Markets blurring

• Private markets are now as liquid as public ones
• Public markets are responding by raising valuations and easing conditions
• Issue remains how to become an owner of choice to innovators

These trends are both part of the blurring between public and private capital markets.

As Pitchbook noted: “As VC firms have pushed for companies to grow faster and remain in the private market longer, non-traditional investors realised they were losing out on valuable growth by waiting until companies completed an IPO [initial public offering].

“Rather than wait, these investors quickly moved to recapture a stake in that growth, investing in private rounds in a part of the venture market that did not previously exist. Now, larger and more mature companies remain in the private markets.”

But with private markets effectively as liquid as public ones, entrepreneurs increasingly can look to decide their future owner of choice. Last year’s relaxation of direct listing rules in the US, so companies can raise capital in an IPO as well as list existing shares, or the spectacular growth in special purpose acquisitions companies (SPACs) to take private companies public through a reverse acquisition as well as a global record $500bn of primary and secondary issuance of shares through more traditional methods indicates a capitulation of sorts to the febrile valuations seen in private markets.

In its 2021 US Private Equity (PE) Outlook, Pitchbook said: “Price multiples in both public and private markets have been elevated for some time, and we foresee no reason for this to change in 2021.

“The S&P 500 now trades at a cyclically adjusted price-to-earnings ratio (CAPE) of 33 [on Yale professor Robert Shiller’s analysis] due to a plethora of factors including monetary easing, widespread risk-on appetite, and the emergence of large growth-oriented companies that trade at high multiples of revenue, let alone earnings. On the private side, the median EV/Ebitda [enterprise value divided by earnings before interest, tax, depreciation and amortisation] multiple for buyouts was 12.7x through Q3 2020, tying its record high….

“Buyout funds are increasingly targeting growth-stage technology companies that tend to trade at a much higher multiple of earnings than the traditional PE target. For example, software specialist Thoma Bravo acquired UK-based cybersecurity firm Sophos for about 46x TTM [trailing 12 months] EBITDA in January 2020, an eye-popping figure that is becoming less infrequent.

“Many of these internet-native businesses have seen bottom-line improvements from the accelerated move to a digital economy during widespread lockdowns. Even if pricing stays the same for most businesses, a higher proportion of buyouts taking place in sectors such as software and biotech should boost the proportion of deals taking place in this pricier range.”

Private equity firms setting up growth and venture units to be eyes-and-ears on disruptive industry trends that might affect multiples and returns on their core buyout assets will be a strategic complement to the returns from the VC bets themselves.

Similarly, hedge funds, mutual funds and SWFs benefit from the insights about entrepreneurs and investors but relatively few have joined up their thinking to explore how corporate venturing and intangibles are deciding between the winners and also-rans in their region and public portfolio, although there are promising signs this is starting to happen.

As Cathie Wood wrote in the Financial Times last month: “In Ark’s view, any company not investing aggressively in one or more of five major platforms of innovation will lose its way. In harm’s way are companies that have engineered their financial results to satisfy the short-term demands of short-sighted investors.

“Those that have leveraged their balance sheets to buy back shares and pay dividends are at particular risk as they will have less balance sheet flexibility to invest in response to the technological shift….

“While risk-free interest rates are likely to remain low, spreads between companies on debt costs could widen dramatically as disruptive innovation — the likes of which we have not seen since the telephone, electricity, and the automobile burst on the scene in the Roaring Twenties — causes dislocation.”