The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.
Host Thomas Mucha welcomes Global Industry Analyst Yash Patodia to discuss how US/China tensions and rising rates impact the tech sector, the future of strategic sectors such as semiconductors and big data, and why he believes the Asia technology sector is pivotal to innovations like EVs and the metaverse.
THOMAS: Asia tech has been in focus for a long time. It’s been one of the key drivers for globalization, for societies, and of course for markets. Recently it’s also been one of the more volatile sectors for a variety of policy, macro, and geopolitical reasons. But as we look to the future, Asia tech is also the key supply chain and driver of many of tech’s most exciting innovations like EVs and the metaverse. To help sort out the near-term uncertainty and long-term opportunities, we’re joined by Yash Patodia, a global industry analyst at Wellington who focuses on the software and internet sectors in Asia. He joins us from Singapore. Yash, welcome to WellSaid.
YASH: Thank you, Thomas. Thanks for having me.
THOMAS: Well, let’s start with the big, big picture. Why Asia tech? How do you define it? How should investors be assessing both the risks and the opportunities here?
YASH: So, I put in three broad buckets. Growth, leadership, and localization. So, first is growth. If you look at Asia, almost any way you slice it, whether you look at it by population, GDP, it's one of the fastest growing regions in the world. Especially when you look at the middle class, which is the consumption class, it’s growing the fastest, again, in the world. Now you add to that the idea that technology or digital penetration in Asia is still in its early days, and you have these natural tailwinds in this entire region. Second is leadership, and this is an area where I feel like Asia is misunderstood. So today, many of the leading companies in the semiconductor supply chain, which is the supply chain for everything from phones, tablets, to now cars, and in the future for wearables like virtual reality and augmented reality devices. A lot of the key companies in the supply chain are in Asia. So, for example, many of the leading companies for the materials that go into the semiconductor manufacturing process actually come from Japan. For wafers, some of the leading companies are in Taiwan. Memory is in Korea and image sensors are, again, in China and Japan. Third is localization. Now increasingly, the internet companies that are winning in Asia tend to be local players who understand local nuances. And there’s also a geopolitical angle here which I’m sure we’ll get into.
THOMAS: Oh yes, we will.
YASH: And this is true even outside of China. And I think this trend is going to continue. And another angle of localization is software. Software is at a very early stage in Asia, primarily because in many regions of Asia the cost of labor has been very low, so it’s been easier to just hire a head instead of actually deploying software. That equation is starting to change now. And if you look at the West, there’s been trillions of dollars of value that’s been created through software, and in Asia we’re just getting started. So, if I put all of this together, for me Asia is a region that is growing fast, is levered to digitization, which is still at an early stage, and it has the heart of the semiconductor industry, which is only getting more and more important as the years go by.
THOMAS: So that’s a really good summary of the growth drivers and the structural factors that make the sector interesting over the long run. Now you know, we just hinted at it with the geopolitical comment but let’s dig into that a little bit, because I think the geopolitical side of this, the policy side of this, is certainly in focus for the markets. So, let’s start with US/China tensions. How is that impacting the sector?
YASH: Right. Yeah, so US/China tensions are critical, and I think they’re going to continue. This is something that you helped us a lot with. There are many issues here that come up from a near-term standpoint, such as entity lists and sanctions, which as investors, we have to navigate around. But what I’m really focused on are some of the longer-term trends, which I think are quite interesting. So, one is decoupling for the key technologies. So, if you think again about the semiconductor industry, given the dependence of the world on semiconductors, it’s become absolutely critical for countries, especially superpowers and emerging superpowers, to make sure that they are not too dependent on others in order to actually have enough supply of these semiconductors. So, what you’re seeing as a result of that is the US is starting to invest more in actually creating their own semiconductor industry.
