Internet
Market analysis
For the full-year 2012, US retail e-commerce sales reached US$186.2bn, an increase of 15%—the strongest annual growth rate since before the recession. 4Q12 sales grew 14% YoY to US$56.8bn, marking the first ever US$50bn quarter. It also represents the thirteenth consecutive quarter of positive YoY growth and the ninth consecutive quarter of double-digit growth.1
Worldwide mobile advertising revenue is forecast to reach US$11.4bn in 2013, up from US$9.6bn in 2012. Worldwide revenue will reach US$24.5bn in 2016, with mobile advertising revenue creating new opportunities for app developers, ad networks, mobile platform providers, specialty agencies and even communications service providers in certain regions.2
Amazon posted strong 4Q12 results, with upside in gross profit and consolidated segment operating income (CSOI) driven by the continued shift to third-party (i.e., other vendors’ products which are sold on Amazon’s site), strong AWS growth and improving leverage in shipping losses. These results suggest that Amazon is beginning to yield bottom-line returns on its heavy investments of the last couple of years, and the CSOI margin trajectory may now be in the early stages of moving higher.3
Amazon’s annual performance was average and despite a growth in revenue, the company reported an overall loss in 2012. However, the outlook seems positive, with the increasing growth of the eBooks category and the ever-growing popularity of Kindle. Amazon’s digital media library grew to 23mn movies, TV shows, songs, apps, games, etc. in 2012, and it launched Kindle stores for Brazil, Canada, China and Japan.
eBay posted solid fourth quarter results with accelerating growth across many key metrics including Marketplaces and PayPal users, US ex-vehicles GMV, Payments Merchant Services and overall organic revenue and EPS. However, results overall were mostly in-line with expectations and the outlook for 1Q13 and the full year 2013 came in a bit below consensus expectations.3
eBay aims to benefit from a web-enabled multichannel commerce environment which is evolving quickly. The company continues to be a mobile commerce and payments leader. eBay Mobile finished the year with US$13bn in payment volume—more than double the prior year—and PayPal Mobile handled almost US$14bn in payment volume, more than triple the prior year.
Google reported stronger than expected revenue and EBITDA in 4Q12 for its core business. On the positive front, international revenues increased 36.7% YoY, driven by strength in the UK and Northern Europe, offsetting continued weakness in Southern Europe. On the other hand, US revenue growth decelerated YoY, largely a result of self-inflicted policy changes. Additionally, Motorola Mobility continues to create noise around financial results, with negative margins, charges and the discontinued Home business.4
Google crossed US$50bn in revenues in 2012 and continues to grow in profitability despite admitting that its Nexus supply was constrained, resulting in lower than expected device sales and higher core margins. Analysts see margin deterioration as a factor in 2013, assuming stronger device sales.5
In December 2012, Google entered into an agreement with Arris Group, Inc. and certain other persons to dispose of the Motorola Home business for a total consideration of approximately US$2.35bn in cash and stock, subject to certain adjustments. The transaction is expected to close in 2013.
