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20-03-2014, 09:02 PM
Remember dotcom: time to call 'bulles' on the new tech bulls
Comment James Mackintosh
893 words
18 Mar 2014
The Australian Financial Review
AFNR
English
Copyright 2014. Fairfax Media Management Pty Limited.
It is, say the bulls, different this time. The new dotcoms are proper businesses, with tens or hundreds of millions of users, generating real revenues and disrupting existing organisations. Traditional valuation tools like price-to-earnings ratios may suggest they are outrageously expensive, but that is because the opportunity is so large they will be investing for years before they settle down to reap outsize rewards from the fat margins they are already demonstrating.
Such thinking has been driving the price of social media stocks, online retailers and other technology stars such as biotech, 3D printing and electric carmaker Tesla through the roof. This creates big dangers for investors – but it also creates opportunities.
It is true that March 2014 does not feel like March 2000, when the dotcom and biotech bubbles popped. Back then, merely being associated with the internet was enough to make a company's shares soar. Companies were listing with no revenue, happily being valued by Wall Street on the basis of their clicks, or the "burn rate" at which they were consuming cash (perversely, higher was better). Dinner-party talk was about whether individuals had secured an allocation in the latest initial public offering.
Supporters of the new technologies insist there is no comparison with the late 1990s. James Anderson, a partner at Baillie Gifford, an investment partnership, and manager of Scottish Mortgage Investment Trust, says investors have "to think about the scale of the opportunities involved". These are companies that need relatively little capital – or staff – to have global reach and enormous customer bases, meaning they can be very profitable.The parallels are troubling
But the parallels to the late 1990s are troubling. Just as then, investors have been disappointed by emerging markets. Momentum has grabbed the attention of investors willing to take risk after a five-year bull run in which the S&P 500 has risen 175 per cent.
Add in easy money from the world's central banks, and it is easy to think this is not just a bull market, but total bulles, if you pardon my French ("bubbles").
Here is the basic problem with the investment thesis: if there are opportunities available to make abnormally high profit with little capital, they should be competed away rapidly by new entrants. Investors need a good reason to think those opportunities will persist. Investors have convinced themselves that network effects, in particular, offer what Warren Buffett calls a "wide moat" to new competition; after all, you want to be on the same social network as everyone else. Others see technological advantage in things such as Tesla's batteries, Ocado's grocery logistics or the whitegoods retailer AO World's control of door-to-door deliveries.
History suggests shareholders may be fooling themselves. Social media sites are a litany of disasters, and already this year Facebook has spent $US19 billion buying WhatsApp, which is used as an alternative to social networks by many people. Online shopping is fiercely competitive. And technical advantages rarely last, especially in the research-driven luxury car industry.
On the other hand, some of the moats may persist, or at least be wide enough to protect a decent profit margin (and maybe, in a few cases, justify today's share prices). Even if they are not, a new dotcom bubble would leave these shares plenty further to go before the final burst.Trying to pick the winners is risky
Trying to pick the winners in five years when technology is developing so rapidly is inherently risky, especially when valuations are already so extreme. But look at the story the other way round and the lesson may be clearer.
At the moment investors are throwing money at new tech companies. They have cheap capital; they can hire the best and brightest; and, most importantly, they need lower profit margins than their old-world competitors, allowing them to offer more competitive prices.
Whether they will ever make enough money to justify the hype is doubtful. But investor behaviour means these new companies definitely pose a threat to existing companies. These old-line companies already face a struggle to adapt their business models to the changes that underpin the new tech hype. Add in competitors with access to plenty of cheap cash and some will have real trouble.
The sector most directly affected is retail. Shares of online shops may be expensive, but much of traditional retail is not particularly cheap. True, the most obvious victims of the move online – electronics and office-equipment stores such as Staples and RadioShack – have been hammered already. But clothing, furniture and do-it-yourself chains do not look cheap.
The victims of social media (apart from their users) are traditional recipients of advertising dollars: old media. Newspapers have long been marked down by investors as they face so much online competition, but television has only just begun to be affected.
Carmakers were pouring much-needed cash into unprofitable electric-car projects long before Tesla arrived, but it certainly has increased management appetite for shareholder-unfriendly research.
The more new-tech shares rise, the more they beget further rises. Investors able to resist the lure of this momentum should concentrate instead on avoiding the stocks that will suffer from the frenzy.
