Business Maverick

Big tech is under fire. Could that mean it’s time to buy?

By Ruan Jooste 18 June 2019
Caption
Illustration: Leila Dougan | Company logos: Facebook, Amazon, Apple, Netflix, Google

The big tech companies nicknamed FAANGs (Facebook, Apple, Amazon, Netflix and Alphabet's Google) are in the crosshairs of policymakers and regulators, now more so now than ever. As ever, the issues are tax avoidance, data privacy issues or concerns around concentration risk. In the past, they rewarded investors despite the regulatory pressure. But could it be different this time? Or does the recent dip mean its time to buy?

When word leaked about possible antitrust investigations by the American Justice Department and the Federal Trade Commission, stock prices of Facebook, Amazon , Apple , Netflix and Alphabet – the parent company of Google – were crushed.  The so-called FAANG stocks lost nearly $140 billion in value on the day.

Activists say that Big Tech has too much power and needs to be broken up. Senator and Democratic Party presidential candidate Elizabeth Warren tweeted that “…they’re using that power to hurt small businesses, stifle innovation, and tilt the playing field against everyone else.”

But Victor Mupunga, Research Analyst at Old Mutual Wealth Private Client Securities, says the so-called network effects could make splitting off parts of Facebook an ineffective avenue for spurring innovation.

Part of the reason Facebook is so powerful is that everyone is already using it, making it hard for small incumbents to compete. Even if Instagram or Whatsapp were to be split off, they might simply become the new dominant network, barely changing the status quo.

“Breaking up Facebook without doing anything else probably isn’t going to solve that problem,” he says. “Because you might have a new monopoly just re-emerge through that network effect.”

Another issue is that antitrust laws are intended to address competition problems, not some of the other concerning practices of big tech companies, like how they handle consumer data, he adds.

Experts say the latest onslaught, however, could be a blessing in disguise for investors as it presents a massive buying opportunity.

This after the FANG stocks were already bleeding money from the fallout from the US-China trade war.

The friction is posing a great risk to these companies, says Kyle Hulette, head of asset allocation at Sygnia who heads up the asset manager’s FAANG Plus Equity Fund –  a high-risk dynamically-managed fund, which was launched last year. He says the performance of shares came off significantly.

He says tariffs are the least of the corporate economy’s problems, it is tech carnage that they should be concerned about.

According to a recent JP Morgan Report, the US tech sector has a revenue exposure of 27%to the Chinese market – the highest portion of the S&P 500. To put that into perspective, the second largest allocation in the index is consumer discretionary, which stands at 4%.

But it is not only Washington that is looking to draw blood.

Digital music application, Spotify, has managed to convince EU regulators to investigate the business practices of Apple’s app store, which they allege is uncompetitive, by being able to control and participate in the distribution pipeline. Spotify has stated that Apple is gaining an unfair advantage by being both the playing field and a competing participant with apps like Apple music.

No formal announcement has been made but the Financial Times has reported that a public announcement on the matter will be made in the next month or two.

Amazon is already under investigation for similar behaviour by EU competition authorities, which are in the process of studying the retail behemoth’s dual role as a seller of its own wares and platform for rivals.

Furthermore, Apple is facing a consumer class action back home, where users are contesting the 30% commission charged by Apple on revenue generated from apps hosted on their platform. The Supreme Court has recently that the plaintiff group’s case holds water and the case is allowed to go forward.

If this comes to fruition, together with the investigation in Europe, Apple will be fighting legal battles on both sides of the Atlantic Seaboard.

Meanwhile, experts say the chances of these companies being broken up are slim and their fundamentals point to further long-term growth. So cheaper trading levels could be a good entry point for investors looking for exposure to some of the best-performing stocks in recent years.

Analyst consensus for Amazon and Apple is a buy, stating the latter is particularly attractive at current levels trading at just 15 times their annual earnings.

The market also likes Facebook’s value proposition. Consensus expectations are for the stock to hit $221.5 a share this year, which would see a 32% upside on the current price.

But if history is anything to go by, and even if state agencies aren’t successful in their bids to break up company structures, their efforts can still cost investors. Antitrust lawsuits create massive distractions, enormous legal bills and cast a shadow over companies.

The thee most well-known examples of antitrust lawsuits: IBM, AT&T and Microsoft, stock valuations deteriorated during years-long periods of litigation — and sales growth decelerated even after the cases were decided.

“Similarities among historical outcomes suggest that investors should reduce exposure to any stock that becomes subject to an antitrust lawsuit,” Goldman Sachs writes.

AT&T, which controlled more than 70% of sales among public US telecom companies between 1950 and 1980, according to Goldman Sachs.

In 1974, the United States sued to break up Ma Bell. The case took eight years to be decided — and dealt a sizable blow to AT&T’s valuation along the way.

AT&T’s relative price-to-book multiple tumbled from 1.3 in 1974 to 0.7 after the breakup was ordered, Goldman found.

Like AT&T, Microsoft’s once-lofty valuation shrank to more pedestrian levels during the time of a similar lawsuit.

Microsoft faced an antitrust lawsuit in 1998 due in part to the commanding position of its Windows operating system.

And Goldman Sachs found that Microsoft’s valuation continued to rapidly decline — even slipping out of the S&P 500 — until 2011 when the settlement with the government expired.

And there is much more room for these big tech companies to fall. Big Tech may have become too successful for its own good, especially in today’s shrinking stock market.

Google and Facebook laid claim to 87% of last year’s sales within the interactive media & services space, the firm found. Google alone accounted for 63% of the sales.

And while Amazon makes up just a small slice of the massive retail industry, it generated 72% of last year’s revenue in the internet & direct marketing retail space, Goldman found.

In many ways, this dominance fueled the rise of these superstar stocks, enabling them to wrack up monster sales growth, enviable margins and lofty valuations.

So exposure to this sector remains a risky one, and Hulett says he does not advocate a significant portion of your portfolio be invested in this offshore sector.

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