TIME Companies

Here’s Why Netflix Can Shrug Off its Stock Plunge

US Online Streaming Giant Netflix : Illustration
In this photo illustration the Netflix logo is seen on September 19, 2014 in Paris, France. Netflix September 15 launched service in France, the first of six European countries planned in the coming months. Pascal Le Segretain—Getty Images

Netflix is hanging on tight to its core mission

It’s not every day that a brand-name stock loses a quarter of its value in a matter of minutes, as Netflix did after reporting its financial earnings Wednesday. It’s even rarer when executives respond as if it’s no big thing.

After Wednesday’s stock market close, Netflix reported a net profit that exceeded Wall Street’s expectations. So far so good. But Netflix’s success hinges on whether it can keep signing up new subscribers, and it’s here where the company came up short: The company added 3 million net subscribers around the world after publicly predicting it would add 3.7 million.

Investors read those numbers and started running for the hills. It took about 30 minutes for Netflix’s stock price to fall by more than $120 a share. After the plunge, the company was more philosophical than apologetic. “Our internal forecast . . . will be high some of the time and low other times,” CEO Reed Hastings shrugged in a letter to shareholders. Later, on a Google Hangout with select analysts, he was just as Zen-like, saying he expected to miss subscriber estimates “frequently.”

There are a few reasons why Hastings can get away with this attitude without investors calling for his head. Wednesday’s stock market was a tumultuous one in general, seeing the Dow close down 173 points after a 458-point drop at its worst. And amid lingering concerns that tech valuations in general were too high, many investors were ready to sell any stock on bad news.

On top of that, Netflix has long been a favorite of speculators, who have made it one of the most consistently volatile issues in the tech sector for the past decade. This has long been a headache for Hastings, who’s complained before about “momentum investor-fueled euphoria.” Such euphoria usually ends in nasty hangovers, like the 80% plunge in Netflix’s stock price after it raised prices in 2011. What Netflix is seeing today is another bender coming to an end, one Hastings predicted a year ago.

The main reason Netflix is shrugging off the current decline is that the company has always hewed, come what may, to a single strategy of finding a more efficient way to distribute video content. That tactic, which has always worked out in the long run, is the classic distrupt-the-incumbent model. And in the world of video content, no one has done this better, and more consistently, than Netflix.

The creation myth of Netflix says that Hastings founded the company after racking up $40 in video rental late fees. As DVDs emerged, Hastings started delivering them by mail, precipitating the slow but sure extinction of video-store giants like Blockbuster. As bandwidth improved, Netflix switched to an even more efficient way to deliver movies: by streaming them online. Today, 87% of Netflix revenue comes from streaming movies and TV shows. Netflix has effectively disrupted its own founding business model. Netflix wasted no time disrupting its founding business model, splitting off its DVD-by-mail business into an ill-fated venture called Qwikster. Today, Quikster is an unsightly footnote in the company’s history, and 87% of Netflix revenue comes from streaming movies and TV shows.

More recently, Netflix has begun to bump up against the cable companies that are so loathed by consumers by pushing more into TV programming, notably several of its own series. In a victory for cord-cutters, Time Warner said Wednesday it would offer HBO as a standalone online service starting next year. That will provide Netflix a strong competitor, but it’s likely to do more damage to the cable providers in the long run. In effect, HBO is hedging its future by adapting to the model Netflix pioneered. CBS followed suit Thursday with its own launch of an on-demand subscription service for its programs.

Now Netflix is moving into a new area by producing its own original films, reasoning that it’s often cheaper than entering into bidding wars for titles every several years. This is likely to work with “branded” films, like a sequel to Crouching Tiger Hidden Dragon and a series of Adam Sandler vehicles (Netflix says data shows Sandler’s comedy translates well in global markets like Brazil and Germany — who knew?).
This latest move is angering movie theater chain owners, mostly because their own aged business model has turned into another unpleasant experience for consumers. Moviegoing often involves paying upward of $15 a ticket to endure a gauntlet of pre-film commercials and obscenely overpriced popcorn. Another recent technological development, the rise of affordable, high-def home entertainment systems, is making it easier to bypass that experience. And Netflix is now working to speed up the time it takes for new movies to reach home theaters.

All this is costing Netflix a lot of money. Streaming content obligations rose to $8.9 billion from $7.7 billion in the last three months alone. Netflix is warning that these obligations will weigh down cash flows for years. This is risky, because the new content costs may not translate into enough new subscribers. And that’s why investors freaked out about the low subscriber figures this quarter. Netflix keeps building more content, but what if subscribers don’t come?

Right now, Netflix is shrugging in the face of all this fretting. Investors also worried two years ago, when the company’s overseas operations were losing $400 million a year. This year, Netflix’ international subscriptions are close to breaking even. Most of all, the company has learned to ignore speculators and naysayers as it pursues its core strategy of finding better ways to bring quality video content to consumers. Producing movies may sound like a new and risky area to move into, but as Netflix sees it, it’s the same old business model that’s worked so well in the past.

TIME Silicon Valley

In Silicon Valley, You Can Forget Aging Gracefully

HP CEO Meg Whitman Visits China
ChinaFotoPress—ChinaFotoPress via Getty Images

Getting old isn't easy, especially in tech

Nature abhors the old, Emerson said. In 2014, we can add: so do technology investors. Because in the tech sector, where innovation and growth are worshipped and rewarded with obscene valuations, the esteemed companies that helped establish Silicon Valley and shape the Internet are not being allowed to age gracefully.

