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Private is now the New New-Private not the Newish Public

The recent transition of a slew of high profile tech companies from private to publicly listed corporations has reinstated the valuation premium that public companies hold over private ones. Spotify, Lyft, Pinterest, Zoom and soon to be listed Uber clearly show that public markets still dominate private ones when it comes to valuation.

The Private-is-the-New-Public mantra advanced the view that raising capital had become easier in the private markets than in the public ones, therefore obfuscating the need to list. Since access to capital was previously perceived to be the fundamental advantage of the public markets, listed companies should have traded at a premium. The rise of Venture Capital and Private Equity created the ability for private companies to raise capital on similar or better terms than the public markets.  This should have arbitraged that public-listing premium away. Accordingly, newly listed privates should trade at the same price as before listing, or at least at the IPO price set by the brokers leading the deal…

Apparently not.  Spotify, Lyft, Pinterest and Zoom each listed at 12%, 15%, 30% and 72% premium to their pre-listing prices.  Lyft subsequently declined below its pre-listing price but it still had its first public day in the sun and was welcomed heartily.

Critics of the private markets argued that going public would expose the over-optimistic expectations of the fancy Venture Capital and Private Equity firms to the full scrutiny of institutional investors, in turn marking down their irrational exuberance. That is, the public markets would see through the cult-like blue-sky beliefs and bring valuations back down to earth. Perennially loss-making unicorns would face the reality of the need for profits and dividends; failure to do so would see prices slashed…

Apparently not.  Even in the pre-market roadshows to institutional investors, each of the newly listed companies priced their offers at or above the top of the range suggested by the brokers.

The most interesting result of the recent listings is that being public still commands a premium.  Access to capital cannot be that reason.  Two possible explanations are either (i) access to liquidity accounts for the additional premium or (ii) the VC’s and PE’s expectations were too pessimistic.

Liquidity is precious to investors who cannot influence decision making – the ability to exit a position if the investor doesn’t like what he sees is much easier in the public domain than when there is no secondary market.  Back of the envelope calculations can easily justify a 15 to 30% liquidity premium for a listed corporation with a 0.5% to 1% reduction in the required risk-premium.

Pessimistic VC’s and PE’s?  There is an element of truth in this explanation as well.  We are all taught that the value of a company is the discounted sum of all future cash flows.  Traditional ‘value’ investors like Warren Buffett are more comfortable dealing with positive cash flows today and extrapolating these forward.  ‘Growth’ investors tolerate extended periods of early losses in order to harvest fantastically rich cash flows in the future. Exactly how those riches will be generated and how much they will be is difficult science, so a smart VC/PE investor risking their own cash would surely prefer to underestimate their magnitude rather than overestimate.  Growth investors are only really competing with Value investors for the same deals, so if the likes of Buffett don’t even consider investing in firms that post losses early on, then the VC/PE can effectively buy these companies at a price-point where the competitors drop out.

Irrespective of the reason, the clear message from the unicorn-parade is that being public still commands a premium.  Founders and shareholders in unlisted companies should pay close attention to this fact.  Opting to remain private may appeal to a founder’s romantic notion of non-conformist disruptor but it’s still going to cost everyone money.  Private may have become more sophisticated and Newish, but Private is not the New-Public.

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