Private equity: the royal road to technology
In a recent article in ‘Le Temps’, Pierre Stadler, Head of Thematics - Private Equity at Pictet Alternative Advisors, discusses how Private equity (investment capital) is now looking like the most suitable asset class for participating in the breakneck growth of technology stocks.
Who will be the Apple, Amazon or Facebook of tomorrow? That’s the million – or rather billion – dollar question for every investor hoping to surf the technology wave. Identifying up-and-coming unicorns remains important, but the real challenge lies in capturing their growth. Private equity (investment capital) is now looking like the most suitable asset class for participating in the breakneck growth of technology stocks. Although some pundits think that high valuations are causing the sector to overheat, there are still plenty of interesting investment opportunities available. The software sector, for example, is still growing very rapidly and is expected to post a compound annual growth rate of 15.6% from now till 2024[i]. As internet usage explodes, the World Wide Web is set to continue expanding, since 41% of the planet has yet to access it[ii]. Then there’s 5G. In the Internet of Things, the next generation of wireless technologies promises to kick connectivity to a whole new level.
It must be said that regulation presents a significant risk. Governments and antitrust authorities are taking drastic steps to improve data privacy while seeking new ways to tax the sector. A close eye also needs to be kept on valuations. The digital revolution, which has benefited from the effects of the pandemic, has pushed technology stocks to record highs. The price/earnings ratio of the components of the MSCI ACWI Tech index has surged to 25.0x, compared with an average of 15.7x over the past ten years.
An alternative to listed technology companies
Private companies offer an increasingly attractive alternative. Not only do they often have more sensible valuations, but unlisted firms make up a larger portion of the investment universe, which contains companies at very different stages of development. While there is an abundance of private companies, the listed investment universe is steadily shrinking. Since the year 2000, the number of listed companies has dropped from 7,000 to 4,000 in the United States. Furthermore, when companies do float, they are doing so at a later stage: the median age of a company entering the stock market in the United States has risen from 7 years in the 1980s to 11 years between 2010 and 2018. This is true for technology firms in particular. Start-ups are finding more and more private financing without having to open up their accounts and their stock to the public. Postponing their initial public offering is particularly suitable for technology companies, which often grow at a blistering pace. They usually prefer to keep quiet about their research during the early stages, and therefore favour a closed group of shareholders. When a company postpones its stock market launch, an increasing proportion of its value has been created before its flotation.
By the time they float, tech companies have sometimes gone past the stage of breakneck growth, and with it the period of juicy returns for investors. By way of illustration, Amazon went public three years after it was founded, compared with six years for Google, eight for Facebook and twelve for Spotify. As of the date of the IPO, investors were able to pocket more than 1700x their initial investment in the case of Amazon, compared with 24x for Google, 8x for Facebook and a mere 2x for Spotify. Finding a way to purchase a stake in the private equity of these companies in order to capture their growth is becoming a key issue for investors. In venture capital transactions, the founders seek partners with high added value: i.e. investors who are not simply financial backers but are also able to contribute the expertise and network of contacts that are essential to the firm’s expansion. This is in major contrast to the big listed companies, in which even the largest investors hold just a fraction of the shares and often have only a limited influence.
[i] Gartner Research
[ii] Internet World Stats, data as of June 2019
Source: Le Temps, March 2021