IBM (IBM): IBM reported good results in a tough macro environment, further increasing our confidence in the transformation underway at the company.  Revenue and EPS exceeded expectations with strength across all segments of the company.  Management raised 2022 revenue guidance and maintained free cash flow guidance.  The only real negative in the quarter and outlook is currency translation due to U.S. dollar strength.  While this leads to lower EPS estimates, investors largely overlook the impact since it equally affects all companies.  On the quarterly call, analysts asked about the long-term outlook previously provided calling for mid-single-digit revenue growth and $34 billion in free cash flow in the 2022 thru 2024 period.  Management reiterated confidence while noting increasing foreign exchange impact and a few signs that weaker demand may emerge in Europe.  Demand in the rest of the world is firm.  IBM serves very large corporations where IT upgrades to cloud computing so far remain intact given they have a quick and meaningful financial payoff.  Northlake’s thesis on IBM is that the company is going to grow again thanks to the acquisition of Red Hat driving a corporate transformation focused on hybrid cloud computing.  The new CEO engineered the acquisition before he was promoted.  The company spun off most of its slowest growth potential businesses a year ago to continue the strategic shift.  IBM shares have done well this year, down just 5% and a flat total return after the healthy dividend.  The shares trade at about 13X forward earnings estimates and we think multiple expansion will occur if the company continues to meet expectations.  Investors still are not buying the IBM turnaround despite multiple quarters of good results.  Our morning notes from a dozen brokerage firms only contained one note recapping IBM’s results.  A year from now we expect the story to be better appreciated, resulting in multiple expansion.  A P-E of 15X on 2024 estimates would put the shares at $160, up 25% on top of the 4% gain post the earnings report.  The stock carries a safe 5% dividend yield enhancing the total return potential and providing near-term support.

Alphabet (GOOG/GOOGL): GOOG reported a disappointing third quarter.  We expected a continued slowdown in revenue growth, but the weakness accelerated even excluding the material impact of the strong U.S. dollar.  Search held up better with a bigger deceleration at YouTube.  Most disappointing to us was the sharp contraction in operating margins.  With the benefit of hindsight, it is clear that GOOG over-earned in 2021 due to the pandemic accelerating the top line and depressing certain operating expenses like travel and marketing.  One of our core reasons for holding GOOG shares has been the added discipline that CFO Ruth Porat brought to the firm when she was hired years ago.  While it may be beyond her control given the circumstances of the pandemic and unusual macro environment, 3Q22 was a step backwards.  GOOG now employs 186,000, up from 150,000 a year ago, and up 12,000 since June 30^th.  GOOG is smart to continue invest in the many opportunities it has across search, media, mobile, and entertainment; sustaining industry leading AI and machine learning is critical to the company’s long-term growth and competitive position.  Nonetheless, Wall Street is going to penalize the shares until better cost discipline is revealed and revenue growth trends improve.  Management remains quite confident in in its growth opportunities and feels that Search and Cloud are doing well against a tough macro environment.  Management also indicated that headcount growth would slow in the next quarter but remain elevated against revenue trends.  Northlake still sees GOOG as a good long-term growth investment with a great balance sheet.  Capital and expense discipline have improved markedly over the years but presently are out of balance with macro-pressured revenue growth.  It may take a few quarters for trends to turn and investor confidence to improve.  We are willing to wait given current valuation of the shares is just 10X EBITDA, below the historical average.  Moving back to an average multiple of 12X on depressed 2023 estimates gets the stock back to $125.  If revenue growth and operating margins are showing improvement later in 2023, estimates for 2024 should show double-digit growth which can drive the shares substantially above $125.  It will take patience and a better economy, but patience will be rewarded from current prices.

Meta Platforms (META): META shares are plunging following the company’s 3Q22 earnings report that included initial guidance for operating expenses and capital spending for 2023.  The stock is down 22% as we write to $100, a level last seen at the start of 2016.  In our recent write-ups on META, we have noted that the top line was under pressure but had the possibility to stabilize in late 2022 and 2023.  We also noted that the company was reigning in expenses to help protect earnings against below budget revenue trends.  3Q22 showed hope for stabilization in the top line with reported revenue and engagement, while qualitative 4Q22 guidance was mostly in line with recently lowered expectations.  Heading into the quarter, investors expected another signal that expenses were being budgeted cautiously given macro, competitive, and privacy headwinds.  This turned out to be far from the case.  Stunningly, management plans for operating expense and capital spending in 2023 to each be $10 billion higher.  This budgeting is crushing for earnings and free cash flow.  Ahead of the report, 2023 consensus EPS and free cash flow were $10.75 and $20 billion.  New EPS estimates range from $6.50 to $8.00 and free cash flow is $10 billion.  In 2021, the company was at nearly twice these levels.  Just maintaining expense and capex guidance would have led to a forecast just below prior consensus. Not surprisingly, the conference call went very poorly.  We listen to a few dozen calls each quarter, and this META call was about as bad as we can ever remember.  Management seemed unfocused and did not provide detailed answers to many questions, instead often just repeating that it had confidence in the core business and ability to grow again as metaverse investments stop growing and the core business benefits from continuing investment of operating expenses and capital spending.  We concluded last quarter’s META blog by noting, “Simply put, the shares are valued as though META is going the way of MySpace and AOL, a much too drastic scenario.”  Today’s plunge in META shares reflects concern that the company may be facing an existential crisis.  Investors clearly do not believe that current strategy is going to reinvigorate the company.  Management’s willingness to accelerate spending against uncertain revenue growth could be read as reflecting internal concern of that existential crisis. Northlake generally will not invest where we do not believe management is industry-leading.  Right now, for META, that is hard to believe.  However, the company still maintains a massive and highly effective advertising reach.  Arguably, the best in the world besides Google search. We may admit defeat and sell the shares, but we want to let the dust settle first and evaluate in a less emotional, lower volatility environment.

