IFR: Hello, everybody. Thanks for joining us at the 2019 IFR US ECM Roundtable. Craig, could you characterise the year so far in terms of what verticals and products are driving issuance?
Craig DeDomenico, Managing Director, Stifel: When we step back and think about this year, a lot of us forget we started with the US government shutdown. Then later in the year we had a ton of, as I call it, fake IPO news. Ultimately, ECM continues to put together a pretty good year when we think about the longest government shutdown, which basically froze the new issue market in first quarter. Then we had huge second and third quarters. And now we are in a bit of a buyers’ strike.
But extrapolating, we are thinking about 175 IPOs and US$60bn for the year, which is not too far from what we saw in 2018.
Drilling down into the data there has been a lot of focus on certain sectors. Consumer is the only industry where volumes are up year-over-year, so there has been pressure on other sectors.
We are being asked a lot about performance of IPOs. New issues, both large and small-cap, have struggled as an asset class, while middle market and traditional IPOs have outperformed. Overall IPOs as an asset class are up about 5%, which is not great.
There has been a lot of investor and media attention on tech IPOs. I know we are going to spend a lot of time on some of the recent tech offerings.
Software-as-a-service remains a big area of focus of investors and investment banks. SaaS companies like Zoom Video, Datadog and others benefit from predictable cash flows that has contributed to outperformance. Even if they have an operational hiccup, there is an M&A floor underlying SaaS.
Special purposes acquisition companies (SPACs) have enjoyed another strong year.
There has also been a lot of focus this year on convertible bonds. With a lot of stocks near all-time highs and low interest rates, converts have provided companies with growth capital. In a number of situations we have even seen companies go directly from IPO to convertible, skipping the first-time follow-on entirely.
IFR: It’s hard not to overstate the effect of the government shutdown on new issues. It seems like such a long time ago. Hard to remember that at the beginning of the year SPACs were the only product that were able to sell new issues.
Anna, can you talk a little bit about venture backing of biotechs and the role of crossover investors in late-stage private rounds and the IPO?
Anna Pinedo, Partner, Mayer Brown: Pre-IPO financings and crossovers are important to many companies that are thinking about undertaking IPOs, but more so for companies in the life sciences sector.
Life science investors tend to be pretty selective. The amount of private capital looking at life sciences is small relative to venture capital overall. A lot of the IPOs we have seen for life sciences companies in the last few years have been preceded by a private round in the prior 12 months.
Another important attribute that distinguishes life sciences IPOs from those in other sectors is that having a cornerstone investor is a really a make-or-break event. Having a known sector investor step up and want to participate in the IPO is incredibly significant. Similarly, the last pre-IPO financing for a life sciences company takes on a great deal of significance.
IFR: David, can you talk a little about KKR’s life sciences platform and, in particular, the firm’s involvement on BridgeBio Pharma’s IPO.
David Bauer, Managing Director, head of public ECM, KKR Capital Markets: KKR is well known for traditional leveraged buyouts. In the last three to four years, we have pivoted to more of a growth equity orientation as well, in technology and healthcare. We have made a significant number of investments in growth companies at a later stage.
In June, we executed an IPO for BridgeBio, which at the time was the second largest biotech offering of all time and certainly the largest this year. There were a lot of dynamics specific to the pre-IPO and crossover investors that were important.
If you take a step back, there is a lot of fast money chasing opportunities in life sciences. Capital does chase alpha, and as successful as that space has been, you have seen a lot of funds flood into the sector, before the IPO and at the IPO.
It is incumbent on investment banks and pre-IPO investors to be diligent about how the IPO is structured. Who are the partners that truly want to support a company? What does the post-IPO cap structure look like? There are a lot of investors that can play the game. But who’s going to really stick around when things get rough?
It’s incumbent on everybody involved to make sure we get it right.
BridgeBio is a very attractive, multi-platform asset and one of the better performing IPOs of the year, at least up until the latest correction.
IFR: Mike, sticking with life sciences and the role of crossover and insiders on IPOs, what effect does their participation have on trading liquidity after an IPO? How has the relative level of participation by crossover investors and insiders changed over time?
Michael Kuchmek, Head of ECM, Schonfeld Strategic Advisors: We’ve noticed that insiders and crossover investors are, in many cases, taking 70%-80% of an IPO. That has crowded out public investors.
Two years ago, insiders and crossover investors were taking 20% of biotech IPOs. Last year, it was around 50%, and this year it is 60%, 70%, 80%, 85% in a lot of cases.
It has made it difficult for other investors. After the first or second day of trading, liquidity really dries up.
And more importantly, a lot of the biotechs are going public at earlier and earlier stages of their development. For earlier stage biotechs, it could be a year, a year and a half, where you don’t have data from clinical trials.
Insiders are being asked to take so much (of an IPO) to ensure a deal gets done, so there is less price discovery. Because of that dearth of investors, there isn’t the same level of investor engagement as is the case on other types of IPOs.
