Historical Impact of Regulation on Big Tech A Case Study by Manning & Napier Originally Published: January 2019 www.manning-napier.com Introduction After years of growth, the information technology sector is facing renewed regulatory scrutiny over its size and power. The inquiries have come at a time when the roles of privacy, fake news, and information bubbles are being challenged in our increasingly digital lives. While little has derailed the internet giants thus far, calls for government oversight are on the rise. With the immense scale and market power of these companies, we should expect regulatory scrutiny to be an ongoing issue. To better understand the consequences of ongoing regulatory scrutiny, Manning & Napier’s technology group looked at past tech industry leaders that faced similar bouts of government oversight, and analyzed the regulatory impact on historical stock performance. The Process In conducting the analysis, our team analyzed eight US-based technology companies that were dominant in their respective eras. Within the companies, we identified 54 discrete regulatory cases from 1900 through the present day1 . We built regulatory timelines for each case and measured the before and after stock price returns per case, per company. Additionally, among the identified cases that led to a significantly negative impact, we observed key warning signs. 2 www.manning-napier.com Key Takeaways The Companies Studied Regulatory scrutiny is usually a non-event. IBM • The vast majority of the tech companies IBM’s first brush with anti-trust scrutiny was reviewed posted strong absolute and relative in 1932. Then again in the 1950s. The famous returns well beyond their first brush with 1969 -1982 case was actually IBM’s third brush with regulators. the Department of Justice (DOJ), and the case was dismissed. • In most regulatory cases, there were few negative outcomes, if any. Microsoft (MSFT) • In some cases, there was a moderate impact, The DOJ and European Commission (EC) first but the regulatory requirements were usually looked at Microsoft in the early 1990s, with the not material and not always bad. Federal Trade Commission (FTC) starting its investigation in May of 1990. This was a full six • In a few cases, the regulatory outcome was years before the more widely recalled DOJ case in significant and harmful to both the business 1996 through 2001. and stock performance. AT&T (T) Regulatory scrutiny is not an automatic sell AT&T was investigated by the DOJ in 1913, signal. nationalized during WWI (1918), investigated by the • Rather, it is an ongoing issue that should DOJ again in the 1950s, and a third and final time be expected with the world’s most dominant in 1974 - 1982. As with IBM and MSFT, the case companies. everyone recalls is the last case, when AT&T was broken-up. Regulation can become a sell-trigger when it Kodak (EK) meets the three criteria below: The DOJ first investigated Kodak in 1913, and • Regulation had a fundamental impact on then again in 1951. Private anti-trust cases were the business by creating new competition or launched in 1973 and 1987. The DOJ consent materially changing the business economics. decrees were actually overturned in 1994. • The stock was over-valued entering Google (GOOG) the period of regulatory scrutiny and Google has been under non-stop investigation since underperformed due to regulatory-driven the EC opened its case in February 2010. multiple compression. • The future intensity of government oversight Qualcomm (QCOM) increased, representing a clear turning point Like Google, Qualcomm has been under in the degree and style of tech company investigation since an EC case in 2005. Its legal oversight. battles with licensees extend back to 1996. Otherwise, investors are best served to remain Intel (INTC) focused on the fundamentals of the business. The first case was initiated in 1991, and an EC appeal remains ongoing. Investors may overestimate the impact of regulatory sanction. Xerox (XRX) Xerox was placed under anti-trust investigation in • We believe there is a human propensity to 1973 and was sued again in 1992. only remember the last case, which is often the most impactful, and forget all of the immaterial cases along the way. www.manning-napier.com 3 Strong Historical Performance In our most basic analysis, we looked at the total return of tech stocks that came under heavy