Joseph Mariathasan explores where the megacap companies of tomorrow might originate
In February, Google beat Apple in market capitalisation. But does size really matter? The Top 4 companies in the 2015 Forbes Global 2000 list of the world’s largest, most powerful public companies – as measured by revenues, profits, assets and market value – are all Chinese. Apple does not make even the Top 10 on this basis since it fails on the metric of assets.
But Apple, measured on market cap alone, of course led the list, followed by Google, Exxon Mobil, Berkshire Hathaway and Microsoft, with eight of the Top 10 being US companies, alongside China’s Petrochina and ICBC. On the Forbes criteria, the US leads the list with 579 companies, while China (mainland and Hong Kong) has 232, adding more companies than any other country and surpassing Japan for the first time. The UK is in fourth place, while France ceded fifth to South Korea. Europe overall, with 486 companies, was beaten by Asia with 691.
One manager told me the key attribute for companies to be able to grow to megasize is “a long runway”. Nestlé would never have been a global megacap if its market was just Switzerland. The dominance of the US and Chinese companies is unsurprising in this respect, given the size of their markets. As the manager explained, one reason the US has so many megacaps that have grown since the 1980s is because of the runway the US market offers domestically for retail companies. Companies such as WalMart or Home Depot can start off in Maine and roll out their stores to Los Angeles with no changes required at all for local conditions. In Europe, that would be inconceivable, with at least five languages required for an analogous rollout. Whilst the US retailers may not have succeeded outside, the US is big enough.
What that also means is that certain sectors and types of companies are pretty limited – utilities are a case in point. But, as Coca Cola and Apple have shown, there are few restrictions for consumer companies and tech companies, and that holds true for drug companies as well. But ageing countries can also face challenges in developing the next generation of mega companies – few would expect to see new ones coming out of ageing Japan.
The limits to growth for companies with a long runway depend on the business strategy a company chooses to follow. What does appear to be the case is that the limits to growth are further away for companies with three key characteristics.
The first – as famously outlined by Warren Buffet as the characteristic of a company he favours – is one with an economic moat that protects against competitors, with a well-known brand name, pricing power and a large portion of market demand. This provides the opportunity to expand, but disruptive technologies can sometimes overwhelm even the widest moat. Kodak is a classic example where its domination of photography could not withstand the impact of digital technology.
A second economic driver requires high-quality companies to be able to improve as they grow. There is a tendency for large caps to emerge when you get network effects in areas such as technology or consumers. Apple is the clear example of this, combining technology and consumers. Apple is not a one-trick pony, having built an ecosystem around a seamless integration of innovative products and applications way beyond the production of commodity hardware. It has become the ultimate consumer brand, with the ability to create interest in any new product or variation of an existing product by just adding the prefix ‘i’.
Bigger does not always mean better, however, and the banking industry is the prime example of this. Even for those banks such as Citibank with a global footprint, their value lies in having a few particularly strong local franchises in countries such as Mexico. Chinese banks may have a high position in the Forbes list because of the size of their domestic markets, but their domestic focus precludes their being global companies. But others could certainly become so, Alibaba being an example.
The third key characteristic virtually all mega companies have is the ability to seek customers in the emerging markets that are driving global growth. China and India are huge markets still experiencing phenomenal growth rates compared with the developed world.
Investors, however, need to be aware that becoming a megacap does not necessarily go hand in hand with being a good investment. Just because a company needs a lot of capex, such as the energy industry, does not make it a great investment if the returns on the investment are poor. Tech companies may not have an issue with capex, but issuing a tremendous amount of stock options reduces earnings-per-share growth, reducing returns to investors.
Where will the megacaps come from in a decade’s time? While Asia may supplant Europe, it is difficult to see the US losing its position as the undisputed champion of megacap generation.
Joseph Mariathasan is a contributing editor at IPE