Despite Tech’s Correction, the Digital Transformation Is Real
The markets are closed today. Given what happened at last week’s Fed meeting, the subsequent 75-basis-point rate hike and how it continued to panic investors, the ongoing digital transformation seems relevant.
Every day, the physical world becomes more intertwined with digital processes, and the opportunity to climb aboard only gets more imperative.
Remember: The digital transformation is the biggest investment opportunity in a generation and it’s only getting started.
Digital transformation is alive and well, even if investors aren’t currently paying attention.
Since 2017, I’ve been writing about this transformative process. During that time, innovative digital infrastructure businesses created tremendous shareholder wealth by telling a single, compelling story: Digital businesses are intensely agile.
Unfortunately, that story is no longer resonating with investors.
Since December, the performance of the tech-heavy Nasdaq (NDAQ) has been abysmal.
Weakness for software, semiconductor and e-commerce shares has destroyed the index. From Dec. 1, 2021, to the time of writing today, the Nasdaq Composite has dropped 29.89%.
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Analysts expect even more weakness in the coming months as investors discount future growth based on rising interest rates. The Fed is set to raise its short-term interest rate target this week by half a percentage point.
Despite these market concerns, we're seeing the digital transformation play a bigger role in our lives than ever before.
And there's a new digital transformation success story with Microsoft (MSFT), a company that is performing much better than many of its big tech rivals. This story is a microcosm of how powerful the digital transformation really is.
A Digital Transformation Win at Microsoft
The Financial Times reported on Monday that Lego is about to invest hundreds of millions of dollars to hire software engineers. The Danish toymaker is augmenting its famous plastic toy bricks with virtual ones.
Ironically, Microsoft is at the center of the Lego digital transformation story.
"Minecraft" was acquired in 2011 by Microsoft. "Minecraft" is a popular online game that is the digital equivalent of Lego toys. Children acquire virtual bricks and then go about building new virtual worlds where they can play together.
The game was developed in 2009 by Mojang Studios, a small Swedish software company.
Although "Minecraft" was developed on a shoestring budget, the game has since sold 238 million copies, making it the best-selling video game title ever. And the multi-platform franchise continues to enjoy 140 million monthly active users, creating additional streams of revenue.
Those revenues, and the status of "Minecraft," are a sore spot at Lego.
The Times notes that "Minecraft" is like a ghost at Lego. In 2003, the company began to outsource its internal game development.
Clearly, executives saw the potential of digital … However, they were unwilling to make the kind of investment needed to build games in-house and take full control.
That is changing now.
In April, Lego announced a partnership with Epic, the parent of the "Fortnite" video game franchise. The objective of the $1 billion deal is to build a child-friendly metaverse. Lego will also spend aggressively to triple the number of in-house software engineers to 1,400.
That's the digital transformation in a nutshell.
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Companies now understand they must be in the game as not playing means losing out to competitors.
In April, during the Microsoft Q1 conference call, CEO Satya Nadella was asked about tech spending going forward. Nadella said that tech spending as a percentage of GDP is likely to double from current levels by the end of the decade.
At the time of writing, shares of MSFT are down nearly 27% and are trading at $251.76 — well below the 50- and 200-day moving averages.
The company will announce Q2 earnings on July 26. The consensus forecast for earnings per share (EPS) is $2.31. MSFT maintains a strong Weiss Rating of “B,” so savvy investors will want to look for a potential bottom leading up to the next earnings date.
Remember to conduct your own due diligence before entering any trade.
Digital transformation is the correct long-term investment, yet it seems it's going to take some time for the stocks to return the favor.
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Jon D. Markman