Investment opportunities in digital innovation remain if investors know where to look
Certain companies may be better positioned to benefit from long-term secular trends than their peers
DIGITAL innovation has sparked large changes in the way we live, work and play. From online marketplaces to content streaming, people’s habits have been changed significantly at a much faster clip than before. With these changes in habits, some companies have leveraged these trends better than others.
Online advertising, for instance, has disrupted traditional print and television advertising and spawned a whole generation of creators who can distribute their content globally to anyone with an Internet connection.
Companies that have been in the thick of such trends have also generated stunning returns in recent years. The FAANG (Facebook, Amazon, Apple, Netflix, Google) have all posted returns in excess of 530 per cent over the last 10 years, compared to the tech-heavy Nasdaq composite index, which returned 332 per cent as at August 2022.
However, the tech sector has been hit harder by the current macroeconomic climate during this period. The Nasdaq composite index delivered -24.6 per cent in total returns, as compared to the broad-based S&P 500 index, which delivered -16.3 per cent year-to-date as at Sep 14.
Rattled by hawkish central banks bent on curbing soaring inflation rates, investors have shown little appetite for riskier tech companies that were largely seen as overvalued late last year.
Still, DBS chief investment officer Hou Wey Fook said that compelling investment opportunities remain on a select segment of the sector, despite the corrections that have affected the sector as a whole.
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“In particular, we have seen a bifurcation in returns between the Big Tech and emerging tech names, which have yet to deliver real profits,” he said, adding that DBS’ chief investment office maintains convictions on industry leaders that have “demonstrated the capability to sustain pricing power and profitability during economic cycles”.
This long-term outlook is driven by a number of factors.
Firstly, Hou believes that businesses adopting agile data management models will continue to drive cloud computing and data centre demand.
A report by real estate consultancy Colliers in July found that data centre rents will rise at an average rate of about 3 per cent annually. Demand from network and IT services as well as the growth of hyperscalers like Google, Amazon and Meta are likely to contribute to this rise in rents.
Secondly, the burgeoning demand for electric vehicles will continue driving the development of power management chipsets and logic integrated circuits.
Thirdly, the United States Chips and Science Act that was signed into law on Aug 9 will benefit upstream equipment makers in the long-term.
The Act includes US$52 billion to promote the production of microchips that power everything from cars to computers. It will also allocate billions of dollars towards scientific research and development.
Lastly, Hou expects global demand for cutting-edge chips will remain strong.
“The sector’s valuations have corrected to the lowest level in more than 2 years while the fundamentals and earnings quality continue to be supportive,” he said.
Chipmakers like Intel, AMD and Qualcomm have seen their share prices plummet year-to-date. As at Sep 14, Intel has declined 43.3 per cent, while AMD has fallen by 46.2 per cent and Qualcomm has shed 30.3 per cent.
Adapting to new trends
These opportunities do not only lie within the tech sector. Companies that hail from more traditional industries may also have adapted significantly to emerging trends.
Under the DBS I.D.E.A thematic strategy, there are 4 types of companies: innovators, disruptors, enablers and adapters.
“In particular, adaptors are companies currently operating in the old-economy industry but transforming themselves to capture the new digital paradigm,” Hou said.
This sort of dynamic can be observed with companies in the content streaming space, which is a key investment theme with the I.D.E.A strategy.
However, not all companies in the streaming space are destined to prosper.
Online streaming pioneer Netflix, for its part, has declined by some 62.8 per cent as at Sep 14 this year, weakening further than the 25.1 per cent decline posted by the Nasdaq composite index over the same period.
“With content being the nerve centre that powers social media and streaming platforms today, we’re actively watching industries such as music, video and gaming as they navigate the new normal and execute their content strategy to drive monetisation.
“We also look at the best opportunities in the value chain and identify the sector’s key players who will continue to dominate,” Hou said.
Hou noted that Bill Gates coined the term “content is king” back in January 1996 – words that sound rather prescient considering the state of content streaming today.
“Content is where I expect much of the real money will be made on the Internet, just as it was in broadcasting,” Gates said at the time.
Netflix has always been in the business of distributing content. From mail-order DVD rentals to automated retail kiosks, the early life of the company was built on analogue media.
Yet, the company had the foresight to look ahead into the future to imagine what could be.
In an interview with Variety, co-chief executive Ted Sarandos said that co-chief executive Reed Hastings was attentive to technological developments that would help video streaming take off as the future of content consumption. The company launched its streaming service free for existing subscribers in January 2007.
“Back then, (Hastings) said that postage rates were going to keep going up and the Internet was going to get twice as fast at half the price every 18 months,” Sarandos recalls. “At some point those lines would cross, and it would become more cost-efficient to stream a movie rather than to mail a video. And that’s when we get in,” he said.
Still, its early success has been challenged by other studio incumbents which also craved a piece of the content streaming pie.
In August 2017, Disney acquired majority ownership of BAMTech, a direct-to-consumer streaming technology company which helped it launch its own streaming service, Disney+, in November 2019. A similar story played out across other studios like Warner Bros and Paramount Pictures.
Since then, these studios have also declined to renew content deals that allowed Netflix to stream their content. You would be hard-pressed to find movies from the Harry Potter and Marvel Cinematic Universe franchises, weakening Netflix’s position as a one-stop subscription service.
Hou noted that while content streaming is poised to see tremendous growth, especially in emerging economies where Internet penetration improves, competition has heated up as more players enter the industry.
“To sustain subscriber growth, platforms are also required to pump in heavy investments on content acquisition and/or creation,” he said.
Netflix lost subscribers for the first 2 quarters of this year, with subscription numbers declining by 1.2 million subscribers to 220.7 million subscribers. Other competitors are gaining steam, with Disney+ clinching 152.1 million subscriptions in the quarter ended Jul 2.
To be fair, Netflix has tried to create its own original content with some levels of success, with Korean drama Squid Game and science fiction horror drama Stranger Things garnering 1.65 billion hours and 1.35 billion hours of watch time 28 days following their releases, respectively.
Still, it continues to lag the extensive back catalogue of much more experienced studios which have continued to create content specifically for streaming as well.
Hou said that ultimately, he prefers content owners over content distributors.
“Sharing may dominate in the music and video space, but content owners with extensive media libraries have highly monetisable assets, and will emerge as winners in this space,” he said.
In addition, he added that he is optimistic on advertisement-based models which could lower the subscription prices of streaming services.
Already, Disney+ will have an ad-supported subscription offering starting from Dec 8 this year starting at US$7.99 per month, lower than the current price of US$10.99. While Netflix has held on to its advertisement-free model in the past, recent reporting suggests that Netflix could be looking to reach about 40 million viewers worldwide through its upcoming ad-supported plan.
“We’re optimistic on advertisement-based models since consumers are more inclined to choose these over costly advertisement-free models, especially with inflation eroding purchasing power; as well as platforms powered by user-generated content, given their high growth potential and low capital outlay,” Hou said.
Staying invested in difficult times
Investors who are looking to invest during this period will likely be exposed to more volatile markets.
After the US posted higher-than-expected 8.3 per cent increase in Consumer Price Index (CPI) and 6.3 per cent rise in core CPI, the Cboe Volatility Index rose to a 2-month high on Sep 13.
Still, head of DBS Treasures Singapore Steven Ong said that investors should think long-term and focus on the basics of investing.
He advised investors to understand that market declines are a part of investing and that downturns do not last forever.
Furthermore, emotional investing can hamper returns and time in the market beats timing the market in the long run, Ong added.
“These, along with a focus on long-term secular trends, can help guide investors towards building resilient portfolios that are well placed to ride out short-term volatility,” he said.
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