We begin this week with the latest update in the throwing of the kitchen sink story which we first elaborated upon, what seems like years ago, in March. Back then we posited that the Federal Reserve would become the lender of last resort for the corporate sector and dispense with all sense of normality. And so here we are, the Federal Reserve has, as of last night (15 June), made a commitment to buy corporate bonds on an individual basis (as opposed to the high-yield ETF that was bought through a special purpose vehicle). This latest action should make for some interesting watching when Powell goes up in front of Congress on June 16th and 17th where he will surely be asked the question of whether the Fed is in the process of nationalising corporate debt. At this point, we ask the question: is it such a stretch to imagine that once you can put credit risk on the balance sheet of a central bank it's not too far to equities risk, is it?
So what does the latest central bank policy shenanigan have to do with this week's topic of tech giants and their place in a post-Covid world? Firstly, as most of our readers are aware, the technology giants have been some of the biggest beneficiaries from central bank largesse, as indicated by the Nasdaq reaching all-time highs. The lowering of interest rates around the world to zero-bound have ensured that the valuations for higher growth prospects have been able to expand to previously unfathomable levels and the confirmation, from a markets perspective, of a central bank put should, at least in the short-run, benefit them disproportionately from a risk-on trade. Though apparently the punters deemed Hertz, in Chapter 11 bankruptcy, to also be a beneficiary.
Sarcasm aside, let us actually see the latest in tech news and what the Goliaths have been up to (unfortunately, no David in this story).
M&A, the Bankers Nirvana tinged with a touch of megalomania (or could it be MAGAlomania?)
Amongst all the noise around Covid-19, the vagaries of everyday market volatility, Australian investors are sometimes unable to hear the news that will surely impact our planet and our lives for decades to come. To begin with, the crisis has been close to a godsend for Big Tech, flush with cash and steadily laying the groundwork for continued dominance.
Let’s begin with Facebook which has placed a strategic investment in Gojek (a Super App that gives it access to the South East Asian market), a 5.7bn USD investment into Reliance Jio (one of India’s largest telecommunications providers across 4G and fibre with the expectation that it will be the leading contender for a 5G rollout when it comes to the sub-continent), an unknown quantity of billions to build a 23,000-mile deep-sea fibre-optic cable encircling Africa, and the 400m USD acquisition of a GIF company along with the building out of a Venture Capital arm.
The others aren’t so far behind, Microsoft snapped up three cloud computing companies in the last couple of months alone to complement Azure, the dominant cloud infrastructure platform alongside Amazon Web Services (AWS). Believe it or not, if you have health insurance, have a TFN or use any banking app, it would’ve gone through one of these platforms. Amazon, as always, has gotten even more creative, it has now added twelve Boeing 767’s to its fleet of seventy-odd delivery planes (Prime Air), not to mention their now forgotten acquisition of French shipping company, Colis Privé, back in the dark ages of 2016. After all, it considers the likes of UPS and FedEx to be competitors. We would like to ask though, are there any companies out there in particular that they don’t consider to be competitors? Oh, and by the way, they are also currently in talks to buy Zoox, an autonomous vehicle startup.
Apple, a company that has always been known for its pursuit of organic growth, isn’t behind the other busy bees either. With about 193bn USD in cash and debt, it has moved to the dark side. They have gone on a spending spree, buying up everything from an AI (Artificial Intelligence) Startup to a Virtual Reality Company (NextVR) to a smart weather app. The quiet one of the lot has been Google which has nevertheless still made some rather big-ticket purchases, the first being Pointy in Ireland and the second being Fitbit for 2.1bn USD. One would assume that they are focused on getting this over the line and integrating it before making any new waves. After all, Alphabet has always been a serial acquirer. In the enterprise space though, Cisco has also made some decent moves through this crisis. The acquisition of ThousandEyes, another troubleshooting/network monitoring software company that complements their previous big-ticket purchase of AppDynamics.
So, what is the point of highlighting this news?
For one thing, this consolidation is likely to get even more interesting given that the top five tech giants, Apple, Amazon, Microsoft, Facebook and Google sit on about 557bn USD in cash that they are willing to throw around. The crisis enables them to not only benefit through consolidation but also expand whilst the rest of the world is in crisis mode.
