Tech’s comeback contenders
It’s not all gloom for investors in technology stocks, writes Chris Keall, as he profiles four companies that could be due for a rebound
Technology stocks have been hit harder than the broader sharemarkets in New Zealand, the US and Australia.
And there are still more factors beyond companies’ control than at any other time in recent history, from whether the war in Ukraine will escalate, to the risk of a fresh Covid variant, to the possibility of the world sliding into recession.
But as things stand, here are four beaten-down tech stocks that analysts reckon have good prospects over the next 12 months.
Xero
The Wellington-based, ASX-listed Xero saw its shares rocket to an alltime high of A$153.34 ($173) in September last year, before sliding to a recent A$83.04 (for a market capitalisation of A$12.84b).
Jarden, which has a “buy” rating on Xero, last week released new research on the cloud accounting firm that gives it a 12-month target price of A$107.90.
Although Xero swung to a firsthalf loss as its sole trader and small business customers felt the pandemic squeeze, Jarden analyst Elise Kennedy said investors who dumped its shares were being too pessimistic.
The company’s fundamentals were moving in the right direction.
Now, Kennedy and fellow
Jarden analyst Tim Halliday are picking that a push by the US Congress to digitise tax returns for small businesses will lift Xero in that country, just as similar moves in Australia and the UK buoyed the firm’s business there.
It’s still not clear whether the US$15 million ($25.7m) Congress allocated to the Internal Revenue Service will result in US small businesses breaking with the consultants and Turbo Tax software they use to negotiate the current, very complex setup.
But Kennedy and Halliday give the US reforms a value of A$6 per Xero share today, and say that could rise to A$41 per share if Xero holds its current (modest) market share in the US, but the market expands dramatically as 90 per cent of small businesses digitise.
Rakon
Rakon reported a record profit for the year to March, but despite that its shares have slid from $2.22 on the NZX in the New Year to a recent $1.24. The Auckland firm has been caught in the general downdraft from Tech Wreck 2.0 — plus fears that an improving global supply chain might benefit rivals (Rakon made hay during the pandemic by being able to supply product when its indirect competitors could not).
Rakon’s stock continued to slide even after its annual shareholder meeting on August 11, where it bumped up its operating earnings estimate for the 2023 full year to $36m to $44m.
Forsyth Barr’s James Lindsay was encouraged by the numbers, however. The analyst lifted his estimate for 2023 earnings before interest, tax, depreciation and amortisation by 6 per cent and his spot valuation by 2c to $2.11.
New chief executive Sinan Altug told the Herald in May that a multiyear re-engineering of Rakon had seen it shift from consumer markets, such as components for smartphones, to higher-margin industrial markets.
That shift was now starting to pay off for the Auckland-based maker of advanced frequency control and timing solutions — used in everything from 5G telecommunications gear, to low Earth orbiting satellites, to data centres that need to keep exact time.
Forsyth Barr’s Lindsay said the increased guidance given at the AGM was a “solid update, showing the continued benefits of the renewed strategy”.
Vista Group
Vista Group shares fell from their pre-pandemic high of $5.78 to 96c in April 2020 as theatres around the world closed their doors.
The Auckland-based firm that dominates the global market for cinema management software recovered to $2.70 in late 2021 as the world reopened, only to be knocked back as Omicron hit. The shares were recently trading at $1.59.
And there was always the worry that although Covid would eventually pass, it might change viewing habits forever — a fear that was underlined as Disney enjoyed considerable financial success from releasing its liveaction remake of Mulan straight to Disney+ (for $39.99 on top of the service’s usual monthly fee) in September 2020.
Countering that, early in the pandemic, Vista chairman Kirk Senior told an online meeting of shareholders that people would return to multiplexes, because ultimately we’re social creatures.
The return of Hollywood’s usual blockbuster production schedule and strengthening box office receipts (New Zealand was back to 83 per cent of pre-Covid patronage in July) proved Senior’s gut feel was right. His company recently upgraded its full-year revenue guidance from a range of $118m to $123m to $123m-$128m, or about a third more than 2021. The firm, which lost $18m — or $4.2m after a non-cash impairment — for the June half-year, has given no earnings guidance but says it will be cashflow-positive for the full year.
Jarden has an “overweight” rating and a 12-month price target of $2.10 (or 34 per cent above last Friday’s closing price). Yet the hangover from a long, difficult Covid period continues.
Just last week the UK-based Cineworld, which runs 750 theatres worldwide, filed for Chapter 11 bankruptcy protection in the United States.
While Cineworld is one of Vista’s largest customers, Jarden’s Guy Hooper noted the company was still trading, and that a mooted restructure closing 20 of its sites would reduce Vista’s revenue by just 1 per cent.
The road to recovery will probably have a few more bumps yet, but Vista, which raised $65m and slashed costs early in the outbreak, is bolstered by $51.9m in cash (or $33.5m net of borrowings), according to its August 29 filing.
