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Recent announced transactions (e.g. AVGO/BRCM $37bn, INTC/ALTR $17bn) prompt speculation that parts of the technology sector are set to experience a wave of consolidation as secular growth slows, costs of competing increase and profit margins contract. With interest rates expected to rise in 4Q15/1Q16, the window for financing mega-mergers appears limited so the argument goes so get while the getting is good. This may be true in semiconductors (think slowing PC sales trends) and software (MSFT thought to be considering $50bn+ offer for CRM). However, new technologies serve to offset old. Case in point to consider here is the likelihood that 4K high-definition television sets will prompt consumers to accelerate the shift towards streaming content from the internet and cut the cord with cable. This will make winners out of companies such as AAPL, AMZN, GLW, NFLX, NVDA, Samsung & YHOO (i.e. see recent announcement to stream the 10/25/15 game between Jacksonville Jaguars and Buffalo Bills, admittedly not division leading teams but a move by the NFL away from cable). So, we are far from convinced that tech sector growth is limited. Nevertheless, we do not disagree that larger transactions will happen. Note with interest the upcoming split-ups of EBAY ($74bn mkt cap) and HPQ ($59bn mkt cap) into smaller entities will likely create either additional bidders for or targets for bigger deals.
AAPL – Focus on Upgrading iTunes Service While Apple TV Not Quite Ready:
After the $3bn acquisition of Beats Electronics in 2014, AAPL investors have been waiting to see what Dr. Dre and Jimmy Iovine would do to liven up and make fresh AAPL’s vaunted iTunes music service offering. Part of the attention ahead of today’s WDC has been whether AAPL will give a better cut than the 55% labels and 15% publishers get of monthly subscription fees at competitors such as spotify. Meanwhile, the FTC is monitoring AAPL, so we expect the company will come in line with competitors on pricing but look to offer more extras to differentiate itself. Disappointing that AAPL apparently further away from completing negotiations with video content providers so do not look for any announcements on the Apple TV service at WDC today.
Tech – Sector Consolidation Offers Upside, Return of Enterprise CapEx Supports Outperformance:
Historically, product cycles such as the introduction of a new Microsoft PC operating system would trigger sector growth with attendant stock appreciation in anticipation of the product demand upturn. This year will see the introduction of Windows 10, but the effect will be muted by historical comparison as competitor products such as Google Android and Apple iOS have become more significant in terms of the installed PC base, particularly mobile devices. Nevertheless, while such product cycle dynamics may be muted, there does remain a positive backdrop of rising capital spending. Recently, The Economist noted that corporate capex in 1Q15 outstripped the levels of corporate buyback activity, an indicator that enterprises are returning to the point of growing their business. Clearly, a positive indicator for tech sector product demand. Meanwhile, the prospect of increased merger activity should sustain the sector’s continued outperformance versus the broader market averages.