GAFA: Objectively Analyzing Impact Of Antitrust Scrutiny

Summary

• Alphabet, Apple, Facebook and Amazon are being scrutinized because of dominant market position.
• Their combined market capitalization is worth more than the GDP of some developed countries.
• Also, each company makes use of multiple technologies with each at a different phase of maturity.
• Still, challenges posed by antitrust regulations need to be objectively analyzed using a risk matrix.
• Valuations are consequently reviewed to reflect the results of the analysis and also the total addressable market.

The bosses of Alphabet (NASDAQ: GOOG) (GOOGL), Apple (NASDAQ: AAPL), Facebook (NASDAQ: FB) and Amazon (NASDAQ: AMZN), sometimes referred to the gang of four (or GAFA) have faced the US congress last week.

They are accused mainly of market dominance.

According to David Cicilline, chairman of the House Antitrust Subcommittee in his opening statement at the big tech antitrust hearing:

Whether they control access to information or to a marketplace, these platforms have the incentive and ability to exploit this power," he said. "They can charge exorbitant fees, impose oppressive contracts, and extract valuable data from the people and businesses that rely on them."

There have also been breaking-up talks by some commentators leaving investors awake at night as well as fears of some drastic action before the November polls when viewed in light of doubts about foreign interference in the 2016 elections.

Also, there is daily media coverage of potential regulatory actions impacting GAFA.

Therefore, the primary risk to investing in big techs has shifted from fundamentals to regulatory.

This is the reason which motivated me to focus on objectively analyzing the challenges using a risks matrix and I will also support my views through specific examples.

I also use the Gartner Hype cycle to show the importance of emerging technologies for GAFA.

I have also taken the liberty to include Microsoft (NASDAQ: MSFT) despite its leader not having to testify before congress. The reason is for peer review purposes in specific areas when common services are provided.

I start with the finances.

More than just market cap

The combined market cap of GAFA, estimated at $4.8 trillion is, thought provokingly, two times the entire GDP of France 2020.

Therefore, it is no wonder that they have enabled the US to dominate the global internet, right from communications, social interactions to e-commerce.

Figure 1: Key metrics for the four big techs invited by the congress.

Source: SeekingAlpha

Exploring this further, just looking at the total market cap and the number of persons employed would amount to pure shortsightedness as there is much more.

Firstly, in order to generate such high gross margins within their respective industries, these companies operate in a well-managed ecosystem with the developer community groups just being one example.

In addition, for many small businesses, had it not been for the tentacular expansion of these giants, there would never have received any visibility from the masses.

Secondly, new technologies, some organically developed but mostly acquired are critical to GAFA for delivering that stunning level of growth and earnings while other tech companies are scrambling to cut costs.

Figure 2: An update on earnings for the latest quarter.

Source: SeekingAlpha

This means that those technologies play a fundamental role in the way these four companies process data as well as build data-driven applications which differentiate them from the rest.

Therefore, for the average investor, it is imperative to provide an indication in terms of the technological mix.

For this purpose I use the Gartner Hype cycle.

The multi-technology space

The Gartner Hype cycle is used to discern between the hype from what is commercially viable in terms of new technologies which have a tendency to make bold promises.

It all starts with innovation progressing to high expectations until there is some disillusionment. Eventually, the technology becomes productive.

Some investors may not agree with the position of a technology or company along the cycle. My answer to them is that my objective in using this cycle is not to demonstrate competitive strength but more how specific technologies are being used.

Figure 3: Gartner's Hype Cycle with the company utilizing the technology encircled in blue.

Source: Hype Cycle obtained from Digital Communications and augmented through additions of big techs by author.

Furthermore, this cycle is by no means an exhaustive positioning as the big techs have a long acquisition history and are dynamic in terms of integrating acquired companies, but it has the advantage of providing a high-level view as to which technologies are being used to drive growth.

Hence, AI (Artificial Intelligence) which has already left the Innovative Trigger phase and is on its way to the peak of Inflated Expectations phase is used by the four big techs plus Microsoft.

