Following earnings, several big name tech stocks took a beating.
Pandora (NYSE:P) posted lackluster user metrics in its earnings report -- are these disappointing numbers here to stay, or are they the result of free trials from competitors? Next, we take a look at FireEye (NASDAQ:FEYE) and examine whether or not the story has changed for the cybersecurity company. Finally, we discuss the recent Hewlett-Packard split into HP (NYSE:HPQ) and Hewlett-Packard Enterprise (NYSE:HPE) and determine whether the split has helped or hurt the respective businesses.
A full transcript follows the video.
Sean O'Reilly: We're talking beat up tech stocks on this technology edition of Industry Focus. Greetings Fools, I am Sean O'Reilly joining you here from Fool HQ in Alexandria Virginia. It is Friday, November 13. Watch out where you walk, Dylan. And joining me to talk about earnings devastation in the tech sector is the one and only, Dylan Lewis. How's it going man?
Lewis: Pretty good, pretty good. I think this is kind of like the give me your tired, your poor, your huddled tech stocks.
O'Reilly: Oh God.
Lewis: Like the Great Colossus episode.
O'Reilly: They should build a mini statue of liberty and put it in Silicon Valley for these guys and then they'll just acquire them. Anyway. So we're talking about three tech stocks. You did the research on two of them, I did the research on one of them. Do you want to rock, paper, scissors for who goes first?
O'Reilly: Alright ready? Rock, paper, scissors, shoot.
Lewis: Oh I lost. Alright. So I guess it's my turn.
O'Reilly: It is, yes.
Lewis: I'm surprised you threw scissors.
O'Reilly: I don't know what to tell you.
Lewis: I'm a rock guy.
O'Reilly: I'll remember that.
Lewis: Yeah we'll have to do the number game next time.
O'Reilly: Oh yeah.
Lewis: Where it's like odds or evens.
Lewis: Because otherwise I'm going to start gaming it too much [...]
O'Reilly: I love the game theory that goes into rock, paper, scissors because it's like oh will they keep doing it or will they change it up? What's the changing up going to mean? Love it.
Lewis: It's one of the few childhood games that persists as an adult and it actually works. Like Tic-Tac-Toe sucks as an adult.
O'Reilly: It's cats all the time. Anyway.
O'Reilly: So the first company we're talking about is Pandora. I know you have an attachment for this company. My son does. He actually knows how to go pull up Pandora on our phone and play nursery rhymes.
O'Reilly: Which is endlessly scary. But anyway.
Lewis: I always forget about how deep their catalog is. It's from the, beyond standard pop rock music. The standup comedy channels that they have, some of the kid's stuff that they have. It's kind of surprising.
O'Reilly: Mary Poppins, ABC's, Barney.
Lewis: The things you forget about when you don't have children.
O'Reilly: Yeah. So the benefits of the product aside they're having a rough time making money. Tell us a little bit about that.
So basically with them earnings happened, right? That's what happened, that's what caused all this devastation. So the company reported in late October over the last three months they'd reach peaks of $22 bucks a share, they're down around $13 right now.
O'Reilly: When we last talked about them, where was it? I mean the number 25 pops in my head but I feel like that's wrong.
Lewis: No it was a little lower than that, and when we did our check in post-acquisition of Ticketfly. I think that was about a month ago and they were in the high teens, maybe low 20s around then. Basically in their quarterly report, we look at some of the main metrics for their business and they were a little disappointing. So listening hours and active listeners. Those are kind of your two money metrics to look at for an ad-based business. So listening hours were up just 3% year over year and down 3% sequentially.
O'Reilly: This is 2015, we're all supposed to be moving to the cloud and online and stuff, CDs are supposed to be dead, those are really low. That's not what you want.
Lewis: Not what you want. And active listeners up 2% year over year, so they reached 78 million but down 2% sequentially. So again like you're seeing some growth year over year, but you're not seeing it sustained over the calendar year, which is kind of frustrating.
O'Reilly: Do you feel like, and you might have some thoughts on this later, but have they reached the saturation point? Because $78 million, 78 million listeners is a respectable number. But I mean is it, they got everybody, and now they just need to wait 10 more years for more people, or what?
