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The FAANG stocks are Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Google/Alphabet (GOOG) (NASDAQ:GOOGL). They include three of the four largest companies by market cap in the world. With the exception of Netflix, all are massive operations in numerous cutting edge businesses on a worldwide scale. The FAANG stocks have become the new blue chip stocks, replacing the likes of GE, IBM and Coca cola. That makes them defensive and growth stocks at the same time which adds to their value.
Last week there was the following headline in Seeking Alpha "Big tech has a big problem in D.C.". The opening line was "Wedbush's Dan Ives warns that an anti-trust storm cloud is building in the Beltway that may be more than just talk."
In recent years there have been periodic calls for the breakup of our largest tech companies from members of both political parties. Some arose from leftist candidates in the Democrat primary. The Wall Street Journal on May 21, 2020 reported that the Republican controlled DOJ and several State Attorney Generals are preparing an anti-trust lawsuit against Google. The lawsuit would focus on Google's online advertising business.
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Criticisms of the FAANGs
There are numerous criticisms of the FAANGs. This is due to their massive scale and their cutting edge innovations. When new technologies come along, they both disrupt older ones and create new issues not dealt with before. Some of the criticisms are coming from the disrupted. But the bigger issue is how do you deal with the side effects from new products and services that for the most part significantly improved our world. The larger criticisms of each of the FAANGs are summarized below.
Alphabet (Google) - Major criticisms include anti-trust, privacy, spying through Google Earth, censorship, and tax avoidance schemes. Anti-trust is due to Google's near monopoly on internet search in the Western world. Censorship is needed to some degree to stop fake news and hate speech. Tax avoidance is a real issue. That will likely require an international agreement to address. Much of the criticisms are due to Google's breadth, it is in more businesses than most. Everything they do impacts someone and often hundreds of millions. Part of why Google is target is the same reason unions go after Walmart and Amazon, due to its size. Bigger means a bigger target. More details of criticisms of Google can be found here.
Facebook - Major criticisms include tax avoidance, privacy, censorship, hate speech, and fake news. In the case of hate speech and fake news, they can't win, because stopping those brings calls of censorship. However, our society demands some censorship for those two items. More details of criticisms of Facebook can be found here.
Apple- Major criticisms of Apple include anti-competitive behavior, tax avoidance, and environmental issues such as e-trash. Anti-competitive behavior includes the price and location of apps on their app store. More details of criticisms of Apple can be found here.
Amazon - Major criticisms of Amazon include dumping, copying popular products by third parties on their website, workplace safety, paying a living wage and tax avoidance. Unions have targeted Amazon due to their size, lower wages, and workplace safety. Amazon has countered by making improvements in wages and safety but also firing union agitators. Amazon clearly sells its own retail goods at a loss. They make up for that with profitable third party sales and advertising. The result is a large amount of bankruptcies of other retailers in recent years. More details of criticisms of Amazon can be found here.
Netflix - Netflix has few major criticisms compared to the others. This is due in part to being much smaller, and only in two primary but related businesses. More details of criticisms of Netflix can be found here.
Reasons Given For a Breakup
The concerns about the FAANG companies leading to breakup talk are discussed below
Too big - The concern is too much influence in the hands of too few. For some reason, in this country we don't like big. Whether its big government, wealthy people or big corporations. It probably has something to with our rugged individualism, but envy and fear plays a role too. I would agree that big government is an issue. Large corporations are often criticized for profiteering and damage to the environment. However, a strong case can be made that large corporations are the backbone of our economy and our society. Not only do they directly and indirectly provide the most good paying jobs, they are very innovative and are increasingly leading us in positive social change too. Keep in mind, all five of the FAANG companies got as big as they are through incredible innovation and strong management. All literally invented or vastly improved their largest businesses. There will be more discussion about the benefits of large corporations in the next section.
Anti-trust limits to competition - Wasn't anti-trust to avoid price gouging? The Google and Facebook functions being criticized are free. There are legitimate concerns about all five crushing competition by tilting the playing field. They often require bundling or moving competitor's listings or apps lower in the page. This is better addressed firstly by pointing it out and asking for a change, and legislating change if needed. In the majority of cases the corrections are being made after the issues became public.
