The current COVID-19 crisis has changed the global economy- unemployment numbers are at all-time highs in recent decades, but Wall Street has been defying Main Street and rallying from its March 2020 lows
The major indices S&P 500 and NASDAQ Composite precipitously dropped 25 to 30% in one month from their February all-time highs and have risen back to nearly -5 to 5% respectively.
Source- Google Finance, 25th May 2020
The biggest attribution to this rally in these indices is because of BIG TECH
What is BIG TECH?
Big Tech is commonly referred to the largest 5 Technology companies FAAAM (Facebook, Alphabet (Google), Amazon, Apple and Microsoft. These companies totally account value $5.6T in market cap, 13.3% weightage in Dow Jones index, 21% weightage in S&P index and 46% in Nasdaq 100 as of May 22nd 2020.
Their 43% market gains from the March bottoms have been holding this rally while the broader US markets have gained 33%.
Source- SlickCharts, 22 May 2020
The question I ask does Big Tech have the moat to continue to Rise or Fall?
There are Wall Street pundits and millennials who believe that Big Tech is going to emerge even more stronger from the Covid-19 crisis and then there are few who believe that dominance of Big Tech is going to end soon or probably in this coming decade.
In this blog post, I present both viewpoints and finally give my own assessment of these 5 companies using my Company Lifecycle Model as well as historical analysis of the Big tech top 5 companies in the late 1990s.
Case for Big Tech to continue to Rise
High Demand for their Product & Services
Big Tech is selling high demand products & services
· Ecommerce– Amazon is benefiting from the Shelter in Place as people are ordering online purchasing instead of buying from physical retail stores. Facebook has launched its Shop Services collaborating with Paypal and Shopify making it easier for merchants to promote their virtual storefronts.
· Public Cloud Services– Amazon, Microsoft and Google have been growing their public cloud offerings, which are high profitable and double-digit growth businesses. CIOs would prefer OPEX – pay for you use consumption rather than make significant IT Capital expenditures (CAPEX).
· Social Media – FaceBook (Whatsapp, Instagram, Facebook) and Microsoft (Linkedin) are seeing higher levels of engagement during this crisis
· Software Services– Microsoft (Teams), Facebook (Whatapp, Live) and Google (Meeting) are offering integrated collaboration tools for employees to work remotely. People love their mobile apps and App licensing fees will be strong for Apple and Google
· Phones, Personal Devices and Laptops– Consumers will continue need to upgrade their phones laptops and Ipads
$500B+ Cash War Chest
Big Tech companies are sitting on stockpiles of cash. Even if the Covid-19 situation exacerbates damaging their revenues and profits, they have the power to dominate while the smaller players will struggle to survive.
They continue to invest in R&D so they can out innovate their smaller rivals and have the cash to protect their tech talent from layoffs during the downturn. They also have favorable low interest rates to take on debt and favorable small company market valuations to make potential acquisitions.
How did these companies become Big Tech?
There are thousands of companies that incorporate each year but only select few survive and become behemoth Goliaths. I explain this using Company Lifecycle Model that I had written about in 2017. Every company evolves through different phases of the lifecycle.
- Startup– Create a product for an unmet need. 9 out 10 companies fail in this stage
- Growth– Aggressive Sales, add customers, crucial stage to cross the chasm
- Maturity- Hire and sustain Talent, launch new products, time market transitions, exit markets and grow by acquisitions
- Decline- Experience declining revenue and sometimes run into losses, unable to sustain. Either get acquired or file for bankruptcy
Microsoft– Founded in 1975. Developed and sold Basic Interpreters. Dominated the 1980s and 1990s with Windows Personal Computer operating system and Office Suite products. Late to the Internet wave but reoriented company direction. Successfully survived the Anti-Trust Litigation in late 1990s (Netscape vs Internet Explorer)
Survived Dotcom crash throughout the 2000s with Cash cows Office and Windows. Forayed into Search, Gaming, Tablets, Music devices, Mobile Operating Systems, Collaboration software and phones but failed to make impacts versus Apple & Google. Failed acquisition of Nokia.
Strategic Decision to build Public Cloud business Azure in 2008 leveraging its strong enterprise relationships. Broke the competitive rivalry norm and made Office 365 available in Apple products.
Apple- Founded in 1976. Developed and sold Apple 1 computer and competed with IBM/ Microsoft through the 1980s and had significant decline in 1990s. Launched the Think Different campaign in 1998 introducing the iMAC and after that there was no looking back.
Introduced the numerous product innovations in 2000s IPOD, legitimatized iTunes with Music industry backing after Napster debacle, Iphone and Ipad and created the IOS Application App Store Ecosystem, which has created an entire new Apps industry.
