Written by Jeremy Gleeson. Portfolio Manager, Equities. AXA IM.
Originally featured on AXA Investment Managers.
The coronavirus pandemic has rapidly accelerated the digitalisation of the global economy. Lockdowns meant adapting to a new way of life, they meant the world had to be more digitally interconnected than ever – and this environment drove a significant shift in demand across a plethora of sectors - from entertainment and retail, to technology services and cyber security.
And even with economies re-opened and restrictions eased, the backdrop for these industries continues to flourish. We have identified several key areas within the digital economy which are driving its growth - discovery, decisions, delivery, as well as data and enablers. Together they are creating a widespread pool of investment opportunities across the entire value chain, as digitalisation becomes an ever-greater part of our lives.
Below we examine each of these areas in more detail, examining what we see as some of the strongest long-term investment opportunities.
‘Discovery’ is all about how consumers search for, and identify products and services, and how businesses attract new customers.
COVID-19 was responsible for a boom in e-commerce as lockdowns meant that a greater number of people than ever before were shopping online. This created a greater opportunity for online advertising, and companies operating in the social media space.
This has proved a highly beneficial for many firms working in this universe where they help large corporates with vast international customer bases better engage with their clients online.
Among the companies helping brands to harness social media and the internet more broadly is Hubspot, which offers tools for businesses to gather and analyse data and to help convert leads into sales. Its latest earnings figures showed a 47% year-on-year jump in revenue in the third quarter (Q3) of 2021, as small and medium-sized businesses increasingly scaled up their digital operations in the wake of lockdowns.
Sprinklr is another company helping businesses manage their social media channels, and it saw its own Q3 revenue jump by 32% year-on-year. The bulk of that expansion is made up of subscription growth – and such recurring revenue streams can be highly attractive for investors seeking some degree of potential future earnings’ visibility.
‘Decisions’ covers e-commerce companies, web portals and mobile apps which provide consumers with convenient and reliable product choices.
The pandemic rapidly increased the popularity of streaming services. Netflix, for instance, reported almost 22% more paid subscribers at the end of 2020 compared to the end of 2019, and 9% more still at the end of 2021.
However, as lockdowns faded, there were some concerns that such firms would endure a fall in subscriber numbers. However, it appears that online media consumption has become the ‘new normal’. While Netflix has seen a post-lockdown dip in subscriber growth, its subscription base has remained strong, helped undoubtedly by its continued drive to offer new content. The past year has seen it enjoy huge success with international hits such as The Queen’s Gambit and Squid Game – the latter of which was streamed by more than 142 million households, making it the streaming service’s most-watched series to date. Netflix has recently increased prices by around 10% for its US and Canadian customers, indicating it is confident its content can retain subscribers going forward.
Equally Disney+ reported that it had 118.1 million subscribers worldwide as of its fourth quarter (Q4) of 2021 – marking subscriber base growth of some 92 million since the start of the fiscal year of 2020.
Within the retail sector, we believe that while premium shopping areas may retain flagship stores, far more transactions will be completed online due the greater range of products available, ease of comparability and simplicity of transactions.
Online retail over the holiday season was expected to top $200bn for the first time though on Black Friday - on 26 November - one of the biggest shopping days of the year, online sales dipped slightly to $8.9bn from $9bn in 2020.
This could reflect the fact that some retailers started promotions earlier than usual, in part to avoid logistics and supply problems. However, Singles Day - China’s biggest e-commerce phenomenon, which takes place each 11 November, broke records in 2021, with gross merchandise value growing 8.5% to ¥540.3bn ($84.5bn) – though the pace of growth was the slowest ever as Chinese technology firms experienced tricky regulatory and supply chain challenges.
‘Delivery’ covers those companies which help facilitate and secure payments and logistics to keep pace with consumers’ increasing expectations of rapid dispatch and same-day delivery. This is a diverse area that spans companies in the payments space, cyber security, logistics and real estate.
