20-26 February 2003

Techs test the waters - Business Review Weekly

A second group of small Australian technology companies is preparing to float on stock markets, despite the clouds hanging over the global technology sector. More than one-third of the 50 companies interviewed for my new book, Innovation and Emerging Markets, want to list on a stock exchange here or overseas within two to five years. These companies may face unfriendly markets. Investors are still suspicious of tech stocks after the hype of the internet boom. Only a handful of technology companies have been brave enough to list on the Australian stock market since the end of 2000. Few have performed well but the new group of companies has learnt from the mistakes of the old ones.

Interest in initial public offerings (IPOs) is often sparked by the needs of investors rather than the people running the companies. The early investors in many technology companies are eager for a return on their funds, and a stock market float is usually a neat way for them to get out of their investment and realise gains. Most companies are also considering the option of a trade sale, which avoids the risks of a public float but can lead to forfeiture of management control of the company's destiny. Venture capitalists, having made most of their technology investments between 1998 and 2000, are getting ready to cash in their chips. Five years is about their usual wait between making an investment and cashing it in.

Investors' interests will not be the main motive for all IPOs. Some companies will seek an IPO to provide liquidity to founding shareholders, or to create scrip for use in takeovers.

The bearish market means valuations for companies today are likely to be half of what they were in the tech boom. Although each company will be priced on its merits, analysts suggest technology companies that float today are likely to attract price/earnings multiples of about eight. Three years ago, some companies had attracted multiples of 19 or higher.

The list of potential candidates for an IPO is long. It includes software developers, biotechnology companies, communications equipment makers and specialist technology providers to markets such as mining, agriculture and financial services. A big difference between this group and many of the companies that listed during the tech boom is their longevity. Companies such as software tools developer ManageSoft and data management specialist Tower Technology are 12 and 15 years old; most other potential IPO candidates are more than five years old.

ManageSoft has raised more than $25 million since 1999 from a range of venture capitalists. Its regional general manager, Andrew Hewitt, says any company that has venture-capital backing must eventually look at how it will repay its investors. "You have to look at what the venture capitalists want," Hewitt says. "Typically they are not long-term investors. They invest for the medium term and then look for some way of achieving liquidity. One of the options would be to list."

The other option would be a trade sale, but Hewitt says this depends on the buyer. "You get to control your own destiny if you list, but then you might be more successful if you were part of something with a large client base and an existing infrastructure around the world."

Technology companies that try to list will face far more rigorous scrutiny than those that went to the market during the tech boom. Analysts agree that many technology companies that had minimal revenue and profit listed too early in their development.

Direk Utharntharm, an investment analyst at the specialist funds manager TechInvest, says some of the biotechnology companies listed too early because they could not find the venture capital needed to continue as private companies. For information technology (IT) companies and dot-coms, the hype of the tech boom created an opportunity to float with business models and revenue that would normally be classed as highly speculative. In both cases, crashing share prices have left many with market capitalisations under $10 million and little liquidity in their stock, making it almost impossible for these companies to raise more funds.

"The late 1990s was the period when people believed that if you had some technology story, it didn't really matter if you had revenue or not," says Utharntharm. "If you had some exciting internet or telecommunications-related story, the venture-capital and public markets would fund it regardless. But that is not going to happen again in the next 10 or 15 years - at least not in the timeframe of current investors' memories.

"Any technology company that is going to the market in the future will be considered just like any other company - on the merits of its financials and its management quality. And for the next five years people are going to be even more sceptical of, and perform tougher-than-average due diligence on, these companies."

Utharntharm says the poor performance of listed IT and biotechnology companies makes it hard for private companies to achieve strong valuations that are based on comparable listed companies. "At the end of the day, anyone with the smell of tech will find it very hard to find a good price," he says. "The market now is risk averse - yield has become very important again."

One of the most bullish IPO candidates is the biotechnology company Proteome Systems. Founded in 1999, Proteome's science is proteomics, the study of proteins to help diagnose and treat various conditions. The company manufactures numerous diagnostic products for consumer and commercial use.

The founder and chief executive of Proteome, Keith Williams, has made no secret of his desire to take the company public in the latter part of 2003. But he says any decision will depend on Proteome's revenue position and the state of the stock market.

Proteome carries a valuation of more than $400 million from the Japanese industrial company Itochu, which is an investor. Williams' goal is to list the company with a valuation of $500 million. He concedes that much of that valuation is built on comparisons with listed companies and on predictions of rapid revenue growth. Proteome has signed numerous partnership deals in the United States and Japan that will start producing revenue this year. Sales for 2001-02 totalled $7.7 million. Williams expects that to grow to more than $15 million in the current financial year, and the company is expected to sign several important sales deals before June 30 that should bring it close to cashflow positive. The float will provide a way out for existing investors, and scrip that Williams could use in takeover opportunities.

"If we do go out at $500 million, that will be unusual for a company that started out from scratch four years ago," Williams says. "But I would like to think we are selling pretty hot stuff, and we have never said we are cheap. We have the best team and people who work very hard and are very focused on what we are doing."

Williams will watch the performance of any floats in the first half of 2003 to gauge investor sentiment. "With the float of Telstra 3 not happening, there is a dearth of significant floats this year. So if the market does get a bit of an appetite you may be able to do reasonably well [with a float] because people are looking for a quality float to go on," he says.

Another float candidate for 2003 is the biotechnology company Alchemia, which has developed technology for the manufacture of artificial carbohydrate molecules to be used in the treatment of diseases. Alchemia has been the subject of much discussion among merchant bankers regarding a possible listing before June 30 this year, but its chief executive, Dr Tracie Ramsdale, declined to comment.

