International Business Machines (IBM): IBM reported a good quarter with nice upside on the all-important free cash flow.  Guidance was also good with free cash flow again surprising positively.  The stock responded very well to the earnings report, mostly because management noted another big acceleration in orders related to artificial intelligence.  As a reminder, IBM has been investing in AI for many years, long before the ChatGPT Generative AI breakthrough last year.  Watson has been winning on Jeopardy and beating chess grandmasters for decades.  Now the company has rapidly moved to reorient Watson to address AI models and governance and use the company’s strong presence in technology consulting to assist other organizations with their own AI needs.  We have to admit we got a little lucky with IBM becoming an AI stock.  Our investment thesis was built on a return to growth after a new CEO prioritized the company’s acquisition of Red Hat that created growth opportunities in hybrid cloud.  Hybrid cloud happens when an organization uses combination of public cloud services like Amazon’s AWS with their own servers or internal cloud.  IBM was perfectly positioned for hybrid cloud thanks to its strong market share in privacy dominated sectors including health care, financial services, and government.  Hybrid cloud continues to be a driver of growth for IBM.  AI adds a second high-growth area and adds a lot of excitement for investors.  Even after the runup in the stock this year, we still find the shares undervalued at 18x 2024 earnings estimates and 15x free cash flow.  Both these measures are discounts to the market when IBM is growing faster than the average company with a clearer line of sight to future growth.  Management credibility has also gone way up as a result of the successful restructuring of the company to growth vectors and consistent execution as evidenced by beating free cash flow guidance against a skeptical analyst community.

T-Mobile USA (TMUS): TMUS continues to at least hit all of its financial and operational guidance.  4Q23 saw subscribers, revenue, EBITDA, and free cash flow all grow again at multiples of its peer wireless and cable competitors.  We still like the shares, but the investment thesis is transitioning.  Previously, we expected regular beat-and-raise quarters because of the company’s innovative marketing as a value wireless service, and better-than-expected synergies from the acquisition of Sprint. We also anticipated a big increase in share buybacks and the establishment of a dividend.  TMUS showed far superior growth to the wireless and broadband industries over the last couple of quarters, but subscriber and financial growth was in line with elevated expectations.  We expect more of the same with TMUS steadily gaining market share leading to double-digit growth in EBITDA and greater than 20% gains in free cash flow.  With cable and wireless peers growing low single digits, TMUS remains an attractive investment on a relative basis.  Absolute performance should be helped by continued aggressive share buybacks.  We expect another big buyback announcement later this year.  The main risk is aggressive competition that leads to discounting.  Right now, however, wireless promotions are at nadir as each of AT&T, Verizon, Comcast, and Charter Communication have reason to harvest profits.  TMUS faces no internal pressures and can happily grow in a stable competitive environment.  We don’t expect TMUS shares to rocket higher, but the ability to grind out steady gains and provide defense should the stock market enter a correction make the stock an attractive investment for the year ahead.

Alphabet (GOOG/GOOGL): GOOG met targets for most financial measures in the fourth quarter, but the compositions of revenues caused a shortfall against elevated expectations.  Revenue actually beat expectations, but the upside came from subscriptions like YouTube TV and Music when investors were looking for a positive surprise in digital advertising at Search and YouTube.  Both divisions reported another quarter of accelerating growth, but investors wanted more after analyst checks indicated upside was possible.  Continued good expense control allowed operating income and EPS to slightly exceed consensus estimates.  Free cash flow fell short but only due to a large tax payment management had alluded to on the third quarter earnings call.  The bull-bear debate for GOOG revolves around the impact of AI on Search.  Bears believe that AI chat products like ChatGPT or Google’s own Bard will take a material share of search queries and hurt monetization of Google Search which is the company’s dominant product.  Furthermore, the cost to compete in a new AI era could be higher, pressuring Google’s margins and return on capital.  Two aspects of the 4Q23 report stoked bearish sentiment.  First, the fact that Search revenue did not positively surprise despite checks could be an indication that Search market share is shifting to AI chatbots.  Second, management announced a large increase in capital spending to support the company’s AI efforts, a sign that return on investment might indeed be lower in the future.  These two points plus the huge runup in GOOG in 2023 (up nearly 60%) dominated trading and overwhelmed an otherwise good earnings report, leading Alphabet shares to fall 7% following the report.  In the near-term, it may be hard for the company to disprove the risks as the AI transition is early.  Earnings also face tougher comparisons later in 2024, and many observers think Alphabet is going to lose the antitrust case filed by the DOJ.  Thus, the short-term setup for the shares has headwinds.  Northlake invests on a multiyear time horizon.  We think bearish investors are underestimating Alphabet’s leadership in AI, which has been integral to the company’s product, services, and operating execution for many years already.  We believe Alphabet will ultimately be an AI winner, setting the stage for a return of the shares to a premium valuation.

IBM, TMUS, and GOOG/GOOGL 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.