Hong Kong"s IPO Mania Goes White Hot, Drives Up Interbank Rates

IPO mania is gripping Hong Kong and if you’ve been looking for a warning sign that equity markets are close to a peak, just maybe this is it. It was a feature of the Hong Kong market in 2006-07, before the Great Financial Crisis, and in 2000, prior to the bursting of the Dot.com bubble. No surprises, the current mania is also focused on the technology sector. The focal point today is the China Literature Ltd IPO which began trading this morning. The stock price rose as high as HK$110 per share compared with the HK$55 IPO price. No wonder the company’s executives were looking smug.

China Literature is an Amazon Kindle “look-alike”, being the Chinese mainland’s largest publisher of e-books. However, it is also growing its own network of contract writers and owns the rights to well-known Chinese online novels, such as the Grave Robbers’ Chronicles and Ghost Blows Out the Light series. The HK$8.3 billion IPO was more than 600 times oversubscribed with 5% of the city’s population applying for shares. According to Bloomberg.

Hong Kong demand for new share sales has hit fever pitch, with 417,000 people applying for lots in Tencent Holdings Ltd.’s online bookstore unit -- more than 5 percent of the city’s population. China Literature Ltd.’s retail offering was 625 times oversubscribed, according to the company. That locked up at least HK$520 billion ($67 billion), or a third of the city’s monetary base, the South China Morning Post reported. It’s easy to see why the clamor: China Literature’s shares surged as much as 100 percent on their Wednesday debut…"You can tell Hong Kong investors like tech stocks," said Daniel So, Hong Kong-based strategist with CMB International Securities Ltd. "If you’d managed to get the stock, you’d have made a lot of money.”

One signal of the scale of the current IPO mania is that the China Literature had a 200-basis point impact on Hong Kong’s interbank rate, as Bloomberg explains.

Interest in initial public offerings is so intense it’s affecting the city’s interbank rates. The overnight Hibor fixing jumped 2.1 percentage points on Oct. 31, the most in a decade, as investors placed orders for China Literature.

In contrast to some of the Dot.com era’s IPOs, at least China Literature is profitable and has a coherent strategy. It uses “big data” to drive revenues and aims to cross-sell content into other media.  As Bloomberg reports.

China Literature had profit of 213.5 million yuan ($32 million) in the first half of this year, compared with a 2.4 million yuan loss for the same period in 2016, according to its prospectus. The company -- created through the merger of Tencent’s online literature business with Carlyle Group LP-backed Cloudary Corp -- had 9.6 million works and 6.4 million writers as of June 30. Customers can pay for an entire book or buy a few chapters at a time to see if they want to keep reading.

 

“We can study our users’ social network and understand their preference and recommend to them what their friends like to read,” Co-Chief Executive Officer Wu Wenhui said in an interview. “We already have compiled a great amount of user data, which will enable us to study what they like.” The company also wants to leverage its content into other forms of entertainment, such as movies, TV series and anime, as Tencent aspires to create a Marvel-like empire. Shenzhen-based Tencent became China’s second-biggest technology company on the strength of its WeChat messaging app, which since has morphed into a portal for shopping, banking, gaming and consuming entertainment.

China Literature will select some content, and co-invest or co-produce movies or anime series, co-CEO Liang Xiaodong said. He added that his company is closely working with Tencent’s film and video units. “User demand for content is getting very strong, especially original material,” Liang said in an interview with Bloomberg Television. “Our content can easily be converted into movies and games to maximize coverage.”

The China Literature IPO came on the heels of HK’s largest ever fintech IPO, ZhongAn Online Property & Casualty Insurance. ZhongAn raised $1.5 billion and priced at the top end of its valuation range. As Bloomberg notes, there are more tech IPO’s in the pipeline with the focus now shifting to the gaming accessories sub-sector.

China Literature’s IPO follows ZhongAn Online P&C Insurance Co., which went public in September. The first major fintech listing in Hong Kong, and backed by Ant Financial, the owner of Alipay, the retail portion was almost 400 times oversubscribed. Focus will now shift to Razer Inc., a manufacturer of high-spec gaming accessories, which will begin trading in Hong Kong on Monday after raising $529 million.

The Razer Inc. IPO will make co-founder and CEO, Tan Min-Liang, a dollar billionaire. The global gaming market is “hot”, with growth expected to increase by 52% to $160 billion by 2021. Buyers of Razer shares will include Singapore’s sovereign wealth fund, GIC.

