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3 Picks from the Still-Strong Internet Services Industry
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Macro factors currently driving the economy, such as the relatively high interest rates, continued strength in labor markets, supply chain issues (though minimal right now and in pockets) and so forth have a varied impact on players in the extremely diverse Internet – Services industry. However, the outlook for the industry is positively correlated with a stronger economy.
Additionally, since this is a capital-intensive industry with high fixed costs of operation and the fairly constant need to expand capacity, a high interest rate environment just doesn't work in its favor. Therefore, the slimming possibility of rate cuts this year along with the fact that a recession seems extremely unlikely make us only marginally positive about the Internet Services industry. Valuations have risen over the past year, but there is still money to be made.
Internet - Services companies are primarily those that rely on huge software and hardware infrastructure, referred to as their properties, to deliver various services to consumers. People can avail the services by accessing these properties with their personal connected devices from almost anywhere in the world.
Companies generally operate two models: an ad-based model and an ad-free model where the service is charged. Alphabet, Baidu and Akamai are some of the larger players while Crexendo, Upwork, Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players. Large players (mainly Alphabet) tend to skew the numbers.
Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. The effect of macro factors such as inflation, rate hikes, supply chain issues and so forth vary by company
Factors Determining Industry Performance
It goes without saying that increased digitization of different aspects of daily life is a driver for the entire industry because digitization essentially transfers work online, which is where Internet service providers are required to be. The pandemic proved course-altering for the industry because of the huge volume of transactions that moved online. And people are not giving up all of these conveniences to go back to their old ways. The expansion of the installed base of connected devices beyond PCs and smartphones to IoT, automotive and more is creating additional opportunities for targeting. The ownership of multiple devices automatically drives people to use these services more as they increasingly automate routine chores.
Being a capital-intensive industry, there is the need to raise funds to build out costly infrastructure. Funds are also needed to maintain this infrastructure. Given the secular demand prospects, companies continued infrastructure investments in 2023, despite rising interest rates. With interest rates expected to come down this year, capex is likely to continue trending north.
Alphabet is headed toward cost rationalization, including a reduction in its workforce and office space, which given its size, could have a positive effect on industry margins.
Debt levels have been relatively steady this year, coming down slightly in the March quarter and again in December, as Alphabet’s debt levels were lowered. Two things typically trigger major increases in debt levels (and the two are not mutually exclusive), i.e. fixed asset investment and acquisitions. The 2023 net PP&E trend looks non-exceptional, following seasonal patterns in earlier years. The appetite for acquisitions appears to be low however, as seen from the aggregated intangibles balance. The still-high interest rates could be playing spoilsport. Alphabet, for which swallowing smaller players is all in a day’s work, also appears to be going slowly for now.
Traffic acquisition is one of the most important drivers of revenue, so companies invest in advertising or building communities that can draw more users to their online properties and get them to spend more time there, much like a store owner would try to keep a prospective buyer within the store. Some large players, including those providing infrastructure services, grow by tying up with other such large players for access to their customers. Since the personal touch is absent in an online store, many rely on cookies and increasingly, other technologies to track users, collect data on them and profile them in order to better understand their needs.
As these companies have grown over time, some of them have collected such a wealth of information on their users that the data itself is now helping them build artificial intelligence (AI) to generate revenues from new technologies and services and also lower the cost of operation. Ad-based services are no longer considered free. The EU’s GDPR and the CCPA (California Consumer Privacy Act) for example require service providers to acquire explicit permission from users before collecting their data. While not all businesses are built on the same scale or have the same customer reach, AI tools are increasingly helping organizations of every size. They are tremendously increasing operational efficiency and the scope for growth. Since larger companies and companies dealing directly with customers have direct access to customer data, there is a corresponding effect on the competitive dynamics as well.
Zacks Industry Rank Remains Positive
The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #80, which places it among the top 32% of more than 250 Zacks-classified industries.
The group’s Zacks Industry Rank, which is basically the average rank of all the member stocks, indicates that there are several opportunities in the space. However, the diverse range of companies makes stock selection tricky.
