Vito Sperduto
Welcome to Strategic Alternatives, the RBC Capital Markets podcast, where we break down the trends and advice driving decisions for how to raise capital, drive growth, and create value in a fast changing world. I'm your host, Vito Sperduto. In today's episode, we're sharing a segment from “Ok Computer” a podcast featuring host Dan Nathan and RBC’s Jesse Chasse, who's the head of technology equity capital markets here at RBC. They will discuss a range of topics from the state of the IPO market, lessons learned from SPACs and direct listings, strategic M&A, and the path to going public. They will also talk about the comparisons to the dot com bubble, Ubers’ wild ride, and the economic environment right now. Let's dive into it with Dan and Jesse.
Dan Nathan
Jessie, welcome to the pod.
Jesse Chasse
Good to be here, Dan.
Dan Nathan
Listen, we thought we'd have this conversation. Because stock markets an all time high, it feels like it's just like, you know, we're back baby. And we really wanted to get a sense we get this question all the time, when are new issues coming to market and we thought who would be better to talk about that than you Jesse?
Jesse Chasse
Yeah, sure. You know, it's interesting. As the IPO guy, the guy who does IPOs for a living, it's been rough. You know, it's been sort of 25 months now. So the longest sort of drought, and we define drought, as call it two or more periods, with sort of 60 days without a tech IPO, the longest drought by far in history, so well beyond what we saw post the dot com bubble. Well beyond what we saw post the great recession. But I think you know, one of the one of the good things is it's feeling a little bit better. Now, look, last year was a low bar we got three tech IPOs this year, you know, we think will be a little bit better. We just had to flip public last week with Reddit and another company Astera labs and so it's starting to feel a little bit better. But I will tell you, you know, I spend most of my days and times running around the Valley in New York and other areas talking to you know, founders and the VCs that fund these businesses, and it still feels largely like everyone is focused on the window for 2025. So I don't think there will be a massive wave of issuance this year. But I do expect that there will be more than last year. So again, low bar, more than three for sure. But the companies that that we see coming public, are those that are likely going to come and hit this window for very idiosyncratic reasons. So whether it's an investor that just needs the liquidity, whether it's an AI theme company trying to take advantage of the multiple appreciation, the hype around that theme, you know, companies that frankly, just you know, it's time right, they're mature and their employees need liquidity and there's RSU settlements and tax reasons to get public. And then there's also some smaller companies that, quite frankly, are better off coming out now. Because next year when the window does reopen, we think there's going to be a wave of issuance from headline marquee names and so being out in front of that is a good thing. So that's sort of the setup for this year. So better but not ideal.
Dan Nathan
Some of the biggest names some of the most anticipated names, the names that have been on the tips of lots of investors tongues, bankers tounges for a very long time, have stayed private for longer. Talk to us about that dynamic and then I definitely want to kind of focus on what you just said, but some of the smaller sort of issues because, you know, when we think back to 2020, or the back half of that, and 2021, there was a lot of small companies that were coming public through SPACs - it seems like that window has kind of closed, but let's go back to the ones that people were really focused on back in 2020 and ‘21, that they thought might come that are still private today. What are the dynamics that have caused or at least literally given some of those companies, I guess, enough runway to stay private for longer?
Jesse Chasse
Yeah, I think look, the first thing is, we all know this but, things got crazy in 2021. But, and if you just think about the sheer amount of capital that was raised, you know, these companies have a lot of cash on the balance sheet, right? They then sort of got fit, right? They spent 2022 taking down burn and getting fit. And so because of the cash on the balance sheet and the ability to take down burn, they don't need the cash, right? So there's no forcing function getting them public. Now what we have started to see in the past 12 months is both financial sponsors and VCs needing to return cash to LPs, right? That is going to be a big forcing function. But the thing that is kept in and the thing that's not often talked about, the thing that has kept I think most of these companies out of the market, right? Everyone talks about the IPO window being closed. IPO Window is not closed, the demand is there. Investors want to buy IPOs, it's the supply that's an issue. And the major issue is while the broader economy has been resilient, the consumer has been resilient. We've been in a B2B recession for the past 12 months, right? So the software companies that everyone's most excited about the companies that I spend a lot of my time with, they're having a tough time forecasting their businesses, you know, again, they spent ‘22 taken down burn ‘23 was a year of enterprise optimization in sort of a softer demand backdrop. So if I show up to a CFO and say, ‘Hey, let's go public,’ you better be bang on with your financials, your first six quarters out of the gates, that's a tall ask in this environment. And so look, it's starting to feel better. I think Q4 We finally started to feel like we were bottoming around enterprise optimization and Q1 earnings season or Q4 earnings season rather has, I think, confirm that and solidify that view. And so that's really what points to the window reopening and 2025.
