The selloff in technology stocks around the world in recent weeks has been nothing short of brutal.
It has wiped the fortunes of tech tycoons – US$1 trillion (S$1.37 trillion) from the world’s 500 richest people. Sea Limited’s (NYSE: SE) founder Forrest Li lost 80 per cent of his US$22 billion net worth, while Amazon’s (NASDAQ: AMZN) Jeff Bezos shed US$58 billion.
Nasdaq, US index home to many technology companies, has declined more than 20 per cent since its last peak in November 2021, entering bear-market territory. The slump in tech shares, which has lasted seven weeks, is the longest sustained weekly decline since 2001 when the dot-com bubble burst.
The wider US market is sailing precariously close to the wind, with the S&P 500 down 19 per cent since its high in January. Only 131 of the 500 counters have managed to deliver a positive performance since the start of the year.
Many of those companies in the black are either directly or indirectly related to the oil industry that have benefitted from the surge in crude prices. So should we be worried about the tech slump?
Dot.com the sequel
Investors, it would seem, have fallen out of love with technology companies. That has led some pundits to draw parallels with the bursting of the dot-com bubble two decades ago.
At that time, technology shares were flying high on hopes the Internet would prompt a paradigm shift in the way that we conduct business and, perhaps more importantly, the way that we go about our daily lives.
In a similar way, some believe the new breed of disruptive tech companies today could change how we deal with finances, consume media, and perform daily chores.
But there are distressing similarities between the share-price performance of those disruptive companies today and what happened to many dot-com companies at the turn of the millennium.
In 2000, most dot-com businesses hoped the Internet would allow them to challenge the dominance of established businesses. Investors were happy to buy into the new paradigm. They were keen to invest at almost any valuation, even if the company was still unprofitable and unlikely to ever make a profit.
When the penny dropped that many did not have the ability to survive, numerous companies crashed spectacularly. Online pet store Pets.com was valued at more than US$400 million at its peak, when its shares were trading as high as US$14 each after its IPO in 2000. When its bankruptcy was announced just nine months later, its shares crashed 98 per cent to just US$0.22.
Likewise, fashion retailer Boo.com collapsed when it burnt through US$120 million of venture capital money in 18 months.
We are not quite at that stage yet in the current technology sell off. Today’s tech companies actually have a business plan rather than a flaky idea written on the back of a paper napkin.
For instance, Pets.com didn’t quite appreciate that many of the goods sold on its website could be easily purchased from a store just around the corner. Why would a buyer wait for days to receive items they ordered when they could simply get it straight away?
However, the headwinds that many disruptive companies face do bear uncanny similarities with the events in 2000. These include rising interest rates to tame inflationary pressures, excessive liquidity and over-exuberance in the stock market.
A sea of red
There are already signs that investors have been growing wary of companies with high valuations. A high valuation generally means investors are paying money today for profits that might not materialise for years into the future.
That was fine when interest rates were almost zero. But waiting for profits to turn up gets more expensive when interest rates are rising.
For instance, yet-to-be profitable Sea Limited was valued at 21 times annual sales in 2020. That dropped to 12 times annual revenue in 2021.
Today, the market is only prepared to pay US$3.30 for every dollar of 2021 revenue that Sea Limited could make this year. The compression in Sea Limited’s price-to-sales ratio, along with Chinese tech giant Tencent (HKSE: 0700) selling down its stake in January, has led to Sea’s share price collapsing 80 per cent from its peak in October 2021.
Meanwhile, there are concerns that the company might have spread itself too thinly by using funds from its profitable Garena division to prop up its loss-making shopping platform Shopee.
Sea Limited is not alone. Prior to its listing in the US, another unprofitable company, Grab Holdings (NASDAQ: GRAB), was valued at more than 100 times annual revenue. That fell to 40 times sales in 2021 before falling further to just 11 times forecast revenue this year.
Elsewhere, PropertyGuru (NYSE: PGRU), which floated on the New York Stock Exchange in March, has seen its share price crash by 50 per cent since its initial public offering.
The challenging market conditions have affected fledgling businesses that had hoped to list on the stock market this year. Singapore online market-place operator, Carousell, which was expected to be valued as much as US$1.5 billion, has reportedly shelved plans to go public via a blank-cheque companies or SPACs.
Amazon’s survival strategy
The outlook for tech companies looks worrying. But they can at least take comfort in the fact that not every dot-com business went bust in 2000.
Amazon has been a notable survivor. It was able to do so because it successfully raised US$672 million in cash just months before the stock market crashed.
Another factor that worked in Amazon’s favour was its robust business model. It was able to collect money from customers before its suppliers had to be paid. Its negative cash conversion cycle effectively provided Amazon with “free money” to grow its business.
Today’s tech companies should take a leaf from Amazon’s playbook. The e-commerce platform, which started as an online bookseller, survived from its ability to generate free cashflow to grow its business and sell more books. The more books it sold, the greater its negotiating stance with suppliers to extract longer payment terms.
While Amazon survived the dot-com crash to become an Internet juggernaut, it has not been spared from the recent tech sell-off. Its shares have slumped 36 per cent for the year after the tech giant reported a slowing of online sales growth.
But there is more to Amazon than online sales. Its cloud computing unit, Amazon Web Services, saw a 37 per cent rise in revenue and a 59 per cent jump in operating income, which more than compensated for weakness elsewhere.
Each start-up today will have a different game plan. But cash generation should be at the heart of their survival kit.
Focus on the playing field
Looking back at the dot-com era, perhaps the mistake that many investors made wasn’t that they believed the Internet would change everything, but that they underestimated just how big the Internet would become 20 years later.
In 1997, Amazon’s share price was US$1.70. It rose to US$107 in 1999 before losing 85 per cent of its value just two years’ later. Today, the shares are worth over US$2,000 apiece. But for every Amazon, there were lots of dot.com wrecks.
That said, nobody could have predicted in the 2000s that the Internet would become the backbone of our economy and lifestyles, powering the way we work, shop, and transact. Even if investors saw the potential of Internet companies then, it still took 15 years for NASDAQ to regain its pre-dot-com glory.
For tech entrepreneurs today, patience and focus are key. Warren Buffett famously said games are won by players that focus on the playing field and not on the scoreboard. This is why tycoons like Forrest Li losing billions is par for the course.
Today’s disruptive companies need to hunker down and focus on cash generation rather than be fixated with their share price. Without cash they will not be able to survive and capitalise on the opportunities new digital technologies could bring.
Note: An earlier version of this article appeared in Channel News Asia here.
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Disclaimer: David Kuo does not own shares in any of the companies mentioned.