Looking at the aggregate earnings estimate revisions over the past year, we see the bottom in March 2023 and a pop back up in July the same year, after which they have trended moderately up. Overall, the industry’s earnings estimate for 2023 is up 9% from April 2023. The average earnings estimate for 2025 is down 0.9%.
Historically, the top 50% of Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. So the industry’s positioning in the top 50% of the Zacks-ranked industries should be considered a positive, even if a recession, albeit a shallow one, cannot yet be discounted.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Leads on Stock Market Performance
Through most of the past year, the industry has traded at a premium to both the broader sector and the S&P 500. The technology sector did pull ahead in Feb 2024, but ended lower as the industry drove sharply higher since the beginning of March this year.
As a result, the industry’s gain of a net 48.4% in the past year is somewhat ahead of the broader sector’s 42.3% and roughly double the S&P 500’s 24.2%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 23.46X multiple, which is a premium to its median value of 22.13X over the past year. It is also a premium to the S&P 500’s 20.88X -- still a discount to the sector’s 26.39X.
Over the past year, the industry has traded in the range of 20.05X to 23.46X, remaining at a premium to the S&P’s 17.86X to 21.47X throughout. The sector has traded in the 22.26X to 26.62X range.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
3 Solid Bets
Of the three stocks selected today, Crexendo and Upwork are rated Zacks #1 (Strong Buy), while Uber Technologies is rated #2 (Buy).
Crexendo, Inc. (CXDO - Free Report) : Tempe, AZ-based Crexendo is a provider of Unified Communications as a Service (UCaaS), Call Center as a Service (CCaaS), communication platform software solutions, and collaboration services designed to provide enterprise-class cloud communication solutions to any size business through their business partners, agents, and direct channels.
Crexendo is very well positioned in both its software solutions (35% revenue share, high-margin, faster-growing) and telecom services (65%) segments. In the software segment, the company services more than 220 UCaaS customers out of an estimated 500, which through middlemen like MSPs, service providers, white labelers, tech companies and telecom companies reach a broad cross section of end users.
Telecom services are provided both directly and through around 200 agents. In both cases, the company focuses on the subscription model (75% of software solutions and 78% of telecom solutions at 2023 end), which provides improved visibility and generates a relatively steady revenue stream. Customer retention is very strong, with churn in both segments under 1% in the last quarter. This speaks to the quality of services it provides. Crexendo is also active on the M&A front, with a stated target of acquiring one company every year, usually from among its customers.
Crexendo topped estimates in the last quarter. Its revenue beat by around 3% while earnings beat by 50% (the company earned 6 cents instead of the 2 cents estimated by analysts). The 2024 and 2025 estimates are up 5 cents each to a respective 23 and 24 cents in the last 60 days. At these levels, the revenue and earnings estimates represent a respective 9.9% increase and a 4.2% decline in 2024, followed by a respective increase of 15% and 4.4% in 2025.
The shares are up 206.6% over the past year.
Price and Consensus: CXDO
Image Source: Zacks Investment Research
Upwork Inc. (UPWK - Free Report) : San Francisco, CA-based Upwork operates a work marketplace connecting individuals, agencies and companies in search of work or of talent to do work. It operates primarily in the U.S., India and the Philippines.
Upwork is using AI to significantly improve outcomes for both freelancers and corporate clients, which is also improving its own profitability. The company has reported an increase of more than 230% in visitors to its AI Services hub from the first half of 2023 to the second. Concurrently, its EBITDA margin has more than doubled from the second quarter to the fourth quarter of 2023.
The company posted strong results in the last quarter, beating revenue estimates by 3.1% and earnings estimates by 17.7%. The Zacks Consensus Estimate for 2024 is up 11 cents (15.9%) in the last 60 days while that for 2025 is up 7 cents (7.8%). Analysts are currently projecting revenue growth of 12.7% in 2024 and 14.3% next year. They expect earnings to grow 53.9% this year and 21.3% in the next.
The shares are up 12% over the past year.
