Two tech giants, Reddit Inc. and Astera Labs Inc., ignited the stock market with their recent IPOs, offering a glimmer of hope for investors and startups. Despite their successful debuts, the road to public offerings in 2024 remains uncertain. With markets cautiously assessing profitability over growth, the aftermath of the cheap-money bubble persists. As venture capital struggles to deliver returns, startups face the sobering reality of adjusting strategies to weather the storm of over-investment.
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By Paul J. Davies
Two knockout stock-market debuts by tech companies last week will boost confidence among others waiting for their chance to go public – and lift the hopes of investors in venture capital funds who’ve endured meager returns in the past couple of years.
But Reddit Inc. and Astera Labs Inc. don’t herald a blizzard of initial public offerings in 2024.
Beyond the still-uncertain economy and a US presidential election, West Coast tech bankers and venture fund managers also recognize that markets have a long path to recover from the excesses of the cheap-money bubble that peaked in 2021 – and that stock-market investors remain sober and clinical in appraising new companies.
Reddit and Astera Labs both did much better than expected in pricing and early trading, but for reasons that illustrate the limits of what public investors will buy. Mostly, they’re no longer interested in growth without profitability – or at least the promise of profits very soon, according to bankers.
Reddit is an unusual success: It’s a relatively mature, but lossmaking business that has yet to prove its rowdy and rebellious user base will sustainably draw advertisers. It attracted buyers mostly by being cheap. The IPO valued Reddit at $5.4 billion, down heavily from the $10 billion mark in its last private fund-raising round in 2021.
Astera Labs is also lossmaking but is riding the great AI gold rush. Along with security software, AI is one of the only sectors almost guaranteed to get investors salivating. Even so, Astera Labs’ bankers were conservative with valuation, as shown by the fact that its shares priced above the proposed range and then jumped more than 70% on their first day of trading last Wednesday.
The appetite for AI-linked stories is still bonkers. At the end of last week, Astera’s $10.5 billion market value meant its stock is trading at a multiple of 92 times last year’s sales of $115 million. Chipmaker Arm Holdings Plc, whose stock has rallied recently after a very bumpy few months following its debut last year, trades at 52 times sales, while market darling Nvidia Corp. is valued at 39 times 2023 sales.
Reddit is a very different prospect, although it’s still a company touting an AI theme because it is starting to sell access to its chats as training data — it closed a deal with Alphabet Inc. in February. Still, Reddit finished Friday with a market value of a relatively pitiful nine times sales.
These offerings have at least started well, though that was true initially of Arm and two other tech companies, Instacart (officially, Maplebear Inc.) and Klaviyo Inc., that listed last September: Each traded well for a day or two, but then fell toward or even below their offer price.
Startups and their backers still haven’t reckoned with the huge wave of over-investment in 2020-2022. More than 500 companies became unicorns in the US alone, which means they raised funds at valuations above $1 billion, according to data from Pitchbook, the research firm. Collectively America’s unicorns have been valued at almost $2.5 trillion at their last private fund raising. However, a large and undetermined share of that value has already evaporated – proving about as tangible as magical horned horses – even if the companies and their backers haven’t yet admitted to the fact.
Bankers and investors differ in their guesstimates of the residual value of these startups: Some think that easily 50% will never realize anything close to their peak valuation. The share that will make it to an IPO is even smaller, maybe 15% to 20% at most, according to bankers I chatted with recently.
But companies and their backers aren’t blind and many have spent the past year or two adjusting to reality by slowing the rate at which they burn money. For businesses with a viable product and existing customers, that typically means sacrificing growth and slashing costs. There are lots of ways to adjust strategy and potentially generate some value, which I intend to come back to in a future column. But few will manage it quickly.
That’s a problem for many venture-capital and growth fund managers because they desperately need to return more cash to their investors, known as LPs. Venture capital payouts have been even worse than those from private equity since 2021. Cash distributed on a rolling 12-month basis hit its lowest level in six years for venture funds at the end of September 2023, according to the most recent data from MSCI. For private equity, it was the lowest in three years.
Still, opposing the pressure to realize returns is the duty that managers have toward LPs and company founders to maximize value. That can mean holding on for an extra year or more to turn businesses into something worth buying.
For hundreds of companies, the reckoning will take time. Tom Loverro, a general partner at Menlo Park-based IVP, predicted early last year that a mass extinction event was on the way for startups. But it will be a slow burn, not a meteor strike. Investors showered tech companies with so much cash in the mad years, particularly 2021, that they are still spending it today. Many are zombies: Once their last infusion runs dry, only hard choices remain.
Absent an unlikely and quick return to a goldilocks economy that’s neither too hot nor too cold, even the best companies from the bubble years won’t be ready for public markets for some time yet.
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