More updates…

We start the week with the latest news that have been shaking up some of the topics we have already covered in this blog.

News brought to you courtesy of Warren. Credits: Daily Mail.
News brought to you courtesy of Warren. Credits: Daily Mail.
  • Apple struggles to maintain its market share in China according to the company’s latest filings released last month. Although Apple’s revenues in the country are up 50% compared with 2014, local rivals such as Huawei, Vivo and Oppo have been offering cheaper although similarly powerful devices. The firm is supposedly eyeing towards India as its next revenue growth driver. In the meantime it launched its latest ‘product’, a retrospective book entitled ‘Designed by Apple in California’, and priced the Apple way: $199 to $299 depending on the edition.
  • Twitter has announced it would cut 9% of its workforce in order to keep costs down. This comes at a bad time for the firm which have been increasingly criticised for allowing cyberbullying, racism and misogyny to flourish on its platform and now has to find a new COO after the departure of Adam Bain. Twitter responded by suspending several accounts belonging to right-wing extremist groups, although it has for the moment ruled out ‘instant message moderation’. The idea that “good speech naturally wins out” is a fallacy, argues heather Brooks in the Financial Times.
  • The election of Donald Trump in the US caused a mini-stock market shock to tech values. Mr. Trump is indeed believed to ease the tax policy surrounding corporate earnings made overseas – currently those earnings are taxed at 35% and the rate could go down to as low as 10%. This explains why Microsoft, Apple and Google have been keeping billions of dollars offshore. This news could have been welcomed but are investors actually fearing what executives are going to do with this ‘idle’ money?
  • Notwithstanding this rumour Facebook announced earlier this week a $6bn share buyback aimed at curbing the negative share price impact of an expected growth slowdown expressed during its latest quarterly result presentation. This decision represents an archetype of buyback for ‘wrong’ reasons, as flagged in my post a few months ago. Facebook is not buying shares because it believes they are cheap but because it needs to satisfy its existing shareholders – a typical value-destroying move.
  • Microsoft’s acquisition of LinkedIn could trigger a wave of antitrust challenges, according to Marc Benioff, Salesforce’s CEO. LinkedIn’s data could indeed provide Microsoft with a unique competitive advantage especially in the field of CRM – hence Mr. Benioff’s ire. As a response Microsoft proposed to give rivals access to its software and offer hardware makers the option of installing other services.
  • SoftBank is entering the ‘tech unicorn’ investor market the big way, through the launch of a $100bn fund anchored by Saudi Arabia. The implied equity cheque size (up to $5bn according to its CEO) could provide a private exit door for a handful of existing unicorns reluctant to go through the ‘IPO gateway’.
  • Sigfox, the French ‘Internet of Things’ specialist, could soon join the unicorn club, being valued at €600m according to its latest fundraising round. The operation was relatively unique in the sense that it gathered public entities, private companies and VC funds around the same (investor) table.
  • Fitbit could conversely become the next ‘unicorpse’. The company’s share price has declined by 80% over the last 18 months as tech behemoths have been progressively entering the field of connected objects. On its side, Fitbit tried to put the blame on one of its suppliers to explain its recent supply chain disruptions – whereas analysts attribute this phenomenon to incorrect demand forecast.
  • Karhoo has already reached this status, filing for bankruptcy after just 6 months of activity. The start-up, which raised $250m and was employing 120 people despite only generating $1m of revenues in London. A very aggressive promotional policy, consisting of ‘thousands of pounds of vouchers’, alongside a “ludicrous lack of corporate governance”, led the company to ruin in a highly contested market.
  • Nutmeg managed to raise £30m from international investors despite posting pre-tax losses of £9m this year.
  • Snapshat could be the big IPO of 2017, hoping to raise additional equity at an implied valuation of $20bn to $25bn – although the exact amount still needs to be determined. The two founders will keep the control in any case through the use of preferred shares.
  • Uber faces legal challenges in the UK, where a court ruled that Uber drivers were not independent but actually salaried workers. In France the fact that some Uber drivers could under some circumstances be promised a minimum wage is also a cause for dispute.
  • The Airbnb business model is being challenged in an increasing number of cities. After New York and San Francisco, Berlin and London have joined the fight to prevent the firm from putting pressure on dwelling supply and subsequently pushing rents up in the most touristic areas. After relentlessly fighting all forms of regulatory resistance, the firm has changed its approach and is now intending to strike as many tax deals as possible with the cities it operates in – bringing the figure up from 200 to 700 and covering 90%+ of its revenues.

