As Donald Trump never tires of boasting, the US stock market is enjoying an extraordinary boom. Last year the S&P 500 recorded its first ever perfect calendar year of monthly total returns. But the bull run has failed to soothe one of the biggest and most intractable conundrums on Wall Street: the dearth of companies going public.
Last year was a respectable one in the US for initial public offerings. According to Dealogic, 189 companies floated on the US stock market and raised nearly $50bn, almost twice the amount in 2016, a particularly poor year. Last year’s showing has provided some hope, but concerns remain.
In the 1980s, the US averaged more than 200 IPOs a year, and during the dotcom boom — when the focus was on going public quickly on a prospectus of ideas and enthusiasm rather than a record of success — US markets saw 547 listings in 1999 and 439 in 2000. Now companies seem to delay going public indefinitely, rather than listing too soon.
This is particularly stark in the technology sector, which has powered the US stock market’s ebullient run. Snap, the owner of the Snapchat photo-sharing app, proved to be the only major tech listing of the year, raising questions about whether some of the large, well-known names of the gig economy, such as Uber and Airbnb, will ever list.
Bankers once talked about unicorns: companies that achieved valuations of more than $1bn through private funding rounds with venture capital firms. Now they have had to invent the term “decacorns” to describe businesses whose private valuations exceed $10bn. But the fact that IPO activity is essentially average at a time when markets are so welcoming indicates there are factors at work beyond investor sentiment about stocks.
“If you cannot go public with Nasdaq at 7,000 for a tech company, I don’t know when you can,” says Deepak Kamra, a partner at Canaan, a venture capital firm.
Decacorns 1: Uber and Airbnb
Uber, a ride-hailing app turned transport company, is probably the most famous of the Silicon Valley unicorns. It is now moving into deliveries and self-driving cars
The online broker between property owners and guests looking for a short-term stay has fallen foul of some city authorities restricting growth in its operations
There are plenty of reasons to want to avoid the frenzy of the dotcom bubble, when more than two-thirds of all tech IPOs went bust within five years of listing, according to research from University of Florida business professor Jay Ritter. Yet the downward trend in the number of IPOs is raising concerns about both the appeal of America’s public markets and the way that the benefits from the new technology boom are being distributed.
Although tech companies get the most attention, the issue is not confined to that sector. The broad pool of US listed companies is in long-term decline. After peaking at nearly 7,500 in 1997, the number of public companies fell to about 3,600 at the end of 2017, the lowest level since the early 1970s, according to Wilshire Associates which compiles a benchmark for the US stock markets.
Exchanges, investors, regulators, business groups and politicians have all expressed worries that the ability to take stakes in young and potentially exciting companies is being disproportionately enjoyed by small groups of insiders and elite investors rather than the wider investing public. Some fear that a less vibrant IPO market will sap the US economy of some of its vim.
“The importance of IPOs to the US economy cannot be overstated,” Michael Piwowar, a commissioner at the Securities and Exchange Commission, said in a speech last year. “A robust IPO market encourages entrepreneurship, facilitates growth, creates jobs, and fosters innovation, while providing attractive opportunities for investors to increase their wealth and mitigate risk.”
The SEC, under new chairman Jay Clayton, a lawyer who worked on Alibaba’s $25bn US listing in 2014, has made solving the listings decline a priority.
“It’s about improving investor opportunities,” Mr Clayton told a recent meeting of Sifma, the main US securities industry group. “A broader portfolio of public companies is important to retail investors. A broader portfolio, and [one] more exposed to the growth stage, that would be better. If you continue to shrink that pool, you are going to shrink their opportunities.”
The shrinking pool of US listings is blamed on a series of factors. For some, the self-image of the founders as tech visionaries intent on changing the world clashes with the short-term demands of investors in public markets.
Securities and Exchange Commission Chairman Jay Clayton © AP
The experience of Snap, which was the largest US tech deal since Facebook in 2012, resonates. Out of the gate the stock rallied sharply, but less than a year on, shares are trading 14 per cent below the offer price of $17 as competition from Facebook has proved intense and early results failed to meet expectations.
