Squarespace’s Buyout Signals a Recovering Financial Market

Key Points

• One way to assess the financial market's health is to follow the money.
• Private equity firm Permira offered to acquire Squarespace in a $6.9 billion all-cash deal, sending Squarespace shares soaring nearly 30%.
• Despite higher-than-target inflation at 3.4%, the current economic environment is pushing investors towards companies with strong fundamentals, as seen in Permira's confidence in Squarespace.

One surefire way investors can figure out the financial system's health is by following the money. 

Shares of Squarespace Inc. NYSE: SQSP are up nearly 30% after private equity firm Permira offered to take it private through a $6.9 billion all-cash deal. Before this offer, Squarespace had a market capitalization of approximately $4.6 billion. So, what could make this private equity fund willing to pay a 50% premium for this technology stock?

The simple answer lies behind the Federal Reserve's (the Fed) plans to cut interest rates later this year. It looked like the first cuts would come in March, then May, and now September, according to the CME's FedWatch tool.

Forget the Noise, Here's What Matters

After a disappointing 1.6% U.S. gross domestic product (GDP) growth in the past quarter, investors should have become worried about the economy's current state, but that didn't seem to happen.

Low economic growth is expected to push the Fed's agenda into cutting rates sooner rather than later, as the economy needs a more flexible financing environment to heat up again. According to ISM PMI readings, the manufacturing and business services sectors contracted in the past month. This is bad news for future GDP growth and may create another pressure point for the Fed to act more quickly than expected. 

Inflation is another factor nudging the Fed into a decision. For the past month, inflation has been above the Fed's 2% target and just came in at 3.4%. Still relatively hot, and with no prospect of slowing down toward the Fed's target, it may pose a problem for investors betting on interest rate cuts to come relatively soon.

However, that's not the view at Permira, as the recent Squarespace acquisition leads many to believe that the financial markets may not be as shaken as they seem. 

Investors Want Quality, Not Empty Promises

Despite recent rallies in meme stocks, those hoping to see GameStop Corp. NYSE: GME and AMC Entertainment Holdings Inc. NYSE: AMC reach a new ceiling might be in for a surprise. Because these companies lack one essential thing, their recent rallies may be short-lived.

According to the company's press release, one of the main reasons behind the Squarespace buyout is cash flow, which reached $85.2 million in the past quarter. Even after capital expenditures of $47 million, the company walked away with a free cash flow of roughly $38.2 million, giving investors confidence that this business can cushion low economic growth and high inflation (also known as stagflation). 

This financial stance compares with GameStop's negative free cash flow. AMC is close behind, with share dilutions being the only strategy to keep funding losing operations. The takeaway? Investing is cool again, but it must come with solid fundamentals.

Better Fits for Today's Market

Knowing this, investors can find a much better proposition in Adobe Inc. NASDAQ: ADBE, especially now that the stock trades at 76% of its 52-week high today. 

Exposed to the broader tailwinds found in the artificial intelligence space, analysts are willing to bet that Adobe could deliver 12.8% earnings per share (EPS) growth in the next 12 months. Above-average growth is the driver here, as these same analysts see a valuation of up to $700, according to those at Piper Sandler. To prove these projections right, the stock must rally 43.9% from its current price.

Another example of technology exposed to the bullish trends in the U.S. real estate market is SoFi Technologies Inc. NASDAQ: SOFI. When and if rates do come down, cheaper mortgage financing could spark a new demand boom in real estate. Because of this, analysts are willing to bet that SoFi can deliver up to 200% EPS growth this year, not to mention that Jefferies Financial Group slapped a $12 price target for SoFi stock, calling for a net 64.3% upside from where it trades today.

The lesson here is that if investors want to beat stagflation today, they must choose solid fundamentals at a reasonable discount; anything else is just noise.