David Garrity on CNBC’s The Nightly Business Report: IBM and Netflix

The Nightly Business report replay can be found here. The GVA Research interview starts at 3 min 30 seconds.

Netflix (NFLX) came out with better than consensus results after the close. Should investors consider purchasing the shares as they are 20% higher after hours?

NFLX 3Q16 subscriber growth and 4Q16 forecast was a positive surprise addressing one of the main criticisms against the company, namely that subscriber growth was slowing in the more profitable U.S. market and that overseas subscriber growth was challenged, especially as China is proving difficult to enter. With the backdrop of consumers “cutting the cord”, however, NFLX is positioned to continue to benefit. Nevertheless, with NFLX trading at 50x EBITDA, a great deal of good news is already priced into the share price. Also, with NFLX indicating that original content production will increase to 1,000 hours in 2017 from 600 hours in 2016, risk of programming failures increases and total production costs are set to rise. This clearly indicates NFLX will continue to experience substantial negative free cash flow going into 2017. Meanwhile, note that other well-financed competitors (e.g. AMZN) are focused on the opportunity for streaming video and original content, so NFLX is not alone. As such, we would not chase the stock at this point.

While IBM results were better than consensus, the shares are off after hours. What are the prospects for Big Blue?

For IBM, the good news was Strategic Initiative revenue at $8bn increased +15% year-over-year (y/y) and now represent roughly 40% of total IBM revenues. Meanwhile, total revenues at $19.2bn were almost flat y/y and EPS at $3.29 beat consensus, but the lift was due to “one-time” benefits from IP licensing and EPS were still down y/y. For IBM, 3Q16 represented the 18th consecutive quarter of declining financial performance, something raising investor concerns that absent its Strategic Initiative efforts supplemented by an aggressive program of buying up small complementary technology companies IBM’s core business is contracting at a pace faster than management’s efforts can offset. Also, while Strategic Initiative +15% growth is encouraging, note that the growth rate lags that of other tech sector peers. On the positive side, IBM represents an inexpensive way for investors to participate in the growth of artificial intelligence (AI). As such, we are inclined to stay with IBM shares for now.

What kind of insight will it tell us about the rest of tech earnings?

As noted, NFLX benefits from a positive consumer shift towards streaming video both domestically and overseas and offers a clear positive indication for other companies with internet video exposure. With IBM’s status as a legacy enterprise IT vendor, the company has over time lost the bellwether status so we do not see IBM 3Q16 results as indicative of the broader sector.

Of the companies reporting, which is GVA Research watching closely watching and why?

With global economic growth forecasts declining steadily over the course of 2016, investors are herding into those names with solid growth prospects. To that end we are focused on AMZN (3Q16 results out Thurs 10/27 with Revs $32.7bn (+29% vs. prior year $25.4bn) and EPS $0.83 (+388% vs. prior year $0.18)) and FB (3Q16 results out Wed 11/2 with Revs $6.9bn (+54% vs. prior year $4.5bn) and EPS $0.97 (+70% vs. prior year $0.57)).

Do we see a difficult quarter for Q3 results?

Yes, with the outlook for economic growth becoming more uncertain following the 6/23/16 “Brexit” vote, we expect 3Q16 results will show weakness as enterprise customers most likely pulled back on decision making in what is already a seasonally weak quarter.

Analysts see the third quarter as the bottom, and then getting better in the fourth quarter and beyond, does GVA Research see the same?

The level of popular discord and civil unrest attending the U.S. Presidential election is unprecedented and may not abate following election day on11/8/16. Consequently, the prospects for a 4Q16 rebound are somewhat muted and the outlook for 2017 clouded.