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Transcript:
Daniel Newman: Hey everyone, it’s Friday and we are back for another episode of The Six Five Podcast. I’m your host today with my super smart, handsome vest wearing podcast partner, Mr. Patrick Moorhead. I was going to try to do a pickle pepper thing and I failed miserably, but it is episode 153, and there is a lot going on today. Patrick, how goes it for you?
Patrick Moorhead: I am doing great. Thanks for asking. A little bit spicy today, as we discussed in the green room. It’s been a very productive week, a lot of stuff coming out. People still pretty much asking about the impacts of the economy and what’s going on. But I’m glad to be here. This is my favorite thing to do on a Friday.
Daniel Newman: It is my favorite. It’s been a big week. There’s been a lot of earnings this week. There’s been some news this week. We’ve got some economic data in this week. After kind of a fast, furious technological start, CES, NRF, lots of early in the year product announcements and momentum. We’ve hit that kind of end of the month, where you’ve got crazy earnings palooza. You and I kind of always joke like, “We don’t love doing earnings, but it is kind of the ground truth moment.” And as of two years ago, it was all up, up, up, up, and now it feels like everything’s d-d-d-d-down. But you know what? It wasn’t all bad. Some of the companies did quite well, so we’ll talk more about that today.
We’ve got a action packed show. We’re going to be talking about Salesforce and an activist investor. We’re talking about Microsoft and OpenAI’s deepening partnership. Then we’re going to hit earnings, Microsoft, SAP, Intel and IBM. And we’re going to talk a little bit about what maybe the market should be, how they should be thinking about what’s happened in the past week.
If this is the first time watching our show, The Six Five is all about analysis, light on news, deep on analysis, six topics, five minutes each. We love our community, so I’ll ask you now, and I’ll ask you at the end, hit that subscribe button. But I do have to give that little disclaimer, especially this week, when we do talk about a lot of earnings. This show is for information and entertainment purposes only. So while we will be talking about publicly traded companies, please do not take anything we say here as investment advice. In fact, as Patrick always likes to say, “Do the opposite.” All right, so rock and roll, Pat, why don’t I call your number first? Let’s talk about Elliot Management storming the doors at Salesforce.
Patrick Moorhead: So Dan, for the past couple years, you and I have talked on and off about activist investors taking big stakes in companies that they think they can run a play on. And for those who don’t do a lot of investing, essentially, an activist investor looks at a potential victim, somebody that they think they can come in and buy a certain piece of the company, which gives them rights to either suggest to bring in a new board, make a lot of changes, get into a proxy battle. Elliot Management is a big one. Starboard is a big one as well.
And this week activist investor Elliot Management joined Starboard in targeting Salesforce, to go after, essentially, to get them to do things and then the stock goes up, and then they sell. That is the grift. So really kind of got me thinking, if you look at, again, we’re not equity analysts, we’re industry analysts, over the past year, Salesforce stock is down 22%. Now a lot of other stock is down. Five years, the stock is up 50%. But I do think that people have the right to question, let’s say, organic growth versus acquisitions that the company has made, like Slack as an example.
My recommendation to Salesforce is, first and foremost, don’t over rotate on this. They came in… It’s interesting, Elliot wrote this love note to Benioff that they did publicly, talk about how much they respect him, and what a great company he has built, and how they followed him for so long. And I think that’s typically just BS just to show that, “Hey, we’re not going to be hostile. We’re going to start nice, before doing a complete broadside on you.” And it’s important that Salesforce and Marc Benioff don’t under rotate either, and ignore it. Because what happens is companies like Starboard and Elliot, they start to raise the heat over time.
We’ve seen this at Apple. We’ve seen this at Qualcomm. We’ve seen this at Intel. We’ve seen this at a bunch of other companies. So I’m going to be watching this very closely about how this rolls out. Salesforce is an easy target, right now. Where you had the CEOs in play, you’ve had multiple senior executives stand down. That 25% growth rate that just seemed like guaranteed went down to 14, is expected to go down to 9%. Mark Benioff spends a lot of time in the limelight, that’s not necessarily tech. So it’s going to be interesting to watch.
Daniel Newman: I think the last several months have been refocused months for a lot of companies, and we’re in a refocus period for Salesforce. The company did a lot of inorganic growth. It’s well documented. You and I both published some various pieces about this. I think they made some good acquisitions. Companies like Tableau were a very strategic acquisition in a world where data and the ability to visualize data is going to be paramount in the long term.
The company’s been very sort of siloed in how it’s told its story, Service Cloud, Sales Cloud, Marketing Cloud. And I think what’s happening is there’s sort of these capillaries that need to run between the veins and arteries, and it’s going to be one of these moments where the company needs to retell its story again as a more horizontal story, and not in these kind of silos. Elliot coming in, I’m not sure how much value it really adds to the company right now, but I do think it’s a reminder that even the companies that look the most stable, and like you said, consistent growth, can very quickly become targets of an activist.
