The war in Ukraine, the ongoing Covid-19 crisis in different parts of the world, the intensifying US-China trade war and rising inflation – the past year has had no shortage of challenges. So much so that this past earnings season will likely be seen as one of the most tumultuous the tech industry has experienced in the past decade.
There are still major questions about the future of the tech industry. Will the stock market crash of 2022 continue in 2023? Will the industry continue to see layoffs and declining company values? Is and how is the industry changing direction? Is now a good time to invest in tech stocks?
General trends to watch out for – from an investor’s perspective
Initially, the Covid-19 pandemic increased focus on technology, resulting in unusually strong demand and overinvestment in 2021. But the global macro environment has shifted in 2022, causing companies to make idiosyncratic decisions to realign investments—including headcount, capex, product development, and more—in the face of a slower, more mature revenue growth model. We now expect weakness in the first half of 2023, with more layoffs, followed by a modest recovery in the second half of the year.
In 2022, stocks of large-cap companies will underperform the broader market, gaining only 10-20%. In 2023, we will continue to focus on scaled companies with proven track records, or those that can be valued based on earnings, cash flow and/or favorable profit narratives. We view Alphabet and Microsoft as highly cash-generating and shareholder-oriented companies.
Still, Alphabet has been challenged by one of its biggest investors. In our view, management must clarify its 2023 strategy as soon as possible. When we looked at Amazon and Meta, we found that their narratives about investment and profit dynamics were modified by subsequent company layoff announcements. These are all things to watch out for next earnings season.
Regarding risk factors, we recommend monitoring the following: (1) changes in business and consumer spending trends could affect operating forecasts, (2) regulatory developments could impact P&L and inorganic growth through M&A, especially for large companies, (3) Increased competition in certain verticals, such as digital advertising.
Our base case envisages a likely consumption recession between the second half of 2022 and the first half of 2023. In our opinion, we need to wait for the second half of 2023 to achieve stabilization in the different end markets.
Global Technology Sub-Industry Trends to Watch
Digital Advertising – Showing a slowdown given macroeconomic headwinds, increased competition, industry maturation, and Apple privacy changes. Four themes stand out in early Q4 2022: (1) Visibility into the operating environment remains low; (2) Competition for user time remains intense, especially with short videos, Reels (Meta) and YouTube Shorts (Alphabet); (3) New media competition intensifies and uncertainty in 2023; (4) Resilient consumer behavior in the US and weakness in Europe. Overall, the industry is likely to continue moving in the same direction in the first half of 2023; it will return to solid growth only when the environment returns to normal.
e-commerce – Elastic performance with scale players, as consumers and merchants alike find increasing value in aggregators. The divergence in spending trends between low-end and high-end consumers is likely to persist, as well as widespread cost rationalization and scaling back of non-growth initiatives by sellers. Third-quarter results and early-October data point to weakness in Europe.
Online travel, local commerce and food delivery – The short-term trend remains high (especially in the US). Recent management comments contradict investors’ concerns. If consumer behavior weakens in the first half of 2023, we expect investors to have a healthy debate on demand trends (ie units and pricing).
Israel’s tech industry today and tomorrow
2021 will be a record year for Israeli start-up funding (nearly $25 billion). In 2022, the aforementioned funds will continue to be used by startups to develop solutions, although we will see the value of Israeli stocks listed on Nasdaq depreciate and high-tech companies fall in value. These funds will allow the start-up to follow through on the execution of the strategy; thus, new developments may emerge at a faster pace. We expect cybersecurity, automotive, healthtech and fintech to grow significantly in 2023.
In 2022, venture capital funding rounds in Israel slow down, while early-stage funding rounds increase. This trend mimics the rest of the world as VCs become more cautious during times of uncertainty. While we expect this trend to continue into 2023, we also believe that Israeli case funding rounds may reach their previous high in 2024.
Israeli high-tech is a mature market, and more and more startups are scaling up to become global players. Furthermore, the Israeli government aims to grow the sector by 10% to 15% through different incentives. Despite the current economic downturn, the industry is likely to grow in the coming years and continue to be the backbone of the country’s economy.
Gerry Livnat, Managing Director, Rothschild & Co Wealth Management Representative Office in Israel