At the start of May, with US stock markets at record highs and investors hoping president Donald Trump’s tax reforms might yet prolong a bull run already into its ninth year, Adena Friedman, president and chief executive of Nasdaq, chose her moment to ladle out some cold water.
She pointed the stock market bulls away from rising index values and towards the dramatic and prolonged fall in the number of listed companies.
Dealogic data show that 2016 was the third-slowest year for US initial public offerings on record, with just 98 new flotations, the fewest in any single year this decade and the lowest since 2009.
Friedman unveiled a blueprint to address what she calls fundamental structural concerns in the public equity markets, calling for new limits on frivolous shareholder litigation, on costly and burdensome disclosures and management of proxy processes, and on shareholder activism. Friedman argues that:
“As the US has continued to add layer after layer of obligation, we have reached a point where companies increasingly question whether the benefits of public ownership are worth the burdens. If not addressed, this could ultimately represent an existential threat to our markets.”
Credit Suisse strategist Michael Mauboussin analyzes this closely in a report published in March called ‘The incredible shrinking universe of stocks’.
Mauboussin takes a 40-year view that shows that while US stock-market capitalization has increased more than 10-fold since 1976, the number of listed companies today, at just 3,761, is not only far below the peak of 7,332 in 1996, it is even below the 4,796 that were listed 40 years ago in 1976.
What’s more, Mauboussin points out that the propensity to list was already declining even before the Sarbanes-Oxley Act of 2002 ramped up regulatory and disclosure requirements on boards of public companies and management teams.
The meaning of decline
This decline in numbers of listed companies is now attracting growing scrutiny, with much debate focusing on public-policy issues.
Does a decline in the listing of public companies correlate with a decline in economic growth and job creation? Does it denote an excess of concentration as M&A accounts for a large portion of de-listings, implying cartel-like pricing power for fewer, much larger companies to direct against consumers? Does the concomitant growth of private equity and private financing markets imply the potential for a further rise in inequality?
Will small investors miss the chance to participate in the wealth created by large companies that stay private for longer, delivering more growth in value into the hands of fewer, better-connected and already wealthy insiders who fund start-ups through opaque angel investing networks and retain ownership through subsequent private funding rounds?
Amazon floated three years into its life as a revolutionary new internet business. It and the cohort of growth stocks with which it is often lumped – Facebook, Apple, Microsoft and Google – have each delivered hundreds of billions of dollars in value to public equity investors since their IPOs. Airbnb is still private 12 years after it was founded. It is now valued at $30 billion. Uber, too, remains private, with a valuation around $68 billion. The Wall Street Journal finds 155 private US companies today worth over $1 billion, up from 54 as recently as 2014.
Does it matter? Direct retail participation in the stock market is also declining. Is it a bad thing if companies can efficiently fund growth in private markets? Remember that individual investors can still gain some indirect exposure through institutional allocations to alternative managers including venture capital funds.
Mauboussin points out that these days the tech companies delivering the most growth hardly need huge capital investment in plant and machinery. And they have plenty of access to private capital. The five US start-up companies with the highest implied valuations have raised a combined total of more than $28 billion in the last few years. It was reported that Airbnb Inc.’s financing round in the autumn of 2016, which raised $850 million and valued the company at $30 billion, allowed employees to sell $200 million of stock. Increasingly, private markets offer liquidity.
While the decline of public markets deserves attention, so does the growth of private capital markets.
Euromoney meets the founders of The Hub Exchange, a fintech company that builds platforms for private investment networks that might operate among high net-worth individuals and their advisers, between family offices, groups of angel investors or venture capitalists, even among corporate venture investing teams. The Hub, founded by ex-investment bankers keen to deploy in primary capital formation the same kind of technology that has transformed secondary market trading, builds platforms that these private networks can white-label and customize for the kind of often early-stage deals their participants pass between each other. As a key differentiator, The Hub also offers its clients the connectivity and syndication opportunities of linking to other investment networks.
In April, The Hub struck a strategic alliance with the London Stock Exchange’s Elite platform for smaller companies to build the infrastructure to raise capital through private placements.
Axel Coustere, The Hub
“Although private investment networks will continue to rely on doing business based on trust, privacy and personal relationships, our core technology provides a common infrastructure framework to help standardize key investment workflows and transaction details, while helping create new connections and opportunities between networks,” says Axel Coustere, founding partner of The Hub.
“Each platform is bespoke, independent and invitation only, yet our clients have the ability to reach out to each other on their own terms through our technology.”
In this way, private investment networks that previously operated in silos can identify new opportunities for deal syndication and grow their networks, without compromising on confidentiality, relationships and branding.
“For example, if one network of angel investors has filled 50% of a transaction, there may be investors in our wider network who use our technology that could express interest after viewing a blind deal and signing a digital non-disclosure agreement,” Coustere says.
How does The Hub earn its revenue?
“Our business model is based on sharing,” Coustere says. “We share any commissions earned with all networks involved only on the additional capital we bring, encouraging collaboration. Our key focus is on the quality of deal flow and relevant matching of deals to the investor.”
The Hub appears like a decentralized exchange, a network of networks that might follow companies through each stage of funding from start-up to late-stage and perhaps eventually to full listing. Coustere stresses that the company is a tech provider and that it does not originate deals, but it sees connections between its networks.
Stephen Ong, The Hub
Stephen Ong, founding partner of The Hub, says: “We are seeing more late-stage venture capital investors and institutional investors taking an interest in early-stage funding alongside family offices. Simultaneously, we see early-stage investors looking to exit parts of their portfolios.
"Our role, as an unbiased infrastructure provider connecting networks focused on the early-stage companies to pre-IPO, enables us to bridge institutional capital to the earlier stage companies who need funding to thrive and continue to innovate.”
It might be that private and public capital markets that have traditionally been quite separate could be becoming much more attuned.
Coustere says: “Public markets have benefited from technology, infrastructure and standardization for decades. Increased regulation and low yields are driving investors to seek returns in private markets, deepening liquidity. Technology and entrepreneurship are driving innovation at an accelerating pace. Innovative capital-raising platforms have spawned for several asset classes, with the next evolution connecting these private marketplaces through a common infrastructure. All these factors contribute to a deeper, more efficient private market.”
With networks of networks such as The Hub increasingly aggregating investment communities with specific interests and connecting them to adjacent communities focusing on next financing stages, a new fabric is emerging.
Ong says: “In time, new technologies will mature in the fields of artificial intelligence and security which will automate many of the manual processes, help evaluate complex decisions made over large data sets, and help connect companies not just to the capital they need but to strategic partners as well.”
The overwhelming majority of companies remain private. Exchanges, regulators and policymakers might have a vested interest in promoting public listings, but Euromoney’s guess is that more creativity is already at work in the bigger story of transforming private markets.