The Mega Era: Will Microsoft, Alphabet, Meta, Amazon always be invincible?

If the consumer internet in China in 2023 is described as "the fall of the gods, followed by the rise of the new generation", then the consumer internet in the US stock market is dominated by giants.

If we list the technology consumer internet companies with a market value of over 10 billion US dollars in China and the US according to their market value, a very intuitive feeling is that it is the Chinese internet companies that have suffered setbacks, while most of the US stock market giants have regained lost ground.

As part of the comparative study of the Chinese and American internet, this research by Dolphin Research focuses on two main questions:

Why is the consumer internet in China a stage for various players to perform, while the consumer internet in the US stock market appears to be dominated by giants? How should we view the differences in the competitive landscape of the consumer internet in the US stock market?

How should we view the investment opportunities in the consumer internet in the US stock market in 2024 and beyond?

Here are the details:

I. Is the dominance of giants eternal? Ghost stories exist, but they are ultimately false alarms

Looking back at the history of the five internet giants in the US stock market over the past seven years, except for the industrial internet company Microsoft, the other four consumer internet giants have all experienced some ghost stories to varying degrees:

a. Apple with a P/E ratio of 10x in 2018: After the penetration rate of smartphones reached its peak, industry competition intensified, mainly due to the rise of Huawei. Other factors such as the failure of iPhone X were mainly due to product cycle issues; Apple, without major hardware innovations, was more like information noise.

Actual deduction of logic: The core issue was that Huawei's overseas business was undermined in the trade war; other issues such as product cycles and overpricing naturally improved; at the same time, with smartphones solidifying their position as the primary gateway for mobile data, the P/E ratio soared to 30x.

b. Meta with a P/E ratio of 7x in 2022: After the user penetration rate reached its peak, industry competition intensified. On one hand, there was the issue of Apple's privacy policy affecting the distribution of internet advertising cake, and on the other hand, there was the threat from the rising star TikTok. Another minor reason was the heavy investment in secondary business AR/VR, which had little short-term output and quickly led to a decline in ROE.

Actual deduction of logic: Apple's privacy policy was a technical adjustment and did not have a lasting impact in the long run; however, this indirectly prompted Meta to focus on AR/VR, betting on the next phenomenon-level hardware entry point, which is currently in a state of retreat after failure; TikTok is facing a hearing in North America, and its future is uncertain, leading to a return of advertising investment to traditional platforms, and there are also signs of user DAU returning. By the end of 2023, the crisis was narrowly averted, but the fundamental problem remained unchanged.

c. Amazon with a P/S ratio of 1.6x in 2022: On both ends of the industrial and consumer internet, there was a mismatch between investment and output in the consumer internet, leading to a collapse in performance; on the industrial internet side, competition intensified, with Microsoft squeezing market share, and the economy weakened, leading to a cyclical downturn in the industrial internet. Logical Deduction Result: The consumer internet corrects its input-output ratio, and profits are quickly released; competition continues to worsen, but the weakening economy is refuted.

In summary, it can be seen that the mature consumer internet, in the three major factors that determine the relative strength of stock prices - its own input-output (product) cycle, industry cycle, and industry competition deduction, what really needs to be guarded against is the deduction of industry competition expectations.

From a macro, industry cycle, and product cycle perspective, in the long run, it simply affects performance and valuation. However, after the cycle, stock prices can still rise. In a stock market with existing stocks, the deterioration of industry competition completely kills the logic of stock prices, and there is no lower limit to how far they can fall.

And if the final logic is refuted, the investment opportunities brought about by this reversal of predicament are also the greatest. Its returns are no less than finding the next stock that will increase tenfold.

So, the question is, what kind of industry and industry competition cycle will the US internet giants face in 2023? And what about 2024?

II. 2023: Excess returns brought about by the correction of income and expenditure mismatch

In fact, Dolphin Research has already elaborated on the common cycle of the giants' decline in the US stock market at the beginning of this year in the comprehensive overview of the US stock market, "Apple, Meta, Amazon: Who is swimming naked after shedding the 'pandemic fat'?".

This chart clearly shows that the two companies with real problems behind the decline of the giants in 2022 are Meta and Amazon, with significant income and expenditure mismatch. Among them:

a) Amazon: Due to significant income and expenditure mismatch, the key for Amazon is the marginal improvement of profit margin. On one hand, it relies on continuous revenue growth that outperforms the industry, and on the other hand, it relies more on prudent investment.

c) Meta is facing a predicament brought about by the resonance of three cycles. It is a stock that truly focuses on the reversal of predicament. At a low enough price, when Meta starts to clearly reduce investment spending, it will have considerable elasticity.

