Apple, Amazon, and other soon-to-be Trillion Dollar Babies

The summer of 2018 has been populated by speculation on the future of the tech industry and tempestuous debate on the direction of our economy. We have discussed the scandals of the likes of Facebook and Twitter but, this time, we are looking on the bright side of the tech industry with the frontrunners of innovation, Amazon and Apple. The recent highlight? Apple reached the inconceivable $1 Trillion valuation crux for a company… Amazon quickly followed suit.

The only way to aptly start this article is to awe over what ‘Trillion’ means and looks like. To begin, find the nearest ruler or roughly picture one foot in your head. Now, you need to visualize the distance between the earth and the moon. That distance is roughly 1.3 Billion feet long and in order to reach one trillion, take 770 trips to the moon or take a trip to Mars. Let that sink in. Comparing the companies to countries, per 2017 GDP data, both Apple and Amazon would find themselves beating all but 16 countries.

A year ago, Apple’s total Market Capitalization (total firm market value) sat at $830 Billion while Amazon’s fell short at $460 Billion. With Apple’s colossal popularity, we expected the firm to hit the milestone sooner or later. On the other hand, Amazon burgeoned from a new way to order textbooks to capturing 49% of the e-commerce market and now, potentially, a soon-to-be healthcare provider, all within the past decade.

Now that 2 of the 5 FAANG giants (Facebook, Amazon, Apple, Netflix, and Alphabet/‘Google’) have soared to a trillion dollar valuation, and with Alphabet flirting with $900 Billion after a strong Q2 earnings report was released, which company will join the podium? The tech industry has seen a jet-fueled growth due to strong quarterly reports, technological and e-commerce needs, and the continued expansion of the US economy. While Wall Street analysts expect to see the largest growth from a $530 Billion valued Berkshire Hathaway, the race boils down to two true contenders: Microsoft and Alphabet, yet two more tech companies.

In the case of Alphabet, despite a $5 Billion fine in Q2 from the European Union, the company still managed to have a strong quarterly performance. However, ever since the earnings report brought Alphabet’s peak, the firm has been in decline; Google’s absence at the congressional hearing did not help. With ensuing claims of shadow banning via Twitter, Facebook, and Google, the US Senate looks to further regulate the industry. Unlike Alphabet, Microsoft did not have to make an appearance at the September 5th congressional hearing. Much like Alphabet, they and many other tech stocks took a hit, with Microsoft falling 3%. The industry took a massive drop but this could just be the start of a drawn out regulatory battle.

According to Goldman Sachs Chief US Equity Strategist, David Kostin, we may see pressing regulation and even potential reclassification. Kostin speculates that this could separate the more “social” tech firms, such as Facebook and Google, to be redefined with a new industry description. Could they fall into a subdivision of tech or something new? Furthermore, Kostin mentions that the remaining ‘tech’ firms would be deemed “legacy” tech. By splitting the mammoth tech industry into two categories, investors will have a stabler, hopefully regulation-averse, positions that separate the hazy futures of the likes of Facebook, Twitter, and Google while maintaining the sincere domination of true tech firms. Since Alphabet is a conglomerate that has branched into social media with Google Plus, they have a large representation of information tech thanks to the Google Pixel and Chromebooks, technological research, and so much more. Seriously, click here to learn more. Goldman Sachs’s Kostin is trying to categorize a giant with arms in multiple industries; Facebook and Microsoft have far simpler distinctions. This is where I draw my conclusion and shift my focus back to the question at hand, who’s the next trillion dollar baby?

Separating the non-information technology firms from the social media-esque firms will allow investors to capture the growth of the tech industry without having to deal with as much of its regulation and spotlight. On September 5th, the only companies that were scheduled to appear at the congressional hearing were Facebook, Google, and Twitter, and the largest of the three did not even show. Despite the hysteria of regulation focusing on Kostin’s “Communications Services” firms, Microsoft and other major tech “legacies” took huge hits. Goldman Sachs’s reasoning? The massive presence of contemporary tech positions in ETFs (exchange-traded funds). The split would tighten the current industry and shift the focus of investors to their respective sides. It would also reduce the overall volume of holdings and trades of tech companies that are included in the same indexes, but only because they are in the tech industry with the likes of Facebook. The chief US equity strategist states that the legacy firms will grow at a slower pace than the new communications services sector, despite including the burgeoning Amazon and Apple.

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Goldman Sachs’ David Kostin
With that being said, we’ve come to our answer. And the winner is… it depends. If Alphabet continues to face ensuing regulation, do not expect the company to reach $1 Trillion next. Unless the firm quickly survives the tumultuous sentiment of the public spotlight, expect Microsoft to take the crown.

