John Kolz
Hello and welcome to Strategic Alternatives, where we uncover new ways to raise capital, drive growth and create value in an ever changing world, with insights and outlooks from RBC Capital Markets. I'm John Kolz, Global Co-Head of Equity Capital Markets at RBC, and I'll be your host today. I'm joined by Chip Wadsworth, Head of TMT Equity Capital Markets, Jesse Chasse, Head of Tech Equity Capital Markets, and Kelsey Baumgardner, Vice President in ECM at RBC. In this episode, we're broadcasting from RBC’s, annual Global TIMT Conference, where we've been speaking to industry leaders, innovators, decision makers, investors and everyone else in the ecosystem, helping to shape the dynamic sector and the equity strategies being leveraged to support its growth. So maybe Jesse, I'll start with you. Anything that you heard that was particularly noteworthy, that you think is sort of shaping the environment?
Jesse Chasse
Yeah, sure. You know, in some ways it's similar to the sentiment that we felt this time last year. You know, broadly, it feels like both investors and companies are more prone to action. There's a broad, post the election in particular, risk-on sentiment, and you're seeing that in certain asset classes, whether it's the run in crypto, whether it's to run this past few weeks in unprofitable software. So I think broadly, sentiment is definitely better than it's been than any other time in the past few years. But last year felt a little bit like a head fake. You know, I think what we saw coming into year-end last year was a broadening of the equity rally down cap, to sort of some of the beaten down names that hadn't really participated year to date. We also saw a little bit more excitement around a bottoming, in particular in the software environment and enterprise spend and the earnings environment there. It feels very similar this year, but I think the broad expectation from investors is it's not going to be so much of a head fake, and there's some sustainability post this tailwind. As we move into a year that's not going to be bogged down by some uncertainty around the election, we're going to finally have a shift in the interest rate environment. A lot of that work has sort of been done and sort of put behind us.
John Kolz
Well, and we always come into this in mid-November with sort of this mentality of investors shopping for their next new idea in the new year. Maybe even more pronounced this year, coming through elections, coming through the macro that we've had. We've obviously got a lot going on around the world still, but Chip maybe for you, how much of the conversation has been with that mentality, getting through some of these huge events that the market's been waiting for and now, looking forward to ’25?
Chip Wadsworth
Yeah, well, there’s no doubt. I mean, first, just looking at the numbers, back to Jesse's point around the buzz that's going on at the conference. This is our largest conference ever, right? Over 1000 people have shown up this year, and in many ways, it's kind of a continuation of the dialog we've been having with investors over the course last three to six months. A ton of people at that conference really looking for, not just kind of the broader ideas and what they can act on, but to your point, thinking about some of those macro items that we wanted to see boxes getting checked, and ultimately free up some opportunities for folks. So definitely having an election out of the way has been really important, and in many ways, if you think about not just who won, but the clarity and the speed at which it was determined that I think, created this upside that Jesse's highlighted. I think saying that, looking into 2025 there are these broader themes around, how does this private market that we've seen being extremely active match up with a public market that hasn't quite yet seen the number of IPOs that we all want to see, the number of follow-ons that we think are out there. Once we start to see that moving in the right direction, I think that's going to really clear the decks for a lot of folks.
John Kolz
I think last year Jesse, we talked about how there was not a demand problem, but there was a supply problem in the markets. And so we're still, frankly, trying to put supply and demand together, but it seems like we're a lot closer.
Jesse Chasse
Yeah, yeah. I agree. You know, look, we've had, what, eight tech IPOs this year on the back of three last year, so better, but still a low bar. And I think that trend will absolutely continue into next year, where we'll start to see a normalization of the tech IPO market. Now, you know, some of the things that I think are a little bit different from what folks are expecting is, you know, I don't think you're going to broadly see a lot of the higher profile software IPOs that everyone's been super excited about. Those still feel like a lot of businesses that, frankly, have the ability, whether it's because of their, you know, large cash balances, whether it's because how active the secondary markets have been, their ability to sort of do tenders, they can continue to wait. But from what we've seen, and honestly, this is even just in the past three or four weeks, you know, we've now got line of sight to eight IPOs next year that we frankly didn't even have three or four weeks ago.