Insiders and crossovers are essentially backstopping (a biotech IPO) within the marketing range. The number of biotech deals that come below range is lower than you would expect because of the lack of true price discovery,
Don’t get me wrong, biotech is a very important part of the new issue market. The amount of capital raised (by biotechs) in the past few years has been at historic highs. A lot of these biotechs will still go on to be successful, but we believe their performance benefits fewer and fewer public investors. That means that the first marketed follow-on, after the release of clinical trials, is really where you are seeing the widening of investor bases.
It’s not that any of this is healthy or unhealthy. It is what it is. When investors are going into (biotech IPOs), they have to go in eyes wide open, really do due diligence on the asset and be willing to be there for the long term.
Robert McCooey, Senior vice president, Nasdaq’s Listings Services: For you, the tough part about biotechs is their illiquidity?
Michael Kuchmek, Schonfeld Strategic Advisors: Yes. If you look at the biotech aftermarket and you look at the average daily volume, it’s at historic lows for many of the recent biotech IPOs. So you have to due diligence it because you’re not going to have liquidity to exit if something goes wrong or if something happens from a risk standpoint.
David Bauer, KKR Capital Markets: Mike, the only thing I would quibble with is that because biotechs are going public earlier in their life cycles, investors need to be able to weather risk tolerance. No one should be trading in and out of these stocks.
You really have to be diligent about how much you open up access to outside, new investors. To a certain degree, biotechs are a glorified SPAC, in that they are truly a bet on whether a management team can execute. You really want to have investors that truly understand the asset and have been there with the company.
Investors that have participated in the Series B, C, D rounds and then backstop the IPO feel a lot more comfortable about their long-term objectives. They are more willing to hold a stock through bouts of volatility, whereas a new investor that maybe met with a company for an hour may not have that same tolerance.
Michael Kuchmek, Schonfeld Strategic Advisors: I completely agree but would add two things. Going into a (US presidential) election year, a lot of biotechs are trying to ensure that they have enough capital to get them through the next year, given they have such high cash burns.
The other thing we’re trying to figure out is the extent to which crossover investors are dictating when companies go public. Because we are seeing more pre-IPO crossover rounds, those investors are looking for guaranteed exits, whether through the public markets or otherwise.
You want investors that know the asset really well. I do believe there is a risk of investors looking at the historical biotech performance. The future is different because the investor composition has changed. Again, it’s not good or bad. It’s just a difference in the market.
Anna Pinedo, Mayer Brown: Mike, you are attributing a lot of that change to ownership by insiders. Isn’t a lot of the change in biotech performance over the last, let’s say, 10 or 15 years attributable to a decline in the number of research analysts that cover biotechs? Over the years, there has been a decline in the number of research analysts assigned to smaller or mid-cap stocks, and that correlates almost directly with limited liquidity.
IFR: Bob, I understand that the SEC recently rejected a proposal submitted by Nasdaq that would have strengthened the exchange’s listing requirements, most notably by excluding restricted shares from inclusion in a company’s outstanding share count. Could you talk a little bit about the proposal and what Nasdaq was trying to accomplish?
Robert McCooey, Nasdaq’s Listings Services: In general, our job as a self-regulatory organisation is to ensure that we are protecting investors. We are constantly looking at areas where we think we can strengthen capital markets. I could talk about the proposal you specifically referenced, but it might be worthwhile to take a step back and talk about what Nasdaq has been trying to do and some areas where we have had success.
About two years ago, we put out a white paper called ‘Revitalize’, talking about revitalising US capital markets. Taxation, regulation and disclosure are probably the three biggest themes covered in the white paper. A couple of things we advocated was to allow all companies to be covered by confidential filing provisions, not just emerging growth companies, and that testing the waters would also be available to larger companies. Some of the things we have seen the SEC approve in the past year and a half were nudged on them through Nasdaq’s Revitalize plan.
We recently put out a new FAQ that covers foreign issuers and some of the Nasdaq’s new rules associated with the minimum value of holdings by individual shareholders. Every shareholder in a Nasdaq IPO is required to have US$2,500 of stock, rather than just a 100-share round lot.
We want there to be a little more commitment to the IPO. There needs to be a real nexus to US capital markets.
We are really trying to look at where Nasdaq has seen challenges to market structure. Where there may be issues that we want to get in front of and make sure that we avoid some of the regulatory setbacks that came into the market over the past 20 years.
IFR: That US$2,500, can you talk a little bit more about that and why that would be a risk to the market?
Robert McCooey, Nasdaq’s Listings Services: On a number of recent IPOs, particularly some of the foreign deals, there were inside rounds, also known as friends and family rounds. (In some of those situations) there happened to be a large number of shareholders holding 100 shares of stock. So, 100 shares of a US$10 stock is a US$1,000 investment; not that much of a commitment.
We are asking for a little more commitment by a shareholder to hold US$2,500 of stock. That is not a tremendous burden on somebody who truly believes in a company.