Dan Nathan
So let's talk about that. That one aspect of, you know, sponsors and VCs looking to return capital, right? So kind of having that exit, versus what some of the raises in late 2021, and 2022 and the valuation resets that we saw over the course of 2022 and ‘23. How does that dynamic play out when you think about that, right, so the need for return of capital and exit versus let's say, peak valuations at the height of the market versus kind of where they are now?
Jesse Chasse
Yeah, look, it's there's going to be down rounds. One of the biggest issues is we think about hurdles to the reopening of the IPO market. One of the issues that we were contending with for a while was this just this bid ask spread, right? The gap between where public market investors were willing to buy these businesses and where private market investors were willing to sell them. We've done a lot to close that gap. I think some companies have grown into their valuations to some extent. And then I think we've just normalized the idea that the public markets rerate every day and a down round, there shouldn't be some negative perception associated with it. Right? You're seeing in Reddit. You saw that in some of the IPOs that came out last year. I think it's normalized to some extent. So that being said, look, valuations that were achieved in 2021, were all time highs relative to any period in history, even in most cases relative to the dot com boom. So it's not surprising that those valuations aren't going to be achieved again. And, you know, look, one of the things we do with our clients is, we just sit down and do some simple math. We look at the AR multiple that you raise capital at and 2021, we look at your expected growth rate over the next five or six years and we say ‘okay, so how long will it actually take for you to grow into your evaluation, if that is in fact what you're waiting for?’ And all the time you see pretty quickly, it's going to take 7, 8, 9 years. I mean, that's the type of multiples that these companies were raising at and 2021; so it shouldn't be a surprise to anyone that there's going to be the same rewriting that we've seen in the public markets is going to happen for private companies. We just haven't had enough liquidity to actually see that come to fruition yet.
Dan Nathan
Yeah. So you just mentioned Reddit that was announced, I think last week or so and it looks like kind of a funky structure. We just mentioned SPACs and how many companies came public via SPAC in 2021 and how few came in 2022 and obviously nonexistent in 2023 What about structure direct listings were catching a little bit of steam this was back in 2020- ‘21. Also like what are what are you seeing companies. What are you seeing let's say sponsored like what are people kind of leaning into now? Well, how do we come out of that period? And what are some of the lessons we've learned of those different structures?
Jesse Chasse
Yeah, so there's a couple of ways I think about that. The first is this there was a massive value our whereby your next dollar being raised was better off in the public markets than there was in the private markets. And not surprisingly, because of that, we started exploring all sorts of different ways to get public right. And in a lot of ways the SPAC was just a reaction of what is the best way to get a company public that quite frankly, might not be ready to go public via traditional IPO. And the SPAC had a technology that allows us to use financial projections. And so for a lot of the hyper growth or even pre revenue companies, that was the best way to get those businesses public. Similarly, with the direct listings. Again, we alluded to the fact that companies had the ability to raise massive amounts of capital. They didn't need cash so the IPO was no longer a financing event. So the direct listing sort of emerged as a tool to get public. I think, you know, what we're seeing now is rather than both sponsors and PEs both evaluating different ways to get public. They're just evaluating different opportunities for liquidity. So when I used to show up, I'd say ‘hey, there's three different ways to get public. Let me walk you through the pros and cons.’ Now I have to show up and say, ‘Hey, there's an IPO is one option. But you also might want to consider a minority recap, take some chips off the table and go public at a later date. You might want to consider a straight sale, right?’ Like we've sort of tacked it back towards different alternatives as it relates to public and private markets versus just different ways to get companies public. Look, I think longer term, the genies not gonna go back in the bottle, there will be an opportunity to take companies public vs back or direct listing, but it's going to be a very small part. of the market.