If we were to be strictly precise, the ZhongAn IPO was 391 times over-subscribed, while China Literature was 625 times over-subscribed. Consequently, the latter beat out ZhongAn to hold the record for a Hong Kong IPO. We look forward to seeing the metrics for Razer, but Hong Kong IPOs are obviously white hot.

Shouting on deaf ears no doubt, the FT reports that one analyst urged caution.

In recent years, a doubling in the share price on the first day of trading for a Hong Kong listing has been rare. The strong appetite for China Literature stock on Wednesday was driven by retail investors trying to get a piece of what many perceived could be the next Tencent, said Kevin Tam, an analyst at Core Pacific-Yamaichi in Hong Kong.“ They expect this to be Tencent number two,” he added. “Many retail investors missed out on the first Tencent IPO and the 10-times growth.” But Mr Tam cautioned that such expectations for China Literature were misguided. Much of Tencent’s value is locked in its userbase but China Literature has “just a very small slice of that”, he said.

Wu Wenhui. co-chief executive of China Literature, stated that he wants to bring original Chinese literature to a global audience. He might eventually be successful in this but, right now, he"s bringing the melt-up stage in the Chinese bubble to a global audience.
 

Snap's New Business Model

From the Slope of Hope: One of the hottest, most widely-anticipated IPOs in years took place in March of this year - - Snap, Inc., which is, of course, the owner of the Snap app (although they insistently refer to themselves as "a camera company".) Perhaps another mission statement is in order, however, as they appeared to have now expanded to..........Halloween costumes.

No, I am not making this up. The one and only product from Snap you can purchase on Amazon is, in fact, this costume in which you can pretend you are a hot dog. 

So the company has never made a dime, and in fact loses hundreds of millions of dollars, and its shareholders have managed to lose half their money since this dog (so to speak) went public:

In spite of this fiasco - - and laughable diversification of its business model - - I must again request that you cut Evan Spiegel, Snap"s CEO and founder, some slack, as he continues to be fully distracted by his new wife, Miranda Kerr, who found Mr. Spiegel terribly attractive around the time he made his gigantic fortune. How about that.

Is The Aramco IPO On The Brink Of Collapse?

Authored by Nick Cunningham via OilPrice.com,

In what could be a humiliating decision, Saudi Aramco is considering not staging an IPO next year as planned, due to the difficulty of pulling off an international listing.

On Friday, the Financial Times reported that Aramco is weighing a different strategy: selling stakes in the company to private investors and sovereign wealth funds. No final decision has been made yet, but there are several potential paths forward, including a public listing on Saudi Arabia’s domestic stock exchange plus a private sale. Or a private sale followed by an international listing, but maybe not until 2019.

Aramco officials tried to beat back the report, insisting that everything is moving forward as planned. “A range of options, for the public listing of Saudi Aramco, continue to be held under active review. No decision has been made and the IPO process remains on track,” Saudi Aramco said in a statement, according to the FT.

However, Reuters echoed the FT, reporting on Friday that Aramco was in talks with a Chinese investor.

Saudi officials, according to the FT, are concerned about the legal risks involved in taking the company public. The powerful crown prince has favored a New York listing, due to the political alliance with the U.S., while some Aramco officials and financial advisors prefer a less risky listing in London. A New York listing could expose Aramco to legal action stemming from Saudi Arabia’s alleged role in the 9/11 attacks—legislation passed by the U.S. Congress in late 2016 authorizes lawsuits from 9/11 victims against Saudi Arabia.

But a London listing is apparently not that much more attractive. Saudi sources told the FT that Aramco would face tough legal scrutiny there as well.

Those roadblocks have led to second thoughts on the IPO altogether, with Saudi officials reportedly now considering a private sale.

After hyping the IPO for more than a year, shelving the plans would amount to a significant climb down for the state-owned oil company.

On the other hand, as Bloomberg Gadfly points out, there are also upsides to a private sale that go beyond the difficulties of listing in New York or London. For instance, if Aramco attracts a disappointingly low sale figure, that figure could remain undisclosed if the sale was private. Also, Saudi Arabia could deepen its ties to Asia if it makes a private sale to major investors in China or India. Finally, Aramco would not have to publish estimates on its oil reserves – a long held state secret.

In addition, Saudi Arabia might have troubles engaging in coordinated production cuts within OPEC if it listed in New York, a practice that might be considered price fixing, and thus illegal.

But, even with all of that said, scrapping the IPO would amount to a defeat. It would also raise deeper questions about the country’s finances and its long-term fiscal health. The IPO has been billed as the largest ever public offering, with Saudi officials boasting that Aramco is worth some $2 trillion, which would translate into around $100 billion for 5 percent of the company. Independent analysts dispute those figures, estimating the company could be worth maybe only half of that.

