THE SHIFT IN VALUE FROM PUBLIC TOWARDS PRIVATE MARKETS: AN ISRAELI PERSPECTIVE
In one of their most renowned presentations, Andreessen Horowitz (a16z), the $4 billion venture capital firm, outlined some of the most dominant trends in U.S. tech funding and the “Rise of the Quasi-IPO”. The presentation, published in 2015, delved into the most notable differences between tech investments in the 2000 versus today, and contains numerous lessons for investors in both global and Israeli venture capital. One of the most important points to emerge from their findings was the growing shift in value creation between the private and public phases of companies.
Historically, companies have opted to turn public at earlier stages, and until 2001, most companies did so with less than $20 million in revenues. However, in recent times, the threshold for an IPO has increased dramatically with the median pre-IPO revenue level at around $100 million. This trend has pushed companies to seek what a16z has dubbed, “Quasi IPO Rounds”, which consist of larger financing rounds at higher valuations that allow companies to stay private for longer. This trend has resulted in a shift in the value created for shareholders from the public to the private phase of a company. Whereas previously, the majority of value was created in the public phase, today, value has clearly shifted to the private phase and has eroded the returns available for investors in the public market. For example, while the return for private investors in Microsoft (1986 IPO) was just above 200x, the return for public investors was almost 600x. In contrast, the return for private investors in Facebook (2012 IPO) was just above 800x, while the return for public investors is nearly non-existent, relative to the private market returns (about 4.5x).
With late stage financing at all-time highs, and recent news on the Kite Pharma and Mobilieye acquisitions, we decided to study the shift in value from public to private markets from an Israeli perspective. In 2016 the growth of late stage rounds in the Israeli market was significant, both in terms of the number and value of deals. Over the year, 76 rounds of over $20 million were announced totaling $2.62 billion – an increase of 25% and 22% from 2015, respectively. This trend has continued in H1/2017, with $1.23 billion raised by Israeli companies in rounds valued at over $20 million. As highlighted in the a16z presentation, we have seen that the significant increase of capital available for late stage financing has shifted returns in the U.S. from public to private investors. Our analysis has revealed a similar pattern among highest profile Israeli IPOs.
Our analysis focused on four companies – Mobileye, Kite Pharma, Wix and CyberArk, all of which went public between 2013 and 2014. While two of the four, Kite Pharma and Wix, have seen tremendous growth on the public market, their value creation on the private market far exceeded that of the public one. Kite Pharma for instance had a gross multiple of 22.5x while private, as opposed to its public multiple of 6.2x. Wix had a private gross multiple of 12x vs. a public multiple of 3.7x. The two other companies, Mobileye and CyberArk, have produced even smaller returns for public investors versus their private investor counterparts. Mobileye had a gross private multiple of 17.3x and a public multiple of a 1.7x. CyberArk produced a gross multiple of 15.5x while private and a multiple of 1.3x when public.Clearly our analysis has indicated that in recent Israeli IPOs most of the value in the company was created when it was private, and has mostly benefited private investors. One point which should be noted is that we did not exercise a time value perspective to our analysis and that time may increase the value of these companies on the public market. However, if one were to apply the private market returns (x) of each of these companies to their IPO market cap, the valuations which these companies would receive appears unrealistic; Mobilieye would have to be worth $154 billion while Kite Pharma would be valued at $42 billion. While we acknowledge that the value of these companies may increase in time, it is difficult to entertain the notion that that their public multiple could eventually surpass their private one. Our analysis on the returns of private vs. public investors in Israeli companies has yielded similar results to the trends seen in the U.S. and we believe that investors in technology should shift their allocations to the private market in order to obtain returns that were once provided in the public domain. In addition, and as highlighted above and in our previous newsletter, the growth of late stage financing in Israel was accompanied with a sharp decline in the allocation towards early stage investments, as early stage investments (US$1 – US$5 million rounds) represented only 5% of total capital invested in Q2/2017 and have dropped by 58% between 2013 and 2016. This structural shift in the Israeli venture capital market has created a favorable environment for early stage investors, as reduced competition leads to attractive valuations of technological companies and augurs well for future returns. While value has clearly shifted from the public to the private market, within the Israeli private market a well-defined strategy is required in order to derive strong returns. Our view suggests that, given recent trends in the Israeli market, a favorable allocation towards early stage investments will be supportive of future gains.
