Big Tech Oligopoly

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Includes: AAPL, AMZN, FB, GOOG, GOOGL, MSFT
by: Gene Chan, CFA
Summary

The tech world is increasingly dominated by 5 players, who also occupy the top 5 spots of the world's biggest public companies.

These 5 tech titans each carved out their own territory, and are literally peerless in their core domain.

Their lead is expected to keep extending until it's near impossible for other competitors to catch up.

The stock for 1 company of the 5 appears to be the most buyable.

As I write this today, the top 5 biggest publicly traded companies in the world are all American technology companies, with over $4.5 trillion of market capitalization between them (equivalent to roughly the size of Japan's GDP, the world's 3rd largest economy).

Rank Company Market Cap ($ Billion)
1 Microsoft Corporation (MSFT) 974
2 Amazon.com, Inc. (AMZN) 930
3 Apple Inc. (AAPL) 907
4 Alphabet Inc. (GOOG) (GOOGL) 810
5 Facebook, Inc. (FB) 534
6 Berkshire Hathaway (BRK.A) (BRK.B) 515

World's most valuable public companies as of May 10th, 2019

Never in the history of the tech industry has so much value been concentrated in so few entities. To be fair, this extreme concentration of capital and power is in some ways an intended consequence of capitalism. Each of these tech giants has been rewarded for the tremendous value they create for humankind, as nowadays most of us can no longer imagine life without the products and services that made these giants.

Some will say that they got the reward they deserve, but where do we go from here? Where will this level of concentration lead us, and is there any way for small investors to participate in this mega-trend?

Big Tech Oligopoly

Oligopoly

Big Tech's dominance is even more pronounced when we look at the individual segments.

Over the recent years, the tech giants have each been carving out their own territory, wisely retreating from lost causes in order to focus on key strengths. To name a few of the more memorable recent concedes:

  • Alphabet (hereafter referred to as "Google") shut down Google+ and retreated from the social media space
  • Microsoft and Amazon exited from the mobile phone hardware business
  • Microsoft ceded mobile OS to the iPhone/Android duopoly
  • Facebook Search has toned down its initial ambition to be an alternative to Google Search

As they ceded territory to each other, they strengthened their positions in their own core areas - forming duopolies in some cases, and, perhaps alarmingly, de-facto monopolies in other cases.

In military circles, it's been said that China is emerging as a "near-peer" competitor to the United States. There are many ways to measure military capabilities, but to keep it simple, let's go with annual defense spending:

Source: Statista

Numbers vary a bit depending on the year, but China's military spending is generally running at 1/3rd of US's (Russia runs at around 1/10th of US).

Similarly, for the purpose of the analysis below, I'll define "near-peer" as a competitor that is at least 1/3rd the size of the dominant player by market share.

Below are the industry segments that Big Tech has claimed total dominance. These are, or once were, key battlegrounds of our time, but they are now completely owned by one or two corporations. In fact, it's surprising how many of these key segments are basically one-horse races where there is not even a near-peer competitor in sight.

Battleground Dominant Leader Near-peer Competitor
Consumer Social Network Facebook None!
Professional Social Network Microsoft (via LinkedIn) None!
Online Advertising Google Facebook
Office Productivity Tools Microsoft None!
Desktop OS Microsoft None! (Apple is less than 1/3rd)
Mobile OS Google Apple
Mobile Devices* Apple None!
Search Engine Google None!
Cloud Amazon Microsoft
US Online Retail** Amazon None!

* By smartphone profit share rather than unit sales.

** Amazon's closest competitor - eBay Inc. (EBAY) - is less than 1/3rd its size by GMV. I've purposely excluded the Chinese online retail market, as it's a semi-closed economy and many of the giant Chinese firms owe their existence to economic barriers and difficulty for foreign firms to do business, but that's a discussion for another day.

As we can see, Big Tech's control over their core segments is absolute. Even in newer segments such as cloud, it is becoming a two-horse race. This could be bad for consumer choice but it is no doubt great for business.

There are peripheral battlegrounds not included in the above table that are still contentious today, where the current winner's lead is not as clear-cut - areas such as enterprise software, gaming, content creation and distribution.

However, I expect Big Tech to leverage their complete dominance in core industry segments to give themselves an unfair advantage in the adjacent periphery. For example, in enterprise software/SAAS, the dominant cloud service providers - especially Microsoft, who also has a strong foothold in ERP/CRM - will most likely have an advantage going forward over pure-play companies that do not have a large cloud market share, like SAP (SAP) or Oracle (ORCL).

Power Begets Power

There's this thing in nature called the Power Law (also known as the Pareto Principle or the 80/20 rule) - it describes a naturally occurring phenomenon where certain characteristics or attributes tend to be concentrated in the hands of a few rather than normally distributed among a population.

