Cash-rich investors face ‘value indigestion’ as biotech, software, fintech stocks tank

Is the party over?

Has this winter’s sell-off, set off by inflation and rising interest rates, finally slowed the bull market that has pumped up private-company valuations, initial public offerings (IPOs), and stock prices since the late 2000s?

The S&P 500 is off a modest 5% from its peak late last year, but the hottest sectors look much worse: Software indexes are down 20% in the same period. And the S&P 500 Biotech Index has dropped by more than 40% since its high a year ago.

And yet there is still so much investor money chasing profits that 2022 could still prove a fertile year for new stock offerings, saidMark Lehmann, a veteran Silicon Valley investment banker.

IPOs, which would enrich founders and early investors, are in the preparation stages for such local companies as snack-delivery service Gopuff, human-resources software developer Phenom, and business-analytics purveyor Qlik, Lehmann noted.

He should know. Last fall, Lehmann sold his San Francisco-based firm, JMP Securities, to Citizens Financial Group, and now scouts deals for that company, which sponsors the Phillies stadium and owns Citizens Bank.

“I’m wildly bullish about the capital markets,” Lehmann said, contrasting this volatile investment climate with the dot.com bubble of 2001 and the subprime-mortgage crash of 2008-09.

He calls what we’re going through a bout of “value indigestion,” rather the beginnings of a market collapse.

What’s different, Lehmann said, is that now there’s still “an insatiable amount of private capital” desperate for profits. This largess includes private-equity dollars pumped into new and emerging firms by state pension funds — which are still betting on high-roller deals.

U.S. equities remain “the best game in town,” he added. As long as big money is chasing the best deals, “the death of capital markets has been exaggerated.”

Philadelphia-based Gopuff, valued at $15 billion at its capital-raising in July (updated), “has what UberEats and GrubHub have, and the market really likes: a business that was great even through the pandemic,” Lehmann said.

Ambler-based Phenom is in human-resources software, a sector that has done extremely well as more office staff work from home.

King of Prussia-based Qlik, which was public from 2010 to 2016, is plotting a second IPO after its private-equity owners enlarged the company with a string of acquisitions.

The price drop flashes yellow caution lights for some investments, Lehman acknowledged. To be sure, “we’ve had frothy markets in certain sectors,” especially biotech.

“We’ve had a lot of companies that have been really good science experiments, but then they went public,” at high prices, long before their technologies led to products and sales, let alone profits, he said. “And that’s not necessarily a good thing.”

Too many newly public gene and cell therapy company stocks fell into a “nuclear winter last year. I don’t think the research people or the doctors who developed those technologies have gotten any stupider in the last 15 months,” he said. But for gene therapy, CRISPR gene-slicing technologies, and other much-hyped innovations, “the promise has been far better than the results” so far.

But Lehmann expects that the new bioscience and technology will pay off for some investors in time. And there’s still plenty of hopeful money ready to pour in: As biotech stocks have been falling, IPOs have continued to find buyers.

Fintech lenders have also suffered price reversals. Lehmann pointed to Affirm Holdings, a San Francisco-based “buy-now, pay-later” digital finance company that went public a year ago at $93 a share. It peaked at $164 in November, and has lately traded down about $65.

A not-yet-public rival, Klarna, was valued at $45.6 billion (updated) by its latest investors, right about the time last fall, when Affirm was at its peak. But with Affirm losing more than half its value, it became tough for Klarna to go public at a price that would be profitable for those last investors.

All this points to a cooling-down period. In biotech, “we are going to create many more [products] that will cure diseases. But we aren’t going to get to 1,000 IPOs a year,” as some boosters once hoped, said Lehmann.

“We are going through ... a correction in valuation” due to the lack of rapid profits from new medical technologies, and also to the “biggest jump in interest rates since 1982,” and the prospect that rate hikes will continue, adding to everyone’s borrowing costs.

Hiring is a much bigger problem, Lehmann adds. In biotech, software and other growing industries, “everyone’s trading up for [better] wages. We have a dearth of immigrants or new employees to take those jobs, so everyone is asking for more money. Wage inflation is real, and it’s not temporary. It’s the biggest thing [companies] have to calculate in their earnings estimates.”

Pension funds and college endowments reported large paper profits in late 2020 and early 2021 from the non-public, pre-IPO companies they owned through private investment managers, after tying their valuations to those of public companies. Will they have to write down large losses because the stock market has reversed?

“That’s the $64,000 question,” said Lehmann.

A sustained drop in valuations could lead to loss reports and dry up new investments. “It’s really easy to mark things up when the market is rising, but it’s really painful to mark things down,” he added. “These valuations will be looked at much more severely if this [downturn] lasts another quarter or two.”