John Kolz
That's right, and you layer into it as well. And Kelsey, I'll throw this to you, we just, of course, did a deal to finance M&A right? And I know that theme has been pervasive all year and sounds like has taken up quite a bit of the airtime today as well. How does M&A drive us in the ECM world?
Kelsey Bumgardner
Yeah, I think one of the things that we've heard really consistently from investors is their desire and willingness to support existing companies fund M&A, or fund strategic initiatives. Long only investors much prefer to be taken out of the market and brought over the wall for opportunistic primary capital raises where there's a clear use of proceeds or some type of catalyst. I think in the month of October alone, we had at least three acquisition related wall crosses across our desk. And the situations that work the best have some sort of established pattern recognition with investors, and what I mean by that is, a track record of successfully identifying, financing, and integrating acquisitions. You just pointed out an example of a deal we worked on last month for a small cap SMB software business going through a bit of a transformation at an inflection point today. We served as exclusive financial advisor and sole book runner on the equity financing. We underwent a pretty extensive and hands on confidential marketing process in order to educate the street, not only on the equity narrative but the acquisition its strategic rationale, and why it was both strategically and financially accretive. We ultimately saw 100% conversion from the wall cross process and upsized the transaction, which I think importantly underscores the fact that there is indeed appetite for small cap growth stories from institutional investors. You don't need to have a billion plus of ARR to raise capital in this environment. And we really did leverage the full RBC platform to deliver a comprehensive set of solutions tailored to our clients very specific needs. And I think the deal showcases our leadership in advising SMB focused tech companies and reflects what I describe as a really seamless cross product collaboration to drive exceptional results.
Chip Wadsworth
Yeah, it was pretty amazing today. I mean, we had across us probably 15 or so, one on one meetings with corporates. At each and every one of those meetings, M&A came up. But more importantly, you know, kind of you think about these bigger trends and these bigger themes, M&A has been stuck. It's been stuck very similarly to the IPO market. And it feels like we're right on that precipice where things are going to start to shift and move. And there are a few things that are important to us. The success of the M&A market will probably beget success in the IPO market, right? Having both of those functioning and functioning well. But then, second of all, when you think about how those M&A transactions are going to get financed, there's no doubt the convert market is going to be really important to that. So entities using the convert product as kind of a war chest. To raise capital and go after assets. 2025, it's probably going to be an element to how we think about convert product overall.
John Kolz
Yeah, with the overall volumes in the capital markets period and ECM being up, what roughly 50% I think converts right similar to that 50% increase in volume, certainly more appetite, and we hear more interest from those investors to do just that, to finance M&A, to finance growth, etc., and that trend will continue. One of the other dynamics that's… I’m interested in your views, and whether this comes up throughout the day, we sort of have this thesis that every deal these days is a dual track, right? We talk about M&A sometimes and IPOs as different things, but most of the time, in particular for private equity, they're always deciding, should we go public, should we sell, and oftentimes running those right next to each other. So I guess the question in there is, do you see that trend continuing? We're starting to move into our prognostication part of the program here of how we see ‘25 rolling out. Do you continue to think that that's the case, that every transaction is a dual track?
Kelsey Bumgardner
I mean, the truth is, we've seen more tech companies taken private this year than gone public, so our M&A team has been a little bit busier than us. Hopefully that changes in 2025 but Squarespace and PowerSchool are two businesses that we took public less than three and a half years ago, back in ’21. Both sold to private equity firms. We advised Advent this year on their $6 billion plus take private of Nuvei, a global payments platform. That deal actually just closed last Friday. And so, unsurprisingly, we've gotten a lot of questions from corporate and private equity clients around the IPO path, and we're having many more dual track conversations as boards, management teams, existing investors weigh their exit alternatives. It feels like DPI is kind of the word of 2024.