HP is breaking into two, despite years of its CEO saying this wouldn’t happen. eBay’s spinning off PayPal, after its CEO insisted this made no sense. Both companies knuckled under shareholder pressure. Now Yahoo is facing pressure to cash out of Alibaba and merge with AOL. That follows Dell going private and IBM ditching its low-end servers. There are even investor rumblings that Microsoft would be better broken into pieces.

Spinoffs, breakups, LBOs and shotgun marriages aren’t uncommon among aging, troubled companies. But the wave of events hitting companies once considered blue-chip tech firms is unprecedented. Only a decade ago, most of these companies were at the top of their games. Even today, many are so profitable they annually pay out billions, if not tens of billions, to shareholders through dividends and buybacks. And while many of these companies have been undervalued by investors for years, they are now being treated as if they are entering a period of advanced decay.

In sectors like utilities or retail, slow growth is tolerated as long as a healthy profit margin is maintained. But in tech, profits aren’t enough without growth. And there is plenty of growth among the younger generation of tech giants like Google, Facebook, and LinkedIn. The gap between long-in-the-tooth tech giants and lithe, growing companies is getting wider by the year. While the latter are driven by innovation the former are pushed around by shareholder demands.

Tech investors have always been growth-oriented, but now it’s becoming an obsession. And why not? As the network effects long promised in the early years of the Internet finally kick in, growth at a successful startup can mushroom from seed round into large cap in a few years. Airbnb, Uber and WhatsApp were all founded about five years ago and today are valued at $10 billion, $18 billion and $22 billion, respectively.

Often, the new generation of successful startups push to stay out of public markets as long as possible to avoid the public scrutiny, quarterly earnings parades and exposure to shareholder activists that are plaguing the likes of HP, eBay and Yahoo. The world of secondary markets and venture investing have evolved to accommodate them, allowing institutional investors who can afford substantial stakes to become investors while the startups remain private.

Yet there’s a cautionary lesson here that startup founders should consider: The same forces that are accelerating tech growth curves are also accelerating the time to maturity. Grow big enough and companies will need to draw on public markets for financing. To meet quarterly targets, they need to maintain billion-dollar businesses even when they stop growing. That limits the ability to find new, financially risky areas of innovation. Soon enough, dividend and buyback programs are rolled out to placate antsy investors. That, as we are seeing this year, only placates them for so long.

No one is demanding a dividend from Google, or calling for Facebook to spin off Instagram. Both are delivering growth that often surpasses investor expectations and rewarded with rising stock prices. Others like Netflix and Amazon are getting a pass by investing profits into future growth. But as much as HP talks about, say, developing a mass-market 3D printer, investors only look with disappointment at the slow-growth business of PCs and IT services.

There are a few companies founded before the dot-com boom, notably Apple and Amazon, that have so far been able to buck the trend. But they may not be able to stay ahead of the curve for long. The campaign to pressure Apple for more dividends has halted because Tim Cook keeps promising new product categories like the Apple Watch. Amazon has lost nearly a quarter of its value in the last nine months amid concerns its spending is outpacing its promised growth.

For now, Apple and Amazon are anomalies among companies more than 20 years old that are promising more growth in coming years. That’s leaving their CEOs independent enough to pursue blue-sky innovations. But age catches up to all companies. And these days, companies in the tech sector are growing old faster than ever.

TIME technology

This Is GoPro’s Plan to Continue Conquering the World

GoPro goes public on Wall Street
GoPro's CEO Nick Woodman holds a GoPro camera in his mouth as he celebrates his company's IPO at the Nasdaq MarketSite in New York, June 26, 2014. Seth Wenig—AP

IPOs can not only provide startups with new capital, they can also offer a lot of free publicity, especially when the company has a product beloved by its users, a charismatic founder and a backstory of entrepreneurial grit. In that sense, GoPro’s IPO has been nothing short of a boon for the company.

In a year that has seen the allure of the IPO market fizzle early on, GoPro is just the poster child Wall Street needs to reignite interest in new offerings. The company was founded in 2002 by Nick Woodman, the son of an investment banker who saw a need for a portable, durable, and affordable camera to capture surfing footage.

As GoPro’s cameras grew smaller and capable of higher-def video, word of mouth spread quickly. GoPro became the high-definition action camera of choice for sports enthusiasts who shared their filmed exploits through social media. That word of mouth pushed GoPro’s share of the US camcorder market to 45% last year from 11% two years earlier. Revenue grew 87% in 2013 to just shy of $1 billion.

That success explains GoPro’s initial rise in the wake of its IPO. GoPro went public in late June at $24 a share, rose 31% on its first day alone and within its first week had more than doubled its offering price. It was just the spark that the sluggish IPO market needed going into the summer, and GoPro bulls argued that the initial surge was justifiable.

The bull case went something like this: GoPro represents the rise of a new consumer gadget brand. Sure, it competed with hoary old camera companies like Canon, Nikon and Polaroid. But it had a shiny, 21st Century feel to it, the way Sonos does and Panasonic doesn’t, or the way Nest does and a General Electric thermostat does not. GoPro was emblematic of a new breed of consumer electronics.

The early rally soon drew the attention of bears, who felt the post-IPO surge in GoPro’s stock was speculative, leaving it at an overvalued price. Even now, the stock trades at nearly 10 times its 2013 revenue and 100 times its net income.

Such a rich valuation overlooks the uncertainties in GoPro’s future. As impressive as the company’s growth in camcorder market share has been, it won’t be long before it starts to reach saturation. At the same time, such rapid success tends to draw emulators. And struggling companies like Olympus and Canon have resources to develop and market similar cameras.