Dan Nathan
Normally we used to hear about a dual track right as you're kind of like pursuing an IPO you would also kind of consider strategic M&A as a possible outcome. You just mentioned a third right there like there's like you know, some alternative financing and the like and I suspect that that dual track from prior periods now moves to try sort of track or something like that. We've seen M&A pickup, strategic M&A, we also there was a headline I think I saw earlier that February for corporate bond issuance was one of the highest amounts on record. So if you think about, you know, corporates, they have pretty good balance sheets. A lot of these public companies right now like, you know, years of zero interest rates, let them kind of get their balance sheets in order now. We obviously saw a lot of cost cutting in 2022 and 2023. And now you see all of this debt issuance at a time where companies seem inclined to actually do strategic M&A also. How does that sort of change the game in a way because in past periods, you really had to get to market the kind of strategic M&A wasn't sort of good; they were debt fueled right like it like for all intents and purposes. Now, these companies have great balance sheets, lots of cash, they can raise debt, too. And they did raise a lot of debt when rates were much lower.
Jesse Chasse
Yeah, look, we and I'm borrowing a bit from my M&A partners here, but we absolutely expect M&A to pick up and really M&A across the board, whether it's take privates was, you know, last year was a record year for that. We expect that to continue, maybe not at the same pace. And I think the regulatory environment has made some of these mergers in the big mergers, in particular, tougher. So that's a bit of a headwind. But big, larger mega cap, mergers and M&A we absolutely expect to continue and then also just broadly portfolio optimization. So you have two companies that frankly, in the past cycle could get public independently. Now maybe you need to put them together to create enough scale to get public. So we absolutely expect that to continue. I think the biggest hurdle up until now has been this same issue around this gap in this bid ask spread on valuation. As I said, I do think that's starting to close. There's plenty of cash and now sort of with interest rates likely going the other direction, the cost of capital environment is likely to get more attractive. And so really, you know, in our view, there's only upside to M&A volumes.
Dan Nathan
So when you talk to some companies that are looking to kind of get on that path to IPO, what are some of the characteristics what are some of the profiles that really work well, for what you see is maybe like a second half 2024 IPO in a market that let's say it looks much like we are in right now, an economy that looks like we are in right now, and possibly getting better in 2025 if a lot of those soft landing folks are sort of, right. Tell us what are some of the characteristics that probably set you up well to get on that IPO track for this like next year.
Jesse Chasse
The common blanket answer that you'll often hear from folks in my seat is scale, growth, and profitability, right? Which is great and it's not surprising that the best companies and the companies that I think have this sort of most direct path to the public markets will be those that are scaled, growing and profitable. Although, you know, I have a bit of a contrarian view around this. I don't think that's what's necessary. There is a price in the public markets for all sorts of assets. And I personally think for the tech IPO markets to truly heal, we need the return of sort of the mid cap IPO, whether that's the mid cap FinTech IPO the mid cap software IPO.
Dan Nathan
Define find that really quickly just billion in capital…
Jesse Chasse
Yeah so I actually we would look at it on a revenue scale perspective, because multiples move around a lot, but sort of if you look at the 2015 2016 period, you know, it was sort of $100 million of revenue you had the ability to get public. If you look at sort of just what happened over time, scale grew a lot, right. The average size of company in 2021 was more like 400 500 million in revenue. I actually don't think that was a reflection of what public market investors were looking for. It was more of a function of the private markets maturing, capitalizing these companies as they scaled in the private markets. And that's just what was left when they decided to go public. Look, I think if you are a 200 to $300 million revenue company, particularly in the enterprise software space, if you're growing, if you have line of sight to profitability, and most importantly, you have a strong grasp of your financial model and your projections such that you can execute in the public markets and not miss in your first six quarters out of the gates. That's what I think you need to get public more so than any perfect financial profile. The question just then becomes price.
Dan Nathan
Isn't that odd, though? You obviously track it much closer than I do, but I'm usually sitting on the desk at Fast Money on the day of, you know, a big tech IPO. And so we're always opining on the first day performance. We're trying to, you know, opining on the valuation relative to its last private raise, and then I'll be sitting on the desk, you know, that three months later, whatever that period is, when they're announcing their first quarter as a public company. And I gotta tell you, I can probably count on one hand over the last five years prior to the drought of how many companies meaningfully beat and are able to raise in that first quarter as a public company. Is that fair? Like it's it seems like I can recall more downside gaps than upside gaps in that first quarter. So what is it that companies are not doing by the time that they get to the public markets, putting themselves in a position to kind of beat and raise it?
