Earnings season is in full swing, and the market is sending stocks flying every which way on reports. In this week's episode of Industry Focus: Tech, analysts Dylan Lewis and Tim Green go over the very different market reactions to Twitter (NYSE:TWTR) and AMD (NASDAQ:AMD).
Listen in to find out why Twitter's stock soared even though the company reported pretty weak earnings, while AMD's stock fell on what initially appears to be solid results; what exactly AMD does, and why its long-term story doesn't look as healthy as this quarter's results might lead you to believe; why Twitter's mix-up in monthly average user calculations isn't inspiring any new confidence in the company's management; and more.
A full transcript follows the video.
This video was recorded on Oct. 27, 2017.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, Oct. 27, and it's earnings season. We're going to be going through results from a few big tech names. I'm your host, Dylan Lewis, and I'm joined on Skype by fool.com's Tim Green. Tim, how's it going?
Tim Green: It's going pretty well. We got a little bit of snow here in Denver, but it's not too cold yet.
Lewis: Not enough to shut down the roads or anything like that?
Green: No, not even close.
Lewis: I guess it has to be pretty serious over there. But, we tape in the morning, I appreciate you getting up early to prep with me. I know you guys are over on Mountain Time, right?
Green: Yeah. I usually wake up pretty early, so this isn't too big of a deal.
Lewis: Well, I appreciate it. This is actually your first time on IF. Listeners, you may recognize Tim's voice from Pitch week. He actually made the case for IBM. The reason I'm bringing you on the show this week, Tim, is because I wanted to talk about AMD. They had a pretty interesting earnings release, and the market reaction was also kind of head-scratching. We're going to talk about that, we're also going to talk about Twitter results. Let's just dive right into it. AMD, this is a company we haven't spent a ton of time talking about on the show. Tim, do you mind giving listeners a quick rundown on what they do?
Green: Yeah, sure. AMD is kind of like if you took Intel (NASDAQ:INTC) and NVIDIA (NASDAQ:NVDA) and combined them together and made them much smaller. They design CPUs for PCs. They're actually the only company other than Intel that can design the specific type of processors that and Mac OS run on. So, it's a duopoly in that business. They design CPUs for servers, also mostly competing with Intel, and they design graphics processing units for graphics cards, for PC gaming, and increasingly more workload acceleration stuff and data centers and things like that. They compete with NVIDIA in that market. Again, only two competitors there. That's their core business. They are the No. 2 player in all of them. In some of them, they're a very distant No. 2 player. They have pretty much no presence in the server market anymore. They're trying to change that. We'll talk about that a little later. The other part of their business is, they do some semi-custom chip design work. They take their CPU and GPU technology, they build custom chips around that. The biggest business they have is, they design the chips for the PlayStation 4 and the Xbox One game consoles. So, that's a little less than half of their business now. That's pretty much what they do. They don't manufacture chips anymore. They spun that part of their business off in 2009. Unlike Intel, which still manufactures chips as well as designs them, AMD is now just a chip designer a lot like NVIDIA is.
Lewis: This is a company that powers and really provides a lot of juice for a lot of the devices that we know and love. It's been a very good stock to own over the past 12 months. They're up over 70% over the past year. Actually, folks that bought in in early 2016 are up 500%. We look over at this most recent set of results from the company, it seems like they put together a pretty good quarter, Tim.
Green: Yeah. Overall, the numbers were fantastic.
Lewis: So, to dive into that, AMD put up $1.64 billion in revenue for the most recent quarter, which was up 26% year over year, and was actually $130 million higher than what analysts were expecting. You get down to the bottom line, gaap EPS came in at $0.07, non-gaap EPS was at $0.10, handily beating expectations of $0.08 per share. One little surprise for me was seeing gross margins move quite as much as they did. They're up 35% now, which is up 4% year over year. You talked about some of the specific segments, that you wanted to dive into thosea little bit. What else really jumped out to you in the report, then?