Comcast (CMCSA): CMCSA reported a better quarter with no new negative surprises for the first time this year.  This is an encouraging sign that could lead to a material recovery in the shares over the next several months. The company is not out of the woods given the competitive dynamic in broadband and secular decline in the linear cable and broadcast businesses.  However, management continues to do a good job, remains transparent, and has improved focus on shareholder friendly capital allocation in lieu of the company’s history as an acquirer of assets.  The share buyback in 3Q22 was aggressive, and on the conference call management noted that acquisitions are not necessary and less attractive given a higher cost of capital.  In 3Q22, revenue, EBITDA, free cash flow, and broadband subscribers all exceeded consensus.  The company added 14,000 new broadband subs and saw broadband ARPU rise about 4%.  This is encouraging after a string of subscriber misses.  The ability of the company to sustain price increases on broadband amid a heated competitive environment while subscriber growth is expected to stay minimal is critical to maintaining financial strength that supports shareholder friendly capital allocation.  Management also reiterated its capital spending plan against concerns that it would have to spend more to sustain subscriber levels against increasing fiber and fixed wireless competition.  Comcast shares trade at just 6X 2022 and 2023 EBITDA, a discount to Verizon and AT&T despite a still faster growth profile, a better balance sheet, and more free cash flow.  The better quarter and accelerated share buyback give Comcast and the cable industry a window to rebuild investor confidence, leading to slight multiple expansion due to stability in financial and operational performance.  A target in the low $40s is plausible but we may exit in the mid to upper $30s.

T Mobile USA (TMUS): The TMUS story is developing exactly as we hoped when he purchased the shares in February.  The stock is up almost 25% in a lousy market as each milestone we had hoped for has been achieved.  3Q22 earnings were the third consecutive beat and raise quarter in subscriber and financial growth.  Synergies from the Sprint acquisition are exceeding initial estimates.  Integration of the Sprint network came in ahead of schedule and is now complete.  The benefit of gaining Sprint’s mid band spectrum has made TMUS the leader in 5G just as consumers are upgrading phones.  Expansion into rural and business markets is proceeding and TMUS market share has a lot of room to rise.  Free cash flow is on target and set to explode in 2023 as costs to obtain synergies disappear and cost savings fully kick in.  One thing we did not anticipate was that the timing of closing the Sprint deal allowed TMUS to lock in long-term contracts on many costs, thus allowing inflation of operating expenses to be minimal.  Management delivered the promised share buyback two quarters ahead of schedule and is already aggressively buying back stock.  The strength in TMUS shares shows that investors have recognized all the good news, but we still think there is room for more upside as growth looks secure as the wireless industry benefits from 5G, and the share buyback kicks in to dramatically shrink shares outstanding and perhaps the float if Deutsch Telecom continues to hold its large stake.  TMUS is emerging as the wireless industry leader and deserves its premium valuation with a couple more years of highly visible elevated growth.  We think there is another 20% plus upside.

Apple (AAPL): AAPL reported a solid quarter against mixed signals coming into the report.  Guidance for the December quarter was cautious but still showed growth near estimates despite even harsher U.S. dollar strength impacts.  Surprisingly, to Northlake, the shares jumped about 8% in response.  We saw nothing in the report that was concerning but neither did we see anything that was materially better than expected.  However, after Alphabet, Meta, and Amazon reported earlier in the week with clear disappointments and weak guidance, Apple stood out for the resilience of its reported results and forward guidance.  It seems like AAPL’s core business is only being impacted by macro whereas the other tech leaders face issues beyond macro (Amazon: overbuilt cost structure, Meta: excessive operating expense and capital spending and weakening competitive position, Alphabet: weakness at YouTube from Apple privacy changes).  Since AAPL shares are not that expensive at a low 20s P-E multiple, resilience is good enough for investors and treated as a positive surprise.  Key for the next move in the shares will be the outlook for growth in 2023.  Macro is definitely a headwind impacting services growth the most.  iPhone still has upside from the transition to 5G phones.  Mac needs to digest an unusually strong quarter led by filling the channel that lacked inventory.  Overall, the stability of AAPL’s business, its well defended competitive position, and the strength of free cash flow and the balance sheet makes the shares a good investment for the current tricky macro environment.  We do not see a lot of upside, but we are happy to continue holding an overweighted position.

VICI Properties (VICI): VICI had another boring quarter in terms of financial results.  That is exactly what Northlake loves about VICI! The business mode is simple:  the company collects rent from high-quality tenants on the casino properties it owns in Las Vegas and regional gaming markets.  The pandemic shutdown of casinos battle tested the model as not a single VICI lessee missed a rent payment.  This is very comforting ahead of a possible recession.  VICI is essentially an alternative source of financing to casinos and experiential real estate and it is becoming a more attractive alternative as high yield credit markets have tightened making VICI a low-cost alternative.  This is keeping the pipeline of projects full which builds on inflation-protected growth in current rents.  While another quarter of mid-single-digit growth in revenue and earnings provides little fodder for analysis, VICI’s proven management team is executing on its growth strategy and taking advantage of the current environment.  In casino financing, the company announced it would buy another regional gaming property in Maryland.  VICI was also active as it diversifies into experiential real estate with new agreements with Great Wolf (family resorts), Canyon Ranch (spa and wellness), and Cabot (golf).  Shareholders are benefiting directly from the consistent performance as management announced an 8% dividend increase.  Mid-single-digit core growth plus acquisitions should provide 8-10% earnings and cash flow growth which when coupled with the current 5% dividend yield provides a low-risk, mid-teens total return for VICI shareholders.

IBM, GOOG, META, CMCSA, TMUS, AAPL, 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.