MSFT Q3 & GOOG Q1 – Two more strikes.

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Microsoft and Alphabet compound Ericsson’s and Intel’s woes

Microsoft FYQ3 16A

• Microsoft reported reasonable results as the weakness in the PC market did not hurt the company as much as Intel’s troubles lead me to fear.
• FYQ3 16A revenues / adj-EPS were $22.1bn / $0.62 compared to consensus at $22.1bn / $0.64 and RFM at $20.3bn / $0.52.
• The continued shift towards cloud based businesses is putting some pressure on gross margin but also increasing the tax rate which was largely responsible for the EPS miss reported.
• Growth has continued in all of the really important areas (cloud and Office 365) and Microsoft has done well to mitigate the impact of weakness in the PC market.
• Phones continued their tail-spin leaving the question with regards to what Microsoft will do with its consumer ecosystem wide open. (see here).
• Guidance for FYQ4 was also a little soft with revenues forecast at $21.7bn – $22.4bn compared to consensus at $23.1bn (4.5% miss) and RFM at $21.9bn.
• PC weakness and very slight softness in the cloud is being blamed for the small undershoot, but frankly I don’t put too much weight on single quarters.
• The net result is a small reset in expectations that in reality does not change the long term outlook.
• Here Microsoft remains a dominant force in Digital Work and that alone is enough to justify holding the shares.
• The free option that is the consumer ecosystem remains a huge question mark which I hope will soon be addressed.
• I still see value in Microsoft and with the market selling off to the low $50’s, it just became more interesting.

Alphabet Q1 16A

• Google reported weaker than expected results as traffic from sites and devices not under its control grew faster than its owned properties.
• Q1 16A revenues-Ex TAC / adj-EPS were $16.47bn / $7.50 compared to consensus at $16.56bn / $7.96 and RFM at $16.12bn / $7.69.
• Alphabet explained away this weakness by stating that profits had suffered as a result of mobile’s growth and the higher Traffic Acquisition Costs (TAC) that are associated with it.
• I think that this is not a very good explanation as growth in mobile has been going on for some considerable time and this has never been a problem before.
• Hence, I suspect that the reality here is that the last few quarters have been driven by the increase in market share of iOS where Google generates far higher revenues than it does on Android.
• The end of the iPhone 6 product cycle means that Android devices are once again growing their share in the Google ecosystem and here I think that Google has lower gross margins.
• I think that these lower gross margins are driven by the costs of developing and maintaining the Android OS as well as the nature of the revenue sharing agreements compared to its deal with Apple.
• These agreements often have a cap and it is likely that the iOS cap has already been surpassed.
• This combined with the slowing outlook for mobile devices and ecosystem user growth in general means that the Google business will slow in the medium term.
• This is something that is not unexpected but for a market that struggles to see past the next three months, it is comes as a surprise.
• In light of the slower outlook, Google is taking action and I see the rationalisation of its investments in Other Bets as well as the fact that G&A expenses fell to 7.5% of sales in Q1 16A as a good sign for fiscal discipline.
• Alphabet is becoming a mature company which combined with its recent rally makes me pretty indifferent to the shares.
• I am also indifferent to Apple but there are far fewer risks to the outlook at this time making this a better place to hide.