Last week, we saw two successful IPOs: Astera Labs and Reddit, breaking a six-month dry spell since ARM, Instacart, and Klaviyo went public in September of last year.
These three “2023 IPOs” were supposed to re-open the IPO market after nearly two years of dormancy, the longest in recent history, but failed to do so.
Will this time be different?
Will the stellar performance of Astera and Reddit finally re-open the market for the 35-40 Israeli private unicorns who are quality “IPO material” and ready to join the ranks of public companies over the coming 24 months? Let's break it down...
It is common for the IPO window to shut down post-bubble burst. This was the case after the internet bubble in 2000-2001, the credit and real estate bubble in 2008-2009, and most recently, after the end of 2021's ZIRP era bubble, marking nearly 14 years of virtually zero interest rates.
However, unlike past crises, this time we saw a prolonged closure period as the conditions for a robust IPO environment were not yet being met.
For a healthy and functioning IPO market, a few conditions are needed.
We have observed significant macroeconomic instability once inflation kicked into high gear at the end of 2021/beginning of 2022, resulting in the Fed embarking on an unprecedented rate hiking regime. This had a chilling effect on stock prices, valuation levels, and investor appetite to buy new stock issuances.
At present, the macroeconomic environment is meaningfully better than it was a year ago. US GDP growth is forecasted to be double the rate from this time last year. Additionally, the interest rate outlook is markedly different than at the beginning of 2023. Previously, three hikes were still expected, whereas now, the consensus is for three cuts in 2024. Inflation is finally getting under control, steadily declining towards the Fed’s 2.0% target, and recession probability and prospects for a hard landing are down to 15% from 35% this time last year.
While the S&P and NASDAQ indices are currently at record highs, this alone isn't adequate. Another crucial factor is tempered volatility as measured by the VIX index. For an IPO market to flourish, the VIX needs to be consistently under 20, (or better yet) under 15. At present, it stands at 13 and has been in this territory since November 2023. In contrast, the VIX averaged 25 from November 2021 (when the stock market correction started) till end of 2022 and declined below 20 only in March of 2023.
We witnessed a remarkable valuation re-rating since November of 2021, where the median multiples of software companies got slashed by 50-75%. The second half of 2023 saw stabilization in multiple levels and over the past few months, medians of all growth tiers have been steadily climbing, serving as a solid reference base for new transactions to come.
While ARM and Instacart are now trading above their issuance price, this was not the case in the days following their IPO. Klaviyo, which holds more significance, has consistently traded below its IPO price since becoming a public company. The reason for Klaviyo’s increased significance to future issuances is that it was the first true software company to go public post-shutdown of the IPO window, and served as a potential pre-curser for the many software unicorns in the IPO queue. Moreover, Klaviyo was considered an excellent IPO prospect, at the right scale and financial profile, making it attractive to IPO investors.
This subpar performance of Klaviyo since IPO and of ARM and Instacart during the initial period post-IPO made investors nervous and far more selective in evaluating additional IPOs. This skittishness typically translates into a demand for a higher “IPO discount”- a buffer that first-time investors require to mitigate the risk associated with yet-to-be-proven issuers. Historically, this discount has ranged from 20-30%, but at times of elevated nervousness, it can soar to 40-50%. The mirror image of this discount is the first-day “pop” we got accustomed to seeing in the stocks of new issuers. In the case of Klaviyo, Instacart, and ARM, the “pop” was timid, at 9%, 12%, and 25% respectively, pointing to IPO pricing that may have been too aggressive in hindsight.
The IPOs of Astera Labs and Reddit last week were different. Astera and Reddit closed up 72% and 48%, respectively, on their first day of trading. For Astera this was after its IPO range was revised upward during the IPO roadshow, and the stock was ultimately priced (allocated to investors) at a premium to the revised higher end of the range. This after-market performance entices investors to seek additional IPOs.
Firstly, the overall sentiment has significantly improved compared to September 2023. Secondly, idiosyncratic factors played a role in shaping the performance of both companies.
Astera Labs developed a platform that enables deployment and operations of high-performance cloud and AI infrastructure at scale, essentially riding the AI wave and providing investors exposure to this hot sector. Despite its limited scale of $116m LTM revenues, the company’s market cap at IPO was $6.3bn and is now $10b+.
Reddit on the other hand, is a more mature company, which operates one of the US’s top 10 most visited websites with more than 500m monthly visitors. However, its financial profile differs significantly from Astera's. Despite generating over $800 million in revenue in 2023, Reddit's growth rate of 21% and margin of 9% are less than half of Astera's metrics. Additionally, Reddit's exposure to AI is more limited. These differences result in significantly different trading multiples for the two companies.
Irrespective, both were priced correctly relative to investor expectations and performed well in aftermarket trading, the crucial elements of maintaining investor appetite for additional IPOs to come to market.
For IPOs to continue, top-tier companies will need to continue pricing their offerings correctly. This often entails revising their last valuation as private companies ahead of an IPO. Instacart and Reddit, for instance, adjusted from $39 billion to $10 billion and $10 billion to $6 billion, respectively. Other companies, like Stripe, have proactively followed suit, slashing valuations from $95 billion to $50 billion. These revisions don't signal inherent issues or low quality; rather, they reflect excellent companies whose managements and boards chose a pragmatic path forward.
Getting “stuck” as a private company for too long can pose risks such as missing out on opportunities for real liquidity, using their stock as acquisition currency for M&A, and enhancing their overall internal processes and brand.
Israeli tech has seen unprecedented growth over the past decade. The number of publicly listed tech companies valued at more than $1bn increased from 6 to 23 in the past decade and the combined market capitalization of these companies increased from $30bn to $150bn!
At the same time, the number of private unicorns increased from 1 to approximately 35-40. Many of these unicorns are prime candidates for IPOs, with some already poised to enter the public market, while others are gearing up for potential IPOs within the next 12-24 months.
However, achieving successful IPOs will require a pragmatic approach to valuation.
I'm confident that boards and management teams will carefully weigh short-term and long-term considerations, and as a result, Israeli companies will likely join the ranks of successful IPOs alongside their counterparts from the US and Europe in the near future.