An even bigger threat may come from the wearable cameras being developed by Apple, Google and others. Early videos promoting Google Glass revealed an even more portable video camera, one that is likely to drop in price once it reaches the mainstream market. For many amateur videographers, the increasingly high-definition cameras included in smartphones may also make a GoPro seem obsolete in time.

To counter these competitive threats, GoPro is working to expand internationally, innovate new features in its cameras and promote the GoPro brand as a source of original and user-generated content. The push from gadgets to media is a logical one, but it also highlights some of the barriers the company faces in finding future growth.

GoPro’s prospectus says it’s investing in video programming for partner platforms such as Virgin America and Xbox Live. While welcome partners, these platforms aren’t nearly as big as, say, YouTube. The GoPro channel on YouTube has a little more than 2 million subscribers. Not bad, but also not nearly enough to put it in the top 100.

The biggest benefit of more visible GoPro content may not be to generate media revenue but to market GoPro cameras. The company says it plans to build new marketing relationships, increase its presence inside stores and spend more on advertising – initiatives that may need to draw on the proceeds raised in its IPO. However, the bulk of those proceeds went to pay off loans and pay out insiders. And the increased spending is likely to weigh down margins even as the company’s revenue growth slows.

Such concerns have weighed on the stock in the past two weeks. After reaching a peak of $49.90 on July 1, the stock has since fallen 22%. The initial surge created a demand for GoPro shares available for borrowing by short sellers. Right as GoPro shares peaked, an analyst noted that “borrowers are snapping up all the available GoPro shares they can, and are willing to pay a high price to do so.”

Another analyst at Vertical Group issued a sell rating on GoPro an a price target of $28.50 last Thursday, citing a media strategy that was “fraught with risk” and a “still-questionable competitive moat.” Since that report, GoPro’s stock has fallen 10%. On Friday alone, GoPro fell 7.3%.

The shift in momentum in GoPro’s trading away from the bulls and in favor of the bears doesn’t mean the company won’t have a bright future ahead of it. But it’s a caution for investors hoping to buy the stock of a well-known consumer brand right after its IPO. GoPro needs to show it can fend off competitors and produce a viable media strategy before it can come close to earning its post-IPO price.

TIME technology

The Days of the Chief Executive Bro Are Numbered

Evan Spiegel
Snapchat CEO Evan Spiegel poses for photos, in Los Angeles, Oct. 24, 2013. Jae C. Hong—AP

Skipper: Now, aren’t you all ashamed of yourselves?
Thurston Howell III: I’m ashamed we got caught.
-Gilligan’s Island

It’s not a bad gig, being a CEO. Not only is the mean compensation 257 times that of the average worker, you often get a carte-blanche license to be a jerk. Jeff Bezos can verbally abuse workers with an inane insult like, “I’m sorry, did I take my stupid pills today?” and be hailed as the best CEO in tech. Because the CEO he stole that mantle from, Steve Jobs, took executive assholery to a whole new level.

Still, there are exceptions to that carte-blanche rule. Jerk behavior takes on a toxic quality when the insults involve pernicious social problems, like sexism in the tech industry which has been there all along, yet is growing more visible—and therefore more opprobrious—by the week.

And the past week has been a banner one for what we have come to call brogrammers. A co-founder of RapGenius resigned after being blasted for exceptionally tasteless comments on his own site. Uber’s CEO saying that his luck with the “ladies” was pretty great now that his company was successful. The latest example is Snapchat CEO Evan Spiegel, whom TechCrunch declared in a headline was “kind of an ass.” Spiegel’s leaked Stanford emails said over and over again things that, when the rest of us rewind to our college days, recall people we met and never wanted to deal with again. Now here they’ve gone and created the apps we’re stuck with using.

Spiegel sent out an attorney-masticated apology saying he’s “embarrassed that my idiotic emails during my fraternity days were made public.” Like Thurston Howell, he’s sorry he got caught. It’s not really an apology, but at least there’s a modicum of honesty in it.

Mark Zuckerberg’s undergrad IM’s, scorning the “dumb” users of Facebook’s prototype, presaged the privacy policies of his $164 billion company today. Similarly, Spiegel’s company Snapchat seems to realize an adult fantasy of erasing for good all the stupid things he ever said in his emails five years ago.

Nevermind for a minute all the talk about brogramming, this is what’s important here–trying to erase what can’t be erased. Reed Hastings founded Netflix (apocryphally) after returning a late DVD. Zuckerberg wants (spuriously) to connect the world. Spiegel, it seems, wanted to let people erase the present because it can bite your future in the butt once it becomes the past.

That makes Snapchat an app tailor-made for CEOs, not just in tech but in most other industries. The abhorrent comments leaking out are things that have been said among men in business–and frats, the preschools of business-for decades. His emails are written in the argot of the old-boys club. Except that men on Wall Street are better at keeping it, and men in the chemical or automative industries don’t have to worry about their stupid comments leaking out to the media, because nobody pays attention to the chemical or automotive industries.

In the Internet industry, they have to worry. Because Internet startups like Snapchat and Uber are attracting the spotlight of not just the tech media, but of the mainstream media. And because, as much as companies like Google try to position themselves as companies of the future, they are very much backward looking when it comes to parity. Google said this week only 17% of its technical employees are women.

