Pando

The incumbents are winning

By Kevin Kelleher , written on October 26, 2016

From The Disruption Desk

The fickle attention of technology investors has taken an interesting turn this year – and when you think about it, a not entirely unexpected one.

A year ago, there was a good deal of anxiety about the tech sector. Companies such as Alphabet and Microsoft were seeing their stocks trade sideways, while private companies were unsure if there would be enough demand for the modest sliver of ownership they floated into public waters.

2016 has shown that there is indeed a good deal of investor affection for publicly traded technology companies. The thing is, the attention is primarily focused on a handful of them. And by and large, they are not startups. Or at least, they haven't been startups for a decade or longer. They are the usual suspects, the tech giants that have been dominating their markets, even at the exclusion of promising newcomers.

The five biggest market caps of companies traded on US stock exchanges belong to familiar names: Apple at $628 billion, Alphabet at $566 billion, Microsoft at $465 billion, Amazon at $388 billion, and Facebook at $379 billion.

After them follow the older-school, non-tech dinosaurs that frequented this list in previous decades: Exxon-Mobil, Berkshire Hathaway, Johnson & Johnson, General Electric. Rounding out the top 10 is Alibaba, at $257 billion, suggesting that more tech companies will be rising up on the list, especially ones focused on China's growing consumer-tech market.

But it's not just the size of these technology giants that stand out. It's their performance over the past 12 months. Apple has risen 3% over the past year (this was before its earnings report on Tuesday, which cause the stock to fall 3% in after-hours trading overnight. So Apple may end up flat, and in doing so is the laggard of the five.)

Meanwhile, Alphabet has risen 23% in the past year, while Microsoft has risen 26%, Facebook is up 36%, and Amazon is up 47%. All four of them have hit an all-time high in the past month. Three of them in the past week. Think about that. If you had bought these stocks at any time after they went public, the odds are very, very good you are in the money right now.

Alibaba is beating them all, with a 50% gain in market value over the past 12 months. That these five tech companies – five of the biggest ten – have risen between 20% and 50% during the past 12 months says something about the amount of capital flowing into this sector. Maybe those dollars have nowhere else to go (okay, they have nowhere else to go), but this says a lot about how investors are thinking about big tech.

Compare that with QNET, the Nasdaq's Internet Index, which includes these large-cap stocks as well as smaller fare such as eBay, Twitter, and Web 1.0 relics such as 1-800-Flowers.com and EarthLink. QNET is up 16% over the past year.

Yes, that's much better than the Nasdaq Composite's 5% gain, but remember that the Nasdaq indexes are weighted to favor large-cap giants. Filter the biggest ones out, and many of the remaining, smaller tech companies haven't done so well. eBay, for example, is up a modest 3%, while Twitter is down 45% and Earthlink is down 27%.

Compare that with the IPO class of 2016. While Twilio and Acacia are trading above their first-day levels, others are not. Nutanix has declined 21%, NantHealth is down 29% and Secureworks is down 18%. Even Twilio, perhaps the star IPO of 2016, is losing steam, having lost 43% in the past month despite its early post-offering rally.

It takes far less capital to push up a $3 billion market-cap company like Twilio than it does a $500 billion behemoth like Alphabet. From a liquidity standpoint, the giants are pulling in much more investor love. And in a week when a company like AT&T (with a relatively minor value of $222 billion) and Time Warner (with an even punier $66 billion value) feel they have to merge to remain competitive, this should provide all the evidence you need that the future of tech belongs to the big.

This may not be surprising, but it's also not always been the case. Two decades ago, VCs backing Amazon crowed that Wal-Mart had no idea what was about to hit. Just as, a few years later, anyone paying attention knew that Blockbuster's ubiquitous chain of video-rental stores was vulnerable to Netflix. But Amazon has no comparable rival today. Bezos 2016 has no fear of Bezos 1996. Nor is there a young Netflix that can challenge its adult counterpart. There is only an older generation of incumbents uniting to fight the onslaught that is Netflix.

The narrative has changed, if not flipped over entirely. It's no longer the new and the scrappy that are taking down the Goliaths. It's the giants that are eating any and all lunches. The incumbents are winning. They can afford the salary and perks to hire the best, and then acqui-hire the few that end up working for a hot startup. Investors see this, and pump another few tens of billions of dollars into the incumbents. And the gap between big and small grows even bigger.

This isn't to say innovation – or even startup culture – is dead. New fields like AI emerge, new companies are founded to solve some unmet need. But more and more of the intellectual talent that drives innovation is moving from the cheek-by-jowl office rental to the sprawling workplex with lush greenery and executive chefs on hand. Maybe giants like Alphabet (now devoted to AI) can peddle back from corporate VC because their HR departments are being just as effective when it comes to pushing capital to entice young talent.

You can argue whether, overall, this is good or bad, but the trend is at odds with the comfy narrative of startup culture that Silicon Valley has long told itself as a bedtime story. In those tales, the Davids win by dint of sheer grit or even desperation. These days, it seems, the Goliaths are winning because that's where the investor capital is heading.