Big Tech’s prof­its wan­ing?

In­vestors yet to come to grips with per­ma­nent lower mar­gins

Weekend Argus (Saturday Edition) - - FRONT PAGE - SHIRA OVIDE

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

PIC­TURES: REUTERS

Face­book’s mis­sion to become a TV-like des­ti­na­tion will af­fect prof­its.

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