But the question remains, where to next? Hint: what is the common thematic between, Fitbit (tracks human activity), AI, virtual reality and telecommunications. Data, the currency of our age. We will come back to this issue after exploring the hurdles that they are coming up against.
Some Hurdles - The New Trust Busters
(Oh Teddy, Where Art Thou)
The latest in the headlines is the European Commission’s opening of a formal antitrust investigation into Apple. In particular, whether Apple’s rules for app developers and the distribution of apps via the App Store violate EU competition laws. This is rather complementary to the ongoing Amazon investigation, opened in 2018, in order to look into merchant complaints around the collection of data and agreements that require third-party sellers to share certain data with Amazon that then enables them to introduce their own products at a lower price (think about it like private label at supermarkets, except on steroids). There are also ongoing investigations into Alphabet which has been the highest-profile company consistently slapped with fines, the most recent back in 2019 and a 1.69bn USD bill. Somehow we doubt whether this might make all that much of a difference to their practices. It does make rather more sense to pay the fine and continue with business as usual, we are talking about a company with close to 170bn USD in revenue.
Though these investigations in Europe have often drawn the ire of the US State Department and the administrations in the US, the fact that Congress is in the process of its own investigations into Big Tech is rather telling. The latest victim will be the richest man in the world, Bezos, who is set to testify before the House Judiciary committee around an antitrust investigation. The CEO’s of the other companies under investigation, Apple, Facebook and Google, have already appeared with Bezos being the outlier to date. This changed when the committee publicly threatened to compel Bezos to appear via legal avenues.
The current investigations make up part of a larger backlash, amongst both lawmakers and enforcement officials, against the power of large technology companies. We have seen this story before, just not in our lifetimes perhaps.
The last time we had this sort of concentration in market power goes back to the days of Standard Oil and its breakup into the still very large behemoths that are Exxon, Chevron and Marathon Petroleum. One of the US’ more memorable Presidents made his legacy as the “Trust Buster”, breaking up large railroad corporations and the aggressive use of antitrust laws. Teddy Roosevelt, the Trust Buster.
Unfortunately, despite the possibility that market power will continue to be concentrated and the fact that rising populism might create some short-term catalysts, there is another side to this equation. Last year, in writing about the US-China Trade Kerfuffle we pointed out that the big issue that is at stake is the idea of Industry 4.0 and technology being at the forefront of global leadership in the 21st century.
In fact, the recent stimulus packages have included, with bipartisan support, a new trust fund for federal grants to match state subsidies to encourage new semiconductor factories as well as subsidies for companies reshoring production in high-tech back into the USA. The New York Times did a good job digging deeper into this should you wish to learn more. A key strategic component of this will be the inevitable involvement of the tech giants as competitors to the national champions created by China. The White House and governments will continue to seek the help of and work closely with the technology firms to ensure America’s survival in the race. This is the reason that the White House takes such a confrontational approach to nations that work with Huawei and this is the same reason why there is likely to be a gradual disentanglement of supply chains. Despite the rhetoric, the issue is not so basic as the current account deficit or low-value add manufacturing jobs (though this plays well in an election cycle), it is the determination of the pecking order going forward.
So where does this leave the tech giants?
Fortunately for the investors and the companies, we don’t have Theodore Roosevelt in the White House and neither do we have a functioning policy environment. My view is that we will continue to see massive consolidation as companies seek to expand their product line to hoard the greatest commodity of the 21st century (no, not gold), data.
Let us give you an example, what if I could accurately figure out the likelihood that you could get diabetes or when you might have a child or the likelihood of you getting married and when? And do so before you do. Imagine the potential for monetization in that. This is the very reason that Amazon is not a retail company, it is the same reason why Microsoft is not just a tech company and why Apple, despite what our esteemed Mr; Buffet says, is not a consumer discretionary company. They are businesses that could be anything, ranging from media, financial services to health care. Their starting point and competitive advantage is data.
