Why these fundies are still bullish on tech platforms
Unless you've been living under a rock or happened to be searching for this article on Facebook (too soon?), you probably know about the Australian government's legislative attempt to make big tech pay local news publishers for content.
In short, the News Media Bargaining Code (which is still winding its way through parliament) is intended to level the playing field between tech platforms and news media companies. Not surprisingly, it has sent ripples of anxiety around the digital media world, with Facebook and Google taking radically different stances in the stand-off.
Facebook has deployed the nuclear option, obliterating Australian news from its platform. Google has embraced news (News Corp, that is) with a global deal, as well as brokering other deals with a clutch of local publishers. Elsewhere concerns have been raised over the impact this legislative precedent could have on the "free internet".
To explain what this all means for investors, Livewire's Ally Selby spoke to Magellan's Vihari Ross and Montaka Global Investments' Chris Demasi. They discuss the repercussions of this news for investors in Facebook and Google, the potential windfall for publishers, as well as whether regulation curbs companies' ability to grow and innovate.
Note: You can watch, read or listen to the discussion below. This episode was filmed on 17 February 2021.
Ally Selby: Welcome to Buy Hold Sell brought to you by Livewire Markets. I'm Ally Selby, and today we are talking regulation and big tech, with Google already penning deals with the likes of Seven and Nine. It has the world's eyes on Australia, as the government moves to implement new legislation which could level the playing field between news and tech companies down under. But what does this mean for investors? Well, I'm joined by Vihari Ross from Magellan and Chris Demasi from Montaka Global Investments to find out.
First up, I really would like to know a little bit more about this legislation and what it could mean for investors.
Chris Demasi: Well, to tell you the truth, Ally, I think for global investors directly, it's not a big deal. Quite frankly, Australia's quite a small market for investors in Facebook and for investors in Google. But I think that the broader concern was that there'd be implications in other jurisdictions.
Ally Selby: Do you agree, Vihari?
Vihari Ross: Yes and no. I think yes, Australia is maybe at best 5% of Google's revenues. This is something that's been going on for a number of years. Ultimately, when there's been regulation around the world and if it's been reasonable and sensible from Google or Facebook's point of view, they've actually toed the line.
they say that this is unworkable for them and potentially creates a dangerous precedent for them in other parts of the world. Obviously, the rest of the world's eyes are on what Australia is doing. Is it immaterial to Google? Are they likely to simply exit news here rather than give up search or give up the revenue stream altogether? Yes, that's what I think will happen, but whether it's actually irrelevant, I think it's yet to be determined.
Ally Selby: What would happen if other countries followed Australia's lead? What do you see as the implications of this legislation spreading around the world?
Vihari Ross: Yeah. Look, I think regulation is part and parcel of tech investment, particularly on the global sphere. These guys are looking at what Australia is doing, but at the moment, the situation with Google is, whether they are actually able to remove news based content from their search? Only 1% of their search results actually are news-based content and they themselves say they only make $10 million in Australia of all their global revenues from news-based ad clicks.
So I think, is it material in and of itself? All this code potentially does is enable a negotiation between Google and between the news media. I think the interesting thing here is Google has provided a platform for not only big news companies, but also small players to get visibility and get distribution out there.
Ally Selby: Do you think, Chris, that maybe this is the windfall that publishers have needed? I mean, advertising has just been cascading down a slippery slope for many years now.
Chris Demasi: I think the news publishers need a lot more than some of these $30 million deals that have recently been cut. That's just not going to be enough to turn the tides for these businesses. They really missed the digitalization of their industry, the changing consumer behaviours and their business models have become obsolete. So, I don't think $10-$20 or $30 million here or there is actually going to change the fortunes of the news publishers here in Australia or overseas.
Ally Selby: Do you see this extending to other industries as well? Could Google eventually have to pay for links to other types of content?
Chris Demasi: I don't see it going that way. Quite frankly, I think that other industries derive a lot of value from the advertising services that Google and Facebook offer. We saw that like no other in 2020, when businesses were forced to turn to digitalize their operations, to turn to digital advertising, to really connect with consumers. And it was Facebook and Google and their advertising businesses that really, really stood up and enabled small and medium businesses to do that across so many different industries.
Ally Selby: Vihari, do you agree? Is it a case of us needing Google just as much as they need us?
Vihari Ross: Yeah. Look, I think that's why I think that negotiating point is a really important one because it enables Google to actually put forward the value that they're adding to the party, to the decision as well. I think the point that Chris raises is really relevant here. The news media are not making less money because of Google. The reason that their advertising revenues have fallen so dramatically over a number of years is largely because of this classified advertising that's moved. It's the realestate.com, the carsales.com and it's the domains. Previously that journalist income was being subsidised essentially by that advertising, classified revenue.
What Google has done has actually opened up, as Chris said, to the small and medium-sized enterprises that now have an opportunity to advertise. So they've grown that advertising market dramatically. So I think, yes, do we need Google and Facebook? In many ways, of course we do and a lot of small businesses certainly do, but at the same time, Google and Facebook are providing a service.