FOREIGN CORPORATE INVESTMENTS IN ISRAEL CONTINUE TO INCREASE
The Israeli Foreign Trade Administration at the Ministry of Economy (FTA) recently published its report on foreign corporate investments in Israel during 2016. The report indicated that investments by foreign corporations in Israel totaled $12.6 billion in 2016, an increase of 7% from 2015. The report also noted that there are about 320 multinational corporations active in Israel and that in the past decade the number of new foreign corporations entering the Israeli market on annual basis has tripled from 10 in the beginning of the decade, to about 30 today. The FTA noted that the foreign corporations active in Israel largely invest in R&D activities, accounting for about 50% of their annual expenses. They employ about 50,000 employees for such tasks, who enjoy a salary premium of about 14% above the equivalent Israeli company. In addition to their R&D activities, multinational corporations have also been active investors in Israeli technology through their corporate venture arms. Microsoft Ventures made five investments in Israeli companies in the past year alone, and recently announced its investment in Airobotics, an autonomous drone company, as part of a $32.5 million round. QUALCOMM Ventures made 14 investments in Israeli companies to date, including their successful investment in Ravello in 2015, which was acquired by Oracle for $500 million just one year later. Intel Capital made 13 investments in Israeli companies to date, including an investment in Orcam, a company founded by the founders of Mobileye. Additional corporate venture arms remain highly active in Israel, including Google Ventures, Nielsen Innovate, Salesforce Ventures, Cisco Investments and GE Ventures.
NOTABLE INVESTMENT ROUNDS
Via, a Pitango Venture Capital portfolio company, secured its series E funding for $220 million from Daimler, Pitango Venture Capital and other current investors in the company. Via develops a shared rides platform and is active in many of the major cities in the U.S.
Redis Labs, a Carmel Ventures portfolio company, secured its series D funding for $44 million from Goldman Sachs, Carmel Ventures, Bain Capital Ventures and Dell Technologies Capital. Redis Labs develops a data management system.
Airobotics, an UpWest Labs and OurCrowd portfolio company, raised its series C for $32.5 million from BlueRun Ventures, Microsoft Ventures, OurCrowd and other current investors in the company. Airobotics develops fully automated drone solutions for commercial use.
NOTABLE "EXITS"
Signet Jewelers, the world’s largest retailer of diamond jewelry, acquired R2Net, an e-commerce and supply chain platform for the diamond industry, for $328 million. R2Net was a Israel Growth Partners portfolio company.
Vista Equity Partners, an American private equity firm, acquired Applause, which provides market insight services, for an undisclosed amount. Prior to its acquisition, Applause raised $115.8 million from its investors.
NOTABLE FUND FORMATIONS
StageOne Ventures announced the closing of their third fund with aggregate commitments of $110 million. The fund will focus on investing in 15-18 companies in seed and round A financing rounds. From a sector perspective, StageOne will focus on deep-technology endeavors in B2B software and next generation IT infrastructure.
RECOMMENDED VENTURE CAPITAL READS
Waymo and Uber Head for a Self-Driving Car Crash in Court [Bloomberg]
Bridgewater's Ray Dalio Spreads His Gospel of 'Radical Transparency [The New York Times]
Led by CEO Christina Tosi, Milk Bar is Slowly Building a Dessert Empire. How Far Can the Maker of the Compost Cookie Go? [Eater]
For Now, WeWork Is an Owner and Operator of Co-Working Spaces. Before Long, the $20 Billion Company Wants to be Much More [Wired]
Facebook Knows a Great Deal About Many of Its Users. But is the Company's Eye as All-Seeing As We Think? [The Atlantic]