The Wall Street Journal - 02.08.2019

B12| Friday, August 2, 2019 THE WALL STREET JOURNAL.

Calm Before the 5G Storm

Smartphone sales slump ahead of a rollout that is uncertain to bring relief

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ON

THE

STREET

FINANCIAL ANALYSIS & COMMENTARY

LSE Still Must Prove

Refinitiv Deal’s Logic

Transaction will lift exchange owner’s earnings per

share by 30%, but jury is out on strategic wisdom

Do investors like theLondon

Stock Exchange Group’s $14.5 bil-

lion acquisition ofRefinitiv—or do

they just like leverage?

LSE shares jumped 6.5% Thurs-

day after the company formally an-

nounced an all-share deal to buy

the financial-data provider for $27

billion including debt. They are

now up 24% since LSE gave prelim-

inary details over the weekend.

It is easy to jump to the conclu-

sion that investors think the combi-

nation makes strategic sense. LSE

specializes in the plumbing of fi-

nancial markets, with assets such

as provider FTSE Russell and clear-

ing house LCH as well as its name-

sake stock exchange. Refinitiv is

best known for its Eikon informa-

tion portal that competes with

Bloomberg. LSE Chief Executive Da-

vid Schwimmer made much of the

potential synergies Thursday.

But there is a less speculative

explanation: leverage. LSE is paying

Refinitiv’s shareholders—a financial

consortium headed byBlackstone

andThomson Reuters—in stock,

but the target comes with more

than $12 billion in debt. The net re-

sult is that LSE is more than dou-

bling its earnings while increasing

its share count by just 59%.

Earnings per share will rise by

more than 30% in the first full year

after completion, the company said

Thursday. LSE stock has jumped,

but analysts will need to upgrade

their earnings estimates by even

more.

LSE has spent the past decade

shifting its portfolio away from the

increasingly competitive exchange

business into other areas. A data

business is therefore a logical step.

Refinitiv isn’t really a hot data

asset, though, with constant-cur-

rency revenue growth of 3% last

year. Rival data providerFactSetis

growing at roughly twice that rate.

LSE itself is growing faster. Even

though Refinitiv makes three-quar-

ters of its revenue from data, it

seems more like a bet on a turn-

around project that was started

last year by Blackstone. And LSE,

ambitiously, wants to revive the

company even as it strips out sig-

nificant costs.

Exchanges have bought data as-

sets before, most notably when

NYSE ownerIntercontinental Ex-

changeacquired Interactive Data in

2015. This is the first all-out bet on
      the two worlds converging, though.
      Mr. Schwimmer has found a neat
      way of boosting returns, but still
      needs to prove the strategic logic.
      —Stephen Wilmot

Concerns about shale have

roared in recently like a Texas tor-

nado—sudden and violent.

Permian Basin oil-and-gas

drillerConcho Resourcesposted a

25% drop in adjusted second-quar-

ter earnings Wednesday night de-

spite a year-over-year increase of

more than 40% in oil and natural-

gas volume. The results sent Con-

cho’s shares plunging by over one-

fifth on Thursday.

Concho wasn’t alone:Whiting

Petroleum’s shares were off by

more than one-third after a sur-

prise quarterly loss. The results

dragged down shares of other re-

gional drillers including

Pioneer Natural Resourcesand

Parsley Energy.

Prices for oil and gas were

lower in the quarter, which didn’t

help, but costs were the real cul-

prit in Concho’s disappointing re-

sults. They underscore challenges

shale drilling poses for energy pro-

ducers. At Concho, higher volume

helped push up total operating

revenue by more than 19%.

However, extracting the oil us-

ing water and sand at high pres-

sure is increasingly expensive. To-

tal operating costs and expenses

more than doubled in the

second quarter.

Shareholders have become more

sensitive to the cost side of the

equation recently and have pres-

sured drillers to rein in spending

and to focus on returning cash. It

isn’t working.

