3 Super Strong Tech Companies

In this podcast, we talk through the natural and curated monopolies that exist in the tech landscape and use three companies -- Alphabet (GOOG 0.37%) (GOOGL 0.35%), VeriSign (VRSN 0.77%), and Axon Enterprise (AXON -0.74%) -- to explore the traits of businesses with incredibly strong market position and why they're so attractive.

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This video was recorded on Dec. 10, 2021.

Dylan Lewis: It's Friday, Dec. 10, and we're talking about stocks with monopolies. I'm your host Dylan Lewis, and I'm joined by Fool.com's most minuscule momentum man of monumental mystery Brian Feroldi. Brian, what's going on?

Brian Feroldi: Hey, Dylan, how's it going? I think this is going to be a fun episode. Importantly we're going to be talking about tech monopolies. Not named Facebook, I mean Meta.

Dylan Lewis: Yes. I think that's one of the signs that you are becoming pretty close to monopoly. If you change your name into something that suggests an umbrella brand, you're heading into monopoly territory, Brian.

Brian Feroldi: It's just to get off two of the three companies we're going to highlight have changed their name, maybe it's time you start the third you know what I'm saying.

Dylan Lewis: You had pitched this show idea and I loved it. I want, before we even get into some of the businesses we are going to be talking about, to just talk through why you wanted to talk through this concept and why this is a helpful perspective for people to have when they're looking at businesses.

Brian Feroldi: Monopolies tend to get a bad rap and I understand why especially if you look at history, monopolies tend to be extremely bad for consumers. Some of the famous ones were AT&T, which was broken up in 1982, Standard Oil, which was broken up in the 1910s or 1920s, and there are reasons that there are laws on the books that prevent monopolies from existing and abusing their power. What you might find interesting is that actually if you look at the details of the laws, U.S. laws do not punish companies for being the sole provider of a product or service. In other words, monopolies are not outlawed. However, they are designed to punish companies that abuse their market position to put forth unfair practices that stifle competition.

Dylan Lewis: Yeah, and this is one of those spaces that always gets debated. You have these dominant companies, you may come under antitrust scrutiny and we dominate this market. If you look at it this way, we have 80% of it. But if you take a step back and you realize that's just a piece of this overall market, we only have 20% market share, Brian.

Brian Feroldi: That's right. It totally depends on how you define the market that you are going after. What's interesting is when you start to dig into monopolies, there are actually lots of monopolies that exist out there and many of the companies are publicly traded. A lot of utilities, for example, are natural monopolies. There are companies that provide water or trash services or electricity to a market, and they would just be prohibitively expensive for there to be multiple providers of that service to the geography that it operates in. For that reason, governments allow monopolies to exist with the caveat that pricing is controlled by them so they can't abuse it.

Dylan Lewis: Yeah, I think one of the interesting things with a lot of the modern monopolies that people tend to think of, the Metas of the world and one of the first companies we are going to be talking about, Alphabet, is they don't really conjure up the same ideas as a trust-busting Standard Oil, where the consumers are shouldering additional costs in a very obvious and explicit way. These are products that are often consumed for free by the consumer, and the traditional monopoly dynamics are actually more behind the scenes.

Brian Feroldi: Yeah, Alphabet is the first company that we're going to talk about and they have a dominant market share in several markets. But to your point, are consumers being hurt by the preference and their extreme dominance? I would say no, I've never been charged for a Google search myself. However, you could argue that Google's actual customers, which are the advertisers on their site, maybe they're being abused.

Dylan Lewis: Yeah. If you want to take that one step further, you could say higher costs for advertising may get translated into higher prices for consumers. But it's a little bit more of a difficult argument than some of the past monopolistic arguments that we've seen. We wanted to start with this one because I think it is probably one of the easiest ones for people to wrap their head around. You may find us by using Google product or an Alphabet product. They've become so ubiquitous, they've been verbed. I think that's usually where you start to get into monopoly territory, Brian.

