Modern Trustbusters Target Silicon Valley

John Jagerson is a columnist for Investopedia, as well as author of the Chart Advisor newsletter. The views expressed herein are his alone and do not necessarily reflect the views of Investopedia.

The Nasdaq Composite Index moved into technical correction territory on Monday with a loss of more than 10% from its highs on April 29, 2019. Besides general market weakness, most of Monday’s losses can be attributed to bad news for Facebook Inc. (FB), Alphabet Inc. (GOOGL), Inc. (AMZN), and Apple Inc. (AAPL). 

Investors learned that the Federal Trade Commission (FTC) will be investigating Facebook and Amazon for antitrust behavior while the Justice Department will tackle similar probes of Alphabet and Apple. All four stocks were down on Monday: Apple fared best with just over a 1% loss, while Facebook’s stock price lost a whopping 7.5%. 

The important questions for the government are whether these companies have used their dominant market positions to unfairly compete with smaller firms. This issue has been surprisingly popular among both Republican and Democratic politicians, including presidential candidate Senator Elizabeth Warren who has called for some of these companies to be split up a la Standard Oil Co. Inc. or AT&T Inc. (T).

Perhaps this shouldn’t have been as big a surprise to investors considering FTC Chair Joe Simmons announced the formation of an antitrust taskforce on February 26. At the time, no one really took much notice and the share price of all the potential targets of that taskforce were up that day. 

There are a few likely areas of antitrust violations among this group including previous mergers and whether these companies use their market position to harm competitors who depend on their services. 

For example, have these companies used their market position to unfairly acquire other potential competitors or obstruct entry by new firms? Depending on the terms and size of a merger, a deal could be considered an antitrust problem. The government might determine that when Facebook acquired Instagram and WhatsApp it was essentially shutting down potential competitors and harming the consumer by providing less choice.

A related problem is how these large firms treat potential competitors who also depend on them for services. European Union trade investigators are already probing Amazon for using data about their independent sellers to better market Amazon’s own products. 

Alphabet controls its search algorithm, Search advertising, and the DoubleClick ad network that places banner ads outside Google; that leaves advertisers with few or no alternative choices. The government could find that Alphabet’s behavior has increased advertising costs, stifled alternative competition (like Yahoo!) and harmed consumers in a market with fewer choices. 

This new round of investigations is in addition to the scrutiny that some of these companies are facing in other jurisdictions like the European Union, and unrelated investigations into how companies like Facebook have misused private user information.  Put together, these issues could give antitrust hawks in Congress much more ammunition to use against the growing wealth and power of these firms. 

What Is the Likely Effect on Share Prices?

In my opinion, the most important question is: what, if any, remedies are possible to emerge from these investigations? Some politicians and corporate activists have recommended that these companies be treated as utilities and prevented from competing with firms who depend on their platform. If that were to happen, we would see changes like Google’s search business separated from its advertising business. 

In the short-term, this would be a very difficult issue to include in the price of these stocks. That said, large antitrust actions have become a thing of the past and any potential actions taken by the FTC and Department of Justice are unlikely to lead to a breakup of these firms or their recent mergers. Considering the power these companies can use to influence public opinion, I wouldn’t expect the political resolve for breakups to last longer than the companies can litigate against the government.

However, that is not to say that some discounting in each stocks’ share price isn’t appropriate. What I expect is that we will see a series of cash settlements from these companies and subtle changes to contracts between the companies and their clients and partners. That’s what happened in the European Union: they have been reaping billions of euro from a series of fines for antitrust behavior from Alphabet. 

On March 20, the European Commission announced that Alphabet would be required to pay another $1.7 billion fine for using exclusive terms in their contracts with advertising partners, which brings the recent total of fines paid by Alphabet to the European commission to over $9 billion. This antitrust practice had been employed for 10-years, and while the fine sounds large and should impact the share price, it was insignificant to the profits the company reaped during those years.

What I expect is for the government to follow a similar route as the European Commission and work with these companies to change their policies and pay fines. While that certainly warrants a small share price discount, I think the most significant impact will be a chilling effect on future acquisitions and mergers.

Although most of these firms reached a dominant industry position through organic growth, acquisitions have played a more important role in profitability as they have matured. For example, we don’t have detailed breakdowns of revenue from each venue, but analysts that follow the industry expect that a quarter of Facebook’s revenue could come from Instagram by 2020.

Now imagine if Facebook or Alphabet must face a more rigorous and skeptical FTC and Department of Justice when seeking approval for the next big acquisition. If tech firms are constrained from using their capital to seek acquisitions, they will likely grow more slowly and deserve a lower premium in their stock price because future cash flows will be smaller. 

We don’t know how much of Monday’s reaction was due to the news, expected short-term enforcement, or feared long-term changes in the industry. I suspect that some of Monday’s selling was due to poor investor sentiment overall. Its easy to find an excuse to sell stocks right now while stress from the trade war is rising and economic data is falling. However, the bottom line is that investors hate uncertainty, and having the government’s antitrust crosshairs on the sector seems likely to lead to underperformance in the short-term.

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