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Finally, Silicon Valley’s Dog Days Are Over: Here Come the IPOs

November 28, 2016

Until recently, Silicon Valley companies and investors alike have bemoaned the lack of technology initial public offerings.

After 53 tech IPOs in 2014 and 35 last year, only 18 tech companies had managed to go public through September of this year, the lowest number since 2009, according to the Wall Street Journal. The situation had cast a pall on otherwise successful, growing startups that needed a path to raising money and providing investors and employees with liquidity after the long IPO drought.

Now, with the recent successful IPOs of Twilio Inc., Nutanix Inc. and others, a lot of people are hoping the drought is over.

We are optimistic that they are right. In fact, many private companies face both “carrot” and “stick” incentives that will push them toward an IPO sooner than later.

The Carrots

On the carrot side, tech IPOs have been the best-performing asset class of 2016. As of the end of July, these offerings were up 50.4 percent, compared with 19.1 percent for other IPOs and 6.3 percent for the broader S&P 500, according to the Chicago-based investment firm William Blair & Co. The marquee tech IPO of 2016, Twilio, trades at about $32 a share today, more than double its offering price in June even after shares fell in October over concern about a secondary offering. Several large one-day “pops” as well as strong after market performance have created a frenzy of interest among institutional investors looking for a boost in returns for their funds.

Another key factor spiking institutional investor demand is the surge in mergers and acquisitions. Merger and acquisition activity is driving up valuations, leading to some very positive returns, but also taking many of the best emerging-growth companies off the market. Institutional investors are left scrambling for growth stories and seeking more opportunities to invest in pre-acquisition.

Furthermore, with the exception of Brexit-related turmoil earlier this year, the markets have mostly enjoyed prolonged periods of calm in 2016. At one point in June, markets had gone 42 days without a decline of 1 percent or more, the longest period of relative tranquility since July 2014, according to CNN Money. Placid public markets give companies an incentive to price IPOs without fear of a broad downturn that could scuttle their plans or lead to unattractive pricing.

Beyond the newly relatively rosy conditions for public offerings, there are a number of “sticks”—threats looming for private companies—that will also prompt more of them to jump into the public market.

For one, there are more than 170 private “unicorn” companies valued at $1 billion or more, according to CB Insights. While many of them raised significant capital in 2015, they can’t last forever and many will need to raise capital in 2017. At the same time, late stage private financing sources have pulled back from the frothiness of 2015, so many large private companies will be forced to tap the public markets for the additional capital. Lastly, there is a risk that mature companies miss their window to define a category or can’t maintain high growth rates if they wait too long before going public, which would impact valuation multiples.

There are also broader market concerns and the robustness of the IPO market remains uncertain. Risk factors, such as the election and the likelihood of a Federal Reserve rate hike, could dampen stock market conditions, making it tougher to go public later.

The market may also be missing a monster IPO like Netscape Communications Corp., Google Inc. and Facebook Inc. were for their eras. These tend to raise awareness and enthusiasm for IPOs. We anticipate big names such as Uber Technologies Inc. and Airbnb Inc. may wait out this IPO cycle. Airbnb seems content to continue raising funds in the private markets, including another $850 million investment in September. Uber has indicated in public comments that it is in no hurry to go public. However, there are rumblings about Snap Inc. going public early next year, so they may be further along and could serve as that catalyst.

That said, the reticence of the big names also presents a huge opportunity for smaller companies. These “appetizers” will get bid up near-term, until the real feasts come to market. And we believe many companies are now getting ready to take the leap into the public markets.

Well-Received IPOs

Already in September, we saw the well-received IPOs of Nutanix, Coupa Software Inc., Apptio Inc. and The Trade Desk Inc. These New Age enterprise companies, many of them Software as a Service models, have predictable recurring revenues that comfort investors. Our estimate is that there are at least 50 private venture-backed enterprise software companies with over $50 million in revenues, which is likely an all-time high. Several of these mature companies such as Okta Inc., Mulesoft Inc., and Anaplan Inc. are likely now accelerating their IPO plans. We’re likely to see several more S-1 filings by the end of the year and a material pickup in 2017.

At the early stages of venture investing, which is the focus of Menlo and many other VCs, the dynamics of the IPO market over the next few months would seem to be immaterial. However, factors such as a robust M&A and IPO market have a significant impact on the availability of late-stage capital which has helped fuel much of the high growth of the past few years.

If the public markets go on a hot streak and investors are able to realize gains, it’s highly likely to set off another robust capital cycle in which late-stage investors pour money into the next crop of perceived winners, and prices rise. However, if looming macro risks and other factors put the market back on its heels before a significant number of successful IPOs emerge, it’s not hard to imagine many sources of capital pulling back for a prolonged period.

Great companies emerge in either environment, but certain types of models and growth rates just can’t be financed in environments when capital is expensive or scarce. So even though we are fundamentally optimistic about the IPO market, and very optimistic about current tech trends, the performance of the new crop of public companies will go a long way toward defining the strength of the next tech capital cycle.