Dynamic Times in Capital Markets

[MUSIC]

Carly Roddy: Incredibly dynamic times in the capital markets. This is Carly Roddy, Head of J.P. Morgan's West Coast Private Capital Markets team. I'm excited to be here today and I am joined by Mike Millman, Global Chair of Investment Banking at J.P. Morgan.

Michael Millman: Carly, thrilled to be here today. Certainly interesting times and look forward to sharing our perspectives.

Carly Roddy: We will be unpacking two topics in today's podcast; IPO sentiment and private capital markets. Let's dive in. Mike, I wanted to start with a question to set the table. What is the lay of the land today in IPOs?

Michael Millman: So, in terms of initial public offerings, 2021 was an incredibly active year. 300 plus IPOs verse this year, 15 IPOs. Last year, the composition was almost 50% of the activity was from technology companies. Contrast that to this year where there's only been one tech-oriented company to go public. This year has been represented by financial companies, healthcare companies, and energy companies. And what we expect in 2023 and 24 is to see the full composition of industry representation return.

Carly Roddy: Given that, what are some of the factors impacting the pause in the IPO market?

Michael Millman: Both market uncertainty and volatility are impacting the IPO issuer and buyer mindset. Inflation, interest rates, quantitative tightening, GDP growth, credit market conditions, and geopolitical challenges are certainly amongst the top factors that people look to when they think about what's causing the pause in the IPO market. On the flip side, the encouraging elements in the backdrop heading into a hopefully a stronger 2023 IPO market, the underlying strength of the US economy, corporation balance sheet strength and some of the labor market metrics.

Carly Roddy: Mike, I know we've seen a lot of predictions about when the IPO market will be open. From your perspective, what needs to happen for IPOs to make a comeback?

Michael Millman: The factors that I think will be the most important for both issuers and the buy side; one is volatility. Right now, it's elevated level, certainly north of 30 times versus historical levels of sub 20 times. And the best metric to look at is the VIX index. The second is multiple stability. So when you think about how those companies are valued, the multiples and outward years, they have been seeing a lot of variability. When they continue to stabilize, that will give the buyer base the confidence they need. Also confidence in forecasting, both by the issuer and the expectations the buy side will have. And then lastly, how the prior IPO is performing. Those are typically the most important factors. The precursor for the IPO market tends to be how receptive and strong is the secondary follow-on market. That market saw significant issuance in Q3. That, we hope, is a precursor heading into 2023.

Carly Roddy: Mike, I wanted to touch on one of the points you raise, which is the buy side. Obviously, a critical component of the overall market. Can you tell us today what the buy side is focused on?

Michael Millman: There's probably three areas the buy side is most focused on; the durability of those business models, the consistency they have in both top and bottom line performance, and then thirdly the sustainability of their margins, particularly in the outward years, depending on what economic backdrop people want to forecast. Soft landing, hard landing, anything in between. Understanding the durability of those businesses is probably the most important component to reopening the market. So, Carly, in the private capital markets, there's certainly been no shortage of activity. How would you characterize the private capital markets today? 

Carly Roddy: Mike, if I leave you with any takeaway today, let it be that private capital is available. There's almost $2 trillion of dry powder in private equity and venture capital funds sitting on the sidelines, and a lot of that capital will have to go into minority investments. However, that capital is now more expensive, likely more structured, and coming from different investor bases than it has in the past. As we look back, 2020 and 2021 were both incredibly strong years from a capital raising perspective. But 2022 is actually holding up pretty well. The private markets this year have become critical sources of funding while the IPO market is finding its footing. And we've seen over $200 billion in private placements raised this year versus about $13 billion in IPOs. We've seen large deals get done in the private markets. About half of the private placements are over $100 million in deal size. And so far we've only seen fewer than 10% of capital raises as down rounds. We credit this the flexibility of the private capital markets where there is additional room for negotiations on terms versus those in an IPO. And issuers and investors can craft solutions to meet objectives more efficiently than in scenarios where you are issuing common stock.

Michael Millman: Hmm. And what do you think has changed with respect to private transactions to make them successful?

Carly Roddy: There's a few deal dynamics worth highlighting. The first is diligence. We are seeing investors spending increasing time on diligence and deals are taking longer as investors dig into business plans, cash runway, and modeling out very different upside and downside scenarios. Gone are the days of raising $200 million rounds in two weeks, that's for sure. Second would be valuation. You know, private market valuations are now being compared to where the public market comparable are trading in the current market environment. There is the ability, though, to bridge that perceived evaluation gap with structure. Which leads me to the third deal dynamic that has changed, which is terms. This is probably where we are seeing the most evolution since 2020. While some deals are getting done at what we could call, 'clean terms', many are with structure in today's market and investors are requesting contracted returns via mechanics such as dividends, guaranteed multiples of invested capital upon exit, to protect their downside. And this is likely a function of the types of investors that we've seen be more active in the 2022 private capital markets.

Michael Millman: And how would you characterize the buyers in the private markets today?

Carly Roddy: Let's break down the categories. Crossover investor participation or investors that can buy both public and private securities has decreased for a few reasons. First, they are more focused on their public market portfolios that are trading at discounts to 52 week highs. Second, preference for more liquid investments. And third, fund mandates that focus on cleaner equity versus debt like structures. So if they're a little bit less active today, we are seeing growth equity and private equity funds continue to participate at high rates as well as structured funds that were more on the sidelines last year be more aggressive and more active this year. As terms evolve to contracted returns and avoiding straight equity risk, they definitely see opportunities in this market. And then lastly, family offices and sovereigns, and pensions continue to participate in today's environment. However, they are also focused on their current portfolios and public equity trading performance. Now that I've discussed the buyer base that's active in the private markets, Mike, let me turn the tables back to you. What can private companies be doing in this period of volatility and uncertainty?

Michael Millman: I think there're probably three best practices private companies ought to consider doing in this time. One is stress testing both the business model and importantly their forecasting efforts. When they think about various economic backdrops, we've heard the bookends, soft landing, the hard landing. How is your company able to forecast the outward years and the outward quarters in light of what may or may not happen is number one. Number two is analyzing both the balance sheet needs you might have as well as potential insider or employee monetization needs and thinking through that in advance. And then thirdly, on the back of that, what relationships ought you foster on the buy side and across VCs and private equity firms and sovereign wealth and family offices to have that type of robust relationship network to capitalize on in either a case where you raise primary capital or help facilitate secondary sales. 

Carly Roddy: Mike, we're really excited about something the firm is doing to further help private companies. Can you describe our initiative Capital Connect?

Michael Millman: Sure. Capital Connect is a digital capital raising platform for earlier stage companies. So think about from seed to series-A, to series-B, to series-C. It's a platform where issuers and investors will be able to network, and access and deploy capital. It's a self-service approach, which is powered by AI tools, and it will have data and insights that offer transparency at every stage of the process. And it's underpinned by a digital capital table effort, based on the recent acquisition of Global Shares, which is to help manage employee ownership and liquidity. It is a very exciting initiative. 

Carly Roddy: Thanks Mike. And as we wrap up, we wanted to leave you with two points. The first is the IPO market while quiet today will absolutely reopen and when it does it will happen swiftly. Our best advice is to start getting ready and be prepared. And second, there are plenty of paths to liquidity whether for primary capital, employee tenders, or insider monetization, many opportunities lie ahead for capital formation. 

Michael Millman: Carly thank you for those insights and thank you all for joining us on this episode of What's the Deal. Stay tuned for the next episode. Thank you all.

[END OF PODCAST]