How To Avoid Investment Traps In The Platform Age

By Roger Montgomery, Montgomery Investment Management

Right now, investors are in love with new, disruptive businesses, particularly those with platforms that shorten the path between supplier and end user. Many of these businesses are sporting eye-watering valuations that seem hard to justify. Is it time for a return to value investing? We think so.

Some call the avenue of disruption that shortens the path between the supplier and the end user 'collapsing the supply chain'. The gig economy is an example, as are 'platforms' provided by the likes of Playtech, Apple, Alibaba and Tencent. These are businesses we have invested in or are invested in.

Playtech is a business with a near monopoly in business-to-business gaming management software. As more online betting sites (retail service providers or RSPs) employ its platform to supply their service, its deeper data becomes a competitive advantage and more valuable to the RSP. As the platform grows in strength it becomes entrenched in the offering of the RSPs, allowing it to collect subscription revenues as well as a percentage of revenue income from over its expanding number of licensee customers.

Apple is a near-monopolist in the provision of premium smartphones and tablets. It is certainly the monopolist of its own ecosystem. With a customer base of more than 600 million users, developers are both enamoured by and beholden to Apple.

Tencent is a near-monopolist of mobile internet traffic via its WeChat app in China.

WeChat has fast become the platform of platforms with offerings in social media, games offerings and development, news, video, banking and payments as well as e-commerce and online travel. In an example of collapsing supply chains, consumers at KFC outlets in China - those that now don't accept cash - can purchase a meal using facial recognition technology (FRT) or telephone via WeChat, doing away entirely with the need for a credit card.

Also in China, Alibaba owns the largest e-commerce platform in the world. It commands a population of more than 440 million active consumers and US$0.5 trillion in annual gross turnover. The company has become a required channel for retailers and suppliers.

An ecosystem is a community of interacting organisms - typically symbiotic or mutually beneficial - and their physical environment. In the digital world, the owner of a successful ecosystem can command some very special returns on its investment. Without being either the seller or the buyer, the ecosystem owner can share in the revenue of the suppliers and charge the consumer a fee for participating. And that is just the tip of the iceberg when it comes to the revenue streams available to the monopolist owner.

Firstly, the platform's bargaining and regulatory power over vendors will be larger than that of any single individual business within the ecosystem.

Secondly, because the owner of the platform has sole access to the data generated by all of the activity on the ecosystem, it has the power to target, leverage and monetise that data by designing algorithms that enhance marketing, advertising and customer experience.

Thirdly, as more businesses, applications and/or services are added to the platform, more customers are attracted to the ecosystem creating a virtuous circle called a Network Effect. Mutually beneficial is the value created for the platform provider and the businesses and consumers using it. An example of this is the millions of dollars generated by YouTube 'stars' who might do little more than attract a following of, say, a couple of million scooter aficionados. Another example is a food or fitness business built on the back of a large Facebook following on the same platform.

There is little doubt we are witnessing a seismic shift in the way business is conducted, but investors are also making some fundamental mistakes.

First, they believe the current disrupter will win. Secondly, they believe the disrupter will be confronted with few if any speedbumps on its path to inevitable dominance. Few believe that the legislative and competitive landscape will shift again. And finally, investors believe that the disrupter will accrue all of the profits and revenues of the firms it disrupts. Tesla and Uber are examples of this latter category whose market values are filled with the hot air of expectation.

Investors need to remember that disruption is just a fancy name for change. And change is a constant, meaning the disrupters will themselves be disrupted or meet with antitrust regulation. Therefore, forecasting their ongoing dominance is fraught with danger.

In conclusion, investors need to remember that massive P/Es in 1999 and 2000 were replaced with price-to-eyeballs and price-to-clicks ratios. Ultimately these latter variations in valuation techniques pulled the rug out from many investors in the tech crash of 2000.

Today, value investing appears dead and buried again but it has always been revived, and when the current P/E ratios of greater than 250 times bump up against unmet expectations it will be the investors who are disrupted.

The Montgomery Global Funds own shares in Apple, Alibaba and Tencent via Naspers

 

Roger Montgomery
Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

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