Digital Economy – The COVID effect.

Amazon and Microsoft are in pole position. 

• The COVID-19 pandemic is making both temporary and permanent changes to the way the economy works but picking the beneficiaries is much more difficult than it would seem.
• The net result of everyone staying at home has been skyrocketing internet usage which is beginning to put a strain on the core network which is coping but is now running materially more slowly than it was.
• Fortunately, that reduced speed is still plenty fast enough to enable all the hotly demanded services to run to an acceptable level of quality.
• The new usage falls into three categories:
  • First, Homeworking: With a large part of the workforce stuck at home, almost all meetings are now being conducted over video.
  • To put this in context, Zoom recently stated that its actively daily users for meetings have gone from 10m in December 2019 to 200m in March 2020.
  • Before anyone gets excited, the vast majority of these users will be free users for whom Zoom offers an excellent user experience with meetings only being limited to 40 minutes in length.
  • With large numbers of these users ill-prepared for this move, demand for home office equipment has also been strong.
  • Second, Homeschooling: Hundreds of millions of school children are taking their classes at home.
  • This means further demand being placed on video streaming for classes as well as online teaching live for older children.
  • Very few homes were properly prepared for this, meaning that laptops, cameras, printers, paper and stationery are all likely to have seen a bump in demand.
  • Third, Quarantine entertainment: Only a small portion of the workforce can work as efficiently as home as it can from the workplace meaning that a lot of people are sitting at home with nothing to do.
  • Unemployment claims in the USA and UK are already skyrocketing.
  • Hence, people are going to spend far more time engaged with Digital Life services especially media consumption, messaging, gaming and social networking.
• The net result is a very large increase in traffic but not very many companies are actually in a position to benefit from it.

Winners

• Video conference providers. These companies have seen an explosion in usage, but the nature of their business models does not necessarily mean more money and more profits.
• Zoom is an obvious one but a large part of its 20x increase in DaUs will be free users.
• Furthermore, existing subscribers are on all-you-can-eat packages meaning that an increase in their usage does not mean more revenues for Zoom.
• What it does mean is an increase in costs as Zoom will need to ramp up capacity to support all this increased usage, potentially without an increase in revenues.
• Hence, the short-term looks like it will be difficult financially, but this is going to be a great advertisement for Zoom and I think corporate subscriptions will really take off once the economy gets going again.
• Hence, things could be bad when it reports Q1 and Q2 2020 earnings potentially providing a good entry point.
• Microsoft Teams is another beneficiary in terms of usage but as this comes as part of the Office 365 package that users are already paying for, I cant see an increase in revenues being attached to it.
• Cloud providers are the biggest winners.
• This is because their business models are entirely based on usage and much less on subscriptions.
• This means that Amazon and Microsoft are likely to see a substantial bump in revenues as a result of the big jump in internet usage that is being experienced by their customers such as Netflix.
• Google Cloud and Alibaba will also benefit but this is a much smaller proportion of their overall revenues.
• Gaming is also likely to fare well with a big increase in usage.
• More users are likely to sign up for multi-player services and digital copies of games are likely to materially increase in volumes.
• Microsoft, Sony, Activision, Epic Games & Ubisoft should all benefit materially.

Losers

• Digital ecosystems are not likely to benefit much from this trend, again mostly as a result of the business models they use.
• Monetisation via hardware (Apple) is going to be soft given that the smartphone market is expected to fall this year as a result of longer replacement cycles and disrupted supply lines.
• Monetisation via advertising should benefit in theory as it is driven by usage, but this is unlikely to be the case this year.
• This is because the customers (advertisers) are cutting spending hard meaning that there are far fewer dollars chasing a greatly expanded inventory of potential advertising space.
• This means rates will fall heavily leaving Google, Facebook, Twitter, Baidu, Amazon, ByteDance in a difficult position.
• Subscription services: that are already well established like Netflix.
• Netflix is seen as a beneficiary as its share price has recovered almost all of what it lost in the crash but I do not see a big increase in its revenues.
• This is because it already has a large number of subscribers and when these subscribers spend more time using Netflix, there is no lift in revenues.
• Quite the contrary, costs will go up because its hosting bill at Amazon will be higher as a result.

How to play

• There are a number of trends to invest in of which Amazon and Microsoft come out top in my opinion.
• Amazon will benefit from a further shift to online e-commerce and an increase in its AWS cloud business.
• Microsoft will benefit from Azure, Xbox Live as well as the increase in purchasing to equip home office and schools.
• At the other end of the supply chain, there are already signs of robust demand for semiconductors and components that are destined to end up in enterprise-focused devices as well as cloud servers.
• Intel, AMD, Western Digital and Seagate all look they are in a good position for a sudden uptick in demand triggered by the economy being transferred to the home.
• I would stick very much to the enterprise focus as the consumer (smartphones and tablets) demand is looking much less robust.
• Hence plays like TSMC, Samsung, Qualcomm and MediaTek look unlikely to benefit from this productivity-focused demand upswing.
• I am kicking myself for not buying Zoom in December (I could not stomach the still high valuation) but if its upcoming results are poor, this could provide a great entry point.
• I have yet to pull the trigger and buy any of these, but these are the ones I am considering.