Jesse Chasse
When that occurs, it's really more so a failure on the part of your bankers right? And IPO is a unique time, whereby there's a safe harbor that you can interact with research analysts, you can help them build their models, they have the opportunity to build pretty extensive models. And you've primed them and given yourself enough cushion, such that you know, even in a worst case scenario you can at least meet or beat expectations, right? And so there's really no reason that that should ever happen.
Dan Nathan
So let me ask you this, is that is it more that you're gearing towards a higher valuation that I know therefore, you're kind of getting misaligned to what you do after the fact? That's kind of the push and pull of that whole?
Jesse Chasse
Yeah, look, the entire IPO market is at the end. of the day, if you think about it, the decisions you make often revolve around. are you optimizing for price on day one at the IPO pricing date? Or are you optimizing for long-term performance. And if you're optimizing for price on day one, you're going to jack up projections, you're going to try to show him over a more robust financial profile and then also try to price off of a higher forward revenue estimate or EBIDA estimate or whatever you happen to be valued on. And so that sort of is the point where you're on either side. And you know, the question is and what we all often tell our clients is you know, ‘the IPO is the wedding, but you can't forget about the marriage.’ These are your new long term, but I see your smiling like that. These are your new long term partners into perpetuity. And so you owe it to them and to yourselves to set yourself up for success. And sometimes that doesn't mean that you're optimizing for pricing. You should also not get ripped off by the market. But it's on your bankers really to set the stage, find out what you're solving for, and create an IPO that allows you to solve those problems.
Dan Nathan
Yeah. So right now we're seeing a lot of comparisons in the public markets to you know, the dot com sort of bubble. So this kind of fascination with AI and generative AI is specifically and, you know, it's interesting, though, when I look back, you know, a lot of those companies in the late 90s were very small in market cap terms, you know, they obviously had revenue you hear a lot about little or pre revenue that there were no companies that were pre revenue for the most part, I mean, SPACs let you do that a little bit in these last couple of cycles or so. But back in the late 90s, you know, there were revenues there just weren't any profits, right? So, now I look at this and I look in the in the private markets and we see stuff, you know, related to generative AI and some of the valuations are lgoing to be really hard to grow into the public market. So there's going to be companies that come at big numbers, they're not going to be profitable, right? And so how do you think that shakes out over time or do some of these companies because they are backed by some of the biggest platform companies right now right in the private market? Will there not be this you know, like, will there not be this dramatic push to get into the public markets before they can reach profitability?
Jesse Chasse
So look, I think to some extent, this is why VC exists, right? This is why power law dynamics exists. You have what in front of you is potentially the biggest secular tailwind and revenue opportunity of our lifetimes. And so you need investors that are willing to fund that opportunity. And in that type of environment and any sort of hype cycle, there's going to be some that win and some that don't, and the ones that win are probably going to be a lot smaller, or a lot a lot smaller than the ones that don't. And so that's why VC is set up to fund these themes and the secular tailwinds. I think one of the things that makes this particular theme different than some of what we saw across maybe, you know, enterprise SAS, for example, is just the capex cycles and the amount of capital and this necessity that you need, sort of to fund these themes. And so it's not surprising that there's a ton of capital being raised at crazy valuations. But this is different from 2021. 2021 everything was getting funded. I actually think this is sort of a little bit different in that this is why VC exists, to fund these types of things.
Dan Nathan
And Uber is kind of like a great example when that finally got to the public markets and 2019. First of all, it was a public down round, right? And then, but for whatever reason, the public investors were not willing to continue to subsidize their growth right, given the losses that they had and that stock, you know, I think it was like mid 40s IPO price or something like that, obviously got absolutely destroyed during the pandemic, but it already started selling off fairly aggressively. It was a busted sort of IPO. Here we are now the company is amazingly profitable. They have different business lines than they had back then that beat some investors were kind of worried about the continued subsidies of delivery and the like here, and the stock is just been kind of lights out. So talk to me a little bit about that dynamic. And is that something you see that might play out with some of these fairly richly valued companies that are losing money in AI? In the private markets right now? Is that a good kind of path that you might see to public markets for some of these companies in the next year or two?