But I think if you look at an Elliot, this is a much sort of longer term safe play, and I know that they’re going to try to make this move in the short term, but I think it’s going to take a few quarters. The math is pretty simple to me. You’ve got workforce reductions everywhere. Salesforce is a subscription service in most cases, which means less people working, less seats, it’s going to be harder to show growth. So they’re not only growing against a slowing, but they’re growing against actually having reduction in utilization of their subscriptions. And then now you’re going to have to see those people added back.
Now, just like semiconductors go through troughs and peaks, you’re going to see a similar thing here. We’re seeing workforce reductions. We’re waiting for the Fed to cut rates, when the Fed starts cutting rates, stocks are going to go up, companies are going to start hiring fast growth is going to come back to the economy, and SaaS numbers are going to go up.
Salesforce has more competition, there’s more SaaS out there, there’s more cloud-based solutions out there. So they’re going to, of course, be under some level of pressure, but I actually think the acquisitions they’ve made could bear fruit, but that’s up to them to make it happen. Slack for instance, for the last two years, I’ve been advising, “you’ve got to tell a better story. Microsoft Teams are going to eat your lunch. Here’s a better approach to it.” They’re listening, but there’s been a lot of turnover, a lot of change, new leadership in the Slack group, and they haven’t quite gotten Slack first to be Slack first. But I do-
Patrick Moorhead: No.
Daniel Newman: 280 million users, it doesn’t take a huge chunk of market share to be won over by Salesforce to make a difference. Elliot will put some pressure on Marc Benioff, but I don’t see him as the type that’s going to cede a lot of power or control to an activist investor. He’s built the company to a very, very sturdy and stable point. The market largely does respect him, and if he does, to your point Pat, get back in the chair and show that he, now without Bret Taylor, now without Stewart Butterfield is willing to lead the company the way a company needs to be led, I think he can get it back on the right track. So-
Patrick Moorhead: There’s been a lot of folks who have kind of bounced back. Michael Dell “retired” and then came back to take the helm. I mean, we’ve seen, I mean, Steve Jobs came back. Michael-
Daniel Newman: Michael goes in and out of the company.
Patrick Moorhead: Has he actually gone out though? I mean-
Daniel Newman: Well, not really, but I mean he certainly seated a lot… I mean, he hired two CEOs to not be running the company. But what I’m saying is whenever it gets tough over there, he suddenly shows up again with a new concept, a new idea, and he reinvigorates his audience and his customer base, and off they run. I think Marc will probably be fine. Actually, I’m certain of it.
So, yep, I think you some good analysis there, Pat. Let’s dive into another big piece of news before we kind of get to the earnings run here on the show. And that’s the Microsoft/OpenAI. So we all kind of had heard about the $10 billion investment that was planned for Microsoft in OpenAI, and so that one kind of deepened this week. Pulling up some notes here, I’ve got a research note that I’m finally going to get published, took me a little while. But they, basically, finally announced that the partnership has been expanded.
And what does this really mean? Well, what it really means is that Microsoft not only is investing the $10 billion, but it’s looking to democratize. I think as you know, every company on the planet is using some Microsoft software, whether you’re running Windows, whether you’re using Office, it’s pretty much pervasive. Well, OpenAI and it’s potential, is really in its earliest days. We’re hearing a lot about ChatGPT. And ChatGPT is interesting and powerful. There’s a lot of ethics and use rights and content rights that need to be explored further, especially in using it in the open domain.
Interestingly, Pat, my daughter came home and I guess it’s a whole ethics thing now in the high schools, because guess what kids immediately started doing when ChatGPT came out? Is they’re all cheating, on everything. And the bottom line is it is pretty much an enabler. But just as fast as they’re able to learn to cheat, there will be AI tools set to help catch them to cheat on different things.
But long and short is there’s a much bigger and more opportunistic part of the partnership with Microsoft and OpenAI, and that’s the more democratization of the OpenAI technology throughout the Microsoft portfolio, which is the Microsoft advantage. And then, of course, how this can potentially translate to other tools and technologies in the Microsoft ecosystem. Microsoft, some of the first things they’re looking at doing is supercomputing at scale. They’re looking at creating kind of AI powered experience, what they call it in the Azure AI, OpenAI services that’ll go across the portfolio. And then of course, this is the big Microsoft moment, that’s going to be the exclusivity of its cloud partnership, which means OpenAI will be running in how many clouds Pat?
Patrick Moorhead: One cloud.
Daniel Newman: One could. Sorry, I just felt so cool to do that. I was kind of getting your crowd, when you go on stage-
Patrick Moorhead: Also see if I’m paying attention, I get it.
