Technology Investing Insights: From Bubble to Valuation Strategies

Investing in Technology Online is disrupting everything Decent valuation appearing even for tech now the bubble has burst Charles Elliott Founder, Inflection Point Investments charles.elliott@ipinv.com Inflection Point Investments

Tech goes from Bubble to Trouble to Bubble 2 10% of NASDAQ dotcom listings bust by 2004 Frankfurt Neuer Markt - Mar 1997: 1,000 - Mar 2000: 9,631 - Oct 2002: 313 - Jun 2003: Shuts down fall of 97% !! Amazon Share Price ($) 700 Amazon shares fell from $107 to $6 .but trade around $630 today 600 Up 113x from trough 500 400 300 200 Advantage to investors who identify winners, average down and hold! 94% fall peak-to-trough 100 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Yahoo Finance Inflection Point Investments

Identifying winners 3 Principles Spot the disruption which lets small, rapidly-growing companies replace tired, old ones Find the Bottleneck in a newly-emerging industry Maintain proper disciplines when valuing stocks, using S-Curves to model future earnings, potential intrinsic value Inflection Point Investments

Disruption: Online has taken off 4 Source Notes Estimated for 2015 World GDP $ 78.5 trillion IMF World Bank % Household Final Consumption Expenditure 60% 2015 Global Consumer Spending $ 47.1 trillion Implied Estimated for 2015 Business-to-Consumer E-Commerce $ 2.25 trillion eMarketer Online (E-Commerce) Penetration 4.8% Global Mobile Commerce Forum Estimated for 2015 Mobile Commerce $ 0.3 trillion Mobile Commerce Penetration 0.6% but penetration is still low (especially in Mobile): For Internet & Software models, there are teething problems, not saturation issues Inflection Point Investments

Bottlenecks 5 PCs: Microsoft + Intel = 90% of industry earnings 1989-2009 Smartphones: iPhone + Android dominant Online Advertising : Google / Facebook Online Retailing: Amazon The need for standards creates massive barriers to entry Inflection Point Investments

Valuation 6 Ignore nearly all published models Instead, BYO (Build Your Own) Projected S-Curve + Market Share = Revenue Forecast Costs: largely fixed, mainly outsourced P/E ratio: Compellingly below market average on Genuinely Achievable Earnings Inflection Point Investments

After the 2015 Bubble: Some Trouble 7 There was a Bubble in FANGs in 2015 Stock EV: Revenue Jan 2015 EV: Revenue Dec 2015 % Revenue Beat/(Miss) Share Price Jan 1st 2015 Share Price Dec 31st 2015 % Increase Facebook 12.1 16.2 (1%) 77 105 36% Amazon 1.2 2.9 4% 307 676 120% Netflix 3.8 7.3 (6%) 49 114 133% Google 6.1 7.8 15% 520 758 46% Sources: Previews published before Q4 2014/Q1 2015 results, compared with year-end forecasts There was also a Double Bubble in the private tech market: Jet.com valued at $1 bn four months after foundation, raised $500 mn to compete with Amazon on price and marketing Square valued at $6 bn in last private round, IPO d at $2.9 bn There will be a lot of dead unicorns Marc Benioff, Salesforce.com Inflection Point Investments

New Troubles 8 Maturity Issues: Smartphones: Unit growth has fallen below 10%, heavy pricing pressure at low end (1.5 bn units pa is enough) PCs still shrinking c.10% In 2015, fell below 300 mn units (smartphones & tablets act as PC substitutes and lengthen their renewal cycle) Growth Problems: Enterprises invading their neighbours territory: o Facebook vs. Google in advertising o Google & Microsoft vs. Amazon in Web Services Large Enterprises extending their footprints into high growth areas (eg: Microsoft Power BI in big data, impacting Tableau s growth) How companies are responding: Less hypergrowth in revenue Emphasis on generating & increasing free cash flow Reduced moonshot investments (eg: Alphabet s Other Bets business) Inflection Point Investments

Differentiate Maturing from Emerging Tech 9 Should Maturing Tech be reclassified as The New Engineering Sector ? Company Share price (a) 2017E P/E (b) Cash as % of market cap Alphabet (Google) $724 17.9x 14.3% Apple $105 10.5x 24.2% Microsoft $53 17.4x 12.3% Rolls-Royce 684p 17.0x -4.9% (a) Pre-market, 22 April 2016 (b) Consensus estimates Tech investors hate slowing growth Value investors fear tech as earnings are hard to product This creates an exploitable anomaly Inflection Point Investments

Differentiate Maturing from Emerging Tech 10 Nevertheless, the multi-bagger potential is in Emerging Tech. Traditional businesses getting disrupted by technology Market Online penetration * Fashion <10% US consumer loans c.4% Education <1% * IPI estimates Inflection Point Investments

Decent valuation staring to appear 11 Undervaluation is following overvaluation. EV: Sales ratios were 8-10X in mid 2015, are now in 2.5X-3.5X range. Etsy share price chart, last 12 months First purchased at $7.68 Source: Yahoo Finance Inflection Point Investments

Summary 12 Real use of the Internet is still very low relative to potential Adoption changes industries and throws up new Winners The real Winners are almost always Monopolists / Oligopolists Tomorrow s Winners usually have cheap valuations - they shouldn t do! Spotting real Winners is horribly difficult. Inflection Point Investments

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