The Technology Letter Podcast: Recent Episodes
Tiernan Ray
Tiernan Ray recaps the week’s developments among technology companies and tech stocks, and previews things to look for in the week ahead.
You can often gauge the ambition of a tech company based on the size of the problem that the company tackles. Think of Amazon, which early in its existence shifted from the already gigantic goal of being the world’s biggest bookseller online to the even more gargantuan aim of being the biggest seller online of anything and everything.
Juniper Networks started out twenty-six years ago with the audacious goal of giving serious competition to Cisco Systems, the incumbent vendor of networking equipment to phone companies. What was essential was the scale of the problem. Founder and then-CTO Pradeep Sindhu explained to me at the time that Juniper was seeking to solve the utter havoc that the Internet had brought to phone company networks, something Cisco hadn’t adequately addressed, leaving a hole to fill.
Sindhu even had a vivid technical term for the problem, “the small-packet tsunami.”
Don’t worry if you don’t know what a small-packet tsunami is, or even what a packet is. All you need to know is that solving the small-packet tsunami for phone companies succeeded superbly, and Juniper became a very viable and very prosperous second choice to Cisco. That lead to huge revenue growth for many years.
Somewhere along the way, Juniper sought a second act as revenue growth cooled. For a time, the shift to cloud computing was the biggest challenge facing the networking world. While Juniper did well selling to cloud computing operators, its sales growth still languished.
Suddenly this year, sales growth is sharply higher at Juniper, higher than expected, and Juniper shares are outperforming those of peers and of the broader market. It seems the company may have found a problem of size and scope worthy of its ambition.
“One of the biggest bets that I made when I took the CEO role was on the enterprise,” says Rami Rahim, who just completed his eighth year running the company, in an interview he and I had earlier this month via Microsoft Teams.
“There were quite a few skeptics, both inside and outside the company,” says Rahim, “but we nonetheless charged forward.”
“That bet we have made on the enterprise is really starting to work,” he says.
The term “enterprise,” in this case, means selling Juniper equipment to the largest corporations in the world to run their own internal networks, and it means eating into Cisco’s most valuable franchise.
STORMING THE ENTERPRISE
From almost nothing a few years ago, Juniper’s equipment has risen to 2.4% of total industry revenue for “campus” switching equipment versus Cisco’s 56.4% in the third quarter of this year, according to Mauricio Sanchez, Research Director with market research firm The Dello’Oro Group. Juniper has also taken meaningful share in other categories, says Sanchez, including 4.3% of data center switching, versus 28.6% for Cisco.
“We are a relatively small player,” concedes Rahim. A number of other vendors compete, including Arista Networks, China’s Huawei, and Hewlett Packard Enterprise. And some of them have larger share than Juniper.
But that may not matter as much as the fact that the prize is big. Enterprise is a twenty-billion-dollar market annually, says Rahim, and more if one folds in a lot of additional categories of enterprise networking beyond the campus switches and data center.
“It is a massive market, we have very small share, and we enjoy significant market differentiation, so that's a great recipe for continued sustainable growth.”
The contribution to growth is impressive. From nearly seven percent revenue growth last year, Juniper’s sales this year are expected to rise by twelve to thirteen percent, the company projects, higher than an expectation earlier this year for just ten percent. The outlook for next year’s revenue growth of “at least seven percent” is also higher than initially expected.
JNPR stock chart by TradingView In the September quarter, Juniper’s sales rose by nineteen percent. Sales to enterprises, at $516 million, was neck and neck with the company’s sales to service providers, and both rose about seventeen percent. But, “I expect the enterprise will be our fastest-growing segment” going forward, he says.
“For the first time in history, in Q1 of this year,” the March quarter, “we reported an enterprise quarter that was actually bigger than service provider and cloud” revenue, notes Rahim.
“Within a few years, enterprise will not only be the biggest segment, it will be the majority of Juniper's revenue,” he says.
COMPLEXITY IS IT
The enterprise opportunity, like the opportunity a quarter century ago, at Juniper’s founding, is an opportunity to tackle vast complications inside companies’ networks. It is a degree of complexity not seen before, wrought by the simultaneous occurrence of several new factors: the continued movement of everything to cloud computing; the "new world of work” and its sudden requirement that everyone be working a little bit remote, a little bit in an office, and a little bit on the beach; the rise of numerous unauthorized “Internet of Things” devices connecting to networks — and on and on and on.
“My problem right now is battling complexity,” says Rahim of the new regime. “I have so much of my team just keeping the lights on, working day in and day out with the proverbial pager attached to their belts, getting calls in the middle of the night because the experience to my end user is terrible.”
Add in, of course, the fact that the pervasiveness of networking since the pandemic lockdowns makes all of it more serious as employees and customers and shareholders and suppliers all expect everything to be delivered to their devices.
“Enterprises today are dealing with massive complexity challenges, and if you can give them a simple solution that actually just works and works effectively for the applications that they care deeply about, you win,” says Rahim.
Rahim is the kind of individual you would want running a complex technology business. Employee number thirty-two at Juniper at its start, he has a deep attachment to the the technology, the products — the most successful of which he helped build — and by now, an extensive sense of what works and doesn’t work.
OUT OF THE MIST
Juniper’s success in selling to the enterprise so far is thanks in no small part to an acquisition Rahim had Juniper make back in 2019 of a startup called Mist Systems, nestled in Cupertino, not far from Juniper’s Sunnyvale, California offices in Silicon Valley. Mist had patented technology to automatically detect what’s going on with a piece of networking equipment, such as when a laptop user has a problem connecting to the WiFi access point.
More important than just detecting, the company had developed ways of sorting and sifting such data to divine where there are patterns of problems. Using machine learning forms of artificial intelligence, including what are called “recurrent neural networks,” the Mist software would correlate events that happen in time. Something as simple as a WiFi access point rebooting itself, or multiple frustrated users unable to get a signal were clues. The Mist software would chase down a root cause, such as a software upgrade that had introduced errors into the functioning of the equipment.
This kind of stuff is known as “AI Ops,” meaning, using artificial intelligence to automatically do some of the things that IT people would do manually to keep things running.
IS AI FOR REAL?
When it comes to AI, as a reporter covering AI for a long time, I automatically flinch. I’m inclined to be skeptical that anything AI does what the sales pitch says.
“There are a lot of AI skeptics out there, and I understand, because I am a recovering skeptic,” says Rahim. “There’s a lot skepticism because there's a lot of AI washing out there,” which is certainly true, especially in industry.
“But, I think that, actually, AI is truly revolutionary, and the impact is totally underestimated by most people,” says Rahim.
What I have not yet grasped, says Rahim, is that there is what you would call a feedback loop. The AI program or programs process more and more data, in this case, signals from the network about how everything’s doing, and the programs gets better at detecting the flaw the signals are collectively shouting about.
The idea is akin to Metcalfe’s Law, which is not a law, but a kind of heuristic, named for Ethernet networking inventor Bob Metcalfe, which says that the value of a network increases as more and more people participate in it.
“There’s a similar sort of effect, one not yet named,” says Rahim, comparing AI to Metcalfe’s Law.
“If you could accumulate data and then you can leverage that data to become smarter about a particular problem you're trying to solve — and, obviously, you can't do that through human processing, it's just way too much data, you need to have artificial intelligence — then what you do is you leverage that knowledge and that insight to improve the service or the product or the solution that you're delivering to your customer.”
The Mist software runs in a cloud computing facility, so it sees everything from all its customers. The eyes on everything start to amass a shared history of collective patterns of behavior. Mist represents “an AI engine that has been learning over the last six years or so about what is good and what is not good,” as Rahim puts it.
“What ends up happening is your customers are delighted” as the software fixes things like the inability to connect to the WiFi, he says. “And they buy more and you acquire more customers, and guess what happens when you do that, you accumulate even more data.
*We are winning very large enterprise franchise deals today,” says Rahim. “And it's not like we're getting table scraps or, you know, a small percentage of share to keep the primary vendors honest — these are big, new, wonderful opportunities.”*
“And that additional data gives you even greater insight, which improves the product even more, which results in this virtuous flywheel effect that's extremely powerful.”
Rahim liked the Mist AI so much, he had Juniper spread it beyond just the WiFi access points, to more and more of the networking boxes Juniper sells.
A PROBLEM OF SCALE
The question, of course, is why this is a problem of size and scope worthy of Juniper’s ambition. Says Rahim, everything gets more complicated when trying to use Mist to serve the biggest companies.
“We have one customer that has north of one hundred and fifty thousand Juniper network elements,” he says, where every “network element” is a networking box with lots of cables and lights and switches connecting stuff. “Every one of those network elements is providing us insight about the end user experience every one or two seconds.”
Networking, at its most basic, is “a game of scale,” a realm in which “it’s easy to do something for one to a dozen users,” but, “it’s a whole different ballgame to be able to do it for millions and millions of people that are using the network for whatever purpose.
“It's so important to be able to do this at scale, for every user that's on the network, around the globe,” says Rahim. “And, yes, it's as hard as it sounds.
“That is precisely the problem that we have solved.”
The payoff for a customer is reduced labor for the IT staff, and faster everything, says Rahim. “A total reduction in trouble tickets, ninety-plus percent, and a massive reduction in resolution time” are things customers are seeing, he tells me. “What used to be many months to deploy a new network, we can do it in a few weeks.”
The small startup that was Mist, notes Rahim, inside of Juniper has grown to represent $850 million in annualized sales at the current “run rate.”
“It’s been a big home run for us.”
STOCK BOOST
As Mist has pushed Juniper’s enterprise foray into forward momentum, it has had a noticeable impact this year on Juniper stock. At a recent price of $31.36, the shares are down just twelve percent this year, way better than the twenty-five percent drop of Cisco, and the seventeen percent decline of Arista, and, obviously, way better than the thirty-four percent dive in the Nasdaq Composite Index this year.
The outperformance is surprising given that in Rahim’s eight years at the helm, Juniper stock’s total return on an annualized basis is 6.8%, trailing Arista’s, 28%, and Cisco’s, 10%.
How far, I wonder, can Juniper go in taking share from Cisco, and from others such as Hewlett Packard? It is not hard for a company to bite off a bit here or there, to be a convenient alternate supplier to customers. But to take successive billions of dollars, year after year, is something else.
“We are winning very large enterprise franchise deals today,” says Rahim. “And it's not like we're getting table scraps or, you know, a small percentage of share to keep the primary vendors honest — these are big, new, wonderful opportunities.”
It has taken many years, says Rahim, to build teams to sell the products into enterprise, where Cisco’s dual powers of its massive direct sales force, and its relationships with resellers and systems integrators, have always reinforced customer loyalty.
“That was all new muscle that we built over the years,” he says of redeploying sales and marketing, “and the go-to-market team has really executed exceptionally well on that front.”
The playbook for this move into Cisco turf is very much the one that worked in the early days going up against Cisco, says Rahim: prove yourself, and then build from there.
“Sometimes there are these very large RFPs, and you become an incumbent in a very large network” for a very large customer, he says. But not always.
“There are other occasions where the strategy is one of a small insertion, leveraging that small insertion to demonstrate that you can be a very viable, larger, more strategic partner to a customer and then expanding from there.”
“You have to go in and say, Look, just deploy me in this one little area, and then, if you like us, give us more business.”
JOUSTING WITH ARISTA
Arista, of course, is also pushing into the enterprise, as I discussed with Arista’s CEO Jayshree Ullal earlier this year. Rahim says Juniper rarely goes up against Arista in the campus switch category of enterprise. In that category, Arista has only about 1.1% share, according to Dell’Oro’s Sanchez.
In the data center, where Arista has 21.1%, closer to Cisco and well ahead of Juniper, Arista is a factor, he said.
“They're certainly going after that market opportunity, and I understand why, it’s a large and lucrative market opportunity,” says Rahim. "But I would say that this is where we are taking share faster than anybody else.”
The data center market will get even more interesting in 2023 and beyond as enterprises move closer to adopting the fastest networking speeds in their facilities, moving data at fiber-optic speeds of four hundred billion bits per second, known as “400G,” or “400-gig.” Those kinds of big upgrades come every few years, and when they do, they are a boon to equipment vendors to sell a new wave of equipment, like an iPhone with a much better camera.
“400-gig is an extremely important market opportunity for us,” says Rahim. “It’s happening today in the service provider and cloud market; it’s not yet a big trend in the enterprise but it will come, and it will play out over a few years.”
RE-SHAPING THE COMPANY
If the immediate payoff has been a boost to Junipers’ sales, what is the longer-term achievement for the company? As Juniper goes up against Cisco and others, will they merely make a dent, or will the company be actually changed in some way?
That sales muscle to which he refers, says Rahim, the ability to first win a seat at the table, and then learn to nurture large enterprise accounts, will leave its mark on Juniper.
“Once you've inserted, it’s a muscle of cross-sell and up-sell of new capabilities,” he says. “That is going to achieve a larger Juniper, a more profitable Juniper, a more resilient Juniper.”
The ability to meet or exceed expectations has been commendable since Rahim and CFO Ken Miller laid out a plan for the Street at the last analyst day event, in February of 2021. At the time, Miller said Juniper would see revenue growth of three to four percent in 2021 and “at least low single-digit” growth in 2022 and 2023. The company has now blown past those promises with the results this year, and with the higher-than-expected forecast for next year.
“We have exceeded all of our three-year plan,” says Rahim. In addition to revenue growth, Miller promised non-GAAP operating profit margin will “expand each year,” via a combination of keeping expense growth slower than revenue growth, and boosting gross profit by selling more and more software such as the Mist AI programs. Software automatically comes with higher profit margin than machines made of sheet metal.
The profit picture this year looks good. From a non-GAAP operating profit margin of 15.9% in 2021, taking into account the company’s forecast for the current quarter, Juniper is on track to make a profit of a little over eight hundred million dollars on revenue of $5.3 billion this year, a margin of eighteen percent.
LOOK PAST THE SUPPLY CHAIN
As good as these numbers look, it is rather striking that Juniper has managed those results given the continued deleterious effects of the supply chain. Like Arista and Cisco and others who ship physical product, Juniper has been going to extraordinary measures to get its supply of chips, and to wrangle special freight arrangements here and there.
“I actually get quite involved in working directly with our strategic suppliers to get our fair share of components,” says Rahim. “We're shipping meaningfully more product this year than last year, but is it normal? No. Are we still sitting on massive backlog that we're trying to work through? Absolutely.”
Things will continue to improve through next year, “but it will still not be normal.”
Rahim directs investors to think about the potential upside as supply issues eventually abate. “If in fact the supply situation next year becomes materially better, then I think we should be able to exceed that at least seven percent [revenue growth forecast] meaningfully,” he says.
Profit, too, can get a lift. Juniper this year paid $155 million more than usual for expedite fees and broker costs on additional freight arrangements. “Next year, I don't think the full $155 million in incremental cost of supply goes away, but I do think it gets better,” he says. “So, that bodes well for building more leverage in our P&L, essentially seeing that that revenue growth translate to operating margin expansion.”
CAPITAL RETURNS
Expansion of operating profit is an immediate proxy for capital returns to shareholders, as the company has pledged to pay out half its free cash flow, annually, in the form of dividends and buybacks. Juniper has frequently exceeded that, including this year, even as unprecedented capital costs for supplies weighed on its cash flow.
The company’s been active most quarters in buying back a couple of percent of its shares outstanding, and the dividend has steadily increased since Rahim has been CEO. The current payout, twenty-one cents per share per quarter, is a healthy 2.7% yield.
With success this year and last, and probably in 2023, it seems time for another analyst day, I offer. “Stay tuned,” he says. “I know our investors certainly have been asking about it, so we will schedule one shortly.”
As we conclude our chat, I have the chance to ask one of my favorite questions for CEOs and CFOs. At the current price, Juniper trades for two times next year’s projected revenue, as a multiple of enterprise value divided by sales.
Is that a good buy? I ask.
“Look, I can't say whether it's a good buy or not,” Rahim replies. “What I can say is the following: I am a huge believer in our ability to continue to be successful in winning in the market, and in using that to grow our financials, our revenue and our operating margin, in the future. And I think that's going to bode well for our stock price.”
*Some software stocks have had returns in the one- and three-month periods that defy the gloomy state of the software market.*
Most of this year, software stocks have been among the bigger disappointments. Out of about five hundred tech stocks I regularly follow, most but not all of which are U.S. firms, the average price decline for the industry designated “packaged software” is just under fifty percent this year.
Out of forty-seven industry categories in the five hundred or so stocks, that sharp drop puts packaged software in the bottom twenty of industries. Semiconductors are down only thirty-seven percent in that time, by comparison, and the group of electronic components names, including Corning, has been among the strongest, down only fifteen percent.
The poor performance is not surprising given massive disappointments in the most recent earnings reports from names such as Twilio and Crowdstrike. Software sales have been under pressure for pretty much every vendor, whether they have met expectations or not.
However, in the past month to three months, software performance has brightened. The average decline for the packaged software group in the past month is just under six percent, better than the one-month average across all industries of an eight percent decline.
And while software trails on a three-month basis, down almost eight percent versus an average of all industries of down three percent, some software stocks have notched extraordinary gains in those three months, such as Nutanix, up twenty-two percent in three months.
Below is a list of the sixty-seven software names among this group that have beaten the average for one-month and three-month returns.
*Software names that have done better than average on a one-month and a three-month basis.*
Why is this happening? It’s not tied to quarterly financial outperformance or underperformance. For example, GitLab, a company that has delivered results that defy the gloom in software, has had a weaker-than-average three months, down twelve percent.
But Dynatrace, which had to cut its outlook last month, nevertheless is up almost ten percent in three months, and has managed to be just a little better than flat the past month in comparison to that nearly six percent average decline.
Rather than hypothesize some over-arching theorem, I would suggest there are a variety of things going on. I think the “expectations reset,” as they say on the Street, where bad news is baked in, allows some buyers to creep back into a stock such as Dynatrace.
Dare I say it, some software investors may feel they’re getting bargains in some beat-down names. Confluent, for example, is a company that is not profitable, and won’t be for years yet. (Street consensus is that it loses money through 2024, and there’s no consensus yet about 2025.)
But Confluent has had better-than-average performance in three- and one-month periods. Its results have held up better than some other names, and after a seventy-two percent decline this year, Confluent trades for a multiple of enterprise value to next twelve months’ revenue of six and a half times. That is lower than the multiple of eight times just six months ago, and way below where Confluent traded at a year ago: thirty-four times revenue.
Perhaps that doesn’t sound like a screaming buy to you, but I can imagine that some folks must be eyeing the multiple contraction for stocks such as Confluent and thinking that if the estimates are correct, then the stocks are a decent buy relative to the exorbitance they once commanded.
Chip stocks continue to lose altitude but investors liked Azanta (AZTA), Tesla (TSLA) was once again a mighty dog, life sciences AI hopeful Absci, and predictions of AI doom from one of AI’s luminaries.
It’s not news that this year’s multiple energy crises, including the soaring price of gasoline in the first half of the year, and now the prospect of Europe starved for oil during the winter because of Russia’s war in Ukraine, have been a boon to the solar energy industry.
These are a gaggle of hardware vendors that include the bellwethers, First Solar and Sunpower, two panel makers that have been around since the previous solar boom, in 2007 or so; and some newcomers, including Enphase and Array Technologies, the former a maker of “inverters,” the latter a maker of “trackers” for solar farms.
As you can see in the accompanying table, the stocks of the group are up an average of thirty percent this year, pretty terrific. As interesting, their average stock valuation as a multiple of enterprise value divided by the next twelve month’s sales, has risen from one times a year ago to four of late.
One stock in particular stands out as having special momentum, if you will. Enphase, which came public back in 2012, has the second-highest revenue growth rate after Array, and unlike Array, it is profitable, with expectations it will make about $606 million in free cash flow over the next four quarters, according to FactSet estimates.
And Enphase has a perfect four-year record of topping analysts’ sales expectations, versus the rest of the group, which have done rather mixed in their reporting. I first pointed this out last year, when I wrote that Enphase was managing its business very well considering that it was struggling during the supply-chain mess to get parts to build its inverters.
Enphase builds what are called “microinverters,” parts that convert energy from DC to AC power in a solar energy system, and that do it in a “distributed” fashion, which has advantages over traditional inverters that are “centralized.”
Enphase has been riding the wave of home solar installation with the inverter product, and with a contractor model that lets a third party install the devices on the roof. Sales are expected to rise sixty-seven percent this year, to $2.3 billion. To be that size and growing that fast is impressive.
What strikes me in particular is the valuation. The company trades for a whopping fourteen times the next twelve months’ projected revenue. That kind of sales valuation makes it one of the most expensive stocks among the five hundred or so tech names I regularly follow.
In fact, in my collection, Enphase has the same multiple of enterprise value to sales as Snowflake, the cloud database software vendor. On some level, that kind of multiple makes sense because they are of similar scale and growing at similar rates.
Enphase is a little cheaper than Snowflake on a profit basis, at seventy-two times projected free cash flow versus ninety times for Snowflake. And its free cash flow yield, meaning, its free cash flow divided by stock price, is better, at 1.5% versus 1.10% for Snowflake.
That looks like a good deal, given that Enphase is doing better at generating real cash profits than Snowflake. Although Enphase has a lower gross profit margin, at forty-one percent versus Snowflake’s seventy percent, Enphase has a free cash flow margin of twenty percent, twice that of Snowflake.
ENPH stock chart by TradingView And yet, it is rather extraordinary for a hardware maker such as Enphase to trade at the same or similar multiples of sales and earnings as a software maker. Typically, there’s a discount for the lower gross profit margin, and the greater risk, of a hardware maker. That greater risk is in contrast to cloud software sales, where there is a degree of certainty baked into the way software is billed and invoiced.
I’m inclined to think that the sixty-three percent run-up in Enphase this year is an effect of traders fixated on the energy crisis story, and that the stock has gotten ahead of itself.
But maybe uniqueness plays a role. Over the transom Thursday came a long report by Daiwa Capital Markets analyst Jonathan Kees, in which Kees initiates coverage of Enphase and First Solar with “Outperform” ratings, and a Neutral rating on SolarEdge.
Kees believes the outperformance of the group can continue, and Enphase and First Solar, in particular.
With respect to Enphase, Kees’s three principle points are that a) there is, indeed, an energy crisis, maybe temporarily with the Ukraine war but permanent given broader risk; b) Enphase is in a duopoly with SolarEdge for inverter sales in the U.S., and duopolies tend to be a favorable structure for protecting pricing; and c) the Inflation Reduction Act passed by the U.S. Congress is a windfall for further building.
Kees notes that the stocks have all become something of a momentum investment. “In our view, the sector has gone from high-risk and somewhat distressed to high growth and momentum,” he writes. “We believe the run over the last three years can continue even with higher interest rates as utility companies to homeowners can justify the higher cost of capital by raising rates or saving more money on utility bills.”
On the matter of energy security, it’s top of mind everywhere, he writes: “Geopolitical events like the Ukraine war have highlighted the vulnerability of energy security. The lack of global investment in fossil fuel development also can keep supply/demand tight and prices high, barring a recession.”
On the matter of duopoly, Kees writes that Enphase and SolarEdge have about ninety percent of the U.S. residential market for inverters. That’s thanks in part to the fact that the world’s dominant seller of inverters, China’s Huawei, is banned from selling in the U.S.
Enphase, writes Kees, has been doing better than SolarEdge within that duopoly: "Enphase has gained market share over SEDG in the US residential market. This favorable market has high growth and high margins.”
On the matter of the Inflation Reduction Act, it’s one of several initiatives he thinks will add fuel to the fire, so to speak: “We believe the sector is now entering a catalyst-rich environment as companies announce new manufacturing facilities to benefit from the US Inflation Reduction Act (IRA), and for order activity to accelerate during 2H23 owing to that policy, providing booking visibility into 2024-25.”
As far as valuation, Kees thinks the multiples on the entire group are “surprisingly reasonable” given how much the companies have to offer. His main defense of the stock multiples is that the stocks are “within historical range.” Meaning, Enphase’s historical multiple of sales over a two-year period is 13.3 times, not far from what it is now.
I suppose that’s true, though it ignores the fact the stock has been much cheaper many years ago. I still suspect some of the valuation is that momentum trade from a market that is enamored of alternative energy as a narrative at the moment.
I also suspect that some of the hot air that came out of Snowflake and other pricey software stocks went into these renewable energy stocks, especially Enphase.
Probably, as Kees suggests, as long as the results at Enphase continue to deliver, it will maintain the momentum, and that keeps the stock high.
As for the title of this article, it may not really be fair to call it a bubble, for one stock does not a bubble make. However, I suspect that regardless of individual valuation multiples, there is a bit of the momentum element in all of th names, as Kees suggests.
Shares of memory-chip powerhouse Micron Technology declined by one percent in late trading after the company this afternoon reported fiscal first quarter revenue and profit that missed analysts’ expectations, the third time in a row it has missed sales expectations and the first time in quite a while the company has missed profit expectations.
CEO Sanjay Mehrotra noted the company met its own forecast “despite challenging conditions during the quarter,” and said the company is on “solid footing to navigate the near-term environment,” adding, “we are taking decisive actions to cut our supply and expenses.”
Mehrotra continued, “We expect improving customer inventories to enable higher revenue in the fiscal second half, and to deliver strong profitability once we get past this downturn.”
The company’s forecast for revenue and profit this quarter was also disappointing, the third quarter in a row of weaker-than-expected forecasting.
MU stock chart by TradingView In a companion deck of slides, Micron said it sees NAND flash memory chip sales coming in lighter than previously expected this year, changing its language for “industry bit demand growth” for NAND from “slightly higher than 10%” in its previous report to now “low to mid-single digit percentage range.” That’s not a big surprise for anyone watching the collapse of NAND pricing this year.
For 2023, the company thinks demand for DRAM will rise by ten percent, and for NAND, by 20% or so.
That is a moderation from the prior quarter’s statement, “For CY 2023, we expect demand growth to be closer to the long-term growth rate of both DRAM and NAND.”
Micron again cut its outlook for its capital spending, to a range of seven billion dollars to seven and a half billion this fiscal year, down from an already reduced eight billion in the prior report.
It said its spending on wafer fab equipment, or “WFE,” will decline this fiscal year by “more than 50% Y/Y,” which is sharper than the prior language, “nearly 50% Y/Y.”
The company said its own supply in DRAM is going down this fiscal year:
Expect Micron’s CY23 production bit growth to be negative in DRAM and up slightly in NAND. Full impact of the wafer start cuts will be realized beginning FQ3-23. Micron’s bit supply in 2024 will be materially reduced from the prior trajectory.
Here are both slides side-by-side, the most recent one on top, the prior quarter’s slide below it.
Micron’s latest outlook slide.
The prior outlook slide.
Micron indicated it will continue to have a hard time with some end markets for its products. For example, in cloud data centers, where server computers need powerful DRAM, the company stated, “Expect cloud demand in 2023 to grow well below historical trend, due to the significant impact of inventory reductions at key customers.”
And for personal computers, the company said in 2023, “PC unit volume to decline by low to mid single digit %.” That is not as bad as the “high teens percentage” decline in 2022.
*“We're going to look back on history and realize that that was one of the pivotal moments that changed our industry,” says Absci founder and CEO Sean McClain, “when we put a de novo antibody that was designed on a computer in humans.”*
The world was dazzled last month by the debut of an artificial intelligence program called ChatGPT, from the Microsoft-backed startup OpenAI. Posing questions in natural language via the keyboard, a person can prompt GhatGPT to give a full-paragraph answer to a factual question, such as, When did people first land on the moon?
But the same program can spit out endless reams of text, fulfilling much more ambitious queries, such as, Write a poem in the style of Walt Whitman about scuba-diving in Paris.
The wide-open nature of GPT is at the heart of its intrigue. The program seems to have such a broad nature that it prompts one to imagine all sorts of potential applications.
One afternoon this month, at the Manhattan satellite offices of Absci, an eleven-year-old, promising biotech firm, ChatGPT was being put to good use.
“We had a board meeting this week, and I needed something to open up with,” says Sean McClain, founder and CEO of Absci.
“We used ChatGPT to write a rap,” explains McClain, standing amidst the cubicles where the company’s AI team works.
“We asked it, Write a rap on AI drug discovery for biologics.”
“Here we go,” says McClain, nodding to a staffer who starts a beat track on his phone. McClain gives himself a three-count, then launches into the rap with gusto, swaying as he recites each line displayed on the screen in appropriate hip-hop swagger.
AI in the lab, making moves with biologics
Fast and precise, our algorithms are prolific
Discovering new drugs with efficiency and speed
Leaving our competitors in the dust, with no time to bleed
The full poem goes on for several stanzas, as you can see in the accompanying sidebar. The staff gathered around on this Tuesday afternoon are delighted with their boss and give him a round of applause when he’s done.
“ChatGPT wrote that, it’s incredible,” McClain marvels.
He will later inform me, in a follow-up email, that his board of directors, at dinner the next day, upon hearing his rap, “suggested I stick with my day job rather than moonlighting as a rap superstar.”
ABSI stock chart by TradingView But that’s alright. The playful diversion is merely meant as an illustration of what McClain believes is being heralded for life sciences by the increasing power of AI programs.
ChatGPT is just one example of a broad class of AI programs known as “generative AI,” applications that don’t just label pictures of cats and dogs, but that instead produce a new artifact in the world.
Today, it is rap lyrics, but down the road, says McClain, generative AI will generate formulas for novel biologics, or drug products, with highly specific powers tuned to the biology of illness.
“The exciting part is being able to be the first company to put a biologic, or an antibody, into humans that was designed on a computer,” says McClain.
“We're going to look back on history and realize that that was one of the pivotal moments that changed our industry, when we put a de novo antibody that was designed on a computer in humans.”
AI’S BROKEN PROMISES
That is a bold statement about drug discovery, and as a journalist, I’m wary. AI in life sciences has been a long time coming, and I’ve heard many claims over the years about its potential. Following McClain’s rap, we sit down in the conference room, and I have a chance to convey my skepticism.
> Write a rap on AI drug discovery for biologics.
OUTPUT:
AI in the lab, making moves with biologics
Fast and precise, our algorithms are prolific
Discovering new drugs with efficiency and speed
Leaving our competitors in the dust, with no time to bleed
(Chorus)
AI drug discovery, for biologics
Revolutionizing the way we treat our illnesses
With precision and power, we're making waves
In the world of science, we're the crafters of new days
Our machine learning models are top of the line
Finding cures for diseases, one at a time
We're changing the game, with our cutting-edge technology
Making strides in healthcare, for the betterment of humanity.
(Chorus)
AI drug discovery, for biologics
Revolutionizing the way we treat our illnesses
With precision and power, we're making waves
In the world of science, we're the crafters of new days
(Bridge)
Gone are the days of trial and error
We're using AI to find the right answer
Bringing hope to those who need it most
With our cutting--edge technology, we're taking the reins and we're on the rise
(Chorus)
AI drug discovery, for biologics
Revolutionizing the way we treat our illnesses
With precision and power, we're making waves
In the world of science, we're the crafters of new days
Journalists, including myself, have been like the boy who cried wolf, promising trusting readers about amazing breakthroughs with AI just around the corner.
And yet, to date, no drug has emerged from Phase III clinical trials that can uniquely trace its success to AI. None of the supposed efficiency benefits of AI have changed the economics of the industry.
Instead, the marketplace continues to see upwardly spiraling costs for drugs. Take the recently approved Hemgenix, from the U.S. pharma company CSL Behring of King of Prussia, Pennsylvania. Designed to restore precious clotting proteins to hemophiliacs, Hemgenix is the most expensive drug in the world, at three and a half million dollars per dose, according to Nature.
Nor has AI solved the extraordinarily low success rate of drugs that get approved, about four percent of those that are attempted. Even the success rate for Phase I or II trials is stuck at about eighteen percent. For successful drugs, the time frame is still stuck at a decade or more from basic chemistry to Phase III trials.
It feels as if the promise of AI in life science, if not a broken promise, is one that has been extraordinarily over-hyped.
As I recite my chastened view, McClain nods. “I think that we are in the early innings,” he says. “We have shown fundamental advancements in the space, and actually showing, yes, this technology does what they say it can do.”
