There’s been much talk recently around whether we are in another “tech bubble”, as valuations of tech companies close in on those seen during the dot-com bubble of the early 2000s.
In Australia, the tech sector is particularly hot, with tech companies trading at a median revenue multiple of 5.5x. Take Afterpay for example, which at 31 March 2021 was trading at a value more than 40 times its last twelve-month revenue levels. Australian multiples are even higher than the US, where listed technology businesses are trading at revenue multiples of 4.4x
Nevertheless, median revenue multiples in both countries are still lower than they were on 10 March 2000 – the height of the tech bubble. At this time, Australian tech companies were trading at revenue multiples of 6.1x and US at 4.8x.
Given risk-free interest rates in Australia at the height of the bubble were sitting around 5.5%, this would likely put valuations of tech companies in March 2000 way ahead of where they are today on a risk- adjusted basis.
So why the increased valuations? Will they hold? And what should investors be aware of?
Liz Smith, Director, Corporate Advisory at William Buck said the adoption of Software-as-a-Service and similar models since the tech boom plus record low interest rates are behind the high valuations. Not to mention our burgeoning adoption of technology during the pandemic.
“Investors have been willing to invest in tech businesses at high valuation multiples for some time due to the adoption of SaaS and similar models, which have the potential to significantly increase the size of the addressable market and provide the ability to scale quickly and with minimal cost of goods sold,” said Liz.
However, while the underlying fundamentals of SaaS businesses are strong, the number of companies providing such business models is growing.
“The high number of new entrants is likely to provide a challenge to businesses in the sector that are seeking to maintain and grow their market positions,” she urged.
To add to the challenge, as the global economy recovers from the pandemic on the back of unprecedented monetary and fiscal policy, there is a risk that rising interest rates could depress asset valuations and trading multiples.
“When interest rates increase, tech companies with a strong competitive advantage that can continually grow their revenues and scale quickly at a minimal cost could maintain strong valuations.
“However, at the more speculative end of the sector, those without a compelling business case could struggle to deal with the higher cost of capital driven by higher interest rates as investors look to other options to allocate their capital.”
Adam Gandel, Manager, Corporate Advisory at William Buck said it’s important that investors consider basic valuation fundamentals before investing in a tech company.
“Before investing in tech companies, consider whether they have built a business model that will be sustainable in the long-term,” he urged
“In 2021, the likes of Facebook, Netflix and Visa have overtaken companies such as Vodafone, Nokia and Orange, all of which occupied a place in the top 20 in March 2000, but could not sustain their positions as other players entered the market with superior business models.
“However, those with a strong competitive advantage and the ability to grow their cash flows and earnings in the long-term can most likely justify their current valuation multiples and deliver solid returns for investors. For others however, rising interest rates and an increasing number of market entrants will impact on their ability to drive growth and sustain their current valuations.”
For a deeper analysis and further commentary, please see Liz and Adam’s full article on growth expectations and tech valuations here.
Note: All multiples have been sourced from S&P Capital IQ.
About William Buck
William Buck is a leading firm of accountants and advisors with offices across Australia and New Zealand, with a particular focus on the middle market. With over 100 directors and 700 professional staff, we recently celebrated our 125th anniversary year.
As part of the Global Praxity Alliance, the world’s sixth largest accounting alliance, William Buck advisors are supported by an international network of accomplished tax professionals.
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