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Microsoft Earnings: The Nadella Makeover is Working

The numbers are in: Microsoft (MSFT) reported fiscal fourth-quarter earnings per share of $0.55 on revenues of $23.38 billion.  This is actually a pretty substantial earnings miss for MSFT—the Wall Street consensus was for earnings per share of $0.60—though revenues came in better than the expected $22.99.

The main culprit? Fallout from the Nokia acquisition, which has been a mixed bag at best for Microsoft.  The Nokia acquisition reduced earnings per share by about 8 cents.  Inventory adjustments to its Surface tablet also chopped another 7 cents off of Microsoft earnings per share.

MSFT stock actually rose in after-hours trading, so the Street seems to be taking the news in stride and focusing instead on the positives.  Revenues from the Bing search engine were up 40%, and Bing now has a U.S. market share of about 19%.  And  the Windows unit—which has been hurting for the past several years—also showed signs of strength for MSFT, with revenues up 3%.  This was driven mostly by business spending on new PCs, something that “Wintel” partner Intel (INTC) confirmed in its earnings release earlier this month.

Microsoft’s transitioning of Office from a “shrink-wrapped” software suite to a subscription service is also doing well.   MSFT added more than a million new Home and Personal subscribers to Office 365.

But the biggest news—and something that bodes very well for MSFT’s future—is the smashing success of its cloud business.  Per Microsoft, “Commercial cloud revenue grew 147% with an annualized run rate that exceeds $4.4 billion.”

$4.4 billion is still chump change to a company that does $87 billion in annual revenues.  But MSFT’s success here is critical to CEO Satya Nadella’s vision for the company’s future as an enterprise and cloud services company.

“Bold ambition” is what Nadella promised to deliver in a memo to employees earlier this month.  And he’s off to a good start.  Wall Street reacted well to his attempts to make MSFT leaner and meaner: earlier this month, MSFT announced it would be laying off 18,000 workers—or fully 14% of its workforce—as it reduces overlap with Nokia, whose devices business it acquired  last year.  But even outside of Nokia-related layoffs, the company will be letting go of about 5,500 workers, or about 5% of its pre-Nokia workforce.

This is Nadella’s second major concrete move in his attempts to steer MSFT away from former CEO Steve Ballmer’s emphasis on consumer devices.  The first, of course, was his decision to make Office available on the iPad—a move that strengthens MSFT’s position as the dominant maker if office productivity software but weakens its position as a seller of tablets such as the Surface.

So, what does all of this mean for MSFT stock going forward?

Nadella appears to be doing a fine job of remaking Microsoft.  But his competition hasn’t sat idly either; just last week, Apple (AAPL) and IBM (IBM) announced plans to join forces on the enterprise front.  MSFT stock is priced at a modest premium to AAPL: MSFT trades for 17 times trailing earnings and 16 times forward earnings, compared to 16 and 14, respectively, for Apple. MSFT stock is also up about 20% year to date, implying that the market has already priced in much of the good news.

Still, would consider MSFT a solid buy at today’s prices.  MSFT stock is by no means expensive by the standards of today’s market, and I would expect earnings to accelerate in the coming quarter as the legacy PC businesses continue to firm up and as Nadella’s growth initiates really start to bear fruit.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.  This article first appeared on InvestorPlace.

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Who Won the Console War? Ask a Gamer



Marco Chiappetta’s article in Forbes earlier this week caught my attention.  Like Chiappetta, I have considered the possibility of a bifurcated gaming market in which casual, low-end gaming is dominated by phones and tablets and the higher-end market is dominated by hard-core gamers with custom gaming PCs.  In this scenario, consoles like Sony’s (SNE) PlayStation 4 and Microsoft’s (MSFT) Xbox One would be squeezed in the middle.

Friend and colleague Daniel Stark–who unlike me, actually plays games recreationally and can speak from experience–takes a very different view, which he was willing to share:

The PC gaming market is alive and well, but claiming that the war is over and the PC has won ignores the facts.