That’s the thing about brogrammers. The Spiegels et al are just the uglier edge of a broader, shrewder and much quieter culture of sexism in Silicon Valley. Forget the rhetoric about how tech is forward-thinking. It’s no different from any older industry where bias has been there all along. What matters is this: The Internet apps and technologies these educated dolts are helping to create are not only exposing their secret thoughts, they are also creating a platform for others to criticize them en masse.

CEO’s will always be jerks, maybe well paid for their peculiar dysfunctions. And we’re not even close to seeing the end of executives, tech or otherwise, saying sexist stupidities and being publicly shamed for them. It’s not that there are suddenly more sexist CEOs, it’s that they’re being hoisted more often by their own petards. That will make for headlines of CEO’s being caught saying stupid things, but the more it happens, the better it is in the long run. Because it means the days of the Chief Executive Bro are numbered.

TIME technology

Meg Whitman Has the Hardest Job in Silicon Valley

Technology Business Leaders Address Salesforce Conference
Justin Sullivan—Getty Images

See correction below.

Meg Whitman has vowed to turn around HP, a task that many thought impossible in her early years at the company. Judging from the company’s stock performance over the past year, she may finally be gaining ground but it could come at a cost. In slashing costs to fix HP, is Whitman slashing too aggressively?

In October 2011, a month after Whitman took over, HP employed 350,000 people. That wasn’t as big as IBM, which employed 431,000 at the time, but it’s vastly larger than most of the startups that are having a big impact on the tech innovation these days. (WhatsApp, to offer an extreme example, had 35 employees when Facebook bought it.)

The following spring HP announced it would lay off 27,000 employees through the end of 2014. By fall, headcount had fallen to 318,000 and HP upped the number of layoffs to 34,000 jobs – equal to about a tenth of its peak employment. To manage that, HP said it would take $4.1 billion in charges related to the layoffs, a figure that exceeds its annual budget for R&D spending by a good margin.

When HP reported its earnings last week, the company said it would cut as many as another 16,000 jobs. Many of those positions are expected to come from declining businesses like personal computers, traditional printers and enterprise services, areas that all declined in 2013.

The idea, in theory at least, is to reduce spending enough to generate more corporate cash that can be invested in new innovations like tablets, cloud computing or 3D printers. But more often these savings go into the stock buybacks and dividends that placate antsy investors. HP’s board allocated $10 billion worth of stock to be repurchased in 2011, and the company still has $7 billion to spend.

The broader issue facing HP and others is that big tech is very often old tech. Companies that have grown successful in the past decade years are less dependent on hardware manufacturing and are able to benefit from technological efficiencies. As a result, Google can boast revenue per employee of $1.3 million while Facebook’s sees $1.2 million per worker. HP’s revenue per employee is $354,000.

So even while the tech industry is growing in revenue, it’s not really growing as a source of jobs. Technology jobs grew through the 1980s and 1990s but have declined in Silicon Valley and the US during the past decade. In 2000, technology accounted for 5% of jobs in California, but that ratio has since settled down to around 4.3%, even as the share of technology companies contribute to California’s economy has remained stable.

The layoffs are helping HP’s performance in the short run. HP’s stock rose as high as $34.09 on Friday on the news that Whitman was axing even more positions. That price marks a 175% increase since November 2012, when HP’s stock hit a decade low. The last time HP’s stock traded above $34 a share was in August 2011, a month before Meg Whitman was named CEO.

Whitman was left with a difficult hand to play. A series of scandals and a longer series of ill-advised and costly acquisitions by her predecessors, coupled with a decline in PC sales left the company in a tough spot. Layoffs were widely expected to be part of the process of stabilizing HP, but they come with a catch: Cut too many employees and you weaken the company’s ability into the kind of growth investors are demanding.

In words that must sound callous to departing HP employees, Whitman declared her willingness to cut more jobs if things don’t turn around soon. “Listen, I’m not at all disappointed. I think it’s the natural course of what makes sense in a turnaround of this size and scale,” Whitman said on a conference call with analysts last week. “HP must be manically focused on continuous improvement in our cost structure.”

Some on Wall Street, mindful that endless rounds of layoffs can both help and harm, doubted whether HP’s newfound mania was a good thing. “Serial restructuring cannot solve HP’s secular challenges, particularly following years of underinvestment,” wrote Goldman Sachs analyst Bill Shope in a research note. Kubinder Garcha of Credit Suisse wondered if the restructuring charges, now estimated at $4.9 billion, would undo any cost-savings benefit. “HP is turning into a perennial restructuring story,” Garcha said.

Neither is HP’s maniacal focus on cutting jobs certain to position it against an ever competitive market for enterprise IT. While HP is defensively cutting costs, companies at the high-end are investing in improving their strengths, while those on the low end, including Asian companies like Lenovo, are growing by aggressive pricing.

HP may be, as Whitman says, “making us a more nimble and decisive company” and putting it back on a track to revive revenue growth. But it’s also true that the slashing jobs, while pleasing to investors in the short term, maybe hobbling the HP’s ability to become, in the longer run, a company that can keep growing in the growth-driven tech industry.

Correction: A previous version of this story mistakenly identified WhatsApp as another company.

TIME mergers

AT&T’s $50 Billion DirecTV Buy Is Risky, Probably Not Great for You

The telecom giant will pay $48.5 billion in stock and cash as it looks to keep up with rival Comcast, but it's a risky deal that may not benefit consumers

I’m as guilty as anyone: Readers of business news hunger for big numbers. The bigger, the better. On that front, the $48.5 billion that AT&T said Sunday it will pay to buy DirecTV did not disappoint. Eat your heart out, Mark Zuckerberg.

