Tuesday, 19 June 2018

The Hunt for Red Sixteen

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  • Peters 475px June 2014

Is the tech sector more utility than Wild West?

THOSE OF US who are children of what has gone down in economic history as the post-industrial era know what it feels like when the driving forces in the economy prove to be busted flushes. To know what I mean you don’t need to look at the current components of the major stock indices but at the former ones, many of which no longer exist. Yes, there was a time when the market was principally made up of steel mills, shipbuilders and colonial trading companies.

Economic expansion comes in waves as new industries take hold – as we have experienced with the tech sector. Technology has transformed the world and in doing so has made shareholders wealthy and said world, I suppose, a better place. The question now, though, is whether the great leap forwards has been made and whether some hot stocks might not be set to become the new utilities.

I was last week speaking to a senior strategist who has worked for over 35 years at every level of the industry, both in bonds and in equities, including a prolonged stint as CIO of a well-known investment company. He was talking about the heyday of the telecom companies. Between January 1997 and December 2002, the stock of Vodafone rose from 50p to just under £4 before falling back to 112p. During the same period, Deutsche Telekom leapt from (converted into euros) €16 to above €100 in March 2000 – only to fall to €8.42 two years later.

FOR A BRIEF while telcos could do no wrong – or so it seemed. In fact, they got it entirely wrong when they entered into competitive bidding for 3G licences. Although criticised by many for his catastrophic handling of the national balance sheet and the crazy sale of the UK’s gold reserves, Gordon Brown – no longer the invisible Scotsman since his barnstorming speech on the eve of the independence referendum – played a blinder when he achieved a sale price of £22.5bn for the UK’s 3G spectrum in April 2000. Germany then sold its own for another 40% more. (Of course, by the time the Italians had got their act together, the price of 3G spectrum had fallen out of bed and there were great moans in Rome).

Anyhow, the crux of my man’s argument was that telephone companies are utilities and, although for a few brief years this was widely forgotten, it never ceased to be true. The problem was that everyone was in pursuit of, so to speak, the better mousetrap. The 3G fiasco of course coincided with the collapse of the dotcom bubble so, in many respects, its occurrence was masked by the white noise surrounding it.

Yet the pursuit of the big one continues. And, don’t get me wrong, there have been a few of them – think Google or Facebook. However, of the 2,555 stocks listed on the Nasdaq, only 692 have a market cap of above US$1bn of which only 122 are valued at over US$10bn and only 13 of those are value at over US$100bn. As it happens, Vodafone isn’t one of them.

The game is now over as we have seen many of the prospective sure-fire winners go to the dogs

ANYHOW, WHAT I am wondering is whether we are, from an investors’ perspective in the “post-tech” era? Have all of the big plays been made? Is there another Google or another Apple or another Cisco Systems still out there or are markets chasing windmills? During the dotcom boom, the game was to buy 10 start-ups in the expectation that nine would fail and in the hope that the 10th would do well enough to cover the loss on the other nine and still leave a profit.

That game is now over as we have seen many of the prospective sure-fire winners go to the dogs. King Digital, the games maker of the ubiquitous Candy Crush, came to market with much hype and a price of US$22.50. Now they are trading at just over US$11. More recently, the shining light of the German tech sector, Rocket Internet, was priced at its IPO at €42.50, only to fall below €32 in the first few days of trading.

Are internet companies perhaps now also simply becoming utilities? The space for making quantum leaps looks to be diminishing and the low cost of entry in the retail space, for example, makes competition hard to fend off. Poor share price performance is usually the result of one of two features: either under-delivery on the part of the company or inflated expectations on the part of investors. I took a close look at Rocket and found it to be the internet equivalent of a generic drug maker which invents nothing and specialises at arbitraging the gaps left by the real movers and shakers. They might be clever but they’re simply not clever enough to reinvent the wheel.

OVERINFLATED EARNINGS OPTIMISM is surely the equity market equivalent of the credit markets’ blind reach for yield which serves to justify the purchase of an asset at a price one knows to be wrong but hopes might, in the not too distant future, prove to be right.

The eyes and the ears of the markets have for too long been solely focused on the central banks and their monetary policy and as a result have turned a blind eye to fundamentals. Then, from time to time, investors take a punt on one index defying trade – the big bet on red sixteen. In the IPO space of the tech sector, many of these appear to be failing.

Perhaps the sector is already too mature to be traded as though it was still the Wild West and maybe the time has come to turn the one in 10 rule around. How about one buys boring and hopes to make enough out of the nine to cover the losses in the 10th? A painful thought and, although possibly not all that unwise, probably far too close to the way bond portfolios work.

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