Exxon Mobil, Not Facebook, Is Trailer Trash - Forbes

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The founder and CEO of Facebook Mark Zuckerberg. (Photo by CHRISTOF STACHE/AFP via Getty Images.)

AFP via Getty Images

Step back to look at tech’s run past five years. Amazon AMZN sprinted 500% with Alibaba BABA and Microsoft MSFT logging in at 300%. Not bad! Facebook’s a triple. The Nasdaq 100 Index more than doubled, but the S&P 500 Index just pushed over 60%. How many investors stayed the course, overweighted in tech paper for five years? Note the wipe-out in Exxon Mobil XOM . This so-called polite investment, dropped 60%. Management still clings to its blue-chip history, maintaining its dividend in the throes of operating losses and serious asset write-downs. This is boardroom obtuseness which turns me off.                 

  Tech, The Only Distance Runner

So far, the market ignores wide variances in R&D spending among major tech houses. The spend ranges down from 20% of revenues for Facebook to under 10% for Apple AAPL . These are raw numbers and management rarely divulges any research priorities.

Xerox XRX and Polaroid, decades ago made the spend, but brought forth zilch. For growthies, failure to renew drives down your stock to 10 times earnings sooner or later, even worse. Where’s Eastman Kodak KODK today? IBM IBM had to summon a new headman, Lou Gerstner, to save itself from inner-bureaucratic bloat.

Tom Watson, IBM’s venerable honcho had bet his company on development of the System 360 computer line. Burroughs and Remington Rand stayed fast asleep. IBM won big. Same goes for Elon Musk fielding his stylish electric car while General Motors GM was struggling to downsize their ugly tank. I’m waiting for Musk’s finishing touches on home battery power and what’s annualized expense to write off initial battery investment. What’s the break-even time? I’ll accept five years but little more.

Microsoft mirrors the tech norm for R&D expense and operating income valuation. The spend, at $20 billion, runs 13% of revenues and grows 10%, annually. Stock based compensation is at 11% of net income, an acceptable number. They do break out their intelligence cloud sector, now one-third of operating earnings and greater than its personal computer business.

At a 25 multiplier of operating income, Microsoft has renewed itself, but don’t expect downside protection relative to the S&P 500 Index. Still a hot potato but not so volatile as Facebook and Amazon, both defying analytical constructs.

The Facebook dream persists for me, valuation somewhat contained by the hostile financial press and Mark Zuckerberg’s feisty public persona. Analysts’ earnings projections carry no weight, always wide of the market. Who dares project core-advertising revenues in our shut-in world, stuttering month-after-month?

Metrics in Facebook’s income statement remain startling but go unremarked. Research and development spending is staunch, running at 22% of revenues. The spend in dollars is nearly equivalent to Microsoft and more than double Apple’s numbers. God only knows where such capital is earmarked. Management tells you nothing. We just get a raw number one-liner.

Facebook’s share-based compensation for key employees runs over 20% of net income, pretty much a constant. Let’s call free cash-flow near $20 billion on a market-capitalization base over $750 billion. With operating income near $30 billion, Facebook sells at 25 times, a tolerable working stat om valuation. There’s one other stat that intrigues me, but again, management tells us nothing: Facebook’s employment rolls, year-over-year increased 32% to over 56,000. Are these all entry-level people - fact checkers - whatever? Cost of integration must be huge.

I’m tuned in on Facebook, awaiting the next couple of cards to flip face-up on the poker table. Meantime, note Exxon Mobil is writing off tens of billions in decades-old oil field assets. Goldman Saks now sells below book value while Apple has lost some luster, construed more like a small appliance producer. Citigroup C still is considered a can of worms. My ragamuffins, Freeport-McMoRan FCX and Halliburton HAL are managing through an iffy-commodities setting. Who dares project GDP numbers?

I’d feel more comfortable with the market at 15 times earnings, not its feisty 20 multiplier.

The battle to renew yourself is ongoing for tech houses. IBM fell behind in the seventies while Intel INTC today deals in a highly-competitive, cyclical, integrated circuit business. Same goes for Hewlett-Packard HPQ and Cisco Systems CSCO , finding it tough to stay viable and hang onto an above average price-earnings ratio.

The danger of overpaying for sizable acquisitions is ever present. Xerox ended up buying financial services entities that faded badly. Berkshire Hathaway BRK.B carries over $70 billion in goodwill on its balance sheet with a recent $14 billion write-down on its acquisition of Precision Castparts, an old-line producer of jet aircraft sub-assemblies.

What about Apple? Could it run out of new toys to sell? Can annualized product upgrades in cellular telephony still stimulate hand-held phone demand, year-after-year?

Apple’s annualized R&D budget is inscrutable. It advanced from low single-digits to its current 7% of revenues. Should Apple’s price-earnings ratio be adjusted downward for its low spend compared with Facebook’s 20% allocation? Or, is Facebook’s price-earnings ratio at 25 times forward 12-months earnings power still too low today? Why give ‘em more credit here considering their spend could prove fallow?

After stepping back from high-magnitude numbers on R&D, product development expenses and allocation of sizable equity chunks to management and key employees, how evaluate what makes sense and advances the operating footprint of these tech house and benefits shareholders?

I’ll put them aside and concentrate on the operating income account, operating cash-flow and what is the yield on free cash-flow. A 5% yield on free cash-flow makes me happy, because this is a residual for shareholders.

Secondly, I’m looking for an operating cash-flow multiplier no more than 20 times market valuation. This is wherewithal for an operator to grow his footprint. When this residual starts to diminish, you check out and try to forget you ever owned such a trashy piece of paper.

Facebook, Microsoft, Alibaba and Amazon are my horses. I hold ‘em on a soft rein as they gallop down the track. My last word on Facebook. Employment rolls surge on at a breathtaking clip, latest quarter up 32% to over 56,000. Is this what it takes to monitor and service half the world’s internet users? They’re serious.

Sosnoff and/or his managed accounts own Facebook, Amazon, Alibaba, Microsoft, Apple, Freeport-McMoRan and Halliburton.

msosnoff@gmail.com

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https://www.forbes.com/sites/martinsosnoff/2020/11/05/exxon-mobil-not-facebook-is-trailer-trash/

2020-11-05 19:11:07Z
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