Ali Unwin, chief technology officer and manager of the Neptune Global Technology Fund, gives his views on Amazon and Apple’s latest earnings and explains its high conviction holdings in both despite their diverging results.
Earnings season is noisy in the technology sector. Numbers that come in marginally ahead or behind ‘market expectations’ are extrapolated to produce narratives showing the rise or fall of companies.
Our job as technology investors is to pay closer attention to longer-term trends that are far more meaningful in terms of each company’s future prospects: competitive position, pricing power and sustainably growing cash flow streams.
We then work hard to value these assets.
We remain extremely bullish on the long-term prospects of internet companies in both the US and China, and it is pleasing to see Facebook and Amazon stocks rally on strong numbers. But a good quarter does not make a good investment.
The reasons we remain high-conviction, long-term holders of these companies relate to our research and understanding of the power of network effects and scale in the technology space.
A good example of our process in action is Amazon, which is widely held across Neptune funds and is the largest relative overweight position in the Neptune Global Technology Fund. We have been buyers of the stock for the past year as we saw growing evidence that Amazon’s ‘flywheel’ business model is starting to turn more quickly.
We see Amazon taking share from bricks and mortar retailers in the real world, and our discussions with IT managers have indicated the immense traction that Amazon Web Services is generating within the enterprise.
Amazon shares sold off heavily after the December quarter as analysts were concerned about a slip in gross margin (after 15 consecutive quarterly beats) and the sustainable level of profitability as the company invested (yet more) for growth.
Our analysis suggested that Amazon had decided to spend more on third-party fulfilment as customer demand temporarily outstripped their ability to meet it internally.
Bears saw this as a demonstration that margins were unsustainable but we felt that Amazon’s commitment to impeccable customer service would, in the long run, be more valuable than a temporary margin hit would hurt.
This quarter we have seen extremely impressive growth across the board from Amazon and gross margin bounce back strongly (up 3 points year-on-year).
Apple, on the other hand, saw a demand ‘pause’ as fewer consumers upgraded to the iPhone 6s after a mammoth upgrade to larger form factor phones (iPhone 6 and 6+) in the first quarter of 2015.
The iPhone installed base is now 80% larger than it was two years ago, so we anticipate a steady – if not spectacular – upgrade cycle over the coming quarters.
Apple’s 5.4x EV/FY16 Ebitda implies a company in serious trouble, which we believe looks to be an inaccurate description of its position today.
Our main concern has always been what has historically killed consumer electronics companies: competition. This does not just refer to the hardware that Samsung or Huawei might produce, but the whole Android ecosystem, brand value, access to apps and user experience versus Apple and iOS.
We watch this very closely (especially in the emerging markets) and it seems that Apple still retains top position.
Apple has spent $22bn on R&D over the past 36 months, and while R&D spend is by no means synonymous with ‘innovation’ (see Nokia/BlackBerry), it seems investors are giving them negative credit for the possibility that some of this spending might see an incremental return on it over the next few years.
In the technology sector we are used to bumpy quarters and grandiose predictions of impending doom, but we think some are writing off Apple as yesterday’s company far too soon.