Tech is one of the market sectors that has experienced a major repricing in 2022. Anurag Rana, Bloomberg’s senior analyst for the software and IT services spaces, has been observing companies, such as Apple and Adobe, and sees a lot of change happening in the industry. He joins the ETF Think Tank to discuss the tech sector and some of its biggest names.
The discussion begins with Apple in light of the reports that demand for the iPhone 14 is weak. Even though 53% of the company’s revenue comes from the iPhone, Rana sees Apple as having a very stable business model. In his view, people buy new units every 1-3 years, so you have to think of Apple’s business model as a subscription service. The product is just devices instead of information. The business could fluctuate in a recessionary environment, but if Apple can deliver 2-3% revenue growth and 8% earnings growth, that would be solid. Rana notes that the App Store has fueled growth on the services, but there will come a time where this finally stops and long-term growth rates decline to the high single digits.
One of the reasons Rana is positive on Apple is the stickiness of the customer relationship. Once you get used to an Apple product, you are not going to switch. You may delay upgrading to the newest version of a product, but you won’t change. Apple can continue to grow in the 5-10% range based on what they are selling, but it does improve their entire ecosystem. When you upgrade to the latest iPhone, perhaps you upgrade Apple Care or increase cloud storage or get a new pair of AirPods. This relationship helps create more stable free cash flow looking forward.
Is Apple going to build a car? Rana thinks so but has no idea what it will look like. The key question will be what the price point is. He thinks that the company will either build something for mass adoption or something more expensive. Overall, Rana does not think the move makes a lot of sense. If you have a services business with 70% gross margins, why would Apple want to get into a space where Tesla has a 20% gross margin and Ford has 12%? Can the company build a sub-$60,000 car with a 50% gross margin? Rana doesn’t think so, but they may be able to get there with a high end $200,000 car. The question is can you sell enough units to make it worthwhile. Rana would prefer the company spend money developing new shows, acquire NFL rights or something like that.
The next company Rana was asked about was Adobe. While he’s been a fan of the company for a while, he has some questions about some of their recent moves. The acquisition of Figma, he says, looks like a desperation move. To pay $20 billion for an asset that was worth $10 billion at its peak in June proves that they read the market wrong. Their bread and butter is PhotoShop and PDF. You don’t get away from that. Antitrust regulators could have a field day with this because it looks as if they are trying to take out a competitor. It could also be a reflection of their lack of confidence in cash flows. Adobe’s days of growth are long gone.
Other key takeaways:
- Is buying Activision a good strategy for Microsoft? If it closes, it will be a good deal because then they will become the biggest player in the gaming space. Cloud gaming should eventually work and if you can offer a good product on a subscription basis, it can be very good for the business model.
- Does Rana have a favorite in blockchain? It would probably be one of the services companies because they are the ones that are implementing it. Seeing what Accenture, IBM, and InfoSys are doing is probably a good starting point.
- Shopify is a fun story. The problem with all of the pandemic stocks is the massive pull-forward in demand. Now, they are kind of stuck. It could begin to look better sometime in 2023, but what is the long-term growth rate and how do they start taking market share?
- The only thing that matters now in terms of stock valuation is inflation because that will determine the discount rate. If inflation has come down a year from now and the yield on the 10-year is still 3.8%, Rana believes tech stocks could go way up. He expects growth rates to come down over the next 12 months, but if inflation comes down, the following 12 months could see a big rebound.
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