Although we have crowned a winner- well two tentative winners- what if neither company hits the landmark soon? With all of the discussion surrounding continuously increasing market caps within the current tech industry, analysts often poke at the idea of potential overvaluation; and your local Pitt Business Review Analyst will quickly do the same. So, what is the major difference between the dotcom bubble and our hypothetical tech bubble? Well for starters, some of our major tech firms have lived through the bubble already, but the prime reason is that they were backed by tangible goods and technological advancements. FAANG is comprised of five leading tech corporations frontrunning advancements and differentiation in the tech industry, however, two of the firms generate their profits through intangible services: Netflix leading as the largest video streaming service (double that of YouTube) and  Facebook managing 2.5 Billion active individuals (with even more accounts) on its four media platforms. The companies’ values come from their massive user bases.

Nowadays, you cannot simply slap on a .com and see an immediate rise in stock price. If you’re looking for potential bubble speculation, I am sure you have read up on some of the ICO (independent coin offerings) names thanks to the crypto craze. Back in late 2017 and early 2018, with names including coin or blockchain, your stock could rise 200%; just ask the new and improved Long Island Iced Tea, which changed its name to Long Blockchain Corp. Or, maybe you have heard of DogeCoin, the coin named after an internet meme? While I will not touch upon cryptocurrency any further, focusing on the more qualitative side, name changing serves as a strong example of a potential bubble. Furthermore, many of our contemporary tech giants felt the wrath of the dotcom bubble and survived. Amazon in particular, now valued in the $1900 per share range, eclipsed at $107 and dropped to less than $7 per share during the crash. Companies like Amazon have already passed the hurdle by diversifying their companies internally to be more than just part of a new fad or craze. To add another point to the argument, strong consumer sentiment and economic expansion have driven every major index to new highs in 2018. With economic expansion comes an increase in equity and an increase in equity drives investor sentiment; just ask the roaring 20’s. As the FED moves closer to raising interest rates 4 times this year, thanks to continued growth, it is tough to ignore the paralleled growth of the S&P 500 and the Dow Jones Industrial Average specifically. Keep in mind that this is a quick qualitative analysis on a potential bubble and there is far more digging that can be done; I encourage you all to dig further yourselves. Lastly, in 1999, the Capital Markets were on a completely new level, with 468 firms seeing an initial public offering (IPO) in the US markets, while in 2017, we saw 174 IPOs. The US markets have learned their lesson on the maturity of firms and their readiness to see the public markets. The last questions remain, what does the future hold for the tech industry? Will we see a slip in tech market caps?

Within the tech sector, homing in on the “Communications Services” group, the major performers that come to mind will be the obvious Alphabet (depending on its distinction) and Facebook. However, most of the industry, in terms of frequency, are made of positions on the smaller, large-cap side. Can you guess one of the most infamous or, in better words, disappointing tech positions? Here is a clue, they opened up with a market cap of ~$28 Billion, hit its high the next day, and dropped 55% since its initial offering, which occurred a year and a half ago. If you guessed Snap Inc (or Snapchat) you have earned a pat on the back. Another security historically performing poorly, Twitter. Social media-esque firms have been criticized for their necessity to be a social ‘requirement’ and develop their revenue streams constantly.

A 2011 Aalto University research study discussed, in the abstract, what MySpace could do to keep up with the fast-paced growth of the social media realm. As abundantly clear now, MySpace is virtually non-existent. They have gone through different remodelings and ownerships but the platform is painfully on the verge of extinction. For this reason, if social media were the main a driver of the tech industry, there would be a much more concerning question about bubble potential. However, the only social media-esque firm in FAANG is Facebook and the strongest performers in the tech industry fall under the “legacy” category anyway.

Ultimately, the growth of the legacy group is not in question, especially if separated from the communications services sector. Citing Kostin, “The Zuckerberg hearing revealed to many government officials the scale of personal data that FB users had agreed to allow the firm to gather, raising regulatory risks.” And now under fire for allegations of improper shadow banning, there is a grim uncertainty for firms connected to Facebook, which focus mainly on Alphabet but further extend to the rest of the FAANG group. Companies connected with Facebook on Goldman Sachs’s radar have underperformed the industry.

With ensuing regulation, Alphabet’s strong connection with Facebook, and no apparent tech bubble, the future shines brightest for Microsoft, taking its third place spot on the trillion-dollar pedestal. I will be checking back in once we see a company approach quadrillion!

