The U.S. stock market in the past decade has shifted much of its focus to the technology sector. Tech ‘unicorns’ - start-ups with valuations of over $US 1 billion – have attracted the interest of many investors and are dominating news headlines. Think about companies such as Facebook, Twitter and Snapchat – when these companies file to go public they receive large valuations as well as strong investor interest. The most recent unicorns to list on the U.S. are Dropbox Inc. and Spotify.
Dropbox Inc. is a San Francisco-based cloud storage company which listed on the NASDAQ on the 23rd of March 2018, a Friday ending the S&P 500’s worst week in more than two years amid talks of a global trade war and interest rate rises. Despite this, Dropbox saw gains of 35% on its first day with a valuation of over $US11bn.
Music streaming service Spotify listed on the New York Stock Exchange (NYSE) on April 3rd 2018 and has taken an unusual path to the public markets, with a direct listing that allows investors and employees cash in their shares without the company raising new capital or hiring a broker to underwrite the offering. Shares opened at $US165.90, 25% higher from their $US132 reference price and finished the day at $US149.01. This valued the company at $US26.5 billion, up from its $US8.4 billion private valuation in 2015 – making it the biggest technology IPO in over a year since Snapchat Inc.
Large valuations and strong gains for well-known tech companies are not uncommon when listing on the stock market due to the huge demand from investors. The most recent major tech listing before Dropbox, Snapchat Inc. saw its share price gain as much as 44% on its first day of listing, closing at $24.48 a share from its IPO priced at US$17.
However, such high valuations and investor demand during the IPO phases leads to greater expectations on company performance in the long run, and poor performance results often lead to various consequences for the company and its investors. Twitter (NYSE: TWTR) is an example of this – the social media app saw gains of 72.69% in its stock market debut, closing at $US44.90 per share from its IPO valuation at $US26 per share. However, due to its inability to significantly grow its user base and thus generate strong, consistent profits, its share price has suffered since and its current market cap is roughly the same as after IPO at approximately $US24bn, after over four years of being a public company.
Dropbox and Spotify understand this market environment, and it is fair to compare the two. Both are relatively well-known tech ‘disrupters’ that have yet to turn a profit but have a large base of customers using their free-based services. As such, both companies are pitching to the public not to focus on their current business models, but rather the future and its potential for each company.
Dropbox, co-founded in 2007 by two MIT graduates, Andrew Houston and Arash Ferdowsi, reported 2017 revenue of $US1.11bn, while its net loss narrowed to $US111.7 million from $US210.2 million in 2016. It currently has reported over 500 million users with over 1.2 billion files uploaded daily onto its platform. However, in its video presentation to potential IPO investors, all customers featured in the video are businesses rather than individuals who currently make up the vast majority of its paying customers. Businesses were also the main focus in its financial prospectus to potential investors and is the fastest growing part of the company. Its strategy to grow is essentially to start with a handful of business workers as customers and then convince the whole company to use its services.
Spotify, originally from Sweden is available in more than 60 countries and has 157 million monthly users, of which 71 million are premium subscribers paying $US 11.99 a month. This is almost twice the number of users as its main competitor Apple music. It has reported net losses every year since it started in 2008, but the company says its growth orientated strategy will make the business more valuable in the long run.
“Becoming the world’s largest music-streaming subscription service has been expensive,” said finance chief Barry McCarthy during the company’s first investor presentation. “but the trend toward profitability is clearly apparent.”
On an operating basis, Spotify has been edging towards profitability since 2016, when its free cash flow turned positive, according to its financial documents. In 2017, the company generated $US134.7 million in free cash flow. Its outlook for 2018 has outlined expectations to increase its revenue by as much as 30% and boost its premium subscribers by as much as 46% year over year. It remains a global leader in a growing market - U.S. consumer spending on music-streaming services is likely to grow by 29% to $US6.6bn in 2018.
Tech unicorns and stock market newcomers, in general, are often treated as bets on potential rather than current circumstances. Facebook had almost no revenue from advertisements at its time of listing, which now generates most of its revenue. However, Spotify and Dropbox are different from many unicorns that came before. They are not young up-and-comers, but rather decade-old companies with track records in their core businesses and valuations far greater than average. They both offer solutions in their respective industries and are currently the number one among the competition.
To become apart of the technology space, the first move is to begin looking at international share markets. This sector within the Australian Stock Market leaves little opportunity to find such great companies as most opt to list in the United States. Australia is a resource-rich country and thus outperforms many other markets in this space. However, to truly diversify your portfolio, it is important to gain exposure to other markets and sectors so that your risk is spread out and one-sided events don’t shock your entire portfolio.