Fund Team: Technology, Media & Telecoms Update

Devin Zhang, TMT Sector Leader 2015-16

Technology, Media & Telecoms Sector Analysis Report

1. Introduction

It seems to be unrealistic in this case to implement the full-scale financial analysis of companies, considering the required length of time and professionalism it may ask during the process, taking into account academic commitments. In light of this reason, I decided to change my strategy from completing the detailed financial analysis to giving reasonable trading ideas based on concise analysis. This change could be still helpful in the sense that I think we may focus on making a good profit on our investment more than hitting a target price.

The idea of finding potential target companies I mentioned makes me focus on relevant perspectives of a company, which I think are crucial for evaluating stock price on the basis of my financial knowledge and understanding of corporate finance. The prediction horizon is assumed to be 3- 6 months. Sales revenue, profit margin, cash flow from operating activities, growth rate, market environment etc. are selected and considered case by case. This analysis report is probably not that comprehensive, but I believe it at least captures those key numbers that could reflect the main picture of a company. It may be limited by the level of my knowledge and expertise, though.

The philosophy of this analysis is following: sales and profit margin (net income/ sales revenue) are paramount for any companies, so these two features were selected. That being said, I also included the item “Cash Flow from operating activities” in the first part of my analysis. This is due to two reasons. First, companies could “manipulate” their profit by conducting irregular business activities (One example could be Yahoo boosted their profit in 2014 by selling shares of Alibaba after its IPO) and this is legal under the current accounting standard. However, the operational activities could reflect how the main business of a company is going to a large degree. Second, we all don’t want to see that a company with high sales revenue is struggling with profitability due to high bad debt rate (think about the roots of financial crisis. The sales numbers were almost meaningless at that time, albeit looks great. This is simply because they can’t convert those sales number to money). Therefore, I want to look at “Cash Flow from operating activities”.

Accounts receivable and inventory were also considered due to the worry of possible channel stuffing and company’s underperformance in the future. Same concept applies to “Accounts payable” and “long term debt” items. Companies could boost their profit margin sometimes by delaying necessary repayments to next financial year, so a high increase in “Accounts payable” is suspicious. Profitability can be significantly influenced if a company repays its long term debt in that financial year. On the other hand, an obvious hike in long term debt could be interpreted that the company may invest in new business, which is usually a good sign. Also if possible, we can check the relevant borrowing rate. If the rate is low, it means borrowers (who also must have conducted thorough analysis of the company) believe the company’s future is promising.

In addition to these traditional financial analysis, I also tried to incorporate other indicators of a TMT sector company, such as growth potential, market share, and industry environment to name a few. This consideration is based on idiosyncratic features of the TMT sector. Amazon did report financial loss for five years in a row after it went IPO, but its share price was going up most time during the same period.

In this report, I focus on three companies: IBM (as requested by Ferdinand, the Fund Team Manager), JingDong (a highly growing Chinese online sales company) and Alphabet (Google is a more familiar name for most people).

2. Short discussion of IBM

  1. Preliminary analysis: the value numbers are in USD millions
2015 2014 2013 2012 2011
Sales Revenue 81741 92793 98367 102874 106916
Net Income 13190 12023 16483 16604 15855
Profit margin 16.14% 12.96% 16.76% 16.14% 14.83%
Total selling, general and admin. Expenses 20430 21385 22214 23463 22865
Cash Flow from operations 17485 19585 19847 19549

Note: the profit margin of IBM last year is satisfying compared to that of last four years, but it is noted that the increase in profit margin is also contributed by the continuous downturn in sales over last five years. The cash flow number show the consistency in its lousy sales picture. I added “Total selling, general and admin. Expenses” to the IBM analysis because I realised the staff cost was declining most time over last five years. Downsizing sometimes is not for improving efficiency but making the accounting performance nicer when the overall performance is weak.

  1. Changes in proportion of “Accounts receivable” and “Inventory” of Total Asset (value numbers are in millions of USD)
2015 2014 2013 2012 2011
Value % Value % Value % Value % Value %
A/c receivables 28554 25.84 31831 27.08 31836 25.22 30578 25.65 29561 25.39
Inventory 1551 1.40 2103 1.79 2310 1.83 2287 1.92 2596 2.23
Total assets 110495 100 117532 100 126223 100 119213 100 116433 100

Note: Account receivables did not change too much last year, but the trend of lowering inventory is distinct for past five years. It should be noted that the decrease in inventory was not because of the excellent performance of sales but more like efforts to lower its operational cost. If we combine this trend with the sales number, we can conclude that IBM has actually been reducing its production over last five years. Usually, I won’t interpret this as good signals unless the company is shifting their business to other areas.

  1. Changes in proportion of “Accounts payable” and “inventory” of Total Liabilities (value numbers are in millions of USD)
2015 2014 2013 2012 2011
Value % Value % Value % Value % Value %
A/c payables 6028 6.26% 6864 6.50% 7461 5.91% 7952 6.67% 8517 7.31%
long term debt 33428 34.74% 35703 33.79% 32856 26.03% 24088 20.21% 22857 19.63%
Total liabilities 96233 100.00% 105664 100.00% 126223 100.00% 119213 100.00% 116433 100.00%

Note: The Account payables did not change too much las year, but the long term debt is increasing, particularly in past two years. It is worth investigating. I did some research and found the significant debt issuance could be related its buyback program.