That is it for this week in terms of updates! Next post (hopefully later this week) will introduce the cybersecurity topic.

Floating or sinking? 5 questions to understand the IPO challenge

Mark Zuckerberg at the NYSE in 2012
Mark Zuckerberg at the NYSE in 2012

In this post I would like to take an interest in ‘Initial Public Offerings’ or ‘IPOs’. We all remember the big tech offerings of the last two decades (Yahoo in 1996, Google in 2004, Facebook in 2012) which made their founders join the billionaire club. Today a company founder is usually considered as ‘unanimously successful’ if he has managed to ‘float’ a significant share of his company – and if the share price has not collapsed since then, meaning that he has won a ‘seal of approval’ from the stock market. Behind this phenomenon, I have highlighted 6 questions worth thinking about in my view.

 

What are the pros and cons of public as opposed to private ownership?

‘Public ownership’ means by definition that shares are made available to the public. Shares in a public company are therefore much easier to buy and sell through marketplaces (stock exchanges) or ‘over the counter’ (where the buyer and the seller negotiate directly). Private company shares can only be exchanged through the latter way. This largely prevents small shareholders (such as employees) to monetise their shares.

Credits: www.cartoonstock.com
Credits: www.cartoonstock.com

Public ownership requires that all potential investors benefit from the same level of information. This explains why public companies’ annual reports are usually hundreds of pages long. Producing this information and, more importantly, making it compliant with regulatory requirements, comes at a (significant) cost, notwithstanding the fact that a public company may have to reveal competitively sensitive information – one of the reasons why they tend to have recourse to cryptic jargon. Conversely, private companies do not need to release any data to the public -they just need to maintain an even level of knowledge within their current investor base.

The fact that information is limited and that share trading mechanisms are more difficult to implement makes the potential shareholder base narrower in the case of a private company. As a consequence, the investor base in a private company is usually much more concentrated, meaning that it is easier for shareholders to push management in the same direction – this one of the core governance principles underlying private equity – and this may seduce ‘activist’ investors.

On the contrary, public companies can attract a higher number of small investors and could thus raise a higher amount of money – a few years ago raising money to fund growth was one big reason for companies to go public, at least in Europe. Nowadays, with quantitative easing in place and interest rates in negative territory, private companies can fund their growth without having to go public – see Uber’s recent $3.5bn fundraising round.

Source: Financial Times
Source: Financial Times

So, to summarise, going public provides liquidity to existing shareholders and enables the company to tap into a wider investor base, but this comes with a price associated with the publication of regulated information.

 

Why is there a push for private tech companies to go public? Is this push unanimous?

Tech company shareholders (e.g. venture capital funds) perceive the current environment (excess of liquidity, stock markets reaching all-time highs etc.) as extremely favourable for introducing new stocks at a relatively high price compared with historical standards. These funds typically have 10-year lifespans and are in a pressure to return liquidity to their investors. Pressure has been formalised in Spotify’s last debt fundraising round terms: the more the company waits to file for an IPO, the more expensive the debt will become. Separately, employees in these companies accepted to trade a share of their cash compensation for shares (‘stock-base compensation’ represents 31% of revenues at Twitter) and would like to see their hard-working, poorly remunerated efforts ultimately pay – as mentioned earlier, it is nearly impossible for an individual shareholder to sell the shares he owns in a private company.

On the other side, you have management teams which, as mentioned above, do not perceive the need to go public any more to fund growth, although they can clearly see the regulatory burden associated with public ownership.