Price and Consensus: UPWK
Image Source: Zacks Investment Research
Uber, Inc. (UBER - Free Report) : San Francisco-based Uber Technologies provides ride-hailing, food delivery and freight (leasing vehicles to third parties) services through its Mobility, Delivery and Freight segments, respectively. The company operates across the Americas, Europe, Middle East and Asia.
Both its ride-sharing and delivery platforms are growing in popularity. This is generating strong demand, which along with new growth initiatives and continued cost discipline are driving the company’s results. In the last-reported quarter, gross bookings grew 22% year over year, with mobility growing 29% and delivery 19%. Trips were up 24%. The strong momentum in the business helped generate a 19% increase in gross bookings for the year, with revenue growing 17%, trips 24% and EBITDA a whopping 137%.
As a result, the company beat the Zacks Consensus Estimate by 340% in the last quarter on revenue that beat by around 2%. The 2024 earnings estimate has increased 9 cents (8.1%) in the last 60 days while the 2025 estimate increased 17 cents (9.2%) in the last 60 days. Analysts are looking for 16.1% revenue growth and 37.9% earnings growth this year, followed by 16.7% revenue growth and 67.7% earnings growth in the next.
The shares are up 134.6% over the past year.
Price and Consensus: UBER
Image Source: Zacks Investment Research
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3 Picks from the Still-Strong Internet Services Industry
Macro factors currently driving the economy, such as the relatively high interest rates, continued strength in labor markets, supply chain issues (though minimal right now and in pockets) and so forth have a varied impact on players in the extremely diverse Internet – Services industry. However, the outlook for the industry is positively correlated with a stronger economy.
Additionally, since this is a capital-intensive industry with high fixed costs of operation and the fairly constant need to expand capacity, a high interest rate environment just doesn't work in its favor. Therefore, the slimming possibility of rate cuts this year along with the fact that a recession seems extremely unlikely make us only marginally positive about the Internet Services industry. Valuations have risen over the past year, but there is still money to be made.
Our picks are Crexendo (CXDO - Free Report) , Upwork (UPWK - Free Report) and Uber (UBER - Free Report) .
About the Industry
Internet - Services companies are primarily those that rely on huge software and hardware infrastructure, referred to as their properties, to deliver various services to consumers. People can avail the services by accessing these properties with their personal connected devices from almost anywhere in the world.
Companies generally operate two models: an ad-based model and an ad-free model where the service is charged. Alphabet, Baidu and Akamai are some of the larger players while Crexendo, Upwork, Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players. Large players (mainly Alphabet) tend to skew the numbers.
Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. The effect of macro factors such as inflation, rate hikes, supply chain issues and so forth vary by company
Factors Determining Industry Performance
Zacks Industry Rank Remains Positive
The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #80, which places it among the top 32% of more than 250 Zacks-classified industries.
The group’s Zacks Industry Rank, which is basically the average rank of all the member stocks, indicates that there are several opportunities in the space. However, the diverse range of companies makes stock selection tricky.
Looking at the aggregate earnings estimate revisions over the past year, we see the bottom in March 2023 and a pop back up in July the same year, after which they have trended moderately up. Overall, the industry’s earnings estimate for 2023 is up 9% from April 2023. The average earnings estimate for 2025 is down 0.9%.
Historically, the top 50% of Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. So the industry’s positioning in the top 50% of the Zacks-ranked industries should be considered a positive, even if a recession, albeit a shallow one, cannot yet be discounted.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Leads on Stock Market Performance
Through most of the past year, the industry has traded at a premium to both the broader sector and the S&P 500. The technology sector did pull ahead in Feb 2024, but ended lower as the industry drove sharply higher since the beginning of March this year.
As a result, the industry’s gain of a net 48.4% in the past year is somewhat ahead of the broader sector’s 42.3% and roughly double the S&P 500’s 24.2%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry's Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at a 23.46X multiple, which is a premium to its median value of 22.13X over the past year. It is also a premium to the S&P 500’s 20.88X -- still a discount to the sector’s 26.39X.