In the first quarter of this year

a basket of seven unconventional

oil-focused drillers collectively re-

ported free cash flow of negative

$1.58 billion, according to Wood

Mackenzie—more than twice their

free-cash-flow burn in the fourth

quarter of 2018 and more than

four times worse than during the

first quarter of 2018.

Shale is uniquely problematic

because of rapid production-de-

cline rates and the constant need

to reinvest.

Other drilling, such as deep-wa-

ter, has high upfront costs but rel-

atively modest continuing

investment.

True, other producers are less

nimble than shale producers and

are making more of an outright

long-term bet on commodity

prices, but investors seem to have

rediscovered the charms of con-

ventional-oil production.

For example,HessCorp, in a

partnership withExxon Mobil, has

plunged into a big project

in Guyana.

Hess’s return on invested capital

has been negative since oil prices

collapsed in 2014, yet its shares

are suddenly in favor again, rising

almost 60% so far this year.

Other Permian drillers such as

Pioneer Natural Resources have

started to rethink their ambitious

targets and instead are slimming

down operations.

Conversely, big integrated oil

companies such asChevronand

Exxon Mobil have raised their

spending on shale whileOcciden-

tal Petroleumhas launched an

ambitious deal forAnadarko Pe-

troleumto plunge further into

the area.

The wisdom of those bets will

take years to dissect, but for now

the wind suddenly seems to be

blowing the wrong way.

—Lauren Silva Laughlin

Source: FactSet

60

–40

–20

0

20

40

%

J FMAM J J A

Share-priceperformance,yeartodate

Hess

ConchoResources

ExxonMobil

Even at record prices,Yum

Brandsshares aren’t cooling off.

The owner of KFC, Taco Bell and

Pizza Hut reported strong second-

quarter results Thursday morning.

Comparable store-sales growth

of 5% blew past consensus analyst

forecasts of 3.1%. Yum reported ad-

justed earnings of 93 cents a share,

which topped expectations and was

good for 15% growth from a year

earlier. The stock rose sharply and

has now returned nearly 25% so

far this year.

Like many fast-food stocks, Yum

shares aren’t cheap at the moment

by traditional valuation metrics:

They fetch 28 times forward earn-

ings, according to FactSet. That is

closetoarecordbut,fornow,

Yum’s performance justifies a pre-

mium multiple.

The company’s recent strategy

to convert company-owned stores

into franchised restaurants is pay-

ing off. Company-owned stores

book higher revenues but face an

increased risk to profits when op-

year. That tally was about $1 bil-

lion as recently as 2015.

Accordingly, Yum increased op-

erating margins by 8.6 percentage

points from a year ago to 44.1%.

And while the impact of that

shift means that company revenue

actually fell from a year earlier, un-

derlying restaurant results are go-

ing strong. Comparable sales at

KFC and Taco Bell rose 7% and 6%,

respectively. Pizza Hut’s compara-

ble sales grew 2%, but that chain

managed to significantly boost

margins.

Importantly, Yum achieved these

results in an unforgiving currency

environment. Total operating

profit rose 11% from a year earlier,

but that growth was 17% before

foreign-exchange translation

losses.

With an operating environment

this smooth, paying record prices

for the stock doesn’t seem so

crazy. There are still plenty of cal-

ories left in this meal.

—Charley Grant

Investors Remain Hungry for Yum Brands

erating costs increase, as they are

now with rising wages and food

costs. Income streams from fran-

chisees, in contrast, are more sta-

ble and therefore get more credit

from investors.

The strategy also generates cash

that can be returned to investors:

Yum bought back nearly $200 mil-

lion of stock in the quarter and cut

its total shares outstanding by 5%

from a year earlier. Franchising

also has the continuing advantage

of lighter capital expenditures go-

ing forward, which doesn’t hurt.

Analysts expect less than $200

million in capital spending this

For now, performance at

the owner of KFC and

Taco Bell justifies a

premium stock multiple.

Workers install a 5G antenna system for AT&T’s network in San Diego. Early reviews of 5G have been rough.

MIKE BLAKE/REUTERS

The global smartphone market

is taking a significant pause ahead

of the rollout of 5G services. The

big question is just how long that

pause will last.

