Proof-of-the-pudding syndrome creates opportunities in Tech sector

Marc Kennis

Valuations of pre-revenue and early-stage commercialising Tech companies are typically driven by the longer term commercial potential of their technology and their near to medium term development progress. The former depends on factors such as addressable market size, growth, sector incumbents and particularly the innovative/disruptive potential of the technology being developed. The near to medium term development progress should be measurable through company announcements in which technical development milestones are announced and referenced back to the company’s development roadmap.

The balance, or attributed weight, between the two will depend on individual investors’ preferences, investment profiles and investors’ patience levels. On aggregate, we would say that early stage Tech stocks listed on US and European exchanges tend to have investor bases that mostly put emphasis on the longer-term potential of the technologies being developed rather than on near term milestones that need to be hit.

We believe the key reason for this is that US and European investors generally have a solid understanding of technology and can see beyond the development milestones that Tech companies need to achieve in order to unlock the longer-term potential of their technologies. As a consequence, Tech companies listed in these markets tend to be valued at levels that reflect this long-term potential.

Smaller ASX-listed tech stocks suffer from “proof-of-the-pudding” syndrome

Smaller ASX-listed Tech companies, on the other hand, typically have an investor base that is more than 75% Australian. And given that Australian investors’ backgrounds in technology is generally less developed compared to Tech investors in the US, Europe and Asia, we find that local investors oftentimes struggle to see the long-term potential of certain emerging Tech companies.

In other words, local investors actually need to see the development milestones being hit to verify that the company is on track to achieve that long-term potential. These milestones may be non-events for more experienced Tech investors overseas who are familiar with that specific technology and/or development process.

And given the extreme focus of Australian investors on near term revenues, ASX-listed Tech companies that indeed hit their development milestones, which would confirm that they are on the right track to achieve their long-term potential, may still not rerate towards valuation levels seen in more Tech-savvy markets.

Put differently, whereas overseas’ Tech investors invest in the potential of a technology, we believe Australian investors tend to invest in the actual monetization of a technology, i.e. in a “proof of the pudding is in the eating”-type approach.

In our view, this “proof of the pudding” syndrome is particularly prevalent among smaller ASX-listed Tech stocks in the semiconductors, data analytics/processing, artificial intelligence and microsystems subsectors. Therefore, valuations of many high potential Tech stocks listed on the ASX are substantially lower than what they would likely be, had these stocks been listed in Tech-savvy stock markets overseas.

You can’t keep a good stock down

But given the high potential of their respective technologies, we believe many of these Tech companies will eventually be able to successfully license and/or sell their technology, if they haven’t started to already. And we believe there is a good chance some of these companies will be acquired by larger industry peers at some point, most likely by overseas’ Tech companies.

In other words, we believe great investment opportunities exist among smaller ASX-listed Tech companies, whose valuations are very modest in an international context, but whose value we expect will be unlocked at some stage.

Examples include BrainChip (ASX:BRN), 4DS Memory (ASX:4DS), Weebit Nano (ASX:WBT), BluGlass (ASX:BLG), OpenDNA (ASX:OPN), Pointerra (ASX:3DP), Linius (ASX:LNU), Sensera (ASX:SE1), Elsight (ASX:ELS), CCP Technologies (ASX:CT1) and UltraCharge (ASX:UTR).

Given the Proof-of-the-pudding syndrome though, capturing their upside potential will likely require some patience on the part of investors.

Disclosure: Several of the companies mentioned in this article are research clients of TMT Analytics.


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Dean Fergie

It's understandable that Australian investors are cynical about the future value of these unproven tech businesses. Unfortunately there have been only a handful of domestic success stories and plenty of disappointments. Indeed if these ASX listed stocks are perceived as undervalued because the ASX market is not "Tech-savvy" then the question must be asked as to why the directors of these companies resolved to list them locally in the first place?

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John Karlsson

With my scientific background I have watched some of the Biotechnology concepts. But the lead time to a salable product long and costly frequently requiring sale to a multinational company. We are good on the discovery but not so good at commercial implementation.

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Michael Whelan

Some tech companies can be like mining explorers....waiting for them to hit the mother-lode and move from explorer to developer to producer. Memories of the dot-bomb era are not too far back in people's memories.

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