“That should translate into increased clinical success — but we're not there yet.”
The technology breakthrough to which McClain alludes is encapsulated in a research paper posted by he and his team on the free bioRxiv pre-print server in August. The paper, which has not yet been peer-reviewed, describes how the company used a neural network to predict whether a protein with a certain pattern of amino acids would be more or less likely to “bind” to an antigen — in lay terms, how likely it would be for the protein antibody to attack the pathogen in the body.
Like ChatGPT, the neural network in question is a generative AI program, in this case one introduced in 2019 by scientists at Facebook called RoBERTa, which anyone can grab off the shelf and play with.
The paper showed two remarkable results. One, RoBERTa’s predictions of which antibodies would bind were “highly accurate” compared to what could be measured in the lab by actually observing binding under a microscope. In other words, you could run the experiment on the computer instead of a lot of the lab work, potentially a huge time and materials saving.
More dramatically, McClain and team asked the neural network to invent novel combinations of amino acids by altering sections of known antibodies to create variants. Again, RoBERTa predicted how these new variants would bind and, again, the predictions of the machine were highly accurate compared to what a lab results showed.
The point of that second step is that the computer using AI can run many more explorations of possible amino-acid variants than can be run through a lab where the actual assays, even “high-throughput,” take tremendous time and care to prepare.
Similar to how ChatGPT spits out whole stanzas of poetry, the Absci program is able to spit out reams and reams of amino acid variants. In the paper’s results section, McClain and team declared, “Deep language models can expand the search space of an experimental dataset by orders of magnitude.”
As McClain explains it to me, “For drug discovery, it’s essentially saying, create me a drug that has these attributes — that is the future.” Pharma, he says, then goes “from drug discovery to drug creation, where you’re actually using AI to create novel drugs that don’t exist.”
FROM WET LAB TO AI
It has been a long time coming to this point. McClain founded Absci eleven years ago after graduating a year early from the University of Arizona, where he began as a mechanical engineer but then switched to molecular biology. His focus back then was not on AI, but on the art of protein expression.
McClain’s accomplishment at the start of Absci was a refinement of the mechanism by which E. coli cell lines in the lab can be made to produce enormous volumes of proteins. The cells become like little factories for producing custom proteins that a drug maker would want, such as monoclonal antibodies that can fight viruses.
That was a breakthrough in scale. A typical test tube of animal cells would produce merely thousands of antibodies. With McClain’s approach, “You could basically take a single test-tube of our engineered E. coli, take a billion different antibody sequences, and in that single test-tube you have a billion different drug candidates.”
Absci has patents and patent applications on that protein synthesis with McClain as the lead author. Because it’s rather like a production line for proteins, in an article about Absci for ZDNet earlier this year, I dubbed McClain the Elon Musk of protein manufacturing, a moniker he told me gave him some amusement.
With the ability to mass-produce proteins, McClain’s company was waiting for the proper vehicle to exploit that laboratory capability. The arrival of “deep learning” forms of artificial intelligence appeared on the scene as a perfect complement.
Deep learning is generally data hungry. “There wasn’t enough data” with the mammalian cells of traditional protein research, observes McClain. “We solved that problem,” he says. A billion proteins in a test-tube, rather than thousands, meant there was suddenly enough training data to fit the power of those neural networks like GPT-3.
“It was basically eleven years at Absci developing the wet lab technology that would allow us to leverage generative AI,” he says.
“The craziest part is, I had no idea that E. coli was going to be the key to unlocking data for biologics with genitive AI.”
Shortly before going public in July of last year, Absci bought another startup, Denovium, a three-year-old firm pioneering deep learning AI in medicine. The company was using AI to tease out novel proteins from DNA sequences.
THE FEEDBACK LOOP
Hitched to McClain’s protein factory, the Denovium AI becomes a way engineer a kind of feedback loop. One first manufactures tons of proteins, then sends the proteins into the AI software, as symbols of amino acid chains, and out come predictions from the program about binding. Those predictions are then sent to the wet lab to be validated in the test tube. The lab validation then becomes further data for the AI programs, and the process starts all over again.
Absci as a company functions a little like a feedback loop. The main headquarters where McClain built his wet lab is in Vancouver, but he flies out once a week or so to New York, where he maintains an apartment, to visit the AI hub on the 43rd floor of 152 West 57th, an imposing modern high-rise next to Carnegie Hall where we are having our chat.
What is discovered in the AI hub in New York becomes the input to the wet lab’s test tubes in Vancouver.
“The fact that we can go from wet lab data, to training the [AI] models, in a six-week time period, that’s what’s allowed us to make these huge advancements in a short amount of time,” says McClain. Other companies have wet labs, such as Recursion Pharmaceuticals, but that is for small-molecule drugs, not large, complex molecules such as antibodies, McClain points out.
The feedback loop has attracted some of the top talent in the field, including AI lead Joshua Meier, who was previously with Facebook’s AI team. Another top AI scientist recently joined from Tesla’s self-driving team.
“They joined because we spent ten years building that feedback loop, and that’s an advantage now no one else has.”
That tight coupling, says McClain, puts the company ahead of other firms that don’t have a lab, that just use software and data.
“A lot of these papers that are coming out, they say, Hey, we developed this computational metric that got improved,” he says of competing AI efforts. “But they never showed that it worked in the lab.”
The lab is important for ruling out false positives, he says.
"Because we have that six-week cycle time that we have and no one else has, that's what's really allowed us to figure out what directions are important to go in.”
“Sometimes, we see the industry going in a certain direction on a metric that they think is important,” he says, “and we find out that that metric doesn't actually correlate to the wet lab and what we actually want it to do.”
Eventually, says McClain, it will be possible to do most of the work on the computer, in silico, as it’s called. He expects to get there, but it won’t magically happen overnight. It will happen as a progression.
“Ultimately, you're still going to want to validate everything you do” in the lab, he says, "but you're not going to have to validate it to the extent we do now.”
The AI software program developed by Google’s DeepMind program, AlphaFold, is, of course, an important advance in what can be done on the computer. AlphaFold has essentially solved the problem of how proteins fold, the problem of structure, in other words.
Structure is important, but it won’t solve the problem of an antibody binding to an antigen, says McClain.
“Structure is a part of the solution, it’s not the solution,” says McClain. “At the end of the day, you don’t actually care about the structure, you care about, Does the antibody bind to where I want?
“AlphaFold won’t tell me this structure will bind to this target at the affinity I want,” he says. “AlphaFold isn’t telling you how to design the right drug.”
TURNING THE TIDE FOR DRUG DISCOVERY
To my point about the unmet promise of AI, McClain is convinced the feedback loop will dramatically change the success rate in drug development.
“There's never been a technology out there that's been able to, let's say, take a brand new target and be able to design antibodies that hit every single epitope,” meaning, the part on the antigen to which the antibody has to attach. “And, then, to be able to go instantaneously into the lab and say which of these gives me the biology I want to achieve.”
“This is the huge game changer — boom! You can instantaneously know what’s going to give you the biology that you want.”
What’s more, not only binding but also other qualities can be predicted at the same time. In the August paper, the research showed that RoBERTa could predict what Absci has christened “naturalness.” Naturalness means how close is an antibody to naturally occurring antibodies. Greater naturalness can make an antibody easier to produce, and make it more effective against a target in practice.
*“You’re not going to have this iterative traditional drug discovery process that takes years and, ultimately, gets sub-optimal hits,” says McClain. “We can get everything right the first time and dramatically reduce the time it takes to get into the clinic.”*
By divining both the binding ability of a protein, and its naturalness, “You're no longer having to sacrifice different attributes for each other, and, kind-of, taking suboptimal hits,” says McClain. “You're able to take the optimal hit the first time.”
In AI, the ability of something like ChatGPT to spew out rap lyrics the first time you ask it, without practice, is called “zero shot.” Effectively, McClain is saying that his company’s AI models, in conjunction with the wet lab, will get so good, they’ll be zero shot at generating a good antibody.
“Again, it’s just like how I told ChatGPT to write a rap on drug discovery; we’re going to be able to do that same thing for biologics, feed in the target sequence and have the AI then give us an antibody with all the attributes we want.
“You’re not going to have this iterative traditional drug discovery process that takes years and, ultimately, gets sub-optimal hits,” he says. “We can get everything right the first time and dramatically reduce the time it takes to get into the clinic.”
The normal time to get from chemistry to clinic is four years. “We believe we can get that to about eighteen months,” says McClain.
Following on the success of the paper posted in August, McClain expects that “soon, very soon here, we're going to be releasing where we sit on on the de novo design,” he says, meaning, tailoring a drug from scratch. That may come at an investor conference, he says.
“Things are accelerating faster than we had anticipated,” says McClain.
WORKING WITH BIG PHARMA
Startups don’t generally do their own drug development, and Absci is partnering with multiple drug giants to take its AI and wet lab into the clinic, the most prominent partnership being with Merck.
“Our goal is to be in the clinic in 2024,” says McClain.
To do so, McClain has lured star talent.
A third hub for the company is in Zug, Switzerland, south of Zurich, where pharmaceutical luminary Andreas Busch runs the company’s “innovation center.”
Busch had been on the board for four months when McClain said, “We need you full time” to oversee the company’s work with the drug makers.
Busch has the important duty of bringing traditional Swiss cookie samplings with him on his trips to the New York office, which he puts out in the common area for all to enjoy. He finds New York fascinating, he tells me, but confesses the pace and complexity make him happy to return to the sleepy terrain of Zug.
He also has the important duty of being a steady hand who’s seen the full cycle of drug development. The sleepy Zug canton is, in fact, the locale of many Big Pharma companies, and Busch has helped to run R&D at many of them, including Sanofi, Bayer, and Shire.
“It’s incredible that we even landed Andreas,” says McClain. “He is one of the most prolific R&D, large pharma executives in the industry, I mean, he’s gotten over ten drugs approved, all the way from the bench, which, I think, is more than any other large pharma exec.”
*McClain with chief innovation officer Andreas Busch, center, and chief AI officer Joseph Meier, in the company’s New York satellite office. The unique assets such as the wet lab have been a big factor attracting “the best of the best” in talent, says McClain.*
EXPLAINING THE ODDS TO INVESTORS
All of this research has to come to market, and what expectations to set with investors is a complex matter. Absci is growing very fast off of a very small base of revenue. The Street models sales doubling to a little over nine million dollars this year, and almost doubling again next year to eighteen million.
Absci releases quarterly press releases, but it has not held the traditional conference call with Street analysts since coming public. The stock is covered by a handful of analysts including Credit Suisse, Cowen & Co., and Stifel Nicolaus.
“We didn’t want to set a precedent of doing it [conference calls] because we’re not an earnings story,” says McClain.
All investors, including Fidelity Investments, the second-largest holder, says McClain, know that “It’s going to take time for revenue to ramp up.” In the breach, the right metric to watch is the company’s programs with Big Pharma. Those programs pay out in multiple ways, starting with up-front payments, followed by payments for milestones achieved, followed by, someday, royalties, assuming a drug succeeds.
So far this year, Absci is ahead of its intended goal of signing eight programs with pharma companies, having achieved ten, including three with Merck. The Merck deals, which carry the option of collaborating on three different drug targets, are valued at $610 million in milestone payments and eventual royalties. Meaning, up-front payments and milestone payments to Absci would be about $200 million per drug.
“Building up that portfolio [of programs], things get more advanced, and that's when you start getting that cascade of large milestone payments being hit, and ultimately, ramp up to royalties,” explains McClain.
The company doesn’t say how much the up-front payments are that are baked into each deal. “I will say it is a significant payment that definitely covers the cost of the work that will be done.” Revenue of $2.4 million in the most recent quarter was mostly from milestone payments by Merck, the company has said.
Given that it can take time for the total $610 million value of something like the Merck deals to be realized — if ever — Absci’s CFO, Greg Schiffman, will point out at investor meetings that the net present value, the discounted cash flows, of future deals is in the neighborhood of $15 million to $20 million per program.
“The way to think about it is, if we were today to go to a royalty farm that buys royalty streams, they would pay you today $15 million to $20 million for that particular program,” says McClain. “And so, if you did ten programs, that’s $150 million to $200 million of lifetime value that you’ve created; you’re not recognizing it today, but if you wanted to, you could go off and sell those.”
McClain is quick to add “But that’s not the business model,” meaning, selling the royalties.
As far as the ramp, while it’s highly dependent on what happens in the lab, and the AI hub, and the clinical path, it’s also tied to clinical success and commercial marketing if a drug happens to make it that far.
“You could think of it as, a good chunk of it is in-clinical development, and then we get royalties on top of that,” says McClain. “I would expect in the next three to five years, we will see revenues ramping up significantly, and really starting to create that hockey stick from a revenue perspective.”
Those milestones can come quicker if Absci can boost those dismal success rates of four percent overall and eighteen percent for Phase I and II trials. The bet McClain and team are making is that they improve those success rates, which would improve the payoff represented by net present value.
“All of our investors and analysts know that that's highly conservative,” he says of the $15 million to $20 million estimates. “Because with our technology, it should — and it will — in future increase success rates,” he says. “Even if you go from four percent to eight percent” success rate for drugs, he says, “that’s huge, even just on a net present value basis, that’s going from $15 million or $20 million to $30 million to $40 million — you double success, you double the NPV.”
PROOF OF CONCEPT
At the same time that it partners with Merck, says McClain, Absci will pursue some programs of its own. “We’re actually going to be developing our own pipeline” of drugs he says. “We don’t plan on taking these to Phase III, because that’s extremely expensive, but if you can take it to a proof of concept, let’s say, get an efficacy readout in Phase I, that’s a huge value to the asset.”
He predicts “we’re going to be able to get there faster than anybody else can,” meaning, getting to a Phase I. As for what those drugs might be, it won’t be a cure for cancer, he says. Rather, the orphan drug market, where disease cohorts are small enough that they usually don’t attract much investment, “is a really interesting area,” he says. He declines to say which indications those might be, but says the company intends to disclose that next year.
Getting to a Phase I trials with its own drug, and proving the Absci feedback loop, “gives you huge credibility, huge validation that the platform works, and that’s going to be driving even more partnerships our way,” observes McClain.
While oncology is off the table for the moment, McClain does allow as the topic is an intriguing one.
“The issue with oncology is that everyone’s going after the same known targets,” he says. “What we need to do is actually find new targets.”
PATENTS PENDING
If the company finds new targets for anything, it opens up a whole other aspect of the business: patents. The more that drug discovery turns to drug design, the more that Absci may be able to establish patents on both antibodies and drug targets, says McClain.
“We have very broad IP here,” says McClain. That includes both the wet lab technology of protein expression and whatever is developed with AI.
“If you can take a novel target, use the platform to develop antibodies against all the epitopes [locations on the target], then that enables you to make patent claims that you couldn’t have enabled in any other way.”
The dynamic of designing antibodies and linking them to the antigen becomes a kind of circular dynamic that establishes exclusivity, says McClain.
“You give yourself a big runway to go after that target where no one else could come in after you because you’ve defined the target as a function of the sequence variety [of the antibody] that goes after it.”
The company’s general counsel, Sarah Korman, who had been the head of IP and licensing at Amgen, was lured to Absci in part because of the patent prospects, McClain tells me.
“She saw the diversity that our AI models could create, and how that could actually enable very broad patent claims that previously were unattainable,” says McClain.
“Broad claims means you can block other people, and ultimately, kind-of, dictate who can come into a target.”
A power, no doubt, one must wield carefully, I offer.
“No, absolutely,” replies McClain. “You have to always remain, What is best for patients? How do we do what’s best for patients, and make money, and create shareholder value?”
THE BEGINNING OF THE ROAD?
If, as he says, Absci gets into the clinic in 2024, and if its AI models are really “zero shot” drug development machines, how soon will it be clear that this whole approach is going to make good on the promise of AI? Is it ten years down the road? Is it more than that?
“No, I think you’re going to see clinical proof of concept way sooner than ten years,” says McClain. “Even being able to get a Phase I efficacy readout, so you can actually show something that gets people excited, and then you go to Phase II and show that proof of concept.”
“This goes back to having somebody like Andreas on board that really knows the clinical development side, knows where to look for targets that could give us early efficacy signals in a phase one.”
It is still early innings, McClain reminds me again, as we wrap up. “I think the public needs to know that,” he says. “But, early innings are exciting.”
I’m reminded of cancer biologist Robert A. Weinberg’s great book, Racing to the Beginning of the Road. Weinberg wrote that the 1970s and 1980s were the decades that taught scientists the mechanism of cancer, why cells go rogue, why programmed cell death fails to rein in chaos.
Looking back from the 1990s on those decades of fitful, meandering research, Weinberg declared, hopefully, “after so long, we finally know where to look” for a cure.
Perhaps after years of work in wet labs and in AI, McClain and others have the tools they need to begin to make serious breakthroughs.
As we walk to the elevators, McClain, Absci’s biggest shareholder, with a ten percent position, tells me, “I think this will show you my bullishness: in eleven years, I haven’t sold a single share of stock.”
Absci shares, at a recent $2.38, are down seventy-one percent this year, and down eighty percent since IPO.
After a forty-four percent decline in shares of Nvidia this year, expectations for the chip giant have been thoroughly washed out, and now is the time to buy the stock, writes Needham & Co. analyst Rajvindra Gill in a note to clients Monday.
TL20 stocks in focus
“NVIDIA is our Top Pick for 2023, and we are adding it to the Needham Conviction List,” writes Gill, while raising his price target on the shares to $230 from $200, and reiterating a Buy rating.
Estimates for Nvidia, notes Gill, have been cut by fourteen percent this year for the company’s revenue in 2022, from $31.2 billion to $26.9 billion, and the earnings per share estimate has been cut by thirty-four percent. (Nvidia’s fiscal year actually ends in January, but Gill uses calendar years to simplify the matter.)
For 2023, estimates have been slashed by twenty percent for revenue and thirty-one percent for EPS.
Gill argues that the company’s slump in sales of video game cards is about to come to an end, writing “Gaming revenue has bottomed (inventory cleared exiting this year).”
You’ll recall that Nvidia cut its expectations in August because of rising inventory of GPU chips brought on by slowing sales in the video game market.
NVDA stock chart by TradingView Following that, CEO Jensen Huang told the Street last month that Nvidia is finally finding its footing in the gaming market. “We are quickly adapting to the macro environment, correcting inventory levels and paving the way for new products,” he said at the time.
Meantime, writes Gill, the data center market, which is actually the larger category of product for Nvidia “remains on a solid footing,” excluding the weakening of sales into China’s data centers.
The data center market, moreover, is extra attractive given that Nvidia is dominating sales of “GPU-based accelerator cards” that speed up server tasks. Citing data from Gartner, Gill writes that such cards have an “attach rate” of sixteen percent, meaning, sixteen percent of servers sold sell with one of those cards. “We believe NVDA dominates the market here; corroborated by our Top500 analysis” of supercomputers, he writes. That dominance, he argues, is prompting customers to upgrade to Nvidia’s latest and greatest GPU for data centers, the “H100,” or “Hopper” chip that came out this fall.
See also:
Nvidia CEO Huang: cloud expands the company’s reach into enterprises, November 15th;
Nvidia’s forecast in-line with street, says ‘quickly adapting’ to global economic slowdown, November 15th.
Last, the valuation has come down for Nvidia, even if it’s still pricey. The multiple of enterprise value to sales for calendar 2022 estimated sales is 15.4 times, which is down thirty-five percent from what it was at the beginning of the year. And the multiple for next year’s estimated sales is 14.3 times, down twenty-nine percent.
“Nvidia’s multiples have come down significantly since the start of the year, alongside its stock price,” writes Gill.
That means Nvidia’s stock is less risky than the broader market, he opines:
Market multiples have expanded meaningfully since the October bottom. We posed the question “is this the bottom another head fake?” in our recent earnings review. We expect the first half of CY23 to remain choppy as estimates likely need to come down further. Yet for NVDA, we think estimates are much closer to the bottom. We believe the shares can trade closer to their pre-COVID levels as both Gaming and Data Center growth accelerates in 2H23.
Nvidia shares, despite Gill’s positive missive, closed down two percent Monday.
Nvidia is one of the TL20 stocks to consider. Its shares are up three percent since the TL20 was inaugurated in July.
News of the Fed Reserve half-a-point hike on Wednesday sent everything into sharp decline, but chips stocks, in particular, have reversed their recent winning streak. Tesla (TSLA) was one of the biggest losers of the week, and Elon Musk could fix what ails the stock if he’d make more disclosure about metrics around car sales.
A week ago or so, I received a tweet in my Twitter feed from Elon Musk, informing me that Twitter’s average load time has improved by four hundred milliseconds. I doubt I noticed the difference, and I doubt many other Twitter users did either.
Frankly, while Musk is re-arranging the deck chairs at Twitter, I suspect most investors would be a lot more interested to hear more from Musk about measurement at the one company of his that has the most prospect of actually being a great business, Tesla.
Tesla has been a real dog for the past four months or so. I refer to that amount of time because it is the time since inception of TL20, The Technology Letter Twenty, the list of twenty great companies to consider investing in. Tesla is a great company, and it’s one of the TL20. It could be a great stock, but it’s been terrible since the inauguration of The Twenty.
Tesla is the worst performer since the July 15th inauguration date, down thirty-seven percent. Because the TL20 is market cap-weighted, Tesla exercises a disproportionate effect upon the group. The entire TL20 is down 12.6% since inception, but excluding Tesla, it would be down just 2.2%.
By that alternate measure, the TL20 would be ahead of the 6.5% decline in The Nasdaq Composite Index since July 15th, and it would be a lot closer to the Standard & Poor’s 500 Index, which is roughly flat since July.
What will stem this decline? What might help is if Musk were to share more data about how Tesla’s sales prospects look. The data the company traditionally discloses is vague, and has lately become very cloudy and hard to interpret.
That is happening at a time when there is rising anxiety that Tesla’s sales may be about to fall apart. Tesla is a bubble stock, and to an extent, a bubble company, and it has never been tested in a prolonged economic downturn.
Founded in 2003, Tesla came public June 28th of 2010, after the last major economic contraction, The Great Recession. Its vehicles, which list starting at just under fifty thousand dollars for the base Model 3, represent pricing in a time of relative economic prosperity.
In an economic crunch, even some bulls think Tesla will have to cut prices. An Uber-bull on the stock, Trip Chowdhry of the boutique Global Equities Research, writes in recent missives to investors that both Tesla, and competitor Lucid Group, “will need to drop vehicle prices by at least 10% to 15%” because neither is “immune to recession,” as he put it.
TSLA stock chart by TradingView If it is true that Tesla is now entering its first real test of demand, it might be good to have a more solid measure of demand. That’s where metrics come in.
Tesla’s financial reporting has to date consisted of a two-step: deliveries and revenue. The company reports total car deliveries shortly after a quarter is over, and two weeks later, it reports revenue. In between, the Street writes predictions about revenue using deliveries as a leading indicator.
That kind of very simple calculus is a thing that works just fine when business is going up and up in good times, much as Netflix, another bubble company, for a long time dazzled the Street with rising subscriber numbers — until it stopped growing.
For Tesla, deliveries have become problematic as a reflection of anything of late because they’re under pressure from factors unrelated to demand.
Tesla, like many firms that make real, physical stuff, has been dealing with the supply chain issue. As a result, deliveries lately are not keeping up with expectations. Musk, and CFO Zachary Kirkhorn, have set a goal to increase both production of cars and deliveries, on a unit base, by fifty percent, annually, over a multi-year time horizon. Production rose fifty-four percent last quarter, but deliveries rose only forty-two percent, and Musk and Kirkhorn said deliveries will continue to be under pressure.
The Street expects deliveries will still be under pressure in 2023, forecasting total delivery growth of just forty-four percent next year.
There’s a second reason deliveries are cloudy, and that’s the rising backlog of cars not delivered. The company has been raising prices this year to offset rising costs, not just materials costs but the rising cost of freight.
Consequently, cars in backlog, once they are delivered and recognized as revenue, will probably skew Tesla’s average pricing upward irrespective of demand. That can cloud Tesla’s true pricing power, quarter to quarter.
If deliveries aren’t a great indicator of demand, Tesla’s actual commentary about demand is vague.
Musk and Kirkhorn typically talk about how the “order book” is doing in broad terms. On the October earnings call, Musk remarked that, “demand is a little higher than it would otherwise be,” without elaborating.
It would be nice to have another measure of demand. The balance sheet provides some extra data, but not much. The deferred revenue balance includes many parts of Tesla’s offering that have nothing do with the vehicle sale itself, such as the company’s self-driving software and system software updates.
The other balance sheet metric that’s slightly relevant is the figure of Tesla’s customer deposits, which is the amount a customer has to put down when they place an order, such as the $250 deposit for a base Model 3. But that figure also includes deposits for Tesla energy products, so it’s not a clean auto number.
And the deposit amount per vehicle is highly variable based on the model and configurations. To my knowledge, no one has triangulated how customer deposits correlate to aggregate car demand for Tesla in any given period.
So, there is no good measure for demand, other than Musk’s upbeat tone — that, and the company’s past performance of generally increasing sales nicely over many years.
Other areas of tech have come up with additional measures to reassure investors. The prime example is the software industry.
A year ago, I wrote a broad overview about how the software world has sprouted numerous measures of the business quarter to quarter. The Metrics, as I term them, include tons of non-GAAP numbers such as “remaining performance obligation,” a measure of the total value of software contracts signed that has yet to be realized as revenue.
If Musk and Kirkhorn had any desire to reassure the investing public, they could disclose a similar sort of measure. For example, what is the total order book value in dollar terms? How much of that might be realized in a given period, the current portion of the order book, would be a nice complement.
Based on the remarks and tone of the conference calls, I don’t get the sense Musk and Kirkhorn have any urgency to provide such reassurance. And I expect they don’t want competitors to know those kinds of things.
That means investors will have to decide: Is this a company that’s priced too high for a recession, or will its position as an EV leader prove more durable than people suspect?
Even in a tough market, if prices fall as Chowdhry expects, Tesla would still be the best house in a bad neighborhood, as it is far ahead of the competition in making product.
I wrote last month that the crop of young contenders are a mess. Lucid, Rivian Automotive and Faraday Future have continued to miss expectations as they struggle to get to volume production. All three, moreover, are pricing their wares at the high end of the market, so none of them are a budget alternative.
See also:
TL20: Not dumping Tesla yet, November 10th,
How does Rivian, Tesla’s most interesting competitor, stack up? July 9th.
Ford and others can be a budget alternative, buttheir progress in EV sales still leave them far behind Tesla. A report in November by S&P Global Mobility stated that of 525,000 electric vehicles registered in the U.S. in the first nine months of this year, sixty-five percent, 340,000, were Teslas.
Ford has sold a total of 53,752 electric vehicles this year, making it number two behind Tesla, according to The Detroit News’s Jordyn Grzelewski. While Tesla doesn’t report regional numbers, you could say that based on deliveries of 343,830 cars, worldwide, in the third quarter alone, there is good reason to believe Ford is a very distant second place.
If Tesla isn’t recession resistant, but if management won’t reassure investors with additional disclosure, then at some point, the prospect of share buybacks will probably become one of the most important parts of the story.
Musk during October’s earnings call indicated a big buyback is a distinct possibility.
“We've debated the buyback idea extensively at board level,” said Musk. “The board generally thinks that it makes sense to do a buyback.
"Even if next year is a very difficult year, we still have the ability to do a $5 billion to $10 billion buyback,” said Musk.
“This is obviously pending board review and approval, so, it's likely that we'll do some meaningful buyback.”
Having watched a few companies fall under the weight of their own promises over the years, I’m pleased anytime I hear a company’s management being circumspect in how it talks to the Street. It is absolutely always better to under-promise and over-deliver.
“I wanted to stress that these new opportunities are still in very nascent, kind-of, sapling days,” says Craig “Tooey” Courtemanche, CEO of Procore Technologies, in a chat he and I had this month via Zoom.
Courtemanche is talking about his company’s first analyst day meeting since coming public in May of 2021, which took place last month. The analyst day is the annual ritual when tech companies regale the Street with tales of future product and future financial success.
It’s a day. In other words, laden with a certain amount of puffery, and so it’s an especially dangerous time for promising too much.
Courtemanche used the day to talk up some planned enhancements to Procore’s software. Procore makes programs that can streamline the challenges of the construction industry, selling to thousands of general contractors, sub-contractors and project owners.
At the analyst day, he talked up future offerings such as a financing component and an insurance component — the company plans to write loans and sell project insurance via financial partners.
It’s a thrilling prospect, a potential “FinTech”-style business, one with potentially huge incremental profit. It is also a bold attempt to re-write what construction is as an industry: to turn it from an “analog” business, Courtemanche tells me, where things get decided over games of golf, to one of rational data analysis.
PCOR Chart by TradingView As exciting as all that sounds, Courtemanche took care to emphasize to the Street last month that these saplings, as he refers to financing and insurance, are small projects in incubation, not yet prime time.
“I wanted for them not to over-index on them in the short term and put them in their models,” he says, meaning, the spreadsheet projections of Procore’s future that financial analysts construct.
And that’s just fine, actually, because the existing business at Procore is working nicely.
PROFIT PROMISE
The fiscal third-quarter earnings report, delivered November 2nd for the quarter ending in September, was the sixth quarter in a row the company beat revenue expectations, and the fifth quarter out of six that showed a smaller-than-expected net loss. And the forecast for this quarter’s revenue beat as well, the third time the company has raised this year’s revenue outlook.
All that at a time, mind you, when many, many software vendors have had to reduce their outlook.
Nor is Procore a tiny shop. It is on track for $800 million in revenue this fiscal year, increasing at a rate of thirty-four percent, and the Street is modeling that going to $970 million next year, so it’s a sizable software business.
Procore is not yet a profitable business, however, and likely won’t be until 2026, according to Street consensus. Courtemanche has told me in our prior conversations that the company’s commitment to investors is to “continue to show progress to cash-flow breakeven.”
On that score, CFO Paul Lyandres, during the analyst day, didn’t promise specific deadlines, but instead showed a rather complicated slide that represented how profit margin improves over time. His point was that Procore has demonstrated an ability to narrow its negative non-GAAP operating profit margin by three to four percentage points a year over a multi-year period.
“So, it might not happen every year in a consistent fashion, but that's the right trend line,” said Lyandres.
Free cash flow, he said, will “mirror” that improvement in operating margin in coming years, maybe even “slightly better improvement.”
*CFO* ***Paul Lyandres****, during the analyst day, didn’t promise specific deadlines, but instead showed a rather complicated slide that represented how profit margin improves over time.*
WHAT IS THE ‘PLATFORM’?
In our chat via Zoom, my agenda with Courtemanchewas not the current financial picture, but this notion brought up during the analyst day that the software is becoming a more complex collection of functions, including the forthcoming FinTech stuff.
Numerous times during the analyst day, Courtemanche used the term “platform.”
“What is that, and what does that mean to you?” I asked.
“The way we think about it, is, a common data environment that we build on top of so that everyone can be assured that they're working off the same set of information” when something is being built, is Courtemanche’s definition of the platform.
The Adobe version of platform software includes Photoshop and Illustrator, etc. In the case of Procore, prior to 2016, the company sold just one function to general contractors, project management software. That has now sprouted multiple different “apps” such as for bid management and invoice management.
“Our customers value us because we manage estimating to bidding to contract management to change orders, invoicing, lien waver management, and now we're going to launch Procore Pay,” a new function going live in January that will streamline how a general contractor pays a sub-contractor.
“So, this is a very complex workflow that they deal with every single day, and once we have Pay and we're in the flow of funds, and people look to Procore as, kind-of, the funds control for their projects, we then think that that exposes a whole bunch of these novel business ideas on top of that that we can explore.”
*Prior to 2016, Procore sold just one function to general contractors, project management software. That has now sprouted multiple different “apps” such as for bid**management and invoice management, and what the company terms a platform, a means for itself and partners to continually add new functions.*
Most intriguing is how data collects in that platform. The general contractor and the project owner and the subcontractors all have various information they work off of about dates and materials and payments and specifications, and all the other stuff about a project, says Courtemanche.