Not many new product innovations in 2010s but have sustained growth. Has unique distinction of having 25% market share of mobile phone market but controls 65% of the profits.
Amazon– Founded in 1994. Started as an Online Book retail store and then successfully started selling other products such as consumer electronics, games, home improvement etc. Has the reputation of reinvesting the profits to fund growth.
Does not believe in capital conservation, stock buybacks and dividend payouts. Is not worried about failing- learn and move on to next venture. That has been the mantra for success.
Invested heavily in IT infrastructure early 2000s to meet the Holiday Season demand and not breakdown. Realized that this idle infrastructure could be rented out the rest of the year. Started Amazon Web Services in 2006 and no looking back. First mover advantage- currently 13% of total revenues but 71% of operating profits
Dominated the online retail with 50% market share. Pioneered Prime- offering 1 to 2 day Delivery and also forayed into electronic Book readers, personal digital assistant using AI and Media Streaming.
Alphabet (Google)- Founded in 1998. Launched a search engine in crowded competitive search engine market and revolutionized search. Dominated the search market for last 20 years. Built a business model on advertising and successful created an ecosystem around Search- developing G Suite products such as Gmail, Google Drive, Sheets, Docs.
Made good acquisitions of Youtube, Android, DoubleClick and successfully monetized them. Credited for rivaling Apple in Mobile Operating Systems race and convincing mobile hardware vendors such as Samsung, Motorola and other vendors to adopt Android- developing ecosystems of apps, which ultimately enabled search.
Late into the public cloud race and is third behind Amazon and Microsoft. Betting on next generation ventures such as Waymo (Self Driving Cars), Calico and Verily (Human Health) and DeepMind (AI).
Facebook– Founded in 2004. Primarily started as a social media platform for university students but took off globally extending to other verticals. Currently has over 2.5 billion active users. The primary business model is Facebook Ads. Was extremely successful in embracing the Mobile phone wave.
Controls 4 of top 5 most downloaded apps (WhatsApp, Messenger, Facebook and Instagram but not Tik Tok). Key acquisitions are Whatsapp and Instagram. Recently made $5.7 Billion taking 9.99% stake in India’s Jio Platforms to promote E Commerce via Whatsapp. India is Whatsapp’s biggest market with more than 400 million users.
The common thread in these companies is that they are nimble and time market transitions. They are not afraid to take risks, innovate and adapt their businesses as the market demands. You can get a deeper dive of their revenue streams visually.
Case for Big Tech to Fall
Worsening Macroeconomic conditions
Like all other economic downturns, Big Tech is not immune to global macroeconomic conditions. Consumers may be currently spending online due to shelter in place and due to current economic stimulus checks and Pay Protection Programs in America and Europe.
Consumers might also delay upgrading their phones or laptops or not renew their paid mobile apps due to fear of job losses and economic downturn.
Companies like Amazon may have gained market share recently, but other retail competitors like Target and Walmart are stepping up their online presence with same day delivery from their physical store.
Facebook and Google are dependent on small business advertising revenue and they have been impacted.
In 2009, McKinsey did an analysis from the peak to the trough of recessionary periods, spending on the goods and services that the high-tech sector generates traditionally drops four to seven times more than GDP does.
In three of the prior four major downturns, IT spending fell twice as much as GDP did; after the dot-com bubble burst, in 2000, IT spending fell by 27 percent, GDP by 3.7 percent
Though this study is dated, it is interesting to note IT growth over the past decade (2010-2020) has been phenomenal like in the 1990s.
In the late 1990s, it was all about the euphoria of the Internet and currently it is same chatter of a Tech Super cycle with increased Cloud spending adoption, Mobile apps and advancements in AI/ML
Earlier this month, IDC lowered the forecast for Worldwide IT Spending to a Decline of 5.1% in 2020, but said Cloud Spending remains relatively Resilient.
Gartner has also projected Worldwide IT spending to total $3.4 trillion in 2020, a decline of 8% from 2019.
Anti-Trust Litigation, Regulation and Taxation
The biggest threat to the BIG Tech is global regulation, Anti-Trust litigation and Taxation. Prior to the Covid-19 crisis, there was momentum in the Washington (US) and Brussels (EU) to limit the powers of Big Tech companies.
The Wall Street Journal recently ran a story that the Justice Department and group of State Attorneys are planning to file an Anti-Trust litigation against Google targeting the online advertising business and focusing more broadly on concerns that Google uses its dominant search business to stifle competition.
Amazon is being accused of developing competing products using the data of independent sellers on the company platform as well as Apple for dominating its App Store promoting its own apps in App Store search versus its competitors.
