- Less private funding may mean more startups turn to IPOs
- Better balance sheets will be needed for higher valuations
Expect a resurrection of technology initial public offerings in 2016 as private fundraising options cool. But when it comes to valuations, it may not be pretty.
After a slow year for tech IPOs, market-bound companies will need to show profitability -- in addition to lofty promises of sales growth -- before investors are willing to pile into share sales the way they have in the past.
“Investor sentiment has changed for those kinds of companies,” said Michael Goldberg, head of U.S. equity capital markets at Royal Bank of Canada, of young IPO-bound tech companies. “They embrace growth but they want to see a path to profitability and to cash flow.”
The backlog of closely held technology and Internet companies has piled up, with more than 144 valued at more than $1 billion, research firm CB Insights said in a recent report. That $1 billion mark turns private companies into unicorns, named after the mythical creature that founders and investors are always chasing.
Private vs. Public
For the most part, technology companies avoided the public markets in 2015, with the help of large private funding rounds that totaled $51 billion, CB Insights said. That’s more than six times the $8.26 billion raised in U.S. tech and Internet public offerings this year -- the widest divergence since at least 2000, according to data from CB Insights and Bloomberg.
The number of companies in the industry that went public -- 48 -- was also the lowest since 2011’s 45, according to data compiled by Bloomberg. Equity market volatility, which picked up in August, further delayed some of the biggest expected offerings across industries.
Still, those companies waiting for better market conditions may find themselves fording uncertain waters, as bankers and investors say concerns about high private-market valuations may curb investments in non-public companies.
“No longer will private placements be the main domain where you can find very strong valuations with a plethora of investors hanging around the hoop,” said Colin Stewart, managing director at Morgan Stanley, who oversees tech financing at the investment bank. Less availability of private funding may also prompt more companies to face the scrutiny of the public markets to get capital, he said.
Recent IPOs are illustrative of the promise -- and pitfalls -- of going public in these days of increased scrutiny of tech company balance sheets. Lackluster public offering valuations late in the year also serve as cautionary tales for private investors who hoped for lofty returns.
Public investors were willing to pay up for a piece of collaboration software maker Atlassian Corp. after the company pitched its track record of conservative spending, annual revenue growth upwards of 40 percent and 10 years of net income. The shares sold in mid-December above their already increased marketed IPO range, valuing the Sydney-based company at about $4.4 billion -- more than its $3.3 billion private value.
By being consistently profitable, Atlassian was an outlier among unicorns, where growth-at-any-cost is the norm. The company’s deal set a high bar for successful tech IPOs, reminding founders eyeing the public markets that a lucrative offering is still possible when the numbers are right.
On the other hand, payments company Square Inc.’s stock priced in November well below its marketed range (and its private valuation) as investors questioned its road to profitability. All-flash storage company Pure Storage Inc.’s public value of $2.96 billion at its October market debut was largely unchanged from the private valuation it fetched 18 months prior.
Companies that have already gone public, like artisan goods marketplace Etsy Inc. and flash-sales site Groupon Inc., face concerns from investors about revenue growth and profitability, as shares languish below their IPO prices. These underscore how once-darling tech companies can fall out of favor with public investors if they don’t eventually show net income growth.
The abundance of late-stage private money has “not only delayed companies from going public, it’s also delayed some of them from getting prepared and acting like a public company in advance of an offering,” said Ryan Sweeney, a partner at Accel Partners.
Sectors to Watch
It also points to a part of the industry that may continue to attract strong valuations. RBC’s Goldberg and Morgan Stanley’s Stewart both said enterprise software makers will remain a popular group. Companies that sell tools for businesses have been better received by investors because revenue models and cash flow are typically more predictable than consumer tech businesses, the bankers said.
“Companies with strong growth and fundamentals will be well received regardless of market timing,” Sweeney said of the next wave of tech IPOs. “Rather than focusing on potential technology bubbles and open or closed windows, investors should be concerned with what they can control -- investing in great entrepreneurs, sectors and business models.”
One such company, Nutanix Inc., filed in the last week of the year for an IPO to list its Class A stock on the Nasdaq stock market, with a $200 million offering size placeholder, an amount used to calculate filing fees that may change. Cloud computing firms Twilio Inc. and Coupa Software Inc. are also preparing to sell shares next year, according to reports.
Nutanix -- backed by Lightspeed Venture Partners and Khosla Ventures -- makes data center software and hardware, and its revenue is up 316 percent from 2014 to 2015. Net losses are also wider because it’s investing in its business, the company said.
After this year’s scant showing of tech IPOs, San Jose, California-based Nutanix looks set to kick off a more active market in 2016. Those companies considering following in its footsteps will be watching closely to see how it’s received.