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(Bloomberg Opinion) -- Monopoly power is a good gig if you can get it. The trouble is keeping lawmakers from knocking on your door. Tech titans Apple Inc., Amazon.com Inc., Facebook Inc. and Google parent Alphabet Inc. managed to do just that until last week, when a House subcommittee summoned the chief executive officers of the four companies. Lawmakers took a dim view of the tech giants’ grip on their respective industries. “These companies as they exist today have monopoly power,” said Representative David Cicilline of Rhode Island, who leads the House investigation into the companies. His prescription: “Some need to be broken up, all need to be heavily regulated.” The sentiment appeared to be shared widely.As a matter of public policy, the issue is relatively straightforward. Monopolies are trouble, which is why antitrust laws are designed to stop them. They have the power to raise prices and thereby stifle demand. They often turn into big, lazy, unwieldy bureaucracies that have little incentive to innovate or look after customers, workers and suppliers. And perhaps most problematic, they can use their money and influence to seize political power, making it more difficult to dislodge them. There’s little disagreement that Apple, Amazon, Facebook and Google pose such a threat. Apple controls nearly half the U.S. smartphone market and dominates the distribution of apps; Amazon all but controls e-commerce; Facebook rules social media; and Google has a firm grip on internet search and online advertising. It’s difficult to overstate their power. The four companies make up just 0.8% of the S&P 500 Index by number, and yet they account for 6.1% of its total revenue, 8.9% of its earnings and 16.8% of its market value. For investors, the issue is a bit more complicated. Monopolies are impregnable money-minting machines, so everyone wants a piece of them. It’s no accident that Apple, Amazon, Alphabet and Facebook are four of the seven biggest companies in the world by market value. Nor is it surprising that their profits have trickled down to shareholders. An equal investment in the four tech giants since Facebook — the youngest of the bunch — went public in 2012 has produced a return of 31% a year, including dividends, more than double the return from the S&P 500 over the same period. It turns out they’re not alone. Stocks of highly profitable companies tend to beat the market. Shares of the most profitable 30% of U.S. companies, sorted on return on equity and weighted by market value, outpaced the S&P 500 by 1.6 percentage points a year from July 1963 through June, according to the longest data series compiled by Dartmouth professor Ken French. And they did so with roughly the same amount of volatility as the broad market, as measured by standard deviation, a common proxy for risk.Astonishingly, the odds of capturing this profitability premium favored investors regardless of the holding period. Shares of the most profitable companies outpaced the market 65% of the time over rolling one-year periods, 76% of the time over three years, 83% over five years and a whopping 93% over 10 years, counted monthly.But markets aren’t supposed to work this way. You shouldn’t be able to reliably beat the market using widely available information without taking more risk. One explanation for the profitability premium is that investors are rubes: They don’t pay attention to profitability when picking stocks, or worse, they errantly favor less-profitable companies, allowing more cunning investors to exploit their mistakes. That seems unlikely. Profitability has long been a key feature of security analysis. More recently, there has been a proliferation of indexes, and funds tracking them, that pick or weight stocks based in part on profitability. And as the market value of Apple, Amazon, Alphabet and Facebook show, their shares are hugely popular. A more plausible explanation is that the profitability premium is compensation for the risk that today’s profits will evaporate tomorrow. Highly profitable companies rarely maintain the same level of profitability. More often, competition squeezes it away or, as in the case of Apple and its cohorts, the competition is crushed or acquired, resulting in greater market share and profitability but also inviting lawmakers and regulators to step in.Microsoft Inc.’s antitrust entanglement with the government in the late 1990s is instructive. Bill Gates and Paul Allen founded the company in 1975, and by the early 1990s, most personal computers ran Microsoft’s operating system, first MS-DOS and then Microsoft Windows. In August 1997, the company became the second largest in the U.S. by market value, behind only General Electric. A year later, in May 1998, the U.S. Department of Justice and 20 U.S. states sued Microsoft, accusing it of attempting to illegally protect and extend its monopoly by undermining competitors. By the time the case was argued in early 2001, much of the evidence against Microsoft had spilled into public view. Although profits continued to grow, the legal and regulatory scrutiny around the company clouded its future, and shareholders paid the price. The stock returned a negative 4% from May 1998 to December 2000, even as the Nasdaq Composite Index and the S&P 500 returned 33% and 23%, respectively, over the