The attraction is further lessened by time-consuming and expensive regulatory requirements, say some market participants and pro-business groups. The Jumpstart Our Business Startups Act of 2012 was meant to ease the path for small companies by loosening securities regulation and there are calls for further reforms.
The same act removed one of the main reasons for companies to bring forward their IPOs — the rule that forced them to publish financial information once they had more than 500 shareholders. Spared that requirement, which helped trigger both the Google and Facebook IPOs, the latest batch of tech stars has been freer to stay private longer.
For smaller companies — another area where the decline in listings is marked — the regulatory burdens of being public can be onerous. About 60 per cent of all IPOs in the 1980s raised less than $30m, but by the 1990s this proportion has shrunk to about 30 per cent, according to the SEC. Since the turn of the millennium small IPOshave only accounted for 10 per cent of the total.
Decacorns 2: SpaceX and Palantir
The Elon Musk founded space exploration and transport company denied, last May, that it had any plans for an IPO
Palantir Technologies is a software and services company providing analysis of large data sets to governments and financial institutions
“I don’t think people are choosing to go public or not based on [regulatory costs]. But if you are a small company, a few million dollars a year in compliance costs does impact the bottom line,” says Adam Smith, head of capital markets at KKR, the private equity firm.
It reflects the reality that the entire market ecosystem has become less hospitable to small IPOs. In other words, if a company valued at $10m is going public and an individual fund would only buy a maximum of 10 per cent, the work required to invest at most $1m wouldn’t be worth it for most multibillion-dollar mutual investment funds.
Smaller companies also tend to trade less often, and their chances of being followed by analysts, who mostly focus on companies that can offer lucrative advisory work for their investment bank, has receded over the years. As Mr Smith puts it: “If you are too small you end up being a market orphan. No one follows you or trades you.”
Prof Ritter sees mergers and acquisitions as the defining factor. He notes that between 1990 and 1998, 50 per cent of the sales of successful venture-backed companies were via M&A — typically to a larger company in the same industry — while the other half were IPOs. By 2001-17 that share jumped to about 90 per cent.
The most often cited reason for the drop in tech deals is that the increasing availability of private capital has allowed companies to stay private for much longer than in the past. Once the sole domain of venture capital funds, the private market now includes hedge funds, mutual funds like T Rowe Price and Fidelity, sovereign wealth funds and family offices — all of whom have flooded the market with cash.
The lure, says a banker at a large US bank, “is a bit like when you go to a club on a Saturday night. You not only want to get behind the velvet rope, but get into the VIP lounge. People want to have access to unique ideas to generate alpha [returns above the average] versus seeing the ideas that everyone else is seeing.”
The phenomenal growth in this type of investing occurred in the aftermath of the financial crisis when central banks were intent on keeping interest rates at historic lows. The monetary policy designed to stimulate the economy has also driven investors of all stripes into riskier assets.
Decacorns 3: WeWork and Pinterest
WeWork provides shared offices and virtual workspaces around the world
Pinterest’s software allows users to curate online scrapbooks that showcase their interest in areas such as food, fashion and crafts
“Rates are low and everyone is in search of yield,” says Pat Grady, a partner at Sequoia, a venture capital firm. “When you cannot find yield, you look for growth and growth existsin technology and change.”
A decisive move by central banks to dial back stimulus could be a catalyst for the pendulum on private versus public funding to swing back. “If and when central banks tighten the money supply, and the availability, cost or terms of capital in the private market deteriorates and volatility increases, that may push more private companies to the public markets,” says Paul Donahue, head of equity capital markets Americas at Morgan Stanley.
Bankers argue that most entrepreneurs, even headstrong technologists, ultimately want to run public companies — or will have to.
David Ludwig, head of Americas equity capital markets for Goldman Sachs, predicts that the US will see a “significant” number of big tech IPOs. “While the private markets have allowed these innovative companies to grow into leaders without going public until later in their life cycles, we expect the vast majority will be public at some point in the next few years.”
