This guest commentary was written by Mike O'Rourke of JonesTrading. This piece was originally published on 8/2.
FANG (Facebook, Amazon, Netflix & Google) has been the market darling for over three years. Its reach and excitement expanded to two of the largest companies in the world, Apple and Microsoft, creating what we call the Fab5 and others call FAAMG (Facebook, Apple, Amazon, Microsoft and Google). Apple has consistently been a strong grower for the past 15 years and Microsoft has experienced a renaissance shifting to the cloud and social media through its LinkedIn acquisition. Lacking the two older and larger behemoths (Apple & Microsoft), FANG is considered the more speculative of the two acronyms. The combination of faster growth and lower, or in some cases minimal, net income reinforce that market perception.
Over the past 3 years, FANG has nearly doubled from approximately 4% to nearly 8% of the S&P 500 (chart below). Over the same time period, FANG has grown from a combined market capitalization of approximately $700 Billion to $1.7 Billion (chart below), its value compounding at more than 30% per year. The market capitalization of the group has risen 33% in 2017 alone.
FANG has been larger than life. As a collection of organic hyper-growers in a low growth world, earnings have been a less import, secondary factor. The group has also been impervious to certain negative developments. During this earnings season, there have been developments on the periphery that merit investors keeping a close eye on the group for signs that its incredible run of momentum is due to take a breather.
Over the course of the past 12-18 months, Facebook had multiple separate incidents during which it revealed its ad metrics were inaccurate. That prompted some thoughts that digital advertising is a black box, but there was no meaningful reaction in the shares, in fact, they continued to march higher. This past spring, several large brands pulled their advertising from Google’s Youtube.com because the ads were sometimes placed prior to offensive videos and there was no way to monitor the placement. Once again, it was a non-event from a market perspective as the shares hit new all-time highs in May and June. The combined valuation for FANG peaked on July 24th, the day Google reported earnings.
Google’s shares traded lower the next day. The other key date was July 27th, a strong but very short lived intraday pre-earnings push higher in Amazon’s shares temporarily made Jeff Bezos the richest man in the world. Amazon’s shares traded off following its earnings report. As such, the two larger members of FANG began to experience profit taking following their earnings releases. Facebook and Netflix both reported earnings that were well received by the market.
Facebook’s earnings were on July 26th and the shares traded up 6% early the next day, before dropping 4.5% through today’s low. Despite Facebook’s earnings beat, it is Procter & Gamble’s earnings call on July 27th that has garnered attention. Procter & Gamble is the world’s largest advertiser. P&G revealed that:
“In the fourth quarter the reduction in marketing that occurred was almost all in the digital space. And what it reflected was a choice to cut spending from a digital standpoint where it was ineffective. Where either we were serving bots as opposed to human beings. Or where the placement of ads was not facilitating the equity of our brands. Importantly, as we made those decisions and put our money where our mouth has been in terms of the need to increase the efficiency of that supply chain, ensure solid and strong placement of individual ads, we didn't see a reduction in the growth rate. So as you know we delivered over 2% organic sales growth on 2% volume growth in the quarter. And that, what that tells me is that that spending that we cut was largely ineffective.”
This is something Procter & Gamble foreshadowed back in January. The last thing anyone in the digital advertising space (where Facebook and Google combine for 60% market share) wants to hear is that P&G found the spending it eliminated made little difference. Those black box concerns about digital advertising begin to return to the forefront and fears arise that others may follow P&G’s move.
The last member of FANG, Netflix, was the first to report earnings. They were well received and shares have sustained the overwhelming majority of its sharp gains. The company also has had its share of negative press recently.
Over the weekend, the Los Angeles Times published a story titled “Netflix is on the hook for $20 billion. Can it keep spending its way to success?” The story highlights that the company has accumulated $4.84 Billion in debt and $15.7 Billion in streaming content obligations.
It may be the Content Cost 2.0 theme taking hold. Content Cost 1.0 was back in 2011. From July through November 2011, shares dropped 80% primarily on fears that the company’s content costs rose too rapidly. At the time, costs increased 800% over the course of the year to $800 million and the obligations over the next 5 years were $1.3 Billion.
Netflix was then a $15 Billion market cap company that declined to $3.6 Billion. At that time, revenues were just shy of $3.2 Billion relative to this year’s forecast for $11.5 Billion. The momentum behind these names has been so strong for so long it is hard to know if the tide is turning.
That being said, these stories appear to be taking hold and some weakness has begun to emerge. We would be watchful to see if these themes gain additional sponsorship, because new weakness in these names will have serious ramifications for the broad market.
This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.