IT’S been described as “the $4.2 trillion (£2.7 trillion) opportunity”. According to the Boston Consulting Group, there will be 3bn internet users globally by 2016. If it were a nation, the internet-based economy would rank in the world’s top five. And the UK sits at the forefront, with 8.3 per cent of GDP now online – the highest proportion in the G20.
London has also emerged as a global hub for technologists to start their businesses. There are at least 20 home-grown break-out companies in this category in the UK today. Yet the vast majority of institutional investors are missing out. Those leveraging this part of the economy are early-stage investors and technology angels. More recently, private equity firms like KKR, Permira and Silverlake have become involved.
But many young internet businesses are now maturing into significant companies, growing by 30, 60, or 80 per cent per annum. Many are highly profitable – they scale quickly and efficiently. RightMove, for example, has disrupted the property advertising market, and its profit margins sit at levels rarely seen by publishers before. Investors have benefited from RightMove and the few other pure internet businesses that have gone public (like MoneySupermarket and Asos). But these are the exceptions.
Most home-grown internet success stories either decide not to go public and sell themselves too early to a large US corporation, or they seek to list on Nasdaq, tempted by higher valuations. That’s a great pity for the UK.
Part of the problem is that many potential investors are gun-shy. A “once-bitten” attitude lingers from the 2000 internet and telecom bubble, and there are fears that some firms that have come to market have been overpriced. But the most significant dimension is insufficient knowledge among fund managers about how these “new” companies operate, and the nature of their profit dynamics.
New business models need fresh ways of analysing raw data. Take retail. One of the primary means of analysing a retail business is its sales productivity. A company is benchmarked against another on a sales per square foot basis. But there is no concept of sales per square foot online. Nor is there one of sales per page – you can have an infinite number of pages at almost zero cost. Should Asos be listed as a retailer or an internet company?
The metrics required to analyse an ecommerce company are different. Instead of sales per square foot, you might consider on-site conversion rates, the lifetime value of the customer, the cost of customer acquisition, and time spent on site. If I was an equity analyst without in-depth knowledge of how a digital company works, it would be impossible to assess accurately how that business was performing, how it compared to its peers, or whether to advise clients to invest in it.
The best way of encouraging investment houses to recruit internet-specialist analysts would be for European stock markets to create a separate classification for internet companies. This classification could encompass any company doing the majority of its business online, while including incumbent companies making the transition. Not only would this shine a much-needed light on the internet economy, it would generate specialist coverage of the internet category to the benefit of investors.
I welcome the LSE’s recent proposals to help kick start London’s IPO market for high growth companies – including the reduction in the minimum float requirements - but they are not enough in themselves, of course. Now investors must bring their best companies to market, and the investment community must develop its analytical skill in the sector – and start investing.
The pipeline of companies capable of listing over the next couple of years is very long indeed. It doesn’t just include UK firms, but European, Israeli and Russian businesses, many of which would choose to list in London, if only they thought it had an established reputation for internet floatations, and that there were investors who were ready to invest in the sector’s stock.
For years we’ve heard the same question asked: “why can’t Britain produce the next Google or Facebook?” The answer is we can. We are already seeing dozens of home-grown companies scaling rapidly. But faced with the choice of selling to a US giant or staying independent, many are going to take the first option. Unless, that is, we develop the capital markets – and specialism among analysts and fund managers – to persuade them to stay.
Robin Klein is venture partner at Index Ventures and founder of The Accelerator Group.