Investing in Tech's Critical Infrastructure with Sean O'Hara - 7investing 7investing

Investing in Tech’s Critical Infrastructure with Sean O’Hara

7investing founder Simon Erickson chats with Pacer ETFs President Sean O'Hara about how investors can creatively get exposure to the digital transformation. Sean believes data infrastructure companies, such as datacenter real estate and cell phone tower operators, will be necessary to support the world's largest developing technology trends.

May 12, 2020 – By Simon Erickson

Investors are already quite familiar with several of the biggest trends taking shape in the tech world. Artificial intelligence, autonomous vehicles, e-commerce, and digital streaming are huge movements that are attracting hundreds of billions of dollars all across the globe.

The companies who are leading these trends — such as Microsoft, Amazon, and Netflix — are also attracting hundreds of billions of dollars in their stock market valuations. Several growth-style investors who are intrigued by these trends might want to find smaller opportunities who haven’t already become the market’s largest companies.

But perhaps there is a less obvious and more creative way to invest in the world’s largest tech trends. And we reached out to an expert in the space to learn more.

Sean O’Hara is the President of Pacer ETFs, an ETF issuer with more than $5 billion of assets under management. His team is investing in the critical infrastructure that is crucial to support the developing tech trends, such as datacenter buildings and cellular tower operators. Several of these companies are organized as publicly-traded Real Estate Investment Trusts (“REITs”), and they’re benefiting from the exponential growth of data.

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In an exclusive interview with 7investing, Sean describes “the four horsemen of the internet” and explains why 5G is such a big deal. He reveals who will be the largest beneficiaries of increasing cellular traffic, and what companies could be the hidden gems that are still off the radar of most investors.

Sean also describes several other ETF strategies, such as identifying “global cash cows” with high free cash flow yields and how his firm is investing in China. Sean and Simon also have some fun sharing thoughts about self-driving cars and how some companies represent Texas bovine.

Interview timestamps:

0:00 – Introduction

0:38 – The “four horsemen of the internet”

3:41 – Who are 5G’s biggest beneficiaries?

6:17 – The cellular tower “landlords”: Crown Castle and American Tower

11:17 – Balancing international growth and free cash flow yield

13:38 – “Global cash cows” and the importance of free cash flow

18:10 – How Pacer is investing in China

20:50 – What should individual investors be watching right now?

Publicly-traded companies mentioned in this interview include Facebook, Amazon, Netflix, Alphabet, Disney, Equinix, Digital Realty Trust, American Tower, Crown Castle, Lamar Advertising, Outdoor Media, AT&T, Verizon. 7investing’s advisors and/or guests may have positions in the companies that are mentioned.

This interview was originally recorded on May 7, 2020 and was first published on May 12, 2020.

Complete Transcript

[00:00:00] Simon Erickson: Hi everyone! I’m 7investing founder Simon Erickson. And this morning, we’re talking about several of the biggest tech trends taking shape in the world. You’re already familiar with most of them: autonomous driving or artificial intelligence or the Internet of Things. But we’re going to be looking at some creative and untraditional new strategies on investing into those later this morning.

My guest is Sean O’Hara. He’s the president of Pacer ETFs. Pacer is an ETF issuer with more than $5 billion dollars of assets under management. They’re based up in Malvern, Pennsylvania, right outside of Philadelphia. Sean, thanks for joining 7investing this morning!

Sean O’Hara: Good morning. Thanks for having me.

[00:00:38] Simon Erickson: Sean, you have described the “four horsemen of the Internet”: which is artificial intelligence, streaming, e-commerce, and autonomous driving. We’re pretty familiar with those trends and the largest companies that are part of each one of them.

But as an investor, what intrigues you and how do you think about investing in these types of trends?

Sean O’Hara: Well, you know, technology has been driving the markets here lately. Five stocks have basically been dominating and most of them are tech names and embedded in this business. But what most people don’t understand is that the technologies you spoke about all are not possible unless there’s a critical infrastructure built out to support them.

So as an example, Amazon, Google, Microsoft are all competing in the cloud business. And the cloud is where all computing in the future, by and large, will take place. And the cloud is going to drive those technologies like the Internet of Things or streaming and e-commerce.

But what most people aren’t yet aware of is that the cloud is basically a building, a data center that is filled with racks and racks of computers. And in most cases, the cloud providers aren’t manufacturing those buildings. Those buildings are being manufactured by specialty real estate companies like Equinix or Digital Realty or Cyrus One. And so without that critical infrastructure in place, those technologies can’t go forward.

