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What the end of ’30 years of one-way traffic’ means for private markets

As rates rise and the money fuelled tech bubble pops, private companies – and their investors – are buckling down. The hard question, for which there is no good answer, is about what happens next.

“The fact that we’re having a period of softer markets, delayed IPOs, that recent history of underperforming IPOs…” begins Brendan Lyons, head of private investments and portfolio manager at Perennial. “On balance it’s good for the market; it’s not good on a day to day,”

“We want things to be successful and for people to have successful investments. But to the extent that it creates a bit of a reset in mindset, in structures and valuations – we do think that’s probably a good thing.”

There’s “no doubt” that it’s been a frothy period for markets both public and private; some businesses that IPOd in late 2020 perhaps shouldn’t have. The public markets started selling off from around April, but the derate in tech companies began late in 2021 in the US market; it was the first of the sectors to show some weakness. Some of that strain is showing in the IPO pipeline, which has slackened even more after two years of disruption.

“It’s harder for tech businesses, particularly loss making ones, to list; there’s been a greater focus on profitability than there was 12 months ago, partly because of interest rate rises,” Lyons says. “But the whole IPO market has been tough, in all sectors, other than possibly resources and mining.”

“We’ve had a tough period… It takes one bad IPO to close the market and one good IPO to re-open the market, and we’re just waiting for that one good IPO. But there’s a pipeline of IPOs that have been waiting 6-12 months to list that will come back and test the market, and we’ll know more by Christmas whether there’s a bit more positivity. The market does have times when it falls in and out of love with certain sectors.”

Perennial started telling its own portfolio companies to “buckle down” and start managing for cashflow in February. It’s proved a wise move with the pages of the Australian Financial Review now littered with tales of staff reductions and cost cutting.

“We don’t know the second degree impacts of what we’re seeing now in inflation, interest rates, supply chain issues, geopolitics,” Lyons said. “And so I think the question in all that – people are already calling recession in certain countries, we might have close to a technical recessions in some of them – is what impact that has on the broader outlook for businesses.”

“It won’t just be about valuation; it’ll be about what happens to the top line of these businesses, whether they can continue to grow, how cyclical they are. We haven’t seen – especially in Australia, it’s been 30 years of one-way traffic that predates all these businesses we’re talking about, and certainly the majority of businesses we’ve invested in, even listed businesses –  we haven’t seen a full economic cycle to that extent since the early 90s.”

Still, Lyons is positive on the outlook. Valuations have been reset, terms are more attractive. And “there are plenty of great businesses out there in Australia”.

“There are a number that can grow through any cycle,” Lyons says. “Good people, good founders, good ideas. We’ve had some fantastic success stories in the last ten years, so I’m still really positive.

“There’s some fantastic innovation going on out there. Some of the tax breaks and the early-stage venture funds have created an ecosystem in the last five or ten years and were still seeing the dividends of that play through.”

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