Tech Stocks Defy Bad Press to Profit

In the face of some significant corporate governance issues, investors continue to want to hold the US technology giants. Why?

Cherry Reynard 27 June, 2018 | 7:18AM

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The US has once again led global stock markets for the year to date. However, those gains have been drawn from a narrow selection of stocks. Without the impact of the FANG tech stocks – Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOGL), the S&P 500 would be in negative territory this year. This performance follows a strong year in 2018, where share prices for these companies rose 30-40%.

Yet news flow has been almost universally negative. From Mark Zuckerberg being forced to testify before Congress, to new data protection law GDPR, to social media addiction, many believe Big Tech has been slow to address its problems. In the face of some significant corporate governance issues, investors continue to want to hold the US technology giants. Why?

In many cases these technology companies have grown at a considerable pace, and not necessarily had the time to put the appropriate structures in place. Richard Clode, portfolio manager on the Global Technology team at Janus Henderson Investors, says: “Many technology companies are founder-led and sometimes the shareholder structure gives them sufficient voting rights to do whatever they want. As such, there isn’t sufficient oversight and the board may not have sufficient experience or independence. These companies have grown very quickly and there are certain growing pains.”

Until GDPR, technology companies had also grown up almost entirely unregulated. Part of the difficulty is that they do not necessarily fit into existing laws around monopolistic behaviour. Walter Price, manager of the Allianz Technology Trust (ATT), says regulators have been slow to act: “Europe has been the pioneer of trying to put laws into place with GDPR. The US was ignoring that issue for a while, but when the data was taken from Facebook and people started worrying about where their data was going to end up, that caused Congress to get involved.”

Regulators are on the case and the fines are mounting. William Kovacic, a former Federal Trade Commission (FTC) chairman, joked that the potential fine from the FTC investigation into whether Facebook violated its 2011 consent decree could be “more money than there is on the planet.”

Is Tech the New Tobacco?

Certainly, it would appear that it will run to trillions. It is eerily reminiscent of big tobacco and, to a lesser extent, big pharma, where the threat of apparently unlimited fines loomed large for decades.

This is an uncomfortable parallel, but there is an important if subtle difference with tobacco. As Clode points out, “the difference is that these companies are creating wonderful things. Voice recognition on Alexa, autonomous driving.” Price agrees: “Fundamentally, they provide great products, so users spend a lot of time on those products, and I don’t see people spending less time on them, not uploading pictures of their family or not doing searches any time in the near future.”

This may be why share prices have held up so well. Certainly, earnings have not been dented by the recent scandals. Facebook’s first quarter earnings were well ahead of expectations – $1.69 per share, versus $1.35 expected, while Google’s earnings also pipped analyst forecasts – earnings per share were $9.93 versus $9.28 expected.

Problems Already Priced In

Clode believes that many of the problems were already embedded in the prices: “The data protection problems didn’t start with the Cambridge Analytica scandal. GDPR is the culmination of five years of data protection concerns. These problems have been embedded in these companies’ guidance for some years.” Equally, everyone knows about the scale of the potential fines. Clode believes that up to a certain point, it may simply be seen as the price of doing business.

He believes it may be companies further down that are more affected by data protection issues. The ‘closed wall’ ecosystem of a Facebook makes communicating with users easier. “It is more problematic for other companies who need to write you a letter,” Clode adds.

It is easy to forget that these companies have been through this before. Apple saw the dent to its brand from its supply chain scandals and woke up to the necessity of managing its suppliers more effectively. It built a far stronger supply chain as a result. These companies are recognising they have to engage or see the good will on which they rely ebb away.

Price remains cynical on their motivations: “Their motivations are to prosper and grow and make money and they make very powerful sounding comments about how they want to make the world a better place, but when you look at what they do, they built a database so they can do targeted advertising more effectively.”

However, shareholders have become more vocal and these companies have woken up to the need to take corporate governance seriously, not least to keep the share options of irreplaceable engineers intact. Clode believes these companies are listening. They may listen even harder if share prices started to drop. However, big tech is likely to get its house in order before that happens.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Allianz Technology Trust Ord1,335.00 GBX-4.30
Alphabet Inc A1,049.36 USD-2.57
Amazon.com Inc1,636.16 USD-4.45
Facebook Inc A141.55 USD-2.35
Janus Henderson Global Technology I Acc2,000.01 GBP-0.20
Netflix Inc294.07 USD-3.10

About Author

Cherry Reynard

Cherry Reynard  is a financial journalist writing for Morningstar.co.uk.