Below are the read throughs for the upcoming Apple and Amazon September earnings based on results from Google, Microsoft, and Twitter, along with their key takeaways.
- As for the macro, Google did not caution as much about the soft supply environment in December as Facebook and Snap. Positive for holiday sales.
- The accelerating digital transformation continues to be strong, a positive for Apple hardware sales. We believe this tailwind is more signifiant than many anticipate and will last 2-3 years.
- Microsoft Surface hardware business was down 17% y/y, compared to down 20% y/y in June. While a potential red flag for Apple’s Mac and iPad sales, it’s worth noting that in June, Mac grew revenue at 16% and iPad at 12%. We expect that gap between Surface growth and Mac/iPad to remain. We’re looking for Mac and iPad revenue to be up 8% and 7% respectively in September.
- Apple’s IDFA had a fractional negative impact on YouTube growth, and no measurable impact on Google Search and Twitter advertising revenue. We want to hear more from Apple about the business model behind its SKAdNetwork which has become an ad topic focus with the changes to IDFA.
- Microsoft gaming content grew 2% because of tough comps given less time was spent at home gaming compared to a year ago. It’s a slight negative for App Store gaming revenue, which the Street is already anticipating with Services growth declining from 33% in June to 21% in September.
- The accelerating digital transformation continues to be strong, which is positive for ecommerce.
- Google did not caution as much about the soft supply environment in December as Facebook and Snap. Positive for holiday sales.
- Azure revenue up 50% which is a a positive for AWS.
- Google continues to live up to its role as the oxygen of the internet, evidenced by September revenue growing 41%, the highest mark in 14 years.
- Beat the Street revenue by 3%.
- Profit was up 3x over the start of the pandemic.
- Retail foot traffic is slowing, so online ads spending increases. Small businesses in particular are buying search ads.
- Overall the business was not impacted by Apple IDFA, outside of a modest headwind to YouTube, which posted revenues of $7.2B (up 43%) vs. the Street at $7.4B. YouTube is now on a run rate to be as big as Netflix.
- Cloud was $5.0B vs. the Street at $5.1B
- Google is taking a page from Apple when it comes to hardware. With the Nexus 6 coming out, Google is talking about being good on hardware, software and services. This is more to pull off because of the open nature of Android compared to Apple’s vertical integration.
- Waymo and Verily are still lagging monetization.
- $1.9T market cap, up 60% YTD.
- Sleepy good results.
- Remote working and learning continue to help Microsoft, with revenue up 22% and beating the Street by 3%.
- Azure grew 50% y/y, vs. Street at 48%.
- Gaming content grew 2% because of tough comps given less time was spent at home gaming compared to a year ago. The Xbox console sales were a bright spot, up 166% y/y.
- Hardware sales were down 17% off of hard comps last year. We expect Apple will buck that trend.
- LinkedIn up 42% y/y but expect headwinds in the numbers. They have scaled back operations in China, which is the 3rd largest market for Linkedin.
- $2.3T market cap, up 32% YTD.
- Ad revenue up 41% yy.
- Results were inline as their brand ad model avoided the direct response mess that Apple’s IDFA changes caused Facebook and Snap. Twitter is inching forward on their two year return to growth roadmap.
- The big picture is they have work to do over the next two years around their DAU and revenue growth targets.
- DAU growth. They need to add 100m DAU’s (up 50% from current levels) over the next 9 quarters to hit their target. That implies a step up and sustained DAU growth of 18% y/y each quarter. Before the pandemic and election ramp, DAU growth was around 10%. That step will be challenging.
- Revenue growth target of $7.5B (up 40%) in two years is more achievable given they have done almost no direct response advertising and are starting to turn that on.
- Big picture: They are struggling in the US. They have 37m DAU in the US, up from about 36m a year ago. As a point of comparison, Snap has 96m US DAU’s and Facebook has 196m. That begs the question, why can’t Twitter get more US users? They have new products like Spaces (Clubhouse), and Revue (Substack newsletter) that are directed at solving the US DAU challenge.
- Twitter is an under-rated metaverse play because they are building in NFT ownership validation and just turned on Bitcoin tipping into the product.
- $49B market cap, up 13% YTD.
Apple’s September quarter results and commentary around the December quarter will likely follow a well-traveled narrative of demand outpacing supply, but with a twist. The twist is that unlike many companies, it’s a function of time before Apple wins the sale. In other words, today’s supply pains will eventually equate to 2022 sales gains. We believe investors will leave the September quarter results with a belief that the step up in demand is sustainable, driven by the accelerating digital transformation for the foreseeable future.
