Over the last few weeks, I had been reading numerous sell-side research reports from investment banks, and all of them were in union with low-expectations for the quarter for Apple, especially around iPhone. Apple, overall, beat the lowered expectations, which post-earnings commentary indicates, is positive. What was quite interesting was the commentary from Tim Cook during the call that before the economic impact of COVID-19, Apple was trending to the top end of their previous guidance. This suggests the iPhone was trending stronger than many realized into 2020. There was also likely, a strong lift from China that could have been even stronger should COVID-19 not have happened. This should give observers a great deal of confidence that what many of us have been saying about iPhone demand not going away, just being delayed, is what happened. Overall, Apple is staying quite resilient< amidst the backdrop of COVID-19, and I think it is safe to assume that will remain the case as the economic issues continue or even worsen. I want to highlight a few constants that can now be depended upon.
- Growing Installed Base. I beat this drum frequently, and have for many years, but a highlight of Apple’s earnings was executive commentary that the active installed base is at all-time highs. This data point was not just about one product line or one geography, but each product line and every geography saw a new high of the active installed base. People are not leaving the Apple ecosystem. This point may be one of the most important fundamentals to their business to understand.
- Services Continues to Roll. The services growth train just keeps on rolling. I have said to watch how this business will not be subject to the same seasonality of Apple’s hardware business, and now people are starting to realize that it is true. Apple is setting quarterly records quarter after quarter in the same way they did with the iPhone for many years straight. There will come a time this business slows down, but it is likely not anytime soon. Apple’s ecosystem is uniquely positioned to keep growing services, and this business could be one of the most recession-proof.
Wearables Growth. Wearables remain the single greatest hardware growth segment for Apple. This business has massive headroom to keep growing. From a variety of research reports, I’ve seen suggest the penetration of Apple Watch and AirPods has neither product penetrating deeper than to 20% of the iPhone installed base. I don’t expect the adoption curve here to be sharp, so my expectation is the steady and continued growth of this hardware business over many years to come. Both AirPods and Apple Watch are becoming as indispensable to their owners as iPhone is, and that speaks to the value of both products.
Overall, Apple looks to be positioned to have a strong series of quarters toward the end of the year, or even longer, as the global economy picks up steam again.
I am not going to dive too deep into the fundamentals here, but I want to touch on two specific things. As the impact o COVID-19 began, I saw a number of reports come in suggesting dramatic advertising declines as a whole. What was most interesting to me was how it seems specific advertisers knew their businesses were the ones that would be impacted and therefore stopped advertising. Things like clothing, retail products, travel and resorts, automotive, etc. These are big advertisers whose main channel is TV, so it made sense the reports were outlining the networks struggling with ads.
My theory all along was those who were still advertising could move to Facebook because of the more targeted nature of the ads, and hope they saw better engagement there. Couple that with the reality that during the shelter in place, people were spending more time on social media, and Facebook’s properties were beneficiaries. Facebook reported daily active user growth of 11% when prior quarters, this number was flat to declining. This confirmed more people are spending more time on Facebook during the lock-down, and even some people re-activating their deleted accounts. This current global situation actually worked in Facebook’s favor.
The main question is how sustainable this is going forward. After the shelter in place, an economic recovery is underway, people will not stay as engaged, and therefore some of these fundamentals may turn negative. The key for FB is to prove to those engaging more with their service that it is again a safe and meaningful way to engage socially. And the upside potential is for them to retain advertisers and show the benefit of Facebook ads platform. If Facebook can retain some of the shifts in the ad budget they received during this time, then hopefully, they can keep them when this is over.
I only want to touch on one data point from Microsoft’s earnings as it is indicative of an accelerated trend where Microsoft is well-positioned. Azure grew 59% YoY. It seemed like common sense that the shelter in place and work from home mandate would force many businesses to invest in the cloud more quickly than they had planned. We had seen IT surveys and had anecdotal evidence this was the case, but to see the massive growth in Microsoft’s cloud business affirms this is what is happening.
What is interesting to me is how Microsoft saw larger growth for Azure than Amazon did for AWS. Azure grew 59% to AWS’s growth of 34%. I have a sense Microsoft’s growth is also tied to the growth in Office 356 and the remote collaboration and productivity tools Microsoft provides. While these are two separate businesses, the Office/M365 offerings and the essential role Office plays in the modern business is something Amazon does not have. In a way, Microsoft can provide levels of integration across these segments in ways Amazon can not given AWS as a pure backend solution. This is an interesting dynamic to watch as Microsoft can leverage a holistic set of solutions during sales conversations. This is an advantage I think Microsoft has that perhaps only Google can offer as well.
There is an overall point here that cloud infrastructure companies and specifically AWS, Microsoft, and Google are well-positioned to grow as the shelter in place and work from home mandate is accelerating digital transformation in the workplace much faster than anyone could have predicted. Making this space one of the most competitive to watch in the near-term.
I want to lastly touch on the macro theme from many tech company’s earnings thus far, and that is of the resiliency of the tech sector. I was watching many macro-economic reports as the lock-downs started happening, and most of them were significant doom to the economy and the stock market. I saw investor calls that were pretty wild about how far the market could drop. But tech stocks have not come to anything close to what people were thinking. This is a fascinating point.
We learned during the last few recessions that tech was resilient, but this time around it seems even more resilient. And even more resilient still are the big tech companies like Apple, Microsoft, Google, Amazon, etc. It seems that there are many more safe bets in the stock market than people thought going forward, and big tech stocks are one of them. This will not comfort much those who feel there is an unfair monopoly-like market power given to those names I mentioned, but the reality is as every single company in the world becomes a tech company in some fashion, it is these companies who are the tried and true, vetted, solutions businesses can count on.
Many of my friends in venture don’t like the power given as they are investing in companies that hope to fill the gaps or provide alternate solutions to those of the big tech companies. Big tech’s dominance is not exactly a startup-friendly environment when it comes to more dollars from IT going to the big companies. This does not mean startups don’t have opportunities, only that their world needs to be one of co-existence with big tech rather than displacing it. At least for the time being.