Lex Midweek Letter: Big Tech’s unstoppable earnings machine

Dear readers,

The first three months of 2021 are proof that the US tech industry can have it both ways. Pandemic-forced shutdowns may have been a gift to the sector but so is post-pandemic recovery. Ecommerce, online advertising, device sales and cloud computing are all on the rise. Companies are flush with cash. Only regulators can spoil this party. 

Quarterly results have offered an early glimpse of how tech companies might fare once vaccine programmes have fully rolled out and economies have reopened. Pretty well, it seems. Online shopping habits have become ingrained and the shift out of offices means that digital working tools are still required. Sales of the PCs, smartphones and tablets that facilitate life online are up. Research company IDC estimates that tablet shipments rose 55 per cent in the first quarter — the most since 2013. 

Everywhere you look, investors are flinging cheap money around. A gloomy prognosis that the pandemic might cut funding to early-stage tech companies turned out to be spectacularly wrong. US start-up investment doubled to $73bn in the first quarter of this year, according to Crunchbase. The number of initial public offerings has reached a record. Special purpose acquisition companies are so intent on finding targets that it is no longer uncommon for companies without sales to plan flotations.

The real stars of the show are still big tech companies. Humiliating appearances before the US Congress and increased surveillance by regulators have not diminished consumer appetite for their products and services. Growth in the last quarter eclipsed already high expectations. At Microsoft, revenues rose 19 per cent. Alphabet’s sales grew 34 per cent, Facebook’s 48 per cent, Amazon’s 44 per cent and Apple’s 54 per cent. Costs fell and profits rose. Amazon’s net income was $8.1bn, up from $2.5bn the previous year. Microsoft profits rose 44 per cent. Facebook’s average price per ad jumped 30 per cent. 

The pace of growth from some of the biggest companies in the world is astonishing. Between them, these five companies now account for a quarter of the S&P 500. Alphabet, the laggard stock of 2020 thanks to an advertising freeze, has outperformed its peers this year with shares up 36 per cent already.

Is this blowout quarter a one-off or the start of a new reality? Naysayers will point to streaming service Netflix, where subscriptions are slowing down. But venture capital firms and big tech companies are still swimming in cash. Alphabet’s net cash position, to take just one, is more than $121bn. Revenue growth in the first quarter of 2022 may not match the past three months but profit growth might. 

Mergers and acquisitions make pandemic-driven outperformance by Big Tech look sustainable. Not only are the main businesses of companies such as Apple doing well, but so are their multiple side ventures. Apple’s 2014 purchase of Beats Electronics fed into Apple Music and the high margin Services segment of the company. Amazon’s $13.7bn acquisition of Whole Foods Market in 2017 marked its move into physical retail as well as online sales. Facebook has still not begun to monetise WhatsApp — the messaging service it bought for $19bn in 2014. Microsoft’s recent $20bn bet on artificial intelligence via Nuance Communications, like Google’s 2014 purchase of DeepMind, is designed to ensure it has the right talent to compete in the future of computing.

Of course, regulators are primed to fret about exactly these sorts of large-scale acquisitions. Europe has already imposed big fines and proposed a Digital Services Act along with new checks on artificial intelligence.

In the US, President Joe Biden’s decision to nominate Lina Khan to the Federal Trade Commission is a signal of tougher oversight to come. Khan is famous for publishing a paper called the “Amazon Antitrust Paradox”, which criticised the way in which the traditional understanding of monopolistic behaviour, judged on rising consumer prices, could not be applied to the tech industry.

There is a growing consensus that tech is so important that, like banking, the government should supervise it more closely. It is unclear what that supervision would look like. In the meantime, Big Tech will keep on vacuuming up competitors, consolidating its position and reporting outsized earnings. 

Enjoy the rest of your week.

Elaine Moore
Deputy Head of Lex