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The Lex newsletter: rates realities trash stocks of the metaverse builders

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Dear reader,

The brilliant digital artist Simon Stalenhag imagined a dystopian future in his 2018 book The Electric State. Here, jaded Americans checked out of reality by tapping online narcotics via Oculus-style virtual reality devices. The vision is disturbing given that US tech giants such as Meta Platforms, the owner of Oculus, hope to lure us into the all-encompassing artificial environments known as metaverses.

It is Meta that has been living a nightmare this week. Its shares crashed 27 per cent. The failure of the tech giant’s hubristic Diem/Libra cryptocurrency project ranked as light relief in comparison.

The proximate causes of the share price rout were a slowdown in advertising revenue growth and tougher data privacy rules.

But about $240bn of Meta market value does not vaporise in a few hours simply because quarterly numbers are a tad disappointing. The rout showed that only the tremor of a finger on the market’s hair trigger is required for a tech share to implode. Investors know they have to cut their exposure to growth stocks as inflation drives up interest rates. The question is when to do it. That breeds nervousness.

You could see the same forces at work in the US market’s fevered response to other tech results. PayPal, the payments group which has served as handmaid to the rise of ecommerce, suffered a 29 per cent drop in its shares over two days. Growth is lower because consumers are returning to physical stores. PayPal is battling fake accounts, which Lex believes is a significant problem for Facebook too.

Amazon sales looked weak and its costs steep. But shares in the business of the world’s richest man still rose 15 per cent in after-hours trading on Thursday. You could theorise that cloud computing and ecommerce is a defensive mix.

Lex pointed to the potential for share price collapses at the end of November in a note titled “US stocks: earnings forecasts are perilously high”. The same week, this newsletter followed up with a laundry list of warning signals and the claim that markets were at, or near, a peak.

Strong earnings expectations have preceded previous market corrections

That certainly proved to be true for the tech-heavy Nasdaq index, which has fallen about 14 per cent according to S&P Global. The S&P is about 4.5 per cent lower. The downtrodden FTSE 100, which is stuffed with mature value stocks, has actually risen 3.6 per cent.

Any rotational benefit is masked at Shell by the much stronger driver of energy shortages and a soaring oil price. The results are fat profits and, thanks also to the sale of onshore Permian assets, an $8.5bn share buyback.

So much for renewables. We remain bullish on green energy in the medium term, but are dismayed by the drubbing the sector has received after a year in which the wind simply failed to blow hard enough.

Vodafone, the UK’s other payout champion, has more to gain than Shell from a rotation into value stocks. The shares are up 21 per cent this year. Lex still sees big telecoms groups as ex-growth purveyors of a relatively undifferentiated commodity: telephone and broadband airtime. It is unsurprising that Cevian, an activist with a métier for break-ups, has taken an exposure to the business.

BT, for its part, has a French tycoon on board in the form of 18 per cent shareholder Patrick Drahi. Like Cevian, Drahi has yet to declare his intentions. BT is spinning off its sports rights and broadcasting arm, a vanity project of erstwhile boss Gavin Patterson, into a joint venture with Discovery. Good riddance, Lex reckons.

Banks have defensive qualities of their own in the current rotation. Their investment banking arms will make less money as flotations and takeovers abate. But higher rates should fatten net interest margins. That should help the likes of UniCredit of Italy, which has dodged a bullet by dipping out of negotiations to buy Russia’s Okritie amid worsening east-west tensions.

Santander may yet buy the retail division of Banamex of Mexico, valued at about $6.5bn. Emerging market assets are cheapening as global investors lose their risk appetite. Unfortunately, this means shares in the Spain-based banking multinational are also falling. Lex was unimpressed by decent quarterly numbers. Santander is reportedly on the hook for a €51mn settlement for its bungled attempt to hire ex-UBS executive Andrea Orcel, who is now running UniCredit.

His induction at Santander was the best day’s work he never did.

Growing bearishness will make it harder for buyout groups to raise new megafunds or exit via floats. But they will only become badly exposed to the tech rout if it spreads to the mature, cash-generative businesses that are their stock in trade. Besides, Blackstone has grown too big to take a serious biff. Its market worth of $160bn is way ahead of BlackRock. Blackstone’s assets should hit $1tn this year. BlackRock’s are already at $10tn.

If Tom Nook was human, he would probably work for Blackstone. Instead, he is the Machiavellian entrepreneur in Nintendo’s cutesy Animal Crossing computer game. The cartoon raccoon dog is a canny capitalist. He is represented more modestly than is typical in Japanese popular culture, where outsized genitals are a humorous attribute of the species.

Lex reckons Animal Crossing, with its personal habitats, transactions and shared spaces is a blueprint for a metaverse. But Nintendo needs to increase its proportion of online games to keep up in an industry whose 2021 revenues of $180bn exceeded the world movie industry. The same applies to Sony, which is spending $3.6bn on games developer Bungie.

Personally, I don’t think I’d hook up to a metaverse like the guy in the Simon Stalenhag artwork if all it offered was cartoon raccoon dogs and bunnies in Hawaiian shirts. We already spend half our working lives gazing at screens. It’s pleasant to go offline for a while, particularly when stocks are crashing.

Have a relaxing weekend, however you spend your downtime,

Jonathan Guthrie
Head of Lex


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