Chips are down for tech stocks
AI has been a saving grace for some local firms, but global layoffs continue as tech giants fight for market share, writes
Microsoft is staging a comeback as a technology innovator, driven by its association with advanced chatbot disrupter ChatGPT. The stock is up more than 10% this year.
But it remains 11% down over 12 months, and many other international and local technology investments have cratered over the past 12 to 18 months, losing billions of dollars in shareholder value.
Unlocking value and finding deals have been made more difficult by a global downturn, sending valuations across the technology and telecommunications sectors off a cliff.
Telkom, for example, was expected to list its masts and towers unit, Swiftnet, on the JSE for R13bn in early 2022, but the plan was abandoned when the group realised it could only get about twothirds of that.
Rising interest rates have made capital more expensive, deterring many investors from the speculative activities that characterised the past decade, thereby lowering market caps.
THE DOWN MARKET
“We’ve definitely seen valuations come down,” PSG Wealth chief investment officer Adriaan Pask tells IM.
Fund managers and other investors tend to split their investments between local and international counters as a way to spread risk and maximise returns.
Big tech players Cisco, Amazon and Google parent Alphabet are down 11%, 36% and 28% respectively over the past 12 months.
On the JSE, technologyrelated stocks such as MTN, EOH and Telkom have also fared poorly, losing 33%, 46% and 18% respectively. Bright sparks such as Altron,
Datatec, Lesaka and MultiChoice are in positive territory, but sentiment has generally been down.
“The key question is whether we’ve seen all of it [the decline] and, in our view, there could be another letdown. One reason is that profit margins remain quite elevated; they haven’t really come down at all,” says Pask.
Tech companies’ margins are fluctuating around 12%13% but are expected to be between 0% and 6% at times of recession.
“That’s quite significant. Even if they manage to protect the top line on the revenue side, the margins will definitely come down,” says Pask.
For now, investors appear unconvinced that technology stocks will be the sure bet they grew used to during a decade-long bull market.
HURT BY TECH
The past year has been tough on tech portfolios, and local fund manager Peregrine Capital — whose technology investments did well for its funds in 2020 and 2021 — saw a decline in 2022.
“The previous decade — 2010 to 2020 — was just a glory period for these tech stocks,” says CEO Jacques Conradie. “Facebook was tiny at the start of the 2010s. Amazon, Google … were smaller than they are now. They all had a fantastic decade and compounded at an amazing rate.
“We are seeing them more and more being very large companies and they’re all entering each other’s spaces”.
Google, Microsoft and Amazon compete in the cloud computing market, for example, while “a decade ago they didn’t compete at anything, because they were small enough to grow in their own fields”.
Conradie adds: “The behemoths are having to fight it out, where for the previous decade they just got market share from the real-world companies and old businesses, so it was always easy pickings.”
While tech hasn’t done well for Peregrine, its bet on Thungela Resources, the coal miner hived off by Anglo American in 2021, paid off handsomely. It was by far the best-performing stock on the JSE last year.
CHINESE DEFIANCE
Naspers and Prosus, up 100% and 68% over the past year, appear to be defying gravity thanks to an uptick in the Chinese tech sector. The feat points to the continued polarisation between East and West for global technology companies.
Tencent, the biggest investment for the Naspers stable, rallied through January, in line with other Hong Kong
Amazon, Google and others have announced staff reductions after years of growth as they seek to lower costs
technology stocks, on signs that a two-year crackdown is easing and will soon end. That regulatory action wiped out billions in value for Tencent and Naspers.
Signs of a softening in Beijing’s stance bode well for investors. Chinese tech players have done well in 2023, and are expected to continue doing so as the country opens up fully.
While Naspers has done well in the East, prospects in the rest of world have weighed on the company, which recently said it would be cutting 30% of its corporate workforce. It has also shut down its R1.4bn South African tech investment fund,
Foundry.
Its international unit, Prosus, is said to have dodged a bullet by cancelling a $4.7bn deal to buy India’s BillDesk. What would have been its largest acquisition would have substantially bulked up its presence in Asia’s secondmost populous country.
