226. Elon Musk and the potential demise of Twitter

TRANSCRIPT: EPISODE 226
Published 30 November 2022 (pre-recorded 21 November 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

Juliet Schooling Latter (JSL):
Hello and welcome to the Investing on the Go podcast. I’m Juliet Schooling Latter, and today I’m joined by Jeremy Gleeson, manager of AXA Framlington Global Technology. Hi Jeremy.

Jeremy Gleeson (JG):
Hi. Good morning, Juliet.

(JSL):
The technology sector has had a difficult year. Can you explain why this is please?

(JG):
[00:27] Yes, absolutely. It’s actually had a very difficult year. At the time of speaking, the tech sector is down around about 27% in US dollar terms year-to-date, and that’s about 10% worse than the broader equity market.

Multiple factors have contributed to this, this year. Firstly, from a macro perspective, there is the expectation that the global economy is in, or going into a recession, and that is being factored into the price of equities. And equities have not been performing well in the face of that significant concern, especially with regards to the growth outlook.

Secondly, the geopolitical situation took a significant turn for the worse earlier this year, when Russia invaded Ukraine. And then layering that on top of the relationship situation between the Chinese and the US, there’s definitely been an encouragement for a sort of a ‘Risk Off’ mindset amongst investors this year.

And then drilling into the technology sector in particular; during 2020 and 2021, spending for tech saw quite a significant uptick as a result of many of the sort of trends that took place as a result of covid. So, work from home, school from home, e-commerce and home consumption of media entertainment, were all positive for the technology sector.

And growth for a period of time was, you know, above normal trend lines. In some ways, we saw … we experienced some super growth for aspects of the technology sector. And then, now growth comparisons are just looking more difficult, and especially as you drive into this headwind of the economic slowdown, it is creating some very challenging growth numbers for some of the companies involved in the technology sector.  And that’s also being reflected in the valuations that we see right now.

But it is interesting to note actually, if you look over the last decade, prior to 2022, tech had actually outperformed the broader equity market in the nine previous years. And, on average, over those nine previous years, the outperformance is around about 10% per year. So, with tech trailing the broader equity market year to date, by about 10%, we’re kind of giving up approximately one year’s worth of those gains made over the previous nine years. But, you know, when we’re talking about a down year, which is, you know, 27%, almost 30%, that sort of relative number feels, you know, … it kind of pales into comparison with that sort of immediate down 27% that we’re feeling this year.

Yes. So, rather a gloomy picture, but how are the companies actually doing? Have earnings been as expected or are they suffering too? We’ve heard about Facebook recently, and redundancies, is this a
common thread?

(JG):
[03:45] Yeah, no, that’s a good question because that’s actually something we spend a lot of time doing which is drilling into the actual fundamentals of what the companies are actually delivering in terms of results. And, you know, I would say it’;s a mixed bag. It’s not by any means perfect, but it’s not all doom and gloom, unlike the performance of the stock market kind of suggests. If you look at the most recent set of results, companies have been reporting their third quarter results.

In terms of upside surprises, tech has performed broadly in line with the broader equity market; about 65% of companies in the technology sector have reported better than expected revenues, and 64% of reported better than expected earnings. And actually, for our fund, whilst it’s about the same on revenue upside, 89% of our investments have actually reported better than expected earnings. So, we feel that the fundamentals of these businesses has certainly not completely unraveled, you know, they’re still fairly intact, but there have been, especially in this last quarter, some very high profile disappointments.

So, you mentioned Facebook, but also Alphabet, which is the holding company behind Google, Amazon, and even Microsoft, [all] reported some disappointing or had some disappointing commentary around their results this most recent period. So, I think that sort of certainly created some awareness that not all is good and rosy for these technology companies right now.

For Facebook in particular, their business model is firmly based around the advertising world; that’s the vast majority of their revenues comes from companies who want to advertise on Facebook or Instagram and pay Facebook for that privilege. And advertising spending is a discretionary level of spending and it’s something that can get hit very sharply during an economic downturn.

And it can certainly get hit very sharply when there is [a] significant event like that of Russia invading the Ukraine, where brands don’t want to potentially risk associating their products, their brands, alongside some of the terrible news stories that we’ve seen come across media during this year. So, you know, Facebook is sort of frontline and centre of receiving, or being impacted by that downturn in advertising spending.

And, more recently, the company went from indicating that they wanted to continue to invest to help them drive growth, which they’ve been doing very successfully over the years since they came public, to making quite an abrupt U-turn, with regards to acknowledging the slow-down and acknowledging that they might have to pare back some of the spending and also make some layoffs, in order to sort of to ‘right size’ their business for the current economic environment.