Mr. Chiappetta compares a current generation console to an “entry-level PC.”  The issue is that a state-of-the-art computer today can cost upwards of several thousand dollars.  After just a few short years, the pinnacle of processing power becomes middle-of-the-pack, often requiring hefty upgrades in RAM, processing power or graphics power.

Today’s generation of consoles may be as powerful as an entry-level PC, but the machine, with less than a $500 price tag, will continue to be relevant for years to come, with no upgrades, no reconfigurations, and no changes necessary for the ownership of the console.  A PC built today may not be able to play the game that comes out in five years; the console will.

Most of the top titles today are being created specifically for consoles and then later ported to the PC.  Several months ago, the highly-anticipated Watch Dogs arrived to consoles and PCs alike.  The PC version was riddled with bugs, with awkward controls and a lack of focus that has people questioning whether an incomplete PC version was released.  At launch, games.on.net stated that the version was “half-working at best.”  With several months passing, users are still struggling to play the game on even high-end PCs, while the game is being enjoyed without the same errors on the current AND the previous generation of consoles.

While Mr. Chiappetta trumpets the graphical quality of high-end machines, he is ignoring the content quality, which is identical between systems.  Games such as Diablo III, once thought of as a PC exclusive, have now been fully ported to consoles with no loss in content.  And while more and more PC games are being ported to consoles, the same cannot be said for the other direction.

AAA titles such as Grand Theft Auto V, Call of Duty, and the upcoming Destiny are all three of the most expensive games ever made, but the PC version is secondary or non-existent.  Grand Theft Auto V won’t arrive on the PC until over a year after its initial release.  In the case of Destiny, noted developer Bungie (makers of Halo and intimately familiar with the PC gaming market) is NOT porting the title over to PCs.  And that’s for a $500 million game, the most expensive media ever created, trumping even film.  If a former PC developer is willing to forgo a PC version of the game, how has the PC market “won?”

In short, the PC has not won the war.  The battle rages on, with more powerful PCs emerging, stronger consoles being created, and massively expensive games being developed.  The war rages on, so grab your popcorn and enjoy the ride, because regardless of the war, the winners are the consumers.

 

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Carlos Slim Taking a Wrecking Ball to His Mexican Telecom Empire: What It Means for AMX and TEF

At first glance, it looked as if the condemned man had stolen the executioner’s axe and cut off his own head rather than wait for the inevitable.  Facing imminent antitrust legislation in Mexico aimed squarely at his telecom empire, Carlos Slim opted to act first with announced plans to break up America Movil (AMX). America Movil will spin off some of its fixed-line and mobile assets into a new, independent company, and it will also spin off its wireless towers.

Slim is no dummy; he knew the jig was up and he figured he could better shape the outcome if he acted early.  America Movil controls 70% of the mobile phone market and 80% of landlines, and its dominance in the Mexican market and the lack of significant competition has led Mexico to have some of the most expensive communications costs in the world.

The OECD published a study last year found Mexico to be the most expensive of twelve major markets for a basic talk, text and data mobile phone plan.  And recent ranking of broadband internet costs by country had Mexico’s service ranked as the 16th most expensive in the world, more than three times more expensive than that of the United States after adjusting for incomes.

AMX stock has been rallying on the news of the breakup; shares are up more than 10% since Tuesday.  Investors have taken the view that the divestures and subsequent competition—which will bring America Movil’s market share to below the 50% threshold at which the Mexican government would impose penalties—will be less damaging than the potential punitive actions by the Mexican government.

So, what does this mean for AMX stock and for its largest single competitor in Latin America, Spain’s Telefonica (TEF)?

To start, this will, by default, massively diversify AMX’s revenue stream globally.  Though AMX is the number-one or number-two mobile provider in nearly every Latin American country, its home market of Mexico is by far its biggest.  Mexico currently accounts for about a third of sales and nearly half of profits.  The new AMX will be a pan-Latin-American telecom giant based in Mexico rather than a Mexican telecom giant with operations in Central and South America.

