Economic Affairs

The risky business of looking overseas for tech buys and growth

Business veterans are out of their depth when asked to evaluate tech start-ups. They need help.

More and more these days, with technological disruption happening at an exponential rate, big companies in long-established industries are finding that they have to shake things up just to stay in the game.

Quite often now, this means investing in or even fully acquiring small tech firms, maybe even start-ups, from all over the world.

This is not only the quickest way for that large firm to acquire the innovative technologies being produced by the start-up, but it can also be more cost-effective.

After all, the large firm may have to sink in an even larger investment to hire new talent, buy new equipment and spend lots of time on research and development to produce the same innovation.

But as any venture capitalist would tell you, most start-ups - upwards of 70 per cent - fail.

Even those that might seem promising at the start could still end up becoming duds if, for example, the technology they are working on gets outstripped by even newer technology, or if a competitor comes out with a better, cheaper product.

For a large corporation looking to make an investment in an innovative start-up, this poses a conundrum. In this age of rapid change, staying still is not an option, so bold decisions have to be made. But the bold step of investing in an innovative start-up is also one that means taking on a lot of risk.


ST ILLUSTRATION: MANNY FRANCISCO

THE SINGPOST EXAMPLE

Nowhere was this Catch-22 situation more apparent than in the recent case of Singapore Post, which acquired a 96.3 per cent stake in United States-based e-commerce provider TradeGlobal Holdings for US$168.6 million (S$233 million) in October 2015.

Of all the industries in the world most at risk of technological disruption, postal services is certainly among those at the top of the list.

Certainly, traditional firms have their work cut out for them. They have to take risks in order to stay competitive in a rapidly changing world, yet still maintain a sense of caution and conservatism when making such bold investments. As technology disrupts ever more aggressively in our daily lives, the challenge of striking this balance will only become more pressing, and more difficult.

SingPost has avoided redundancy with its laudatory moves to embrace change and reinvent itself as an end-to-end logistics provider for the e-commerce age - moves that have earned it international plaudits.

But the acquisition of TradeGlobal turned out to be something of a misstep.

In its fourth-quarter report in May this year, SingPost announced it had taken a $185 million write-down on the loss-making TradeGlobal, causing it to report an overall net loss of $65.2 million.

Even before that, shareholders had been questioning whether SingPost had overpaid for the stake. It had stumped up US$168.6 million and booked about $169.1 million in goodwill - the premium paid over the acquisition target's book value.

That is, more than half the purchase sum was goodwill.

These concerns were validated when law firm WongPartnership, hired by an independent committee to review the TradeGlobal deal, said in an update last month that it had made several troubling observations surrounding the deal. From the outset, WongPartnership said, there was no clear leader or clear structure within the team handling the acquisition, which led to a lack of ownership and accountability, which in turn led to problems when it came to information flow. That is, there was important information that was not raised to the board of directors, or raised with little detail or explanation, before it approved the deal.

As a result, the board was unable to fully consider key risks relating to the acquisition. For example, WongPartnership noted that TradeGlobal had been purchased by the seller, private equity fund Bregal Sagemount, in 2013 at a significantly lower price. In fact, this price was not made known to the SingPost management until one week before SingPost completed the acquisition.

WongPartnership noted too that the earnings and revenue forecasts, upon which the TradeGlobal valuation was based, were aggressive and may have been over-optimistic. A more detailed review of TradeGlobal's performance in 2013 and 2014 may have revealed that its main operating subsidiary had significantly underperformed its forecasts in those years, WongPartnership said. Despite this, the valuations presented to the board were based only on forecasts, and no valuations based on historical multiples were presented. Furthermore, the law firm added, the valuation was not conducted in a way that fully accorded with best practices.

At its annual general meeting on July 20, chairman Simon Israel said through a letter read on his behalf by non-executive lead independent director Fang Ai Lian that SingPost has a turnaround plan for TradeGlobal.

SHIELDING SHAREHOLDERS

To be clear, acquiring start-ups that continue to be loss-making years later is neither unusual nor necessarily a cause for alarm over corporate governance.

For example, Singtel's digital marketing arm, Amobee, which it acquired in 2012, is still loss-making today but that has not raised too much concern among shareholders.