The Big Picture
It’s clear that growth will slow next year, as it will for almost all big tech. For Apple, we believe FY22 revenue growth will likely end up in the mid to high single digits compared to the Street, which is looking for 4% growth. If Apple continues to modestly exceed expectations over the next year, we believe shares of AAPL will continue to appreciate. If the next year plays out inline with our expectations, we believe shares of Apple can reach $200 in the next one to two years, based on applying a 28x multiple to EPS of $7 in 2023 (the Street is around $6).
We believe that 7-9% top-line growth is sustainable for a few years until Apple launches into new product categories like AR, wearables, wellness, and automation (maybe vehicles). At that point, growth will step up again putting investors’ growth sustainability questions to rest, at least for a few more years.
Tight supply impact on September
For the September quarter we expect 1-2% upside to consensus estimates of $85B in revenue. Based on commentary from Apple’s last earnings call and our tracking of lead times, we believe the supply constraints along with recent power conservation measures in China reduced sales in the quarter by about 5%. As a reminder, a 5% reduction in supply equates to 4-5 days increased lead times from historical levels across all products, a trend we have observed throughout the September quarter.
Tight supply impact on December
Apple does not give formal guidance, opting instead to give commentary on trends in the business. For the June quarter outlook, the company gave expectations supply challenges would have a negative $3.0-$4.0B impact on iPad and Mac supply. In the end, the actual impact was slightly below expectations, coming in at $2.5B.
- For the September quarter, the language around the supply environment worsened, with the company noting the impact for the September quarter will be greater than the June quarter for iPhone and iPad. We interpret this to be $4B headwind. The only difference is in September the constraints primarily impact iPhone and iPad.
- For December, we believe the supply chain has further tightened and therefore believe the company will suggest a 5-7% headwind for December. This would imply about a $6.0-$8.0B headwind.
Putting it together, we believe expectations for December revenue will settle in around $115B, compared to current Street estimates of $118B.
Expectations by segment for September
- Revenue: Loup at $86.4B (up 34% y/y), slightly ahead of the Street at $85.0B. Keep in mind the strong y/y revenue growth is aided by the shift in timing of the iPhone release.
- EPS: Loup at $1.30 (up 77% y/y), slightly ahead of the Street at $1.24.
- iPhone revenue: Loup at $42.0B (up 59% y/y), ahead of the Street at $41.2B. Our estimate of 59% growth gets about a 30% benefit from the shift in timing of the latest iPhone release. Adjusting for the timing of the iPhone, we believe overall iPhone sales would have been up about 25% y/y.
- Mac: Loup at $9.9B (up 10% y/y), above the Street at $9.1B.
- iPad: Loup at $7.3B (up 8% y/y), ahead of the Street at $7.2B.
- Wearables, Home and Accessories: Loup at $9.7B (up 24% y/y), ahead of the Street at $9.4B.
- Services: Loup at $17.5B (up 20% y/y), essentially inline with the Street at $17.7B.
- Gross margin: Loup at 42.5%, ahead of the Street at 41.0%.
Outlook for December
- Revenue: Loup at $115.2B, vs. Street at $118.7B
- iPhone: Loup at $62.9B (down 5% y/y) vs. the Street at $68.1B.
- Mac: Loup at $9.4B (down 8% y/y) vs. Street at $9.2B.
- iPad: Loup at $9.0B (down 7% y/y) vs. Street at $8.9B
- Wearables, Home and Accessories: Loup at $15.6B (down 20% y/y) vs. Street at $14.2B
- Services: $18.3B (up 16% y/y) vs. Street at $18.6B
- Gross margin: Loup at 38.8%, essentially inline with the Street.
App Store Policy Changes Will Continue
In mid-September Judge Gonzalez Rogers weighed in on the Apple v. Epic trial. Apple won 9 of the 10 counts, with the loss related to steering. In hindsight, Apple anticipated the same outcome, and proactively made changes to App Store policies around steering in the month leading up to the September decision. The central topic related to App Store policies is the commission rates.
While commissions were not directly addressed in the suit, indirectly they were the central topic. The ruling allows Apple to maintain its current 30% commission for larger developers and 15% for smaller ones. While the court decision is a win for Apple, we believe the free hand of the market will determine the App Store’s long-term commission rates. History shows Apple is willing to change. In 2016, Apple reduced its commission for the 2nd year of subscriptions to 15% from 30%. In 2020, the commission for smaller developers was reduced to 15% from 30%.
