When it comes to America’s biggest technology companies, it seems like regulatory risk has never been higher. Most large technology platforms are facing pressure from US and European authorities, while lawmakers on Capitol Hill seem more inclined to doing something — rather than nothing.

As an internet analyst, I am in perhaps the unusual position of having studied another intense regulatory cycle as a bank analyst: the Dodd-Frank legislative process in the wake of the global financial crisis. During that period, I spent many weeks on Capitol Hill meeting with key lobbyists and congressional staffers as part of my due diligence into the large US banks.

Living through that experience has helped me calibrate my thinking on three key risks faced by Big Tech, which primarily fall into the categories of privacy, content and antitrust. Before I dive into those issues, I’ll share how my experience as a bank analyst has influenced my views.

Applying lessons from Dodd-Frank to this Big Tech regulatory cycle

1. Trying to predict the exact nature of regulatory outcomes is an inexact science. In my experience, it can be very challenging to develop a research edge on predicting regulatory outcomes. In my view, investors tend to spend too much time on it. I believe it is better to spend more time trying to assess how willing and able companies are to adapt to regulatory change.

2. Companies can survive, and even thrive, following intense regulatory cycles. The Dodd-Frank Act included almost 28,000 new rules and restrictions on banks! Revenue pools were curtailed, capital requirements doubled and compliance costs soared. At the time, some thought big banks just weren’t investable. But starting in 2013, a few large bank stocks went on to significantly beat the broader market over the rest of the decade.

3. Regulatory adaptation is a powerful and often underestimated force that separates winners and losers. In the years following the passage of Dodd-Frank, banks adapted to regulation. They restructured, changed their business mix, became more efficient, learned to optimise capital and developed new competitive edges in areas of technology and marketing.

4. Starting valuations matter a lot. A big reason that big bank stocks had such a great run after Dodd-Frank was their low starting valuations. In my view, among the large US tech companies Alphabet and Facebook are already pricing in a typical regulatory shock, based on past studies of other industries that faced such pressures. These tech giants also trade at cheaper valuations than Visa and Mastercard, both of which I consider to be high-quality companies with wide competitive moats and pricing power.

5. Politics often prevails more than economic logic in policymaking. I believe there are many examples in banking regulation of irrational policies and unintended consequences. For example, regulators realised that the SLR (supplementary leverage ratio) rule for big banks did not quite work as intended, but it took more than a decade and the risk of a deep recession to recalibrate it. (The rule stipulated the amount of common equity capital banks must hold relative to their total leverage exposure.)

 

1. Sources: Factset, Standard & Poor's. Earnings estimates for calendar year 2022 as of 25 May 2021.

 

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