Tech in a post-COVID world
Earnings growth drives stock prices. It’s a truism that holds through all market conditions and all cycles, and the COVID-19 induced market volatility is no exception.
It is important for investors to look through the volatility, beyond the short-term gyrations, and to focus on the companies that will be better off on the other side of this crisis.
If there has been one consequence of COVID-19 that everyone can agree upon, it is the impact it has had on digital enterprise, and the way it has accelerated the take-up of technology. Zoom, Webex and Microsoft Teams, among others, are now mainstream meeting tools that have become the mainstay of business continuity. Our children are learning from home with them as well.
Digital enterprise is a sector that continues to show promise – along with e-commerce and digital payments – and they are all sectors that are set to be beneficiaries of the brave new COVID-19 world.
When it comes to digital enterprise, the current crisis will only accelerate the move to cloud-based systems and software.
E-commerce, similarly, has been a growing trend and this crisis means the shift will happen even faster than initially predicted. From that point of view, Amazon and Alibaba are two names that are set to benefit.
Given a slowdown in commerce, payments overall will take a hit this year, but ultimately the shift to digital will only accelerate. PayPal is set to be a beneficiary in this space.
Another sector to watch is digital advertising. While there is no doubt that the likes of Google and Facebook will be impacted this year, they are also expected to outperform over the long run.
The positioning of our portfolio is reflective of this new reality; and while we have been long-term investors in each of these themes, they should see earnings growth over the next three to five years, despite the backdrop.
Source: Munro Partners
This is not to downplay the scope and impact of the COVID-19 pandemic on global economies. But however it plays out financially, unlike previous financial market crises, this is essentially a health crisis, and by extension a solvency crisis, for many small businesses across the globe.
Consequently, governments and central banks alike have seen little need to worry about moral hazard or sovereign debt levels, instead moving quicker than usual to provide unprecedented levels of stimulus and far-reaching interventions into credit markets which together have provided a strong firewall against any near term solvency concerns.
In this environment, it is important not to be distracted by the fiscal stimulus measures being undertaken. Over the medium to long-term it is far more important to correctly identify an area of structural growth, and the companies set to benefit from that growth, than it is to try to predict the direction of the economy or market.
With so many areas of disruption occurring at once post COVID-19, there are a number of opportunities ahead over the medium to long term. One that looms large, is the cloud computing ecosystem – which includes Infrastructure-as-a-Service (IaaS) and Software-as-a-service (SaaS). It is probably the biggest theme of the coming digital revolution and there are compelling reasons why its growth is set to accelerate.
IaaS is a form of cloud computing that provides virtual computing resources over the internet. IaaS offers a lower cost, more flexibility and scalability. IaaS implementation can be compared to the railroads of the industrial revolution, but in this instance, providing the infrastructure, speed and computer power without geographical constraints.
SaaS, by contrast, is the application layer of cloud computing. When software is hosted in the cloud, the end user can access the application anywhere, anytime over the internet. So if IaaS is the railroad, SaaS is the locomotive, delivering the software product to consumers and business alike.
To put the scale of this opportunity into context, worldwide IT spending sits at $2.1 trillion a year. This spending is split between software, devices, IT services, and data centres. But there is a structural change developing with three of the big IT spends – of software, IT services and data – where they are increasingly being stored in the cloud.
You need look no further than a Microsoft 365 subscription for a clear example of this in practice.
But despite the huge growth in cloud computing over recent years, it only represents about 5%-6% of the total global IT expenditure.
Source: Munro Partners
Obviously, there is a very long runway of growth ahead, and there are clear reasons why this growth is here to stay. Cloud computing is a one-stop shop that continues to take a bigger share of an increasing IT market spend. Consumers like ‘the cloud’ because it is far more simple, secure and cheaper than traditional methods of software usage.
Source: Munro Partners
Businesses like the cloud as well. For software companies and corporates globally, the cloud provides real and discernible benefits: companies can run virtually any application or operating system on the infrastructure and they can easily scale their use of the service, be it up or down, depending on demand.
It is no wonder that companies are increasingly migrating to the cloud in some form, and when they do, they are going through the big IaaS vendors including Google, Microsoft, and Amazon, and in the developing world, Alibaba.
These four companies are the big winners from the cloud computer trend. They provide scalable, commoditised computing power via their network of data centres and servers. Collectively, they account for 94% of the global IaaS market.
Meanwhile, the underlying cloud computing providers are growing strongly and they have attractive business models. They operate on high margins – which can be greater than 90% – they are very scalable and revenue is recurring – with low churn and customers on long-term subscriptions. Additionally, they are paid in advance of providing the service so have a steady secure flow working capital.
As the big four IaaS players continue to benefit from the migration of workloads to the cloud over the next five years, they could easily see a doubling of their cloud infrastructure revenues. We would also expect many of them to continue to improve margins as they enjoy the benefits of scale, which will ultimately contribute to sustained earnings growth.
VOICES OF CEOs
A number of recent announcements from the CEOs who at the forefront of digital transformation have described the changes they have seen since COVID-19, emphasising the impact of the digital revolution.
Most significantly, Satya Nadella, chief executive of Microsoft, said: “we’ve seen two years’ worth of digital transformation in two months”. He said there were more than 200 million Microsoft Teams meeting participants generating more than 4.1 billion meeting minutes, in a single day.
Similarly, Shantanu Narayen, Adobe chief executive, said “the mandate to digitally transform has taken on heightened urgency”.
He cited the example of the 175% increase in usage of its cloud-based e-signature solution since the start of their fiscal year and mobile usage exploding with Acrobat Reader installations increasing 43% year-on-year.
Finally, [cloud computing for life sciences system] Veeva chief executive Peter Gassner said “doctors are telling us they find digital meetings effective and they look forward to a mix of in-person and digital interactions once things get back to normal”.
In Veeva’s case, US remote meetings between pharma and doctors with Veeva Engage – are up more than 30 times from February to April.
Nick Griffin is head of investments at Munro Partners.
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