Despite phenomenal long-term share price performance, Big Tech has been besieged from all sides – governments and regulators have been forced to increase scrutiny, investors are questioning the future economic consequences, while consumers question the FANGs’ social licence to operate. In response to the major issues faced by Big Tech, Sickly Tech, a report by Eoin Murray, Head of Investment at Hermes Investment Management, raises deep questions about Big Tech’s future, the risks for investors, and outlines the necessary steps to drive reform.
Even the market ruckus earlier this year failed to derail the trajectory of the Big Tech leaders. Instead, the market witnessed dramatic outperformance by Big Tech and the FANGs (Facebook, Amazon, Apple, Netflix and Google), which benefit from the ongoing growth in internet commerce. Indeed, if the FANGs (plus Nvidia and Microsoft) are stripped out, the S&P 500 has fallen over the year to date - such is the influence of their phenomenal momentum. Even from a global perspective, the FANGs are a vital positive story, with global markets overall having fallen slightly in 2018.
However, according to the report, concerns over data privacy have cast a shadow over the strong returns. The report highlights the Cambridge Analytica (CA) scandal as illustrative of the potential vulnerability of the FANGs. CA obtained data from 50m+ Facebook users and quite possibly used it for political purposes. What seems beyond doubt is that it used this information without either Facebook’s knowledge or consent.
Eoin Murray, Head of Investment at Hermes Investment Management says: “Facebook claims this technically wasn’t a data breach, but it does bring into light the sophisticated algorithms used to target adverts – and similar tools in use at other Big Tech providers. It has not yet become clear exactly what CA did with all the data, but the public reaction thus far is largely one of incredulity that Facebook could fail to understand that the data could be used in dangerous ways.”
Stewards of responsibility
What is increasingly obvious, is investors need to think more deeply about FANG stocks and question their standards of responsibility.
Murray continues: “They are an important part of US and global business, and influence the fortunes of a vast ecosystem of companies. They dominate consumer growth, technical innovation and economic trends. Furthermore, they influence our communication, are pre-eminent in logistics, and are looking to burgeon into new industries, including healthcare and insurance. However, the question is: are they are responsible stewards of the power they control?”
There are serious questions around accountability and this has been played out clearly in the realm of publishing. Companies such as Facebook and Google are disseminating content, but without the same checks and balances as conventional publishers. This has led to well-publicised issues around fake news and the promotion of rogue content, such as terrorist or paedophile activity.
In June 2017, the European Union fined Google €2.42bn after finding the technology giant abused its internet search monopoly, promoting its own shopping service at the expense of other price comparison sites. It was the biggest competition fine to date from the European Commission, and according to the report, Big Tech could not necessarily be trusted.
The dominance of data
From shopping records to political affiliation – the prize for Big Tech is data. European policymakers have been worried enough to bring in the new General Data Protection Regulation (GDPR), which represents a robust set of requirements guarding personal data.
“This pushed Facebook to publish privacy principles for the first time and to roll out educational videos helping users understand and exert some control over who has access to their information. Moreover, Big Tech has the backing of a powerful lobby looking to limit future reform. While it is less powerful in Europe, the US Federal Communication Commission’s decision to roll back ‘net neutrality’ rules demonstrates the power of this lobby,” says Murray.
Moreover, FANG stocks are increasingly monopolistic in their individual spheres and Amazon’s dominance has been implicated in the failure of high street rivals.
Murray continues: “US antitrust policy is clear: If a company brings clear consumer benefits, it can be as big and powerful as it wants. In the short-term, Amazon is pushing down prices and giving consumers choice, but will it have the incentive to do so if its monopoly builds? There are questions over whether antitrust legislation is fit for purpose in the digital age.”
Poor engagement with shareholders
According to the report, shareholders can play an important role in holding companies to account, but only if a company needs to listen to them.