“That’s very valuable, to Procore but also to our customers, because we can give them insights and predictive analytics around projects,” he says.
“Imagine if you're a contractor and you're building a hospital,” offers Courtemanche.
"If Procore can pop up in the middle of your job and say, ‘Look, based on the number of RFIs [request for information, a planning tool] that you have of unapproved submittals, you have a twenty-five percent chance of losing money on this job, you should try to do A, B, and C’ — and we know that because we have so many hospitals on the system that we can look at it and do cohort analysis — that becomes very, very valuable to a contractor,” he says.
DATA SCIENCE FOR CONSTRUCTION
Quite valuable, potentially, because the data becomes the basis of the FinTech services he is working on, one known as “Mat Fi,” materials financing, where Procore and banks will lend construction firms money for materials; and a future insurance product, where Procore and banks will sell contractors and their collaborators project insurance.
*“This is a very complex workflow that they deal with every single day” says Courtemanche**of the expanding software functions from estimating to bidding to contract management. “And once we have Pay and we're in the flow of funds, and people look to Procore as, kind-of, the funds control for their projects, we then think that that exposes a whole bunch of these novel business ideas on top of that that we can explore.”*
“Those are the types of things that we're trying to build now with our data scientists and our insights team, is to be able to deliver actionable insights,” he says.
“We can put together risk profiles which enable our businesses around Mat Fi and Insure because we know where risk lies because of all the data.”
The data gathered from all these customers is anonymized, says Courtemanche. Customers still own their own data, and it is not leaked, he pledges. Instead, averages are gathered that can be meaningful across the whole customer cohort.
“Customers are very grateful that we can take the averages of different data elements and present them back to them and show where risk lies on a project that they're running,” he says.
NO MORE GOLF GAMES?
How far can that go, I wonder, because construction has always had its way of doing things, and data science is not the first aspect that comes to mind.
In such established fields, some of the “ecosystem” doesn't want to become more rational, I point out to Courtemanche.
True, he says. “I'll tell you, in today's world, general contractors will select their sub-contractors based off of who they played golf with last — it’s not a data driven decision.”
But, says Courtemanche, the industry is actually “really desperate” to do things smarter. “You could be a sub-contractor on a job, and you could be winning big time on that job, but if the job itself is failing because of other sub-contractors, you're about to lose, right? So nobody can win in isolation.”
The data platform he’s building, he insists, will take the industry “from analog, where they're playing golf, to actually making good business decisions with the data.”
Another example, he says, is the half-a-trillion-dollars worth of “re-work” that goes on annually in construction, stuff that should never have been done to begin with. “That brand new air handler should never have been put into a building, ripped out two days later, and put into a landfill,” he explains, a source of enormous cost over-runs and just plain waste.
“We believe we can have a massive impact on that because people will be working on the single source of truth, the right information” about a project. “You won't have as much of that waste, which should, by definition, drive down either the cost of construction or drive up the margin of people's businesses.”
EVERYONE INTO THE POOL
The final element in the platform push by Procore is the company’s rather unusual practice of letting as many people use the software as are involved in a project. Most software vendors charge a seat license, or, these days, a seat subscription, for a particular user. Procore instead has an “unlimited use” policy: contractors, their sub-contractors, and lots of others can use the same Procore program licensed to the contractor.
The point, says Courtemanche, is that is how the software spreads.
“Let's say we sell to your general contractor, you become a customer, you upload your directory [into the program]: all of your sub-contractors are now in Procore and actually on the jobs in which you're using them,” he explains.
See also:
Like an aircraft carrier: Procore’s bet with investors on a $14 trillion opportunity, September 14th;
Procore CEO: ‘As things get tougher, Procore is something that’s sought after,’ June 5th.
Those collaborators are “engaged in Procore on a daily basis, not paying us anything, but they're basically in your account, finishing their daily tasks, and we can tell those folks, ‘Hey, you work with lots of general contractors and across lots of different projects, wouldn’t you want your own account to manage your bids and your current projects and your work?’”
It’s a try-before-you-buy thing, and although there is not exhaustive buying data, says Courtemanche, “we do know that the heavily engaged collaborators have a high propensity of becoming customers.” New customers tend to be previous Procore users by a wide margin, he says.
The Procore Pay product going live in January will be the first test of the more ambitious platform strategy. Procore has partnered with Goldman Sachs to run that payments system for customers.
The forthcoming materials financing bit and the insurance bit are works in progress. “We are now growing [Mat Fi] into slightly larger than a small business, but it's still pretty small,” he says.
Ultimately, Mat Fi and Insurance will involve partnerships as well. Procore “have a short list and we have definitely have not chosen one” yet for financing. For the moment, “we are still operating off our balance sheet” as far as lending money in beta mode, he says, “but it's a very, very small amount of capital, so it's inconsequential today.”
Shares of Procore, at a recent $52.88, this year are down thirty-four percent, and are up five percent since the third-quarter report.
I generally think I can pattern-match pretty well with respect to corporate earnings, having reported on them for decades.
Take, for example, GitLab, a young software vendor that came public in October of last year. It sells a set of software capabilities that are woven together that serve application developers. On the simplest level, it is what is called a a “version control system,” a repository where coders put their pieces of code that tracks which is the latest version, who has what, and other such functions.
The company a week ago reported their September-quarter results, and it was the fifth quarter it has beaten expectations — by a very healthy margin, I should add — and the fifth time its forecast was higher.
In a case like that, where a company seems to be defying gravity, my sense of pattern tells me some analysts on the Street might just start to expect the company has to stumble at some point, to have a sophomore slump. No company can keep a streak going forever.
“That’s fair,” says the company’s chief financial officer, Brian Robins, when I propose my theory to him on Zoom interview last week.
There were, he admits, “watch points” in the quarter, things to keep an eye on. Specifically, “there's starting to be a little bit more deal scrutiny,” last quarter, by which he means, “there's a higher level of sign-offs required, basically, to get some deals done.”
More generally, he adds, “the second quarter, we weren't feeling any macro when a lot of companies were,” meaning, the broader economic distress didn’t touch GitLab’s business.
“We felt that more in third quarter,” just ended, he adds. Some of the company’s expansion with its existing software customers, when people who have already been a customer license more “seats” to use the program, was not as high as it should have been, based on GitLab’s statistics of “cohorts.”
“It did have a material impact,” he says, meaning, GitLab left money on the table last quarter.
GTLB Chart by TradingView Still, none of that is hurting reported results, obviously. GitLab is holding it together while other continues are trimming their forecasts. My pattern recognition, in other words, seems off in this case.
“You know, we executed really well in a in a tough market,” says Robins. “We delivered sixty-nine percent year-over-year revenue growth; we beat consensus by seven percent [for revenue] when a lot of companies aren't even beating, they're missing consensus; we did a small raise on top of that, so we had a beat-and-raise quarter.
“And then we also gave our soft guidance for fiscal year 2024, and also said that we're targeting to be cash-flow breakeven in fiscal year 2025.”
The term “soft guidance,” in this case, refers to Robin’s preliminary assessment that next year will see forty percent revenue growth, about in line with consensus. In other words, GitLab reassured analysts.
If things are not breaking down at GitLab, contrary to my pattern-matching hypothesis, what is happening?
“I like to try to do pattern recognition, and I came up with a hypothesis,” says Robins. He has told me in past that GitLab is the “best-prepared” among tech companies, doing assiduous research before, during, and after earnings season.
“You know, there’s been two hundred and ten thousand tech layoffs this year, and forty percent of that happened in the third quarter,” he says. That was, he notes, just around the time Meta, Google, Amazon, Twitter, and other firms were announcing a bunch of giant layoffs. “It almost felt like there’s this sentiment in the market, where executives said, holy crap, where is this economy?”
“It reminded me of when COVID first broke out,” he says, back in February of 2020. “A big drop in the stock market, and everything’s just, sort-of seized up.”
Business for GitLab has not, however, seized up. Although the expansion deals were held back last quarter, the company had a stealer quarter for what it calls “first orders,” when first-time customers buy. The first orders, referred to as “new bookings,” rose seventy-five percent, year over year.
New orders should have been performing about in line with expansions, he had expected, but instead, they did much better.
“To me that is awesome in the sense that, you know, people are coming on the platform,” says Robins. “I think the economy is really helping push people towards do more with less, greater collaboration, get more efficient, show an ROI [return on investment] — and so, I was super-happy with that.”
*You can’t artificially pump up sales results, says Robin’s. “You can't unnaturally grow way faster than the market, and you’re not going to unnaturally grow way slower than the market, but there's a range that you can grow in, and you just have to make sure that you invest accordingly to that range."*
To Robins, the fact new customers are coming in the door at a time of economic uncertainty, when repeat business is harder to sign, is evidence of his conviction, which he’s told me before, that “we're a mission critical platform, we have some resiliency to the broad macro markets and things that are happening.”
To play devil’s advocate, I ask Robins if his firm should step on the gas, in Street terms, meaning, apply even more sales and marketing effort to win business when other vendors are struggling.
You can’t artificially pump up results, is Robin’s reply. “You can't unnaturally grow way faster than market, and you’re not going to unnaturally grow way slower than the market, but there's a range that you can grow in, and you just have to make sure that you invest accordingly to that range."
“The feedback there is, we've been really consistent,” says Robins. “Our number-one objective is to grow, but we'll do that responsibly, and so that's why we've grown into improved operating leverage in the model.”
The operating leverage, in this case, is having forty-six million dollars more in revenue expected this fiscal year, with $2.3 million less in operating expenses.
Last quarter, operating profit margin, while still negative, improved by a whopping seventeen percentage points, year over year. It is likely that in 2023, GitLab will add something like another one hundred and seventy milloin dollars in revenue even as lower costs go down.
Does the investor pattern-match on all that’s working here? Do they, as I suggested, fear some kind of stumble for GitLab?
It doesn’t sound like it.
“In three days, I spoke to thirteen analysts and over fifty investors” last week following the report, says Robins.
“When you got to the investors, the questions were all over the board,” he recalls. “I think you know you had a pretty good quarter when there’s not, like, three or four key themes everyone is asking about.”
GitLab stock this year is down forty-three percent, and it is off fifty-two percent since the IPO.
Shares of software giant Oracle rose by about two percent in late trading Monday evening, as the company reported another quarter in which revenue growth sped up, echoing the prior quarter, with the focus heavily on how the company is winning new customers for its cloud computing business.
Founder and CTO Larry Ellison rattled off names of “big customers” who had moved to using the company’s cloud service, including Fedex, DeutscheBank, and the Tokyo Stock Exchange.
"We're the only ones running a major stock exchange” of all the cloud service providers, said Ellison.
Given a rising backlog of business, “we expect our infrastructure business to continue to grow very, very strongly into the future.”
The forecast for this quarter’s revenue, in addition, was ahead of the Street, with a projected revenue range of $12.3 billion to $12.5 billion versus consensus of about $12.28 billion. That’s stronger than the forecast offered in September.
Oracle is the start of the earnings season. Although it trails other reports and is one of the last companies to report, it closes the books faster than other tech companies and so it is reporting not on September or October results, as most companies have been, but the quarter ended in November.
Sales once again topped expectations, even though foreign exchange continued to hamper reported sales growth, reducing the top-line number by six percentage points. The “constant currency” growth rate of revenue would have been twenty-five percent, though reported growth was a still-healthy eighteen percent. That figure includes one and a half billion dollars of revenue from Cerner, the health care information systems giant that Oracle purchased in June for twenty-nine billion dollars.
ORCL Chart by TradingView CEO Safra Catz noted the company’s continued revenue speed-up: “Even excluding Cerner, total revenue grew 9% in constant currency,” she said. "That's higher than Q1, and on top of a revenue beat this time last year,” she added.
Catz reiterated an expectation that the company’s cloud computing business will rise faster this fiscal year ending in June, stating, “our business continues to accelerate, we expect organic growth for our fiscal year 2023 Cloud revenues will be over 30% in constant currency.” The term “organic” here means excluding the portion attributable to Cerner. Last fiscal year, growth was twenty-two percent, and Catz had said in June, on the fourth-quarter call, that the growth rate would pick up.
Analysts seemed clearly delighted with the cloud growth. Oracle is much smaller than Microsoft, Amazon and Google in cloud “infrastructure,” the basic running of workloads. Its reveneu for “IaaS,” the portion that is infrastructure “as a service,” was just a billion dollars last quarter. But, as analyst Phil Winslow of Credit Suisse noted on the call, the rate of growth of IaaS last quarter sped up from fifty-eight percent in the August quarter to fifty-nine percent this past quarter.
Asked how the company is speeding up, Ellison’s reply was partly boosterism — the continued move of computing to Oracle’s cloud from either on-premise or other clouds — but he also gave an interesting insight into how stuff is moving to cloud generally, including artificial intelligence.
“The workloads, AI and machine learning, is a huge – is exploding,” said Ellison. “Nvidia, the people who provide the GPUs for most AI workloads, they're moving a huge amount of stuff to the Oracle Cloud and a bunch of other companies that are doing that.”
Sifting what’s perhaps broadly interesting in all this, I would say it is a) companies continue to plow money into using cloud computing, so that they are shifting how they run their operations in spite of the fact the economic outlook is supposedly volatile; and b) Oracle itself is continuing to spend to build out its cloud operations.
Said Ellison, Oracle has forty “public cloud regions” around the world, and nine underway. He said the company will continue to spend on building such data centers.
“We are careful to pace our investments appropriately, but need to continue to build to meet our accelerating demand,” said Ellison.
That, I think, should be good news for networking firms, including Cisco Systems, Arista Networks and Juniper Networks.
Overall, I’d say the report suggests data centers should continue to be a relative area of health for tech for the foreseeable future.
*The Philadelphia Semiconductor Index’s three-month return. Its surge from mid-October has been among the best areas of tech stocks of late.*
China’s pivot away from “COVID Zero” as its governing approach to the virus is leading to a surge in cases that will have a “dampening” effect on semiconductor production, opines chip observer RC Rajkumar of the boutique Lynx Equity Strategies in a note to clients Monday.
That might not bode well for semiconductor stocks, which have been among the best tech performers of U.S. issues recently, with the benchmark Philadelphia Semiconductor Index up almost a percent in the past month versus a 1.6% decline for the Nasdaq Composite Index. The Philly has risen despite continued negative data about inventory build-ups of chips and weakening tech spending.
China’s government last week eased off on the lockdowns imposed as part of its COVID Zero policy, and Bloomberg Sunday reported that Covid is “rapidly spreading through Chinese households and offices.”
The supply chain, writes Rajkumar, “has been looking forward to upside as China eased up” on its stringent COVID measures, but, “overnight media reports warn of a dramatic increase in Covid cases across China,” including in Beijing, Shanghai, Shenzhen and Canton. Rajkumar doesn’t cite specific articles.
SOX Chart by TradingView Rajkumar references “checks” suggesting that smartphone chip production, specifically, is already hampered, and The current unlocking corresponds with some of the heaviest travel time in China, writes Rajkumar, leading up to the Chinese New Year on February 1st.
“Smartphone component makers are planning for a slowdown, in anticipation of CMs [contract manufacturers] reducing capacity in CQ1 [calendar Q1 of 2023] as Covid-infected workers return after Chinese New Year travel,” writes Rajkumar.
“While the expected slowdown is likely not as bad as a government mandated shutdown, the supply chain is nevertheless planning for CM build plan under-shipping end demand.” That will probably hamper already strained supply of Apple’s iPhone 14, Rajkumar writes.
Rajkumar cites the example of what transpired in India before that country began widespread vaccination efforts, suggesting that COVID cases in China are “likely to explode to the upside in the near term.”
“Caseloads then hopefully comes down in 3-6 months as herd immunity kicks in,” while cautioning, “There is little evidence globally of caseloads dropping sharply on the basis on herd immunity alone.”
Chip maker Wolfspeed has gotten a lot of attention from the Street as the “pure play” with respect to the relatively new chip technology silicon carbide. But Wolfspeed’s high valuation — eleven times this year’s expected revenue, based on enterprise value — has left some looking for less-expensive investing alternatives.
That’s the situation for Susquehanna Financial’s Christopher Rolland, who on Monday morning initiated coverage of Wolfspeed with a Neutral rating, instead preferring Analog Devices and STMicroelectronics, starting those stocks at “Positive.”
“While we recognize the company’s clear leadership today, shares trade at a premium valuation,” writes Rolland, “even when adjusting to the company’s ambitious long-term target model, implying near perfect execution.
"We therefore opportunistically await a more favorable set up,” he concludes.
Silicon carbide, of course, is a chip technology that is leading to greater range in electric vehicles, as I detailed in a piece in February. The technology is used most prominently in what’s called the “traction inverter,” a component in a car that sits between battery and motor and that converts direct current battery power to alternating current power to drive the motor. More effective conversion makes better use of the battery, and SiC, as it’s known, has that attribute.
WOLF Chart by TradingView Rolland sees pretty stunning growth for silicon carbide through the end of this decade, most, but not all, of that from automotive applications:
We forecast the overall SiC (devices and materials) TAM will reach $10 billion by 2030, a +17.6% CAGR through 2030. Likewise, expect automotive SiC revenue to grow at a +19.1% CAGR from 2022-2030, ultimately reaching a TAM of $8 billion. Rising EV penetration is a key driver for SiC growth, with the highest value in traction inverters as we believe ~65% will contain SiC MOSFETs by 2030, a stark increase from the current level of ~10% as OEMs shift from IGBT-based power products to SiC.
Wolfspeed is the leader, but Rolland’s enthusiasm is tempered by the company’s massive spending plans. As I reported in October, Wolfspeed’s CEO, Gregg Lowe, has told the Street the company needs to be able to cover six and a half billion dollars worth of capital expenses over the next several years to expand their SiC factories in the U.S.
While acknowledging Wolfspeed’s enormous head-start, Rolland writes that the big spending is a turn-off:
Wolfspeed has spent decades driving Silicon Carbide manufacturing to become the undisputed market leader in materials/wafers today. Furthermore, the company is quickly and successfully building its capabilities in finished semiconductor devices. However, we note these capabilities require capital at a cost that is dilutive to shareholders in the near term. Furthermore, competition is coming on fast, and risks of commoditization remain a possibility.
ST Micro, writes Rolland, is just starting out in SiC, and it may be something that increases the company’s sales growth rate, he opines:
On top of STMicro’s core analog and power management business, the company is addressing new greenfield opportunities, including Silicon Carbide, Gallium Nitride, connected MCU, 3D Sensing and more. These new opportunities can allow the company to reaccelerate growth and expand margins beyond today’s conservative mid-40%s today. This reacceleration in growth, combined with margin expansion, could help drive a meaningful re-rating in the valuation multiple, which today remains in the bottom decibel of the industry. Initiating Positive with a $50 price target.
Analog Devices is not a way to play SiC, per se, it is just a great chip maker that has “opportunities around electric vehicles (BMS), communications (5G RF), and specialty analog (medical, instrumentation, aerospace),” he writes, that “should help maintain industry-leading margins and growth.”
Rolland doesn’t mention the other big SiC chip name, ON Semiconductor.
Shares of Wolfspeed this year are down twenty-six percent, while ST Micro is off twenty percent, ADI is flat for the year, and ON Semiconductor is up five percent.
Analog Devices is one of the TL20 list of stocks to consider.
If you want even more SiC-related names, check out the long table of stocks at the bottom of that February article.
The week was a reprieve for software stocks, with GitLab, SumoLogic, MongoDB, C3.ai and DocuSign among names seeing big jumps in price, Alteryx is imagining a big role for its software going forward, ChatGPT captures the imagination, and subscriptions are coming to The Technology Letter.
I’ve been thinking a lot lately about The Great Recession of 2008 to 2009, and one of my favorite activities with historical stock data is to look back at what happened to various tech names going into and coming out of that period.
The key thing that you should meditate on is that some great companies that came public just before the recession came out of that economic contraction stronger. People will tell you new technology suffers in a downturn. CIOs, they might say, won’t spend on new stuff, they’ll buy the essentials to which they are already committed.
Don’t be mislead by that conventional wisdom. Important technology thrives and ultimately triumphs through a downturn.
I’d cite two important examples in particular that really make the case for new technology. This is not cherry-picking, though it is selective.
VMware came public moments before the recession, on September 28th of 2007. The officials start of The Great Recession, according to the National Bureau of Economic Research, the body in the U.S. charged with setting these landmarks, was January of 2008, following the peak in activity of the preceding economic expansion in December.
A few years before VMware and the Recession, Salesforce came public in July of 2004.
Both companies were not just young public companies in January of 2008, they represented relatively new technology waves at the time.
There was nothing like VMware as a company when it came public, even though the company by then had been shipping product for nine years. The only comparable software efforts that emerged at the time were from inside of public companies whose main software business had nothing to do with the “virtualization” that VMware spearheaded. In 2008, Microsoft was VMware’s biggest competitor.
To some extent, Citrix Systems had some overlapping offerings. Later, Intel added some virtualization to the chips it sold. Versions of virtualization were already emerging from the open-source software community, such as Xen, but it took a few years still for the biggest of them, such as OpenStack, to emerge. Follow-on works such as the Kubernetes container management software, didn’t emerge until 2015. And Nutanix, the closest comparable as a company, wasn’t founded until 2009.
So, September of 2007 was a time when it was still early in VMware’s influence. Mind you, VMware had already hit $1.3 billion in revenue in 2007, so it was an established company in that respect, even though it was still early in its mission.
Like VMware, Salesforce in 2008 had established itself as a successful company, but it hadn’t yet changed the landscape. For the fiscal year ending January of 2008, it had racked up $750 million in sales.
Salesforce was the poster child for cloud computing for years because there weren’t any other “Saas” — software as a service — companies back then. Its biggest competitor, Workday, which had been founded a year after Salesforce’s IPO, didn’t come public till 2012. And large, entrenched software vendors in 2008 were still largely disparaging of Salesforce in public. It took Larry Ellison of Oracle years more to get with the SaaS thing.
Microsoft’s Satya Nadella would not take over from Steve Ballmer until years later, 2013, which is when Microsoft’s SaaS engine really started to hum.
Consider that when venture capitalist Marc Andreessen wrote-his OpEd for The Wall Street Journal in 2011, two years after the recession, about how “software is eating the world,” he referred to Salesforce as a new kind of software giving competition to older, established software vendors Oracle and Microsoft.
Here is where it gets interesting. Both stocks had deep declines during most of 2008, with VMware dropping sixty-eight percent between January of 2008 and June of 2009, the entirety of the eighteen-month contraction. That was the total damage. And, it dropped a staggering seventy-nine percent from January of 2008 till it finally bottomed on December 1st of that year.
I’ve laid out the course of events in a chart of the two for the whole eighteen months, comparing the two to the broader market:
Similarly, Salesforce had to lose thirty-nine percent from January, 2008 to June of 2009, and from January of 2008 till its bottom on November 19th, it lost **sixty-five percent**.
However, both stocks saw solid gains from their lowest points. From its bottom in December, VMware went on to notch a fifty-two percent gain in the subsequent seven months of the Recession, and Salesforce saw forty-two percent upside in the ensuing eight months.
Both of these stocks — and this was characteristic of many tech names — bottomed way before the broader market, which didn’t bottom until March 9th of 2009, in the case of The Nasdaq Composite Index and the Standard & Poor’s 500 index.
More important, both companies grew during the recession. VMware saw an amazing forty-two percent growth during 2008. Even though its growth was drastically reduced in 2009, at almost eight percent it was still growth. The following year, 2010, VMware rebounded sharply, with sales growth rising forty-one percent.
More remarkable, Salesforce saw an amazing forty-four percent increase in sales in the fiscal year that roughly corresponded to 2008. It then went on to twenty-one percent during 2009. After that year, growth picked up to the mid-thirties on a percent basis.
Both of these companies became richer companies, too. Free cash flow for VMware increased a staggering forty-five percent during 2009, to almost nine hundred million dollars that year, real cash profits. Salesforce’s free cash flow increased a slower but still very respectable twenty-eight percent in 2009.
So, what does all this tell you? Good companies with a hand in important technologies that are changing the landscape continued to sell even more stuff during the worst economic contraction the U.S. had seen since World War II. The growth rates were no doubt diminished by what was going on, but sales did not collapse. The companies became more rich on a real cash basis, and their shares bottomed ahead of the broader market and saw healthy gains months before the Recession was over.
Not a bad outlook for tech stock investing. My recollection of covering the market during those later months of 2008 is that everyone was still staggering, dazed and confused by the collapse of Lehman Brothers and the near-collapse of Merrill Lynch, and the folding of retail banking operations such as Washington Mutual. Very few people could see their way to a market rebound in March of 2009, and few were seeing what was already a turn in a couple of great stocks.
Now, the mind turns naturally to the question of which companies today might be in a similar position. Off the top of my head, I would say that software companies at a similar scale and similar rates of growth seem like parallels. In that regard, Snowflake, one of the TL20 stocks to consider, is a highly successful cloud software company that just reported nearly two billion dollars in revenue in the twelve months ended in October, similar to the scale of Salesforce back in 2008. And it has some small free cash flow, similar to Salesforce and VMware.
In a similar vein, Confluent is a software vendor of important infrastructure that has just notched a little over half a billion dollars in twelve-month revenue, though it won’t be profitable for another couple of years.
If you want to know how those two stocks have fared this year, relative to the seventy-nine and sixty-five percent declines of VMware and Salesforce. As a rough approximation, Snowflake is down fifty-seven percent this year, and Confluent is down seventy-two percent. You could say that the declines of both stocks — again, without any clear indication recession has happened or will happen — approaches the kinds of declines that their predecessors endured. Allowing, of course, for the fact that Snowflake and Confluent were declining this year from very extended, if you will, valuations, which makes the comparison difficult.
I don’t have a crystal ball to tell you those are the two winners. And I suspect there are several other very good candidates, maybe not all of them as far along in revenue. The bigger takeaway is, companies with important technology and market momentum tend to come out alright on the other side of a financial contraction, and if there technology is really meaningful, it even changes the landscape.
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Anderson in the company’s Manhattan satellite office. The biggest companies, he says, use lots of cloud services. “They can't put all their eggs in one basket.” He believes Alteryx can be an “orchestration or automation layer” across cloud services and on-premise. “We think there's permission that exists for us to build that platform as an independent company.”
Mark Anderson has spent two years “re-tooling” software vendor Alteryx, as he puts it, since he came aboard in late 2020, to be better at going after the biggest customers.
He worked from a playbook honed at prior tech companies, such as Palo Alto Networks, where he was president for four years, and other big firms.
“The majority of the C-Suite is new, the majority of their teams are new,” says Anderson of Alteryx now, “and the people that were here prior to me coming on board, they've really worked hard to get evolved and enabled and trained for what customers need today and tomorrow.”
As Alteryx approaches what the Street expects will be a billion dollars in revenue next year, what comes next?
The “platform” is what comes next, a surprisingly ambitious bid to revamp the company’s offerings to be a much more comprehensive suite of software programs.
I sat down with Anderson this week at the New York satellite office of Alteryx in midtown Manhattan as he took a breather from customer meetings. Alteryx is based in Irvine, California.
It was two years ago that Anderson set out to change Alteryx, which he told me at the time needed new blood with a different pedigree, people who, like himself, had taken companies to multiple billions in annual revenue, people with “stage experience.”
The re-tooling of the team is working great for Alteryx’s financials.
After repeatedly missing expectations in 2020, the company in late 2021 began a very hot streak under Anderson. The third quarter reported last month was the fourth quarter in a row of revenue upside. And while some software makers are trimming their outlook because selling is getting harder, Alteryx raised its revenue forecast for the year for the third time in a row.
What happens now is that the product itself needs to grow up. The many programs that make up the company’s offering, lead by its flagship app, Designer, are tools to let employees stitch together various data sources throughout an organization and to run analytic operations on them. It’s a window into operations, to see how sales have been trending, say, or pinpoint where future leads are going to come from, or how the new manufacturing target should be set.
In one of the many instances of what he calls “pattern recognition,” Anderson sees a shift in Alteryx customers. Before taking over the CEO role in October of 2020, Anderson had already been a director at the company for over two years.
“I used to talk to CFOs, just as a board member, before the pandemic, and they would say, ‘We'll get to our transformation when we're good and ready’,” he reflects. “And now, it's like they can't get there fast enough.”
“The pandemic, the ensuing supply chain nightmares, the rampant inflation and talk of recession — companies need help seeing around corners,” he says. They need more of the analytics functions, in other words, with a new urgency.
AYX Chart by TradingView Giant customers, he says, are now saying they’re “digital” companies. “I’ve heard the CEO of Capital One say, ‘We’re a technology company that moves money around,’ right?” Another customer, Coca-Cola, “is a technology company that facilitates performance experiences for their consumers.”
Those companies need to run more analysis in order to make those transformations, but they can’t make their data scientists be both scientists and marketing and sales experts, he notes. “For one thing, there just aren’t enough of them” given data scientist is a high-price-tag role.
And so, “you need to transform the functional knowledge workers with solutions that automate their output,” he says. The tool should be taking people in sales, in marketing, in product development — all over the organization — and make their work turn their expertise into valuable analytic insight.
“If you're a supply-chain person or an analyst in FP&A [financial planning and analysis], we want to make you automated and great at what you do,” is the pitch. “We don't need to send you to school for five years to teach you how to use Alteryx, you can do it in a day.”
At the same time as re-skilling is necessary, he says, some giant companies are in crisis mode in a digital age.
“I've had three customer meetings already this morning,” he tells me. “One just left, a large insurance company, they have thousands of knowledge workers that are still working primarily with spreadsheets.
“They're closing the books of one of the most famous insurance companies in the world — it’s really in the U.S — with spreadsheets and manual work.”
This re-skilling, incidentally, is a mission of the company, he says. “We're advocating for an up-skilling of the world,” he tells me. “We're donating licenses to universities and polytechnics all around the world” to use the software for free.
It is also a belief, I learn, that runs deep with Anderson. “I was born in the slums of West Belfast,” he later tells me. “And my dad got an education, and we got out of Belfast as fast as we could.
“So, you know, education is super-important.”
And so, the immediate opportunity is to have companies use more of the Alteryx software on a daily basis, more broadly throughout the organization.
The first way to do that is to take a product that is used mostly on premise, meaning, inside a company’s down data center, and move it to public cloud computing facilities — to make it a cloud app, in other words.
Alteryx is one of those rare birds these days, a software maker that hasn’t yet transitioned to being a cloud computing vendor.
Because the Alteryx program ingests customers’ own data, cloud traditionally didn’t matter because the data was going to stay mostly on-premise. “Today, ninety percent of our customers’ data is still on-prem,” notes Anderson.
However, the logic to offering customers public cloud computing, rather than just a Microsoft Windows version of Alteryx, is to spread usage throughout enterprise.
“With easier access” to the program, he says, "I can sell to more users, and if I sell to more users, I can sell to different personas” within a company.
That starts to lead to economies of scale for customers, says Anderson. “If I do more personas and more users, I can get the unit cost down for people dramatically,” he explains. With greater economics, “I’m not going to charge you the same that I charged you for the first hundred users that I will for the next thousand or the next two thousand.”
Hence, the move to the cloud is now underway.
“What we did in a hurry was really start to accelerate the cloud agenda,” says Anderson. “So, bringing in the right people in product and engineering that have seen the movie before, that have that pattern recognition.”
The move to accelerate cloud has been lead by acquisitions of small, young firms that have brought new capabilities to Alteryx.
Hyper Anna of New South Wales, Australia, a purchase last year for undisclosed terms, lead to one new cloud product, Auto Insights. That tool lets a business manager avoid analysis per se an instead have the system tell them where in the data to dig more deeply for potential insights.
The second cloud product, Alteryx Machine Learning, offers some “basically, pre-built machine learning models that Alteryx Designer users can really go get to without becoming a data scientist,” says Anderson.
Also last year, the company spent four hundred million to buy San Francisco-based startup Trifacta, which had built an analytics program of its own that already was running as a cloud service.
The Trifacta code has been a key addition to propel the flagship Designer program’s move to a cloud version, Designer Cloud.
"That was our re-platforming option,” he says of Trifacta. “It took what would otherwise be a five-year journey to basically rewrite our software in all three public cloud environments globally, and would have required more engineers than we have.”
