Meta Platforms (META): After rallying from under $100 in the fall of 2022 to over $500 this year, META faced high expectations for its 1Q24 report.  The first quarter results were good but did not offer the big upside surprise investors had gotten used to.  Guidance for the second quarter and full year was good but not good enough for short-term traders.  This combination of reported results and guidance led to a 15% drop in META shares.  The digital ad market remains strong but foreign currency and lapping a big pickup in growth in 2023 led management to indicate the top line growth outlook would moderate.  Regarding costs, management raised the low end of its operating expense range, a change from the usual pattern of lowering expense growth.  Much of the expense growth was due to elevated depreciation from another big step up in capital spending related to AI investments.  Significantly, CEO Mark Zuckerberg warned that the higher AI spending would not lead to new sources of revenue in the near-term.  META is already an AI leader and benefiting from better engagement and ad placement, so we believe he was being conservative.  After a very rough stretch from mid-2021 until late 2022. Zuckerberg has gained much credibility with investors. One of our first reactions to the conference call discussion of AI spending and opportunity was that Zuckerberg is spending some of his credibility chips to sustain and enhance META’s AI leadership.  Despite the slightly weaker than expected revenue forecast and higher expense guidance, earnings estimates did not come down much.  META is expected to earn $20 in 2024 and $23 in 2025.  We had been in the bullish camp for earnings thinking $25+ was likely in 2025.  Following the big decline in the shares, the stock trades at less than 20 times 2025 estimates, about in line with the broader market. META’s leadership in digital advertising and AI is worth a premium valuation, which we expect to re-emerge later this year as it becomes apparent that revised estimates are conservative.  The primary risk is for a market-wide setback in expectations for monetization of AI initiatives.

Alphabet (GOOG/GOOGL): In contrast to META, expectations at GOOG/GOOGL were low.  The company is clearly an AI leader and has been using early versions of AI for several years to drive growth in Search and YouTube.  However, Microsoft and OpenAI/ChatGPT beat Google to market with Generative AI and Google’s initial efforts had some missteps.  A growing bear case for GOOG/GOOGL is that Generative AI like ChatGPT is a threat to Search as it siphons inquiries from Google and is more challenging to monetize than Google’s list of links.  None of this bothered GOOG/GOOGL in 1Q245 as earnings below past expectations across the board.  Search and YouTube and Cloud all accelerated ahead of estimates.  Management never announced a big headline expense control program but operating expenses were lower than expected, leading to a big positive surprise on profit margins.  The mantra at GOOG/GOOGL has been a “durable reset” of the expense base.  It’s not fancy but it is clearly working.  The AI discussion on the conference call was much improved from recent quarters with greater focus on the fact that the company has a multiyear history of AI success and a leadership position in Generative AI and is already monetizing its efforts.  The improved focus and tone are important because like META, GOOG/GOOGL announced a big increase in capital spending related to its AI efforts. GOOG/GOOGL shares responded well to earnings, rising as much as 12%.  The stock has a higher P-E than META at 21 times 2025 estimates.  Valuation is in line with history on a relative and absolute basis.  Market loss to AI in Search and multiple regulatory investigations and lawsuits are risk factors.  We will take the risk and continue to support a multiyear bullish outlook for GOOG/GOOGL shares.

IBM Corporation (IBM): IBM reported slight upside to EPS on better profit margins even though revenue fell barely short of consensus estimates.  The company also announced a multibillion-dollar acquisition of a company with recent inconsistent growth but clear synergies with IBM.  Taken together, investors were unimpressed and the shares pulled back 10% after a big run from $120 to $180 in the past twelve months.  The culprit for the revenue shortfall was the company’s consulting business which had held up much better than peers recently on industrywide weakness.  IBM’s AI efforts continue to grow nicely with AI bookings over $1 billion up from $400mm during last quarter’s update.  AI has helped each IBM segment including software, consulting and infrastructure.  Infrastructure is almost entirely mainframes used by giant organizations valuing privacy like government, health care, and finance.  The need for AI to have massive computing power is helping this business.  1Q24 is the first disappointment at IBM in the past year and undercuts the return to growth story that is the core of our investment thesis.  We do not think it is death knell, however.  Burgeoning AI model and observation efforts around Watson, acceleration in Red Hat software, and consulting for the AI transition each offer long-term growth that has long eluded the company.  We think 1Q24 is blip but the next couple of quarters need to get on track.  Fortunately, free cash flow for this year is off a good start (an important item for investors) and the stock pays a healthy 4% dividend yield while we wait. After the pullback, IBM shares are back to a material discount that we do not think is justified given the company’s return to long-term growth.

T Mobile USA (TMUS): TMUS reported 1Q24 results a little ahead of expectations and raised the low end of all the key operational and financial performance measures.  The only blemish was a small shortfall in revenues due to low upgrade rates of smartphones.  Equipment is not important to the story relative to revenue from wireless services.  TMUS continues to gain share in wireless phones but looking at AT&T and Verizon and the cable resellers, it appears that new subscriber additions are slowing.  This puts pressure on TMUS and competitors to keep churn down.  Fortunately, that appears to be the case.  In a good sign for future financial performance, service plan prices are going up indicating the promotional environment is stable.  These industry fundamentals tie into the fact that the TMUS story has transitioned from a “beat and raise” theme to a steady, above average growth.  Northlake’s investment expected this transition.  TMUS looks more like blue chip leaders such as Apple, Alphabet, Walmart and Home Depot.  Steady market share gains, above average growth, low debt, and high free cash flow are the hallmarks of a good long-term investment.  An investment that can ride out the inevitable corrections that come with any stock.  Transitions can be tricky in the short-term though when traders see slowing growth and decelerating momentum.  We believe TMUS will navigate the transition well as long as it continues to gain share of wireless users and the industry’s promotional cadence is stable.  This is our forecast for the balance of 2024.  TMUS are valued primarily on EBITDA and free cash flow where the shares hold a premium to cable and telco peers.  We think the premium has been well earned through consistent execution.  We are watchful due to the investment thesis transition but remain comfortable with TMUS as a core holding.

META, GOOG/GOOGL, IBM, and TMUS 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.