The Future of Tech Investing: Platforms, Not Services
Investing in ‘technology’ can mean many things. It can refer to manufacturers of computers, semiconductors, software, or even online travel companies. If the product or service touches a computer chip, it’s usually called a ‘tech’ company, at least initially.
We all know ‘technology’ companies can provide great stock returns. It is also true that a minority of stocks represent the majority of returns. Layer on the fact that ‘technology’ is constantly evolving and iterating on itself, the term becomes so broad it basically becomes meaningless.
The real power of the internet is that it enables new ways for people to cooperate with each other. With the advent of the internet, these evolutionary steps have increasingly bifurcated tech companies into two camps: platforms and services.
Platforms have garnered a growing share of market cap. Look no further than Alphabet, Amazon, Apple, Meta, and Microsoft. These are platforms in the strictest sense representing a market cap of about $8T and 20% of the S&P.
It’s increasingly important to distinguish between the two.
Platforms can be defined as any operation where the density of suppliers yields a proportionate value to users. The more suppliers the more user value. User value can be defined as increased time savings or time savings at a lower cost (i.e. productivity).
Moreover, platforms are very difficult to disrupt because they inherently exhibit winner-take-all dynamics and new segment optionality. This is because scale benefits both sides of the transaction. As a result, platforms largely transcend economic cycles. This is especially true in the earlier stages of development.
Services can be defined as any business which provides a product or service directly to users. User value is generally maintained through R&D spend. Competition contains pricing power and acquisitions are often required to maintain revenue growth. Further, end user demand and margins are much more at mercy of the economic cycle.
Below we illustrate the characteristics of platforms versus services:
Investing in Platforms
It’s important to note the table above reflects the operations and business prospects of a company and not the stock price.
In down market cycles valuations fall across the board. The opportunity is the ability to buy secularly advantaged businesses (i.e. platforms) at cyclically depressed prices. This is where things stand today.
While it’s easy to see the value of platforms across established tech, it’s much more difficult in earlier stage companies. If you can identify it, however, history has demonstrated there’s a lot of money to be made.
To be sure, market participants know this and most company valuations are priced accordingly.
So long as the platform characteristics are evident and growth curves persist, it’s safe to pay up for these companies, especially at the earlier stages. While the multiples inevitably come down, the growth rates are high enough and last long enough to more than offset the contraction.
Simply put, the cloud is not an incremental step in technology. It is an evolutionary leap. Like all evolutionary leaps, it took approximately 10 years to build out the infrastructure. Now, with the build out largely complete, the stage is set for new platforms to emerge.
While it is rarely “different this time”, the cloud is unique when compared to previous transitions. In theory, a cloud based platform has almost no limits to how universal it can become, as it is unbounded by scale and geography. Meaning, it’s only truly limited by the size of its addressable market.
In contrast, back in 2000 Cisco still had to make its products, sell them, and ship them. When long distance telephony went away, so did its revenue growth, down by 74%. So while the valuations back then and today are comparable, the market is fundamentally different today. Although economic growth rates may slow, the amplitude on the downside is much smaller.
Take a company like Snowflake. This is not a traditional platform company serving as a two-sided marketplace like the Apple App Store. It is a platform in the world of data.
As background, Snowflake is a cloud-first data storage and analytics company. Its corporate clients upload company information into Snowflake in order to glean insights into their operations within individual business units and across entire organizations. By itself this is just a service.
But given the fluidity the cloud provides, Snowflake’s customers upload their data privately and securely into a “data lake’’. What this means is that a customer can process and leverage data across all of Snowflake’s customers to supply business insights.
Essentially, customers are securely sharing their problems and using each other’s data to find solutions. The more customers the more data, and in turn, the more value to customers.
One of the things that make platforms such great investments is the revenue optionality that organically emerges. The clearest example historically of these emergent properties is how Amazon’s business developed.
By relentlessly building out its logistical platform, Amazon was able to develop its Prime offering, then 3rd party fulfillment (3P), Amazon Web ServiceS (AWS), and media and advertising. The only “transformative” inorganic segment was the Whole Foods acquisition.
More importantly, the 3P and AWS opportunities were not appreciated. When both were announced, Wall Street effectively greeted them with a yawn. But today they have proved to be incredibly accretive to gross margins.
Data sharing in the cloud is an evolutionary jump, not an iterative one. The best recent evidence for this is Adobe’s willingness to pay 50x sales for Figma.
Adobe’s offerings can largely be considered as services. What Figma brought to the table was the ability to transform Adobe into a platform and conceivably become the default operating system for design.
To fully utilize and benefit from the productivity and cost saving the cloud provides, a cloud native infrastructure is required. This means everything from security to data analytics to customer management…all the legacy systems need to be cast aside one way or the other.
For companies that either make this transition or exploit it natively, this secular trend will make them great investments.
Investments in secularly advantaged businesses with cyclically depressed multiples are very rewarding. It’s remarkable to think that many valuations for best-in-class companies are now below that of peak Covid levels despite continued operational outperformance.
Buy platforms. Sell services.
Clockwise Capital is an asset management firm with a private equity approach to the public markets. We focus on the meaning of time and the role it plays in people’s lives.
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