same time. Several months later, a federal court found that Microsoft had violated federal antitrust laws. As it turned out, of course, Microsoft has maintained its status as a tech powerhouse. Today, its market value is second only to Apple among U.S. stocks, and shareholders who stuck with the company through its antitrust battles have been richly rewarded. Microsoft has returned 27% a year since it went public in 1986, compared with 11% and 10% a year for the Nasdaq and S&P 500, respectively. But that was far from a foregone conclusion when Microsoft was in the government’s crosshairs. And if lawmakers, regulators or prosecutors muster the will to go after Apple, Amazon, Facebook or Alphabet, their shareholders should prepare for more paltry returns and perhaps worse. For now, investors don’t seem worried that the tech titans are in danger. All four of their stocks were higher after the hearing than before. And all four companies reported financial results that beat analysts’ expectations a day after the hearing, no doubt emboldening their shareholders. Still, Big Tech’s faithful should bear in mind that monopolies are only as durable as a government that tolerates them. The profitability they enjoy, and the skyrocketing stock prices that accompany it, are no free lunch. They’re payment for the risk that lawmakers are more serious about breaking up or regulating the tech titans than investors seem to believe.This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young. For more articles like this, please visit us at bloomberg.com/opinionSubscribe now to stay ahead with the most trusted business news source.©2020 Bloomberg L.P.
(Bloomberg Opinion) -- The aspiration for the biggest medical deal of the year is commendable — to transform cancer treatment so sufferers can live longer and better lives. In pursuit of this goal, German diagnostics group Siemens Healthineers AG has agreed to pay a high price to acquire U.S. radiotherapy specialist Varian Medical Systems Inc.Covid-19 has displaced existing medical priorities this year. Cancer hasn’t gone away, but spending on the technology used to treat it has, at least temporarily. With elective procedures pushed out to make space for coronavirus patients, and hospitals spending heavily on safety measures, Varian’s underlying revenue fell by 19% in its most recent quarter. A 14% decline in orders for its oncology systems division was a troubling indication of the future trajectory.It’s the same challenge everywhere. Siemens Healthineers isn’t replacing its order backlog at the same rate it’s making shipments to customers. The company, whose controlling shareholder is industrial group Siemens AG, points to an “investment reluctance” caused by the pandemic. Rival General Electric Co. recently warned of a challenging environment for its health-care business.That backdrop may explain why Varian was willing to consider an all-cash takeover by Siemens Healthineers even though its stock had bounced from its March lows and was approaching pre-pandemic levels.Strategically, the deal marks a new departure in marrying diagnostics with treatment. The thinking is that customers will benefit from a having a company that provides the kit for both, and that research and development will become more productive.But financially, this is an expensive transaction despite a seemingly low 24% takeover premium. Strip out Varian’s small amount of net cash and the deal will cost about $16 billion. Varian’s operating profit is forecast to be around $600 million in its 2021 financial year when the deal would complete. That would imply a paltry 3% post-tax return on investment initially. Siemens Healthineers investors will want returns to climb to double or high single-digits.Two leaps of faith are needed. One, that Varian’s performance is going to markedly recover from this depressed level. That could happen if a recent investment phase starts to bear fruit. And two, that Siemens Healthineers can deliver on a promised 300 million-euro ($353 million) profit boost from the deal. But this will take until 2025 to fully materialize. Only about one-third of it comes from cost savings. The bulk is revenue synergies — a challenge to achieve in any transaction.While hospitals may see an initial spike in medical procedures from a loosening of lockdown restrictions, the longer-term trend is complicated by a potential resurgence in coronavirus cases. Patients could delay procedures due to changes in employment and insurance coverage, according to a report last month from Bloomberg Intelligence analyst Glen Losev. He expects it to take a year for demand for medical procedures to return to prior levels. Hospitals will struggle to make significant investments in the foreseeable future.The acquisition cash is being provided by a cheap bridge loan from Siemens AG. That will eventually be refinanced by a share sale by Healthineers, in which Siemens will be diluted. The structure means the buyer can do this transaction without immediately relying on the debt or equity markets. That’s just as well. Investors will need to look beyond the current crisis to get behind this deal.This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.For more articles like this, please visit us at bloomberg.com/opinionSubscribe now to stay ahead with the most trusted business news source.©2020 Bloomberg L.P.