 

Sources:

{1}http://fortune.com/2017/03/06/apple-iphone-use-worldwide/

{2}https://www.marketwatch.com/story/this-is-how-much-money-exists-in-the-entire-world-in-one-chart-2015-12-18

{3}https://www.nytimes.com/2018/09/04/technology/amazon-stock-price-1-trillion-value.html

{4}https://ycharts.com/companies/GOOGL/market_cap

{5}https://abc.xyz/investor/

{6}https://abc.xyz/investor/pdf/2018Q2_alphabet_earnings_release.pdf

{7}https://www.watchlistnews.com/q3-2018-eps-estimates-for-alphabet-inc-class-a-reduced-by-analyst-googl/2329901.html

{8}https://www.cnbc.com/2018/08/03/these-are-the-next-companies-poised-to-hit-1-trillion.html

{9}https://www.investopedia.com/terms/f/faang-stocks.asp

{10}https://ca.finance.yahoo.com/news/goldman-regulation-hit-big-tech-134500977.html

{11}https://9to5google.com/2018/07/23/alphabet-q2-2018-earnings/

{12}https://www.cnbc.com/2018/07/10/eu-hits-alphabet-google-with-android-antitrust-fine.html

{13}http://www.proactiveinvestors.com/companies/news/204268/faang-report-google-snubs-us-senate-hearing-on-election-meddling-j-crew-sets-up-shop-in-amazoncom-204268.html

{14}https://ycharts.com/companies/MSFT/market_cap

{15}https://www.cnbc.com/2018/01/31/microsoft-earnings-q2-2018.html

{16}https://ycharts.com/companies/SNAP/market_cap

{17}https://seekingalpha.com/article/4079526-tech-stocks-overvalued-market

{18}https://seekingalpha.com/article/4079735-overbought-overvalued-top-tech-stocks-much-might-think

{19}https://www.bbc.com/news/technology-33862367

{20}https://www.cnbc.com/2018/07/18/microsoft-earnings-q4-2018.html

{21}http://epub.lib.aalto.fi/en/ethesis/pdf/12544/hse_ethesis_12544.pdf

{22}https://www.geekwire.com/2016/study-amazon-video-now-third-largest-streaming-service-behind-netflix-youtube/

{23}https://www.lombardiletter.com/companies-that-died-and-survived-the-dotcom-bubble/9106/

{24}https://www.nasdaq.com/article/the-number-of-2018-us-tech-ipos-will-double-over-the-next-10-days-cm949716

{25}http://www.historyofdomainnames.com/dotcom-bubble/

{26}https://www.cnbc.com/2017/12/21/long-island-iced-tea-micro-cap-adds-blockchain-to-name-and-stock-soars.html

{27}https://www.fxstreet.com/news/fed-on-its-way-to-raise-rates-four-times-this-year-uob-201809100642

{28}https://www.marketwatch.com/story/ipos-shatter-records-in-1999

{29}https://www.statista.com/statistics/270290/number-of-ipos-in-the-us-since-1999/

{30}https://www.ey.com/Publication/vwLUAssets/ey-global-ipo-market-climbs-to-10-year-high-in-2017/$FILE/ey-global-ipo-market-climbs-to-10-year-high-in-2017.pdf

 

The Experience Economy Strikes Again

If the death of traditional retail shopping were to have a martyr, Toys R Us might be the perfect contender for such a role.  Once the go to place for toys, games, and children’s electronics, the brick-and-mortar retailer finds itself saddled with $5 billion of debt and depleted cash flows as Amazon, Walmart, and Target sap up market share like taking candy from a baby.[1]  The general public finds itself asking, “How could this happen?”, but I think we all know the answer: When was the last time Toys R Us was at the forefront of anything? When were we talking about Toys R Us like we were Amazon or Walmart or Target? The answer was decades ago, and it is not hard to see why.

Death by Innovation

The last time I walked into a Toys R Us, the lonely building sat by itself on a hill surrounded by a sea of empty parking spaces.  The year was sometime around 2006-2007, right after Bain Capital took the toy giant private in an effort to make some quick profit in a 3-5 year turnaround (more about that later).  The store, right outside of Lancaster City in Pennsylvania, is pretty big, but has a strange effect on shoppers: the colorful toys and games are dimly lit, and the slight twang of a pop song follows you around the store.  Here and there you hear a child scream, hopefully in delight, but the store is devoid of customers and maybe even salespeople. If I happened to find something in the store, I could not recall for you today what it was, just another example of the sorrowful show Toys R Us had on display.  I could describe for you the terrible experience, but not the actual toy I bought.