Chip Wadsworth
As it was the word of 2023 and will be for 2025 but, it kind of goes back to… there is now a reality to an IPO, right? Getting a business public, it's definitely has not been a demand issue. It's a supply issue. But having the conversation around a dual path, you can have a very, very credible discussion with a potential seller, around what an IPO can look like, versus what an M&A transaction looks like, because both those markets are starting to come together and starting to function.
John Kolz
Well, Jesse, I know you had a big piece out earlier this year trying to dispel one of the common misconceptions in the IPO market regarding size and what scale you actually have to be. I suspect the debate still rages though on growth versus profitability versus scale. How do you how do you see that evolving? And what are you hearing from investors?
Jesse Chasse
Yeah, I think, look, the first thing to address is this question of what revenue scale do you need in order to get public in this market? And there's this narrative that's been really strong in the valley, and really has not slowed down, even as the market has gotten better. You know, over the past, call it 12 to 24 months, that all of a sudden you need massive scale to get public in the US markets. You need, you know, upwards of a billion dollars of revenue. And the reality is, you know, our view is that it's just plain wrong, right? So we did a ton of work and dug in and, you know, looked at things like, what's the correlation between revenue scale and valuation across all tech companies? The answer is there's zero. What's the correlation between revenue scale and post IPO market performance for the 2021, and 2020 IPO cohort? The answer is there's zero. We then scan sort of the universe of small cap investors and just, you know, ask them, like, what are you looking for, for a company to get public? And the reality is it's nowhere near the 500 to a billion dollars that sort of some of the prognosticators are speaking about. I think what those investors are looking for is a substantial enough float and market cap such that there's sort of enough liquidity and not too much technical overhang on the stock that it could trade sort of on fundamentals rather than on technicals. And you know, the reality is, is that market cap tends to be closer to a billion to a billion and a half, which would sort of imply a, you know, revenue base of 100 to 200 million, versus 500 million to a billion. And so, you know, we think that's, frankly, a misconception in the market. We think that will start to cure itself as there's just more deal activity, which will beget more deal activity and encourage some of the smaller issuers to enter the market. But the answer there is, it's just not right.
John Kolz
It might also be a leftover of the fact that the IPO calendar, even in tech, has been dominated by that activity, right? That just is by definition bigger, a little bit slower growing, certainly more profitable. And what has been missing is the traditional venture capital backed IPO, right? So what are you pivoting that regard? Is that something we see reinvigorating the IPO markets?
Chip Wadsworth
100%. Now saying that the eight or so IPOs that Jesse has highlighted, they're definitely more angled towards private equity. So those will be the first ones to come. But the venture community, up until now, our view, has been the difference between what's happened in the private market and where they raised capital for those private entities versus what could be garnered in the public markets. That delta has been significant enough that it's held a lot of folks back from being public. We think that's starting to thaw. You're starting to see multiples shift up in the software space in particular, which will help many of these businesses. Their models have improved as well. So you start to put those things together, and that should drive venture moves into the marketplace. Now saying that, look, our view is this growth versus growth with profitability question, that's got to play itself out. Rule of 40 is really important. There's no doubt about it, and that's going to be a watch word for folks. But the classic growth IPO, where there isn't profitability and there isn't profitability for a little while, that's probably going to be there. There’s going to be a few of those coming out in 2025 because back to Jesse's point, growth assets, risk on, that mentality is in the marketplace right now. You start bringing a few growth assets into the marketplace, growth IPOs, our sense is those will garner a lot of attention.
Kelsey Bumgardner
Especially because there's a scarcity of growth companies in the tech public markets today. I mean, we have a dashboard of 400 plus public tech companies that we track. About half of them are in software. There's less than 10 that are expected to grow more than 25% next year. Said another way, 85% of public software companies today are growing less than 20% and so the IPO market, you know, remains a really important opportunity and avenue for investors to underwrite growth stories that are absent today.
Chip Wadsworth
Yeah, I think saying all that, we definitely have to see the buy-side come over to that side, right? We have not seen it yet. You kind of go back to rule of 40. Our analysts just put out free cash flow per share as a an important KPI for them. So if you kind of think about it, they're really looking for other areas to measure profitable growth, instead of just going down the path of growth at all costs.
