The Tech Takeover

There are a few things that any financial media outlet can’t go without mentioning as of late.

The virus, the Fed and the FAANGs.

The first is exogenous and critically misunderstood, the second is acting as a deity orchestrating the markets, while the third is keeping major indices afloat as the economy slowly recovers.

When talking about mega-cap stocks, we often hear them referred to as FANG, FAANG, or FAAMG. With the focus here on the 6 largest constituents of the Nasdaq-100, we will be referring to them as FAAMG+. These include Facebook, Apple, Amazon, Microsoft, Alphabet and Tesla.

Just how big are they?
Amazon, Apple, Facebook and Google account for 35% of the total weighting of the Nasdaq-100. Add in Microsoft and Tesla, and that’s another 14%. Combined, the six mega-cap giants account for basically half of the Nasdaq’s total weighting.
If FAAMG+ was a country, it would be the 17th largest in the world, positioned between Indonesia and the Netherlands.
These blockbuster stocks are in the news on a daily basis and have emerged as the beneficiaries of the stay-at-home economy. So let’s shed some light on how exactly they make their money and why investor sentiment may (or may not) remain in their favor in the foreseeable future.

Amazon, Inc.
Bull case (2x / 3x Amazon ETP)
  • Growth
    E-commerce is growing at about 16% per year in the US – expected to accelerate to 18-20% over the next five years. Amazon has 40% market share of US online sales
  • AWS
    Cloud computing (infrastructure segment) expected to grow 25-30% in the coming year. Amazon has more servers than any of its competitors and has a global presence.
  • Vertical integration
    Amazon is steadily growing its logistics operation – it delivers more than half of all Amazon packages in the US, competing directly with UPS and FedEx.

Bear case (-1x Amazon ETP)
  • Regulation
    Its large size attracts negative regulator attention, often around the topics of consumer data and antitrust matters.
  • Overpriced?
    Forward P/E ratio is around 120x, 6 times higher than the S&P 500 average.
  • Third party sellers
    An increasing percentage of retailers jeopardize quality and safety of products sold on the platform with fake and counterfeit items.

Apple, Inc.
Bull case (2x / 3x Apple ETP)
  • Robust ecosystem
    Current Apple users make up over 1.5 billion active devices globally, leading to record services revenue, which has higher margins.
  • Omnipresent
    Nearly 1 billion iPhones are presently in use, and about 350 million are in the window for upgrading. AirPods sold in 2019: 60 million, 100% growth YoY and taking over 50% of the global totally wireless (TWS) headset sales.
  • Innovation
    New gadgets are on the horizon, as rumors hint at introduction of ‘smart glasses’, self-driving cars, and further healthcare initiatives.

Bear case (-1x Apple ETP)
  • iPhone saturation
    Over half of Apple’s revenue is from its phone sales, and consumers are now waiting longer than ever prior to upgrading to newer models.
  • Release uncertainty
    There is a possible 5G iPhone delay due to market uncertainties caused by the coronavirus.
  • Fierce competition
    Samsung and Huawei are resilient in maintaining their smartphone market share, slightly behind Apple.
  • Alphabet, Inc.
Bull case (2x / 3x Alphabet ETP)
  • Control
    Absolute dominance in web search, video content sharing, browser usage and many other markets.
  • Ads
    Online advertising through AdWords, AdSense, YouTube and Android OS give it almost 50% of US digital advertising revenue.
  • M&A
    Having acquired more than 200 companies, it has diversified holdings into sectors like self-driving cars (Waymo), drone deliveries (Wing), smart home products (Nest), and many more.