Issues with privacy - These companies are using our personal information for profit. This specifically regards Google, Facebook and Amazon. Again, Google and Facebook provide their valuable primary services for free. They need to get paid somehow. For the most part, the information is used to better target marketing. That benefits consumers by spending less time searching and making them aware of products and services they are more interested in. What is more, Google, Facebook and Amazon allow you to opt out of their analytics used for targeted ads. Here is Google's.
Fake news - Fake news was so prevalent at one point that many believe it tipped the last American presidential election. Google and Facebook are spending billions addressing this. They can do it internally much more efficiently than government. It has become such a large function for them that there was a recent news story of burnout by their moderators.
Hate speech and pedophiles - This primarily impacts Google and Facebook. The discussion above regarding fake news also applies here. But there is another consideration too. If they crack down too hard then there are censorship criticisms. No matter what they do they will be criticized. I believe both are now doing a good job walking the tightrope here.
Price gouging - Amazon has from inception run its retail segment at a loss to gain market share. It's still doing so. Amazon makes up for it with profits from AWS, third party sales and advertising. Is that fair to other retailers? Certainly, many retailers have gone under because of this. But things are starting to change. Wayfair and Carvana are now doing the same at scale. One advantage, the lack of sales taxes, has gone away.
High app store fee - Both Apple and Google charge app providers a 30% cut for customers to download through their app store. This is clearly a duopoly though there are still direct downloads. Another issue here is favoring their own services in the app store. That needs to be addressed when it happens.
Algorithms can make or break an online business - Google, Facebook, Apple and Amazon all use algorithms to determine where your websites, ads, apps, and articles, appear on the page. For the most part these are based on popularity or spending. They periodically change the algos to stay current, reduce hate speech, fake news and the like. As long as they don't change it to help their own businesses what they do is understandable and often necessary. There will always be winners and losers.
Why We Shouldn't Break Up the FAANGs
Let's talk first about large corporations. American large corporations are way out front of the rest of the world. America has 4.3% of the world's population but its corporations are close to 50% of the total world market cap. They account for well over 50% of the inventions, innovation and advances worldwide. Facebook, Apple, Amazon and Google in particular have invented or vastly improved whole industries that many of us cannot live without.
American large and mid-sized corporations lead the world in innovation, return on investment and profit margins. They also provide some of the best paying most rewarding jobs in the world. There are many reasons for this. There is a corporate culture in the U.S. unmatched anywhere else in its productivity and depth. It starts with a belief in the most powerful factor in economics…the profit incentive. We pay our executives more and in return we get more qualified executives who work harder. Many like Elon Musk and Indra Nooyi immigrated here because of the opportunity. They work longer hours and develop strong communication skills. Our universities teach them problem solving which they apply to the situations they face.
Corporations have also become a force for common good. Most now have strong policies for inclusion non-harassment and diversity. This is not just about doing the right thing. Diversity benefits corporations by providing a larger universe of qualified workers, more diverse input, and lines companies up better with customers. The workplace in large and mid-sized corporations is much less prone to harassment than people get elsewhere. This is due to policies put in place the last 30 years at almost all such companies. We can argue that a lot of this was in response to laws and lawsuits, but that is beside the point. I worked in corporate America, and it is mostly an environment of mutual respect. Corporations are also increasingly embracing limiting their carbon footprint despite contrary movements from Washington DC.
Our large corporations are strong, deep in executive talent, innovative and motivated to the point that it will be hard for our governments to mess it up. Policies such as breaking up large companies, limiting immigration, heavy regulation, excessive litigation, and high taxes all can do damage. But they are nowhere near causing irreparable damage.
Regarding the FAANG companies specifically, these are our National champions. No country in the world has anything like them is size, scale, capital, innovation and reach. They are worldwide leaders in almost everything they do.
All five of them are trading close to their one year highs. They have almost single-handedly held up the U.S. stock market. They are the primary reason our stock market has outperformed the rest of the world this year and the last five years. Others, especially the Europeans and Chinese have increasingly become envious. Breaking them up means weakening them. That weakens the U.S.
How Would You Even Do It?
So, you still want to break them up? How would you even go about it in such a way that achieves the goal of changing their behavior?
Let's look at Facebook first. It is not really possible to break up a website. They are not like AT&T or Standard Oil where it could be broken up regionally. All that could be done is to spin-off smaller pieces such as Instagram.