CEO Bob van Dijk says the group would have overpaid for the online payment platform because its valuation fell substantially between the announcement of the deal in August and its scheduled conclusion towards the end of the year. Prosus had agreed to pay nearly 20 times BillDesk’s annual revenue.
On the flip side, Prosus has used the downturn to its advantage. It recently took full control of Brazilian food delivery platform iFood for €1.5bn, about half of what it would have paid a year earlier.
With an estimated $20bn war chest and a number of good deals on the table,
Prosus appears to be taking a more conservative approach in the prevailing market conditions.
START-UPS AND PRIVATE MARKETS
While the market is simple to read for listed stocks, private markets — where technology start-ups are looking to raise capital — have been affected a little differently, says venture capitalist Fabian Whate.
He says start-up valuations have taken much longer to fall, with hotspots in places such as Europe where large cheques are still being written for artificial intelligence (AI)related companies.
“We’ve seen listed tech valuations come down quite materially, at least over the past 12 to 18 months. Initially that didn’t hit private valuations, but now we’ve definitely seen that come through. And it’s going to play out differently, depending on life stage and sector.
“Probably the hottest stuff has been growth-stage fintech. Those guys are going to be the hardest hit in terms of valuations, because fintech and growth stuff was superhot. Tons of money had gone into that area. That’s where we’re seeing quite a significant pullback and definitely down [funding] rounds.”
The largest capital raises in recent times for local startups have been $120m for Jumo, led by Fidelity Management & Research Co at a $400m valuation; $48m for Ozow, led by China’s Tencent; and $83m for Yoco. All three are fintech players.
For now, Whate says the best case for such companies is simply remaining at the same value when trying to raise funds. “If you can get a flat round, that’s a good outcome as a growth-stage fintech,” he says.
But all hope is not lost as AI appears to be the saving grace for some tech companies. Insurance technology platform Naked, for example, which uses AI to offer cover for cars, homes and other valuables, recently raised $17m in a third round of funding. But even then, cofounder Alex Thomson says raising capital is tough.
“Perhaps our business being in a strong position has helped in having a number of keen investors,” he says. “We’ve also probably just had a bit of good luck.”
By now, everyone knows about ChatGPT, the generative AI platform developed by Elon Musk-backed OpenAI, which can write poetry and answer all manner of questions while also being able to pass university-level exams.
Microsoft’s association with ChatGPT and a $10bn investment in OpenAI has won favour from the investment community, leading to a bull run in the stock so far this year.
Alphabet, on the other hand, recently shed $100bn from its market cap when Google bungled a demonstration of its competing product.
AI promises to push the industry forward but for now it’s unlikely to be a panacea for the wider economic downturn.
LAYOFFS AND PROSPECTS
Continuing pressure on margins for listed tech is the reason for many layoffs. In addition to Naspers, Amazon, Google and others have announced staff reductions after years of growth as they seek to lower costs and improve profitability.
IBM, one of the originators of personal computing, recently became the latest to do so, saying it would cut 1.5% of its global workforce, or about 3,900 staff. Entertainment giant Disney has also unveiled a restructuring plan to slash 7,000 jobs and cut costs by $5.5bn.
For now, it appears job cuts haven’t become a factor for local players, with the exception of Naspers.
“Remember, many of these businesses rely on advertising spend that contributed more and more to their bottom line,” says Pask. “But in an environment where there’ sa recession, advertising cost is one of the first things to go, so there will be some top-line pressure as well.”
He is concerned that despite falling markets and a threat to profit margins, analysts’ consensus forecasts remain high.
“They essentially don’t just signal a moderately tough time or even the same as last year, they say last year was excellent and this year is going to be even better,” he says. “We think that’s completely detached from reality.”
Pask expects such market players to get a big reality check. “And then we’ll see a sell-off. That’s our base case. We could be wrong, analysts could be right. We could see further margin expansion and further volume growth. We just think, on the balance of probabilities, that things are significantly skewed in favour of a further letdown.”