Tech bubble? Analysts see warning signs

Concern is rising at an apparent recklessness creeping into listed tech company investments.

Some market professionals and commentators are already calling it a bubble, with all the history and prejudices associated with such a word.

Others won’t go that far – but they’re still shocked at the money being thrown at technology companies, without basic research being undertaken.

Everyone seems to agree it’s a phenomenon brought on by Xero’s [NZX: XRO] stunning rise (justified or not), which has created a panic from investors who think they’ve missed the boat. Somehow they think they’re best-placed to pick the next success story.

Wynyard Group [NZX: WYN], SLI Systems [NZX: SLI], Snakk Media [NZX: SNK] and GeoOp [NZX: GEO] have listed this year and there seems a solid pipeline of tech prospects waiting in the wings.

But there are concerns that part-time investors, who are probably more used to pumping money into companies such as Telecom, are now warming to high-risk tech companies when they really can’t afford to lose their original investment.

Xero, which had a recent share price surge on news of a $180 million capital raising, has a market cap of $3.76 billion, making it one of the country’s biggest companies.

Yet, this is a company which is yet to turn a profit and, according to Thursday’s cashflow report, had revenue of $28.7 million for the financial year’s first half, while lifting its quarterly cash burn to $13.1 million.

Tech company potential at those multiples are clearly making some advisers uncomfortable.

Compare Xero to retirement village operator Ryman Healthcare, which has the same market value. In the 12 months to March 31 it made an underlying profit of $100.2 million.

Fresh pause
What seems to be giving market watchers fresh pause this week is tech firm GeoOp’s NZAX debut.

The baby of Leanne Graham (ex-Xero), the company finished the week at $2.50, $1.50 above the offer price, with a market valuation of $68 million.

This from a company which had revenue of $124,000 for the year ended March 31 and recorded a loss of $312,000 in that financial year. By September it had 4500 customers.

GeoOp ticks the right investment boxes, it seems.

Tech industry commentator and investor Ben Kepes says he was told by a friend, who successfully raised money recently, if you want your New Zealand tech company to resonate with investors there are three key words you need to include in your pitch: Xero, cloud and Saas (software as a service).

GeoOp can tick all three boxes, while also having the added appeal of a high-profile chairman, Mark Weldon.

(It’s worth noting Mr Weldon managed to snare 2.56 million shares, or 9.4% of the company, when NBR ONLINE has been told the experience of average investors is that they were heavily scaled back. By Friday’s market close, Mr Weldon’s stake had appreciated by $3.84 million).

Mr Kepes is seeing warning signs. He says companies should be listing that have good fundamentals behind them.

“If we’re purely listing companies and giving companies good market caps because they are part of some kind of industry trend then there’s a huge danger there.”

Canterbury-based Mr Kepes, who has invested in 15 companies in the last few years, describes tech investments as “super high risk.”

His advice? “If you don’t understand it, don’t do it.

“I probably wouldn’t go so far as to say it’s a bubble but I think that there’s some shaky fundamentals in our market right now.”

Herd mentality
JB Were’s head of advice Barry McLauchlan isn’t so reticent.

He says the money being thrown at Kiwi tech companies reminds him of the kind of behaviour leading up to the wholesale collapse of internet companies in 2001.

“It’s like herd mentality. They see these great rises in the market and so you start taking phone calls from people who haven’t done any analysis on the company at all – they just don’t want to miss out.  That’s the makings of a bubble.”

The risk profile is high and the analysis is almost impossible, he says. But he’s big enough to admit he might be wrong.

“On the plus side of Xero is that they’ve got some pretty heavy-hitting, tech-savvy funds and people who have put some money into it who understand that sector, who have taken a pretty good shot at it.”

Meanwhile, Craigs Investment Partners adviser Gretchen Williamson says small tech companies coming to market are unlikely to attract any interest from analysts, making it hard for people like herself to give clients a recommendation.

“It’s very difficult when you go and pick up the annual report to say, oh OK, they’re running at a loss but they’re valued at $20-30 million. That doesn’t fit any other logic – it puts something like 60-70 times any revenue, so you have to be future thinking.

“It’s simply not possible for me to give a recommendation on a sector that’s really still quite fledgling in terms of monetising and success and who’s going to be the best.”

Her three top tips for assessing tech companies are:

• Check the track record of management and endorsements from tech-savvy investors;
• How much cash does the company have and how quickly will they burn it;
• Recurring revenue helps predict future earnings, as opposed to one-off projects. Plus, it pays to check the margin on products.

Ms Williamson says there’s a different mindset with tech companies – it’s less about when it might turn a profit and more about how many customers it has and what value somebody else might place on it.

The money being thrown at tech companies reminds her of the mining boom. A company merely taking a passing interest in iron ore seemed to experience a share price rise, she says.

All in all, it seems a bit of a guessing game.

And JB Were’s Mr McLauchlan says uncertainty over tech stocks is making his firm more conservative.

“I would invest my clients’ money like I invest my money. I wouldn’t be putting my money there [in newly-listed tech firms].

“One of our jobs as an adviser is to understand the downside risks for clients. And we just do not know whether Xero is a $30 stock or a $10 stock.”

dwilliams@nbr.co.nz