Designer Cloud was first introduced in Amazon AWS in a simple version last year, before the Trifacta deal. Since the deal, Alteryx has been “knitting together” the desktop Designer features to the Trifacta infrastructure, he says. “We have a bunch of early adopters giving us feedback,” and the new Designer Cloud will go live in January.
In revamping Designer for the cloud, Alteryx is placing a big emphasis on governance functions. Governance wasn’t as important on-premise because IT was able to closely control access to date. Governance becomes a more sensitive matter in cloud.
“You start making your innovation available in a public cloud, and you’re now starting to pull meta-data out of their environments, you’ve got to have governance and security that’s rock solid.”
“We over-rotated on innovation, and, in retrospect, probably under-rotated on governance and security,” says Anderson of the legacy Alteryx code.
Trifacta, he notes, already had worked on governance factors because the startup was cloud-first, as they say. At the same time, Alteryx itself has “chopped a lot of wood on governance” in the past two years, he says.
It will take time for the cloud versions to be an exact match with the on-prem versions, says Anderson, rather like how Microsoft’s Office365 had to evolve.
“There will be a point where people will go, wow, this is identical” to the desktop versions, he says of Designer Cloud.
Alteryx isn’t yet disclosing the amount of its cloud revenue. Back in April, CFO Kevin Rubin told the Street Trifacta might produce total contracts, or “annualized recurring revenue,” worth twenty million by the end of this year. But ARR is a non-GAAP metric, it is not the same as reported revenue. Rubin has said there is likely to be “limited revenue contribution this year” because of the timing of deferred revenue from the Trifacta acquisition.
Anderson says of future cloud revenue, simply, “I think it ramps.” As an early sign, Anderson told the Street last month the company signed two million-dollar-plus deals with customers for Designer Cloud.
A second avenue where Anderson has moved the company, in order to spread the use of Alteryx, is what are known as “enterprise license agreements,” or ELAs, a manner of pricing for usage that is “way more flexible.”
The ELA is “not rocket science,” says Anderson, but one of the many tried and true ways to sell to large enterprises that he saw in his time at Palo Alto and other shops.
“If you think about this in the old software contract, when you get to the one-thousand license threshold, and you go over, you're in trouble, we’re going to wrap your knuckles,” he explains, referring to how vendors limit the number of users in a software contract.
“What our software does for businesses and for people matters so much, especially now of all times, we want them to go faster,” he says. So the ELA lets a customer “burst,” to temporarily extend the product to more than they’ve contracted for. A thousand-seat license would now burst to one thousand five hundred, without the customer having to spend more.
The beauty of bursting comes when it’s time for a customer to renew their contract at the end of a year. “When it comes time for them to renew, we say, You’ve been using 1,500 for the last six months, do you want to pay for 1500? Because if you do, we'll let you go to 2,250 — you know, fifty percent more.”
That can prompt more usage. “We say, Congratulations on transforming manufacturing as well as finance, let's get into supply chain.”
Already, says Anderson, forty percent of the ELAs Alteryx has sold are in burst mode.
This is a savvy way of finding opportunity by not being chiseling. “Maybe they don't have the budget for it, but the sense of urgency for deploying it to more people is there,” he says of his customers.
“I've done this before, in a previous life, when we were doing virtual firewalls” at Palo Alto and F5 and Cisco, he says. “I did the exact same thing,” meaning, extending usage without gouging customers. “And it was like throwing gasoline on a fire because you accelerate adoption.
“People aren't doing this to run a worse business or to, you know, run a looser ship,” says Anderson of the need to throw more people at analysis. “They're doing this because they need to transform, and time is your enemy when you're transforming.”
Both cloud and ELAs are meant to bring more and more users in a company onboard and prompt a virtuous cycle economically.
“The more we can make it easy for people to adopt our technology, the quicker the journey, I think the more successful we're going to be, the more users we will have, the easier it will be for us to get unit costs down even further.”
What comes next after simply spreading usage is to be “more relevant,” he says.
What does that mean? “This industry has been its own worst enemy,” says Anderson of the data analytics software field. “There are a few legacy platforms that have not transitioned to be more modern.”
Companies such as Informatica, he says, and SAS, very prominent vendors of data management, “really haven't modernized.”
"I've been in tech for thirty-five years, and platforms win in every other area like operating systems, public cloud, security,” he observes. “Platforms win because customers want fewer vendors, they want less complexity, they want more automation, they want fewer necks to choke as one customer would tell me.”
“The more we can make it easy for people to adopt our technology, the quicker the journey, I think the more successful we're going to be, the more users we will have, the easier it will be for us to get unit costs down even further.”
Even as competing vendors such as Informatica and SAS have been static, he says, the cloud service providers have been trying to build their own mass-market cloud analytics platforms.
“The hyper-scalers have made acquisitions,” he says, using the sobriquet for giant cloud providers. “You know, Salesforce buys Tableau, Google buys Looker, Microsoft buys PowerBI — they’re going to take mid-market and below because they're the people that will put all their eggs in one basket.”
But the enterprises, says Anderson, the customers that are his focus, want diversity, and they want more to pick and choose.The new vision is for Alteryx to be a central tool for companies to move data and move analysis between different databases and cloud platform.
"This big insurance company that was here, they've got a lot of stuff in AWS, a lot of stuff in [Microsoft] Azure,” he notes. “They even started putting stuff in Google Cloud.” However, “they can't put all their eggs in one basket,” he cautions. “We want to be that orchestration or automation layer across the enterprise for analytics” to help the largest firms jockey across clouds.
“We think there's permission that exists for us to build that platform as an independent company,” says Anderson.
What Anderson is describing as an orchestration layer is not unlike the “trans-cloud” opportunity that I have mentioned recently at software makers such as SumoLogic and Nutanix. For a vendor of desktop analytics, it is a rather substantial step beyond an on-prem product built on a discrete set of data sources.
It sounds like quite a substantial engineering project, and M&A project, I point out.
“For sure,” replies Anderson. “You know, in two years we’ve done three acquisitions, and they haven’t been giant acquisitions, but they’ve given us a modern engineering team,” he observes.
That team is more capable, he says. “That’s really a global team — a lot more people in India, a lot more people in Eastern Europe — a modern engineering team that can crank out innovation at a much more accelerated pace.”
What’s more, Alteryx, he notes, has formed a venture capital investment unit to prospect among startups. “We want a front-row seat to the smartest people and the most innovative tech that's bubbling up today that might be of interest to us three, four, five years down the road,” says Anderson.
The platform he is describing, says Anderson, starts to bring more customers to the bleeding edge of analysis.
“You know, McLaren, for example,” the British car maker, a customer of Alteryx’s, “they use us to simulate three hundred million potential outcomes of a race before a race even starts, and every race, they move around one-point-five terabytes of data.
“They’ve got fifty analysts back in England, pounding away on keyboards, many of them using Alteryx,” he adds.
“I think the thing that amazes me, is, every company wants to be a McLaren, it doesn't really matter from building cars and watching them race around the track, or Stanley Black & Decker building tools — they all want to run as efficient a supply chain as possible."
The platform Anderson is describing — some of which already exists in the company’s product suite — goes beyond the traditional use case of Alteryx. It is no longer just to let employees assemble analysis but also to take over tasks in data preparation across a company. That includes things such as extract, transform and load,” or ETL.
That starts to invade other companies’ turf. ETL is the main function of Informatica, for example, whose CEO, Amit Walia, is leading his company on its own transformation.
Is this platform gambit biting off too much? I ask Anderson.
Not really, in his view. “Well, I mean, our engine as it exists today allows people to pull data from infinite sources and infinite formats, whether structured [data], unstructured, and transform it,” he points out. “That’s what the software at its core does.” His point is that could, in a sense, be the description of ETL.
What about Microsoft and the rest? Will they try to crush Alteryx?
“We often get compared to PowerBI at mid-market accounts because Microsoft will give that away with enterprise license agreements,” says Anderson. “And, you know, I've competed against free for the better part of the last fifteen years, you know, free firewalls — free security if you buy our networking with Cisco [Systems].”
“I love having that conversation about how the headline is going to look when you accepted free security,” says Anderson with a chuckle. “And I think, you know, analytics is right up there as well in terms of sense of urgency but also importance for the business.”
All these product angles — the move to cloud, the ELAs, the engineering of a platform — are “just waypoints in the journey, and how quickly it leads to two billion and three billion” in annual revenue, says Anderson.
Alteryx is, again, cruising toward a billion dollars next year, he reminds me. “Based on how well we do with customers at that scale, the next year will dictate you how quickly we get to double that or triple that,” says Anderson.
See also:
Alteryx CFO: in a downturn, customers may need us even more, November 15th, 2022;
You can’t make a mistake in a market moving this fast: turning Alteryx around, Feb. 21st, 2021.
He has seen this movie, he reminds me. “Between Palo Alto Networks and before that, F5 — both of them grew fifteen to twenty-five-X in seven, eight years,” he recalls, alluding to revenue. “It's doable.”
What comes along with scale, he notes, is leverage.
“[CFO] Kevin [Rubin] loves the fact that, you know, we're looking at our business and looking to get better leverage out of it,” he says. “Because, you know, these days shareholders care a lot more about free cash flow margins, they care about operating margins and profitability.
"And of course, as we prepare for fiscal year ’23, we're taking all that into consideration into how we're planning for this next year.”
With the expenses to re-tool Alteryx, and to acquire technology, the company has been only modestly profitable of late. The forecast offered last month is for the company to end the year with a non-GAAP profit in a range of negative five million dollars to breakeven, and a non-GAAP net loss per share of thirty-two to thirty-seven cents a share.
Free cash flow this year is estimated at negative eighty million dollars.
But a view to profit is on the horizon, suggests Anderson.
As any company gets bigger, “As a percentage of your top line, you spend less, and that's how you start generating free cash flow and positive operating margins,” he points out.
“And, you know, in my experience, it happens right around the stage when we're close to a billion dollars.
Alteryx will next report financial results in February, he says. “We'll give guidance for at least our first fiscal quarter, that’ll be a stake in the ground on year-on-year prediction of the first part of fiscal ’23,” he says. “And, hopefully, the path to free cash flow shows up there — that's the objective.
As sincere and serious as all this re-tooling is, I’m reminded, as I shake hands and part with Anderson, of how he characterized things when first we spoke last year.
“Going from this stage to two or three billion dollars,” Anderson had assured me, “there’s tons of really fun experiences requiring tremendous focus on the right things.”
As I make for the elevator, a gong is heard. It’s Anderson, helping to bang the gong with a salesperson who’s being celebrated for having just landed a big deal. Anderson gives the team member an affectionate demi-hug, and the gaggle of team members who’ve clustered in the common area laugh with delight, clapping and whooping their applause.
At a recent $42.97, Alteryx shares are down twenty-nine percent this year.
The biggest money maker in software stocks this earnings season has been video game authoring tools company Unity Software, based on its seventy-seven percent rise in stock price since it reported on November 9th. The biggest dog so far is payments processor dLocal.
The earnings season isn’t quite over, but after seeing reports from a hundred and twenty-five names in the past month or so, I thought it might be instructive to see how things have done.
The latest earnings positive surprises, Monday evening, are GitLab, makers of versioning control systems for programmers, and Sumo Logic, makers of DevSecOps platform software and tools, both of which saw their shares rise sharply after-hours after reporting better-than-expected revenue and earnings and a better-than-expected forecast.
What I’m after, however, is how the software names have done not just in their immediate response but in the days and weeks following.
And so the table at the bottom of this post includes the stock jump right after earnings in one column, but also the cumulative return of the share price since the day of the report. The table is sorted by the latter metric, the cumulative return.
A fundamental thing to take away are the reversals. Companies that had a big pop on their report, have in many cases notched big declines subsequently, such as legal firm software maker CS Disco. The reverse is true too: some companies sold off big but recouped losses and even rose handsomely, such as Five9.
I wouldn’t say there’s any deep reason for those reversals. They are merely a lesson not to take the pop from the report too seriously. After the smoke clears, some people find value in beaten-down names, while the enthusiasm for earnings reports for some names fades upon more careful reflection.
Another fundamental thing to take away is that companies that did everything right, such as Alteryx and Confluent, nevertheless sold off subsequently, whereas companies that blew it as far as reported results, such as Telos or Shift4Payments, were able to bounce back in the days following.
As you can see from the average return in the footer row of the table, the next-day pop for these stocks hasn’t been too good, just one percent, on average. And from report date to today, one percent as well.
It’s no surprise why software’s having a tough season. As I’ve chronicled in the past two months, many software names are reporting what they call “deal push-outs,” more time required to sell software, more scrutiny. It’s been harder and harder to sell software as companies tighten their belts.
I’ve tried to weed out companies that are software to an extent, but that include too much of a focus on content, such as online learning firm Coursera, which I dropped, or that are really making money by sales of items even if they regard themselves as a software company, such as luxury goods marketplace Farfetch. If you come across names you think do not belong in this group, please point them out.
I’ve included the most recent quarter’s revenue, as well, so that you can get a sense of each company’s scale. While there have been winners and losers of all sizes, I will point out that the average quarterly revenue of all the companies whose stocks have declined since their reports is $407 million. The average quarterly revenue of all the companies whose shares have stayed flat or risen since their reports is three times as large, $1.25 billion. So, on average, bigger companies have seen their shares hold up better than smaller companies.
Feel free to download the table in Excel format if you’d like to slice and dice it.
nteresting time for earnings from younger companies, including CrowdStrike’s (CRWD) disappointing report, but PureStorage (PSTG) was a bright spot, and diving deep into everything that’s going on with Qualcomm (QCOM), plus, beware next year’s flood of absolutely awful “generative” AI nonsense.
Some technology companies have gone through “transformations” where you had to really squint to see what, if anything, had changed.
When Microsoft and Oracle, for example, were early in their respective transitions to being cloud companies from being plain-old software vendors, you had to have a kind of monastic devotion to the scholarship of their quarterly filings to figure out what the heck was going on.
In contrast, chip giant Qualcomm has been going through a transformation for several years that is written in neon lights.
The company has expanded its sources of revenue dramatically, especially in chips for automobiles; and it has expanded its chip operating profit margin by a stunning seventeen percentage points in just two years.
At a gathering in September for analysts in New York City, the company’s CFO, Akash Palkhiwala, told analysts the company is well ahead of plan on signing up tens of billions of dollars worth of future revenue from car makers, lifting Qualcomm’s multi-year goals.
Qualcomm’s stock, however, doesn’t seem to reflect much if anything of that success. The shares, down about twenty-nine percent this year at a recent $125.66, track slightly below the benchmark Philadelphia Semiconductor Index, the SOX, in the past twelve months.
The valuation, moreover, as a multiple of enterprise value divided by projected next twelve months’ sales, at 3.7 times, hovers just slightly above where the stock was five years ago, when Qualcomm was a much less diverse company.
It is also toward the low end of valuations of the SOX companies, and well below the SOX average of 5.8 times.
Qualcomm’s stock is one of the inaugural picks of the TL20 group of stock to consider. Given that I think its shares are a good buy, I was in the mood for a good chat about why the market might not be fully valuing Qualcomm.
And so, when Palkhiwala sat down to chat with me via Zoom this past week, one of my main questions for him was, At what point will investors get the message that the company has changed?
“Yeah, that’s obviously a very fair question, and top of mind for investors,” says Palkhiwala. Since the company’s analyst day meeting a year ago, he says, when the new approach at Qualcomm was formally laid out, “the amount of progress we’ve made within the year is very significant.”
In truth the past year has been the culmination of a multi-year journey for Qualcomm to move away from its historical reliance on selling smartphone CPUs and modems for the vast majority of its revenue.
Under former CEO Steve Mollenkopf, the company set an agenda to expand into the realm of wireless chips it didn’t control, the “radio frequency’ filters that navigate the airwaves. That product line is now over four billion dollars a year, bigger than the two “pure plays,” Qorvo and Skyworks Solutions.
A plan was nascent under Mollenkopf to spread the Qualcomm chip expertise more deeply into the automotive market, to equip cars with wireless and media processing; and into the Internet of Things, a grab-bag made up of all kinds of things including chips for Windows PCs and chips for Meta’s Oculus gaming gear.
Both of those markets received a greater emphasis as Cristiano Amon, formerly president, took the reins from Mollenkopf last year as CEO. For the first time, Qualcomm regularly broke out the revenue from both autos and IoT on a quarterly basis. Autos and IoT have grown from six billon dollars in revenue two years ago to over eight billion in the fiscal year that ended in September, thirty-eight percent growth.
More important, autos and IoT now make up twenty-two percent of chip sales that were once almost entirely smartphone-chip sales.
“When you step back and look at the long term strategy, it's playing out exactly as we had hoped for,” says Palkhiwala.
“Cristiano became CEO a year and a half ago, and we came up with this new approach on how we're going to lookgoingforward as a company, effectively transitioning from a connected smartphone company to a processor company that powers the connected, intelligent edge.
“It becomes a different company with that, right?” he asks, rhetorically. “It's about diversification. It's about expanding the technology portfolio that we have, and bringing it to auto and IoT. And, as you saw from our numbers and our guidance, we're very much on track in those areas.”
SKATING TO THE GOAL
The financial goals as articulated by Palkhiwala have been fairly straightforward.
As he laid out a year ago at the company’s analyst day in New York, over a three-year period, fiscal 2022 through 2024, the company would increase its revenue from chip sales, its division called Qualcomm CDMA Technologies, QCT, by “mid-teens” on a percentage basis, compounded annually. It would keep its patent licensing business, Qualcomm Technology Licensing, QTL, which makes up the other fifteen percent or so of revenue, at the same size and margin going forward.
And non-GAAP expenses would be kept in a tight range of twenty-one percent of revenue to twenty-three percent while operating profit margin for the chipset business would be maintained at thirty percent or better.
The company is already off to a good start. Its revenue outlook for its automobile business for the next several years is now higher than originally forecast. And operating expenses this fiscal year were just under twenty percent, while operating profit in QCT, known as earnings before taxation, “EBT,” was thirty-four percent for the year.
But the Street is not entirely buying it. Not only does the valuation multiple appear low, the Street consensus for revenue in the fiscal year ending in 2024, the end of that three-year range, is for $40.39 billion. That implies a compounded growth rate of fourteen percent, which is a little lower than would be suggested by “mid-teens.”
Hence, as I suggest to Palkhiwala, investors are still grappling with something in the story.
QCOM Chart by TradingView TALENTED MESSENGER
It is not that Palkhiwala isn’t an excellent messenger for the Qualcomm story, because he most certainly brings unique talent and experience essential to the task. Since he took the role of CFO in August of 2019, he has harbored an excellent reputation on the Street as a reliable forecaster of Qualcomm’s financials, and a straight-shooter.
He knows the company inside and out. The rhetoric about transformation is backed up by his own career reflections, having started at Qualcomm twenty-one years ago.
“The talent in the company I think has expanded a lot” in that time, he tells me. “We used to be very much focused on one set of technologies, and now, as we've grown up as a company, and we’re going into different markets, it really is in some ways a very different company than we used to be.”
The continuity, he says, is in the fact that “we’ve, kind-of, retained the soul of the company and the technology that we created,” that portfolio of chips now being moved into automative and IoT uses.
An affable manner probably helps ingratiate Palkhiwala with the Street. His self-effacing humor can be disarming. When we met for the first time in September, at the auto event, and I asked him for an interview for The Technology Letter, I told Palkhiwala I’d interviewed Amon many times in past, and Mollenkopf before him. “So, now you’re ready for the consolation prize,” quipped Palkhiwala.
No runner-up, actually, Palkhiwala, an engineer by training, often frames his financial talks by tying them back smoothly to the technology vision laid out by Amon.
ON THE EDGE OF SOMETHING BIG
Investors, says Palkhiwala, understand the company’s position as a chip supplier to the “connected edge.”
In a nutshell, as more and more of computing has been sucked into centralized data centers of cloud computing services such as Amazon’s AWS, a second wave is happening where those servers have to connect to devices of all sorts at the far corners of public and private networks.
The devices might be smartphones, yes, but increasingly they are other kinds of things: point-of-sale smart terminals hooked up to networks; your Internet-equipped car; heavy equipment with wireless capabilities to send status information back to monitoring dashboards.
“We have the ability to be the other side of the cloud, right?” says Palkhiwala. “So, we would be the device on the edge that is connecting to the cloud and we're doing an activity of processing artificial intelligence at the edge.
“That message and that understanding of the opportunity in front of us resonates with investors.”
The technology trends that matter, he argues, are propelled by economic tribulation.
“We see this digital transformation driving this tremendous change in these end-markets that is very much in our favor, and that brings those end-markets closer to the technology that we already have,” he says.
“Those trends,” he says, “are, if anything, accelerating as we hit some of these economic challenges,” meaning, the use of automation or other resource-saving technology measures.
"Because if you are a retail company, if you are a manufacturing company, the use of technology becomes even more important,” and “digital transformation becomes a tailwind in a challenging macroeconomic environment, and that's something that we expect to benefit from as we look out the next several years.”
Included in that opportunity is the prospect of re-using decades of Qualcomm’s amassed intellectual property in new markets. “The key assets that we have as a company is maybe the broadest technology portfolio of any semiconductor company out there,” says Palkhiwala.
“We created this portfolio for our handsets, now we can leverage it into automotive and IoT,” the newer areas, “and there'll be more opportunities in the future because it's a portfolio of technologies that is extremely relevant to every end-market in the semiconductor industry.”
With investors, Palkhiwala has emphasized that the leveraging of that portfolio has produced financial leverage, too, most immediately in the surge in QCT’s profit margin from seventeen percent of revenue two years ago to thirty-four percent most recently.
“Since we are reusing the technology we created for mobile, it allows us to grow revenue in a very profitable manner,” he says. “That's where the operating leverage of the business comes into play: if you look at our actuals for the last couple of years, as we've grown revenues, we've been able to expand our operating margins — and that's a framework that I think sits well with our investor base.”
If the big picture is promising, and the financial goals are clear, and the messenger is an exceptionally talented one, what, pray tell, is holding back the Street’s fully valuing this stock?
SHORT-TERM ANXIETIES
There are at least a few things at the moment that are affecting investors’ ability to get their arms around “the New Qualcomm,” if you will. Our wide-ranging talk covered pretty much all of them.
Most immediate is that, as always, Qualcomm’s business still is very much impacted by what happens in smartphones, and smartphones have been a dog this year.
That has lead to last month’s downward revision in Qualcomm’s estimate of the market, and a disappointing revenue outlook for this quarter.
“In the shorter term, the semiconductor industry is going through some significant challenges,” Palkhiwala observes when I ask what is top of mind in the company’s fourth-quarter earnings report last month. “One, the inventory build that has happened in the channel,” he says, meaning, chips that now have to be first used up by phone makers to clear their stocks as sales come in lower than expected. “And, second, is just, kind-of, the market weakness we're seeing because of macro-economic conditions.”
The macro-economic picture for Qualcomm is construed by investors very specifically: Since China became a huge market for Qualcomm smartphone chips some years ago, China has featured heavily in results as boon or bane.
It is certainly a bane at the moment. Handset sales among China vendors using Qualcomm chips, companies such as Xiaomi, Oppo, Vivo, are down by over twenty percent this year in unit terms, according to some market data.
Palkhiwala is inclined to play down China’s uniqueness, however. “Clearly, the restrictions that are in place has an impact on total handset sales,” he says, referring to the country’s strict COVID-19 measures. “But there are cyclical things that are impacting the entire industry,” he adds.
“You're definitely seeing a post-COVID shift of spend from goods to services for the consumer” globally, says Palkhiwala. “Rather than buy a phone, someone is going on a vacation, sitting in a hotel, having a meeting in a restaurant.”
“That is obviously a temporary thing that'll happen.” When will China return to something more like normal? “I’ll stay away from speculating on it, there are so many factors that play into it that are beyond my understanding,” says Palkhiwala. “I will say, when that happens, we’ll be ready to take advantage of it.”
If he won’t predict the China market rebound, investors would love for Palkhiwala to discuss how the rest of the handset market may offset China’s slump. While China handset sales are down by twenty percent or more, Palkhiwala’s comment to the Street last month was that the total global smartphone market is declining by “low double digits,” implying there are bright spots elsewhere.
“Generally, the U.S. has obviously continued to be very strong,” says Palkhiwala in response to the question of what markets offset China. “Emerging markets are going to have their own trend of transitioning from 4G to 5G” wireless networks, the latest speed bump in connectivity, he adds.
“India is a great example where they're at the front end of a rapid shift from 4G to 5G, and so that’s going to be a positive development for us in the next year or so.”
He is inclined, though, to view smartphones “on a macro, global basis, rather than each individual market.”
That global handset market is not always well understood by investors. It may be more robust than they think, suggests Palkhiwala.
Many investors believe it is a “cash cow” business, very little growth but healthy profit margin.
“From a market perspective, it’s definitely an accurate portrayal,” says Palkhiwala. However, even in a maturing market there are trends that favorable, he says. One is the shift to more premium phones needing more brawny chips at a higher price. “A great example is emerging-market TV,” he says. “There used to be there used to be one TV where fifteen people were watching, and now you have fifteen phones, each person watching the content of their choice.”
As a result, “The next time that person buys a phone, they're going to buy a phone that is more capable on audio and video experiences and movie experiences and which makes for a more expensive chip and revenue growth for us.”
Consequently, there may be more growth than the cash-cow theory implies. “We’ve said that consistently,” says Palkhiwala, “that these are factors that help us in a mature market to grow revenue.
“The proof is in the pudding,” says Palkhiwala. “If you look back over the last couple of years, there has been a significant increase in our weighted average selling price [for phones] as people would calculate it, outside of the share gains that we had.”
Temporary though the handset slump may be, the forecast offered last month spooked the Street, which has been used to the steady hand of Palkhiwala’s forecasting. The revenue outlook was twenty percent below consensus at the time, sending the shares down sharply.
I ask if the current market decline has forced Palkhiwala to change how he talks to the Street about the outlook. “You know, the philosophical approach to guidance is something that you keep forever, you don't change based on the environment, and that approach is really focused on transparency and reflecting the best-available information,” he says.
“To be honest, in talking to investors, that's what they would want from us anyways,” he says, “because there are things that we know, and we want to reflect that, there are things that we don't know on the macroeconomic environment, and we want to be transparent about that as well.”
*A practical element of Qualcomm’s strategy is that it hinges on changes in markets such as autos being inevitable, and Qualcomm starting from a relatively small base of sales. “The fortunate part for us in the automotive business is we are a very small player, relatively speaking, on our way to become a very large player,” says* ***Palkhiwala****. The company “could achieve our forecast” for automotive revenue “without any growth in the total number of cars” sold.*
COMING TO GRIPS WITH EXPENSE
Even if there’s more growth down the road for QCT than the cash-cow theory suggests, what happens right now to the company’s ability to spend as QCT sales temporarily come under pressure?
Delivering last month’s gloomy quarterly forecast, Palkhiwala told the Street that “we will be decisive in managing operating expenses, especially if the downturn gets steeper.” That already includes a hiring freeze at Qualcomm.
How much more rigorous will the company need to be? Does a freeze turn into layoffs?
For the time being, more of a shifting of emphasis in the workforce, he says.
“In order to get our mix of businesses right and redirect investment, we have to make some changes in the skill sets we have,” says Palkhiwala. “So, it requires some amount of cuts.
“But overall, as a company, when you think about it, we gave very specific guidance on OpEx [operating expenses] for the year as well, or qualitative guidance on OpEx for the year, so we're planning to execute to that and, then, as we said, if we need to do more, we're willing to do it.”
More broadly, operating expenses are, of course, a balancing act.
“The way we think about it is, we want to invest in the growth areas for us, which is automotive and IoT,” he says. “What we're looking to do is reduce our investments in mature businesses and redirect those dollars to those areas.
“Second, is, we're still in this time frame of macroeconomic uncertainty and COVID restrictions, and so while we have that overlay in the economy, we want to be managing our expenses more carefully than we would normally, just because we don't know what we don't know.”
THE PROFILE OF PATENT LICENSING
If some investors believe, however incorrectly, that chip sales are now becoming a cash-cow, QTL, the licensing business, is the original cash cow, a royalty business with amazing profit margin of seventy percent or better. The multi-year plan, again, that Palkhiwala has articulated is for QTL’s rich margins to remain pretty stable.
However, there can be an occasional dip in profitability, as was the case last quarter. Such a blip can send investors scrambling to understand if they are seeing the start of something ominous. It is a passing phenomenon, says Palkhiwala of the slight margin decline of a couple percentage points.
“As the size of the market goes down it puts pressure on margins, there’s nothing beyond that,” he says, referring to the current handset slump. Volume of sales by licensors, the phone makers, directly affects the royalty stream.
On the plus side, the move to 5G wireless is going to show up in new patent opportunities for QTL. For example, in automobiles, connections from the car to the Internet are going to move over time to 5G from the current 4G modems Qualcomm has been selling, with perhaps five dollars per vehicle in new licensing payments.
When I ask about that prospect, Palkhiwala, careful to keep within his lane, steers clear of things that lie too far beyond the three-year forecast he has offered.
“It is definitely something that's going to boost the profile of QTL,” says Palkhiwala of 5G. “The timing of that is further out in the future, right? It doesn't help the shorter term, but it does create an opportunity for us as we look forward.”
THE CHINA ISSUE
Another current-market concern, one that is now a multi-year journey, the U.S. export restrictions on sales of chips by U.S. firms to China.
The U.S. Department of Commerce has now ratcheted up those restrictions during not one but two presidential administrations. The anxiety sometimes seems at fever pitch in the media and perhaps among investors.
Palkhiwala’s general tone, when I ask about the matter, is to present Qualcomm as somewhat at a remove from the most damaging restrictions. “We're in the consumer business,” he points out. "Some of the restrictions that have come up recently that were implemented do not impact us because we're focused on consumer devices, portable devices versus data centers.”
His point is that the U.S. seems acutely focused on those kinds of chip technology that can power existential technologies such as forms of AI developed on the biggest computers inside research facilities. Those data centers may connect to the edge Qualcomm is pursuing, but the edge could be viewed as technically a separate market at arm’s length.
Just as important, the Qualcomm edge market is a worldwide phenomenon, he adds. The implication is that there are plenty of other markets. “You go back to our original strategy, which is providing chipsets for the connected intelligent edge, which is really being fueled by digital transformation and cloud connectivity, and that's a global phenomena that will continue to remain in place.”
DO INVESTORS UNDERSTAND THE TECHNOLOGY?
The short-term stuff, stuff like China’s handset sales, or a couple points of margin, are, I’m convinced, the kind of hand-wringing that comes and goes. It seems to matter most to a kind of outer circle of investors who haven’t done much research on Qualcomm or its business model.
But one the elements that I’m convinced is more significant is investors’ confusion about just how the new markets of automotive and IoT are playing out. Although the vision is in neon lights, as I said, there may still be elements of the details that need explaining.
“I'd say within IoT, we have some more work to do in providing more evidence of being on track and succeeding,” says Palkhiwala.
That’s good, frank, self-reflection. IoT seems perhaps the hardest part of the picture for investors to put together, and the hardest to articulate financially — not surprising, given it is not one technology, product category, or market. IoT is a grab-bag of stuff. The term is what AI scientist Marvin Minsky called a “suitcase word,” a word into which you throw just whatever you want. It was invented by industry to have a convenient way to talk about so many newfangled technologies relating to the Internet, and that can make it hard to get one’s head around it.
IoT includes lots of infrastructure that governments and municipalities have been deploying, things such as lamp-posts with wireless connections for remote control, and the ubiquitous camera systems on street corners. Amon has been talking about those opportunities for Qualcomm for years, long before he took over.
But more recently, more high-profile opportunities have included shipping millions of Qualcomm chips inside the Oculus 2 headset from Meta for virtual reality, and chips that compete with Intel processors in Microsoft Windows-based laptops.
In these newer markets, Qualcomm faces the same challenge that great chip companies always face, which is that they are at one or two levels removed from the end user.
In smartphones, over decades, Qualcomm managed to curry a little bit of brand recognition for its Snapdragon chips that powered the handset. Still, consumers cared mostly whether it was an Apple or a Samsung device.