Over the past year, the industry has traded in the range of 20.05X to 23.46X, remaining at a premium to the S&P’s 17.86X to 21.47X throughout. The sector has traded in the 22.26X to 26.62X range.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
3 Solid Bets
Of the three stocks selected today, Crexendo and Upwork are rated Zacks #1 (Strong Buy), while Uber Technologies is rated #2 (Buy).
Crexendo, Inc. (CXDO - Free Report) : Tempe, AZ-based Crexendo is a provider of Unified Communications as a Service (UCaaS), Call Center as a Service (CCaaS), communication platform software solutions, and collaboration services designed to provide enterprise-class cloud communication solutions to any size business through their business partners, agents, and direct channels.
Crexendo is very well positioned in both its software solutions (35% revenue share, high-margin, faster-growing) and telecom services (65%) segments. In the software segment, the company services more than 220 UCaaS customers out of an estimated 500, which through middlemen like MSPs, service providers, white labelers, tech companies and telecom companies reach a broad cross section of end users.
Telecom services are provided both directly and through around 200 agents. In both cases, the company focuses on the subscription model (75% of software solutions and 78% of telecom solutions at 2023 end), which provides improved visibility and generates a relatively steady revenue stream. Customer retention is very strong, with churn in both segments under 1% in the last quarter. This speaks to the quality of services it provides. Crexendo is also active on the M&A front, with a stated target of acquiring one company every year, usually from among its customers.
Crexendo topped estimates in the last quarter. Its revenue beat by around 3% while earnings beat by 50% (the company earned 6 cents instead of the 2 cents estimated by analysts). The 2024 and 2025 estimates are up 5 cents each to a respective 23 and 24 cents in the last 60 days. At these levels, the revenue and earnings estimates represent a respective 9.9% increase and a 4.2% decline in 2024, followed by a respective increase of 15% and 4.4% in 2025.
The shares are up 206.6% over the past year.
Price and Consensus: CXDO
Image Source: Zacks Investment Research
Upwork Inc. (UPWK - Free Report) : San Francisco, CA-based Upwork operates a work marketplace connecting individuals, agencies and companies in search of work or of talent to do work. It operates primarily in the U.S., India and the Philippines.
Upwork is using AI to significantly improve outcomes for both freelancers and corporate clients, which is also improving its own profitability. The company has reported an increase of more than 230% in visitors to its AI Services hub from the first half of 2023 to the second. Concurrently, its EBITDA margin has more than doubled from the second quarter to the fourth quarter of 2023.
The company posted strong results in the last quarter, beating revenue estimates by 3.1% and earnings estimates by 17.7%. The Zacks Consensus Estimate for 2024 is up 11 cents (15.9%) in the last 60 days while that for 2025 is up 7 cents (7.8%). Analysts are currently projecting revenue growth of 12.7% in 2024 and 14.3% next year. They expect earnings to grow 53.9% this year and 21.3% in the next.
The shares are up 12% over the past year.
Price and Consensus: UPWK
Image Source: Zacks Investment Research
Uber, Inc. (UBER - Free Report) : San Francisco-based Uber Technologies provides ride-hailing, food delivery and freight (leasing vehicles to third parties) services through its Mobility, Delivery and Freight segments, respectively. The company operates across the Americas, Europe, Middle East and Asia.
Both its ride-sharing and delivery platforms are growing in popularity. This is generating strong demand, which along with new growth initiatives and continued cost discipline are driving the company’s results. In the last-reported quarter, gross bookings grew 22% year over year, with mobility growing 29% and delivery 19%. Trips were up 24%. The strong momentum in the business helped generate a 19% increase in gross bookings for the year, with revenue growing 17%, trips 24% and EBITDA a whopping 137%.
As a result, the company beat the Zacks Consensus Estimate by 340% in the last quarter on revenue that beat by around 2%. The 2024 earnings estimate has increased 9 cents (8.1%) in the last 60 days while the 2025 estimate increased 17 cents (9.2%) in the last 60 days. Analysts are looking for 16.1% revenue growth and 37.9% earnings growth this year, followed by 16.7% revenue growth and 67.7% earnings growth in the next.
The shares are up 134.6% over the past year.
Price and Consensus: UBER
Image Source: Zacks Investment Research