- Amazon, Alphabet, Microsoft and Facebook’s Q1 weighted-average capex exceeded consensus by 40%.
- We expect accelerating capex investments to continue since it is part of a broader trend.
- This trend raises multiple questions for investors. In this article, we raise two.
Last week, ending April 27th, was an extremely important week for the technology sector, as we discussed on our blog. Tech earnings really picked up last week as four out of the five largest (by market capitalization) U.S. tech companies reported earnings (or four out of the ten largest companies in the world): Alphabet (GOOG, GOOGL), Microsoft (MSFT), Amazon (AMZN), and Facebook (FB). There are a lot of information to digest, but one observation really stood out to us: big tech companies are ramping capex. Furthermore, we noticed that this is part of a broader trend and expect this acceleration to continue. We believe every tech investor should be aware of this phenomena and ponder its implications.
In this article, our aim is to first demonstrate that this phenomena is real and then consider the questions and implications of this trend.
Tech Giant’s CY Q1 Capex vs. Consensus Estimates
The easiest first step to see that large tech companies are accelerating capital expenditures (“capex”) is to look at their actual calendar year (“CY”) Q1 capex vs. consensus estimates. As mentioned previously, four of the top five tech companies reported last week, so this information is still being digested by the broader market. Three of the four tech giants that reported last week spent significantly more in capex than expected, with the weighted average beating consensus by an incredible 40%:
|CY1Q18 Capex vs. Consensus, $M|
|GOOG||$ 7,299||$ 3,501||108%|
|MSFT||$ 2,934||$ 2,558||15%|
|AMZN||$ 2,727||$ 2,389||14%|
|FB||$ 2,812||$ 2,858||-2%|
|Total||$ 15,772||$ 11,306||40%|
|Source: ZenAnalyst.com, FactSet, company reports|
Capex Ramp is Part of A Broader Trend
Although the tax reform may have helped capex spending marginally for these tech giants, we believe the capex acceleration is part of a broader trend.
As you can see from the chart above, Alphabet’s capex number was the biggest surprise at over double consensus estimates. In its Q1 earnings call, management said that the large capex number in Q1 was evenly split between compute capacity and facilities, citing their need to support Google cloud, AI, Assistant, and YouTube, and preference for owning real estate over leasing.
Alphabet’s CFO said that they “remain focused on investment to support long-term revenue and profit growth” as they see “very compelling opportunities” that will create shareholder value, which suggests to me that a large part of this significant capex increase (even excluding the acquisition of Chelsea Market) will be recurring. In fact, as a % of total revenue on a trailing 12-month basis, Alphabet’s capex has increased from 7.9% in CY Q1 2012 to 15.3% in CY Q1 2018:
In its CY Q1 earnings call, Microsoft’s CEO cited “tremendous opportunity” in the “intelligent cloud and the intelligent edge” (i.e. AI) and that they are “realigning our entire engineering organization to accelerate innovation”. Microsoft’s CFO said, “We increased capital expenditures on a sequential basis with $3.5 billion invested to support current and future growth of our cloud offerings”, and they expect “sequential growth in capital expenditures”. For FY19, the CFO said, “We will continue to grow our investment and capital expenditures to meet the growing demand for our cloud services.”
Tech investors will know that Microsoft’s cloud is the solid number two after Amazon, and the company has invested aggressively in this business. As a % of total revenue on a trailing 12-month basis, Microsoft’s capex has increased from 3.2% in CY Q1 2012 to 9.4% in CY Q1 2018:
As for Amazon, we already noted in our July 2017 article, Amazon Bears Will get Crushed, that investors should not fear Amazon’s plan to ramp up investments and capex. As of Q1 2018, they are still in their planned investment phase. In its Q1 earnings call, Amazon’s CFO noted that they continue to invest heavily in Prime, Advertising, and AWS (cloud). Yet, Amazon’s accelerating capex investments didn’t begin in mid-2017 – it is part of a much longer trend. As a % of total revenue on a trailing 12-month basis, Amazon’s capex has increased from 3.7% in CY Q1 2012 to 6.2% in CY Q1 2018.
With capex coming in roughly in-line with consensus, Facebook is the only tech giant that didn’t beat capex expectations last week. It is still worth noting that Q1 capex growth outpaced revenue growth at +121% y/y vs. +49% y/y. However, in its Q1 earnings call, Facebook revised its FY18 capex guidance up to the high-end of its previous range, to $15B, “driven by investments in data centers, servers, network infrastructure and office facilities.” Furthermore, Facebook “also expect continued growth in capital expenditures beyond 2018 to support global growth and ongoing product improvements.”
The longer-term capex trend is less clear for Facebook vs. the other tech giants discussed above over the same time period (Q1 2012 through Q1 2018). However, since hitting a bottom of 14.0% in Q2 2015, Facebook’s capex as a % of revenue increased to 18.6% in Q1 2018. The increased FY18 capex guidance and commentary for out-years suggests that this acceleration will continue:
Capex Acceleration And The Questions It Raises
The trend of increasing capex investments by the tech giants raises many questions for the broader market, but we want to focus on two. The two questions are somewhat contradictory as the first question deals with the issue of “too much dominance”, and the second question deals with the issue of “too much competition”.
First, every one of the four tech giants discussed in this article posted strong Q1 top-line results, and every one of them spoke of the exciting opportunities ahead of them that justifies their increased capex investments. It is clear that they are all doing great as they compound their respective competitive advantages. However, investors who followed the tech market closely will notice the increasing backlash against their dominance. We’ve already written about Facebook and Amazon’s challenges on this front. Meanwhile, Google has been gaining unwelcome attention from regulators and the media. Microsoft has not received as much negative attention recently, but their history with anti-trust regulators is well documented. These are dominate tech companies with a lot of money at their disposal to invest in the future, but the question now is how much further will society allow them grow.
Second, as you may have noticed from their earnings calls, AI and cloud compute infrastructure (including cloud) are common areas of investments for all four companies. Each of these four tech giants have dominated their respective niche (e-commerce for Amazon, social media for Facebook, search for Google, and enterprise productivity software for Microsoft), and they are increasingly running into each other as they seek growth. We have also written about Amazon’s growing advertising business, which is encroaching on Google and Facebook’s territory. Amazon, Microsoft, and Google are each trying to dominate public cloud industry. All four companies are locked in a bidding war for AI and engineering talent, and all four are getting into the consumer electronics business. The question for investors in these tech companies is if they have already largely exhausted the opportunities in their niches, and that incremental growth will be increasingly dependent on competitive markets. If this is true, the implication is that the increase in capex is here to stay, but without the expected profits as each tech giant tries to outspend the others.
These are difficult questions to answer and beyond the scope of this article, but we encourage investors to realize the broader trend of accelerating capex investments by these tech giants, and consider its various implications.