Lewis: I think that's the market concern right now. So you look in ad-based business, the ways to make more money are to grow your listener base or have your listener base on there longer. Those are the multiples in that equation. And so if you see them starting to plateau then you need to see them also becoming profitable.
The people that invest in tech have an appetite for losses so long as it's coming with nice growth that can eventually be monetized well. And I think people are worried that we're hitting saturation on the service, but the monetization plan isn't clear yet and it could be even more cloudy in a month or so when the new ruling comes out on their royalty rates.
O'Reilly: Right and that of course still remains to be seen. Revenues were up a bunch but for funny reasons.
Lewis: Yeah so they were up 30% year over year. They hit $311 million in revenue which was pretty solid.
O'Reilly: For a quarter, yeah.
Lewis: But losses widened. They get crushed with legal settlements about some song royalties that dated prior to 1972 I think. So it's a sign that it's just been tagging them along for a little while.
O'Reilly: Michael Jackson's estate, owner of the Beatles album suing them?
Lewis: So they wound up with a charge of, I think it was $85 or $90 million.
O'Reilly: If that hadn't been there, would it have been a decent quarter?
Lewis: It would've been alright. I think they would've been just about breakeven.
O'Reilly: Okay so it is still highly depressing.
Lewis: But yeah, I mean it was a big charge for them to take and obviously the market was not happy to see the losses widen but I think it's really more of an issue of the core metrics for the business of active listeners and listening hours.
O'Reilly: Got it, OK. So are people willing, how much more rope does Pandora have with Wall Street?
Lewis: Yeah, I think there are some silver linings here. So full disclosure I'm a shareholder and I am definitely...
O'Reilly: Plugging your portfolio, Lewis.
Lewis: Well I think it's important to note and I'll say it's, I'm a little frustrated because I was watching the climb recently, and you saw over the last couple months, like I said they hit that peak in the low 20s. And a lot of that was due to the market thinking that they would have a very favorable ruling with the new royalty agreement that would be reached.
O'Reilly: Because was it a lower court or what was it that they got the hint of a better ruling?
Lewis: It was basically that an agreement that they reached with an independent label was decided that it could be a reasonable benchmark for larger negotiations. And so that was obviously something that worked very well for their cost structure and the market was happy about it.
So we had this climb over the past couple months because of that and you know, it's not that the business outlook changed at all. The streaming space was still becoming more crowded and so I think I'm personally a little frustrated that I didn't see that and have a little more hindsight. I think it might have been a good time to get out. But I have to say I really do like the Ticketfly acquisition.
O'Reilly: That was my other question. So you're still happy about that because from what I remember about it, it still sounds like a really good idea.
Lewis: Yeah when we did the show a little while back I was super bullish on that. I think it's one that integrates extremely well into the platform as is, and I think as a stand-alone business it's pretty solid. You know, to have someone like that under your umbrella is great. It's like I think the concert business is like a $6 billion business right now. Right now it's being dominated by Live Nation or Ticketmaster.
O'Reilly: Well it seemed like a win-win for everybody because of memory serves, Live Nation and just Ticketmaster and everybody, they do Taylor Swift tickets. They'll be better for the second tier like the, I don't want to name names, but people that aren't Taylor Swift.
Lewis: Well no, so I mean I went to a show last night in DC at Black Cat which is like maybe a 150-person venue and Ticketfly sold the tickets. They are the mid-market ticket seller and they're perfect for people like that. And I think it's a largely underserved market right now.
O'Reilly: Did you find the band on Pandora?
Lewis: I did not. I think NPR got me over to the band.
O'Reilly: Oh God. I would not have guessed that by the way.
Lewis: I'm an NPR listener. What can I say?
O'Reilly: You Bostonists.
Lewis: So I think Ticketfly is definitely a big catalyst for them and it's something that, I have a small position with them so I think I'm going to hold it and see what happens. Because I like what's going on there and there's the possibility -- I was talking with Vince, our CG analyst a little bit earlier -- I said, "There's the possibly this is kind of like an eBay / PayPal type thing where it's like they wind up with this better business under their umbrella at some point. That might become the more viable option.
