Alphabet (GOOG/GOOGL): GOOG/GOOGL provided a mixed update with its 2Q24 results.  Earnings were generally good with modest upside for Search, Cloud, and operating margins.  YouTube advertising revenue fell short of estimates.  Management does not explicitly guide earnings but reiterated higher margins for 2024 and spoke confidently about all key revenue drivers on the quarterly conference call.  The comments did imply margin headwinds and tougher advertising revenue comps in the current quarter, although this should come as no surprise.  Margin pressure is mostly due to higher depreciation from the massive increase in AI capital spending.  So far, the company has done a good job to “durably re-engineer the expense base.”  This has served to increase margins but now will have to absorb the impact of higher capital spending.   Investors focused on the near-term margin outlook, leading the shares to decline about 5%.  GOOG/GOOGL shares have a more challenging setup over the next few months after a big run this year.  On a long-term basis, the company is making good progress with AI across the company.  The bear case is focused on lost Search market share to AI chatbots like ChatGPT.  The company’s response has been to integrate its own chatbot, Gemini, into search results.  So far, this appears to be well received by users given ongoing strength in Search revenue and encouraging engagement, especially among younger users.  Other aspects of AI appear to be helping advertising and cloud.  Management and third parties have noted improved returns for advertisers that use newly introduced AI functions to design and place ads.  Cloud revenue growth is holding near 30% and has become firmly profitable.  Beyond the near-term headwinds for margins and tougher revenue comparisons, investors also worry about the return on the huge increase in capital spending to support AI development and the upcoming verdict in the trial brought by the DOJ that could alter the company’s business model and highly profitable relationship as the default search engine for Apple.  Overall, we feel better about the company’s long-term investment outlook even as we see challenges in the near term.  GOOG/GOOGL shares are still up 24% this year, well ahead of the S&P 500’s 14% gain.  Valuation on P-E and EBITDA is not historically elevated like other large cap growth leaders.  We will continue to monitor developments, particularly on AI’s impact on Search and the DOJ trial. We think the shares continue to offer good long-term value and are willing to ride out near-term headwinds unless our view of the company’s Search business weakens.

IBM Corporation (IBM): IBM’s 2Q24 results again reinforced Northlake’s “return to growth” investment thesis for the shares.  When we made initial purchases of IBM back in early 2022, we thought the market was ignoring the positive impact the Red Hat acquisition was having on the company’s revenue growth.  IBM had gone ex-growth years ago, largely missing the new technology paradigms of software internet, and communications technology.  Red Hat got the company back in the game with its focus on Linux operating systems that are widely used at large corporations.  Red Hat allowed IBM to develop software applications to run on Linux and use the company’s large consulting workforce to assist clients in technology development.  The Red Hat acquisition was spearheaded by Arvind Krishna, who ultimately became CEO.  Many additional smaller scale acquisitions built out the software business and further propelled consulting.  A second growth engine is artificial intelligence.  IBM was years or decades ahead of the current AI craze with Watson.  You may remember Watson beating world chess champions in chess or winning at Jeopardy.  Watson has been relaunched and the company now has received over $2 billion in orders related to AI.  Investors and the analyst community are paying more attention to IBM and the shares are up about 50% over the past two years, while paying a healthy mid-single-digit dividend yield.  Investors and analysts have come around to the IBM growth story but there remains a healthy dose of skepticism.  Despite a clean beat and raise quarter, management faced challenging questions on the conference call.  We think the questions about a slight deceleration at Red Hat and whether AI projects are causing weakness in other consulting business should be monitored.  We are happy to have some skeptics about our once far out of consensus bullish view on IBM.  An old Wall Street adage is that stocks climb a wall of worry.  It makes sense since if everyone is bullish, everyone already owns the stock.  We expect IBM to continue reporting good quarters, leading those on the sidelines to become buyers.  The stock’s P-E ratio has expanded but remains at a significant discount to the market and other companies with material AI exposure.  We see further upside to $220, or 20-times next year’s earnings estimates.