While the precise figure is up for debate, few doubt it will be large, playing a crucial role in the country’s plan to diversify the economy. Saudi Arabia’s National Transformation Program (NTP) consists of a series of economic reforms aimed at accelerating growth, cutting spending on wasteful subsidies, while also raising tax revenue from non-oil sources. There is a bit more urgency to stimulate the economy because of Saudi Arabia’s sizable budget deficit and the fact that the economy entered a recession this year, in part because of the government’s own austerity measures.

The IPO of Aramco is considered a pivotal move that could address a lot of these problems all at once.  But Saudi officials have been hoping to time an IPO with oil prices trading at least as high as $60 per barrel. However, rebalancing the oil market and lifting prices has taken much longer than expected. In that context, it is no surprise that the Saudi King made his first visit to Russia earlier this month, desperate to make the OPEC deal work, not only for higher oil prices in the near-term, but to set the state for the country’s highly-anticipated IPO.

A decision not to take Aramco public would be a major setback.

UK PMs Push Back As Regulators "Bend The Rules" To Accommodate Saudi Aramco IPO

All IPO’d up and no place to go? UK portfolio managers with $6.9 trillion resist rule bending by regulator to achieve Aramco London listing

Another potential problem for the world’s biggest ever (potential) IPO…

A lobby group representing UK portfolio managers with $6.9 trillion AUM has warned the UK financial regulator that bending the rules to accommodate Aramco’s IPO will damage London’s status as a global financial centre.

In a letter to the head of the Financial Conduct Authority (FCA), the embattled Andrew Bailey, the Investment Association (IA) argued that it threatened the “high standards” of London’s listing regime.

In “Funds fire broadside over Saudi oil float”, the Sunday Times noted that “Britain’s largest investors have turned up the heat on the City watchdog over its controversial plans to allow Saudi Arabia’s oil giant to float in London.”

Besides the tricky issue of its oil and gas reserves (especially the Ghawar field), the IA argued in the letter that “For the premium segment of the UK main market, investors must have confidence that a company is run for all shareholders, not just the major or controlling shareholder.”  

Selling only 5% of the share capital, rather than the prescribed 25%, is one of the major stumbling blocks in terms of the listing regulations.

According to the London Stock Exchange, a premium listing meets “the UK’s highest standards of regulatory and corporate governance.”

However, regulations are made to be broken…not just by banks and funds…but (when it suits) by the regulator itself, it seems. The FCA’s Bailey has proposed a new category of premium listing which would be tailor-made for government-controlled companies, like Aramco.

According to Bailey, investor safeguards would not be “weakened.”

It turns out that Bailey proposed the new category of premium listing after meeting and having conversations with Aramco and its advisers. As the Sunday Times reports, Bailey “emphasised during those conversations that we (FCA) were reviewing the listing regime.”

Perfect timing.

Clicking on the “About Us” tab on the FCA’s website, the regulator champions its wish that “consumers can place their trust in transparent and open markets” under the heading “Enhancing Market Integrity”.

Having said that, there is an option to click “No” after the question “Was this page helpful?”

In Bailey’s defence, it is possible that he’s being lent on by the British government to find a way to accommodate the high-profile Aramco IPO.

After all, Theresa May travelled to Saudi Arabia in April with the CEO of the London Stock Exchange, Xavier Rolet.

Here is Mrs May making the introductions in Riyadh on 5 May 2017.

Given the stringent anti-trust laws in the US and Aramco’s pivotal role in the Opec cartel, a US listing is also looking problematic. So, it’s no wonder that chatter about delays to the IPO or a private sale to China, or a consortium of sovereign wealth funds, has gathered pace.

Aramco denied such reports on Twitter over the weekend “All listing venues under review for optimal decision, IPO process is on track for 2018.”

If three denials are forthcoming, maybe we’ll know what’s really happening.

In the meantime, it’s embarrassing to the Saudi regime and not good news for improving its short/medium term cash flow problem.

Saudi Aramco Reportedly Shelves IPO In "Face-Saving" Move

We noted a month ago that the long-awaited Saudi Aramco IPO, scheduled for mid-2018, could be delayed to 2019, but now, according to The FT, Aramco is considering shelving plans for an IPO altogether in favor of a private share sale to the world’s biggest sovereign wealth funds.

The FT notes that talks about a private sale to foreign governments - including China - and other investors have gathered pace in recent weeks, according to five people familiar with the IPO preparations, amid growing concerns about the feasibility of an international listing.

