#TechTop3 – Our top three tech stories of the week

By septiembre 19, 2014ES insight

By the London Technology Team

Alibaba and the over £40 a share stock floatation

Both the press and the broadcast media have been bubbling with excitement over the eagerly anticipated floatation of Alibaba, the Chinese e-commerce giant. The company, despite accounting for 80% of total online retail sales in China remains relatively unknown amongst the British public. The company floated on the New York Stock Exchange on Friday, with an initial share price of a staggering $68 (£42) each, the largest US initial public offering (IPO) in history. This therefore values Alibaba at $167.6bn, exceeding the market capitalisation value of not only other online giants, such as Amazon ($150.2bn) and eBay ($67bn), but also companies such as Disney, American Express and Boeing.

The news clearly reflects the strong level of investor confidence and appetite for the company, and is perhaps less surprising when one considers both the strength of their second quarter results, with revenues increasing 46% year on year and profits tripling to $1.99bn. Furthermore, their user base rocketed to 279 million over the past year (a 50% increase).

Michael Schuman’s article in Time provides a particularly thought provoking analysis, providing details of what Alibaba’s IPO tells us about the changing world economy. In his piece, Schuman explains how, in the future, more and more of the world’s largest and most prominent companies will be from “the developing world”, also stating that the global economy is rebalancing, with consumers in the West largely constrained by weaker job prospects and stagnant wages, unlike their counterparts in China and India.

Inevitably, a large number of fascinating articles have been written on the subject over the past week, including in-depth biographies of  Jack Ma, Alibaba’s flamboyant founder (BBC News),  guides on whether to invest or not (Washington Post) and lists of the most bizarre things that can be bought on the site (Telegraph).

 No Phones 4 U

As the week comes to a close, the future of Phones4U looks very bleak. Since going into administration on Monday, short lived rescue attempts haven’t worked and the business is likely be wound down. This is the first technology retailer to cease trading since the recovery started to take hold.

On paper, Phones4U is a very successful business- it makes healthy profits, has hundreds of stores employing over five thousand staff and has £100m in capital reserves. However, they are first and foremost a reseller, exposing them to the whims of the mobile operators and this dependence hurt them as the mobile networks withdrew. They had a burgeoning MVNO (Life Mobile), and sold SIM-free handsets, but these were never aggressively pushed and did not drive the required volume to keep the business going. In short, Phones4U’s dependence on the operators was their downfall. The supply chain has also been widely affected, with manufacturers, distributors, creditors millions of pounds out of pocket from failed investments and little prospect of getting their invoices paid.

The networks were put in awkward position too, when Phones4U publicly blamed them for the crisis, with the founder calling them ‘ruthless’. The networks cited the debt leveraged on the business as the reason for failure, but Phones4U need to share the blame.  Their dependence on reselling other businesses services with no contingency plans was clearly too risky. Combining this with their debt obligations (which were serviceable), they were not flexible enough to come up with a viable rescue plan, or diversify their offering.

So what now for mobile phone retail on the high street? Mobile networks want to further increase their own direct sales, as despite the added costs of running shops, they get more revenue per user (RPU) compared to selling through an indirect channel. Phones4U’s main rival Dixons Carphone must be delighted and scared at the same time as even though they will inherit market share, they have a similar business model to Phones4U. Smaller chain Fonehouse is growing and now has almost 50 stores, and is agile enough to diversify and develop a presence.  Despite the variety of places to buy phones on the high street, it has become increasingly hard to sell contracts. Phone contracts require customers to sign up for 2 years, so even with innovations like EE Early Upgrade and O2 Refresh, most customers are not in a position to sign up to a new contract.

The collapse was the largest retail collapse since the recovery took hold, and could negatively affect consumer choice so understandably gained a lot of press. Trade mag Mobile Today (here and here too) covered the story widely and The Register ran a great story with leaked Phones4U  audience segment documents. The Guardian, Financial Times and The Evening Standard also had good pieces on the store’s demise.

How to become a tech billionaire: start a profit-less company

Writing in The Guardian this week, Dominic Rushe drew attention to warnings from two influential tech investors regarding the rate of ‘cash burn’ and the level of risk being taken on by tech start-ups across Silicon Valley. The ‘burn rate’ refers to the amount of money a start-up is spending and some fear that the rate is alarmingly high when compared to small or non-existent revenues. The comments come after a spate of high profile valuations of companies that have never actually made any money.

Snapchat, the social messaging service, is a case in point; with more than 100 million monthly active users, sending around 500 million messages a day. The apps popularity is clear but the service is free and the company is yet to indicate how it will make money. Despite this, it was recently valued at $10bn.

The comments came from Bill Gurley, partner at Silicon Valley-based investor Benchmark and Fred Wilson, the New York-based co-founder of Union Square Ventures. Both are well placed to comment and have impressive track records when it comes to shrewd tech investments; Gurley’s portfolio includes investments in OpenTable and Uber whilst Wilson can count Twitter and Tumblr amongst his best investment decisions. Their comments may inspire more speculation about another ‘dotcom’ crash.

Whilst it is not surprising that fears of another ‘dotcom’ crash grow stronger after a period of high value acquisitions and valuations, it is interesting to note what those fears communicate about the state of the market.  As business confidence rises and investor appetite increases, access to finance becomes easier and firms increasingly look to acquisitions for securing high growth rates. Fears of another ‘dotcom’ crash should be balanced by a consideration of of the extent to which traditional economic models still apply. Indeed, whilst valuations may appear overblown, today’s tech investors appear happy to buy into exciting start-ups without a proven route to profit but on the basis of massive growth potential and the capacity to constitute a threat to dominant actors. Perhaps confidence to invest at seemingly inflated rates is based on the assumption that the largest players in the market will pre-emptively acquire the fledgling company?

Furthermore, many tech start-ups have managed to develop reliable revenue streams whilst attracting far smaller operating costs than many a ‘traditional’ business, upon which many economic models are based. However, there are legitimate fears over the true worth of companies that are yet to find a revenue model and it is also true that some companies are reaching risk levels comparable to those immediately prior to the bubble bursting. Ultimately, only time will tell whether or not the recent spate of eye-watering valuations are looked back on as evidence of an impending crash or are demonstrated to be sound indicators of business success.