The SEC still has a 400 minimum round lot shareholder rule for companies to do an IPO. Most of an IPO gets put in the hands of institutions and it’s the small tail that is used to meet that regulatory obligation. Investment banks and law firms are making sure that a company meets that threshold.
We want to make sure that there is a little more commitment by every shareholder to every IPO that comes to market.
IFR: Warren, SPACs have been incredibly resilient in terms of the front-end funding but have been challenged to complete back-end acquisitions. And some SPACs that have completed acquisitions have not performed particularly well. Are SPACs over-banked? If so, is there reputational risk to the product?
Warren Fixmer, Managing Director ECM, Bank of America: SPACs are a product that has had a number of different iterations over the years. The SPACs of 10, 15 years ago are very different than what we are seeing today. There a couple of pre-crisis SPACs that liquidated or failed. But the actual success rate and even how success is defined varies. When you look at the 2014-2016 SPACs, where we have complete data, 70%-90% in any given year were successful.
If you think about some of the changes that Nasdaq has implemented, SPACs are public listing alternatives. Because Nasdaq operates as a public stock exchange, you want to have a stock that trades each and every day and has a real liquidity. Liquidity, much like in the biotech space, evolves and builds over time.
SPACs are a very flexible product, and a lot of that flexibility is on the back-end, though initially they require a leap of faith on the management, their thesis, and the actual deal flow they will see.
There is an element of both buyer and seller being the target, with investment banks and the SPAC management as intermediaries. Ultimately, success comes down to valuation and a lot of that comes down to the structure of the back-end financing.
I think the product is far better today than it was 10 years ago and it continues to evolve. With each new SPAC IPO filing, there tends to be some nuances that change the product for the positive. Everyone looks at the amount of issuance over the last couple of years. We are likely to surpass the peak from pre-crisis this year. I’ll stop short of saying it’s different this time around, but it is a very different product today.
We are seeing companies emerge through SPAC mergers where there really are solutions to alternative stock listings. SPACs provide another entrée into the public markets. There are situations where an IPO or a traditional M&A may not be viable solutions to providing liquidity. Those are the applications of the product that I think are most intriguing.
Are SPACs over-banked? There is certainly a lot of product out there. But the onus is on those sponsor teams to go out and find and structure good deals. The sponsors obviously are compensated handsomely for completing a successful acquisition, but it is not easy. You have to find a deal that works for not only buyer and seller, but also for public shareholders.
Robert McCooey, Nasdaq’s Listings Services: One of the interesting things about SPACs is that large, well-known private equity firms are sponsoring deals. Riverstone, TPG, Mistral Equity Partners, and Gores Group have each done two or more SPACs.
That has created a kind of a magnet to others who say, “Wow, if this is some place that those large, really smart sponsors are getting involved in, we should think about that too”.
Probably a third of the meetings with sponsors who haven’t done a SPAC will segue into talking about a SPAC and whether they should do one or not. It is a super interesting space.
As Warren pointed out, some will do well, some will do poorly. Look at the two Riverstone SPACs: one did really well and the other, not so much.
IFR: Warren, can you walk us through the structure of the latest generation of SPACs?
Warren Fixmer, Bank of America: If you think back to the pre-crisis structures, you had to vote ‘no’ in order to redeem. Post-crisis, that changed and the warrant structure changed. There were a lot of things that made it easier for a sponsor to get an acquisition over the finish line if they could produce the cash
In terms of the structure of today, the elegance is very much on the back end. Again, it is really about finding a deal that works.
Four or five years ago, you really didn’t see earn-outs as part of the de-SPAC. Now you are seeing earn-outs allowing you to produce an à la carte menu, whereby you can align the interests of shareholders, management and the sponsors.
The baseline SPAC structure that you see at IPO is often very different in the end. Obviously, warrant dilution is far less than it was years ago. We just saw the first quarter-warrant SPAC IPO. Four or five years ago, TPG Pace had the first one-third warrant deal.
There have been advancements in the product that remove some of the friction points, which I think has been quite helpful.
There is always a lot of debate around innovation in the ECM world. Obviously, there is intense debate around direct listings. SPACs go hand-in-hand with direct listings as alternatives to traditional IPOs. As long as there’s a positive feedback loop, that innovation will continue.
SPACs are a product that is here to stay. In what magnitude, I’m not sure, but it is a viable solution for a lot of private companies.
Craig DeDomenico, Stifel: In terms of being over-banked, there are so many banks underwriting SPAC IPOs that are not traditional investment banks. Those non-traditional banks have incentives to bring management ideas for acquisitions. One important distinction of a SPAC merger is that SPAC management teams can put out their own earnings projections. On a traditional IPO, the sell-side research analysts provide those projections.
The onus is on banks to ensure that those projections are realistic.
We see a lot of SPAC deals that are a good company but have a really bad letter of intent or a bad merger agreement. They’re risks that we, as investment banks, need to keep an eye on to make sure there is enough vigilance to keep investors buying.
