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April 30, 2014
GROWTH AS THE CRITICAL PREDICTOR OF SUCCESS IN HIGH TECHNOLOGY

THE WOLFSON CASE STUDY

The final chapter in the saga of Wolfson Microelectronics (the UK-based fabless semiconductor firm) coincided with the release of some interesting data from consultants McKinsey & Co and, in so doing, highlighted the absolutely critical importance of growth as a driver of value creation in the high technology sector.

Wolfson is an Edinburgh-headquartered company with particular expertise in designing high performance, mixed-signal chipsets (audio chips). The author – who was running a technology investment banking group in the UK at the time – remembers the excitement that greeted Wolfson’s flotation on the LSE in 2003. WLF floated on the main board at £2.10 per share, swiftly rising to £2.75 before closing the first day of trading at £2.46.

Subsequent to the IPO Wolfson secured a roster of brand-name clients including Apple, Samsung and Microsoft and posted highly impressive increases in turnover (below). By 2006 its shares had more than doubled (the market capitalisation touched £630 million). Yet by 2014 the shares had sagged to half of issue price and Cirrus Logic stepped in to buy the firm at an equity value of £278 million or £2.35 per share (a 75% premium to the unaffected pre-announcement share price).

 

10 YEARS… 25 PENCE

In ten years Wolfson’s share price budged, start to finish, by 25 pence from issue. What is the lesson here? It is instructive to look at Wolfson’s revenue growth up to and after the market capitalisation peak in 2006. Broadly speaking, 2004 to 2006 saw growth sag from ~60% to ~40% to just over 20%. The 20% number, whilst impressive in many other contexts, would be (as we will discuss below) flagged by McKinsey as something of a warning sign: a sign that may have effectively prefigured the troubles of 2008 (when the company lost Apple as a customer in the wake of delayed deliveries).

Wolfson Microelectronics Revenue Growth (FY restated to conform to the calendar year):

2004:      57.6%

2005:     39.6%

2006:     22.5%

2007:     13.5%

2008:   -14.4%

2009:   -38.8%

2010:     29.7%

2011:    –  0.3%

2012:      14.5%

 

A CORE ARGUMENT – THE GREATEST PREDICTOR OF SUCCESS IS GROWTH

McKinsey analysed three decades of data on almost 3000 companies in the software and online services sectors. Their research argues that by far the greatest indicator of long-term success is the growth rate. Until $1 billion of revenues is attained, profitability or cash flow is much less relevant than top line performance.

This was underscored recently when Mark Andreessen (of well-regarded venture capitalists Andreessen Horowitz) attempted to demystify some of the nosebleed valuations paid for profit-less startups. It would not be hard to surprise that top of his mind was the the $19 billion price tag secured by Whatsapp – a messaging platform posting dizzying growth – in its transaction with Facebook (where Mr Andreessen sits on the board). This deal was explained in the context of “attachment rate” (i.e. what would be the economic results of “attaching” this fast growing base of users to Facebook’s revenue model?).  Fast growth was described as having enormous value.

 

20% GROWTH RATES A PATH TO OBLIVION?

In most industries 20% would be considered a commendable performance. In technology, so McKinsey argues, it is oft-times a signpost on the path to “stalling” or even corporate oblivion.

 

Companies analysed:                              2952

Reached $100mm in revenue:                826

Reached $1 billion in revenue:                  96

 

Almost all the companies that breached the $1 billion revenue mark were 60% “supergrowers” and the rest had posted growth rates of 20%-60%. Equally striking was the strong correlation between a growth hiatus and long-term underperformance: those companies that grew consistently performed much more strongly than those that paused and then re-accelerated.

It would further appear that success in this regard depends, to quote John Morgridge, the former Chairman of Cisco, on being able to make the right decisions about people and corporate structure as a firm moves through key revenue thresholds of $20 million, $100 million, $500 million and $1 billion. We will discuss this in  a blog post to come.