June 07, 2019

Regulatory Day of Reckoning for Tech?

Several of the largest Technology / Communication Services stocks have sold off sharply recently on the report that the Department of
Justice (DoJ) is planning to launch an antitrust probe into Alphabet’s Google (GOOGL / GOOG). The move is part of a broader investigation of the IT industry which has drawn heavy criticism from the news media and politicians on both sides of the aisle (for different reasons). 

Amazon.com (AMZN), Facebook (FB) and Apple (AAPL) are also expected to face increased scrutiny based on their dominant global platforms. In fact, the Washington Post reported that multiple regulatory agencies with antitrust authority are getting involved with the DoJ focusing on Google and Apple and the Federal Trade Commission (FTC) taking aim at Amazon.com and Facebook. Netflix (NFLX) looks like the only one of the five “FAANG” stocks that has been given a pass for now.

The initial stock price reactions to the news seemed a little extreme given the fact that these types of antitrust inquiries                       can drag on for many years with the ultimate resolution typically unclear. On a percentage basis, FB was down the most (-7.5%) followed by GOOGL (-6.1%), AMZN (-4.6%) and AAPL (-1.0%). The combined market value lost by these four Tech Titans was $134 billion, or ~60 bps of market capitalization for the overall S&P 500. 

It’s ironic that these companies are under attack at a time when the Tech sector (more than most others) has been buffeted by the deteriorating U.S.-China trade relationship. While Apple has significant exposure to China, the other FAANG stocks are more insulated from that market, and have been relative safe havens until recently. 

Though the Republicans and Democrats can’t agree on much these days, it seems they both feel that Silicon Valley has accumulated too much power and is using it unfairly. However, it appears that the Democrats are mainly concerned about concentration of economic power (i.e. the companies make too much money and don’t pay enough taxes); while President Trump and the Republicans are focusing more on the political power of the big Tech platforms (i.e. favoring liberal points of view and silencing conservatives). The big risk is that once an investigation gets underway, neither party will do much to stop it.

Tech stock performance March - May 2019

While there will be no shortage of headline risk, including every time the executives from these companies are forced to testify in front of congressional committees, it’s not at all clear (and we would argue unlikely) that the end result of these inquiries (assuming they move forward) will cause the companies to be seriously constrained or broken up. Some potentially large fines along with relatively minor tweaks to their business models seems much more likely based on historical precedents (recall the Microsoft antitrust battle in the 1990s).

It’s also not clear how much influence President Trump will have in this process. His antipathy for Amazon’s CEO Jeff Bezos (who personally owns the Washington Post) is well known. He has complained that Amazon hurts small retailers (many in “Trump Country”) and doesn’t pay enough in taxes. He’s also taken some swipes at Google. Last fall, the President tweeted that Google rigged its search results and only showed negative news reports about him. Google has denied the charges, but a White House spokesman said the administration is considering the possibility of government regulation. While he spoke out against AT&T’s acquisition of Time Warner (the parent of CNN), his DoJ appointee Makan Delrahim, led the government’s case and was unsuccessful in overturning the deal. 

At least one of the Democratic 2020 presidential candidates (Elizabeth Warren) has been calling for the Tech giants to be broken up, but the odds of her winning the nomination appear to be low at this point.

To summarize, the major regulatory risks facing the Internet giants risks fall into three buckets:

1. Data Privacy – This is the main issue that had Facebook, Google and Twitter on the hot seat last year. In March 2018, Congress raked Facebook CEO Mark Zuckerberg over the coals for allowing user data to be inappropriately accessed by Cambridge Analytica, a UK-based political consulting firm; and last fall, European regulators passed the Global Data Protection Regulation (GDPR) which required companies to make it easier for users to opt out of data collection. While the impact to their online advertising businesses has been limited so far, FB is expected to pay $3 - $5 billion to the U.S. government for violating terms of a 2011 consent decree with the FTC concerning data privacy.

2. Abuse of Market Power – Google seems most at risk here. Over the past several years, Google has been hit by the European Union (EU) with three separate fines totaling EUR 8.2 billion for allegedly manipulating shopping results and abusing its dominant position in mobile search and online advertising. GOOGL has modified some business practices and is appealing the decisions but it isn’t out of the woods yet. While U.S. antitrust laws differ in some respects from those in Europe (focusing more on the impact to consumers), the DoJ could follow a similar playbook in going after Google. However, the FTC already investigated certain aspects of its search business in 2011 – 2013 and let the company off the hook. An argument can be made that the other Tech giants have abused their market power in e-commerce (Amazon), cloud computing (Amazon), social media (Facebook) and online application stores (Apple). However, each of those cases is less obvious.

3. Underpaying Taxes – The Tech giants have been accused of paying too little in taxes, especially in international jurisdictions where they may generate substantial revenues but don’t have much of a physical presence. The EU attempted to pass a 3% Digital Turnover Tax last year but the effort failed mainly due to opposition from Ireland, which benefits from its favorable tax environment, and several Nordic countries, which have been popular locations for cloud data centers. The latest idea which the G-20 (or Group of Twenty) countries are considering would allocate taxes based on a different set of criteria (e.g. where Facebook’s users are located). While higher tax rates are clearly a long-term risk for these companies, it will be hard getting everyone to agree on a (very complicated) new set of rules.

The bottom line is that regulatory risks are mounting for the big Tech companies, but the issues are extremely complicated and nothing happens quickly in Washington, DC (or Brussels). Therefore, it’s far more important to stay focused on company fundamentals for now.

 

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