The New Criterion: when high-flying tech darlings return to earth

February 10, 2020

 The savage share sell down of aerial mapper Nearmap (NEA, $1.94) highlights the dangers of investing in tech stocks valued on lusty revenue multiples that leave little room for error. Given that billion-dollar valuations have become common in the sector, no doubt other casualties will emerge as the reporting season unfolds.

Nearmap shares tumbled 30 per cent after management in late January issued a relatively benign revenue guidance downgrade, but one which pointed to wider issues of increasing competition and overly rapid expansion into the US.

Nearmap’s revenues are derived from subscription services to its database of high-resolution images, which are interpreted and enhanced with 3D and artificial intelligence techniques. Subscribers include builders, architects, town planners and tradies such as solar panel installers.

As with other ‘cloud’ based tech providers such as accounting software house Xero, the customer bases are costly to build but then are highly scaleable once they are in place.

As long as revenues are growing, investors tolerate years of losses because they know that earnings will flow like rivers of gold once the subscriber mass becomes big enough.

But what if this snowballing subscriber growth is interrupted? Indeed, what if the shorters sense a downturn? Nearmap is suddenly one of the most shorted stocks on the ASX with about 14 per cent of the register held by short traders.

Ahead of its February19 half year results, Nearmap disclosed the annualised contract value (ACV) of its subscriptions was likely to be $102-110 million for the full year to June 2020, compared with the $116-120m guided at its November AGM.

Management’s preferred measure, ACV is the expected annual worth of customer contracts in place.

CEO Rob Newman cited unforeseen “churn and downgrade” events” in the US, including the cancellation of two contracts related to the emerging autonomous vehicle sector. Another client was stymied because of a legal injunction and another bailed out because of “budgetary constraints”.

In Australia and New Zealand – where Nearmap still derives 60 per cent of its revenue – “internal execution issues” contributed to customer churn rates creeping up to 7 per cent from 5 per cent a year ago.

Even on the dampened guidance, Nearmap still expects 18 per cent ACV growth over the 2018-19 year and management still expects 20-40 per cent annual growth in the “mid to long term”.

Given the ACV downgrade at the midpoint is a 10 per cent decline, the punishment doesn’t seem to fit the crime.

But investors clearly that Nearmap’s US ‘land and expand’ strategy – funded by a chunky $70m capital raising in 2018 –faces stiffer obstacles.

The sell-off is not the first for Nearmap: in August last year the stock fell 9 per cent after the company announced full-year results, even though they were in line with the pre-announced numbers (ACV climbed 36 per cent to $90.2 million).

So far brokers who research the widely-covered stock are sticking with their ‘buy’ recommendations, albeit with more qualifications and shaved ‘price targets’.

According to Citi, Nearmap trades on a multiple of six times expected revenue in 2020-21, compared with 13 times for its tech peers. The firm forecasts a current year loss of $40.8m, improving to a $35.3m deficit in 2020-21.

Citi opines that with an expected $22 million of net cash in 2020-21, Nearmap will have enough to fund its existing growth plans but will likely delay entry into new markets.

The broader issue for the company is that the North American push has stretched management’s ability to keep an eye on its home market.

“We are confident in the long term outlook for the Australian market,” Newman says. “. We are still better than any other player and we are adding content to expand our total addressable market.

“But the majority of our growth will come from North America.”

Nearmap has come a long way, having evolved from patent protection group Ipernica in 2007.

Back then the shares traded at around 5c.

Aerometrex (AMX) $2.28

While an acknowledged sector leader, Nearmap is not the only ASX-listed aerial mapping play.

Founded by three former Nearmap staffers, minnow Spookfish listed in early 2015 but in late 2018 was acquired by the Washington based industry giant EagleView for $US90 million.

The buyout was a nice payday for local Spookfish backers including Rod Jones, founder of education group Navitas and telco entrepreneur Tony Grist.

Filling the ASX void is the Adelaide-based Aerometrex, which listed in January after raising $25 million at $1 apiece. While Aerometrex may be new to the bourse there’s nothing new about the company itself, having been founded in 1980.

“We have a business that is profitable and investing in R&D, doing all the things along established business should be doing,’’ says CEO Mark Deuter.

Aerometrex operates in several industry sub sectors including the geospatial market which caters for government bodies and other heavy-duty users such as surveyors and engineers.

Another mining-oriented service called Lidar (light detection and ranging) involves measuring land or asset aerially by emitting laser pulses. Lidar is widely used by the miners and has other uses including managing bushfire risk.

Now, Aerometrex is going head to head with Nearmap in the corporate market: users such as banks, insurers and tradies who need more of a qualitative take on, say, the location of trees.

“To give our competitor due credit, Nearmap has done a good job creating that market,” Deuter says.

Aerometrex clients include the federal and state governments, Santos, and OZ Minerals. In keeping with the philosophy that it’s better to co-operate with the tech giants rather than compete with them, the company has provided 3D image capture for Google and Microsoft.

As with Nearmap, Aerometrex is bound for the US but sees greatest potential there with its 3D products. “We think the US market is too crowded for our regular Lidar and aerial photo products,” he says. “We won’t be just throwing money at it.”

Unlike Nearmap, Aerometrex operates its own fleet of eight twin-engine aircraft.

This week Aerometrex said it had signed up Landchecker to use its aerial images. Backed by the Royal Automobile Club of Victoria and Kogan founder Ruslan Kogan, Landchecker provides property data such as title history and planning permit information.

On prospectus numbers Aerometrex generated a net profit of $2.57 million in the 2018-19 year, with revenue climbing 22 per cent to $16.1 million.

The interim results in late February will give a better feel as to how the company is performing as a listed company, but so far it doesn’t look to be sharing Nearmap’s growing pains.

Investors ascribe a $200 million market valuation to Aerometrex. Nearmap meanwhile has dropped out of the billion dollar club but is still worth close to $800m.

Tim Boreham edits The New Criterion

Disclaimer: Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.