THOMAS: I think that’s a really important point, Yash. And what I’ve seen in my research is this increased focus on strategic sectors as great power competition intensifies. I think you’ve put your finger on the most strategic sector of all, which is semiconductors, because they go into everything as you mentioned earlier, but also into advanced military applications, and all of these dual-use civilian military things that are at the forefront of competition. And I’ll say that the Pentagon, for a long time, has been really focused on this sector, and now that’s bleeding into the US policy side with the CHIPS Act, and continuing support for domestic production and all that. So, I guess my question to you is, how do you see geopolitical tensions broadening in the companies that you look at?
YASH: I would put in two buckets. So, one is on the semiconductor side, right? That’s only going to increase. So, if I think about all the major countries in the world, they are trying to be more protective about their ability to manufacture as well as have some of these strategic semiconductor industries. When countries are starting to develop their own semiconductor industries, they need to basically replicate the equipment and the capabilities in different locations, which means you need more equipment, which means you need more factories, you need more materials, etc. So, it’s actually a benefit in the short- to medium-term. In the long-term, you can argue that you’re going from an industry that had somewhat consolidated to deconsolidating again, which means that it becomes more difficult to manage some of the cycles within this industry.
THOMAS: And that creates lots of winners and losers from an equity perspective, right?
YASH: Absolutely, absolutely. I think it’s going to be a positive for a lot of companies that have exclusive R&D or have knowledge or knowhow that is not easy for others to replicate, which in the semiconductor industry, which is highly research-intensive, tends to be fairly commonplace.
THOMAS: Moving beyond semiconductors for a minute here, you talked about the increasing digitization of societies, of business. How do these companies manage through geopolitical tension? Big data is what these companies do. How do you look at the geopolitics here, and how does that feed into your research process in these types of companies?
YASH: Yeah, that’s a really interesting point. And it’s something that I feel like we’re just at the start of. So, when we discuss semiconductors, it’s fairly commonplace, you know, there are bills going out that talk about the strategic nature of these. But for data and how it applies to internet companies, I think we’re just starting on that journey of countries realizing the importance of it. Right now, you have two factions, right? You have the big US companies, which are sort of global companies, and then you have China which has some companies that are very much focused on China. But increasingly, a question that you’re seeing come up is the other countries outside of the US starting to think about hey, why does a social networking company know more about my constituents than I do as the government? And as a result of that, you’re going to see action taken on that. That action is coming in a couple of different forms today. You’re seeing the EU come up with data privacy laws and I think it’s natural for the EU to be the place where all of this begins because the Googles and Facebooks of the world are American companies, they’re not European companies. But you’re also seeing this in different parts of Asia. You look at India, they’re requiring companies that operate any service that uses personal data to have their data stored in India. But then you take it to the next level, you have data just stored in local services but still owned by a foreign company. It gets tricky. And I can see a state that you reach where you say wait a minute, I don’t want my data to be owned by a foreign entity. I want the data to be local, owned by a local company that I can control and I can regulate. So, I think we’re just at the early stages of regulation within the internet sector. I think it’s going to be pervasive. China went through a big cycle of that last year. We can talk more about that because they do things a little differently. But I think it’s going to be a global trend, and it’s only going to increase going forward.
THOMAS: Well, let’s move on from the geopolitical risk and onto the next risk. It seems like there are lots of risks at the moment. And I’m talking here about rising rates. We’ve seen the Fed start the process. What’s the impact of this on Asia tech?
YASH: Yeah, so interest rate changes impact the discount rates that investors apply to stocks or the returns that they expect from stocks, and as a result it affects stock prices negatively. And you do see high growth that is more impacted from these changes than low growth companies. Technology generally tends to be higher growth. But my view is that the idea of interest rate increases is well known. And whenever it’s well known, it’s usually priced into the stocks. And we’ve seen that in the movement year to date. Now that’s not to say that you can’t have more of these interest rate hikes. But what I think we should really focus on is sort of the long-term on what happens over time. Over time, stock prices follow earnings. If I think about five to 10 years from now, your reliance on technology is probably going to increase. In addition to phones, you probably have more internet-enabled devices. Perhaps your refrigerator will start talking to you. You’ll have wearables that you use. And what that means is more chips, more sensors, more bandwidth, more internet services that you use. So, if you look at things on a multiyear basis and you see your own reliance on technology is going to increase, the reliance of the companies we work for, their reliance on technology is going to increase, whether it's in the form of software or other services. Then those are earnings for some companies. And if earnings are going to grow, then stock prices as a whole should follow. So, I think it’s very hard to make a case against tech today just given that some of these trends are sort of undeniable.
