Most tech flotations are characterised by prioritisation of revenue growth over profitability and extravagant extrapolation. It is not surprising that investors’ hopes are often dashed and sometimes dramatically so.
At time of writing the Nasdaq Technology Stock 100 Index is down 43% year to date and coincidentally by the same amount over the past year.
Even at the beginning of 2022 when the tech Index was still rising high, an analysis by Renaissance Capital concluded that 80% of the tech IPOs in the US in 2021 were trading below offer price and an average investor would have lost 30%1. The situation in London had actually been slightly better early in 2022 – after a record year for IPO floats in 2021 raising £14 billion, those on AIM had risen by 21% since their IPOs in February2. But the falling markets in the US since the beginning of the year have encouraged equivalent falls in London in recent months. The losses suffered by investors in a wide range of high profile London flotations from The Hut Group, through Deliveroo to Made.com have attracted attention.
I explained in my book The Flat White Economy3 why there is in fact an economic rationale for using a different basis for valuing tech stocks. Tech companies are often characterised by what I called ‘supereconomies of scale’ where an initial investment in technology can be amortised over increasing volume. These economies are often enhanced by ‘network effects’ – the value of many apps increase with the number of others that are using them. The huge reduction in unit costs if a tech company can gain sufficient volume tempts many managers to overinvest in achieving growth.
But even the tech giants which have already achieved scale have not been immune from the tech writedown. In early November this year Meta (parent company of Facebook, Instagram and WhatsApp) was down 73% over the past year, Alphabet (parent of Google) down 42%, Microsoft by 35% and Amazon 46%. Only Apple bucked the trend with a fall of only 8%4.
The falls in share values have been followed by the announcements of layoffs, averaging around 15% of staff.
Meanwhile regulators around the world are casting a more sceptical eye over tech monopolies. In the US the American Innovation and Choice Online Act looks set to complete its passage through Congress by the end of the year. This limits big tech platforms from using their positions in one area of tech to give preference to associated businesses in other areas. In the EU the Digital Markets Act came into operation on 1 November 2022 and its Digital Services Act will apply in late 2023. Together they are attempts to ensure that big tech does not exploit its position.
It’s tempting to think that faced with the 2022 joint headwinds of market disappointment and increasingly zealous regulation that the tech story is over.
But that is unlikely to be the case. Cebr research has identified a wide range of fast-growing tech applications that are likely to dominate the world economy in coming years and could, if harnessed properly, kick start the economic growth that has slowed to a standstill in most Western economies. Our report for Virgin Media Business identified growth opportunities that could add 10% to UK GDP5 by 2040. Other still to be published Cebr research has identified at least 20 coming tech trends that could redesign our economies with Artificial Intelligence and its applications probably the most significant.
So tech is still likely to drive our economy. How can investors be part of this without losing their shirts? There are perhaps lessons for investors from the performance of recent floats. 1) Avoid giving tech style valuations to ordinary businesses with tech addons that in reality offer limited scope for scale economies; 2) don’t ignore profit line trends even if they only show diminishing losses; 3) be careful about extrapolation of trends – the bulk of tech trends play out over around 3-7 years and are replaced by new trends; 4) watch out for an increasing battle with the regulators and don’t assume that tech businesses will get away with using dominance in one area to promote cross selling in others; 5) most importantly, fly under the radar: the most hyped IPOs have almost always generated the biggest losses. But that obscures the fact that a balanced portfolio of tech investments should still deliver returns.
Eventually interest rates will fall and growth will return. And with labour forces in advanced economies showing signs of increased lethargy, greater technological sophistication looks to be the only way in which such economies can advance. Currently around 10% of all jobs are in what I have loosely defined as The Flat White Economy. By 2035 that share should at least double.
1 https://www.barrons.com/articles/worst-performing-big-ipos-51643409868
3 Douglas McWilliams The Flat White Economy Duckworth 2015
4 https://www.investorschronicle.co.uk/news/2022/11/07/slowing-economy-didn-t-cause-the-tech-rout/
5 https://www.virginmediabusiness.co.uk/revolutionise-the-everyday/CEBR-report/
For more information contact:
Author: Douglas McWilliams, Deputy Chairman
Email dmcwilliams@cebr.com Phone 07710 083652
Cebr Media: Eva Piskadlo, External Relations Associate Email episkadlo@cebr.com Phone 02073242863
Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.