In addition to the buyback program, IBM is also shifting from its traditional product and services mix – think mainframes – to faster growing segments such as cloud, analytics, mobile and security. This trend is in line with our discussion of usage of long-term debt in the last section. However, people think IBM is struggling with this shift, although the direction of this change is correct.

  1. My opinion

Overall, I will suggest not to buy IBM. If the stock has been in our portfolio, from a long term perspective, I may suggest a hold because its dividend is still good.

Last, this article is worth reading if you want to get a picture of IBM stock quickly, whose opinion is similar to mine.


3. Short discussion of Inc (NASDAQ: JD): This Chinese B2C online retailer surpassed Amazon China and Dangdang (E Commerce China Dangdang Inc, NYSE: DANG) last three years and has become the second biggest e commerce website in China. started with a focus on online direct sales selling. As it gained popularity, it started accepting other retailers as an e-commerce marketplace. Currently, Alibaba (the world largest E-Commerce website) which made the biggest IPO in history regards as its biggest competitor.

The price of is more volatile. Possible explanation of the price descending movement from May 2015: JD.Com started trading on the NASDAQ back in 2014, when it raised $1.78 billion in its initial public offering (IPO). The company’s stock performance was great in the first half of this year, but concerns around China’s economic slowdown have sent the stock plummeting since.

Preliminary analysis: The value numbers are in millions of CNY.

2015 2014 2013 2012 2011
Sales Revenue 115002 69340 41381 21129 8583
Net Income -4996 -50 -1729 -1284 -412
Profit margin -4.34% -0.07% -4.18% -6.08% -4.80%
Total selling, general and admin. Expenses 17337 6459 4797 2317
Cash Flow from operations 1015 3570 1404 -624

Note: the sales revenue of soars significantly over the course of last five years. This skyrocketing number is probably the best evidence that it surpassed Amazon China and Dangdang (the first listed Chinese e-commerce website in the US) at the same time. The profit margin is still negative, but is not the worst over the same term, so I may more look at its growth potential when evaluating this company. The fact that the staff cost boosted exponentially indicates the strong confidence in its future.

Changes in proportion of “Accounts receivable” and “Inventory” of Total Asset (value numbers are in millions of CNY)

2014 2013 2012 2011
Value % Value % Value % Value %
A/c receivables 4037 6.07% 1301 5.00% 674 3.77% 480 4.54%
Inventory 12191 18.33% 6386 24.55% 4754 26.58% 2764 26.13%
Total assets 66493 100.00% 26010 100.00% 17886 100.00% 10579 100.00%

Note: The most notable pair of numbers in this table is the jump in inventory and the general decreasing proportion of total asset. Considering that more focuses on online direct sales selling, the significant increase in inventory means it is expanding. At the same time, the lower proportion of inventory can be understood that the efficiency of is improving. This is particularly should be noted when its sales revenue ascended very quickly. I won’t worry about the rise in A/c receivables too much because it is not very significant compared to the increase of its sales revenue.

Changes in proportion of “Accounts payable” and “inventory” of Total Liabilities (value numbers are in millions of CNY)

2014 2013 2012 2011
Value % Value % Value % Value %
A/c payable 16364 56.44% 11019 66.10% 8097 70.51% 3636 78.28%
Long term debt 0 0.00% 0 0.00% 0 0.00% 0 0.00%
Total debt 1891 6.52% 933 5.60% 867 7.55% 0 0.00%
Total liabilities 28995 100.00% 16670 100.00% 11483 100.00% 4645 100.00%

Note: the item of total debt was added in this table because has zero long term debt.

Usually, decreasing Accounts Payables indicate the healthy financial status of a company. This is even better in this case because the total liabilities were slowly increasing simultaneously. I won’t worry about the change of total debt too much because:

  1. There is no long term debt. Therefore the total debt mainly comes from short-term debts. This indicates that may need “quick” money to support operations, but it does not need borrowings from a long term perspective.
  2. The increase in total debt is bit of trivial compare to that of total liabilities.

Overall, I think does have a healthy financial status. This is distinct for me because is expanding its business exponentially.

Other information

1. chose Russia as its first foreign market for expansion and intends to become an e-commerce leader in this market within five years. It has already launched a Russian-language website in June and signed a delivery contract with Russian logistics operator SPSR Express.

2. Personally, I think the biggest advantage of is its “own” logistic team. Yes, it doesn’t rely on any third-party delivery companies unless it is a retailer who entered into and chose to use other delivery companies. The delivery service of is probably fastest one of online shopping website you can have. Here is one example.

If your address is in a city/town of eastern parts of China and you submit your order before 11.00 am, you can receive your goods on the same day. If your address is in the rural area, it is guaranteed that you will get the goods next day. This service is free if your order is more than 8 pounds.