THOMAS: Yes.
YASH: And if anything, historically we have underestimated the impact of tech or how much more prevalent it will be than actually overestimated it.
THOMAS: And that’s amplified by your first point about the growth prospects for Asia, right? That’s going to be a long-term demand driver as well.
YASH: Yeah, exactly. You take something like ecommerce for example. Ecommerce in Asia, penetration is say somewhere in the mid-teens today. That means mid-teens of retail transactions happen through ecommerce. Developed markets or even markets like Korea, which are at the forefront, are at mid-thirties percent. So, you again take a five to 10-year view and you see that consumption growth is actually growing fairly fast, that should double in the next 10 years. And on top of that, you have ecommerce penetration that probably goes 2-3x from here and you’re talking about 5-6x growth in just the ecommerce opportunity. And remember that a lot of places in Asia don’t have the same retail footprint that the US has. They don’t have the big Walmarts and the Targets that people walk into. This is much more fragmented, unorganized retail. And ecommerce is going to be that step change in order to organize retail for a lot of the people over here and we’re just at the beginning of that.
THOMAS: So, looking beyond ecommerce, let’s dig into a little bit of these thematic or secular growth drivers. Let’s start with EVs, the auto sector, autonomous vehicles. Clearly that trend is well underway and likely to accelerate in coming years for all the reasons that we know about. How does that impact your sector?
YASH: Yeah, so EVs, as you mentioned is on an accelerating trend. I think it’s another one of those areas which is an undeniable trend because of top-down reasons. Reducing the carbon footprint has become critical for almost every country globally and EVs are a way to actually do that. And there’s another interesting aspect of EVs, which is that there is a lot more innovation that goes into EVs than traditional ICE cars. So, I think today you’re seeing more innovation in the auto sector than you’ve seen for the last few decades.
THOMAS: Yeah, they’re computers with wheels.
YASH: Exactly, they’ve become smartphones on wheels. And if you take that analogy and you put it to what I said earlier about Asia being in the heart of the semiconductor supply chain, well a lot of the components that go into the EVs are actually going to come from the same supply chain that sells into the semiconductor industry. So, if you think about cameras, for example, when the cameras go in your smartphones, now the companies that make those cameras and optical systems will also sell into EVs. And then you mentioned autonomous, which is going to be another very interesting area. It will start off with ADAS, which is more assisted driving, as opposed to just autonomous cars. I think autonomous cars are still several years away. And with assisted driving, I think one of the areas that is somewhat underappreciated is that, just as in smartphones, everyone wanted to first start developing their own OS. There was Blackberry, there was Nokia, Apple, HTC, and Google. And then, things sort of came together to just iOS and Android because that’s where a lot of the innovation was happening, and once developers start developing for it there are network effects. And as a result, you ended up having these two systems. And I think you would likely see something similar for EVs and autonomous, where today there are 300-plus EV brands just in China. And each of them don’t have the R&D capability to develop their own intelligent ADAS and autonomous systems. They will ultimately want to buy something that’s best of breed off the shelf. And there are opportunities within Asia of companies who actually develop that best of breed autonomous driving capability, ADAS capability, or even just the OS of the car. And I think that’s going to be a really interesting opportunity going forward.
THOMAS: Yeah, and a lot more work for you going forward. Now, the other buzzword that is out there in the markets now is the metaverse. So much so that a certain US company has even changed its name to reflect this. So, how do you think about the metaverse? And define it quickly for us. And then what’s the long-term sort of structural impact on the sector as we move into this metaverse thing?
