It’s been a tough start to the new financial year for NZ based technology and biotech companies, with share price declines of between 30% – 60%. There are a number of contributory factors to such a sharp and severe drop;
- An ‘over exuberance’ around technology company valuations has seen prices rise far more rapidly than the underlying company’s progress has warranted. This has also occurred in the US.
- The rapid appreciation attracts ‘fast money’ looking to profit from the upward momentum in the company share prices, rather than long term investors who understand and believe in the company’s prospects.
Valuations can move to ‘exuberant’ levels during periods of significant change in technology as investors are not certain exactly how the new business models will develop. This can lead to over bullish expectations around future revenue and profit growth.
What confuses matters (and investors) is that these are not entirely new businesses. There have actually been numerous examples of companies moving from large loss making technology companies into making substantial profits (and investors making lots of money). Companies such as Google, Apple, Trade Me and Diligent have all become very profitable companies after initially being unprofitable. Investors are searching for the next ‘big thing’.
But rapidly rising valuations can leave a sector susceptible to a sharp sell off once confidence in the market is hit. We’ve had a few knocks recently with events in China, Russia and the US which could have sparked the decline. However with ‘fast money’ involved, the moves can be perpetuated as those investors try to either lock in profits or stem losses at the same time.
The sharp fall in share prices is a good reminder of the risks involved when investing in these types of stocks. Geo-op for instance, closed at $1.26 after trading as high as $4.40 intra day in November.
The market moves do have some broader implications for the listed companies within the sector and those aspiring to be in the listed sector. It will make raising new capital for these types of businesses more difficult in the future.
This means that companies such as Xero and Wynyard which have raised substantial amounts of capital recently, are somewhat immune from the recent machinations of the stock market as they can continue to fund their growth plans without being too concerned about where their share prices sit.
A strong balance sheet is vital for a technology company that is trying to establish itself as a global platform player where all the rewards can accrue to only the top one or two companies in a market segment. They have to be well funded to develop a new market or grab existing market share from an incumbent.
While these investments are risky, they should be considered within the context of a portfolio of investments, as we do at Milford.
We have to be realistic too.
The NZ technology stock prices are at levels substantially higher than they were six months ago. Wynyard, for instance, has had a sharp fall, but was trading at $2.33 at time of writing, over 100% ahead of last years $1.15 listing price. This compares to Mighty River Power, supposedly a low risk profitable business which listed last year at $2.50 per share and closed yesterday at just $2.16.
There is risk and reward in all segments of the market which needs to be constantly assessed.
Senior Equity Analyst
Disclosure of interest: Milford invests in shares on behalf of clients in most of the companies mentioned in this blog.