IFR: Elisabeth, we haven’t really addressed the poor aftermarket performance of some the large unicorn IPOs. Are unicorns simply too large?
Elisabeth de Fontenay, Professor of Law, Duke University: There is a lot of focus on the number of IPOs. What interests us as academics is the long-term decline, the several decades-long decline, in the number of US companies that are going public and remaining public.
There are several important factors contributing to that decline. They all fall under the category of we’ve got rid of both the stick and the carrot that drive companies to go public.
One big piece is regulations. Is there too much regulation of public companies? Certainly that could be the case and a contributing factor.
What’s really contributing to a lot of the decline is the deregulation of private capital. It’s much easier now to raise capital privately than used to be the case. In the past if you wanted to become a larger company and raise a lot of capital, you effectively had to go public. That was your only choice.
Now you can raise infinite amounts of capital from institutional investors without any disclosure and very limited regulatory obligations. Companies have seized on that opportunity, and private equity, venture capital and alternative pools of private capital are all a product of that evolution.
Companies are going public substantially later than they have in previous decades. They are older and much larger than in the past. Big unicorns are a product of that regulatory development, and a big reason why they exist.
Congress and the SEC are fairly focused on what that means for the public market investors. Does it mean that when they finally get a crack at these unicorn IPOs, it is it too late? That they have already experienced most of their growth, and are they just going public to provide liquidity to their financial backers and other insiders?
This is very much a live question right now, particularly in light of the recent performance by some of these unicorns since they’ve gone public.
I think the private market valuations for a lot of these unicorns are at best aspirational, at worst fairly fantastical. Their aftermarket performance has borne that out.
IFR: Elisabeth, has the SEC done enough to make it more compelling for private companies to go public?
Elisabeth de Fontenay, Duke University: Congress and the SEC are both very worried about the decline in the number of companies going public. But what’s very odd is that all of the regulatory steps that have been taken in recent years have gone entirely the other way. They have made it easier and more likely that companies will stay private.
In fact, the SEC is making a very big push to loosen the securities laws further, to make it easier for companies to stay private. And they are also considering a range of options for getting more retail investors to invest, either directly or indirectly, in private companies.
I don’t think it’s very hard to follow the logic here and see that these the proposals would create more incentives for companies to stay private and not to go public. It is a little bit of a mystery why, given concerns about the declines in the number of companies going public, the regulatory response so far has been very much in the other direction of making it easier to stay private by allowing more investors into the private markets.
IFR: Opening up access to private markets for retail investors? What are the implications from the proposals Elisabeth outlined.
Anna Pinedo, Mayer Brown: The SEC has been quite focused on the private markets. Most of the changes that we’ve seen in the last couple of years have been simply to extend the benefits. In other words, the changes have been incremental, and not really substantial.
We have not made it significantly more attractive to be a public company in the US, in part because we haven’t addressed many of the regulatory requirements. Things like the disclosure burdens and market structure issues such as research coverage. There are a number of aspects of going public that the SEC has just chosen to ignore because they are hard problems to solve.
IFR: Being private allows companies to be exempt from registration requirements. And because their securities are unregistered, private companies have fewer disclosure requirements to investors. Is that correct?
Anna Pinedo, Mayer Brown: Some of these very large unicorns are raising money via successive private placements where there are no disclosure requirements to prospective investors. Investors do not benefit from due diligence conducted by underwriters or legal counsel to ferret out information, vet the company, and otherwise subjecting it to scrutiny.
IFR: So a private company could provide a one-page document to provide investor disclosure?
Anna Pinedo, Mayer Brown: Absolutely.
Robert McCooey, Nasdaq’s Listings Services: A company could, but I doubt that Benchmark or KKR or any sophisticated investor is going to invest off a one-page document. They are doing tremendous due diligence before they invest in any of these companies. There are high-net-worth individuals that can get into these companies.
Taking a little exception to the facts that Elisabeth outlined, the number of issuers, public companies, on Nasdaq today is higher than it was four years ago. It has gone up every year over the past four years.
I will grant you that there are not as many listed companies on Nasdaq as there were in the1990s. But, arguably, a lot of those companies probably should not have been public - Pets.com comes to mind. But the reality is that (the decline in listings) has started to turn.
Again, I would encourage everyone to read Nasdaq’s ‘Revitalize’ proposal. A lot of the things that have just been just talked about on the Roundtable are included in there. Some people might look at Nasdaq (and the NYSE) as a competitor that is very focused on doing things for ourselves. But companies want to know who’s trading their stock. So much of the stock is being traded in the dark these days - 40% of trading happens in dark pools.
The reality is that we’ve put forth a proposal that a company should be able to choose to have all their shares traded on the stock exchange that they choose to be listed on. That would allow them to have better price discovery, not have fragmented markets, have them understand better who their shareholders are, and be able to track them in a much more transparent fashion.
There are a lot of things that are out there that we think are very positive for the market.
