Competition, Regulation and Valuation

By May 7, 2018 Blog

       AT&T has a market capitalization of 196 billion.  Facebook book has a market capitalization more the 2.5 times greater.  Why the difference?  Both can be seen as operating in businesses that have natural monopolies.  The difference is that AT&T has been around for a century and the regulators have caught up.  For decades now, the ability of AT&T to take advantage of the natural monopoly in telecommunications has been constrained by various forms of regulation – particularly anti-trust.  The current lawsuit over the acquistion of Time Warner is just the most recent example.

        Facebook also has a natural monopoly related to the network effects associated with social media.  This allows them to play a central role in buying personal data from consumers and selling it to advertisers.  The purchase price is the free service the company offers.  This business model is much newer than telecommunications and it has left regulators in its wake – just as AT&T did it the early years of its operation.  But eventually the regulators will catch up.  They will become concerned about the natural monopoly.  They will worry about the operation of a market in which consumers “sell” their personal data without understanding fully what they are doing and whether they are getting fair compensation in the transaction.

       The same lag is true of other “technology” companies like Uber and Air BNB.  To date they have been large exempt from the detailed regulations imposed on hotels and taxi companies.  This exemption has played a big role in supporting their sky high valuations.

        For investors considering buying stock in companies like Facebook at today’s lofty prices, the key is spending the time trying to understand how regulation will evolve.  Yes, a natural monopoly could be incredibly valuable if it were allowed to expand unchecked, but that has never happened.  In businesses from railroads, to oil, to telecommunications, growing power has been met with added regulation.  It would be foolhardy to assume that something similar will not happen to today’s tech giants.