When WeWork spent $60m on a Gulfstream G650 jet last year, its private investors shrugged off the expense. The lossmaking property group’s valuation had soared over the years and would eventually reach an eye-watering $47bn, allowing its backers to record substantial paper gains.
Now WeWork has been presented with an $8bn valuation — part of a rescue package from its biggest investor, Japan’s SoftBank Group — and the Gulfstream is up for sale. It follows the scrapping of plans to list on the US stock market last month. Public equity investors — dismayed by lax corporate governance and escalating losses — simply did not want to own the stock.
In calling off the IPO and turning back to its private market investors, WeWork symbolised the powerful forces that are reshaping America’s capital markets as the number of new listings shrinks while the power of the private equity industry continues to surge.
Over the past two decades, the number of companies listed on the US stock market has almost halved. The world’s largest, most liquid public equity market — which has provided capital to the likes of Google, Amazon and Facebook — has lost its shine.
WeWork’s failure to convince the mutual funds, pensions and sovereign wealth funds that own the bulk of US stocks about its IPO plans could discourage other companies from listing and attracting the sceptical glare of the markets.
Instead, investors have rushed to back fast-growing private companies, even though they may be less profitable and more difficult to sell than public competitors. This has distorted global capital markets and fomented fears of a bubble in private markets that may spill over into the public realm.
A boom in share buybacks, where companies purchase their own stock to increase the price, has further shrunken the stock market by reducing the number of shares from the remaining public companies. Historically low interest rates have compounded the trend, tempting companies to raise cheap debt rather than sell equity.
Even the companies that are looking to access public markets are trying to find new ways to list shares that reduce the influence of banks and give them more flexibility.
“Companies are staying private for longer and getting funded longer,” says Jim Cooney, head of equity capital markets for the Americas at Bank of America. In 2013, a quarter of the equity raised from new shares came from the private markets, according to the bank’s data. Today the figure stands at 48 per cent — a trajectory set to continue, Mr Cooney says.
The global market for private equity, including venture capital, has swelled fivefold in the past two decades to $4.2tn of assets under management, according to end-2018 data from Preqin. This has put pressure on fund managers, overseeing an additional $1.6tn, and waiting for worthy investments to put that capital to work.
WeWork’s decision to backtrack is also significant because it points to another important consequence of abundant private money — the persistent criticism that some companies are able to hide losses by simply raising more money. SoftBank and its $100bn Vision Fund, the world’s largest private equity vehicle, has embodied this strategy more than any other investor.
Those companies that eventually list do so after a longer time in private hands and emerge larger than ever before. But by delaying an IPO, businesses ignore profitability and “create a culture of growth at any expense”, says Larry Fink, chief executive of BlackRock, the world’s largest fund manager.
“That’s why so many recent IPOs haven’t done well. Public markets force more financial discipline,” Mr Fink says. “Private companies are waiting too long to go public.”
This year several hotly anticipated listings have flopped. Uber shares remain 30 per cent below their May IPO price, while shares in Lyft, its ride-hailing rival, have nearly halved since their March debut. Shares in Peloton, which sells exercise bikes, slipped 12 per cent when it listed in September and are now a fifth lower than their IPO price.
Each was among the so-called “unicorns” — start-ups valued above $1bn — that have soaked up capital from private investors. Data company CB Insights counts 410 that remain private, a nearly tenfold increase from 2013.
“There are more alternatives today for companies to raise capital publicly or privately from a larger swath of investors than there were 20 years ago,” says Sarah Bayer, a managing director for equity capital markets at Citigroup.
Other factors may be thwarting potential IPOs, including heightened corporate reporting demands. US listed companies not only open their books for investors every three months but also provide guidance on future quarters — a requirement the likes of Warren Buffett and JPMorgan chief Jamie Dimon have railed against as a driver of short-term thinking.
“The appeal of being a public company has been eviscerated,” says Rob Arnott, chairman of the fund group Research Affiliates. “The pressure is overwhelming.”
Former US president Barack Obama attempted a remedy with the 2012 Jobs Act, which was intended to support small business and ease IPO registration for groups with under $1bn in annual revenues.
But it also expanded the number of private shareholders that companies are permitted before being forced to release public financial reports — from 500 to 2,000 — and excluded employees from the total. As a result, private companies can keep their finances hidden for longer and rarely bump up against shareholder limits, as Facebook did before going public in 2011.
US government actions dating to 1996 also made it easier for start-ups and private backers to raise capital, by loosening the application of anti-fraud rules governing share sales and increasing the number of investors allowed in private market funds. A study published by the National Bureau of Economic Research in September found these changes “played a significant role in changing the going-public versus staying-private trade-off”.
“This increased supply of private capital appears to have helped strengthen founders’ bargaining power vis-à-vis investors,” the study’s authors wrote. Former WeWork chief executive Adam Neumann, for instance, held majority voting control over the company until he was forced out as part of the SoftBank rescue package.
