Beware, unicorns may not be what they seem. Who knew?
According to Victor Basta of Magister Advisors, the markets ‘exit 2015 with an overall flat but worryingly cautious tech market. We expect to exit 2016 with valuations having reset, greater instability, and the key tech companies and investors being far more cautious about where they place their bets going forward. In other words, 2015’s reality distortion field should dissolve back into plain reality – and not a moment too soon.”
“The S&P 500 is ending 2015 pretty much where it started. Yet all is not stable in the technology industry. 2015’s extremism is setting the stage for a turbulent, and unstable, 2016.”
Magister Advisors’ key 2016 predictions for the global technology industry are as follows:
1. The vaunted IPO market will be distinctly quiet
Victor Basta said: “IPOs come in waves, and all signs point to a quiet sea next year. Interest rate rises coupled with macro/political uncertainty will give an already unsteady IPO market serious vertigo. Box, Theranos, and Square join a trend likely to continue. In fact 2016 will simply reflect years of poor tech IPO performance; since Facebook’s May 2012 IPO, tech IPOs overall have returned only 7% in a period when the S&P500 delivered 60%. Public investors eventually tire of poor performance.”
2. Unicorn valuations will compress
The vast majority of the 150 unicorns are high quality, sustainable companies; the problem is valuation not quality. As 2015 ends, the aggregate value of the Unicorn class is half a trillion dollars. Fidelity’s Snapchat write down and the Square IPO re-pricing are the valuation “iceberg tips.” Applying a Square-like adjustment to the Unicorn stable implies a disconnect in the aggregate valuation of approaching $200 billion. Since many unicorns are funded to their next round, not to break-even, we expect a large number to be re-valued lower during 2016/2017 as they are forced to raise money. This will hurt the Series B and C investors and founders in these companies more than anyone, as they get squeezed between original angels with low in-prices and last round investors with downside shareholder protection.
3. Unicorns will raise less than they expect; layoffs are inevitable
Many unicorns have no choice but to begin managing to break-even, not to a next round or IPO. This means a hard look at staffing, and inevitably the weakest 10-20% of their workforces will be looking for their next job unexpectedly early.
4. A unicorn (or two) will blow up in 2016
Fab.com showed how to go from a $1 billion value to a $15m fire sale in 12 months. While the story since Fab has been of successful exits like Twitter, WhatsApp, Tumblr and others, we believe at least one Unicorn from the e-commerce or FinTech sectors will follow Fab.com’s “exit route” into bankruptcy, either during 2016 or shortly after.
5. The financing chill will cascade down to the mid-tier.
Unfortunately market downturns are rarely contained, and the biggest losers of a decelerating market will be the “Unicorn aspirants” aiming to raise $15-50m at $100-500m valuations. As IPOs go quiet and Unicorns get marked down, these aspirants will only raise a fraction of what they seek, and will do so at lower valuations than their investors ever expected. If an aspirant hasn’t already raised enough money to see through the next 3 years, they may well get caught in the storm.
6. Valuation resetting will quiet the M&A market temporarily
Expectations take time to reset, and always lag reality. Many investors will not accept a new (lower) normal, until at least 9-15 months have passed. Meanwhile there will be an imbalance between seller price expectations and what buyers are prepared to pay, taming the M&A market while price expectations re-align. Ultimately though more reasonable expectations will drive even greater M&A activity into 2017-18
7. Safety and resilience will shift attention to B2B models and away from B2C.
Scaling a B2C business has been the rage these last few years. However, nearly all such businesses focus their first years on gaining audience reach, then deepening engagement, and only afterwards shifting to monetize their (significant) investment. A harsher funding market means investor preference for stable earlier revenue, inevitably shifting attention to more “boring” B2B businesses. Whether in e-commerce, fin-tech or SaaS, we expect a valuation shift towards B2B during 2016 and beyond.
8. Within FinTech, payments and Blockchain will be the most active segments
2015 saw large financial institutions accelerate their pursuit of blockchain initiatives, and we will enter 2016 in a ‘race to production’ with vendors and FIs alike, vying to see who can be first to reap the benefits in actual deployment. Our views on the evolution of the space and potential investment opportunities are highlighted in our 2016 Bitcoin & Blockchain Landscape & Outlook. Payments has gone from “boring” to “disruptive” in a very few years, and we see a range of larger players from PSPs to alternative payments giants continuing to broaden their offerings as they seek to capture margin and customers.
9. Valuation compression will help drive SaaS M&A.
Many SaaS M&A deals don’t happen as a result of sellers’ expectation of 5-10x revenue (based on their last inflated round value) and buyers’ unwillingness to pay more than 3-5x. We see that gap closing quickly through 2016 as money becomes tighter and loss-making SaaS businesses start to see the go-alone vs. M&A trade-off differently. We believe there is high latent M&A demand for quality $25-100m revenue SaaS businesses, and the 2016 environment will catalyze many deals “waiting to happen.”
10. Private Equity will represent 30%+ of tech M&A activity above $100m.
The buyer group with $1 trillion of “dry powder” is the group of PE sponsors. PE firms will continue to feature prominently in $100m+ deals, and we expect these sponsors to deploy their capital aggressively as valuations re-set.
11. Far fewer VCs will raise $100m+ funds in 2016.
It has become relatively easy for VCs in the US and Europe to raise $100m funds these last few years, as their investments have been re-priced up repeatedly. A softening valuation environment inevitably causes LPs to rein back VC commitments, especially outside the US. Perversely, this will happen in 2016 even as VCs enter a far more attractive investment environment where quality companies will look for money at reasonable prices.