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The Death of Technology Investing c.2020/1. Long live technology Investing 2022.

The acronyms are changing. TAM is now replaced by ROI.

Technology is a sector famed for its ability to quickly change and shape the times; of the day and of the future. The change in the focus of investing in the technology sector in can now be added in equally quick measure.

There is a significant pace of change in what a technology company should now be focused on (as directed from investors, bankers and VCs). GAAP (Growth at any Price) strategies (not to be confused with GAAP accounting), popular in the era of scarce growth and low rates - appears to be dead. The new buzz word for the next 12 months is likely to be ROI (Return on Investment). In this fast-changing macro environment, companies will likely need to change their philosophy and seek tangible ROI and defensible margin structures. The Tech world is always full of jargon, buzz words and acronyms. What buzzwords does ROI replace? TAM, SAM and SOM.  (TAM = Total Addressable Market for your product or service, SAM = Service Addressable Market, the percentage of TAM you can focus on based on your targets and business model, and SOM = percentage of SAM you can realistically capture.) These were the buzz acronyms which had morphed from the VC world into the public corporates. For example, Uber, who pitched that they could expand the TAM. Or Coinbase suggesting a nascent market was going to explode –“explode” could now probably be replaced with “blow up”. Storytelling, optimism and high risk appetite worked well in a backdrop of QE. The problem is, we are now in a world of QT, and tangible path to profitability, evidence of cash flow rather than cash burn and disciplined strategy are back in vogue.

Perhaps the next outcome is also reflective of the VC world? What do we mean by this? Let us remember the “VC Power Law Curve” which was provided by a huge data analysis by Horsley Bridge of 7,000 investments over 30 years. Just 6% of deals produced at least a 10x return and made up 60% of total returns. And half of all investments returned less than the original investment. In other words, there will be a company which has a series A with a TAM which, for example that is focused on books, that can move into adjacent markets (hello Amazon, 1995). But there are many that can’t expand the TAM, or move into adjacent markets, or become the first to scale in a nascent market. This current reset means we need to change the focus, and not assume it is safe to maintain a high burn rate while hoping for a quick “V” recovery. It is not to say that there isn’t an innovation super cycle because we can see that there has been decades-long digital transformation of the global economy. But just like investors reviewing their portfolios against inflation and rising rates, so corporates need to prepare for an inflationary cycle. One potential impact of margin compression caused by higher operational costs could be an increase in the number of “zombie companies” – those that may struggle to repay debt after increasing leverage during the era of ultra-low interest rates. Between 2015 and 2019, roughly 10% of public companies were considered zombies, according to the Federal Reserve.

The questions being asked are changing. A reality check on the SOM (Serviceable Obtainable Market) rather than hypothetical TAM. At what cost? How can you scale, without significant cost and cash burn? The conversation has changed. Tangible ROI with FCF Growth = winner.

“Growth at any price” is dead. Thinking of the dynamic effect of this –  keep an eye on the “GAP” going forward – namely the gap between GAAP earnings and Non-GAAP earnings; there is a risk that the more immature businesses will seek to compensate price for the stock price declines through  higher “variable comp” ( more stock comp for staff -  which dilutes existing shareholders – with what appears to be on (PBIs) performance based incentives being a secondary consideration because shutting the emergency exit door for talent has to take priority. If a company is massively FCF generative, then it is possible to offset these types of plan through stock buybacks and ensure fair policy to ALL shareholders. But – this balancing act is a tough one to execute when you are less mature or/and are trying to balance that growth versus margin versus talent versus “rule of (insert “40”, “60”, “80” as appropriate)”. Where is the loyalty to the company from a high performing sales executive if her/his/their compensation is massively geared to the stock price? It works great on the way up. It also works as a ‘chain breaker’ on the way down.

For the first time in more than five years, we are hearing that “ROI” is really important for customers. It is. It is a key KPI – for any company. It just happens to NOT have been a KPI in focus in recent years because of central banks’ policies of “free money”, which translates into the corporate culture of “growth, regardless of quality or sustainability”. What is the conclusion from all this? Navigate your path through companies with good FCF generation and tangible ROI because the “Field of Dreams” of tech investing which typified technology investing in recent years has suddenly been replaced by a speed of change in sentiment that has left companies feeling “Punch Drunk”.

Author

Neil Campling

Head of TMT Research – GTS Group

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