By Bill Kelly, CEO, CAIA Association
How do you turn a millennial into a capitalist? Sell her SNAP in the post-IPO market. A little hindsight here shows how ridiculous this all looked. The initial sellers of the shares were the founders and their VCs (just under 30% of the offering), along with an underwriting group made up of the usual suspects. The underwriters in turn allocated these shares to their largest institutional clients. The offering was set at a froth-inducing price of $17 per share, which generated demand equivalent to 12 times what was available, which is what makes an IPO hot. Mission accomplished, as the shares soared up 44% on the first day of trading giving SNAP a market value of $33B, equivalent to the worth of certain well-established brands such as Marriott and Target. We know who the buyers were on the other side of this trade and they didn’t seem to care (or know) that SNAP lost over $500M in the fiscal year leading up to the IPO, and that those highly coveted shares came with zero voting rights. Needless to say, that stock price and the related valuation were not sustainable, and the clever money knew when to leave the room… and then there is Spotify.
The smart minds at the Thinking Ahead Institute recently put out a short piece on private equity as part of a series that looks at the asset classes of tomorrow using Spotify as a case study to make their point. Spotify went public in April of 2018 under an IPO which wasn’t really an IPO at all. In fact, it was a Direct Public Offering or “DPO” that did not look to raise any new capital, mostly because they didn’t need it. This was a simple case of creating “a channel for the general public to buy shares of the company from its existing owners.” This DPO essentially bypassed the underwriters and their institutional clients and put the founder shares up for direct purchase, where the public markets were a vessel for liquidity rather than the more typical mechanism for capital formation.
In the good old days, when the private markets were not so awash with cash, fledgling brands actually needed the public markets as an essential source of capital formation. That trend has seen a decided shift almost in a direct and inverse proportion to the record growth of dry (PE) powder. Consider this from the Thinking Ahead Institute: in 2004 when Google went public, they needed/raised fresh capital that was 76x what they were able to gather in the private markets. Eight years later it was Facebook’s turn and that ratio shrunk to less than 7x; when Uber stepped up to the IPO window this May, that ratio was a barely visible .37x, and we now know Spotify spooled up its own self-effacing version of the hit Saved by Zero, where they needed none. It sounds like a lot of the value creation is now happening in the private markets and the public market participant is gaining access only at the very mature stage of the growth cycle.
How did this all work out for the public market shareholder of Spotify? You be the judge. Pre-trading indications of interest established a reference price of $132 per share in April 2018 and the stock opened that first trading day at $165 (+25%). This gave Spotify a market value in the same neighborhood as the aforementioned SNAP, despite having posted an operating loss of $1.5B going into their DPO. As of Friday, you could get a piece of this action at $112 per share which is a third less than the peak; think about that as you stream Don’t Let Me Down by the Chainsmokers during your morning commute.
The referenced series from the Thinking Ahead Institute is worth a read, and the private equity installment ends with a look at what this might all mean for the future. It seems clear that despite the massive run-up in capital gathering in the private markets post the GFC, only a tiny fraction of the value of the world’s unlisted companies is represented. Perhaps we are just getting started with a set of new normal norms in our capital markets... “Alexa, stream We’ve Only Just Begun by the Carpenters!”
Seek diversification, education, and know your risk tolerance. Investing is for the long term.