Internet services companies have become divided in two majors groups, where size and existing market share are two of the major factors that determine business success for companies in this industry. In e-commerce, the last several years there has been a greater differentiation between the haves and the have-nots, analysts say, adding that there’s consolidation in the space where the smaller have-nots tend to get bought by larger companies before they reach a critical size. Analysts say there is potential for expansion in other countries, especially countries where the postal services are still developing. In countries such as China, however, there already are dominant players in e-commerce, but analysts say there are still niches that could be filled by non-Chinese companies.
Online advertising is a growing category, analysts say, but only if mobile is included. Although pricing has fluctuated for online advertising, analysts say there still is a tailwind, but it is still being figured out by companies. Analysts note, however, that spending hasn’t exactly come at the expense of more traditional media. They say mobile viewing of content will eventually win, but traditional viewing methods are not expected to disappear.
In the general internet services space, when choosing stocks, analysts say category winners — the best in class — are the names to pick. Once a company gets a certain amount of traffic online, it’s hard to dethrone a category leader and change customer behavior. Another reason investors may want to look at larger companies is that analysts warn investors to be careful about internet stocks that have limited liquidity or a limited Wall Street following, as these can have violent swings in price in any direction.
On the storage side, analysts say data center REITs have performed well over the last two years. This year the six publicly traded data center REITs on average have seen their stocks appreciate 33% this year versus the S&P 500 at 7%, they say.
Data center REITs operate the buildings that are the brains of the internet, analysts say, and these buildings have been in short supply and have seen increased demand because there has been an explosion on the need for data storage. Because data center REITs can build out facilities more efficiently than their customers, companies have been outsourcing to them. The cloud is booming, according to analysts, and there aren’t enough data centers.
Analysts think we are early in the cycle of this data storage demand boom, not only from the standpoint of demand being seen, but also in the willingness of the enterprises to outsource rather than build their own facilities. Two years ago, 15% of storage was outsourced, they say, and now it’s about 25%. Analysts think over time the majority will be outsourced.
Full report available here.
Chief Investment Officer Adam Abelson of Stralem & Company says Intercontinental Exchange Inc (NYE:ICE) is an underappreciated growth story. He says this premier provider of underwriting derivatives and clearing is growing 24% top line year on year, with 80% gross margins and 15% growth in earnings.
It’s a fast-growing secular business with the added attribute that 50% of its revenue comes from owning stock exchanges from which they collect the trade data and sell the exhaust, the transaction exhaust, to hedge funds and others seeking to profit from flows, for a very hefty sum.
So half their growth comes from very fast-evolving and high-volume derivative underwriting. Again, the world is being financialized, and everybody’s got a counterparty, and that is the more attractive thesis to invest, along with this recurring revenue from data dissemination. The CME Group (NASDAQ:CME) would be a decent example of derivative underwriting, but it’s a more expensive stock than Intercontinental Exchange and doesn’t have an ancillary cash flow business.
ICE is a perfect Stralem stock, as the data business has the characteristics of an annuity-like revenue but with global aspirations, as the derivatives market expands globally, and gets more complicated and financialized. It’s a $33 billion-market-cap company with $4 billion in revenue, growing 24% top line year on year, 80% gross margins, 15% growth in earnings, 37% net margins and $1.3 billion in free cash flow growing at 30% per annum. This is an overlooked gem in terms of looking at the structure of the financial community. Intercontinental Exchange is definitely an underowned, and underappreciated name.
Michael Genovese covers companies that sell equipment to service providers, enterprises and cloud providers. He breaks down sentiment by sectors. In the service provider market, he says the capital spending of carriers is flat to down into the future. He says the good stories are things related to fiber and optical, and most of his favorite stocks play in the 100G market. Mr. Genovese says the main trend in the enterprise side is the concentration of buying power in the market, as a new class of cloud service providers, the Web 2.0 companies, are building bigger data centers and selling to enterprises.
Full interview available here.
Alex Henderson says the issue in data networking is the shift from private to public cloud causing a diminution of longer-term growth potential. He says suppliers to the Web 2.0 players have significant opportunity, as there is a major upgrade cycle in the data center for scaled-out data centers.
Full interview available here.