“The end result is that more founders now have both the board votes and the private capital to realise their preference for control by delaying — or avoiding altogether — an IPO,” they said.
Companies such as data analysis group Palantir Technologies have taken advantage of this new environment. The group, last valued at $20bn, has recently looked to raise extra cash from private investors and delay its IPO for two to three years, despite having operated as a private company since 2004.
Such long waits can frustrate venture capitalists, who typically look to exit investments within 10 years and view high-profile IPOs as reputation-building events. Employees holding stock options nearing their maturity dates have also urged some companies to go public, such as the accommodation rental site Airbnb.
These pressures are building momentum behind a new way for companies to list. Private investors such as Benchmark Capital partner Bill Gurley are pushing start-ups to consider going public through direct listings, where their shares become tradeable on the stock market but no money is raised.
The procedure allows companies to wrest control from the bankers who typically portion out shares to investors in an IPO, resulting in lower overall fees. Reporting requirements are similar, but companies can forgo the investor roadshows banks organise to woo investors. Direct listings also eliminate traditional lock-up periods blocking share sales, allowing early investors to realise gains.
Slack, the online messaging platform, and Spotify, the streaming music service, both sidestepped IPOs by using the process, paving the way for imitators. Airbnb, the next widely anticipated unicorn flotation, is leaning towards a direct listing when it goes public next year, say people familiar with the plans.
The shift towards direct listings has triggered a burst of competition between the world’s largest investment banks to market their expertise and land the next big direct listings.
Goldman Sachs and Morgan Stanley, along with the tech adviser Allen & Co, advised on both Slack and Spotify’s listings. Each recently hosted panels discussing the merits of direct listings after being excluded from a conference organised by Mr Gurley and other venture capitalists.
Some executives considering direct listings have voiced concerns about their ability to attract blue-chip investors such as the dominant mutual fund companies, which are typically long-term buyers of newly public companies.
Groups such as Fidelity and T Rowe Price are allocated shares in an IPO but in a direct listing have to buy stock on the open market alongside everyday investors. Others argue those investors can be targeted in private fundraising rounds before direct listings.
In October the Securities and Exchange Commission heard arguments about authorising new share sales during direct listings. Backers of this new approach say it would encourage more companies to consider the IPO alternative and increase the efficiency of public offerings.
But it remains unclear how direct listings would be used to raise capital, which could introduce additional volatility into early trading for newly public companies. Any proposal would likely need sign-off from the SEC.
Nick Giovanni, head of global technology, media and telecom investment banking at Goldman Sachs, says direct listings “should over the long term create more public companies”.
“The main benefits of a direct listing are compelling — auction-based pricing, flexibility to sell and democratisation of allocation,” Mr Giovanni says. “The fact that companies cannot get these benefits while raising capital is something that I think needs to be fixed.”
Ukrainian software development start-up GitLab is one of the few companies that has publicly discussed a potential direct listing in the US. The office-less group maintains an unusually open corporate culture in which it publishes a list of business goals every quarter.
GitLab has said it plans to go public on November 18, 2020, after deliberations about the ideal timing. Co-founder Sid Sijbrandij says one reason to plan for a direct listing is the company can “make it into an IPO at any point, but you cannot do the reverse”.
GitLab does not currently release financial information, but Mr Sijbrandij says he hopes to host a video streamed quarterly earnings call before listing. “We can delay this by five years,” Mr Sijbrandij says. “We have opted not to do that because we think it’s very fitting to be a public company if you’re transparent.”
Fund managers build their own private investments
As private investing has grown, institutional investors have pledged more capital to the space, seduced by a record of double-digit returns. Traditional fund managers, reeling from the twin pressures of lower fees and the shift to passive investing, have responded by building out their own private investment offerings. These portfolios typically command a higher fee for asset managers than the stock and bond funds that constitute the bulk of the investment management business.
BlackRock this year launched its first private capital vehicle and over the summer the fund secured its first buyout, acquiring clothing and licensing group Authentic Brands for $870m. Traditional fund groups like BlackRock now compete head-to-head with leading private equity firms such as Carlyle, KKR and Blackstone.
Fund managers are also permitted to include small holdings of private stock in public equity mutual funds. This can bump up returns for fund groups which struggle to outperform their benchmarks, but it also introduces risks.
Neil Woodford, the UK fund manager, was forced to shutter his eponymous investment firm this year after steep losses tied to holdings of illiquid stocks.
“A lot of private equity investments don’t work out,” says Lee Spelman, head of US equity for JPMorgan Asset Management. “It’s absolutely risky for the end investor.”
Copyright The Financial Times Limited 2019
2019 The Financial Times Ltd. All rights reserved. Please do not copy and paste FT articles and redistribute by email or post to the web.