So, we’d actually taken the opportunity to reduce our investment in the company at the beginning of the year, largely because of those, sort of, economic and geopolitical headwinds that the company was facing. So, our weighting in the fund is much lower than it historically has been, but with hindsight, you know, we should have sold that entire position back then. But we don’t think their business model is broken. You know, they’ve got a significant number of users, engaged users, across their three main platforms, which are Facebook, Instagram, and WhatsApp. We don’t think those are broken, we don’t think they’re unraveling. We do think at some point advertisers will come back to this platform, but clearly, they are going to be facing some challenging times in the near term.

Yeah. And on social media, Elon Musk has obviously just bought Twitter. Do you have any views on social media, as an investment over the long term?

(JG):

[07:47] Yeah, it is interesting actually because I would argue that at least in the western world, Facebook, or Meta Platforms as they are now known, has been the only real success in social media.

There’s quite a graveyard of broken social media companies out there and it’s starting to look like Twitter might be added to that list now. So, I think it’s a challenging area for investors, for sure.

I think it’s something that, you know, I think it fits well within a diversified portfolio, but to try to identify just one social media company that you want to back as a long-term winner is quite a difficult proposition, given how many social media companies have failed.

We’ve never owned Twitter in the portfolio. We’ve always been … we’ve met with the management team and company many times, particularly on my trips to San Francisco – their headquarters are in San Francisco – but there’s been issues with the company model, which I’ve just never felt comfortable with.

And some of them have been … sort of come to light actually during this whole process when Elon Musk’s been trying to buy the company; fake accounts, users with multiple accounts, obviously the background, some of the unsavory [and] unnecessary types of usage of Twitter, the types of posts that you get on the platform, they’ve never sat right with us, and we’ve never had a high enough conviction in the company to want to actually own stock.

Whereas Meta, for example, we’ve held for quite some time, and actually one of the things I’m looking at right now is, whether, if Twitter does decline further, if it does, you know, demise completely, is whether that’s actually beneficial for a company like Facebook.

One of the things that Twitter has actually done very well is create a bridge between social media and companies being able to engage directly – direct messaging – with some of their customers. And if you look at the other social media companies, the one that does actually have solutions for both of those is Meta Platforms, which is, you know, their Facebook and Instagram social media sites along with their WhatsApp messaging platform. So, perhaps that’s an element of traffic, an aspect of business, which could actually move away from Twitter, and towards Facebook or Meta Platforms over time.

Right. And you mentioned reducing your holding in Facebook, but I just wondered, have you made any other recent changes, perhaps taken profits or picked up some bargains when valuations have fallen?

(JG):
[10:45] Sure, yeah. So, I mean we take a pretty long-term view of our investments. When we’re making a new investment, we’re looking at a three-to-five-year opportunity. So, our turnover is typically relatively low; it’s typically less than 20%.

So, changes haven’t been dramatic in recent times, but we have constantly been looking at the portfolio and looking at the companies that we invest in and just making sure that the long-term thesis behind our investments are still intact, and where they aren’t intact, we’ve taken some money off the table or reduced those or sold those positions entirely.

So, we’ve trimmed some of our positions in semiconductors because we’re mindful of the economic sensitivity of that group of companies. But at the same time, we’ve also identified new opportunities in semiconductors as well. So, over the summer, we built up a position in the German semiconductor company, Infineon [Infineon Technologies AG]. Infineon has a very strong involvement with both the automotive and the industrial sectors and both those markets, those end markets for semiconductors, still remains pretty strong. And Infineon was trading at very attractive valuations, based upon both its historical valuation and also its valuation versus its peers. So, we felt it was a good time to start building up a position in Infineon over the summer.

And then we’ve also been making some changes around our cybersecurity investments. So, once again, reassessing some of the companies that we have owned, deciding whether we wanted to own them for the long term or not, and maybe buying some new cybersecurity names because that’s an area of spending, which seems to be somewhat resilient right now, so we added Cyber Ark and Splunk to the portfolio, while selling our positions in Okta and Rapid7.

Right. And most of the portfolio’s invested in US companies, but I notice you have more in emerging markets than in the UK, Europe and developed Asia put together. What opportunities have you found there?

(JG):
[12:48] Yes, so yeah, that’s a good observation. So, I mean the US aspect probably isn’t a surprise. US technology companies have just done such a great job of commercialising the opportunities within the technology sector on a global basis. So, that explains our heavy weight in the US. [With] regards to Asia, it’s typically emerging markets… it’s actually just two companies which makes up the bulk of that exposure, it’s Taiwan semi [ Taiwan Semiconductor] and Samsung. So, Taiwan Semi from Taiwan and Samsung from Korea. You know, they, they might sit within the emerging markets component of our portfolio, but these two companies are not emerging companies. They are global powerhouses in their own rights.

One of the things that we like when we are looking at technology companies are companies that exhibit global strength. And both these companies have been able to do that. They’re both leaders in their own rights, hence they make up a big portion of the outside of the US component of the overall fund.