O'Reilly: Then you'll have to spin it off.
Lewis: Right. I mean it remains to be seen. That's a little bit of speculation here. But the other thing that I think investors want to keep in mind is, so these were rough numbers and you know it's kind of surprising to see numbers sequentially dip. Like even in the some of the struggling social media companies.
Even if year-over-year growth isn't fantastic, you'll at least see 1% or 2% climbs sequentially. And so something to keep in mind is that Apple Music introduced its product at the end of June. And that was a free trial product, right?
O'Reilly: When does the trial end, Dylan?
Lewis: So after three months you look at the period that Pandora's reporting for, a good portion of that was while Apple was running it's free trial.
O'Reilly: So they held their own when a major competitor ramped up.
Lewis: Yeah. That is if you're trying to defend these poor business metrics right now. And I think in the coming quarters now that most people will be off of that free trial, we'll be able to see whether this is a momentary dip influenced by that, or if the competitive pressure from Spotify, Apple Music, etcetera, is too difficult to overcome.
I happen to think there will be a decent number of defectors from Apple Music. I remember seeing a stat that 61% of people that had Apple Music had turned off the auto-enroll option so they wouldn't be rebilled once the trial ended. So I don't know that Apple Music is going to be as sticky as people think.
But again, I think if you're looking for something to be happy about with Pandora still, it's Ticketfly. It's not quite the core business right now.
O'Reilly: Cool. So since you beat me at rock, paper, scissors, you get to talk about your other company before I get to talk about mine. Who are we talking about next?
Lewis: We are going to talk about FireEye.
O'Reilly: Oh gosh. How did I know you would do this?
Lewis: Another Dylan Lewis holding.
O'Reilly: Now full disclosure you own it. A lot of people in this building like it, they have the, this is the best bullish. I'll just preface this. They've got the only certification for the federal government of the United States for something.
Lewis: Yeah, I can give you the specifics if you want.
O'Reilly: Yeah let's do that.
Lewis: So the U.S. Department of Homeland Security has certified FireEye's multi-vector virtual execution engine and dynamic threat intelligence cloud platform under the Safety Act.
O'Reilly: I will give you $20 to say that again 5 times fast.
Lewis: Oh God I couldn't.
O'Reilly: You nailed that by the way.
Lewis: Yeah, right? I was shocked because I remember we actually, this is rehashing what we talked about a couple podcasts ago and I stumbled all over that sentence.
O'Reilly: Butchered it.
Lewis: Yeah, it was brutal. So they are currently the only company that enjoys that certification. So that's fantastic.
O'Reilly: That was pretty cool.
Lewis: And basically what it does is it protects customers of FireEye against allegations of technological negligence when it comes to acts of cyber terrorism. So it's basically protecting them against any lawsuit liability I kind of think.
O'Reilly: So Dylan, if Uncle Sam loves them so much why is their stock down so much?
Lewis: Yeah again tied to earnings. That's going to be the theme I think throughout this show. In their case I think it came down a little bit more to them being overly ambitious when they provided guidance last quarter. And maybe not realizing that they were going up against some pre-tough comps from before.
O'Reilly: Are they newbies to playing the Wall Street earnings projection game?
Lewis: No, they've been around for a little bit. I think it's, like I said, it's just maybe getting caught up a little bit in not realizing that the previous year's quarter was absolutely stellar and they landed a very large contract that I think influenced their results pretty heavily.
So basically one quarter ago they talked about their guidance for this quarter and they said that for eight consecutive quarters they've raised their quarterly billings guidance, which was one of the main metrics they use. And basically looking to continue that they issued guidance of $225 million to $230 million, and they wound up delivering billings of $211 million. So there's that dip there.
O'Reilly: And it was that 5%? Yeah, it is what it is.
Lewis: But you know Wall Street always anchors to those. And of course, and this is again a company that I think has been struggling a little bit. You look at their chart from mid-summer or so and it's been a pretty precipitous fall. And a lot of the things that were specific to this most recent drop off, the management cited weakness in Europe, there were some shorter contract lengths, lower average deals with some of their large enterprise customers, and so on service level I think that looks bad.
