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Back to basics for tech stocks

AUTHOR: Alan Valvasori   DATE: 30.08.02   ISSUE 2, 2002

A concern frequently expressed by executives of Australian high-tech companies is that their home-based stock exchange systematically undervalues their stocks when compared with major capital markets like the NASDAQ in the US.

However, new research conducted by a joint AGSM and Stanford Graduate School of Business academic team strongly contests the belief that the US capital market values high-tech companies higher than does the local market does.

“Our research has challenged that popular view,” says Baljit Sidhu, associate professor at the AGSM.

Working with Stanford’s professors George Foster and Ron Kasznik, Sidhu gathered six years worth of data from more than 2000 high-tech companies in the US, the UK, Israel and Australia.The data revealed that the factors that most explained valuation differences across countries were profitability, leverage, company size and revenue growth rates.

The study was commissioned by the Australian Stock Exchange (ASX) because there was a lack of empirical evidence about relative valuations of listed companies across markets internationally, says Robert Bladier, national manager of strategic business development at the ASX.

The data revealed that the factors that most explained valuation differences across countries were profitability, leverage, company size and revenue growth rates.

ILLUSTRATION: Gregory Baldwin

“Many market participants, including listed companies seeking to raise capital and some investors and intermediaries, often claimed that the relative valuation for an equivalent firm was much higher in foreign markets,” says Bladier.

In asking the decisive question of whether it was ‘country’ or ‘company’ variables that most affected the comparative value of tech stocks, the research team’s findings came down firmly on the side of company variables.

The report finds that a shifting of stock trading location from Australia to an overseas market such as the NASDAQ, in and of itself, is unlikely to be a major factor in providing a more favourable market multiple to an Australia-based stock.

A difficult sector to value
Regionally or globally, tech stocks generally involve more uncertainty when compared with mature industries. High growth valuation calculations often involve highly subjective projections of the company’s future performance.

Three related factors make it difficult to value high-tech stocks. First, many are new and have losses or very small profits for the first few years. Second, these companies are growing rapidly.Third, by their very nature, high-tech stocks are highly volatile and their fate is uncertain.

Size matters
Study team member professor Foster, an Australian expatriate who has consulted widely with firms in the Silicon Valley, says the Australian high-tech sector faces some sizeable challenges (see Key Capital Market Statistics table).

“Australian high-tech firms are generally disadvantaged because they are small players in a market that offers a premium for being a large-scale player,” says Foster.

“The absolute value of the Australian high-tech market is comparatively small, and its importance in its local capital market is relatively low versus the US market.

“The Australian market is highly concentrated and dominated by a few companies which account for most of the ASX’s high-tech market capitalisation, unlike the US market where the largest firm accounts for no more than 8 per cent of the sector’s total value.

“The Australian high-tech sector has more loss-making companies than the other countries examined in the study, and their revenue growth is less consistent.

“Australian companies with strong revenue growth in one year have less steady growth in subsequent years, compared to their counterparts in the US and the UK.

“The smaller size of Australian companies can be a double-edged sword. It can be an advantage in early years because small companies are more likely to produce high growth rates. But small companies based in a small economy face greater challenges in scaling up sufficiently to compete in global markets,” says Foster.

Going Global
So, what does a company need to do to achieve a critical mass to become a successful global player?

The research report includes case studies on five companies with successful growth strategies: eBay and Siebel from the US; Checkpoint from Israel; and Computershare and ResMed from Australia.

The market correction of March 2000 sparked a general decline in all markets studied. However, several key factors emerged from analysing these five companies, which the researchers suggest can offer guidance for a global expansion program (see Lessons Learnt table).

First, having a highly-focused product or service strategy was a common thread. The message here is for companies to stick to what they do best and not be distracted by too eagerly expanding into a broad range of products.

Second, successful companies engage third parties through meaningful alliances and joint ventures to gain distribution channels in multiple markets as well as much-needed credibility for their product.

Third, early revenue from serious customers is needed to validate the product. Profitable customers need to be won early on – not only for the health of the company’s balance sheet, but also for its position and profile in the marketplace.

Fourth, companies aspiring to global expansion need to be flexible. Different countries may require different strategies and modes of entry and transition, so it is important to be sensitive to idiosyncratic market conditions and adapt accordingly.

Finally, executives in the company need to be stubbornly focused on achieving a global footprint.They need the vision, drive, entrepreneurial skills and courage to confront the inevitable challenges of global technology competition.

The ASX’s Bladier believes the AGSM-Stanford research has wider application to any knowledge-based industry, such as biotechnology. He says the research findings were well received by the broad investment community.

Don't blame the market
“The general reaction [to the research] by the broad community of government, regulators, business, investors and brokers has been one of praise, both for the initiative in undertaking this research and also for the depth of analysis that many see as [being] directly beneficial to … their businesses,” says Bladier.

“Specifically, the ‘company versus country’ factors alerted some, or at least reminded them, of the importance of the basics of business, and was seen, I think, as somewhat refreshing.

“The research provides valuable insights for companies seeking to compete globally. [Companies should] focus on the business and have a clear and viable strategy for expansion and growth.

“I think the research highlights that there is no easy fix to industry development. It is not as simple as changing tax or spending more government money, although the report does give guidance to government for policy direction.

“Companies need to want to be global, and need to have a good strategy to achieve this. But foremost they have to have a sound business and be good at what they do. Understanding this is critically important,” says Bladier.

Baljit Sidhu is an associate professor at the AGSM specialising in corporate financial reporting and financial statement analysis. George Foster is the Wattis professor of management at Stanford Graduate School of Business, and Ron Kasznik is associate professor of accounting at Stanford GSB. For further information about the report contact Baljit Sidhu at:

*Alan Valvasori is the AGSM’s manager,media and public relations.

Profitability Problems
The front-end investment nature of key high-tech areas (such as software), coupled with the extreme pressure for rapid growth (in part from venture capitalists), creates sizeable profitability challenges for many early-stage high-tech companies. Selected companies in non-high-tech sectors are less likely to be loss-making enterprises.

Selected percentages of high-tech and non-high-tech companies with negative net income in the 1990—2000 period range as follows:

High-tech sector
1994	1997	2000
Australia	62.3%	76.5% 68.1%
US	39.5%	51.1% 62.8%
Non-high-tech sector
Australia	37.9%	40.9% 40.3%
US	32.1%	35.7% 41.0%

Key capital market statistics that raise concerns about the Australian IT sector

Scale of total Australian capital market is less than 2%

Relative importance of IT sector
1998 1999 2000
Australia 10.7% 16.3% 10.2%
US 34.8% 47.8% 40.9%

Dominance of new players
Top 2 in Australia = 55—70% of high-tech sector capitalisation
Top 2 in US = approx. 12% of high-tech sector capitalisation

High proportion of firms with losses
1998 1999 2000
Australia 73.6% 62.2% 68.1%
US 58.7% 58.6% 62.8%

Lessons Learnt
Earn a premium with a focused product/service strategy

Engage third parties to expand distribution

Maintain flexibility/be opportunistic

Seek revenue from customers to validate product

Focus on achieving a global footprint

Think global, act local

Anticipate surprises