The European Union Goes After Amazon

By John Banks

A day will come when it makes sense to short the juggernauts: Amazon, Apple, Facebook, and Google.

That day is not today, and it may not be here for a while yet. But it will come.

As we explained on Aug. 3, the tech juggernauts are trading like a zero-coupon U.S. Treasury substitute. Investors have been reflexively trained to buy Amazon, Apple, Facebook, and Google when little else is working, because the tech giants are seen as impervious to downturns and competition, with reliable cash flows that function like a hidden yield. (They are “zero-coupon” because, rather than offering an annual dividend, the cash flows accrue for a payoff down the road.)

The trouble, though, is that the valuation multiples for all four have gone into the stratosphere, in the same manner that the price of a U.S. Treasury 10-year note yielding less than 1% can be said to be stratospheric. (When yields go low, prices go high, in a mechanical inverse relationship.)

The extreme valuation multiple for the tech juggernauts is comparable to treasury bond pricing that pushes the nominal 10-year yield below  1% (and the real yield — meaning the yield after inflation is accounted for — below zero).

What this means is that, if long-term yields begin a sustainable rise for any reason — at the time of this writing, the U.S. Treasury 30-year bond yield is about half what it was two years ago — then bond prices fall a lot, and so do valuation multiples for the tech juggernauts.

That, in turn, means you could see these names lose 30% to 50%, in share-price terms, even if the business case (revenues and profits, for example) does not change all that much.

If, say, the share price of Apple can double in 2020 for reasons almost entirely related to macro factors (because the underlying revenues barely rose), then macro factors can, at some point, do the same thing in reverse.

Meanwhile, the tech juggernauts have additional problems beyond inflated multiples. The world’s governments are increasingly starting to treat the four like hostile nation-states.

On the hostility front, consider Alibaba (BABA), which could be considered China’s version of Amazon and Google combined. The cancellation of the Ant Group IPO and a new wave of anti-tech regulations from Beijing have given BABA its worst run of share price performance since 2015.

Not long after we wrote about the Ant IPO cancellation (which directly harmed BABA), it was revealed that the cancellation was directly ordered by Xi Jinping — China’s leader for life — to put Jack Ma in his place. Talk about a chilling effect.

Meanwhile, in the United States, the House Subcommittee on Antitrust has issued a scathing report advising extreme remedies for the monopolistic behavior of the big four — Amazon, Apple, Facebook, and Google — including the possibility of breakup. The Department of Justice (DOJ) is also pursuing Google in its biggest antitrust action in decades, and Facebook has aroused bipartisan ire on multiple fronts.

The tech juggernauts have mostly brushed off all these threats. They are seen as too big, too powerful, and too well-lawyered to be seriously threatened.

That view may be more or less correct — and yet, regulatory and political winds are consistently blowing against them now. It is possible those winds turn into a gale at a highly inconvenient time. Like, say, against a backdrop of investors rotating their capital into small caps (and out of safe-haven big tech) in a vaccine-themed recovery play, or when long-term rates are rising because the specter of inflation has returned.

This tees up the latest antitrust effort from Europe: They are now pursuing Amazon.

On July 19, 2018, the European Union (E.U.) hit Google with a fine of 4.3 billion euros relating to Android, the Google smartphone operating system. This was part of a broader ongoing fight, with the E.U. accusing Google of anticompetitive behavior in areas including web search results, the Google Play Store, Google Maps, and the acquisition of Fitbit.

Google has appeared to mostly shrug off Europe’s challenges, filing court appeals in some places, paying fines in others, and agreeing to behavior compromises in still others. The net effect has been like a Chihuahua nipping at the heels of a Great Dane — so far. But the Chihuahua is persistent.

Now the E.U. is bringing Amazon into its sights. On Nov. 10, the European Commission concluded a year-long probe by hitting Amazon with antitrust charges.

Europe’s main accusation is that Amazon broke the rules by using non-public data, collected from third-party sellers, to sell its own products.

If, say, floral print dresses were selling well through the Amazon website, and Amazon reviewed the data of third-party floral-print-dress sellers to see which styles in particular were selling, and then made its own version of the dress, that would be considered a breach of EU competition rules.

The EU is also looking into whether Amazon wrongfully gave its own products preferential treatment over third-party sellers on the Amazon platform, or gave better service to logistics and delivery customers who paid more than other customers.

“We must ensure that dual-role platforms with market power, such as Amazon, do not distort competition,” said Margrethe Vestager, Europe’s top competition regulator.

Amazon’s third-party-seller business generates roughly $69 billion per year, according to the Wall Street Journal. That is far less than the $128 billion Amazon generates through direct sales, and less sexy than Amazon’s $40 billion cloud services business (which is smaller but growing far faster).

This means that, even if Europe draws blood on the third-party-seller front, it will only impact a portion of the Amazon empire, and won’t touch the most important areas. Then, too, Amazon, like Google, can afford the world’s best lawyers and will hire them by the dozen, which means most aspects of the case could drag on for years.

Still, it isn’t a good look. The hostile regulatory actions against Apple, Amazon, Facebook, and Google are starting to pile up. Beyond a certain threshold of scrutiny, investors could start to feel twitchy. One can only wonder, for instance, what kind of political heat Facebook will feel in 2021.

For investors, the primary takeaway here is that the tech juggernauts are not safe to buy on every dip. Their competitive positioning — in terms of the business of tech — may still be invincible. Their macro and regulatory positioning most certainly is not.