The Saudi state oil company has struggled to select a suitable international venue for its shares, as New York and London have vied for what has been billed as the largest ever flotation.

The company would still aim to list shares on the kingdom’s Tadawul exchange next year if they pursue the private sale, the people said.

The latest proposal by the company’s financial advisers was described by one of the people as a “face-saving” option for Saudi Aramco, which has worked on plans to list its shares internationally for more than a year.

Desk chatter included comments that the Saudis were anxious about the level of due diligence and transparency involved in a public offering.

A Saudi Aramco spokesperson said:

“A range of options, for the public listing of Saudi Aramco, continue to be held under active review. No decision has been made and the IPO process remains on track.”

The planned listing of a 5 per cent stake in Saudi Aramco is the centrepiece of an economic reform programme led by Saudi Arabia’s powerful crown prince Mohammed bin Salman, who is keen for a 2018 IPO. He has said the company could be worth $2tn although a Financial Times analysis put the valuation figure at around $1tn.

An economic recession in the kingdom is piling pressure on the prince, the king’s son and next in line for the throne, amid calls for the government to increase investment and ease austerity. As we noted previously, there could be more at play here...

Some analysts view the possible IPO delay as a sign of the problems Aramco and the Saudi government currently face. A lack of transparency, issues with its oil and gas reserves, and the role of the Saudi government as the main stakeholder have all been suggested as the reason for this possible delay. Most of these suggestions, however, are based purely on issues surrounding the IPO itself. The true reason for this delay, however, likely hides among the intricate societal and economic problems in the Kingdom.

One obvious reason for a delay is the still-fledgling global oil price. A higher price setting—above $60 per barrel—would surely drive up the overall interest in the IPO. As long as OPEC and non-OPEC members, such as Russia, are still struggling to get a grip on the oil market, the potential for disaster looms. Needless to say, an oil price slump would have a detrimental effect on the expected revenues of the IPO.

The analysts, it seems, feel no need to look any further than this simple oil price explanation, but several other key factors should be addressed…

The impact of an influx of $1-2 trillion into the current Saudi economy is bound to have a significant impact. The implementation of Saudi Vision 2030 is broad and ambitiously planned. A full diversification of the economy is needed to guarantee work and salaries for future young Saudis, with the end of government subsidies or handouts.

A multitrillion investment scheme in a rather small local economy will likely result in total disorder, inflation and possibly ineffective investment schemes. The attractiveness of investing the total amount could lead to staggering inflation, higher costs and superfluous projects being realized.

A delay of such an influx of cash seems to be more and more attractive, giving the Saudi government and local industries more time to adjust and put in place the right steps for a sustainable and commercially attractive economic future.

We previously indicated that China could step in as a financial savior. With around 8.5 million bpd of crude oil imports, which is 2.5 million bdp more than in 2014, the attractiveness of having a stake in Saudi Aramco is huge. Even though an energy diversification program is in place, China’s imports from Saudi Arabia are going to increase. For Beijing, a stake in one of its main suppliers is a very attractive proposition. It will not only lock in Saudi crude oil and petroleum product exports to China but it will also provide some additional political and strategic clout in the heart of the Middle East.

There will, of course, be a few big bankers who will be upset as their billion dollar fee/commission just went up in smoke, but this may give MBS some breathing room - without the undue attention of an IPO -  as he deals with the nation"s economic slowdown. However, coming just a few days after the Saudi king"s trip to Moscow, the timing of this leaked information seems interesting at the least.

Why Saudi Aramco Delayed Its IPO

Authored by Cyril Widdershoven via OilPrice.com,

The long-awaited Saudi Aramco IPO, scheduled for mid-2018, could be delayed to 2019.

International news reports have stated that the Saudi government is currently putting together contingency plans for a possible delay to the biggest IPO ever. The listing of 5 percent of Saudi Arabia’s crown jewel, the world’s largest oil company Saudi Aramco, could bring in around $300-$400 billion, based on a valuation of Aramco at between $1.5-2 trillion.

The cash generated by the IPO has already been earmarked for the coffers of the Saudi Public Investment Fund (PIF), to be used as financial support for Saudi Vision 2030, the economic diversification program proposed and pushed for by Crown Prince Mohammed Bin Salman (MBS).

Doubts about the valuation have been strong, but a success story for this particular once-in-a-lifetime IPO is all but guaranteed. International interest is growing and media reports are stumbling over each other to assess, criticize or support the IPO strategy. Presently, international advisors and banks have already been appointed, but no decision (officially) has yet been made on where Aramco will be listed. New York, London, Frankfurt and Hong Kong are leading the race, but no white smoke has plumed from the chimney of the Saudi Royal Palace.

