There has been ample commentary about how the current market environment feels eerily similar to the year 2000, prior to the burst of the dot-com bubble in 2001. Of late, market analysts have been reminding the market about how it all started with a slew of tech-related IPOs for companies that should never have been listed.
We recap, in point, the key elements leading up to the dot-com bubble and the triggers that eventually sparked a collapse in stock market values. Fast forward to 2019, we share 3 analyses on Tech IPOs, underlying cashflow fundamentals of listed tech companies today and our assessment of public capital market risk.
Dot-com bubble: Initial build up
There was great optimism around the turn of the millennium. Technology was much talked about and the internet has just about become mainstream.
E-Commerce and online grocery shopping were to be a mega trend riding on the proliferation of home internet. In the startup scene, Google has just turned 1-year old after Sergie Brain and Larry Page founded the search platform with initial funding from angels. Venture capital was hot, and the many Tech IPO exits have flushed both GPs and LPs with cash (for even larger cheques).
Tech giants like Dell, Cisco and Microsoft were of a different league, having more matured businesses and stable cashflows. They were each market leaders in respective fields, set to benefit from sales of personal computers, data centre networking equipment and PC Software.
Valuations were rich in the public markets, with mature tech companies trading at multiples characteristic of early stage high growth firms. There was of course the other end of the spectrum where many listed .com companies enjoyed similar valuations with little to no earnings or cashflows.
2001 Market Collapse: Key Triggers
In an unexpected move, the board and management at Dell and Cisco concluded that their companies were over-valued and decided to place sell orders on their own shares.
While one could argue that such a move was prudent management at the company level, the consequences was market wide. If companies like Dell and Cisco, with stable / growing cashflows, were of the view that they are over-valued, what about those trading at similar valuations but continue to burn cash quarter on quarter?
Sentiments turned. Investors cashed out when their IPO lockups ended. Pundits who had rode on these IPO took profit. Everything else was history.
2019: Where we are today
Instead of spelling out the obvious similarities, there are a number of notable differences in the current market environment that are worth calling out:
- Staying private longer – Startups (tech or otherwise) today are taking a different path. Many are choosing to stay private longer and there are infact more privately held billion-dollar unicorns today, then there were billion-dollar Tech IPO exits between 1997 – 2001. We believe this is in part driven by #2 and #3 below.
- Abundant private capital – There is a lot of liquidity in the private capital markets and among corporates. VC funds are rolling over their Series A investments into new Series B funds. Corporates from the likes of Toyota to Alibaba and Tencent are flushed with cash and are investing in startups at billion-dollar valuations. Superfunds like Softbanks $100b Vision Fund are also plugging the space traditionally filled by public capital markets.
- Tighter IPO rules – IPO requirements have tightened over the decade and exchanges / regulators have in general shifted the burden of due-diligence towards bankers and sponsors.
- But there are ways around – Nonetheless, bankers continue to exeunt creativity (and the latest seem to take the form of Direct Listing in the US, which has less stringent listing requirements)
Cashburn: An analysis on global listed tech companies
We studied the IPO and cashflow profile of 1,701 listed tech companies globally with an emphasis on operating cashflows (“OCF”). The study focuses not on P&L profitability as those are often easy to game, but on the average OCF of individual companies in the 4 most recent financial quarters (so as to avoid seasonal effects on cashflows either due to P&L or working capital shifts). The study also intentionally excluded Facebook, Google, Microsoft and Amazon to avoid skews.
We categorised listed tech companies in 3 broad buckets. Companies that:
- Are OCF positive on average for the last 4 financial quarters;
- On average, have negative OCF in the last 4 quarters but there are signs of OCF improvements;
- On average, have negative OCF in the last 4 quarters and there are no signs of OCF improvement
Between 2016 – 2018, we count ~450 tech IPOs globally. By vintage, the rate at which tech companies were brought to public capital markets in the last 3 years (avg. 150 per year) outpaced the past decade. This is likely a reflection of higher equity market valuation in recent years which favours IPO as an exit route
There is indicative evidence that companies brought public in the last 3 years are of a different quality. Of the 2016 – 2018 IPO vintage, there are far fewer companies that are today achieving positive OCF. Perhaps, only time will tell, and these companies will (emphasis) eventually achieve cashflow breakeven. On the other end, there is a marked increase in the proportion of IPOs where companies are today still burning cash with no signs of a turnaround.
Snapshot today, ~1/3 of listed tech companies globally have negative OCF. Among which, there are clear signs of OCF improvements (i.e. cash burn is reducing) for most of these companies. 200 companies (~12% of listed tech companies) have negative OCF and showed no signs of cashflow improvements QoQ.
Collectively, listed tech companies with negative OCF account for US$ 306b in current market cap (as of end-April 2019) and are concentrated in a few key global exchanges.
Herein, we make 3 observations:
- Quantitatively, the combined market cap of listed tech companies that are still burning cash is small compared to the market cap of the individual exchanges; so, the risk of a systemic shock does not appear materials
- In reality, a write down for any / all of these cash burning companies could trigger a crisis of confidence, which would likely play a bigger role in contributing towards a correction (if indeed)
- An economic downturn (which we have not assumed in this study), would inevitably affect all companies, including those who are today doing OK in terms of cashflows
2019 Tech IPOs
While the above study does not cover companies that have gone public in 2019, there are sufficient literature in the public domain asserting the following:
- Few of these IPOs have done well
- The ones who had extracted value are early stage private investors
- While the terms of individual fund-raising rounds and associated liquidation preferences are typically not disclosed, there is indicative evidence that post-IPO, private investors for some of these companies are already underwater
- There’s little left on the table for public market retail investor