While we expect revenues to grow as shoppers continue to return to the high street, online sales are likely to remain strong. The arrival of a new coronavirus variant - Omicron – has stirred up further uncertainty and put activities associated with travel and leisure in doubt but we believe the pandemic has accelerated the scale of opportunities for payments providers.
At the same time, we believe some debit and credit card providers have not benefited fully yet from the reopening of economies after lockdown and are likely to receive a boost from increased international travel when new restrictions ease.
For example, the revenue recorded by payments’ companies fell in 2020 because of the pandemic, but McKinsey projects a return to historical mid-single digit growth rates in 2021, in tandem with increased adoption of electronic and e-commerce transaction methods.
The e-commerce boom has meant that many retailers need to rethink the structure of their supply chains to meet consumers’ expectations of items always being in stock and available for next-day or even same-day delivery. This has created additional opportunities for companies offering automated warehouse solutions as well as warehouse real estate, such as Goodman Group, which recently reported better than expected results and significantly raised guidance, supported by the tailwind of increasing demand for logistics space for e-commerce. Meanwhile Prologis said space was “effectively sold out”, with high demand also driving record increases in rents and valuations.
Delivery firms have also benefited, such as Deutsche Post DHL, which reported a 23.5% increase in revenue in Q3 2021 compared to the same period a year earlier.
Cyber security is also a critical issue that has come increasingly under the spotlight as more people work from home and more transactions are conducted online. For example, cyber security company Tenable reported a 23% rise in Q3 revenue, citing “unprecedented demand” as more companies move to cloud-based computing.
Data and enablers
‘Data and enablers’ together refer to companies that provide technologies or services that help their customers adopt a digital ethos.
IT services companies, such as Accenture at the larger end of the spectrum to Endava and Globant at the smaller end, have enjoyed good growth as businesses undergoing digital transformation seek help from experts to hone their digital strategy. We have also seen good potential investment opportunities in companies exposed to the digitalisation of the back office, such as Workday and Paylocity, which handle services such as payroll processing and human resources management. In November, Workday announced a 20% rise in third-quarter revenue year-on-year while Paylocity reported a 34% jump in revenue for its fiscal first quarter.
As businesses resume hiring post-lockdowns and the job market improves, they may need to navigate changing employee expectations as well as new legislation for employers. A report by Paylocity and Deloitte recently highlighted how automating certain processes can be more efficient in this new working environment, saving businesses time and money.
Companies that were traditionally offline need expertise from third-party specialists to compete in the new environment with ‘digital natives’; that is, companies that were originally designed to operate online.
New Relic, for example, is a cloud-based platform that allows companies to collect, store and analyse data in real-time. This helps firms to better understand a customer’s journey on their website and build on that learning to potentially encourage more people to make a purchase. For many companies this type of service has gone from being ‘nice to have’ to a ‘must have’.
The reopening of economies has however brought its own set of issues including supply chain bottlenecks, labour shortages, inflationary pressures and resurgence of the virus in some areas. But we continue to believe that the opportunities driven by the long-term themes of the digital economy remain intact.
While the COVID-19 pandemic accelerated the digital transformation for many companies, it has been a long-term structural trend, with new opportunities that will continue to develop over time as new technologies and consumer trends emerge.
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At AXA IM our purpose, to act for human progress by investing for what matters, is central to every action we take as a business. As a responsible asset manager, we actively invest for the long-term to help our clients, our people and the world to prosper. Our conviction-led approach enables us to uncover what we believe to be the best global investment opportunities across alternative and core asset classes. We are already entrusted with more than €860 billion in assets. Working as part of the AXA Group, a world leader in financial protection, our team of over 2,400 people2 around the world combine a range of specialist skills and experience to best serve the needs of our clients. The combination of responsible, active and long-term defines our investment philosophy, but also how we run our business, what underpins our clients’ partnerships with us, and what drives our people.