Barclays found that on average the share price of companies that held an IPO on Wall Street last year fell 28%, while the average share traded on the S&P 500 Index rose 16% (between January 2021 and the end of January 2022). Barclays Israel country manager Ilan Paz said, "In terms of the capital market, an IPO is an asset class investment option, the riskiest that institutional investors can make on the public market. They can invest in bondsand veteran companies or they can take a gamble and invest in new companies that have held an IPO.
"When the market is directed towards growth at any price, and the appetite for risk is large, many flock to IPO investment options that are by definition the most dangerous. When there is rotation and the focus switches from growth shares to value shares, the IPO investment option suffers more than the long-established companies."
Does that mean we will see less IPOs and more modest multiples than in 2021?
"Both. But I think that it is important to take into account the point of reference. If we look at the first half of 202, it was the peak of valuations and multiples that we have never before seen. But that isn't an accurate way of looking at it because even if the number of offerings returns to the average of recent years, it would be a decline compared with 2021."
Is it more accurate to look at 2019, before Covid?
"Yes although there are all kinds of cases in different sectors but on the whole to valuations similar to valuations before Covid. They weren't cheap but not like at the beginning of 2021. From a broader perspective, over time, they are similar, if not higher than those two or three years ago."
Has the volatility in the market and the fall in tech shares reduced the appetite of investors to take part in IPOs?
"I don't think that to define it as losing appetite is right but the pricing will certainly suffer. Good companies will succeed in conducting IPOs but not at the valuations of the beginning of 2021. Companies that are built more on the model of 'we'll grow and the profits will come later' will find it more difficult. Some of them will succeed in convincing investors and some of them won't. So there will be less IPOs but it is not very fair to compare.
"Interest is growing in the ESG sector"
Are there sectors that are more suitable for IPOs today?
"There is a lot of interest in ESG sectors. Companies in alternative energy, electric vehicles and all things that have that sort of angle are relatively more interesting to IPO investors than in the past. The view is not only about money and financial data but also how it helps the world to progress, and so the interest in these companies is higher, relatively speaking, than it was in the past."
What about SPACS? There are many SPACs with money that they have raised that need to find a company to merge with, or they will be forced to return the money to the investors.
"This will be more and more difficult. The money that the SPAC has raised comes with a very big 'if.' Whoever invests in a SPAC has to agree to the investment at the valuation at which it is carried. If the SPAC reaches an agreement with a company according to a valuation that the SPAC investors don't agree with, the SPAC money is theoretical, because the investors can redeem their investment. In my estimation, there will be many SPACs that don't succeed in finding companies to merge with at a valuation that the investors will feel comfortable with and they will need to give back the money."
What do you expect to happen with the SPAC mergers that have already been signed? Will we see more reductions in valuations?
"I estimate that we will see a little bit but ultimately most of the deals that have been signed will be done. There is enough interest and enough money to support this and there are valuations that have already been agreed. So it's possible that there will be a certain erosion in some of the valuations, in order to adjust them to the market, but the chances of completion are higher than for those who are still seeking a deal."
If there is a decline in the number of IPOs and SPAC mergers, does that mean there will be a rise in mergers and acquisitions?
"This is a more complex question. People tend to think that if a company has raised a lot of money and is sitting on a pile of cash, then we will see more M&As. The problem is that an M&A is also a psychological matter and when the valuation of the company to be acquired falls, there is less of a tendency to spend the money quickly.
"At the same time, the companies that are a target for an acquisition saw different valuations six months and a year ago and they won't be in a rush to be sold at today's prices. What is usually seen after a period of very great volatility in the market is definitely a slowdown in M&As, and then slowly there is an adjustment to the new situation. So to the question of whether there will be more M&As in absolute terms in 2022 than 2021, my answer is no but whether there will be more M&As than IPOs, I think that the decline in the number of IPOs will be larger, so that relatively speaking the answer is yes."
"The private market reacts more slowly
An interesting phenomenon that Barclays points to is the gap created between the private market and the public market. Investments in the private market stayed strong throughout 2021, even when the publicly traded market began to "creak" the number of venture capital fund investments of more than $100 million jumped.
The valuations and the multiples of privately-held companies stayed high. How do you explain this dissonance?
"The stock exchange reacts in a very quick way and the ups and down can happen in a space of hours and days, while the private market reacts much more slowly," Paz said.
"Even the stock exchange rises in 2020-2021 took place more quickly and the private market took more time but it rose and I expect it will be the same in the opposite direction, so that the dissonance is temporary. In private financing, to agree to a down-round, (raising money at a lower valuation than the previous round) is not something that happens a lot and takes place only when the company has spent all its money.
"Private funds, especially the big ones that invest in pre-IPO rounds, invest the money in relation to the public market. They invest in companies that they estimate that in two to three years will hold an IPO and they conduct analyses to examine what will be the market cap of the company in the future. They want to get back two to three times what they are investing and they derive the valuation from this.
"But how do you decide what will be the valuation on the stock exchange in two to three years? You take the multiples of today, so that if the reference point is the price on the stock market, and it is 30%-50% lower, so this will also be the case on the private market, which cannot be unconnected."
"The valuation in Tel Aviv is a point of reference for Wall Street"
Several companies traded on the Tel Aviv Stock Exchange (TASE) have recently announced plans to list on Wall Street. Some of them (Nayax, and SaverOne) have even filed with the US Securities and Exchange Commission (SEC). Without relating to this or that company, Paz commented. "This was always the case that if a company was of the size and a sufficiently interesting valuation for Nasdaq, then why not, and if in earlier stages it holds an offering in Tel Aviv. I think that there are companies that have grown and want to make the move from the TASE to Nasdaq."
In such cases, does the valuation of these companies in Tel Aviv represent a marker for the valuation that they can receive on Wall Street?
"We are grappling with this question each time such a company comes to us. I don't know whether I would define it as a marker, but it is a point of reference that cannot be ignored. When private companies come to us we work according to multiples on the DCF model and set the valuation ourselves. Here, we can try to decide but there is a point of reference and international investors are also looking at that.
"Companies cannot list on Nasdaq and trade on the first day at triple the valuation in Tel Aviv. That simply doesn't happen. You have to come with realistic expectations and understand that at the start the price will be about that on the TASE and after they will prove themselves, then the valuation can be much higher."
Published by Globes, Israel business news - en.globes.co.il - on February 8, 2022.
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