Friday, March 06, 2020

Zombie unicorns and struggling tech startups in Ireland and Singapore

This year's FT 1000 ranking of European companies that achieved the highest compound annual growth rate in revenue between 2015 and 2018, released in March, has 259 entrants comprising 189 technology firms together with fintech and e-commerce.

The Financial Times says "Most winners come from Germany, closely followed by Italy, the UK and France, with these four nations accounting for about 70% of the overall ranking. London retains its lead as the city with the greatest number of fast-growing companies, followed by Paris and Milan, while Warsaw and Vilnius make the top 10 for the first time."

The minimum average growth rate required to be included in the ranking this year was 38.4%.

The top rank goes to OakNorth Bank, a UK fintech, followed by Wolt Enterprises of Finland which provides software for food delivery and Bolt Technology of Estonia which provides electronic platforms for ride-hailing taxi services.

The UK has 173 entrants; Finland has 18 and Estonia has 8.

Ireland has none.

The Organisation for Economic Cooperation and Development (OECD) in 2019 produced a report on entrepreneurship in Ireland for the Irish Government. It includes themes I have raised myself on low employer startups, low number of indigenous exporters, and low productivity. Some of my own material is cited in the report. Ireland needs to reduce its over-dependence on American firms if it wishes to raise its material standard of living — US firms spend more than 80% of research and developmemt (R&D) expenditures in America and most of the rest in big foreign markets.

OECD Studies on SMEs and Entrepreneurship: SME and Entrepreneurship Policy in Ireland — Ireland has a low employer startup rate but in 2017 it had the highest ratio of high growth firms (HGF) in the EU at 16.5% based on the Eurostat/OECD definition as firms with at least 10 employees in the start-year and annualised employment growth rate exceeding 20% during a 3-year period. However many of these firms are foreign affiliates that do not qualify for the FT 1000.

The OECD study also refers to research on Irish zombie firms but data are not recent and the impact of foreign-owned firms is not clear.

Zombie firms

Zombie firms are typically unable to cover debt servicing costs (loan interest) from current profits over an extended period, and in recent times they have attracted the attention of academics and policymakers.

In 2018 economists at the Bank for International Settlements (BIS) estimated that the ratio of zombie firms among 32,000 in 14 advanced economies had risen "on average, from around 2% in the late 1980s to some 12% in 2016 under the broad definition (left-hand panel), and from 1% to about 6% according to the narrow measure (right-hand panel)" — see chart above.

The BIS is based in Basel, Switzerland, and was established in 1930, making it the world's oldest international financial institution. It is called the central bank for central banks.

The BIS economists said that the rise of zombie firms has been driven by firms staying in the zombie state for longer, rather than recovering or exiting through bankruptcy. "Specifically, the probability of a zombie remaining a zombie in the following year rose from 60% in the late 1980s to 85% in 2016 (broad measure) and from 40% to 70% (narrow measure)."

Historically low interest rates coupled with weak banks that do not wish to recognise losses by pulling the respirator plug on struggling firms are the main factors.

Other research shows that keeping zombies alive can impact on the growth of new and young firms. Their impact can also be reflected in low productivity data.

Policymakers may also be slow to react to changing business patterns — David Autor and colleagues at Massachusetts Institute of Technology (MIT) in several papers document how difficult it is to revive a flagging economic region.

Nikkei of Japan, owner of the world's largest financial newspaper, and also the owner of The Financial Times (FT) of London since 2015, in research on zombie companies, examined the financial health of about 26,000 listed firms in Japan, the US, Europe, China and Asia, excluding financial institutions, using data from QUICK FactSet. The number unable to cover debt-servicing costs from operating profits for at least three consecutive years hit about 5,300 in fiscal 2018, accounting for 20% of the total, compared to 14% of the total of 18,000 listed companies in 2008.

Europe has the largest number of zombie companies with 1,439. The US is second with 923 companies.

According to Nikkei:

"In fiscal 2018, the global total of operating cash flows — cash earned by companies through business operations — hit a record $5.7tn. But the total of investment cash flows, or money spent on facilities and equipment and on mergers and acquisitions, plus cash returned to investors through dividends and share buybacks, was even bigger at $6.6tn.

While the ratio of interest payments to debt stood at 3.9% in fiscal 2018, down about 1 point from a decade earlier, the actual amount of interest payments grew 40% to $800bn due to sharply increased indebtedness. This borrowing dynamic explains the rise of zombie companies."