Green: AMD has been launching new products pretty much all year. A lot of them are premium products, so, the gross margin being up that much is really just being driven by all of these product launches. The Computing and Graphics segment includes PC CPUs and graphics cards, that was up 74% year over year to $819 million. That's driven by the CPU business. They launched their new CPUs, called Ryzen, this year. They've launched them ranging from super high-end, $1,000 processors, to low-end $100 processors. That's driving part of that growth. They also launched high-end graphics cards. Vega is the name of those. They've launched a couple of those. That's the first time in quite a while that they've been even remotely competitive at the high end of the graphics card market. Both of those are doing pretty well based on these results. One benefit that AMD is getting in its graphics business that they talked about a little bit on the conference call is cryptocurrency mining demand for GPUs. This year, I think most people are at least somewhat aware that cryptocurrency prices, Bitcoin and all the other ones, have gone crazy. It turns out that GPUs are pretty efficient at the computational stuff involved in mining those cryptocurrencies. So, both NVIDIA and AMD are seeing a lot of demand for their graphics cards from that source. AMD didn't provide any estimates for. NVIDIA actually did in their conference call back in August. They put the number at about $150 million for the quarter. AMD is kind of in the same ballpark. A big chunk of their growth in this Computing and Graphics segment is due to this cryptocurrency demand.
Lewis: Tim, if I remember correctly, in the conference call, they talked about how it's possible that that might to taper off a little bit as the year goes on.
Green: Yeah, they said they expect it to level off. I don't know if anyone can really predict what's going to happen with cryptocurrencies at any amount of time in the future. They could collapse tomorrow. I don't know. This same exact thing actually happened back in 2013, there was kind of a mini bubble in cryptocurrencies. Bitcoin was the big one. Litecoin was the alternative one. AMD was actually selling out of their graphics cards because they were being bought up for mining Litecoin. They got this initial surge in revenue, and then eventually it collapsed and they had some trouble in their graphics business after that. So, I don't know if the same kind of dynamic is going to play out. I would expect probably, but I don't know. So, this demand, I don't think it's going to be durable, but it's hard to say.
Lewis: Listeners, I realize we just threw a lot at you there with cryptocurrencies, with Litecoin, a lot of terms that some people might not be familiar with. Fool.com has some pretty good primers on that stuff if you want any information on cryptocurrencies or on Bitcoin specifically. I believe we have some old Financials show, and we also have some great articles. If you want any more information on that, shoot us a note at email@example.com, and we'll be sure to get that over to you. Tim, bringing it back to the market reaction for these results, we talked about how broadly, things look pretty good. They beat expectations, they beat guidance. And yet the stock is down 15% this week. So, it seems like they did pretty much everything right. Good guidance hit, they showed pretty good stuff on the margins, they even revised future guidance up. What exactly happened here with market expectations and what they delivered?
Green: AMD's stock quadrupled last year. As you said, it was up 500% or something since the beginning of 2016. Most of that gain was due to the hope that these new products that they've launched this year would generate revenue growth or profits and return AMD to the glory days of the past. They've lost money every year between 2012 and 2016. It's been a rough ride. But, these new products, the hope was they would bring AMD back to being profitable. The third quarter started to show signs this was happening, these new products are doing that. The problem is, when you have stuff that goes up by 500% on expectations of something happening, and then that thing starts to happen, there's always kind of a discrepancy between the expectations and how it's actually playing out. I think AMD's turnaround was pretty much priced into the stock, and maybe even then some prior to this earnings report. Back in May, AMD gave some long-term guidance in an investor presentation. They said they expected non-GAAP earnings to reach $0.75 per share by 2020. Prior to the earnings report, the stock traded at 19 times that number. So, 19 times what AMD hopes to earn on an adjusted basis three years from now assuming everything goes right. So, I think the expectations are just so high that all these new products are going to drive AMD's revenue and profits higher pretty quickly, so any sign that maybe it's not going quite as fast as people want it to go, that's going to push the stock down.
Lewis: That's one of the dangers of investing in super high-growth stocks, and ones that have very big expectations priced into them. Looking forward for the rest of the year, management expects 2017 annual revenue to beat 2016 numbers by over 20%. Originally, they forecasted for mid-high teens percentage growth. So, revising that guidance up looks good, but as Tim mentioned, there's still a lot of things that need to go right for this business, I think, to even stay where they are, let alone show some serious share price appreciation.
Green: Yeah. They have to exceed the already pretty inflated expectations, which are going to be difficult. A lot of their new products are going to take a while to ramp up. The server business, they launched new server CPUs, Epyc, earlier this year, but it's going to take a while. It depends on server manufacturers building systems around these chips and cloud infrastructure companies building them into their platforms. So, this is something that's going to take probably a couple of years to really play out and start generating a lot of revenue for AMD. I think the stock was pricing in this quick comeback. I think the comeback is going to take a while.
