Investment Banking

The tech pulse: Inside the 2024 technology investment landscape

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Pankaj Goel: Hi, you're listening to What's the Deal, our investment banking series here on J.P. Morgan's Making Sense podcast channel. I'm your host, Pankaj Goel, co-head of J.P. Morgan's Technology Investment Banking for North America. I'm looking forward to giving our listeners an update on trends in the M&A and equity capital markets across technology and our expectations on deal activity going forward. Today I'm excited to be joined by my colleagues, Drago Rajkovic, Vice Chairman and Head of Technology M&A, and Greg Chamberlain, Co-Head of Technology, Equity Capital Markets. Drago and Greg, welcome to the podcast.

Greg Chamberlain: Thanks for having me, Pankaj.

Drago Rajkovic: Hi Pankaj. Thanks for having me on the podcast.

Pankaj Goel: As you both know, we had our 52nd Technology, Media, and Communications conference at the end of May in Boston. We had 267 companies in attendance, of which 42 were private and over seven trillion in public market cap. There was definitely more enthusiasm and optimism about the markets this year. The attending companies saw a near 15% increase in their market caps for the past 12 months. So Greg, looking at the equity markets, how do you think the mood is coming out of the conference?

Greg Chamberlain: So overall, I would characterize mood as being good. Equity markets are trading around all-time highs and the tech sector has outperformed this year. As we approach the end of Q2, NASDAQ is up around 15% and that's on the back of a very substantial 43% rally in 2023. There's certainly been some stellar performance concentrated in certain parts of the market. For example, the mega cap stocks continue to do particularly well with several of the largest leading tech platforms like NVIDIA and Meta and Alphabet and Microsoft continuing to outperform the market and their impact on both the tech ecosystem overall, as well as from an investment perspective, their contribution to the performance of these main indices continues to be very significant. From an industry perspective, the semiconductor sector has been the standout winner this year. It recently surpassed software and services as the single largest industry group within the S&P 500 and now represents 12% of that entire index. So it's a part of the market that's had extremely strong tailwinds over the course of the year. The exposure to AI that this sector provides, as that technology continues to trigger significant capital investment, and that remains a dominant theme across the market. And then finally one point I’d just make on software which is an important part of the tech sector. We recently conducted a survey across all our public market tech investors around software and despite some recent volatility and in share price movement in that sector in that space the output pointed to continued optimism around both sector multiples and increased exposure to the sector.

Pankaj Goel: Thanks for that. How do you feel about the deal volumes, which has been 15 and under, indices are at all-time highs? Do you expect more deal volumes for the first half of this year or do you feel it aligns with your expectations?

Greg Chamberlain: It's an interesting question. If you go back, tech IPO issuance peaked in 2021 with 112 IPOs that year. And they came to a virtual standstill for 18 months as we saw tech valuations compress and investor appetite for new opportunities effectively come to a halt. The green shoots of recovery finally emerged in the second half of last year when we saw five IPOs price. We've already matched last year's number in 2024 and there are signs of improvement in activity and most importantly investor appetite. These deals are priced at the top of their IPO price ranges, in some instances pricing above, and despite some mixed fortunes are trading on average 27% above IPO price, so better than the market. What's encouraging is the breadth of issue we've seen in the market this year with deals coming from a range of sectors, including STEM, software, and internet. However the run rate for US tech IPOs is around 35 year. We've seen that for the last decade or so. So we are yet to get back to typical averages despite this big up and activity. When we look forward at our pipeline, it looks strong for the remainder of the year and also next year. So it does feel like this market is gonna see a gradual reopening over time. I think one of the reasons we're not seeing a flood of deals in the tech sector is partly due to the fact that many companies raise money privately in the valuation rich environment of 2020 and 2021, and they're looking to grow into these values over time. Another reason I think is because they've become more disciplined with their cash funds so there's less of a rush to raise IPO capital. A consequence of these two factors is that we're seeing more scaled private companies with an attractive balance of growth and profitability and these issues when they do come will be very well received.

Pankaj Goel: And what do you think has been driving the performance? Some of these IPOs like Astera Labs that you and I worked on have ended up being successful and some others have not fared that well. So what are you hearing from the investors? What are they expecting from the first line of IPO that are coming to the market?

Greg Chamberlain: I think there are certain things that investors have been looking for. Firstly is an ability to articulate a clear and differentiated vision. There is a premium on durability in this market. Investors that understand the competitive advantage that a company has, the sizeable opportunities looking to penetrate is a really important factor as they think about making multi-year investments. Another factor is the expectations that these issuers have set at the time of coming public. Investors look for reasonable expectations both in the short and the midterm, that they think the company can match exceed as they mature in the public market. And then the final point is the amount of time many of these issuers have spent getting to know the investment community. They've ensured that by the time it comes to the IPO roadshow, there's a pretty fulsome understanding of the business, its vision, and a familiarity with the management team well in advance of that final investor meeting, which has led to a strong reaction at the time of the IPO itself.

