Mike O'Donnell: Wynyard highlights the need for profits - even for tech stocks

"The collapse of Wynyard is also likely to have got the full attention of the shareholders of GeoOp, Serko and Rakon as ...

"The collapse of Wynyard is also likely to have got the full attention of the shareholders of GeoOp, Serko and Rakon as they contemplate their trajectory." - Mike O'Donnell

OPINION: A couple of years ago I wrote a column bemoaning the death of the 1990 style "padded shoulder, creamy, disco chardonnays".

These were the big oaky chardonnays that were buttery as all get out, thanks to strong malolactic secondary fermentation and more time in oak than many young winemakers had hot dinners.

Indeed contemporary winemakers and contemporary wine critics seem to look down their noses on such wines, considering them uncool and blue collar.

Lucky for me a handful of buttery bogans still make such drops – notably the folks at Marlborough's Wairau River vineyard whose Reserve Chardonnay will whisk you straight back to 1990.

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Clearly out of touch, I personally think the buttery chardonnay will come back into fashion, much like profitability has for technology companies, at least for those with slowing growth.

Long ago profitability was everything in tech companies. If your bottom line (revenue less expenses) wasn't black then serious questions needed to be asked.

That was before the internet and the rise and rise of Service as a Software (SaaS) companies. Here, growth was everything.

In this context growth meant number of users and/or top line revenue. So long as you were growing dollars in the door, positive earnings seemed about as relevant as bicycles do to fish.

But then at the start of this year a funny thing happened. The bum fell out of the SaaS market.

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Not just the countless small SaaS companies, but the big hairy assed ones who's bums you didn't want to see.

This saw the likes of Salesforce, Cornerstone and LinkedIn lose billions of dollars of value.

LinkedIn was the most dramatic, with its share price drop from US$200 (NZ$280) to US$100 in one teeth-clenching day.

Suddenly profitability was fashionable again. And a whole bunch of SaaS companies that were destined to never be profitable were simply erased.

At about this time a rule of thumb started being promoted by United States venture capitalist Brad Feld, started gaining real traction.

Called "the 40 per cent" rule it posits to be a sustainable high performance company a businesses annual revenue growth rate and its operating margin needs to equal 40 per cent or more.

So a company that was growing 20 per cent per year with 20 per cent operating margins would qualify. But so would a company growing 60 per cent a year with negative 20 per cent margins.

Two extensions of this rule are that it is ok to lose money if you are growing fast enough, but equally you need to make money and heaps of it as your growth slows.

Against this background it was interesting to see New Zealand investment bank Clare Capital put out a piece of analysis in their regular tech sector report last week.

They applied the 40 per cent rule to the 16 largest listed tech companies here in godzone. And for the profitability metric they used earnings before interest, tax, depreciation and amortisation margin.

The results were focusing, with less than a third of those companies managing to deliver positive share price movement over the last year.

In other words, over two thirds actually went backwards, something that's often lost on investors over-eating on tech stocks

The report paints an insightful picture of high performance companies from lower growth but high profitability to high growth but loss making.

It also throws into sharp relief those local tech companies that are struggling with performance.

In total five companies managed to chin the 40 per cent bar with the three standout performers against this metric being Pushpay (80 per cent), Trade Me (74 per cent) and Eroad (65 per cent).

Beneath this there was a tepid transition zone of seven local companies, ranging from Xero which just missed out making the top cut at 37 per cent to Orion Health with a pedestrian but still positive 4 per cent.

Then at the bottom were five fizzers that were categorised as poor performers. This included Finzsoft (-1 per cent), Rakon (-10 per cent), Serko (-21 per cent), GeoOp (-82) and Wynyard Group (-133 per cent), which managed to win the award for the worst performance of the lot.

Clearly there's something in the 40 per cent rule as less than a week after Clare Capital released its analysis Wynyard went into voluntary administration, where external accountants take over the business and decide whether to wind it up.

For the 2000-odd shareholders like me, who bought into the initial public offering at $1.15 in 2013, this is a catastrophic development for a company that apocryphally said a year ago it didn't want a "tight-arsed accountant" or "bean counter" as a chief financial officer.

The collapse of Wynyard is also likely to have got the full attention of the shareholders of GeoOp, Serko and Rakon as they contemplate their trajectory.

Profitability isn't everything when it comes to high performing SaaS companies, but its damned useful when your growth starts to slow.

Meanwhile I imagine there's not a lot of chardonnay being drunk at the flash new Wynyard offices at the moment, as around 100 unfortunate staff face an uncertain future.

Mike "MOD" O'Donnell is an e-commerce manager and professional director. His Twitter handle is @modsta and he's not afraid to embrace disco chardonnays.

Declaration of interest – MOD holds shares in Wynyard, SLI Systems, Trade Me, Rakon and Xero.

 - Stuff


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