Bear case (-1x Alphabet ETP)
  • Assimilation issues
    Many companies under one roof means integration issues (company culture, lack of synergies among disparate products, etc.).
  • Data worries
    Privacy issues regarding user data use has landed it with a $57M fine and ongoing scrutiny regarding its lack of compliance with GDPR. This is in addition to $5B antitrust fine by the EU.
  • Market share decline
    Google’s share of U.S. digital ad market (its cash cow) is expected to fall from 31.6% in 2019 to 29.4% in 2020, continuing a downward trend due to competition from Facebook, Amazon, and Instagram.
  • Microsoft Corporation
Bull case (2x / 3x Microsoft ETP)
  • Solid network
    Strong distribution channels. works with all the major computer hardware producers such as Lenovo, Dell, Toshiba and Samsung and major computer retailers to make sure computers would be sold with already pre-installed Windows software (biggest revenue generator).
  • Azure
    SMicrosoft Azure (Microsoft’s cloud infrastructure) is growing at a faster pace than AWS and tightening the market share gap between first and second place.
  • Future strategy
    Plans to buy TikTok’s US operations to become meaningful player in digital advertising space. TikTok global downloads have nearly doubled from Q1 2019 to Q1 2020.

Bear case (-1x Microsoft ETP)
  • Cloud wars
    Amazon’s AWS holds pole position in the growing cloud market, with Azure’s share at only half that amount. Additional competition is also presented from Google Cloud and Alibaba.
  • Lacking innovation
    Microsoft has been failing to grow its hardware products sales such as surface pro computers and phones.
  • Unsuccessful acquisitions
    WebTV, LinkExchange, Massive, and Danger resulted in failures and divestitures. Its current target, TikTok faces a Sept. 15 deadline to either complete the sale of its U.S. operations or face a ban in the United States.

Facebook, Inc.
Bull case (2x / 3x FacebookETP)
  • Relentless growth
    Despite legal issues and Covid concerns, FB beat earnings estimates, and revenues are expected to grow at a CAGR of 17.2% from 2020 – 2024 (average for media industry is 15.7%).
  • Partnerships
    In May 2020, Facebook further penetrated the e-commerce space by teaming up with Shopify. The company aims to enable small businesses on its Facebook and Instagram platforms to create a digital storefront.
  • Commerce
    Investment in Jio e-commerce platform and increasing success in messaging commerce (via Messenger and WhatsApp) could translate to new revenue streams.

Bear case (-1x Facebook ETP)
  • Regulatory scrutiny
    It has been called upon to face congressional hearings regarding election meddling, data privacy issues, cryptocurrency, and anticompetitive behavior.
  • Ads boycott
    Insufficient combatting of hate speech has led to boycotts from Unilever, Sony, Adidas, Ford, Microsoft and other Fortune 500 companies.
  • Normalization
    User engagement and growth is expected to revert to the mean as countries ease coronavirus restrictions around the world.
  • Tesla, Inc.
Bull case (2x Tesla ETP)
  • EV market
    Electric vehicles (EV) are expected to make up 57% of global passenger car sales by 2040. Tesla controls about 75% of the EV market in the U.S. today.
  • First-mover advantage
    Having produced 1 million cars, its battery technology is estimated to be three years ahead of the rest of the industry. Tesla’s battery cells are cheaper per kWh and the fleets’ drivetrains allow it to get more range out of similar-sized batteries. Current EVs with the furthest range in the industry are all Teslas.
  • More than just a car
    Software updates, autonomous driving technology and driving data helps improve the experience and deems Tesla as much a tech company as it is a car manufacturer.

Bear case (-1x Tesla ETP)
  • Revenue composition
    Without regulatory credit sales (where producers of EVs can sell ‘credits’ to non-producers of EVs so they avoid fines), Tesla’s net income in 5 of the last 6 quarters would have been negative.
  • Expensive
    Tesla’s forward P/E is at around 230, which is 10x that of the NASDAQ-100 Composite.
  • Competitive landscape
    Zero Emission Vehicle (ZEV) regulation means more competition in the EV space. Traditional manufacturers like BMW, VW Group and Toyota are all shifting their focus to electric vehicles and are expected to increase their market share.