Until now, believe it or not, the Goliaths have been rather balanced and nuanced with regards to their customer base and issues of privacy. They have the opportunity though to be otherwise. Take, for example, Clearview AI, a Silicon Valley startup that provides facial recognition software to law enforcement agencies around the world (recent information suggests that corporates have also been paying for its services too though). They scrape over 3bn images from Twitter, Facebook, Instagram etc. The CEO insists that the company works for respectable law enforcement agencies and allies of the USA (i.e. ruling out China, North Korea and like). But apparently Saudi Arabia and UAE are fair game and we all know the stellar respect for human rights that those two governments have. Similarly, as we alluded to in our article Surveillance Capitalism, one country that has been a prolific user of such technologies has been China with its own startups and tech giants such as Weibo, Baidu and the “Skynet Project”.
Where to next?
The next few decades should see further consolidation within the space. Their place will be much determined by the balance between politicians' self-interest in maintaining power and the national interest of competing with other nations. We don’t have the statistics to back it up but we would not be surprised if the public perception of Big Tech isn’t similar to that of Big Pharma pre-Covid, leaving in the possibility of further regulation. Regulation isn’t necessarily bad as it levels the playing field that is needed for markets to function properly. Take, for example, Amazon’s ability to not pay (amongst other things) retail property taxes and instead only industrial tax rates on its warehouses (fulfillment centres) or the ability of Facebook or Twitter to get away with behaviour that would be unacceptable for any other media outlet in terms of the information they help disseminate.
However, whether this regulation is forthcoming depends on two important factors 1) reputation and 2) geopolitics. When we say reputation, we are referring to environmental factors. The reputation of Big Pharma changed quite quickly since the advent of Covid and the royal commission was quickly forgotten following the Covid crisis too, they were seen as crucial to the recovery and broader economy. We are quite sure that Bezos’ purchase of the Washington Post wasn’t purely business-minded. In terms of geopolitics, as the Industry 4.0 race accelerates it creates a further need to rely on technology to advance national interests and, in this instance, antitrust might not be within the appetite of any administration. Though the prospect of direct intervention and bringing them into the political orbit might be well within the realm of possibility. It isn’t such a stretch to imagine that national security laws will be used to circumvent any pesky issues arising from confrontational management, whether it is in the realm of data sharing or the making of new laws like the DPA (Defence Production Act) used during the Korean War. Political actors can always be counted upon to use the “national interest” to expand their sphere of influence or confuse national interest with that of self-interest.
Is there an investment case?
The problem, as you might’ve imagined by now, is that while there is a reasonable case to be made for a long runway of growth for the majors (despite their already considerable size), this growth in itself increases the risk of intervention. The risks predominantly come from public perceptions of equity and fairness as well as the political environment. In our opinion, we will see a gradual shift away from growth to maturation, warranting a different investment mindset. Just as Big Pharma, after the initial growth phase, reached maturation with consolidation and new growth coming predominantly from acquisitions and, just as Standard Oil became the oil majors of today, so too is it likely that what we currently call Big Tech will gradually become the conglomerates of tomorrow.
For the growth-minded investor it might make sense to still have exposure to the majors just as it makes sense to have the Big 4 Aussie banks in your portfolio given their role on the index and to the broader economy, but understanding the risks and the expectation that the growth trajectories that we have grown accustomed to might not be quite the same (and neither would you want that). The growth will come instead from finding smaller more nimble companies that look attractive from a takeover perspective. Just as one keeps in mind the potential for M&A when investing in a biotech firm or the potential for niche products within the financial services space (an example might be the BNPL space). Nevertheless, any risk-on trade and accommodative central bank policies will make them primary beneficiaries from a securities price perspective. So, the simple answer is, have them in the portfolio but don’t expect the same returns and be cognizant of regulatory risks that are inevitably going to arise.
Note (18 June 2020):
Since the initial publication of this article the DoJ (Department of Justice) has released a 25-page memo recommending changes to Section 230 of the Communications Decency Act. Something which enabled the likes of Twitter, Facebook and YouTube to have broad immunity for content posted using their services and platforms. The onus is now being placed upon the companies to police harmful and disingenuous content (including, one would expect, so-called "fake news" in its many and varied forms both left and right).
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