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For investors, a big question is how or where to find the next Seek.com or REA, whose success has now transformed them from being disruptors, placing them firmly into the new “establishment”.
This is the fertile ground in which Under the Radar Report spends much of its time investigating. After all, back in 2005 Seek was a small cap, with a market capitalisation of close to $500m, which was well outside the S&P/ASX 200 Index. At that time, Fairfax Media, publisher of numerous newspapers, which include the Sydney Morning Herald and The Age, had a market cap of about $4.1bn.
Fast forward to today and the situation has well and truly reversed. Seek’s market cap is close to $7.5bn. Meanwhile, Fairfax has gone the way of the dinosaurs, having been taken over by Nine Network for less than $1.5bn.
I’ll go into more detail below about what happened there and how to define a “disruptor” but first, let’s look at three ASX listed disruptors.
Afterpay Touch (APT)
In the past few weeks ME Bank CEO Jamie McPhee proclaimed “I don’t think my daughters will ever own a credit card. They will have a debit card and a buy now pay later account,” before outlining why the BNPL disruption has forced his bank to discontinue its investment in credit cards.
Under the Radar Report covers other BNPL stocks, but none compare to Afterpay Touch (APT) in terms of its novel offering and the effect that the business is having around the world in changing payment habits (mainly of the young).
When Under the Radar Report first tipped Afterpay (it hadn’t merged with Touchcorp then) in May 2017 it was only two years ago and based on its $2.51 price had a market capitalisation of $450m. Back then it accounted for 3% of all online sales here and a whopping 15% of Australian online fashion retail transactions. It already had some big name clients include Myer, Officeworks, Big W, Telstra and the Solomon Lew controlled Premier Retail, which historically has been reluctant to cede margin to payment intermediaries. Lew knows a good thing when he sees it.
Fast forward to today and its price is well over $32 and its market cap is $8.1bn. In FY19 its number of active customers doubled to 4.6m and its active merchants also doubled to 32.3k. Moreover, the company is generating big growth in the big US market and it showed evidence that the longer people use Afterpay, the more they use it.
Radar’s Comment: Afterpay has first mover advantage and its competitive advantage is strengthening. It heads into FY20 with strong momentum and if management successfully execute the offshore strategy this stock will likely run further. Having already taken risk off the table, we are happy to hold on and ride the Afterpay wave, which is our preferred buy now pay later exposure.
In terms of company life cycle Hazer is much further down the curve than AfterpayTouch, but it does have a technology that can make a bigger difference to the way we live.
Its “Hazer Process” turns human waste into clean energy, which could disrupt conventional producers of hydrogen and graphite miners. Not only is the Hazer Process cheaper, but it produces zero emissions, its by product being water, and it fulfils the local requirement of waste removal.
The company has successfully developed two pilot plants that convert the methane from land fill sites and waste water treatment plants into hydrogen and graphite. The hydrogen produced can be used for clean energy for the mobile sector – trains/buses/ferries, while the graphite is commercial grade (versus graphite mined, which is 95%) for use in lithium ion batteries.
Radar’s Comment: Almost too good to be true? At 30 June the company had $6m in cash, having burned though almost $2.6m in the prior 12 months, so it does have some latitude to get to its next stage, which is a commercial demonstration plant, that if successful would produce enough hydrogen to fuel a small fleet of buses. The plan is for this to be operational by the end of 2020.
Adelaide based LBT has developed an automated machine that utilises artificial intelligence for use in pathology laboratories. Its Automated Plate Assessment System (APAS) platform technology automates culture-plate screening and interpretation, speeding up the process by at least three times compared to manual reading. The technology was developed by LBT in collaboration with the University of Adelaide’s Australian Institute of Machine Learning (AIML).
Last May the company’s shares spiked after it announced that its 50% owned joint venture Clever Culture Systems got US FDA approval for its Automated Plate Assessment System (APAS).
This is an important milestone for LBT as it clears the way to ramp up US commercialisation activities. It does not guarantee that sales will follow, but the US is a large market so it markedly improves the company’s prospects.
Radar’s Comment: We would advise prospective investors not to get carried away. While the US approval is a big step forward for LBT but it is still at the high end of the risk spectrum. The group has only completed one sale to date and has still a long way to go to achieve profitability. While the balance sheet is strong, risks of further capital raisings remain.
Fairfax was taken over for almost zero premium by the Nine Network and observers will remember that it had been worse for the media group. The company’s shareholders were forced to put their hands back into the pockets and raise up to $684m in March 2009; and its market cap went as low as $823m in late 2012.
It must be particularly galling for its shareholders, whose board at the time of Seek’s listing in 2005 was led by the ex-Woolworth’s managing director Roger Corbett and was offered a 25% shareholding prior to the IPO. This stake was taken by then Channel Nine owner Publishing & Broadcasting. According to Tom Burton, a former Fairfax executive, who was speaking to the ABC:
“They decided, “We can beat them, we are Fairfax, we’ve got the rivers of gold”, and it was just arrogance.
“Recruitment is half the money that subsidizes the journalism – you can’t afford letting anyone else in the market.”
Back in fiscal 2005, Seek was generating revenues of $70m and a net profit of $19m. This financial year analysts forecast that Seek will achieve record sales of $1.8bn and a net profit of $164m (and is forecast to rebound to over $200m in FY21). Meanwhile, Fairfax’s revenues didn’t move much over the period prior to being taken over in late 2018. They were $1.87bn back in 2005 and ended up at $1.66 billion in FY18. It made $241m in net profits at the start of the decade and made $138m in FY18.
The story of their profits growth and decline, more than any share price graph shows how Seek’s “disruptive” business model of providing companies a cheaper and more effective means of advertising for employment usurped Fairfax’s older redundant model, based as it was on its now non-existent Classifieds section, referred to by Burton, and most notably by the media mogul Kerry Packer, as “the rivers of gold”.
To put it another way, a disruptive business is taking existing demand (in this case for jobs advertising) and introducing a new business model which undercuts the established competitors, effectively taking their profits away from them. In its efforts, Seek has been ably assisted by fellow e-tailer, realestate.com.au owner REA, which also has a lower cost business model. Both don’t have to fund lots of journalists and newspaper printing and distribution plant and equipment, like Fairfax does (or did).
Arguably, you could classify innovators into the disruptor category. These are companies that create a new market that has never existed. You could include arguably the world’s most successful companies Apple and Microsoft into this equation. These companies are creating new reasons for spending money that had not existed. For the innovators, the sales cycle is often a much longer time frame – you need to convince people that what you’re doing is worth paying for.
Either way, the super profits disruptive business models can make are enough to satisfy any investor hungry for returns. If you were lucky enough to get stock in the Seek float, you would be making over 10 times your initial investment based on its current price. In contrast had you held on, you would have lost over 60% on your Fairfax shares.
Disruptive technologies abound. You just have to notice that the local video store has largely disappeared, and in its place are on-demand movie and TV streaming services such as Netflix, which now has about 151 million paying subscribers. Watching the battle between rival streaming services in Australia and elsewhere will be fascinating.
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