So we built an ETF, “SRVR”, that basically focuses on the data centers, the fiber optic network, which is really where the information is going to flow. It’s like the superhighway for all these bits and bytes. And then the cell phone tower companies, which are critical to this infrastructure as well.

We sort of like to think of it like we’re the landlord for the “FANGs” [referring to Facebook, Amazon, Netflix, and Google]. And so, you know, if we’re all stuck at home, working from home, doing these webcasts, binge-watching our favorite streaming service — whether it’s Netflix or Disney+ or whatever happens to be — what most people don’t understand is that information is coming from a data center someplace. And embedded in that data center, right next to the racks that push out the content, there’s probably an artificial intelligence computing network that’s actually trying to figure out what your preferences are. So when they push out suggestions, they say, “Hey, you might like these five movies.” That’s all artificial intelligence. And it all relies on that same publicly traded real estate network that’s data centers, fiber optic networks, and then the cell phone tower companies.

And what we’re learning, I think, in this environment, is that we’re not quite built to capacity. As these things continue to grow, we’re going to need more and more and more infrastructure.

So we’re really on the tech side. We’re invested in the tech business. I mean, obviously, our products own all these big names in other areas. But this is a kind of a diversifying story for people who think tech is going to be the driver but want to be diversified away from owning just straight out equity names. You can participate in that growth by owning publicly traded real estate.

[00:03:41] Simon Erickson: Let’s double-click on those cell phone towers that you mentioned. And I want to talk about 5G, because 5G is in the headlines everywhere.

Sean, how big of a deal is 5G? And what applications do you think are going to be the biggest beneficiaries from this?

Sean O’Hara: Well, 5G is a big deal because it’s all about the ability for one computing network to move the information to your handheld device or to communicate with your car, for example. I like to say: I drive home every day from work and I can tell you where the dead spots are on my coverage on my way home. It’s Upper Gulf Road, once I make a left off of King of Prussia Road.

And so we can’t have autonomous vehicles unless we have a bigger footprint for the coverage. And unless that coverage can move more data. And so that’s why 5G is such a critical component.

It’s a part of the technology story. It’s a smaller part of an overall bigger theme that we think of here at Pacer ETFs: like the Internet of Things and streaming and e-commerce and artificial intelligence. But it’s certainly critical to the infrastructure if we’re going to have autonomous vehicles, for example. Or if we’re going to want to watch or download or use our handheld devices or our iPads or whatever tablet we’re using that’s not directly connected to a network someplace. That it might be connecting via a a cell phone tower connection. So our cell phone connection.

So it’s a big deal. And Crown Castle and American Tower are the two big players in that market. There needs to be an enormous amount of additional cell phone nodes placed on these towers. So you’re going to see four and five times those little sort of white rectangular disks, if you will, if you look up and see a cell phone tower. There’s not enough of them to get to where we need to cut for the density of coverage that we’re looking for.

You’re also going to start to see them in kind of strange places. You’re going to see them on traffic signals and on the top of buildings. And one of the holdings in the ETF, or two of the holdings, that are kind of interesting are two companies that people wouldn’t think of as traditional tech names. And that’s Lamar Advertising and Outdoor Media.

So those are just big, giant billboard companies. And they’re converting themselves into dual purpose companies. They are going to continue to operate the billboards as we’re driving across the highways. But what they’re also going to do is connect the fiber optic wire to those towers and electricity billboards and put cell phone tower nodes on those. And if you think about what they cover, they basically cover the vast highway network across the country. So that’s a secondary play in the 5G world.

[00:06:17] Simon Erickson: Mentioning those cell phone tower operators. Like you mentioned, a lot of these companies are taking the CapEx onto their balance sheet. They’re renting that out to the telecom companies on a per-customer basis, based on the bandwidth that they would need.

You mentioned American Tower and Crown Castle. I know that those are two very large players in an oligopoly of this industry. There’s not a whole lot of companies at the top. They own the majority of market share.

Is that what attracts you to this industry, Sean? Are there certain things — the economics of the oligopoly structure — that are really interesting to you as an investor in these types of companies.

Sean O’Hara: Well I mean, think of it as “short term, long term.”

Short term, what’s attractive to me is that the components or the constituents in these ETFs are not saying that they’re going to withhold all guidance between now and the end of year. They’re actually reaffirming it. And in a lot of cases, they’re increasing their guidance between now and the end of the year.

