How To Play The Next Tech Disruption Wave

Three weeks ago, I outlined six key investment themes for the next decade. I neglected to mention one for wont of space and because I wanted to devote an entire post to it. Namely, further technological disruption to established industries. Everyone knows how the likes of retail and newspapers have been transformed by the internet. Well, there’s much more to come as it’s clear that supermarkets, healthcare and education are next in line for technological upheaval.

For instance, UK online grocer Ocado appears to have nailed an industrial scale pick and delivery model. For more than a decade, companies have tried and failed to make inroads into the online grocery business, the most notable failure being the 1990s internet-bubble inspired, Webvan. Through trial and error, Ocado seems to have mastered the notoriously difficult logistics involved in the business. And it will soon be out-doing supermarkets, offering a broader range of products, at lower prices and with the convenience of ordering via a simple click of the mouse. What Amazon did for books, Ocado is about to do for groceries.

As investors though, how can you take advantage of the emerging opportunities from the digital revolution? The obvious answer is through up-and-coming tech companies. But this is more difficult than many suppose. For every Facebook, there’s a Myspace – the wannabe Facebook originally backed by media billionaire Rupert Murdoch – and hundreds of others. In other words, the creative destruction in tech is enormous and trying to pick winners requires extensive knowledge and a large dose of luck.

I’d argue that the best way to play future technological disruption is through companies servicing the key players. What I’d term: facilitators. They would seem to be surer bets. For example, the internet’s transformation of retail and soon groceries means supply chains will need to quicken even further. Consumers are going to want goods delivered yesterday. That means quality logistics companies will be in high demand. And industrial warehouses near key airports and ports will be valued at a premium given increased demand for the fast turnaround of goods.

Today, Asia Confidential is going to discuss these opportunities and more, as well as the companies which are likely to benefit.

Digital revolution is just beginning

There are many who think that tech is a gigantic bubble waiting to burst. You have the IPO of Twitter, a company being valued at US$13 billion and yet doesn’t earn a cent. And on a larger scale, Amazon (Nasdaq: AMZN) is still loss marking despite sporting a US$166 billion market capitalisation.

Then you have the internet start-ups being sold for millions and the venture capitalists backing them becoming quasi celebrities. Not to mention that residential property in Silicon Valley is now one of the most expensive in the United States.

But before writing tech off as a bubble, a few things should give you pause. For one, many large tech companies are now cheap as they’re considered yesterday’s heroes. Apple (Nasdaq: AAPL) is valued at less than 10x earnings if you strip out its enormous cash pile, compared to the S&P 500 12-month forward price-to-earnings ratio (PER) of 16x. Similarly, Microsoft (Nasdaq: MSFT) is on a PER of just 11x. More broadly, the tech sector has actually under-performed the S&P 500 this year. And similar tech under-performance has been witnessed in my neighbourhood of Asia.

The other thing is that history suggests this may not be a bubble. The evolution of railways in conjunction with the industrial revolution in the 1800s resulted in a long series of stock market booms, aka bubbles. The creative destruction involved then was similar to that of tech today.

Finally, if you think about the history of the current digital revolution, you may appreciate the enormous opportunities which lay ahead. Go back to the 1990s and the enthusiasm generated by browser technology. Then there was the advent of domain names and portals as well as email and instant messaging reaching the masses. Domain names assumed less importance with the rise of search and the behemoth, Google. And increased bandwidth has since paved the way for a huge uplift in web traffic.

While the digital revolution has been largely confined to the web so far, that’s starting to change as it moves into the real world. And that’s where things are about to get interesting.

I’ve talked previously about how 3-D printing is transforming the world of manufacturing. Physical objects can be designed on laptops and the designs can be shared online as files. Factories have been able to do this for decades but the big change is that now anyone with a computer can do it.

There are other examples of how the internet is being applied to the real world. You’ll know that smart phones are like quasi-computers these days. But do you know that each phone is uniquely identifiable on the internet? That is, the smart phone which may be in your hand right now has a mobile internet address. That means you can be connected to the internet 24/7. And companies can track your location via your device at any time.

One of Paypal’s latest inventions is Beacon, which gives retailers the power to recognise Paypal members as they enter their store (or walking past) and for these members to be able to make a transaction with a phone swipe or simple nod of agreement. In other words, there’s no need for these people to use credit cards or paper money. A virtual world, indeed. Needless to say, card issuers like Visa aren’t happy about it.

Think about the broader implications of this though. Retail companies no longer have to lure you into their store via your laptop at home. They can track you in real-time to market business opportunities.

Next industries to be hit

< p style="font-family: Georgia, 'Times New Roman', 'Bitstream Charter', Times, serif; font-size: 13px; line-height: 19px;">There are tens of thousands of start-up internet companies which are currently targeting digital applications for the real world. The most vulnerable industries are likely to be those which don’t offer the best prices, broad product ranges and convenience – or a combination of all three.

Online companies have been targeting supermarkets for the best part of 20 years. Everyone to date has tried and failed with an online grocery model. The most famous failure was Webvan, which went bankrupt in 2001 as the Nasdaq bubble burst. Amazon has also attempted to make headway in the space with AmazonFresh. But to little avail.

