Big Tech’s profits waning?
Investors yet to come to grips with permanent lower margins
INVESTORS love Big Tech for the combination of growth, competitive “moats” and fat profit margins. But would their feelings be so strong if tech giants’s margins were a little less plump?
A theme in recent earnings from Apple, Google, Amazon and Facebook has been rising costs from changes in strategy or the hunt for their next big businesses.
This could be savvy investing in the future, but all four are at or near record stock prices and investors may be disappointed if they’re betting on current levels of profitability persisting.
Apple stock touched an alltime high on Wednesday on the heels of strong results. Apple executives are enthusiastic about its newest products and the company continues to swim in profit. But Apple is getting a bit less flush.
In its most recent quarter, operating profit as a share of revenue was the lowest in nine years because Apple is splurging more in areas like research and development. Its operating expenses in the last 12 months were nearly 12% of revenue, the highest percentage in seven years.
Chief executive Tim Cook has deflected previous ques- tions about what exactly Apple is spending money on, but he has said the company is “making a big investment” in technology for autonomous systems, including driverless cars.
Either way, shareholders are picking up the cheque now for investments that may not pay off for years.
At Amazon, shares fell last week after investors realised – belatedly – that profits aren’t going to rain from the com- pany’s Seattle headquarters. Spending on merchandise warehouses, web video programming and computer data centres slimmed its operating profit margin to 1.7%.
Unlike its peers, Amazon expands its warehouses and data centres through capital leases and when those costs are included, its free cash flow was $1.5 billion in the past 12 months.
That means out of every $1 coming into Amazon, it’s left with one cent after accounting for all its cash expenses.
Amazon hasn’t said much about its pending acquisition of Whole Foods, but it’s safe to guess that will require a spending splurge. It isn’t cheap to fulfil the boundless ambitions of chief executive Jeff Bezos. After the earnings report, Wall Street scaled back its expectations of Amazon’s profits.
Facebook and Google tend to have high profit margins, but even their businesses are shifting in ways that change this. Google’s parent company Alphabet is handing over chunks of its revenue to partners, like the companies that make YouTube videos and owners of web browsers such as Apple that provide portals for Google searches.
Google in the second quarter handed over more than 22% of its revenue to these partners. Google’s revenue is growing quickly from ads in YouTube videos and mobile searches, but that still means each dollar of future sales comes with thinner margins.
Facebook’s mission to become a TV-like destination will squash its margins too. Facebook is planning to share more revenue with companies that agree to make videos for its news feed.
Video ads “almost certainly will be a lower margin source of revenue than the current thing that we do”, Facebook chief executive Mark Zuckerberg said.
These companies’ absolute profits are all still climbing and that may matter more to investors than their margins. Still, I’m not sure investors have come to grips with the possibility that Big Tech may have permanently lower-margin futures. – Bloomberg
Facebook’s mission to become a TV-like destination will affect profits.