YASH: Yeah, I’m laughing because you asked me to define it, which I think is really important, and it’s telling, because there’s so much disagreement out there about what the metaverse is, and everyone tries to cater it towards what benefits them the most. I’ll give you how I define the metaverse, which is a real-time, persistent, immersive virtual environment that has a strong sense of presence. Now, that has a lot of jargon in it. So, if I just simplify it: it is a virtual environment where you feel like the interactions you have feel real. I think that the key word here is just “feel.” It feels real. You can think about just hanging out with your friends who are all over, and you’re looking around, and you can see them, you can talk to them, and everything is very seamless. Or you could summon, your favorite character, say Iron Man, and Iron Man comes right next to you, and you hang out with him, or you go save the world on a mission. And all of that has to feel real. It really has to feel like you’re there and it’s immersive.
THOMAS: It also sounds very fun.
YASH: I think that’s what attracts people to it, right? It just sounds really exciting. If you take that and put it in where we are today, we are years and years away from that experience. And if I give you a crappy experience, you’re just not going to get engaged with it. I liken it a little bit to taking your current smartphone, say you have an iPhone 13, if you take all of how you use it and say you play Fortnite on it, and you try to do that on the first iPhone that was released, which was about 15 years ago, that experience would be terrible because your processor wouldn’t be fast enough to handle it. Your data download speeds will be really, really bad, because there wasn’t even 3G, much less 4 and 5G. Your graphics card won’t be able to handle it, and most importantly, Fortnite wasn’t around because they couldn’t develop the game they didn’t have access to all the software that was required to actually run on that. So, you didn’t have the ecosystem, you didn’t have the developers, and you didn’t have the hardware. And I think that’s where people start confusing the impact of metaverse. It’s a lot of hype today, the reality is several years away. I think where there is opportunity today, if you want to invest in the promise of metaverse, one is on the infrastructure side, which is who are the companies that are actually putting into place the building blocks that will enable the metaverse to work in a seamless fashion where you can actually get that feeling of presence. And there’s a lot of work that needs to happen for that, right? You need application processors that are orders of magnitude faster than they are today. You need bandwidth speeds that are much faster, and then you can actually start deploying the software on top of that. The other bucket I think where there is opportunity is to invest in some of the companies that have sort of the knowhow and IP. And if you think about which is the industry that is closest to the metaverse experience today, I think it is the video game industry. Because a lot of these games, especially if you look at the massive multiplayer games, they’re actually creating an entire universe which has its own economy, which has people interacting at the same time, so many of the same attributes as what we envision in the metaverse. Of course, in the metaverse it happens at a different scale compared to where we are in these games today. And then there are, of course, sort of the IP owners, right? When you summoned Iron Man, Iron Man is IP owned by a company. And similarly, there are many different IP owners which you and I may not know about, but they have a very hardcore fan following. And the value that can be created in actually using the metaverse as a channel to monetize some of their IP is going to be incredible. So, those are the areas that we see a lot of opportunity in.
THOMAS: Yeah, so as you say, it’s several years away from really revealing itself. But let’s fast forward three to five years. How are you thinking about the social implications, the economic implications for people living more and more of their lives in this metaverse?