Some analysts view the possible IPO delay as a sign of the problems Aramco and the Saudi government currently face. A lack of transparency, issues with its oil and gas reserves, and the role of the Saudi government as the main stakeholder have all been suggested as the reason for this possible delay. Most of these suggestions, however, are based purely on issues surrounding the IPO itself. The true reason for this delay, however, likely hides among the intricate societal and economic problems in the Kingdom.

One obvious reason for a delay is the still-fledgling global oil price. A higher price setting—above $60 per barrel—would surely drive up the overall interest in the IPO. As long as OPEC and non-OPEC members, such as Russia, are still struggling to get a grip on the oil market, the potential for disaster looms. Needless to say, an oil price slump would have a detrimental effect on the expected revenues of the IPO.

The analysts, it seems, feel no need to look any further than this simple oil price explanation, but several other key factors should be addressed…

The impact of an influx of $1-2 trillion into the current Saudi economy is bound to have a significant impact. The implementation of Saudi Vision 2030 is broad and ambitiously planned. A full diversification of the economy is needed to guarantee work and salaries for future young Saudis, with the end of government subsidies or handouts.

A multitrillion investment scheme in a rather small local economy will likely result in total disorder, inflation and possibly ineffective investment schemes. The attractiveness of investing the total amount could lead to staggering inflation, higher costs and superfluous projects being realized. 

A delay of such an influx of cash seems to be more and more attractive, giving the Saudi government and local industries more time to adjust and put in place the right steps for a sustainable and commercially attractive economic future.

The crown prince’s future, and that of his supporters, also depends on the whole endeavor. A fully-fledged economic revival and restructuring could threaten power brokers and religious entities in the Kingdom. MBS has appeared to misunderstand the significance of these issues, but is currently stepping up to remove some of the apparent hurdles. His current policy to remove hardline fundamentalist religious leaders (partly under the name of Muslim Brotherhood allegiances) is a step he needs to take to control the opposition and solidify his own position.

At the same time, MBS’ future will also be decided soon, as rumors are growing of an upcoming abdication of the throne by King Salman. For MBS, as the new heir, stability is needed to prepare for this unprecedented move. Internal security is put in place, which could be impacted by the Aramco IPO not going according to plan. Opposition groups will take the opportunity to protest against his new status under the umbrella of an unsuccessful sale of the key company, while also dealing with Iranian tensions. A delay of the IPO could be a sign that for MBS, stability and the future of House of Salman has taken precedent over the Aramco IPO.

Taking this all into account, delaying the Aramco IPO until 2019 could be an astute move. The enormous task that the Saudi government has established under the umbrella of Saudi Vision 2030 will be incredibly difficult to achieve. Last week’s statements about an extension of the National Transformation Program (NT), the basis of Vision 2030, was the first sign of this.

Change is always difficult, but Saudi Arabia faces a daunting task. An implementation slowdown is needed in order to reduce the risk to the Saudi government. Aramco’s attractiveness is undebatable, and will be there, whatever happens. The future of the Kingdom of Oil however, is at risk if this transition is not carefully controlled.

Without MBS as captain of the Vision 2030, there will be no Vision 2030.

Blue Apron Tumbles To Record Lows After Slashing Workforce By 24% (Just 36 Days After IPO)

As one veteran market participant exclaimed: "Seriously, how is that not illegal?"

Just 36 days after the company IPO"d to much CNBC-based applause and "the IPO market is back", Blue Apron shares are languishing at record low $6.01 (down 45% from its highs of $11) drastically below the IPO price of $10.

It is tumbling to fresh lows today after announcing - ahead of its earnings next week - that the company is cutting 1,270 jobs from its New Jersey facility according to a public notice Friday. It had 5,202 workers as of March 31.

Last month the company said Chief Operating Officer and co-founder Matt Wadiak is stepping down.

Solar-Energy Company Sunrun Lied To Investors To Boost Its IPO Price

The largest solar-energy company in the U.S. has been called out by The Wall Street Journal for manipulating a key sales metric shortly to try and boost the company"s share price ahead of its IPO.

In a report published Monday, WSJ got the jump on investigators at the SEC, who had announced their own investigation into shady reporting practices at solar-energy companies earlier this month. WSJ alleges that Sunrun Inc., the largest solar-energy company in the U.S., encouraged its managers to delay reporting hundreds of contract cancellations - figures that would"ve prominently factored into the company"s sales metrics - during the months leading up to the company’s August 2015 IPO.

