Making sense of Tech valuations
Thunderbolt in the world of Tech. Klarna, one of the finest European success stories in the sector, has just seen its valuation crumble by nearly 85%! Valued at $45.6 billion in the summer of 2021, it only weighs $6.5 billion at the end of its recent fundraising with existing investors. A spectacular “downround”. And a scenario unimaginable not long ago, and which is not specific to Klarna. So just what is happening in Tech?
Rather than a bubble, we should speak of a correction: the record valuation levels observed at the time of Thanksgiving 2021 were not sustainable. They granted a premium to economic models that brought technological innovation and presented a strong recurrence of revenue. But they were too far from the fundamentals of corporate finance that were never too far away.
In a significantly deteriorated macroeconomic context, the rise in interest rates had an immediate effect on the valuation of listed technology companies. A large part of the cash flow of these companies is long-term and therefore future-oriented, which makes them more sensitive to rising interest rates than companies in the “traditional” economy.
Should we then stop investing in Tech or at least consider these assets as one class among others? Above all, what is their fair valuation? In reality, the current situation is much more complex than it seems, and calls for a detailed knowledge of the sector to learn from it.
The fall in Tech valuations is far from uniform. Unequal according to assets, it has turned out to be much more brutal for unprofitable companies. A phenomenon illustrated by the Pitchbook index relating to companies recently listed on the stock market and supported until then by VC funds: the latter recorded a drop of 75%!
The obsession with growth at the expense of profitability seems over. In fact, companies that are unable to demonstrate that they can become profitable — and quickly — are the most heavily sanctioned. In contrast, the Tech giants with undeniable profitability show more resilience. At the end of April 2022, Apple had thus fallen “only” by 19% since the start of the year.
Moreover, the forced digitalization following COVID-19 represents a profound and lasting change in our economies, a fundamental difference compared to the crisis of technological stocks in 2001. Tech has now proven that it can produce innovative models , durable and resilient and that it was not just a fad. We must go further in the perception that we have of it, and apprehend it in its verticality.
In this context, the challenge for investors is to promote the emergence of “winning” assets, embodying proven (and therefore profitable) economic models and supported by healthy “unit economics”. From then on, the selection between assets will no longer be based on simple factors (COVID-proof, etc.), but on objective financial and extra-financial criteria allowing investors to introduce a real differentiation between assets. These assets will be for some the highly profitable companies of tomorrow, the favorite playground of private equity.
In a “hard landing” scenario where interest rates and inflation remain high, the risk cannot be ruled out of a negative development in the valuation of the entire asset class, especially if the context macro-economic and geopolitical continues to deteriorate.
However, stopping to invest would be an unfortunate mistake. Many opportunities remain, the successes of tomorrow continue to germinate. It is up to investors, in offensive mode, to duly select the gems of tomorrow by favoring in particular the criteria of profitability and efficiency. I am convinced: the current period remains conducive to investments in Tech!
