US retail and higher costs to meet customer service deadlines led to lower gross profit margins.  Following a meeting at the Amazon headquarters in Seattle, we are satisfied that the higher costs incurred are symptomatic of the ‘customer first‘ strategy that has driven the company to its ranking of number one for market share in developed markets’ e-commerce.  The magnitude of strength in demand from sellers for Fulfilment by Amazon (FBA), which helps online sellers on Amazon with logistics, delivery, customer service, etc. surprised the company and resulted in unexpected costs, but is ultimately an indicator that Amazon is building upon its competitive advantage in e-commerce.
Amazon Web Services continues to drive the adoption of cloud infrastructure and services, and it has the lead market share in a sector that is in its infancy.  While competition from Google, IBM and Microsoft is likely to intensify in 2016, Amazon is in pole position to benefit from the secular trend of how technology systems and services are adopted.  We are encouraged by the company’s recent commitment to buy back $5billion of its own stock but look for a more attractive valuation point to add to the holding.
The above stock comments are intended for illustrative purposes only and are not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy.
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