After all, Singtel's overall earnings have not been greatly affected by the unit's losses, and it has been transparent over the years about the fact that Amobee is still in "growth mode".

Meanwhile, investments by CapitaLand in Tujia and City Developments in mamahome - both Chinese firms in the online apartment rental business - have not caused much of a stir in the investment community because they were relatively small amounts and have not affected either firm's overall earnings.

Others, like the local banks, have ventured into the start-up world at an even greater remove, by forming partnerships or taking tiny stakes, instead of making whole acquisitions.

So the crux of the issue, really, is that managers and directors have to be aware, as much as possible, of the risks they are taking on when making such purchases - and pay a fair price for those risks. That may sound like a no-brainer, but it is far harder to pull off than it sounds.

The fact is, as Pricewaterhouse Coopers (PwC) Singapore's managing director of valuations Adam Sutton notes: "Assessing the value of start-ups is just hard, full stop."

He adds: "What can be surprising is the opportunistic nature of some of these investments. Although diligence is performed, it is not uncommon to find that relatively little strategic planning has gone into supporting the expected return or impact of making the investment, and also how to best incubate and support the business once it has been purchased."

Mr John Kim, managing partner of Silicon Valley venture capital firm Amasia, says it can be especially hard for traditional business veterans to evaluate start-ups.

"The metrics and ranges used in evaluating a tech company differ drastically from traditional businesses. One classic example is that investors with a bricks-and-mortar mindset often focus on profitability, whereas tech investors focus much more on growth," he notes.

"While real estate and tech are both fields of business, asking a real estate mogul to evaluate a tech start-up would be like asking Bono to sing Handel's Messiah."

Mr Akshay Mehra, co-founder of peer-to-peer lending platform Crowd-Genie, agrees.

"The usual metrics in a large organisation are all about repeatability at scale - so a business unit should be able to project its business for the next 12 to 24 months, and then the managers are expected to meet or beat these numbers.

"Now in a start-up where business models are in flux, any future projections are at best valid for six months. So when a start-up misses its projections... the traditional company managers will always struggle to assess such teams. This leads to frustrations from both sides - the acquired start-up and the acquirer."

THE (POTENTIAL) SOLUTIONS

In the face of such difficulties, the answer might simply lie in calling on expert help, experts say.

PwC Singapore's strategy leader Richard Skinner says: "Hiring people with experience in early-stage technology business investment would help, but so could partnering with more experienced start-up investors.

"These investors may not bring the operational synergies a traditional business can offer, but they may have assessed hundreds of potential start-ups and can therefore make more informed judgments about key success factors, such as the founder and his team's likely ability to succeed."

Mr S. Sivanesan, a senior partner at law firm Dentons Rodyk, notes it would also help to have clear lines between the roles of the management and the board in such deals.

"Usually, management leads the due diligence and engages professionals (for example, lawyers, accountants, tech experts and valuers) to assist. What the board should do is to carefully review the due diligence report and findings, and question the management, so as to satisfy itself that management has done thorough due diligence, forecast and strategic plan," he says.

"The danger is when a board delegates that responsibility for an investment to management, and then fails to do its own proper due diligence on the management's findings and recommendations or even understand the nature of the transaction."

Mr Amit Saberwal, founder and chief executive of start-up RedDoorz, says a win-win solution for both parties would be for the big firm to start its own venture arm.

"The best way to do it is to have a completely new team to run this part of the business with enough exposure to tech investments and to also allocate enough capital at the beginning in a separate entity or vehicle, and then let it run its course," he says. "Unless this happens, it would be really difficult for the big firm to create the right environment for success."

This is because many traditional investors, he says, are overly worried about quick profitability, which is possible but might happen at the cost of the start-up's growth.

Certainly, traditional firms have their work cut out for them. They have to take risks in order to stay competitive in a rapidly changing world, yet still maintain a sense of caution and conservatism when making such bold investments.

As technology disrupts ever more aggressively in our daily lives, the challenge of striking this balance will only become more pressing, and more difficult.

A version of this article appeared in the print edition of The Straits Times on August 02, 2017, with the headline 'The risky business of looking overseas for tech buys and growth'. Print Edition | Subscribe