David Garrity on The Watch List: The Prospect of Regulation in Big Tech & Blockchain in Healthc
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1) Tech Sector Regulation/Oversight
For background, here are my talking points from CNBC interview on 3/11/19:
“Big Tech” Breakup Proposals on 2020 U.S. Presidential Election Radar:
Last Friday 3/8/19 Senator Elizabeth Warren (Democrat, MA) as part of her 2020 Presidential election bid put forth a proposal that would result in substantial controls and possible break-up being imposed on tech companies with revenues in excess of $25bn with a specific focus on Alphabet, Amazon and Facebook.
In the proposal, Senator Warren is picking up on the September 2017 Yale Law Review article by Lina Khan (“Amazon’s Antitrust Paradox“) which argued that “Amazon is amassing structural power that lets it exert increasing control over many parts of the economy.” The concept of “structural power” breaks with more traditional tests of anti-competitive behavior such as the unilateral ability to set prices. “Structural power” goes beyond pricing power to touch on a company’s ability to determine the market access of other companies, much as railroads controlled market access in the last half of the 19th Century. In Khan’s view, “the thousands of retailers and independent businesses that must ride Amazon’s rails to reach market are increasingly dependent on their biggest competitor.”
Senator Warren has moved to translate the concept of “structural power” into an anti-monopoly legislative and regulatory program. Namely, companies with over $25 billion in revenue that offer the public an online marketplace/exchange/platform for connecting third parties would be designated a “platform utility”. Accordingly, such companies would not be able to participate in the platform they operate (e.g. Amazon would have to stop selling its own products on its website). If elected President, Warren would also appoint regulators committed to reviewing and potentially reversing previous acquisitions (e.g. Amazon/Whole Foods, Facebook/Instagram, Google/Waze).
Anti-Monopoly Policy Is Competition Policy Which Needs To Be Set In Global Context:
U.S. Anti-monopoly policy was last substantially updated in 1949, a point in time where policy makers were primarily concerned with the domestic U.S. economy as the global economy was only just beginning to recover from the devastation of WWII. Now, with a global economy no longer as dominated by the U.S. and one challenged increasingly by the government-led technology sector’s development in the PRC, policy makers need to think in terms of a larger global stage.
As the PRC’s “Made In China 2025” plan clearly spells out, it is China’s intent in concert with Chinese technology companies (e.g. Alibaba, Baidu, Tencent) to dominate critical emerging technologies such as AI, autonomous vehicles & others. In this sense, anti-monopoly policy if it results in U.S. technology companies not having sufficient economic scale to support their own emerging technology development efforts may have significant national security ramifications. In essence, in the 21st Century context, technology development has become like diplomacy before it, “the continuation of war by other means.”
Consequently, Senator Warren’s proposal while a positive development in moving forward the idea of increased regulatory oversight for the technology sector needs to consider the current and likely future realities against which it would be implemented.
Not All Tech Companies Created Equal, Some Names Merit Greater Oversight And Possible Breakup:
It is difficult to say that social media technology companies such as Facebook and Twitter are critical to the future national security of the US, especially given the substantial lapse in necessary vigilance around the 2016 Presidential election, but nevertheless should for these very reasons be subject to increased regulatory oversight. To this end it is our view that following a thorough in-depth examination from economic and national security perspectives that current anti-monopoly policy be developed and then applied to the technology sector.
2) Earnings Season
We call Amazon, Facebook and Alphabet/Google “non-Tech Tech” because all three are clearly Technology companies but none are actually in the S&P Technology sector. The first is in the Consumer Discretionary bucket and the latter 2 appear as the top weightings in Communication Services.
Whatever you want to call these mega-cap disruptors, they have an outsized influence on the S&P 500:
They have a collective weighting of 8.0% in the index. If they were their own sector, they would be more important than 5 other groups: Consumer Staples (7.4%), Energy (4.9%), Utilities (3.3%), Real Estate (3.1%), and Materials (2.7%). Put another way, these 3 companies are almost as important (8.0% weight vs. 9.1%) to the S&P 500 than the combined effect of Utilities (27 companies), Real Estate (31 companies) and Materials (27 companies).
The long and short of it is that Amazon, Facebook and Google are systematically important enough to merit attention when they report earnings even if you are a generalist portfolio manager or investment advisor. All three are on deck this week, with FB reporting on Wednesday and AMZN/GOOG(L) on Thursday. And as much as one might associate these names with +20% earnings growth supporting outsized valuations, their Q2 expected results are anything but uniformly spectacular.
Here’s how Wall Street analysts see Q2 results for each, along with current valuations:
Amazon (3.3% of the S&P 500, 23% of Consumer Discretionary)
Expected EPS growth: +10%, to $5.58/share Expected revenue growth: +18%, to $62.4 billion Current 2019 consensus estimate: $27.41/share, up +36% from 2018 Current valuation: 72x 2019 EPS
Our take: AMZN faces a classic “tough comp to last year” problem, when it beat analysts’ numbers by 100%. Still, to maintain its lofty valuation it will have to at least show stable margins by logging earnings growth of +18% – not the 10% baked into analysts’ estimates.
Facebook (1.9% of the S&P 500, 20% of Communication Services)
Expected EPS growth: +7.5%, to $1.87/share Expected revenue growth: +25%, to $16.5 billion Current 2019 consensus estimate: $7.10/share, down -6% from 2018 Current valuation: 28x 2019 EPS
Our take: FB faces real margin pressures as it continues to upgrade its platform to keep global regulators at bay. The best case here: enough of a beat that 2019 earnings resume a modest growth trajectory rather than current expectations of a decline.
Alphabet/Google (2.8% of the S&P 500, 23% of Communication Services)
Expected EPS growth: negative -3.6%, to $11.33/share Expected revenue growth: +17%, to $38.2 billion Current 2019 consensus estimate: $45.67, up +4.5% from 2018 Current valuation: 29x 2019 EPS
Our take: Google has missed expectations the last 2 quarters on a combination of revenue misses and higher expenses as it bolsters its cloud computing business. As a result, it is the only one of the three major “non-Tech Tech” companies expected to post an outright decline in EPS this quarter. Based on those 2 points, Google clearly has the most to prove when it reports on Thursday but (hopefully) the lowest bar as well.
Bottom line: as much as we focus on Fed policy and interest rates, how these 3 companies performed in Q2 will be important market drivers in the week ahead.