In its announcement of the deal, AT&T threw out even more mega numbers. Toss in DirecTV’s net debt and the deal’s value rises to $67.1 billion. The combined company will have 26 million customers in the US and 18 million in the growing market of Latin America. AT&T even said it expects “cost synergies to exceed $1.6 billion on an annual run rate basis by year three”—whatever that means, but it has a ten-digit number in it, so it sounds impressive.

But there’s something about AT&T’s big numbers that grow stale quickly. The problem with big spending is, if you don’t put it toward something worthwhile, it’s just a waste. Time’s Sam Gustin noted on Twitter that the sum AT&T is spending on DirecTV could deploy a hell of a lot of gigabit-fiber service to homes that want it. Instead, it’s going to buy one more aging incumbent in the fast-changing TV market.

So once the transitory buzz of the large numbers ebbs, the strategy behind the deal will start to be scrutinized a bit more. And so far, the strategy seems to be: Well, Comcast has gotten big, so AT&T needs to get bigger too. This isn’t AT&T’s only recent big-ticket bid. In 2011, the company tried to buy T-Mobile USA from Deutsche Telekom for $39 billion, but that deal fell through after the Justice Department intervened.

Why is AT&T so keen to buy its way into growth? Because no matter how much blood the company tries to squeeze from its customers, the stock can’t break out of the flatline it’s been in for a while. As this graph shows, AT&T’s stock has risen less than 10% in the past two years. The S&P 500, during the same period, has risen more than four times as much.

Screen Shot 2014-05-18 at 7.20.45 PM

Some people have taken a look at the strategy behind the DirecTV purchase and not been kind in their conclusions. When rumors surfaced last week of a possible acquisition, analyst Craig Moffett suggested that the acquisition could be a distraction from an inevitable decline in AT&T’s growth. “When DirecTV begins to shrink, then the price paid will no longer matter,” Moffett wrote. “It will merely be another liability that AT&T will need to offset by growth somewhere else.”

Aging companies often make big acquisitions when facing a decline in their own businesses. In the best case scenario, the acquired company is snapped up at a discount and revives overall growth for years to come. More commonly, the big buyouts are merely attempts to buy time. Integrating incompatible operations for a couple of years, and providing excuses for large-scale layoffs. The smoke and mirrors works only for so long. Then another expensive deal is required to keep the ruse going.

The DirecTV deal is looking like it will fall into the latter camp–an expensive gambit that may at best offer growth and cost-savings in the short-term. Pay-TV has an uncertain future in an era where over-the-top offerings like Netflix and video consumption on mobile devices are seeing much stronger growth. DirecTV’s stock has quadrupled in the past five years, but there’s little reason to think growth will continue at anything close to that rate.

Moffett, who was a top-ranked analyst at Sanford C Bernstein & Co. before setting up his own research firm, put it more severely. “Like skid row junkies in the final wretched tremens of downward spiral, telecom/cable/satellite investors now appear to need a deal fix almost daily to stave off the messy crisis of incontinence that comes with the inevitable withdrawal.”

Other analysts speculated about AT&T’s motives for the deal, but few of them shared the sunny interpretations of the acquirer. The timing, coming after Comcast’s plans to buy Time Warner Cable, could be an attempt to piggyback on another telecom deal, one likely to win regulator approval. Or maybe Comcast sparked a merger mania in the telecom industry, with DirecTV the first to be snapped up. Sprint may be prompted to buy T-Mobile. Dish Network could also be in play soon.

In other words, no matter how you slice it, this deal has little to do with helping the consumer. Yet in announcing the deal, AT&T referred to the consumers who are its customers (19 times) nearly twice as often as it did its shareholders (10 times).

So far, the consensus is that DirecTV is unlikely to draw the regulatory criticism that T-Mobile did for AT&T. But AT&T isn’t taking any chances. The company took a $4 billion writedown after the T-Mobile deal fell through, most of it related to breakup fees. AT&T made clear today it wouldn’t pay a fee to DirecTV should regulators foil the deal this time.

That’s good for AT&T, but it adds an air of desperation to DirecTV. Another sign DirecTV wanted to sell quickly: Rumors of the deal last week put the price at $100 a share, but the actual deal is only $95 a share. DirecTV’s stock only rose as high as $86.90 on the $100-per-share rumor, reflecting the Street’s skepticism on the price. Some of that skepticism, it seems, was warranted.

For consumers, the bigger question is, when will these telecom mega-mergers end? Benefits from mergers are usually passed on to shareholders in the form of share repurchases or higher dividends. They rarely benefit customers—in fact, reduced competition in telecom has historically meant higher fees.

That’s why consumers should be wary of these big-ticket mergers. Don’t be too dazzled by the big, flashing numbers of the headlines. The more and the merrier the mergers grow, the more the consumer becomes an afterthought.

TIME Technology & Media

Microsoft’s Brand New CEO Needs to Do Much More

Satya Nadella
Microsoft CEO Satya Nadella speaks at the Build conference on April 2, 2014 Harry McCracken / TIME

fortunelogo-blue
This post is in partnership with Fortune, which offers the latest business and finance news. Read the article below originally published at Fortune.com.

How does a CEO grab attention when he’s the follow-up act to a brash, voluble leader like Steve Ballmer? For Satya Nadella, who hardly seems prone to the same kind of sweat-soaked stage performance of his predecessor, the answer lay in a bold strategic gesture: Get Microsoft Office onto the iPad.

