No more ‘private for longer’? Alium Capital thinks the tide has shifted in the unlisted space
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By any measure, the implied valuations of privately-owned tech companies have run pretty hot over the last 12 to 18 months.
Amid the excitement around the scale-up potential of SaaS-based business models, tech startups have routinely been marked up — either through new funding rounds or revaluations.
And pricing metrics have often skewed towards the top line, with a focus on revenue growth rather than incremental costs.
However, the sector has been doused with a cold dose of reality after some high-profile train wrecks — the most notable of which was real estate platform WeWork, which saw its implied valuation slashed from $US47 billion ($68.9 billion) to around $US8 billion and required emergency funding to stay afloat.
A number of funds in the local market have been forced into making some material write downs on privately held assets.
For Rajeev Gupta, a principal at crossover investment fund Alium Capital Management, the focus on underlying profits has never really shifted.
Alium holds a portfolio of around 50 investments comprised of both ASX-listed stocks and private companies.
“One of the critical questions we ask in the first conversation with a company is ‘what is your sustainable operating margin?'” Gupta told Stockhead.
“Showing evidence of actual profitability is absolutely paramount at some point in time. Continuing to grow your top line is terrific, but if your losses are occurring at the same rate there’s no advantage.”
Gupta said that quite often when that question was asked, the response was a blank look.
Evidently, a lot of companies pitching for capital aren’t even thinking about profitability. And that hasn’t changed much, despite the recent shift in the market.
“We still get those blank looks. In the last 12 months if we’ve met 1,000 companies, less than 100 have actually answered the question,” Gupta said.
“Growth is important but you’ve got to have an avenue to convert your revenue less costs to profit, otherwise it’s almost impossible to calculate a return.”
Aside from the revenue projections and financial modelling, Gupta says the Alium team also looks at qualitative factors to assess the viability of a given business.
Amid the tech hype, he said it’s important to distinguish between serious tech companies and those trying to paint themselves with the same brush. (A common criticism of WeWork is that it’s a real estate platform masquerading as a tech business).
“One thing we look at is the amount of staff in engineering and product development. If you’ve got 100 staff and there are less than 10 people in engineering, that’s not really a tech company,” he said.
He also cited some interesting anecdotes from his vantage point amid the recent period of excess –founders of “very early-stage” startups living it up on investor roadshows, with five-star hotels and business class flights.
“You’re taking shareholder money and living the Life of Larry — we notice these details as investors,” he said.
In terms of allocating capital, Gupta said the team at Alium assessed private market opportunities with a three-step investment process – people, product and price.
He reiterated that the best tech companies were usually run by technologists and engineers, rather than finance or marketing experts.
Alium also red-flags companies that are heavily reliant on outsourcing. “We don’t like teams that are off-shored because you lose too much control,” he said.
“On the product side we’re focused on how it scaled (or can scale). What’s proprietary and what’s your ‘moat’ — if those aspects aren’t robust then your business is failing at some point in time,” he said.
More broadly, Gupta said the recent shift in sentiment is a reminder that vigilance is a pre-requisite when assessing private market opportunities.
“I think the idea of ‘private for longer’ has markedly shifted in last three months, mainly because of WeWork,” he said.
“You had one investor that kept laddering the valuation with an expectation that someone in public markets would bid, and turn it into a listed asset with a higher value.”
“But the reality is private markets can still be efficient. Ultimately everyone wants liquidity, but that’s not as easy to get in the private space, so I think in response investors will often be more price sensitive.”