Murray says: “In many cases, big technology companies don’t need additional capital. They have vast cash flows and cash mountains large enough to support whatever innovation (or corporate acquisition) they choose to pursue. Many of these companies have multi-class share structures that make it harder for shareholders to call company management and boards to account, as voting control is concentrated around the founder.”
Technology companies’ aggressive tax planning arrangements are increasingly concerning. Many technology companies have structured their financial arrangements to avoid domestic taxation in countries in which they operate. For example, Amazon paid just €16.5m in tax on European revenues of €21.6bn reported through Luxembourg in 2016.
So what are the risks for investors?
While Big Tech has seen significant share price growth, sustainability issues pose a risk to its ability to grow revenues, profitability and – ultimately – its ability to operate effectively in a societal context.
The report outlines three major risks:
Increasing regulatory intervention
UK Prime Minister Theresa May acknowledged in September that Facebook and other tech companies had made progress in their efforts to tackle these issues, but added that they still needed to go "further and faster". In particular, the speed at which terrorist-related material should be erased has been a contentious issue and signals the potential for intervention.
Advertisers are sensitive. Wary of their reputation by association, advertisers do not want their products associated with rogue content. Ultimately, businesses such as Facebook or Amazon are dependent on consumer engagement. If they become disillusioned, or switch off, their business model will struggle.
This is a tail risk: low probability but with high potential impact. For the time being, most of these companies have not engaged in the type of anti-competitive behaviour that would bring them to the attention of antitrust legislation. However, there are signs of more aggression. Amazon named one campaign to approach small publishers “The Gazelle Project,” designed to target them “the way a cheetah would a sickly gazelle.”
Positive change in Big Tech can be achieved by collaborative action between companies, government and asset managers and outlines areas where progress needs to be made.
- Checks and balances
The fortunes of many of these companies are wrapped up with those of their charismatic founders, who may or may not have political ambitions, but have philanthropic ambitions. For many companies, this is the main check to their power and ambition. But is it enough? After all, this still rests with one person. Given the prevalence of data, it doesn’t seem unreasonable to charge Big Tech with acting as an information fiduciary
- Digital Geneva Convention or Tech Magna Carta
It took until 2015 for the UN to follow Microsoft’s suggestion that existing international law applies to cyberspace. Microsoft, among others, has proposed a Digital Geneva Convention. Under their proposals, there would be ample scope for the involvement of all stakeholders, whether government, individual citizens or Big Tech. Agreement on a basic set of principles is an obvious first step.
- Engagement with governments
These companies are increasingly recognising that they need to engage with governments and tax authorities to prevent a more onerous and intrusive clampdown. Google agreed a deal with British tax authorities in 2016 to pay £130m in back taxes and promised to bear a greater tax burden in future. However, countries may continue to arbitrage tax laws, so an international agreement may be difficult.
- Changing business models
Apple and IBM recently launched public relations efforts to demonstrate their responsible use of data. Apple’s new privacy website shows features that differentiate it from, say, Google – algorithms that work at the level of individual devices rather than in the cloud. There is increasing mileage in being seen to use data responsibly.
- Role of asset managers
As asset managers and asset owners, it is not good enough to simply place Big Tech on a banned list of companies unless they reform – asset managers’ role as stewards of capital must be to engage with those companies directly in order to help change their modus operandi, earn their social licence, and to seek the help of government in reclaiming ownership of our data.
Shareholders have the ability to reinforce the need to manage personal data more carefully, to be cognisant of the unintended effects on democracy, and to call into question the societal propriety of social media.
Murray states: “Existing share structures with dominant founders make this challenging, but careful, well-structured engagement on these difficult, but vital issues, should be able to make a difference.
“It has been easy to see Big Tech as a one-way bet with a uni-directional positive societal impact, but sustainability considerations are its Achilles Heel and present an only recently acknowledged risk to investors. As it becomes an increasingly important component part of the US indices, investors need to consider whether these companies are adequately addressing governance and myriad other considerations.”