How can a value investor buy into technological innovation?

In a world where Google is a verb and Amazon web services has nothing to do with spiders in the rainforest, it is easy to understand why some of the biggest and most highly priced companies in the world are technology firms. However, as the TMT (Technology Media and Technology) bubble of the late nineties showed, investing in technology does not always end successfully.

How can a value investor – someone who likes to invest in a business based on the current (rather than future) value of its assets, profits or cash flow – make money out of this technological revolution? It may seem an impossible task, especially if you look at the valuation of Snap Inc, for example, the owner of Snapchat.  This loss making company recently floated in the USA and now has a value of $24bn1, roughly 59 times its last year’s revenues.

But value investors needn’t give up. Many traditional businesses are now benefitting from technological innovation in quite surprising ways. These companies are using technology to drive efficiency, improve health and safety, or enhance their competitive position.

Here are just a few of the examples I have discussed with the management of companies in the last few weeks2.

Energy giant Royal Dutch Shell, is using drones to inspect large, complex oil refineries. Not only is this far easier and cheaper than sending engineers up tall ladders, it can considerably reduce health and safety risks in the business.

HSBC is introducing voice recognition into its call centres in a bid to remove the need for customers to remember their passwords. The bank is also developing the capability to provide customers with instant bank or credit cards on their smart phones, without the need to manufacture and deliver a physical card.

Construction firm, Balfour Beatty is using fingerprint recognition for its workers and subcontractors when they enter and leave building sites. This technology enables the firm to know where its people are at any time. It should eliminate potential disagreements with subcontractors over hours worked, and should have considerable health and safety advantages too.

The gambling company Ladbrokes Coral is introducing facial recognition into its shops which, along with other digital technology, will allow it to monitor customer behaviour without breaching data protection rules. This can help them identify and support “problem gamblers”, even anonymously.  The same technology should allow Ladbrokes Coral to optimise their product offering for regular customers, with personalized incentives that reflect each gambler’s circumstances. As a result, the business can reduce its regulatory risk on one hand, and help improve player yields and profitability on the other.

A final example is the construction company Kier, which is also using drones. On behalf of water utilities the company will use these machines to spot the slight changes in ground temperature associated with water leakage in pipe networks, without needing to dig up the ground itself. This will help the utility meet its environmental obligations in a more cost effective way.

While none of these examples is going to radically transform the fortunes of the companies concerned, they are all situations in which traditional businesses are exploiting new technologies in relatively low risk and incremental ways. In some cases this may drive a competitive advantage, in others it may increase efficiency, drive productivity and improve profitability. These technologies also bring opportunities to improve the social or environmental impact of businesses, by improving health & safety, helping alleviate reputational and regulatory risks, or reducing environmental damage.

I don’t expect any of these businesses to suddenly re-rate onto technology type valuation multiples. However, they are modestly valued and these minor developments represent genuine progress within the business.  If these – and similar – companies can improve their growth rate or profitability via the selective adoption of technology, that can lead to higher shareholder returns in due course.

Simon Gergel

 

1 – Source Bloomberg: 05.06.17
2 – This is no recommendation or solicitation to buy or sell any particular security

 

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Author - Simon Gergel

Simon Gergel

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