Pankaj Goel: Got it. So you think pre-education before the deal launch is critical to getting a successful outcome. Thanks for all those views. Drago, let's start with the current tech M&A activity. It's definitely been more robust than '22 and '23. What do you think is driving increased volumes?

Drago Rajkovic: Yes, the M&A activity has been more robust this year. It is up about 20% year to date. And I would say a couple of things that are driving this phenomenon. Number one, we have entered this year with an improving economy. There are expectations that the Fed is going to be very constructive on the interest rate side. And we also have very strong equity markets. That in turn is driving confidence in the boardroom. And having sat a couple of years on the sidelines, many corporates are eager to move forward with their strategic plans. In addition, many of the strategics have also optimized their businesses over the past couple of years and are looking to drive value from incremental M&A gains. So this more positive sentiment has driven both strategics and sponsors to get more active. And we're seeing elevated dialogue across the spectrum of buyers, strategic sponsors, size, except the mega deals. Those transactions we're still not seeing yet in the marketplace. These are transactions 30, 40 billion plus. Companies are still uncomfortable doing those in this environment. And I don't think we'll see any of that until 2025.

Pankaj Goel: Let's pull on the trend a little bit. So we advise Altium on the same earlier this year. We advise HP on the acquisition of Juniper. We also advise Squarespace on Go Private transactions recently. There's been a mix of strategic private equity sponsors and VC firms who are approaching the market. What's the difference in their approach as they look at the M&A as an outcome?

Drago Rajkovic: Yeah, so Pankaj, the strategics are still somewhat resistant in this market, even though a lot of them are seeing their business stabilize and demand stabilizing, and they're feeling more positive about the outlook, there are a number of things that are still holding the strategics back. The investors are valuing profitability more than growth in many instances today. And many of the strategics have been focused on delivering that. So we've seen a lot of companies be inwardly focused and still are. Activism in tech has risen significantly. So making sure your housing order is also important as well. The interest rate and cost of debt are still high and finding accretive deals has been more difficult in this environment. And then investors are still not fully risk-armed, so any transformative or even material deals are a source of risk for investors, and we have seen negative share price reactions for many of the announced transactions. The last thing I would say is regulatory, of course, in certain sectors, especially semiconductors, has been difficult to solve and is chilling the activity as well.

Pankaj Goel: Thanks, Drago. In IPO markets, as you know, success plays in the public domain, but in M&A context, there's a lot that happens behind the scenes. We have seen a lot of deals not getting across the finish line. What are some of the reasons for deals falling apart and not getting to the finish line in your view?

Drago Rajkovic: Yeah, Pankaj, it's still very difficult to get to the finish line We're seeing them fall apart very close to the announcement date as people are moving through diligence and negotiating agreements. First in the approach stage, it is still difficult to bridge the valuation gap and value expectations from the sellers, especially with healthy businesses. We have a strong equity markets and given where that market is priced, you would think that would be easier to do. But a lot of pockets of tech are still recovering in terms of valuation. Number two, the market volatility has also made it very difficult at times to agree on price and has a number of times disrupted already agreed upon deals and taking those offers and premiums out of act to a point where people had to just part ways. Lastly, we're seeing a lot more scrutiny around diligence. The bar is certainly higher, both with strategics and sponsors and certain liabilities that buyers used to accept in the past and nowadays, they just won't. And so overall, while we're seeing a lot more intent, a lot more dialogue, it is still very difficult to get to the finish line.

Pankaj Goel: Thanks so much for that, that’s a really great point. Let's look forward. Greg, we have seen an extremely robust private capital markets, the first half of the year. Nearly $50 billion has been raised this year, which is more than the volume in all of 2023. As you look forward, what do you expect from the IPO markets in '24, balance of 2024 and going into 2025? And more importantly, given this flow of private capital, do you expect the larger blockbuster IPOs to make a comeback?

Greg Chamberlain: Several interesting topics there, Pankaj. I think on the private capital markets, volumes are up pretty significantly year-on-year. The level of interest and participation from crossover investors being those that can invest both in the late stage private as well as public markets has picked up pretty dramatically, and some of the valuations in these deals are up to pretty lofty levels, much higher than they have been in the last couple of years. So it feels like a market that's doing very well. Within that volume, almost half of the equity private-placed issuance has been around the AI sector. Investors very hungry to invest capital in a variety of different opportunities directly connected associated with AI. So that's been a real tailwind terms of the IPO market, I think the pickup in issuance is gonna be gradual. The outcome and receptivity of some of these deals that we've led and we've talked about on this podcast has been fantastic and I think that bodes well for future assurance. As Drago picked out in his commentary, that could also be fueled by the macro tailwinds that we may get from rate cuts that could benefit growth sectors. For many of the larger potential blockbuster issuers, they can afford to be patient. Private markets providing plenty of capital and they are navigating very large market opportunities away from the glare of the public markets. That said, companies have different incentives to go public, both strategic and financial. So I really do feel it's like a matter of time before several of these larger private companies do dust off their plans, start working with banks and the regulators to prepare to go public.

