This article first appeared in Forum, The Edge Malaysia Weekly on December 16, 2024 - December 22, 2024
Capital markets are crucial for driving innovation as they provide both the high-risk, long-term funding and an exit mechanism for early-stage financing sources such as bank borrowings or venture capital. As companies compete against their rivals through innovation and investing in technology, know-how or research and development (R&D), they need high-risk, long-term funding that only the equity markets can provide. This may be summarised as the interaction between “No money, no tech; no tech, no money”. You have to take risks in investing in technology, without which there is no money for competing. But if you don’t invest to improve your comparative advantage, you will be overwhelmed by the competitors and you will lose money. Eat lunch or be lunch.
In other words, vibrant, liquid capital markets that are able to provide high-risk, long-term and patient capital are vital for the future of tech companies. And in recent years, it has been the rapid advances in technology, especially artificial intelligence (AI), semiconductors and tech equipment, that have been the darlings of the stock market, creating in the US a liquid, vibrant tech stock market that has created more than US$10 trillion in investor wealth.
Tech companies have become the most valuable entities around the world, dominating stock indices such as the S&P 500, Nasdaq and Taiwan Stock Exchange Capitalization Weighted Stock Index (Taiex). If you look at the markets that are bank-dominated, such as the London Stock Exchange, European stock markets, Singapore and Hong Kong, they have not performed as well as the US or Taiwan.
The tech sector accounts for over 33% of the S&P 500’s total weight. Apple Inc, Nvidia Corp and Microsoft Corp are among the top contributors of the S&P 500 by index weight. For instance, Apple holds a weight of 7% in the whole index while Nvidia and Microsoft have about 6.7% each. The Nasdaq is also weighted heavily towards tech companies, with major tech companies contributing more than 50% to the index’s performance. This means the US tech companies rely on capital markets to raise funding for innovation, while capital markets rely on the success of tech companies to drive value creation and economic growth. The combination of good tech companies and high stock market returns boosts American leadership in tech and finance, underpinned by the US dollar.
This phenomenon has significant lessons for the new development model of emerging markets and economies. Europe, which is suffering from a lack of growth, has seen traditional stock market leaders, such as automobile companies, being pummelled in terms of profit and prospects in the face of an onslaught of cheap and good quality Chinese electric vehicles (EVs). The Draghi Report laments the fact that the European private equity/venture capital and tech markets are lagging behind the US and China, hurting European competitiveness and innovation.
The Taiwan stock market index Taiex is even more heavily weighted towards tech companies. Taiwan Semiconductor Manufacturing Co (TSMC) alone contributes over 30% to the index, boosting the entire tech sector weighting to around 68%. Over 70% of TSMC’s shares are held by foreign investors, providing the asset-heavy company with the substantial capital needed for cutting-edge research, development and equipment. This phenomenal growth in market capitalisation makes share options of employees valuable, which means that TSMC is able to attract, reward and retain the best tech talent, and at the same time devote considerable resources to R&D, thus enabling TSMC to maintain its global market share of the best quality semiconductor chips at 60%.
In short, both the US and Taiwan leverage local champions to drive innovation through stock markets. US tech giants like Apple and Microsoft saw their combined market cap grow from US$1.2 trillion in 2019 to
US$5.8 trillion in 2023, while over the same period, Nvidia’s market cap increased eight times. These companies consistently traded at high price-earnings ratios (PERs), exceeding the S&P 500 tech sector’s range of 15 to 31 times. This significant market cap growth also contributed to the US economy, with the tech market cap-to-gross domestic product (GDP) ratio rising from 21% in 2019 to a peak of 41% in 2021, before settling at 38% in 2023.
In essence, global investors are willing to pay high prices for listed tech companies or platforms that have the potential of take-off scale in terms of business, revenue and cutting-edge technology that competitors cannot match. Having a higher market cap enables the tech companies to acquire more technology or new start-ups with technology that fit their overall strategy. Acquisition by equity swaps is cheaper, because the seller is willing to exchange their assets for high-value tech stocks with liquidity. Success breeds success — the higher the technology lead, the higher the market valuation, the higher the stock prices.
