Big Story

There’s byte beyond FAANGs

Hari Viswanath BL Research Bureau | Updated on July 31, 2021

Keen on netting some US tech stocks? There’s a flourishing ecosystem of companies beyond the biggies. Here’s how you can hook some prize catches

In recent times, investors in India have been warming up to investing in the US as is evident from the emergence of US-focussed investing platforms and NFOs from mutual funds.

Usually, the FAANGs (Facebook, Amazon, Apple, Netflix and Alphabet, formerly known as Google) or the FAANGMs (including Microsoft) hog the limelight.

But the return prospects, while still good, might be tapering for some of these stocks. For example, in the last three years, while the ‘N’ in the FAANG — Netflix — has given 45 per cent returns (13 per cent CAGR), the broader Nasdaq Composite index has given 90 per cent returns (24 per cent CAGR). Media conglomerate Disney has given CAGR returns of 17 per cent during the same period, outpacing Netflix, driven by optimism around its streaming business that competes head-on with Netflix.

Similarly, while one of the ‘A’s in FAANG — Apple — has given stellar returns in recent years, returns in future might taper, given its heightened valuation and slowing growth.

Also, while an equal weighted investment in the FAANG stocks five years back would have yielded CAGR returns of 34 per cent, there are many stocks within the tech space, such as Advanced Micro Devices, NVIDIA, Fortinet, Paypal and Square that have yielded even better returns.

Given that Indians also have convenient means now to directly participate in the US markets,we explore some of the stocks in other spaces within the tech sector.

Software as a service (SaaS)

SaaS is a way of delivering applications over the internet, a theme that has become mainstream globally in the last decade. This has been taking market share from traditional licensing-based software business models, which involved making a large upfront payment for installing software within the premises of each customer in their hardware/s, and requiring them to maintain it or pay the software company to maintain.

SaaS, which started as a concept during the days of the dotcom boom, began to flourish as a business model post the financial crisis of 2007 as companies wanted to save costs. Also, improving internet infrastructure by then made SaaS a viable option even for large companies with stringent data security and speed requirements.

The payment model for SaaS is typically a per seat, per month, charge based on usage.

The growth in this space and the structural shift in customer acceptance of this business model has been very strong and further accelerated during the Covid pandemic.

As in many segments in the tech industry, US companies dominate this space globally with Salesforce (customer relationship management software, analytics) and Workday (human capital management software) being pioneers of this model. Early adopters like Adobe (content creation and publication software), Autodesk (computer aided design software) too are well-established in this realm and are positioned to capitalise on the market opportunity, going forward. Going by its track-record of excellent execution, business prospects, financial and valuation metrics, Salesforce seems to be the most promising in this space.

Software security

The global digitisation trend, structural shift to cloud and virtual networks, work from home, digital payments, running of mission critical applications, swathes of private individual data with corporations that need to be protected, etc, have all accelerated the necessity for enhanced software security.

Nothing drives home the point better than the recent ransomware attack on US oil pipeline company, Colonial Pipeline. The attack by hackers halted the operations of the largest petroleum pipeline in the US, creating fuel shortages and panic-buying in parts of the US. And the only way out for the company was to pay the ransom of $ 4.4 million (75 bitcoins at that time) demanded by the hackers.

In April this year, the personal data of over 500 million Facebook users was leaked online.

These factors appear to provide very strong structural tailwinds in favour of enterprises spending more on software security. Some of the pure-play companies listed in this space in the US, and well-positioned to capitalise on the opportunities are Palo Alto Networks, Fortinet, Proofpoint and Check Point Software.

While Fortinet has outperformed the returns of FAANG stocks over the last five years, Check Point is a good play for long-term investors.

Fintech

Post the Zomato listing, excitement is already building up in India in anticipation of the IPO of fintech company Paytm. The US offers quite a few interesting candidates in this space — some well-established global giants in digital and mobile payments like Visa, Mastercard and PayPal, as well as new innovative companies like Square.

The growth in this space can be assessed by a simple fact — PayPal was originally acquired by eBay for $1.5 billion in 2002. Later, it was spun off from eBay in 2015 and now has a market capitalisation of around $325 billion, eclipsing eBay’s market cap of $50 billion. While all the companies have performed exceptionally well, Square, in particular, stands out for its whooping 87 per cent CAGR returns to investors in the last five years.

Some of the US fintech companies like Mastercard, Visa and PayPal were profitable even before listing unlike Zomato or Paytm. However, investors excited about this space need to note that these returns were possible as the pricing of these stocks was reasonable five years back. For example, Square was trading at a very reasonable EV/Revenue multiple of around 2.5 times five years ago. Visa is a promising play in this segment.

Gaming

The listing of Nazara Technologies recently created a lot of buzz in India, with Nazara being the first pure-play gaming company to hit the bourses. The pandemic resulted in a structural boost for companies in this sector globally, as more people took to gaming when confined to their homes.

In fact, the surge in demand for gaming consoles is partially responsible for the global semiconductor chip shortage.

Investors can check out some of the global leaders here like Electronic Arts, Activision Blizzard and Take-Two Interactive. These are companies that develop, market, publish and deliver games, content and services that can be played and watched on game consoles, PCs, mobile phones and tablets.

While some Chinese companies like Tencent are bigger in the gaming space, many of them are not listed in the US. This apart, the recent crack down by the Chinese government on many of the companies in the tech space could work in favour of US companies. Electronic Arts seems to be a good bet for long-term investors, going by financials and valuations.

Semiconductors

The investible universe of semiconductor stocks in the US alone is over 100. The combined market cap of the top 10 companies listed in this space in the US is over $2 trillion, with many of them having unique competitive advantages and intellectual property.

Unlike software and internet sector where local investible options can emerge, as far as seminconductors are concerned the dominance of US listed companies will remain intact for the foreseeable future. The importance of this industry has been clearly validated by the worldwide chip shortage affecting business across industries. Intel, Advanced Micro Devices, NVIDIA Corporation, Micron, and Qualcomm are some of the leading companies well-positioned to ride the new digital wave that’s driving demand for chips.

However, investors need to factor in that most of these stocks have appreciated significantly since the start of the pandemic last year and better opportunities would emerge on corrections. Each of them has a strong competitive positioning in different segments within the semiconductor industry, like PC chips (dominated by Intel, but now facing heat from Advanced Micro Devices), DRAM (Micron), graphic chips (NVIDIA), mobile baseband processors (Qualcomm), etc. NVIDIA and Advanced Micro Devices have been the star performers in this space with five-year CAGR returns at 70 per cent.

Apart from providing unique plays not available in India for investors, US investing also turns attractive when considering the fact that the rupee has depreciated against the dollar by about 5 per cent annually in the last ten years. This may or may not play out in future though.

Investors can directly buy US equities through investment platforms such as Vested Finance, Stockal, Winvesta and Globalise.

Indian brokerages such as ICICIdirect, Axis Securities and Motilal Oswal Financial Services also facilitate overseas investments through tie-ups with US brokers.

Safety limit

While Indians can invest abroad up to the LRS limit of $2,50,000 per financial year, it is advisable to not have more than 10 per cent diversification to international stocks/funds in one’s portfolio

Published on July 31, 2021

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