Sunrun"s shares have dramatically underperformed in recent years as solar demand in California, the U.S."s largest market, has slowed, contributing to a string of bankruptcies. Sunrun shares recently traded at $4.91, about one-third of their IPO price.

The SEC is also investigating Elon Musk’s Solar City for engaging in similarly shady reporting practices, WSJ reported earlier this onth.

The paper hangs the story on on Darren Jennings, a former manager at the company who says he was pressured to delay reporting more than 200 cancellations - amounting ot a whopping 40% of total orders - while working for the firm in Hawaii, it’s biggest market, and three other former managers. Solar firms typically give customers a few days after installation to reconsider. 

 “The big internal push was to cram as many sales as we could through the pipeline,” Jennings said. “If those deals cancelled, we would not report it.”

When approached by WSJ, Lynn Jurich, Sunrun’s chief executive and co-founder and Edward Fenster, Sunrun’s co-founder and chairman, both declined to comment.
However, they did provide a statement to WSJ – but it didn’t directly address the allegations that the pair had overseen a managerial culture where employees were encouraged to misreport material information and mislead investors, all to try and boost the offering price.

Jurich said the company “reviewed the digital audit trail in our systems” and “turned up no evidence that our sales employees changed cancellation dates in our systems to delay the reporting of cancellations.”

“I proudly stand by Sunrun’s workplace culture, our values and our unwavering commitment to customer satisfaction and the principle of integrity upon which our company was founded.”

Solar City was headed for bankruptcy when Musk - who had installed his cousin, Lyndon Rive, at the helm of the perpetual cash burner – announced last June that Tesla Inc. would step in and buy the troubled energy company, combining two firms where Musk is the largest shareholder, raising questions about whether the acquisition was really in the best interest of Tesla"s other shareholders.

It"s important to note that the solar energy industry as a whole has developed a reputation for shadiness that stretches beyond these two firms: As WSJ reports, many have complained about solar companies" aggressive sales tactics, with WSJ reporting one incident where a sales representatives literally following people home from Home Depot Inc.

And let’s not forget about “Solyndra-gate,” when the Obama Administration approved a more than $500 million loan to solar energy firm Solyndra, only to see it file for bankruptcy soon after, leaving taxpayers on the hook.

SNAP Cracks Back Below $20

With a plethora of analysts pushing "buy" recommendations - enough to pump the stock back above its post-IPO open at $24...

It appears hope is fading fast once again for the so-called "camera" company as it drops back near its record lows below $20...

Is Public Equity A Broken Concept?

Submitted by Nick Colas of Convergex

Is Public Equity A Broken Concept

David Einhorn’s proposal to GM that it split its stock into dividend and capital appreciation shares got us thinking about the bedrock principles of public equity ownership.  Other catalysts for this examination: recent IPO SNAP’s lack of shareholder voting rights, the reluctance of venture capitalists to list their “Unicorns”, and the dearth of IPOs generally.  The critical question here is “Does the traditional one-size-fits-all model of publicly-held equity still work in a world that increasingly values customization?”  Further, will other social and economic trends force a change in this structure, such as aging demographics in the US population and the investment-heavy nature of major technological developments like autonomous cars, workplace automation, and artificial intelligence?  Bottom line: “public equity” needs to be a fluid concept that responds to the changing needs of both providers and users of capital.

If it is true that we learn the most from our mistakes, then I would posit that we can glean a lot of useful information from analyzing troubled industries rather than just focusing on commercial “Winners”.  For example, I have studied the US auto industry for the last 25 years as both a sell side and buy side analyst, and more recently in the context of the macro work I do in these notes.  It has been an education that has served me very well, even if the group has historically presented limited long term investment potential.

Here is a summary of everything I know about this auto industry:

• Demand is economically sensitive and volatile in major markets like the US, Europe and Japan. Since it takes years to design a new vehicle and that process is expensive, automakers have high fixed costs.  This leads to significant variability in earnings over a typical economic cycle and the threat of bankruptcy in a bad downturn is real.  “Hot” product offerings can mitigate this pressure, but not reliably so.


• There is too much supply. The auto industry employs a lot of people both in final assembly and in the supply chain.  These tend to be good-paying jobs, which means governments are perennially throwing money at car companies to set up shop in their jurisdiction.  Moreover, those same governments don’t ever want to see a plant close.  This makes capacity very sticky, and in some places like Europe there are still too many auto plants.


• Those two factors make it very hard to earn a decent return on capital over a cycle. Boom times bring excellent free cash flow, but those earnings are later consumed by the lean years.  As a result of both industry structure (point #2) and company-specific earnings volatility (point #1), public equities in the sector tend to have very low normalized valuations.

