14th Aug 2023
Amidst the AI hype and scepticism, the UK’s AI landscape boasts substantial potential and a robust foundation, despite the US tech giants having dominated the limelight. A look into the implications for the UK stock markets assesses the broadly negative narrative on the AI theme but also considers some of the opportunities that may be being missed.
For all the equity fund managers you hear blathering about AI – I think most investors’ response is probably something along the lines of ‘well thanks chaps but how about using some of your real intelligence to give me some returns better than bonds?’ Touché frankly and while that’s proving a challenge, maybe it’s easy to dangle the AI carrot as a reason to stick with risky assets. Does the UK really offer much exposure to AI anyway? You’ll struggle to get through a small cap pitchbook without a slide on AI – with the narrative usually ‘threats and opportunities’ but the latter outweighs the former. Phew. Sometimes it reminds us of Y2K readiness slides 23 years ago.
Much of the conversation around AI so far has focused on the US and understandably so given it is the home of many of the Big Tech companies, which have been driving research in the field and leading in the commercialisation of the technology. The US stock market has reflected with enthusiasm the view that US Big Tech will be major beneficiaries of AI, with the 63% YTD performance of the ‘Magnificent Seven’ arguably having been driven by this theme.
Source: True Insights, Bloomberg; Data as at 26 July 2023
Exacerbated by the lack of equivalent tech heavyweights in the listed market, the UK has not been able to capture the limelight to nearly the same extent on the topic of AI. In fact, much of the discussion focused on the negatives for incumbent businesses – we’ll come onto this more later. However, despite the relative lack of coverage, the UK punches above its weight in AI against global peers.
Given it’s harvest time across this sceptered isle, maybe we should try to sort the wheat from the chaff in AI chat. Firstly, is the UK in the game? The answer here is most definitely yes. In fact, the most widely available ranking of AI IP and investment ranks the UK as no.4 globally. This tees us up nicely for the predictable decline from inventor to has-been, be it rugby, radio telecommunications or T’internet. Is there any reason for it to be different this time? The UK has a strong foundation in AI, with a history of R&D in the field dating back to the birth of computing. Some of the UK’s world-class universities have been integral to development in the subject, supported by government-funded research centres, such as the Alan Turing Institute. Furthermore, AI has been an area of strategic focus for the government, reflected in the launch of the National Artificial Intelligence Strategy in 2018 and a £1bn AI Sector Deal, supported more recently by an expansion of funding in the 2023 Budget.
Though there are those with deeper pockets – with the US and China, for instance, having launched AI investment programs of greater scale – the UK benefits from an established ecosystem around AI, which reflects a strong base level of capability and talent. The fact that various highly regarded AI companies, including Google’s DeepMind and Graphcore, are based in the UK is testament to this.
In terms of what all this means for the stock market, it is notable that the perceived implications of AI for UK-listed companies have been broadly negative. Keywords Studios, for instance, has experienced a material de-rating through 2023 from the 25x+ PE it entered the year with (and more so from the heady highs of 40x+ of 2021). Whilst AI isn’t the only factor – clouds have emerged in the formerly blue-sky outlook for video game development spend more broadly this year – the threat of AI tools undermining the need for the same extent of outsourced support when making games have been a key driver of multiple compression.
Future is another example where the narrative of AI fuelling a proliferation of digital content and a potential change to the Google search-led world order that has been the foundation of Future’s business model (monetising ‘best value laptops’, ‘top cycling equipment’, etc.) has been an important driver of de-rating, leaving the former stock market favourite trading on a particularly modest 5.5x PE.
Whilst we share concern around the challenge to some business models from AI, we feel that balance to the argument is being missed and, in some cases, that the AI threat to business models may be being overestimated. A positive case for Future, for example, is that AI tools supercharge the company’s ability to generate quality content, which can be leveraged across a broad set of well-respected publications across a wide range of verticals. Similarly, the prevailing view on the impact of AI on Moneysupermarket is at best neutral, given that a high proposition of existing traffic is sourced through search. However, in a world where the effective monopoly of Google search is broken by the proliferation of chat bots from a range of providers, is it possible that more competition could reduce Moneysupermarket’s biggest cost item (paid search) and boost margins, rather than undermining the business model itself?
There are also examples of under-the-radar beneficiaries that we think could get more airtime as the implications of AI play out. EMIS is a company potentially on its way out of the stock market (and our portfolios), now that the CMA has given provisional clearance for the takeover by UnitedHealth. However, as a holder and processor of NHS data, we see significant scope for AI tools to be applied to generate valuable insights around health trends and preventive care that could be beneficial to the UK’s healthcare system. Equally, we expect that the latent value of YouGov’s vast proprietary data assets will increasingly come to the fore as improved analytical tools augment existing capabilities and provide new routes to monetisation. At the smaller cap end of the spectrum, the growth of AI should prove helpful as a structural driver of demand for Gooch & Housego. Whether this manifests as persistent demand for the semiconductor equipment required to support ever-greater processing power requirements or the need for improved undersea cabling to facilitate a higher rate of cross-border information exchange, the company can expect a useful long-term driver of demand for its specialist electrical components to persist.
Catching our breath after the initial excitement around AI reaching the mainstream, there are clearly many unknowns from here and the impact on many UK companies will run both ways. However, as always, we are on watch as UK equity specialists to monitor the markets for the key risks and opportunities on this theme to benefit portfolios for our clients. There may come a time when AI can fill this role, too… but, until then, we’ll keep plugging away.
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