Yes, They’re That Valuable! When Private Tech Goes Public.

Yogen Mudgal, BSc Accounting and Finance Student at Warwick Business School

When a new wave of tech start-ups began listing in the late 2010s, investors welcomed them with little enthusiasm. Alas, the chilly listing of Uber and Lyft and the disaster at WeWork went to show what investors thought of the companies from the Valley [1]. Most tech headlines from 2019 discuss at length why start-ups were delaying their move into the public markets despite the record value of VC-backed IPOs [2][4]. But much like everything else in our lives, the conversation in 2020 has revolutionised, thanks to a stunning year for tech IPOs and their performance on Wall Street [3].

On the face of it, the arguments are straightforward. VC-backed tech firms can IPO at higher valuations as investors hunt for companies performing well in a pandemic, and the new digital era is setting in [3]. Low-interest rates and lacklustre prospects for other sectors of the economy are also helping. Big names like Airbnb, Doordash, Palantir and Snowflake went public this year with a bang so loud that even value investor Warren Buffet couldn’t resist making a quick buck on that last one [13]. Of course, reality goes much further than that. So, let’s try to understand what’s behind this enthusiasm (apart from Stonks bros, of course).

The explosion in entrepreneurialism in technology has well been supported by an ever-expanding VC industry, which itself has been enjoying a boom in the private markets [2][8]. VC investing today is far from what it was in the rush of the dotcom bubble. With access to unprecedented capital levels, venture investors have begun holding companies in the private markets for much longer with seed capital, early-stage capital, late-stage funding and rounds after rounds of start-ups raising new cash and burning through it [4]. Buyout shops too have jumped onto the scene, offering their versions of investment in mature tech businesses, thus prolonging the time before these companies can be listed [14].

Just a few decades ago, it would have been impossible for asset managers to fathom thousands of multibillion-dollar companies that have global operations being held privately. But the new domains of VC and Private Equity investments have made this ever more likely. Today there are more than 7500 private companies of scale held privately versus a mere 3500 listed on the exchange, opposite of what was true before 2000. As Evercore’s Ralph Schlosstein points out, we can’t even find enough companies to fill the Russell 5000 anymore [15]. It’s the reason behind the SPAC frenzy, it’s the reason behind the extreme albeit comprehendible valuations of new listings, and it’s also the reason behind this 1999-style rush for tech stocks [10].

The fact remains that we are not having many more tech IPOs than before, but the average value that these companies now command is significantly higher [2]. If anything, VC exit by M&A has become much more common and a much-preferred way out [2]. Ventures change multiple hands, are excessively traded in the private markets from one fund to another, often have a consortium of investors behind them and are quite frequently held by large buyout players before reaching the ultimate milestone of a public listing.

The data suggests that patience and avoiding public markets for as long as possible has paid off for many of these companies as they finally make their leap to the public markets [6]. There have been concerns about whether spending their fastest-growing years outside the public markets can hurt their valuations, but so far investors seem to have cast aside such doubts. Taking a more long-term view, investors rewarded companies like Airbnb and Uber, whose immediate prospects have been damaged by the pandemic.

The final argument could be that there are genuine concerns about investor exuberance, regulations, taxes, and even reporting accuracy (Wirecard!). True, tech start-ups have taken advantage of the pandemic-induced online spur to go public [9] but to write-off the tech rally as having no legs might be naïve at best and a costly mistake at worst. The market is not irrational (at least not yet) in attributing the value it does to tech start-ups. There’s no dotcom-style bubble in tech, least of all because we’re still very far away from the kind of weekly listings of the late 90s and the valuation-by-clicks philosophy [5]. Most of the large venture-backed IPOs this year have been companies with significant revenues and solid business models. Asset managers can no longer afford to see technology as an isolated subsection of the economy for it is very much the way business is done in the 21st century [11].

It is not unlikely that the 2020s will not be the best decade for growth stocks. The shift to the value already seems to be in the works as the conversation has progressed to talking about a return to the ‘roaring’ 20s. Another rationale is to see it as most of the gains in the largest technology companies that drive the Nasdaq as having been already taken. It still, however, doesn’t mean that there isn’t money to be made from further venture-backed listings. Europe’s IPO scene is just beginning to heat up again [12], and VCs and PE firms are already funding the next generation of the innovative companies in space, data, AI and so much more [7]. That’s a conversation for another time, though.

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