Beware: Watch for falling WAAAX!
Do Australia’s rocketing tech stocks – particularly the so-called WAAAX stocks Wisetech, Afterpay, Altium, Appen and Xero – deserve their lofty premiums? The market certainly thinks so. But I’m not so sure.
I have previously alluded to the dangers of investing in the pointy end of the US technology boom and specifically warned about Uber. Uber has now listed its shares but its IPO price was below the valuation struck at the last private equity funding round. From original hopes of listing at a valuation of US$120 billion, Uber finally listed at less than US$75 billion. It is still an insane price for a company that may or not make a profit in the future.
But the hype that has virtually defined this bull market is not confined to the US. Here in Australia, both profitable and profitless companies have achieved extraordinary multiples.
Take the case of Appen, a company that crowd sources cheap labour to tag millions of photos, subsequently collated and fed into the search algorithms of clients including Facebook and Google. Appen trades on an Enterprise Value (EV) that is 33 times its earnings before interest tax depreciation and amortization (EBITDA). What is most interesting about this number is that it is about four times higher than the multiple on which its near competitor, US-based Lionbridge, was purchased two years ago by Private Equity.
Back in 2016 Lionbridge was described as a Waltham, Massachusetts-based provider of globalization services to technology companies with more than 6,000 employees worldwide, serving more than 800 customers via its technology platforms and global base of more than 100,000 contract translators. Lionbridge’s customers included Microsoft, Google, Rolls-Royce, The Gap, HTC and John Deere.
In December of that year Lionbridge agreed to be acquired by US-based Private Equity Group H.I.G Capital for about eight times EV/EBITDA.
And even though neither Lionbridge nor H.I.G appear to have any business in Australia, they plan to list here in Australia this year. It doesn’t take a rocket scientist to work out the vendors are probably looking to take advantage of some of the world’s most ridiculous multiples ‘investors’ here are willing to pay.
But Appen isn’t alone at the top of the EV/EBITDA tree in Australia. Afterpay Touch trades at 294 times EV/EBITDA, Nearmap is at 109 times, Wisetech Global trades at 65 times, Altium is at 43 times, Superloop at 37 times and NextDC, Technology One, Fisher & Paykel and Jumbo interactive are all at between 25 and 31 times.
And even truly high-quality large cap business with decades-long histories have been dragged up in the rush to buy growth.
CSL is one of the Australia’s finest listed companies, and continues to grow thanks to demand for its immunoglobulin products rising faster than supply. But if we were to halt CSL’s growth and prevent it from ever raising prices, it would earn about US$2 billion. And if we capitalized this number at 8.5 per cent – a reasonable return for a business that doesn’t grow – we might be willing to pay US$23 billion for CSL. Currently however the market values CSL at US$63 billion. In other words, the market is currently willing to pay the equivalent of three current CSLs to buy one CSL with some growth.
Since 2014, the lowest price to earnings ratio CSL traded at was about 15 times. The average PE has been 25 times. Today, CSL trades at almost 31 times.
I don’t know when these companies will return to Earth in terms of their multiples but decades of experience tells me they always do. And when that happens it will be painful for many who have not experienced a correction.
For now, however, low interest rates and accommodative central banks will make sure cash in the bank is far less attractive than being invested in fast-growing companies. While that remains the case, it is probably the case that blind optimists will continue to look like winners.