Tech IPO Clog Poised to Burst
We could soon have a great uncorking of the clogged pipeline of tech IPOs. And clearing the blockage could leave a gigantic mess in Silicon Valley.
Some of the brightest minds in the tech world are predicting big Silicon Valley startups may start to go public by the latter half of next year or 2018. Dropbox -- last valued at $10 billion in a 2014 private stock sale -- could be among them. The San Francisco company has met with advisers to talk about the possibility of an IPO as soon as next year, my Bloomberg News colleagues reported on Monday.
The enchanted startup forest could use a good clearing out. Only four U.S. tech startups backed by venture capital firms have gone public so far this year, according to Bloomberg data. That's far off a recent peak of more than 50 hitting the public markets in 2014. Meanwhile, there is a scary long backup of about 170 "unicorns," the terrible but handy term for private tech companies valued at $1 billion or more. This backlog has been building and holding, but eventually all of those companies will go public, get sold or go bust.
Many of those unicorns have been able to avoid the public markets so far, finding it far easier and more hospitable to sell stock in private transactions instead. For all but a handful of the richly valued startups, that happy period is coming to an end, and an uptick in IPOs is the inevitable result. Not everyone will be happy with the outcome.
Some of the unicorns -- Snapchat, maybe? -- will go public by choice because they've reached the right financial stage to make them lasting public companies. Others will go public by force, as financial backers demand a way to cash out their investments, or because the companies will find it too hard to raise more money in private markets. 1
The unicorns that do go public can't wait forever to do so. No one wants to invest in a newly public company that has slowed to 5 percent revenue growth. And that moment could be soon. A JPMorgan banker recently predicted that a big chunk of companies would go public, including tech startups, in 2017 and 2018. Privately, some dealmakers have been saying the same. It's worth noting that bankers and other financial professionals always see better days on the horizon. So we should take predictions of the Great IPO Uncorking in 2017-2018 with a healthy dose of skepticism.
Still, there are plenty of signs that the pump is being primed for an IPO deluge. Look at what startups themselves are doing. Executives at young tech companies used to brag about how fast they were growing. A switch seemed to flip about a year ago, and some of those same executives are instead trumpeting their profit measures -- or "profit" measures. Dropbox CEO Drew Houston said a couple months ago that the company was generating more cash than it was spending. The profit bragging is a nod to public market investors, who increasingly want to buy into young tech companies with a mix of strong sales gains and profits, or at least a blueprint to becoming profitable soon.
Some unicorns like Dropbox may not like what they hear as they start talking to advisers and investors about going public. Dropbox's similarly named public rival, Box, trades at about four times the company's expected revenue for next year, according to Bloomberg estimates. 2 The Wall Street Journal last year cited a source who said Dropbox's revenue was likely to hit $500 million in 2015. If Dropbox's sales double this year, and do so again in 2017, Dropbox could be valued at about $8 billion at Box's revenue multiple. If Dropbox does go public at a valuation below its current one, it will have plenty of company. Box did it, too. 3
Other brutal valuation comedowns are likely because of the recent proliferation of financial arrangements that let unicorns put off painful valuation haircuts. Spotify is among unicorns that are essentially on an IPO shot clock because of onerous financial penalties if they go public after a certain date. Those companies can't wait to go public at the right moment, and there will be some ugly headlines when they finally do.
For a tiny herd of unicorns like Uber and Airbnb, the recent years of ample private financing have let them build huge, likely lasting businesses outside the glare of public markets. For many other unicorns, the private markets enabled them to live on distorted stock prices they can never live up to. And that means their day of reckoning is coming soon.
Investor force is likely a more common motivation for IPOs than we realize.
Dropbox will most likely argue it deserves a premium to Box, but its closest publicly traded peer does set a valuation floor for Dropbox.
Some investment funds that own Dropbox stock have already written down the value of those shares, though it's hard to know how seriously to take the up-and-down valuations in the illiquid portions of investment portfolios.
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