A common problem for float candidates is balancing the need to provide an exit for investors with maximising the valuation of the company through increased revenue and profit. In the case of the wireless communications technology developer Yambay, its chief executive, Leon Levit, says an IPO might be possible within the next two years. "It is important to us to have some sort of exit, be it a trade sale or an IPO," Levit says. "But clearly, first we need a good strong business with good fundamentals. And the focus of the business at the moment is still on the objective of building the business. But we are increasingly turning our attention to what an exit strategy looks like."

The IPO plans of Brisbane-based communications technology developer Braintree Communications are designed to satisfy external investors. It has never received venture funding in its 15-year history. The chief executive of Braintree, Peter Hall, says its listing ambitions come from a desire to increase its pool of working capital for international expansion, and to make the value of the company clear to internal shareholders.

Hall says his company will be ready to list at the end of this financial year. But a float will probably be delayed to give Braintree time to increase its revenue and profitability, and hence its valuation. Hall believes Braintree could achieve a market valuation today that is three times its earnings before interest and tax, but the company will wait until five to 10 times becomes possible. "Braintree is not a whole bunch of guys with an idea and no revenue. The choice to IPO is a strategic choice, not a must that's been forced upon us. A lot of IPOs don't have the luxury of being a choice. [Some companies] don't have any other way of getting the money."

Hall says he has been in regular contact with brokers and analysts about Braintree's progress, and believes that will help them understand the dynamic nature of the IT industry.

Opinions vary on the desirable size of a company before listing, but generally analysts want companies with revenue of between $50 million and $100 million, and strong profit. The only privately held Australian technology company of that size is the Brisbane-based software developer Mincom. It began life 23 years ago as a developer of planning software for the mining industry before broadening its products to other industries. Mincom's revenue for the 12 months to June 30, 2002, was $207.8 million and it made a net profit of $5.7 million.

The company is expected to list in the next two years, having cancelled a proposed $50 million float in late 1999 because of a bad market for enterprise software developers brought on by the year-2000 scare. But Mincom still needs to satisfy the exit requirements of its external investors, Colonial First State and the industrial manufacturer Caterpillar. No timetable for a new listing has been mentioned.

Mining technology and services is one of the hidden gems of Australia's technology industry. Figures compiled by the industry group Austmine show that gross exports from this sector are expected to grow by 25% for much of this decade: from $1.2 billion in 2000-01 to $1.9 billion by 2005-06. Australia is regarded as a world leader in mining technology, which helps with overseas sales.

Austmine's chairman, Alan Broome, says that if this growth can be achieved it will mean "exporting mining technology and know-how will be the second-largest mining export behind coal. That makes it larger than aluminium, zinc, iron and every other metal combined".

In the past, mining technology companies have struggled to attract venture capital and have relied on on angel investors and government grants. In recent years this has begun to change, with venture capitalists such as Foundation Capital and Amwin Management investing in Fractal Technologies and Gekko Systems. Fractal's managing director, Jenny Archibald, says going public is a long-term objective for her company.

Another industry sector that may produce publicly listed technology companies is agribusiness. Candidates for a float include the farm machinery automation specialists Beeline Technologies and KEE Technologies, and Klaxon IQA, which is developing systems for tracking the movement and condition of refrigerated shipping containers.

Beeline and Klaxon have received investments from Gresham-Rabo Management's Food and Agribusiness Investment Fund (FAIF), which was able to raise $128 million late in 2002 despite conditions that deterred other technology-oriented venture capitalists. FAIF's managing director, Brian Hanley, says agribusiness is particularly attractive because the market for food is always likely to increase.

But for many companies that intend to go public, Australia is too small a market from which to do it. Edward Tapanes, the founder and managing director of security products company Future Fibre Technologies (FFT), says listing on NASDAQ might be more effective. "We can't grow our company at the rate needed if we focus on, and stay purely in, Australia," Tapanes says. "Everybody is telling us - and we have conceded the fact after market research - that we really need to be domiciled in the US. That is where we are going to gain maximum value for the company."

The chief executive of the banking software developer Financial Network Services (FNS), Tony Ward, agrees. He says that after an intensive survey of the Australian market, there are simply too many factors that would make it undesirable to list here. These include the general lack of support for small-capitalisation stocks in Australia, as well as a general unwillingness to invest in technology companies.

Ward says that were FNS to float, it would most likely list on NASDAQ or in London, but emerging markets such as China, Taiwan, Hong Kong or South Korea are also appealing. These are untried markets for Australian technology companies, but they are ones in which FNS believes it can grow. Ward says Asian and European markets take a longer-term view of their investments.

Ward says FNS would need revenue of $US50-60 million before listing, which he says is at least two years away. But it is structured as a public company, he says, and is otherwise ready to go.

FNS has considered a float before, in 1998, before deciding that a listing in Australia would be too difficult. Ward says that had FNS floated, its share price would probably have been decimated in the tech wreck and it would have been a target for a hostile takeover. "By September [1998] we could see the internet coming, and saw that there would be opportunities if the economy stood up. But the difficulties of the Australian market meant it was never going to be the panacea for us."

FAIF's Hanley agrees: "For a small-cap company, there is no market in Australia. The market is dominated by institutions and superannuation companies, and they won't make investments in small companies - the cost is not worth their effort. If they are not going to invest in small-caps, the analysts are not going to cover them and push their prospects to the public market. So it will be thinly traded, and hence hard for the founders and other shareholders to realise any value."


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