It’s the Pace of Disruption that Matters

  • The focus on disruption has led to rising valuations for technology companies and depressed multiples for traditional sectors including Automotive, Healthcare and Energy
  • Capitalism thrives on disruption, and changes in technology have brought the high standard of living we currently enjoy
  • Transitions in technology often span decades, not years, yet the market prices in immediate disruption
  • This overreaction creates opportunities to find attractive investments in businesses where change is likely to be slower than the market currently expects
  • During the dotcom bubble, investors believed e-commerce would radically change the landscape of the economy. We can conclude that their prediction was largely right. Where the stock market went wrong is in expecting this change to occur overnight
  • Even in the current age of Amazon, e-commerce only makes up 9.5% of total US retail sales, a full 18 years after the dotcom bubble ended
  • Retail customers are creatures of habit, infrastructure is unavailable to support instantaneous change and new companies need to time to scale
  • Similarly diesel, a radical new technology introduced commercially in 1911, offered 50% more efficient engines but had not completely replaced the steam engine in ships more than thirty years later
  • The slow uptake of diesel was due to a limited ecosystem of diesel infrastructure, an immature technology, and inertia among engineers used to working with steam technology
  • We do not doubt electric autonomous cars will achieve a high market share in the future. Electric cars offer a superior driving experience, use energy more efficiently and emit no direct GHG; autonomous driving promises increased safety, higher utilization of the current car fleet and more productive use of the time spent in the car
    • While we do not disagree with the market on the likelihood of these trends, we do disagree on the timing of this change and its impact
  • An example of the current pessimism surrounding the traditional automotive industry is BMW
    • Based on its 2017 net income, shares in the company can be bought for close to 6x earnings, and at 5.3x earnings if one is willing to purchase the non-voting preference shares
    • At 5x earnings or 20% earnings yield, not much has to go right for it to be an attractive investment
    • This low valuation is largely due to fear surrounding potential disruption by electrified autonomous cars
    • Disruption from electric cars faces the same hurdles as previous large scale energy transitions; battery tech is not mature with battery capacity only improving slowly, infrastructure is insufficiently present and customers are used to driving internal combustion cars rather than EVs
    • If it was easy to transition to EVs, market share would currently not stand at 0.7% in the EU, despite all the tax incentives provided
    • Even when EVs take over, the current producers, including BMW, are likely to take a large profitable share given their expertise in mass manufacturing
  • Major transitions, especially energy related transitions, span decades, not years
  • When faced with new technology investors price in immediate disruption when instead they should be more careful in assessing the timeline of disruption
  • We believe this creates opportunity to buy businesses where investors misprice the speed at which the industry changes

Kempen – The Dividend Letter: It’s the pace of Disruption that matters, July 2018

Image Source: CNET