There is a very good reason why seven of the top-ten biggest companies in the world are tech companies (Amazon, Apple, Microsoft, Google, Alibaba, Tencent and Facebook). And the reality is that they must form part of a global investment portfolio if investors want market-competitive returns over a reasonable investment horizon.
The recent results from these companies confirm growth rates that are multiples of traditional blue-chip companies but also, more significantly, massive cash flows. Most surprised positively, relative to expectations (Amazon, Google and Apple), while Netflix and Facebook disappointed – although the latter was company specific as it gears up to spend more on data privacy. Their profits and share prices will never move in straight lines but, we believe, the growth trends will persist.
The amount of money consumers can spend is finite, but these companies are capturing an increasing share of our wallet. Hence, as their market share rises, so the market shares of traditional players decrease, and the value continues to shift. But, these tech companies can reach much bigger audiences than their predecessors, with much less new investment. Amazon does not need more stores, Netflix does not need additional cable installations and Tencent does not need to sell more gaming consoles.
As current trends persist, these businesses are becoming near-global monopolies, and this is why they can generate such big margins and profits. This is easily understood if one thinks about the advertising and entertainment markets. Online advertising now comprises more than 50% of media spend in the US where, before Facebook and Google, ten major newspapers dominated print ad spend.
Each of these newspapers had a big slice of the pie and had massive variable costs in delivering their medium, thus restricting their operating margins. The business model of Facebook and Google is the complete opposite – each one is a critical mass platform, they can each reach a global, rather than local, audience and their incremental cost is low for new users as their service is digital.
As an example, if each of the abovementioned ten newspapers earned US$10 in revenue (US$100 collectively), this would translate to around US$1 in profit each (or a collective profit of US$10). This shared US$100 in revenue, if it had been earned by Facebook and Google, would account for around US$40 of profit due to lower costs associated with these tech companies – that is four times as much! This is part of the secret to their value – as revenue shifts to tech companies, so the corporate intermediary makes more profit. And they are also building barriers to entry that are the ultimate moat.
Facebook has four platforms with over one billion users each (Facebook 2.2bn, WhatsApp 1.5bn, Messenger 1.3bn and Instagram 1bn). No other company on earth can offer an audience of 2.5bn people (we note that some users utilise more than one of the various platforms).
So, share prices of these companies have already performed extremely well, the economic value of each company is certain to continue increasing steadily, and the cash flows are absurd: Tencent generates over US$17bn a year and Google over US$25bn a year in cash. They will continue to invest and build and invent and this will further enhance their future value.
We are getting to the stage where the old traditional companies (and even new tech companies) cannot compete with the big guys. Custodians of people’s wealth should ensure they are invested in funds that have exposure to these growing giants of the global economy.
AUTHOR: Peter Armitage, CEO, Anchor Capital