NAOS Asset Management

NAOS recently attended the 36th Annual Canaccord Growth Conference in Boston where over 300 predominately US based companies presented. As the title suggests this conference is all about growth companies hence there was a strong presence of both biotechnology and technology companies presenting to investors. NAOS does not place an investment emphasis on the biotechnology due to the higher risk profile so we chose to pay attention to the technology companies. In the article below, we’ve summarised a few key themes which were consistently repeated throughout the conference.

Key theme 1 - SAAS not just a buzzword anymore

SAAS – Software as a service, or essentially ‘on demand’ software is now seen as a pre-requisite for success. Understandably, the idea of being a SAAS platform is something which is a lot easier to implement if you are a young company, as it is likely to be the revenue model which you have built your business around. The benefits of a SAAS business model are:

  1. A ‘smooth’ revenue growth curve
  2. Revenues that are ‘real’ as they are unlikely to be subject to heavy discounting/not recognised upfront
  3. Lower customer churn/higher annuity revenues
  4. Easily understood by the investment community hence can attract a premium valuation

It would seem that nowadays investors are actually discounting technology businesses that are not SAAS revenue based. Generally speaking, investors are recognising that only ‘new world’ SAAS technology businesses have the ability to dramatically scale at low cost.

Key theme 2 - Tackling the Old World

Building upon the point above, the companies which find it the hardest to adjust to this ‘new world’ SAAS revenue model are the ‘old world’ companies which run contract revenue models. Think the big software vendors such as Ingram Micro & Cisco or the systems integrators such as SAP and Oracle.

The disruption to the competitive landscape is not a new phenomenon but what we found interesting is how these nimble software operators are able to successfully compete against the massive balance sheets and reach of the dinosaurs.

We saw a big focus on ‘integration to everything’. To be successful a new software or technology has to be easy to use in conjunction with a person or company’s existing technologies and software. The SAAS business model is to give product to someone for free and then charge when its used, so to ensure usage occurs many of the technology companies we saw are placing a heavy emphasis on being integrated (meaning a shared flow of data) into not only the ‘old world’ systems such as SAP ERP systems but also into ‘new world’ giants such as Salesforce, Google and Facebook.

We imagine new world technologies consider integrations in the same way economists traditionally looked at a public good. Once the cost to integrate has occurred the benefit of such is provided at no cost to anyone. As a user of an integrated software, the consumer is far more likely to use it if it seamlessly connects to other key functionality, which in turn drives organic revenue growth.

Key theme 3 - R&D over Sales & Marketing

It is commonly accepted that a growth technology business is reinvesting every dollar of revenue back into the business. In fact, it is increasingly rare to see one that is profitable at the bottom line! Bootstrapping growth is commonplace, but management teams and investors seem increasingly fixated upon where the high margin revenues are being reinvested. Justifiably so.

Talking in % of revenue terms, we believe there is a trend to higher investment in R&D and lower investment in sales & marketing. Whilst this might seem counterintuitive at first it can potentially mean a much higher quality business is created over time. Mass adoption of a technology is driven bottom up and not top down hence companies can afford to focus less on sales & marketing if user adoption is occurring organically. It is worth noting that this is easier to achieve for consumer and SME software rather than enterprise grade software (think Xero, Atlassian, Shopify).

We believe there is a much heavier emphasis placed on R&D as this is what drives ARPU (average revenue per user) growth through increased customer engagement as well as creating more sustainable competitive advantages.

Key theme 4 - How big is the Total Addressable Market (TAM)?

TAM was a topic of conversation in all the tech companies that presented. Why is this the case? Investors are always paying today for tomorrows earnings potential but this is compounded with high multiple technology companies.

Investors want to see that a company’s TAM is large enough to justify paying what might look like a very high price today. This means that companies will provide in depth analysis of how big their market opportunity could be if they are successful.

In our view a TAM can evolve over time, which is extremely difficult to accurately measure. Whilst we acknowledge this is a significant factor for a potential investor, we think it is more important to see a company focus on how & when cash flow generation will occur.

Overall we came away from the conference impressed with the depth and quality of technologies which help the consumer and enterprises drive efficiencies within their own business. We expect to see the above trends translate to the Australian market and continue to drive an already healthy technology sector in Australia.

Article contributed by NAOS Asset Management: (VIEW LINK)


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