Mr Smith of KKR points out that his firm helped to list six companies last year, and thinks fear over the death of the American IPO is overwrought. “People have been staying private for longer, not forever, and that’s an important distinction,” he says.
The dynamics of the funding markets may have changed, but the benefits of public ownership have not, many argue. It is a way for early backers, executives and employees to cash out holdings, it provides a currency for M&A deals and a certain level of legitimacy and scrutiny.
“Would Uber have been a better company today had it been public? There are a lot of conversations going on at the board level about the difference between serving a couple of folks at the top or a broader shareholder base,” says one banker who requested anonymity. “Bigger companies see the public markets as a better governor.”
Decacorns 4: Lyft and Dropbox
The ride-hailing app is one of Uber’s main rivals in the US
A service that allows users to store and access files from the cloud on multiple devices
Source for all valuations TechCrunch based on latest funding rounds
In one sign that sentiment in Silicon Valley is turning, Dara Khosrowshahi, Uber’s new chief executive, said in September that he hoped to take the company public within the next three years.
Spotify, the Stockholm-based music streaming service, aims to list on the New York Stock Exchange by the end of the first half of the year, in an unconventional “direct listing” where shares can trade without the formal IPO process.
Excitement, too, is building about large Chinese tech companies coming to the public markets, although like the potential IPO of state oil producer Saudi Aramco, which is tipped to be the largest ever, it is unclear whether these companies will list in the US.
In the meantime, some executives on both Wall Street and in Silicon Valley suggest that the trend of companies staying private longer is a good thing. They contrast the current era with the dotcom bubble when IPOs were viewed more as branding events and ways to cash out quickly.
Ready to stream an IPO – Spotify © FT montage; Alice Green/Unsplash
The downside for investors in public markets, however, is that they will sometimes be buying into businesses that have already seen explosive growth in revenues and valuations. And with companies having reached high valuations in private deals, those levels are hard to match or exceed in the public markets.
Investors and bankers talk euphemistically about companies waiting to list to “grow into those valuations.” It is a polite way of saying they do not want an investment that values the company at below the previous funding round, delivering at least a paper loss for existing shareholders.
“The public market is the ultimate arbiter of truth,” Mr Kamra says.
Additional reporting by Richard Waters
Cryptocurrencies: Initial coin offerings provide $5.6bn boom
Bankers and investors may be hopeful for a further uptick in US IPOs, but in the meantime a novel area of raising capital has been heating up. Riding on the wave of interest in cryptocurrencies and the meteoric rise in their value in 2017 — the price of one bitcoin jumped from less than $1,000 early in the year to more than $19,000 at one point — billions have been raised in initial coin offerings (ICOs).
ICOs are a mechanism for early-stage companies to crowdfund using cryptocurrencies, without giving up any equity. Although it is hard to get precise data, tracker TokenData.io, put the 2017 total raised at $5.6bn from 442 ICOs, with $1.2bn raised in December alone. Proponents of ICOs argue that the sales give greater access to capital markets for ordinary retail investors. But many ICOs sell heavily discounted tokens in sweetheart deals to advisers, early backers and hedge funds, before the public sale.
And with some ICOs endorsed by celebrities including Paris Hilton, the socialite, and actor Jamie Foxx, regulators chided famous boosters for failing to disclose if they were being compensated for their support.
While regulators are considering ways to boost the IPO market, they also warn of risks connected to volatile digital assets and scams that can accompany new funding areas. The Securities and Exchange Commission has already halted an ICO called PlexCoin, accusing it of being a fraud.
Most of the projects which launch ICOs are based on blockchain networks, and some buyers purchase the digital coins to access these services later. But regulators have warned that the tokens tend to act like securities, and will be regulated as such. Jay Clayton, Securities and Exchange Commission chairman, has said that ICOs “can be effective ways for entrepreneurs and others to raise funding,” but warned that if an ICO implied that investors could expect a return it would be considered a security, and may be subject to US securities laws.
Chloe Cornish and Nicole Bullock
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