You must have been living in a cave if you haven’t heard of today’s tech giants and their triumphal march on share markets. Apple, Amazon and Co have pushed the Nasdaq, which is heavily weighted in favour of tech shares, to new highs, and while businesses are battling worldwide to shake off the burden of Covid-19, it appears as if these large tech companies are immune to the impact.
True, we have no companies on the FAANG scale, such as Facebook, Apple, Amazon, Netflix or Alphabet (Google), but we do have many ingenious technology entrepreneurs, who are in the right sector to appeal to private equity companies looking for acquisitions, says Andrew Bahlmann, MD of Deal Leaders Africa, a boutique advisory firm. “We’ve seen a definite appetite for lending to or investing in technology companies. The companies that are attracting acquirers’ attention are those that have rand-denominated overheads, while they generate dollar revenue. They deliver those services that work easily across borders,” says Bahlmann.
He believes what does count against South African companies is their size. “Most of the international acquirers are on the lookout for opportunities of R1bn or more. This is a problem for SA companies serving the local market. At the moment, there is more interest in this sector from the venture capital market than from private equity acquirers.”
There are only a handful of SA companies that are listed in the software and IT-sector on the JSE: Adapt IT, Altron, AYO, Bytes, Capital Appreciation, Cartrack, Cognition, Datatec, EOH, Etion, ISA, Jasco, Mixtel, Naspers*, PBT Group, Prosus, Sebata, SilverBridge and TCS.
Although they're not in abundance, they do attract the attention of investors. Adapt IT is constantly in the news regarding the Huge Group’s offer, which offered shareholders R5.52 per share and now the Canadian Volaris Group made an all-cash offer of R6.50 per share.
Another tech company that is constantly in the news is Altron. Bytes UK unbundled from Altron in December 2020 and currently trades on the JSE and the London Stock Exchange. Altron is also planning to sell Altron Document Solutions, Arrow and People Solutions.
Rella Suskin, head of research at Benguela Global Fund Managers, reckons the SA technology sector has had a relatively good 2020. “However, share prices in the sector have largely been driven by the strong beta rally across the SA market as global uncertainties waned and risk-tolerant investors looked for opportunities. The FTSE/JSE’s All Share Index increased by approximately 60% last year, and the FTSE/ JSE’s Small Cap Index, under which the majority of SA’s tech sector falls, is up a stronger 70%. In a risk-on market environment, it is generally the most geared companies that see the largest rise. We also see this in SA with Adapt IT, which, for example, increased by 150%, while Datatec (more stable and with less debt) rose by single digits.”
Suskin believes that the Covid-19 pandemic has certainly created more opportunities in the sector, with among others, cloud storage. She believes even with the progress made with vaccines, working conditions are likely to remain flexible for a long time, thus supporting the continued demand for ongoing IT support.
But what if I want to invest?
Peet Serfontein, an independent market analyst, says it’s advisable to compare any sector with the general market. It gives one a good indication of whether the sector as a whole is under- or overvalued (graph 1).
“If one looks at the relative graph of the FTSE/JSE’s Technology Index, it is evident that the sector is underperforming compared to the general market, the All Share Index. Therefore, on a basis where one compares apples with apples, it does look as if there’s value to be had. Since 2018, the index has increased in a very stable bull trend, so it’s not going to give you sleepless nights completely.”
Suskin on the other hand, believes that technology stocks make little sense if one looks at the price to tangible book value.
“Technology businesses are usually asset light, most of their value is made up of intellectual property and relationships. These undertakings also grow through acquisitions, so they have a fair amount of goodwill on their balance sheets. The tangible book value of Adapt IT and EOH is, for example negative, given their historical growth through acquisitions. This makes it difficult to evaluate them on this basis,” says Suskin.
She then states that most of these companies’ earnings profiles are also volatile, owing to their high fixed-cost bases, the impact of acquisitions and the constant restructuring that led to onceoff charges. That is why it’s difficult to determine a price-to-earnings multiple.
“One should rather look at an Enterprise Value-to-EBITDA-multiple as these companies’ EBITDA is more stable,” she says. Suskin mentions that the value of a business ultimately depends on its ability to generate cash and therefore they prefer the price-to-free cash flow metric.
A FEW OF SA’S LISTED PLAYERS
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