Key Takeaways:
- Pre-IPO investments can be a core part of the growth equity allocation of your portfolio in all market environments
- Recent indicators support the case for considering adding pre-IPO investments today following the upward movement of public equity markets over the past six months
You wouldn't have predicted this six months ago.
On February 18, we published a post titled "The Pre-IPO Investing Opportunity in a Down Market." The S&P 500 and NASDAQ Composite were fresh off declines of over -7% and -11%, respectively, to start 2016. The stock prices of certain public tech companies had plummeted after poor earnings announcements. Where was a U.S. equity investor to go?
Chart 1: Performance of S&P 500 and NASDAQ Composite Indices
(Feb 16, 2016 - August 31, 2016)
Source: Google Finance
Since the week of our post, public equity markets in the U.S. have rallied (Chart 1), and the tech sector has performed well. The lesson? When making long-term investment decisions, past performance, especially that of the recent past, of an asset class or sector is not necessarily indicative of future results.
Invest. Or invest not.
Investing is filled with over-simplified advice, one of the most long-standing examples being that market timing doesn’t work. While there is a class of investors and traders that would argue against that belief, the fact remains that making an investment is often more important than when you make the investment. This can be true in public equity markets and certainly applies in private markets.
In February, we wrote about pre-IPO investments as a way to preserve value – because private investments are not as subject to the fluctuations that can be caused by market volatility – and as a way to diversify your investment portfolio (see our post “Why Alternatives Should Be Part of Your Investment Portfolio”). How should you think of pre-IPO investments after a period of upward movement in public markets?
Investing for Growth
Pre-IPO investing is first and foremost a growth investment.
It’s been widely reported that market returns are shifting from public markets to private markets. Companies are staying private longer, and names like Uber ($63B), AirBnB ($30B), and Pinterest ($11B) are generating value for their private investors and raising “quasi-IPO’s” – $100M+ private funding rounds.1
Chart 2: U.S. VC-Backed Tech IPOs vs. Private Tech IPOs
Source: CB Insights
One way to capture this upside potential, therefore, is to allocate to the private markets. A recent Cambridge Associates report showed that endowments with more than 15% allocated to private investments have outperformed their peers consistently for decades.2
Chart 3: Institutions with 15%+ Allocations to Private Investments Are Top Performers
Source: Cambridge Associates
With an eye to the future, here are a few indicators supporting the case for pre-IPO investing as part of the growth allocation in your portfolio today:
1. Strong Tech Earnings
Technology was the bright spot in an otherwise lackluster second-quarter earnings season and is currently the standout sector showing promising third-quarter expectations, particularly on the heels of strong performance reports from Alphabet (Google), Facebook, and others. While strong earnings from specific public companies does not necessarily mean that private companies will perform similarly, these are the companies in whose footsteps current private companies seek to follow.
2. Uptick in M&A
Global tech M&A revenue has reached $1.9 billion this year, according to Dealogic. In the past few weeks alone, activity has picked up significantly – both public and private companies are getting scooped up in deals like Verizon-Yahoo, Didi-Uber, Tesla-SolarCity, Walmart-Jet, and Unilever-Dollar Shave Club. Buyers are out there, which is a good sign for growth-oriented investors.
3. Multiple Expansion
Public investors have shown they are willing to pay more per dollar of revenue (or dollar of earnings) for tech stocks.3 This has positive effects on private tech companies and their prospects of commanding higher valuations in any type of near-term exit (acquisition or IPO). Twilio, which went public in June at a revenue multiple of 6.4 and now trades significantly above its $15 per share IPO price,4 is an extreme example.
Traditionally, investors have turned to assets like foreign stocks and real estate for growth. Given current uncertainties in global markets and property values, pre-IPO investments deserve a look.
Sources:
1 https://www.cbinsights.com/blog/private-ipo-tech/
2 https://www.cambridgeassociates.com/news/articles/endowment-portfolios-with-more-than-15-allocated-to-private-investments-consistently-outperformed-peers/
3 https://ycharts.com/companies/NDAQ/pe_ratio
4 Revenue multiple based on company valuation of $1.23 billion at $15 per share and $193 million in trailing-12-month revenue as of March 31, 2016. See:
https://techcrunch.com/2016/06/22/twilio-prices-its-ipo-at-15-per-share-above-its-previous-target/ https://www.sec.gov/Archives/edgar/data/1447669/000104746916013448/a2227414zs-1.htm
https://equityzen.com/path-to-ipo/twilio/