Nasdaq continues to push for change. We have an entire team in Washington that pushes the SEC and Congress on a regular basis because we do have an obligation to make sure that our markets continue to be the best in the world.
From a global perspective, I run our Asia-Pacific and Lat Am businesses. One of my colleagues asked the other day, “Why do all these Chinese companies continue to want to list in the US?”
We have the best markets in the world. We want to make them better incrementally, but the reality is we are already way ahead, and the rest of the world is chasing us.
Warren Fixmer, Bank of America: The aspects that Anna hit on related to market structure are really interesting. We are all part of this ecosystem.
Taking a look back at the late-1990s and thinking about private and public markets, a Nasdaq IPO was the private round of today. Now, we’ve swung all the way in the other direction.
There is a ton of capital devoted to late-round private investment strategies. Even financial sponsors, who we often thought of as more private equity in their orientation, have late-stage growth equity pools of capital. The due diligence they do is very different, obviously, and it’s not like access to that capital is immediate. Private investments are well researched and there is a lot of thoughtful investors competing with each other.
The origination funnel to private companies involves many investment professionals across firms with different mandates and investment horizons. One day a company may be meeting with General Atlantic and the next day with SoftBank. Those investors are all fighting and bringing a different edge. But they are sophisticated; the private markets are sophisticated.
At the end of the day the private markets are a very different product but disciplined.
Compared to an IPO, private investors go with a five or seven-year investment horizon. They have that visibility and due diligence is an asset against risks of that longer horizon.
When Mike is buying an IPO, he is talking to the research analyst, building his own model. He has a different level of information.
There is some asymmetry of information when it comes to investing in private companies. Obviously, a number of these are younger companies, and with that comes some volatility.
Michael Kuchmek, Schonfeld Strategic Advisors: On the disclosure, maybe private companies are not obligated to disclose as much. From a practical standpoint, though, you get a lot more disclosure than you do during the IPO process.
You are able to conduct due diligence on the asset yourself, you have full access to a data room, all the models, all the projections. You have full access to management, and multiple iterations. You go through, you do your due diligence, you refine your model, and you meet them again.
It is a bit trickier in the secondary markets for private companies because there you do not have that same access. If we are putting in money in a private round, we have direct access. It’s a primary placement. The secondary placements are trickier.
Regarding the headlines, we haven’t really noticed the impact of all these unicorns that keep surfacing in the headlines because there is only a few of them. The ones being talked about, whether it be WeWork, Uber, or autonomous driving, are unproven business models. You could argue the same thing in normal IPOs, whether it be FitBit, GoPro, or LendingClub. These things all happen. It’s just we’ve been talking about unicorns going public for two or three years, to the point that they were overhyped.
No one is talking about successful unicorns that have gone public like Zoom and Pinterest. It all goes back to the fact that you have to do the due diligence.
What you are seeing has more to do with the world being awash in liquidity. More capital goes into places, and so if I can go and I can test out a theory, say If I’m SoftBank and have US$100bn to put to work and I want to build this business to where I think the cash burn’s not going to be there, I can do that privately. There’s just so much liquidity pumping through the system.
I think that liquidity is causing more of these issues than the actual market structure. There are a lot of great unicorns out there. And the ones that are out there, such as basic software companies, not only do well in private rounds but will become very successful when they IPO.
Warren Fixmer, Bank of America: Private and public investors define success differently. Traditional public investors get paid on an annual basis. Private investors have a multi-year investment horizon, which I think is what causes some of the friction when it comes to the IPO. The same is true in the SPAC world, where a sponsor may have a three-year or five-year vision for a business, but investors want to see progress sooner. Whether it’s an IPO, a SPAC, whatever the case may be, you want to have that cadence of progress along the way.
Michael Kuchmek, Schonfeld Strategic Advisors: Warren, you also have the issue that some of these private companies do not want to be in the public eye as they are building and executing on the business model. Imagine if Facebook could have delayed their IPO for another year, given their switch to mobile (as they were going public), and how successful it would have been, as opposed to being called one of the biggest failures in IPO history.
Facebook wasn’t a failure, they were executing the business. To that point, there is a reason why KKR/private equity and others are able to aggregate money. It’s because they are able to execute in a reasonable timeline to get to that scale; to get the businesses where they need to be without being judged day in and day out.
IFR: With more money going into private capital, how credible are private valuations?
Warren Fixmer, Bank of America: There is a lot of discussion around down-round IPOs. Aside from Pinterest, Box did it. Square took a down-round on their IPO, and now they are a US$25bn company. Square executed their plan and built a really great business.
Down-round IPOs are getting a lot of scrutiny. I can understand that there is some tension and pressure from the private round of investors and employees. But if they can go on and execute and roll out new elements or features to their business that drive shareholder value, that scrutiny tends to fade into the background.
Robert McCooey, Nasdaq’s Listings Services: If SmileDirectClub and Peloton end up being US$15bn or US$20bn companies in a year or two, we are not talking about how their stock traded in the first week, month or whatever. It all comes down to them executing their plan.