Zombie unicorns

Amazon which went public in 1997 as a 3-year-old loss-making company, is seen as the benchmark for other digital firms that put growth before profits. The Earth's biggest bookseller continued to report losses until the end of of 2003 when it was over 9 years old

However, while Amazon lost $2.8bn in 4 years and one quarter as a public company, Uber lost about the same amount in 2015 alone. Besides, Amazon expanded from just being an online bookseller.

Aileen Lee, an American venture capitalist in 2013 coined the term 'unicorn' in a post for TechCrunch, “Welcome to the Unicorn Club.” Lee, the founder of seed-stage venture capital firm Cowboy Ventures and her team identified 39 US-based software companies started since 2003 that were valued at over $1bn by private or public-market investors.

Lee called the $1bn+ tech firms unicorns as they were so rare. They accounted for about 0.07% of all venture-backed startups with an average of four born each year in the previous decade.

CB Insights, a US research firm, estimates that the number of unicorn firms in early 2020, totals about 451. The US leads with 220 firms followed by China and the UK.

The leading US valuations are SpaceX $33.3bn; Stripe founded by the Irish Collison brothers $35.25bn and Airbnb $35bn. China's top unicorn Toutiao (Bytedance) is valued at $75bn; Didi Chuxing $56bn and Kuaishou at $18bn (see list link below).

Intercom, which was founded in Ireland, is included with US firms as its main operations are in San Francisco.

Venture capital deals in the US with at least one Chinese investor dropped to 163 deals and $6.5bn of investment in 2019, according to Preqin, a private equity data tracking firm in London — down from 236 deals in 2018, which were valued at $10.8bn.

SoftBank, which was founded in Tokyo in 1981 by Masayoshi Son, a son of Korean immigrants who is Japan's third richest man, has become the global rainmaker in recent years and the Saudis invested $45bn in its first Vision Fund.

The Vision Fund invested $4.4bn in WeWork, the real estate desk leasing unicorn, at a $20bn valuation in 2017 — it was one of the biggest investments in a private company in history. In 2018, SoftBank added another $4.25bn and in late 2019 WeWork pulled its planned IPO (initial public offering) as the house of cards wilted under external scrutiny.

In 2018 the FT's Lex team estimated the value of WeWork at $3bn compared with the headline value of $20bn. By January 2019 the value had jumped to $47bn.

Softbank also invested in Uber, the tech-based taxi service which lost $8.5bn in 2019. The IPO market value was over $82bn. It was $60bn this week and has been as low as $26bn in the past 52 weeks.

The firm faces regulatory and employment challenges and it has abandoned China and Southeast Asia.

Travis Kalanick, the ousted founder of Uber, has received a direct investment of $400m from the Saudi Public Investment Fund for a “ghost kitchen” delivery start-up called CloudKitchens.

SoftBank has a 25% stake in China's Alibaba, which is seen as collateral for the Japanese investor's debt of $140bn.

Last year the Vision Fund invested $800m in Greensill and $440m in OakNorth (the top-ranking FT 1000 this year), two London-based fintech firms, according to industry group Innovate Finance. Those investments accounted for 25% of the $4.9bn raised by fintech startups in the UK in 2019.

This week Masayoshi Son, promised investors in New York that he will be more cautious in future following the collapse of WeWork. He forecast that about 15% of Vision Fund companies would go bust, while another 15% would account for 90% of profits.

The 70% of the Vision Fund companies that will provide just 10% of the profits will die, be acquired or linger on as zombies.

Unicorns are private by definition and the time to a public listing has grown.

Most countries require private companies above a certain size threshold to publicly disclose their audited accounts, but the US has no such requirement.

Therefore zombies can continue without public transparency.

Zombie tech firms in Ireland and Singapore

Singapore is a tech hub with strong government support but in recent years there have been concerns about zombie tech firms while the focus should be on risk and so-called 'deep-tech' areas such as artificial intelligence (AI) and machine learning.

In 2017 the Entrepreneurship Centre of the National University of Singapore (NUS) issued the results of a survey of 530 tech companies which found that more than half had fewer than 5 employees, on average with mean annual sales of S$200,000. Only about 8% of startups were high-growth “gazelles”(an old term for high growth firms), with average annual sales of S$4m ($2.9m).

The NUS reported that many of the high growth firms were copying successful ideas from elsewhere rather than engaging in innovation — less than one-third of “gazelles” were introducing new products.