So, the process of correcting the income and expenditure mismatch in 2023:

a) As of the third quarter of this year, even Microsoft, which is supported by AI logic, has seen a decline in its total number of employees. Meta and Microsoft have the most significant decline in the number of employees. In comparison, Amazon, which previously had a large number of new hires, did not see a significant reduction in its workforce.

b) In terms of another key observation item for corporate investment - capital expenditure, Microsoft is the only exception. In the case of AI driving the growth logic of the industrial Internet, Microsoft has only increased its capital expenditure while developing human resource reuse, which includes investments in servers, bandwidth, and other areas.

However, other consumer Internet companies have all reduced their capital expenditure, with the most significant reduction being seen in Amazon. In this wave of cost reduction and efficiency improvement, Amazon has mainly optimized its capital expenditure rather than human resources. One possible reason for this is that the US e-commerce market has entered a period of same-day delivery-driven fresh food and grocery dividends. While the delivery workforce cannot be reduced, profit margins can be increased by improving the connection and efficiency of warehousing, logistics, and fleet management.

1. As for the final improvement in operational efficiency, the most significant improvement is mainly seen in Meta and Amazon. Google and Apple, which already had relatively good performance, showed relatively average improvement.

The improvement in Microsoft's performance is partly due to the recovery of its PC business in the consumer Internet sector, and partly related to the incremental Office business brought by AI.

III) Covering both internal and external markets, each holding its own ground

If we say that there is no essential difference between the cost reduction and efficiency improvement of the US stock giants in the past year and the cost reduction and efficiency improvement of China's Internet industry in the past two years after the epidemic, then the main difference between the core of the Chinese and American Internet lies in the revenue side.

a) US stock giants are more cyclical than China's Internet

The epidemic has further driven the onlineization of the Internet population and business, benefiting both Chinese and American Internet companies. However, from the post-epidemic period to 2023, both the Chinese and American mobile Internet have basically entered a cyclical phase.

One counterintuitive observation is that the cyclical nature of the US Internet is actually more severe than that of China. The revenue growth of US Internet giants has basically synchronized with the nominal GDP growth. However, considering the revenue of Chinese Internet companies, such as ByteDance, after the third quarter of 2023, the commercial growth of China's Internet can still clearly exceed GDP growth.

After the anti-monopoly measures following the epidemic, the rise of emerging Chinese Internet giants such as ByteDance and Pinduoduo has driven higher commercial efficiency, resulting in even higher growth rates in China's online business than GDP growth.

b) Domination in both domestic and international markets, stronger resilience against economic fluctuations

Compared to Chinese internet giants, the overseas market share of American internet giants is generally around 50%. Their success in internationalization also means that when the US economy weakens and the US dollar depreciates, the devaluation of the exchange rate can lead to an increase in non-US income growth. They have better resistance to cyclical fluctuations compared to their American counterparts. Moreover, with their domestic income as a stronghold, their income performance will not be too poor even during the current period of strong US economic growth and a strong US dollar.

c) "Always trying, never broken"

Both Chinese and American internet giants have been striving to reduce costs and increase efficiency after the epidemic, and they have also experienced the cyclical nature of the industry's maturity. Even the relative growth rate of the Chinese internet industry is still relatively good. So, what makes the American giants stand out?

One key difference is that after the cyclical period, the Chinese economic landscape deteriorated, while the American internet giants remained relatively stable.

In China, both internet advertising and e-commerce have undergone a reshuffling of user engagement and commercial monetization share through the penetration of short videos and the expansion into lower-tier markets. However, in the American internet business, although there have been changes in user volume and engagement, there has not been a significant impact on commercial monetization.

Regarding the deep excavation of the underlying factors, there are several interesting findings:

a) In terms of the rural population, the large number of permanent rural residents in China has basically determined that the penetration rate of Chinese netizens has always been lower than that of the United States. The increase in the internet penetration rate among China's rural population was achieved through the penetration of smartphones and the consumption of short videos from 2017 to 2020. In contrast, the United States experienced a one-time non-linear increase of 11 percentage points in 2015-2016, and then entered a stable state.

b) In the case of China's severe urban-rural dual structure, the online transformation of the secondary population, mainly in lower-tier markets, has led to a significant change in the consumption patterns of the internet. This is why we have seen the rise of three popular apps in the lower-tier markets: Toutiao for news consumption, Pinduoduo for e-commerce, and Kuaishou for short video consumption. The COVID-19 pandemic has further accelerated the growth of short video consumption in China, with a 10 percentage point increase in penetration rate from 2020 to June 2023.

