Software companies still a risky bet

Nicki Bourlioufas | 11 Sep 2017

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The number of software companies listing on the ASX has jumped in recent years, and while the gains to be made can be spectacular, so too can the losses.

 

Experts are warning investors to do their due diligence and spread their bets, as not all companies will make money.

One of the main areas of software development is artificial intelligence (AI). Companies are rapidly developing software that mimics human processes and activities.

Whether it is voice-powered computer assistants like Apple's Siri or Microsoft's Cortana, speech recognition, or suggested internet searches, AI is quickly becoming integrated into everyday activities.

As this happens, the case for investment in the companies developing AI is arguably growing.

Just this month, ETF Securities said it would launch an exchange-traded fund (ETF) that invests in companies focused on developing robotics and automation technology.

The Robotics and Automation ETF is due to launch on the ASX in September and will invest in both established and emerging tech companies that generate a material proportion of their earnings from robotics, automation, or AI.

According to Marcus Ohm, a partner at HLB Mann Judd, an ETF could be an excellent way for investors to spread their risk.

"Obviously, they will still be subject to the vagaries of the industry itself. Therefore, it is important to have a balanced portfolio whereby they invest in a diversified manner in accordance with their risk tolerances and financial advice. However, an ETF could enable them to 'dip their toes' in the water without concentrating their risk on a particular company," says Ohm.

Direct investment in companies seeking funding from investors represents a riskier proposition.

In March, software company Bigtincan (ASX: BTH) made a lacklustre debut on the ASX. Its Bigtincan Hub platform for sales and service organisations is powered by a machine learning and AI system.

While the IPO was oversubscribed, Bigtincan shares fell below their 26-cent issue price on listing and have traded below that level all year, hitting a low of 16 cents in May.

In November last year, OpenDNA (ASX: OPN) listed on the ASX on the back of its AI and machine learning software. The company's shares dropped on their first day of trade on the ASX in November last year below their 20-cent listing price and have traded below 20 cents for most of 2017.

In contrast, Appen (ASX: APX), which listed on the ASX in January 2015, was the top-performing IPO of that year. The company has been developing datasets to train these machine-learning algorithms. Its shares have been steadily rising since listing and are up around 60 per cent just this year.

So, the opportunities are big, but so are the risks.

"These [examples] show that there is a high degree of variability between the attractiveness of the initial concept and subsequent shareholder returns," says HLB Mann Judd's Ohm.

"Given that it is very difficult even for fully informed and educated investors to determine what will do well and what won't, investors need to diversify and balance their risk across companies and across industries, and types of investments."

According to Cengiz Ali, associate director with Invast Australia, investors should understand that by investing in a software company, the marketplace is fast paced and constantly changing. A company's product needs to respond quickly to change and be adaptable.

"It is critical that the business has the right leadership and technology know-how to continue to evolve its product offering in order not only to thrive but to survive, and in a way we are seeing this evolving nature in traditional businesses, using Harvey Norman (ASX: HVN) as an example with its move into the online space in 2011 in response to changing trends in online shopping and the success of Kogan (ASX: KGN)," says Ali.

"DigitalX (ASX: DCC) is a personal favourite in my portfolio. The business has been responsive to the market and its capital structure by leveraging its core skills in the blockchain space to evolve their offering.

"Listing on the premise of being a Bitcoin miner they were able to refocus and evolve their business with recent developments such as the recent joint venture with Stargroup to develop ATMs for both cash and cryptocurrency transactions, the development of their remittance platform AirPocket, and their advisory work in the initial coin offering for Bankera (a blockchain-based bank).

"This really links back to the concept that investors should expect an ever-evolving business when investing within this space."

Another important consideration is to ensure the company has a real product, from which it is able to generate revenue.

"One of the main struggles which follows is when companies fail to deliver the product quickly ... those [companies] that fail to deliver the product that was promised within the specified timeframe are highly and publicly criticised," says Ohm.

Due diligence is therefore essential before all investments.

"Investors should make sure they fully understand the business and the risks via the prospectus," says Ohm.

"Furthermore, it is worth looking at other factors which increase the chance of success, such as the previous track record of management and the directors, what other businesses they have been involved with, how successful were they in developing and delivering value for shareholders, and so on."

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

This report appeared on www.morningstar.com.au 2017 Morningstar Australasia Pty Limited

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.