Which means that in this environment, where the economy is shut down globally so we can stop the virus, they’re actually operating in a profitable basis and getting more profitable every day. So, short term to me, I like that. I like to invest with certainty as opposed to uncertainty.

Long term, we believe that these are critical infrastructure providers that are necessary to have the kind of growth that we’re looking for. We started the technological revolution from having everybody connected to the Internet. And when we are done, it’s going to be everything’s going to be connected to the Internet. And you’re starting to see it in your house every day. You know, everybody’s probably got a Ring doorbell now that’s got a video component attached to it so you can see whether somebody’s stealing your Amazon package or not.

So we just think long term, it’s very, very early in the cycle in terms of the amount of infrastructure that needs to be built out in order to satisfy the consumer demand and the business demand for these types of services.

Simon Erickson: And long term, how do you think about the relationship between 5G cellular signal and wireless broadband internet?

We’ve kind of gotten used to jumping between bringing our laptops and our tablets to Starbucks to connect to Wi-Fi there. But now there’s more and more of a transition to 5G over those cellular networks.

Does 5G gradually displace wireless internet – or even replace wireless – in the long term? Or is this kind of a a complementary, new applications opportunity?

Sean O’Hara: I think they go together. You know, as we start to have more of a burden, if you will, in terms of the types of things that we’re downloading and using on our handheld devices or our tablets, we need multiple solutions. There’s been so much written about 5G and AT&T and Verizon are spending voraciously trying to get that coverage up.

But we think if you just focus on 5G, you’re missing a much bigger story. E-commerce, for example, which I’ve just recently seen the statistics and the spike in e-commerce sales as we’re all locked down. And I think everybody thought it would get to 30% of all retail buying at some point. But it looks like it’s accelerating. Well we can’t do that without these networks being built out. Not only on the technology side. But on the other side, on the distribution side.

Internet of Things, artificial intelligence. All of those things are, I think, as big or if not bigger than just 5G. And all of those different segments of the technology market are covered by the data centers, the fiber optic networks, and then the cell phone tower companies.

Simon Erickson: Sure. And any overall thoughts about autonomous driving? We hear a lot about that in the news. Your perspective on self-driving cars?

Sean O’Hara: My personal opinion is it’s going to be a long time before I get in one. But I think, you know, I think you’ll see it evolve over time. And as we start to prove out its effectiveness and as people become more comfortable with the safety of it, I think it’ll become a bigger and bigger part.

I know you’re down in Texas. I know early in my career, I drove all over Texas, Louisiana and Oklahoma. And I’m kind of a “be in control” of my own car — you know — “explore the wide open spaces” kind of guy. But in certain a bigger metropolitan markets, to deal with some of the congestion, I think you’ll see more of this as the technology evolves. And as we get more comfortable society as a society with sitting in the back of a car with nobody up front steering. Except it’s connection to a cell phone tower that’s transmitting all of these bits and bytes of information via a fiber optic network to a computer someplace that knows where you’re going to go and is then sending the directions back.

Simon Erickson: It certainly makes a lot of sense in those densely-populated areas. I can only imagine, though, in some parts of Texas, what it would it be like on the highways with a autonomous car driving in front of you in the fast lane!

Sean O’Hara: Exactly.

[00:11:17] Simon Erickson: Sean, let’s shift gears a little bit on this (no pun intended with the car reference there). PacerETF, we’ve talked a lot about 5G and data infrastructure. But you guys actually have a lot of different strategies. A variety of options and ETFs that are available for investors.

I wanted to touch on just a couple of those here quickly, to get your broader thoughts on why these are interesting strategies and why you’re investing here.

One of them, the ticker is PEXL. It’s the “Export Leaders ETF” is what you’re calling it. Which is basically, it looks like, they’re deriving most of the sales from international markets. But also have high free cash flow yields for these companies.

Could you talk a little bit about the strategy that you’re using for that ETF?

Sean O’Hara: Well, you’re certainly going to make my partner really happy, talking about PEXL. Because he loves that strategy.

The basic premise behind this story is that if you think about companies in the US and those that have a greater chance of being more profitable and grow faster, it’s those companies that get the bulk of their sales outside the U.S. Because the U.S., although it is a ginormous economy, it’s only one economy throughout the world. And there are other economies growing more rapidly than ours. And there are markets to be to be tapped into.

So what we did with PEXL was we just basically screened the US market for those who have the highest percentage of their overall sales outside the US. And then what we wanted to do is to try to put a fundamental or a an economic screen on top of it, so that we knew we were buying companies that were at least generating positive free cash flow. And so that’s where the free cash flow yield screen came in on that.

