As the bull market has progressed, a narrow band of technology stocks has transpired. The investment universe has not seen so much capital concentrated in a single sector that, through ETFs, can be sold at the click of a mouse.
Meanwhile, the emerging perception of increased regulatory risk for FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks has not only capped prices, it has served as an important reminder that excess profitability cannot be extended indefinitely and come up against an opposite force. That may be competition, but it may also take the form of societal rejection or regulatory backlash.
Listed among the 10 most valuable companies in the world, Google dominates search with a 90% share, Facebook commands 88% of social media traffic in the US and by some accounts, nearly half of Americans obtain their news from Facebook. By 2016, the share of online US consumers bypassing search engines in preference for Amazon was 55%, and the biggest Chinese tech companies including Tencent, and Alibaba command similar or even larger shares.
As recently as February, the NSYE FANG+ Index (also including Baidu, Netflix, Alibaba, Nvidia, Tesla and Twitter) was collectively valued at multiples of three times that of the broader market. The divergence is even greater than during the peak of the tech bubble in 2000. While the S&P500 has advanced a phenomenal 331% in the nine years since 2009, Amazon is up over 2,100%, Apple 1,100%, Netflix 5,300% and Google is up 586%. Adding Facebook, Microsoft and Nvidia to that list and eight stocks now account for over 15% of the entire S&P500 and just shy of 50% of the NASDAQ-100 index.
While much of the commentary during the recent technology boom lauded the superiority of everything from the disruptive asset-sharing models of Uber and Airbnb, to 3D printing, digital advertising, electric vehicles and the autonomous fourth industrial revolution, the underlying business models of many operators remain unviable without the support of private equity injections at increasing valuations. Where this is the case, investors need to be especially cautious. By way of example, Uber continues to be loss-making, despite valuations of about $US51 billion.
Meanwhile, Amazon is being openly attacked by the US President on Twitter and Airbnb hosts are being levied with conditions that limit short-term leasing.
It was inevitable that as these companies gained unprecedented power and influence, there would be a societal or regulatory response.
In the US, the Democrats, who were arguably defeated at the last election because they cosied up to big business, are returning to their roots with an election blueprint and new economic agenda ahead of the November midterms called ‘A Better Deal’.
The section of ‘A Better Deal’ entitled “Cracking Down on Corporate Monopolies and the Abuse of Economic and Political Power” is focused entirely on antitrust enforcement and merger law, the most important but arguably weakest component of America’s competition policy.
Meanwhile, in a decision with far-reaching consequences for many tech companies, Europe’s highest court, the Luxembourg-based European Court of Justice, responded to a complaint by a Barcelona taxi drivers association, that wanted to prevent Uber from setting up in the city. The court agreed that Uber drivers should be regulated like a transport company and not a technology service.
In Europe, a set of sweeping reforms under the banner of the ‘General Data Protection Regulation’ (GDPR) was recently established in May. Under the GDPR, European residents have control over how their digital data is used and arranged, including the “right to be forgotten”. They have the power to remove or update data on company servers, be able to request the data and port it to another company.
Let’s take a look at a couple of tech stocks.
51job Inc (NASDAQ:JOBS) – the good
Founded in 1998 and listed in the US, 51job Inc. is headquartered in Shanghai, China. The company provides human resource outsourcing and consulting, as well as recruitment solutions, training and assessment.
The company has a long runway of revenue and earnings growth ahead, as more employers migrate to online advertising for jobs. Meanwhile, the company has put through a range of price increases of up to 45%. Previously, and for six years, a 1-month membership with 20 job listings would cost an advertiser 600RMB (A$123). As of 1 February, the price increased to between 800RMB and 1000 RMB (A$164-A$205). These price increases carry no incremental costs that will boost margins beyond the strong increases of 2.5% year-on-year in the fourth quarter of 2017.
Despite a 128% increase in the share price in the last 12 months to over US$88, we believe there is value and currently estimate the company’s intrinsic value at circa $US100.
Netflix (NASDAQ:NFLX) – the bad
Netflix hit a record 117.6 million subscribers in the last quarter of 2017, thanks to the addition of 1.9 million US and 6.4 million international subscribers. International subscribers grew 11% in the fourth quarter from the third quarter and US subscribers grew at just under 4%. In 2017, the number of international Netflix subscribers surpassed US domestic subscribers.
Netflix shares are trading at between 74 and 153 times earnings and Disney announced in November 2017 that its own two largest franchises, Star Wars and Marvel, will move exclusively to Disney’s own streaming service from 2019. Fourteen Disney films have grossed more than $1 billion worldwide, including two Star Wars releases and four Marvel movies.
With 55 million Netflix subscribers, compared to 94 million pay TV subscribers in the U.S. and a steeper growth trajectory, 40 of the 56 analysts covering Netflix have a Buy rating, and only 2 have a Sell rating. We believe the most expensive tech names are at the greatest risk of disappointment.
*The Montgomery Global Fund owns shares in 51Job, Facebook and Google.
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