We could talk about why people have different views as to why they traded so poorly, but it really doesn’t matter. Because one priced at the top end of the marketing range, and the other a dollar above didn’t change their economics. The only people who are underwater are those that bought the deal with the full transparency of an IPO filing.
IFR: What about the Nasdaq Private Market? Shouldn’t there be a bridge to the public markets to relieve some of the tension we are seeing on IPOs? How much liquidity are you seeing on the system and what function does the private exchange serve?
Robert McCooey, Nasdaq’s Listings Services: We have seen US$22bn of volume traded on our private exchange so far this year. A number of years ago we bought both SharesPost and SecondMarket and merged them into the Nasdaq Private Market. The exchange is a vehicle private companies use for their liquidity programmes. That could be liquidity programmes to allow exits for early stage employees and investors. Those programmes can be set up on a quarterly, semi-annual or annual basis.
Additionally, a lot of companies want to clean up their cap tables as they get closer to IPO. Again, the private exchange provides liquidity to that same group of people, be it a year or sometimes a little bit less before IPO to get a more solid cap table.
We have put in place liquidity programmes for private companies, including some of the largest unicorns that have gone public, such as Spotify.
But again, US$22bn so far this year, and we think this will be a market that continues to grow.
I always try to scale back the rhetoric when we start talking about what types of investors have access to these private markets. When we allow an institution to access the market, such as Schonfeld, they have a bunch of high-net-worth individuals, pension funds and others that are putting money to work in their funds.
The private exchange is a highly functioning market that we think will just continue to grow. We have seen volumes grow by 100% year-on-year for the past three years in terms of the size and number of deals that we have executed.
Warren Fixmer, Bank of America: Is that a leading indicator for new listings? Does it give you a leg-up? It seems like a really competitive differentiator. In many respects, the private exchange is a different marketplace than the Nasdaq Stock Market. Good housekeeping for a private company by creating less friction in terms of moving shares from one party to another.
Robert McCooey, Nasdaq’s Listings Services: We put it in place because we saw it as a differentiator for companies, because they could control their liquidity programmes. Let’s assume two private companies were trying to hire an engineer and the salary and equity compensation were identical between company A and company B. If company B was already using Nasdaq Private Market but an IPO might not happen for two or three years from now, that company would have an advantage because they are able to provide the engineer with liquidity as shares vest.
On the other side, we hope that company chooses to list on Nasdaq. I just mentioned one company [Spotify] that didn’t choose us for their IPO. Regardless, there is a lot of technology behind the private exchange and we work closely with private companies, providing liquidity for all of their shareholders. We believe that it gives us a leg-up versus our competitors in terms of winning an IPO.
IFR: One of the things we have noticed is the difficulty of locking up those private-round investors on an IPO. What are the investment agreements on private investments in terms of IPO lock-ups? Are private investors able to get around those lock-up restrictions?
Michael Kuchmek, Schonfeld Strategic Advisors: In terms of private capital markets, money goes towards alpha. I don’t want to use the term ‘liquidity bubble’ but in a market that trades less on fundamentals and more on macro and what the Fed’s doing, the amount of liquidity in the system generates alpha. Traditional regular-way funds are moving upmarket, whether through crossover rounds or other private placements, as a way to generate alpha.
It’s a very intelligent way to generate returns and a lot of funds have been very successful. A lot of funds have transformed themselves - whether it’s Tiger Global, D1 Capital Partners, Dragoneer, they are all experts in the space.
We have seen the same thing in life sciences with OrbiMed, Perceptive Biotech, and others. It’s great for the whole ecosystem because when you see one of those brand names on a company and the amount of due diligence and the amount of work they had to do, it is a very good validation.
Where it gets trickier is as we see more and more proliferation of private capital markets, toward the more quant-driven strategies that are less fundamentally oriented. Those strategies are looking at the data to track valuation step-ups and everything else. They are not as in the weeds on the fundamentals. They are playing it more from a statistical edge of, “If I invest in 100 privates, here’s what the data would look like”. The data only look that way because the fundamental investors were digging in and doing all the work.
I don’t think the increase in private capital markets is a positive or a negative. I think it’s just an adjustment to the capital markets, where, when you walk in, the amount of supply is not necessarily what you think it is due to the way a lot of funds can avoid fund structure.
If we invested in a private company through our 460 Fund, theoretically we short that company post-IPO through a different fund under the same umbrella.
It is difficult to enforce IPO lock-ups in those situations.
I know a lot of banks are talking about lock-ups. You could make adjustments on the stock loan side, where you basically make all the underwriting banks agree to not loan out the stock for a period of time.
There are a lot of different things that will come out of this. The Lyft IPO really kicked this off.
But again, I don’t think it’s a problem. When you walk in, you just have to understand that it’s not just the traditional VC money that invested in an IPO privately. There are other funds and you have to understand those funds no differently than if you were to buy a stock in the market right now.