And, you know, this is no secret. Maybe half of all the profits in the S&P 500 come from outside the US. So in this, sort of, globally interconnected world that we live in, where we’re not as open as we want in all cases on trade, there is a great deal of trade potential and commerce available outside the US.

These larger companies, we think, are better suited to do that. And then those with free cash flow to spare can make investments in places to continue to grow their sales outside the U.S. as well. And what we hope is that eventually down the road, that translates into a group of companies that have more profits than this broad-based S&P 500, let’s say.

[00:13:38] Simon Erickson: And double clicking on that a little bit farther. You have another ETF, “GCOW” (I love the ticker on that one, by the way). But it’s a “global cash cow”, right?

This is another index that is based upon high free cash flow margins — and high free cash flow yields, for that matter — that are paying a good portion of those out as dividends.

Sean, how do you think about… First of all, free cash flow is an unfamiliar term for maybe some of our audience. But it’s basically the cash coming into the business after the business pays all of its operating costs and all of its capital costs, including that for future growth. So it’s the cash that’s hitting the bank after you pay for what you need to pay for.

But how do you think about free cash flow? Especially from an international perspective. It seems like there’s a lot of opportunity, maybe temptation, to expand aggressively to build out in other countries. You have to build a sales force. You have to build an infrastructure. You have to build a presence. I mean, it costs a lot of money to do that.

But then you’ve got another strategy that’s looking for companies that are international, that are paying that out as dividends rather than going out and expanding aggressively.

How do you think about free cash flow in investing? Or is this something that truly is a company-by-company or industry-by-industry basis?

Sean O’Hara: Well, we have a whole suite of what we call cash cows, which use free cash flow yield as the screen. So free cash flow yield, if you wanted to think about it — if you were going to buy a company, what you would want to know is what you’re paying in total to buy the company, and then how much cash you would get as a result in terms of cash that would be generated once you purchase that company.

So free cash flow yield is just the free cash flow a company it generates divided by its enterprise value. And enterprise value is what you really pay. You pay for all the stock and then you have to account for the debt. And then you give the owner once you buy the company, whatever cash is on the balance sheet back.

And then once you find that number, say it’s ten dollars. If that company has a dollar’s worth of free cash flow, then you’re getting a 10 percent free cash flow yield. You’re buying a dollar’s worth of cash flow for 10 bucks. That’s a pretty good deal, we think.

So we have a whole series of these. They’re all called cash cows. We had fun with the tickers. The US’ is “COWZ”. You mentioned “GCOW”, that’s global. We have an international cash cows, that’s “ICOW”. We have a small cap version. If you have a small cow — you know this, being in Texas — it’s “CALF”. So that’s that ticker [laughs]. And then we have a fund version, which, as you know being from Texas, if you have a whole bunch of cattle in a pen it’s called a herd. And so that ticker’s “HERD”.

And the premise is really simple. And it’s been interesting the last couple of years because high quality companies that generate a lot of cash and have high free cash flow yields that look like they’re solid, have good solid balance sheets and can continue to support their dividends — and by the way, use that free cash flow to grow and expand or maybe buy somebody, that type of investing approach has not been really rewarded over the last decade. It’s all been growth, growth, growth, growth, growth.

This “growth versus value” or “growth versus quality” cycle tends to change places over time. But we’re way, way into a long term cycle here with where growth has outperformed value or quality.

If we have a significant slowdown, those companies that are positioned like the names in GCOW, which are high quality companies with free cash flow, tend to do better coming out of that because they have the cash to withstand the downturn and they have the cash to be nimble and opportunistic coming out.

So we’re big fans of the strategy. We’re a little bit disappointed that investors aren’t paying much attention to it. But there will become a cycle here, probably coming up, where this type of approach to investing will get rewarded.

And in the meantime, you’re getting very attractive dividends to wait. The dividend on GCOW, I think is north of 5%. And the dividend on the U.S. version is getting close to 3%.

So if you have a long enough time frame and you want to buy high quality companies and collect some competitive and attractive dividends in the meantime. And you believe at some point that we’re going to go through a cycle where those high quality companies are really rewarded for being what they are — which is good, solid, long term investments — the “cows” is a suite of products that we are pretty excited about going forward.

[00:18:03] Simon Erickson: Well, and I might have to buy in personally, just because of all the Texas bovine references. Which I really appreciate being done here in Texas as well.

Sean, one other ETF that you have is “AFTY”. This is one that’s focused on China. Some of China’s largest companies. You’ve got Ping An, which is a large insurance company. You’ve got exposure to consumer staples and financials as well.