 

What I am getting at is that the last thing a consumer wants from a retailer selling something as exciting as toys is the experience I had as a child above.  Just like the products themselves, stores should mirror the type of experiences one has when using the product at home. Toys R Us wanted to do this after first filing for Chapter 11 bankruptcy protection last year.  The retailer had started to put Toy and Baby “labs” in some 200 of its stores, which would allow consumers to test and experiment with new products in creative games and showcases.[2] These types of experiences create positive memories for consumers to associate with a retailer’s offerings, bolstering their chances of buying the product or service and elevating the image of the brand.  However, debt servicing syphoned off much needed capital that Toys R Us would have used to modernize the brand and continue to innovate the consumer experience, so the retailer was handicapped from the start in competing with innovative giants like Amazon and Walmart.

The Worst is Yet to Come

When Joseph Pine and James Gilmore wrote their defining article for the Harvard Business Review in 1998 entitled “Welcome to the Experience Economy”, it is as if they were predicting the fall of retail right then and there.  Pine and Gilmore’s primary argument was that there has been a progression in economic value, from raw materials, to goods, to services, and now experiences as the highest source of economic value.

Progression of Economic Value

They go on to explain the implications: those organizations who do not enhance their economic offerings (for example, turning traditional retail shopping into retail experiences like those of Barnes & Noble’s partnership with Starbucks or Apple’s “town square” feel) are doomed to fail in this new economy.[3]

Toys R Us is one, but not the only brand, to fall under Pine and Gilmore’s prediction.  In the past we have seen the likes of Circuit City, Radio Shack, and others close due to this “experience” problem, and others including Sears/Kmart, Macy’s, Rue21, American Apparel, Bon Ton, and more are filing for bankruptcy and closing stores with the same set of problems: declining sales and poor brand images.[4]

 

Moreover, even brands built on experiences are struggling, as the recent bankruptcy of Claire’s demonstrates.  The teen accessory outlet specialized in combining products (earrings, head-ware and the like) with service offerings like ear-piercings.  But even Claire’s unique offerings are not enough to truly warrant the higher economic value in this day and age, and although they have reduced their debt by $2 billion in the past few years, it was not enough to save them.[5]

 

The story is similar to Toys R Us, which was saddled with $5 billion in debt from the Bain Capital buyout from early.  Payments on this debt amounted to $250 million a year and so what little cash Toys R Us did have coming in wasn’t enough to both pay down the debt and reinvest in new toy experiences.  Bain and others who invested in the company for their part weren’t able to turn the company around, a strategy which settled on growing the international portion of the business, cutting costs, and reconfiguring what stores they could [6].  It just wasn’t enough and the innovation and experiences weren’t there to lure new customers into the store.

 

So what does the future hold for retailers and service providers that do not shape up and adapt to the experience economy?  First and foremost, we will surely see more retailers file for bankruptcy and close, with the potential for huge consolidations in a variety of industries.  I am predicting grocery is ripe for disruptions and experience innovation, as evidenced by Amazon’s foray into grocery with their Whole Foods purchase and the aggressive expansion of Walmart’s “Neighborhood Market” grocery concept, both staging grounds for fantastic customer experiences.  However, it’s not just grocery; market players in brick-and-mortar retail in general need to put more emphasis on consumers experiencing their store and their products over simply getting in and getting out. I think we will see some retailers do this really well (Best Buy is a great example of both a business turnaround and an improvement to the consumer experience, with faster delivery and a better online interface)[7]  while others will try and fail or won’t try at all.

As consumers, we have come to expect more from our stores.  If brands do not give us the experiences we deserve, then they’ve doomed themselves already.

 

[1] https://www.usatoday.com/story/money/2018/03/18/toys-r-us-bankruptcy-liquidation/436176002/

[2] https://www.forbes.com/sites/neilstern/2018/03/15/toys-r-us-prepares-for-its-final-curtain/#760fbd232a0b

[3] https://hbr.org/1998/07/welcome-to-the-experience-economy

[4] https://www.cbinsights.com/research/retail-apocalypse-timeline-infographic/

[5] http://www.post-gazette.com/business/pittsburgh-company-news/2018/03/19/Claire-s-hair-accessories-preteen-ear-piercing-mall-chain-files-for-bankruptcy/stories/201803190101

[6] https://www.ft.com/content/02a5edbe-9d93-11e7-8cd4-932067fbf946

[7] https://www.reuters.com/article/us-best-buy-ceo/best-buy-ceo-says-turnaround-done-room-to-compete-with-amazon-idUSKCN1GL2Y8