Big Tech Regulation – The road ahead

Despite the headwinds posed to technology stocks with the latest development, investors should stay calm and rational in addressing this topic, for two reasons
Chief Investment Office28 Oct 2020
Photo credit: AFP Photo

First salvo fired on Big Tech – Lawsuit filed against Google (GOOGL US). And so, it has begun. After years of procrastination over how Big Tech should to be restrained, words have finally translated to action.

The US Department of Justice (DOJ) has filed an antitrust case against Google last week (ended 23 October), claiming that the company has made its search engine the “default” choice in electronic devices and this impedes the abilities of other search platforms to compete.

And for the first time, this lawsuit has received bipartisan support from both sides of the political aisle, a rare feat considering the deep divisions and extreme polarisation in US politics today. The landmark lawsuit may herald the start of changing power dynamics between governments and corporates in the years to come. 

How big is Big Tech? That’s the question. This antitrust lawsuit is going to be a complex and long-drawn affair and there will no easy solution. To begin with: How big is Big Tech and are the accusations valid? Based on our calculation, there are indeed serious merits to this case:

·        The combined market cap of Apple (AAPL US), Amazon (AMZN US), Facebook (FB US), Google, and Microsoft (MSFT US) combined has reached USD6.8t in 2020 and this makes up 23.4% of the S&P 500.

·        With combined revenue of c.USD900b, Big Tech is equivalent to the 18th largest economy in the world by GDP.

In today’s bifurcated world and with the rise of the Internet of Things (IoT), technology has essentially become a part of our daily lives. The influence of Big Tech in this seismic shift is profound because in today’s world:

·        Google commands 92% share of global internet search engine.

·        Facebook controls 75% of global social media usage.

·        Amazon accounts for 37 cents of every dollar US consumers spend online.

“Kill Zone” – Strategies employed by Big Tech to limit competition. Big Tech has been known for its “Buy and Kill” strategy. This entails acquiring competitors that pose the biggest threats to their operations and shutting them down before they gain further momentum. No doubt, the common push-back given by Big Tech is that they are merely creating synergies by combining the best features from their competitors’ products with their own suit of offerings.

Figure 1: Big Tech makes up 23.4% of entire S&P 500 Index

Source: Bloomberg, DBS

But research from The University of Chicago Booth School of Business suggests otherwise. Their work shows that whenever Big Tech acquires a startup, it creates a “Kill Zone” – a situation whereby the market segment becomes over-concentrated and as a consequent, this stifles venture capital (VC) funding for new startups.

And here are the facts: According to Chicago Booth, whenever a startup is acquired by Google or Facebook, venture capital investments in the same space dropped by 46% in subsequent three years while the number of deals also fell by 42%.

This suggests that Big Tech acquisitions not only deter investments in the same space, it also stifles innovation.

Figure 2: Big Tech dominates US digital ad spending

Source: eMarketer, DBS

Figure 3: Amazon accounts for 37% of US retail ecommerce sales

Source: eMarketer, DBS

The Counterpunch – Are 20th century antitrust laws still relevant today? Back in the day, US antitrust laws were originally created to regulate the large oil and railroad companies of the 19th century. These laws are based on the “consumer welfare” standard which dictates that big companies are acceptable so long as consumer’s welfare is not negatively affected. And in the olden days, the price of good sold essentially constitutes the key component of “consumer welfare”.

But in the modern world, the narrative has changed. Today, Big Tech gives away most of their services for free. Facebook, for instance, does not charge consumers for using its Instagram and WhatsApp platforms. Similarly, Google does not charge for the usage of its Google Maps, Gmail and YouTube apps.

Instead, Big Tech generates revenue through the monetisation of their user data via targeted advertisements. So the argument against antitrust laws is that regulators should no longer be fixated about how mergers and acquisitions would reduce competition so long as prices remain unchanged and “consumer welfare” is not negatively affected.

Investment Implications: Stay calm and maintain rationality as a “centrist approach” to Big Tech regulation will likely be the eventual outcome. Given the high-octane rally in US Technology stocks this year, the prospects of rising regulation in the US Technology space has unnerved investors. We understand that.

But at the same time, we urge calm and rationality in addressing this topic. For two reasons:

  • The spinning-off of a business division in Big Tech may result in value creation for the investor

  • Prevailing geopolitical realities suggest that policy makers may not be too draconian in their pursuit to regulate Big Tech

  • Value accretion arising from spin-offs: Scott Galloway from New York University has been making the case for the break-up of Big Tech, arguing that large companies tends to be less innovative and value creating for shareholders as compared to smaller ones.

    There are indeed strong merits to this view, and one need to look no further than the share price performance of PayPal (PYPL US) after it has spun off from eBay (EBAY US). As Figure 4 shows, PayPal has outperformed eBay by 346% since 6 July 2015 and currently, the company trades at 49.2x Forward P/E (a 222% premium to eBay) (Figure 5).

    We believe that the global bifurcation wave, which sees traditional industries getting disrupted by technology companies, will persist in coming years. So even in the event that Big Tech is forced to break up, there are still strong merits in staying invested in the spun-off subsidiaries.  

Figure 4: PayPal has sharply outperformed eBay after spin-off

Source: Bloomberg, DBS

Figure 5: PayPal trading at 222% valuation premium to eBay

Source: Bloomberg, DBS

  • Emergence of “Digital Iron Curtain” between US and China: What started off as a trade war between the US and China has clearly morphed into the fight for global technological dominance. This development is inevitable given the rapid advancements made by Chinese Technology companies in recent years (Figure 6 and 7) and judging from the steps the US has taken against Huawei, the fight will only intensify in coming years regardless of the US elections outcome.

    So in this context and from a geopolitical perspective, it may no longer make strategic sense for the US to undertake draconian steps to break up Big Tech while their Chinese counterparts (Alibaba (9988 HK), Tencent (700 HK), ByteDance, Baidu (BIDU US), Huawei, Xiaomi (1810 HK), and (9618 HK)) are expanding and widening their reach.

    Regulation of Big Tech entails both commercial and geopolitical considerations. Regardless of who wins the upcoming US presidential election, we believe that strategic rationality will prevail and the next incoming president, be it Republican Trump or Democrat Biden, will adopt a “centrist approach” to this issue.  

Figure 6: The Rise of China Tech – Worldwide downloads

Source: CNBC *Note: This is as of 1H18

Figure 7: The Rise of China Tech – 5G patents

Source: ZDNet *Note: This consists of declared, filed and granted patents

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