The ASX is currently undertaking a public consultation for feedback on a proposal to place stricter regulations on small companies trying to list on the ASX, particularly those with little or no revenue. While the changes aren’t significant, it creates an interesting debate around what the role of the ASX should be between companies seeking capital, and the investing public willing to provide it.
But first, let’s go back to where this debate started. It may come as a surprise to learn the ASX had a very distinct tech bubble in 2015. Part of the reason why this bubble didn’t become well known like the “dot-com” bubble in 2000 was because it was generally restricted to the small cap tech companies on the ASX. Looking at the following charts, you can see a picture paints a thousand words:
Ok, so I might have cherry picked three charts to make my point, but late 2015 was a very prosperous time for small cap tech companies on the ASX. But, as always, all good things must come to an end, and you can clearly see where the bubble burst in November last year.
So now imagine you are a small tech company, not making any money but with a great product and large market to potentially tap into. You are watching peers on the ASX trade to insane prices and multiples, and in the process become capitalised at valuations much higher than any venture capital you could access. So you rush to list, but as we see above, the bubble bursts as quick as it started and the markets appetite for risky tech stocks is now over.
This isn’t a hypothetical situation; this is what happened to a lot of tech companies over the past year. In 2016, we have had a number of small tech companies list on the ASX including: ApplyDirect, Tesserent, Shark Mitigation Systems, 9Spokes, DroneShield, Kyckr, LiveHire, ChimpChange, Aurora Labs, Family Zone Cyber and Gooroo Ventures. While some of those names have performed well, it is fair to say that most have had rocky starts to their listed lives.
And that doesn’t include the list of names who intended to list but for one reason or another decided not to. These include Alphatise, Bitcoin Group, Koolsee New Media and the highly publicised Guvera (which was likely a key reason ASX introduced the proposed changes).
So with investors underwater on their small cap tech punts and a long list of similar companies looking to list, the ASX decided to introduce some small changes to their listing restrictions earlier this year. The ASX proposed to increase the market capitalisation threshold from $10m to $20m and the net tangible assets threshold from $3m to $5m (companies must satisfy one of the requirements to list).
I believe the proposed changes will come into effect (currently slated for mid-December this year) given they are relatively minor and will not affect most potential new listings. However, it raises the question of how far the ASX should go in regulating the exchange of capital.
All of the companies I have mentioned provided detailed prospectuses before listing with key risks identified, including a lack of revenue if it was the case. If anyone looking to invest in these companies was able to access all the necessary information to make an informed decision, do they require further protection from the ASX? Not to mention that disappointing IPOs are not restricted to risky small tech companies. Read Luke Durbin’s blog here to see some well publicised (and well-supported) IPOs that have tanked shortly after listing.
Even during the bubble it was clear these companies were overvalued. New listings on the ASX must report their cash earnings quarterly, and overtime it became clear that despite good products or potential markets, these companies were struggling to generate cash to cover their costs. This means further capital raisings, diluting shareholders and devaluing existing shares. Any investor applying even basic fundamental analysis would realise how risky these small cap tech companies were. Certainly none of them began to tick the boxes on Farnam’s value investing checklist.
Finally, I wonder whether this issue should be arising in the first place. Tech companies in Australia have often claimed the difficulty they have in finding seed stage venture capital locally, especially compared to the ease of capital early stage tech companies can find in Silicon Valley. It could be seen as an indictment on Australia’s venture capital industry that some companies believe they are forced to list publicly to gain access to additional capital to grow.
In the end, these changes are small and will likely come into effect with little fanfare and not change a great deal. I’m sure in 2017 there will be some small cap tech companies that list and do well, and others that list and do poorly. I believe more onus should be put on the investor to ensure they are making an informed decision rather than ASX making that decision for them.
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This document has been prepared by Farnam Investment Management Pty Ltd (Farnam) ABN 15 149 971 808 AFS Licence 430574. While every care has been taken in the preparation of this document it does not contain any recommendations to buy or sell any particular stock(s) noted. Farnam makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation and needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to their objectives, financial situation and needs. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.