Carmignac: Axelle Pinon on big tech

February 16, 2023

Please find below a comment by Axelle Pinon, member of the Investment Comity and Equity Product Specialist at Carmignac, on big tech.

Over the last decade, big tech stocks were the best way for investors to capture superior growth versus the rest of the market in a global environment where growth was scarce. The reality now seems quite different. This quarter, Apple reported disappointing quarterly results that ended a three-year run of sales and profit records, Meta top line fell 4% and Microsoft managed a 2% sales rise, but a 19% drop in its PC segment.

Big tech are sensitive to the cycle

The first reason behind these weak earnings reports is that IT spendings are decelerating. After accelerating their digital transition during the pandemic, companies are now optimizing their cost structure because of the weakening macro backdrop which is hurting the cloud market.

The issue is that Amazon, Microsoft and even Google are heavily dependent on the cloud. Although Amazon Web Services generates less than one-sixth of Amazon’s revenue, the company wouldn’t be profitable without its cloud division. And for the first time in the history of the industry, there are signs that the amount of business migrating to the cloud is slowing.

The second reason is that the consumer is also decelerating: Apple warned that its products (Mac and iPad) would be hit by lower demand in the coming months. Finally, Alphabet’s advertising revenue fell for only the second time in its history on the back of weaker macroeconomic outlook and currency headwind.

Austerity seems to be the watchword of the big tech

The model of most tech companies - huge investment programs to fuel long-term growth at the cost of short-term profitability – is no longer favoured by investors.  And most tech companies have understood this, as evidenced by the announcements of layoffs and by comments from managements during this earning season. A good illustration of this change of mindset is how investors welcomed Meta's restructuring plans.

Cost-saving measures are needed as a big chunk of tech companies are still suffering from a covid-hangover effect. Indeed, many tech companies extrapolated covid trends and are now running out of steam. For Meta, even after the layoff announcement the headcount is still 50 per cent higher than it was in early 2020.

Investors are not approving anymore firms chasing revenue growth at all costs. And with the ultra-low-rate days behind us, it’s clear that companies that can better adjust their cost structure will cope best.

Big Tech have also increased their focus on Return on Investment. Several of them announced during this earnings season that they would either exit or scale back projects with a low ROI i.e. Meta with the Metaverse and Amazon with the Alexa Division.

Overall big tech revenue growth, both absolute and relative, is decelerating. This means that the differences that had characterized technology stocks relative to the rest of the market are tapering off.

Furthermore, multiple expansion should be much more limited for these names than over the last 10 years. The main reason is that we are unlikely to return to the 0-2% inflation framework, which implies higher rates for longer and therefore, lower multiples.

As a result, we are convinced that the market should adjust to this new reality. Therefore, now’s the time for good old fashion stock picking.