For more than a year, the world's largest tech companies have found themselves faced with escalating levels of political risk. Calls to break them up have increasingly garnered mainstream appeal; Apple (AAPL, Financial), Amazon (AMZN, Financial), Facebook (FB, Financial) and Alphabet (GOOGL, Financial) have all felt the political heat.
The political pressure on tech giants, as well as the threat of regulatory interference, has continued to intensify and, as 2021 kicks off, the state of big tech remains uncertain. Should calls to rein in, or even break up, big tech turn from talk to action, tech stocks are likely to suffer.
Tech investors would be wise to consider the potential ramifications if the political pressure should boil over.
Political pressure mounts
Calls from political leaders to break up big tech have grown in number and volume in recent years. Senator Elizabeth Warren made it a central talking point of her campaign for the Democratic presidential nomination in 2020, going so far as to name specific companies that needed to be broken up. Other leading candidates, such as Senator Bernie Sanders, echoed Warren's proposal, as have other influential members of Congress in recent months.
In October, Democratic lawmakers released a report based on a 15-month investigation by the House Judiciary Committee into the business practices of big tech companies. According to the Associated Press, the report could result in sweeping changes to the tech sector:
"If such steps were mandated, they could bring the biggest changes to the tech industry since the federal government's landmark case against Microsoft almost 20 years ago. The investigation found, for example, that Google has monopoly power in the market for search, while Facebook has monopoly power in the social networking market. The report said Amazon and Apple have 'significant and durable market power' in the U.S. online retail market, and in mobile operating systems and mobile app stores, respectively."
Democratic lawmakers are not the only threat to big tech. Indeed, Republicans in Congress and the Trump administration have repeatedly claimed that social media companies engage in censorship policies that unfairly impact their side of the political aisle. Some Republican lawmakers now appear willing to make common cause with their Democratic colleagues in a rare case of bipartisan consensus.
Black swan for tech
Tech companies have enjoyed years of light-touch treatment from both lawmakers and antitrust regulators. Free from worries of antitrust action, companies have been able to grow, expand and obtain considerable market power in their respective niches. But times are changing. Indeed, it has become increasingly clear that the long period of salutary neglect is at an end. The Department of Justice opened antitrust investigations into Apple, Amazon, and Alphabet in 2019, while other antitrust lawsuits against tech giants have continued to proliferate.
The roadmap for action laid out in the House's October report could, if implemented, severely alter the growth and profit trajectories of many tech giants. Lawmakers singled out "a high volume of acquisitions" by leading tech companies as a major source of "significant and durable market power." Consequently, antitrust actions could well take the form of forced divestitures and bars from engaging in certain lines of business. Facebook, for example, might be forced to divest some of its acquired social media and messaging platforms, such as Instagram and WhatsApp. Alphabet could face similar pressure over its YouTube video platform.
Thus far, big tech's antitrust risk has largely been discounted by the market. In fact, many of the biggest names in the sector saw their stocks rise to all-time highs in 2020. According to the Wall Street Journal on Dec. 11, tech stocks have reached historic levels of valuation divergence from the broader market:
"We are witnessing one of the widest valuation gaps ever, with the S&P 500 selling for nearly 22 times forward earnings compared with almost 18 times for the Russell 2000 index and just 15 times for the even cheaper Russell 2000 Value index. Meanwhile, the 'six' are selling for an average of 34 times next year's earnings, with Amazon sporting the highest multiple at 70 times."
Huge growth and profitability expectations are baked into the biggest tech stocks. Any government action to break them up, or even curtail their market power, could result in severe valuation compression.
My verdict
In my view, big tech has never looked more vulnerable to governmental interference. The risk that Amazon, Facebook, Apple and their peers could actually be broken up under antitrust laws – an unthinkable prospect just a few short years ago – is now very real. With most big tech stocks having surged to new heights over the past year, the risk to investors has also been magnified to an unprecedented degree.
A concerted effort by the federal government to break up, or otherwise curtail and control the behavior of, the largest tech companies could cause serious damage to their high-flying valuation multiples. Even if the effort is not so gung-ho as its advocates hope, any serious threat of a potential breakup could result in significant compression of tech valuations. A re-evaluation of the political risk could force revaluation of tech stocks, even if the risk is considered relatively small.
My advice to investors for 2021 is simple: Be prepared for big government disruption of big tech.
Disclosure: No positions.
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