LinkedIn reported another strong quarter with all the three business segments performing materially better than optimistic expectations. Starting in July, LinkedIn redesigned the homepage and company pages, introduced notifications and endorsements as well as the launch of Influencer, and added five more languages for a total 19. Management attributes the strong performance of online sales directly to the new product launches, which drove deeper engagement.6
Analysts believe that LinkedIn’s business has many positive growth opportunities this year, and expect initial 2013 guidance will likely prove conservative. On the top line, LinkedIn has incremental user engagement exiting 2012 driving the Marketing segment (and likely new member products to come), continued scaling of the international and sales solution businesses, new newsfeed-oriented ad products (including on mobile) and a modest price increase for the Recruiter business. On margins, LinkedIn will benefit from international sales force investments made in 2012, generating more revenue and positive margin mix shift from growth in Ads/Subscriptions. LinkedIn will clearly continue to invest this year (facilities, field sales, a new data center), but, if execution continues, margin expansion will exceed 2012 levels.7
Netflix delivered a strong quarter with US domestic streaming subscribers (excluding DVD subscriptions) up 2.05 million to 27.15 ,million, just above the top of guidance range of 26.5-27.1 million, and EPS of US$0.13. Management guided to 1.75 million US streaming subscriber additions for Q1, highlighted a hold on its international expansion plans and also announced that it is looking at buying the exclusive rights to Sony film studio content, as it has done for Disney. However, analysts are skeptical about Netflix’s ability to drive subscriber growth to sustainably keep revenue ahead of content cost increases, and how Netflix can manage other operating costs like marketing and tech/development as well as it did in 4Q12. Additionally, Amazon and Redbox will provide more competitive pressure over time and any hopes of M&A look even less likely now.8
Growth of domestic streaming subscribers for Netflix in 4Q12 and in the 1Q13 outlook suggests that Netflix can deliver a comparable number of net additions in 2013 as in 2012—around 5.5 million. The combination of secular tailwinds, an improving service and expanding content suggest that Netflix can break through the approximate 30 million subscriber level of HBO in 2013.3
Yahoo!'s 4Q12 results and outlook were mixed overall, but given low expectations for the core business and a much heavier buyback pace than expected, analysts believe Yahoo! shares are likely to respond favorably in the near-term. Better than expected Search revenue offset Display declines, and Yahoo! showed that it is focused on cost controls even while continuing to invest in the business. Overall, analysts are positive on Search margins and capital returns to shareholders, but still uncertain that Yahoo! will become even a modest growth company going forward. Alibaba Group and Yahoo Japan provide substantial value, however, and the core Yahoo multiple is low.3
Yelp reported solid 4Q12 results with revenue and EBITDA ahead of Street estimates. Analysts think the company continues to make good progress on mobile—both in users and monetization—while international remains at very early stages. Analysts are incrementally more positive on continued strong revenue growth in Yelp’s older market cohorts, margin expansion in 2013, as well as the company’s transition to mobile, which represented 25% of local ad impressions in 4Q12. However, Active Local Business Accounts were lower than expected and international remains relatively unproven.9
- Comscore, Feb 2013
- Gartner Press Release, Jan 2013
- JP Morgan, Jan 2013
- Deutsche Bank, Jan 2013
- Oppenheimer, Jan 2013
- Jefferies, Feb 2013
- Macquarie Equities Research, Feb 2013
- Macquarie Equities Research, Jan 2013
- JP Morgan, Feb 2013
Revenue and gross margin
Internet companies reported a strong quarter in terms of revenue with all the companies registering a positive growth. Amazon’s revenue grew 54% over the previous quarter, driven by higher sales during the holiday shopping season. The company also had a 22% YoY growth in revenue due to the increasing popularity of eBooks and Kindle readers/tablets. eBay’s revenue grew by 17.3% sequentially and 18.1% YoY, led by a strong performance of its Marketplace business in the US. The Paypal and GSI businesses also registered YoY growth of 24% and 10% respectively. Google’s revenue grew marginally vis-à-vis the previous quarter, but it registered a growth of 36.2% YoY primarily due to a 22% increase in advertising revenue (which comprises almost 89% of the total revenue). Additionally, Motorola Mobility contributed US$1.5bn as revenue this quarter which was absent in Q4 2011. LinkedIn recorded the highest YoY growth of 81% amongst the Internet companies in the analysis. This was driven by a 90% increase in revenue from Talent Solutions, a 68% increase from Marketing Solutions and a 79% increase from Premium Subscriptions. Netflix’s addition of 2mn members in 4Q12 and a strong holiday season quarter with consumers buying new electronic devices, including tablets and smart TVs, led to the 4.4% QoQ and 8% YoY growth in revenue. Yahoo! reported YoY revenue growth for the first for the first time in four years, with revenue up by 1.6%. This was primarily driven by the signing of key partnerships and launching new mobile experiences for Yahoo! Mail and Flickr. Revenue for Yelp was up by 13.2% sequentially as the company continues to launch new products to improve the consumer experience.
Despite higher revenues, gross margin for most of the Internet companies showed a negative trend this quarter. Google and Yahoo! had marginal increases in gross margin sequentially, but registered a decline YoY. Gross margin for eBay and Netflix declined both QoQ and YoY. Gross margin for LinkedIn grew by 147bps QoQ and 247bps YoY as the company gained from the revamped underlying development infrastructure. Yelp has historically reported low cost of sales and hence operates a very high gross margin. It reported a gross margin of 92.7% this quarter, which was almost flat compared to the previous quarter.