Expected Change: It’s unclear how commission rates play out. Apple has until mid-December to build a framework to allow developers to steer. In 2022, we expect developers will be in data gathering mode to determine the most favorable approach. On one hand, if the developer steers customers to pay outside of iOS, costs will decline because commissions are no longer paid. That said, costs will not go to zero, given there’s an expense to maintaining a payments platform. Additionally paying customer conversion will go down given the extra payment steps. Humans are of course lazy, and transacting within iOS is easiest. The math for the large developer will most likely come down to a 80% breakeven hurdle. If conversion rates are above 80%, the developer will likely continue to steer. If conversion falls below 80%, they’ll likely transact inside of iOS. If the large developers have the brand to drive greater than 80% conversion, Apple may consider lowering the 30% take rate to win them back. In the end, I believe it’s unlikely we see any commission rate changes over the next five years. If I’m wrong, we see a floor of the large developer commissions at 15%.
Tesla’s September quarter results reveal a company that is defying the odds around demand and profitability. Deliveries were up 73% while the top five automakers were down 27%. Gross margin ex-credit was a record 28.8%, up from 25.8% in June. It’s easy to write about the outperformance, it’s hard to do it. Just ask the rest of the auto industry. While there’s still a light year gap between making about 1m cars in 2021 and the company’s long-term goal of 20m a year, the formula to get there has been successfully tested: build the best EVs for the money at scale. Equally as impressive is the fact that the company will eventually scale and add businesses outside of making cars that eventually could represent 25% plus of total sales.
Key takeaways from September
- Inching toward tech profit margins. The most important metric was automotive gross margin ex-credits. While the Street was expecting 25.1%, Tesla reported a record at 28.8%. In three to five years, we believe Tesla will have Apple-like 40% gross margins based on three factors: increasing manufacturing efficiencies with Austin and Berlin gigafactories, growth in high-margin software subscription growth driven by FSD pricing and FSD uptake increases, and an expected decline in battery costs over time.
- Operating margin. CFO Zach Kirkhorn expects “considerable upside to margins” over the next few years based on higher FSD adoption and insurance.
- Demand. Backlog continues to grow with 2-6 month lead times.
- Growth target. Company maintained its view to expect 50% compound vehicle growth over the next decade.
- Autonomy. The time table for level 4 autonomy remains a mystery. Musk’s comments a year ago suggesting we would have full autonomy by year end 2021 is no surprise, off the table. All Kirkhorn would add is “it’s difficult to be specific on time lines . . and they are making progress quickly.” Our interpretation is that it’s easy to miss the forest for the trees with these continued delays. The big picture is Tesla is making measurable progress toward autonomy. Whether we get level 4 in 2022 or 2026 doesn’t matter. We’ve been waiting 100 years for this and investors will reward shares of TSLA when they finally release general availability FSD.
- Cybertruck. The design is maturing, and it now has rear steer and other smaller improvements. It’s still on track for initial deliveries late in 2021 and volume in 2022.
- Model 2. When asked on the earnings call about timing of the $25k Model 2, the company stated that right now they don’t want to add any new cars when they can’t keep up with Model 3 and Model Y demand. Previously they had hinted at a 2023 release, which means it’s more likely in 2024.
- Insurance. Kirkhorn made a compelling case that insurance could be big. The concept that most insurance today is unfair given it’s based on good drivers subsidizing bad drivers resonates. Tesla has the data to fix the pricing and reward good drivers with lower rates. At the same time, it faces an upward battle with the highly-profitable incumbent insurance industry that will resist change. This resistance will result in a slow, multi-year rollout of Tesla insurance in the US.
- Negative. A negative on the quarter was solar and storage (6% of revenue) was flat sequentially, but still up 46% and 71% y/y.
The case for the TSLA
Near-term TSLA shares are unpredictable. Our long-term perspective is based on Tesla targeting large markets including EVs, energy, autonomy, and insurance, along with the long shots of HVAC, VTOL, and robots. These businesses should deliver sustainable revenue growth, and our thinking is sales can increase from $70B next year to $400B in 2027. Given the hardware, software, and services nature of Tesla’s model, it seems appropriate to apply a 6x multiple on $400B in 2027 revenue, which yields about a $2,500 share price. We caution, a lot of things need to go right (including keeping competition at bay) to get there, but that potential is on the table.