The Dominant Themes That Guide Our Investment Search
Moore’s Law . . . Better, faster, cheaper
Moore’s Law, named after the co-founder of Intel, Gordon Moore, refers to the notion that semiconductor chips (and by extension all computer hardware related technology) will double processing speed and cut cost in half every 24 months. Technology is ultimately price elastic—the lower the price and the better the performance, the greater the demand. To remain competitive, businesses must refresh their technology.
Metcalfe’s Law . . . Harnessing Network Effects to Drive Intrinsic Value
As everything becomes more connected – network effects become critical drivers of intrinsic value. Bob Metcalfe, a MIT and Harvard educated electrical engineer, is credited with the co-invention of the “ethernet”. He used the following chart in several presentations in 1980 to explain the theoretical growth in the intrinsic value of a network of connected devices. The primary element of information that Aberdeen incorporates in its thinking is the notion that a network’s value grows by a function of the square of the number of nodes in the network.
The Aberdeen M x M Business Paradigm – Combining Mr. Moore’s and Mr. Metcalfe’s Laws
We have attempted to express the interaction of Moore’s Law and Metcalfe’s Law in the following graphic. One should view the “x” axis as the number of nodes in a network. The “y” axis should be thought of as the calibration of value in the case of the upper half of the graphic and of the aggregate network cost in the bottom half. Aberdeen is most attracted to businesses that have proprietary software related services that are enabled by extensive data networks. Such businesses ideally generate increasing amounts of recurring revenue as the number of connected nodes multiply.
Interactive Networks Are Becoming Integral to Business and Leisure
Being unconnected is no longer and option for economically active and productive individuals, companies or countries. People would more readily give up their television and landline telephone than give up their cell phones and internet. We are still in the early period of fully discovering and leveraging the power of ubiquitously deployed smart and internet accessible devices. “Software as a Service” or SaaS where business applications are delivered on demand over the internet instead of being sold and installed on a server will increasingly dominate the way businesses operate critical applications.
Pervasive Computing Is Becoming a Reality
Technology advances in device design, convergence of wired and wireless internet connectivity and completion of massive infrastructure build out to cover virtually all meaningful urban areas and roadways has launched a new paradigm in computing and telecommunications. The greatest growth in computing is in the “untethered” world creating opportunities for new software and services for retail, personal, enterprise and machine to machine interactions.
Exploding Need For Energy Productivity and Management
Electrical power demand growth has outstripped growth in capacity and will continue to do so in the coming years. The U.S. is beyond the point where building capacity could avoid an extended time frame of broadly dispersed and recurring power outages at peak load periods. This condition will push adoption of “smart grid” technologies employing millions of connected devices to effect material reductions in power consumption at critical periods while minimizing grid performance degradation.
Exploding Need for Productivity in Healthcare
The aging of the Baby Boomers will result in an explosion in the number of healthcare incidents. We will not have enough doctors, nurses, therapists, orderlies or janitors to provide healthcare services in the manner they are provided today. Technology will have to play a key role in effecting a dramatic increase in healthcare productivity in the coming years.
Demography of the Investing Public . . . Marching up the Efficient Frontier
The math is clear . . . the investing public must have higher returns to meet retirement requirements. Capital will migrate up the Efficient Frontier toward smaller cap, higher growth companies . . . namely, the types of technology companies on which Aberdeen focuses it’s attention. Increasing investor demand will support the case for growing stock prices. The 2008 financial crisis triggered massive redemptions from alternative investment funds which will conceivably drive capital to the left on the frontier and into Aberdeen’s sweet spot – high growth, small technology companies.
Favored Technology Areas
The Aberdeen focus is on businesses in industries transitioning from an analog to digital state and where network effects can be maximized. These conditions are consistent with emerging “green” investment opportunities.
Attractive areas for investment include the following:
- Broadband wireless software, hardware and services
- Software centric medical technology and services
- Internet commerce software and services
- Internet content and advertising delivery and management
- Machine to machine computing
- Smart grid related technologies
- Enterprise data storage, management, backup and recovery, utility and SaaS computing platforms
Aberdeen continuously monitors the marketplace for evidence of technologies reaching points of rapid adoption.
Small Tech = More Growth, Better Value and Bigger Returns
Small technology companies, such as those comprising Aberdeen’s area of focus, generate far more growth than larger companies. Technology stocks with less than $1 billion in market capitalization tend to have median revenue growth that is over 3X greater than the S&P 500. They also tend to be cheaper than S&P 500 stocks in terms of the revenue multiple paid per point of revenue growth.
Climbing the “S”
Aberdeen believes that many small technology companies are following normal technology adoption patterns. We are confident that the “best is yet to come” in terms of the revenue growth and value creation as the businesses leave the “chasm”. Revenues will ramp when technology is “sold” to the mainstream customer. An example has been the launch of next generation wireless data applications. After years of preparation, the large carriers are now mass marketing new smart phones such as the iPhone and data applications with an attendant growth in data enabled handsets, software and content (e.g. music, ring tones, games, sports information, real-time stock quotes, etc.).
Valuation Upside Formula – Growth and Multiple Expansion
Aberdeen searches for companies capable of achieving the scale and valuation similar to more mature tech stocks in the market today. We target companies capable of sustainable top line growth in the area of 25% per year. This level of growth implies a 3X growth in revenue in five years. Companies of $300 million in revenue or more with this kind of growth command revenue multiples of as much as 3.5 to 5.0X. Our job is to find companies that can be purchased for 2X +/- revenue today that can trade for 3.5X to 5X revenue in five years. Our downside should be the core revenue growth and our upside should be the expanded valuation multiple. In the example below, the stock of $8.00 would grow to $42.72 in 5 years assuming 25% annual revenue growth.
Technology Bargain Selection Criteria
Prospects should address large markets with well-documented and validated growth outlooks.
Prospects should have “proven” elements:
- Established Customer Base—Identifiable customer base with established market share
- Developed Technology—Established, field proven technology requiring ordinary levels of investment for enhancement.
- Accepted Revenue Model —The revenue model should be stable with demonstrated sales and marketing traction, preferably with some recurring revenue elements.
- Battle Proven Management Team —The management and board of directors should have demonstrated leadership and ability to make tough decisions.
- Proven Ability to Produce Cash Flow —The companies should have demonstrated positive cash flow or should be within a definable horizon for achievement of positive cash flow. No “hope” stories, no turnarounds.
Our Analytical Disciplines
Aberdeen performs fundamental market research to:
- Verify the demand metrics and growth opportunity,
- Verify customer satisfaction,
- Evaluate competitive positioning,
- Establish the economic validity of the business model,
- Review intellectual property value and technology substitution risks