Josh Sambrook-Smith: What does digitalisation mean for charity investors?

11 Mar 2019 Expert insight

Josh Sambrook-Smith narrates the story of digitalisation.

The digitalisation theme emerged over 20 years ago during the dotcom boom, but it did not end when the tech bubble burst in the early 2000s. Far from it. Digitalisation is a multi-decade phenomenon. But what does it mean, and how can charities invest in this compelling long-term theme?

The foundations of a digitised world

Digitalisation is a result of increasingly pervasive interconnectivity and technological sophistication in the global economy. Its significance to society is on a par with some of the most enduring transformations of the industrial revolution and later 19th century: the telegraph, the radio and the railroad. Like digitalisation, these technologies changed consumer and corporate behaviour and galvanised commerce.

The theme of digitalisation dates back to the 1990s dotcom boom. Telecom operators kicked off large-scale investment programmes in anticipation of the wave of demand which they believed would be created by the emerging internet economy. Capital spending rose from $47bn in the early 1990s to over $120bn at the peak in 2000, with as much as 40 per cent focused on long-haul network infrastructure – large fibre-optic pipes connecting cities and countries. When the requisite demand did not materialise, many network operators went bust, leaving behind over 500,000 km of fibre networks in place – enough to circle the earth 12 times over. Though over-optimistic and over-supplied at the time, these cables were the vital antecedent for the explosion in hyper-connectivity that was to come.

Meanwhile, another process was fast reaching an inflection point. Co-founder of Intel, Gordon Moore, famously predicted in Moore’s law that the number of transistors (semiconductor devices used to amplify or switch electronic signals and power) on a microchip would double every two years; the implication being that performance of a chip would double and the cost halve every two years. This better affordability led to higher adoption of increasingly powerful consumer electronics and communications hardware, further compounded by semiconductor and computing hardware manufacturers increasing their production capacities accordingly.

Building on a cradle of connectivity

By the early 2000s, then, a nascent digital economy existed. The fibre backbones connecting cities had been built, personal computer adoption was steadily increasing, and basic broadband services were taking shape. People were becoming increasingly connected.

The first messaging applications, IRC (internet relay chat) were introduced in the late 1980s and peaked in the early 2000s. Rudimentary data-sharing technologies emerged and rapidly gained adoption, with hyper text markup language (HTML) emerging as the leading technology for sharing documents and data across distributed networks. Suddenly thousands, then millions, of people and companies began creating web pages and online business models.

With mobile phones, the revolution in communications technology has continued with the introduction of 1G all the way to 4G, with data download speeds rocketing from a few hundred kilobytes per second to over 40 megabits. Meanwhile, more investment has been ploughed into online products and services. The arrival of the iPhone in 2007 was a watershed moment, signalling the start of a ten-year period of hyper innovation that captivated consumers and accelerated many of the defining innovations of the previous 30 years.

Six distinct trends in the digitalisation theme

The interplay between technology, economics and behaviour includes a strong feedback element: as technology develops, the economic advantages of a product change, altering behaviour, in turn influencing the evolutionary direction of the technology itself.

The results are multi-decade trends, where we are afforded some visibility in terms of the direction of travel. We believe these can be grouped into six discrete, investable long-range trends within the digitalisation theme:

Digital content

We increasingly consume content online through mobile devices, laptops and TVs. Indeed, most forms of media consumption have migrated to the digital world (eg music and video streaming), and advertising and marketing strategies must follow users’ consumption habits. Taken together, this has created a thriving digital marketing ecosystem.

Example stocks: Facebook, Activision Blizzard, Netflix

Cloud

In its simplest form, cloud is a form of IT outsourcing that means enterprise no longer need to in-house each segment of their IT infrastructure. Instead of buying hardware and data centres, a service provider can manage this for you elsewhere, while you connect to your applications and business services remotely. Cloud computing, in its many forms, is aggressively taking share of IT budgets globally.

Example stocks: Salesforce, ServiceNow

Ecommerce

This is one of the most established long-term trends, which saw Amazon emerge as an early leader in the late 1990s. Today practically every consumer-facing retailer and manufacturer has an ecommerce strategy, and still the total share of ecommerce spending in the US is low (20 per cent of total spend) and is only set to increase in coming years.

Example stocks: Alibaba, Amazon

Processing power

Following Moore’s law, the brain power within the microprocessors initially doubled every two years since inception in the 1970s. While the speed of this process has slowed in recent years, the semiconductor manufacturing industry will continue to improve the speed and cost of microprocessors; supporting growth and innovation in numerous secondary hardware and software markets.

Example stocks: Taiwan Semiconductor Manufacturing Company, ASML

Analytics

Hidden in plain sight is the torrent of information surging from the world’s complex networked ecosystems. Coupled with advances in modern computing, this information is now being analysed to a degree that has only very recently been made possible. The results reveal patterns and insights that are revolutionising the modern world.

Example stocks: Nvidia, Splunk

Network traffic

An explosion in data creation and transmission is arising from the hyper-connectivity of the modern economy. With data traffic volumes expected to grow five times in the coming years, the economic importance and durability of today’s networks will continue to feature as a prominent investment trend.

Example stocks: Equinix, American Tower

The digitalisation theme is not mere speculation: it is actually happening. Demand for cloud computing and the transformation of $50bn in IT spending, the digital marketing industry that is re-balancing $500bn in global advertising budgets, the $400bn semiconductor industry that continues to push the boundaries of physical possibility, and the nascent $40bn in analytics spending that continues to skyrocket in lockstep with the adoption of artificial intelligence technologies – all stand as evidence to the vast potential of this theme.

How can we harness this theme in portfolios?

Like those of its technological antecedents, digitalisation trends will endure for many years. This lights the path for investors, illuminating pockets of demand, pointing us towards the sustaining technologies of the future while reducing the possibility we stray into the more speculative end of the market. As long as we know that these trends will endure, we know a long-term investment case exists for the companies that operate in these fields.

Importantly, many of these companies and trends are established. And so are their business models. Proven, demonstrable, recurring ways of generating revenue. Again, this not only reduces the likelihood of straying into speculative ends of the market but also imbues investments with a vital element of sustainability. For example, it makes a very big difference for a long-term investor that ServiceNow enters into a subscription relationship with its customers or that Equinix locks customers into five-year minimum contracts (and they usually stay permanently). It is difficult to imagine this theme being displaced in the foreseeable future, and we expect it to maintain its durability and investability well into the long run.

Josh Sambrook-Smith is a global equities analyst at Sarasin & Partners

Charity Finance wishes to thank Sarasin & Partners for its support with this article

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