Now, however, a UK company has emerged and appears as a genuine contender to take on the big supermarkets. Ocado (LON: OCDO) was formed by three former Goldman Sachs bankers in 2002. It received early backing from large UK department store operator John Lewis. And it listed in the UK in 2010 to much investor skepticism.

That skepticism is slowly dissipating though as the company is set to turn its first profit. It follows a huge 25-year deal with UK supermarket chain Wm Morrison to distribute online groceries. Ocado suggests overseas deals may flow from the Wm Morrison agreement.

Other sectors besides supermarkets also appear ripe for tech disruption. Education and healthcare are probably at the top of the list.

With education for instance, everyone know the enormous price inflation which has occurred across universities over the past 30 years. And yet education standards, particularly in the developed world, have shown minimal improvement during that time. What’s worse is that many university graduates don’t have the skills to get jobs in the current tough marketplace.

It doesn’t take a genius to realise how online study could totally displace university lectures and tutorials. And slash university costs along the way. In essence, universities should soon turn into venues where students go to collaborate or discuss what they’ve learned online.

Emerging tech companies worth looking at

But now you’re probably thinking: that’s all great, but how do we, as investors, take advantage of this tech revolution? The easy answer to that is to find the next Google (Nasdaq: GOOG). Only, that’s not so easy.

The U.S. offers some great tech companies, including Google itself as well as the likes of Ebay (Nasdaq: EBAY). These companies are innovators, with enormously scalable business models and generating prodigious amounts of cash.

Less known is that Asia also has some fantastic tech companies which probably offer even greater opportunities. China’s version of Google, Baidu (Nasdaq: BIDU), is one. You also have Sina (Nasdaq: SINA), which owns the Chinese equivalent of Twitter. Then there’s Youku (Nasdaq: YOKU), which you may have guessed is a wannabe Youtube in China.

There are many others which look just as interesting. I’d suggest Naver (KRX: 035420) in Korea is worth a look. It has a 70% share of search in South Korea. And it owns a social messaging service which has attracted more than 250 million users across Asia.

The problem that I have with investing in many of these tech companies is that it’s extraordinarily difficult to predict how the digital revolution will evolve from here. And who the winners will be. If you’re going to invest directly into tech companies, it’d be sound to spread your bets across a variety of companies, given this uncertain future.

But there may be a better way…

Better potential opportunities

Let me give you a rough analogy first. Unless you’ve lived in a cocoon for the past decade, you’ll know about the enormous commodities boom which has taken place. Many mining companies generated an enormous amount of wealth. What’s not publicised to the same degree is the number of failures during the period. I’d estimate 1000 failures for every success story.

Not only that, but even the largest miners wasted enormous amounts of cash on projects which has since been mothballed. Since the pullback in commodity prices from 2011, there’s been much criticism about this and that’s why you see the large mining companies cutting back on capital expenditure and promising to give more money back to shareholders via dividends (a revelation that’s been a decade in the making!)

Anyhow, my point is that investing directly into the mining companies, even the large ones, was not the best bet. For instance, most of these companies trailed commodity indices by a distance.

The companies where investors made more money were those servicing the mining industry. The mining contractors. As well as others servicing the areas where new mines developed, such accommodation providers and so forth. These companies were surer, less risky, but more profitable investments.

I’d suggest that same thinking may be profitable in the digital world too. Rather than playing the tech companies directly, investing in those servicing the industry may have a better payoff.

I’ll give you one example. Think about who else will benefit from the ongoing disruption in the retail sector. Inventory management and distribution have been, and will continue to be, crucial as the industry evolves. That means faster supply chains. To enable faster chains, logistics will be at a premium.

In addition, many distributors will prefer warehouses around key airports and ports, so goods can be turne
d around quickly to consumers across the country or abroad. That means real estate around key infrastructure should become more valuable given relative supply scarcity versus growing demand. And also ports themselves, particularly in oligopoly-type markets should also become more valuable as greater throughput occurs from quickening supply chains.

For logistics companies, you probably have to look to the U.S. as they’re are few quality listed vehicles in Asia. The likes of UPS (NYSE: UPS) and Fedex (NYSE: FDX) would seem to have bright futures.

In terms of industrial real estate around key infrastructure, Goodman Group (ASX: GMG) in Australia and Mapletree Industrial (SGX: ME8U) in Singapore give you partial exposure to this. I also like the world’s largest industrial property operator, Prologis (NYSE: PLD), in the U.S. It focuses purely on property near key infrastructure and is run by one of real estate’s most brilliant minds, Hamid Moghadam.

For exposure to port operators La Ka-shing’s Hutchison Whampoa (HKG: 13) is a great play not only on Hong Kong but European ports too. Chinese state-owned Cosco Pacific (HKG: 1199) also gives you exposure, though the quality of the company is questionable.

The above provides just a few examples of how to potentially invest in those facilitating the digital revolution.

This post was originally published at Asia Confidential:
http://asiaconf.com/2013/10/27/playing-next-tech-disruption/