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Dan's Perspective: Download from Silicon Valley

Dan Rohinton's picture

open pdf versionOver the summer, we had the opportunity to visit Silicon Valley on multiple research trips. The companies we met with stretched from consumer technology companies, which we see and interact with daily, to technology infrastructure that supports our modern way of life. Over 50 meetings later, I’m reminded of the great learning experience visiting the valley has been for me, from meeting some of the first Amazon employees and early competitors of Google to experiencing the next wave of disruptors today. It’s not every day you have a front-row seat to the future while also getting valuable insights into how and why the successful companies today got to this point.

What’s New in Silicon Valley?

Almost universally across the companies we visited, it was clear that disruptive innovation is here to stay and that it’s happening on a scale that was previously not possible. For consumer technology, that tectonic shift is all around us and in our pockets; it’s the advent of high-speed internet access through our mobile phones that opens a world of possibilities for richer and more tailored experiences at our fingertips. While this is old news (“That’s so iPhone 1, Dan; we’re in 2019, what’s new?”), in the valley, this mobile shift has been happening and increasingly enabled by the shift to cloud computing.

Cloud computing, which was pioneered by Amazon Web Services, is a fundamental change in how both consumer and business applications are built and operated, and it’s still in the early stages. The shift to cloud computing makes it possible to immediately stream a full graphic game from Activision Blizzard using a Google data centre near you, without the need to pay hundreds of dollars for a PlayStation or Xbox console — and that’s just the tip of the iceberg.

The advent of cloud computing infrastructure enables business software to transform at a rate that was not practical at scale. Until more recently, making software applications and keeping them updated meant individually installing new versions on your desktop. Not only was this quite expensive for your IT department, it was also expensive for the blue-chip software companies such as Microsoft Corp., which had to support all the older software in addition to the newest version. (Anyone remember Windows ’95 and how excited you were to get the faster and sleeker Windows ’98?) As we move to a cloud-first world, software can be updated in real time and at a lower cost than before. This is beneficial to consumers since they will always have the latest software, and its good news for software companies as well who can deliver and support their product at a lower cost.

Innovation also doesn’t stand still — we have already heard about the new wave of venture capital investments that are going into artificial intelligence, edge computing and the shift to NoSQL (not only structured query language) non-relational databases — but that’s for future blogs!

What Are the Valuations of These Rapid Innovators?

For some companies, valuations have risen to all-time highs, driven by the belief that this time is different. The narrative is that these companies are more profitable than ever, lower interest rates leave room for more upside and there is nowhere else to go in the stock market. It was very common during our trips to hear the following from venture capital investors: “This is just like ’99,” “Frothy public markets are leading to frothier private markets,” and “I feel silly not investing in this venture investment early, I could have made five times my money in two years.” Taking these sensational examples aside, valuations across certain parts of the information technology and communication services sectors have increased dramatically over the past three years. But that is painting a very diverse group of businesses all with one broad brush.

I believe the most disruptive software companies that we met during our trip are trading at some of the highest valuations in their history, which leaves little margin of safety. When investors are paying anywhere from 30-40 times price to sales for an investment to deliver an adequate return, they need to grow at least several times bigger, significantly improve their profitability and, most important of all, nothing can possibly go wrong from this point on. This, however, is just one part of the sprawling technology sector.

What Technology Investments Does Cambridge Global Equity Fund Have?

We are seeing opportunities in select high-quality, large-capitalization compounders in communications and technology companies (such as Alphabet Inc. (Google’s parent company) and Activision Blizzard, Inc. to name a few). We believe these companies have innovative new products (e.g., driverless vehicles, connected TV, Google Cloud, mobile and cloud-streamed games) with significant potential to transform consumer lives for the better. We also believe certain companies in the space have attractive valuations that afford us downside protection and deliver attractive risk-adjusted returns over time.

Closing Thoughts

Research trips such as these are one of the foundations of our bottom-up research process, and they give us invaluable on-the-ground perspectives. It’s this type of insight that give us the confidence to look ahead to the future with excitement, while doing it the Cambridge way.

As always, thank you to our clients for entrusting us with your savings and giving us the opportunity to help compound your wealth and secure your future. We wake up every morning focused on making that a reality.

Dan Rohinton

 

Sources: Morningstar Research Inc. and Cambridge Global Asset Management, as at September 9, 2019.

 

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Published September 23, 2019.

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