Is Facebook Stock The Best Mega Cap Tech Play?

  • Apple and Samsung presented small improvements in their latest smartphones that couldn't convince customers to upgrade.
  • Both companies look for new revenue streams to offset declining smartphone sales.
  • I believe Facebook is well positioned to replace Apple and Samsung as a top notch innovative tech leader.

Both smartphone market leaders Apple (NASDAQ:AAPL) and Samsung Electronics (OTC:SSNLF) released their latest smartphone devices and received cold reactions from the media, the public, and investors. The latest iPhone 6S and Samsung Galaxy S7 offered smaller technological leaps and fewer innovative value-added features than did the previous generations, which is a sign of a maturing market. In every consumer electronics segment, the first devices present most of the innovative technologies related to the new devices and the marginal improvement gen-over-gen slowly reduces until it reaches a point at which changes are so tiny that consumers have no incentive to upgrade or purchase a new one.

When the market reaches that point at which consumers don’t find a reason to upgrade, it widens the refresh cycles for a product. The PC market experienced that a few years ago when it slowed down rapidly until it started to stabilize at a much lower level than before; the tablet market is going through that right now, and it seems that the smartphone market is on the verge of being a victim of that trend too. This is a clear sign of a market peak and an indicator of a decline in sales volume.

According to an IDC report, smartphone sales growth is expected to drop from 5.7% YoY growth in 2016 to 4.3% YoY growth in 2020. This decline in growth rates is mainly driven by a continuous decline in smartphone sales in China and North America.

Both Apple and Samsung are well aware of this trend, and they address it differently. Apple launched an iPhone upgrade program in which customers pay $32 to $45 per month to have a brand new iPhone every year with an AppleCare+ subscription and with no carrier obligations. This is a short-term resolution to the refresh cycle problem. However, in the long run, Apple addresses the concern of reduced iPhone revenues by focusing on adjacent segments, services, and autonomous cars. While revenues from smartwatches, tablets, and Apple Pay will probably not compensate the company for the revenues lost in the iPhone segment, the Apple Car is intended to replace the iPhone dominance in the company’s financials.

Samsung, however, chose a different strategy. It decided to strengthen its partnership with Facebook's (NASDAQ:FB) Oculus VR and offer a free Gear VR headset for pre-orders. Gear VR is a low-end version of Oculus’ VR headset, and it runs Oculus’ software using a Samsung’s smartphone as the hardware generator. For Facebook, this is an attempt to expand the Oculus VR ecosystem, beyond the Oculus branded devices. However, for Samsung, this is an opportunity to strengthen its attempt to offer an adequate VR solution that could gain market share and generate revenues for the company.

Investors should acknowledge that the two tech leaders will experience a difficult time in the upcoming years as their smartphones business declines and they struggle to grow new business lines. In my opinion, the efforts of both Apple and Samsung to replace the declining smartphone revenues with revenues from payment services (Apple Pay/Samsung Pay), VR headsets (for Samsung), adjacent devices (Apple watch/Gear Watch), autonomous cars (for Apple), low-cost devices (iPhone 6C/Gear VR), and other services will not generate a significant amount of revenues to completely offset the decline from smartphone sales. Moreover, I believe that both companies will struggle to maintain reasonable growth in the next few years from their current product portfolio.

During this transition period, tech investors should shift their mega-cap tech companies’ focus from Apple and Samsung to other firms that could deliver sustainable growth at a reasonable price. Three such companies come to my mind: Microsoft (NASDAQ:MSFT), Alphabet Inc-C (NASDAQ:GOOG) and Facebook. All three are excellent companies with a strong portfolio, ecosystem and growth prospects. However, as a long-term investment that will partially replace my Apple position, I prefer Facebook over the other two mainly due to Facebook’s strong presence in the most prominent emerging trends and its growth potential in other segments.

Microsoft and Google have a strong software enterprise offering. However, a simple Slack-like solution like Facebook-At-Work has a tremendous growth potential in that market just because it’s simple, employees are already familiar with the UI, and it includes some communication forms like instant messaging, VOIP calls, live forum threads and more. Microsoft and Google are moving in that direction, but Facebook, in that case, has the advantage of joining the market late and learning from the mistakes other players made. On the steaming hot VR/AR market, Facebook is the obvious market leader through its Oculus Rift and its partnership with Samsung over the Gear VR. While Microsoft and Google lead the AR market with Hololense and Aura, the social acceptance and general adoption is not clear based on the previous attempt Google had with Glass that received very harsh criticism over its social impact. Unlike AR (Augmented Reality), VR (Virtual Reality) is more fondly accepted as it is used in very specific events and for very specific uses that include mostly recreation or professional use cases.

Unlike Google and Microsoft, Facebook has a powerful hook in social media that allows it to leverage every service or product it launches and integrate them into the Facebook social media ecosystem. This is how Facebook will implement Oculus VR in the market and Facebook-At-Work. Additional initiatives like Facebook’s Venmo-like peer-to-peer payments and e-payments partnership with Uber and Lyft uses the same concept. As the world is moving towards using more and more social media elements in everyday life, I believe Facebook will not only be able to integrate the new initiatives into its social media ecosystem, but will also grow its business significantly in the future. In my opinion, assuming on-par valuation metrics for Facebook, Alphabet and Microsoft as long-term technology picks, investors should add Facebook stock to their portfolio while downsizing Apple and Samsung to reflect the process of the temporary Apple/Samsung decline and Facebook’s rise.

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