YASH: Yeah that’s a great question, I think it’s way longer than three to five years, I would be really impressed if it’s in three to five years. But yes there are many, many implications for it, right? Societal, as well as economic. So, if you think of it from an economic and this sort of combines the two, but you can have people who have real jobs that just reside in the metaverse, right? Just like you pay people to make buildings in the physical world, you can have the same thing happen within the metaverse. You’re already seeing a component of that reflected in art, where you see NFTs today, nonfungible tokens, which are essentially art being put in the digital realm that before that we only had essentially in the physical realm. Now that comes with sort of this dystopian view of hey, what happens to everyone, are they living in the metaverse all the time, and doing nothing else? I think metaverse is going to be broader than just a VR headset that you put in and then you’re just transported to a different world where you live the rest of your life. I think it’s going to be a combination of the physical world interacting with this virtual world, so it’s not exclusive to just the virtual world. When you’re walking around, you can actually feel like you’re still with a bunch of your friends, but still physically visit your coffee shop or what have you. So, I think it’s going to be a huge generator of value through an entirely new industry that comes about and yes it will take some of the time that we spend in the physical world and go into the metaverse. But you know Thomas, it’s not so different from us right now speaking to each other on a Zoom call versus doing this within the metaverse where we felt like we’re actually right next to each other. I feel like some of the use cases would transform quite directly from what we’re already doing into a much richer experience, but there’ll also be this stream of experiences that comes about which is going to be unique to the metaverse, which I think will be highly value creative.
THOMAS: And in the future, maybe you’ll look like Spiderman, and I’ll be dressed as Iron Man, and we’ll have the same conversation. So, Yash, a lot of variables that you have to study, a lot of moving parts, from the policy, to the geopolitical, to the company, to the social, to the technological, and on, and on, and on. How do you conceptualize your research process?
YASH: Yeah that’s a great question. And the research process is very much a mosaic of different inputs. I’ll tell you what really matters to me within investing in technology and that’s competition. One of the things that I am super sensitive to is disruption. And part of the reason is because I lived through one. I used to work at Microsoft in their Windows phone division, and we were at that point one of the leading OS developers for phones. And I was there when you had the iPhone and Android devices were released, and we literally got the rug pulled out from under us. And we were, to put it succinctly, we were disrupted. So having lived through that, and having seen the implications of that, even at a company as large as Microsoft, has had a big influence on me in terms of how I think about the technology world. And this again comes back to the point on the trends that are going on in the industry, the idea of disruption. And I think that remains the single biggest risk to most of these companies, which is somebody else out there in a garage is working on an idea to basically eat your lunch. So, I focus a lot on the competitive mode of these companies. I focus a lot on what the private companies – I meet a lot of them – what they are doing within the industry and whether there are threats to the sustainability of a company’s staying power essentially. So, that would be number one. And then of course we look at what is the size of the market a company is after, what kind of products do they have, the management team – I think that’s critical – the management team is such an important input into even saving yourself from that risk of disruption. So, those are the things that I focus on a lot, and of course you mentioned geopolitics. That’s become sort of the overarching theme over everything that I do, geopolitics as well as regulation. So, that’s become a fairly critical input. On the long-term, I feel like it does help us sort of think about where things are heading. In the short-term it also ends up being more of a risk construct where we’re thinking about how are some of these uncertainties going to play out in terms of risk, and how do we protect against that?
THOMAS: So creative destruction is alive and well in your thinking.
YASH: Absolutely, that’s what keeps me up at night.
THOMAS: So, Yash, before we let you go, I do want to ask one sort of personal question. If you weren’t a global industry analyst at Wellington, what do you think you would be doing?
YASH: Well, there are so many options. I’ll tell you some of the things that I’ve tried and failed at. I’ve tried a startup and I think that’s what I will do again. I’ve had one experience of failing through it, maybe I’ll give it another crack. But the idea again of this creative destruction process, it's really fascinating to me. We get to observe it on a much broader level. I think the idea of living it in a much narrower level and trying to solve one problem better than anybody else is solving it is also super appealing to me.
THOMAS: All right Yash, hey thank you so much. It’s been really fun to walk down this path with you and we’re really fortunate to have you at Wellington sifting through all of these really complex but very exciting industry implications. So, thank you so much.
YASH: Yeah, thank you Thomas, and thank you for all your help in helping us think through all of these different geopolitical events that are going on in the world, since they’re clearly super influential in the shape that tech and our lives take in the years coming.
THOMAS: All right, thanks, and stay safe out there.
YASH: Thanks.
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Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced April 2022.
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