Source: Financial Times
Source: Financial Times

To hep the two sides meet, ‘secondary markets’ have recently developed as a middle ground between unstructured private ownership and fully-fledged public stock markets. These secondary markets enable early-stage investors to cash out while maintaining the ‘private’ nature of the company.

 

Why is the IPO window said to be narrowing?

The number of IPOs has over the last few months collapsed – only 14 since the beginning of 2016 compared with an annual average of 49 since 1980. Not that the flow of candidates has dried up: Misys, a UK financial software provider, cancelled its IPO last month while O2 has indicated that the company’s planned IPO would not happen this year.

After having been attracted by the new shiny unicorns, ‘public investors’ are now proving much more cautious in their approach – possibly still having in mind the misfortune of past so-called ‘success stories’ such as Zynga. See for example this list of ‘top 10 IPOs to watch in 2016’ and compare it with the actual number of completed IPOs to get a feel of the chilly market weather.

Yes, 2015... Credits: www.turner.com
You could recycle the list for 2017. Credits: www.turner.com

Now a shiny brand name and a glossy equity story are usually not enough and the days of valuation based on revenues (i.e. putting aside any profitability consideration) or eyeballs (the mantra of the late 1990s) are over. Investors are looking for an established business model, a diversified product portfolio (suspected to be the cause of Dropbox’s IPO delay), a clear strategic edge, proven profitability (at least in some geographies) or a clear path to achieving so in the short-term, and a robust and fully committed management team with significant ‘skin in the game’.

This list of selective criteria does not prevent some IPOs to successfully complete. Coupa (despite having not made any profit) or BlackLine are two recent examples of recently floated companies which experienced significant share price growth on their first day of trading.

 

If the environment happens to be so favourable, why are Airbnb or Uber delaying their IPO?

Airbnb and Uber are often announced as the ‘hottest IPOs of 2017‘ – alongside with Snap. Those two brands however have been enjoying success for years now and one could wonder why these firms have been waiting before testing the public markets.

Credits: www.licdn.com
Credits: www.licdn.com

The reasons can be found in the previous questions. Airbnb currently does not need public markets to raise new money. Uber is burning cash at a gigantic speed – more than $1bn in H1 16 according to estimates – which makes the aforementioned ‘path to profitability’ tedious at best. Another less honourable reason is that the firms’ current valuations ($68bn for Uber, $30bn for Airbnb) would probably not withstand public markets scrutiny. Indeed, these valuation figures are purely based on extrapolations of the last fundraising round (see my previous post for further explanation) and tend to be substantially higher than the value allocated to a larger share of the equity.

As another example we could have mentioned Palantir which, despite being privately valued at $20bn, has yet to report a profit. According to Alex Karp, the company’s CEO, the IPO was postponed on the belief that large public companies struggle to recruit the most talented engineers – this statement must have been welcomed by Alphabet‘s teams.

 

Many of the tech start-ups, from small to very large, will have to face the ‘IPO hurdle’ in the coming months or years. In a world where investor liquidity does not represent a discriminating factor any more, public markets may become the next justice of the peace.

Want long-term inflation? Raise rates, now

janet_yellen_official_federal_reserve_portrait
Credit: Wikipedia

Central banks across the world have been trying to reignite inflation by injecting a massive amount of liquidity and buying financial instruments, most recently corporate bonds. In theory, a higher supply of money should devalue the currency, thus boosting both exports and domestic demand. In particular, demand translates into more investment, which is a necessary cornerstone for long-term growth. Needless to say, this classic monetary tool has been more than widely used over the last few months. But the target remains out of reach in many countries. Despite more than $1tn of debt now yielding negative interest rates, inflation barely climbed to 0.6% in the UK. The US Fed is considering raising interest rates again although inflation in the US is 2.2% and thus barely exceeds the official 2% target.

