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Big Tech - Time Is Running Out

James Chapter 4 verse 10 states, "Humble yourselves before the Lord, and he will lift you up."


I like this verse because it teaches me to seek God in the midst of all aspects of my life. Over time I've learned that my expectation or idea of what lifting me up means has become more clear. In many ways, I think I know what is best, but the reality is that I need to see more clearly how to love and serve others. Lifting me up tends to help me better understand my selfish tendencies and how to let that go and focus on others.


Being an aggressive growth investor is challenging as markets move in a volatile and fast fashion. I've found that having management strategies and tools is very helpful, but it doesn't eliminate the core need to make decisions under pressure. It can get very frustrating when things are dysfunctional and inconsistent, especially when the core of what I own is being selectively targeted. But it is during these times that I need to separate the elements out of my control and to focus on the goals and opportunities on the horizon.


All was off to a great start for Big Tech as Alphabet, Inc. (GOOG), Apple, Inc. (AAPL), and Microsoft Corporation (MSFT) all rallied after their results. Netflix, Inc. (NFLX) had a rough hit and with Meta Platforms, Inc. (FB) debacle, the tides have finally turned. We've also seen some very weak results and forecasts from other large peers, notably PayPal Holdings, Inc. (PYPL) and Spotify, Inc. (SPOT). Make no mistake, Big Tech has received a tailwind from the pandemic and a free pass to boot with respect to valuation, while stronger aggressive growth peers have been targeted and attacked, much earlier and with more severity.


The issue here is that while companies like Roku, Inc. (ROKU) have been decimated for the "slowing growth" Wallstreet narrative, Big Tech will be seeing exponentially slower "slowing growth" as the pandemic subsides. I have my own political views regarding the current Administration's connections with Big Tech, Big Pharma and pretty much Big Everything, but I still am optimistic that the U.S. will see a paradigm shift driven by younger generations back towards less centralized policies and economic restrictions. Here's a snapshot of where things are headed for Big Tech based on my updated financial models.


Alphabet

Alphabet has traded with a pre-pandemic historical valuation multiple of 5 times EV/Revenue from 2008 through 2019, and 17 times SP to OCF/share from 2017 through 2019. From 2008 through 2016, Alphabet sported an average SP to OCF/share at around 50, so only recently has this valuation multiple broken below 20 times.


Today, Alphabet trades 7 and 21.5 times EV/Revenue and SP to OCF/share respectively. From 2008 and through 2019, Alphabet averaged annualized Revenue growth of 20%. During the pandemic, Alphabet's Revenue growth has increased to a 26% average over the past couple years. I am modeling Alphabet to grow a little faster than average analyst estimates and still, growth is expected to slow further towards 12% annualized over the mid-term. I've also included EV/Revenue and SP to OCF/Share multiples at 6 and 18 times respectively. I feel that this multiple is a premium that may fall further depending on performance.


Alphabet is still extremely dependent upon its advertising and services businesses. Interestingly, the Google Services segment generated nearly $92 billion in Operating Income for 2021, and yet all other segments and corporate operational needs lost $13 billion, with Google Cloud losing $3 billion of this total. Google has big ambitions for autonomous vehicles and AI, and as of now, these are not fruitful. Bullish investors will claim that these will one day become larger parts of the business. But I don't see Alphabet as a leader in these spaces. I will have the opportunity to work directly with Waymo and like many other Big Tech companies, I feel that Alphabet will continue to waste R&D spend while more focused players will lead these markets - remember Google's social media ambitions. Over 81% of Alphabet's Revenue is still dependent upon the bread-and-butter, Google Advertising Revenues.


Apple, Inc.

Apple has traded with a pre-pandemic historical valuation multiple of less than 3 times EV/Revenue from 2008 through 2019, and less than 11 times SP to OCF/Share over the same period.


Today, Apple trades 7.5 and 25.5 times EV/Revenue and SP to OCF/share respectively. From 2008 and through 2019, Apple averaged annualized Revenue growth of 19%, similar to Alphabet. During the pandemic, Apple's Revenue growth has declined to an18.5% average over the past couple years. Similar to Alphabet, I am modeling Apple to grow a little faster than average analyst estimates and still, growth is expected to slow further towards 6% annualized over the mid-term. I've also included EV/Revenue and SP to OCF/Share multiples at 6.5 and 20 times respectively. I feel that this multiple is a premium that may fall further depending on performance.


For Apple, the buzz words are EV and Metaverse. Big Tech in many respects is reliant upon mergers and visionary buzz words, while the most likely outcome is business as usual, or the status quo. From what I've seen, Big Tech is appended to Big Government now, and politics is the easiest way to keep the status quo, despite Big Government's claims to one day, break up Big Tech. I don't see Apple breaking through the EV Revolution opportunity, and similarly for the Metaverse, I think there will continue to be stronger focused companies with superior management teams and human capital that will win out. I believe that Apple will recognize this at some point and look to make a deal to bring in a new operating segment.


Microsoft

Microsoft has traded with a pre-pandemic historical valuation multiple of 3 times EV/Revenue from 2008 through 2019, and 10.5 times SP to OCF/Share over the same period.


Today, Microsoft trades 12 and 28 times EV/Revenue and SP to OCF/share respectively. From 2008 and through 2019, Microsoft averaged annualized Revenue growth of 7%. During the pandemic, Microsoft's Revenue growth has increased to an15.5% average over the past couple years. Similarly, I am modeling Microsoft to grow a little faster than average analyst estimates and still, growth is expected to slow further towards 11% annualized over the mid-term. I've also included EV/Revenue and SP to OCF/Share multiples at 10 and 25 times respectively. Like the others, I feel that this multiple is a premium that may fall further depending on performance.


