Will Increased Regulation Hurt Tech Stocks?Guest Post
It’s been a bit difficult to write the past two monthly newsletters. If you ignore Trump’s Twitter account not much exciting has really happened in the markets or economy. Sure, there has been some turmoil in other countries like Turkey but I don’t think me or my clients should really get worried about a market that makes up less than a tenth of a percent of our portfolios.
However, there has been one subject in the news lately. The markets latest fear is that tech companies will be the target of greater government regulation. Tech stocks make up about 26% of the US stock market and about 30% of our stock portfolio. There’s also many stocks like Amazon and Netflix that people consider technology companies but are technically considered to be Consumer Discretionary stocks. A little less than 40% of our stock portfolio is in either technology or technology type stocks like Amazon, Booking Holdings, and video game publishers.
Here are my thoughts on what more regulation for the technology sector might mean.
What I’ve usually read or heard is that some type of nebulous as of yet undefined regulations will negatively impact future growth and profitability for the tech sector. I’m not so sure this is completely correct. In fact, for some industries, strict regulation has actually been beneficial. Look at tobacco stocks. For decades, the incumbent tobacco companies in the US benefitted from the complete lack of competition. Because of regulations, it was prohibitively expensive or basically impossible for a start-up company to enter the market with a new cigarette. The result was tobacco company’s made money hand over fist. Then look what happened once lightly regulated e-cigs appeared on the market. Suddenly the newcomer, JUUL Labs, was taking market share and selling flavored tobacco products (flavored cigarettes are banned by the FDA). Just the other week the FDA said it would start cracking down on e-cigarette sales to minors and will look at banning flavored e-cigs. The stocks of the traditional tobacco companies jumped over 5% or more! More regulations can be good or bad depending on the type of regulations and the companies you own.
Increased regulation could take many forms. Let’s start with the most extreme, splitting up the “monopoly” tech companies like Amazon, Facebook, Twitter, or Google. Of these, we only own Google at above market weights so we’ll focus on that. Google’s two main revenue generators are search and YouTube. The market has been clamoring for either more financial disclosure around YouTube or even spinning off YouTube into a separately traded company. Much like the separation of PayPal from eBay the split of YouTube from Google could turn out to be great for shareholders. We don’t really see much to be concerned about on this front. We don’t have significant investments in any of the companies that might be split up and separating YouTube from Google would probably benefit our clients so we don’t care much about that.
The other possible outcome is the term “increased regulation” that everyone throws around but never precisely defines. As we showed with tobacco companies that isn’t always a bad thing. Perhaps new regulations regarding consumer privacy increase costs in the short term but in the long term it serves as a barrier to keep out competitors. The more expensive it becomes to enter a market the more the incumbents are protected. Very strict data privacy laws and strict regulations on what data the companies can collect could be great in the long term (for us and our stocks) if it keeps competition out.
It’s possible that restrictions on the type and amount of data the tech companies collect about consumers will impact their ability to attract advertisers. Google and Facebook know a lot about you as a consumer and can help companies better target customers with ads then an old school media company like CBS can. Here again I don’t see any reason to panic. Ultimately companies advertise where their target customers are. People are spending more time on new media like YouTube and Instagram (owned by Facebook) and less time on traditional media platforms like linear TV. Changes to what data the companies can collect and share shouldn’t matter very much in the long term if those are still the platforms where your target audience spends their time. A company trying to sell something to teens isn’t going to drop their Instagram marketing campaign and suddenly start running ads on Fox’s nightly news shows just because Congress passes a law restricting the data Facebook can collect.
There’s one interesting outcome that is rarely discussed but might have the most impact. That would be banning company’s of a certain size from merging or acquiring other companies. Consider Facebook’s acquisition of Instagram for $1B or Google’s acquisition of YouTube for $1.7B. Both of those businesses have flourished and are worth vastly more now. In fact, with Facebook’s user growth declining or stagnating in key markets and Instagram’s rising importance for advertisers it might not be so crazy to think Instagram could one day be more valuable than Facebook! Acquiring companies for their talent, platform, or technology is a regular part of doing business in Silicon Valley. Preventing acquisitions could have a real effect on many technology companies’ business models. This is the least likely but probably most impactful outcome.
Given that the DOJ along with some state attorney generals are investigating some of the tech companies and there have been several Congressional hearings I’m sure there will be a lot of noise around the sector in the future. I’m sure there will be some fines here or there as well (in a company with a 100,000 employees there’s bound to be someone somewhere that did something wrong). But a billion dollar fine here and a billion dollar fine there (all usually tax deductible incidentally) don’t mean much to companies worth $500 billion or $1 trillion dollars. The threat of “increased regulations” is more like the libertarian version of the scary “boogey man” story you tell kids to keep them up at night. The market may be afraid of the regulations boogeyman when it comes to tech stocks but we think the real impact will be minimal.
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Article by Ben Strubel, Strubel Investment Management