Credit: Getty Images
Credit: Getty Images

I have already highlighted in this blog the importance of confidence in driving the decision of individuals. When people are confident about the future (i.e. they can predict with relative certainty the future state of the economy and the implication for their personal wealth) they do not hesitate to invest part of their income in ‘non-vital goods and services’ such as domestic appliances, automotive etc. The same logic applies to companies – this is what we call investment. Today’s environment largely lacks visibility. Geopolitical concerns (elections in the US, France and Germany, Brexit in the UK, tensions in the Middle East) make economic decisions even harder to predict. As a consequence, despite the affordability of debt, households and companies prefer to save today in case the situation gets tougher tomorrow. The resulting drop in demand has been widely pointed out as a cause for low inflation or potentially deflation in some areas (e.g. food in the UK).

Not only are hyper-low interest rates inefficient, they are counterproductive, and central banks should raise interest rates as early as feasible. Let me explain. The excessive amount of non-invested liquidity has led individuals and companies to invest in financial assets such as bonds or funds. Venture capital funds have been particularly in demand given their risk-reward profile; they tend to be more risky than ‘plain LBO’ funds and according to theory should yield better expected returns. Unsurprisingly E&Y in its latest global venture capital trends report states that venture capital deal activity increased by 54% in 2015 to reach $148bn.

Flooded with liquidity venture capitalists are begging for start-up ideas to invest their money – given that the worst scenario for an asset manager is to show his investors that their commitments are sleeping at the bank. The number of start-ups has been logically soaring in all developed economies as a result, sometimes giving birth to incubators, the most famous certainly being Rocket Internet, and a few have been raising tens or even hundreds of millions of dollars to boost their development.

In the 2.0 economy, where marginal costs are almost non-existent and barriers to entry are low, ‘customer acquisition’ and ‘network effect’ are the new mantras. Rather than investing in expensive marketing campaigns, start-ups have decided to invest in prices, most often selling their services at a loss to ensure maximal penetration. Uber is a good example. Rides in London are on average 30% cheaper than a black cab. The company is present in more than 500 cities and has been valued at $68bn in its latest fundraising round completed last year. And yet, Uber reported $1.2bn in losses in H1 2016 – this raises a broader debate about the criteria for start-up valuation, which we will address in a later post.

Credits: bpplan.com
Credits: bpplan.com

Private investors have shown patience so far, hoping that the ‘hockey stick’ will materialise. And if it does not, investors often believe that it is simply due to a lack of scale and that further investment is required to ensure the user base is large enough to prove profitable. The stock market, conversely, has been indifferent to this thesis and very few start-ups have succeeded to make a strong enough profit to reach the IPO stage – a feature that differs from the 2000 ‘dot-com’ bubble.

Exit of VC deals: IPO vs. M&A (value in $bn). Source: E&Y.
Exit of VC deals: IPO vs. M&A (value in $bn). Source: E&Y.

My point is that for months now many aspects of our daily life have been ‘subsidised’ by increasingly risk-seeking venture capitalists and that behaviour has largely been driven by the abnormally high amounts of liquidity made available by Central Banks. Paradoxically, these start-ups have most often been bringing down prices and ultimately favouring deflation, pushing Central Banks further away from their initial objective. I am not saying that price cuts are always bad. But in this case price cuts have only come at the cost of corporate losses – simply put: value destruction.

The argument about the ‘hunt for worldwide scale’ is dubious. Although this hunt is legitimate in a limited number of cases (social networks represent the most typical examples), entering new markets brings limited benefits to most start-ups. When Uber decides to enter Santiago, it cannot rely on network effect: the taxi drivers operating in Santiago are different from the ones in Singapore and the customer base is also very distinct. Given the very lean cost base, the only synergy it can expect is the brand power – which may not justify hundreds of millions of dollars of losses. And, even if you do so, you cannot prevent an aggressive competitor to emerge with even lower prices – only the depth of the investors’ pockets will make the difference.

My recommandation to Central Bank governors is thus simple: raise interest rates and clean up the mess. We will not find growth by artificially subsidising value-destructing activities. The fear of the next crisis and the willingness to avoid recession at all costs are leaving everyone in doubt. Take the hit, start from a fresh and economically sane breeding-ground and build again from there.

flower
Credit: www.ericnguyen23.com