While recently sidelined by the moves in the marijuana stock space with companies such as Tilray (TLRY) moving every which way, US technology stocks (commonly rolled up into the FAANG acronym) tend to be the topic du jour for investors. This makes sense of course, considering the staggering performance and sheer size these companies possess. An interesting chorus is building around these names though and that revolves around government regulation and whether regulators need to step in to rein these companies in. This is particularly prevalent with Facebook (FB) given the attention it has received for election outcomes and privacy. All of this leads an investor to begin to wonder what the end game is for these companies, aside from goals of world domination. Below we look at a few issues facing the space, specifically Apple (AAPL), Amazon (AMZN), Facebook (FB), Google (GOOGL) and Microsoft (MSFT). Some things to note before you dive in here, is that this piece is a bit of a ramble in an attempt to rationalize where these companies might go in the future. It will come off as negative toward the FAANG names, but my view of these companies (many of which are owned in personal portfolios) is actually positive, but we always need to look at the other side of things. Society has never seen companies like this. If you do not want some food for thought that you may or may not agree with, then don’t read this. 

The issue with large numbers

The larger these companies get, in theory, should mean that it gets more and more difficult for these companies to generate meaningful growth. If you are a $100 million company and sign a $10 million contract, that is a lot of growth for the company on a percent basis (10%). Further, there should be a higher frequency of $10 million contracts out there than higher value contracts, so the odds of getting one of these types of deals would be higher. If you are a company like Apple, with a $1 trillion market-cap, to get that same growth you need to generate $100 billion in sales! While a company like Apple may have a better ability to win more business than competitors, that is still a lot of business they would have to win.

Taking a look at some of the numbers at these companies can be eye-opening: 

Of course, these numbers are so big, some context needs to be applied for them to make any sense. Total revenues for all companies on the TSX 60 amount to $763 billion (adjusted for the exchange rate) compared to Facebook, Amazon, Google, Apple and Microsoft at a total of $669 billion. The total GDP of Canada was $1.88 Trillion in 2017 while the market-cap of the TSX composite (300 companies) is $2.53 Trillion. This is compared to the market-cap of the above noted companies totalling $4.2 Trillion. The Canadian marketable debt outstanding amounts to $400 billion (in USD) compared to cash at the US tech companies totalling $383 billion. The eighth largest city in Canada (Winnipeg) had a population of 778K compared to 798K employed by the five big tech firms. Yes, these are apple to orange comparisons here but these numbers put into perspective how big these companies have become. They could form their own country if they wanted to! This leads to another issue we will touch on but suffice to say these companies are so large, it becomes difficult to imagine how they will continue to grow or at least be allowed to continue to grow for a few reasons.

Stifled Innovation

One of the big policy issues that will likely need to be addressed with these companies is their ability to stifle innovation. Most would probably agree that the next ‘big thing’ in the past has not come from big companies and is unlikely to come from a big company in the future, no matter how many research dollars are thrown at a problem. However, these companies have so much cash that the ease with which they can purchase any competitors means that any new ways of doing business could be purchased and shut down. You see this with Facebook buying any companies that hint at showing high user growth and network effects (Whatsapp, Instagram). 

On top of this, even if smaller companies aren’t bought out, the larger companies can very easily throw large budgets at the next big trend (think cloud computing, AI) and crowd out any younger companies. This is how competition works, which is fine to a degree, but this also stops the next Facebook or Microsoft from being built. My guess is that if you go back 30 years or more to talk to Jeff Bezos, Bill Gates, Mark Zuckerberg or Steve Jobs and showed them these companies without them knowing it was THEIR companies, they would be terrified. Why? Because these same companies are likely the things that would prevent them from creating what they built. Even if they were able to turn down a couple billion dollars in the early days, it certainly would have been difficult to stop the companies from copying their creations. These companies today would be happy to pay fines in the billions to stop an incumbent from disrupting their business, this is the cost of doing business to them. As a real-life example, Facebook has sort of done this to Snapchat where they mimicked their best features and threw it on Instagram.

Can they and should they be stopped?

Probably not. These companies are already becoming a bit of a tech conglomerate type of set up. Any new technology or threat to their business, they often have some sort of toe in the water as a hedge or growth opportunity. They are so large and flush with cash that there will likely be two types of tech companies: Smaller tech firms the larger players don’t want and then the large players that own all the others under their umbrella.

Adding on to the question of ‘stopping’ these firms is if you would even want to. They all employ so many people and invest so heavily in research that hindering them could impact an economy. The bigger these companies get, the more influential they also become on the political landscape as well as through a voting bloc of employees that potentially share the same views. None of this is either good or bad, just a fact that the larger they become, the more concerned governments will become. 

So, what is a government to do, faced with issues of addiction to social media, political meddling, lower tax bases from these companies and so much power that they could actually be viewed as a threat to some governments? The two logical expectations here are that they either get aggressively taxed and/or fined or governments step in and force them to break up. I think this is the logical conclusion when you extrapolate the size and growth of these companies. Aside from some sort of disruptive technology upending these businesses (which by definition is hard/impossible to forecast let alone assume these companies would not just acquire it), it is hard to see a scenario where these companies do not just get larger and buy more competition.

Interestingly, one wonders if breaking these companies up down the road is a way to lead to another leg of growth where all of these smaller companies hire more people and innovate more. 

Are these Mature or Growth Companies

Turning to valuations, if an investor agrees with the idea that they are too large to grow meaningfully in the future, should they not sport a mature company type of valuation in the 15 times earnings range? At first blush, this makes sense. However, if you also believe that these companies can and will just buy up any true competition or grow organically into any other new technologies and businesses, you should argue that there should be a scarcity premium in these names. If there is indeed a void where you have smaller companies with high prospects that ‘big tech’ just buys, other companies no one really wants, and nothing in the middle, your only choice here is to own the big tech names. If you want the smaller and innovative technologies, you have to own the FAANG names because these companies own the new, innovative and high growth technologies, even if it is only a drop in the bucket to the parent. This creates that scarcity value where you essentially need to own FAANG stocks, because the FAANG stocks in turn already own all the new high growth companies OR are already working to price incumbents out of the market. If you can’t beat them, join them.

These thoughts have been a bit of a round trip but I think there are a few conclusions we can make:

1. These companies are not done growing yet
2. Increased regulations are probably a given, it is just a matter of when not if.
   1. But they likely have enough clout at this stage to blunt any overreach
3. A different lens on valuation may be appropriate for this niche vs traditional valuation metrics
4. Right when you think these companies cannot get any larger, the final act could be a breakup/spinoff of businesses to create more value for stakeholders (we are speculating here obviously, with the assumption that there will be some cap set on how big society allows these companies to get).

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