We have always found quite bizarre when a supermarket cashier suggests to us a cash out. As if there is an assumption that we may not have enough already.
For anyone who has vaguely followed the IPO-sphere in the last 2-4 years, the buzz around ten+ digits valuations of social media companies, overnight billionaires and the strong reminiscence that an internet/app-based start-up is the formula for becoming rich, young and proud, couldn’t have gone unnoticed. Here comes the third, and sadly, last part of the series Irrational Markets where we suggest the IPO windwhirl is another bubble to burst, but this time a better one.
III. Towards a Better IPO Bubble: profits, famine and cash outs
We wouldn’t be the first ones to compare the Dotcom appetite for young and non-profitable companies, followed by the bust with the 2010-2015 IPO context. If Facebook’s more profitable business model has been seen lately as the key to investors’ enthusiasm and therefore a factor contributing to the growing stock price, there are certain alarming signs that one may want to consider in the context of the social media and technology market. A reference back to the quote at the Prelude of the series, claiming that currently there is a technology stock bubble, reminiscent of the 2000 Dotcom one, provides an alternative perspective.
The Financial Times has previously argued that this ‘better bubble’ is not related to any outstanding monetising strategies of a cluster of social media companies, but to high-growth shares trading in times of a famine for growth ideas. The straightforward reminiscence of the Dotcom bubble may not be clear due to the ‘real revenues’ and age maturity of today’s firms, but all preceding bubbles had a ‘solid story’ too, as does the current one. Today’s story of internet stock tells that due to the vast potential for disruption among traditional companies, one may justify the $19 billion purchase of Whatsapp or the $14.2 billion valuation for Twitter with or without any indicator for revenues.
One of the explanations for this buzz comes from the Head of UBS Wealth Management, who states that seeking disruption after ‘years of weak economies have left investors without the usual sources of growth from the economic cycle, so rising optimism was directed to new technology instead’. Therefore, it could be said that the current market experiences ‘a better IPO bubble’ than the ones from the past, but the question in place is how long this optimism will last.
Part I and II already discussed that the market efficiency hypothesis highlighted that according to neoclassical economists, trust in the market is not simply required, but essential; market failures are bound to happen; irrational behaviour does not occur and financial markets are the best place for the ‘capital development of the economy’. Not surprisingly, Fama’s notion of information efficiency, Panglossian finance and Friedman’s beliefs seem less applicable to the themes that have emerged in the series Irrational Markets, namely overconfidence allowing prices to move away from fundamentals, underwriters disregarding some basic indicators of clients’ profitability, and stock prices reflecting enthusiasm rather than value.
A late 1970s view is that the main purpose of an organisation is maximising shareholders’ value, but we think that this view could have a contemporary twist in light of the ample number of social media and technology companies that have been emerging in the last 10 years. It could be suggested that early rather than long-term shareholder value maximisation has been prioritised, namely in the form of ‘the big cash out’ that has unremittingly been occurring when lockout periods expire. And if the notion of ‘the house always wins’ has been further reiterated, the suggestion that ‘the market can stay irrational longer than you can stay solvent’ implies that major players should consider how much capital would be enough to prove the underlying models of financial instability wrong.
Next time you’re shopping and get offered a cash out, have a little think.
Suits and Books. Our pleasure.