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Regulatory Update: Big Tech Under Fire

Regulatory pressure surrounding big technology firms in the U.S. continues to mount, raising questions about what the future may hold for the sector. Research Analyst Tom DeLong and Portfolio Manager Denny Fish offer their insights on how investors should view these issues over the long term.

Key Takeaways

  • Facebook was recently charged a record $5 billion fine by the Federal Trade Commission for privacy violations, adding fuel to the growing regulatory fire surrounding large U.S. tech companies.
  • Antitrust reviews of the tech giants are also looming, causing many to question what the future may hold for the sector.
  • In our view, strong fundamental analysis and a clear understanding of how these issues may evolve is critically important for investors striving to make good investment decisions in the technology sector.

Large technology firms remain under regulatory fire. The latest development: On July 24, Facebook agreed to pay a $5 billion settlement for charges that it violated a Federal Trade Commission (FTC) order, deceiving users about their ability to control the privacy of their personal information. It is the largest FTC fine for a privacy violation on record. In addition, the Department of Justice (DOJ) has said it plans to open an antitrust review of the tech giants to examine their power and size. Other regulators are pushing for similar reviews.

But rather than assessing these regulatory issues on a broad scale, we think it is better for investors to view each case carefully and individually.

By Definition, Antitrust a Hard Argument

In the U.S., antitrust laws assess the health of competition in markets as measured by factors such as whether prices remain low for consumers, output is being constrained in the market and innovation is healthy. However, the network effect inherent to Internet platforms (i.e., the platforms grow in value when more people use them) often drives these companies to prioritize growth over profits. This approach keeps prices low (or free) for consumers, which generally means the companies are not violating today’s antitrust laws in any significant way.

Consequently, for antitrust allegations to stick, we think the current interpretation of the law would have to change. The House could bring about this change through new legislation (which would also need to be passed by the Senate). Alternatively, the Supreme Court could eventually offer a new interpretation of current law through an FTC- or DOJ-initiated court case.

Other Ways to Regulate

In the meantime, regulators might pursue change through other avenues. For example, data could be incorporated into the definition of “price,” given that users are effectively paying for the platforms’ services with their personal data. In the U.S., new privacy protocols are expected that could expand the power of the FTC by enabling it to issue regulations related to data privacy.

Even then, we believe regulatory scrutiny is likely to result in only modest changes to tech firms’ business models. In our opinion, the bigger issues that companies will have to grapple with are regulatory noise and, potentially, a diminished ability to compete aggressively. For example, the House’s more public investigation could result in negative headlines that make business partners wary of working with the platforms. Fear of criticism and increased regulatory scrutiny could lead big tech companies to take a more conservative approach to growth than they would have otherwise. And future acquisitions could be closely watched, making it more difficult for large-cap tech to acquire the innovative startups and talent that typically help propel growth.

From a stock perspective, the threat of regulation could weigh on multiples and potentially widen the range of outcomes as a result of incremental change to company fundamentals. For example:

  • Google’s vertical search, the bundling of apps with Android, network advertising and the Google Play store could all be subject to heightened scrutiny.
  • Regulators could object to Amazon using data from third-party marketplace sales to inform first-party retail and private label businesses. Amazon’s strategy of leveraging its dominance in retail to extend its dominance in other industries – such as logistics – and its bundling of products in Prime in a potentially predatory pricing manner could also be contested.
  • Globally, Facebook has been unable to adequately moderate content at scale, increasing the risk that major geographies shut off access to the service, as some areas have already threatened.
  • Apple could face scrutiny for App store practices, such as take rates and the limiting of innovation and user choice for competitor products (think Spotify vs. Apple Music).

The bottom line is that, in the U.S., we think the likelihood of today’s large Internet platforms being broken up or heavily regulated is low because of the wide gap between the current political outcry and the legal definition of antitrust. That said, we think incremental change is likely – with varying impacts on companies – making it important to consider big tech firms individually. Microsoft, for example, seems somewhat insulated after having dealt with antitrust suits in the early to mid-2000s. Its current business model is also less susceptible to regulatory scrutiny.

In our view, strong fundamental analysis and a clear understanding of how these issues may evolve is critically important for investors striving to make good investment decisions in the technology sector.

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