BERENBERG INSIGHTS: TECH BUBBLE 2.0 – OR NOT?
A DISCUSSION WITH ADNAAN AHMAD
In a comparative analysis of today’s “Tech Bubble 2.0” market versus the late 1990’s, Adnaan Ahmad, Research Technology Hardware Analyst at Berenberg, with over 25 years experience in the sector a top-ranked analyst since 1999 (Reuters/Institutional Investor/Extel), discussed several key issues that pose credible threats to the technology giants of today, and endeavoured to answer the underlying question; are we in Tech Bubble 2.0 and, if so, when will this bubble burst?
The two “bubble bursting” indicators of the late 1990’s were arguably the AOL and Time Warner merger in January 2000, and the “Nortel moment” (the CEO claimed that Nortel were in “an investment glut (worth 2 years of revenues), with significant overcapacity in the system” six weeks after stating they were enjoying “100% year-on-year growth”). If history is likely to repeat itself, Adnaan anticipates that a leading company, whether it is the deceleration of Facebook’s growth or the collapse of Bitcoin, will burst the next bubble. Whilst such events are of course difficult to predict and identify, Adnaan argued that the industry may have already been defined by recent historical events, such as the Facebook/Whatsapp deal or the 38% Alibaba IPO gain, the effects of which can only be at a later stage.
The tenet of Adnaan’s investment thesis, referred to as “Tech Titans” was another topic of discussion. Having had a generally bearish stance on Technology Hardware since 2011, he argued that the Tech Titans cannot continue their market domination, as their market share and margins will be squeezed by technological discontinuity and other local players. By looking at the technology giants of yesteryear, we can understand what drove many of their downfalls and how industry trend shifts left only a few survivors and successful re-inventors. When comparing IBM against Microsoft and Mac in 1987, for example, it was IBM who was the “mainframe king” having reached its valuation peak of 17x P/E with a 17% margin. However, when Microsoft and Mac evolved the mainframes to PCs, the Titan struggled to adapt and was de-rated to around 9x P/E with a -12% margin in the early 1990s. Fortunately IBM was able to successfully reinvent itself by evolving from hardware to middleware and enterprise services by 1993.
This example highlights a key point in Adnaan’s thesis, which isn’t directly related to the companies but to human behaviour. History has proven that sell-side analysts are not always able to forecast earnings cliffs as company earnings didn’t tend to fall immediately after a technological discontinuity. It was only in 1992, five years after the mainframe/PC technological disruption that IBM’s numbers were affected.
Tech Titans are not invincible; their dominance can be superseded by immature, innovative companies in new verticals that capture the “next big thing”. No company has a completely flexible structure, less so are the Titans who have seen years of success in specific areas. Today, Technology Titans are not just competing against each other, but with emerging countries that are fast becoming technological powerhouses, such as India and China, or what Adnaan aptly referred to as “China Inc.”.
Within the past 10 years, China’s R&D spend has grown from 1% of that of the USA’s to 50%, and Huawei, a China Inc. company, has become the leading global infrastructure player, despite having no presence in the USA, Korea or Japan. Such investment trajectories and achievements demonstrate the vast national developments which will increasingly become a significant disruptor in the technology industry.
China Inc.’s competitive edge is centred on low-cost, high quality products. The smartphone space, for example, includes more nascent China Inc. companies such as being Xiaomi, Huawei and Lenovo. Their low-cost smartphone devices are disrupting the traditional high-end market, impacting on market shares and business model perspectives for global, mature incumbents. In simple terms, how can the global market compete with these new players who are selling at cost price and retaining margins?
A combination of China’s power over what companies sell in the country and rising cyber security/political tensions has inadvertently helped Chinese players grow both domestically and abroad. Cisco is an example of this, having been turned out of China (and post-Snowden, turned out of other emerging markets), has been replaced by Huawei. In summary, following these monopolistic practices, China Inc. has ramped up local investment in the technology industry, which could potentially displace some of its global competitors’ market share.
Adnaan’s comments provoked thoughtful discussions and Berenberg received great feedback from the event: “Adnaan’s talk was very informed and thought provoking. Although the technology sector continues to hold significant, above average, risks for the investor, as Adnaan’s analysis of the bubbles in the Private Equity valuations demonstrates, he adds to the impression that the quality of the Berenberg equity research team is very high.
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