Prof Kam Wong of the NUS explained to the FT that the Lion City had copied a funding scheme from Israel in which the state provides up to 85% of co-funding for tech firms leaving private investors with the other 15%. However, Singapore was less stringent in its requirements than Israel.

Prof Wong noted that poor proposals had been supported rather than transformative technology.

Last month Singapore announced it is strengthening its support for deep-tech startups in the country with an additional S$300m (US$215.4m) under the Startup SG Equity scheme to encourage investments into such companies.

Startup SG Equity, the public agency, wants to attract private-sector investments into homegrown startups with intellectual property and global market potential.

Grab the leading ride-hailing service in Southeast Asia is a Singaporean unicorn that began as an app in 2012 developed by Anthony Tan and Tan Hooi Ling [no relation] when they were MBA students at Harvard Business School.

Grab began operations in their native Kuala Lumpur and it got funding of US$5.1bn from SoftBank in 2018 and 2019.

Recently Grab announced an investment of over US$850m from two Japanese investors, Mitsubishi UFJ Financial Group (MUFG) and TIS Inc. to fund accessible and affordable financial services to “boost financial inclusion” in Southeast Asia.

Anthony Tan has said that Grab will not go public until it's profitable.

Last year it launched a GrabFood service.


"Data on HGFs (high growth firms) in Ireland is sparse," the OECD report linked to above notes.

The same could be said of the indigenous high tech sector.

The Deloitte Ireland Technology Fast 50 top growing firms in 2019 had Electricity Exchange on top for a revenue growth rate of 1442% over 4 years. Belfast-based company Catagen Ltd, an after-treatment automotive emissions specialist, had a growth of 1162%. Code Institute, a training service achieved 1084%.

The overall average rise was 347%.

Unlike the FT 1000, there are no data on actual revenues or number of employees.

The base year revenues must be at least €50,000 (€100,000 minimum FT 1000) and be at least €1m (€1.5m FT 1000) in the fourth year.

Unlike Deloitte Central Europe the full listing of revenue rises is not published.

According to Eurostat, in 2018, some 8.9m persons worked as ICT specialists across the then EU-28. The highest number (1.6m) was in the UK which provided work to almost one fifth (18.4%) of the EU-28’s ICT workforce. Germany (also 1.6m) had the second-largest ICT workforce (18.3% of the EU-28 total), followed by France (1.1m; 12.0%). None of the remaining EU member states accounted for a double-digit share.

Finland had the highest share of its total workforce employed as ICT specialists at 182,000 persons or 7.2% of total employment, followed by Sweden at 346,000 or 6.8% of total employment. Relatively high shares were also recorded in Estonia, Luxembourg, the Netherlands and the UK — in 2018, they each reported that at least 1 in 20 persons within their total workforce was employed as an ICT specialist.

Ireland was at 102,000 or 4.5% of employment.

Information and communications technology (ICT) is a subset of the Eurostat category 'Information and communication' — the latter includes publishing, newspapers and broadcasting.

In 2017 there were 13,161 ICT enterprises in Ireland and there was a 6% birth rate compared with an overall Irish employer birth rate of 4.2%.

The Central Statistics Office (CSO) has issued 2016 employer firm death data but it has given an estimate for 2017 to the Organisation for Economic Cooperation and Development (OECD).

2017 OECD data confirm low business dynamism in Ireland even in the key ICT sector.

Information and communication birth and death (in brackets) employer data for comparative countries are Austria 10.3% (8.3%); Denmark 17.2% (14.7%); Estonia 21.3% (15.7%); Finland 13% (11.6%); Netherlands 13.6% (10.3%) and Sweden 12.8% (7.0%).

Ireland was at 6.1% (5.9%).

Low Irish business dynamism indicates the presence of zombies. Yet the delusion continues.


CB Insights tracking tech unicorns

CB Insights 339 Post-Mortems "In the spirit of failure, we dug into the data on startup death and found that 70% of upstart tech companies fail — usually around 20 months after first raising financing (with around $1.3M in total funding closed)."

Bank for International Settlements on zombie firms

Asia's zombies concentrated in India, Indonesia and South Korea

David Autor’s groundbreaking work on the neglected costs of trade is revealing

State of Irish high tech and biotech 2020

Entrepreneurship in rich countries declining; Innovation also sliding

Trinity College Dublin and its Innovation District dream