A good comparison could be Amazon China. Amazon relies on its own logistic team and other delivery companies alike. It normally takes 2 days to deliver the goods to customers if you are in a city/town of eastern parts of China. If you are in a rural area, normally it takes 3 or 4 days. The delivery service is free if your order is more than 10 pounds.

This fast service provides significantly increases customer satisfaction in China where life is indeed “hustle and bustle” in most places.

3. In addition to Amazon China, is another website that continuously sells a large sum of exported goods with a reasonable price by itself.

My opinion

Generally, I highly suggest as a potential choice. A further analysis may be need if we want to make a more cautious investment decision. This advice is consistent with the suggestion from the article that the link below guides to: Inc. (NASDAQ: JD) was raised to Buy from Neutral and the price target was raised to $35 from $27 (versus a $26.69 close) at Nomura. The consensus analyst target is $35.52, and the stock has a 52-week range of $21.55 to $38.00.


4. Short discussion of Alphabet Inc

Preliminary analysis: The value numbers are in millions of USD.

2014 2013 2012 2011 2010
Revenue 66001 55519 46039 37905 29321
Net Income 14444 12920 10737 9737 8505
Profit margin 21.88% 23.27% 23.32% 25.69% 29.01%
Total selling, general and admin. Expenses 13982 10986 8946 7313 4761
Percentage of Staff cost in revenue 62.49% 58.88% 53.83% 50.21% 42.97%
Cash Flow from operations 22376 18659 16619 14565 11081

Note: the profit margin decreases, but the percentage of staff cost in revenue increases at a faster rate. We may argue the higher increase in staff cost is contributed to more R&D expenses because its Cash Flow from operations continues increasing over the course of past five years. Because Alphabet doesn’t disclose R&D expense, this claim needs further investigation. Overall, we see the increase in revenue, net income and CF from operational activities.

Changes in proportion of “Accounts receivable” and “Inventory” of Total Asset (value numbers are in millions of USD)

2014 2013 2012 2011 2010
Value % Value % Value % Value % Value %
Cash 64395 49.37% 58717 52.94% 48088 51.27% 44626 61.49% 34975 60.46%
A/c receivables 10849 8.32% 9390 8.47% 8585 9.15% 6172 8.50% 5002 8.65%
Total assets 130426 100.00% 110920 100.00% 93798 100.00% 72574 100.00% 57851 100.00%
Net goodwill 15599 11492 10537 7346 6256
Long term investment 3079 1976 1469 790 523

Note: Accounts receivable did not change too much over past five years, but cash Alphabet holds were decreasing gradually. On the other hand, total assets arise, so I think the decrease in cash may be “converted” into other assets, such as Goodwill (due to acquisitions) and investments. This is the reason why I included items of “Goodwill” and “Long-term investment”in this table.

Changes in proportion of “Accounts payable” and “inventory” of Total Liabilities (value numbers are in millions of USD)

2014 2013 2012 2011 2010
Value % Value % Value % Value % Value %
A/c payables 1715 6.46% 2453 10.39% 2012 9.11% 588 4.08% 483 4.16%
Accrued expenses 7499 28.23% 6253 26.48% 5497 24.89% 3188 22.09% 2371 20.42%
long term debt 3228 12.15% 2236 9.47% 2988 13.53% 2986 20.69% 0 0.00%
Total liabilities 26566 100.00% 23611 100.00% 22083 100.00% 14429 100.00% 11610 100.00%

Note: The Accounts payables decreased last year, but the accrued expenses keep increasing over past five years. This is maybe related to undecided legal expenses in the future, which could be a pitfall for our investment.

Other information

1. Despite focus on reduced spending, Google still went ahead with some daring acquisitions this year. These include: Pixate, Timeful, Tilt Brush, Thrive Audio, Red Hot labs, Softcard, Odysee, and Launchpad Toys. Alphabet – Google’s new holding company – is now going to be the main acquisition vehicle, at least for major companies. The company has historically killed off all unsuccessful non-core products, which makes an acquisition under its existing umbrella much cleaner.2. In 2015 the company formerly known as Google—Alphabet —revamped its corporate structure to allow further scrutiny of the various efforts (Nest, Google X, Life Sciences) adjacent to its core advertising business. Its dedication to AI spans both its core and experimental divisions and could accelerate the ad business responsible for most of its revenue. (Alphabet is expected to make $85.7 billion in total revenue in 2016.) “Investors can tolerate losses in moon-shot businesses because they’re planting the seeds for longtime growth,” says Colin Sebastian, a senior analyst at Robert W. Baird. Our take: Buy.

My opinion

I will regard Alphabet as a good investment choice, especially its current price is lower than three months ago, which has been circled in the first graph. A more important thing I think is investment in Alphabet is “safe” given the possibility of its various and mind-boggling future products. The only concern for me is the unsolved legal investigation and fines, because it may affect the return of our investment if the investment horizon is 3-6 months. A more ideal timing to buy this stock is when it is clear how much European authorities impose the fine, but it is hard to predict when that day will come.

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