Alantra Partners S A : Not your parents’ technology bubble

By Kulbinder Garcha

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Alantra Global Technology Fund (ALGTF ID Equity)

Now let's address the $12.9tn elephant in the room. With technology sector at record highs, the Nasdaq surpassing levels of year 2000 in 2014, the software sector on the highest multiple levels ever seen, a robust IPO/SPAC market that shows no sign of slowing, it is hardly a surprise the casual observers fear we are in bubble territory. Indeed, comparisons are often made between the surge in share prices last year with the dot.com mania and crash of 2000. There is undeniably a lot of 'froth' in the market. We see extremities in many ways, for example:

• Tesla is now worth north of $800bn, it is valued more than the next 9 biggest publicly quoted car companies combined. Airbnb is worth materially more than the 20 largest quoted hotel chains. Such companies still have a lot to prove in spite of visionary management, even if we believe Tesla may have a shot in an autonomous robo-taxi world, or that AirBnB has a data and brand advantage on a global scale rarely seen in the travel industry.
• We recently counted that there are almost 30 companies that sub $1mn of annual revenues, valued anywhere between $2bn to $20bn.
• The recent retail interlude in markets also bears an uncanny resemblance to the participation in late 1990s, (we note in certain markets has reached 30% of market volumes). The subsequent short squeeze in certain share prices was as severe as it has proved short.

Whilst we do detect degrees of excessive valuation in both public and private technology markets, equally we are of the view that current valuations in technology sector are very different to the fundamentals seen in the year 2000 (something we still have not quite erased from memory). In fact, we argue a clear distinction needs to be made between rampant speculation in certain areas and significant, fundamentally sound technology industry. This could sustain market leadership for decades to come and making the risk of severe multiple contraction is less likely.

Multi decade themes in play. We believe there exists strong thematic tailwinds for growth, at early levels of adoption in several areas, notably Digital Transformation, Electric Vehicles, Cybersecurity, Cloud and E-Commerce. The growth of these we believe can be measured in decades as opposed to years and will benefit equally across the market capitalization spectrum. It is for this reason that such themes account for 70% of the AGTF portfolio.

MFAANG franchise are solid, regulation permitting. Unlike in 2000, many of the more established technology companies are dominant global businesses and have a solid financial footing. Microsoft, Facebook, Apple, Amazon, Netflix and Google have all become giant companies with highly lucrative franchises in their chosen sectors, their fate will largely depend on other factors (regulation being one). Although, with a combined $1.3tn in sales, EBITDA margins of 30% (on average), growth of 15% per annum and healthy cash piles, even increased levels of regulatory scrutiny maybe enough to dent rather than stop such juggernauts.

Valuation compared with market levels are back to pre-bubble norms as noted above. As shown the trailing P/E relative of the sector has fallen back to its ex-TMT bubble norm, admittedly the 12-month forward P/E relative is one standard deviation above its ex-TMT bubble norm. However, the last time the sector reached similar levels, it continued to rerate significantly. Note that in 2000 many companies went public with no earnings and just conceptual business models.

The technology sector has solid fundamentals, the strongest growth, profitability, and balance sheets. The AGTF holds a 52% exposure to software, where we hold 15 of 27 positions, we expect healthy revenue growth of almost 30%, by contrast the S&P growth is expected to be around 6.1%. In fact, we believe that software could account for 40% of incremental FCF growth of the entire S&P 500 in coming years, in other words it is now a major driver of the entire market and for good reason - digital transformation lies at the heart of every industry today. Moreover, across the sectors as the charts above demonstrate the sector drives superior revenue growth and FCF compared with rest of the market, very different from the early 2000s.

• The tech sector is a strong driver of market growth and margins in the aggregate. As shown above, in aggregate when we take a broader definition of technology, we observe revenue growth and profitability outside the sector far less attractive.
• High cash conversion means that the FCF yield remains reasonable at 3% for global IT and 3.6% for the top 20 names (2021 median adjusted for share-based compensation)

• Revenue estimates are in line with their trend and have not risen significantly above the rate of growth of CAGR of 10.2%). This is unlike the late 1990s, when sales rose to be c.12% above trend (compared with 0.1% now).

Conclusion. History teaches us that when sectors drive stock market leadership, they tend to dominate the market for 4 to 5 decades. For technology, this really started in 2000… implying there could be 3 decades of tech sector dominance yet to play out, in the same way the previous century saw real estate, industrials and financials dominating the market, now it could be the technology sectors turn and for some time.

Alantra Global Technology Fund Team

• Kulbinder Garcha

  Managing Director

• Fiorangelo Salvatorelli

  Managing Director

*This article is an extract from the fund's 2021 outlook letter. If you would like to be added to the fund's distribution list contact [e-mail]

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