Trade war is ‘lose-lose’ and ‘stupid’
The tech giants that have revolutionised our lives are bent on a winner-takes-all path with scant regard for dividends, and some of Donald Trump’s policies are just plain stupid.
The tech giants that have revolutionised our lives are bent on a winner-takes-all path with scant regard for dividends, and some of Donald Trump’s policies are just plain stupid.
They’re just some of the musings veteran US fund manager Bill Priest shared with the adviser community during a recent visit to Sydney.
Priest is the founder and CEO of Epoch Investment Partners and has accumulated more than 50 years in financial services.
In a lively presentation, Priest charted the revolutionary changes in the business landscape that he argues began just over a decade ago with the emergence of tech giants such as Google and Facebook.
In the same way the processing power of a computer chip doubles roughly every two years, the power and scope of the tech giants “suddenly exploded in our face in 2007,” he said, alluding to the famous observation of Intel co-founder Gordon Moore.
Netflix is a key exdample of a company whose valuation defies fundamentals
Indeed, 2007 proved to be an epochal year, marking the advent of companies and services that have become part of our everyday lives: it was the year Facebook began; the year Google bought a video-exchange service called YouTube; the year Apple invented the iPhone; Amazon revolutionised the way we read by launching Kindle; Android emerged as an operating system to rival Apple, and the year in which an accommodation-sharing platform called Airbnb changed the way we take holidays.
However, Priest sees these new technology businesses as adhering to a "winner takes all" mentality. Their focus is less on dividends but rather a mission to completely own their respective markets.
In the case of video-on-demand service Netflix - the first iteration of which began in 1998 - its low subscription fee in today's terms enables it to exponentially grow its subscriber base.
Projecting out this growth is why the company is regarded so positively, Priest said.
No cash, no problem
Despite its dominance, Netflix is beset by problems, Priest argues, chief among them being cash flow and debt.
"Netflix generates no free cash flow,” Priest said. “They don't have any, but they do have cash flow and they reinvest every dime in the firm.
"And by the way, they borrow money like it's going out of style."
Netflix's debt has more than tripled from about $2 billion in 2015 to more than $6 billion.
"A company that spends more money than it makes every quarter, and yet it has an amazing market cap. How can that be?"
And for the investor, such an approach is no guarantee of dividends. "None of these companies create cash that is going to pay dividends. They don't care about that; they just want to race to where they own all that space ... it's a winner-take all approach," Priest said, noting similar flaw in music-streaming service Spotify.
In what he describes as a "capital light" world, he views the technological shift as a "substitution of bits for atoms".
Capex is falling, dividends are rising
This is changing the relationship between debt leverage and equity. Because most businesses have at least some debt, "if you like the leverage ratio that you have, and you can substitute technology for labour and physical assets, you don't have to keep building equity to do business".
Priest believes payout ratios from companies are going to rise considerably.
"You're going to see more buybacks, more dividends,” he said. “In a capital-light world, companies return a higher proportion of cash to shareholders as dividends.
"This year is going to see a record year for buybacks. Dividends are high, and they're going higher."
He refers to US examples, but the same thing has been seen - albeit to a lesser degree – in Australia.
"Capex is falling, and it's doing this because you're substituting technology for capex; you simply don't need the same amount of capital anymore."
Trump's war on trade
Priest also let rip on the US-China trade war, Priest slamming the assertion of US President Donald Trump that his administration is winning the trade war.
"No one wins a trade war. It is lose-lose," Priest said.
He illustrated this point by explaining the law of comparative advantage. "What's going on in the trade war is unbelievably stupid. If you unwind [the law of comparative advantage], this is not good.
"Will protectionism shrink manufacturers' margins? Are you kidding me? That's a certainty."
Priest argues some of the policies Trump is proposing "are just plain stupid".
"If you think margins are going to hold up, you're smoking dope, it isn't going to happen,” Priest said.
"As you start to get into the back half of next year, the markets start to be pretty suspicious of what might be happening to global profits.”
Priest also cast doubt on the wisdom of the administration’s tax cuts, say they must eventually be paid for.
"So next year, our deficits are going to be spectacular ... it's forecast that next year the treasury will have to finance US$960 billion of debt to finance this tax cut."
In the credit space, Priest noted the US economy has shifted from quantitative easing to quantitative tightening. "Under QT, they're selling bonds - US$50 billion of bonds and treasury bills. So next year you're going to be looking at between US$1.5 trillion and US$1.6 trillion worth, that's a big percentage of our GDP."
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Glenn Freeman is senior editor, Morningstar Australia
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