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Will interest rate-driven multiple contractions make their way to private tech?
With the threat of an increase in interest rates looming, growth tech stocks in the public markets started 2022 on shaky ground. The average forward revenue multiple for these companies contracted by 50% from 22x to 11x.
In a recent Bloomberg appearance, David Rubenstein of Carlyle speculated that we could see up to 5 interest rate increases next year. The median analyst consensus is 3.
As a result, investors are flocking to stocks with great cash efficiency metrics. Tighter capital markets enhance the need for quality capital management over growth at all costs and investors are acting accordingly.
In the graphs below, you can see the shift occurring over the last month. Expected growth remains the primary driver of valuations, but the correlation has declined by 10%, while "Rule of 40" - a measure of cash efficiency - has increased by ~60%
This outcome isn't surprising. As capital markets tighten, investors value companies that can manage cash more highly.
Will capital markets actually tighten for technology companies in the private markets? That's yet to be seen, you could certainly argue that a down public market combined with tech being in the early innings (yes, it's still early) could keep the capital flowing. 2007-2008 were great years to be a venture investor.
However, the boom cycle is now going on year 13 and recently fueled by cheap capital, the latter of which is seemingly coming to an end.
If public markets remain down, and interest rates increase in the next 3 months we should get a good sense of how much public multiple contraction will trickle down into the private markets. Until then, it's anybody's guess.