If someone bought something because Warren Buffett owned it and they understand his style it’s the same as a lot of the companies we’ve been talking about. Through PitchBook or other private-company databases, you can see the five or 10 funds that are invested. It’s not like it takes a ton of work to get your head around who the funds are, whether they are engaging on fundamentals or on a quant basis.
It doesn’t really change much. You still have to be diligent in your investment processes.
Craig DeDomenico, Stifel: Lyft and Uber were basically follow-ons; they’re not really IPOs. Most large institutions had multiple bites at those stories well before they got to the public markets. Add the secondary liquidity of private markets, and their shareholder base becomes very disparate. On a middle market IPO, there are large, controlled shareholders that are under a lock-up for at least a couple of quarters after going public.
To Elisabeth’s point, companies are staying private so much longer because many of them have access to capital. They should think about cleaning up their cap tables in a much larger way, perhaps even with a large private tender offer. Provide shareholders with an alternative way to get liquidity that crystallises what may be a double on where they invested privately, and then list on the public market.
The tender process may be very hard to manage. But some of these companies are very large and should consider providing alternative forms of liquidity ahead of an IPO. The private markets are becoming more sophisticated, so we should probably think of tools to facilitate liquidity.
Warren Fixmer, Bank of America: Often on an IPO, the primary proceeds raised are used to provide liquidity to private investors. Some of those negotiations are happening behind closed doors.
There are a lot more funds that are investing in privates today. There was a lot of hoopla three or four years ago about traditional long-only mutual funds making crossover investments. A lot those companies did not go public in the timeframe they wanted them to, so they were forced to mark their books accordingly.
Private capital run by funds who run public money are now purpose-built private funds. As a result, you have to give them far more leeway in how they manage those portfolios. There have been nuances under the radar that have made the private market thrive.
IFR: How should we think about the effect of super-voting corporate structures on the size of companies going public, and when they go public?
Elisabeth de Fontenay, Duke University: When a company with a dual-class share structure goes public, typically the founder and other members of management have super-voting shares and the public will have low or no voting stock. That arrangement has become a fixture of the tech companies,
and possibly expanding beyond that, though
there are some companies that have bucked the trend.
Overall, dual-class structures feed into companies’ reluctance to go public, and the reason some are enticed to them.
Founders, in particular, might resist going public because they know they are going to have to be more responsive to investors. One way of combatting the need to go public is dual-class stock structures.
Among economists, the consensus is that these structures are very bad from a corporate governance standpoint. Over the long term, they are going to contribute to shareholder wealth destruction; as opposed to the counter-argument frequently made in support, which is that (super-voting structures) allow companies to execute long-term plans and grow without being subject to the constant barrage of public company investors.
It’s too early to say which viewpoint is right. We don’t have enough data on this. There are concerns that these structures are problematic over the long term, but we just don’t know yet.
A bigger question is whether the more recent contemporary style of venture capital, which is building companies around founders, is potentially being called into question. A lot of these companies were potentially overvalued, so dual-class stock structures may not always end well. Perhaps it’s time to reconsider a more traditional approach to venture capital, where the founder does not retain control through dual-class shares.
IFR: How do dual-class structures affect valuation?
Michael Kuchmek, Schonfeld Strategic Advisors: The market is self-regulating and in that context, you also have to consider that the overall market has moved more towards passive investment strategies, that companies with supermajority structures are not eligible to be included in stock indexes. If a company really wants to have supermajority, they are basically saying that the asset is so good to offset that friction. I think that that’s a big ask.
When we look at it, we are valuing a company as it is. I feel like we’re focused too much on Lyft, Uber, SmileDirect and WeWork. Those are eccentric situations at the end of the spectrum but are fair game because they caused a lot of value destruction.
Our general view is that we don’t want to participate in IPOs with super-voting structures, unless it’s a must-own business, because of factors such as passives’ inability to own. It is just something that’s always in the back of your head, and historically or over time there has been a lot more value destruction in those dual-classes than value creation.
Google was one of those must-own businesses.
It’s a judgment call. If you’re running a good business but it’s not a must-own, not transforming the world, then (super-voting) will be a very limiting factor. It could be a situation where you say: “Well, if it’s not going to be in the index, I don’t really need to be there right now”.
Warren Fixmer, Bank of America: In many respects that just reinforces the influence in the growth of passive investing. Passives now account for more than 50% of every dollar under management in the US. Indexers are by definition long-term focused, so they don’t really care about quarterly financial metrics, etc. Governance and how that aligns with long-term shareholder value creation is much more important to them, because those are the things that they control. It is a binary decision on whether or not they buy or don’t buy, and it’s up to the index provider to decide.
The growth of ESG investment strategies has had a lot more to do with the ‘G’ (governance) than the ‘E’ (environmental) and the ‘S’ (socially responsible), but it does speak to market structure and the flows of investor capital.
Anna Pinedo, Mayer Brown: Index providers have started to regulate the dual-class structures in a way, indirectly. But in large measure that is a function of the SEC not doing anything on dual-class structures.