Pankaj Goel: Thanks, Greg. Now let's go to Drago. Drago, you gave a really good backdrop of what's working and what's not working. But if you look at the balance of 2024 and going into 2025, you also have an election year later this year. What are you expecting from the M&A market?

Drago Rajkovic: The M&A market is, as I said before, it's confidence driven. So as long as we have an economy that continues to march towards a soft landing and an easing trajectory by the Fed, I think the M&A market will continue to improve incrementally. This fall with the election, a number of people will wait for that to pass as we all do expect some volatility in the markets and it is typical in that context. However, I do see as we get into the next year and there's a lot more clarity around this economic cycle and how we're going to turn and at what rate we're going to turn, I think the activity will pick up significantly. And number one, the strategics, as I said earlier have been... even though they're looking at more things, they're still reticent to do things, uh, given some of the uncertainties in their own businesses. The sponsors have been picking up in their activity. They're looking at a lot more things. They have still significant amounts of money in their funds.

We're also seeing them putting lot of their assets in the market by necessity. As you all know, their LPs have been demanding some return of capital. And then lastly, they do need to synergize some of the businesses they paid high multiples for three, four years ago. So they're looking to add on complimentary businesses to those assets. And then when it goes to private companies, we are seeing more of them coming into the marketplace. They have been able to buy more runway with their balance sheets than we were expecting. We're hoping to see a lot of privates come to market last fall, early this year. That hasn't been the case, but slowly they're coming to market. The VCs are sorting through their portfolios, trying to decide what they're going to fund and what they're not going to fund going forward. And I think we're gonna see a lot of activity there. We still expect that to continue to be structured. A lot of these assets have had their last rounds to be in 29, 2020, '21, at very early evaluations. So a lot of them are looking for either equity deals or earn outs or partial deals where they can keep some upside and a continuing stake. So overall, I think we're gonna see gradual increase over the course of this year with a little bit of a lull around the election. And then next year, if the economy starts turning slowly, I think we're gonna see quite a bit of volume.

Pankaj Goel: Thanks, Drago. Now, maybe the final question is to both of you. What advice are you giving boards and companies right now when they're thinking about IPOs or private capital markets on M&A? Maybe we start with Drago this time.

Drago Rajkovic: Yeah, sure thing. The key things we're telling to the boards these days is number one, whatever you do, it has to be highly strategic. It has to be very clear to the investors as to what the purpose of that transaction is. And it has to be very clear as to where the value and synergies are going to come from that transaction. As I said before, the market is not still fully risk on and investors get nervous with larger deals unless they're perfectly clear in terms of strategic intent. We're cautioning folks not to go too heavy on the balance sheet. We're seeing a meaningful discount being applied in terms of valuations to the traded companies that have elevated leverage levels. So we are in many cases recommending the folks to go the equity route. And then lastly, we are very sensitive to the terms that any transaction can be affected at. And I'm talking about multiples and premiums 'cause there are only so far you can go with that, even if the value equation works for you, just from an investor reception perspective.

Pankaj Goel: Over to you, Greg.

Greg Chamberlain: Yeah, Pankaj, I think there are several areas of focus that I would recommend any management or board think about as they prepare for either a public market listing or even a capital raising in the private markets. First is to make sure that they have a very clear articulation of the market opportunity, their vision and how they see the company operating over the next five years. Secondly, it's very important to determine the key performance indicators that they want to convey to investors as these will be the quantitative metrics that investors judge them by and through which they will articulate the performance of their business going forward. They're very hard to change once you've gone out with them so ensuring that everyone within the company feels comfortable with the data and the numbers that the company will articulate its success is important. So getting around to meet investors privately well in advance of any raise, public or private, I think is critical.

And then the final thing I just say is companies can't control many of the factors that could impact the timing of their transaction. We've seen that in spades in recent years. So I think there's a real importance on being prepared. You may not be able to choose your exact timing of a transaction, but there is significant option value in being prepared and taking advantage of an appropriate market window. I think looking ahead, we're really optimistic about the next wave of issuance. There are plenty of really well-placed and attractive opportunities in front of us, and we look forward to working closely with clients and bringing many of those to market. Thanks very much for your question, Pankaj.

Pankaj Goel: Thanks, Greg. To recap, today we had a great conversation on trends in tech equity and M&A markets. Overall, we are seeing trends to be more favorable in 2024, and we expect deal activity to continue picking up. Drago and Greg, thank you so much for joining us today.

Greg Chamberlain: Pankaj, great to spend time with you. Thanks for having us.

Drago Rajkovic: Pankaj, thank you for having us today. This was a great discussion.

Pankaj Goel: And thanks to our listeners for tuning in to another episode of What's the Deal? We hope you enjoyed this conversation and be sure to tune in to our next upcoming episodes. I'm your host, Pankaj Goel. Until next time, goodbye.

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