This phenomenon is typically observed in situations where an initial advantage compounds into further advantages, locking the early winners into a virtuous cycle. For example, wealth distribution follows the Power Law (i.e. being wealthy leads to better health, better education, better network, which leads to even more wealth), but height is normally distributed and does not follow the Power Law (i.e. being tall does not automatically make you grow even taller).

Big Tech is in an enviable position of having formidable economic moats while being on the right side of the Power Law.

To begin with, all of these 5 tech giants have great brand recognition, economies of scale, and network effect. Brand recognition leads to more users and also gives them a leg up on any ventures into new areas. More users strengthen the network effect which leads to even more users, allowing the tech giants to increase scale, lower costs, spend more on R&D, improve their products and further enhance brand recognition, which leads to even more users, stronger network effect and even bigger economy of scale etc., etc.

Their advantages will pile on and on, as the positive feedback loop puts them on an exponential path - their lead will keep extending until at some point it will be near impossible for other competitors to catch-up.

If their market caps are any indication, we may have already passed that point.

Disruption Insurance

To further cement their dominating positions, and to serve as insurance, most of these firms have amassed huge cash piles which will allow them to outright purchase any technologies or companies that may threaten or disrupt their core business in the foreseeable future. One example of a brilliant anti-disruption acquisition is Facebook's purchase of Instagram.

How much of a cash hoard should they keep? Let's use the recent Uber IPO as a benchmark. It was one of the biggest IPOs ever, valuing Uber Technologies, Inc. (UBER) at $76 billion. But then it kind of fell flat on its initial trading, so the IPO price seems to be a good proxy of an upper limit for how big a disruptive start-up can get.

The thinking here is that if a tech giant's cash holding is higher than $76 billion, then they can fall asleep and let a potential threat grow to the size of Uber and still be "OK." They are uber-safe from disruption if they have an uber cash hoard to buy out any Uber-level threats.

While all of the Big 5 tech giants have a sizable war chest, 3 of them are cash-rich enough to meet this ridiculous criteria:

Cash & Marketable Securities ($ Million)

Uber Safe?

Microsoft 134,021 Yes
Amazon 37,020 No
Apple 225,411 Yes
Google 109,140 Yes
Facebook 45,243 No

Source: Latest quarterly reports

In short, we live in a world where a handful of companies exert near-total control over our technologies, and their dominance is likely to increase further over the foreseeable future. I won't try to make a social statement one way or another about this. For small fry investors like myself, we can only observe, react, and make the best of the situation.

Investability

Out of the big 5, I can immediately eliminate 2 of them as investment candidates. Both Facebook and Google have multiple share classes with different voting rights, and the shares available for purchase by the public have severely restricted voting rights.

For Facebook, roughly 70% of its voting rights go to its unlisted class B shares, with the vast majority controlled by one person - Mark Zuckerberg.

For Google, 60% of its voting rights rest with its unlisted class B shares that have 10 times the voting rights of the publicly traded class A shares (NASDAQ:GOOGL). The class B shares are held by its founders and some insiders. Google also has class C shares (NASDAQ:GOOG) that has zero voting rights and usually trade at a discount to class A.

This type of share structure represents poor corporate governance as it gives the existing insiders complete control. As a rule, I avoid all stocks with unfair voting rights for the following reasons:

  1. No chance for any outsider/activist investor coming in to shake things up in the event that the business is not being run as well as it could be.
  2. No chance for any hostile takeover to unlock shareholder value in the event that the shares persistently trade below intrinsic value.
  3. If I buy a stake in a business, I want a say in the business that is proportional to my stake. There's just no two ways about this.

So this leaves 3 of the 5 tech giants.

Amazon is the most richly-valued business of the 5, and being a value investor, I have an issue with this, Berkshire's recent investment notwithstanding. Amazon has poor profit margin, low cash level, only recently turned a profit, and it is still trading at an extremely high P/E.

Apple is reasonably valued, but with over 60% of its revenue coming from the iPhone, it has an acute single-product vulnerability. We already see the iPhone starting to lose its luster, and even the much-acclaimed Apple Stores are starting to follow suit. Apple is now trying hard to pivot to services which historically has not been its forte, but we shall see. I may revisit this company if it successfully diversifies its revenue stream away from the iPhone - for now, it belongs on the watch-list.

So this leaves Microsoft as the most eligible candidate. How does its business look qualitatively, and what is its intrinsic value? Should we buy now or wait for better prices? I will address these questions in the follow-up article to Big Tech Oligopoly.

Takeaway

The tech world, and by extension our economic future, is dominated by 5 corporations. Each of the 5 is literally peerless in their own core domain, and they will leverage their position to dominate adjacent domains over time. If they happen to miss an emerging technology that threatens their core, they have a large enough war chest to buy it out.

But great businesses don't automatically make great investments. From my perspective, the publicly traded stocks for 4 of the 5 companies are uninvestable at this time.

In my follow-up to this article, I will go back to my roots as a value investor and publish an in-depth analysis on Microsoft, which in my opinion is the only investable company of the Big 5.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.