I was therefore intrigued by investor David Einhorn’s proposal, made public today, to split GM’s stock into two pieces: a dividend paying equity and a capital appreciation “stub”.  To be clear, I have no idea if it would improve the company’s equity market valuation.  You can read a description here and see the slide deck from his firm, Greenlight Capital, as well: http://www.zerohedge.com/news/2017-03-28/david-einhorns-presentation-how-gm-can-unlock-between-13-and-38-billion-value

Einhorn’s proposal got me thinking about the nature of public equity capital.  His thesis is that GM’s equity does not have a clean and distinct ownership base.  Dividend-seeking investors are put off by the company’s share buyback program since it drains cash for purposes they don’t value, and capital appreciation-focused investors would prefer that GM just use all their cash generation to repurchase shares.  Split the stock and the conflict goes away, or so the idea goes.

Regardless of the merits of the idea for GM, Greenlight’s proposal raises a provocative macro question: “Is a one-size-fits-all equity structure really the best approach to both maximizing corporate value and giving shareholders the types of investments they desire?”  Once you pose the question that way, a raft of other capital market trends pop up:

• Voting rights. The vast majority of public stocks feature a “One share, one vote” structure of corporate governance. Shareholders can elect Boards, vote on major corporate actions like takeovers and mergers, and lobby for changes in management if they feel the business is being mismanaged.


• The recent high-profile SNAP IPO had an unusual feature, however: no voting rights at all.  While novel, this is the continuation of a trend among technology companies, which in many prominent cases have dual classes of stock with different voting rights.  The intention here is to limit public shareholders’ traditional rights in favor of management’s/core shareholders’ long term business plans and judgment.

• Dearth of IPOs. Look at a long term chart of the number of Initial Public Offerings in US markets, and you’ll see a significant decline in the number of new issues from the 1990s to now.  The good times were in the late 1990s, of course, when it was customary to see 30-80 IPOs per month.  Now, that number is more like 10-20.


• Venture capital’s reluctance to list “Unicorns”.   You might argue that capital markets are simply more selective now and the 1990s IPO cycle was an outlier.  But then why are so many truly revolutionary companies like Airbnb, Uber, Lyft, Palantir, and other “Unicorns” all still private?  These are transformational businesses, but the venture capitalists that fund them see no need to take them public. 
  

  Now, I am sure that Uber’s shareholders are happy just now that the company isn’t subject to the daily vagaries of the stock market, but on balance the absence of “UBER” as a symbol on the NYSE or the NASDAQ  is troublesome.

  
  

At its core, the social compact between public equity markets and society is simple: over time, any investor should have access to the equity of important enterprises created by that society.  If that isn’t happening by virtue of some misalignment of incentives, then those need to be fixed.  The alternative – that the winners stay private but the losers are public – is untenable.  Investors will choose to hoard cash and capital will slowly stop circulating to its best possible use.

Given the pace of innovation that seems to be on its way, this problem may only get worse.  If the futurists are correct, there are several societal sea changes just over the horizon, from artificial intelligence to workplace automation to driverless cars, all in various stages of development.  The home for that capital right now too often has a Sand Hill Road address rather than 11 Wall Street.

We’ve come a long way from what now seems like a pretty humble proposal regarding one car company, so let’s put on bow on all this.  A few summary points:

• For all the innovation on offer in American industry, the concept of public equity is perhaps overly reliant on an outdated concept where one equity security with proportional voting rights is the only flavor available. It is, at least, a topic worth discussing.


• Investors, in their role as consumers, are used to custom solutions in every facet of their life – so why not think about how to apportion the value of a company to fit their needs? Yes, equity and debt are the traditional solutions.  But why do you think Exchange Traded Funds are so popular?  In part it is because they target investor needs in creative ways.  Corporate boards and investment bankers might take a page from that book.


• Demographics and technology may force the issue. An aging US population might embrace novel approaches to accessing the corporate cash flows of public companies.  And if there is a new wave of innovation ready to drop on us, the only nature hedge might be to have access to the equity of those businesses.  Even if they don’t carry voting shares or other traditional features.

Now, one caveat: all of this needs sufficient regulation to curtail abuse.  The mortgage market of the early 2000s is the cautionary tale here, of course.  Changes to the notion of public equity need careful scrutiny to make sure disclosures are complete and structures are sound.

But in the end, “Equity” will need to evolve in the same way everything else does in a capitalist society – in a way that serves both investors and users of capital.

SNAP Initiated With Sell Rating, $10 Price Target At Pivotal

Pivotal Research"s Brian Wieser braved the storm today and issued the first "Sell" research on Snap Inc.

