For the past few years, investors have warned of a bubble in privately held tech companies: Valuations simply couldn’t be justified based on comparisons with their publicly traded counterparts. Companies such as Uber, the ride-hailing company that has since gone public, were raising venture-capital funding at higher and higher valuations even as blue-chip tech powers such as Apple were given valuations that made them seem like old-fashioned industrial companies. But the roles now seem to have reversed. Based on sentiment, share prices and news flow, one can now argue that the place to go shopping for bargains is in the private markets or among companies that have recently gone public.
Look back to early 2016 to see how extreme the sentiment difference was then between public and private tech companies. That was the trough in the global economic slowdown that began in mid-2014. Manufacturing was weakening, and industrial production had fallen on an annual basis in the US Corporate credit markets, particularly in the energy sector, were signalling economic trouble and analysts were calling for recession. From its peak in November 2015 to its bottom in February 2016, the Nasdaq 100 fell more than 16%:
Despite this turbulence in the economy and the stock market, this was one of the frothiest times for tech unicorns, or closely held companies valued at $1 billion or more. In December 2015, Uber Technologies Inc raised $2.1 billion, giving it a valuation of $62.5 billion — a higher valuation than it has four years later as a publicly traded company. The same month, Lyft Inc raised $1 billion, giving it a valuation of as much as $4.5 billion, and almost double what it had been in a funding round earlier that year. Powered by investor exuberance, 2015 was the year of the unicorn, and the number of companies that passed the $1 billion valuation threshold almost doubled. QuicktakeUnicorns
Last year was rockier for unicorns, as many of them suffered disappointing debuts when they went public. No company proved more embarrassing than WeWork, which had to cancel its initial public offering amid doubts about the valuation it wanted and a litany of corporate governance concerns. Because of the disappointing performance of many high-profile IPOs and the pall that WeWork cast over private companies, the bar will be higher for start-ups to go public in 2020. Companies will have to provide more disclosures about how their businesses work, show a path to profitability and be willing to accept lower valuations than they may have hoped for a year ago.
Closely held companies may also have their troubles securing capital in the future; SoftBank, the high-profile backer of WeWork and Uber, recently walked away from funding rounds it had intended to complete.
This skittishness comes as public markets have renewed their embrace of tech companies, particularly the industry leaders. Apple Inc and Microsoft Corp both have market values of more than $1 trillion and, based on various valuation metrics, are the most expensive they’ve been in at least a decade. Google parent Alphabet Inc and Amazon.com Inc are closing in on the $1 trillion mark as well:
So if public tech stocks were cheap in early 2016, but private tech companies were expensive, the roles seem to have reversed.
This may well set the scene for acquisitions instead of IPOs. Private tech companies that can’t attain the scale or the growth needed to become viable on their own may find their best course of action is to sell to a large public company. This seems to be happening at this very moment: On Wednesday, GrubHub Inc shares soared amid reports that the company is exploring strategic options, including a sale, as the cash-burning meal-delivery industry seemed poised for consolidation. Takeovers may be particularly appealing to big companies with lofty valuations but limited growth potential; they can use their expensive shares to scoop up promising private companies at relative bargains.
As 2020 plays out, some private tech companies may still end up as public entities, only it will be accomplished through acquisitions rather than IPOs.
Conor Sen is a portfolio manager for New River Investments in Atlanta.