Markets in Review

As a follow up to my previous article found here: link

Due to widespread uncertainty at the beginning of 2020, many IPOs were put on hold. However Q3 through the end of 2020 and spilling into 2021, the technology IPO market has been on fire. As the pandemic has forced the world to shift remote and online, beneficiary tech companies have rushed to the public markets to take advantage of their favorable business models amongst a broader pool of investors.

FactSet reported that in Q3 and Q4 2020, 208 and 168 companies IPO’d on U.S. exchanges, respectively. Even with a slow start, the volume of IPOs in 2020 was more than double that of 2019. This trend is expected to spill into 2021 with reported and rumored IPOs from companies such as Robinhood, Coinbase, Better.com, Instacart, Stripe, and Nextdoor.

In addition to traditional IPOs, direct listings and the popularization of special purpose acquisition companies (SPACs) have created a pathway for even more businesses to go public in ways that best suite each company’s specific needs.

As it stands, I believe that there is enormous opportunity on the private markets to find fairly valued, high quality, businesses that would materially benefit from going public due to reasons that will be explained in further detail below.

Double Pops

One interesting trend that we have observed this year is the “Double Pop” — a scenario whereby a company experiences major valuation increases between

Photo by Elisha Terada on Unsplash

(1) their last private round and IPO price and (2) their IPO price and first day of trading price. This value creation is often driven by significant multiple expansion, as we saw with DoorDash and Airbnb in December 2020 as well as Affirm in January 2021. DoorDash initially indicated an IPO at $75 per share, but went public at $102 — representing a 144% premium to its Series H raised just ~6 months earlier. Similarly Airbnb initially indicated $44 per share but went public at $68 — representing a 161% premium to its final private round. The Double Pop for both companies came upon IPO as DoorDash debuted 78% above its IPO price while Airbnb opened up 115%.

The Double Pop has created a fiercely competitive dynamic for allocations at the pre-IPO stage. More and more VCs and growth funds are moving up to invest into pre-IPO companies, while hedge funds and private equity are aggressively competing capture these favorable economics. This can also be highlighted by the unprecedented rise of SPACs. In 2020, SPACs accounted for half of all IPOs!

On the company side, we have seen new measures taken to try and prevent these Double Pops so that companies don’t lose as much upside economics — this can be seen across the rising popularity of direct listings. For instance, Roblox recently postponed its IPO and pursued a $29.5 billion Series H (up from a $4 billion round just last February) and will soon go public via direct listing. There has also been a push to include more retail investors in IPOs so that they too can participate in the experience and potentially benefit from the pops. Airbnb offered exclusive access to its hosts during its IPO while companies such as PrimaryBid are paving the way for even broader retail participation.

We have also seen companies that exhibit stronger than average revenue growth and unit economic metrics (i.e. Snowflake, Unity, Palantir, C3 for example) will immediately trade in the upper valuation ranges of the public companies, which as detailed in Part 1 and my weekly newsletter, are at all time highs. That said, I am not a macro investor and cannot be certain on how long this music will last. For now though, the public markets are a soft landing pad for the fast growing technology companies.

2021 will be an exciting year for the deep pipeline of IPO companies. I anticipate that many of the ‘hot’ pre-IPO companies, including a few of our own portfolio companies, stand to benefit from this mismatch between the private and public markets.

Below is a select group of 2020 (+/-) technology IPOs. With a few exceptions, almost every company has exhibited the Double Pop to some degree:

Lower Barriers to Becoming Public

Median LTM revenue for public SaaS companies currently stands at $540 million. Of the select IPOs listed above, the median LTM revenue at the time of IPO is approximately $200 million. I predict that the current state of the capital markets will continue to attract businesses to go public at earlier stages and through more creative listing avenues. From my many conversations with growth companies and public investors, $100 million in annualized revenue is increasingly becoming a new IPO milestone.

2019 vs. 2020: Shifting Quality of the IPO

There has been a big shift in public market reception to tech IPOs between 2019 and 2020. While it may be hard remember, just last year a completely opposite story was playing out. Forbes published: Has 2019’s Unimpressive IPO Class Spoiled It For The Unicorns? It became apparent that public investors looked unfavorably toward capital intensive businesses including Uber, Lyft, SmileDirect and Peloton, which all raised more than $1 billion and traded substantially below their IPO price shortly after going public.

Most of you will recall the infamous attempted WeWork IPO. SoftBank had marked the company up as high as $47 billion, while Goldman Sachs allegedly told investors that it could trade up to $65 billion after going public. Reality quickly set in as the public markets valued the business at $10 billion before the IPO was pulled — as of March SoftBank marked the company at $2.9 billion.

This is not to say that WeWork or any of the 2019 IPO’s were necessarily bad businesses (9Yards Capital actually started in a WeWork along with many successful businesses!). It is simply a mismatch between private and public market valuations.

So why today has this mismatch flipped? Why has 2020 been such a great year for IPOs compared to 2019? Some thoughts below:

  • The most apparent…multiple expansion: Not to say that the private markets are necessarily undervalued, we have however seen valuations reach all time highs in the public markets (as highlighted in the Exhibit section below). As public investors continue to look to equities for yield, high performing SaaS companies — specifically those with strong growth and long term beneficiaries of COVID — will continue to post favorable valuations.
  • Shift in business models: 2019 seemed to be far more defined by capital intensive businesses that required investor capital to seemingly ‘sponsor company loss’ (i.e. Uber, Lyft, WeWork, etc.). From an investment perspective, these business models are much more thesis driven with a longer path to profitability, which can explain why public investors turned out to be far more pessimistic than privates. 2020 has been defined more by high contribution profit businesses with strong unit economics that investors can better understand, benchmark, project, and underwrite. Interestingly DoorDash seems to fall into the class of 2019’s profile, albeit a COVID beneficiary.
  • Quality of management teams: It is hard to forget the Adam Neumann (WeWork) and Travis Kalanick (Uber) corporate governance controversies. While the private markets can look past this, public investors require a much higher bar for institutional-level leadership. 2019 was defined by a higher frequency of corporate governance issues drawing skepticism from public investors.
  • Downturn strength & resilience: Many companies that have gone public this year have proven that in times of distress, they are able to either benefit or remain more resilient than competitors. In the case of DoorDash, food-delivery has obviously benefited from COVID and investors are currently rewarding them for this. Similarly BigCommerce, a SaaS eCommerce platform, continues to benefit from eCommerce trends which has positively impacted the company’s value. Airbnb on the other hand was negatively impacted by COVID due to a massive halt in the travel industry. The company, however, swiftly shed 25% of its workforce along with other cost cutting measures to achieve strong profitability. Airbnb also proved that it is more than a hotel substitute by dominating the medium-term rental market. This demonstration of resilience has caused investors to favor Airbnb over other travel businesses investments.

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Exhibits

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