In the case of VR, it is a sure bet that most users of Meta’s headset have no idea there’s a Qualcomm chip in there. Ditto for Microsoft’s Surface Windows tablet family. The recently introduced Surface Pro 9 has the option of using Qualcomm’s processor and modem in place of the dominant Intel “Core” family of x86 processors.
The problems of being at a remove can be manifold. When I watched Amon a year ago onstage in New York talking about Mark Zuckerberg’s Metaverse, I couldn’t help but shake my head at the incongruity. The Qualcomm chips were doing good work to power a revamped headset for video gaming, and if video gaming was the sales pitch, everything would have been just fine.
But, as a partner, Amon and team are conscripted into the sales pitch for a bold new world of VR and augmented reality, and everything else, under the rubric “XR,” which really doesn’t exist. Qualcomm, in addition to supplying great chips, is carrying water for a market, the Metaverse, that is, essentially, vaporware at this point, and bound to be so for a long time.
The prospect of the Surface is more straightforward. The PC market wants competition. And Apple, which dumped Intel chips for its own parts, has provided a fine example for Qualcomm and its partners that there is a realistic chance of unseating Intel. The PC industry is a “great example” of Qualcomm re-deploying its mobile phone technology, Palkhiwala tells me.
“Apple made the transition from x86 to ARM-based architecture, really bringing their iPhone technology to bear in Macs,” he explains. “The same advantage exists for us where we can take the technology portfolio we created for phones and go disrupt a very large silicon market by extending that technology portfolio.”
Except that, again, there are some drawbacks to being at a remove from the end user. In this case, there are still growing pains for the Qualcomm PC effort.
One reviewer of the Surface Pro 9, The Verge’s Monica Chin, noted last month the Qualcomm version of the machine has “exceptional hardware,” and she lauded the inclusion in the Surface of built-in 5G connections — something the Intel-based model doesn’t have.
However, she also noted that aside from great video conferencing, “most other tasks you might need to do in a workday were frustratingly slow,” including very basic things such as chat and watching videos. Those apps weren’t written natively for the Qualcomm ARM-based processor, and so their performance was degraded, she notes.
“Windows on Arm is not ubiquitously unusable — but it is ubiquitously limited,” wrote Chin. Ouch. That’s the problem being a partner and not in control of the total product. In the case of Apple’s chips, when it dumped Intel, it made sure the Mac’s software and hardware worked together mostly smoothly. Qualcomm can’t control the progress of Microsoft’s code nor how well it uses the Qualcomm silicon.
AUTOMOTIVE’S HEAD-SPINNING PROGRESS
If IoT needs a little help, the automotive market seems crystal clear, especially after the well-received September auto event in New York.
The greatest immediate opportunity at “the connected edge” for Qualcomm is the connected car. Amon and team have repeatedly emphasized that it is a once-in-a-lifetime opportunity for chip companies because the “content” in cars, the number and variety of chips, is surging dramatically as the things the car is supposed to do increase.
A decade ago or so, all the chips were for were anti-lock braking mechanisms and the fuel control system. Today, chips in cars are the eyes and ears of road sensing via technologies such as LiDar; the real-time wireless connection to the internet for the cockpit; the ever-more-feature-rich dash and central stack; the seat-back entertainment screens; the network of cabin sensors; and on and on.
Qualcomm is already well established selling modems to car makers for the network connection, and it is currently expanding into that digital cockpit that is sprouting more and more devices with connectivity chips and processors and display controllers.
The next step is ADAS, advanced driver assistance systems, everything from automatically nudging a car back into its lane, to, someday, a car that drives itself. The financial payoff of ADAS will start to become material starting in Qualcomm’s fiscal year 2026, Palkhiwala told the Street at the September event.
Oddly enough, the success in automotive is coming so fast, it may be leaving investors a little confused.
In particular, the September event had a big headline from Palkhiwala, the jaw-dropping revelation that Qualcomm has secured from car makers thirty billion dollars worth of “design wins” for future chip sales, meaning, statements of intention, if not formal contracts, for car makers to use the company’s chips.
That thirty-billion-dollar figure had been just thirteen billon a year ago, at the analyst day event. What’s more amazing is that at the time of the August earnings report, Palkhiwala had said it was only nineteen billion.
Thus, the wins with car dealers soared by eleven billion dollars “in just two short months,” Palkhiwala boasted at the September event.
Watching the room, it seemed to me Street analysts were fairly taken aback at the magnitude by which Qualcomm’s good fortune had surged. How do you go from nineteen billion dollars in commitments from customers to thirty billion in two moths? I asked Palkhiwala.
“These are deals we were negotiating for a long period of time,” he notes, and they just happened to close. “Sometimes, the timing just works out in your favor, and this was an example of that.” Had those deals happened earlier, August’s figure would have been higher than nineteen billion, he notes.
That particular time frame is less important, says Palkhiwala, than what the steady increase — first thirteen billion, then nineteen, now thirty — says about the company’s steady march to win over the auto world.
“What we're trying to convey is really show progress towards the revenue targets we set.”
Design wins are a pipeline of future business. The represent the company’s estimate of the future revenue from a particular chip in a particular model of car — a “socket,” as it’s known — which takes years to come to market.
“If the design value over the life [of the socket] is one billion dollars, and you start shipping in about three years” from the time the car maker agrees to buy the part, “you then ship it for another four or five years after that,” for an entire lifespan of seven or eight years.
“That billion dollars plays out over that period of time, and it informs our revenue targets.” In particular, Palkhiwala told analysts that the company now has ninety percent of expected revenue for the next four years essentially secured, or “covered,” as he put it, by that thirty billion of design wins.
That allowed him to raise the company’s revenue outlook for automotive. A year ago, he had told the Street to expect three and a half billion dollars in revenue from automotive in the company’s fiscal 2026, and now that was looking more like four billion. And the target offered a year ago for 2031, eight billion in automotive revenue, is now nine billion.
Interestingly, the ninety percent of revenue now covered by that pipeline is higher than the coverage had been at the analyst even a year ago, when it was just seventy percent of future revenue. Because I suspect the pipeline, and the coverage, can be mysterious, I ask Palkhiwala if there’s a goal to secure design wins to cover a certain amount of future revenue.
“It’s the other way around,” he says, “where you have the pipeline of design wins and it informs your revenue targets.” That strikes me as significant: deals are happening as they are happening, which seems more honest than concocting a stream of future business to produce a certain revenue forecast on a PowerPoint slide.
I point out that during the September event, analysts wanted to nit-pick Palkhiwala’s projections for the total market value of automotive, the “total addressable market” or TAM. Come 2030, he told the audience, the value of things such as the car connectivity chips, and the digital cockpit, and ADAS — that ever-expanding constellation of content — will total one hundred billion dollars in industry chip sales annually.
Some seemed to quibble with that.
“To be honest, this is like one of those things where everyone can come up with a different estimate,” he says. “The fortunate part for us, in the automotive business, is we are a very small player, relatively speaking, on our way to becoming a very large player.”
Although Palkhiwala estimates auto sales to calculate the design win pipeline, nevertheless, the design wins, and revenue, are happening as an effect of that expanding use of chips, not as a result of automobile sales growth.
“We could achieve our forecast” for automotive revenue “without any growth in the total number of cars” sold, he says. “The addressable market for silicon [in the car] is expanding, and then we’re picking up share within that market.”
“And so, that gives us the confidence that it's not really betting on the scale of the market.”
*Amon, center, with Palkhiwala, left, and Nakul Duggal, general manager of the automotive division, during September’s automotive presentation to analysts. Palkhiwala, an engineer by training, and a twenty-one-year Qualcomm employee, often frames his financial talks by tying them back smoothly to the technology vision laid out by Amon.*
IS ADAS SAFE AT ANY SPEED?
Aside from market size and timing, I have my own hesitancy about the automotive market, and it has nothing to do with Qualcomm’s acumen as an obviously highly skilled maker of chips.
No, my concern is the viability, for all parties, of ADAS, the part that Palkhiwala says becomes material for Qualcomm in 2026. Palkhiwala says almost sixty billion dollars of the hundred-billion-dollar market opportunity for Qualcomm, come 2030, will be in ADAS, and the company intends to win there.
Qualcomm may be just as talented at building ADAS as competitors Nvidia and Mobileye, the recently spun-out unit of Intel.
The problem is, I’m not sure key parts of ADAS will ever work.
The sense that I get from talking with people in the fields of AI is that a lot of self-driving hype is never going to lead to real product. In October, for ZDNet, Yann LeCun, one of the deans of today’s AI, told me in very blunt terms that he thinks the entire field of self-driving cars is on the wrong path.
“People working on autonomous driving have been a little too optimistic over the last few years,” LeCun told me. “The first thing you do is you build a demo where the car drives itself for a few minutes without hurting anyone.”
But then, said LeCun, “you realize you are never going to get there because there is all kinds of corner cases, and you need to have a car that will cause a fatal accident less than every two hundred million kilometers, right?”
LeCun’s conclusion is “You’re going to have to engineer the hell out of it,” by which he means, “if you have a large enough team of engineers, you might pull it off,” meaning, self-driving, “but it will take a long time, and in the end, it will still be a little brittle.”
That’s rather damning coming from a certified AI genius. Closer to home, even fans of Mobileye are concerned.
Writing to clients this past week, New Street Research analyst Pierre Ferragu, while endorsing Mobileye, noted that the technology of self-driving, industry-wide,
“displays impressive reliability in the five nines” but “deployment remains challenging.”
Translation: it’s really hard to do stuff on the open road and avoid killing people more often than one every two hundred million kilometers, as LeCun suggests.
And so, I ask Palkhiwala, should I be concerned that Qualcomm, as talented as it is, is going down a path that is bound to be one of disappointment, pursuing a dream, self-driving, that computer science still has not figured out?
“I think it's actually a great question,” says Palkhiwala,
“and it’s something that's a strength for us, let me tell you why.”
ADAS, he says, “is not a yes or no answer.” A lot of the press, says Palkhiwala, has been focused on the most extreme areas of self-driving, but that’s not necessarily where the market is at.
The U.S.’s National Highway Transportation Safety Administration, which oversees tests of ADAS on top of its tireless work investigating why car crashes happen, has described the five levels of ADAS. The NHTSA’s framework is everyone’s touchstone for talking about ADAS.
At the low levels, levels zero, one and two, the car is always driven by a person, and vehicle technology only intervenes in things such as an emergency situation, or to help periodically with braking or steering.
At Level Three, the guidelines specify, a car’s auto-pilot may take over while a person is in the driver’s seat, ready to jump back in. The extreme things are at Levels Four and Five, where there may be no person ever in the driver’s seat, just a machine all the time.
“People have this view that eventually we're going to have self-driving cars and the extreme vision of the industry,” says Palkhiwala. That is the yes or no answer, the binary, he alludes to. “And I think a lot of that vision, well, people are revisiting the timeline” in which it may happen.
Qualcomm, he says, “are very focused on, and most of our design pipeline is centered around, Level Two and Level Three,” those simpler functions of braking assistance or partially automated driving with human driver present. Those functions, “are actually a very achievable set of experiences,” he says.
“We are not a Level Four or Five company,” he continues, “and all of our competitors are actually just focused on those areas,” including Nvidia and Mobileye.
If Qualcomm is "a very small player” in automotive chips “on our way to becoming a very large player,” then it is, he says, because “we're focusing on the sweet spot of the U.S. market versus those those [more-ambitious] parts.”
Again, the proof is in the pudding.
“You’re seeing the difference in design pipeline show up,” he says. Some of that thirty billion dollars is stuff that will be practical in years from now when it is on the road, such as Levels Two and Three ADAS.
See also:
Qualcomm shows off its automotive chip chops, September 22nd, 2022;
Hanging with Qualcomm and hearing the Metaverse pitch, November 16th, 2021.
DON’T FORGET M&A
As we round out our discussion of things that might be clouding investors’ view, there is also room to discuss what might be a secret weapon of the firm, something that I’m inclined to liken to the third dimension relative to investors’ Flatland horizon: M&A.
Not only is Palkhiwala an asset in thinking about the technological scope of things, he is also an astute custodian of one of Qualcomm’s favored means of growth.
Palkhiwala started at Qualcomm in 2001 in the M&A department, after a few years in private equity in Cleveland. “I think my plan was to get as far from Cleveland as possible, and San Diego qualified,” he recalls.
“We've had a very successful M&A program,” Palkhiwala observes.
The company has a long history of buying important assets that it then builds into meaningful franchises. That was the case with the three-billion-dollar purchase of radio frequency assets from TDK in 2019 that cemented Qualcomm’s position ahead of Qorvo and Skyworks in RF. Big deals have tended to be few and far between, such as the abortive bid to buy auto-chip maker NXP Semiconductor for fifty billion dollars in 2018.
The TDK assets are a good example of how Qualcomm does successful M&A, Palkhiwala says. “They were number four, number five in the industry, we made them number one,” he says, meaning, RF share that had trailed Qorvo and Skyworks. “So, we had an organic plan to expand” into RF “but we were able to do it faster because we made an acquisition.”
The PC market that is so tricky with Surface Pro 9’s limitations has the intriguing prospect of getting a lift from a $1.4 billion acquisition last year of a conspicuous Silicon Valley startup, Nuvia. The company is staffed with stellar former Apple engineers, including Gerard Williams, who lead Apple’s move from Intel to its own Mac chips.
The company’s work prior to the deal, a chip code-named Phoenix, has an ability to operate at very low power levels that “are well-suited to mobile devices,” wrote longtime chip observer Linley Gwennap of the Microprocessor Report last year.
The Phoenix chip could boost Qualcomm’s high-end smartphone processors, but also, “could boost Qualcomm’s efforts in laptop PCs, enabling the company to create a chip similar to Apple’s M1 but for Windows systems,” wrote Gwennap.
Says Palkhiwala, Nuvia “is going to allow us to accelerate our entry into the PC space, among other things.”
The other prominent recent deal is Arriver AB, a software maker for those ADAS functions in the car. Arriver is an intriguing example, like the TDK deal, of Qualcomm stepping in at the right moment in time to pick off choice assets. The company is a carve-out from Veoneer, a Swedish firm that up until May of 2021 had traded on the New York Stock Exchange. Veoneer had been the electronics unit of Stockholm-based auto parts supplier Autoliv and was spun out as a public entity by that company in 2018.
Qualcomm teamed with New York investment firm SSW Partners to take Veoneer private for four and a half billion dollars last year, under SSW’s ownership. Qualcomm then turned around and bought the Arriver software unit from SSW, leaving the rest to SSW.
When you think about that multi-year chain of deals — Autoliv to Veoneer to Arriver — the deal is a window into Qualcomm’s ability to zero in on just what it needs to complement what is already in-house at Qualcomm. Rather than take whole companies, Amon and team artfully pick and choose the parts they want.
“We have a very strong chipset roadmap for ADAS,” says Palkhiwala, "and Arriver brought software assets that really are driving a large portion of our design win pipeline in automotive.”
Since taking over Arriver roughly six months ago, Qualcomm has been busy developing a software “stack,” meaning, several levels of capability that are optimized to run on the Qualcomm chips. The focus is “computer vision” applications of machine learning that will advance the ADAS functions. That work has proceeded in close collaboration with Qualcomm’s auto customers such as BMW.
In other words, with Arriver in autos, Qualcomm has a chance to meld hardware and software closely unlike the way that it has been at one step removed from Windows users in the PC market.
Those two acquisitions are proof, says Palkhiwala, that the strategy to enhance Qualcomm’s own abilities works well. “In the context of that strategy, there are certain — given where the asset values are today — opportunities for us to continue to do that,” he says.
M&A will focus “almost exclusively” outside of the handset area going forward, he says. “It’s more about things that fit into our diversification plan” in autos and IoT.
SO, WILL INVESTORS GET IT?
To return to my original question, At what point will investors get it? How many audiences with Palkhiwala does it take for them to understand the value of the New Qualcomm? You might think the third time is the charm, and investors have now had more than a few encounters.
“To be honest, the way I think about it, is, it’s not my job to speculate on that — I’d be a lot richer if I were doing that well,” he says.
"We've given a set of commitments to investors, and our focus is on executing and exceeding those targets.”
Among all the potential areas of clarity and confusion in the Qualcomm story, there are things the company can control, and those it cannot.
“While there are short term cyclical challenges that the entire industry is facing, the long term secular trends are still very much in our view,” Palkhiwala reminds me.
“We're on this journey to prove our ability to diversify away,” he says, recalling the initiative that began with Mollenkopf but that has become clearer under Amon. “And I think we've made a lot of progress in a year” since the November analyst day meeting in New York.
Of course, an explicit stump speech for a stock is something that executives from time to time can offer. And so, I ask, at a recent price around $125, and with its below-average forward sales multiple, is the stock a good buy?
"I have a lot of confidence in the technology of the company we have, with the opportunity in front of us because of digital transformation and cloud connectivity,” says Palkhiwala.
"And so, I’m bullish on what's in front of us, and that's how I'm focusing on my work.”
Among this evening’s positive earnings results, one deserving mention is Nutanix, whose CEO, Rajiv Ramaswami, was kind enough to talk with me following the report via Zoom, as he has in past.
For an in-depth view on Nutanix, see the interview I had with Ramaswami a couple weeks ago.
Tonight’s results are consistent with what he and I talked about then, namely that the company’s able to continue to deliver better-than-expected revenue growth despite the broad-based weakness we keep seeing in the software world.
“Our quarter performed even better than our guidance on all the metrics; we kept our revenue guidance for the rest of the year; [and] we raised our operating income and free cash flow guidance for the rest of the year,” is how Ramaswami sums it up.
“Given everything else going on around us, we are very happy with how we’ve done.”
The stock rose initially in late trading, and then slumped a bit. Nutanix has been a great performer this year, down just eleven percent.
The surprise this evening in the company’s fiscal first quarter report was a positive non-GAAP operating profit for the first time, which was a big surprise because Ramaswami had told the Street back in August to expect a negative operating profit margin of about six percent.
NTNX Chart by TradingView Revenue beat expectations, and on top of that, Ramaswami has been keeping a rein on expenses, which is leading to that positive surprise on the bottom line.
“It’s continued discipline in terms of how we manage our expenses, and we will keep that going forward,” Ramaswami tells me.
Indeed, the outlook for this quarter is for that operating profit margin to expand to five percent to ten percent. For the full year, Ramaswami expects the margin to be positive two percent to four percent.
“We know what we can control” in terms of operating expenses, Ramaswami tells me, “and we have a history of controlling that in the time that I’ve been here, so we’re very confident about the ability to be able to manage that.”
The revenue outlook for this quarter is slightly higher than consensus, $460 million to $470 million versus the average $458 million, but the company kept its outlook for the full year the same, which is just in line with consensus.
The reason Ramaswami is not increasing the outlook is because of the unknown pace of signing new customers. He’s said for the past couple quarters that signing new “logos,” as it’s known, has an element of uncertainty given the macroeconomic situation.
Getting new customers is the most expensive, the hardest, and the most uncertain part of the business in a shaky economic climate.
*Despite keeping a tight rein on expenses, “We are not short-changing our R&D at all,” says Ramaswami. “I will keep us on the high side” of R&D as a percentage of revenue, he says, "because, for me, one of the key things here is continuing to invest in innovation.”*
Results last quarter were consistent with that cautious view, but the company still added customers, the total customer count rising by twelve percent last quarter, to 23,130 total customers, the same rate of growth as the prior quarter.
That’s actually a little bit better than is typical for Nutanix at this point in the fiscal year, says Ramaswami. Overall, he says, “We’re fine with where new customers are tracking from a global perspective, and also the quality of the logos that we get, and the initial size of the deal,” says Ramaswami.
“I’d love to get more of those VMware customers coming to us,” says Ramaswami, referring to what he has told me before is an opportunity to poach given VMware is being bought by Broadcom. “But it takes time,” he notes, to pursue those prospects and to woo them.
Renewals, on the other hand, continue to be “strong,” he says, with the overall “retention rate” in the vicinity of ninety percent.
When it comes to the improved profit outlook, I offered to play devil’s advocate. I asked Ramaswami, if the company sees lower operating expenses going forward even as its revenue outlook stays constant, is he potentially under-investing?
“That’s a great question,” says Ramaswami. “I can tell you that — we do a lot of benchmarking in terms of what our R&D is as a percentage of revenue relative to other companies — we are on the high side, and I will keep us on the high side because, for me, one of the key things here is continuing to invest in innovation.”
“We are not short-changing our R&D at all.”
I asked Ramaswami if any of the analysts asked him this evening about the take-out rumors in The Wall Street Journalin October.
“There was not a single question about that,” he says. “Again, my answer is, it’s not for me to comment on rumors and speculation, but we are very much focused on running our business.” (The day brought another speculative article, this one from Bloomberg’s Liana Baker, Katie Roof, and Scott Deveau), saying that Hewlett Packard Enterprise is interested in Nutanix and has had talks with the company in recent months, citing multiple unnamed sources. We did not discuss that article.)
Before parting, Ramaswami gave me a tip on his current reading interest: Behavioral economist Richard Thaler’s Misbehaving: the making of behavioral economics, published by W.W. Norton in 2015. Ramaswami recommends the book.
“He talks about how economists generally assume people are very rational, but that’s not the case: people do a lot of things based on emotion.
“You have to factor that in, otherwise your economic models are all off.”
This continues to be a quarter of uneven performance in the face of corporate technology buying.
Following the painful example of cybersecurity vendor CrowdStrike on Tuesday evening, which missed expectations with its forecast for revenue for the first time ever, and saw its shares plunge nineteen percent, Wednesday evening brought a very mixed bag of quaintly results from vendors selling to enterprise.
On the bright side, Pure Storage, vendor of flash-based storage equipment and accompanying software, one of the TL20 stocks to consider, beat expectations but missed slightly with its revenue outlook. No one seemed to mind, as the overall report and comments tonight were much better than last week’s depressing outlook from competitor Dell Technologies.
TL20 stocks in focus.
Security software vendor Okta is up fifteen percent on a clean beat and raise quarter and outlook.
But Snowflake, another TL20 pick, while beating expectations, said it is taking a cautious view on its outlook. And so, its view to this quarter’s product revenue was the biggest miss relative to consensus since the company came public in September of 2020.
First, Pure. Its revenue outlook this evening of $810 million for the January-ending quarter is just slightly below the average estimates for $813 million. That’s the first miss on outlook in two and half years, back to the “COVID” quarter of April 2020.
However, the call was upbeat, and the sense from the analysts’ posture during Q&A is that everyone is happy the wheels have not come off at Pure like the way they did last week for Dell.
CEO Charlie Giancarlo highlighted positives such as the company’s “annualized recurring revenue,” a measure of the contracted value of deals stretching out twelve months in time, for the category of subscription specifically, surpassed one billion dollars for the first time ever. Pure prices in different ways, but there’s an emphasis on selling more and more on a subscription basis, so this is an important milestone.
More important, Giancarlo reiterated two really upbeat themes he and I discussed back in September.
One, the company sees the declining price of NAND flash chips generally, industry-wide, as helping the company sell more gear to replace traditional disk-based storage for bulk data storage known as “near-line.”
Said Giancarlo, “We expect that the currently anticipated improvements in Pure's NAND economics this coming year will enable Pure to deliver our TLC based products at prices competitive with most near-line disk arrays on a total cost of ownership basis,” he said. “We believe strongly that the days of the hard disk in the data center are over.” Bully for that.
Second, Giancarlo intimated that, as he told me, he foresees more of the large sorts of deals the company did last year with Meta Properties for that company’s gigantic Research Super Cluster for artificial intelligence processing.
Said Giancarlo, “In terms of other hyper-scalers, our conversations continue where we're optimistic that, that we will see, you know realizable opportunities there,” though he added, “But, again, too early to be able to put any real guidance on that.”
Regarding the broader outlook, Giancarlo told analysts he thinks IT spending will hold up in 2023 despite possible recession. “The way we're looking at it, is, a roughly flat US economy next year and perhaps a slightly recessionary international economy, obviously varying a lot country-by-country,” said Giancarlo.
“And as we go into that, we're seeing IT spending, you know a holding steady, maybe a slightly up relative to the overall GDP growth.”
Now, that was a lot better than Dell CFO Thomas Sweet last week telling analysts “these dynamics are creating a broader range of financial outcomes for our upcoming fiscal year.”
In fact, I would say Giancarlo’s outlook is so calming, relatively speaking, his remarks sounded like the kind of upbeat stuff John Chambers, former Cisco Systems chief, used to dole out during conference calls.
I should note that Giancarlo told analysts that despite the “challenges and uncertainties of the current business environment, we remain confident in our ability to take share and outpace the market.”
Asked by analyst Amit Daryanani of Evercore why Pure’s outlook was so “impressive relative to peers,” especially Dell, Giancarlo remarked that it has to do with having a better lineup of product:
It’s based on a much broader portfolio we believe, you know, going from our roots, our initial product, which was you know, block-oriented, to now having file- and object-based systems. And then and then thirdly, now starting to pursue replacements for secondary tier disk alternatives. So, this allows us to expand into a lot of market adjacencies and allows a lot of elasticity in our market as flash prices decline.
Pure Storage shares, with tonight’s slight gain to $29.83, are down nine percent this year, and up fifteen percent since picked for the TL20.
Over at Snowflake, things were not as thrilling or confident, though not bad by any means.
Snowflake continues to have astounding revenue growth at scale. The company’s revenue for the fiscal fourth quarter of $557 million rose by a whopping sixty-seven percent, year over year.
And the company saw a big surge in customers, especially those spending a million dollars a year or more. The “retention” rate, the measure of how much customers spend versus what they spent a year earlier, was one hundred and sixty-five percent, extraordinarily high relative to most software companies.
So, Snowflake continues to find more takers for its software and it continues to squeeze a lot out of existing customers. Pretty great. And, Snowflake raised its outlook for the full year’s free cash flow, on an adjusted basis, to twenty-one percent of revenue, up from the seventeen percent it had offered back in August.
However, one number in the outlook is awful, relatively speaking: Product revenue. Snowflake doesn’t forecast total revenue. Instead, it forecasts just the portion it makes from use of the product, as opposed to professional services. Product revenue tends to be about ninety-five percent of total revenue most quarters, so it’s a pretty good proxy.
The company forecast this quarter’s product revenue to be $535 million to $540 million. That is three percent lower than consensus for $553 million, according to FactSet. Most quarters, Snowflake’s outlook tops consensus. But even the few times the company’s product revenue forecast has missed, it’s been perhaps one percent at most. Ergo, this is the worst miss for product revenue forecast since the company came public.
Like CrowdStrike the night before, the current economic climate is producing a period of “firsts” for some software vendors, and not in a good way!
In explaining the outlook on tonight’s call, Snowflake’s CFO Michael Scarpelli related to analysts how “over the past six weeks, we have seen weaker consumption in Asia-Pacific (excluding Japan], and SMB [small and medium business] segment.”
The term “consumption” refers to Snowflake’s method of invoicing customers. Snowflake, you’ll recall, bills customers not at a pre-ordained time, like the beginning of each quarter, but only as they use the software, as they “consume” it. That means revenue has an unpredictable element.
Added, Scarpelli, “However, recent consumption patterns give us confidence that our largest and most strategic customers will continue to grow.”
Nevertheless, he said, “With the holidays approaching and uncertainty with how customers will operate, we believe taking a more conservative approach is responsible as we resource plan for Q4 and fiscal 2024.”
Basically, Scarpelli is saying, the company just got a lot more cautious about just how unpredictable that consumption will be.
On top of the miss, the preliminary sense Scarpelli gave the Street for next fiscal year is also lower. The company’s assuming product revenue growth rises forty-seven percent for the full year, but the Street has been at fifty-one percent.
Scarpelli said the company is going to slow hiring next year, even as it adds another thousand employees. The result, happily, will be a higher free cash flow margin of twenty-three percent, he said.
One analyst, Sanjit Singh, calling in for Keith Weiss of Morgan Stanley, asked Scarpelli if he could be sure growth wouldn’t actually be even lower next year. Scarpelli replied that the company “have a number of significant customers that we have signed up, that we see them ramping up next year on Snowflake.”
So, hopefully, all that good stuff about growth in customers is going to at least support the outlook.
Among the notes out this evening, Sterling Auty with MoffettNathanson writes that although Scarpelli has a good track record of forecasts as a CFO, “investors are likely to debate the preliminary product revenue outlook for fiscal 2024 in terms of how reasonable it might look.”
Auty notes the stock has “the highest valuation in our coverage,” so it’s bound to “take a hit” on this lowered outlook.
Still, he argues, Snowflake is “a unique asset and it is unlikely to trade at a cheap valuation.”
Snowflake stock, with the decline to the after-hours price of $135.39, is down sixty percent this year, and down eight percent since being picked for the TL20.
CrowdStrike, the cybersecurity technology maker, had not missed a forecast in three years since it came public, until tonight.
The shares are down nineteen percent in late trading after the company’s forecast for this quarter’s revenue came in two percent below consensus estimates for the fiscal fourth quarter ending in January. The company also gave an early indication that its revenue for next year will come in lower than expected.
CrowdStrike is most famous as being the firm working for the Democratic National Committee in 2016 that asserted that Russian operatives had hacked a server of the DNC.
The story this evening is a familiar one now in software circles: slowing deal activity in software land, and sales getting “pushed out.”
In prepared remarks, co-founder and CEO George Kurtz said that the company’s “net new ARR,” a total for contracts in the forward twelve-month period, “was below our expectations as increased macroeconomic headwinds elongated sales cycles with smaller customers and caused some larger customers to pursue multi-phase subscription start dates, which delays ARR recognition until future quarters.”
On tonight’s call with analysts, Kurtz gave more detail. He noted a particular weakness among smaller companies, the non-enterprise types. Some smaller firms were asking for extra time to sign a purchase. That both reduced the amount of ARR signed in the quarter, and also reduced the number of “new logos,” meaning, new customers, that CrowdStrike gained.
TL20 name Analog Devices (ADI) is a different kind of chip company, much to its benefit; Dell Technologies (DELL) gives us a glimpse into a creepy 2023; and I’m about to interview TL20 name Qualcomm’s (QCOM) CFO Akash Palkhiwala.
“The U.S. will lead, and many other countries will follow, and 6-gigahertz will be a mainstream broadband access connectivity.”
“A lot of what was previously batch processing will move into real-time streams … You can view every business process as taking in some data streams and producing some other data streams.”
For chip companies, much of earnings season has been a let-down because of weakening markets such as personal computers. But one chip company is sailing through it.
Analog Devices on Tuesday morning reported its tenth quarter in a row of topping revenue expectations, and its thirteenth quarter in a row of topping consensus with its revenue outlook.
CEO Vincent Roche told analysts during the morning conference call that it had been a “record quarter” to top off “a banner year.”
The stock rose six percent on Tuesday, and was up again on Wednesday. Price targets are rising at numerous shops to over $200, which would be a gain of sixteen percent or more from a recent $172.97.
I was happy to see all that given that Analog Devices is one of the TL20 list of stocks to consider owning. The shares, with this bounce, are now up nine percent since I inaugurated the TL20 in July.
Analysts, though, struggled Tuesday to understand just how this could be such a great time for Analog given what’s going on in the rest of the chip market.
Said Roche, “ADI, like the rest of the industry, is not immune to a softer macro environment and thus, we remain cautious, yet optimistic.”
TL20 stocks in focus.
That was not enough for the Street. “Are you surprised why your orders and bookings are holding up better, even though all the headlines we see from a macro perspective seem to be getting tougher?” asked Merrill Lynch’s Vivek Arya.
Analyst Ambrish Srivastava seconded the inquiry. “I think Vivek asked the right question,” he said. “Were you surprised? Is there a seasonality to it? I mean nobody doubts your positioning and how strong you are in your chosen markets.”
The response from both Roche, and from CFO Prashanth Mahendra-Rajah, was that Analog Devices is not exposed to the same markets and product categories as all those other companies.
Said Roche, "never have we been more diverse in terms of geographies, customer coverage, depth of coverage, depth of engagement,” adding that Analog has “product life cycles that stretch into the decades with very, very stable pricing.”
