Sat, Jan 02, 2016 page13

• IPOs to return, but probably with inferior valuations

  • Bloomberg
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  Expect a resurrection of technology initial public offerings (IPOs) this year as private fundraising options cool. However, when it comes to valuations, it might 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,” Royal Bank of Canada cohead of US equity capital markets Michael Goldberg said 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 US$1 billion, research firm CB Insights said in a recent report. That US$1 billion mark turns private companies into unicorns, named after the mythical creature that founders and investors are always chasing.

  For the most part, technology companies avoided the public markets last year, with the help of large private funding rounds that totaled US$51 billion, CB Insights said.

  That was more than six times the US$8.26 billion raised in US tech and Internet public offerings last 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 last year, further delayed some of the biggest expected offerings across industries.

  Still, those companies waiting for better market conditions might find themselves fording uncertain waters, as bankers and investors say concerns about high private-market valuations might curb investment 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 Morgan Stanley managing director Colin Stewart, who oversees tech financing at the investment bank.

  Less availability of private funding might 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 last year also serve as cautionary tales for private investors who hoped for lofty returns.

  Meanwhile, companies that have already gone public, like artisanal 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 do not eventually show net income growth.

  The abundance of late-stage private money has “not only delayed companies from going public, it has also delayed some of them from getting prepared and acting like a public company in advance of an offering,” Accel Partners partner Ryan Sweeney said.

  It also points to a part of the industry that might continue to attract strong valuations. Goldberg and Stewart both said enterprise software makers would 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, they 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.”

  After last year’s scant showing of tech IPOs, San Jose, California-based Nutanix Inc looks set to start a more active market this year. Those companies considering following in its footsteps — such as cloud computing firms Twilio Inc and Coupa Software Inc — will be watching closely to see how Nutanix is received.

  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 last year. Net losses are also wider, because it is investing in its business, the company said.

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