Blog: A winter of discontent for the trillion-dollar tech titans?



Arlene Ewing of Brewin Dolphin

By Arlene Ewing, Investment Manager, Brewin Dolphin Glasgow

 

It was a difficult October for markets. The FTSE 100 started the month at 7,495 points and dropped to 6,939 by October 25, finishing at 7,128 points on Halloween. Across the pond, the S&P 500 dropped around 300 points, or just under 10 per cent, and the Dow Jones Industrial Average fell more than 8 per cent by October 29.

Perhaps most tellingly, the tech-heavy Nasdaq Composite Index was down nearly 1,000 points, or around 12 per cent, by October 29 before making a slight recovery. The sell-off was largely characterised as a ‘tech correction’, with some big names shedding significant amounts of their value.

One of those has been Amazon. In September, it became only the second company ever to be valued at $1 trillion, closing at $2,039.51 a share on September 4. Eight weeks later it had lost around $250 billion – a quarter of its value. Facebook fared even more poorly, dropping 10 per cent in October and nearly one-third since July.

Yet, by comparison with its tech contemporaries, Apple had a somewhat better October. Although it fell more than 6% at one point in October, the business managed to maintain its trillion-dollar status and was up more than a quarter from the beginning of the year to the end of the month.

That was until Apple’s update on November 1, which sparked a 7 per cent tumble in its share price. Despite the company posting record results - revenues rose 20 per cent to $62.9 billion and profits increased 31 per cent to $14.1 billion - traders sold shares following warnings of weaker sales in the months ahead and the company’s decision to no longer publish the number of units it sells. The latter move sparked fears this may be a means of obfuscating any issues with future performance.

Amazon’s Q3 results left market watchers similarly disappointed. The company reported net income of $2.9 billion, or $5.75 per diluted share, on revenue of $56.57 billion – up 29 per cent on the same period in 2017. Even though the sales were towards the top end of guidance and profits were up significantly, many felt the sales figures were underwhelming amid concerns over international retail and unit shipments.

So, what has spooked investors about these companies in particular? While it would take a brave person to bet against either of them, there are undoubtedly legitimate risks associated with both businesses.

Apple’s technology has set it apart from the crowd. But there’s little stopping it from being replicated, at a cheaper price, elsewhere – particularly in China. In fact, other companies are gaining ground in the smart phone market. Huawei overtook Apple in terms of overall smartphone market share in the second quarter of 2018, taking a 15 per cent slice of global sales, while Samsung leads the way with nearly 20 per cent.

Then there are the disruptors, which are emerging everywhere. Small businesses like Edinburgh-based Beezer, which not too long ago appeared on the BBC’s Dragon’s Den, are finding new ways of changing the markets from which Apple generates its revenues – in this case, the app store.

Meanwhile, there’s always uncertainty over sales of new products. According to Slice Intelligence, Apple’s HomePod captured just 10% of the smart speaker market in its first 10 weeks, compared to 73 per cent for the Amazon Echo and 14 per cent for Google Home – well below expectations.

In a similar vein, Amazon’s main problem could be the sheer number of ideas it’s taking on. For one, it is partnering with Warren Buffet and JP Morgan on the creation of a ‘reasonable’ cost healthcare company in the US – no mean feat. It’s also reportedly looking into car insurance and a host of other markets.

This presents two main risks. The first is quite simple: these ideas don’t work and turn into money pits. Estimates suggest, stripping out its web services division and Prime, Amazon lost about $2 billion in the first quarter of 2018 on some of its other functions, including retail.

The second is the attention rapid expansion attracts – not least US President Trump’s keen interest in Amazon. If the tech giant becomes too big, regulators may start to look at options for breaking it up, citing its effects on too many industries beyond its core businesses – just look at what has happened in retail.

Apple and Amazon have created a lot of value for shareholders. But, in some ways, forecasting their revenues is still guesswork – hence the big share price movements that followed their respective updates. What is clear is that, as the businesses grow, so do the risks - and their ability to not only innovate, but generate cash and diversify, could go the other way.