And the reason the eyeballs have gone there is because of a good user experience. It hasn't been forced upon us to use these platforms. And so they ultimately do want to continue in that vein. They want people to continue to use their product and find it useful to them. So I think you have seen in Europe you had GDPR legislation. They toed the line on things like that and the things that have happened in other parts of the world. Again, it's made sense for them. And the reason they're maybe digging their heels in here is because they've made their position untenable. And I think, yes, we're going to find out how it plays out in the next few weeks potentially.
Ally Selby: This isn't really unique to Australia. Both of you still hold Alibaba though. I was just wondering if this changing environment has changed your outlook on that company?
Vihari Ross: Look, I think when it comes to regulation in China, there are two key components from my point of view. The first is the pulling of the Ant IPO. The implications there are that this is a business that is ubiquitous and very relevant to the middle class in China. Does it make sense ultimately for this business to hold some incremental regulatory capital like every other financial business in the world does and potentially face a bit of extra regulatory oversight, much like a financial institution elsewhere? That seems sensible to us and highly likely to go ahead.
The other component, of course, is the antitrust legislation. I think the only difference in China of course, with the CCP, is the fact that they can make change happen and they can enforce the change in a far more fast and effective way than maybe Europe, it incrementally and in a piecemeal fashion. Ultimately, what we're dealing with here in Alibaba's case is maybe there's an incremental cost to the business around that regulatory impost, but at the same time, you have a business that's remarkably well positioned and continues to be around growth in the Chinese consumer, growth in the Cloud and then financial services, among other things as well. So this continues to be a buy from our point of view.
Ally Selby: What would have to change for you, Chris, for you to have to sell Alibaba?
Chris Demasi: Well, I think what we'd have to see is a dramatic slowdown in their core business. And Vihari was talking a little bit about that and specifically around Tmall and Taobao, which are their two giant online marketplaces and they're growing 20 to 30% per annum still. And they're tremendously valuable to the Chinese economy.
Ally Selby: So there are no fears over regulation that would make you sell?
Chris Demasi: No, I think at the moment that our lens on regulation is that both the regulators and Alibaba can come to a situation, which is really win-win. The language that came out in those guidelines from the market regulator was probably more lenient than people expected. And I think we've also heard as recently as the last Alibaba conference call, that their CEO spoke about being very cooperative, setting up internal task forces and really being willing to collaborate with the government. Both parties recognising just how important Alibaba is to the Chinese economy and Chinese society and how much money they're investing behind innovation and really advancing China's technological ambitions.
Ally Selby: There's also antitrust cases going on in Europe and the US. Is regulation a risk that active investors should really consider?
Vihari Ross: Absolutely is my short answer. Any investor in the tech space would certainly be very much familiar with regulation as a key risk. I think the key implication for a lot of these companies, certainly in the Western world, is their ability to make acquisitions has been curbed, would an Instagram/WhatsApp type acquisition be allowed going forward? I don't think so.
Ally Selby: Does it curb these companies' ability to innovate and grow then?
Vihari Ross: No, I think what it does is I think these are among the most innovative companies in the world. They've changed the way that we've lived our lives in many positive ways. And I think a lot of these investments that Google makes simply through the sheer free cashflow that this business generates is going to change our lives in the next 10 and 20 years, again, through their healthcare based initiatives, through driverless car technology, through artificial intelligence. And it's sort of the same as we discussed in the Chinese example. There is genuine interest in these businesses being successful in those ventures over time. I think they continue to be remarkably innovative, but I do think their ability to buy competitors or potential competitors is thwarted by regulation unsurprisingly now.
Ally Selby: Yeah. Do you agree, Chris?
Chris Demasi: I absolutely think as active investors you need to consider the implications of regulation, but we also need to unpack that a little bit as well. So, there are a few components to the way we think through regulation. And really our starting point when it comes to antitrust regulation is harm done to the consumer? And when there have been trillions of dollars of value created in an economy, and these platforms are just becoming so important and ubiquitous in our lives, all free of charge from Google and from Facebook, it's really hard to argue that the consumer is suffering there. So that's the starting point.
Next, you've got to think about the timeline to regulation. So in the Google case, Google's antitrust case is set for 2023, and there's a whole judgement and then possibly appeal process that's going to come after that. This leads us to believe that there's probably going to be a settlement in between. And then beyond that, you've got to really think about what are the sorts of regulatory changes and activity or actions that will take place. And we've seen time and time again when it comes to financial penalties, they're relatively small in the context of the size of these companies. But I think when you break it all down, the likelihood of there being significant change that's going to impair the enormous long-term value that's ahead for both of these companies is not going to eventuate. And there is just such substantial growth opportunities in front of them.
Ally Selby: Well, that's all we have time for today. If you've enjoyed this episode of Buy Hold Sell, why not give it a like. Remember to subscribe to our YouTube channel so you never miss an episode.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.