M&A and Stock Market Up, But IPOs Way Down
Historically, technology sector IPOs, M&A and stock performance tended to move in tandem. However, this correlation has materially broken down in the past 18 months as technology IPOs have dwindled while the tech stock index approaches new highs and tech M&A surges. This is shown in the following couple of charts. The successful technology IPO of Twilio today (up 92% from the IPO price) was, thus, a sight for sore eyes for technology investors, venture capitalists and employees. In fact, Twilio was the first $1B+ MCAP venture backed IPO since Square went public in November of 2015. While time will tell if Twilio is the beginning of a resurgent tech IPO market, my sense is that the current stock market fundamentals, sentiment and some unique favorable attributes of the Twilio IPO will not make Twilio the beginning of major broad new tech IPO wave in the near term.
Low Economic Growth and Bond Rates Driving “Yield” Investing
I would characterize the current overall stock market sentiment and fundamentals driven primarily by the forces of low global bond yields and lack of economic growth in both developed and emerging markets. Bond yields are now close to zero and even negative in major countries across the world (e.g. Germany, Japan, Switzerland etc.) while economic growth has fallen short of expectations in most of the world including the US, Europe, China, Brazil etc. At the same time, the US stock market is interestingly approaching new highs. This, however, is likely due to the chase for a “safe yield” as returns in cash and bonds are negligible. This is clearly manifested in the S&P sectors of Utilities and Consumer Staples leading the stock market performance in the past 12 months with several of the leading stocks in these sectors (e.g. Procter and Gamble, Coke, Duke Energy etc.) hitting multi-year highs in valuation metrics (e.g. EV/Sales and PE multiples). When safety and dividend driven sectors lead the stock market, it is typically reflective of low global growth, which is not typically the backdrop for a strong tech IPO market.
Cheap Money and Embolden Activists ==> Surging M&A
At the same time, there are many fundamental and financial forces in the technology sector that are resulting in significant discontinuity and low growth for established public companies but at the same time increased M&A. The fundamental impact of cloud on traditional technology companies is clearly very disruptive as demand for traditional products is either diminished, as workloads move to the public cloud, and/or technology company business models are transitioning from appliance/hardware sales to lower revenue software based sales. These forces are making public equity investors less enthusiastic about most of public technology companies unless they are high growth, cash flow generative pure plays in this cloud transition. At the same time, the surge in M&A can be explained by the very low cost of debt (allowing for deals to be more easily accretive) and increased fund raising of private equity and activist investment funds. Over the past 18 months we have witnessed the largest ever technology takeover by a private company (i.e. Dell buying EMC), Microsoft further trying to accelerate its transition to the new enterprise software sales model with its planned acquisition of LinkedIn and activist and private equity investors being more collaborative in taking low growth, but highly profitable tech companies private.
Twilio Was Priced Favorably; Will Other Unicorns Follow or Wait?
For tech IPOs to roar back, I think we will need to see better overall economic growth to encourage an offensive rather than defensive/yield driven investment psychology. Otherwise, there will likely need to be more companies that have the characteristics of the Twilio IPO, namely, high revenue growth rate driven by the transition to the cloud, approaching or already cash flow positive and favorable valuation metrics to the public investor. This last piece on attractive valuation cannot be overstated. It appears that Twilio was priced very favorably at ~8x sales in the IPO, which for its growth rate and size was likely very compelling to the public investor. I do not recall any other software cloud or SaaS tech IPO in the last few years that went public at a similar revenue scale and growth rate at less than 10x sales. Luckily for Twilio’s private round investors, this compelling public valuation was still higher than the most recent “unicorn” venture round. Twilio was also a relatively small “unicorn” to go public. For the tech IPO market to truly bounce back, we will likely need to see some of the higher profile “unicorn” companies (e.g. Snapchat, Uber etc.) go public.