Are AI Firm Valuations Really in a Bubble?

Many are concerned about “bubble” valuations for firms linked to artificial intelligence. And looking at price-to-sales ratios, Amazon, Alphabet, Meta, Microsoft and Nvidia have higher ratios than prior to the launch of ChatGPT, for example. 

That also applies to the “technology-heavy” Nasdaq index as well. Hence the concern about valuations being in a "bubble."

source: Blake Heimann, Wisdomtree 

But it might also be worth noting that price/sales ratios for Amazon, Alphabet and Meta are not out of line with their respective 10-year P/S ratios. In fact, Meta seems to have lower P/S than it did a decade ago. 

That cannot be said for Microsoft and Nvidia, both of which have much-higher P/S ratios than has been the case for most of the past decade. The Nasdaq index likewise seems to show significantly-higher P/S ratios at present than over the past 10 years. 

So if you are looking for possible overvaluation, Nvidia is where the greatest danger lies, with Microsoft and the Nasdaq index both showing possible overvaluation (or simply higher growth expectations). Right now we simply cannot tell whether the valuations are merited or not. 

source: Wisdomtree 

In fact, some might argue that Amazon has lower P/S and price-to-equity ratios than it has had over the last decade. Some will argue that is because so much of Amazon’s revenue comes from e-commerce and is at risk if a recession occurs and shoppers reduce their spending. 

Company	Current P/E Ratio	10-Year Average P/E	Current P/S Ratio	10-Year Average P/S
Alphabet (GOOGL)	22.5	19.8	5.2	4.7
Amazon (AMZN)	34.2	62.1	3.8	5.1
Meta (META)	25.8	22.3	8.1	7.4

As always, one’s perspective matters. Are sales going to grow enough to justify the higher ratios and valuations, or is too much growth expected? Or, looking at it another way, even if the higher growth does materialize, will that growth take longer than presently expected?

AI Capex Apparently Not an Issue So Long as a Firm is Making Lots of Money

The last quarter’s financial reporting suggests financial analysts and investors can tolerate uncertain capital investments in artificial intelligence without qualms so long as the topline revenue and bottom line profits are there. 

Or at least that would seem to be the case, as Meta did not immediately suffer when it announced it was raising its AI capex, though Google was hammered. 

Amazon and Microsoft had mixed reports: Amazon reporting smaller-than-expected revenue growth and profits, Microsoft actually beating expectations for revenue and profit, but showing some weakness in cloud computing. 

Though all the firms’ stock prices were hit by a big downdraft in early August, Meta has held up best. 

Perhaps Meta’s reported ad revenue growth, along with its planned AI investments, shows one way to calm observers: keep making money while investing. That might be easier for some than others, as Amazon might face consumer spending headwinds. For Google, the issue seems more related to concerns about growing search competition, Microsoft could be dinged by a recession that slows enterprise information technology spending. 

In the near term, in other words, so-called “AI stocks” might be evaluated based primarily on how their core legacy businesses are situated, irrespective of any future benefit from AI operations and products, since such benefits will not be obvious for some time. 

And the revenue results might not match the market reaction. As was the case at Alphabet and Meta, Microsoft revenue was up 15 percent, year over year in the second quarter of 2024. Amazon revenue also was up, but less than financial analysts had expected. 

Except at Amazon, revenue growth was not the immediate issue. Instead, capex growth is the concern.

Al capex is up at Microsoft, but “roughly half of FY2024's total capital expense as well as half of fourth-quarter expense, it's really on land and build and finance leases, and those things really will be monetized over 15 years and beyond,” said Amy Hood, Microsoft CFO. 

Over at Alphabet, second-quarter 2024 revenues were up 14 percent (15 percent) in constant currency, year over year. But AI capex is expected to hit $50 billion in 2024. 

Market watchers seem to see danger for Alphabet’s search revenue stream as rival AI suppliers seek to cut into Google’s search dominance, beyond the issue of AI capex magnitude. 

 “The risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where it turns out that we are over investing,” said Sundar Pichai, Alphabet CEO. 

It also is worth noting that, because of regulatory scrutiny, it no longer is possible for Alphabet to “acquire” positions in markets or capabilities. Instead, it has to grow them organically. 

The implications of Meta’s positioning on AI capex might be about as good as it gets: robust core revenue drivers able to support AI capex. Alphabet’s ad growth was not as good as Meta’s in the second quarter, and beyond that there are the concerns of search market share dangers. 

“While we expect the returns from Generative AI to come in over a longer period of time, we’re mapping these investments against the significant monetization opportunities that we expect to be unlocked,” Zuckerberg noted.

In the particular case of Meta, at least some analysts and observers will be heartened by the apparent recognition on Meta’s part that AI is the more-immediate opportunity, compared to augmented reality, for example. 

