For a company that isn’t actually a technology firm, the disastrous failure of WeWork to get its $75 billion float away seems to have been something of a catalyst for the world’s tech investors to reconsider the valuations of the sector’s latest shooting stars.
The share price of Uber is down 34 per cent in three months, and 35 per cent below its IPO price set in May. Rival Lyft has been trading near record lows in recent weeks and is down 50 per cent from its IPO price set in March. Shares in exercise bike firm Peloton, which listed in September, are yet to trade above their issue price.
It hasn’t just been the recently listed groups to have been hit. Amazon (shares down 14 per cent in the last three months), Facebook (down 10.5 per cent over the same period) and Netflix (down 26 per cent) have also felt the pain.
But Credit Suisse tech guru Matt Walsh, who visited Australia from his base in San Francisco last week, says it is important to put the current market sentiment in context.
Yes, there has been a pull-back in tech stocks. And yes, there has been a reversal in private market tech valuations, which had been inflated by investors hit by low interest rates and hunting for better returns.
“In low interest rate environments, investors naturally move further out on the risk curve in search of returns,” Walsh says. “The impacts on private market valuations globally are beyond what anyone expected.”
But most of the pain has been felt in well-known consumer names, which tend to get the big, negative headlines.
Walsh says that behind this is an army of nimble, disruptive tech firms focused on selling to enterprise customers that are increasingly reliant on software to keep their operations on track.
While the poor post-IPO performances of Uber, Lyft and Peleton have led some commentators to question whether the era of the tech unicorn is ending, Credit Suisse has had a role in several of the year’s best-performed tech IPOs in the US.
These include cloud computing group Fastly (up 55 per cent on its issue price), video software provider Zoom Technologies (up 97 per cent), technology monitoring firm Datadog and cyber security group Crowdstrike (up 81 per cent) in which Telstra Ventures has a stake.
Credit Suisse also helped with the direct listing of enterprise communications firm Slack, which soared initially but has had its share price drift below its issue price in recent weeks.
The co-head of investment banking and capital markets at Credit Suisse Australia, James Disney, who returned to the bank’s Sydney office in late 2018 after leading its global software firm team, says the way enterprise software firms have adopted the look and feel of consumer apps is a neat symbol of how the digitisation of the business sector is creating a huge growth opportunity.
“The digitisation of the enterprise has been slower, but that is now happening at a rapid rate,” Disney says. “And that’s why you see some of these software companies that are enterprise-focused – rather than the ones that have a consumer focus – actually have bigger valuations and better businesses.”
This digitisation of the enterprise is being driven by the increased reliance companies across the economy have on software. Walsh gives the example of a fast-food chain: selling burgers might be its main game, but to do that it needs a team of in-house software developers keeping the technology systems that underpin its stores.
This operational reliance on software, in turn, makes enterprises extremely reliant on their software providers – which investors love, according to the local head of Credit Suisse’s TMT team, Tim McKessar.
“Their retention rates are extraordinarily high. So while there’s the question of what other industry’s giving you 30 per cent-plus growth, the other thing is the resiliency of that growth, given the deeply entrenched customer relationships.”
As the bank that brought giants such as Google and Alibaba to the public markets, Credit Suisse’s global tech heritage is rich. Locally it has topped the league tables in terms of tech deals for two of the past three years and worked on prominent recent deals including the float of ASX darling Wisetech and the sale of Aconex to Oracle – notably, two enterprise-focused tech firms.
Walsh says it was another Australian tech firm – the $44 billion project management software giant Atlassian – that underscored two key drivers of the enterprise software boom.
The first was to show that great software companies could be built anywhere in the world, thanks to the proliferation of relatively cheap IT infrastructure and tools. Indeed, Disney points out that tech firms from smaller markets such as Australia, where venture capital is less plentiful than in Silicon Valley, have often built far more resilient and profit-focused businesses.
The second thing Atlassian’s rise did was to prove that selling enterprise software no longer required huge and expensive sales and marketing teams.
Atlassian’s products were often simply embraced by teams inside an organisation, leading to them being adopted by the enterprise, rather than bought by the enterprise.
“These companies have learnt to be remarkably efficient and reach profitability far earlier in their life cycle which is extraordinarily attractive to public market investors,” Walsh says. “There is no better example of that than Atlassian. Investors today are looking for the next generational tech company and are agnostic to geography.”
He says the recent pull-back in US tech valuations should not be mistaken for investors becoming hesitant about supporting growth-focused firms.
“The public market is focused on responsible growth,” he says. “There is no hesitation to invest in companies losing money; however, investors want to see strong unit economics and a clear pathway to break-even. Many of the best performing IPOs of the year are still not profitable.”
Walsh expects US tech IPO volumes to remain robust over the next few years, particularly as companies that tapped private markets for capital move to the next stage of their fundraising journey.
However, there may be some differences in how these companies come to market next year.
Slack, for example, did a direct listing – selling shares directly to the public, rather through a traditional underwritten IPO – this year. And Credit Suisse recently helped Richard Branson’s Virgin Galactic list using a special purpose acquisition company (SPAC), which is a combination of a shell company and an investment fund.
Slack had about $US900 million on its balance sheet at the time of its listing, and so did not need to raise capital via a traditional float.
But its choice of a direct listing comes amid a crusade led by veteran venture capitalist Bill Gurley. The founder of venture firm Benchmark says IPOs are a “bad joke” for venture-backed tech companies, as they let investment banks sell shares to handpicked investors at a big discount, in part by convincing company founders that delivering a big jump in the share price on the first day of trade is actually something to celebrate and not a sign that lots of value has been left on the table.
Did You See This CB Softwares?
37 SOFTWARE TOOLS... FOR $27!?Join Affiliate Bots Right Away
Citing research from University of Florida professor Jay Ritter, Gurley claims that venture-backed IPOs have been underpriced to the tune of $US171 billion over the past four decades.
Ritter has also released research showing that for venture-backed IPOs over the past 10 years, Goldman Sachs and Morgan Stanley underpriced deals the most, by 33.5 per cent and 29.2 per cent respectively. Credit Suisse underpriced the least, with a discount of just 3.3 per cent, on Ritter’s numbers.
“Given the frequency with which technology IPOs have been underpriced historically, it is no surprise that companies are exploring alternative paths to the public markets.
“We believe companies should look at all available options and chose the best path for them. There is no one-size-fits-all solution. We currently have clients considering auction IPOs, SPACs and direct listings in addition to traditional IPOs.”