Snap is a promising early stage company with significant opportunity ahead of itself.

Unfortunately, it is significantly overvalued given the likely scale of its long-term opportunity and the risks associated with executing against that opportunity. Significant ongoing dilution from share-based compensation will likely represent an additional negative consideration for the stock. We value Snap at $10 per share on a YE2017 basis. As the stock priced well above this level in its IPO, we rate its shares Sell.

Snap presents investors with the opportunity to invest in the company behind an innovative, large-scale, and distinctively young-skewing platform which is establishing itself as a magnet for business unit talent and content partners alike. Snap also offers investors a share of the significant economic potential that should follow from Snap’s ongoing business expansion.

At the same time, there are significant risks offsetting these opportunities. Investors in Snap will be exposed to an upstart facing aggressive competition from much larger companies, with a core user base that is not growing by much and which is only relatively elusive. It has a promising and innovative advertising offering, but so far it is still mostly unproven and difficult to quantify its ultimate scale. Investors will also be exposed to what appears to be a sub-optimal corporate structure operated by a senior management team lacking experience transforming a successful new product into a successful company. High expenses and cash costs to run the company are negative as well. And then there are other negatives for shareholders given the degree to which they will be diluted through aggressive share issuances to employees and through the lack of voting rights that they will possess.

While we consider ourselves cautious optimists on the business itself, our model feels potentially “stretched” in even getting to $10 per share, or a $16bn valuation on a YE2017 basis. As the stock priced well above this level in its IPO, we rate its shares Sell.

Risks

As Snap is essentially a venture stage company, investors face a host of risks that are driven by greater uncertainty than might otherwise be presence in a digital media company.

In addition, Snap investors face the following company-specific risks:

• Investors in Snap will be exposed to an upstart facing aggressive competition from much larger companies


• Its core user base that is not growing by much and is only relatively elusive, if still findable on other media


• The company has a sub-optimal corporate structure operated by a senior management team lacking experience transforming a successful new product into a successful company.


• High expenses and cash costs will likely persist for some time


• Shareholders will be diluted through aggressive share issuances to employees


• Management is effectively entrenched, and shareholders are entirely disenfranchised because Snap’s publicly traded shares lack any voting rights.

This seemed to sum up a lot of veteran traders" perspectives this morning...

Is this a fucking joke? pic.twitter.com/PmpDde99C4

— Stalingrad & Poorski (@Stalingrad_Poor) March 2, 2017

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Full Report below:

A Quarter Of Snap IPO Buyers Agree Not To Sell For One Year

For the latest glimpse of the euphoria in the equity market, look no further than the Snap(chat) IPO, whose order book closes at noon today and is expected to price tomorrow, March 1, after the close. While the initial price range was presented as $14-16, according to Bloomberg orders for the public offering are concentrating in the $17-18 range, well above the high end of the range.

Yet while broad interest in the biggest IPO of the past few years is hardly surprising at a time when the S&P is trading at all time highs, what is more notable is that according to Reuters, Snap disclosed yesterday that it expected buyers of up to a quarter of the offered shares in the $3.2 billion initial public offering to agree not to sell them for a year. While Snap cautioned it had no binding commitments yet from investors accepting such a lock-up period, the disclosure is a sign of confidence from the company in what is expected to be the biggest U.S. IPO since Facebook.

In its updated IPO registration document with the U.S. Securities and Exchange Commission on Monday, Snap said it expected approximately 50 million shares of its Class A common stock purchased by investors in the offering to be subject to a separate one-year lock-up agreement. The roughly 50 million shares are designated for new Snap IPO investors who do not currently have a stake in the company, the sources said.

While lock-up periods help companies avoid stock volatility by preventing company insiders from selling within an allotted time, a year-long lock-up period for non-insiders is not only unusual, it is atypically long, potentially signifying strong demand for the IPO. Alternatively, since Snap is requesting it, the company may be worried about selling pressure out of the fate.

Lock-up periods can buoy companies at risk of a stock selloff in the months following their IPO. This risk is particularly strong for companies in the technology sector. Eight of the 10 biggest technology IPOs fell by between 25 percent and 71 percent in their first 12 months on the public market, according to a Reuters analysis of market performance.

Snap is targeting a valuation of between $19.5 billion and $22.3 billion from listing on the New York Stock Exchange on Thursday. While the company was initially looking to price 200 million shares on Wednesday night at a range of $14 to $16 dollars a share, the revised price talk may also lead to more shares being sold, effectively bumping up the valuation in the latest "hot", if money losing, social network.