“A few years ago, I would have predicted that holographic AR would be possible before Smart AI, but now it looks like those technologies will actually be ready in the opposite order,” said Zuckerberg. 

Commenting on “the AI platform shift,” Similar to the cloud, this transition,  Satya Nadella, Microsoft Chairman and CEO, noted that AI is similar to the prior transition to cloud computing, involving  capital-intensive investments. 

In other words, investment has to be made. Public companies that continue to have strong revenue and profit growth will essentially get a pass. But other firms will face greater scrutiny.

The Next U.S. Recession Will Test Resilience of Video, Communications Businesses

Whenever the next U.S. recession happens, we will see whether the many changes in the telecom, cable TV and video streaming markets will change the historic view of how telecom and video entertainment stocks behave during downturns. 

Traditionally, both telecom and cable TV equities have been viewed as resistant to customer defections in recessions as both are “essential” or “important” recurring services. 

But the markets and consumer tastes have been evolving: reliance on mobile phone services and abandonment of fixed network services; substitution or addition of video streaming services and reduced linear video subscription buying; increased importance of internet access and a decrease in importance of voice and linear video services. 

source: Broadband Search, Seeking Alpha 

All of which raises new questions, including the issue of whether streaming services will prove more resistant to customer churn during recessions, compared to linear video. 

Study Title/Author	Findings
"Do Consumers Cut the Cord in a Recession?" by John Beggs and Patrick/2010	Found a slight decrease in cable TV subscriptions, but not a significant decline.
"Telecom Stocks and Economic Downturns" by JPMorgan Chase (Investment Report) /2020	Indicated telecom stocks generally outperform the broader market during downturns.
"The Recession Resilience of Defensive Sectors" by Fidelity Investments (Market Commentary) /2023	Listed telecom as a sector with potential resilience, but noted the importance of specific company financials.
The Recession and Telecom, Deloitte (2009)	Revenue for telecom service providers remained relatively stable during the 2008 recession, but capital expenditures declined.
The U.S. Telecommunications Industry During Economic Downturns, The Brattle Group (2010)	While telecom revenue growth may slow during recessions, it generally holds up better than the broader economy.
Cord Cutting: What Do Past Recessions Tell Us? MoffettNathanson (2020)	Previous recessions saw limited cord-cutting, suggesting cable TV might retain some stability during downturns. However, the study acknowledges the changing media landscape.
Fama & French (1989)	Defensive sectors like telecom and utilities tend to outperform cyclical sectors.
Ang & Timmermann (1993)	Telecom and utilities exhibit lower volatility and higher risk-adjusted returns during recessions.
Blitz & Reichlin (2001)	Telecom and utility stocks are less affected by credit downgrades compared to cyclical sectors.

A recession might accelerate the secular trend of fixed network voice service abandonment, as consumers prefer mobile phone service. Likewise, a recession might also accelerate linear video abandonment rates, considering the relative expense, compared to streaming alternatives. 

To be sure, live sports will be a key issue for a portion of the buying public. Though most observers see a continuing shift of live sports to streaming services, that trend is not as developed, yet. So sports fans might still conclude they have no choice but to keep their linear video subscriptions. 

And that should continue to prop up demand during recessionary periods. 

On the other hand, perhaps a majority of consumers who are not sports fans can buy multiple streaming subscriptions at lower (or near equivalent) prices than they can buy a linear subscription, suggesting the possibility that streaming services could prove more attractive during a recession. 

Also, streaming arguably still is a growth business, while linear video is in decline. Any recession might accelerate such trends. 

source: Ryan Ang, Seeking Alpha 

The most recent recession, caused by the imposition of Covid shutdowns on the economy, might not provide much insight. With the “in person” economy largely shut down in many countries, demand for work from home or learn from home internet access was quite high. 

Take rates and usage of mobility services arguably rose for the same reason. And the value of streaming and even linear TV services arguably was boosted by the lack of other entertainment options. 

So the most-recent major downturns for which we arguably have data would be the 2008 global financial crisis and the 2000 to 2001 dotcom crash, when video streaming was not a mainstream business at scale. 

Are Mobile Services and Home Broadband Really Recession Proof?

Are mobile services and home broadband now “recession proof?” Maybe “recession resistant” is a better characterization. A recession will temporarily halt revenue growth patterns for most suppliers. The bigger question is “how much?” and “how long” the dip will last. 

The probable answers are that growth will turn mildly negative, with that trend lasting perhaps “12 to 18 months. In a worst case scenario of a major and severe recession, the revenue growth dip might be more severe, but probably would not last any longer than a mild recession would cause. 

