What to look out for when investing in ASX tech stocks
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From running a tech company to floating one, Cube Capital advisor Hani Iskander knows the technology industry. Here he sheds light on how Australia’s capital markets are failing local tech start-ups.
How has the move to software rental (“Software As A Service”) impacted listed tech companies?
When I was starting tech companies in the 90s the model was very different.
If you had a software product you sold it for an initial licence fee. The client company would hand over $50,000 or $500,000 and straight away you had that large chunk of revenue.
Over the past ten years that game has changed a lot and does not support the small tech players as much. Now that we have the Software as a Service (SaaS) model, companies essentially rent the software instead of giving an upfront fee.
In doing so, SaaS has crippled growth by revenue, as these companies receive their revenue spread over years instead of upfront lumpy payments. Growth funding is then left to borrowing, which is very difficult, and capital raising. In a conservative market, it’s difficult to raise capital if your technology company is in its early growth phase. The risk is too high in the eyes of private investor.
For a lot of small companies the only reason they have listed is to get early stage capital. What they don’t recognise is that it is much more powerful to be a private company than to have to answer to the market and you can grow something much more valuable before you undergo an IPO.
I have founded tech companies and now work to advise them and in all my time in the industry it’s the new small ASX entrants that worry me a lot.
At Cube Capital we call these the ‘stragglers’ — the ones who have listed for the wrong reasons and struggle as a result.
When can listing on the ASX negatively impact the growth of a small tech company?
Founders of baby technology companies don’t want to lose control and consequently have to limit how much capital they raise.
IPOs may raise small amounts and some of it is used to fund the cost of the IPO. The net capital raised after costs is often less than a 12 months runway. These companies often need to go back to the market within 12 months and traditionally investors are sceptical and ask why a recent IPO didn’t fund the necessary cash needed.
The backdoor listing of SenSen (ASX:SNS) is an example of this, where the product is innovative and garnered good attention but for all the trouble it took to execute the listing, they only raised $6.5 million.
The company has highly optimistic forecasts. It plans to pay back loans in the next quarter but at their current cash burn rate I don’t see how they will have enough cash to fund their operations to say the end of this financial year. Time will tell.
Ultimately, I think Australia as a tech investment ecosystem is at fault. We are a country of 24 million victims because of Australia’s aversion to risk.
It is dead easy for us to dig resources out of the ground and sell it on to someone but when it comes to taking a punt on a tech stock there is much less willingness to invest. All we have to do is compare the USA ecosystem with ours
So some software companies should not be listed on the ASX?
My view is that many companies are being misguided.
If I were a founder of a software company and knew nothing but how to develop software I could easily be taken for a ride by someone who told me I could raise money through an IPO.
Another example of this is Veriluma (ASX:VRI), another fantastic product in the predictive analytics space without many competitors. They backdoor listed about a year ago, raised a little and underestimated the runway to generate revenue.
From their re-listing price of 7c, they went down to 1.5c and are suspended pending a merger or another backdoor listing with a company that I see no technology compatibility to it.
When you do a back-door listing many people forget that you inherit some baggage and the shareholders from the previous incarnation who are quick to sell out.
Certain promoters often pump out shells of defunct companies but the reality is that as soon as they are trading again many of the existing shareholders won’t stick around for long. It makes you wonder why fresh IPOs are not the default method to the ASX.
What should investors look out for when putting money into tech stocks?
There are two key lessons I practise for my personal portfolio:
Despite all the negativity, I think there are many quality small tech companies that will flourish. Take for example the recently listed Velpic (ASX:VPC) which I find a promising stock. They are the “YouTube for e-learning” and I think they will succeed because they have realistic goals and a product that is attainable. Their growth is through online subscriptions.
When you look at a company that has done well from small margin gains, like Dicker Data (ASX:DDR), they are only making a margin of as little as 3 per cent on each product but when you multiply that on a larger scale their share price has reached up to $2.60 – over 22 per cent in the last 12 months.
We call the stocks between $50 million and $100 million market cap our rising stars because they have done the hard yards to push past the $50 million mark.
Companies that come to mind are IT services Empired (ASX:EPD) or RXP Services (ASX:RXP). Once you get over that mark you can have the economies of scale and it is only then that you tend to get quality corporate clients instead of just the average Joe.
Hani Iskander, a partner at Cube Capital, is a serial entrepreneur having 7 software companies and held several C-level roles with global technology companies.
Over the years, Hani has held a regional management role with SAP and has been Vice President of Asia Pacific and Japan with two NASDAQ-listed technology companies. He founded Accelerator Capital in 2000 and managed M&A transactions for 15 years.
With over 18 years’ experience in the software industry and 15 years in investment banking, Hani has a unique understanding of the technology, telecommunications, healthcare and life sciences sectors.
Hani holds a Bachelor of Applied Science (Computer Science) with Honours from UTS.
This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.