The emergence of short videos in the United States did not coincide with the emergence of new internet users. It was more of a "foreign product" brought by ByteDance's expansion and the catalyzing effect of the pandemic. In the United States, short videos are not an endogenous, primary form of content consumption. However, in China, for example, when ByteDance discovered the large natural demand for short video consumption within Toutiao, they created a separate app dedicated to videos. The key is that after three years of total duration growth catalyzed by the pandemic, the high growth of total duration on social platforms in the United States (Facebook, Youtube, IG, and Tiktok) is no longer present after entering 2023. It has completely turned into internal transfer of duration.

In the case of total duration growth rate entering a relatively steady state, the per-user market consumption of Tiktok's short video users is not different from the per-day consumption duration of Chinese users. It is still that addictive form of short videos.

The duration of Reels on Instagram is closer to the current user duration of Video Number. Overall, there is no essential difference in per-user duration between short videos in China and the United States.

The main problem lies in the total number of users. The short video market in the United States has gone through a period of rapid growth, but the penetration rate of both Ins and Tiktok among American netizens is still only at the level of 50%-60% (adjusted for internet penetration rate), which is still far from the highest penetration rate of interpersonal socializing (represented by Facebook at 83%).

China, on the other hand, had already achieved a penetration rate of 70% among netizens before the pandemic. In the first half of 2023, the penetration rate of short videos among Chinese netizens reached 95% (relative to the Chinese netizen population), almost the same as the penetration rate of instant messaging, which is mainly based on interpersonal socializing.

Looking at different platforms, after being attacked in congressional hearings, Tiktok's growth in the United States has stagnated, and there is a tendency for users and duration to shift to Instagram under Meta.

In summary, at least two key differences can be observed in the short video market in the United States:

1) In China, where there is a rural-urban divide, short videos as a new form of content consumption have accelerated the penetration rate among netizens, bringing incremental users. On the other hand, the short video market in the United States lacks a clear logic of incremental users and has not significantly increased the internet penetration rate among American netizens. It is more about the competition for attention and duration among existing users.

2) With a relatively limited monetization model in the upper layer and a user penetration rate of only 50-60%, there are signs of a slowdown in the growth of short video users. At the same time, TikTok's growth momentum in the US has been significantly affected after the hearing, and its ability to challenge giants seems to be greatly impacted.

Is it because the content consumption patterns in the US are more diverse, with stronger competition in medium and long videos compared to China?

Or is it because the proportion of short video ads in the US is too high, and diversification of monetization has not been achieved, resulting in a lack of mutual promotion between users and viewing time, and the current state is only a halftime break?

Dolphin Research is currently unable to provide an accurate judgment and can only track through continuous observation.

III. Midfield competition in the US mobile video market: The monetization battle begins

Overall, with the rise of TikTok in the 5G era, the landscape of internet users and viewing time in the US has indeed changed. However, based on the trend in recent months, the competition for viewing time among US internet giants has slowed down. It seems that Meta and Google can breathe a sigh of relief. But is it really the case?

Looking at the competition in the Chinese short video era, Douyin (TikTok in China) first focused on acquiring users and viewing time, and then introduced monetization. After multiple layers of monetization, users and viewing time were mutually promoted.

However, in the current US market, TikTok's main source of revenue, apart from tipping, is still weak in terms of advertising monetization, and e-commerce and corresponding live-streaming e-commerce have not been fully developed.

Firstly, in terms of advertising, based on estimated data from media disclosures, TikTok's advertising revenue should be around $17 billion, surpassing vertical advertising companies like Snap and Twitter in terms of average quarterly revenue. However, in terms of shaking the dominance of giants, it still has a long way to go and is basically at the level of Microsoft's LinkedIn and Bing.

Short videos, as a content consumption format that is more suitable for advertising with its shorter duration (compared to mid-length and long videos with intrusive and interruptive ads), do not seem to demonstrate strong advertising monetization capabilities in the US. Based on some research information, it seems that TikTok's current strategy and the attempt to replicate the Douyin model locally have encountered some problems, resulting in a less smooth monetization process.

Moreover, TikTok in the US seems to have plans to accelerate monetization: By 2024, the GMV (Gross Merchandise Volume) of US e-commerce may increase tenfold to $17.5 billion (TikTok's global GMV for the whole of 2023 should be around $20 billion, with the main contribution coming from Southeast Asia).

In addition to strengthening monetization itself, there also seems to be an intention to enhance user stickiness through e-commerce/live-streaming. From the perspective of monetization, it seems that TikTok has started to focus on monetization under the competition between duration and users. In addition, its current share of monetization does not match its share of duration.