To be sure, this story is cyclical, not secular; short term rather than long term. The exception to the general trend is the widespread economic shutdown caused by the Covid pandemic, which arguably increased the level of spending, most connectivity suppliers would say. 

Cyclical trends are those which correlate to business cycles while secular trends tend not to correlate. The amount of money consumers spend on various types of products tends to be cyclical: up in good times, down in bad. 

Secular patterns tend to persist across business cycles, such as more spending or engagement with digital products; greater reliance on remote or cloud computing; greater reliance on e-shopping compared to place-based retail. 

As recession looms, we’ll see many more stories about how consumers and businesses are reacting to recessionary conditions. As virtually always is the case, discretionary spending will drop. 

And the issue always is whether mobile phone service, home broadband or other connectivity services are more discretionary or more essential. The historical data suggests mobile phone service and home broadband are more “essential” than “discretionary.”

In recent recessions, consumer spending on mobility and home broadband has dipped, but only slightly. On the other hand, a severe recession, such as happened in 2002 and 2008, will cause significantly more disruption, doubling or tripling the percentage declines. 

Product	Percent Change During Recessions	Percent Change in Buying Behavior for Prior Recessions
Mobile Phone Service	-2%	-5% in 2002, -1% in 2008
Home Broadband	-1%	-3% in 2002, -1% in 2008
Video Entertainment	-2%	-5% in 2002, -1% in 2008

So much depends on the severity of the coming drop, though some (a minority) observers believe it is conceivable no drop will actually happen. Most observers believe a recession will happen, and the issue is whether it is a mild or severe. 

Some might argue that mobile service and home broadband are “recession proof.” Some might argue “recession resistant” is a better characterization.

Predictions for 2023 are Predictable

It is the time of year when analysts make predictions about what comes next in the new year. It might be correct to say such predictions are mostly what we already know, and can extrapolate and foresee. It is the black swans we most want to know about, but, by definition, we cannot foresee such disruptions.

As always in the computing or connectivity business, most of the trends are extrapolations from what happened this year. In businesses as capital intensive and scale-dependent as computing and connectivity, very little that moves the revenue, products or operations volume needles can be started or finished in only a year. 

Consumer price hikes might trigger regulator attention while service providers continue to seek cost cuts. Investment in 5G will continue, as will efforts to align connectivity with higher-bandwidth, low-latency xReality applications and use cases, Analysys Mason suggests.

Some service providers will continue to push into and operate in adjacent areas of the internet ecosystem, such as content and banking. Service providers will make additional efforts to ensure their services support enterprise multi-cloud strategies. 

In the broader technology industry, much the same is true: if a trend was important in 2022, it will be important in 2023. In the connectivity realms, premises networking such as Wi-Fi, 5G rollouts and commercial deployment of low earth orbit satellite constellations will be top of mind. 

source: Zdnet 

Other current trends, such as attention to extended reality use cases, applied artificial reality and machine learning will continue. Effort to reduce energy consumption will continue as well. 

While some might add perspective on sales trends for digital infrastructure, private equity interest in digital infra assets or the possible impact of recession on consumer behavior--most observers probably noting some possibility of slowdowns for such reasons--the underlying trends will remain intact. 

Personally, I am always more interested in all the things that will happen that nobody really predicted. But, of course, we cannot predict such occurrences. 

Marketing Shifted to "Pure Digital" During Pandemic: How Permanent a Change?

 “Customer journey disruptions brought about by the pandemic have prompted CMOs across industries to question long-held beliefs on the relative value of their channel investments,” say Gartner analysts. The biggest trend has been that--unable to rely on in-person channels--spending shifted to digital channels. 

Some 72 percent of the marketing budget of surveyed enterprises is “pure digital,” says Gartner. 

source: Gartner 

What remains unclear is whether marketing tactics and practices will remain permanently shifted in that way.

Some may well conclude that their sales  results have not suffered. Simply put, most enterprises have somehow managed to keep sales and marketing going, if in different ways, and some have even reported revenue gains, even when unable to visit customers directly, or have customers visit them. 

So the big question is whether there have been changes in belief and practices that are permanent, and not simply transitory. 

At a high level, the issue can be neatly summarized: enterprises have had to find some way to keep revenues flowing despite the substantial inability to have in-person contact with business partners or customers. 

The longer term issue is whether executives will conclude they do not need to spend money, time and effort in the old ways, at the same levels. That, in turn, will have repercussions for many in marketing and sales ecosystems.  

source: Gartner 

“CFOs have become comfortable with the lower cost base that spending cuts  in marketing, alongside savings on real estate and travel costs, have yielded,” Gartner says in a new report. “CMOs proved that they could do more with less, curbing spending on events, agencies and ad budgets in the face of a crisis.”

