The TMT sector is in the midst of a comprehensive once-in-a-generation paradigm shift driven by the contemporaneous maturation of several key innovations that offer consumers and businesses new and significantly better ways to use information. In this, we expect the few platforms that control user experiences (AAPL, GOOG, MSFT, maybe AMZN) will capture a disproportionate share of value, with portable device components, content creators, advertizing facilitators and differentiated web-based businesses also likely to benefit. Distribution networks – e.g. wireless operators, telcos, cable MSOs, CDNs, etc. – and their suppliers, may or may not benefit depending on competition and regulation. On the enterprise side, we see cloud services steadily gaining vs. enterprise data center spending, commoditizing hardware and pressuring traditional software in the process. Companies dependent on the staples of the older paradigm – e.g. PCs, Cable TV, private data centers, etc. – will likely suffer. We have built large cap and small cap model portfolios representative of the companies that we expect to prosper in the new paradigm. Thus far, the relative performance of these model portfolios has been strong, although they have underperformed during the past three months.
TMT is in the midst of a tectonic plate shift, akin to the ‘80’s, which saw the rise of a new order of leaders and the death of many old paradigm players. The ‘80’s saw the first PCs, the first cell phones, the break-up of AT&T, the Cable Act of 1984 (which dropped the limit on out of market signals for MSOs), and the rise of Ethernet, setting the stage for all of the TMT developments of the past three decades, including the Internet, and sounding the death knell for the minicomputer era. Today, the simultaneous maturation of portable devices, integrated user interface platforms, fast wireless networks, CDNs, and cloud applications is driving a similarly dramatic, self-reinforcing and irreversible transformation.
A disproportionate share of the value generated by the consumer Internet will accrue to portable platform owners – i.e. Apple, Google, Microsoft, and perhaps, Amazon. The Internet continues to absorb value from the rest of the economy, with an addressable market of trillions of dollars. In contrast to the PC era, where browsers offered a neutral vehicle to web-based resources, portable platform apps, tightly controlled by platform owners, are becoming the predominant way for consumers to use information. This gives Apple, Google, Microsoft, and maybe, Amazon, enormous advantage in pursuing new Internet-based opportunity.
With the rise of portable platforms and cloud-based services, device components, content owners, ad agencies, and well-positioned web services will benefit. Businesses that operate in service of the portable platforms will also have opportunity to take advantage, particularly if they have competitive barriers to protect against vertical integration by the platform owners. We see device component providers (hardware and software), owners of unique content, advertising specialists, and well differentiated web services with critical mass as attractive areas.
Distribution networks – e.g telcos, cable, etc. – have colluded to set speed bumps, but will likely face competition, regulation or both, raising opportunity for their suppliers. The emerging TMT paradigm is driving huge traffic growth, taxing both wireless and wired networks. Operators have responded with price hikes, usage tiers and throttling rather than capex, the product of tacit collusion, hobbled competition and lax regulation. As a result, leading network owners have seen unusual returns on investment. History suggests that such returns are unstable, as innovation, rivalry and/or regulation could spur investment and price aggression at any time. Moreover, we would not discount the potential of wireless to compete effectively for residential broadband or the possibility of investment from cash rich internet platform players to help to make it so. In this case, communications equipment vendors, tower companies, web platform players and consumers would be the biggest beneficiaries.
Enterprise cloud services will gain steadily, benefiting hosts, SaaS, and consultants while crowding out private data center builds and commoditizing traditional IT. After years of investment, the virtualization of enterprise data centers has peaked and surveys suggest that shifting appropriate applications to the cloud is the new top CIO priority. As this trend gains momentum, it will benefit scale-efficient hosting businesses, software-as-a-service application vendors, IT consultants, and commodity components. IT investment will shift away from private data centers toward sophisticated web hosts, sapping demand for the high margin, value added solutions offered by traditional IT vendors.
We expect demand for old paradigm products and services – e.g. PCs, Cable TV, high end data center hardware, traditional enterprise software, etc. – to crest and wane. The new TMT paradigm, based on portable devices, integrated app-focused platforms, distributed public data centers and cloud-optimized applications, will render many stalwart products and services from the past few decades inert. The changing of the guard will play out over years rather than weeks, but we see the decline of x86 PC architecture, channelized television, integrated enterprise hardware solutions (servers, storage, networking, etc.), closed architecture infrastructure software, and other old paradigm architectures as inevitable.
Our model portfolio constituents are well positioned for these opportunities, relatively insulated against threats, and have demonstrated an ability to generate cash flow. We maintain a large cap and a small cap model portfolio composed of representative stocks well placed for the paradigm shift, and screened for cash flow returns and growth. Performance of these stocks has been strong over the life of the portfolio, but poor for the past three months. We are adding WPP and N to our large cap portfolio, replacing RVBD and OPEN, which moves to the small cap portfolio. The small cap portfolio sees N graduate to the large cap, replaced by OPEN. We are also removing UBNT, TTWO and UEIC and adding DDD, MKTG, and ENTG
For our full research notes, please visit our published research site.