Tucked away in the northern half of California, Silicon Valley is the innovative hub of the world. Home to the most dynamic industry on the planet, the southern region of San Francisco Bay boasts a robust ecosystem of technology start-ups. Justin Rosenstein, an American software programmer believes that “technology, community and capitalism combine to make Silicon Valley the potential epicentre of vast positive change.” Despite consuming one-third of all of the venture capital investment in the United States, the revered tech capital has reached a crossroad.
The once thriving region, which employs over a quarter of a million IT workers, has been enduring a severe IPO drought. Investors and philanthropists have become impatient and are eager for some of the region’s biggest players to make their shares public.
The IPO Landscape
Exploring the Disappearing Technology IPO, a report published by IPO research specialists Renaissance Capital highlighted the bleak public market landscape. According to the report, there was an average of 36 venture capitalist backed IPOs every year. This average dropped to just 23 in 2015, and only seven of these floats occurred in the second half of the year. In contrast, 2016 has seen only 14 tech IPOs, a paltry amount compared to the 371 listings in 1999 at the height of the dot-com bubble.
This outlook reflects the wider public markets where the number of US-listed companies has dropped from more than 8,000 in 1996 to about 4,300 today. In tech, the problem is simple. There is an astonishing lack of new entrants as game changers such as Uber and Airbnb opt to stay private. These private companies which are valued at more than $1bn, otherwise known as Unicorns, are essential to the revival of the IPO market. But why are they deciding to stay private?
Private Funding And IPO Valuations
Uber CEO Travis Kalanick vows that Uber will not go public for another decade, adding that “I’ll finally do an initial public offering one day before my employees and significant others come to my office with pitchforks and torches.” To add to investors woes, the rest of the tech community seems to agree with Kalanick.
CB Insights, a research firm that tracks venture capital investments, calculates that private investors placed $362bn in start-ups in the past five years. With vast private spending, these tech unicorns are raising capital at an alarming rate, cancelling out the need for public funds. This, however, has a profound impact on the markets as a backlog of potential tech start-ups begins to build in Silicon Valley. Surprisingly, it is not the vastness of the private investment that results in companies opting to stay private. Ask any CEO of any of the largest tech start-ups, and they will all provide a similar answer: IPO valuations. The enormity of the investment from private market investors creates wildly inaccurate company valuations (Uber’s last private valuation stood at $68bn) and demonstrates a disconnect between the valuations of closely held businesses and publicly traded ones. According to Leslie Pfrang, an IPO advisor:
“The public market is still rational when they’re buying these IPO’s while in some cases private market investors are irrational.”
The difference in rationale means start-ups are typically valued at far less than what their private funding suggests.
These lower than expected valuations tend to cause disappointment for investors who have their hopes pinned on the next big tech float. Wall Street underwriters are urged by eager venture capitalists and over-excited CEOs to price the offerings to perfection. In doing so, the public markets observe a coveted first-day spike in share price, but more often than not these plummet in the days to follow.
Lending Club, a recently floated fintech start-up, priced its shares at $15 upon floatation. The IPO was 20 times over-subscribed and instantly gave the company a market value of close to $6bn. On the first day of trading, Lending Club’s stock jumped by almost 70%, before dropping to $23.42 a share at close of business the same day. For quick selling traders, the windfalls were lucrative. However, less than a week after the IPO, the harsh reality set in. Despite Lending Club producing astonishing financial results with a 100% increase in revenue, the shares continued to plummet. Today Lending Club’s shares trade at little over $8 a share, nearly 50% below its IPO price.
There have, however, been some success stories. Tesla Motors is thriving, LinkedIn has soared in value and Facebook, which endured a rocky and controversial start to public life, is now steadily growing. Google is the standout. It opted for a slightly less conventional form of IPO, whereby it put its shares up for auction. Google’s shares are currently trading at 1500% above its IPO price, giving it a market cap of $500bn second only to Apple’s. The bad news for investors is that these success stories are few and far between.
The End of the IPO Drought
Despite the unattractive offer of going public, it seems that the IPO drought is showing signs of breaking. Investors and employees are upping the ante on their employers as each want a share of the company’s exponential growth. Companies seeking a higher profile or who require more liquid stocks to help fund acquisitions have little choice but to go public. The simple matter is: it is harder to raise money privately.
The region’s biggest game changers are all planning IPOs in the years ahead. Snapchat has hired Morgan Stanley and Goldman Sachs to float in early 2017 with a valuation of more than $25bn. Spotify and Dropbox are expected to follow.
And despite Kalanick’s defiant rhetoric of an Uber floatation, it too concedes an IPO will be necessary in the future. So as large investment banks begin to cosy up to Uber to sweeten the deal, expect to hail an Uber PLC cab in the not too distant future.