Q2 2015 Earnings Preview

As I’ve done in the past, I’m providing a preview of some of the themes to look for in the earnings reports of major tech companies over the next few weeks. Netflix and Google will kick things off later this week and Apple, Microsoft, and others will follow next week.

Hardware vendors

This quarter will likely see a continued bifurcation of the fortunes of major hardware vendors between Apple and the rest. Apple should have another very good quarter, with significant year on year growth in iPhone sales and the first modest impact from the launch of the Apple Watch. I’m still predicting around 20 million total Apple Watch sales for this calendar year and that number will likely be both front and back-end loaded, in that the launch will have seen a good number sold but the holiday season will likely also provide a big boost. It’s also worth watching Apple’s earnings call for questions and answers about the financial impact in Q3 of the Apple Music launch – I think it’s quite possible it will put a substantial dent in music sales in the quarter.

As for the rest, I wrote last week about the trends in the US smartphone market and, later that day, Samsung announced its Q2 was going to be a little softer than expected, with Galaxy S6 sales not great. In that piece last week, I suggested Samsung hadn’t done that well but I also said other vendors had done worse — in the US at least. As such, I’d expect to see a rough quarter for the other Android vendors, especially HTC, which has already reported preliminary numbers for Q2. LG may hold up better than some of the rest but probably still won’t do great this quarter. Not all of the Chinese vendors report publicly, though Xiaomi has already reported some numbers which also weren’t great. Lenovo is well worth watching – the addition of the Motorola business helped to mask some of the challenges it faced at home but, longer term, it needs to see both sides of its smartphone business grow again.

On the PC side, I’d expect Apple to continue to buck the overall trend of decline and post a decent quarter. The other PC vendors will likely mostly report further declines or at least slowing growth, with a similar split here between the top two or three and the rest of the market. AMD and others have already signaled it was a tough quarter and I continue to believe this is the shape of things to come rather than a temporary dip.

Ad-based online companies

Three of the most interesting companies to watch in this space continue to be Google, Facebook, and Twitter. Google is by far the largest but, in some ways, the one that’s facing the most headwinds at present, with the loss of two small but important partners in Mozilla and more recently AOL and the ongoing possibility Apple scales back its search relationship. Last quarter, management sought to reassure investors the mobile advertising business is healthy but, in the process, raised questions about the profitability of YouTube. My main concern about Google continues to be that it has yet to find a mobile advertising product that works as well as search did on the desktop and it’s heavily dependent on partners like Apple for what mobile revenue it does have.

Facebook is, in some ways, the golden child of this space, growing very rapidly and increasingly profitable, while also investing significantly in the future with a pretty diverse set of acquisitions. It’s also got an admirably clear and well-articulated strategy around all that, in marked contrast to Google. The main things to watch for on Facebook’s earnings call are any signs that this story is coming apart, but I’d expect another really strong quarter and many of the same themes as on previous calls. Twitter is in some ways the anti-Facebook, with a muddy strategy, faltering user growth, and management turmoil. The last couple of quarters, it’s actually posted decent financials despite all that, but has to start articulating how it’s going to jumpstart user growth again and, of course, this will be Jack Dorsey’s first call as interim CEO following Dick Costolo’s departure.

Yahoo and AOL are other major companies in this space whose fortunes have seemed closely tied for some time, though AOL is now moving under the Verizon umbrella. Neither company has had stellar underlying trends and each faces significant downward pressures from legacy businesses even as they struggle to find new businesses that will drive future growth. With Yahoo’s sale of part of its Alibaba stake and plans to spin off the rest, it needs to prove that the core business is worth valuing at more than it has been so far. Marissa Mayer has a strategy in place, but the actual performance to date has been out of whack with the story she’s telling, especially around mobile, which continues to be a small minority of Yahoo’s overall business. AOL has been investing heavily in ad tech and this is likely what attracted Verizon to it. With the acquisition of Microsoft’s display ad business, it has the potential to build some much-needed scale in that space, although Microsoft had seen declining revenues there.

Microsoft and Amazon

Microsoft and Amazon are fierce competitors in the cloud services space, but their businesses are otherwise very different. In that cloud market, it’s worth watching for continued detail about the size of their respective businesses, as Amazon broke out AWS in its reporting for the first time last quarter. The composition of the business each company reports is somewhat different, but they’re fairly similar in size, so it’s worth looking at the trajectory of both businesses.

