October has brought an autumn of discontent for tech

By Kevin Kelleher , written on October 29, 2018

From The Earnings Desk

It's been a tough October for tech.

After the mega-cap FAANG gang led the overall market higher for most of 2018, a selloff triggered by rising interest rates and an escalating trade war hit the leaders of tech especially hard.

With two days to go in the month, the Nasdaq Composite has fallen 13%. Apple is down 7%, Facebook down 12%, Alphabet down 15%, Amazon down 23%, and Netflix down 25%.

There are a variety of reasons for the sudden slump. The bull market is approaching its tenth year, elderly by any historical measure, leaving investors half-expecting the music to stop any moment even though, for most of 2018, indexes reached record high after record high. Tech companies cleaning up in their markets were among the market's leaders, giving them an air of invincibility that, we're now seeing, may have gone too far.

Take Amazon. The retail giant's estimated revenue of $232 billion this year is equal to nearly 1% of U.S. GDP. Every move the company makes into a new market like health care or groceries sends stocks in those sectors sliding because, well, Amazon is coming.

But while Amazon blew away profit estimates – net income of $5.75 a share beat forecasts by $2.66 a share – investors were more focused on revenue. This may be what Jeff Bezos gets after 20 years of insisting that net income doesn't matter at Amazon. That message finally seems to have sunk in: Investors saw that Amazon's revenue last quarter was below their estimates. Worse, Amazon indicated revenue this quarter – the all-important holiday quarter – would also be weak, growing about 15%, well below the 22% that Wall Street had been forecasting.

Now, this represents just a quarter or two of lower-than-expected growth, but it gets at what tech investors have been grappling with this month. Amazon, of all tech giants, has been such a reliable growth engine it inspired complacency. Since peaking in early September, Amazon has lost a quarter of its value. Last week, Microsoft (Microsoft!) surpassed Amazon in market value. If those two sentences don't wake Amazon investors from their complacent slumber, what will?

Amazon's is no outlier. Netflix has fallen even further than Amazon in October, despite an earnings report that showed much stronger subscriber growth than most were expecting. But that short-term piece of good news was later outweighed by longer-term concerns, namely those surrounding the rising costs of producing its own content and the growing pile of debt the company is amassing to pay for it.

Those concerns were underscored last week by Netflix's announcement that it would sell another $2 billion in debt, bringing its total amount of long-term debt above $10 billion. On the face of it, the news wasn't itself bad. If interest rates, as expected, keep rising, it makes sense for Netflix to lock in a relatively low rate now. And Moody's indicated it's not worried about Netflix becoming over-leveraged, given subscriber growth in overseas markets.

But the new bond offering also served as a quiet acknowledgment that Netflix knows the clock is ticking on its ambitious project to build a vast library of content. The new dollar-denominated bond will have a 5.875% yield, well up from the 3.625% yield on a bond Netflix issued last year. Netflix is already facing tough competition from Disney's soon-to-launch streaming service and from a similar offering from AT&T based on HBO and other Turner Broadcasting content. If subscriber growth stalls, Netflix's options for spurring new growth will be more limited.

Despite the severity of the tech selloff this past month, the tone among tech investors is one of caution. Not that the sky is falling, but that the FAANG stocks had been flying too high for their own good. But simply recalibrating for the prospect that these companies will no longer to blithely breeze over the same speedbumps that slow down less nimble companies means a something of a reset.

Apple offers a good example here. The company avoided a potential problem after CEO Tim Cook lobbied, wined and dined President Trump to exempt most Apple products from tariffs that Trump was imposing on China goods. On Monday, the Trump administration reportedly threatened new tariffs against all remaining Chinese imports if the coming round of trade talks between the U.S. and China lead nowhere. That news sent stock indexes from the greed into the red, and Apple was hit hard, falling as much as 5% during Monday trading.

Last week's earnings dump had other news to discourage tech investors. Alphabet's revenue also missed estimates, thanks to relative weakness in its hardware and “other bets” moonshots. Snap and Twitter both disappointing user growth (Snap's users fell from last quarter, Twitter's monthly users were below its guidance), but both are doing a decent enough job monetizing the users that cling to their social platforms. Twitter, perhaps the biggest Superfund site on social media right now, emerged as the hero in an otherwise dismal quarter, with its stock up 18% since reporting earnings.

Next up is Facebook, which reports its earning Tuesday. Judging from last quarter's earnings report – which led to a $120 billion lossin market value after signaling slowing user growth – Facebook will be talking to a wary crowd of investors and analysts tomorrow. Analysts are expecting earnings of $1.46 a share (down from $1.59 a share a year ago) and $13.8 billion in revenue (vs. $10.3 billion a year ago). One analyst said "revenue deceleration is inevitable," while another wrote, "Working through Street concerns will take a few quarters.”

Perhaps that sets a low enough bar for Mark Zuckerberg's stiff limbs to jump smoothly over. If so, Facebook could offer some much-needed relief to jittery tech investors. If the selloff that has shaken more than a little loose change out of the market caps of big tech this past month continues, the might FAANG could lose some of their bite.