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Is the U.S. technology industry being defanged?

  • 24Jan 19
  • Karolina Noculak Investment Strategist, Aberdeen Standard Investments

Paypal founder Peter Thiel predicted in his 2014 Wall Street Journal essay, “Competition is for losers,” that Silicon Valley would become the center of the global economy. He claimed that by operating under a set of rules that involve little competition or regulation, his own company, along with Facebook, Amazon and Google–some of the so-called “FAANG” stocks, which include Facebook, Apple, Amazon, Netflix and Google (a subsidiary of Alphabet)–would take control of the technology industry, enabling them to enjoy unusually high profits.

Specifically, Thiel thought that the key to success involved companies minimizing how much tax they spend (a key to Amazon’s success); allowing the sharing of content without concerning oneself with copyright (as YouTube did); outpacing or buying the competition (Facebook’s two billion members removes the need for many more social networks); growing so fast that regulation has, so far, been unable to keep up.

Currently the biggest companies in the world by market capitalization are Apple, Alphabet and Microsoft.

His prediction has proved prophetic. At the start of this decade, the biggest companies in the world were oil companies, such as ExxonMobil and PetroChina. Currently the biggest companies in the world by market capitalization are Apple, Alphabet (the parent company of Google) and Microsoft.

Fears that the authorities are catching up with the FAANG stocks are attributable partly to the puncturing of their share price bubble in the latter half of 2018. We think that there could be worse to come and that as Thiel’s four laws continue to be rescinded, 2019 will be another uncomfortable year for investors in these companies.

So what are governments and regulators likely to do?

We believe that their actions will be shaped by public opinion. Consumers are not yet sufficiently outraged to stop buying Amazon’s cheap and convenient products, but uneasiness is growing over the way these companies avoid taxes. There are also increasing concerns over the part that tech companies play in facilitating political interference, including the mishandling of user information by Facebook, and the leaking of private data from companies such as Yahoo. In these increasingly volatile times, public outrage has a greater capacity to drive regulatory action.

We think that the shape of anti-trust regulation could take the form of anti-tax avoidance measures, privacy and anti-surveillance laws, or possibly self-regulation by the industry. As recently as November 2018, U.S. President Donald Trump said his administration is looking at anti-trust issues with regard to Google, Facebook and Amazon.

Some company executives are trying to get out ahead of any regulation. Apple CEO Tim Cook has made a point in several interviews of saying that regulation of the technology industry is inevitable. We expect this rhetoric to continue and a line to be drawn between companies almost encouraging regulation and seeking to influence what it may look like.

U.S. politicians have been discussing how to regulate tech companies for the past two years. That will likely translate into legislation targeting privacy, political advertising and competition concerns over the coming year.

In Europe, the latest General Data Protection Regulation (GDPR)* rules are having a major effect on how companies handle and protect personal information, with other countries watching with interest.

Elsewhere, the UK is trying to increase the tax burden for technology companies with a new “digital tax.” If this proves effective, we think that cash-strapped governments across the world may introduce similar taxes as early as 2020.

While it appears that the days of tax-free profits for technology companies might be coming to an end, we do not believe that a collapse in profits is imminent. The risk is not that today’s tech companies will turn into dotcom fads. In our view, they should continue to generate strong real cash flows for years to come. Indeed, earnings in this sector are likely to continue rising next year.

However, the FAANGs have been priced for perfection at a time when their outlook is as challenging as it has ever been. Their successful track record has resulted in overly exuberant investor sentiment, crowded positioning and extended valuations, in our opinion. We believe that this may hamper any recovery in the shares during 2019.

Mr. Thiel appears to have grown weary of Silicon Valley, having moved to Los Angeles. It is perhaps too early to call time on the valley’s pre-eminence in the technology world. But if Mr. Thiel’s predictive powers are anything to go by, we think that we should start looking beyond California for the next wave of technology leaders.

* The General Data Protection Regulation (GDPR) comprises a legal framework that sets guidelines for the collection and processing of personal information of individuals within the European Union.

Important Information

Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

ID: US-180119-80950-1