The pandemic-era boom in technology initial public offerings is set to give way to a reverse trend: a reprivatization of many companies that went public but have since seen their share prices crash, as private equity giants eager to put their money to work lead a wave of buyouts.
That’s the expectation of several professionals in underwriting, investment banking, fund management and private capital interviewed by The Globe and Mail in recent weeks. Already, U.S. private equity company Thoma Bravo LP has made two multibillion-dollar takeover bids in recent weeks, for publicly traded U.S. tech vendors SailPoint Technologies Holdings Inc. and Anaplan Inc.
Valuations of publicly traded cloud software stocks “are pretty attractive right now,” said David Greenberg, managing partner with JMI Equity in Baltimore, Md., one of the more active U.S.-based private capital investors in Canada. Meanwhile, the amount of dry powder, or money that private equity firms have to invest, hit a record US$1.8-trillion earlier this year after they raised ever larger amounts, according to market research firm Preqin Ltd.
“All these funds that have raised money recently will be anxious to deploy it,” Mr. Greenberg said. “My crystal ball would be that in the second half of this year, there would be more take-private activity … unless [valuations] recover in the next six months, which I don’t expect.”
David Wismer, co-head of global technology and business services investment banking with BMO Capital Markets, agreed: “I think some [tech companies that went public in 2020 and 2021] will be taken private” by strategic buyers or private equity firms. “Everyone is looking at every public company. It’s not lost on anyone this may represent a moment of opportunity.”
Last year, Canada’s technology sector broke fundraising records, including an unprecedented 16 initial public offerings on the Toronto Stock Exchange; many were vastly oversubscribed. A different situation has unfolded since November: Stocks of all but one of the 16 have traded below their offering price, echoing trends in the U.S. as newly public companies including DoorDash Inc., Coinbase Global Inc. and Snap Inc. have also sagged. Some newly public companies are worth less than when they last raised money privately.
Overall tech stocks, particularly early “pandemic winners” such as Shopify Inc., Zoom Video Communications Inc. and telemedicine stocks, have broadly sold off. The S&P/TSX Capped Information Technology Index has shed 30-plus per cent of its value. “It’s been one of the most challenging times for the sector … going back to the dot-com days” – even though most companies have delivered on their financial promises, National Bank Financial analyst Richard Tse said in a recent note.
The market for tech IPOs has all but closed and many observers agree it will probably stay like that for 12 to 24 months, particularly in Canada. “We would not contemplate bringing a company to market right now,” said Adam Felesky, chief executive of Portage Ventures, which is backed by Power Corp. of Canada.
The selloff has had repercussions for some newly public companies already. Winnipeg agriculture technology provider Farmers Edge Inc., which has missed quarterly projections since going public last year, tapped majority shareholder Fairfax Financial Holdings Ltd. last month for a $75-million loan in the face of shrinking cash reserves.
Online e-book marketplace Legible Inc. and Thinkific Labs Inc., an online platform for course creators, listed on Canadian exchanges, have made big staff cuts, as have a few U.S. tech companies, including fast-delivery provider GoPuff, to preserve cash. “It was about making a difficult choice now to avoid any possibility of a more difficult choice in the future,” Thinkific CEO Greg Smith said of his fast-growing company, whose stock has cratered to less than $3 a share after going public at $13 a year ago. “You may see more companies taking a hard look at cash balances now.”
John Ruffolo, managing partner with Maverix Private Equity in Toronto, said the recent job cuts are “just the tip of the iceberg. You’re going to see more layoffs and belt-tightening.”
The broad tech selloff has been largely sparked by the threat, and now arrival, of rising interest rates, which have the effect of reducing the present value of future, anticipated cash flows. That has particularly hit earlier-stage technology companies that are years from breaking even.
The selloff has translated into a drop in the valuations that public markets investors are willing to give technology companies. During the first 18 months of the pandemic, as companies and consumers moved online, valuations for cloud-based software companies shot up, with valuation multiples peaking above 20 times projected annual sales for top-performing names compared to 12 before the health crisis. The median multiple for all such companies in the sector rose to 12 from eight, according to the Bessemer Venture Partners Nasdaq Emerging Cloud Index. Since November, multiples have withered back to prepandemic levels. Meanwhile, observers say, the “growth at all cost” mantra that fed the private and public tech funding boom in the past two years has been replaced by a more balanced approach to supporting companies that grow fast but also have a clear path to profitability.
The drop in valuations “will have an impact on fundraising, exit expectations (how much value companies could expect to realize by going public), and employee attraction and retention,” Mr. Ruffolo said in a blog post this week. “Positive unit economics and near-term cash generation have returned as key factors in determining value.” Many companies now look too small and too young to have gone public, and are stuck managing to quarterly expectations, paying compliance costs that go with a public listing, and facing unhappy public markets investors, he and others say.
That leaves some observers worried that investors who bought into IPOs at inflated prices might be left with a bad taste.
“I think people will be skeptical again about Canadian technology IPOs … and it will take a while for investors to return,” said Lesley Marks, chief investment officer of equities at Mackenzie Investments. “I do think we will have some battle scars on the Canadian tech sector from having so many unsuccessful IPOs, even though a big part of the reason has been related to market dynamics.”
But the pain for public shareholders has created an opportunity for private equity to buy control of public tech companies at cheaper prices than their private peers, which are still commanding higher valuations, and at the lowest prices they’ve seen for stocks in more than two years. “The public market valuations are relatively more attractive than a lot of the private ones,” Mr. Ruffolo said. “It’s opened up for us to look at public opportunities we would have never looked at.”
Sanjiv Samant, managing partner of Toronto’s Round13 Capital Growth Fund, said he expects the technology sector “will be moving away from the IPO cycle we saw last year and more fully into a mergers and acquisitions cycle.”
Round13, which has primarily focused on investing in private, near-term IPO candidates, this year led a $21-million investment in TSX Venture-listed Tribe Property Technologies Inc. “We will continue to examine high-quality, underappreciated opportunities like this in the public markets,” Mr. Samant said.
Justin Sadrian, managing director of New York private equity firm Warburg Pincus, said: “There are now some very high-quality public businesses growing at a nice clip, with a great market position that are quite capital efficient – and that are trading at multiples that are more attractive than they’ve been in some time.”
But private equity investors say they expect deal flow to pick up only later this year. That is because many companies that recently raised money aren’t in immediate dire straits. The mood will change in boardrooms of public tech companies in the next couple of quarters if “these stocks continue to stagnate and new investors come on board; on-board with a lower cost base,” Mr. Samant said.
When they are ready to talk, cash-rich private equity firms say they will be eager to engage. “I do think we are going to see more private equity firms doing transactions with public companies,” said Eric Byunn, a partner with Centana Growth Partners, based in Palo Alto, Calif., which has backed private Canadian tech vendors Athennian and Vena Solutions. “Every private equity firm, including us, which has the flexibility to do that, have our eyes open to what is in the public markets.”
With a report from Clare O’Hara
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