One of the most profound changes in the investment landscape over the past 15 years has been the loss of a once-vibrant IPO market.
After the dotcom bust destroyed the paper profits of a generation of speculators, the regulatory ethos in the U.S. shifted from facilitating the free flow of capital to preventing the public from succumbing to temptation and greed. Specifically, regulators imposed so much red tape, cost, and scrutiny on public companies that they made going public an act of lunacy for all but the most mature startups.
This change has undoubtedly helped prevent clueless retail investors from losing money.
But it has also prevented aggressive professional investors who understand financial analysis, risk, and portfolio management from investing in promising companies early enough in their life-cycles that they can capture spectacular returns.
For example, when Amazon went public back in 1997, the company had a modest ~$US500 million market valuation. Investors who bought into Amazon’s IPO took a lot of risk, but they also bought the possibility of a mind-boggling return. Two decades later, Amazon’s IPO investors have made 200-times their money.
When Facebook went public three years ago, meanwhile, it was so mature that its hyper-growth years were already behind it. The IPO valued Facebook at about $US100 billion — 20-times Amazon’s IPO value. Now, with Facebook valued at $US225 billion, Facebook’s IPO investors haven’t done badly — they have doubled their money — but they haven’t captured anything like the returns that Amazon’s IPO investors did.
This change has created a problem for professional public-market investors, like hedge funds and mutual funds.
They want to invest in aggressive-growth companies, but by the time these companies go public these days, their aggressive-growth years are over.
But the investors still have customers to please and return objectives to hit.
So these investors now have to look for other ways to invest in young, fast-growing, and, yes, risky, private companies.
This demand for growth investments, which has been exacerbated by a stagnant US economy and paltry revenue growth for most mature companies, has led to the creation of what is now described as the “private IPO market.”
Stymied by over-zealous regulation and the rare late-stage IPO, professional fund managers have taken matters into their own hands — and begun investing huge sums in hot private companies.
The demand for growth investments is so great that the valuations on the most promising of these private companies — the Ubers, Snapchats, and Pinterests — are soaring. And these companies have so much money being thrown at them, by investors who are so desperate that they will pay almost anything, that the companies feel stupid not taking the money. And once their competitors and would-be competitors load up, of course, even abstemious managers feel the pressure to keep up with the Joneses and do monstrous mega-rounds.
Even as the level of excitement and action in this “private IPO market” grows, most veterans know how it will end — in another tech bust.
But knowing how it will end is different than knowing when it will end, and no one knows the answer to that.
In the meantime — before it ends — fortunes and careers will be made.
And there’s nothing like watching your competitors and friends making careers and fortunes because they were bold and you were a wimp.
So now, as the legendary venture capitalist (and cautious veteran) Bill Gurley of Benchmark Capital observes in this Wall Street Journal article by Evelyn Rusli, the private IPO market is consumed by “FOMO” — the Fear Of Missing Out.
Gurley was speaking at the Goldman Sachs Technology Conference, which is attended by the same public-market investors who are driving the orgiastic private-IPO scramble. After Gurley made his remarks, a mutual-fund manager neatly encapsulated his problem:
“You don’t want us to invest in this but the big tech stocks are not delivering enough growth and my competitors are getting into these startups, so what are we supposed to do?”
Read that one again:
“My competitors are getting into these startups, so what are we supposed to do?”
For those who are unfamiliar with (and mystified by) the logic that underlies real-world investment decision-making, there it is.
And it reveals why, no matter how smart and sophisticated we get, we will always have booms and busts.
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