Pursuing further, LinkedIn, which is owned by Microsoft and just like Facebook is a social interactive platform is far less popular.

While many may still remember the hacked profiles of Facebook and privacy concerns during the 2016 elections, it is difficult to recall a similar case for LinkedIn despite the fact that it holds the data of more than 700 million users in more than 200 countries.

Hence, there should be some real concerns by law makers when they grilled Facebook's CEO.

Changing the topic to internet search, Search Engine Optimization consists of increasing the probability of a website appearing in search engines like Google's results page is a mature technology in the productive phase.

Now, Alphabet's search engine, Google has already been under the spotlight by senators due to anti-competitive practices. In this context, the company has already been accused in the past of suppressing certain media in its search engine results.

Here also, a comparison with Microsoft which owns Bing, another search engine which accounts for 6.5% of the search engine market share makes sense.

In this case, the fact that Microsoft has been spared from scrutiny shows that there is not necessarily a purely political dimension to the scrutiny as some would like to think but some genuine competitive concerns as well.

Also, when compared to the previous scrutiny in 2019, the mood has changed from a somewhat casual to a more serious one. It appears that there are 1.3 million pieces of evidence the House Judiciary subcommittee on antitrust has collected in the last year.

Therefore, it is now time to consider the possible changes which law makers may resort to. For this purpose, I use a risk matrix which is normally used when carrying out large-scale change projects.

The risks matrix

There are many options available to the legislators and these can be categorized into four groups each with a different sanction severity level.

Figure 4: Possible change scenarios

Source: Keylogin Risk matrix

First, I strongly believe that the break-up option in the High Impact and High Probability of change (red rectangle) is out of question based on past experience for the Bell Telephone company in the 1980s.

In this respect, AT&T (T), one of Bell's spin-offs when the latter was split into several companies after the U.S. Department of Justice brought a lawsuit with an accusation of abuse of monopoly power.

While a breakup may produce immediate benefits for companies which testified against the four big techs, it could be detrimental to the US in terms of strength in key technologies like AI and VR (Virtual Reality).

More importantly, the benefit to the end consumer is questionable.

In this context, one of the drawbacks of Bell's break-up in 1984 may have been high-speed Internet service for many consumers suffering a delay.

Also, in the aftermaths of the breakup some regulations as to the GSM (a cellular technology) standard may have played a role in the US not having internal 5G strength and having to rely on foreign companies.

Interestingly, at the time of break up, Bell was a highly profitable company.

Therefore, it is very unlikely that US legislators will embark on a high-risk journey to weaken US competitive strength in emerging technologies regulating the growth strategy of their national champions.

This said, there are other medium risk scenarios (in blue) which I consider next.

No high risks but only low-to-medium risks

As for Google and Facebook, some commercial media companies view them as just sponging out writer's proprietary contents without making adequate payments.

Now, according to me, this is a debatable item as in the case of Google, its search engine has to index the companies in the first place so that their content is visible to internet users.

Same is the case for Facebook where a post has to be made for an article to effectively become "visible".

However, there has been many complaints of not doing enough for policing of hateful content by Facebook and Alphabet's YouTube.

As for Apple, it has also been impacted by geopolitics especially the US-China trade tensions but there could now be an internal risk constituted by its developer community.

Here, I refer to lawmakers' scrutiny of the App Store. The focus has been on the fees Apple has been charging third party developers to display their apps and the extreme punitive actions the company has taken in the past.

However, I do not see this as an immediate concern as Apple has demonstrated its willingness to comply with regulations in force in countries where it operates. It is generally viewed as being in the good books of local authorities.

As for Amazon, by gaining a dominant market share, it is viewed as using this position to block sellers from selling products in specific categories.

However, if the authorities were so concerned about dominance, then the FCC should not have attributed the company a license to launch satellites to cover areas of least coverage.

To sum it all, I see less of an impact for Apple and Amazon compared to Facebook and Google.