Microsoft is the poster-child for Big Tech growth by acquisition. From deals like that of LinkedIn Corporation (LNKD), to the most recent nearly $70 billion deal announcement for Activision Blizzard, Inc. (ATVI). Just watching their Revenue segments expand over time is testament to this. The deal will essentially increase Microsoft's Gaming Revenue by over 50%, eclipsing Windows Revenue on an ongoing annual basis. This type of deal will place some pressure on Netflix, who has similar ambitions, it could force Netflix's hand if they are indeed looking to make a move as well. Regardless, I still see Microsoft in the same fashion as the others, highly committed to existing operational R&D, likely looking to make further deals, and incapable of independently competing within core growth markets.


Netflix

Netflix has traded with a pre-pandemic historical valuation multiple of 4.5 times EV/Revenue from 2008 through 2019, and 127 times SP to OCF/Share over the same period. The SP to OCF/Share multiple is misleading as Netflix has witnessed extreme gyrations as it has pivoted to the current streaming model. This has included negative performance for five consecutive years, 2015 through 2019.


Today, Netflix trades nearly 7 and 485 times EV/Revenue and SP to OCF/share respectively. From 2008 and through 2019, Netflix averaged annualized Revenue growth of 28%. During the pandemic, Netflix's Revenue growth has declined to a nearly 22% average over the past couple years. Similarly, I am modeling Netflix to grow a little faster than average analyst estimates and still, growth is expected to slow further towards 14% annualized over the mid-term. I've also included EV/Revenue and SP to OCF/Share multiples at 6 and 400 times respectively. Like the others, I feel that this multiple is a premium that may fall further depending on performance.


Netflix is headed back to its negative OCF performance for 2022. As I've written on before, the company benefitted tremendously from the increased streaming demand during the pandemic, while at the same time, content spend came to a stand-still before beginning to recover. The results of this are clear as during 2020, Netflix witnessed OCF/FCF at $2.4 and $2.2 billion respectively. During 2021, this dropped substantially to just over $390 million and negative $208 million. The financial model above only includes the streaming business, so it will be influenced by Netflix's online gaming moves, whether through increasing organic investment, or acquisition. I see either approach further stressing Netflix's weak business model that to this point is incapable of generating OCF aside from the pandemic. Netflix's is in a dilemma for streaming as today's average paying monthly subscription globally at just below $12 per month, likely should be closer towards $20. Content spend is not going to be linear, nor marginal which will continue to put Netflix in a tricky situation as it plays catch-up by increasing subscription fees for the foreseeable future.


Meta Platforms/PayPal


I have not updated my financial models for either Meta or PayPal as neither has filed their 10-Ks. But I already know from the prior discussion topics above and my cursory review that both companies will be seeing slowing growth patterns similar to their Big Tech peers. PayPal was crushed today declining by just below 25%. Meta is down nearly 23% in after-hours.


With the recent beat-down on aggressive growth companies, these moves for Meta and PayPal are long over due. The same arguments and justifications that have been used by Wallstreet to sell-off aggressive growth plays and downgrade PTs, is what Big Tech will be going through post-pandemic. I see 2022 as a pivotal year in bringing more parity back to markets, which has become disconnected from 2021 performance.


Roku

Before wrapping up, I wanted to illustrate a market leader in Roku as an opposing example. Roku has witnessed its SP drop from a peak in 2021 of over $490 to the current nearly $157 SP. This has reflected a decline just below 70%. Today, Roku's valuation multiples stand at 7.5 and 70 times EV/Revenue and SP to OCF/Share respectively.


Roku went public in 2017 and over this short period of time has averaged an EV/Revenue multiple over 9 times, and a SP to OCF/Share multiple over 500 times. Aside from the December 2018 Tech drop, Roku is trading at its lowest valuation levels since going public. And yet when compared against streaming related peers like Netflix and The Trade Desk, Inc. (TTD), Roku stands out as the clear Revenue growth leader over the mid-term based upon estimates.


Right now Roku is facing immense competitive pressures from the likes of Alphabet, Apple, Amazon, Inc. (AMZN), Comcast Corporation (CMCSA), At&t, Inc. (T), TCL and Samsung, among others, but from what I have seen and gather, Roku is positioned to win out over time. Roku's addressable market runway has been questioned by Wallstreet, but as Roku executes, the company's premium will move higher. I don't believe that an EV/Revenue premium 20-25 times is warranted which was peak 2020, but I do feel 10-15 times is very reasonable, especially as Roku's Revenue growth is anticipated to more than double that of Netflix, and even outperform Trade Desk, at a higher Revenue scale, despite the former's supposed stronger addressable market.


For an aggressive growth investor like myself, this is a core reason why I do not see any reason to own Big Tech. Most of these companies are slowing, more focused on share buybacks and dividends than innovation, and looking to Big Government to help them thwart and in some cases restrict competition and innovation. One could argue that if centralized and socialist policies win out over time and the U.S. no longer values freedom, competition and innovation, Big Tech will continue to thrive. I see an opposite outcome as younger generations look to a wide variety of innovation-based services. These different preferences and interests will be much more of a boon for innovative leaders and risk takers. While it seems contrary to call Big Tech less innovative and more risk-averse, I am of the opinion that this is exactly where they stand.



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