Among the areas most affected are items such as business “travel and hospitality,” which fell nearly 50 percent from 2020 to 2021. Investments in digital processes to support business operations are taking priority over marketing, Gartner says. 

“CEOs state the top focus points for their Chief Digital Officers (CDOs) in 2021 include customer experience and e-commerce.” Marketing execs have reprioritized the spending commitments across their channels and programs to favor pure-play digital channels, accounting for 72.2 percent of the total marketing budget.

source: Gartner

Typically, budget priorities reflect business priorities. So less spending is typically interpreted as “lower value” or priority. That might not necessarily be true for marketing budgets. 

Marketing budgets have always been the first of the enterprise budgets to be cut in any recession and the last to be restored once growth returns, Gartner notes, and rightly so. 

And marketing budgets are falling to their lowest levels in recent history, say analysts at Gartner. 

source: Gartner

So one might conclude that marketing--perhaps always to some extent a “more is better” category--is less important at the moment. That is almost certainly untrue. Unable to conduct face-to-face operations, marketing arguably has been more important. 

But perhaps higher value is perceived even when spending levels are lower. In other words, the ability to “do more with less” might be the conclusion many have reached after their experience with virtual sales and marketing imposed on them. 

“Social distancing rules transformed buying journeys for B2B and B2C customers alike throughout 2020,” Gartner notes. Also, “the majority of customers who used a digital channel for the first time in the first wave of the COVID-19 crisis state that they will continue to use them when the crisis passes.”

That suggests an “inevitable shift to online channels.”

The still-unknown issue is how much permanent change could occur in enterprise marketing practices. As always, there will be repercussions in the rest of the business ecosystem.

Maybe Covid Will Not Have Lasting Significant Impact on Connectivity

One hears much casual talk about permanent changes caused by Covid-19 lockdowns or work from home policies. Where it comes to use of communications capabilities, however, there is some evidence that the impact was quite transitory. 

Data gathered by Ofcom shows that use of the internet climbed in February 2020, but by October 2020 was down to pre-pandemic levels. Most casual statements note the sudden surge in demand as the lockdowns began. Few seem to note that demand has returned to pre-pandemic patterns. 

source: Ofcom 

Some argue that mobility usage climbed during the pandemic. Ofcom data suggests quite the opposite. As you might expect, people confined largely to their homes spent less time connected to the mobile network. 

People were not traveling outside their home areas so much. That is why roaming revenues dropped for virtually all mobile operators. 

source: Ofcom 

In other ways, mobile phone behavior was, in fact, not changed by the pandemic. Many casually make the argument that the pandemic “proves” the value of connectivity. It was important; it is important. But it might not be significantly more important, post-Covid. 

Demand in urban office areas is likely to drop, as more people spend more time working from home, on a permanent basis. There will be some upgrading of connections in suburban or rural areas. But internet access was vital before the pandemic. It did not suddenly become more important because of the pandemic, though the places people used the internet did shift (from office to home; from school to home).

There was less use of mobile phones on the mobile network between March and October of 2020, as more people were confined largely to home, and used Wi-Fi connectivity. 

Nor did calling behavior change. “Our crowdsourced data showed that 75 percent of panellists made a call in the first 11 weeks of the year, and 78 percent of panellists made or received a call,” Ofcom says. “There was no significant change in these proportions between pre- and post-lockdown.”

The impressionistic sense that “communications must be more important” is not necessarily borne out by the facts. It is similar to the anecdotal comments all of us have heard about “communications proving its value,” along with a belief that “communications firms must be making more money because of that.” In fact, most service providers saw revenue dip during the March to December 2020 period, for obvious reasons.

Economic activity was suppressed by government orders. And less economic activity, as in any recession, stifles communications revenues. 

There are likely to be permanent changes because of the pandemic. But a dramatic and permanent leap in communications industry revenues or growth rates is unlikely. 

In fact, there will be some downward pressure on demand, as urban office space begins to go unused. Fewer people working “downtown” means less bandwidth demand. Fewer people at work also means less demand for all surrounding merchants. Those merchants are also likely to require less bandwidth or connectivity demand. 

Bandwidth demand overall will likely keep growing, at past rates. But the pressure is not all “up.” There will be some redistribution of “work” demand to residential areas. But the key driver of residential broadband demand is entertainment video, not use of work apps. 

That will ripple through network planning assumptions, at the very least, even if revenue impact is relatively neutral. What seems to be developing is a rather temporary Covid impact on capacity demand and user behavior. In other words, Covid might, in the end, not have very much impact on connectivity revenue or demand. 

Usage grows every year, irrespective of temporary events. More people watching more video streaming is going to affect usage more than did Covid.