Lewis: And as you mentioned, in a lot of the markets that they participate in, they are not the industry leader. So, when you're competing against the likes of NVIDIA and Intel and you're smaller, particularly in the case of Intel, you're not a market leader, you're not able to plow as much into R&D, and you're not seen as the standard-bearer for what should be going on there, so that also forces them into a little bit of an uphill battle.
Green: Yeah. And they're very far behind in some of these markets. The server market, their market share rounds down to zero at this point. And the PC market is pretty low, especially in laptops. And the graphics market, they've recovered a bit, they launched a mainstream graphics card last year, but it's still not all that high, and they have very little presence in the high end. So, they have a lot of work to do to get back into a strong No. 2 position.
Lewis: Tim, now we're talking about a company that a lot of people are familiar with, won't need to give as much background on Twitter. The social media company reported earlier this week. Revenue for the quarter was $590 million, which was down 4% year over year. It may seem disappointing, but it actually beat expectations. Non-gaap EPS came in at $0.10, beating expectations as well. The market seems thrilled. Shares are up over 15% since the company reported. Man, we've spent so much time on Industry Focus talking about Twitter, I can't help but do it every single time they post earnings results, because there's so much talk about this being a turnaround stock. Why don't we talk a little bit about one of the main drivers for this business, their monthly active users, and what's going on there?
Green: They managed to grow monthly active users by 4% year over year up to 330 million. It's been kind of flat-ish for a couple of quarters, so a little bit of growth is nice to see.
Lewis: I think when we see this market reaction here, for as uninspiring as some of the revenue and income numbers might be, particularly because revenue is down year over year, you see the user growth, and that's what a lot of people are pegging to, this idea that it's still a relevant platform that's growing.
Green: Yeah. It's certainly not growing as fast as most of the other high-profile social media networks, but any growth is good growth, especially when revenue is still falling.
Lewis: I think "any growth is good growth" is the credo that Twitter investors have been holding onto for quite some time. One thing that's worth noting, we talked about their monthly active user numbers, in addition to the update that we got on their financial numbers, management separately disclosed that they had been making a mistake and how they had been calculating monthly active users. So, they had been including users of certain third-party applications in their monthly active user calculation. The issue was related to Digits, software development kit that Twitter had recently divested from. The company has recognized this mistake. They've been transparent in talking about exactly the impact it has. They restated their MAU going back to Q4 of 2016. But, they are not able to reconcile the numbers any further back due to the company's data retention policies. Looking at the actual numbers here, this is not a huge restatement, but it's the kind of thing that shakes my confidence in the team that's managing here, because there have been so many other things that have gone wrong, it's just another frustrating little thing where you're like, this is a core business metric that you guys should have locked down. There shouldn't be any uncertainty about your MAUs.
Green: Yeah. It's a little surprising. One other thing that's related to this, Twitter reports how much their daily active users changes. They reported it was up 14% this quarter. What they don't report is the actual number of daily active users, which is kind of a bizarre thing to do. Whenever I see a company not reporting a number that's one of the most important numbers they should be reporting, it makes me think management doesn't want you to know what it is because it's not particularly impressive. I think that's more concerning than this restatement, even.
Lewis: Yeah. And I believe this is something that the SEC has given them some notes about. And it's weird for a company to say, "Daily actives as a percentage of monthly actives is a great proxy for engagement, and we see daily active says the people who are most valuable to our platform," and then not give people the number for daily actives. It's the kind of thing that has you scratching your head a little bit. This is something that Evan Niu has touched on before, and I think he's actually written a couple of articles. Fools, if you want any of that, right into the show, I'll shoot them along. Like I mentioned, we've been following this Twitter turnaround narrative for a while now on Industry Focus. You look back to where they were before they reported their Q2 results, the stock is more or less flat. They've gone through some peaks and valleys since then, but this most recent report gets them back there. But when I look at this report, I'm still seeing a business that's struggling. We talked about how the top line was down 4% year over year. They're showing MAU growth. The big thing that I don't think enough people are talking about with Twitter is, despite the MAU growth and despite the huge growth in the number of ad engagements, the company still posts year-over-year revenue declines because the CPEs, their cost per engagements, continue to freefall. So, if you're a digital ad business, you basically make money by showing people more ads, or charging more for the ads that you're showing. In the case of Twitter, CPEs, what they're charging for people to be able to throw on these ads, it's been falling for the last nine quarters. This most recent quarter, it was down 54%, and that was on the back of a 44% decline in the same quarter a year ago. I think this is something that people need to be paying attention to a little bit more, Tim.