Erik Suppiger covers security and networking stocks. Mr. Suppiger says the security sector has been very active, with the volume of attacks growing rapidly. He says different security technologies have become effective for specific types of attacks. In the networking space, Mr. Suppiger says there’s been a significant investment cycle taking place in the data center, and that a lot of cloud buildout has occurred. Another trend is the outsourcing of IT infrastructure with services such as infrastructure as a service, where a lot of cloud providers are building out cloud infrastructure. He shares which companies are best-positioned to capitalize on this buildout.
Full interview available here.
David B. Rodgers covers data center REITs. He believes the shift toward a positive sentiment in the industry has been driven by cloud demand. In addition, Mr. Rodgers thinks the strong performance of data center REITs is due to multiple expansion and improving fundamentals. Despite the positive sentiment and performance, Mr. Rodgers is cautious about the sector. According to him, if the hyperscale cloud expansion and demand is unable to keep pace, it could be a potential negative catalyst for investors. Within the sector, he has found the network-centric business model to be the most favorable.
Full interview available here.
Ryan Hutchinson covers data and communication infrastructure. Two of the trends that are making an impact in the sector are the rise of cloud computing and the move toward white box hardware. According to Mr. Hutchinson, broad IT spending is flat, but he does see growth in segments like security and those related to the buildout of cloud technologies. In addition, while the macroeconomic environment has been a challenge for the sector, companies with subscription-based business models have been more insulated than hardware-oriented companies.
Full interview available here.
Senior Portfolio Manager Todd S. Lowenstein of HighMark Capital Management says General Electric Company (NYSE:GE) is restructuring to focus more on its crown-jewel businesses, and is on track to redeploy capital back into acquisitions and shareholder returns.
GE is a terrific example of the type of equity opportunity we seek out. GE has been a relative underperformer for many years now. In the past, it was an empire builder, and during the financial crisis, it got exposed for being heavily reliant on short-term commercial paper financing, essentially funding short and investing long, relying on their AAA credit rating, providing an advantageous funding position. They spent a lot of money building a massive presence in various financial services unrelated to their core industrial business, which resulted in finance at the peak of last cycle becoming close to half their earnings power…
All those financial areas, whether it was real estate, whether it was consumer finance, are being monetized, and the company is being shrunk to fit an attractive set of competitively advantaged, crown-jewel businesses, such as aircraft engines, power generation, health care and locomotive. And they are going to take about $100 billion in capital and redeploy it in industrial acquisitions and shareholder buybacks. They are going to rake in over $100 billion in asset sales and will redeploy that capital back, investing in the industrial businesses, productivity improvements, margin expansion and shareholder returns through stock buybacks and stepped up dividends.
Upside margin improvement is apparent when benchmarking against their peer group and asset return potential, especially on the original equipment side of things as well as on a better recurring services mix, and on capex and operating discipline. We like that the incentive compensation structure for management is being realigned toward an emphasis on returns on invested capital. As a result, we expect an improved margin structure, asset utilization and capital-allocation policies.
So while not an uncomplicated story, however, it is sort of a reset that makes sense to us and that we think is shareholder-friendly. We have some activists now involved in GE who are helping steer the company to the right course, and you have a very handsome dividend yield, so they are paying you as they restructure the businesses for higher and better use. Ultimately, we think this slow-moving transformation will warrant a much higher valuation multiple, higher growth-rate potential, higher-quality earnings, and it’s going to be a very successful investment for our shareholders.
Hendi Susanto covers the technology sectors. According to Mr. Susanto, cybersecurity continues to be a core issue, and it continues to evolve in both intensity and nature. In addition to cybersecurity companies adopting subscription models, Mr. Susanto sees a trend toward security platforms. These platforms give companies a competitive advantage over standalone solutions and allow them to develop new functionalities that can be added to the same platform.
Full interview available here.
Ken Ichikawa Siazon discusses Southeastern Asset Management, Inc., and the Asia Pacific strategy. Mr. Siazon is value-focused and follows a business/people/price discipline. He looks to build a concentrated portfolio with strong businesses. He also wants the businesses to be run by managers who act like owners and to be available at a deep discount. Despite the volatility in Asia, the strategy has the flexibility to invest in the best opportunities regardless of market cap or location. According to Mr. Siazon, some of the trends creating opportunities include the cheapness of equities, the corruption crackdown in China, generational changes in management, the focus on capital efficiency in Japan and the weakness in natural resources.
Full interview available here.