Apple's largest product with well over half their sales is mobile devices. It does not have a monopoly or even a duopoly in that segment. Their largest product is smart phones of which they have about a 50% market share in the U.S. and 20% worldwide. It is important for the U.S. that it maintains its worldwide market share so weakening Apple doesn't make sense. The only break up worth considering is spinning off smaller parts such as the app store, music streaming and buying, Apple Pay etc. But what would that accomplish?
Amazon is primarily two businesses with several much smaller businesses thrown in. The largest is their retail business which includes the profitable third party sales and advertising portions. Those three parts are very synergistic so breaking up that segment would hurt Amazon and Amazon shareholders significantly. The other segment is Amazon Web Services (AWS) which is clearly one business. It is the market leader but has strong competition from Microsoft and also serious competition from IBM, Google and Alibaba. AWS is not a monopoly or a duopoly.
Netflix is one business, TV streaming with some TV production thrown in. It is the market leader but faces increasing competition from Amazon, Hulu, Disney, Pluto and many more. It is far from a monopoly and there is nothing to split up.
Google is essentially a monopoly in the U.S. and western world with its search business. But that service is given away free. The reason given to break up monopolies in the past was price gouging which is not happening. Like Facebook, you really can't break up a website. You could spin-off YouTube, Waymo, or other bets. But how does that help?
Course of Action
Google, Facebook and Amazon have become ubiquitous. They have become a part of most of our lives. They did this by offering services that are clearly superior to their competition. Apple is close to being ubiquitous but has only a 50% market share in its best selling product, their phone. Netflix also has a high market share but will increasingly share that with competitors.
Breaking up any of the FAANG companies does not make economic or consumer sense as it does not address or solve the concerns that have arisen. All it does is weaken some of the strongest, best job providing, most economically important companies in the U.S. Their economic importance is shown by them being responsible for a large portion of the U.S. stock market move over the last five years. In fact, they are responsible for most of the outperformance of the U.S. stock market over that time.
However, there are issues that should be addressed.
Privacy, fake news, hate speech, censorship and how algorithms are programmed are legitimate concerns. They need to be monitored and periodically investigated. If appropriate changes are not made than regulations and fines should be considered. These companies are so large that little things they do can have a big impact on our society or other businesses.
Amazon has a long history of pricing its inventory below cost to gain market share. This has caused more job losses than gains. The jobs gained are primarily lower paying ones. Meanwhile, the other FAANG companies are creating huge amounts of good paying jobs. Amazon purposely does not breakout the earnings of their own retail sales. But seeing how profitable a third party seller such as eBay can be and knowing that their ad revenue is mostly pure profit, it is clear they are selling their own inventory at a loss. It may be time to push them toward profitability of their sales.
Tax avoidance is a legitimate problem. All of the FAANG companies have been paying well below the statutory rates for years. They are all worldwide in scale and routinely claim to have large segments of their business domiciled in the lowest tax rate countries. There needs to be a standard for taxing multi-national companies so that taxes paid are equivalent to earnings from the countries they came from. Eventually this will result in higher tax rates for the FAANG companies.
For shareholders, take comfort that a break up is unlikely. If it were to happen, a spin-off of a segment such as Waymo, Instagram, AWS or YouTube may even add value. The bigger issue is potential higher tax rates, and increased costs to monitor privacy, fake news, and hate speech and the impact of algorithm changes. These issues impact Google and Facebook the most by far. The next most vulnerable are Amazon and Apple. Netflix has the least to worry about. I expect Google and Facebook to face increasing international regulatory headwinds which will be large enough to slow earnings growth in their primary businesses. Fines, restrictions and high internal monitoring costs are the new normal.
The FAANG stocks are all trading above where they started the year and are holding up the stock market. Meanwhile, earnings estimates have dropped significantly for Alphabet, Facebook, Amazon and Apple. That has stretched their high PE ratios even higher. I attribute the high stock prices to the FAANG companies being the new blue chips, thus considered defensive. Except for Netflix all have rock solid balance sheets. You also get significant long term growth and large moats around them. I believe the headwinds discussed in this article are manageable but based on valuation, the upside may be limited in the near term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Source : https://seekingalpha.com/article/4350041-whether-should-break-up-faang-companies