Green: Yeah. They're going to run up against the limit of how many ads they can stuff into people's feeds, with user growth as slow as it is. If these prices keep falling, it's going to be a pretty big problem for revenue.
Lewis: And on a certain level, I think if you're in the digital media world, this is a bit of a proxy for interest. If you're a digital advertiser, if you're interested in advertising on Twitter, you're going to be willing to pay for it. So, the fact that advertisers, they say, are flocking to the platform, they've been getting good numbers, but they haven't been able to find the bottom for CPEs, that's concerning to me. Something that is also concerning to me is, analysts asked management about CPEs, and when they might stabilize, in the conference call, and CFO Anthony Noto gave this response. "We think about CPEs in context of yield, so, effective CPM," which is cost per thousand. "An effective CPM is nothing more than a product of CTR, clickthrough rate, times CPE, cost per engagement. Our effective CPM has been relatively stable the last three quarters, and we think it will remain stable, all else equal in a competitive environment. And that's how we think about CPE in the context of yield on the platform, and we're glad that it's reached a stability point because that will allow us to drive incremental demand." That's a mouthful of an answer that doesn't really even answer the question, because CPEs haven't stabilized, and I don't know when they will. We've seen some periods where the declines haven't been as dramatic. But management is fixated on this CPM, which they say is stabilized. For CPM to have stabilized, that means they're getting more clicks, but the CPEs are still falling. Again, it's management obfuscating a little bit in a way that's super frustrating if you're trying to get down to the nuts and bolts of what's going on with this business.
Green: Yeah. I think this is an example of them picking the number that looks the best and trying to focus on that, which Twitter does sometimes. They always also emphasize their adjusted EBITDA, earnings before interest, taxes, depreciation and amortization. That's always one of the first things they talk about in their earnings release. Which is a nonsense number for the most part. So, this is kind of par for the course for Twitter.
Lewis: And it's frustrating, because as an analyst or someone looking at stocks, you want to try to get to the bottom of what's actually going on. And management here is making it a little difficult. This is all to say, while the market seems pretty enthusiastic with Twitter's results, there are a lot of things with this business that I still haven't seen going in the right direction, CPEs being one of the big ones. But I personally don't love management's transparency, and I still feel like they need to be disclosing some more of these metrics so that we can get a better sense of what's going on with their business.
Green: Yeah. I don't have anything to add to that. Sure.
Lewis: [laughs] I didn't think you were going to disagree with me on that one, Tim.
Green: [laughs] No.
Lewis: We threw a ton of stuff out there. Like I said, folks, if you have any other questions on stuff that we hit on today's show, just write in to firstname.lastname@example.org, and we'll shoot them over. Tim, anything else before I let you go?
Green: I will say, one good thing about Twitter is they managed to really slash their costs in the third quarter. That's one thing that's moving in the right direction. But it doesn't really matter much if revenue is moving in the opposite direction.
Lewis: On that note, I'll say their data licensing business is up 20% year over year. So, that's going well, too. We need to give them a couple of gold stars here and there. But, it doesn't sound like either of us are touching this company any time soon.
Lewis: [laughs] Well, thanks for hopping on, Tim!
Green: Thank you for having me!
Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say hey, you can shoot us an email at email@example.com, or you can tweet us @MFIndustryFocus. Also, if you're interested in coming by HQ, maybe checking out a taping of the show, shoot us a note there, too. Today, we actually have a live studio audience. Thanks to Patrick and Francie for visiting HQ and coming by and checking out the show. If you're looking for more of our stuff, subscribe on iTunes or check out The Fool's family of shows over at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks, as always, to Austin Morgan for all his work behind the glass. He grins at me as I'm saying that. For Tim Green, I'm Dylan Lewis. Thanks for listening and Fool on!
Dylan Lewis has no position in any of the stocks mentioned. Timothy Green owns shares of IBM. The Motley Fool owns shares of and recommends NVIDIA and Twitter. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.