With the travails of technology-based companies such as WeWork and Uber dominating business headlines across the globe, Retail Week looks at whether the UK retail market is trapped in its own tech bubble.

For more than a decade now, the growth of the global economy has been twinned inexorably with the rapid rise of a number of technology companies. Many of those, such as Twitter, Facebook and Amazon, have gone on to become global monoliths worth billions. In the process, their rise sparked a decade-long deluge of public and private equity investment in technology.

However, the next generation of tech-driven businesses has started to run into trouble. The highest-profile and most public of these has been WeWork, the office rental company that claims to be a tech firm. The business was forced to abandon its IPO earlier this year after lukewarm interest from investors who questioned its route to profitability.

WeWork

WeWork sold itself to investors as a tech company when it was really a real estate firm

Following a series of highly lucrative financing rounds, the business had been given a private market valuation in excess of $47bn (£36.1bn). Now it is valued at between $7.5bn to $8bn and is seeking emergency refinancing from its largest investor to rescue it.

As of today, WeWork’s major investor Softbank announced it would provide an extra $5bn (£3.9bn) in financing to save the business, increasing its stake in the business to 80%. 

WeWork is not alone. There have been several tech-underpinned retailers that have struggled of late, particularly after lofty IPOs.

Luxury fashion platform Farfetch is now facing multiple lawsuits in the US alleging that it misled shareholders at its IPO in August, after reporting wider-than-expected losses. Farfetch floated with a $6.2bn valuation last year; it is now worth $2.34bn.

Eve Sleep has fared worse. The mattress in a box business floated on London’s junior AIM market in May 2017 with a £140m valuation and is now worth just £7m.

The struggles of these businesses have drawn analogies with the dotcom bubble of the late 1990s and early 2000s, which led to the collapse of many online companies.

Is a second tech bubble about to burst and take many in the retail sector with it?

Dotcom bubble 2.0

One senior banking source believes the similarities between the current tech market and the dotcom bubble are plain to see.

He says, much like in the early 2000s, there’s been too much “cheap liquidity in the market and investors are chasing [returns] when interest rates are very low,” which in turn has led to a number of businesses “that were built on very shaky foundations floating and getting into trouble since”.

However, OC&C Strategy Consultants partner Tom Charlick is hesitant to call it a tech bubble within retail.

“Ecommerce has removed the barriers to competition and fundamentally shifted the cost structures and benefits to scale within the retail sector,” he says.

“However, during the dotcom bubble, we were still seeing a very small percentage of transaction in the retail sphere shifting to the new models. Today we’re at 20% or 30% shifting in terms of how people buy”.

Retail investment firm True chief executive Matt Truman insists there is no widespread issue in retail and that the businesses struggling simply “do not offer anything particularly unique to the consumer in value proposition terms”.

The senior banker disagrees and puts many of the current issues down to overblown valuations in the technology sector. He says the “world has gone a bit crazy” when it comes to valuing tech businesses.

The banker says the inflated tech valuations have led to many businesses pitching themselves as tech companies to investors, even if they are not. He claims the best example of this is WeWork, which sold itself to investors and big banks as a tech company when it was just a traditional real estate firm.

“It grew and it grew at a rapid rate, selling a dream about what the business would be, selling themselves as a technology business. It’s not a tech business, it’s a real estate business, yet the JP Morgans and Goldman Sachs of this world lined up to float the business and sell the myth,” the banker says.

Resetting tech valuations

Most experts believe that high-profile failures like WeWork, Farfetch and others have cast a wider pall over investor sentiment when it comes to technology-underpinned businesses in all sectors, retail included.

Made.com and Outfittery chair Susanne Given acknowledges that there is “an adjustment” taking place in the investor community around tech investments.

Eve Sleep

The banker points out that online businesses may carry a higher valuation but these companies have bigger profitability challenges to overcome than high street retailers.

The rise of ecommerce may have lowered the barrier to entry spurring many new and similar businesses, he explains. This means companies have to spend more to stand out and acquire customers, which can hammer profitability, as in the case of Eve Sleep. 

This can lead to a vicious cycle, he argues, whereby the “assumptions the business model was founded on go out the window”.

Peel Hunt retail analyst John Stevenson says this has led to investors becoming more hesitant in backing online firms.

He says, five years ago, when shares in pureplay fashion platform Asos were trading at six-and-a-half-times sales, investors wanted to see topline growth above anything else, however, now their focus has since shifted to profitability.

“The mantra was about winning the race and growing at all costs. Everyone was looking to scale up as fast as they could. Fast-forward to now and it’s all about careful profit generation, free cash flow and funding your own growth”.

Is the age of disruption in retail overblown?

While Stevenson believes investors are being more cautious, PWC digital consulting leader Colin Light says they simply can’t find the right things to invest in.

“Many private equity investors right now actually have surplus funds and are trying to find the right businesses to invest in. It’s not a shortage of funding, it’s a shortage of the right, scalable opportunities,” he says.

He says investors are looking for truly disruptive new models, rather than technology-driven tweaks to existing businesses.

“It really needs to be a case of the technology causing significant, long-term disruption.”

While the likes of WeWork and Uber have come under criticism and struggled to turn vast consumer networks into profits for shareholders, few would argue that they haven’t truly changed their respective industries.

By contrast, the last truly disruptive technology that changed how people shop was the internet. 

Charlick argues that there have been numerous disruptive models under the “broad church of ecommerce” which have revolutionised retail. He says he now advises his retail clients “on choosing where to follow, as much as where to lead”.

In terms of what will drive the next wave of retail technology investment, answers differ.

Given claims “shopping as a service”, whereby retailers select personalised products for consumers, will be how people shop and will therefore garner investment, while Light believes peer-to-peer shopping will be the next big phenomenon. 

In fact, Truman mentions peer-to-peer retailer Depop, which he refers to as a “social network-based” retailer that is “capable of significant disruption”.

Whatever the next retail revolution is, it is clear that some equity investors are keeping their powder dry until it arrives.

Stevenson believes the City should fundamentally change the way it values online businesses. Currently, ecommerce firms are valued on a multiple of sales not a multiple of profits.

Has the recent raft of poorly performing online stock changed this? 

Stevenson says he knows a number of fund managers who “no longer invest in loss-making businesses”.

“They want them to come to market more fully formed, not at such an early stage,” he says.

Truman acknowledges that most start-ups materially over-estimate how quickly they can make a profit but says the bottom line has always been important.

“I don’t believe there was ever a time when the importance of the single trade economics, and therefore future profitability, wasn’t profound,” he says.

Most experts agree that wavering confidence in tech and online will lead to consolidation in tech-driven retailers in certain categories where many competing brands struggle to build scale and profits.

This can be seen in the mattress in a box market, which has already seen some attempted consolidation with the proposed merger between Simba and Eve Sleep which collapsed during the summer.

The banking expert also suggests that the ingredients in a box market could be ripe for consolidation in the near future, due to the high levels of customer acquisition costs and competition, as well as the complexity of fulfilment requirements. 

As Given puts it: “Over time, the winners will become stronger and the losers will disappear”.