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How Ocado stole the UK tech crown

Despite the innovation that happens in the UK, an online grocer has become the largest tech company listed in London
How Ocado stole the UK tech crown
  • Ocado, which only recently has started to bill itself as a tech company, is already the largest on the LSE
  • UK tech companies fall easily to bids

The UK is home to lots of geeks. Manchester, London, Bristol, Oxford and Cambridge are counted among Europe's top 20 cities for tech investment, and UK tech as a whole attracted a record £10.1bn worth of investments in 2019, according to UK industry network Tech Nation. Yet that is not reflected in the size of tech companies on the London Stock Exchange. Somehow, Ocado (OCDO), which has only started to bill itself as a tech company since 2019, is the largest in the UK market with a value of £16bn. The pick of listed tech stocks is far from barren: there are plenty of high-quality, promising companies. They just tend to be relatively small, and often listed on the Alternative Investment Market (Aim) instead of the main market.  

 

Food delivery up top

Ocado pushed its proprietary software, Ocado Smart Platform (OSP), out from the shadows of its background operations to the fore last year – and its shares have almost doubled since. Indeed, this week management raised profit guidance for the third time in 2020. Tech-based food delivery companies seem to be a golden thread in the sector: the newly merged JustEat Takeaway.com (JET) saw its revenues climb up by almost two-fifths in its third quarter. In a market that is growing so fast, it will come as no surprise that there has also  been a flurry of corporate activity. The Competition and Markets Authority (CMA) has already provisionally cleared Amazon’s (AMZN) stake in Deliveroo, the food delivery app. Stateside, DoorDash (US:DASH) hit a $60bn (£45bn) market value on its first day of trading. 

Yet food delivery is not the best that the tech sector has to offer. Most companies such as these are held back by complex logistics issues, which typically weigh on profitability. Indeed, there is justified debate about the extent to which the likes of Ocado can be classified as tech companies. Certainly, they do not have the markers of the most compelling investment cases in the sector: software-as-a-service stocks, for example, boast fat margins and great clarity on incoming revenues, which is built on sturdy subscription models. Or even resellers, who although rely on other companies’ proprietary products, have a more direct link to the (rude) health of the technology sector. Best picks include the likes of Computacenter (CCC), which this week also improved profit guidance as its clients continued to spend to keep up with the demands of digital transformation. 

 

Aim's tech nursery

Tech stocks often do not get the opportunity to grow into unicorns on our own shores because they regularly fall to bids from bigger American companies. Just last week IMIMobile (IMO) recommended a £543m offer from Cisco (US:CSCO). Last year, one of the UK’s few big cybersecurity companies Sophos was snatched up by the US private equity firm Thoma Bravo for $3.9bn. More recently, video game developer Codemasters (CDM) recommended a takeover from US publisher TakeTwo Interactive (US:TTWO) for £739m, despite a rather measly premium of 12 per cent. A bidding war could now erupt.

Given this precedent, we would not be surprised if other high-quality, relatively small, Aim-traded companies attract the same attention – take online marketing group Dotdigital (DOTD) or cloud solutions company Iomart (IOM). But that is not to say that there is no reason why the UK’s tech sector appears to be so unloved – there have been some real shipwrecks. Micro Focus (MCRO), for example, has not been able to shake off the botched integration of an expensive software business that it bought from Hewlett Packard Enterprise (US:HPE), although its shares have staged a tentative recovery in the past month. There are also significant advantages of being looked after by a US organisation – chief among them is scale. 

This is something that Ocado appears to be achieving by itself. It has already secured big overseas retailers such as Kroger (US:KR), Groupe Casino (FR:CO) and Coles Group. But Ocado is a complex business. Even if one accepts that it is a technology company, it still straddles the more difficult, and arguably less appealing worlds, of logistics and retail. These are not easy industries to operate in. For investors looking for gems in the UK’s tech sector, they are likely better off vying for pure-play software stocks rather than one with tricky end markets, or a retail business still stitched into the middle.