When Steve Milunovich started his career as a technology analyst in 1983, personal computers were just starting to become ubiquitous. He didn’t have email for another decade.
In the 37 years since, he’s been a critical, and crucial, observer of virtually every technological trend—and every company behind it—through decades of political and cultural change. Investors and business leaders have been wise to listen to him; those who didn’t often regretted it. In 2003, Milunovich penned an open letter to Sun Microsystems CEO Scott McNealy warning that the company needed to embrace Linux or risk irrelevance. Sun stock peaked in 2000 at $258.63.
(ticker: ORCL) bought Sun in 2010 for $9.50 a share.
In 2010, he recommended
(TSLA) stock, and referred to Elon Musk as the next Steve Jobs. Tesla has earned investors about 59% a year over the past decade.
Calls like those landed Milunovich in Institutional Investor’s All-America Research Team Hall of Fame; he recently retired after many years at Wolfe Research. Barron’s sat down with Milunovich—virtually, of course—to hear his views on tech after all these years. An edited version of that conversation follows.
Barron’s: The Nasdaq is up 31% this year, crushing the S&P 500’s 7%. Are we heading into a bubble?
Steve Milunovich: Today does rhyme, at least, with the  tech bubble. And valuations are at extremes. You’ve got day traders coming back, and SPACs [special purpose acquisition companies]. Those all seem to be signs of excess exuberance.
Tech investors who have a bit of a value bias, or just can’t buy stocks at 30 times sales, are extremely frustrated. Many of them were around during the [dot-com] bubble, and they’re waiting for this to blow up. They’re saying, “We know how this ends. We just don’t know when.” To some degree, I’m in that camp. Even growth investors are concerned. In 1999, everybody understood it was getting crazy. But if you weren’t in Yahoo! and other stocks that were hot, you were underperforming and at risk of losing your job. Today has some similarities to that. From a fundamental standpoint, it does feel different. We’re beyond valuing eyeballs.
True, the metric of price-to-eyeballs was used to justify impossible price/earnings ratios. Today, cloud-based software companies like
Zoom Video Communications
[CRM] are trading at triple-digit P/Es, while others, like
[WORK], lack earnings. Is that justifiable?
A lot of these software-as-a-service companies do have visibility on business. You can make a case that with 30% revenue growth and [improving] margins, some of these valuations are justified. And the current ability to generate free cash flow is a difference between today and the tech bubble.
And the coronavirus has sped up the pace of tech adoption.
Covid-19 has been a real accelerant to digital transformation—and Covid is hanging around. When I talk to resellers, they believe that over half of employees will not go back to offices. There’s an increasing belief that there’s a secular tailwind here.
There’s concern, however, that the economy could not come back; that’s an issue even for software companies. And I still worry about valuations. We are also now seeing the promise of the internet that people back then anticipated. We are seeing technology become pervasive in its effect on other industries. The total addressable markets for these companies is much bigger than forecasted.
What’s a big trend you’re watching?
Perhaps the most important thing in the last five to 10 years is the rise of the platform company—a company that sits between two user groups and benefits from network effects. It really is a different form of corporate structure. It inverts the corporation, so that the value is created outside the corporate walls [by others].
Define platform company.
There are two types of platform companies. [First] are platforms that create a transaction between a buyer and a seller, like
[UBER]. The platform company is in the middle, taking a piece of every transaction. The other type is the ecosystem company.
[AAPL] create ecosystems with lots of third-party value.
[FB] are ecosystem-style platform companies. Also
[BABA] and maybe
[MA] are in our tech universe. You can debate that.
Those are huge companies.
Nine of the 10 largest tech companies by market value are platform companies. They’ve been getting stronger as they get bigger, and that, of course, brings antitrust concerns. They get huge because they have very fast revenue growth, because of increasing returns—the more buyers, the more sellers; the more sellers, the more buyers. You get very profitable companies. They still have three to five years of double-digit earnings growth in front of them.
What could limit their growth?
When you look back at technology leaders, they tend to fall off over time. There comes a point where size works against you. That hasn’t yet happened to these companies. So we’re in the middle innings, before size becomes a problem.
[IBM] and Microsoft went through their issues. Antitrust challenges definitely affected their ability to operate, and caused them to be less aggressive than they might have been otherwise.
But on the positive side, it wasn’t antitrust that got them—it was disruptive technology. In the case of IBM, it was the rise of the microprocessor that changed the economics of computing. For Microsoft, it was first the internet, and later mobile, which they missed.
What’s the next disruptive trend?
The new technologies we all think about: the Internet of Things, artificial intelligence, autonomous driving. The platform companies are leaders in those areas; they have the resources. I don’t yet see smaller companies that are going to put them on their back feet.
You’re not concerned that these platform giants will be broken up?
There is certainly some risk; I don’t think it’s going to be the death knell. Breaking them up is negative for consumers, and historically U.S. antitrust regulation uses consumer harm as the criterion. Breaking up a Facebook or a Google would probably reduce the network-effect benefit of the multiple businesses they are in. Regulators might take away the ability to make acquisitions; that‘s concerning. Now everybody looks back and says, “Oh, Facebook shouldn’t be allowed to buy Instagram,” although, at the time, nobody knew Instagram was going to be anything like what it is today.
U.S.-China relations have been deteriorating. What do you foresee?
The China situation goes well beyond the trade concerns we had last year. It’s a philosophical issue in terms of the way the two countries want to run their governments. There’s plenty of evidence that China has stolen U.S. technology for many years, and put companies like
and Nortel in very difficult positions. Espionage helped Huawei [China’s largest tech conglomerate] create products comparable to Nortel and other comm-equipment vendors, then [China] underpriced them. To its credit, the Trump administration woke up to that. China wants to become a technology power. It needs indigenous capabilities. The one thing it has not had is semiconductors.
Semiconductors are used in virtually every electronic device.
I would argue that
[TSM] has become the most important tech company in the world.
[INTC] is having problems; it has fallen behind in fabrication tech and has suffered product delays. TSM is fabbing [fabricating] 80% of the semis used in the U.S. It might actually build a fab in the U.S. in the next four years.
China wants to build its own semi industry. But the equipment makers and software makers are American. The U.S. is trying to hit Huawei and not allow it to buy semiconductors from the U.S. We allow them to buy semiconductor capital equipment and tools—but they can’t design semiconductors if they don’t have software. Probably the status quo will be maintained: The U.S. will limit certain technologies, but a total cutoff of U.S.-based semiconductor-tools technology would cause repercussions.
Any favorite stocks?
[At Wolfe Research] we did a more quantitative screen with a mix of fundamental technical and quantitative factors. When you look at some of the big outperformers over the last six to 12 months—names like
[PYPL]—these companies, I do believe, have sustaining powers. They are category creators.
The most powerful thing a tech company can do is create a new category, and then become the leading brand within that category. Nvidia, for example. It basically created the category of GPUs, graphical processing units [for video games]. Shopify is a fascinating company; it’s the back office for everyone that wants to compete with
ServiceNow wants to be the enterprise software company for the 21st century. It started providing IT service management—tracking IT assets and providing help-desk support—and has branched out into customer and human-resources service management. One reseller we spoke with said, “You’re either a ServiceNow customer today, or you will be.”
Write to Al Root at firstname.lastname@example.org