T Mobile USA (TMUS): TMUS reported another good quarter, slightly beating consensus estimates in what has been a consistent pattern since the company’s acquisition of Sprint occurred a few years ago.  Management raised the 2024 outlook as well.  We had expressed a change in the TMUS story from big upside surprises driven by the Sprint integration to a steady growth profile.  Over the past few months, concern had emerged that the growth outlook had weakened due to the competitive environment for mobile phone and broadband services.  The quarter and guidance restored confidence and the shares rebounded from a recent 5% pullback to just below the all-time high.  We continue to like TMUS shares as a growth compounder with industry leading growth and continued elevated free cash flow.  The conference call also gave management a chance to discuss its recent investments in fiber broadband, a shift in strategy from exclusive offerings of fixed wireless broadband.  Investors were relieved to hear that the company is unlikely to invest a large amount of incremental capital after a couple recent mid-sized acquisitions of fiber providers. We think TMUS shares can continue to work higher based on high single-digit profit growth and double-digit gains in free cash flow.

Meta Platforms (META): META bucked the early trend for the Mag7 and reported better than expected earnings and higher guidance for the year.  The stock reacted well initially, climbing 7% in after-hours trading.  We expect the gains to hold and build.  The company is executing very well and appears to be winning investor confidence for its heavy AI investments.  META shares fell 17% from their all-time high on July 8^th to the recent low on July 25^th.  Along with other AI winners, investors began to question the return on the massive capital spending increases to build capacity for AI.  With the after-hours pop, the stock is still down 6% from the high but it is instructive that the stock rallied despite the company raising the low end of its 2024 capital spending guidance and indicating that 2025 will see another significant increase.  This suggests to us that investors are beginning to accept META’s AI vision.  The vision is built on open-source models built into each of the company’s major services:  Facebook, Instagram, WhatsApp, Messenger, and Threads.  AI is already producing revenue by making it easier for advertisers to build campaigns at improved returns.  Alphabet and Microsoft discussed similar AI investments and potential returns but fell a little short on reported revenue and profits.  META grew revenue 22%, ahead of street expectations of 20% and produced very high margins despite the step up in AI operating expense and depreciation for AI capital expense.  The company also guided to 16% growth in 3Q24, ahead of street estimates.  While this growth is below Alphabet and Microsoft, META faces very difficult comparisons against heavy advertising from Temu and Shein that began in earnest last summer.   2025 earnings estimates seem likely to rise toward $25, leaving the stock at a reasonable forward P-E of 20X.  We think that represents good value and plan to hold current positions.

VICI Properties (VICI): VICI reported another boring quarter inline to slightly above street estimates.  AFFO, which represents cash available for dividends, grew just shy of 10%, consistent with recent growth rates.  The company raised guidance a little, passing through the upside.  As a reminder VICI owns real estate which it leases overwhelmingly leases to Las Vegas and regional casinos in return for rent.  The business model is to raise funds via equity and bond issuances at a lower cost than the yield on the rent payments the company receives.  Since rent payments are fixed and have an annual inflation kicker, the business is highly predictable. Growth comes from rent increases and new investments in experiential properties including casinos, wellness centers, and leisure businesses like theme parks and bowling centers.  VICI was quiet on new investments in 2Q24.  We are not concerned, however.  The company faces a big decision by December 31st whether to exercise its call option on Caesar Entertainment’s Indiana casinos for $2.2 billion.  We suspect they will move forward and may be slowing down elsewhere to build capital for the deal.  If VICI passes on the Caesar properties, we believe there are plenty of other deals across its industry exposure in the US.  VICI also has begun to invest abroad, opening a large addressable market.  We believe the company can sustain near 10% AFFO growth, which coupled with current 5% dividend yield, offers a healthy mid-teens total return over the next 12 months.  With much of VICI’s investment attraction is built on its dividend, the shares have struggled the last couple of years as interest rates rose with the Fed fighting inflation.  Inflation is again receding, and interest rates are now falling.  The Fed indicated at its end of July meeting that the first of what is likely a series of cuts will occur in September.  VICI shares have begun to rally, rising 13% since their most recent low in early July.  With Fed policy turning from headwind to tailwind for VICI’s dividend-driven return profile and supporting the credit quality of its leases, our long-held view that VICI shares can trade to near $40 is strongly affirmed.

GOOG/GOOGL, IBM, TMUS, META, and VICI are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.