Friday, August 8, 2014

High Tech "State of the Union", By the Numbers: Q2 2014 - Part 1

Today is Yesterday's Pupil. - Benjamin Franklin, Poor Richard's Almanack 

Back in late April this year I began a series of articles on the financial history of ten High Tech companies. The companies were selected for their leadership in the semiconductor, systems and software sectors of the industry and for their coverage of the markets served by technology offerings - the three C's, ISM, mobile computing and mil/aero. As such, they constitute my benchmark for the relative health of High Tech.

Q2 2014 numbers have now been reported, so it's time to update the dataset and revisit the analysis of these firms.Many industry pundits forecasted this would be a recovery year for High Tech systems and semiconductors, so the Q2 numbers are particularly significant.

Special note: I am not advocating any kind of investment strategy, nor do I own stock in any of these companies. If I get the itch to gamble, I'd rather go to Vegas. ;-)

The Big Iron (

HP is an excellent barometer for the strength of the consumer portion of the computing market because of its printer, desktop & laptop offerings and provides a window into enterprise server demand. IBM's presence in the computing portion of the enterprise segment is the strongest in the world; furthermore, the company's near monopoly control of the Banking, Brokerage and Insurance markets and its position in the eCommerce and Cloud sectors presents a yardstick for the datacenter market and the general state of the global economy. Cisco's position in enterprise networking is akin to that of IBM in datacenters. Together, the three capture the entire Computing market and serve as a thermometer for the health of the corporate sector worldwide.

Here's how the Big Iron is doing, including Q2's numbers:

There is no mistaking the trends for each of these companies and the enterprise market in general. HP's decline is evident in a continuous stretch from Q1 11. IBM is following suit, despite the confusing manifestation of a regular Q4 holiday season spike. We can also conclude that Cisco has joined its Big Iron brethren in a declining trend (both 2014 numbers are lower than the same quarters of the previous two years.)

This paints a grim picture for the enterprise market. There appears to be a long term retrenchment underway, reflecting a paucity of growth in the global economy. This will, of course, be reflected over time down the sourcing chain to the system house's suppliers for chips and software, who will undoubtedly experience declining demand and increasing price pressure.

The Wintel Duopoly (

The shared regency of Intel and Microsoft over High Tech is at this point a relic of the 80's and 90's, with each company having been forced to look to its own affairs under the onslaughts of ARM and Linux. Microsoft has focused most of its diversification efforts on hardware by following up its game console success with newer versions of the XBox and forays into mobile computing thru the Surface tablet line and Windows phone. It has also attempted to keep current with internet trends thru Bing and its Azure cloud service. Intel's forays into mobile computing have been heretofore unsuccessful, leaving it stuck in the soft PC market. 

2014 is a pivotal year for both companies, and with half the year done, the latest quarterly numbers are telling:

Most market analysts love to trounce Microsoft at every turn, unrelentingly depicting everything the company does as a colossal failure. Headlines over the last 2-3 weeks included layoff announcements and condemnations of the company's efforts in mobile computing:

The evidence is starkly conclusive at this point that these analysts are clueless. Drawing a line thru quarters in successive years reveals that with the sole exception of Q3 12, the company has been steadily growing for five years. 

The announced layoff serves two functions: to clear the decks for 25k new employees coming over from the Nokia mobile acquisition (indicating that rather than backing off, Microsoft is doubling down on its cellphone initiative) and to attack the entrenched bureaucracy of the nearly 40 year old company (the severity of which I can personally attest from the point of view of a vendor trying to do business with the company.)

Though Surface has not conquered the tablet sector, the product line has nevertheless been well received in technophile circles. Some critics lambast Windows Phone as not having yet achieved 3% market share, but since Microsoft's publicly announced goal was to reach only a 2.75% share, these criticisms come across as rather stupid.

Financials aside, an objective observer can readily deduce that Microsoft has the nerve to take risks and never gives up. If any High Tech company is going to outperform the rest of the market over the next decade, Microsoft would be a likely candidate.

The Intel story is more muddled. The revenue trend had been slightly downward for the past 3 years, paralleling the deterioration of the PC market (desktops and laptops, excluding tablets.) Yet in Q2, Intel's revenue's curiously popped up, and significantly so. Gross margin grew as well - another surprise. EPS is up, but this datapoint has become largely irrelevant, as so many S&P 500 companies have been borrowing at extremely low rates in order to purchase shares, reinforcing their stock prices and relative earnings per share and protecting executive compensation packages as a result.

How did this happen? It appears Intel is growing its datacenter business. The growth is certainly not from mobile, which appears to be a colossal failure at this point. 
Some analysts attribute it to a re-ignition of growth in the PC sector, though Intel's own numbers and public statements belie that. Perhaps part of the revenue growth in Q2 reflects Intel benefiting from a final aftershock generated by the obsolescence of Windows XP at the tail end of 2013.A decent summary can be found here:

Though Q2 is obviously happy news to Intel's employees, I don't think it can be safely concluded that the company is out of the woods yet. Much depends on an announcement that Intel is rumored to be preparing for the September IDF in San Francisco. If the rumors are true, it will be a shattering announcement. Of course, time will tell.

In next week's installment, we'll go over the remaining five companies in the portfolio.