Fairfax Media Management Pty Limited
Document AFNR000020140317ea3i0001o
Comment James Mackintosh
893 words
18 Mar 2014
The Australian Financial Review
AFNR
English
Copyright 2014. Fairfax Media Management Pty Limited.
It is, say the bulls, different this time. The new dotcoms are proper businesses, with tens or hundreds of millions of users, generating real revenues and disrupting existing organisations. Traditional valuation tools like price-to-earnings ratios may suggest they are outrageously expensive, but that is because the opportunity is so large they will be investing for years before they settle down to reap outsize rewards from the fat margins they are already demonstrating.
Such thinking has been driving the price of social media stocks, online retailers and other technology stars such as biotech, 3D printing and electric carmaker Tesla through the roof. This creates big dangers for investors – but it also creates opportunities.
It is true that March 2014 does not feel like March 2000, when the dotcom and biotech bubbles popped. Back then, merely being associated with the internet was enough to make a company's shares soar. Companies were listing with no revenue, happily being valued by Wall Street on the basis of their clicks, or the "burn rate" at which they were consuming cash (perversely, higher was better). Dinner-party talk was about whether individuals had secured an allocation in the latest initial public offering.
Supporters of the new technologies insist there is no comparison with the late 1990s. James Anderson, a partner at Baillie Gifford, an investment partnership, and manager of Scottish Mortgage Investment Trust, says investors have "to think about the scale of the opportunities involved". These are companies that need relatively little capital – or staff – to have global reach and enormous customer bases, meaning they can be very profitable.The parallels are troubling
But the parallels to the late 1990s are troubling. Just as then, investors have been disappointed by emerging markets. Momentum has grabbed the attention of investors willing to take risk after a five-year bull run in which the S&P 500 has risen 175 per cent.
Add in easy money from the world's central banks, and it is easy to think this is not just a bull market, but total bulles, if you pardon my French ("bubbles").
Here is the basic problem with the investment thesis: if there are opportunities available to make abnormally high profit with little capital, they should be competed away rapidly by new entrants. Investors need a good reason to think those opportunities will persist. Investors have convinced themselves that network effects, in particular, offer what Warren Buffett calls a "wide moat" to new competition; after all, you want to be on the same social network as everyone else. Others see technological advantage in things such as Tesla's batteries, Ocado's grocery logistics or the whitegoods retailer AO World's control of door-to-door deliveries.
History suggests shareholders may be fooling themselves. Social media sites are a litany of disasters, and already this year Facebook has spent $US19 billion buying WhatsApp, which is used as an alternative to social networks by many people. Online shopping is fiercely competitive. And technical advantages rarely last, especially in the research-driven luxury car industry.
On the other hand, some of the moats may persist, or at least be wide enough to protect a decent profit margin (and maybe, in a few cases, justify today's share prices). Even if they are not, a new dotcom bubble would leave these shares plenty further to go before the final burst.Trying to pick the winners is risky
Trying to pick the winners in five years when technology is developing so rapidly is inherently risky, especially when valuations are already so extreme. But look at the story the other way round and the lesson may be clearer.
At the moment investors are throwing money at new tech companies. They have cheap capital; they can hire the best and brightest; and, most importantly, they need lower profit margins than their old-world competitors, allowing them to offer more competitive prices.
Whether they will ever make enough money to justify the hype is doubtful. But investor behaviour means these new companies definitely pose a threat to existing companies. These old-line companies already face a struggle to adapt their business models to the changes that underpin the new tech hype. Add in competitors with access to plenty of cheap cash and some will have real trouble.
The sector most directly affected is retail. Shares of online shops may be expensive, but much of traditional retail is not particularly cheap. True, the most obvious victims of the move online – electronics and office-equipment stores such as Staples and RadioShack – have been hammered already. But clothing, furniture and do-it-yourself chains do not look cheap.
The victims of social media (apart from their users) are traditional recipients of advertising dollars: old media. Newspapers have long been marked down by investors as they face so much online competition, but television has only just begun to be affected.
Carmakers were pouring much-needed cash into unprofitable electric-car projects long before Tesla arrived, but it certainly has increased management appetite for shareholder-unfriendly research.
The more new-tech shares rise, the more they beget further rises. Investors able to resist the lure of this momentum should concentrate instead on avoiding the stocks that will suffer from the frenzy.
Fairfax Media Management Pty Limited
Document AFNR000020140317ea3i0001o