Looking to the new year, as one contemplates what may befall the U.S.’s biggest tech companies, it’s worth pausing to observe that almost nothing happened of any significance for the top stocks this year.
Apple (AAPL) shares rose 85% even though its revenue is rising at an unexciting single-digits percentage rate. It added a streaming TV service and started offering a credit card, pretty humdrum stuff. But it was TheStreet’s top stock for 2019.
So, the biggest companies in the world have become a little dull while also becoming more dominant in their respective markets. Facebook (FB) introduced a crypto-currency, Libra, but it is turning into a fiasco.
Alphabet’s (GOOGL) only interesting development was its announcement, in the final month of the year, that it will replace its CEO, Larry Page, with Google chief Sundar Pichai. And Amazon (AMZN) and Microsoft (MSFT) really did nothing exceptional, except that in the penultimate month of the year, Microsoft beat out Amazon with a cloud contract for the Pentagon worth billions.
Fact is, Massachusetts senator and Democratic presidential candidate Elizabeth Warren made more headlines by arguing repeatedly for heavier regulation and even a break-up or two of tech giants.
This will be an election year, so expect more of the same from Warren and her peers. That means that Facebook and the rest will be under pressure not to do anything too daring or controversial for fear of greater scrutiny.
But it’s possible to see a couple things that could happen that may be more striking than last year. All five companies are always asking themselves how they can create more value. They have already optimized their operations more than other companies, so it’s all about what incremental products they can find to sell.
Alphabet is arguably the company with the most opportunity to strike out into interesting terrain because it has done little of note for some time now.
With the appointment of Pichai as head of Google parent Alphabet, the chance is there for him to rewrite some of the rules. One possibility is a big M&A deal to bring enterprise expertise into the company to boost the cloud business. Google has for some time been perceived as trailing Amazon and Microsoft in cloud. Buying an enterprise vendor would be a way to instantly add a lot of clients for cloud if Google attached hardware purchases to cloud contracts, similar to how Microsoft has leveraged its Windows installed base to sell cloud services.
The best prospect is Hewlett Packard Enterprise (HPE). It has a great name, tons of customers and strong standing in many product categories, such as servers. And at $20 billion in market value, it would be a manageable acquisition for Alphabet. Hewlett, like other vendors, faces an existential crisis, so management would likely be happy to sell.
The other measure that Pichai might actually implement is starting a capital returns program for Alphabet. The company offers no dividends at the moment, just occasional share buybacks. The company’s board of directors has authorized up to $25 billion worth of buybacks, and through Q3 of this year, the company had bought back $12.3 billion worth of shares. That is equal to just 1.3% of Alphabet’s $924 billion in market capitalization, and it’s about half the $23 billion in free cash flow Alphabet generated in that period, which is less than the payout ratio of many tech companies these days that do pay out.
The stock trailed the Nasdaq this year, rising 29.6%, slightly better than Amazon, which also doesn’t pay out. True, Facebook doesn’t pay out, and its shares rose 59%. But the two other stocks in the group that did well are Apple and Microsoft, both of which have long had consistent capital return programs. The lesson for Alphabet is that if the stock is lagging, payouts to shareholders may be what‘s lacking. It certainly couldn’t hurt Alphabet to try being more shareholder-friendly in that regard.
Apple’s approach to value creation these days is to simply tweak its existing hardware and keep adding more consumables to milk the hardware customers. Hence, Apple TV+. As TheStreet’s Eric Jhonsa wrote in his twenty tech predictions for 2020, Apple could look to bundle products together in 2020.
A more extreme move that would suit Apple’s intention to make services a larger and larger part of the business would be to design a services plan for which hardware is included, similar to a cable plan. This is basically the notion of an iPhone subscription to which Jhonsa alluded. The customer still pays for the hardware, but as a monthly installment that’s part of the services fee.
The move would have the added benefit of producing a big surge in receivables on the balance sheet in the form of future hardware revenue that can be immediately monetized. That pile of receivables can be securitized in order to produce more cash up front. It’s basically a way to accelerate Apple’s cash flow. Boosting cash in that way could give Apple added flexibility in terms of capital returns, which may become important because, as TheStreet has noted, the company faces a crisis of stagnant capital returns come 2023. Without dramatically boosting annual free cash flow in some way, Apple will no longer be able to increase its rate of capital returns, currently about $100 billion annually, given that the company has committed itself to being neutral on a net-cash basis, which limits Apple’s borrowing ability.
Facebook’s problem of value creation is how not to mess up a good thing, because right now, its business model is astoundingly good. Facebook’s number of monthly average users is rising more slowly than in the past, up 8% in September year-over-year, but that’s still faster than the 1% annual rate of growth of the world’s population, according to the United Nations’s Department of Economic and Social Affairs. That slow user growth nevertheless led to 29% more revenue last quarter for Facebook.
So, just selling more ads against and stuff to a steadily expanding base works great. That’s why Facebook created Libra — to expand its utility for its 2.45 billion users, only 65% of whom use the service on a daily basis. Facebook won’t drop Libra, but expect to see the company pushing in 2020 in the direction of more traditional payment systems, akin to PayPal’s (PYPL) Venmo and Apple’s Apple Cash. Such a traditional system, backed by a major bank, is a much easier path than trying to create an entire currency from scratch. Along those lines, It would not be surprising to see Facebook offer a credit card product similar to Apple’s, with the added incentive of some subsidies on purchases, a kind of multi-billion-dollar loyalty program to jump start Facebook’s role in the payments market.
Meanwhile, Amazon’s biggest challenge is overseas growth, which slipped in the nine months through September to 18% from 19% a year earlier, below Amazon’s rate of revenue growth in North America of 21%. At only $50 billion in sales in those nine months, Amazon seems to have a very large opportunity overseas. After all, how many more retailers can it decimate in the U.S.?
But the overseas market is complicated relative to North American retail patterns. It will likely require more local assets, so expect to see Amazon on the hunt for M&A.
Finally, Microsoft, as TheStreet has pointed out, has done so many things well, including staying out of the sights of regulators despite enormous commercial success. As a result, 2020 may be when we see some backlash. The award of the Pentagon’s “JEDI” project, worth $10 billion over a decade and potentially leading to other big deals, has yet to be peeled like an onion to reveal all the potential ethics concerns it may contain. Microsoft has just put a huge target on its back, and so 2020 will likely be less kind to the company, at least from a PR standpoint.