The woes of the technology sector have been making a lot of headlines. Through May, the information technology sector was down 0.1%, versus our broader index (the Leuthold 3000), which was up 3.9%. The sector bounced back in June but is still lagging the broad market. Internet software and services, in particular, has suffered huge losses, led by a handful of social media and high-flying dot-com companies. Some commentators even foresee another Internet bubble unfolding.
We consider “new tech” as online-content related, which singles out Internet software and services among the 14 technology sector groups. New tech companies are content providers and those offering solutions for managing information online: websites that allow one to learn, search, communicate (privately or socially), entertain, network, shop and work (cloud computing).
We define “old tech” as the physical components supporting new tech, making the online virtual world possible. This includes computers and equipment, data centers and Internet infrastructure.
These old tech groups are components of the telecommunication services sector and the consumer discretionary sector (cable and satellite group). Industry trends suggest Internet infrastructure providers are benefiting from the explosion of data usage/transmission, which leads to the likelihood of increasing revenues from new fee structures.
Moving things online is happening on both the enterprise and consumer fronts. User-generated data is flooding the web. Tweets, blogs, YouTube clips and messages sent through communication apps all travel down that Internet pipeline.
Enterprises are moving to the web on three fronts:
• Marketing departments are increasing Internet presence to follow their customers.
• Companies are upgrading IT infrastructure from local networks to the cloud.
• New business models are coming online to serve different and changing needs of the virtual world.
Progressively more devices are connected and data to/from these devices needs to travel online. (Think of smartphones.) Both smartphone representation and the data usage per phone are rising. According to Opera, one of the most popular mobile web browsers, the number of people using their browser has increased sixfold from January 2006 to February 2014, and the data transfer rate has increased a stunning 63 times — an annualized 195% growth rate during that period.
If the Internet is a highway, then Internet infrastructure providers are the toll collectors. As traffic increases, fees collected will rise accordingly. Monthly consumer subscriptions to broadband providers (cable or phone companies) are just one type of fee being collected.
Another revenue stream happens behind the scenes. Internet-based services and content providers including Facebook, Netflix, Amazon and Google pay Internet infrastructure providers (Internet backbone carriers) to carry their content. The pay structure is normally tied to the data volume being transmitted; the higher the volume, the higher the fee.
With higher demand for transmitting data and potential change of pay structures, owners of the infrastructure will see their real estate (equipment, data centers) rise in value.
For computers to be joined around the world and form the World Wide Web, Internet backbone companies lay cables around the globe to link the ISP networks. ISPs pay Tier One carriers to conduct their data transmission, although giant ISPs such as AT&T and Verizon have their own backbone networks.
And finally, another important player in this infrastructure is the content delivery network. CDN operators build data centers to support and transmit the content: webpages, videos, games and commercials. The major U.S. players behind these Internet infrastructure providers, which may be poised to profit from the explosion in content and movement of data, include Level 3 Communications Inc., Cogent Communications Holdings, AT&T, Verizon, Comcast Corp. and Akamai Technologies Inc.
These companies likely will benefit from the ever-growing volume of data being transmitted online. A new proposal allowing fee-based “fast lanes” for content providers could boost revenue of the Internet infrastructure providers and increase the value of their physical assets required for the infrastructure support. Investors should be aware of risks.
Jun Zhu is a senior analyst at Leuthold Weeden Capital Management.