Saturday, June 4, 2016

Barron's Cover: "Are Unicorns Killing the 2016 IPO Market?"

A two-for-one Saturday special. First up, Barron's:

Rising regulatory burdens combined with a surfeit of venture capital are making new stock offerings passé. That’s good for investors.
A paradox is brewing in Silicon Valley and beyond. Entrepreneurs and venture capitalists have spent the past decade creating bulletproof technology companies, a direct response to the Valley’s 1990s failures. The private firms—such as Uber Technologies, Dropbox, and Airbnb—have legitimate business models that are disrupting mature markets, and capital has poured in. The so-called unicorn class now has 147 members, each with a value, on paper, of at least $1 billion. 

But the mythical beasts are running into a mundane reality. While venture capitalists are eager to pump money into the potential “next big thing,” individual investors are hardly clamoring to get into the act. There hasn’t been an initial public offering for a Silicon Valley–based tech company in seven months.
The IPO lull isn’t just in tech. Five months into the year, just 31 companies have gone public in the U.S. That’s down from 69 in the first five months of 2015, and 115 over the same five-month period in 2014, according to Renaissance Capital, manager of IPO exchange-traded funds, including Renaissance IPO (ticker: IPO). While the public’s coolness has been well reported by the business press, there’s a more important message buried beneath the headlines: The bad news for IPOs could be a bullish sign for the market. 

Since 2000, there have been eight calendar years with fewer than 100 IPOs. In the 12 months following each of those years, the Standard & Poor’s 500 index climbed an average of 13.1%, including dividends, according to data compiled by Jay Ritter, a University of Florida professor who has studied the IPO market for 35 years. In the 12 months following a strong year for IPOs—100 or more offerings—the S&P 500 lost an average of 1.2%. 

There are many factors at play here. A robust IPO market typically comes during a period of irrational stock market exuberance. IPOs peaked at 677 in 1996 and averaged 474 in the late 1990s before the Nasdaq crashed in early 2000. They picked up steam again in 2004, heading into the housing crash. Usually, rising markets beget more IPOs, which adds to the paradox of the current climate. “The lack of IPOs when stock indices are near their record highs is unprecedented,” Ritter says.

Bankers, lawyers, and accountants say a confluence of events has contributed to the current IPO lull. The brutal stock market crash of 2008-09 has curbed investor enthusiasm for speculation, and, not 
coincidentally, new sources of liquidity have emerged for company founders and insiders. At the same time, regulatory changes have simultaneously made it easier to stay private and harder to be public. 

And in a business where timing is everything, getting it wrong is more devastating than ever. Take Square (SQ), the financial technology firm, which went public in November. The stock has struggled to maintain its IPO price, which was already lowered by bankers prior to the offering. Other notable tech outfits that went public last year, including Fitbit (FIT), Box (BOX), Etsy (ETSY), and Pure Storage (PSTG), have suffered even worse fates. 

CURIOUSLY, WHILE IPOS have faded, venture-capital firms are still cashing in through mergers and acquisitions. M&A for VC-backed companies has held fairly constant for the past decade, at about 120 mergers per quarter. The first three months of 2016 saw 112 such VC-backed deals, according to Dow Jones VentureSource. 
Put another way, the IPO weakness is less about the sellers and more about suddenly discerning buyers. “The IPO market has become more institutional, because most individual investors and their advisors are buying indexed products,” says Kathleen Smith, principal at Renaissance Capital. “They are not in there flipping IPOs. The individual investor participation, which tends to be the easy money, is not there, and it’s very unlikely to come back.” 

Thus, Uber continues to grow behind closed doors. Last week, the ride-hailing service raised $3.5 billion from Saudi Arabia’s Public Investment Fund. With a $62.5 billion valuation, Uber is more valuable than 85% of the companies in the S&P 500. Lodging-rental platform Airbnb already rivals the world’s largest publicly traded hotel companies, with a value of $25.5 billion.

But there are cracks forming in the lavish world of private investment that go beyond the unicorn class. A year ago, venture-capital investments were being made at a median valuation close to $60 million, a record high. The valuation fell precipitously in the first three months of this year, to $19.7 million, according to Dow Jones VentureSource....MORE
And from FT Alphaville, yesterday:

RIP public markets: The steroid era for start-ups is over
Once upon a time, going public was the pinnacle of achievement for a tech entrepreneur.
This is no longer the case. Tech IPOs have taken a major hit and startups are staying private for longer.

The US IPO market in general is experiencing the slowest year since the financial crisis, but it has been a particularly quiet year for tech IPOs, with only a few companies going public in the US.

The latest to IPO is cyber security company Blue Coat. Back in 2015 Bain Capital bought the company in a deal that valued at $2.4bn. The other two are Acacia Communications which makes components for fibre optic networks, and SecureWorks, the cybersecurity arm of Dell, both have also have listed in 2016.

Last year, investor Keith Rabois from Khosla Ventures summarised the mood by tweeting: “The steroid era of start-ups is over.”

On the European front we are also witnessing a severe slowdown in listings. Data from Thomson Reuters shows London has seen just over $2 billion raised from listings so far this year, a fraction of the almost $18 billion gathered over all of 2015.

The IPO-adverse nature of the latest tech boom can be linked to the venture capital industry both cultivating and encouraging secondary market trading of privately held shares. It seems the days of the IPO are gone as more and more companies seek out private funding.
Further evidence of this trend can be seen in the recent IPOs Proskauer 2016 study from law firm Proskauer Rose LLP:
The 2015 IPO Market1 Entering 2015, we were cautiously optimistic about the U.S. IPO market. We saw 74 IPOs price in the first half of 2015 – a decrease from the same period in 2014, but similar in number to the start of 2013.
Of these 74 IPOs, 54 priced in the second quarter of 2015. The second half of 2015 saw a fall-off in volume primarily due to market volatility, driven by interest rate speculation, geopolitical risks with Greece and China, significant distress on oil prices and the energy and power (E&P) sector, and poor performance by IPOs priced in the first half of 2015.
As a result, only 51 IPOs priced in the second half of 2015 – the lowest deal count during any year’s second half since 2012. The year’s $30.1 billion aggregate deal value (including over-allotment) was the lowest since 2009. For some private companies with high valuations, their public debut was actually a “down round.”