Jesse Chasse
Yeah, that's a great analogy, right? Like if you think about what happened in Uber. You know, there was a lot of complaints when it came public and concerns from public market investors about the long term rationality of that unit, that unit economics and that business. There was also frankly a concern that all the value appreciation had been captured in the private markets and there wasn't much left for public market investors. But the truth is, is, look this was a market where winner was going to take most were overfunding that particular business so that it could win and capture those customers and that sort of flywheel of the two sided marketplace was rational and made sense. And then once they became public, they were forced to sort of have some discipline around economics. Whether it was pure profitability, or from a unit economics perspective, and now that they've turned that part of the business on after sort of capturing again, the winner take most part of the market, it's worked, right. So I think that is a good interesting analogy around VC funds, these ideas, takes them to fruition. But then when the public market steps in, and when these companies get large enough where they're, you know, forced to go public. The I think discipline that's required, particularly from an earnings perspective of existing in the public markets is what helps you get to that next level.
Dan Nathan
Alright, before we get out of here Jesse, let's say this, okay, you talked to kind of really two buckets of folks in you know, in your seat, right? One would be that kind of founder, that management company that's kind of looking for a path to IPO and obviously they're being advised by their VC investors. What would you say to them about the 2024 environment? You and I covered a lot of ground here, but like, obviously, you're often speaking to these folks. They're asking for your advice or asking for your expertise. You talked about these multiple tracks, right to exit that sort of thing. What would you say about the environment right now?
Jesse Chasse
Yeah, look, I'd say number one, the market is healing. But number two, from a macro perspective, I think there's, you know, quite frankly, just as much uncertainty as there's been in quite some time. And so you really need to owe it to yourself to understand what your burn dynamics are gonna look like over the next 24 months. How that ties into the capital you have on your balance sheet, and what the three or four options are as it relates to how you're going to capitalize yourself for the next two years. So don't rely on the IPO window being there. But if you have a great grasp of your business, and you're ready to go now, in that same vein, the markets open, right? investors are absolutely looking for new ideas and looking to put money to work. And so the IPO window is not closed, ladies and gentlemen, there is a supply issue, not really a demand issue.
Dan Nathan
Yeah. And then again, just for that investor who's looking for new ideas, looking to deploy capital, what was one thing that you would say as we start to kind of test that market and we see some deals and, I have to assume that there's going to be a lot more tech deals than there were last year, in 2024. What would you say are like some of the key things to focus on for them right now as they as these deals come to market?
Jesse Chasse
Yeah, look the professional investors are, are much better. At sort of determining valuable investments than I am. That's not really what I do, but I can tell you what they are focused on. I think we've gone really to a back to basics approach to tech investing and there's this rubric over time, that has really overworked for building sort of enduring long term successful tech companies. And it's number one, a massive TAM. There's a lot more scrutiny on TAM than there was in the previous cycle, you just throw some big number on a page and move on. That is not the case anymore. A company that has built a differentiated technology and purpose built that technology to attack that TAM. Companies that have differentiated you get unit economics and most importantly, economies of scale. Businesses that have real durable moats, and then finally, which is a bit of an overused word, but it's real, platform opportunities. So you have multiple shots on goal. So that when you're using a discount rate to discount those future cash flows, you can lower that rate because there's a platform opportunity in this business and they're going to have multiple opportunities. That's really how I would simply sum up what's best in class tech investment
Dan Nathan
Well, back to basics. It has been a pretty difficult I think four years for lots of folks in any way you touch the capital markets. And I think a back to basics approach makes a lot of sense. All right, Jesse Chasse. We appreciate your support in the Funders And Founders Series and I appreciate you being here dropping all this knowledge on what we are likely to see in the new issue market in 20/24.
Vito Sperduto
You've been listening to Strategic Alternatives. The RBC Capital Markets podcast. If you'd like more information on the topics discussed today, please contact us directly or visit rbccm.com/strategic alternatives. This episode was originally published by the okay computer podcast hosted by Dan Nathan on February 28, 2024. If you're enjoying Strategic Alternatives, don't miss an episode. Subscribe to us on Apple, Spotify or wherever you get your podcasts, and please drop us a review and or a comment. Thank you.