He was, in other words, making a case that Analog’s profile as a chip supplier is rather different. And that very much holds up if you look at what the company sells and to whom.
ADI Chart by TradingView
Unlike Intel and AMD and most other chip makers that focus on manipulating digital ones and zeros, Analog, as its name would suggest, has a very large portion of its product portfolio in what are call analog chips. These are chips that manipulate some kind of real-world signal, such as heat or sound or light, or electrical voltage. They either convert that signal to ones and zeros, for processing, or they directly manipulate the signal in real time, as a continuous variable.
This is why Analog Devices is rather unique, and why its current fortunes don’t align with the trouble everyone else is seeing.
As I wrote in a longish piece in 2021, it is the manipulation of those real-world signals that gives Analog Devices a tremendous breadth and depth and variety in the products and markets it supports. Over half the company’s revenue comes from what is called the “industrial” market, which is an amazing cornucopia of devices, things such as sensor chips that monitor factory equipment to detect levels of vibration (for faults or problem hints), or medical devices, where its chips are boosting the resolution of CT scans.
During Tuesday morning’s call, it was all those strange, unique markets that were, according to Roche, still surging even as markets such as smartphones and PCs cause problems for other chip makers.
Roche described a variety of “design wins,” when the company has been selected to have its chips built into a certain product. A piece of diagnostic equipment to “monitor machine health” at a “global supplier for energy exploration.” Chips for “high-voltage testers” of electric vehicles and renewable energy systems. Wireless transceiver chips going into 5G wireless network infrastructure. So-called “gigabit” communications chips that make for high-resolution displays in the cockpit of new cars.
Moreover, said Roche, the company has contracts that allow it to see years down the road for many product categories because they are not things like phones: they don’t change with the fashion every year. These are industrial products that are designed and assembled over many, many years.
For example, said Roche, “digital healthcare has been growing at the company in double digits for the last seven years or thereabouts,” in terms of revenue from health equipment like CT scans. “We expect to see that continue.”
And aerospace and defense markets, he said, are “likely to be a very brisk business,” said Roche. They’ve been “performing well for ADI now, and I believe, at least for the next five years, we will see stellar growth in that area.” The company’s chips for "energy and sustainability businesses are also beginning to really go on the uptick.”
EVs, said Roche, are a particular area of focus that’s paying off. “We're getting a very strong tailwind from the electrification of the vehicle, in fact, we're gaining a lot of share in general, I think, with in-cabin and the electric vehicle,” he said.
At the same time, Analog Devices is defined by what it is not. It sells chips into consumer electronics markets, which make up thirteen percent of the company’s revenue. However, said CFO Mahendra-Rajah, a third of that revenue "is derived from long- life-cycle prosumer applications, including next-gen conferencing systems, professional AV and home theater,” things not necessarily as volatile as smartphones, in other words. The rest of the consumer revenue, he said, the other two thirds, “relates to the faster-growing wearables and hearables as well as premium smartphones.”
See also:
A map of the future in Analog Devices, June 25th, 2021
That latter two-thirds is “cyclical,” meaning, it also succumbs to economic trends, said Roche. But while he didn’t quantify the impact to such consumer chips, Roche pointed out that “our Consumer business continued to grow despite industry-wide weakness.”
The bottom line, then, for Analog Devices is having a better profile to its choice of products and markets, things that are part of building complex systems, such as factories and wireless infrastructure, and electric vehicles, and which don’t suddenly stop when economic times get rough.
I would note, too, one other thing that can easily be missed. Analog Devices’s revenue for the year ended last month was twelve billion dollars. The entire semiconductor market in 2021 was worth over half a trillion dollars, accord to the industry consortium, The World Semiconductor Trade Statistics.
What that means is that Analog Devices is equivalent to about two percent of the market’s total sales value in any given year. And so, the company simply isn’t exposed to the market to the same degree as, say Intel, with $64 billion in annual sales, or Qualcomm, with $40 billion in annual sales.
You can’t see body language on a conference call, but I’d imagine the body language was squirmy on Dell Technologies’s call with analysts Monday evening to discuss the company’s fiscal third quarter and its outlook.
The reported results topped expectations, but just narrowly on the top line. The company’s forecast for this current quarter’s revenue was off by a billion and a half dollars relative to the Street, the second forecast miss in a row.
But the squirmy part came when the outlook for next year was discussed, like something bad sitting at the back of the fridge that no one really wants to look into.
The backdrop is that sales of personal computers continue to fall apart, especially consumer PCs, as has been the case all year long. Sales of server computers and the attendant corporate infrastructure — networking and storage — are the bright spot, but even there, growth turned out weaker last quarter than the company had expected going into the quarter.
Server sales are, obviously, starting to be a victim of corporate customers starting to rein in purchasing. IT is tightening its belt.
When CFO Thomas Sweet got to talking about 2023, or what Dell considers fiscal 2024, ending in January of 2024, he said all the same problem issues will be there, including “ongoing global macroeconomic factors, including slowing economic growth, inflation, rising interest rates and currency pressure.”
And he added, “these dynamics are creating a broader range of financial outcomes for our upcoming fiscal year, particularly as we think about the second half of the year,” emphasis my own.
DELL Chart by TradingView
Now, a “broader range” is Street code for uncertainty, and Sweet tried to help by adding, “With what we know today, it's likely next year's revenue is below historical sequential, using our Q4 guidance as a starting point.”
That was not enough for analysts, and so Sweet was challenged by David Vogt of UBS, who asked, “Can you, kind-of, elaborate on your earlier remarks about the framework for 2024?”
Sweet replied, “I don't want to get into exactly what next year looks like because we're still working our way through it.” But then, he offered a formula:
If you took sort of the midpoint of our guide and then ran normal historical sequentials, say, over a couple of – two-year historicals and maybe haircut those a bit, I think you're going to be in the ballpark of what our current thinking is, recognizing that it's going to continue to evolve and change over the coming months.
Well, if one does a back-of-the-envelope, using historical quarterly growth for Dell, what you come up with is a forecast for next year of about $93 billion dollars, which is five billion dollars below the current consensus of $98 billion.
Here, I’ve put it in a table. The table uses the average ratio of one quarter to the next over the past five years, so, what Sweet calls the “normal historical sequentials,” and extrapolates from the January quarter forecast given this evening.
Some analysts are going to be cutting numbers even more deeply — giving a really big haircut. Aaron Rakers with Wells Fargo, noting that “Dell's F4Q23 guide and directional F2024 comments will be considered negative,” cuts his revenue forecast to $88.7 billion, almost ten billion dollars below consensus, a drop in revenue next year of eleven and a half percent.
I know it sounds contradictory, but this warning from Dell tonight seems to me one of the first concrete reads on uncertainty. The uncertainty is palpable for many companies, and Dell has just given a shape to it, for what it’s worth.
Dell shares declined in late trading by about two percent to $40.21. The stock is down twenty-eight percent this year.
A rebound in chip stocks that’s quite interesting, including TL20 names such as Taiwan Semi (TSM), some software makers such as Alteryx argue they’re recession-resistant, and it may be time to think about what could happen to cloud computing after a recession.
“Historically, people have gone to the cloud because that's often the easy button to push […] I think going forward, people are going to be more careful about how much they want to be locked in.”
An empire run like a teen with secrets to keep: “Mr. Bankman-Fried often communicated by using applications that were set to auto-delete after a short period of time, and encouraged employees to do the same.”
It’s no fun to pile on to Monday-morning quarterbacking disasters, but then every once in a while, a document comes over the transom that is so delicious, it’s hard to resist piling on.
FTX is a crypto-currency exchange that was founded in 2019 by Sam Bankman-Fried and a couple of young friends. It had been, up until a couple weeks ago, perceived as a pillar of the crypto world, if that means anything. It is now in Chapter 11 bankruptcy proceedings, having lost billions in clients’ money.
The vague story leading up to Thursday was that the company had nowhere near the liquid assets people thought it did, and so, no way to safeguard the billions in deposits that FTX’s customers had placed with the company. It appears a hedge fund inside of FTX was secretly taking funds from those depositors and using them to trade — at least, that’s been the surmise of CNBC and other sources to date.
Thursday came the filing in bankruptcy court of a thirty-page document from the person who has taken over FTX to liquidate it, John J. Ray III, who is a career restructuring expert.
Ray presided over the liquidation of the notorious energy failure Enron, among others. Given the amount of malfeasance Ray has seen in his career, it’s quite something to read what he had to say in his dossier.
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” writes Ray of FTX, after a week going through what little there is of the books.
“From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
Among the failures Ray describes,
- “the absence of an accurate list of bank accounts” — it wasn’t even clear where the company’s cash resided;
- Employees bought stuff on the company tab: “In the Bahamas, I understand that corporate funds of the FTX Group were used to purchase homes and other personal items for employees and advisors”;
- An audit firm that sounds nuts: “Prager Metis, a firm with which I am not familiar and whose website indicates that they are the ‘first-ever CPA firm to officially open its Metaverse headquarters in the metaverse platform Decentraland’”;
- An HR procedure that mixed together employee and contractor records, “with unclear records and lines of responsibility”;
- Managing payments worse than a lemonade stand: “employees of the FTX Group submitted payment requests through an on-line ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis”;
- “did not keep appropriate books and records, or security controls, with respect to its digital assets” — custodian with no idea of custody;
- Managed records like it was Snapchat: “One of the most pervasive failures of the FTX.com business in particular is the absence of lasting records of decision-making. Mr. Bankman-Fried often communicated by using applications that were set to auto-delete after a short period of time, and encouraged employees to do the same.”
There are multiple investigations underway of the whole business, including an SEC investigation and a criminal investigation in the Bahamas, where FTX was domiciled and where Bankman-Fried was apparently residing.
If all this is as bad as it seems, then to my mind, it supports what I wrote over the summer, which is that certain foundational promises of crypto have been broken.
Crypto, it turns out, is not decentralized as its mythology would imply; it’s in the hands of massive exchanges such as FTX and other parties that dominate activity including Binance.
And yet, its centralization has not meant protection for investors, in fact, just the opposite. Crypto is like a throwback to the Great Depression, when there was minimal oversight of banking and depositors were abused on a regular basis without recourse.
Crypto is, in a sense, the worst of both worlds: the manipulation of centralizing forces, but with all the disorganization and lack of security of the Wild West.
Update:
It was a very upbeat conference call this evening between CEO Dickerson, CFO Brice Hill, and analysts.
The outperformance the company displayed in the headline results, relative to its warning in October, was a result of two things. One, the company’s hit from U.S. sanctions against China turned out to be less than expected initially, a decrease of $280 million rather than the $400 million that had been forecast.
Second, said Hill, the company’s “execution in the end of the quarter was almost flawless form a logistics perspective.” Applied, he said, “Got more supply chain parts in at the end of the quarter” that helped boost revenue by a couple hundred million dollars.
Both Dickerson and Hill emphasized that the company has a record amount of backlog, meaning, parts that have been ordered that it hasn’t been able to deliver in a timely manner. While the Street has focused on a slowdown in chips, the story for Applied continues to be supply-chain issues that have held back shipments of equipment.
“We are still supply chain limited across a number of key product lines,” said Dickerson, although, he added, “we expect to continue closing supply gaps over the next few quarters.”
As for that backlog of orders, it was up sixty-two percent, a total of nineteen billion dollars. Nineteen billion dollars is, I would note, equivalent to seventy-three percent of all of last year’s revenue. So, you could think of it as Applied has almost a year’s worth of revenue “in the bag,” so to speak.
Dickerson talked about various markets, and on balance, what he had to say was positive. Yes, there is “weakness in consumer electronics and PCs,” and that will continue to be a weak spot for the chip market into 2023, he said. On the other hand, “automotive, industrial, and power markets remain robust.”
2023 will be a “down year” for equipment sales for the whole industry. And Applied may see its revenue diminished to the tune of two and a half billion dollars, he said, because of the continued sanctions on sales to China.
But, said Dickerson, “we believe that Applied's business will be more resilient, thanks to our large backlog, growing service business, and strong customer demand for our leadership products that enable key technology inflections.”
Moreover, said Dickerson, chip complexity keeps rising on the path to one trillion dollars in chip sales come 2030.
“As technology complexity is increasing, we expect equipment intensity to remain at today's levels or rise further,” he said. “This means wafer fab equipment is likely to grow faster than the overall semiconductor market.”
Previously:
Chip equipment giant Applied Materials this afternoon reported fiscal fourth quarter results and outlook comfortably ahead of consensus, and better than a warning it offered in mid-October.
It was the strongest quarterly showing since August of last year, as the company deals with the global economy hitting demand for chips and thus, chip equipment.
The company’s revenue and profit of $6.75 billion and $2.03 per share was higher than consensus of $6.44 billion and $1.75.
Most interesting, the final revenue number and profit number this afternoon are well above a revised forecast for $6.4 billion, plus or minus 250 million, and $1.54 to $1.78, excluding some costs, that the company had offered in mid-October when it warned that new regulations on sales to China would hamper its results. It would appear things turned out much better than feared.
The revenue beat, and the forecast revenue, are both five percent higher than consensus, the best showing that I can see going back to August of 2021.
Gary Dickerson, Applied’s CEO, said the company is dealing with the global economic and geopolitical situation, and will reduce some of its spending, while nevertheless sounding a chipper tone.
Said Dickerson,
Applied Materials delivered a strong finish to our fiscal year with record performance, and we remain focused on mitigating supply chain constraints and doing everything possible to meet customer demand. Though we are slowing the rate of spending growth in the near term amid geopolitical and macroeconomic challenges, we are making the strategic investments to win the major technology inflections that will enable Applied to outgrow the semiconductor market.
Applied will hold a conference call at 4:30, Eastern, and you can catch the webcast of it on the company’s investor relations Web page.
Applied shares are up two percent in late trading. Shares of fellow chip equipment vendors Lam Research and ASML are also rising.
Applied is a member of the TL20 group of stocks to consider. With the small rise after-hours, the shares are up thirteen percent since the inauguration of the TL20.
AMAT Chart by TradingView
Huang says selling his company’s full plate of hardware and software, “the stack,” in public cloud facilities such as Microsoft’s Azure, “is just so much more coherent” as a way to sell to enterprises. It’s conceivable the deal also opens up many more prospective customers, thus expanding Nvidia’s total addressable market.
Following a report this evening of better-than-expected quarterly revenue, and an in-line outlook for this quarter, Nvidia’s CEO Jensen Huang was kind enough to take a moment to talk with me by phone. I told him that Nvidia is one of the inaugural picks in the TL20 list of great companies to consider owning. “Thank you so much” was Huang’s reply.
Huang can be a person of few words in some interviews. When I asked him what is most important from tonight’s results and outlook, he replied, “We are guiding a better quarter next quarter than this.” What he was referring to was that the company says it is getting its arms around a situation of over-supply of chips for video gaming that caused the company in August to cut its outlook. “We have quickly taken care of our inventory, corrected for our inventory,” he told me.
Huang then recounted the product highlights that he’d also talked up with the Street on tonight’s call:
We have multiple products in the early ramps that are that are home runs. Hopper. Transformer engine. The Ada generation of GPUs — off the charts. Orin has our Drive, our autonomous vehicle platform, to make the auto business into our next multibillion-dollar business. Great stuff going on.
The “Hopper” chip is the latest Nvidia GPU being used for artificial intelligence, which is just coming to market and which racked up impressive test results for AI tasks this month. Huang sees connected vehicles with the Nvidia “Orin” chip as being the next big market for the company after video games and AI.
NVDA Chart by TradingView
Huang talked a lot on the call about the cloud service providers, or “CSPs,” including Microsoft. Nvidia had already announced Wednesday morning a deal with Microsoft to offer what Nvidia refers to as its “full stack.” That is jargon for adding to the chips that Microsoft already uses from Nvidia with “tens of thousands” more GPUs, as well as software and chips dedicated to networking together computer systems.
The deal has echoes of the big win that Nvidia had earlier this year with Meta, the owner of Facebook, to buy tons of GPUs for the Research SuperCluster Meta is building for AI. The deal also brings Nvidia’s software to Azure, called “AI Enterprise.” The software acts like a bag of apps for companies, to ease their ability to put together AI into something usable.
I asked Huang what the significance is for his company. Huang can sometimes be frustratingly “on message,” and his response to me was similar to what he said on the call to the analysts.
“We, as you know, always have sold GPUs to CSPs, but CSPs have become two parts,” said Huang. “One is internal, and secondarily, public clouds.” He’s referring to the fact that Microsoft both uses Nvidia chips to develop cloud products and services, and directly rents Nvidia chips to Azure customers who want to use them.
Huang went on to say that Microsoft is going to be “a cheerleader for us” when it comes to pitching the Nvidia chips and software to enterprises, in addition to Microsoft using the chips to run their own AI offerings.
Huang expects that enterprises will increasingly use of AI by renting it from public cloud services. “It’s very clear now that we are at the tipping point of every enterprise company being cloud-first,” as he put it. Basically, that’s because AI programs are so complex, it’s just too expensive and too complicated for most companies to try and do it themselves in their own computer facilities.
That development with cloud is good for Nvidia for two reasons. Deals like the Microsoft deal mean that Nvidia gets a big channel by which to sell its stuff to enterprises. And secondly, reading between the lines, I would deduce that such a deal also means Microsoft may be cooling off on some of its own work on custom chips that they had been pursuing in recent years to try and be self-sufficient. They may be deciding it’s better to just keep buying from Nvidia. If so, it’s a massive win for Nvidia.
What Huang didn’t say, and he also didn’t say when asked the question by CJ Muse of Evercore on the call, is whether selling software will change the financial model of Nvidia’s business, as I had mused in September.
I pointed out to Huang that in the past decade, his company has gone from being what I had considered the scrappy challenger in the data center, trying to unseat Intel, to now being the dominant firm among all chip vendors in the data center, the company in control of the workloads that matter, AI.
How, I asked, does that change in the profile of Nvidia change the kinds of opportunities that Nvidia pursues, or the challenges the company faces?
The question was a philosophical one, but Huang can sometimes be frustratingly evasive when it comes to answering long-winded business questions. In this case, he punted and merely went back to the matter of selling the Nvidia stack in the cloud.
Selling the stack, he said, will make things easier for his customers to use his technology wherever and whenever:
Our ecosystem, the end user, the end markets, the end vertical markets, would be the same. We've always called on, we've always engaged, in part, the end markets. And now we have a coherent, if you will, an organized way of going to the end markets both through cloud and OEMs. And as a result, one architecture and video AI runs on prem as well as in cloud, one full stack. And this way of serving customers is just so much more coherent. And by using the Nvidia stack, they could basically run everywhere. They could run on any OEM server, they can run in any cloud.
What I would take away is that, again, Nvidia expects that Microsoft and the other cloud computing firms, Amazon, Google, Oracle, are going to be a much bigger channel for Nvidia to sell indirectly to enterprises.
See also:
Nvidia’s forecast in-line with Street, says ‘quickly adapting’ to global economic slowdown, November 16th;
Is Nvidia serious about software? September;
Nvidia: All clear from here? August 9th;
Nvidia: No competition, January 25th.
Is that a meaningful development for Nvidia? Yes, I think it can be. It can mean that Nvidia, a company that has been selling gear too expensive for many enterprises, now may have a way to price and bundle offerings in the public cloud that will bring its hardware and software within reach of more companies. In other words, it can expand the total addressable market for Nvidia, something all companies love to do.
Nvidia shares are up two percent in late trading. The stock is up almost two percent since I picked it in July for the TL20.
Artificial intelligence chip titan Nvidia this afternoon reported fiscal third quarter revenue that topped analysts’ expectations, but missed on the bottom line, and forecast this quarter’s revenue a tad light of consensus.
The report follows Nvidia having cut its expectations in August because of rising inventory of GPU chips because of slowing video game chip sales as a result of the weakening global economy.
In prepared remarks, co-founder and CEO Jensen Huang told the Street, “We are quickly adapting to the macro environment, correcting inventory levels and paving the way for new products.”
Huang made a number of upbeat remarks about the company’s latest products and markets:
The ramp of our new platforms ― Ada Lovelace RTX graphics, Hopper AI computing, BlueField and Quantum networking, Orin for autonomous vehicles and robotics, and Omniverse ― is off to a great start and forms the foundation of our next phase of growth. NVIDIA’s pioneering work in accelerated computing is more vital than ever. Limited by physics, general purpose computing has slowed to a crawl, just as AI demands more computing. Accelerated computing lets companies achieve orders-of-magnitude increases in productivity while saving money and the environment.
Revenue in the three months ended in October was $5.93 billion, above the company’s own forecast for $5.78 billion to $6.018 billion. Analysts had been modeling $5.78 billion. Profit of 58 cents a share, excluding some costs, was below the average 71-cent estimate.
Sales of chips for the gaming market plunged by fifty-one percent from the prior-year period and by twenty-three percent from the second quarter.
Sales for the data center, including AI, rose by a healthy thirty-one percent, though that was slower than the sixty-one percent in the prior quarter and the eighty-three percent in the quarter before that.
The forecast for this quarter’s revenue is six billion dollars, plus or minus two percents which is just slightly below consensus for $6.074 billion.
Nvidia will hold a conference call with analysts starting at 5 pm, Eastern time. I’ll be interviewing Huang later this evening, so be sure to check back for that.
Nvidia shares rose two percent in late trading to $163.
Also this afternoon, networking giant Cisco Systems beat with its fiscal first-quarter revenue and profit, and raised its outlook for the full year’s revenue and profit above consensus.
Cisco shares jumped five percent in late trading.
“If you're a company that's going through hardship [in a recession] it becomes even more important that organizations have an intense focus on the data around them to make decisions.”
Coherent (COHR) and DigitalOcean (DOCN), two TL20 names, both had well-received earnings reports. Upstart Holdings (UPST) had a baffling earnings call. The obsession with Elon Musk is a bit much. And a look back at what happened to the mega-caps of tech during The Great Recession.
The urge to dump Tesla stock seems to have reached a boil in recent days.
Take analyst Dan Ives of Wedbush Securities. A week ago, Ives defended Tesla when talking to Barron’s Al Root, telling Root that challenges to Tesla were “a near-term storm that will pass.”
Thursday morning, however, in a note to clients, Ives threw in the towel, removing the stock from his “Best Ideas” list. He has, he indicated, finally lost patience with Musk “crushing Tesla stock.”
The issue is Musk’s stock sales in support of his Twitter purchase, which he consummated on October 28th. The sales are not helping Tesla’s stock price at a time when Tesla’s delivery of vehicles is challenged.
“We have looked at historical patterns in other recessions … What we see is that small and medium businesses perform similar to enterprises … they tend to be like cable and utilities: pretty stable.”
“Companies are getting hordes of customer calls saying, Oh, my god, your software is down … The problem is getting not modestly worse, it’s getting much worse … It’s going to get to a precipice where they can’t operate effectively.”
A year ago, Upstart Holdings, which develops artificial intelligence to approve personal loans, was on such a roll that its CEO and co-founder, David Girouard, proudly compared his company to a great athlete:
Since Upstart's IPO a year ago, we've more than tripled our revenue, tripled our profits, tripled the number of banks and credit unions on our platform, and tripled the number of auto dealerships we serve. With that many threes, Upstart is becoming the Steph Curry of the FinTech industry.
I don’t know enough about sports to know just who would be the anti-Stephen Curry, but that’s rather what Upstart looks like these days.
Upstart Tuesday reported its second quarter in a row in which revenue and profit fell short of expectations, after a prior six-quarter streak of upside surprises. For the third quarter in a row, its forecast was also less than expected.
Shares plunged by twenty-four percent in late trading this evening, the third quarterly sell-off on disappointment. The stock, at an after-hours price of $14.47, is now down ninety percent this year, and down fifty-one percent from its closing price on its first day of trading following its initial public offering in December of 2020.
The initial read on small businesses in tonight’s report from DigitalOcean is encouraging if not decisive.
DigitalOcean, you may recall, is a competitor to Amazon AWS and the other cloud providers. It is focused on being a more economical version of cloud computing. And it is specifically targeting small and medium-sized businesses, who make up the bulk of the company’s six hundred thousand or so customers.
The report Monday evening of third-quarter results was better than expected for revenue and profit, which was an improvement from the last report, in August, but the forecast repeated the pattern of the prior two quarters with revenue missing expectations.
CEO Yancey Spruill on tonight’s conference call with analysts said the company continues to see the impact on its customers base from a combination of factors, including “a global economic slowdown, high inflation, US dollar strength, the Russia, Ukraine war and the decline in blockchain.”
The TL20 group of stocks to consider is having a better November so far than the broader market. The group declined two percent last week, better than the nearly six percent sell-off of the Nasdaq Composite Index. With the group now halfway through earnings reports, the results have been pretty good.
With eleven of ten having reported, the majority of the reports have been better than expected, and the forecasts, for those that forecasted, have been better than expected. And the average stock “pop” following the report has been a decent four percent.
Arista Networks has been the big start of the season, reporting better-than-expected results this past Monday, and a stunning forecast for the year ahead when it held its analyst day on Thursday.
Very mixed week for earnings, with Arista Networks the star, Wolfspeed’s controversial plan for silicon carbide, and some thoughts on stocks in The Great Recession.
While this earnings season has seen a lot of wrecks as a result of worsening macroeconomic trends, the area of computer networking so far appears surprisingly resilient.
In particular, Arista Networks, which sells equipment to hook up computers inside data centers, seems to see no end in sight for its wares.
After beating expectations on Monday evening, and offering a forecast higher as well for the current quarter, the company on Thursday stunned the Street with its analyst day meeting. CEO Jayshree Ullal offered a prediction that Arista’s sales will be ten percent higher next year than anyone’s been expecting, $5.5 billion dollars versus the current consensus for just under five billion.
It was another eventful earnings day, Thursday, with stark disparities in the winners and losers. Among the winners, two of the TL20 stocks to consider, Block and Universal Display, surged in late trading, as did a favorite of this blog Cambium Networks, as it moves past supply-chain issues.
Among the losers, Twilio, the communications infrastructure cloud company, plunged twenty-two percent, and even worse was IT software maker Atlassian, down twenty-three percent. Both missed expectations.
And a most curious star of the evening was Microchip, maker of microcontrollers, relatively simple kinds of processors that are used in embedded applications of all kinds. The company can’t keep up with demand and results and outlook keep beating, making the Street wonder why this company’s doing so much better than most chip makers.
In each of these cases you see an interesting divide: the winners seem to be relatively immune so far from macroeconomic turmoil, while the losers are being hit by it more and more. I can’t entirely explain the disparity, I’m merely observing it.
It’s getting rough out there this earnings season, with even fair performance being punished.
ZoomInfo, a software maker that acts as a kind of rolodex in the cloud to aid sales and marketing for prospecting, saw its shares sell off by twenty-nine percent Wednesday, even thought the company beat expectations with its quarterly report Tuesday evening, and with its outlook.
Problem was, ZoomInfo has, on average, offered a revenue forecast that’s five percent higher than expected the preceding five quarterly reports. This time around, it offered a forecast that was just a fraction of one percent higher, $300 million versus the consensus $298 million. Not good enough.
People are slicing things very thin at this point. The upside-down result of that is that some companies that miss expectations are seeing their shares respond favorably, if the miss wasn’t bad enough, while others are selling off whole-hog if their upside isn’t good enough, like ZoomInfo. Not entirely surprising in a market that is extremely skittish, the Nasdaq Composite Index dropping over three percent on Wednesday.
Wednesday evening, it was cybersecurity vendor Fortinet’s turn to be punished despite solid results. The company beat expectations for profit and revenue and also forecast this quarter higher.
But “billings,” which is one of The Metrics, those non-GAAP measures the Street uses as an extra hint about how things are going — money that has been collected but not yet recognized as revenue — was only a fraction of one percent higher than expected. That’s the smallest upside in billings in years. Hence, the stock sold off eleven percent in after-hours.
It was standing room only Monday morning in a ballroom upstairs at the New York Stock Exchange. I crowded in with about a hundred people to hear management of Wolfspeed make the case for raising a lot of money to advance the semiconductor technology known as silicon carbide.
Silicon carbide, which I covered in a longish piece in February, is a semiconductor that is key to electric vehicles. Tesla started the use of SiC, as it’s called, and all the other carmakers are following suit. Wolfspeed is one of the few chip makers on the planet that can make the stuff, which is more complex than plain-old silicon, more of an art. And Wolfspeed is definitely in the pole position in SiC at this point.
The highlight of the morning was an appearance on video hook-up by Thierry Bolloré, CEO of Jaguar Land Rover. Jaguar has struck a partnership with Wolfspeed to secure supply of SiC for years into the future in order to go all-electric with its vehicles.
The morning was fascinating, both because it offered lots of great detail about how Wolfspeed’s business will progress, but also because there was some controversy.
Investors and analysts are a tad unnerved at the moment because the reality is coming home to them that it is going to take a lot of capital to make all the SiC that Wolfspeed can sell.
That’s not a bad thing: real technology that advances whole industries costs real money. But Wolfspeed stock has spent most of the last few years simply being rewarded because of high demand for SiC. Now, suddenly, it’s as if the waiter has come with the bill.
Arista Networks, which makes the bulk of its money selling networking equipment to the large data centers of giants Microsoft, Meta, and others, turned in a stellar performance Monday evening, which is interesting considering that both Microsoft and Alphabet had warned last week of slowing use of cloud services by their customers.
The revenue number, $1.18 billion, was eleven percent higher than the consensus $1.06 billion, which is the highest upside in years. Profit also beat handily, by nineteen percent.
The outlook for this quarter looks strong as well, a projected level of revenue about six percent higher than consensus.
These are, mind you, within the context of very strong growth. Sales last quarter were fifty-seven percent higher than a year earlier. The forecast revenue this quarter would be more than forty percent higher.
CFO Ita Brennan noted that a year ago, during the company’s November 2nd analyst day meeting, she had outlined an expectation for thirty percent revenue growth for 2022. With tonight’s higher-than-expected forecast, the total should come in well above that, more than forty-five percent growth, about $4.29 billion.
CEO and co-founder Jayshree Ullal told analysts during the evening’s conference call that the results had a disproportionate amount of what she refers to as the “Cloud Titans,” the very largest cloud companies including Meta and Microsoft.
Apple was the saving grace, why can’t Alphabet or Microsoft say anything about the economy, and looking ahead to a big day for silicon carbide on Monday.
“The mainframe of IBM moved to x86 … storage became software-defined … but networking is still the mainframe of the world.”
Update:
On the call this evening with analysts, Amazon’s CFO, Brian Olsavsky, confirmed that the company’s outlook for this quarter assumes consumers are going to be spending less than normal during the holidays.
“We're very optimistic about the holiday, but we're realistic that there's various factors weighing on people's wallets,” said Olsavsky, “and we're not quite sure how strong holiday spending will be versus last year.”
Olsavsky said the company was seeing sales of consumer goods slowing markedly toward the end of the quarter, especially overseas.
“It was mostly in international we saw the biggest impact,” he said. “And we think that is tied to a tougher recessionary environment there, even if you compare it to the US, it's worse in Europe right now; the Ukraine war and the energy price issues have really compounded in that geography.”
What was a big negative surprise on the call was that Olsavsky said not only are consumer sales slowing, but AWS, the Web services unit, saw its rate of growth slow at quarter’s end. Olsavsky says AWS customers are tightening their belts, and not fully spending the amounts they were committed to spend by contract as quickly as they had expected.
“There are some industries that have lower demand […] things like financial services, the mortgage business being down, cryptocurrencies has been down.”
Shares of Meta Properties plunged by twenty percent in Wednesday’s after-hours session as founder and CEO Mark Zuckerberg told analysts how he will increase spending next year at a sharp clip even as the company is starved for growth.
Zuckerberg's comments came as Meta’s third quarter report after the closing bell delivered slightly higher-than-expected revenue, and profit per share merely in line with expectations.
The tension going on in the business could not be more obvious: Revenue is barely growing while Meta’s investment in The Metaverse in its Reality Labs division is burning almost four billion dollars per quarter while producing just a few hundred million in revenue.
The company told the Street to expect next year’s Reality Labs expenses to grow “significantly.”