Office, of course, had long been Microsoft’s great cash cow fenced off from the green pastures of the tablet market. Some believed it was the reason Microsoft started making Surface tablets after decades of not manufacturing personal computing devices. That expensive experiment hasn’t exactly delivered a hit. Surface sales are growing, but its 2% market share lags those of Samsung, Amazon’s Kindle Fire, and of course the iPad.

With Nadella taking the reins from Ballmer, Microsoft has the chance to begin a new era — distinct from the Ballmer years that saw modest growth and a move into enterprise software, and even more remote from the Gates years when Microsoft ruled PC software with an iron fist. Nadella’s Microsoft appears to be a company that aims to compete in markets rather than control them.

MORE: Nadella: Microsoft needs a ‘data culture’

Nadella’s experience is aligned with the same technologies that promise future growth — cloud computing, multi-platforms, mobility, big data — the antithesis of the proprietary software that Microsoft built its historical success on. That’s why the Office 365 for iPad announcement was notable. It wasn’t so much two longtime enemies sharing revenue. It was Microsoft risking its own mobile platform by expanding to another, bigger platform. It was a Microsoft open like never before.

The announcement was also Nadella’s first big public appearance, a product launch cum CEO debut. The move was a risky one: It could telegraph that Microsoft was capitulating to Apple, running its prized wares on its old rival’s device while paying a 30% share of revenue for the privilege. Increasingly, Nadella is instead being seen as a leader who can finally usher the company out of the PC era and into the cloud economy.

Last month, when Microsoft announced that Office apps would be available for the iPad, the news stirred a ripple of notice. Analysis was mixed. The New York Times wondered if it wasn’t the right move too late. Techcrunch found it to be worth the wait. Someone at Forbesdismissed it as a non-game changer.

After a few weeks in the App Store, Office for iPad is proving the early skeptics wrong. More than 12 million people downloaded Office Apps in the first week. Today, Word, Excel, and Powerpoint are the three most popular free apps in the iPad App Store (excluding games, which shows that tablets may be better for idleness than productivity). The basic apps are free for bare-bones functionality, but a subscription to Office 365 opens up more features.

For investors, the arrival of Office for iPad is unlikely to translate into material earnings, at least any time soon. It may open Microsoft to businesses that prefer tablets over traditional PCs, but it could also cannibalize the company’s older, high-margin markets. Desktop and laptop sales have been declining since the iPad’s introduction, although recent months have shown signs those declines are stabilizing.

MORE: For Microsoft’s Nadella, signs of leadership potential

If the move has little short-term benefit for Microsoft, its symbolic value is higher. CEOs of prominent companies like Microsoft often set the tone of a company, and in some ways Microsoft now appears to have lost the cloud hanging over it when Ballmer was there. Ballmer, of course, also worked to push Microsoft into a more open direction, but somehow Nadella’s presence makes it seem like it may finally be happening.

Office, of course, is only one part of Microsoft’s business. It’s the prime contributor to the company’s business division, along with Sharepoint and Exchange. That division makes up a third of Microsoft’s revenue and three-fifths of its operating income. But growth in the division has been flat — revenue rose only 2.5% in Microsoft’s last fiscal year (ended June 2013) and declined 6% in the last six months of 2013.

Microsoft is seeing faster revenue growth in its server and online services divisions, although these segments have much lower margins. (The online division has been a perennial money loser.) So while the Office move is seen as a symbolic victory for Nadella’s Microsoft, the company is still weighed down by many of the same old issues: an enterprise software market and the aging business in PC operating software.

Office for iPad is a strong start to Nadella’s follow-up act to Ballmer. But it will need to be followed by a lot more creative, bold moves to change Microsoft into the dynamic, future-oriented company that investors are hoping it can become.

TIME

5 Fundamental Truths for Tech Companies

Google
Justin Lane—EPA

Maybe that correction in technology stocks wasn’t such a bad thing after all. As tech companies have started the quarterly ritual of reporting earnings, the early indications are that, while many are still growing, they aren’t growing enough to meet the outsize expectations the market had built up.

So far, the flagship tech companies that have posted earnings bore few big surprises or disappointments. While several companies posted solid results, it wasn’t enough for the more hyped, overvalued stocks like Google. Others, like Intel, that were left out of last year’s tech rally performed much better.

It’s almost enough to make a fundamental investor believe the market hasn’t quite lost its head. There are several more weeks to earnings season to come, but if this week is any indication of what’s ahead, there are several trends emerging.

Internet companies are growing fast, just not fast enough. At Google, revenue excluding traffic acquisitions costs rose 23%. That’s a far cry from Facebook’s recent 63% growth but it’s still pretty impressive. According to RBC Capital, only two other large companies have maintained growth above 20% for 16 straight quarters: Amazon and Priceline. Being as big as Google and growing that fast is a tough act to keep up.

But for investors who have strongly associated Internet giants with growth, Google’s feat doesn’t impress much. The stock slid 4% Thursday after Google fell short of revenue and profit expectations. The growth simply wasn’t good enough to justify the stock’s lofty price. Even after its recent slump, Google shares are up 36% in the past year, pricing it at 29 times revenue.

Mobile is driving down ad prices, and it’s starting to be a problem. If there was one worrisome part of Google’s report, it was the decline in cost per clicks, the price charged for ads. CPC’s fell 9% at Google, a decline that has been accelerating for the past few quarters. In fact, Google’s CPC’s have been negative for a couple of years, around the time mobile ads began supplanting ads on the desktop Web.

