Big Tech and Antitrust: Part 1 - Where's the Line?

I put "Part 1" in the title because I am certain that the most important business issue of the next decade will be the antitrust approach to the growing power of Big Tech. Facebook, Amazon, Apple, Google and Microsoft (FAAGM) are the most powerful and profitable companies that I have seen in my investing career and I believe are the most powerful on the history of the planet. John D Rockefeller can only roll in his grave with spasms of jealousy.

If FAAGM are more powerful than Standard Oil and Standard Oil was a violation of antitrust, how is it that these companies are not? The basis of our antitrust is consumer in orientation. Typically, a monopolistic business is injurious to consumers because it holds the prices of goods, products and services at elevated levels. However, in the FAAGM world, many of the services are free. Google's increase in scale only causes consumers to be happy at the combination of free and more comprehensive.

In the FAAGM world, the squeeze is more on the suppliers than it is on the consumers. By gaining scale, these companies squeeze suppliers into an integrated and more seamless experience. Each of these companies is more valuable to the consumer by its increase in scale. Facebook is of more use the more others are available for connection. Despite the increase in benefits to the consumer, capitalism requires competition to avoid the rapid movement from "doing for" to "doing to" consumers. The next important stage economically is to understand the direction of antitrust. The coronavirus issues have only accelerated that process.

For that reason, Circuit Judge Consuelo M. Callahan's language, reversing the District Court’s ruling that Qualcomm was guilty of antitrust violations, is important. She states: "This case asks us to draw the line between anticompetitive behavior, which is illegal under federal antitrust law, and hypercompetitive behavior, which is not." What kind of line is that? Without going into Qualcomm's case, it seems as if businesses are competitive if there are limited barriers to entry. The barriers to entry for FAAGM are simply insurmountable and thus, I could argue, any behavior is "anticompetitive." If the consumers are winning currently, does that justify identifying "anticompetitive" behavior? I have no idea, but an important ruling has occurred.

Dealing Drugs in Decline? Walgreens (WBA)

For years, Walgreens (WBA) was a sound investment with a consistent investment formula. Their motto of "crawl, walk, run" highlighted the steadiness with which they adopted new trends on a profitable and culturally coherent strategy. Yet despite that history and consistently improving metrics, WBA's stock is trading at less than seven years ago. What gives?

Warren Buffett typically breaks down his analyses into unit characteristics, such as the profit per bottle of Coca-Cola. In doing this with WBA, the profitability per store is roughly $350,000 - down slightly from 2019 but up from 2005, when it was $315,000. Despite improving profits per store, the return on capital has declined as stores have gotten more capital intensive (cost of locations and build-out). Intuitively the profits per store don't seem compelling given capital, complexity, retail and legal challenges.

Given the power of the Walgreens brand and the scale of their operations, it is clear that the business model is challenged. The market seems to be marking down those businesses which rely on traditional real estate locations. The most challenged of their customers are home-bound and affected by chronic conditions. Unlike CVS, which is moving to a neighborhood healthcare model, WBA persists in a more capital intensive neighborhood retail model.

As retail and pharmacy moves online, it appears that the market is skeptical of WBA's ability to pivot. For years, WBA has been discussing a movement to digital but has made little progress. Sporting a P/E of less than 8 and a 4.5% dividend yield, WBA bears watching. But in the current environment, the tech-based, asset-light business models seem to be excelling while the "omni-channel" approaches of physical and digital seem to struggle with cognitive, cultural and operational dissonance.

Are Salespeople, Real Estate and Inventories the new Glass Counters of Retailing?

In early 2017, a friend of mine and I went out to Laguna Beach to discuss aspects of the car business. As part of those discussions, we reviewed the upcoming launch of Carvana (CVNA). CVNA, for those unfamiliar with it, is a "contactless" car retailer. 

Retailing has been upended by the internet, as the bankruptcies of Neiman-Marcus, J Crew, Lord and Taylor and others has demonstrated. By moving pricing information to the consumer, profits have eroded. This is typical of capitalism. One hundred years ago, F.W. Woolworth made his fortune by allowing customers to directly handle merchandise rather than keeping everything behind glass counters. 

Internet-only retailers have a challenge to find profitability. The shift of pricing information to the consumer means that the retailer has to find ways to profitability other than marking up the inventory. Amazon has been ingenious with Amazon Web Services and third-party marketplaces. A quick review of the CVNA concept left me unmotivated - no barriers to entry, no structural skills, some industry knowledge (DriveTime) and losses to the horizon. 

Instead I focused my thoughts on CarMax (KMX) - a "big box" retailer which has scooped up market share in a fragmented business. Their secret? They hire no one from the car selling business. Instead KMX focuses its efforts on pleasing the customer with friendly salespeople, a huge inventory of cars, no haggle processes and great locations. In the "real" world, this combination is ideal.

Since 2017, CVNA's operating losses have piled up while the stock has moved from $11 to $200 - an amazing move. During the same period, KMX's operating gains have piled up while the stock has moved from $60 to $100 - representing a contraction in its price to everything else ratios. Further, the market cap of CVNA is roughly $35 billion versus KMX at $16 billion - an astonishing difference.

Starting with the AMZN vs WMT battle, the fights between the incumbent profitable companies and the upstarts internet-only money-losing companies continue to be waged and the market's bets are being placed firmly on the upstarts. Unlike the "bubble" of 1999, the upstarts seem much more powerful. Within the last three weeks, I have spoken with three people who attempted to purchase through KMX only to find themselves most happily served by CVNA.