Intro

The AI revolution has helped fuel the tech IPO sector’s resurgence following a two-year lull. Our Co-Heads of Technology Equity Capital Markets join our Global Head of Fixed Income and Thematic Research to discuss the sustainability of this trend. 

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley.

Diana Doyle: I am Diana Doyle, Managing Director and Co-Head of Technology Equity Capital Markets in the Americas.

Lauren Garcia Belmonte: And I'm Lauren Garcia Belmonte, Managing Director, Co-Head of Technology Equity Capital Markets Americas.

Michael Zezas: And on this episode of the podcast, we'll dive into what's ahead for the tech IPO market this year.

It's Monday, June 17th, at 11 am in New York.

Diana Doyle: And 8 am in San Francisco.

Michael Zezas: Since 2023 only nine technology companies completed an initial public offering, which is one of the longest periods of reduced IPO activity in history. For context, compare that with the all-time record of 124 technology IPOs in 2021. But with the first quarter of 2024 behind us, we're starting to see that picture improve. With tech and AI in focus right now, on today's episode, I want to speak with Diana and Lauren from our global capital markets team to get their take on where the tech IPO environment might be headed and what investors may want to watch for.

Lauren, maybe to start -- what's contributing to this resurgence in IPO activity this year?

Lauren Garcia Belmonte: Well, the market backdrop has been constructive. We've had the SMP and NASDAQ trading up 10 -- 11 per cent this year and multiples have been stable for technology businesses. And against this backdrop, we've seen some IPO issuers recognize that this is a good environment in which to move forward with their IPO event. There are several benefits to becoming a public company, not just the opportunity to raise capital -- but to give liquidity to employees and to early investors in the business, and to set the company up to be a real industry leader as a public company.

So, issuers are seeing the opportunity; and meanwhile, the demand side from investors has been encouraging as well. Investors in the public equities recognize that there's limited opportunity, in some instances, to underwrite growth. Right now, 55 per cent of publicly traded technology businesses are growing top line 10 per cent or less. So, the IPO opportunity, where companies generally have an attractive growth profile, is a way for these investors to get access to an opportunity to underwrite exciting growth profiles -- even when that opportunity isn't so prevalent in the public markets right now.

Michael Zezas: And Diana, do you see the rebound in IPO activity as a durable trend? Maybe take us into 2025.

Diana Doyle: Well, 2024 is definitely going to be better than 2022 and 2023. Now, it'll be a long time before we get back to that 124 tech IPOs in 2021 that you mentioned, Michael. But in an average year, we have about 35 to 40 IPOs, and we expect 2025 to approach more of an average. So, as Lauren said, we're encouraged by the breadth of investor demand for IPOs that we've done this year, and investors’ appetite to take risk. And all that lays the foundation for a healthy IPO market in 12 to 18 months.

But it will be a slow build because IPOs are not a quick turnaround financing. It takes about six months on average to get through an IPO process. So, if you're not already underway, you're likely looking at 2025. In the meantime, we're seeing many late-stage private companies. They have plenty of cash. They're doing secondary raises to provide liquidity to employees and early investors, and they're waiting for growth rates to be more predictable -- for profitability to improve and to get more scale.

So, we're excited for 2025, and the IPO market is wide open for companies that have growth and scale, profitability and that offer investors something different than what's available in the public market today.

Michael Zezas: Got it. And what about macro conditions, Lauren? So perhaps the Fed's pivoting to cutting rates, the overall economic backdrop, geopolitical considerations. How do those things impact the tech IPO market?

Lauren Garcia Belmonte: Yeah, absolutely. The tech IPO market is influenced by these macro considerations -- and it's in a few different ways.

First, of course, and importantly, the valuation impact is real for technology businesses that have a lot of their growth on the come and a higher rate environment. Of course, that future growth needs to be discounted more significantly. The second key impact is around just how these management teams are able to manage, predict, and model out their business.

In a more uncertain environment, it can be more challenging to articulate and defend the forward model that is a part of all IPO processes where you're explaining to the research analysts and investors how your business will perform, as a public company. And, of course, management teams want to set their companies up for success as public companies -- and set up for a beat and raise cadence -- which can be difficult to do when you're dealing with an uncertain macro backdrop.

I think one encouraging signal -- as much as we haven't seen the Fed cut as much as people had anticipated as would have happened at the start of this year -- is that the rate of change has slowed.

So, the rate increase environment was one of the quickest that we've seen; and although we haven't seen the cuts as people had anticipated, I think it's encouraging that that rate of change has adjusted and that will allow for, hopefully, more predictability in businesses going forward

Michael Zezas: Got it. That connection between predictability and rates makes a lot of sense. And it seems that the market's particularly hungry for AI names. Diana, what AI related trends are you seeing?

Diana Doyle: Well, AI is this black hole right now that's drawing all the energy and attention in the private markets. There's this huge enthusiasm because the technology is improving so quickly, and there's an uncertainty how long that rapid pace of advancement will continue. This cycle, in fact, is an exaggerated version of what we've seen in prior cycles, where the monetization typically accrues first to the semiconductors and hardware, then eventually to software. So right now, a lot of the investment is going into the semiconductors and hardware, the picks and shovels, and the fundamental model of research.

But in software, there's still a lot to play out in private companies to create the type of profitable, proven business models that public market investors are looking for. There are big unknowns in how enterprises are going to reallocate spend in a world of AI, what happens with all the efficiency these new tools create, how a lower barrier to entry for software creation impacts margins.

Michael Zezas: And aside from AI, Lauren, what other areas within tech are seeing more activity?

Lauren Garcia Belmonte: I would say that these businesses aren't in a particular spot within the tech landscape, but rather have certain characteristics in that they share -- namely that they are in attractive markets.

Additionally, being a market leader is of critical importance today. No longer do people want to back the third, fourth, fifth player in a market. I think people are really focused on market leadership. So that one or two spot is going to be really important. And investors are looking for businesses that are already scaled. That market leadership typically comes along with a certain scale qualifier. But that is absolutely going to be an important feature of the businesses that are successful transitioning from the private to public markets.

These companies are in the software space and the internet side. So, there's a diversity of companies that have this in common, and that could be great IPO candidates on that timeline that Diana was mentioning.

Michael Zezas: And finally, I'm curious how the political election cycle might have an impact on IPO activity during the rest of this year. Diana, what's your read?

Diana Doyle: Well, we do expect to see some volatility in the pre-election window in the fall, like we do in every presidential election cycle. But what's different this time is that we have a pretty good sense, not only of who the candidates will be -- but also what their presidency is likely to look like and what policies they're likely to prioritize.

So that de-risks the election as a market event materially versus prior cycles. And for the IPO market, any company that's been looking at an IPO in the second half of 2024 has already evaluated pulling it forward to hit the September-October time frame and get ahead of that likely market event.

But there's a narrow window for anyone who hasn't yet pulled the trigger to accelerate. Before the holidays, post-election -- where some IPOs will be able to squeeze in. In practice, most of the companies that aren't already in the pipeline now -- have their eye on 2025.

Michael Zezas: Okay, so, putting it all together, seems you're both pretty confident that there's going to be a durable pickup in IPO activity.

Lauren Garcia Belmonte: That's right.

Diana Doyle: Yes.

Michael Zezas: Okay, great. So, our audience should stay tuned. Well, Diana, Lauren, thanks for taking the time to talk.

Diana Doyle: Great speaking with you, Michael.

Lauren Garcia Belmonte: Yes. Thank you for having us.

Michael Zezas: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen, and share the podcast with a friend or colleague today.