In terms of developed Asia, and that’s largely dominated by Japan, we just haven’t had any Japanese exposure for quite some time. We have this sort of bottom-up thematic approach to investing, and, in Japan, you have a lot of conglomerates, companies who do many, many things, have many lines of business and it’s really hard to find those sort of pure plays who are really successful in some of the growing areas of tech, without those same companies having a lot of sort of legacy baggage, which is no longer growing, might not be profitable or not be as profitable, and just are sort of less attractive areas of technology. So, we have had very little, in fact, no exposure to Japan for quite some time.

And then in Europe, it’s just been a longstanding issue about identifying, once again, great global businesses, but also the ones that have an attractive valuation. So, the problem in Europe is that when a great business appears or is well understood, it goes on to get a very, very high valuation, which makes it somewhat unattractive to us from our investment proposition.

It’s that sort of scarcity effect that takes place in Europe. There are so few great global technology companies in Europe, that when the market identifies one, it gets priced very, very attractive[ly], [at] very, very high levels and that makes it less attractive to us.

So, we do continue to look and, like I said, we bought Infineon recently, it was trading at a very attractive valuation. We have a position in a company called Dark Trace here in the UK, which is a cybersecurity company, which once again trades on a very attractive valuation versus its global peers.

But many of the great European tech businesses are very expensive in our view, so we’d rather own some of their US counterparts, which are trading at lower valuations.

Right. And, and thinking about the next six to 12 months or so, how do you think technology companies will do, as we go into recession? Are there any subsections that are better positioned than others?

(JG):
[16:05] Yes, so that’s certainly a question that we’re constantly asking ourselves and reviewing constantly at the moment, and actually, you know, maybe just looking back on a little bit of history might help here.

If you look at the last recession, which was the global financial crisis in 2008-2009, tech was a horrible place to be, was a horrible place to be to begin with, and then [it] put on a really strong recovery and really didn’t look back from 2009 onwards – and I’ve already talked about the performance of the technology sector versus the broader equity market, over the nine years prior to 2022.

So, this year we’ve been feeling a lot of pain, companies in the sector have started to adjust their businesses for a downturn. Valuations have contracted quite sharply in the space. So, whilst it’s hard to predict how markets will treat equities, growth equities, or the technology sector precisely in 2023, I feel that a lot of the pain has already been felt in the same way that a lot of the pain got felt very early during that 2008-2009 global financial crisis within the technology sector.

So then, if you take a step back and look at the future and the opportunities and the fundamentals of the businesses within the sector, we think tech will play an increasing role in our lives, both personal and work-related.

We think that many of the trends and themes that are in play right now, are still just in their infancy and will continue to proliferate and create opportunity for the next decade or so. So, we think that the long-term picture for technology is good but clearly, we have to go through this period of digestion and resetting of expectations and reinstalling confidence in the equity market as well. So, if you look very near term, we think things like cybersecurity and aspects of the semiconductor industry should fare better.

We also think that some of the subscription models that many software companies have taken on board over the last several years, should also have aspects of resilience in the downturn, because these companies are not dependent on new license sales, but are more dependent on existing customers continuing to use their products. And with software now firmly embedded and engrained in many businesses around the world, it’d be very hard for those companies just to switch off the use of that software, without damaging their actual own businesses. So, those are the areas that we think should be a little bit more resilient in the near term, but longer term we think that the opportunities are still very much intact for the broader technology sector.

Good, good. And finally, I always have to ask, what is your favorite gadget at the moment?

(JG):
[19:06] <laughs>Yeah, so I guess it’s that time of year, the holiday season upon us!

So firstly, my kids have told me that I’m not allowed anymore golf gadgets because they don’t seem to be having any impact on improving my golf at all. So, I have to look elsewhere to answer this question.

So, one of the things I’ve noticed is that, for people who like music, there are some really impressive portable speakers on the market now. So, once upon a time, portable speakers were sort of fairly poor quality in their sound, simply because of the size of the unit and the fact that they used to run off batteries. And, you know, that’s no longer the case; changes in technology, improvements in semiconductors, changes in battery technology have meant some of these products are actually very, very impressive in terms of their sound quality. So certainly, nice ideas for Christmas presents.

And if you want to extend that a little bit further, there are some interesting things like Bluetooth-connected record players that you can buy. So, if you want to dig out the old vinyl collection and actually, you know, rather than collecting dust in the corner like mine have been for many years, you can get one of these relatively portable record players, connect them to one of these Bluetooth speakers, and actually get to enjoy some of your old vinyl classics, which is something I’m hoping to do over the next few months.

Great. Well, that’s given me some ideas to add to my Christmas list. Jeremy, thank you so much for your time today. If you’d like more information about AXA Framlington Global Technology, please visit fundcalibre.com. And don’t forget to subscribe to the Investing on the Go podcast.

OUTRO
Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s team only.