Brian Feroldi: Yeah, it's hard to use the internet and not be using one of Google's or Alphabet's products, and to give you a sense of scale for how dominant they are in a couple of their markets. Google's market share of search globally is about 93%. Ninety-three percent. That is beyond dominant in first sense of scale. The No. 2 search engine in the world is Bing, and that has a global market share of 2.3%. Amazingly, that isn't Google's only monopoly.

Dylan Lewis: Yeah, I mean, if you're looking for information generally, Google is the name of the game. It is the most visited website in the world, they also happen to own the second most visited website in the world.

Brian Feroldi: Yeah. Which you could argue is the second biggest search engine in the world, by the way. That second most visited site in the world is YouTube. In the space that YouTube competes in, its market share is 76%, and the No. 2 provider of online streaming videos. Again, YouTube's market is Vimeo. Now, Vimeo is a a much stronger second competitor than Bing is, but Vimeo's market share is only 19%. Dylan, we're still not done.

Dylan Lewis: Yeah. Often lost in the conversation with Alphabet is the Android operating system. They've taken a slightly different approach to the smartphone market than a company like Apple. Really, in this case with Android, it's allowed them to layer in a lot of these software and app-based ways that they make their money and it's absolutely staggering, 75% market share globally, which I think we can under appreciate here in the North American market, these iOS market share is much higher here than in the rest of the world.

Brian Feroldi: Yeah. You can understand why Google pushed so hard to make Android so dominant. By owning Android, they can obviously set Google as the default search engine and YouTube as the default video engine, which in many ways really feeds why those sites are the No. 1 and No. 2 most-visited websites in the world.

Dylan Lewis: Yeah. All of these digital products really feed everything that Alphabet is able to do. I mean, if you look at what Google advertising looks like as a line item for this business, in the most recent quarter, $53 billion out of $65 billion in quarterly revenue. Absolutely staggering. Search is about 38 billion of that, YouTube adds 7.2. I mean, it's incredible to think about how much money these generate. That is what fuels everything else that we read about this company.

Brian Feroldi: That enormous revenue growth really allows Google, Alphabet, I guess I should say, to spend crazy, basically everywhere that it can. It's known for being a very wonderful place to work, having very lavish employee benefits. Yet, still be unbelievably profitable at the same time. Alphabet's trailing-12-months revenue was about $240 billion, of which it converted $71 billion into net income. That is a sign of a fantastic business.

Dylan Lewis: Yeah, 56% gross margins for this company over the trailing 12 months. I think a sign that it is, one, a digital product and two, one that enjoy some pricing power, which we know is a dead indicator of a company that has a pretty strong handle on the market, Brian.

Brian Feroldi: When you combine that with the general growth in the internet, essentially since this came public, it's no wonder why this has been such a phenomenal long-term investment. If you were smart enough to buy and hold shares of this company since it came public in the mid 2000s, you're currently up 5,400% and counting.

Dylan Lewis: Yeah. I will say, I think this has been an easy one, maybe over the last 5-8 years. An easy one where you've known that this company isn't going anywhere, you've known that no one's coming in and eating their lunch when it comes to search. I think in the early days of this business, it was a lot harder to see how this materialized into the ad giant that we know it to be today. But one of the things that I think you'll notice with some of these businesses we're talking about is when you start getting into the competitive dynamics on where this company sits in the marketplace, you don't have to think very hard for what success looks like for that business over the next five years.

Brian Feroldi: Exactly. Equally as exciting as Google today, if you look at the company's long term growth trajectory, search is still a cash cow, but there's a lot of advertising dollars that still haven't made their way online. It's just a matter of time before those dollars do navigate to online, and Google is a natural beneficiary there. Despite its size and dominance today, plenty of reasons to believe that this company still can grow.

Dylan Lewis: Yeah. It remains something that I continue to own despite the size of its become as a company and I'm happy to do so. It's a product I love and a very well run business. Brian, the second company we're going to look out, we're going to pivot something that I think maybe some people haven't heard quite as much about and might need a little bit more background on, and that's Verisign.

