In Formula 1, just like any other sport, winning is a function of preparation and performance. As each Grand Prix decides its own line up in the qualifiers, the team that takes first place in one race can rank last in the next. World Championship winning teams must have the internal resilience and strategy in place to accommodate the uncertainty that each race weekend brings, and in the same way, the last two years have taught us to account for the curveballs, and the long tail risks, that change the nature of the business environment we operate in. It may be that COVID and a war/inflation combination has made market responses to performance slip-ups extreme; or it may be the “total response” that some larger fund managers now adopt as a strategy (sell out completely at the first sign of trouble, collapsing the share price) - but the recent performance of most tech companies is really rather good despite the obvious challenges of the 2020s. The last fortnight’s news has been positive from all of our tech corporate clients, as management teams become adept at navigation in on wet slippery tracks.
It's not just that a sunny day like today makes everything half full. It’s that small/mid cap, and tech, is a good place to be, and an even exciting place to be as macro-circumstances evolve. Inflation has reappeared and interest rates cannot but respond. How is that good? Well, within the 90 constituents of our finnCap Tech 40 and finnCap Next 50 indices, 74% have net cash; and adding it all up, they have an accumulated £1.73bn net cash on their balance sheets even before dipping into an acceptable <1x EBITDA level of net gearing. (If you’ve got it, use it, otherwise what’s the point in it). Of the 26% that have net debt, the mean net debt/EBITDA ratio is an unchallenging 1.27x. Our ambitious smaller companies can easily either fund M&A from their own resources while not over-gearing the balance sheet; or they can have recourse to equity participation for ambitious and growth generating opportunities which can substantially accelerate often already exciting growth rates. The higher leverage of debt funded FTSE 100 businesses both makes acquisition more expensive, and usually barely move the dial given the size of the deals required to make a difference.
We are not naïve. This year will likely be lean compared with the festival of fund raisings since COVID, but we’ve all been here before. The world keeps going round, and M&A is still a logical route to accelerating growth. For investors wishing to benefit, it is small cap which can still grow meaningfully and affordably even as debt becomes more expensive. Old hands like Tracsis (TRCS) are adept at it, and advance their strategies years at a time with canny acquisitions as alternatives to R&D or territorial expansion; but it’s interesting to note companies like Sopheon (SPE) and Redcentric (RCN) testing out new wheels with small acquisitions funded from existing resources, in each case also adding capabilities which are more efficiently opportunistically acquired than developing in-house. Watch out for the Red Bull energy and enthusiasm we can also gain when they decide to take more and bigger bites. In these uncertain times, with rising costs of people, power and components, cash or new equity funded acquisition opportunities may well offer the best visibility of profitable growth, and those that do reap their just rewards.