Daniel Newman: No, I actually… Where are you paying attention? Because I’m really interesting.
Patrick Moorhead: I was.
Daniel Newman: So anyways, a couple of interesting things that I’ve been thinking about. I think we talked about this, Pat, a couple weeks ago, is the real opportunity for OpenAI is going to be in the proprietary data. So bottom line is we’re already seeing with what people are doing with ChatGPT, and say, I want to write a ethics paper at a 10th grade honor student level, that’s done. You figured it out. It can do it to some extent. As more data becomes available, that.
It’s able to scrape across the web, it’ll keep doing it better. But companies have masses of proprietary data: the data that comes off vehicles, smart city data, the data that lives in our ERP systems, the data that lives inside of our sales data, CX tools, that’s proprietary and unique. So if companies can start to use a tool like OpenAI to rapidly be able to implement meaningful customer journeys, or more intelligently understand customer behaviors, or being able to better understand safety profiles inside of municipalities, that’s going to be a really unique opportunity, where OpenAI as opposed to really extensive and complex data pipelines become more usable.
So I look at this as a democratization of AI as a whole, but also a very thoughtful investment from Microsoft. Because the exclusivity on Azure is obviously going to create a ton of demand for Azure services, and coming off Microsoft’s relatively tough earnings this quarter, which you’ll talk about here coming straight out of this topic, this is kind of what I call a silver lining to what people are saying is slowing growth in the cloud. Because with this partnership, and all the AI that could be done across the Microsoft portfolio and the way they account for cloud, Pat, this should be a way to accelerate their cloud growth coming into the next several quarters.
Patrick Moorhead: Yeah, this story gets more interesting and I don’t know if it’s brilliant communications people, but you and I have managed to talk about these two companies, I think this is our third time. So hats off on dribbling out the content to get us to do that. And that kind of reminds me of a tweet, I wouldn’t call it battle between Yann LeCun and the founder and CEO of OpenAI. But they kind of got into it, where Yann said, “To be clear, I’m not criticizing Open… By the way, Yann LeCun is the most famous AI person out there right now. He said, “To be clear, I’m not criticizing OpenAI’s work, nor their claims. I’m trying to correct a perception by the public and the media. You see ChatGPT as this incredibly new innovative and unique technological breakthrough that is far ahead of everyone else. It is just not.”
Now this is kind of endemic of really, really smart people this notion that just because you might have thought of it first, that that’s where it ends. It doesn’t. I mean OpenAI and now Microsoft are just telling a bigger and better story. LLMs have been around for a while, and I’m certain that Google and AWS both have something in the oven. Maybe for Google it’s going to be DeepMind, maybe it won’t. But the fact is, between OpenAI and Microsoft, they’re playing their A game.
So what was new here, first thing was, hey, they’re doubling down on supercomputer workloads. There were no details on which ones, but you’d have to think things like drug discovery would be out there to be able to do this even better. They said they were going to integrate it into Microsoft consumer and commercial applications and services. Absolutely no details. Right, Dan?, You and I will be on a fourth, fifth or sixth time talking about what this is. But man, I’d love to see this baked into PowerPoint, baked into Word, baked into Excel.
Today, Google Workspace has a lot of AI features already baked in into their tools, but the ability to go with these expensive LLMs, I’m pretty excited to see what it is. Last time we talked, I’m like, “Hey, where’s the differentiation here? Where’s the mote?” Well, I think there’s a short term mote that you called out, and that’s their exclusive, Azure is the exclusive LLM provider for OpenAI. There was no duration that was announced. There was no money that was discussed. But again, that’ll be for our sixth installment of this that we can talk about.
If nothing else, looking big picture, it has excited people. I mean, I don’t know if this is the new NFT, this is the big investment, where everybody’s going to get rich and everybody’s going to get into, and two people will make money and a million will lose money. But I am very positive though it is-
Daniel Newman: Pat, did you-
Patrick Moorhead: … showing a different look at what you can do with AI.
Daniel Newman: Did you lose money on a NFT scam?
Patrick Moorhead: I did. I did. And I don’t think it was a scam. I mean-
Daniel Newman: I’m joking. You just sound very bitter.
Patrick Moorhead: But, well, listen, I mean all I need is one of my investments out of 10 to hit, and it will do well. But after we both got wiped out in growth last year, I was hoping maybe one would hit. But literally, I mean the only thing I made money on this year is horses. So that’s about it.
Daniel Newman: Cars, horses.
Patrick Moorhead: Cars. No, I mean, cars are losing value. But anyways, I just-
Daniel Newman: I know you mean though the assets you would expect to perform have not performed. So, hey, we got to keep moving here, Pat. I’m going to call your number and let you build on your Microsoft commentary. And that’s Microsoft, they kicked off the week, they sort of set the tone and that’s not uncommon.
