The emerging tech bourse

The growing number of technology companies successfully listing on the ASX brings rewards for the local financial markets and its investors, writes Max Cunningham.

In mid-2013, as the initial public offering (IPO) market was opening up internationally after an extended lull, the ASX received word that Matt Barrie, the founder of Freelancer, was contemplating listing on either NASDAQ or ASX. ASX’s chief executive officer Elmer Funke Kupper MAICD reached out to Barrie to put the business case that it made strong sense to list locally. Shortly thereafter, Barrie announced his plans to list on ASX. Freelancer not only became one of the highest profile tech IPOs of all time but the Freelancer listing heralded a mini boom in ASX tech listings.

During the last two years, the number of tech listings has grown dramatically, including a trend of start-ups seeking to use ASX in the same way that junior miners have accessed ASX to fund exploration plays for well over a century. During 2014, we witnessed an emergence of start-ups, either pre-revenue or early stage, seeking to access public capital. While this isn’t always the best option for every company in its early stage, it does highlight the flexibility of ASX as a market that can accommodate a business at various stages of its life-cycle. Indeed, while this trend has recently been established, essentially replacing the miner explorer space, the bulk of funds being raised in the technology sector has been for the growth ambitions of established companies (like 3P Learning and MYOB).

Why this sudden interest in a relatively new sector? Part of the answer is the continued growth in total investable assets in Australia, which is outstripping the supply of investable opportunities. We are also seeing investors grapple with the longest downturn in the mining sector in living memory. While the downturn has been painful, it has also served as a reminder of the importance of diversification. In addition, interest in technology is being driven by a better understanding of the value of innovation and IP. Also, these types of businesses are increasingly global, giving investors indirect exposure to USD earnings at a time when the Australian dollar is suffering due to the mining slump.

A material number of the recent companies that listed have also enjoyed early inclusion in the major stock indices, the S&P/ASX 200 and 300. The benchmarks for inclusion are based on market capitalisation, free float and liquidity, and are materially lower than the benchmarks for NASDAQ and NYSE. A new listing with a free float market capitalisation of $200 – 300 million can be included in the right circumstances in local benchmarks, whereas in the US the entry into the S&P 500 is closer to $4.5 billion. The index inclusion puts these companies on the radar of institutional investors and index funds, and subsequently into the research coverage of brokerage houses and investment banking advice. In the world of listed companies these opportunities raise profile, make it easier to recruit experienced board members and improve corporate governance.

The downside of listing too early should not be ignored, especially for start-up and pre-revenue companies where a materially higher bar can be set for disclosures that are available for everyone, including competitors, to see. On the positive side, many entrepreneurs have seen an early listing as a beneficial way to keep control of their business and grow it without exiting completely. Xero is a strong example of this; now a multi-billion dollar enterprise, its capitalisation at IPO was $50 million.

An undeniable positive from the emergence of technology stocks has been their strong welcome by investors, irrespective of size or revenue. The large institutions have become more willing and flexible investors in companies not yet reporting an accounting profit, as long as there is a “path to profitability.”

While things are greatly improving, the Australian market is still some way from supporting mega cap tech companies, like Amazon, which has never recorded an accounting profit, yet is capitalised at US$200 billion. For the pre-revenue companies, many of which have gone public via the backdoor, expectations are high even though the sums are small and interest often narrowed to a small group of sophisticated investors. Despite the attention the backdoors receive, it is a very small part of the market. The winners are the tech entrepreneurs of the future. The more tech companies that list on ASX and do well, the greater the encouragement that we can maintain a local ecosystem that includes funding these businesses locally through to maturity.