But again I think this kind of goes back to what they were looking at from the previous year quarter. A year ago they signed a five-year eight-digit contract with a federal agency. And so that's huge particularly when you're looking at billings in the $200 million range. That's something that will heavily influence your quarterly results and will kind of throw things off.
O'Reilly: That's so surprising to me because just given the world we live in and J.P. Morgan Chase just had a data breach, I would just think the people would just be throwing money at this sort of thing. I mean, is the bull case still intact?
Lewis: I think so. I'm still pretty bullish on it. And again I own it and a lot of Fools like it. So, take it with a grain of salt. But I think with this the story is still intact, right? What we're talking about with this company is cyber-security experts. And we're looking at the macro trend of some of these huge data breaches costing major corporations hundreds of millions of dollars in actual money and in lost brand equity basically, right?
And so they're the best in the biz when it comes to this stuff. And I think it's something that's only going to become a larger problem. So I think they're extremely well-positioned and I think that story's still intact. One of things that I really like is that they're transitioning from a product revenue to a subscription revenue model. So once they have people that are customers, they're getting this recurring revenue which is obviously fantastic. And I think it offers a lot of stability.
So that's something to watch. One metric that I think is really great and just kind of is a testament to how good they are in their space, their customer renewal rates are 90%.
Lewis: Which is fantastic.
O'Reilly: Real quick before we move on, what about that lovely negative, negative, negative free cash flow number?
Lewis: Yeah, they're turning that around a little bit. I think it was like through the first nine months of last year, they were like cash flow negative to the tune of negative hundred and maybe $130 million.
O'Reilly: I mean, I assume that was capex. I mean it was just a massive investments.
Lewis: Yeah I have to dig into the numbers to be sure. But, and they are cash flow positive for the first nine months. So you're seeing that turnaround. There's a lot of things to be happy about.
Obviously this is not a stock for everybody. You need to have a decent risk tolerance to be in this and it's a small position for me. It's something that I think is a great space to be into. It's something that's going to become a larger issue and they're well-positioned for that. But again, make sure that it's something that matches what you're looking for in your investments before you dive into it.
O'Reilly: Cool. Before we move on I wanted to point our listeners to the newly redesigned Focus.Fool.com. There you'll discover a special offer to join the Motley Fool Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out $129 for a full two-year subscription. Just go to Focus.Fool.com to take advantage of this offer. Once again that is Focus.Fool.com.
Lewis: So we're going to mix it up a little bit in the second half of the show. I know usually Sean hosts and I wind up providing the answers. But do you want to get up and actually switch chairs?
O'Reilly: Yeah, I'm down.
Lewis: Should we do it?
O'Reilly: This is going to confuse everybody.
Lewis: Yeah, Austin probably hates us because we might have just messed up the video shot.
O'Reilly: If only I could do something with my hair.
Lewis: We'll make it work. Do we look centered? Are we good? Sure, yeah. Alright. We're going to roll with it anyways.
O'Reilly: Ladies and gentlemen, the audience.
Lewis: This is what happens when you adlib.
O'Reilly: Austin's giving us a really dirty eye.
Lewis: So now sitting in the host chair, I think we can get on to the second half the show. We're talking about beat up tech stocks. There's one, it's been in this space for awhile.
O'Reilly: There's one that just comes to mind whenever I say beat up tech stock.
Lewis: We can talk about some of the, maybe the older tech companies like the large giant in this space. We're talking about Hewlett-Packard of course. And so when we're talking about them, this is not Hewlett-Packard of old. These are basically two separately run companies.
O'Reilly: Yeah and actually we would not have been able to say that just 30 days ago. The board approved the split of Hewlett-Packard into Hewlett-Packard and Hewlett-Packard Enterprise on October 1st. The split took place in October, here we are on November 13th and they've been publicly traded companies for less than, I don't know, three, four weeks each.
It's not been so hot. This is the one company where it's, they're beat up because of earnings, but not the specific quarter. Basically they split into two companies, and HP kept the PCs and the printer business -- that's a fast-growing industry right there -- and Enterprise. And both of them had terrible results last quarter.