Patrick Moorhead: Yeah, it was interesting. They came out with the press release, their stock goes up, they had some great stuff. People are talking about, “Hey, the recession is not touching, everybody got excited.” And then the call came, and the stock went down. I felt a little bit like the rug was pulled out. MarketWatch’s, Jeremy Owens warned on Twitter for people to do that. I didn’t see his tweet, but I’m going to be careful next week when I’m talking about Microsoft here. I mean, here’s the highlights. I mean, revenue up 2%, operating income off 8%, net income off 7%, EPS was off 6%. But I think there are highlights where you would expect there to be highlights.
So first of all, you need to understand there are some things that companies just can’t turn off and you can’t just turn off using Word, PowerPoint to save money. I mean, what else are you going to do? Sure, you could go use some free service, but that’s not going to work in your corporation. Office 365 was up 11%. You’ve got a lot of people getting laid off.
Where is the first place they’re going to go? They’re going to LinkedIn, right? Sessions were up 10%, record engagement. Microsoft 365 subscriptions we’re up 12%. Again, when it comes to something like ERP, you can’t turn that off. And we’re going to get into a little bit when we talk about SAP. Actually, I misspoke, Microsoft Dynamics 365 was up 21%, and what else would you expect?
The PCs were down, and they were down a lot, right? Market was down 29%, Microsoft was down 19%, and that was a combination of Windows being down, gulp, 39% on OEM. Little surprised at the Surface decline of 39%, because it was just so much higher than market. But I do know that Surface and Apple MacBook, those two brands go head-to-head, and Apple drove a lot of market share over the last quarter.
Now, I left what people lead with, it seems to be the only thing that people care about related to Microsoft, and that’s Azure. Azure was up 31%, still awesome. They had a tough compare though, that’s down from 46% year on year, but they did slightly better than expected.
One final comment that I thought was interesting that came up in the intelligent cloud portion was that energy cost increased. And I don’t remember seeing this in any other disclosure for a major cloud company, but makes sense, right? Energy’s going up, we’re cutting off certain aspects of energy. We have embargoes of energy over in Western Europe, and they’ve had to switch significantly to different sources, particularly around natural gas. So something that I think I’m going to be watching in the future.
Daniel Newman: You hit a lot of it there, Pat. I mean the energy thing’s very interesting. So is that FX, we’ve seen a little bit of a cooling in terms of the dollar, which has actually been a bit of a tailwind for these companies. It could have been worse, actually, had the dollar been stronger coming into this quarter. You look across the Microsoft, nothing about that kind of fall that came after had to do with really this quarter. Yeah, this quarter’s numbers were actually pretty okay, but the guidance was extremely cautious. And for Microsoft, that’s a change of tune over the last several quarters and the past few years, there really hasn’t been what I would consider much of a cautioning guidance. It’s been generally pretty bullish.
Pat, we keep hearing… We got to make a disconnect from the public equities market and the actual economy. And so remember for a year when the market was still showing good results, stocks were falling. So Microsoft and Amazon, they were showing great growth in every quarter and you and I, because obviously, even as personal, you look at our own portfolios and you’re like, “Whoa, they have these great numbers and yet they’re down 30, 40, 50s.” So you look at that and then you kind of see now when things are actually starting to get bad, most of the pundits would say, “When is the recession going to really be seen?” They talk about the latter part of this year is when we’re going to actually measurably see more of a recession.
Now again, that’s debatable because we make that political, because I think we’ve kind of been in one for a little while now, but you’ve got some certain numbers that prop up or pull down rents and energy that can disproportionately make things like inflation or the economy look strong. For Microsoft, you had a 31% Azure growth, I believe it was, not a bad number. You had a lot of parts of its businesses looking healthy. Dynamics 365 looked healthy. The Team’s number, I mean 280 million active monthly users now. They’ve a absolutely taken that, they’ve barnstormed that industry. And that’s goes back to what I said about Slack and others have not been able to keep up at all.
They’ve got the market pretty well surrounded, and they’re well diversified, so it’s not like they’re overly rotated to consumer. I mean, Surface, when the market was screaming didn’t go up that much. And now the market’s falling, I’m thinking it’s probably not going to fall as hard either, because they haven’t really gone full out on surface and there’s obvious reasons with that tied to Windows. And I know Pat, you follow that even closer than I do.
So the long story long on this whole Microsoft thing is that they will bounce back, and when the economy bounce back they will roar back. Will we have two or three quarters of slowing? Yes, it was bound to happen. And what’s really funny is don’t be surprised if the equity price is disconnected from the fact that Microsoft’s results actually get worse. And the last thing I’ll say is remember when they grow 31% in cloud that that’s 31% over a number that was 40 something percent a year ago that people thought was massive. So they’re growing still in mid-double digits over what was considered to be a massively good result, during what’s considered to be a horrible period in the market. So I don’t know, I just think we’ve lost our mind, but let’s keep going anyway. Let’s talk about-
Patrick Moorhead: Sage words.