R&D expenditure
Internet companies raised their R&D expenses when compared with the same period last year except for Yahoo! as it continued its cost cutting efforts. Amazon, Google and LinkedIn reported significant YoY growth of 56%, 49.1% and 83.8% in R&D expenses as these companies continued to invest in improving their technology infrastructure and incur higher employee related expenses. R&D expenses for Netflix was flat sequentially and grew marginally by 1.7% YoY. eBay recorded a 20.8% YoY increase in R&D expenses, while on a QoQ basis R&D expenses increased by 6.9%.
R&D as a percentage (%) of revenue was almost flat sequentially for Internet companies in the analysis and showed an overall negative trend this quarter. Amazon and LinkedIn had a QoQ decline of 231bps and 341bps in R%D as a % of revenue as these companies registered a significant sequential growth in revenue. On a YoY basis, R&D as a % of revenue was in line with 4Q11, with the exceptions of Amazon and Google, which recorded an increase of 140ps and 120bps respectively and Yahoo! which had a decline of 180bps.
Net income
Profitability for Internet companies improved when compared to the previous quarter, with Yahoo! and Yelp being exceptions. Net income for Amazon improved from US$(274mn) in 3Q12 to US$97mn in the current quarter primarily due to higher revenues and the absence of a loss of US$169mn related to equity method investment activity. When compared to the same period last year, net income for Amazon declined by 45.2% due to higher provision for income tax and increased other expenses. eBay’s net income of US$751mn was 62.1% lower than net income of US$1.98bn in 4Q11 as the company had reported interest and other income of US$1.7bn in 4Q11 which was absent this quarter. However, the company had a profit increase of 25.8% QoQ, driven by higher revenues and lower operating expenses. Net income for Google grew by 32.6% sequentially and 6.7% YoY. LinkedIn’s continued investment in talent and technology infrastructure led to its growth in profitability. Net income for Netflix was flat QoQ, as the increased domestic streaming contribution profit (up US$18mn) more than offset a US$3mn decline of DVD contribution profit and a US$12mn increase in international losses, while global operating expenses were flat sequentially. On a YoY basis, net income declined by US$18.1mn due to higher operating expenses. Net income for Yahoo! declined 9.5% YoY while there was a decline of US$2.8bn sequentially due to the absence of a book gain in sales from its stake in Alibaba which was reported in the previous quarter. Net income for Yelp further declined from US$(2.01mn) in the previous quarter to US$(5.3mn) in the current quarter.
Inventory and receivables
Days sales in receivables (DSO) showed a mixed trend this quarter with Amazon, Yahoo! and Yelp reporting a sequential decline, while eBay, Google and LinkedIn registered an increase. DSO for eBay increased significantly due to a substantial increase in its receivables attributable to increase in funds receivables which have a settlement period of 12 months.
EPS
EPS for Internet companies declined in 4Q12 when compared to the same period last year except for Google and LinkedIn. These two companies reported a decent growth in revenue which led to a higher EPS. Additionally, they also reported significant sequential growth in EPS. Amazon’s EPS improved from US$(0.60) in the previous quarter to US$0.21 in the current quarter, but registered a 44.7% decline YoY. The sequential growth was due to the absence of loss due to equity method investments and the YoY decline was due to higher income tax provision and other expenses. eBay’s EPS improved QoQ due to higher revenues and relatively lower operating expenses. However, the company reported a decline in EPS YoY because of lower interest and other income this quarter. EPS for Netflix was flat sequentially and declined 79.7% YoY due to higher operating expenses. EPS for Yahoo! continued to decline as the company goes through a phase of low revenues and restructuring. EPS for Yelp continues to be negative as the company focuses on market and product growth.
Analysts believe that eBay will play a greater role in the overall retail going forward and maintain an overweight rating on its stock, leading to a rise in its P/E from 16.5x in the previous quarter to 25.6x in the current quarter. Yahoo! has demonstrated consecutive quarters paid click growth and appears to be making good progress towards improving search RPS, leading to a positive impact on its P/E. Google reported a strong quarter, but its P/E ratio showed a negative trend, driven by lower licensing and other revenue and supply constraints on its Nexus tablet.
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