Facebook’s platform involvement in disseminating false information during the 2016 Election may also come back in the radar with the upcoming 2020 election.
Microsoft did face anti-trust litigation in late 1990s and successfully survived a breakup.
According to Ruchir Sharma, Chief Global Strategist, Morgan Stanley, Big Tech has flourished because the number of US government regulations in Tech industry is 27,000, substantiating lower than other industries.
Source- NDTV/ Morgan Stanley
This is bound to change in the coming decade.
In his 2019 Social Capital Newsletter, Chamath Palihapitiya compares Big Tech to the Railroads in the Gilded Age (1870s to 1900s) and believes that Big Tech will be forced to break up by end of this decade.
European Union Commission is working on Digital Services Act and due to Covid-19 looking for new sources of tax revenue. According to the commission, digital companies pay on average an effective tax rate of 9.5 percent in the EU compared to 23.2 percent for traditional businesses.
EU Countries failed to come up with a joint digital tax in 2019 and deferred the negotiations to the OECD (the Organization for Economic Cooperation and Development).
The OECD is currently hosting negotiations with over 130 countries that aim to adapt the international tax system and it plans to have proposal later this year. Meanwhile, the European Commission said it will revive talks at the European level if there is no agreement at the OECD this year.
David Livingston, an analyst at the research firm Eurasia Group recently commented on CNBC-
“We see digital goods/services tax conversations advancing most rapidly in Europe, where the scale of ambition to use the EU budget to finance economic recovery from coronavirus may see Brussels taking an increased interest in the attractive potential tax base of e-commerce and digital services,”
Deglobalization- Trade Wars and Competition from other Global Competitors
With the Covid-19 crisis, countries all over the globe are becoming more protectionist and retreating from global integration. We have already seen countries close their borders as national security and public health are primary concerns.
Source- Peterson Institute for International Economics, Apr 2020
According the Peterson Institute for International Economics, since the postwar in 1950s Globalization has been growing steadily and reached its peak in 2008. Ever since it has been decelerating with growing Populism and the Covid-19 crisis is going to be another catalyst. We are going to witness a time period like the Interwar era (1914-1945)
China has been focusing inward and the share of exports in terms of GDP has been decreased from 31% in 2008 to 17% in 2019. US is also embracing America First policy. We witnessed Brexit and interesting to see the dynamics with the European Union after Covid crisis.
There are also other global players from China such as Huawei, Alibaba and Baidu and from Jio from India that have building domestic presence in respective countries and formidably challenging Big Tech.
Source- Visual Capitalist, March 2019
Big Tech significantly relies on global revenues other than ranging from Apple 58%, Facebook (57%), Alphabet (54%), Microsoft (49%) and Amazon 31%. Protectionist measures and economic impacts of the downturns in these geographies will impact Big Tech.
At the peak of Internet era in March 2000, top 5 Big Tech were Microsoft, Cisco, IBM, Intel and Oracle their combined market cap value was approximately $1.5 T ($2.25 T in 2020 $ terms). They were the top 5 since 1995, peaked at 2000 and then traded places until 2005. Companies have been dropping from the list ever since.
The Price to Earnings ratios of Cisco was 120, Microsoft was 55 and Intel was 42.
The Worldwide Internet Adoption was 5% (304 Million) was at that time. The rationale at that time was Internet was still in its infancy. Today that adoption is 58%.
Here is a clipping from Silicon Valley Business Journal article in March 2000
Cisco never reached $1 T market cap and in fact has never touched that March 2000 high over the last twenty years.
Here is the Big Tech Market Cap video over the last two decades and shows the top 5 have changed over the years
Source Visual Capitalist, March 2019
Today Big Tech combined market value is $5.6T. The Price to Forward Earnings (Source- Morning Star) of Microsoft is 29, Apple is 27, Amazon is 98, Alphabet is 33 and Facebook is 32. These companies have been in the top 5 since 2015 and the terrific run over the last year increasing 51% since March 2019.
Here is the S&P Historical chart showing the concentration of 5 largest stocks over a 30-year horizon. In the March 2000 it was around 17% and today it is 21%. It is interesting to note top 5 companies in 2000 were better diversified with 3 Tech (MSFT, Cisco Intel), 1 Industrial (GE) and 1 Retail (Walmart).
Microsoft is the only Top 5 survivor.
If history takes precedence, these current Big Tech companies have reached their peak from a valuation perspective and are due for a correction very soon.
They are solid companies with sound business models but with current macroeconomic, looming regulatory, taxation and deglobalization environment, I don’t believe they will be emerge stronger.
It will be interesting to see who will be in lone survivor in Big Tech 20 years from now. Any guesses?
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