So I dove into the last quarter's results when it was still part of the original HP, and I just wanted to see what each new company would be doing. So for HP, in my notes here I have aging dinosaur. I'm being particularly cruel there and I'm sorry to any of our HP employee listeners. PC sales fell in the second quarter 13% year over year to $7.5 billion, not great. That includes desktops and workstations, printer sales which was for years HP's bread-and-butter.
I mean that's the one business where you know you're going to get a quality printer; those fell 9% year over year to $5.1 billion, and that's just because we're all switching to digital photos and documents online. So let me ask you, when was the last time you printed out a photo, Dylan?
Lewis: Oh a photo? No, the only things I print out now are quarterly calls and that's so I can read them on the metro.
O'Reilly: I have a 21-month-old son. I mean we do it every 3 to 6 months for the annual photo shoots or whatever, and that's definitely going to dissipate as he ages. And then you shift to year to year. I mean my son's life is on Amazon Cloud.
I'm an AWS, my son's whole life is on AWS. This is not good. The other business which I'm slightly more bullish on, but even they didn't have great results before the split, HP Enterprise. I termed them the minnow in the ocean because they're their own company and they can focus more on R&D spending, they can really focus on the customers and they don't have to worry about the PCs and the servers and everything. Not the servers, the printers.
They get to compete now with the coming juggernaut that is Dell/EMC, yay. They get to wake up every morning and get to compete with them.
Lewis: Yeah it's going to be tough.
O'Reilly: Microsoft, Oracle, IBM, they're not slouches in this space either. I mean this is not going to be pleasant. So last quarter before the split, HP's Enterprise services revenue fell 11% year over year to just under $5 billion. IT hardware revenue inched up 2% because just better demand for a couple of their servers which is, full disclosure, I know nothing about servers. But the note said that it was their x86 servers.
So that revenue is $7 billion. Both companies are free cash flow positive and they kind of know where they're at. They know full well that they need to just return cash to shareholders because they probably can't compete with Dell/EMC or Oracle, or Microsoft or something. So both companies have committed to returning 50% to 75% of free cash flow back to shareholders every year in dividends and buybacks.
Lewis: Wow, that's a very shareholder-friendly policy.
O'Reilly: It is, but Wall Street doesn't care. I say that because both companies ... so whenever you do a spinoff, or a split or an acquisition or whatever, you need to tell investors what you think you're going to earn the next year. Both companies are trading post-split for about 8 times forward earnings from what they're expected to earn this year.
Lewis: That's not much.
O'Reilly: That is not a tech stock. That's not even a tobacco stock. That's like, "We don't think you're going to grow and in fact we think you're going to shrink a little bit" evaluation.
Lewis: Yeah, that's crazy. So something that you see most of the time with spinoffs or with people kind of being smart about restructuring is they do it to kind of silo struggling business, right? It sounds to me like we have two silos of struggling businesses.
O'Reilly: It's the minnow in the ocean versus the aging dinosaur. If you had to pick one, the minnow could theoretically eat some plankton and then eat another small fish, and then actually grow. And if I had to pick one of these companies to bet on, I would pick Enterprise because they at least have a shot.
Lewis: You went really deep into that metaphor.
O'Reilly: Yeah, I mean you know. I did that on the spot too.
Lewis: That was good. So the Enterprise one is the one to watch.
O'Reilly: Yeah. Wall Street is modestly bullish. The few analysts that have taken a deep dive into this is, I don't want to call it speculative, but nobody really knows what's going to happen in this because all of these companies are black boxes. Do you know what the heck an Enterprise company?
O'Reilly: Do you know what mean? The analysts that have a decent amount of experience, I did see one note from Barclays. They think that earnings at the Enterprise segment will grow forward as far out as they can project which is about three years. They think they can grow earnings over the next three years, so that's at least modestly bullish. But minnow in the ocean versus aging dinosaur.
Lewis: Yeah, neither of those are great prospects but, well thank you for your time, Sean.
O'Reilly: You bet. And that is it for us, folks. If you are a loyal listener and have questions or comments we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again that was IndustryFocus@Fool.com.
As always people on this program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening and Fool On!
Dylan Lewis owns shares of Pandora and FireEye. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com, eBay, FireEye, Pandora Media, and PayPal Holdings. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.