A VIEW FROM THE TOP END

Markets:

The Trump era has come to an end. Markets greeted the new President Mr. Biden as they usually do when we move from uncertainty to certainty, with a rally. The ASX200 gained 0.88% over the last two weeks while the two major American indices, the S&P and the Nasdaq charged 2.21% and 1.88% respectively. It seemed in doubt for a few weeks, but ultimately power in the US was democratically and peacefully transitioned, as per tradition. Mr. Trump even left a note for the new president, and according to President Biden it was longer than two words. The AUD:USD rate was flat over the past two weeks, and remains around $0.77.

Framework Series – AI: Reg Tech & Legal Tech Profiles

An interesting sub sector of our AI thematic is the emergence of Reg Tech and Legal Tech. We are following a few names on the ASX and private markets that offer products in the field, and we look at one of them here.

Nuix (NXL:ASX) provides cloud-based electronic discovery (eDiscovery) products to regulators, lawyers, and corporate clients across the world. Their e-discovery products are primarily designed to identify ‘evidence’ in a litigation or regulatory investigation process. The company’s platform facilitates collection, filtering/sorting, analysing, and presentation of evidence data, can be sourced from work emails, staff's social media activity, USB data, office files, and other documents.

Apart from litigation personnel, the e-discovery products are used by businesses for internal risk monitoring and maintaining adherence to applicable laws - such as the Sarbanes–Oxley Act, the Health Insurance Portability and Accountability Act (HIPAA), and other guidelines issued by relevant market regulators and central banks.

Tailwinds for the industry:

Judges are now demanding far more thorough cyber-forensic analysis, with stringent deadlines, for each case under investigation. Moreover, there is an emerging trend of increasing regulatory oversight on businesses across countries. Some examples are the ongoing probe into Facebook and Google in the United States, the Royal Commission in Australia, and Alibaba’s scrutiny by the Chinese government. Increasingly, external litigation firms, as well as in-house legal departments are coming under pressure to deploy an end-to-end cyber forensic solution which can analysis terabytes of data in various languages, formats, and from multiple sources – such as chat history, mobile usage, videos, and webinars.

During the recent COVID-related travel bans imposed by many Federal and State governments – judicial authorities have realized the importance of collecting and reviewing electronically stored information (ESI) instead of relying on physical paperwork and evidence collection. It is obviously more economic and faster to collect data electronically, rather than paying for staff to travel on the ground. Further, the ‘new normal’ of working-from-home requires businesses to actively monitor internal operations to avoid critical breaches and disorderly conduct. Moving forward, the focus of e-discovery providers is to address longer term concerns around protecting and maintaining integrity of such ESI-based evidence data.

Lastly, it is getting cheaper to buy server space for storing data in the cloud, which is gross profit accretive for companies in the sector. We have seen Nuix, who operates in the sector improve earnings and cashflow margins on the back of these tailwinds.

Headwinds for the industry:

The industry is not without risk, as eDiscovery providers are operating in a highly competitive, mature, and fragmented industry where most companies are offering very similar products. Nuix’s major competitors include – DISCO Review, Epiq, GoldFynch, Everlaw, Logikull, Veritas and OpenText. For a company to differentiate its offerings, they will be required to make large R&D expenditures in developing advanced features such as optical character recognition (OCR) capability, audio/video analysis, smart dashboarding and advanced data recovery. Currently companies will spend upwards of 20% of their revenue on R&D, in-line with most application software companies, but this will have to increase to grow market share in the space.

Other risks are global giants, as a company like Microsoft has scale and access through Windows and MS Office to threaten a pure-play application software company. Microsoft, however, has kept busy focusing on other cloud-based services and has not made any acquisitions in cyber forensic, since 2015 when they bought Israel-based Equivio for a rumored U$200 million. The only other large-cap companies operating in this space are Xerox (Viewpoint) and IBM (Content Collector).

We continue to keep an eager eye on the sector moving forward and are thrilled at the ability to play the space on the ASX.

Updating our checklist:

• Valuation: ASX & S&P500 levels: Goldman Sachs came out with their 2021 outlook this past week. They are looking forward to the S&P rising 14% in 2021 and 7% in 2022. These predictions are the result of a 31% increase in earnings per share over the next year. Profit gains will not be shared equally between now and 2022, with materials (mining) and information technology leading, and financials and energy shares lagging. They expect that for the next two years the S&P 500 will trade at a fwd P/E ratio of 22x. Currently the S&P is trading at 23.0x fwd PE and the ASX is at 20.9x fwd PE. A tad rich, but within the error bars of Goldman’s analysis. Earnings drive share markets in the long term, so we were very interested in their outlook.




• Global PMIs: As it is mid-month, we take a break from PMIs and look at some of the other economic data out the last two weeks. In Australia we have seen a sharp rebound in consumer confidence. The spike is mirrored by building approvals in the private sector. You are looking at the beginning of a residential construction boom. Record low interest rates for mortgages and a jobs market that saw sectors outside of tourism and hospitality come through Covid relatively unscathed are fuelling demand.






• Downgrades on guidance: In the US banks have started reporting earnings, and they are coming in much higher than expectations. Of note lending margins have been steady. We expect the demand for mortgages to drive bank profits overseas and in Australia. A steepening yield curve in Australia will improve bank profits in the medium term. Banks and housing doing well, is a good indicator that the rest of the economy is continuing to pick up.


• Infection rates to slow globally: The mask rules in Brisbane have been relaxed to their pre-lock down status. We know everyone is happy for us. In the rest of the world, the US has dramatically shifted its rhetoric on the virus with President Biden taking office. Dr. Fauci was able to speak “freely” at his latest press conference and mask rules have been implemented by executive order on public transportation and flights. President Biden has a detailed plan to fight the virus and extend vaccinations in the millions. The shift in the US will be felt globally. In Australia the TGA continues to review the vaccines that Australia has purchased and roll out is expected by March.


• Monetary and Fiscal stimulus announcements globally: We got a figure for the expected US stimulus this week, and it is enormous at $1.9tr USD. It will also include another round of helicopter money with checks for $1,400 USD going out to every citizen. On the news markets globally rallied. Now the news of the package has caused Republicans to preach caution, and they have publicly stated that they will oppose the bill. Ultimately, we expect some sort of package to be issued, but we will have to wait to get exact numbers. Once again though stimulus will help push markets higher.

It has been a very US focused update, but with the events of the last two weeks it was warranted. Moving forward we expect a quieter news cycle from the US. It will be an interesting first 100days for the new administration that will have effects globally, but it always is when we get a fresh President. The book on Biden is well known and we have positioned the portfolios to take advantage of several his policy objectives. As for Australia we continue to lead the world when it comes to Covid cases, when our vaccination program powers up, we expect even further gains as the economy recovers and the RBA keeps rates cheap. If you do find yourself with some extra capital, our advisors have been briefed on our strategies and portfolios and are well placed to implement a strategy that meets your financial goals. We encourage you to get in touch. Till next time please take care and we will write to you again in two weeks’ time.

Regards,