Dolphin Research tends to believe that the competition in monetization for TikTok is not over yet. It is also necessary to continue observing whether TikTok can further drive user and duration growth if it can streamline monetization in the future.

IV. How to view the investment opportunities in the US Internet market in 2024?

After analyzing the above content, there are several general judgments:

a) From the perspective of US Internet companies reducing costs without affecting revenue in 2023: as long as the competitive landscape remains stable and there are no major competitors to disrupt the competitive landscape, as a monopolistic business in the process of population onlineization, the revenue side can still follow the growth of nominal GDP even after the worst cycle of revenue becoming a stock business.

The main input on the cost side, servers, is a deflationary product, and as long as no new business is developed, the workforce does not need to continue to grow and can even be reduced.

In other words, even if the consumer Internet loses its growth potential and enters a stock market situation, as long as the competition remains stable, the monopolistic Internet giants can still have a good business with revenue inflation and cost deflation, continuously improving profit margins. Their global layout also makes them more resistant to revenue fluctuations.

b) However, the current problem is that in the era of mobile video, even if US Internet companies have not suffered the same fate as Chinese Internet companies being destroyed by new short video giants, and it seems that the mobile giants have reversed the situation in the user and duration war and held onto some territory, the monetization potential of US TikTok short videos has not been fully tapped. It is still uncertain whether it is a halftime break in the competition or the endgame. Dolphin Research tends to believe that it is in a state of halftime adjustment and the alarm of competition has not been completely lifted.

c) Purely in terms of the progress of correcting the mismatch between input and output, by the third quarter of 2023, there is little space left for each company. Unless there is assistance from industrial Internet like Microsoft, there is already very little room to improve profit margins from the perspective of layoffs and reducing capital expenditures.

And in the performance signals of the third quarter, whether it is Meta's plan to increase capital expenditures in 2024, Amazon's increased efforts in recruitment, or Google's suspension of layoffs, facing the new interactive AI, all Internet companies in 2024 have increased capital expenditures and stopped absolute layoffs.

Of course, there have been recent news about Google laying off its hardware services department and Amazon laying off its streaming media business, but currently, from the perspective of the entire industry, the phenomenon of layoffs has basically subsided.

The profit growth rate in 2024 will gradually return to the growth capability of revenue itself, and the cyclical Internet is highly dependent on the macro nominal GDP growth rate. Currently, the market generally expects the GDP growth rate in 2024 to slow down.

d) In the past two years, the valuation of US stocks has closely followed the fundamentals. As two driving factors for stock price growth, when EPS (earnings per share) increases, PE (price-to-earnings ratio) also tends to expand, resulting in a Davis Double-click effect. This year, under the drive of EPS growth, PE has also expanded synchronously (except for Apple, which only experienced valuation expansion without significant profit growth). The average increase in stock prices of the five internet giants is around 50%.

Looking ahead to 2024, the valuation recovery of these giants is mostly in a neutral to optimistic state. Unless AI can significantly improve efficiency and achieve unexpected cost reduction and efficiency improvement, in Dolphin Research's view, 2024 may be a year of generating excess returns for these giants compared to 2023.

Especially for Apple, there may be significant pressure in terms of the match between valuation and fundamentals. Dolphin Research will provide a comprehensive analysis of the investment value of these giants after the disclosure of the fourth-quarter earnings report. Stay tuned.

Previous summaries of the US stock market:

September 25, 2023: "The 'Brotherhood' Behind NVIDIA and Tesla, Can They Continue in the Second Half of the Year?"

June 19, 2023: "Unraveling the Mystery: Where Did the Expected US Recession Go? Will It Still Come?"

February 17, 2023: "Endless Dilemma in 2023: Is the US Stock Market in Deep Recession, Shallow Recession, Stagnation, or Growth?"

January 16, 2023: "The Changing Landscape of Hong Kong A-shares' Cost-effectiveness and the 'Danger' and 'Opportunity' Situation in the US Stock Market" On November 8, 2022, "Amazon, Google, Microsoft: Falling Stars? The Meteor Shower in the US Stock Market Continues" was published.

On May 30, 2022, "Only Recession Can Defeat the Inflation Tiger in the United States?" was published.

On May 9, 2022, "Surrounded on All Sides, Can the US Stock Market Survive the Light Version of the Oil Crisis?" was published.

On February 14, 2022, "The Carnival in the US Stock Market Ends, Too Many People Are Skinny Dipping" was published.

On December 3, 2021, "The Flood is Coming to an End, Do Google, Meta, and Netflix Have a Second Half?" was published.

Risk disclosure and statement for this article: Dolphin Research Disclaimer and General Disclosure