Intel Corp is the classic example of the loser’s curse. On Dec 1, beleaguered CEO Pat Gelsinger resigned, leaving an interim management of co-CEOs, while its board of directors figures out how to reposition the company’s business model. Intel’s share price fell to around US$20, compared with its market peak of US$66 in 2020. Intel’s market cap is only US$90 billion, compared with Broadcom Inc, which has a market valuation that is more than nine times higher at US$835 billion. Broadcom is run by former Malaysian Hock Tan, a Penang Free School alumni. There is a rumour that Malaysia-born Tan Lip Bu, a former Intel board member, may return to run Intel.
The Taiwan stock market has become the classic replication of the US tech-driven economic model, with TSMC market cap growing from US$287 billion to US$539 billion between 2019 and 2023. While TSMC stands out as the dominant Taiwanese player, companies like MediaTek Inc and Quanta Computer Inc have experienced even faster relative growth. MediaTek, a specialist in mobile chipsets, and Quanta Computer, a leading computer manufacturer, had market caps growing faster than that of TSMC during the same period. The top five tech companies in the Taiwan stock market have consistently higher-than-average PERs, trading above Taiwan’s general market PER range of 13 to 15 times. Overall market cap-to-GDP ratio grew from 61% in 2019 to 91% in 2023.
China’s tech sector presents a paradox. Despite its huge domestic customer base, leading tech companies like Tencent Holdings Ltd, Alibaba Group Holding Ltd and Meituan have faced volatile share prices and market valuations. Using the weighted average PER of the top five Chinese tech companies (25.3 times), they are priced better than the top five Taiwanese tech stocks of 18.6 times, but lower than the top five US tech PERs of 40.9 times at the end of September 2024. The lack of a consistently strong stock market constrains the Chinese tech firms’ ability to drive the Chinese stock market’s attractiveness, so the overall tech market cap-to-GDP valuation was below 10% between 2019 and 2023.
To compensate for lower levels of international capital flows to the Chinese tech sector, China’s national and local government venture capital funds have channelled US$912 billion into tech start-ups, with 23% of the funds supporting AI start-ups. The Chinese government understands that the fight for tech competitiveness against the US, which remains the leading AI and chip tech leader, will require continued investments in tech start-ups, hoping that these start-ups have the potential to mature into unicorns with eye-popping valuations and new technology. Currently, the underperformance of the Chinese tech stock market hinders this progression.
The Malaysian stock market demonstrates the potential of small but impactful local tech champions, with the combined market caps of the top five leading companies — such as ViTrox Corp Bhd (KL:VITROX), Malaysian Pacific Industries Bhd (KL:MPI), Greatech Technology Bhd (KL:GREATEC) and Unisem (M) Bhd (KL:UNISEM) — rising from US$3 billion to more than US$7 billion between 2019 and 2023, small by international standards. Penang’s tech companies also experience higher PERs (weighted average of 56.2 times), which is partly due to smaller market turnover and investor enthusiasm for tech stocks. For instance, Advanced Semiconductor Engineering’s market cap is five times larger than the largest Malaysian tech manufacturer Inari Amerton Bhd (KL:INARI), but the latter’s PER is higher at 31.6 times versus 20 times.
Tech stocks still have a limited share of Bursa’s total market cap. Unless Malaysian tech companies grow in scale, technology and market attraction, the limited scale of the domestic stock market will constrain the funding flow for local firms, forcing them to rely on foreign partnerships to grow in terms of funding and technology upgrading. Growing partnerships between Malaysian tech companies with regional players, such as China, Taiwan and multinationals, would be critical to upgrade Malaysia’s electrical and electronics industry. The National Semiconductor Strategy will therefore need to look at the role of the local stock market to foster the growth of small and medium enterprises and start-ups, as well as the ability of mid-sized local champions to work with foreign expertise and funding, such as those coming from China, Taiwan, South Korea and Japan.
Furthermore, since Malaysia will chair Asean next year, to what extent can we link Asean stock markets to fund Asean’s tech ambitions? These are opportunities that have a short window. We must grab these opportunities to strengthen Malaysia at a time of Trumpian and tech disruption.
Tan Sri Andrew Sheng writes on Asian global issues. Loh Peixin is a research associate at the George Town Institute of Open and Advanced Studies, Wawasan Open University. The authors are engaged in a major study of the tech industry in Penang.
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