In 2023, said Zuckerberg, Meta plans to spend as much as fifteen percent more on cost of goods — expensive Metaverse goggles — and on operating expenses to hire Metaverse engineers, spending that may total as much as $101 billion. And that’s without giving any indication of what revenue for the year may be. (The Street consensus is that revenue will rise by eight percent).
Moreover, capital expenses are set to soar as well, likely crimping free cash flow, as the company adds infrastructure to build more and more artificial intelligence throughout its products.
Said outgoing CFO David Warner, “There is some increased capital intensity that comes with moving more of our infrastructure to AI; it requires more expensive servers and networking equipment, and we are building new data centers specifically equipped to support next-generation AI hardware.”
If you are looking for a big picture with a totally dispiriting tint, Nouriel Roubini is your man.
Wednesday, Roubini, who acquired the moniker Dr. Doom during the 2009 recession, took part in an hour and a half Zoom chat hosted by the Collective[i] Forecast, a speaker series organized by Collective[i], an AI platform designed to optimize B2B sales. The attendees were a small audience of tech types and journalists, myself included.
It was a rollicking hour and a half swept along by the relentless rush of Roubini’s urgent cataloging of all the ills that make our era sound like the worst period, ever, for the planet.
Roubini, who is head of Roubini Macro Associates, and a professor emeritus at NYU, is promoting a new book, MegaThreats: Ten dangerous trends that imperil our future, and how to survive them.
“I’ve very ambitious,” Roubini told the audience. “I’m thinking about trying to predict not just the course of the global economy, but of our planet.”
I’ve not yet read the book, but Roubini assured us his writing about the ten plagues is “nuanced.” Which is interesting because his long soliloquies during the Zoom chat, delivered as a kind of verbal onslaught, came across not so much as nuanced but rather sweeping and vivid, like an Hieronymous Bosch triptych of hell.
“Right now, the problem is, there’s no single place you can go, there’s no consistent set of information for anybody to look at […] “So, people are just looking at everything, and there’s an element of cautionary conservatism.”
The Street always looks to the largest companies to be seers of the future. It’s a role that some captains of industry have relished in past, such as former Cisco Systems chairman John Chambers.
Others are not so apt to be prophets.
Tuesday’s earnings reports after-hours brought downbeat results from bellwethers, including Microsoft and Alphabet and chip maker Texas Instruments. All three saw their shares sell off after-hours.
The unsettling part of the reports were the vague ways in which the companies spoke about the current economic climate. There’s a broad, shapeless sense that times are tough, things are uncertain, and that there’s absolutely nothing these giant companies can really say to measure the depth of things.
This week will be MegaWeek for earnings season, as I tend to think of it, the week the biggest firms in tech report, with Alphabet and Microsoft reporting on Tuesday after the closing bell, and Apple and Amazon on Thursday. The full lineup is in the table at the bottom of this post.
The accompanying charts show how estimates for the most recent quarter, the September-ending quarter, have changed month by month for all four companies. One chart is for the revenue number for the quarter, the second chart is for the earnings per share, or EPS, estimate.
As you can see, prospects for earnings and revenue for all four have been cut since the beginning of the year. Revenue estimates have been cut by five percent, on average, while EPS estimates have come down by twenty-three percent.
Revenue has held up relatively better than EPS, in other words, but this week could very well see the Street take an axe to those revenue estimates once again.
The bulk of earnings season gets underway next week, when giants including Microsoft and ServiceNow will report. In anticipation of the action, my latest missive for Barron’s Advisor took a look at which software makers have ample free cash flow to go the distance. (Subscription required to read Barron’s Advisor articles.)
Last quarter, as I chronicled on a weekly basis, software makers warned of delays in deal signings, what they term “put-outs,” where more scrutiny is brought to bear on software sales by customers.
My premise for the Barron’s Advisor article is that we will see an increase in this trend during the current reporting season. October is typically a time when companies evaluate budget priorities for the coming year. I expect that such activity by software customers may start to show up in the remarks that software vendors offer about their own outlook, and perhaps even their formal forecasts.
If so, nervous software investors may look for reassurance in the profit profile of software companies. This year has seen an end to “growth-at-any-cost,” and greater scrutiny of the P&L and the cash flow statement. Investors suddenly want to know that software makers can be profitable.
Shares of chip equipment maker ASML Holding surged Wednesday by over six percent following better than expected third-quarter results, and a better-than-expected outlook.
The immediate reaction of anyone watching the chip world these days might be astonishment. There has been a steady stream of negative announcements from chip makers within a short span of time that suggest the chip market is in free-fall.
Consider that Taiwan Semi’s CEO C.C. Wei last week said chip companies continue to “adjust their inventory,”echoing Advanced Micro Devices’s CEO Lisa Su, who had said the week prior that the PC market has weakened “significantly” in the past ninety days. And memory-chip maker Micron Technology two weeks ago said it will cut its capital investment by forty percent and that the collapse in chip demand is “unprecedented.”
All these companies are customers of ASML, either directly or indirectly, so how is it ASML is doing just fine?
There’s a short answer and a long answer.
The short answer is that while demand is breaking down in certain markets such as PCs and smartphones, there is no broad, general oversupply of chips. As I suggested two weeks ago, a market with tight supply overall is a healthier market than one with a glut from over-building.
ASML sells tools to make chips years into the future, and on Wednesday, CEO Peter Wennink, during the company’s conference call with analysts, said ASML still faces a shortage of materials to make its tools. As has been the case all year long, his company can’t build its equipment fast enough to meet demand?
“There’s still such a big gap between the demand side and what we can make,” said Wennink.
Shares of Netflix in Tuesday evening’s after-hours trade were up fourteen percent, perhaps a short squeeze as the company delivered better-than-expected September-quarter results and a slightly better outlook, after what has been a disastrous several quarters of little to no growth.
Netflix’s “net” additions, meaning, how many paid subscribers they added after giving effect for churn, was 2.4 million, which was better than the company’s own forecast for just a million.
“Well, thank God, we’re done with shrinking quarters,” said founder and CEO Reed Hastings during the company’s conference call, which, as in past, was hosted on YouTube as a kind of TV show, with only one analyst participating, JP Morgan’s Doug Anmuth.
The outlook for this quarter’s paid subscribers, 4.5 million, is slightly higher than the Street’s average 4.3 million estimate. Said Hastings, “The results this quarter, and the guidance for Q4, are reasonable — not fantastic, but reasonable.”
The 4.5 million number is a huge comedown from past Netflix history. The average net subscriber gain in Q4, over the preceding five years, was 8.2 million. Hence, Netflix has got a lot of ground to recoup to get back to growth.
Interestingly enough, the company is now divorcing itself from the subscriber number. Going forward, Netflix said in its shareholder letter, the company will no longer forecast subscribers.
“Think about how many times you’re touching things on a mobile device … it’s a fundamentally different challenge to support that from a database, and we have architected that from the beginning.”
Even though the initial public offering window has slammed shut this year, that doesn’t mean that no tech companies came public. In fact, if you paid attention in the third quarter, July through September, you got to see eleven rather curious tech companies coming public, representing everything from puppy-enthusiast Web sites to touch-less gesture controls to crypto-currency mining.
The singular achievement of this cohort of eleven offerings is that it represents a huge jump from only five offerings in the second quarter and eight offerings in the first quarter.
It was, however, a pretty awful quarter to go public, with absolutely terrible price declines.
It started out just fine. The average first-day pop, meaning the rise in price from the offer price to the closing price on the first day of trading, was an average gain of sixty-three percent, which is wonderful for the selling shareholders who cashed out.
But with the broad market declines in late August and September, the average decline in price from the offer price till today, and from the first-day close till today, was fifty-seven percent and fifty-five percent, respectively. Ouch!
They are all below their offer price at this point, and only one company has notched a gain from the first-day price, Laser Photonics, mostly because it had a big nineteen percent jump on Friday.
Taiwan Semiconductor Manufacturing, the largest contract chip manufacturer in the world, overnight reported revenue and profit higher than the Street was expecting, and forecast this quarter’s revenue higher as well, and the tone was relatively upbeat considering how much worry there has been about the chip industry this year.
During the company’s conference call with analysts, CEO CC Wei said chip companies continue to “adjust their inventory,” basically the same comment that memory-chip maker Micron Technology had made during its call last week. The sudden drop-off in demand for PCs and smartphones means that chip makers have to find a way to sell off inflated inventories of chips before they contract with TSM to make any more.
Even so, TSM’s revenue rose by thirty-six percent, year over year, to $20.2 billion, topping consensus for twenty billion, and in line with TSM’s own forecast.
If you were watching stock ratings on Tuesday, you would have seen what seemed like a cataclysmic implosion of faith. Not only did the Nasdaq Composite have its fifth straight decline, closing down one percent, but there were a whopping eight downgrades of tech stocks, the greatest number in a while.
But, not actually that unusual, it turns out. This is about par for the start of earnings season. The chart shows you how things looked at this point in time last quarter, starting with the month of June. Oracle had been the first to report, on June 13th, the unofficial start of earnings season.
Back then, the season was starting with downgrades, and that’s exactly what’s happening again this time around.
I’ve highlighted a few major milestones. In purple, the most recent bar on the chart, are the eight downgrades today, October 11th. In red, you see first the same date three months ago, July 11th. Lo and behold, there were also eight downgrades that day. Same part of the season, eleven days into the first month of the quarter, and the same number of downgrades.
“We're trying to make the lake into something so that you can have everyone work with all the data … that’s actually the model that a lot of the tech companies like Airbnb and Uber and so on use internally already.”
Surely the semiconductor market must be getting to its “trough” level, from which things pick up, but there are many, many shoes that have to drop before that happens.
The most recent warning had been last week’s presentation by memory-chip maker Micron Technology about what it called “an unprecedented confluence of events” that “has affected overall demand” for chips, especially in smartphones and personal computers.
That dour outlook followed Nvidia’s warning in early August that the video game portion of its businesses sustained a much larger-than-expected drop in demand in the July quarter.
And the latest bit of bad news comes to us this evening from Nvidia competitor Advanced Micro Devices, which announced after market close that its revenue for the third quarter that ended last month will be more than a billion dollars below what the company had forecasted back on August 2nd, a total of $5.6 billion versus the original forecast of $6.7 billion, give or take $200 million. Remember, that forecast was already disappointing at the time it was offered.
“Every organization has not only the old databases, they have AWS databases, Azure databases, Oracle databases, Snowflake, Databricks … how do I get a single view of the entire data by not putting it in one place, but by seeing the metadata?”
“Cloud operators’ business model is that they spend a lot of capital ahead of time, they have this stuff sitting there, and then they bring in tenants … they are motivated to partner with us because this is a way for them to get more applications into their data centers.”
Monday was an interesting day for chip stocks: they were some of the best performers, with shares of Nvidia, Intel, Advanced Micro Devices, and Applied Materials all rising four to seven percent.
That kind of bump is in defiance of constant worries about the chip market, including really bad headlines, such as Micron Technology’s forecast last week that missed by a mile.
But, the gains Monday are not so surprising, as I argue in my latest missive for Barron’s Advisor, published today. (Subscription required to read Barron’s Advisor articles.)
What has weighed on chip stocks most of this year is the cycle, the expectation that two healthy years will be followed by at least one, maybe two lousy years. By way of background, the chart below shows ups and downs in revenue going back all the way to 1976, curtesy of the industry consortium Semiconductor Industry Association.
Probably as an occupational hazard of being a reporter, I tend to approach stock investing with two minds, one that I would call qualitative, and the other quantitative. It’s a strategy that has evolved over years for me and it’s different from how some other stock pickers approach things.
On the qualitative side, I tend to approach things first based on the story of what a company is working on. That’s a narrative, and it’s qualitative, not quantitative. What is this company’s mission? What, if anything, is there of substance in the company’s technology? How astute is management? How does the company plan to “crush the competition”?
I tend to fall back on the wise words of Jim Barksdale, formerly head of Netscape and before that, president of FedEx. Barksdale, asked about the key to success in business, said it was all about “finding a parade and getting in front of it.” I tend to think that’s pretty true. The best companies such as Amazon and Apple found ways to insert themselves into markets and extract value by seeing what was coming into formation.
On a deeper level, it goes back to my overarching theory of technology. Technology is a loom, on which a great, never-ending tapestry is being woven. It is larger than any one company, and it runs the entire history of humanity. Companies are stronger to the extent they contribute to the threads of technology, and thereby put themselves in alignment with something very profound that endures.
Because of that focus on the story of technology and companies, I tend to evaluate companies less according to numbers such as this or that income statement line, or The Metrics such as “retention rate” and the like. Don’t get me wrong, those numbers are important, but to me, they tend to be trailing indicators. Long after a company has chosen a wrong path, and run away from the parade, if you will, weak numbers are the symptom.
When Meg Whitman took over Hewlett Packard in September of 2011, the company’s R&D spending was catastrophically low as a percentage of revenue, at 2.6%. But that was after years of wandering in the wilderness as one group of executives after another failed to really have a sensible mission for the company — what I called “more than a decade of multibillion-dollar blunders,” when I wrote about Whitman’s challenge for Barron’s.
Update 2: Micron stock is up almost three percent this morning. Perhaps the talk about a trough in the second quarter of 2023 did the trick.
Update:
During tonight’s conference call with analysts, following a terrible forecast, Micron’s CEO, Sanjay Mehrotra, emphasized the positives for Micron, such as a rock-solid balance sheet, but he, and CFO Mark Murphy, also used the word “unprecedented” a total of seven times to describe the challenge facing the chip industry.
Here’s the short story: the sudden drop-off in demand for PCs and smartphones, two markets making up just under half of Micron’s business for DRAM and NAND memory chips, have created a kind of V-shaped collapse in total chip demand. Customers of Micron are having to use up inflated inventories of chips before they buy any more. Demand should return in the middle of next year, marking a kind of bottom for the chip industry.
However, it’s all a bit clouded by the fact the global economic situation is volatile, noted both individuals.
My trips to the Apple Store at World Financial Center in Manhattan the last couple weeks suggested to me there is a vibrant activity on the part of consumers checking out the new iPhone 14, and also buying stuff. It was hard to get waited on as staff were coming in and out of the back with boxes of stuff people were buying.
So much for my field research, which is always the most dubious form of perspective. You, like me, might have thought Apple’s doing pretty well with this latest round of stuff, but opinions vary, and the news flow has been less upbeat.
Bloomberg’s Debby Wu and Takashi Mochizuki wrote on Tuesday that Apple has told suppliers to halt an expansion of iPhone unit production and instead go back to its original production plan, citing multiple unnamed sources. Not everybody believed the report. Several Street analysts took exception, one, Ming-Chi Kuo of TF International, an oft-cited rumor expert, calling the story “weird.”
However, it is not hard to believe that with the prospect of a recession, a fancy new phone could be causing Apple to revise some production plans, even though the thing was introduced at the same price as the previous model.
So, this is what makes a market, and today brought dueling views on Apple’s stock: a downgrade from Bank of America/Merrill Lynch’s Wamsi Mohan, and an upgrade from Rosenblatt Securities’ Barton Crockett.
On the negative side, Mohan writes that “strong outperformance [is] once again at risk” for Apple, and he expects “material” cuts to Street estimates for the current fiscal year ending in September of next year.
“Eighty to ninety percent of all the bits in the world are still on hard disks … with the next round of price reductions coming for flash, we feel we're going to be able to replace the cheapest disks.”
“You and I are inundated in our personal and professional lives every single day with this dichotomy of work versus personal stuff on every device … The back-end of that experience are cloud applications … spending on that is not going down.”
Tiernan Ray, creator and editor of The Technology Letter, takes you through his thinking about the group of twenty stocks, the TL20.
Qualcomm chief executive Cristiano Amon on Thursday gathered his team at the Classic Car Club beside the Hudson River in Manhattan for several hours of presentations to the Street and press about the company’s expanding opportunity for chips in the automotive market. It was the first time Qualcomm has done a dedicated day just to talk about cars apart from its other businesses.
The presentation was encouraging. The company increased some of its forecasts for revenue from cars for the next several years, and Amon, who is naturally outgoing, and who spent years in the trenches engineering Qualcomm’s technology before ascending to the top spot, went into extra innings fielding questions with vigor and acumen.
A ream of details on products was provided by Nakul Duggal, Qualcomm’s general manager of the automotive division, specifically the three areas that are the company’s current focus: the connectivity, such as the modem for car-to-Internet connection; the “digital cockpit,” a rubric covering all manner of things that happen with the dash, the central stack, the backset entertainment, and on and on; and “advanced driver-assistance system," or ADAS, all the technologies that will make a car, someday, drive itself, or so they say.
CFO Akash Palkhiwala rounded out the presentation with several significant financial updates that seemed to be very well received by analysts at the event.
The key stats are as follows. The company’s revenue from automative is expected to rise by thirty percent in the fiscal year ending this month, to $1.3 billion. That’s out of total company revenue of forty-four billion, so auto is still at the starting line as a part of Qualcomm’s revenue, but rising fast.
The company estimates its “addressable market” for chips in cars at one hundred billion dollars annually by 2030. That’s assuming Qualcomm makes $200 to $3,000 per car.
The company’s “primary KPI,” or “key performance indicator,” is the “design-win pipeline,” the total value of expected future contracts with manufacturers, based on the lifetime of the deal for that part in that car, assuming certain volumes of car shipments. That figure is currently thirty billion dollars, up from thirteen billion mentioned at the investor meeting Qualcomm held in November of last year.
Nvidia has become the biggest chip vendor in the world, at three hundred and thirty-seven billion dollars in market capitalization, by dint of the fact that none of the competition have managed to come up with chips sufficiently superior to crack the company’s hold on the market for the most cutting-edge applications in data centers, especially artificial intelligence.
There is now a prospect of another interesting realm for Nvidia to exploit: software.
This week, Nvidia held another one of its “GTC” conferences, where it touts lots of new products. While the event was full of stuff about new chips, there was also the announcement of two cloud computing services that Nvidia will own and operate.
One service is a way for companies to collaborate on 3-D design via the cloud, based on Nvidia’s “Omniverse” technology, which is its take on The Metaverse, the mostly non-existent something that Meta’s Mark Zuckerberg has touted. I gave a preview of the idea of this service in a recent article.
The other service is a way to run very large AI programs in the cloud without a lot of the owned infrastructure or data science work, especially programs for handling natural language processing, which are becoming important tools for companies.
I covered the announcements for ZDNet. But, beyond the press releases, what interested me was the business question of whether Huang is really serious.
“The subscription economy, ultimately, is a scale business … if you have more subscribers, then you have more revenue to invest in creating what the subscribers are hungry for.”
In my latest missive this week for Barron’s Advisor, I’ve tried to provide a coherent approach to reconciling growth and value in tech stock picking. (Subscription required to read Barron’s Advisor articles.)
The crux of the piece is that one should focus on valuation multiples that incorporate projected growth for a company, which I refer to as “valuation-weighting” a portfolio. On a simpler level, you could say it’s just screening stocks to see which are both cheap and have above-average growth.
The subtler point I wished to convey, which I may or may not have succeeded in, is that one can dial the measures of value and growth as if they are the controls of a stereo mixer to find the right balance in a portfolio of growth and value.
My approach, which I began before Tuesday’s really sharp sell-off, was to look first at which stocks out of hundreds had above-average expected revenue growth, and then ask which of those high-growth names cost the least for that growth.
By way of example, one of the stocks that emerged is one of the names that I picked for the TL20, Snowflake.
“I asked one customer how would they benefit from the Inflation Reduction Act, he said, We just got ten years of guaranteed backlog for our solar and wind division — he was like, Dude, I’ve never in my career had ten years of committed business!”
The broad selloff Tuesday certainly did not spare the twenty stocks in the Technology Letter 20. And the most interesting thing is that the declines were spread fairly evenly amongst the group. The selling did not distinguish relatively more expensive or less expensive names.
The TL20 declined by 5.9% on Tuesday, worse than the 5.16% of the Nasdaq Composite Index, although not as bad as some really pricey vehicles such as the ARK Innovation ETF (ticker “ARKK”), which collapsed by almost seven percent.
As you can see in the table below, the worse declines, lead by Nividia’s near ten-percent decline, were spread across a spectrum of valuation, based on enterprise value as a multiple of projected sales. Nvidia is still one of the most expensive chip stocks around, but Block, which is trading at a serious discount of less than two times projected sales, was also one of the biggest losers. In contrast, Tesla, one of the most expensive stocks in the group, at just under nine times projected sales, held up better than the Nasdaq, dropping only four percent.
The earnings season began again this evening, with Oracle being the first company to turn in results thanks to the fact that it closes the books really quickly. The company finished the quarter August 31st and was already ready to report less than two weeks later.
In fact, Oracle’s CEO, and de-facto CFO, Safra Catz, told the Street that the ability to close the books is proof of how good the company’s software is.
“Now, today's the 12th of September,” Catz observed, during the company’s conference call with analysts Monday night.
“In fact, I signed off with our auditors on Friday,” she said, “but we don't do our earnings on Friday, so we had to wait all the way till Monday.
“Now, no other companies report on the ninth or the eighth day, in fact, most companies were reporting their July quarter last week, and here we are announcing an August quarter.”
What does that have to do with anything? Catz told analysts Oracle’s software is the same stuff that Oracle uses to run its financials. If Oracle can turn the books faster, it must be great stuff, she said.
That kind of puffery, from a CFO, is a fairly routine these days in tech-land. But even by today’s standards, Monday’s conference call was an enormously feel-good affair. Catz, and Larry Ellison, co-founder, chairman and CTO, took turns trying to outdo one another with descriptions of how great the business is doing.
The reported results slightly beat expectations, and the forecast for this quarter missed for the first time since December. But that mattered little. Oracle’s results are held back by the rising U.S. dollar, which has risen over twelve percent this year against the Euro.
“Companies are saying, I can save money, I can be more productive, I can hire fewer engineers if I deploy GitLab … That doesn’t happen unless you’re fairly priced, you offer a good business outcome, and your time to value is quick.”
The carefree days of July are a distant memory with the decline of the TL20 group of stocks to a mere one and a half percent increase since the inception date of July 15th. As you can see in the chart, Thursday was the first time the TL20 slipped below the return of the Nasdaq Composite and the S&P 500 since inception.
The proximate cause are the semiconductor companies. They are the worst performers aside from computer security vendor Check Point.
A further examination of the semiconductor names shows that most had solid earnings reports during the past month and a half, but their forecasts missed in many cases.
Yeeesh. It’s a brutal night for earnings reports, with multiple double-dip decliners, including some high-flying names that have been software darlings.
The good news tonight is that Pure Storage, the maker of a kind of NAND flash-based device for managing data, beat with its results and outlook and is up by six percent in late trading. Pure is one of the TL20 stocks to consider, so I was glad to see that.
Another winner is Nutanix, whose shares are up nineteen percent this evening, a big rebound from the disastrous sell-off in May.
But first, let’s look at the bad news. C3.ai, Okta, MongoDB, and Veeva are all down by double digits.
Tom Siebel, founder and CEO of industrial AI company C3, said in his press release tonight, “the economic downturn is real.” He told analysts on the call, “Our customers and prospects appear to be expecting a recession,” and they are more and more scrutinizing deals for his software.
“In the course of the quarter, we saw sixty-six forecasted deals move out in the quarter, many of which we would have fully expected to close under normal market conditions,” said Siebel. He said the company is responding by making cuts to non-essential spending.
The two Hewletts — Hewlett Packard Enterprise and HP Inc., the concoction of Meg Whitman when she split the business a decade ago — came up short on Tuesday evening, reporting revenue below expectations, and a lackluster forecast in the case of HP.
The one Hewlett is doing quite a bit better than the other, however. Enterprise, the part that sells networking and servers and builds supercomputers, is on track to come pretty close to goals set out a year ago. It has record backlog of orders to fill, which speaks to the health of its market.
The sour result at HP Inc., on the other hand, echoes the gloomy report from competitor Dell last week with its miss on quarterly results and miss on forecast. The PC market is going through its long unraveling, which is having a major negative effect on HP’s revenue. The company doesn’t forecast revenue, but its profit per share forecast for the current quarter, seventy-nine cents to eighty-nine cents, is more than twenty percent below the consensus for a dollar and six cents. That’s in large part because revenue won’t be as high as originally expected given the weak PC market.
The TL20 group of stocks to consider is up over eight percent from its reference date of July 15th, besting its benchmarks by a significant margin despite recent market turmoil.
Or, perhaps, because of recent market turmoil. The TL20 were picked as being good deals, and I think that the virtue of picking good stock buys becomes readily apparent in tough markets.
I’ve cited the TL20 regularly, and the daily performance is shown at the top of the TL20 home page. Given that I’m throwing that number around a lot, it seems fit to talk about how the composite performance is computed, in the interest of being transparent about the group. That way, you can follow along, if you like, and also make your own record of gains and losses if you’re so inclined.
The TL20 performance number I cite is produced as an automatically generated composite number by FactSet, but you can easily do the math with pencil and paper if so inclined.
The TL20 is a market cap-weighted composite, which means that some of the twenty stocks count for more than others in calculating the change in price from the start date. That approach is common to very popular indices such as the Nasdaq Composite Index.
“The cataloguing, governance, master data management —those use cases have ginormously scaled … our investors are back in because the opportunity is a lot bigger.”
Nice night for TL20 pick Snowflake, which reported fiscal second quarter revenue, for the three months ended in July, more than six percent higher than Street expectations, growing at a very smart eighty-five percent; and forecast its revenue for its products, excluding its professional services, this quarter to be in line with consensus.
The stock soared this evening almost eighteen percent in late trading, a nice reversal of the big sell-off in May.
That six percent beat was the highest since the year-ago report. More important, it was a big sigh of relief. Snowflake, you’ll recall, sells on what is called a “consumption” model, meaning, it bills customers not at a pre-ordained time, like the beginning of each quarter, but only as they use the software. That means revenue from cloud has an unpredictable element.
As I mentioned in my interview with Confluent CEO Jay Kreps the other day, there has been a concern about how well consumption would hold up amidst worries about corporate belt tightening, whether people would temper their use to slow expenses.
Not the case, as it turns out. In fact, Snowflake's CFO, Michael Scarpelli, told analysts that out of the total value remaining in signed contracts, what’s called “remaining performance obligation,” or RPO, the “current” portion, “cRPO,” meaning, the amount the company expects its customers to realize over the coming twelve-month period, is fifty-seven percent.
Think of Snowflake like a waiter standing at the table, hunched over the diner, predicting how fast they’re going to eat the meal.
This is why you pick a portfolio of stocks, not just one.
The chart above shows the five-day trend of the stocks in the TL20 group of stocks, and also their cumulative return since inception on July 15th. On the left is the total gain each stock had as of five trading days ago, since inception, and on the right is where they stand in total gains at Monday’s close.
Monday was a big day of declines for most shares, the Nasdaq Composite dropping almost three percent.
The chart for the past five days is ugly, but I’ve highlighted how one name bucked the trend. Fiber-optic component vendor II-VI, which had been initially a laggard in the group, has risen about three percent in the past five sessions, the only one of the twenty to see a net gain. It’s nice how one good stock will step to the fore when other names in the portfolio are weakening.
II-VI is up eleven percent since the TL20’s inception.
Other high-flyers such as Hubspot and Block dropped big-time these past five days, some of it from people likely taking profit on their sharp run-ups, some of it from Monday’s deep disfavor.
Hubspot had been up forty-three percent a week ago, and is still the best TL20 name. Despite double-digit declines this past week, it’s up over twenty-five percent. Block is still up about eleven percent despite its sharp fall this past week.
“We tend to serve these mission-critical software apps that are significant areas of investment. I think that criticality tends to help when it comes to tighter times, which is probably what we’re entering now.”
“Three years back, if you gave someone fifty or sixty megabits per second, people were reasonably happy … the need now is hundreds of megabits per second … from a single-lane highway to now a four-lane highway.”
In addition to Cisco Systems, among other reports this evening, Wolfspeed, the chip maker that I profiled in May as key to the march of silicon carbide technology in electric vehicles, this evening reported a ten percent revenue beat for the June quarter, its biggest top-line surprise in years.
The stock soared by eighteen percent in late trading.
Silicon carbide, in case you haven’t read the lengthy opus cited above, is semiconductor technology that has remarkable properties of electrical conduction. That makes it a kind of wonder material for the traction inverter, the part in every electric vehicle that converts direct current in the battery into alternating current in the motor.
Wolfspeed’s great report follows a strong report earlier this month from a silicon carbide competitor, On Semiconductor. When I was assembling the TL20 last month, I said to myself, these are both excellent companies, and neither of them has seen a big discount to their stock valuation.
The fiscal fourth-quarter report of computer networking giant Cisco Systems Wednesday afternoon was uneventful, in a couple of interesting ways. The numbers were fine, but also not really remarkable given that they were set against a backdrop of lowered expectations.
And, more important to the average stock analyst, Cisco’s report contained no trace of weakness among small businesses, which is important given that Cisco has always been a kind of mood ring of the broader economy.
The results are a good sign for TL20 pick Arista Networks, Cisco’s main competition, and a good sign for tech and for the economy broadly speaking.
Remember that two years ago this week, when Cisco reported in the depths of Coronavirus lockdowns, the outlook was dire, driven lower by small business customers who were really struggling.
Back then, CEO Chuck Robbins told the Street that “The weakness got a little bit worse as you just sort [of] went straight down, as you would expect with small business, medium business and even smaller-size enterprises that were — didn’t perform as well as the very largest of enterprises.”
There was none of that this time. The economic details on tonight’s conference call with analysts were uneventful — happily so.
Robbins told the Street the company had a record number of product orders in the July-ending quarter, and just closed the second-strongest year in its history for revenue. “We had small business growth in Q4,” noted Robbins, “I think it was double digits [percentage revenue growth] on a global basis, which is a good sign that that's continuing to grow.”
“We’ve seen a lot of traction for Amplitude in spite of the macro because we are just so critical to how people build their products.”
It’s been a month since the introduction of The Technology Letter 20 group of stocks, and things are going pretty well. The TL20, based on a return since inception of 18.71 percent — calculated by FactSet as a weighted average of the twenty by market capitalization — is not only head and shoulders above the Nasdaq Composite and the S&P 500, it’s also above several other relevant measures.
TL20 tops the iShares software ETF (ticker “ISV”); it tops the Philadelphia Semiconductor Index (ticker “SOX”), even though the TL20 has mostly chip names; and it’s even above the return of Bitcoin, even though Bitcoin has been lately clawing its way back from the low twenty thousand per Bitcoin to mid-twenties.
Perhaps most interesting to me, TL20 has been trading places on several days with Cathie Wood’s ARK Innovation ETF (ticker “ARKK”).
As you can see from the chart, the TL20 since inception on July 15th is a bit above the return of the ARK ETF, 18.71 percent versus 18.32 percent. ARKK has on a few days surpassed the TL20.
Both TL20 and Wood’s ETF have benefited from gains in some high-flying software stocks that have done well the past month. The two top performers of the TL20 are Hubspot, up almost forty-three percent, and DigitalOcean, up almost forty percent.
This week saw the big annual conference for 3-D animation technology take place up in Vancouver, called SIGGRAPH. The show has been the venue for decades for breakthroughs in the art of 3-D movie-making such as the techniques made famous in Jurassic Park.
This week, Nvidia, a company founded in 1993, the year Jurassic Park debuted, told us that there was something really, really big, as big as Jurassic Park, to pay attention to at the show. I’ve covered the details at ZDNet.
That big, big thing that Nvidia is excited about is something that has so far been a whole lot of nothing, the Metaverse, the much-hyped future world that Meta’s Mark Zuckerberg has said will be the next incarnation of the Internet.
Nvidia makes GPU chips to make possible 3-D animation, both in movies and in video games, and now it is partnering with Meta and Apple and lots of other companies to make 3-D applicable to the Metaverse.
In this vision of the Metaverse, the Internet becomes a playground of interlocking 3-D worlds where everything is rendered in striking detail. Maybe you view it on your phone’s screen, maybe you view it in some future VR goggles. Your likeness might be instantiated as a 3-D character in that world, like the characters in Toy Story, called an avatar.