A lot of headlines also about China right now. A lot of political headlines about China right now. But from an investment perspective, what intrigues you about China the most?

Sean O’Hara: We partnered on this with a Chinese asset management firm CSOP. They had the product in the market for a while and were not really able to get much traction.  And it’s because they didn’t really have a very big marketing focus and a big team. We have a pretty big team here.

And so, we basically reorganized that fund into our trust. And our long term premise is that it’s the second largest economy in the world. And as an investor, you probably need to have some exposure to what’s going on over there just because of the sheer size of their economy. And because of some of the things that they’re great at over there.

Short term, it’s been tough. With what’s going on with all of, you can call it politics or whatever you want to do, in terms of trying to assess blame for the virus.

But what really attracts us more than anything to the index, which is the A-50 index, is that the skepticism on China is that we don’t really get as much information, it seems sometimes. Or maybe it’s not as reliable as we want.

However, the A-50 of the 50 largest companies that are listed on mainland China. And those are the kind of names that big institutional investors tend to look to invest in. And so we feel like we can kind of ride the coattails of the big institutional investors here with AFTY. Because of the 50 stocks that are in the index that it tracks.

And, you know, they’re ahead of us in terms of moving out of the downturn. They’re starting to see some real green shoots over there in terms of reopening their economy and getting things back to “normal”.

So for a diversifier, for a U.S. investor, who needs to have some international exposure, I think we’ve been underweight probably China as an investment because of the way the big, broad based indexes allocate to different countries.

They’re the second biggest economy in the world. And I think they’re like a 3% weight in some of the broader based indexes when they should be a much higher weight.

So if you wanted to allocate capital based on GDP, you would have more money invested in China. And that’s why we that’s why we picked up the body. And that’s why long term, we’re looking at it as a good opportunity.

[00:20:50] Simon Erickson: Sure. And last question for you, Sean.

Our audience here at 7investing is mostly retail investors. Individual investors. Not the institutions.

But there’s a lot of fear in the markets right now. We’ve seen a lot of volatility in the markets right now. A lot of uncertainty. And you guys really have a very broad view of the markets. Several of the ETFs we just mentioned here: we talked about infrastructure, we talked about China, we talked about free cash flow internationally.

What are a couple of key takeaways you would pass along to individual investors, who might want to invest in the stock market right now?

Sean O’Hara: You know, I think the stock market right now is being driven by a couple of things that are not traditional things that drive stock prices.

I think it’s being driven by narrative. In other words, the story is we’re going to get out of our houses one of these days and everything’s going to go back to normal. And the second thing is there’s just no place else to put money. You can buy a bond and basically guarantee you make no return for the next 10 years.

And so, when those two things are working in your favor, the market tends to go up.

At some point, facts, fundamentals, real statistics, earnings, earnings growth, all of those things are going to matter. They don’t matter right now because we don’t know what they are. We don’t know what GDP is in the second quarter or what it’s going to be. We don’t know whether the 33 million people who lost their job or all going to get them back or whether only 25 of them are. We don’t know a whole lot.

And so, when those facts come out, what will interest me more than anything is whether or not they destroy the narrative. In other words, we’re not going back to where we were and it’s going to be a lot longer. We have this nonsense talk about alphabets: “Is it a V recovery? Is it an L? Is it a W?” You know, nobody really knows right now.

So if I was a retail investor, the things I would be looking at would be 1) I’d want to buy high quality, essential companies that are already past what’s going on. Like the datacenter names we talked about. 2) I’d want to own high quality companies that generate a lot of free cash flow. So that, if this does extend further, we at least know we’re buying companies that have solid balance sheets and can sustain themselves. Not have to go to the debt market in order to stay alive.

And 3) I’d probably keep a little powder dry right now. Just in case we get a chance to buy a little bit lower once the narrative runs square into what the facts are, and prices go lower in the short run again.

Simon Erickson: Well, definitely some good advice there to “follow the money.” And that will confirm or destroy the narrative that’s out there right now.

Again, Sean O’ Hara, the president of Pacer ETFs. $5 billion of assets under management up there in Malvern, Pennsylvania. Sean, really appreciate you joining me here this morning with 7investing.

Sean O’Hara: Thanks for having us. Appreciate it very much. Take care yourself. Hope your family’s safe.

Simon Erickson: Absolutely. You as well.

And thank you everyone for tuning into this episode. We are here to empower you to invest in your future. We are 7investing!

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