The Front Page Kiss of Death To Overvalued Tech Companies

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Last Saturday morning, I went to my usual coffee shop in Broadbeach and spread out The Weekend Australian. It’s my weekly treat.

Front page, there it was — the kiss of death.

Over the past 30 years I’ve seen this phenomena before and instinctively I knew it wasn’t a good sign.

Before telling you what it is, let’s do a quick check of the markets. The US market finished strongly overnight…up nearly 2%. Perhaps the prospect of President Trump has them all excited.

Gold held its ground at US$1,230 per ounce. The RBA’s decision to keep rates on hold has maintained the strength in our dollar.

And another day passes and we’re no closer to finding out which pockets Malcolm and Scott are going to pinch to address the debt and deficit issues we face.

All in all it looks like business as usual. Should be a good day on the Aussie market today.

Now back to the kiss of death.

There on the front page underneath the headline ‘Balancing life as accidental billionaires’ was a picture of a smiling young couple — Mike and Annie Cannon-Brookes — outside their $12 million Sydney mansion.

Mike Cannon is the co-founder of Atlassian…which listed on the Nasdaq in December 2015 for US$5.85 billion.

The front page flashbacks started. The entrepreneurs of the 1980s. The tech whiz kids of the 1990s. The financial geniuses of 2007.

Such is my long held belief in the front page kiss of death, I’ve vowed and declared that if ever I’m fortunate enough to have the sort of money that attracts public interest, there’ll never be a front page article.

I confess to having little understanding of what Atlassian does to earn a dollar. However, there were familiar signs in the story that started ringing alarm bells for me.

Under the heading ‘Atlassian doesn’t fear tech wreck’ the founders ‘welcomed the pull-back in valuations of global technology companies…

Pull-back? They ain’t seen nothing yet. The obscene valuations placed on these tech businesses has only been possible because of the equally obscene amounts of money being printed by the world’s central banks.

Money that was allegedly to go into the economy to spread the love around and spark a new wave of economic growth. Yeah, right.

Instead it went into the hands of the Wall Street casino operators and private equity funds. These boys and girls are experts at the bigger fool game. They put a value on something and then everyone else thinks that must be what it’s worth. The old ‘emperor with no clothes’ trick.

Scott Farquhar (the other co-founder of Atlassian) said ‘I think there is always the element of overshooting where businesses that aren’t supported by profits get over-valued.’

Well that’s not quite correct. Businesses that are supported by profits can also be overvalued.

Here’s a quick peek at some of Atlassian’s numbers.

Source: Google Finance

Market Cap (the value of the business) is US$5.04 billion. Price/Earnings (P/E) ratio — 582.06…FIVE HUNDRED AND EIGHTY TWO.

Based on current earnings — which for the December quarter were US$5.1 million — it’ll only take you 582 years to recoup your capital outlay. What a bargain.

For a little perspective the 140 year market P/E average is around 15.

I know the argument for higher P/Es. Companies strapped with potential growth rockets can soar higher and faster to justify these out-of-this-universe pricing.

Rockets can also blow up, run out of fuel or get lost in space.

Atlassian may have profits but these profits, in my opinion, do not support the current share price.

Put it this way, if you had US$5 billion would you put it in the bank to earn 3% (annual interest of US$150 million) with no capital risk? Or would you buy Atlassian which made US$5 million for the last 3 months and who knows what in the future?

Personally, I’ll take the bird in the hand.

Just about every man, woman and their dog is now acknowledging QE and zero interest rates DO NOT work in an economic recovery sense…the combination certainly was an outstanding success for asset price inflation.

So what happens to the price of these ‘tech wonders’ if the central bankers don’t turn the easy money taps on again?

The rocket succumbs to the gravity of long term P/E pricing.

Unless these companies can grow earnings to justify the prices, then prices will fall.

And if they do grow earnings, watch out for keen and hungry competitors looking to undercut the incumbent’s margins. Again, prices will fall.

Back in November 2014, I made this observation in my advisory newsletter, Gowdie Family Wealth:

Ever heard of GoPro? It is a waterproof camera you strap onto a helmet, surfboard, wrist or whatever to take video of you in action.

I know of this device because one of my daughter’s bought one for her action man partner.

GoPro is a nifty little gadget that’s taken the action world by storm. This “flavour of the month” mood has followed through to the company’s share price.

GoPro is a wink off being valued at $10 billion. This “crest of the wave” valuation is based on — wait for it — a multiple of 200 (yes, 200) times trailing earnings.

When investors discover GoPro can easily be replicated by strapping any Asian waterproof camera to your body, it’ll be game over. With such a low barrier to entry, it’s just plain dumb to attribute this level of valuation to GoPro.

Perhaps investors should take a picture of the current share price before it takes them on a not-so-thrilling downhill ride. My prediction is GoPro is going to experience plenty of downside action in the not too distant future.

Around the time I wrote the article, GoPro’s share price was US$80.

GoPro’s PE ratio back then was 575…FIVE HUNDRED AND SEVENTY FVE.

Today GoPro’s share price is US$12.

A fall of 85% fall in value.

GoPro is currently trading on a PE ratio of 55.

Granted Atlassian is not GoPro and may have unique reasons for why its share price belongs in another universe.

But do you want to know what alerted me to the GoPro story back in November 2014?

A front page article on Nick Woodman — founder and CEO of GoPro.

The kiss of death strikes again.

Vern Gowide,

For The Daily Reckoning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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