Daniel Newman: You want to talk about SAP? Let’s talk about SAP.
Patrick Moorhead: Let’s talk about SAP. You want to call your dad?
Daniel Newman: “Oh, Dad, can I talk about SAP?” Hold on, hold on. It’s for me. Dad said, “Yes.” Dad said, “Yes.” All right, so SAP, another company that kind of came out a little bit soft. Now SAP’s interesting, Pat, because they report overseas and you know, and I get the message sometime in the middle of the night. And I do sleep at night. People-
Patrick Moorhead: Do you?
Daniel Newman: … sometimes wonder if that’s true. I do. I woke up, I looked at the number, I think kind of the whisper number or the whisper versus, Pat, we look at those, and they say, “Miss, miss…”It had a lot of misses. I think it had almost all, but they were all really close. And I think that was one of the things where Wall Street’s just very punitive. And so there is no close, there is no 99%, you either hit the number or you don’t hit the number. And that’s kind of how the market looks at it.
So you look at share price, you got to keep that in mind. But when you look at actual performance, you got to kind of look back and say, “In most classes, including the hardest AP classes on the planet and the hardest collegiate classes you’ll overtake, a 99 is still an A.” So there’s an argument to be made that what SAP did was pretty good. Now, over the last several quarters, Pat. And I’ll tell you SAP numbers are harder to parse than a lot.
Patrick Moorhead: Yes.
Daniel Newman: I find them hard. So let me tell you where I look, and where I tend to look are in a couple of places right now. There’s the logical growth, revenue, and profit and of course you’re kind of looking at how is that? Well 11% up, five at constant currency, gross profit up 10%, 4% at constant currency. So again, growing over what was considered to be good growth during stronger economic periods of time. They kind of do this thing where they put cloud and software together and then they parse cloud out.
The software’s kind of the older part of their business, but the cloud part of their business, and you and I have had a chance to talk to Christian Klein, this is the part of the business that I think investors and market and people that are kind of evaluating SAP really need to pay attention to. Cloud revenue growth, Pat, 33%. You know who grew less than 33% in the cloud? Microsoft. All I’m saying, and I’m not trying to be critical of Microsoft, because 31 was good, but I’m saying 33%, $12 billion number in, and I believe, by the way, are these euros I sometimes get torn. I think they’re euros, but 12 billion euros-
Patrick Moorhead: Definitely not Deutschmarks.
Daniel Newman: … in the cloud, and that’s a 33% growth number with a 27% growth number to their cloud backlog, Pat. So when I’m looking at these numbers I’m saying, “Huh? They’re kind of growing in the right places.”
Now what probably irked some people, and by the way longer term will probably drive the share prices up, is they also announced some restructuring. Now, some companies are calling them RIFs, SAP’s very clear that this isn’t a RIF, this is a strategic restructuring of the business. Meaning, they want to put more resources and spend more dollars on things that are going to pump up their growth numbers. And if their growth is coming in the cloud, then they’re making somewhat of a rotation. They’re kind of cutting back on some areas that have maybe become lagging or slowing parts of the business to put more dollars to use into these other areas.
So that’s going to be something that people are kind of debating on whether it was a good or bad. Pat, I across the board, and this is something you know had a great piece, we did this on the show last week about RIFs and the meanings of them. I hate any individual being hurt. And when you look at these at a micro level, you have to be inhumane to not care about people losing their jobs. But when you back off of companies that are hiring hundreds of thousands of people, it’s not equilibrium of performance across the organization, it’s not equilibrium of talent and skills. Companies that make decisions to try to care for the few, oftentimes, really harm the everybody of an organization. So if you have to cut 3% of your workforce to reinvest in a different skill, a different talent to be able to make sure that other 97% have jobs in the long run, are able to continue to grow in their careers, that’s a decision that had to be made.
By the way, Pat, that used to be done regardless of economies. Companies used to just cut 1, 2, 3, 4, 5% of their workforce every year, because they needed to get the lowest performers out and bring the high performers in. There was a time when I don’t think that was scrutinized. There was books written about it, about what great strategy that is. Somewhere in between lies the truth.
Last number that I think we pay attention to and that’s the share of more predictable revenue. Almost 80% of what SAP does is predictable. At the size and scale and scope they are, that’s pretty damn good. When 80% or so of your revenue, Oracle has a similar number, that’s a really nice predictable way. Now the things you got to criticize, the earnings per share way down, operating profits are falling. This is what they’re dealing with these restructuring. I think we give them a couple quarters to come back, but we want to watch that cloud growth. That’s the long term health of SAP.