Netflix
The rise of fractional ownership platforms such as Sharesies and Stake has made the US markets, and stocks like Netflix, newly
accessible to Kiwi investors. Over the past few months the streaming giant has only offered a lesson in how the larger American indices can deliver bigger doses of pain, with its shares falling from an all-time high of US$645.72 in November to a five-year low of US$175.51 in June.
A round of price rises just as lockdowns eased saw Netflix lose streaming customers for the first time during its March quarter. It also slipped back in the following quarter as Disney’s three services (Disney+, Hulu and ESPN+) added 14 million subs for a total of 221.1 million worldwide.
That was a nose ahead of
Netflix, which lost 1 million to finish the June quarter on 220.1 million.
But in the first quarter, Netflix would have been in the black for subscriber growth, if not for the Russian subscribers it decided to cut off in support of Western sanctions. And the streaming giant — which usually exceeds its guidance, invasions notwithstanding — forecast a return to growth in its September quarter (it has yet to report its Q3 numbers).
At the same time, rival Disney has already warned that sports rights setbacks will see its streaming numbers fall short of its forecast.
Analysts have also started to make encouraging noises about Netflix’s pending lower-cost, adsubsidised tier, which will be launched in several countries including the US, Canada and Australia — implying New Zealand as well, given that Netflix runs Australasia as one business unit.
Its setbacks have also introduced new discipline into a production operation that formerly seemed to approve every series 30 seconds into a pitch.
Netflix has told advertisers that advertisements run on its network will reach 40 million viewers by the end of next year, and that it will be charging a premium rate of US$65 per 1000 viewers. For context, the Wall Street Journal says that is the rate a US broadcaster would charge for a top NFL game. For multinationals, Netflix offers global reach. And while broadcast TV viewers can change the channel, or fast forward if they’re watching a recording, ads on streamed services are usually presented in short, unskippable blocks.
“They’re shifting gears and fast,” Raman Gambhir, an associate portfolio manager at money manager Neuberger Berman, told the Wall Street Journal, which said he was bullish on the company and invests in Netflix for the funds he manages.
And remember that Netflix has reinvented itself twice before — first with its shift from renting DVDs to streaming video, then its move from licensing other people’s content to making its own.
Slowly but surely, more investors are gaining faith that its third pivot, to advertising, can succeed. Netflix shares closed on Friday at US$241.16.
The big picture
The good news: analysts say many tech companies are mostly in good shape, with strong prospects.
The murkier news: it’s not clear when that will translate into a sharemarket bounce for tech stocks that are still depressed as a group, or to what level.
There are three notable overarching trends.
One is that tech stocks got thumped the hardest.
“US tech stocks have been weak versus the wider stock market but they are relatively less weak in recent months, given the degree of price reset and as investors start thinking about businesses who can grow through a slower economic cycle,” says Harbour Asset Management senior portfolio manager and research analyst Shane Solly.
He notes that the S&P 500 index (recently down 21 per cent for the year to date) has held up better than the tech-heavy Nasdaq, recently down 29 per cent for the year to date.
After ups and downs, the S&P 500 is up almost 1 per cent over the past three months, while the Nasdaq is up 1.4 per cent.
Locally, the S&P/NZX All Information Technology index is down 41.8 per cent from its yearago 2297 to 1338 as of Friday’s close.
The S&P/NZX 50 is down 11.5 per cent for the same period.
Across the Tasman, the S&P/ ASX All Technology index is down 32.9 per cent over the past year.
You get the picture.
Another interesting big-picture trend: in the prolonged, multi-year tech stock boom that preceded the so-called Tech Wreck 2.0 crash of the past 12 months, the NZX and ASX saw their fair share of technology stars. But looking at the key area of cloud stocks, as tracked from 2017 to 2022 by Wellingtonbased Clare Capital, US-listed stocks were trading at much frothier enterprise value-torevenue multiples.
Some US cloud stocks crashed harder, but only because they had been flying higher.
Clare Capital principal Mark Clare won’t make individual stock picks, but says, “what I will say is that the technology sector isn’t going anywhere. While we have seen a pullback, from a big picture perspective we are still only in the first morning of a five-day test match.”
He says the tech companies that will be valuable have four broad characteristics:
1. They will have large total addressable markets. Typically those markets will be global, and often with a strategic position in a vertical part of that market.
2. They will have a level of scale of true recurring revenues. Customers will typically pay them on a regular recurring basis rather than in a one-off licence manner.
3. They will have good underlying financials. “This typically looks like 80 per cent-plus gross margins and reasonable customer acquisition costs and low(ish) customer churn,” Clare says. Losses are fine as long as value is being created through adding customers. Once a softwareas-a-service company has enough customers to cover costs, every new sign-up is gravy.
4. They are growing. “The faster they are growing, the more highly valued they are. The first three points here are how technology businesses get valued on a revenue multiple basis — and growth drives how large that multiple is,” Clare says.
"The good news: analysts say many tech companies are mostly in good shape, with strong prospects.