Brian Feroldi: Verisign is a monopoly that a lot of people haven't heard of. The ticker symbol here is VRSN. Verisign is a global provider of domain name registry services and Internet infrastructure. Breaking that down simply, if you operate a website that ends in .com, .net, .gov, .jobs or .edu, you're a Verisign customer even if you don't know it. Verisign is the exclusive provider of those top level dot names thanks to an agreement that it has with a non-profit group called the Internet Corporation for Assigned Names and Numbers or ICANN. Another agreement that it has with the US Department of Commerce. That .com top level domain is incredibly popular. For a sense of scale, there is about 364 million domain registrations of all top level domains globally, and 157 million of them end in .com. It is by far the number 1 source.

Dylan Lewis: Yeah. I think you always do a little bit of a double take when you see a not .com. It's becoming more common these days just because so much of the digital real estate of the Internet has been claimed. We've started to see people merge into other domain names, but yeah, that is where the business is. That is where the money is and where people tend to go with this. Brian, I, for one, love when I can own something that is just humming in the background and almost nobody knows about it. I think those are some of my favorite businesses to own because they don't really get on other people's radar, it becomes the sleepy stock that's fun to have in your portfolio. Honestly, it doesn't maybe get the headlines or some of the negative press that some of these other businesses tend to get.

Brian Feroldi: Yeah. As we said, you probably are a customer of this company if you have a website that ends in .com and you might not even know it. Verisign contracts itself out to 2,000 different registrar companies. Those are the ones that you might be more familiar with, such as GoDaddy or Namecheap or Tucows. Essentially, if you go to those sites to buy and register a domain name as a.com, the money that you're paying is passed along to Verisign in the background. It's very much like a utility for the Internet.

Dylan Lewis: Yeah. If you thought that what we were talking about with Alphabet was attractive in terms of financials, whole another story here when we're talking about Verisign.

Brian Feroldi: Yeah. I think the most attractive financial profile that I've ever seen in my life is probably Visa and Mastercard, but Verisign is really, really close to that. It's certainly within that range. The company has monopoly margins for itself. This company's gross margin is 86%, its operating margin is 65%. After taking out all expenses, this company's net margin is 45%, meaning the company converts every dollar of revenue into 45 cents of after tax profit. Incredible.

Dylan Lewis: Absolutely incredible. You can tell it's a digital business and you can tell it's one that has a pretty firm grip on the market. I am sure there are some people that are wondering, "It sounds like there's market is relatively established." we talked about just how deep and penetrated the .com space is already, Brian. What do the growth levers look like for this business going forward?

Brian Feroldi: If you look at how this company has performed since it came public, the returns have been spectacular. This companies have about 3,700% during its lifetime as a public company. However, there are so many domain names that are out there and the growth of those domain names are slowing, and I think there's also a reason to believe that there are some alternatives cropping up, so you don't necessarily have to have .com after your name to be successful. But the way this company grows is by one, registering new domain names, and there are still millions that are registered every single year. Two, by increasing its renewal rates, so people keep paying those fees in order to maintain their .com or .net. Renewal rates for this business hover somewhere around 75%, but three is the interesting one. This company can essentially raise prices for its registration and companies have to pay at these fees to do so. 

Because the government believes that this is essentially a monopoly, it is regulated on how quickly it can raise prices. Verisign does have a contract in place with ICANN that allows it to raise prices on the .com registration about 7% each year through now and 2024. For example, on September 21st of this year, the annual price to register a .com was raised from 785-839. That does not sound like much, but multiplied by hundreds of million to domains, that is a lot of money. The company can even raise prices faster on .net domain names. Prices can increase about 10% each year between now and 2023. There is a limit to how fast this company can raise prices and it's also contract with risk with those things being renewed every time they come up for renewal. But that is essentially how this business grows.

Dylan Lewis: Yeah, I mean, even if you're just looking at the pricing power element of this, that's 7-10% annual growth that they're probably able to work in even without bringing in new customers. If you bring in new customers, you're able to accelerate on top of that, 7-10%, Brian is basically what we expect from the S&P 500. That's OK. Really, knowing that you have the kicker of whatever they're able to bring in for new customers, that's a pretty compelling business idea.

