Wesley Diphoko is founder of Kaya Labs and chairperson of the IEEE Open Data Industry Connections in South Africa.
CAPE TOWN - This week will go down in the economic history of South Africa as the darkest period for digital companies and transformation in the country.

Sagarmatha was planning to list on the JSE. But at the 11th hour, the JSE pulled the plug on technical grounds. This comes after a section of the media sector in South Africa ganged up against the listing by poking holes in the company’s valuation and credibility.

Now that the planned listing for Sagarmatha has been called off, it’s important that the media, business and technology sectors reflect on this moment to understand it for what it is and perhaps learn from it and take corrective measures for the sake of advancing the African digital economy.

The Sagarmatha listing presented South Africa with important lessons for the future: the need for a better understanding of accounting for digital (online) companies, which should be different from offline companies and the role of the JSE in the development of the South African digital economy.

Days before the planned listing some critics questioned the valuation of Sagarmatha, which was determined by a reputable valuation company, Redwood Valuation.

The Silicon Valley-based company has valuated companies such as WhatsApp and Fitbit.

Recently, it has been reported that Uber is planning to list on the New York Stock Exchange (NYSE). Uber is currently valued at between $48billion (R576.58bn) and $70bn. What is interesting is that it has also reported losses over the past few years. Another case is Twitter. Ahead of listing on the NYSE, Twitter reported a loss of $79million, yet it commanded a valuation of $24bn on its initial public offering date in 2013. Twitter continued to report losses for a consecutive four-year period.

Two other interesting company valuations are Microsoft and Facebook acquisitions. Microsoft paid $26bn for loss-making LinkedIn in 2016, and Facebook paid $19bn for WhatsApp in 2014 when it had no revenues or profits.

What do we learn from the listing and acquisitions of these companies?

The most important lesson is that it is possible for digital companies to be valued highly while they are making losses, especially when their future projections are positive.

How is it possible for investors in the US to invest in digital companies that are making losses? The answer lies in the accounting. A book, The End of Accounting, by Professor Baruch Lev, indicates that over the past 100 years or so financial reports have become less useful in capital market decisions.

According to a recent research by Harvard University, accounting earnings are practically irrelevant for digital companies. Current financial accounting models cannot capture the principle value creator for digital companies: increasing return to scale on intangible investments.

A balance sheet is a prime example in this case. Assets reported have to be physical in nature, owned by the company, and be within the company’s proximity. When you look at digital companies, the picture is different.

Digital companies often have assets (software, websites, applications and similar important products) that are intangible but are valuable, and many have ecosystems that extend beyond the company’s boundaries.

The building blocks for a digital company are research and development, brands, organisational strategy, peer and supplier networks, customer and social relationships, computerised data and software, and human capital.

The economic purpose of these investments is no different from that of an industrial company’s factories and buildings. Even though this is the case for digital companies, the investments in its building blocks are not capitalised as assets; they are treated as expenses in calculation of profits. So the more a digital company invests in building its future, the higher its reported losses. Investors thus have no choice but to disregard earnings in their investment decisions.

Recent research by Harvard University has also shown that intangible investments have surpassed property, plant and equipment as the main avenue of capital creation for US companies - which further suggests that the balance sheets have become an artefact of regulatory compliance, with little or no utility to investors.

The balance sheet has become less useful for banks’ lending decisions, because banks rely on asset coverage to calculate their security.

It is important that the South African media, the JSE and local investment community understand how digital companies are valued across the world.

Based on this understanding, it is clear that there’s a need for an overhaul for accounting principles governing digital companies. There’s a need to adopt Information Economics (Infonomics) as a field of study. Infonomics is the theory, study and discipline of asserting economic significance to information. It strives to apply both economic and asset management principles and practices to the valuation, handling and deployment of information assets.

Understanding of Infonomics in South Africa will save current startups that are emerging and enable their value to be recognised by the JSE and other sectors of our society.

In South Africa there’s a need for an institution, a stock exchange that understands digital companies if we are to build the digital economy. In the absence of such intervention, the country will miss out on investments such as the ones that could have been injected into the JSE if Sagarmatha was listed.

Wesley Diphoko is the chairperson of the IEEE Open Data initiative in South Africa and part of the Sagarmatha executive team. He writes in his personal capacity and not on behalf of Sagarmatha Technologies. He is working on developing Infonomics as a field of study and practice in the African continent.

* Infonomics (Information Economics) is a discipline that is a brainchild of the Gartner researcher, Doug Laney.

- BUSINESS REPORT