Leading Australian technology venture capitalists and company founders have warned investors to ignore bearish commentary about high-growth firms being overvalued, saying there is no tech bubble and that companies must be judged individually.
A $2 billion plummet in the value of former market darling WiseTech last week, following disputed claims from short sellers, has led local investors to question the prices of other so-called WAAAX fast growth tech stocks on the ASX, and the valuations of other privately held venture backed start-ups.
However, VC veterans said investment in technology growth companies was inherently risky and should not be approached in the same manner as other industries, due to the inevitability of some failures.
Daniel Petre of AirTree Ventures said investors needed to take a mature approach to valuing high-growth companies, rather than judging the sector en masse.
He said that for emerging tech companies, the only ones vulnerable to the whims of the market and the “bubble valuation” label were those with high cash burn and no line of sight to being cashflow positive for at least two more funding rounds.
“There is clearly the crazy shit like WeWork going on but WeWork is a real outlier in terms of net crazy,” Mr Petre said.
The failure of the US initial public offering of WeWork at the end of September, allied to limp showing after listing of Uber and Lyft, was cited locally after Latitude Financial, Retail Zoo and PropertyGuru all failed to get ASX floats away.
On Monday Street Talk also revealed that equipment rental business Onsite Rental’s shareholders had pulled its proposed IPO.
Mr Petre said there were a number of factors that drove up valuations of technology companies in Australia. These included the relative scarcity of successfully scaling companies and the presence of more investors anxious to write large cheques from outsized funds.
“Any major listed market correction will bring massive over-correction to all tech asset classes,” he said.
“This does not suggest a bubble, but is rather due to investors not knowing what is good or bad so just running for the exits … However, those that exit end up making a bad call in many cases.”
Mr Petre said many of the best VC returns in recent times came from investors who held positions in firms dating back to the financial crisis, which had since proven to be genuinely strong companies.
Blackbird Ventures partner Niki Scevak said technology stocks would always carry the feeling that they were in a bubble, simply due to the reality that no investors or analysts can be certain that they are correctly predicting the future.
He said that at every point in the history of the tech industry nearly all young companies have been overvalued and a small few have been dramatically undervalued.
“The skill in technology investing is picking what companies really matter. There is no value investing, there is only investing in the greats,” Mr Scevak said.
“In actual fact, in aggregate, they are all undervalued because the winners are so big, but it can seem otherwise as nearly all are failures and appear overvalued in hindsight.
“A lot of people said that Google being worth $US15 billion at IPO 15 years ago reflected a huge technology bubble, yet it generated nearly $US50 billion in operational cashflow last year and is today worth nearly $US900 billion.
“There is not the same scorn heaped upon the naysayers being wrong because they are just being ‘prudent’ and ‘conservative’, but they have still missed the biggest shift in business in the past century.”
Shares in top-performing local WAAAX stocks, which comprise WiseTech, Appen, Altium, Afterpay Touch Group and Xero, were collectively down 0.15 per cent on Monday.
All five had seen share price dips over the course of the last week, in the aftermath of the WiseTech short seller’s report.
WiseTech closed on Friday down 12.10 per cent to $26.37 from $30 a week earlier. On Monday, WiseTech rebounded a slight 0.19 per cent to $26.56.
Appen was down 6.4 per cent to $21.52 from $22.98 over the same period, but lifted 1.67 per cent during Monday’s trade to $21.88.
Afterpay dropped 1.18 per cent to $29.30 from $29.65 from Friday to Friday, a much smaller drop from the previous corresponding week when the share price plummeted 15.58 per cent. On Monday, the stock dropped a further 2.22 per cent to $28.65.
Altium shares, meanwhile, were down 3.62 per cent to $32.52 on Friday from $33.74, dipping a further 0.31 per cent to $32.42 on Monday, and Xero stock took a 4.09 per cent hit over the week to $67 from $69.86, winding down a further 0.10 per cent on Monday to $66.93.
Correction to the market
State Street head of portfolio management for Australia Active Quantitative Equities Bruce Apted sent a note to clients saying Australian growth companies were overpriced, and these share price falls represented a correction of sorts.
“Australian growth companies are three times more expensive than growth companies across the MSCI world. Are they really worth three times the earnings of offshore companies?” he said.
“The cohort of Australian growth companies are expected to grow at 38 per cent on average compared to the global high-growth companies at 31 per cent. While the higher growth is a consideration, it isn’t enough to justify the valuation differential.”
Last week The Australian Financial Review’s Chanticleer column analysed the high valuation of local companies by showing how much more expensive WiseTech was than global giant Microsoft.
It found investors buying Microsoft shares pay about seven times forecast full-year revenue and 27 times forecast full-year earnings. WiseTech’s pay 18 and 160 times respectively.
Mr Apted argued that the outperformance of growth has been one of the more “curious anomalies” in financial markets, but part of the reason was that in a post Global Financial Crisis low-growth world, the more limited growth opportunities that did exist made those few companies more attractive to investors.
“This perhaps is even more apparent within a small market like Australia. The growth anomaly has also been accentuated by the prevalence of low interest rates. Many high growth companies tend to have expectations for greater cash flows in outer years and those future cash flows are worth more today if interest rates decline,” he said.
Mr Apted said that no investor wants “the fear of missing out” to turn into the “pain” of not getting out when a growth company that has been “priced to perfection” hits a soft patch.
“Valuations can provide useful insights into both the risk of a company and the extent to which the idea has become crowded. Extreme valuations can provide an opportunity to re-evaluate the business fundamentals with an eye to the potential downside risk as well as the potential upside,” he said.
More disruption to come
The founder of customer experience management tech company Local Measure, Jonathan Barouch, said developments in artificial intelligence and data-driven analytics meant industry would face more disruption over the next decade.
Companies in this area would be completely incomparable to the likes of WeWork, which is essentially a real estate company, he said.
“Investors should rightfully be doing thorough due dilligence on tech stocks and not just taking market hype for granted. However, that does not mean that the high-growth, software driven technology companies are in a bubble,” Mr Barouch said.
“I’d argue we haven’t seen anything yet in terms of revenue growth and profitability of some of the largest platforms. A company like Salesforce has had continual sales growth year on year at a scale we’ve never seen before … what we have seen is increasing prices as investors are realising that a rebalancing of portfolios to include tech is the way to future proof their portfolios.”
Meanwhile, partner at ASX-listed VC fund Bailador Technology Investments Paul Wilson said it was undeniable that some valuations were high. He said the key to understanding whether a company is valued appropriately lies in understanding the quality and sustainability of its business.
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“It requires good disclosure by companies, because the data will often tell the story for a SaaS [software as a service] business in particular,” Mr Wilson said.
“If the company is consistently producing profit per customer that is a multiple of the cost of acquiring that customer, that is a very good start. If customers are being retained for many years, and tend to increase their spend with the company over time, then you have a very solid base.”
“Some valuations currently assume that execution will be pretty much perfect. So if there are mis-steps, or the business does not deliver on very high expectations, there will be consequences.
“The valuations that are built on story or momentum are more susceptible to a fall than those that are built on results.”
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Paul Smith leads the The Australian Financial Review’s technology coverage and has been a leading writer on all areas of the sector for almost 20 years. He covers big tech, how businesses are using technology, fast growing start-ups, telecommunications and national innovation policy. Connect with Paul on Twitter. Email Paul at firstname.lastname@example.org