Via ConvergEx's Nicholas Colas,
It happens at the top of every tech cycle – everyone wants to be a tech company. We’re there now.
But real tech companies do more than employ a lot of programmers. For investors, “Tech” is now shorthand for a range of attributes that go far beyond coding and the cloud. It disrupts and destroys existing businesses and (occasionally) social constructs like government. Tech is clubby - if you’re not inside, you’re outside. Done well, it generates outsized financial returns after first burning through a lot of cash. It engages millennials in the hopes they will be customers for life. And yes, tech makes a handful of people extremely wealthy because employees are also significant owners in the businesses they build. That’s why the world’s sharpest people so often end up in tech.
So before you try to argue for a higher valuation for a public company just because it claims to be “Tech”, consider our seven point checklist – “You might be a tech company if…"
In December 2000 Ford, Chrysler and General Motors almost became technology companies. Between the three concerns, they controlled a market of some $550 billion in auto parts purchases – all the bits and pieces they purchased from their global supply network to assemble into finished cars and trucks. They formed a company for the purpose, with GM and Ford taking stake in a business-to-business online portal called Commerce One to provide the technology. Once their supply chains were online, the rest of the world’s industrial manufacturers would pay handsomely to join the network and save billions of dollars in logistics expenses.
In a classic example of “Right idea, wrong time”, the venture never really hit takeoff speed. The bursting of the dot-com bubble didn’t help, and nor did the economic slowdown of the following year. Commerce One declared bankruptcy in 2004. GM and Chrysler lasted a few years longer, of course, until the Great Recession forced their restructurings.
Fast forward to today, and you see some of the same storyline among established, name brand enterprises that want to be considered “Tech companies”. Unlike the old dot com days, however, the reasons for donning the mantle of “tech” often has more to do with competing for talent than anything else. The rapid growth of everything from Big Data to cloud computing to mobile app development means qualified technology professionals are much in demand. And many would prefer to work for a “Tech company” than say, a commercial bank. Fair enough, I think. Any company that creates a good environment for talented employees and shows they value their work is doing the right thing.
Where things go astray is when investors take up the “Tech company” moniker to argue for different valuation metrics when assessing already existing businesses. It is all too tempting to look at a large industrial company or financial institution and say “They employ more programmers than lots of so-called tech companies. Why shouldn’t they be valued the same way?” This is a slippery slope and, as the auto company example above, can end in tears.
Here’s a quick checklist to see if your “Undervalued” tech-diamond-in-the-rough really merits the “Tech” badge. (With apologies to Jeff Foxworthy.)
You might be a tech company if...
#1 - You disrupt the status quo with a unique vision of the future. This is the essence of a 21st century tech company. Where the existing business model is a yellow cab, you see a smartphone enabled method of providing transportation without owning any cars (Uber, Lyft, etc). Instead of a hotel chain, you envision renting unused rooms and apartments (Airbnb). You don’t care about existing businesses. You destroy them.
#2 - You are either burning cash or generating tons of it. Real tech companies seem to either earn +20% returns on their capital or -20% returns. That’s because their capital is meant to be disruptive, not evolutionary. A “Real” tech company will earn a 5% return for about one month – either on its way to +20%, or just before it runs out of money.
#3 - Your employees have life-changing levels of equity. Payoffs for talent in technology make the lottery look like a money market fund. Whether or not a tech company makes it (and most don’t), key employees generally have enough equity to become very wealthy if things work out.
#4 - Governments don’t know what to do with you. Technology companies disrupt established government protocols almost as often as they upend existing business models. Apple is the poster child of this phenomenon at the moment, with the debate over the unlocking of an iPhone owned by a terrorist. Uber has had its fair share of criticism as well, from local governments around the world. Real tech is so far ahead of societal norms that their innovations often change how we view basic concepts like ownership and privacy.
#5 - Millennials love you. This age cohort – born from the early 1980s to 2000s – is a tough group to crack. They grew up with technology, so they are discerning users – quick to adopt, and equally quick to dismiss. Tech companies that can appeal to this mobile-enabled, multi-tasking customer base have a valuable edge indeed.
#6 - You are “In the club”. It’s no secret that Silicon Valley is a tight knit community of opinion leaders with a unique ability to discern winning business ideas. Members of this group cluster together. They give TED talks. They go to Davos, Allen & Co’s Sun Valley conference, and Bilderberg. And if your company’s CEO doesn’t, they need to.
#7 – Your addressable market grows exponentially because of your technology. In the end, points 1-6 are nice to haves; this one is essential. The reason “Technology” is such a powerful construct is that it destroys pre-existing barriers to competition. The old “Castle-and-moat” approach to business development crumbles in the face of technology. In the end, “Technology” means redefining everything about a given company, industrial sector, industry, and even society itself.
If you can honestly say a company does this, then it really is a “Tech company”.