regulatory pressure from the time of the first regulatory scrutiny through today. Performance was then compared to the total returns of the S&P 500. Five of the eight companies outperformed the S&P 500 from the initial regulatory case through the present day. The median excess annual return was ~3.0%. The results are below2. S&P 500 Ticker First Regulatory Annualized Excess Return Episode Return Return T 12/13/1913 11.0% 9.2% 1.8% IBM 12/31/1932 10.2% 7.1% 3.1% MSFT 05/01/1990 20.3% 10.0% 10.3% INTC 06/29/1991 16.9% 9.8% 7.1% QCOM 10/28/2005 4.6% 9.1% -4.5% GOOG 02/10/2010 18.0% 13.3% 4.7% EK 06/19/1913 2012 Bankruptcy XRX 01/29/1973 4.2% 6.8% -2.6% Source: FactSet. Analysis: Manning & Napier. Additionally, we found that from the day before the regulatory case was initiated, until the settlement of the case, the tech stocks were up 68% of the time (by a median of 23%) and EPS grew 83% of the time. This hit-rate was similar to the one-, three-, and five-year periods after the cases were settled, implying that regulation is not an automatic sell trigger. See the full results below. All Regulatory Case Ending Case Ending Case Ending Case Ending Cases +1 Year +3 Years +5 Years Price P/E EPS Price P/E EPS Price P/E EPS Price P/E EPS Up 32 17 35 34 26 26 33 23 30 30 18 28 Down 15 25 7 12 16 15 12 17 10 12 17 7 N/A 7 12 12 8 13 13 9 14 14 12 19 19 Total 54 54 54 54 54 54 54 54 54 54 54 54 Observations % Up (ex. N/A) 68% 40% 83% 74% 61% 63% 73% 58% 75% 71% 51% 80% % Down (ex. N/A) 32% 60% 17% 26% 39% 37% 27% 43% 25% 29% 49% 20% Median 23% -3% 26% 14% 5% 16% 20% 10% 35% 46% 7% 48% Average 46% -6% 71% 18% 10% 15% 56% 21% 37% 142% 72% 83% Source: FactSet. Analysis: Manning & Napier. It should also be noted in the preceding exhibit that 60% of the time the P/E multiple compressed during the regulatory scrutiny, while the multiple expanded 51% to 61% of the time after the case was settled. Whereas the share price and earnings were up a median 20%+ during the case, the median P/E was down -3%, suggesting that we should expect some multiple contraction while a company is under regulatory scrutiny. The compression is quite modest, however, and the hit-rate is only ~60%. 4 www.manning-napier.com In addition to studying the reactions to each individual case, we also grouped cases into ongoing regulatory periods, or regimes, to identify sustained periods of increased scrutiny. In other words, if a DOJ case started in 1970 and ended in 1975 and a separate EC case started in 1973 and ran to 1980, we consider the entire 1970 - 1980 period as a single regime. The results of this analysis were similar to our case-by-case analysis. The share price and earnings were up ~75% of the time (median of ~30%) during the regulatory scrutiny period, while the P/E declined 62% of the time (median of ~3%). Discrete Case Ending Case Ending Case Ending Case Ending Regimes +1 Year +3 Years +5 Years Price P/E EPS Price P/E EPS Price P/E EPS Price P/E EPS Up 19 8 17 19 13 13 19 13 12 17 11 13 Down 7 13 4 6 7 7 6 7 8 8 8 6 N/A 4 9 9 5 10 10 5 10 10 5 11 11 Total 30 30 30 30 30 30 30 30 30 30 30 30 Observations % Up (ex. N/A) 73% 38% 81% 76% 65% 65% 76% 65% 60% 68% 58% 68% % Down (ex. N/A) 27% 62% 19% 24% 35% 35% 24% 35% 40% 32% 42% 32% Median 32% -3% 30% 13% 7% 16% 18% 24% 11% 39% 20% 17% Average 63% -4% 108% 20% 14% 11% 51% 34% 20% 131% 128% 54% Source: FactSet. Analysis: Manning & Napier. Similarly, we also studied how our sample of companies performed in periods of regulatory “peace,” when they were not under any active investigations. Surprisingly, 57% of the time their multiple compressed by a median of 2%, which was quite similar to the performance during the periods of regulatory scrutiny. One thesis is that these businesses were already in a maturing phase and multiple contraction was inevitable. The data suggest that it is important to analyze the most likely fundamental impact of the Unchallenged Case Ending regulatory scrutiny and to not just make the blanket Periods assumption that scrutiny is a material negative. We Price P/E EPS find that regulation is typically not a one-time event Up 12 6 11 as these strong businesses with de-facto market Down 3 8 3 monopolies should be expected to come under N/A 1 1 regulatory scrutiny. Total 15 15 15 Regulatory reviews are often a Observations signal of business strength. There is also evidence that incumbents are % Up (ex.