The Lex Newsletter: earnings will bring tech stock rocket back down to earth

Dear reader,

After the remarkable rise and fall of tech stocks in the past two years, the general assumption is that 2023 will be fine. Not a blowout, nor a blow-up. Yes, the sight of SpaceX’s latest rocket suffering a “rapid unscheduled disassembly” on Thursday was ominous. But optimism about IT spending and prospects for artificial intelligence is keeping spirits high.

Netflix started things off with news that it had added subscribers in the first quarter — a bonus after the shock fall last year.

News that Netflix is closing its DVD service led headlines. Cracking down on password sharing in an effort to lift revenue will have a greater impact. Lex is also keeping a close eye on Netflix’s gargantuan content obligations — the amount it plans to spend on films and television shows. It is worth noting that this number is falling. Will spending less put off future viewers? It’s a gamble that depends on rival streaming services taking the same path.

In reality, the Nasdaq Composite is up 17 per cent this year, mostly because interest rates seem to be on hold. But tech companies have also ruthlessly culled jobs in order to present themselves as financially responsible. The biggest are still sitting on mountains of cash. Mergers and acquisitions may be coming later this year — if heavy-handed regulators don’t nix plans.

Will that spur the moribund market for initial public offerings too? There are some signs of life. New York-based online ticketing company SeatGeek is reported to have filed to go public. There are several companies with multibillion-dollar valuations sitting on the sidelines, including Reddit, Stripe, Instacart and Discord.

Lex thinks chat app Discord’s subscription-based revenue marks it out for potential success. Revenue was reported to have exceeded $500mn in 2021. It may be closer to $800mn or $1bn this year. Compare that with Twitter subscriptions, which are estimated at just $28mn. For now, however, Discord remains lossmaking. If it could show positive cash flow before seeking an IPO, that would encourage extra interest.

Pharma drama 

In pharma, M&A is already on fire. This week, US pharmaceutical company Merck announced it would acquire Prometheus Biosciences for $10.8bn, following in the footsteps of Pfizer’s $43bn deal for Seagen and Amgen’s $28bn acquisition of Horizon Therapeutics.

Merck is paying $5bn more than Prometheus was valued at three days before the bid. But Merck needs to find new drugs as blockbusters roll off patent — as cancer treatment Keytruda will in 2028.

In the UK, GSK followed the same pattern with its $2bn acquisition of Canadian biotech Bellus Health — double the undisturbed price. GSK is using the funds it reaped from spinning off consumer division Haleon in order to add new drugs to its pipeline. Bellus has camlipixant, a chronic cough treatment, in stage 3 trials. Lex expects more M&A, and higher premiums, this year.

Deposit blight

Morgan Stanley has told analysts it is predicting a pick-up in M&A this year — an attempt to soothe nerves after it reported a near 20 per cent drop in profits in the first quarter.

It also claimed that its mix of businesses helped it to ride out the uncertainty that followed the collapse of Silicon Valley Bank. Elsewhere, SVB’s failure has prompted some existential questions. Given the inherent mismatch between long-term assets and short-term liabilities, are banks that take deposits the best allocators of capital? Blackstone certainly sees an opening in private credit.

Goldman Sachs posted a $470mn loss on the partial sale of its Marcus loan portfolio, conceding that its push for consumer lending had misfired. But it hasn’t given up altogether — and is offering a new high-paying savings account.

US brokerage and bank Charles Schwab announced that its client deposits had fallen 30 per cent from the same time a year ago. Happily for Schwab, however, much of that money moved to its own money market funds.

But for US regional banks, finding profits when costs are rising and regulations are expected to be toughened up is going to be tricky. Even if first-quarter results this week were better than expected, with most posting a year-on-year rise in net income, deteriorating credit quality is worth worrying about. Lex thinks the largest and smallest banks are best placed to ride out the uncertainty.

According to the Stockholm International Peace Research Institute, global military expenditure topped $2tn for the first time last year. Military spending is still on the rise, as the war in Ukraine drives orders for weapons. Look at China’s DJI, the world’s largest drone maker, whose products have been used in the war.

In the US, funding for military research and development rose by a quarter between 2012 and 2021. Yet Lockheed Martin, whose anti-tank missiles are used in Ukraine, reported a drop in revenue and net income last year and another earnings dip in the first quarter. However, that is likely to reverse in the wake of new contracts.

Coronation streets 

On a happier note, the coronation of King Charles III may give British pubs a boost. About 6,600 have shut down in England and Wales over the past decade. High energy prices, high taxes on beer and a general preference for coffee over beer have all played their part. As one reader noted, it fits with a trend of local post offices and bank branches closing too.

But Lex has some comforting words for those mourning pubs. Not every closure is forever — some open under new management or convert to restaurants. Pub sales are rising too — up 5.5 per cent from 2019. Dutch brewer Heineken reported that demand in its important regions in the Americas and Europe was better than expected in the first quarter.

We also have a suggestion for landlords: add more low- and no-alcohol options. It helped in the past. Before the first world war, beer was twice as strong. Milder drinks combated moral objections to public drunkenness. This time they might lure in a few more health-conscious customers.

Other stuff I liked this week

Twitter created the blue check mark in 2009 after celebrities such as Kanye West complained about being impersonated. This week, it began removing them as part of an ill-judged attempt to strong-arm users into paying. I loved this funny obit to Twitter from one addicted user at the New York Times: “It’s possible the party will stretch on until sunrise, when the more sensible guests will return. But for now, someone just turned up the lights, and it’s probably time to ask ourselves: What exactly have we been doing here for the last decade and a half?” 

Even social media influencers are talking about the harm that constant scrolling and parasocial relationships can do, according to this article on “meta-content” from The Atlantic.

“If data really is the oil of the 21st century then Michael Bloomberg is today’s John D Rockefeller.” Bloomberg contemplates life without its founder in this FT article from Robin Wigglesworth.

Enjoy your weekend,

Elaine Moore
Deputy head of Lex