Facebook and Google have been engulfed by a wave of criticism, leading some to conclude that tech faces major regulatory risk.
It’s no secret that the past few years of spectacular performance from the US market has been led by the large technology companies. Over just the past five years (to 9 May 2018), the S&P 500 index, as measured by the SPDR S&P 500 ETF, returned a healthy 63 per cent. But compared with FANG (Facebook, Amazon, Netflix and Google) shares over the same period, the index returns were less than impressive. Google returned 139 per cent, Facebook 562 per cent, Amazon 500 per cent and Netflix 929 per cent.
However, at the start of the year, that outperformance started to weaken. Netflix and Amazon have still been able to deliver strong returns over the past six months (68 and 41 per cent respectively), way above the S&P 500’s 3.6 per cent over the same period. However, Facebook and Google (listed now as Alphabet), both of which have come under close scrutiny recently, have produced flat returns. Over that period, Facebook returned -0.2 per cent and Google 1 per cent. (This article was written for the June print edition of Money Observer in early May. The performance of tech firms has since improved.)
A number of factors may account for this lagging performance, but there is growing awareness and fear among consumers and governments over the extent to which Facebook, and to a lesser extent Google, can collect and use users’ personal data. And the public reaction potentially threatens these companies’ business models.
Jamie Bartlett, in his recent book The People Vs Tech, writes: ‘What [Facebook] knows about you, based solely on the untold hours you’ve spent there, is enough to fill several binders: interests, age, friends, job, activity and more.’
Following the revelation that Facebook (inadvertently or otherwise) allowed a third party, Cambridge Analytica, to access the data of tens of millions of users for targeted political campaigns, awareness of the extent of the company’s ability to collect data and the way it is used has risen markedly in the public consciousness. While users of both services have for years willingly supplied their personal data to make use of the companies’ free services, there is growing unease about the amount of data being collected and the uses to which it is put.
This could spell trouble for Facebook and Google. At the heart of both firms is their ability to collect personal data and make use of it. Growing public unease, then, could spell bad news for their business models. Bartlett notes: ‘The basis of practically the entire business of social media is the provision of free services in exchange for data, which the companies can then use to target adverts.’ And this advertising brings in around 90 per cent of Facebook’s and Google’s revenue.
If there is a backlash against the ability of big tech to collect and use personal data, should investors worry? How great is the risk of a regulatory clampdown or of users exiting these platforms?
Amit Lodha, portfolio manager at Fidelity International, believes there is at least some risk. He says: ‘There is an existential issue here, given that Facebook depends on user engagement to exist. The breach of trust calls this into question.’ Indeed, following the Cambridge Analytica scandal, there were calls for users to abandon Facebook. This, however, is unlikely to occur. ‘Radical claims about quitting Facebook [among users] is a nice concept, but it’s not going to happen,’ says Walter Price, manager of Allianz Technology Trust.
Lodha accepts that there is little prospect of large numbers of users leaving such platforms, especially Facebook. ‘We have seen sites such as Myspace and Orkut go into oblivion quickly once users found alternative platforms,’ he says. But there is one major difference between them and Facebook: ‘There is currently no competitor to Facebook. But we do need to see management getting ahead of the problem.’
Facebook appears to have a substantial ‘moat’: an unassailable competitive advantage over other companies in the same industry. It already has more than one billion users, and the more users it has , the more attractive – and in some cases vital – it is. No other tech company seems capable of matching Facebook’s vast network at the moment.
Price notes that although many people are uneasy about the data stored by companies such as Facebook, there is a tacit acceptance among users of what they are signing up for. He says: ‘There is an understanding that in exchange for a free service, you give the right to Facebook to collect data on you.’ That, Price says, has not changed. According to his trust’s research, there has been little decline in user engagement. ‘Users still appear willing to make the trade-off,’ he adds.
Nevertheless, since the Cambridge Analytica scandal, it seems to have become accepted that there is a personal data ‘red line’ that Facebook and other companies reliant on personal data must not cross. That line is the sharing with third parties of data they collect on people, says Price. It is generally accepted that people give Facebook permission to build a database on them; what is now not accepted is that this gives the company permission to share that data. ‘Facebook has recognised that this is a highly sensitive issue and that it has to be very careful,’ Price adds.
But as long as users are willing to exchange their data for a service and accept that they will be targeted by adverts based on that data, Facebook still has a solid and profitable business model. ‘Right now Facebook is three to four times more effective than advertising competitors in terms of dollars spent,’ says Price.
However, even if users stay with these platforms and advertising business remains lucrative, could Facebook and Google be damaged by increased regulation? Not according to James Thomson, manager of the Rathbone Global Opportunities fund. He says: ‘I think the political and regulatory risks for FANG stocks are overplayed. It’s too late to put the genie back in the bottle: these technologies are here to stay.’
Other fund managers, however, are concerned about the potential costs of new regulation, even if there is little risk of regulators destroying some business models outright. Lodha says increased regulation is something ‘investors need to think about in terms of both calibrating revenue and earnings growth, and the multiples at which they expect these stocks to trade’.
The risk, as Price sees it, is not that regulation will make the business models of Facebook and Google unworkable, or even act as a major structural drag on revenue. Instead, such firms could find themselves slapped with big fines for unwittingly failing to comply with regulations. Regulation can be vague and open to interpretation, and new laws covering personal data would be easy for tech firms to break unknowingly. ‘We do have some concerns on regulations such as the General Data Protection Regulation, especially in terms of how these are interpreted by different regulatory bodies.’
However, Stephen Yiu, chief investment officer at Blue Whale Capital and manager of the LF Blue Whale Growth fund, believes regulators are better off supporting firms such as Facebook and Google, and that they recognise this.
He says: ‘If we accept that social media platforms are going to exist, the regulator is better working with the large incumbents on jointly developed regulation to provide a safe and well monitored environment. Trying to destroy these platforms isn’t an option.’ Were regulations to do so, ‘new unregulated businesses will just pop up in their place, where misinformation campaigns can flourish’. He adds: ‘Large players such as Facebook and Twitter look well-placed to cement their dominance in this domain, and the US government is unlikely to want to impede its tech companies.’
Fund managers divided on the need for rebalancing
It is difficult to gauge how far managers have sold off Facebook holdings in the face of recent events. Some, including Terry Smith of Fundsmith and Jeremy Gleeson of the Axa Framlington Global Technology fund, have held on; others, though, have made adjustments. Fidelity Global Focus initially purchased it in 2012, after its floatation. Manager Amit Lalha grew concerned that Facebook’s deep use of users’ personal data could be its Achilles’ heel, especially given its extremely high valuation.
While noting that Facebook’s management seems to take the personal data issue seriously, Fidelity believes FANG tech firms’ high valuations mean the margin of safety in valuations is limited.
Allianz Technology Trust has also rebalanced its Facebook holding, owing to fears over higher costs, even though it is optimistic about the strength of the platform. ‘We took our position down and back up,’ says Walter Price. ‘We are now a little underweight Facebook. We think it’s a good holding, but it’s no longer one of our top five, as it used to be. Neither is Google.’
Stephen Yiu of the LF Blue Whale Growth fund says: ‘Taking into account all these factors, we remain bullish on Amazon, Google and Facebook. We believe internet and software firms will remain the most attractive in the equity market in terms of structural growth prospects for a long time.'
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