What price growth?
In a period when many companies have looked to juice their earnings by cutting costs rather than investing in the future, tech has provided a rare shot in the arm for growth-starved investors.
This week’s downward lurch in the stock market is the latest sign that things are starting to change. Third-quarter financial results over the coming weeks will provide a chance to reassess. The questions starting to percolate to the top of investors’ minds: What has it cost to deliver the kind of growth the market has been clamouring for and will a slowing economy finally force a rethink about how long the growth spurt can go on?
The shock from WeWork’s failed IPO last month has been echoing back through the private markets, where many “growth stage” companies have preferred to remain rather than going public. Backers who seemed willing to buy growth at any price have been sent a clear message: Wall Street is not about to bail them out.
It is never easy for a company to make the transition from being a pure growth play to one judged on its ability to generate free cash flow. But that is now an unavoidable necessity.
Uber burnt through $9 billion (€8.2 billion) in the three years leading up to its IPO, and another $1.9 billion in the first half of this year. Even after raising more than $8 billion at the time of its public listing, its wilting share price is a clear sign of the limits of investor patience.
The adjustment is already under way. Uber is limiting its new electric bike and scooter services to a handful of markets, choosing to refine the business model before expanding into all the cities it operates in. That is a revolution in thinking for a company whose name once stood for breakneck expansion.
But how to take its foot off the accelerator without giving up on some of its biggest opportunities? The food delivery market is in the middle of the sort of capital-devouring growth spurt that ride-hailing saw three or four years ago.
Following its IPO, Uber’s painful adjustment is playing out in full view of Wall Street. Other unicorns will now have to make similar course corrections if necessary, putting off stock market listings until they have refitted their business models for more cautious times.
For other high-growth public tech companies, meanwhile, Wall Street has started to re-evaluate some of its most optimistic assumptions. The air has started to go out of the most overstretched valuations, but there is still plenty of room for further deflation.
Dizzying multiples
Fast-growing companies selling cloud applications – known as a software-as-a-service, or SaaS – have provided a solid foundation for this year’s IPO market. Even in the shadow of the WeWork debacle, cloud monitoring service Datadog pulled off a successful stock market debut last week, and its shares now trade at a 50 per cent premium to the price its backers first expected.
But some of the enthusiasm for other newly public companies is fading. Zoom Video Conferencing may still be one of the hottest IPOs of the year, but its shares have retreated 30 per cent from their high. Slack is down nearly 50 per cent from its high, after issuing a forecast that revealed just how quickly its growth is slowing.
Meanwhile, the stocks of hot SaaS companies like Shopify, ServiceNow and Atlassian are off 20-30 per cent from their midsummer highs. Yet these companies still trade at dizzying multiples of 2019 revenues – about 20 for Shopify, ServiceNow and Slack, and 40 for Zoom. That leaves little room for error, and any failure to meet high expectations is likely to be punished severely.
Among more established software companies, patchy execution and somewhat muted financial forecasts have contributed to the more cautious mood. Shares in VMware, Oracle and Adobe have all fallen back – the latter two after providing financial guidance in recent weeks that suggested that the slowing global economy may be starting to weigh on business confidence.
This is a critical season for many in the tech industry.
The fourth quarter is the busiest period for corporate IT spending, and provides the most important test of consumer spending. In their upcoming third-quarter results announcements, few companies are likely to start issuing solid forecasts for 2020.
But a wary Wall Street will be on the lookout for any signs that a golden age of tech growth is drawing to a close.
– Copyright The Financial Times Limited 2019