John Kolz
Okay so scale, profitable growth, having a combination of private equity backed and venture capital backed. What sectors do you see being the most active, right? You can't go five minutes walking anywhere without hearing AI and AI derivatives, right? But as I hear you all talk, not sure that's leading any IPO market out right now, right? It may be more of the fintech and other traditional sectors. Where are you spending most of your time?
Jesse Chasse
Yeah, there will be some of that. I actually think the more infrastructure, picks and shovels assets, you know, and this has sort of changed quite a bit in just the last six months, I actually think we'll see some of those IPOs next year. There will be a lot of demand for those IPOs. You know, I think look what everyone expected would reopen this IPO market is software. I actually don't think that's going to happen next year. I think based on the activity and discussions we've been having, there will still be a good bit of sponsored backed, sort of more moderate growth IPOs. I think there will be quite a few fintech IPOs, and a pretty diverse pool across fintech of, sort of more the direct to consumer, and then also the B2B models. And then I think within software in particular, you know, there will be, you know, IPOs, but it'll be skewed towards sort of cybersecurity and infrastructure, just because the earnings environment in those sectors has been much more stable. But again, the big marquee IPOs that the market has really been waiting for still feel like they’re 2026 events. That being said, I think there will be a lot more supply and diverse supply, quite frankly, for investors to choose from next year.
Chip Wadsworth
Diversity across sector and diversity across cap.
Jesse Chasse
Cap, yeah, that's right.
John Kolz
And what is the current thought on again, we're circling back to our time here in being a couple weeks post-election and trying to absorb everything with the new administration. There is some view that the path to IPO, frankly, the path to M&A gets easier in some ways, in a more lax regulatory environment. Do we think that is any call to action from some of the owners here who've been waiting in the sidelines, waiting for some of this? Do we think that is the catalyst or, one of the catalysts, that sparks activity?
Chip Wadsworth
I think it's one of the catalysts. But again, it's, it's more like that box has been checked. We know who is in office. We know kind of the mentality that they're going to go after. It ultimately goes back to fundamentals, strategic outcome, and, quite honestly, the relationships at the level that are making the decisions. Those are going to be the real catalyst to getting things off the ground here going forward.
Jesse Chasse
So, it's much more than just the M&A environment. I think there's a broad expectation that the economy will be better in a deregulated environment.
Chip Wadsworth
But saying all that, we have to watch what the 10-year is doing, because there is definitely this underlying concern that the new administration is going to push things in ways that either the market doesn't understand or it understands and it doesn't necessarily like, and that's why you still see a 10-year with a four, kind of mid four handle on it, and you even see it inch up after the Fed takes rates down. So, all of this is super, super positive, but I think the market is telling us, let's be mindful of what the backdrop looks like at the first six months of this next year.
John Kolz
Well, and the name of our podcast is Strategic Alternatives. And I think what we're seeing is that there are lots of alternatives out there. One of the ones we haven't talked about that is, certainly what weaves its way into everything is the private markets. We talk a lot about the fact that the IPO used to be a financing event. Rarely these days is it a financing event in terms of providing growth capital. Companies can get access to all the capital that they need privately, and it does raise the bar a little bit for what do you get in an IPO? What's it for? But maybe Kelsey, I'll kick it over to you as you think about the strategic alternatives. How do you see, as you're talking to clients, investors, the private markets, finding their way into those discussions?