Mobile is an opportunity and a problem for Google. It’s where the users are going, but it’s also, according to Google, a key reason why CPCs are in decline. Google may also be seeing lower CPCs from emerging markets and ads outside its own sites. The company plans to offer more detailed data on CPCs in coming quarters. Facebook has had better rates with its targeted ads in mobile feeds, but most other companies are struggling to see mobile ads pay.

The market is getting competitive for IT services. IBM’s stock dropped 3% after it said revenue fell 4% last quarter to $22.5 billion. For years, IBM was a stalwart leader in the market for managing IT services for other companies. But rivals like HP and Dell are getting aggressive on costs, and cloud computing is cutting IT costs in general, and it’s all taking its toll on IBM.

Revenue at IBM’s IT and outsourcing business fell 3%, its consulting division was flat and its server and storage business declined 23%. Software was a bright spot, rising 2%. IBM is still vowing to reach $20 in earnings per share next year, although some analysts noted earnings growth is coming from a lower tax rate and an aggressive buyback program.

Old school tech still has the ability to impress. Intel shares reached their highest level Thursday in nearly two years as it delivered earnings slightly above Wall Street estimates, but showed the company is making a slow but sure move into chips powering tablets and mobile devices. That makes for a 23% rebound in Intel’s stock since last September.

Bulls and bears have been arguing over whether Intel can make the transition without eating into costs, which have been weighing on margins in recent quarters. Intel’s manufacturing prowess may be able to lower costs in the long run, while also pushing into new markets like sensor chips for the Internet of Things. So while Intel is still struggling in its legacy market for PC chips, it fighting for footing in growing markets.

Growth in Asian giants is outpacing US peers. For all of Marissa Mayer’s attempts to turn around Yahoo’s core business, investors still scour its earnings announcements for information on another company: Alibaba. Yahoo’s earnings from equity interests in Alibaba and Yahoo Japan rose to $301 million last quarter from $218 million a year ago.

China-based Alibaba was by far the big contributor to Yahoo’s equity earnings. Alibaba’s operating income rose 66% in its most recently reported quarter. Yahoo’s operating profit, by contrast fell 84%. And yet Yahoo’s stock has risen 6% since reporting earnings. Wags have joked that investors like Yahoo as a hedge fund better than an Internet company, and numbers like that show the truth behind the humor.

TIME

Tech Companies Are Bracing for an Extremely Difficult Week

A Google logo is seen at the garage where the company was founded on Google's 15th anniversary in Menlo Park, California
Stephen Lam—Reuters

There’s nothing like a sudden sell-off in technology shares to add a little spice into earnings season. It’s never a good sign when stocks begin tumbling well before the first tech giant of the season reports its numbers. That first report will come from Google later this week, and it could set the tone for the next several weeks for tech shares.

Since March 10—interestingly, the same day the Nasdaq Composite peaked 15 years ago—tech stocks have been suffering a prolonged selloff. The Nasdaq has fallen 7% while the S&P 500 declined a more modest 2%. But that doesn’t begin to illustrate the damage in individual stocks, many of them seen as the growth leaders in Silicon Valley these days.

Google, for example, is down 12% during that time. Amazon is down 15%, Facebook is down 16%, and LinkedIn is down 19%. Still others haven’t fared even that well. Twitter has lost 23% of its value, Netflix 26% and Pandora 32%. All of these are stocks that have surged over the past year, and most are still up by a considerable margin over the previous 12 months.

But those rallies mostly came on the back of unexpectedly strong revenue growth over the past year—particularly in mobile. Investors began to doubt the ability of mobile devices to deliver solid ad revenue, but last summer companies like Facebook, Pandora and Google showed that it could be done. And demand for their stocks suddenly grew.

This year is a different story. For one thing, there is a sense that the quarter could be a disappointing one for all industries, not just technology. At the end of 2013, analysts expected S&P 500 earnings to grow 4.4% in the first quarter of 2014. They’ve since revised that estimate down to flat earnings growth. Earnings are expected to grow more slowly than revenue for the first time in nearly three years (when profits were growing closer to a 12% rate). None of that would make for a celebratory quarter.

So why has tech been hit harder as these estimates have been ratcheted down? After all, one of the things that made tech shares popular over the past year is that many companies seemed primed for earnings growth. The selloff came as that broader concern about slower earnings converged with lingering concerns about overvalued tech stocks. The Nasdaq traded at 35 times average earnings of its component stocks, while the average PE ratio for the S&P 500 Index was 17.

All of this makes for a potentially interesting few weeks in technology earnings. On the one hand, if selling off tech shares has set the bar low for tech leaders, they could easily surprise to the upside. On the other, companies are left with little tolerance for disappointment. Pleas for investors to wait a few more quarters for promised growth may be met with indifference.

Google is often among the first major tech companies to report earnings. Although the company’s main revenue stream is search ads, it’s seen as a proxy for the health of the overall industry: how advertisers are feeling about spending, whether ad rates are rising or falling, how expansion into global markets is going.

Analysts are looking for Google to post an 11% increase in revenue in the first quarter to $15.5 billion and for EPS to grow 10% to $6.39 a share. That’s a flat performance for a company that saw its stock rise 38% over the past year, even after its recent declines. But Google is pushing into new areas of content (Play), e-commerce ads (product listing ads), and mobile (Google’s myriad mobile apps). Together they could accelerate growth.

Google’s report may also give insight into how the income statement will look without Motorola Mobility, the smartphone maker that Lenovo agreed in January to buy for $2.9 billion. Offloading manufacturing costs will likely push operating margins higher. But there could be bad news as well: Last quarter, Google hinted at softness in its mobile ad pricing, and further deterioration could become an area of concern for investors.