For Nvidia, it’s like 3-D is finally growing beyond a niche of big-budget movies and video games to invade all of the world’s connected existence. Now, that would be a great new opportunity for Nvidia.
Except, it doesn’t seem like that’s going to work.
“It cracks me up about CEOs that re-affirm their commitment to being cash flow positive in 2025 … There’s a lot that can go wrong between now and then.”
Wednesday was a nice stock market session, when many companies with so-so results nevertheless turned it around and saw shares climb.
And then, there was cancer diagnostics developer Invitae (ticker “NVTA”), which, after reporting a disappointing outlook on Tuesday evening, and seeing its shares rise a modest four percent in late trading, on Wednesday soared by two hundred and seventy-seven percent.
That’s right, Invitae, which had lost eighty-five percent of its value this year amidst very mixed financial results, and massive losses, is now down only forty-three percent for the year.
The near-quadrupling in the stock Wednesday came, as I said, following mediocre results, and amidst at least one downgrade. Analyst Julia Qin with JP Morgan cut her rating on the shares Wednesday to “Underweight” from Neutral, arguing that it now seems more uncertain whether the company can reach a “long-term” growth target for revenue of fifteen percent to twenty-five percent.
San Francisco-based Invitae, which came public in 2015, and which has been selling its services since 2013, offers genetic testing for a variety of conditions, though testing a person’s DNA for hereditary cancer has been the bulk of that work.
“The enterprise focus that we have today is very prescriptive about who are the prospects, and who are largest companies in the world that we want as customers, and we have very strong campaigns and initiatives to go after those prospects in that regard.”
Tuesday’s dour update from Micron Technology sent the market into free-fall. The DRAM and NAND chip maker said that not only will its results for the July quarter miss expectations, but weakness in markets for PCs and smartphones that was already well understood is spreading to other electronics products.
“Recently, due to macroeconomic factors and supply chain constraints, we have seen a broadening of customer inventory adjustments,” said Micron in its 8-K filing. The outlook had already been sub-par when it was offered on June 30th.
The filing was made in advance of an appearance Tuesday morning by Micron’s CFO, Mark Murphy, who spoke to Keybanc analyst John Vinh in what is often referred to as a “fireside chat” (even in August.)
Nvidia on Monday morning offered what most observers considered the long awaited warning about its business. The company issued a press release in which it revised downward its revenue outlook for this quarter, mostly because its GPUs for video game playing have taken a sudden, sharp turn downward.
The shares closed down six percent at $177.93. Nvidia is one of the TL20 list of twenty good companies whose shares you should consider purchasing.
This hit to the company’s video game business was not unexpected, but the decline, a thirty-three percent drop in gaming revenue, year over year, was bigger than what the company had lead the Street to expect in May, namely, a decline in the teens on a percentage basis. The Street has a lot of questions this evening.
In May, CEO Jensen Huang and CFO Collete Kress had said that a variety of factors were going to reduce demand for the chips. One was Russia’s ongoing war in Ukraine, another was the lockdown of cities in China.
Another factor, they had said back then, is that there is a raft of new products for the video game market that Nvidia is bringing out later this year, and it’s customary that some people will hold off on buying existing chips when there are new parts just around the corner.
“You look at the hyperscalers having just delivered a quarter that was, in aggregate, on the order of forty billion dollars in revenue growing at thirty-five percent … a huge percentage of that are dollars that easily could be available to Dynatrace in the future.
The matter of if the U.S. goes into a recession is still an if, according to Richard Ramsden, the lead analyst covering banking stocks for Goldman Sachs. The more important question, perhaps, is not if but when.
As he explained on Monday, during an online meeting for journalists, “the big debate this time around is what type of recession are we going to get?”
Specifically, consumers, said Ramsden, happen to be “in great shape,” in the sense that average household levels of savings are elevated, and consumers are flush with cash relative to prior periods. And the labor market is super-strong, with data showing the biggest deficit of available workers relative to open positions on record, according to Ramsden’s colleague, Jason English, the consumer goods analyst.
“By any measure, consumers are in very good shape,” said Ramsden. The average consumer who had a couple thousand in their checking account before the pandemic now has more than seven thousand.
Right now, then, consumers are poised to weather a recession well. The longer time goes on, however, the greater the risk that consumers may not be in such a cushy position if a recession comes along.
“The timing of the recession is almost as important as the type of recession we have,” said Ramsden. “If we do go into a recession now, the consumer has got a very good balance sheet, and therefore they will be able to support payments for things like mortgages and car loans much more easily than if we go into a typical recession in eighteen months’ time, when a lot of that cash is going to be depleted.”
Advanced Micro Devices Tuesday afternoon had a good second-quarter report, though you wouldn’t know it given the stock’s seven percent decline in the after-hours.
Although the company beat expectations for the June quarter, and revenue rose by a very healthy seventy percent, the company cut its outlook for the personal computer market, and its forecast for the current quarter’s revenue is slightly below the average Street estimate, $6.7 billion versus $6.8 billion, a two percent miss. That’s the first time in two years the company has missed with its forecast.
AMD is one of the TL20 list of companies whose shares are worth considering for purchase. I think that’s still the case even after this evening’s disappointment. Remember that the shares have been up twenty-two percent in a little over two weeks since July 15th, the reference date for the TL20. There has been a steady rise in expectations heading into Tuesday’s report, and some of what you’re seeing after-hours is profit-taking.
AMD continues to mop up the floor with Intel, but when Intel stumbles badly, as it did last week, missing by two billion dollars on the top line, and missing with its forecast, people would expect that Advanced Micro would have even more upside as they benefit from Intel’s struggles.
That simply wasn’t the case this time around. Look at the chart below comparing what the company has historically promised in terms of revenue each quarter to what it actually delivered three months later. Despite the strong revenue growth this past quarter, Q2 of 2022, the revenue was just slightly above the mid-point of the company’s own forecast.
“I hope we can create a twenty-billion-dollar revenue company here; we just have to keep focusing, focusing and growing, and I think that opportunity exists.”
Arista Networks Monday evening reported a stunningly good second-quarter report, made all the more impressive by the fact that the company is still dealing with supply constraints with respect to getting parts that have been going on for several quarters now. Without that, things would have been even stronger.
I was especially delighted to see all this given Arista is one of the inaugural batch of TL20 stocks recommended for consideration.
Arista’s shares rose over five percent in late trading following the afternoon report.
The company not only beat sales and revenue estimates as it has every quarter since coming public, but its top-line beat relative to consensus for both the results and the outlook are as strong as they’ve ever been.
The tables below show that the top-line beat of over seven percent was the largest in recent memory, and the forecast beat of over five percent was almost as good as the prior quarter’s forecast.
This is the first update to the TL20 list of stocks to consider since the inauguration of the group on July 18th. As you can see, the returns have been healthy, with the group up 13.79% since their closing prices on July 15th, the reference date for that inauguration.
The composite shown in the graphic is a composite created by FactSet as a market cap-weighted average of the twenty stocks. The idea is to smooth out disproportionate effects that could happen from wide differences in the absolute number of shares or prices of the stocks.
I’m happy to see, too, that so far, TL20 has topped Cathie Wood’s ARK Innovation exchange-traded fund (ticker “ARKK”), which is up just two percent in that time. It’s been a rough year for Wood. The ETF is down fifty-two percent.
The cloud computing market is, for the moment, making mincemeat out of doubters.
You’ll recall that last week I noted some rising concern that Amazon would miss expectations, and that its cloud computing unit, AWS, was going to start breaking down.
Not at the moment. Amazon shares soared fourteen percent after hours on Thursday evening as the company’s second quarter report delivered better-than-expected results for June, and a forecast above expectations as well, with particular strength in AWS.
It was a particularly interesting earnings evening. Apple delivered lower-than-expected revenue, missing on sales of Mac computers while seeing healthy phone sales. Roku shocked with its twenty-two percent miss to consensus for its revenue outlook, in addition to missing on reported results. And Intel had a terribly disappointing revenue report for June, missing by two billion dollars on the top line, and missing with its forecast, sending its shares down eight percent after-hours.
In contrast to all that, Amazon was the star of the night. It was the third of the Big Three in cloud to report this week. Just like Microsoft and Alphabet on Tuesday night, Amazon’s results affirm that cloud computing is one of the few bright spots in tech at the moment.
Shares of Meta Platforms, the company formerly known as Facebook, dropped over three percent in late trading, Wednesday evening, after the company this afternoon reported disappointing June-quarter results and lousy outlook as well.
Meta’s miss on revenue was the biggest since the same quarter back in June of 2019, seven percent.
The outlook for this quarter’s revenue, moreover, a miss of eleven percent relative to consensus, is the biggest miss in recent memory, dwarfing the already lousy forecasts of the past three quarters.
Meta’s stock sold off by about five percent in late trading.
The interesting thing is, this quarter looks bad for Meta, but very good for Meta’s supplier, Arista Networks, based on Meta’s intent to keep spending like mad on equipment to network its data centers for artificial intelligence, among other things.
Arista is one of the TL20 group of twenty recommended stocks, so I was glad to see this.
Meta said that its results and outlook were held back by weakness in the advertising industry, no surprise after weakness at Snap last week, and weakness in ad sales at Microsoft’s LinkedIn business, reported yesterday.
Update: Microsoft’s forecast for this quarter’s revenue, $49.25 billion to $50.25 billion, offered by CFO Hood on the conference call, is below consensus of roughly $51 billion.
However, about five percentage points of growth have been lopped off because of the rising U.S. dollar. Were it not for that foreign exchange hit, tonight’s forecast would be above consensus, so that’s good.
The forecast turned Microsoft shares around in late trading, now up four percent.
Hood noted weakness will persist in advertising and PCs, with cloud computing being the bright spot:
Overall, our outlook has the trends we saw in June continue through Q1. Continued weakness in the PC market demand and advertising spend will impact Windows OEM, Surface, LinkedIn and search and news advertising revenue. Our differentiated market position, customer demand across our solution portfolio and consistent execution across the Microsoft Cloud should drive another strong quarter of revenue and share growth, although we expect to continue to see growth moderation in our small- and medium-sized business segment.
This strength in cloud should be music to the ears for data center vendor Arista Networks, as Microsoft is one of their biggest customers along with Meta.
When asked about spending on cloud, Hood said that while the dollar amount that Microsoft spends will decline this quarter, it will continue to be substantial:
“The Company needs additional cash to commercially launch the FF 91,” said Faraday Future, the electric vehicle maker that went public a year ago, in an 8-K filing with the Securities & Exchange Commission Monday evening.
Faraday is the latest casualty of the craze in recent years for special-purpose acquisition companies, or “SPACs,” also known as blank-check companies. These are companies that go public without any actual business, as a shell, and use the public investor funds from the IPO to buy another company.
Faraday, founded in 2014 and headquartered in L.A., is a competitor to Tesla and Rivian and others. Its CEO, Carsten Breitfeld, has decades of auto industry experience. Breitfeld was in charge of development at BMW of the i8 luxury plug-in hybrid vehicle.
The “FF 91” mentioned here is Faraday’s first car, a luxury sedan, which the company has been telling the Street will appear in very small production numbers this year before more substantial numbers in 2023. It is among the more Sci-Fi looking of the new EVs, much more like the Batmobile than most things on the road.
Faraday was bought last year by Property Solutions Acquisition Corp., a SPAC created by real estate wheeler-dealer Jordan Vogel, after Vogel’s SPAC went public in 2020 and raised almost two hundred million dollars.
Update:
After the closing bell, there were several modestly encouraging signs from smaller companies.
Cadence Design, makers of software that chip companies use to lay out the circuits of their chip designs, beat revenue expectations by almost three percent, better than its average revenue beat.
And networker F5 Networks beat on sales and profit and forecast this quarter’s revenue in line with expectations, so at least things are not falling apart for networking equipment, it would appear, though F5 is not a giant company, so it may not be the best indicator.
There were solid results as well from NXP Semiconductors, a very broad vendor of chips into all the world’s industries; and solid results from Celestica, the contract electronics manufacturer. That’s encouraging given that Celestica also has broad exposure to the economy.
Earlier:
It’s that time of the quarter, time for Apple, Alphabet, Microsoft, Amazon, and Meta to report earnings, so we can see if the strongest franchises are showing any signs of slowing based on macroeconomic worries. So efficient, to have it all nicely wrapped up in one week!
I’ve already discussed the case of Amazon, the estimates for which haven’t moved much so far. There’s been no change since last week’s article.
For Apple, estimates are also mostly steady, a few hundred million chopped off here or there, nothing major. Alphabet’s June quarter estimate has been cut by several hundred million, and this year’s outlook was cut by a few billion dollars and the outlook for next year, seven billion dollars lower.
In twenty-eight years of being a journalist, I’ve always worked within a structure set forth by my employers that was designed to prevent conflicts of interest. For a business journalist, that meant not having any personal investment in securities that I was writing about. I followed those rules of compliance at Dow Jones and other places. I never put money into tech stocks I was writing about, ever.
One of the few bright spots in tech at the moment should be cloud computing. After all, the providers of cloud — Amazon, Microsoft, and Alphabet are the Big Three in the public cloud services market — have deep pockets, to put it mildly. They should have no problem navigating any economic downturns.
And cloud computing is coming to represent just about all of global software development, in the sense that computing work is increasingly moving to cloud. It’s hard to conceive of cloud computing activity cooling off even in a recession.
But that doesn’t mean cloud computing is necessarily immune to recession. And so, the Street is fine-tuning its financials for Amazon in advance of earnings on July 28th, bracing for a downturn in Amazon’s AWS cloud services business.
Analysts’ estimates for AWS revenue for this year have stayed relatively stable, with the current estimate for AWS revenue for 2022 being $82 billion. For the June quarter, the average estimate has remained intact as well, at about $19.5 billion. For 2023, however, the number has come down from last month’s estimate by a billion dollars, with the average estimate placing AWS revenue at a grand total of $104 billion in 2023.
Update: The shares are rising on the news, up about almost two percent in New York, although the ordinary shares in Amsterdam are up more, almost four percent, perhaps because of the dividend news.
Previously:
Interesting news tonight/this morning from Dutch semiconductor equipment titan ASML Holding, which happens to be a member of the newly minted TL20: The company has reported June-quarter revenue that was within a fraction of the consensus estimate, but a figure for orders it took in that was a full fifth higher than expected.
Revenue of €5.43 billion was just above consensus for €5.42 billion. New orders for equipment, also known as “net bookings,” came in at €8.46 billion, above Street consensus for €7.05 billion. That was an increase in orders from the prior quarter of over twenty-one percent.
The company’s CEO, Peter Wennink, said in prepared remarks that “Demand from our customers remains very strong.”
“De-SPAC’ing means, ‘Hey, now you’re public, you have to go convince the markets you’re a normal company and not a SPAC’.”
There’s a lot of confusion about technology. It dominates our lives because it holds increasing prominence in society, but most people don’t really know what technology is.
Investors are confused as well. They have a habit of talking about technology in terms of particular products or markets or uses, so that the big picture is lost.
Technology is a transformation. People build things in order to transform their environment. This has been going on for millennia. Ancient peoples built “mills” to convert wheat into flour by a process of grinding. It was a single, repetitive, everyday transformation that was essential for survival.
It’s very telling that the idea of a mill as something that transforms things has passed down to modern times.
Charles Babbage, the Nineteenth Century inventor-entrepreneur who came up with one of the earliest computers, the “Analytical Engine,” called his machine for combining numbers via arithmetical operations “the mill.” Babbage designed his mill to transform one set of numbers into another via addition, subtraction, multiplication and division.
Last week I asked, would Taiwan Semiconductor Manufacturing continue to offer an upbeat outlook for the chip industry when reporting earnings. Thursday morning, the answer was an emphatic “Yes.”
TSM, as it’s usually called, is a contract chip manufacturer that makes chips for all the world’s chip designers, even those that have their own factories such as Intel. So, TSM is the best read on the overall health of the chip industry.
The company reported revenue for the June-ending quarter of $18.16 billion, better than the Street was expecting and at the upper end of the range of revenue the company had said it would deliver. It was a thirty-seven-percent, year-over-year sales increase.
That was impressive coming in the midst of a chip market that has been worried about sales winding down for personal computers and smartphones after a couple years of torrid growth.
This was the company’s third quarter in a row beating expectations, and the outlook was even better, a forecast for revenue that was eight percent higher than the average Street estimate for the September quarter, the highest beat for the company’s outlook in three years.
I think analysts on the company’s Thursday morning conference call were stunned. They gushed about the great results and outlook. The U.S.-listed shares rose by three percent, and, perhaps more significant, shares of chip companies broadly rose on the news, including Intel and Advanced Micro Devices and Nvidia, but also chip equipment vendors such as Applied Materials and Lam Research.
While much of the Street is cutting their estimates for various product categories such as PCs, some analysts are preoccupied with particular market segments, including the risk to small businesses.
DigitalOcean, which acts as a kind of version of Amazon’s AWS cloud service for small businesses, is in the cross hairs at Goldman Sachs. Wednesday, Goldman analyst Gabriela Borges cut her rating on DigitalOcean to Sell from Buy, after concluding that there are signs the prospects are getting weaker for small businesses as they face the risks of a broad macro-economic slowing.
The report by Borges doesn’t mention anything about recession, but that’s certainly in the background in the analyst’s remarks.
“DigitalOcean’s key verticals include Blockchain, SaaS builders, Video, Streaming, and Web Agencies,” she explains, “and we think developer/SMB [small and medium business] activity in each of these end markets is likely to slow.”
There are several clues that Borges lists for coming to her cautious conclusion. One, the company’s outlook at its earnings call in May mentioned Russia’s war in Ukraine as a factor weighing on its business outlook, but the company wasn’t sufficiently “conservative” with that outlook given the risk, she believes:
’Tis the season to lower one’s expectations, specifically, the beginning of the main portion of earnings season.
As I noted two weeks ago, there’s been a steady stream of stock ratings downgrades, and now we’re seeing something else, more and more cuts to analysts’ estimates for various companies.
I expect much more as the season grinds on. Most tech names I follow don’t actually show much change in estimates so far. This is just the beginning.
The latest round of cuts stem from the report Monday by Gartner that personal computer shipments plummeted in the June quarter by thirteen percent, principally within the consumer category of PCs, the worst decline in nine years, the firm said. Researcher IDC had a similar report.
According to Gartner, PC vendors Lenovo, HP and Acer were hardest hit, while Dell’s decline was not as bad. Apple, interestingly, actually saw its sales rise by nine percent.
The take on this is mixed, but hardly catastrophic. Analyst Krish Sankar of Cowen & Co. Monday night told clients that he is cutting his 2022 estimate for PC sales to a decline of nine percent from a prior estimate he had for a five percent decline. The sharper decline is “driven by supply chain expectations for lower growth from consumer and cost-sensitive portions of the PC market,” writes Sankar.
But there is also some decent news on the corporate side, Sankar opines. “We expect enterprise client PCs and high-end notebooks to relatively outperform the overall market decline,” he writes, adding that “enterprise notebook demand remains stable from return-to-office (RTO) trends (good for CPU ASPs [average selling prices]) and build plans for Apple's latest MacBooks with M2 silicon imply Y/Y growth.”
Analyst Sidney Ho of Deutsche Bank writes that the drop in sales “shows consistency with prior data points of weakening demand trends as well as expected economic and geopolitical challenges.” Ho believes Apple may have a chance of taking PC market share at the moment.
You may have missed buying Tesla at its initial public offering in June of 2010 — sixteen thousand percent ago. And so, you may be intrigued by Rivian Automotive, the Irvine, California electric truck maker that came public on November 10th of last year.
And you’re wondering, after a sixty-nine percent decline in Rivian shares through Friday’s close of $31.99, is this the right time to buy in?
It all hangs on what you make of the company’s promises to be profitable some day.
Rivian is set to have higher sales this year than Tesla had the year it went public, but Rivian is also set to lose a bundle of money, much more than Tesla was losing when it came public. The key to Rivian as an investment is assessing when the company’s sales will turn profitable.
Rivian is the most compelling alternative bet on an integrated carmaker after Tesla. The competitors, such as Lucid, Faraday Future, TuSimple, haven’t reached Rivian’s level of production nor revenue.
It’s probably no surprise to you that this is shaping up to be a terrible earnings season, as far as stock performance, at least.
The average price change following earnings, in the three and a half weeks since companies started reporting May-ending results, is a decline of ten percent, the steepest decline for a tech earnings season in recent memory.
The standout feature has been a lot of near-misses in reported results, and lackluster forecasts, the most recent being last week’s disappointing quarterly outlook by Micron Technology for the memory-chip market.
The fun continues next week and the week after, when two important chip industry companies report, Taiwan Semiconductor, the largest contract chip maker, serving just about every chip maker in the world, and ASML Holding, the maker of some of the most expensive chip-making equipment.
If you missed the second quarter’s technology initial public offerings, don’t feel bad, you didn’t miss much. Only five companies came public, down from eight in the preceding quarter and twenty-nine in the same period a year earlier, and they did terribly,
It’s worth reviewing briefly the five for what insights can be gleaned about the broader marketplace.
But first, consider the performance metrics. Buying IPOs at the outset is generally a bad idea, as the stocks on average perform poorly in their first year public. Last quarter was not just bad, it was awful.
The average return from the first day’s close to their price at today’s close is a decline of fifty-one percent. That is worse than the six percent drop of the eight new issues in the first quarter, the twenty percent average decline of all of 2021’s new issues, and quite a reversal compared to the average thirty-eight percent rise of the thirty-eight tech IPOs in 2020.
Interestingly, the first-day “pop,” how much the price rises on the first day from the offer price, was not bad, thirty-seven percent, versus fifty-eight percent in 2021. With just a handful of names, that average is greatly distorted by the huge pop of Lytus Technologies. The other four notched an average nineteen percent decline.
It’s interesting to look back at venture capitalist Marc Andreessen’s OpEd for The Wall Street Journal on August 20th of 2011. Andreessen was prescient about tech trends, even though the companies he wrote about have had mixed success.
That is not a criticism, but an observation about tech prognosticating. Getting the big picture right leaves a lot of work for stock pickers. Even those spotting the trend won’t necessarily pick all the winning companies.
Andreessen’s article, “Why software is eating the world,” was hugely influential at the time it was written, and, I think, holds up well.
Andreessen, you’ll recall, co-founded Netscape in the 1990s after writing his own browser software in the early days of the Web, called Navigator. When Andreessen wrote his OpEd for The Journal, he already had over a decade of success under his belt as a venture capitalist.
What Andreessen wrote in 2011 was that software served up via cloud computing subscriptions was taking over the traditional processes of numerous industries. For example, direct marketing was being consumed by Meta (at the time Facebook) and Alphabet’s Google. The Borders book chain was in tatters, demolished by the biggest online bookstore, Amazon. Blockbuster had been similarly trounced by Netflix in filmed entertainment.
These were just examples, Andreessen wrote, of how all industries were becoming software operations, which meant that the advantage was in the hands of young companies that were approaching traditional problems from the new vantage point of code.
Micron Technology's outlook for this quarter, announced this afternoon, is roughly two billion dollars lower than consensus. The report sent Micron shares down slightly after hours initially, but the stock turned around quickly and rebounded sharply as the late session proceeded.
Is this what investors need to get comfortable with the stock?
When last we heard from Micron, maker of DRAM and NAND flash memory chips, it was the company’s analyst day event on May 12th, in which CEO Sanjay Mehrotra was describing what one analyst called “a more stable business model,” one in which the company has much more of its business agreed to with customers for years into the future.
But stability is, of course, relative. As many have suspected in recent weeks, the market for memory chips is getting weaker at the moment.
In tonight’s fiscal third quarter earnings release, Mehrotra said, “Recently, the industry demand environment has weakened, and we are taking action to moderate our supply growth in fiscal 2023.”
Mehrotra added that “We are confident about the long-term secular demand for memory and storage and are well positioned to deliver strong cross-cycle financial performance.”
The end of the last month of a quarter is generally a quiet time while analysts get ready for the coming earnings season that gets started in earnest in a couple weeks.
But it’s not that quiet at the moment because analysts are taking part in what you might call downgrade season. They are getting ready for the earnings season by lowering their expectations in advance.
There’s been a steady stream of ratings changes, including upgrades, but a lot more downgrades. I count twenty-three downgrades of tech stocks in the past week, compared to just ten upgrades.
In the table, I’ve laid out what happened to these names since the ratings change. A few, such as Coinbase, Cognyte, and Snowflake, have had multiple ratings changes.
“Whether it's because they're frustrated with the existing quality or whether it's because we are just amazing, it’s the combination of both that's giving us more customer relevance … Customers are giving us a seat at the table in a way that's far more strategic, far less tactical.”
The price of Bitcoin is down fifty-six percent this year, at a recent $20,506, and in my latest piece for Barron’s Advisor, I make the case that this is not the same as the prior three declines in Bitcoin’s history. (Paid subscription required to read Barron’s Advisor stories.)
What’s different this time is that certain foundational promises of crypto have been broken, most notably, its capacity as a hedge against inflation, and its promise of anonymity.
Don’t rush out to buy beaten down chip-equipment stocks, because the “trough” in earnings could be coming in 2023, and that means more pain for the stocks, according to New Street’s Pierre Ferragu.
Ferragu offered up a note to clients Wednesday in which he forecasts that after a seventy percent run-up in the total value of semiconductor equipment sold by Applied Materials and ASML and others, in the past two years, there will be a decline of fifteen percent to thirty-five percent in 2023 and 2024, leading to corrections of as much as twenty-two percent in those two stocks.
The notorious “cyclicality” of the chip industry, its tendency to go through periods of boom and bust, has abated in recent years, as there has been more diversification, writes Ferragu. However, cyclicality “is not gone altogether,” he writes, and, “We have multiple indications we are at a peak, or at best close to a peak, with ‘overheated’ spending, in particular in trailing-edge logic.”
Following what Ferragu models as a “peak” in spending on equipment by chip companies this year of perhaps ninety-five billion dollars, the industry may go into one of two scenarios, muses Ferragu.
“Identity is a very interesting market opportunity …the market's changing … everything we do now is digital, and identity is really the front door to those services.”
You might not have noticed, if you’ve totally lost interest in tech stocks, that the past few weeks have seen a gaggle of corporate meetings with analysts to discuss annual and multi-year goals, a ritual the Street calls variously “analyst day” or “investor day” or “capital markets day.”
The analyst day is not to be confused with a company’s annual general meeting of stockholders, which a company is required to hold according to its bylaws. An analyst day is a voluntary event, a chance for management to romance the Street with tales of its technology prowess, and promises of financial greatness to come.
These analyst day events are in addition to conferences sponsored by investment banks in which management give the dog and pony pitch for their stock, a bevy of which have also been going on lately.
The point of the analyst day, in good times, when the stocks were rising, was to throw fuel on the fire. Now, in terrible times for stocks, it’s less clear what an analyst day means, other than to provide free coffee and snacks for analysts.
If any investors are still paying attention at this point, they may glean some very useful insights about companies for a day when the investor again feels bold enough to invest.
Giant companies tend not to hold analyst day events. Their businesses are already fairly well known by investors. Companies such as Apple and Alphabet don’t need to take the time because investors already buy their shares automatically.
I’ve spent some time listening to these talks. What I was most curious about was whether any of these companies are changing their economic outlook to suit the new reality of inflation and possible recession.
The short answer is … sort of. The companies I checked in on are now talking with a tone that has a little more emphasis on someday seeing greater profitability. In some cases, they are boosting their specific profit goals.
Take Snowflake, the cloud database challenger to Oracle. The company, which just hit a billion dollars in revenue last year, and which lost money on an operating-profit basis — even non-GAAP — held its analyst day on Tuesday, in conjunction with its user conference, “Summit.” (Holding the analyst day meeting at the same time as an event for customers is a common thing for tech companies, a way to dazzle financial analysts with a simultaneous display of both product firepower and client enthusiasm.)
Snowflake, as it did last year at this time, presented on Tuesday its goals, a set of numbers that may come about in 2029. The term that Snowflake and other companies use is “long-term operating model,” a phrase that implies less a promise than an intention.
You would think that a thirty-one percent decline in the Nasdaq Composite this year, and a forty percent decline in hundreds of the most-prominent U.S.-listed stocks, on average, might not be the best time to pitch your young tech company.
Well, some companies think otherwise. We are currently in the lull between earnings seasons, the middle of the third month of a quarter, and in the breach, what takes place is what I like to call Financial Conference Season, when executives of tech firms sit down for “fireside chats” with analysts to engage in long conversations about their businesses.
I have been following some of the events and they’re interesting, particularly for the responses peetaining to the economy and the stock market. I chose specifically to look at young companies, those that came public last year, and that are under a billion dollars in annual revenue. These are the companies that are trying to catch investors’ eye by talking up all their great opportunities.
On the whole, the companies replied to questions about potential recession and about the stock market by saying, We’ll be okay. Either these companies are not seeing any issue, and/or they are confident in their ability to weather economic storms. They are pitching themselves as recession-resistant, the kind of tech that must be bought even in a downturn.
Keep in mind, it’s probably not a big deal for a young company to sell a couple hundred million worth of software in a year, even in a recession, given that a couple hundred million dollars is a small amount of money on an absolute basis.
Update: Oracle shares are up over eight percent this morning.
Previously:
Monday’s collapse in the market, across indices and companies of all stripe, wasn’t the worst day this year for most stocks. For the Nasdaq Composite Index, the 4.7 percent drop was the third-worst this year following May 5th and May 18th. It was second in terribleness for the S&P 500 following the 4 percent drop on May 18th. And it was only the third or fourth-worst day this year for many banner tech names such as Apple, Alphabet and Amazon.
But the drop of the S&P into bear territory — down twenty percent from the Index’s January 3rd high — is a new threshold, and Monday was the worst decline for several young tech names, including virtual events company On24, and crypto-currency mining operations Voyager Digital and Argo Blockchain.
The saving grace Monday was Oracle’s fiscal fourth-quarter report and first-quarter outlook, both higher than expected. The company’s revenue in the May quarter was up five percent, year over year, despite the drag of a rising U.S. dollar, and would have been as much as ten percent higher if not for the currency impact. That is higher than Oracle’s forecast had been, for six to eight percent constant-currency revenue growth.
The top-line beat relative to consensus was a healthy seven percent, and the outlook for this quarter’s revenue was fifteen percent higher than consensus.
On the call with analysts this evening, CEO Safra Catz remarked that the results “demonstrate that our business is accelerating.”
“The one trillion dollars that’s shackled in the data center is being unlocked and moved to the cloud … and every one of those workloads that moves to the cloud generates two to three times the volume of data.”
Some things in investing have to do with profit and loss, and some things have to do with everything else.
Merrill Lynch analyst Chaim Israel, the head of “global thematic investing,” on Wednesday offered up a cornucopia of the other stuff, in particular, how companies will respond to broad demographic shifts, and how it will make winners and losers.
Arguing that “demographics is key,” Israel maps ten things that are going to happen in coming decades, with an emphasis on people getting older, people having fewer children, and Africa rising in preeminence in the world.
As Israel sums up in a top-level paragraph,
If you are 50 today, the global population will have doubled in your lifetime, but this is about to change. We could reach 'peak children' in 35 years as fertility rates decline, followed by 'peak people' 7 years after. At the same time, the number of 65+ year-olds will more than double by 2050, as life expectancy increases by >4 years. These are just some of the 10 demographic megatrends shaping societies, economies and geopolitics.
The biggest of all shifts is the new darling generation, “Generation C,” the people born starting in 2017, who are replacing Gen Z:
Potentially the most disruptive demographic shift is that of the next generational cohort. Born after 2016 into an online, decarbonising world, Gen C is the first generation that won't remember the outbreak of the coronavirus, but it will have a significant impact on the world in which they live. Initial studies show a cognitive deficit relative to pre-pandemic children. Made up of 700m so far (9% of the global population) and estimated to reach 2 billion by 2025, Gen C will be a smaller cohort than Gen Z due to falling fertility rates.
Among the marvelous categorical observations, Israel observes that Gen C’s “iconic figure” is Elon Musk, their music choice is “TikTok Influencers,” and their key life question is “What’s hugging?” (As opposed to Gen X’ers, who ask, “What’s the point?” he asserts.)