The tech sector’s opportunities for raising capital look very different from 12 months ago, according to a panel at the RBC Capital Markets Australian Technology Conference. That’s likely to have implications for the types of tech companies - and products and services - to emerge over the next few years.
“FinTech and software are front and center,” explained Chip Wadsworth, RBC Capital Markets Head of Technology ECM. “[While] the D2C [Direct to Consumer] model hasn’t been able to find any real traction.”
The Panel agreed, noting this will shift available capital to the enterprise space, with investors and innovation likely to focus on security solutions, as well as software that automates or eliminates manual processes.
A necessary correction
The last couple of years have been unusual ones for capital markets around the globe, especially when it came to tech companies, observed moderator Layton Bonnici, Head of Technology at RBC Capital Markets, Australia.
“COVID created very specific tailwinds,” agreed RBC Capital Markets Global Head of Software, Owen Bittinger noting that more people were working remotely and transacting digitally. Bittinger said this led to many tech businesses going public - even at a relatively early stage - and attracting high levels of investment and share turnover.
“Zoom became a Kleenex type of word, and we were seeing average tech company valuations at revenue multiples of 30, 40 or 50x - levels that in any academic sense couldn’t be delivered.”
Based on this, Bittinger said a correction was inevitable. (The NASDAQ composite has now fallen more than 30% since its November 2021 peak.) However, he believed that the market may have over-corrected and that many tech companies now looked like better value.
RBC Capital Markets Managing Director, Financial Technology Matt Thomas observed that, “Deals froze up over the Northern Hemisphere Spring and Summer. Although they have now unfrozen.”
Thomas says that this is creating stability in the market and that founders and investors had recalibrated their expectations about their companies’ values.
“People have adjusted their plans. They've taken down their headcount if they were burning too much. They’ve also pulled the trigger on getting capital from existing investors if they’re private, or they’ve extended the runway, so they don’t have to do anything for the next 12 or 18 months.”
“We’re still very busy,” he explained. “We’re just very busy in a different way from 12 months ago.”
Capital looks to revenue rather than growth
That said, the Panel observed that the large-scale IPOs that were a hallmark of the digital boom between 2019 and 2021 were long gone.
“When the VIX [Cboe Volatility Index] is in single digits or up to mid-teens, it usually means equity markets are wide open for IPO product,” Wadsworth observed. “When it’s over 20, you can get transactions done, but there is price sensitivity. Anything north of 25 means the market is pretty much shut down.”
“Right now, it’s around 30.”
The Panel observed that it was private capital - most notably private equity - that had stepped in to finance many tech companies. This included a growing number of ‘take-private’ deals, in which private equity firms were acquiring listed companies and taking them off exchanges.
“There is a record amount of dry powder about,” Thomas observed. “We’re seeing big bets on public markets [from funds], the likes of which haven’t been made over the past few years. If the debt market was more functional, we’d see a lot more ‘take privates’ happening too.”
With these significant investments came a new emphasis on profitability ahead of growth.
“18 months ago, we’d always hear ‘how fast can you grow and what can you do to grow faster?’”, Thomas observed. “Today, the focus is about ‘what are your barriers to competition?’”.
“Cash is king now. The first question asked is, ‘Do they make money?’ If the answer is ‘no’, you’re in for a hard slog.”
FinTech and enterprise software to take center stage
This changed approach will have profound implications for the types of businesses and sectors that get funded. And this, in turn, will impact both levels of innovation and the future shape of the tech sector.
Bonnici asked the panelists which sectors would be most advantaged by these new realities. All three agreed that B2B companies - especially those in the FinTech and software spaces - would likely be the strongest placed over the next few years, and that this is where much of the next wave of innovation was likely to take place.
“Enterprise software has an inherently deflationary element to it,” Thomas said. “It’s something that drives fairly significant productivity in organizations and takes out a lot of costs.”
“Embedded FinTech is a term we’re starting to hear a lot. This is where the software has the primary value proposition, giving it the right to own more of the economics around factors such as payment or lending, around that same set of customers.”
In line with this, Bittinger noted that ‘vertical’ rather than ‘horizontal’ solutions were likely to become more common. These included bespoke enterprise software solutions that would provide incremental value. For instance, he believed, a powerful data engine that could provide specific information to a company engaged in life sciences or drug discovery would potentially carry more value than a more generalist data engine.
Bittinger also observed that we were likely to see growth in software engines that could power an entire small business, automating or creating efficiencies across multiple processes.
Wadsworth agreed, noting that there was still incredible scope for making manual processes digital and that companies entering the space were often presenting ‘greenfield’ opportunities.
Security and auto tech innovation gains pace
Bonnici noted the growing importance of cybersecurity, especially in light of recent high profile data leaks, and asked panelists whether it would continue to attract significant investment.
“Security is the only part of software that is adversarial,” Bittinger observed. “It will look totally different five years from today. If you’ve got legacy [security] technology going up against new [hostile] technology, you’re going to get smoked.”
“This is going to create an innovation cycle. We see that already with the rise of security-specific venture capital funds.”
Wadsworth also highlighted AutoTech as a sector where increased levels of capital would fuel new developments.
“Over the next five years, this will be a really important space. There’s a lot of infrastructure that needs to be built, and there is a significant amount of capital that will be needed to go into it. A lot of the work that will be done will be private.”
Consolidation will drive benefits
Finally, all three panelists agreed that the next few years would be a period of greater consolidation within the tech sector and that M&A activity would be on the rise. However, as Wadsworth observed, this would likely result from growing business synergies rather than cost control.
“There is still a lot of opportunity [in the tech sector],” he noted. “Even in the more mature parts, you’re seeing markets grow by 20% per annum.”
“Consolidation will bring the benefit of more access to capital markets…. [and] private equity will drive larger, more sustainable companies.”