Are the FAANGs losing their bite?

The past few years have seen phenomenal performance from the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) as well as from their Chinese counterparts (the likes of Alibaba and Tencent). 

The impressive operating momentum of these stocks, which have so much reach into the lives of so many people on any given day, has led to ever-increasing investor enthusiasm over time. 

Since the middle of 2018 though, it seems like sentiment has somehow shifted. It is no longer universally bullish and certain stocks have, in fact, underperformed quite significantly on a year-to-date basis.

So, the natural question is whether this golden period for FAANG stocks is nearing an end or not.

We saw some evidence of this with Facebook’s results in May 2018. The stock fell nearly 20% after reporting second-quarter results and, quite astonishingly, wiped nearly US$120 billion off its market value.

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In that context, it is, in fact, the largest single stock move in history. Facebook’s results showed slower growth in both revenues and users, as well as higher costs. The reasons were largely company-specific – slowing growth in the core Facebook app not yet being offset by the faster-growing Instagram and some other new growth and investment initiatives – but were also because of measures that the company had to take to safeguard the platform following accusations of data misuse, inappropriate content and state-directed manipulation.

The big question for the dominant internet platforms of today is whether to self-regulate or to be regulated. The internet was designed to be free, open and innovative, and with that came both a light regulatory touch as well as a need to sell advertising to support these underlying business models.

The laws that applied in the physical, tangible world were not rewritten for the online intangible economy, and the global nature of the businesses that emerged has allowed big tech to arbitrage regulatory frameworks. Following growing public concern over misuse of data content, many politicians are now stating that these companies can be seen as being anti-competitive and perhaps even destructive to the wider society, which has started to prompt regulators to take a closer look at the way in which the internet is governed.

It is less clear how consumers will respond or even if they, in fact, care, given that many of these services are somewhat indispensable and lack any obvious substitutes. In essence, the bargain we make with technology every day is that, in exchange for the benefits of convenience and efficiency, we often surrender privacy and control, whether we realise it or not. The Cambridge Analytica scandal only brought to the fore, in a very public manner, the issue of how our personal data is handled as well as how it is being exchanged.

There is no doubt that big tech is dominant in their core markets, which is a function of the winner takes all, very competitive dynamics of the internet economy in which they operate, and which, in turn, underpins the attributes of the very high-quality business models they possess. However, in the current political climate they are being accused of being perhaps a little too big, and a little too powerful. One cannot really penalise them for being successful, but some question whether they are behaving in an anti-competitive and monopolistic manner. This is a much more difficult question to answer or prove, given existing laws are not well suited to the digital economy of today.

So, what lies ahead for these tech giants? Short-term regulations will certainly encourage these platforms to improve over time. An impact on costs is quite likely, as those that do not sufficiently address these issues will face fines going forward.

We can also assume that these companies will face increased costs in order to comply in the future. Some, too, may face a negative impact on revenues as they adjust their business models. That will have a knock-on impact on targeting, user engagement and thereby advertising spend.

In the long term, though, the companies that evolve and adopt a stronger duty of care will certainly benefit as they will, in turn, enhance the user experience via higher quality user engagement and ‘stickiness’, especially with a lack of alternatives around. Furthermore, the increased compliance costs could, in fact, reinforce incumbents that have the resources, and thereby actually raise the barriers of entry, further strengthening their underlying business models.

The greater risk though is antitrust, but this is almost impossible to forecast.

What is clear to us is that sentiment on big tech is changing, and the previously held consensus views are now perhaps diverging, so possibly these stocks will not all move upwards in one direction, which has largely been the case in recent years. This should be seen as a positive development for bottom-up stock-pickers like ourselves, as it will provide more opportunity for us to add value and alpha over time.  

Rhynhardt Roodt is co-portfolio manager for the Investec Global Equity strategy at Investec Asset Management.