Consequently, using a severity of sanction scale of 1 to 5, Facebook and Google each score 2 points which is still on the low side. These two companies are liable to pay the highest penalties which could be fines or increased scrutiny on acquisitions.

Figure 5: Severity of possible sanctions

Source: Initial comparison data from SeekingAlpha and augmented by author's additional calculations.

One example of scrutiny is Alphabet's planned acquisition of Fitbit, a fitness tracker firm by antitrust regulators. The reason for concern is not the technology itself but more about Alphabet's access to sensitive health-related data from Fitbit's hardware.

However, there is no shortage of growth opportunities as the latest investment in a smart home security company demonstrates.

On an even more positive note, Alphabet advertising revenues fell this quarter but Google still holds more than 90% of search engine's market share and cloud revenues have grown by 43%.

Therefore, I do not view possible sanctions as denting on GAFA's ability to grow and should not impact the valuations meaningfully.

Valuations

First, there are unlimited opportunities to promote structural growth spanning across several geographies, make acquisitions from adjacent markets and as the Gartner cycle shows, further develop the broad array of technologies.

Figure 6: Market forecast by industry

	Industry	Worth in USD	Source
1	E-commerce	$6.54 trillion by 2023	Statista.com
2	Advertising	$332.84 billion in 2020	Emarketer.com
3	Cloud	$330 billion in 2020	Hostingtribunal.com
4	Home Security	$47 billion in 2020	Inc.com
5	Small satellites	$15.7 billion by 2026	Bloomberg.com
6	E-Health	$270 billion by 2023	Marketresearchfuture.com
7	Internet of Things	$1.1 trillion by 2026	Globenewswire.com
	Total	$8.6 trillion from 2020 to 2026

Click to enlarge

Source: Table built by author

This calls for higher valuations, albeit at differing levels.

Moreover, the stock prices of Apple and Amazon have appreciated by 2-3 times those of Google and Facebook.

Figure 7: Comparing the % change in stock price in the last one year.

Data by YCharts

Part of the reason could be due to fear of corporate advertisement expenses decreasing and hence impacting top-line in view of the economic downturn as a result of the pandemic.

However, the fact that the chart is for a one-year period, well before the advent of the coronavirus means that some of the antitrust concerns also weigh on the stock price.

In this respect, there was a 6% drop in the stock price of Alphabet and Facebook in the first week of June 2019 while Amazon dropped 4.6% and Apple slid 1%.

Hence, taking into consideration the potential addressable market, the drops following adverse news and possible sanctions, I have the following targets for the medium term.

Figure 8: Target prices

Source: Author's calculations

Moreover, the target prices provided are based on the following criteria:

• The possibilities of a drastic change in US economic or monetary policies are excluded.
• The technology space is dynamic and competitive.

Finally, investors will also note that I have not used the EV/EBITDA or P/E metrics to justify the potential upsides in stock prices. These are here just for reference purposes.

Key takeaways

As further justifications of these higher valuations are the organizational structures.

In this context, each one of these big techs is not just one company but more a conglomerate deriving above-normal returns.

Law makers have been investigating possible abuse of dominance for months, but the hearings are unlikely to have major consequences in view of the disturbance this may create in the markets.

In a market which favors those organizations which can be productive during COVID-19, big tech's investments and job creation ability are invaluable.

Moreover, in order to authorize action against companies, US law in contrast with its European counterpart requires that their actions clearly harm consumers, for example by driving up prices.

For this reason, GAFA is more likely to face measures outlined in the green box (figure 4) like fines and higher taxation.

Also, in case there is increased scrutiny on acquisitions, this may not necessarily impact growth as the Gartner hype cycle shows that they still have technologies idling in the garage.

In this respect, one will recall that Facebook has still been able to generate growth despite inability to launch the Libra digital currency platform as planned.

Lastly, this is an election year and therefore investors should expect some volatility especially for Alphabet and Facebook.

Analyst’s 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.

I would like to thank Stephen Davies, a digital strategist and consultant for the original Gartner Hype Cycle which I augmented with the Big Techs. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.