Brian Feroldi: If you look at what's management is doing with those extreme profits, it's basically plowing all of that capital into share buybacks. This company's diluted share count is down about 30% over the last 10 years. Another fun fact about Verisign, it hasn't gone unnoticed by Warren Buffett. Berkshire Hathaway is actually the largest shareholder of Verisign, owning about 11 and half% of the business.

Dylan Lewis: Yeah. I'm certainly interested in this one, Brian. One that I think I'd overlooked. One of the joys of doing the show with you, so I get to checkout some companies that maybe missed my radar. This third one we're going to talk about I know is on both of our radars because I talked about it as my top stock for 2021, Brian. That is Axon Enterprise. Probably somewhere between Verisign and Alphabet in terms of awareness for people that are listening to the show. For people who don't know, this is the business formerly known as Taser. They rebranded to reflect company's shift from being stun gun focused to being more focused on their Axon body cameras and evidence.com cloud storage business. Brian, they've been going through this transition over the last half decade or so. We've really started to see it materialize over the last couple of years. It seems like it was 100% the right decision.

Brian Feroldi: Completely. This has been a phenomenal long term investment providing returns that are insanely high if you bought this company anytime during the IPO. I can tell you, while this had been a Motley Fool recommendation for many years, I always ignored it because I just figured it was a hardware company that was selling tasers and I don't like investing in hardware companies. However, when you dig into the details of this company, there's far more to it than just selling hardware.

Dylan Lewis: With that hardware, that's basically their entry into a lot of these police departments and law enforcement agencies, but they have this cloud storage Software as a Service like business model with evidence.com. That's where their financials get much more attractive, and it's also where their business gets a lot stickier. It moves them away from just being a hardware provider to this recurring revenue model. One where your embedded in law enforcement agencies and departments, it's a little bit harder for people to switch. Also hard to switch Brian because the reality is there are not a lot of people that operate in this market. I have looked and tried to find accurate market share data for worn body cameras used by law enforcement. It is tough to find the estimates [laughs] that I've seen, or that Axon has somewhere between 70-80% market share in major markets like North America. 

I think relatively early on, we're seeing more and more local law enforcement agencies use it. Basically, there's Axon. For a while, there was Vievu. Then they decided, "What if we just bought Vievu?" The two major players in this market have consolidated that has come with some regulatory scrutiny though.

Brian Feroldi: That was one of those acquisitions that went through. Made me scratch my head a little bit. It was when Zillow bought Trulia many, many years ago. It was clearly number 1, buy number 2, and it somehow made it through. When Axon made that move, I don't think it's a stretch to say that the company established itself as a monopoly position in those body cameras.

Dylan Lewis: I think they already were well ahead of Vievu in the market, and it was just an opportunity for them to consolidate. It has come with some scrutiny, and the FTC is pretty interested in this acquisition. They've challenged it, they are attempting to undo the merger. Axon has appealed mostly on due process grounds and lost that first appeal. It seems this will be challenged before a judge in an internal administrative enforcement process. It is hard to know what to make of something like that as an investor. The thing that I'll lean on on something like that is Axon was the market leader before this acquisition, they are likely going to continue to be the market leader. Even if this doesn't go through, Vievu is a distant second. 

They really came into the fold because they had reached a major market in New York City law enforcement. That was what spurred their interest in the business. I think one of the other competitive risks for this, knowing that they have the number 2 player, is that there are some companies that operate in law enforcement technology that may expand where they currently are and move a little bit closer into body cameras. Motorola's really I think one of the main companies to watch here. They've been a supplier of law enforcement things like radio, dispatching communications. They have body camera products. You could see them looking to offer something that is a little bit more of a full suite product for law enforcement. I think the challenge for a company like Axon is going to be, can you move wider out from cameras and evidence storage.

Brian Feroldi: That to me is such a reason to be so bullish on Axon. Yes, other companies can produce hardware that competes with Axon, but they have really take it on an Apple-like ecosystem to all of their products to make sure that they all complement each other and work together. Evidence.com is the software that ties everything together, but they're also making their products so that if you use one, then the other products that are associated with it actually automatically work and help with record keeping. While there is competition out there, I could see them having a very hard time displacing Axon because it's made such investments in that software.