Such are the risks of Google and other growth-oriented tech leaders. When the market is going up, risk is seen as an opportunity for big rewards. When it’s going down, it’s seen as, well, risky. For much of the past year, risk has been something tech investors have welcomed. By the end of the month, we’ll have a better idea of which perspective prevails. And the first hint will come later today.

TIME

Every Reason You Should Be Worried About a Destructive Tech Bubble

A New York Stock Exchange screen shows the results of the Twitter Inc. IPO in New York, Nov. 7, 2013 Lucas Jackson—Reuters

The envelope, postmarked Franklin, Tenn., contained excellent news: an “emerging opportunity” in a cheap Internet stock. “With a $10 million warchest,” read the glossy flyer inside, “LiveDeal is crushing Groupon in pilot markets!” Further down, in fine print, was more salient information: “The use of research… is done at your own risk.”

Nevermind that LiveDeal is an Internet stock so revolutionary its virtues deserve to be heralded by snail mail. Or that Las Vegas-based LiveDeal has not $10 million but $500,000 in cash, posted a loss twice as large as its revenue last year, and yet trades at 37 times its sales. What matters about this flyer is that I’ve received junk mail just like it before – but not for about 15 years.

Fifteen years ago, we were in a massive tech-stock bubble. Some people are pointing to evidence we’re already in another tech bubble now. Others are certain we’re nowhere near the insane investing we saw in 1999. It’s possible they can both be right.

But I also think neither side of the debate is addressing the real concern, which is that we have been engaging in the very financial behavior that creates and nurtures bubbles. Behavior like complacency toward irrational valuations and explaining away the threat of a bubble. And that makes the bubble deniers more dangerous right now. Because they are making sensible arguments that overlook the risk of irrational investing becoming the norm.

Those who pooh-pooh a bubble often rely on the same arguments. But each one involves a fallacy. Here are some of the more common.

It’s not at all like the dot-com bubble. This is true as far as it goes. Last month, the Nasdaq Composite hit its highest level in 14 years but is still 26% below its high. The IPO market hasn’t been this busy since 2000, yet still shy of record levels. And companies going public have stronger financials, if many are still losing money.

But bubbles don’t repeat in a similar pattern, so we won’t see the same signs of craziness. Nobody’s dumb enough to use a sock puppet as a mascot, or throw a lavish rooftop party. But that doesn’t mean we’re not seeing signs of excess, like parties that aren’t called parties. Other behaviors are consistent, however, like dusting off dot-com metrics like revenue-per-user.

VCs are showing discipline this time. Again, true enough. Historical data shows venture investments are, at most, creeping higher. But they also creeped higher through 1998 before exploding in 1999 and 2000. The explosion came as institutional investors were desperate to invest in VC funds, and if first-tier firms wouldn’t create them, then second- and third-tier firms did.

Venture firms that survived the dot-com bust did so by investing relatively prudently. But once the more promising dot-com IPOs began hitting the market with huge first-day pops in price, less prudent VCs began recklessly funding questionable startups. That’s when things really got cooking.

Tech companies going public are a different breed. So far, yes. And some of them will see the kind of success that Amazon has enjoyed. But not all of them. Once an IPO market heats up, investment banks line up the strongest candidates first, ensuring early pops to prime the market for more. That stokes demand for more IPOs but after a few quarters the candidates aren’t so hot. Box, Airbnb, Alibaba look great. But not every tech IPO can look that good.

The Internet is kicking into high gear, creating opportunities for business models that never existed before. But it’s much easier to spot big trends than to pick individual winners. And besides, there is something dangerous about pushing this idea too far. It’s just a little shy of saying, it’s different this time. That, of course, is the motto of nearly every financial bubble.

Growth today is more important than profits today. This is a slippery argument, and over time a risky one. Again, Amazon thrived despite early losses, and a few like Box are likely to do so as well. But two things: First, it’s is very difficult to pull this trick off for long – Amazon is the exception proving the rule.

Second, there is ample evidence that money-losing startups that went public in recent years have fared poorly. Skype had trouble going public with its losses in 2011, and others like Jive Software, Brightcove, Groupon all went public with losses and are trading below their offering prices. That’s the rule of money-losing IPOs – and the reason why, in sensible times, investors avoid them.

Only a few stocks are overvalued. Many others aren’t. That’s because many of the big-tech giants like IBM, HP and even Microsoft are struggling with incumbent businesses being displaced by younger technologies. What we’ve called the tech industry has been divided into the thriving and the slowly dying, and investors can easily tell them apart. Besides, a bubble doesn’t have to be broad-based to burn investors when it crashes.

But the market has been going down! Even the most sturdy rallies never go up in a straight line. In fact, they are marked by volatile pullbacks. Remember the mini-crash of October 1997? Far from derailing a nascent bubble in technology stocks, it acted as a coiled spring to send it higher. Also, note that even as the broader market has been slumping, recent IPOs like Grubhub and Oopower have been rising.

In short, the market for tech stocks is not in a bubble like the dot-com or real estate bubbles of the past two decades. But it may well be in the early stages of a bubble marked by irrational investments, a bubble that could easily expand out of control if smart people keep rationalizing away the early warning signs.

And there are warning signs, whether it’s a growing tolerance of insanely priced IPOs and M&A deals, or the return of spurious metrics like revenue per user, or even a piece of junk mail touting an unwise stock investment. Such early signs are kindling that, if left to gather, can make for a bonfire later on. No, it’s not 1999 at all. But it may well be 1998 – or something a lot like it.

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