Patrick Moorhead: Good analysis, Dan. I don’t understand why the market is reacting like it is. That’s one reason why I’m an industry analyst, not an equity’s analyst. I mean, if I look at Oracle, ServiceNow, Microsoft, and Adobe all up over five days, you’ve got SAP that’s down 2%, and with that cloud growth looking really good. I did talk to a few people that said that some of the financial analysts had used a currency conversion that was there three months ago. So it’s just a complete confusing mess to me. So what I need to do is I need to go back and look at the company kind of holistically and its value propositions.
If you notice they spent most of their time, spending about the entire year, in fact, it was hard for me to find what they actually did just in the quarter. And I kind of had to go back and look at their website in real time. I mean it was hard to figure out actually what happened. One of the biggest announcement was that they said they were going to divest itself of Qualtrics, and maybe that had to do with the funny stock price right now. Given how much SaaS companies are getting hammered, maybe that’s going on.
But their operating expenses will go down and that should be good. And then when you tie this with the rebalancing of the workforce or the layoffs, that should be good for the stock. But I’m really interested to see what the company’s going to do with the cash that they get. Are they going to make smaller acquisitions? What are they going to do with it? Are they going to give it back as dividends? What I’d love for them to do is double down in what they’re doing is investing in these small companies, these small cap even start up companies, kind of like an innovation fund out there. So 33% cloud revenue improvement over the year, 27% increase in the backlog for cloud over 2022, and a pretty good fourth quarter, all said.
Daniel Newman: I do want to throw in one comment, when you labeled off the other companies that were up for the week, and I obviously do a little bit of work with ServiceNow, so I want to disclose that. But that company beat and raised across the board. It beat on [inaudible]. So frankly I think companies that accomplished that probably have a warrant, justification to go up. But by the way, that hasn’t been consistent. But that was one that I just noticed. They’ve actually did beat and raise despite this macro condition. The others-
Patrick Moorhead: How about Oracle, Microsoft, and Adobe?
Daniel Newman: What’s that? Those don’t make sense.
Patrick Moorhead: How about Oracle, Microsoft, and Adobe?
Daniel Newman: That’s why I said, your others were right on. Those two didn’t make as much sense to me. Adobe didn’t report, so they’re just getting some sort of indirect impact. But obviously, ServiceNow just had a really good quarter, so that hopefully would be the driver. Even though they’re PE ratios like 400, and I’m not kidding, it’s huge. All right, let’s go on, Pat. We got two more to go. We got 15 minutes left of the show. Calling out Intel, this was one that required Pepto.
Patrick Moorhead: Intel at a very tough quarter, very tough quarter. So I’m probably going to spend less time in a quarter and more time on long term. But listen, they were down big time. I mean, they missed on every single number expectations, except for the revenue number for data center and AI, lovingly referred to as DCAI. Revenue is down 32%, gross margin was down 14 points, debt income off 92%, EPS off 92%. The guide was 40% lower than what they did previously, and their stock, as you would expect, got hammered.
So couple things going on here. First of all, you’ve got a mixture, a confluence of things going on at the same time. And one thing I want to lead by saying is these semiconductor turnarounds take years. I mean you have design, you have manufacturing. Those could take five years to get… It takes five years to make grounds up design to turn something around. And Intel took a three-year fab lead and put it into a two-year lag, and we had the chance, both of us talked to Pat Gelsinger yesterday, and he committed to the on track for five nodes in four years.
So this quarter, mixture of macroeconomic issues, they’re spending a lot of money making big investments on transformations for areas like IFS. I mean they’re going from a complete monolithic design to a complete modular design. The expense of doing five nodes in four years is gigantic. And what happens when you have a product that kicks in, it hits you hard on cost of goods sold. And the final thing is competitive pressure. AMD is taking share, revenue share from Intel in client and in server.
Now, when I look at the gross margins, and I wish I could see the gross margins in the client business, I believe there’s a price war going on, and Intel is doing a meet comp strategy, which is a big reason why their margin was literally 39%. I think it could have been lower, had they not changed equipment depreciation to three years. So that’s really all I’m going to talk about, about this quarter. I mean it was not good.
So you have to look at what drives a company like Intel. There’s a lot of things that I use as milestones. My number one milestone right now is on their core manufacturing technology, aka nodes. So what did Intel say? Intel four is manufacturing ready, Intel three is on track, 18 and 20 Angstrom, silicon is running the fab, and of a major potential foundry customer, it’s a big deal. Meteor Lake, which is the first disaggregated client product, on for second half, and Lunar lake on track for production readiness in 2024.