Over the next year or two, I would expect AMX’s restructuring to be a major distraction for management, which should—all else equal—be a boon to Telefonica. But the Mexican divestures are likely to make Carlos Slim all the more aggressive in pursuing growth outside of Mexico once the dust settles.

Within Mexico, the picture is somewhat cloudy.  AMX has indicated it prefers to sell the bulk of the assets to a single buyer in order to create a competitor strong enough to appease Mexican regulators.  That could mean that Telefonica steps up and increases its presence in Mexico, though Bloomberg reported that broadcasting juggernaut Grupo Televisa (TV) could be the strongest contender.

More details on Slim’s plans will be coming in the coming weeks.  But one point should be immediately obvious.  The biggest winner here will be neither America Movil nor Telefonica but rather the Mexican consumers who should soon be benefitting from increased competition and lower prices.  That may mean lower margins for AMX and TEF in their Mexican operations, at least for a time.  But if AT&T (T) and Verizon (VZ) can profitably coexist in the brutally competitive U.S. market, then investors in AMX and TEF should have nothing to worry about.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

 

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Second Quarter Earnings: What to Expect

The second quarter earnings season is off to a nice start—and FactSet is estimating quarterly earnings growth of 4.6% for the S&P 500.  Though this is down slightly from the 4.9% estimated for the quarter as recently as June 30, if earnings come in at even  4.0% it will be the second-highest quarterly earnings growth rate for the since 2012.

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Not bad.  But how realistic are these numbers, particularly given last quarter’s collapse in GDP?

Let’s take a look.   Alcoa (AA) kicked it off the earnings season last week with a much better than expected performance; earnings came in 50% higher than the consensus analyst estimates.

Alcoa is considered a bellwether for two reasons.  First off, it is the first major large cap stock to report, giving us a potential sneak preview of things to come from the rest of corporate America.  Secondly, Alcoa is a cyclical industrial stock, so changes in Alcoa’s profitability can potentially give clues as to the health of the broader global economy.

Or maybe not.  I tend to downplay the significance of Alcoa’s earnings release (Bloomberg ran the numbers last year, and its usefulness in forecasting the market  is no better than a coin toss).  At the end of the day, Alcoa is a single company whose results can be affected by any number of factors that may or may not affect the broader market.

All the same, the early second-quarter results continue to offer hope.  Per FactSet, “Of the 27 companies that have reported earnings to date, 63% have reported earnings above the mean estimate and 67% have reported sales above the mean estimate.”  Of course, those estimates had already been revised sharply lower; coming into the quarter, 86 companies had issued lower guidance and only 27 had issued positive guidance.  This 76% of companies guiding estimates lower is significantly higher than the five-year average of 66%.

For a better idea of what is happening on Main Street, I would consider the comments last week from Bill Simons,  the head of Walmart’s (WMT) U.S.  division, that the recent improvements in the job market haven’t yet had much of an impact on retail spending and that shoppers are “adapting to what has been a difficult macro environment.”   Things have stopped getting worse, in Simons’ view, but they are a long way from getting better.

Walmart is not an American company; Walmart is America.  Its shoppers represent the middle and working classes of the country, so when the behemoth of Bentonville says that its customers are still hurting financially, that is a telling sign.  This is particularly true when these comments are echoed by other mainstream retailers.

Fact Set has condensed the earnings guidance for the companies of the S&P 500 into three basic trends:

  1. Domestically, with sales still tepid, companies are still focusing on cost cutting to boost earnings.
  2. Europe continues to rebound from its brutal double-dip recession, and Europe is a source of earnings growth once again.
  3. While economic growth has yet to accelerate in emerging markets, S&P 500 companies continue to enjoy revenue and profit growth across the region and particularly in China.

So there you have it.  Even if earnings come in slower than the consensus estimates, we should still see a good quarter by the standards of the past two years.  But profitability is being driven by improvement overseas and not at home.  A good portfolio strategy for the  second half of the year might be to overweight companies that get a large percentage of their revenues and profits from Europe and emerging markets and to underweight those that depend heavily on the wary American consumer.

This post first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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