4 Tech Firms in Transition

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories in the market this week. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: First this week, after what seemed like endless discussions, the ECB finally announces it's QE program. What's the takeaway?

Glaser: This definitely is the biggest story this week, and it could very well end up being the biggest story of 2015.

The ECB will be purchasing 60 billion euros worth of bonds--government debt and some other bonds--every month starting in March and going until at least September 2016. This program is a little bigger than the leaked program and what a lot of investors had been expecting, and it shows that the European Central Bank felt that it had to do something. Given how low inflation was running, given how weak the economies have been--even though they won't admit that they are focusing on economic growth--they had to try to kick-start the economy in some way.

I think that this may have some impact, but it's probably not going to be a cure-all for everything that's happening in Europe. I talked with Bob Johnson earlier this week about it. Europe really has to focus on their structural issues--labor market reforms in France and Italy, dealing with some other underlying issues--to really make the economies look stronger. Just doing a quantitative easing program, just having a cheaper euro alone in a vacuum, is not going to get them all the way there. So this might be one step toward Europe finding its way out of recession, but it's not the only thing that needs to happen.

Stipp: In earnings news, we got several reports this week. Netflix was one of those that continues to be on a wild ride. We saw that again this week as it spiked up after reporting good earnings.

Glaser: We did, and this is one of a few stories this week that showed tech firms in transition and really thinking about their future.

Netflix did jump this week, based on a few things. The first is just that they had a good quarter; they added more customers both in the United States and outside the United States than they expected. But one of the big stories is that they now think they are going to be able to complete their global expansion in two years, and that they are going to be able to stay profitable during this.

Neil Macker, who covers Netflix for us, thinks this is a sign that Netflix is changing the way it's thinking about its expansion, and maybe it is being a little bit more conservative. Instead of coming in with huge blockbuster content deals in every country, they are going to focus on the properties that they own themselves, the original content, and things they already have the worldwide distribution rights for. This is a more conservative way of being able to enter these markets as soon as possible.

I think for Netflix investors, an open question had always been, are they going to be able to execute this global expansion in a way that will maintain their profitability, or is it really just a U.S.-only product. They are showing us some signs that they are going to be able at least to make a play outside of the United States.

But there really is no margin of safety baked into the stock right now, particularly after this big jump after earnings, and investors might want to wait for better entry point, even if they think that Netflix has a bright future.

Stipp: IBM really delivered this week on what they said was going to be a really rough quarter. Their results didn't look good at all.

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Glaser: IBM has not been sugarcoating the fact that the transition they are going through is going to be challenging from a results standpoint. They had withdrawn their guidance earlier in 2014, and we really saw why this quarter, when they had revenue that was down 12%. Now that's only a 2% decline year-over-year when you take out the impact of divestitures and take out the impact of currencies, which seems not quite that dire.

But they are definitely very much in a transition period, as they have been trying to focus on software, focus on areas like cloud and analytics that they think are going to be growing, and get away from some of the hardware businesses that aren't really where the growth in the industry is right now.

I think it's going to take some time for this to happen, though. It's not going to be a transition where you have one or two bad quarters, and all of a sudden you are there. Pete Wahlstrom, who covers IBM for Morningstar, thinks that the shares are in 4-star territory and that a lot of these worries have moved the shares down, but he also doesn't see a lot of catalysts that are going to allow the stock to appreciate greatly or maybe even to move back to fair value anytime soon, given some of these uncertainties.

It is looking cheaper than the market. It does look cheaper than some of the other big tech names, but you have to be aware that there is some uncertainty here. They are going through this transition that's not going to be easy, and you could be sitting on it for quite some time.

Stipp: Speaking of tech giants, Microsoft previewed Windows 10 this week, and that's emblematic of some of the changes that they are going through.

Glaser: New CEO Satya Nadella, who took over from Steve Ballmer, is moving Microsoft in a new direction. We saw that with the preview this week of Windows 10, which is going to combine the desktop operating system and also work on tablets and mobile phones.

Our analyst Norm Young thinks this is a smart strategic move for Microsoft, because a lot of developers can create a desktop application and then with relatively small changes have it work on tablets and mobile phones, and it gives them a larger addressable audience. It also solves one of Microsoft's biggest problems, which is that they don't have a lot of app developers writing for Windows phone, because not that many people use it. And not that many people use it because there aren't that many apps available. This could fix that chicken-and-egg problem a little bit.

This is not a slam dunk; it's going to be difficult to get people to potentially move away from Android and iOS, but it is a sign that Microsoft is very much trying to restart their consumer business using the cash flow and the web services that are so successful in the enterprise business to try to move consumers into buying these products again.

Now, the market has really noticed that Microsoft has been doing a good job with this, and that's led to lack of a margin of safety in the shares, but definitely the strategy has been interesting.

Stipp: eBay is also a work in progress as it gets ready for an upcoming separation, and that was apparent in its earnings this week.

Glaser: It was, and there really was a difference between the quality of the earnings and the market reaction. In terms of the quality of the earnings, there were some problems in the quarter in the Marketplace segment. There were signs that the business is still dealing with issues from the data breach that they had, with issues from a Google search algorithm change, and some other competitive threats. PayPal looked a little bit stronger. They are still doing well in a very rapidly changing environment when it comes to the payments space.

But the market seemed more focused on some other announcements, such as the fact that they are going to cut 7% of their workforce and try to cut costs particularly in the Marketplace segment. And that activist investor Carl Icahn would be getting a board seat and move to have some changes in the change-of-control provision. That is leading to some speculation that either the businesses would be takeout candidates in the future and also potentially spinning off the eBay Enterprise business--that was floated as well during the earnings call.

There is not a big margin of safety in eBay anymore. The shares have run up as they have started to make some of these changes. But management does seem focused on finding ways to unlock the values of these businesses, and I think it's an interesting wide-moat firm.

Stipp: Jeremy, great insights on the news of the week. Thanks for joining me.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.