Now this is the number one, sure design matters, but when you’re playing catch up here, what Intel is trying to do here to compete with companies like AMD and even Ampere Computing out there in the marketplace is their compute tiles are probably twice the size of what AMDs and Amperes are. Again, I’m just making these numbers up, right now, but when you have larger silicon, you can’t put as many cores on a package. It’s just very simple. Intel is taking a bold approach. I like the approach, using accelerators, but it’s not nearly as easy as let’s say what AMD and Ampere are doing. So I have not lost faith in this company moving forward. If they miss their nodes, I will have my doubts, but as long as they keep on this trajectory, I’m pretty positive.
And the other thing is I think TSMC keeps having missteps, and not missteps in process, but missteps in terms of how they’re dealing here in the US. If FIS gets a toehold on advanced technology in the US, it is going to be ugly for TSMC. Nvidia is already signed up for IFS through RAMP-C and Defense. You kind of know my theory here. I’ll air it again that I think once China invades Taiwan, we’re going to move all… Right now all defense needs to be built out of the us. It’s going to be core infrastructure, energy, healthcare, finance. Basically, the US will establish the same rules that China has had in place for over 20 years for systems, that have to be all China software and all China infrastructure. Not necessarily the chips, because they don’t do leading edge. All right, there we go.
Daniel Newman: Well, you hit most of the important stuff there, Pat, but I’ll kind of add a few comments that I think. One is there was no surprise here. What happened was largely what was expected. This is a challenging period of time for Intel in the market. We all knew, we were already in a semiconductor, we had the glut and now we’re going to have the pullback. We got the inventory challenges. Of course, you had the operational and the ramp issues, you had some positive this quarter with the Sapphire Rapid’s ramp, that looks good. It was good to see some growth from IFS. And of course, Mobileye is doing great, but they really are their own company now. So it’s part of their investment portfolio. And they still own a lot of it, by the way. I think you hit it on the head, Pat.
I got asked by a couple of journalists yesterday about what is the turning point for Intel. And the turning point is this four and three, this very aggressive process strategy, this IDM 2 that Pat Gelsinger has laid out, they’ve got to hit it. They got to hit every single time. And if they hit it every single time and they deliver, they’re going to get back on track for process leadership, and they’re going to reinvigorate confidence in the market. But again, Pat came in with this whole say/do thing, and the thing is now he’s being held to it. And so he’s saying the right things, but the doing is going to take time. And seeing it happen, Pat, you know said it’s a multi-year turnaround. It is a multi-year turnaround. Building a fab is a multi-year process. Getting their toe in on leading edge is something I do believe they’re very capable of doing.
And by the way, not only be because Intel’s doing things right, it will also be because it will be driven by policy. The policy is starting with Defense, but it will become more than just Defense. It will be a technology leadership conversation, and it will be a resiliency conversation. A lot of people think CHIPS Act passed because of the supply chain. And realistically the supply chain brought the CHIPS Act more into focus, but it was always about Defense, was why we needed to bring more leading edge back. And Intels the company that’s best positioned to do it at scale for the leading edge.
So I think long term, there’s a better outcome for the company. They still do have large market share in key markets, and if they can just get to execution consistently, I think there’s a promising future. But it’s going to be a couple of tough quarters, if not longer, before it’s going to really show up in their numbers. Let’s call-
Patrick Moorhead: Do you think that TSMC just is ceding the military stuff? Just saying, “There’s no chance we would ever get that, we’re just going to cede it.”
Daniel Newman: They certainly don’t seem to be stepping up and trying to position around it, Pat, but again, we don’t know what’s behind closed doors. I’m not going to proclaim to know that. But out in the market we’re not hearing from CC or anyone else about how they plan to address the concerns. So all right, we’ve got one more, Pat. I-
Patrick Moorhead: Let’s do this buddy.
Daniel Newman: By the way, international business machines, IBM, we can end on a pretty positive note. So CEO Arvind Krishna, and I had the chance to talk to CFO Jim Kavanaugh on earnings day, and he gave me the run through, and it looks really good. Now, I’ll be candid, it’s sometimes hard when you’re at flat revenue without constant currency to say good. But again, you got to remember this macro situation, it was a good result, 15.7 billion flat, actual 6% with constant currency. And noted, they beat. So they beat on revenue, they beat on guy, I mean, near beat, but it beat the range on guidance up, or on earnings, and then they had pretty good guidance mid-single digit growth to continue into the new year.
Their growth was solid against all segments. And as I’ve said a long time, I mean you and I get to sit down with Arvind last year, he talked about his strategy and you know what? Nothing has really changed. His strategy has been implemented. They’re heavily focused on hybrid cloud and AI. Those are areas that are doing very well. Their growth is coming from high margin areas of their business. Software and consulting is now about 75% of their portfolio. So we saw software up 8% constant currency. We saw co salting up 9% at constant currency. 50% of their $60 billion a year is now recurring, Pat.
