The incredible shrinking stock market

If I’d said to you a few years ago that I was creating an end to end encrypted messaging service that I won’t charge anything for, that will not permit advertising, and that any highly literate computer programming expert could replicate in a couple of months – what would you have valued that at? Hard to say, but on traditional metrics of corporate valuation, the answer would likely round quite close to zero. WhatsApp was set up in 2009 and was bought by Facebook for c. $19bn five years later. This is the new era of valuation – where capital doesn’t feature. 

The decline in IPOs

This was an example provided at a recent investment conference at which I heard an extraordinary statistic; the number of companies listed on the U.S. stock market has halved in the last twenty years, owing to a combination of companies de-listing, coupled with a dearth of initial public offerings (IPOs). This seemed to jar with my general sense of things – after all the recent hype around Uber and other high-profile IPOs. 

The recent IPO of Uber, the lift sharing platform, was notable for a number of reasons, not least the eye-popping size of the company by the time it came to the public market. It raised $8 billion valuing the entire company at $82 billion. Amazon had its IPO in 1997, raising the relatively paltry sum of $54m, giving the company a market value of $438 million at the time. Its market capitalisation broke through the $1 trillion barrier in late 2018. To the intrepid investors that did participate, the public markets provided the opportunity to share in the growth of one of the most successful companies in the past two decades. 

The IPO has underpinned equity capital raising for decades but is being increasingly replaced by private capital transactions. So, what’s driving the trend away from public markets? 

Why are companies moving away from public markets?

Many new ideas and businesses are making their way to public markets, not through an IPO but via existing listed entities (a la WhatsApp). Alphabet, parent company of Google, and others for example have become self-contained “markets” in their own right, acquiring companies and supplying the capital that an IPO would normally provide.

In addition, large private-capital pools searching for higher yields in a near-zero interest rate environment are providing entrepreneurs with much better access to capital.  A frequent complaint is that being a public corporation is increasingly or excessively onerous due to corporate disclosure requirements and governance standards. 

I think a significant factor is the changing nature of the market over the last decade. So-called “knowledge-based” business models tend to be very asset light and so companies with little requirement for capital, can stay private for longer. 

Of course, businesses that require less capital investment to grow, are subject to lower entry hurdles from competitors. Both characteristics make it less likely that such companies will access the public markets in the first place or remain listed for long if they do.

Whatever the reason, the outcome is not a positive one for the average investor. The trend for companies to stay private longer is starving retail investors of access to the growth in a part of the economy that traditionally he or she could have accessed. Only large funds and entities can efficiently invest in illiquid sectors such as private equity. This is not a clarion call for investors to stampede in to private equity. But there are lessons for the average investor in this tale. 

Lessons from the world of private equity

The absence of daily mark-to-market pricing must be considered a major plus in my view for private equity over its publicly listed counterpart. A less liquid and more opaque market structure seems like a hard-intuitive sell as an advantage. But a mechanism that denies investors access to their capital at a whim and does not provide a constant valuation of their investment, has a positive impact on investors often myopic timeframe. 

The old joke was that IPO stood for “It’s probably overpriced” as going public was just a mechanism for more informed insiders to cash in on less informed outsiders. There’s no excuse for this. Public markets require such a high level of disclosure that any mistakes by investors, are largely of their own making. More disclosure doesn’t necessarily make for more informed investors. It just creates the conditions for more snouts to enter the trough. Investing has always and will continue to be a battle of emotional minds, not a battle of wits. And that is true whether it’s in the public markets or held privately.  

We should try and treat all investments as though they are privately held – with no short terms access and no ongoing valuation. If you require constant pricing and a frequent bid for your investments, you probably shouldn’t be investing in public, much less private equity.