Press Article: Australian Financial Review

Written by Patrick Commins, Australian Financial Review, 28 March 2018

Facebook's follies are looking contagious. The social network and its fellow Wall Street tech darlings had their worst session in around three years on Tuesday night as investors continued to fret that the reputational damage suffered by Facebook will tarnish the rest of the industry.

At least one investor reckons Twitter is next to feel the brunt of popular opprobrium. Short sellers Citron Research said it is betting against the company because: "Of all social media, they are most vulnerable to privacy regulation". I haven't heard of Citron. They may be a big name on Wall Street, but they certainly have a flair for the dramatic. In any case, the market took heed and the stock plunged 12 per cent.

Advertising revenue-based tech companies have had a torrid time of it over the past month. Facebook is now down 16 per cent and Twitter and Google (actually Alphabet) have dropped 10 per cent, on Thomson-Reuters data. That has spread to other corners of the sector: Apple is off 5.6 per cent and Amazon 1 per cent.

All of which sounds bad, but the losses need to be understood in the context of how far these names have climbed, Munro Partners chief investment officer Nick Griffin says. Over the past 12 months Google is up 20 per cent and Twitter an incredible 87 per cent. Facebook shareholders are a more modest 8.7 per cent higher from a year ago, while Amazon's share price has added 77 per cent.

Those type of gains lend themselves to the notion that recent selling has, at least in part, been a matter of profit-taking.

"I think there is something real behind it - it would be blasé to ignore political and regulatory concerns around the use of data," Griffin says, adding that his fund has trimmed its positions this year to its holdings in Facebook.

But, he adds, "as growth investors we are still exposed to these sectors without a doubt". "We believe the main players involved today will still be the main players in 10 years".

Ultimately the test for the likes of Facebook will be whether users vote with their feet and leave the platform, Griffin notes.

Nick Edgerton of Stewart Investors has avoided the likes of Facebook. Edgerton and his team are long-term investors who put their money in companies around the world which "are well positioned to benefit from, and contribute to, the sustainable development of the countries in which they operate".

The social network doesn't pass the "sustainable test". First off, Edgerton says there should always be a "question mark" around the around the long-term prospects of companies where "fashion" is an element. After all, now largely defunct MySpace was the world's biggest social network between 2005 and 2008. At one stage in 2006 the site was attracting more visits than Google. So things can change, and that is not the type of model that you can have faith in on a decade-long view, Edgerton reckons.

Facebook's revenue model is based on advertising, and over the past six months major advertisers have threatened to pull their business. Why? In the words of consumer goods giant Unilever, because they "will not invest in online platforms that create division".

Which brings us down to brass tacks: do you or I want to invest "in online platforms that create division"? Perhaps not. This week BetaShares made its decision and pulled Facebook from itsethical exchange-traded indexed fund.

The good news is that Edgerton reckons there are plenty of tech companies which can make you money but won't make you queasy. He highlights three American firms.

First is Jack Henry, a $US9 billion business based in Monett, Missouri, a town of 9000 souls and about as far away from Silicon Valley as you can get. They provide core banking software, payment processing, security and IT outsourcing to half of the country's credit unions and is the largest provider to mid-sized banks (there are an incredible 7500 banks in the US).

"The CEO is the new guy in the executive team, having joined 19 years ago," Edgerton quips. "They have maintained the founder's philosophy of taking care of your employees and went into the GFC downturn with net cash so were able to get through without lay-offs."

Jack Henry has 80 per cent recurring revenue and customer retention at 99 per cent, while employee turnover is single digits. They have compounded operating cash flow at 17 per cent on a compound annual basis for 20 years. Not bad for a company an hour and a half from the nearest airport.

The $US14 billion Ansys is also a world away from Silicon Valley, based 30 minutes outside Pittsburgh. The company "provides multi-physics simulation software which enables businesses to design for better efficiency and remove waste", Edgerton explains. "This can be applied to developing an improved industrial turbine, a more fuel efficient internal combustion engine, the detailed design of a car or aeroplane for wind efficiency, a longer lasting battery, a computer chip with dramatically lower power consumption," and so on and so forth. The company has a global reach and is taking on new customers at a rate of more than 1000 a year.

Last is Cerner, which provides healthcare IT vendor systems in more than 25,000 facilities worldwide, including hospitals, physician practices, and laboratories.

"Their software and capture of patient data has been instrumental in taking cost out of the US healthcare system," Edgerton says. The Kansas City-based company is another business with a solid balance sheet, Edgerton says, and has compounded operating cash flows at 25 per cent annually for 20 years.

Article attribution: Australian Financial Review

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views or position of Stewart Investors.