Kelsey Bumgardner
Yeah, I mean, I think as a team, we're spending a lot more time with private clients and talking through what a potential crossover round would look like. We have a couple of mandates that we're working on right now and managing expectations in terms of value and narrowing down the investor universe. And so I think that's another reason that we haven't seen the same level of IPO activity, is there's just a much deeper secondary market for some of our corporate clients to provide liquidity to their existing employees or investors. But we're spending a lot more time in the private market. I think, in terms of crossover investors, I think it's a natural place for some of our clients to find a really strong stamp of approval from a large pension fund, a mutual fund complex, sovereign wealth fund, who can support the business 12-18 months in advance of an IPO, and then maybe even come and participate and be on the cover on the S-1. That's one of the major tactics we've seen emerge over the past couple of years, is issuers and sponsors finding ways to de-risk transactions. Most recently in tech, we had the Ingram Micro IPO last month. Capital World was on the cover of that for around 18% of the deal. Back in the spring, we worked on the Waystar IPO, which was the first HCIT IPO in three years, and they launched with Newberger Berman and QIA on the cover for about $225 million. And so de-risking continues to be top of mind, accessing the private market and, having conversations with investors, you know, not just during the roadshow, not just during the testing the waters process, but building that dialog months and years in advance.
Chip Wadsworth
Yeah, it's interesting, all of these private situations that we're working through right now, the sellers, they want to know what the next step and what the connection is to that IPO. The investors that you're talking to, not only are they investors that the market will respect and will respond to positively when the business goes public, but to Kelsey's point, will they actually then participate in that transaction? That is very central to a lot of the decision making and the targeting work that we do during the course of these private exercises. It just goes back to the fact that each one of these steps, they're linked. They're linked in the context of how people make decisions, and they're linked in the context of how entities are valued, and then ultimately how the liquidity is actually created.
Jesse Chasse
Look, many of these companies have actually gotten themselves profitable as private companies. And with that, I think the spectrum of alternatives that you can use to finance yourselves as a private company has really broadened out. And so, the conversations, sort of from an advisory perspective, that we've been having, have focused a lot more than in the past, around sort of cost of capital and how to think about the spectrum of debt to equity and financing either sort of CapEx cycles, M&A, etc. You know, whereas previously it was like, what does the pre-IPO and round look like that? That is not where those conversations start these days. It's much more broad from a sort of capital alternatives perspective.
John Kolz
Chip, when we're talking to private equity sponsors, I think we're seeing them be as creative as they have been in a long time with the alternatives that they have, right whether it's thinking about margin loans or using derivatives to get out of positions or really everything in the toolbox. What are you seeing there?
Chip Wadsworth
So and this is a this is a theme and a trend that's started years ago with a small group of sponsors, where whether it was DPI or just trying to manage their returns and thinking creatively, we saw a few folks, especially out on the West Coast, working with our team, the SES team, on effectively putting into place derivative structures that enhanced their overall investment in a business. What's played out over the course of the last couple years is the number of sponsors, looking at those types of structures and securities. It's ballooned to a significant, significant amount, and then ultimately, the products themselves and the creativity, especially from our team, in what they're able to provide those sponsors as it relates to solutions. And so your question about creativity earlier, it isn't just go into the public market with an IPO and then follow up with a couple follow-ons and or blocks. It's, let's think about either doing something pre- IPO, or when we structure the IPO, let's make sure that that sponsor has some flexibility on where and how they can monetize those shares. And then once the entity is public, let's really think creatively about putting that that into motion. And so we anticipate that playing out on a go forward basis. And again, it's not just going to be in the context of new issuances, we're starting to see it back on the M&A side in a number of M&A transactions. There's one publicly announced M&A trade that's taken about 12 months to close. Sponsor gave us a call to find out specifically, what can they do during the course of that period of time between now and close to effectively create the returns to their shareholders or hedge either with a margin loan, etc. So that theme is not one that's going to go away.
John Kolz
Obviously something very important to the way we at RBC run our business as well. There's a reason we have our structured equity solutions business, which includes margin loans, which includes call option overrides and variable prepaid forwards and converts, all within equity capital markets, because it's so important to how owners and companies are thinking about their position.
John Kolz
Chip, Jesse Kelsey, thank you so much for joining the podcast today. This has been hugely informative.
You've been listening to Strategic Alternatives, the RBC podcast. This episode was recorded on November 19, 2024. Listen and subscribe to Strategic Alternatives on Apple Podcasts, Spotify, or wherever you listen to your podcast. If you enjoyed the podcast, please leave us a review and share the podcast with others. Thank you.