Large technology and consumer tech firms could face challenges as they get too big to avoid the microscope
While the trend towards tighter regulation of large tech companies have been slowly simmering for years, the sector may have finally reached a boiling point given their much more prominent global role amid the COVID-19 pandemic.
As noted in a new commentary from the Capital Group, many tech companies have grown in power and influence amid the global economic downturn. Currently, five out of the top 10 U.S. companies by market cap are tech or digital businesses, which together command a total market value surpassing US$5 trillion.
“The sheer size of these companies means they're going to get a lot of scrutiny from every part of society, including government and regulatory agencies,” said Mark Casey, portfolio manager at Capital Group. “Some of these companies have also played key roles in the past two U.S. presidential elections.”
Tech was the target of two regulatory actions last year, namely an antitrust lawsuit against Google filed by the U.S. Department of Justice and another similar suit against Facebook from the Federal Trade Commission. More recently in February, the U.S. Senate introduced a bill that could make it more difficult for large companies to snap up competitors.
“Part of what makes this so complicated,” Casey notes, “is that Democrats have a whole set of issues with these companies — largely based on antitrust, privacy and hate speech concerns — while Republicans have another set of issues, particularly when it comes to the perceived censorship of conservative viewpoints.”
The drive for regulation has been further accelerated by the recent drama where retail investors on an online forum drove up prices of GameStop and other beaten-down stocks. Many of the investors incurred large losses as brokerage firms and online trading platforms placed limits on their trading, prompting a rare bipartisan call in the U.S. for Congressional hearings to conduct a post-mortem of the episode.
Regulators in the U.S. are faced with an uphill battle as they seek to curb tech companies’ obvious power. One issue, according to Capital Group analyst Brad Barrett, stems from the companies’ sprawling diversity of competitive profiles that span retail, advertising, and television, to name a few areas.
In Barrett’s estimation, the cases against Google and Facebook are not clear winners by any stretch of the imagination. The furious push for changes in antitrust law from some members of the U.S. Congress, he argued, is a tell that hints at the government’s weak hand.
“That by itself is an admission that it’s difficult to find antitrust violations based on case law going back 20 to 30 years,” he said, adding that traditional anti-monopoly arguments in the antitrust playbook aren’t particularly effective considering how many of the products from Facebook and Google are free.
Given the mixed picture on regulation, some might wonder whether the sky-high valuations of tech names are overstretched. But in the view of Capital Group investment analyst Tracy Li, markets are already pricing in those risks.
A look at the FAANG stocks as a barometer for regulatory risk shows that the two companies at the eye of the storm – Facebook and Alphabet, Google’s parent company – are trading at substantially lower PE ratios than their peers. In fact, despite its rapid growth rate and strong free cash flow, Facebook is trading just north of the average P/E for the S&P 500 Composite Index.
“These companies operate in large and growing markets, they have long revenue runways and they are very profitable,” Li said. “If the regulatory risks were not present, in my view, they would be trading at higher multiples.”
