The traditional initial public offering (IPO) is not yet dead despite competition from new sources of corporate funding emerge.
Thats the viewpoint of Nichola Colas, Co-Founder of DataTrek Research, who recently published a thought piece on the current state of the IPO market – based on the recent Davos confab. Colas reviewed a panel at the global conference and surmised after listening to several views that the IPO market isnt dead yet, they continue to serve important purposes that private capital cannot replace.
Here is the feature, first published by Colas in his daily newsletter.
In 20 years, there wont be any stocks left to trade. A client told me that last week, and there was little doubt he meant it. Look at all the buybacks… all those great tech companies staying private… There just wont be a stock market in a few decades.
It is a point I consider quite often, so I was happy to see a Davos panel last week dedicated to the topic: What Is Happening to IPOs? Theres a link to the full video at the end of this note, but there is no transcript so well review the substance of the panelists comments today. The speakers were:
Anthony Fernandes, CEO of AirAsia (a public company)
Matthew Prince, CEO of Cloudflare (a unicorn private company)
Tom Farley, President of NYSE Group
William Ford, CEO of General Atlantic (Private Equity)
Abidali Neemuchwala. CEO of Wipro (NYSE listed Indian Tech company)
Zanny Minton Beddoes. The Economist magazine, moderating
The easy points first:
#1. Panelists agreed that private companies have unprecedented access to venture capital and other sorts of non-public market investors. The need to IPO is therefore lower than in past cycles, even for companies that need Scale capital (i.e. $500 million and up).
#2. There was also broad agreement that the regulatory framework in the US is especially burdensome. It isnt just Sarbanes-Oxley – companies fear the litigation risk that comes with being a US listed company in the form of shareholder class action lawsuits. The offset: US exchanges have access to the deepest pools of capital in the world.
#3. The panelists who actually run companies felt that public market investors are often too short term focused. There are exceptions, like Amazon (their example) and Tesla (our example), where public shareholders are patient. But generally, they arent. By contrast, private investors are much more patient capital, especially when it comes to projects that will take +5 years.
#4. Even with the surfeit of private capital currently available, good private tech companies regularly get valuation proposals from venture capital firms that are above (sometimes far above) their current public market valuations.
#5. Several panelists highlighted the historical volatility of public markets as another downside.
#6. Private capital also has the advantage of Secrecy (their words, not ours), in that smaller companies with a competitive advantage can raise money without having to stand up in front of 200 people at a roadshow lunch and explain every detail of their strategy.
And some nuanced ones that we thought were insightful:
#1. Private companies with big valuations often have very complex capital structures, with employee/non employee classes of stock and different tranches of equity-like instruments. Moreover, these companies may choose to have different sorts of voting share structures as they develop. All this adds complexity to pre-IPO planning, and public ownership structures are not as flexible. This can delay a company from going public even if it plans to do so.
#2. Venture capital/private companies do still understand the value of public ownership. A listed equity gives liquidity, allows for access to capital whenever it is needed, and is a strong competitive advantage to hiring top talent. The panel was very clear on that, which I found reassuring. Many well-known private companies will go public at some point – there are still compelling reasons to do so.
#3. Private companies raising capital today at artificially high valuations may have trouble going public even if there is a business case to do so. Later stage funding rounds sometimes dictate IPO multiples, to name one hurdle. If the public markets disagree with that valuation, the offering may be delayed until the company can grow into the desired value.
#4. Private capital is much more receptive to complex ownership/voting structures than public markets. For many private companies with visionary founders or multiple early stage employees, that is an attractive feature.
#5. It isnt entirely bad that public market investors do not have the same access to early stage growth companies as they did in prior cycles. One panelist argued that the 1990s dot com bubble showed what happens when public market investors have free access to companies before they are truly ready to go public.
In summary, the content of this discussion gives some hope that there will be public companies in 20 years, contrary to my clients concern. In many ways, the system is working as it should – pairing potentially disruptive (but very risky) technology-enabled businesses with the sources of capital that have the wherewithal to help them grow. The level of complexity in which these companies operate in is high, and private capital also allows them to address that challenge.
But public markets are still the destination for companies that get through this process.
Link to Davos video: https://www.weforum.org/events/world-economic-forum-annual-meeting-2018/sessions/dusk-of-the-ipo-market