Dylan Lewis: I will say, this has actually been a market underperformer year to date. It's a business that's slightly underperforming in the S&P 500. I remain incredibly bullish on it, it's one of my top winners, it's a company that I've owned for a long time. One of the reasons why is as you look at the financials, it has a lot of those monopolistic business trades to it. It's posted 20% plus year over year growth for the last five years, they are clearly a business that is in a growth market, and they own the growth market. 73% of revenue tied to subscription bundles, 63% gross margins. I think that's where you start to pay attention. This company is losing money, but really it's because I think they are spending a lot of SG&A and R&D, trying to make sure that they maintain their market leadership position. This is a business that was making money, posting positive net income just a couple of years ago. I think choosing to make those investments and as a business now.

Brian Feroldi: Plus they also have that business model innovation where they knew that if they got a police force embedded with evidence.com, then eventually they would really cement themselves as an almost hard to get rid of supplier. Because of that, they gave extremely favorable pricing terms for police departments to get them to make that switch. If memory serves, they actually give it away for free for a year. That's obviously going to take a toll on your financial statements, so I would argue this company's financial statements don't accurately represent what the business has actually been doing over the last couple of years.

Dylan Lewis: Interestingly enough, we're still in the phase where, for the most part, the Taser business is the largest piece of revenue. Axon is catching up, it's going to take it over in a couple quarters, you can tell it's getting there, but it's not quite there yet. Even though that's the case, company is up 800% since early 2016. That's when then Axon narrative and this new pivot for them really start to take hold, became a sign that people were paying attention to. I remain a shareholder of this company and also of Alphabet, I think two really quality businesses. Verisign, one for me to checkout a little bit more, Brian. Something I want to do as we wrap the show is just talk through quickly a couple of the traits that we identify here with businesses that have these monopolistic qualities. We talked a little bit about just the sheer ownership of market share. There are a couple other things I think we can point to as well, Brian.

Brian Feroldi: In general, when you're looking for companies like this, something that you're going to be looking for is a relatively stable and predictable business performance. A way that you indicate that it's just by looking at the margin profile of a company. One simple thing you could do is sort all the companies in the world by net margin. The ones that have the absolute highest ones, probably the good indication that the businesses might possess monopoly like qualities. One thing that is worth noting about these companies is while they might have a lock on their current market, that doesn't mean that they're not susceptible to market dynamics in huge risks down the line. 

For example, Verisign has government guaranteed the lock on the dot com registration, but we're seeing a lot of other domain names flourishing out there. People are increasingly willing to move away from them to say nothing about the long term as an [...] that something like blockchain technology could provide. The same is true for Google's core products, you could easily see web free things developing overtime that render those obsolete overtime. History is filled with examples that form a monopolies that lose their stature due to technological innovation, so that is something to keep an eye on.

Dylan Lewis: Heavy is the head that wears the crown. Right, Brian? It's true. If you're first, people are going to be gunning for you and they're going to be people looking for that market opportunity. That's basically the way it works. These are all companies that enjoy a really favorable market position right now, they need to sustain it in order to continue to be quality investments. I think in the case of all three of these businesses, I'm pretty excited for their next five years and the prospects in front of them.

Brian Feroldi: You could do worse than starting your stock investment search for these three companies.

Dylan Lewis: I could do a lot worse with whoever I'm hosting this show with, Brian. You are a fantastic contributor, always happy to have you on. Thank you so much for joining me on today's show.

Brian Feroldi: Always a pleasure Dylan.

Dylan Lewis: Listeners, that's going to do it for this episode of Industry Focus. If you have any questions you want to reach out and say, "Hey." Shoot us an email at [email protected], or tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes, Spotify, or wherever you get your podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell based solely on what you hear. Thanks to Tim Sparks for all his work behind the glass today and thank you for listening. Until next time, Fool on.