As for the rest of Amazon’s business, the ongoing question in my mind is whether Amazon is spreading itself too thin internationally, where its business seems to be underperforming significantly relative to its US business. The biggest frustration with Amazon’s reporting, of course, is that it provides so little detail about the individual parts of its business, notably Prime, where it’s never released subscriber numbers. I’m guessing that, after the initial release of data on AWS, financial analysts will want more details about that business, so there will likely be quite a few questions about that. I’d also guess China and India, important investment markets for Amazon, will also come up on the call – they’re among the markets where I think Amazon will find it very tough to be successful long term.

As for Microsoft, some of the most important questions surround their moves from the last couple of weeks – selling off mapping imagery to Uber and display advertising to AOL, as well as writing down the value of the mobile devices business. Specifically, I’ll be curious to see what the impairment on the devices business represents and what it says about the future of that business, including the feature phones piece that’s been in rapid decline. I see lots of people reading an admission of defeat into the announcement, but I don’t think Microsoft is quite there yet. Analysts will also want more clarity on the suggestion, over the past couple of weeks, that the Bing business might finally be profitable. If it is, that’s a significant milestone, but we’ll need to wait for confirmation and clarification of exactly what that means. Speaking of profitability, the Surface line has repeatedly been profitable at the gross margin level, but presumably still has some way to go before hitting operating profits, so that’ll be another thing to watch for. Beyond that, the overall growth trend is something to focus on – the Nokia business artificially inflated year on year growth numbers since its acquisition (underlying growth was roughly zero without it) but, going forward, we’ll see more meaningful year on year comparisons and I think it’s going to be tough for Microsoft to drive overall growth.

Content businesses

This is a really wide bucket, so I’ll break it up a bit. On the TV side, we have new wave companies like Netflix, as well as Pay TV providers, content owners who supply their channels to them, and a variety of others. I’d expect Netflix to continue to do very well, though there have been some warning signs lately their US growth is slowing. Meanwhile, the costs of their international expansion continue to be covered very nicely by the ongoing profits from the legacy DVD business and it’s important that that continues – it’s what allows the company’s overall profits to remain healthy even as it invests heavily in expanding overseas. Traditional pay TV providers have done reasonably well despite the onslaught from Netflix and others, but last quarter saw the first time, according to my numbers, there was a year on year drop in pay TV subscribers in the US. That trend is likely to continue and even accelerate. Not all pay TV providers are equal in this respect – the cable companies tend to be losing subs faster, while the telecoms companies are still gaining subs, mostly at their expense, while the satellite providers are less predictable quarter on quarter. AT&T’s acquisition of DirecTV should close any day now, so I’d expect more detail about plans for that business on the companies’ respective earnings calls.

On the music side, there will no doubt be lots of questions about the impact of the launch of the Apple Music on next quarter’s results and the overall health of the industry. As I mentioned above in relation to Apple, I suspect it may cause a dent in Apple’s own music revenue for Q3, but it’s also quite possible it will cause revenues across the industry to dip during the free trial period. Pandora continues to be the one big standalone streaming music service that’s publicly traded and it tends to be losing money while Spotify continues to dribble out bits and pieces of its financial information as it suits, though it is also in the red.

Wireless carriers

Last are the US wireless carriers, which I also track closely. This is likely to be the quarter when T-Mobile finally passes Sprint as the third largest US carrier, something T-Mobile CEO has been predicting since the middle of last year, but which was postponed by Sprint’s more aggressive stance since its new CEO took the helm a few months back. It’s a purely symbolic moment, but expect John Legere to make the most of it. Meanwhile, I’ll be watching for signs Verizon and AT&T are suffering at the hands of T-Mobile’s latest moves, especially on the enterprise side. Until recently, T-Mobile had largely targeted the consumer side of their businesses but lately T-Mobile began putting the same focus on business customers and that could potentially take a toll. Sprint continues to respond more aggressively to these moves and try some of its own. It’s made good use of leasing options to attract customers and get subsidies off its books. I’m also looking for more detail from Sprint on its network upgrade plans, which were alluded to last quarter but which haven’t been fully fleshed out yet.

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Jan Dawson

Jan Dawson is Founder and Chief Analyst at Jackdaw Research, a technology research and consulting firm focused on consumer technology. During his sixteen years as a technology analyst, Jan has covered everything from DSL to LTE, and from policy and regulation to smartphones and tablets. As such, he brings a unique perspective to the consumer technology space, pulling together insights on communications and content services, device hardware and software, and online services to provide big-picture market analysis and strategic advice to his clients. Jan has worked with many of the world’s largest operators, device and infrastructure vendors, online service providers and others to shape their strategies and help them understand the market. Prior to founding Jackdaw, Jan worked at Ovum for a number of years, most recently as Chief Telecoms Analyst, responsible for Ovum’s telecoms research agenda globally.

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