Market research firm IDC re-

ported Wednesday that global

smartphone sales fell 2.3% year

over year during the June quarter.

That is the seventh straight quar-

ter of declines for the industry.

IDC’s data showed iPhone unit

sales falling 18% to 33.8 million,

which would be the lowest number

of quarterly sales thatApple’s

smartphone line has logged in six

years. Apple no longer reports unit

sales itself, but the company said

in its fiscal third-quarter report

Tuesday that iPhone revenue for

the same period slid 12% year over

year to about $26 billion.

Qualcomm painted an even

bleaker picture on Wednesday. Fis-

cal third-quarter revenue came in a

bit below Wall Street’s estimates,

though adjusted per-share earnings

exceeded expectations. But the

company’s forecast was a different

story, with Qualcomm essentially

projecting a significantly weaker

business for the following two

quarters as device makers and

wireless carriers clean out inven-

tory ahead of a big 5G push

next year.

Qualcomm also is hurt by its

continued royalty dispute with

Huaweiand the fact that the Chi-

nese smartphone giant uses its

own chips for devices sold in that

country. This means that 5G can’t

appear on the scene soon enough

for Qualcomm, Apple and others in

the smartphone business.

Wireless carriers are indeed

pushing hard to upgrade their net-

works to the next-generation tech-

nology.AT&Tsaid on its earnings

call last week that it expects to

have “nationwide 5G coverage” by

the middle of next year.Verizon

said on its own call Thursday that

it expects to have 5G service up

and running in 30 markets by the

end of this year. China also aims to

have national 5G networks in place

next year.

Billed as the next generation of

wireless networks, 5G promises

blazing speeds and a vastly in-

creased data capacity needed to

underpin future technologies, such

as autonomous cars.

But early reviews of 5G services

have been rough, noting the ser-

vice’s spotty availability and the

tendency of the phones to over-

heat. And those phones are expen-

sive: the 5G version ofSamsung’s

latest Galaxy S10 lineup costs

about 30% more than an equivalent

model without 5G. Wireless cus-

tomers already are resistant to

handset prices that have been

creeping well over $1,000, and it is

unclear whether faster service in

limited markets will be enough to

convince them to absorb further

price increases.

And while Apple hasn’t an-

nounced its plans, the company

isn’t expected to introduce a 5G

iPhone until late next year. That,

too, will likely be a significant con-

straint on 5G demand given the

fact that the iPhone has leading

market share at the premium end

of the smartphone market where

customers are more likely to up-

grade early. As fast as 5G service

promises to be, the wait will be

painful. —Dan Gallagher

LondonStockExchangeGroupshareprice

Source: FactSet

Note: £1=$1.21

£75

50

July 26 July 29 July 30 July 31

55

60

65

70

Aug. 1

Refinitivdeal

announced

Apple Inc.’s AirPods met with

no small amount of derision when

they first hit the market three

years ago, with reviewers and crit-

ics competing to conjure the most

colorful comparison for the wire-

less buds. Q-Tips, bent cigarettes

and tampons were among the fa-

vorites.

Now the company is laughing

all the way to the bank. Sales in

Apple’s wearables-and-accessories

category surged 48% year over

year to $5.5 billion in the com-

pany’s fiscal third quarter.

That is the best growth for

that segment since late 2015. Ap-

ple doesn’t break out AirPod sales

specifically, but the company did

say on its conference call that it

was experiencing “phenomenal de-

mand” for the buds, which were

updated with longer battery life

and a wireless charging case just

before the

quarter be-

gan.

Toni Sac-

conaghi of

Bernstein esti-

mates that Air-

Pods drove the

majority of

gains for the

company’s

wearables

segment.

He also

believes Ap-

ple is now close

to selling about 10

million AirPod units

per quarter.

By way of comparison,

it took the iPod five years

to reach that sort

of scale.

And it didn’t look like a Q-Tip.

Oil Has a Shale Problem,

Not an Oil Problem

OVERHEARD

STEPHEN LAM/GETTY IMAGES