They’ve made eight acquisitions, so they’re continuing to take advantage of the M&A landscape. There aren’t big deals, they’re making smart tuck-ins that help them across their portfolio. Hybrid cloud was up 17% at 22.4 billion, and now more than a third of the company’s revenue is hybrid cloud. And Red Hat continues to truck along at mid-double digit, 17 and a half percent.
Could that area grow faster? It certainly is an opportunity to grow faster, but those are good solid numbers, especially within the IBM machine. Margin went up, income went up, they’re delivering great free cash flow for the company. And Arvind came out, and despite all the kind of rumors about slowing and elongated sales cycles, he actually said, they’re accelerating into the end of the year. So as tough as the last one was to discuss, Pat, IBM seems to be in really pretty good shape. So you got to give Arvin a lot of credit, give Jim Kavanaugh and the team.
You and I had conversations with a lot of the executive suite across the portfolio. They’re doing some restructuring, some new people are coming in, that’ll be interesting to watch. They are making some cost cutting measures, they are lowering some headcounts, that was kind of quietly done. But when companies are hitting numbers and making those decisions, that’s usually very long term and strategic in nature. And kudos to IBM on a really solid quarter.
Patrick Moorhead: Yeah, man, IBM, just when you think… I mean, I love a turnaround story. And I had a lot of people ask me, even some analysts, “Hey, why do you analyze IBM anymore? They’re dead. They’re the mainframe company.” And here we are, 6% looks fricking good in this environment. It’s durability, right? You’re not going to see a 25%. In fact, what they committed to the Street was single digit growth. They’re doing exactly what they said. When everybody’s down, they’re up, right? Gross profit of 132 million, net income up nearly half a billion dollars. Investors got a little bit spooked, I think, about the free cash flow forecast. They had $9.3 billion free cash flow for the quarter. And I’m going to put a big exclamation point, reiterate, which you said, “Revenue mix is over 70% software and consulting,” that is fricking awesome.
Now, what it does do is it kind of like pretend they don’t have this robust hardware business than they do. In fact, IBM Z was up 21%. Hats off to Ross Maury out there. Software, I mean, ARR for their hybrid software and services is $13.3 billion. Red Hat was up double digit, up 15%. Again, isn’t it funny how those numbers now look big? But it just shows how durable IBM is as a company and a technology provider.
I mean, heck, consulting at a knockout quarter, right? Revenue is 4.8 billion. Hybrid cloud, revenue, $9 billion over the year. First time I think I’ve seen Azure and AWS got brought up, bookings doubled, margins were up 2% as they amortized some of the investments that they made out there. So all in all a really good quarter. Company’s doing exactly what they said. And in fact, I think outperforming a lot of the kind of high flying cloud first companies that are out there. So kudos to IBM.
Daniel Newman: And there you have it, Pat, busy week, a lot going on, a lot of earnings. And by the way, next week we got more of that. What are we going to have next week, Pat? I believe we have Amazon, we have Apple. I think AMD is going to go out next week.
Patrick Moorhead: Yeah.
Daniel Newman: Google, Alphabet. So we’re going to get more of a flavor here and I’m sure we’re going to come back and hit on the rest of these. But really good show. We covered Salesforce. We covered Microsoft and OpenAI. And then, of course, hit the earnings, Microsoft, SAP, Intel, IBM. It’s a big moment for technology, Pat, and in the end we will tech our way out of whatever storm we are in right now. I do believe in that. Tech is deflationary, that is not going to change. So anyways-
Patrick Moorhead: That’s right.
Daniel Newman: … thanks all for tuning into the show this week. For Patrick and myself, we’d love for you to join our community. Hit that subscribe button, hit those social follow buttons, if you don’t follow. Pat is absolutely prolific on Twitter and I’m not bad either. We appreciate everybody in our community. But for this show, for this week, for this episode, 153, time to say goodbye. Thanks for tuning in.
Author Information
Daniel is the CEO of The Futurum Group. Living his life at the intersection of people and technology, Daniel works with the world’s largest technology brands exploring Digital Transformation and how it is influencing the enterprise.
From the leading edge of AI to global technology policy, Daniel makes the connections between business, people and tech that are required for companies to benefit most from their technology investments. Daniel is a top 5 globally ranked industry analyst and his ideas are regularly cited or shared in television appearances by CNBC, Bloomberg, Wall Street Journal and hundreds of other sites around the world.
A 7x Best-Selling Author including his most recent book “Human/Machine.” Daniel is also a Forbes and MarketWatch (Dow Jones) contributor.
An MBA and Former Graduate Adjunct Faculty, Daniel is an Austin Texas transplant after 40 years in Chicago. His speaking takes him around the world each year as he shares his vision of the role technology will play in our future.