We have had various individual SEC commissioners express their personal views on dual-class structures or the necessity for sunset provisions that would define when disproportionate voting rights go away. But we haven’t actually seen any regulation from the SEC. All we have seen is this indirect market regulation through the index providers, and then blowback to the index providers in part for imposing that as a standard, which I think is odd.
IFR: Does the growth of passive investment relative to active strategies make it harder to syndicate new deals, in terms of identifying and locating active investors to place stock with?
David Bauer, KKR Capital Markets: It does put a premium on distribution and quality of distribution. Passives are not yet, in size at least, participating in IPOs directly.
The fact that active funds are losing AUM, seemingly on a weekly basis, does put a premium on firms like Schonfeld that will stand up and give you direct views, knowing where those pockets are that have a view and that can withstand volatility. Identifying those pockets is hugely important.
From my standpoint, I would love to see passive money be the liquidity way to play the market and a transition of active money having longer locked-up capital, similar to a private market. I think that’s one of my biggest frustrations.
Warren, you said something that was spot on: the asymmetry between long-term private capital relative to the short-term quarterly evaluation on the public side that might not be willing to withstand bouts of volatility because they are worried about day-one P&L. Active managers have been thinking about this for 40 years, to the extent they can evolve towards a longer-term view. Whether it’s annual liquidity or beyond, to be able to source demand in passive-like pools of capital, something more akin to a private model in the public markets, it could be an interesting transition and be a way to have more sustained public market capital that is actively looking at deals and not dwindling the way (active) is today.
Anna Pinedo, Mayer Brown: Something that isn’t talked about as much is that even in private markets a lot of the investing is passive. It used to be the case that venture investors brought some discipline to a lot of the private companies that they invested in. More and more of the private capital that’s being invested in unicorns and other privates don’t want an active role in governance. They don’t want a seat on the board, they don’t want to be involved in any decisions regarding management because they don’t want to be affiliates by the time the IPO comes around.
The discipline that once existed in private companies that were IPO bound does not exist anymore in all cases.
IFR: Craig and Warren, what are your outlooks for the rest of the year and into 2020? What do you see?
Craig DeDomenico, Stifel: There is a bit of buyers’ strike until the end of the year. The reality is that that the second and third quarters saw huge issuances of IPOs, and the 2019 class is up 4% or 5%. We will see IPOs before year-end, particularly out of some of the more defensive sectors and biotechs. But in general, a lot of the large-cap deals in the backlog have already been pushed into the first quarter.
2020 is an election year, so a lot of companies
that have pushed are going to be laser-focused
on getting deals done in the first and second
quarters. Given the way new issues performed
in the third quarter, you could see some of that backlog pushed into the second quarter (of 2020), which historically has been a really big quarter
for IPOs.
You may see companies choose to downsize their offerings: instead of US$1bn, perhaps they will raise US$500m or US$700m. Thematically, some of these (2019) deals just got very large. Smaller deal sizes may make more sense given that many institutions have already established stakes.
There is also a lot of dialogue around direct listings. There will be more, but I don’t think it’s going to dramatically affect the IPO calendar. I think the public markets are looking for more traditional middle-market, US$2bn to US$5bn market cap companies whose IPOs are US$200m-$400m. Those IPOs tend to be up-rounds because they are generally simpler businesses. They tend not to get the same level of scrutiny over the topics we talked about today. We’d like to see a lot more of those companies go public, but we’ll see. We’ve got some things to prove here after a tough third quarter.
Warren Fixmer, Bank of America: If you look at performance on a cap-weighted basis, the IPO
market as an asset class is flat for the year. A lot
of that is skewed by the jumbo deals. Sub-billion dollar IPOs, the returns are 12%-14%, so a normal
year.
It’s not all bad news. There are great companies going public. Insurance has been a bright spot this year. Who would have thought that P&C insurers and insurance brokers would turn out to be sexy investments? But they have performed incredibly well. There are green shoots in terms of companies that went public this year.
One important factor is that we haven’t seen a lot M&A activity that historically has driven equity issuance. M&As are at a five-year low. Companies tend to pre-fund M&A in the convert market.
We didn’t really touch on the converts, but that market is on track for its biggest year since the financial crisis.
There’s a lot of issuance still to come. But it is worth pointing out that historically we have seen IPO volumes in an election year decline by 25% year-on-year after Labor Day (in September and ahead of the November presidential election).
Who knows what’s going to happen between now and next November? But a lot of companies are getting ready. There are new RFPs hitting our inboxes every day. Companies that we thought were going to wait until 2021, 2022 are looking to write that call option for themselves right now to get ahead of what could be a volatile period.
There are some negatives that could come if companies aren’t prepared. But I think companies are trying to take advantage of a reasonably healthy backdrop that we have right now, notwithstanding some of the buyers’ strike that Craig mentioned.
IFR: Thank-you all for your comments.
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