Killing technology innovation in the public markets
In 2004, Google finally went public in a long-awaited offering, via Dutch auction, that lit the public markets on fire.
But Google’s S-1 filing was probably as unusual as anything the technology markets had ever seen: The company promised to not deliver quarterly guidance to investors, and instead promised to invest over the long term to preserve the culture of innovation that the company so fiercely protected.
That culture of innovation, however, has failed to take hold in the public markets, and the IPO market has recently stagnated. Publicly listed companies have steadily declined in the United States, from 8,025 public companies in 1996 to 4,101 in 2012, according to the National Bureau of Economic Research. The outlook for the IPO market has been even bleaker in the technology sector.
To address this crisis, JPMorgan Chase Chief Executive Officer Jamie Dimon convened gatherings in New York for some of the nation’s leading investors and CEOs, including Warren Buffett. The meetings were held to brainstorm solutions to the deteriorating state of public companies, according to a report in The New York Times DealBook.
In another event on July 28, the Committee on Capital Markets Regulation released a number of proposed changes relative to market trading problems. The committee was responding to charges that the market itself is “rigged.” The actions of Dimon’s group and the committee reflect a big push to restore confidence in a broken system that affects stock performance in a measurable way.
Many lumbering companies of the 20th century have become less nimble these days, just as they’re facing emergent threats from disruptive rivals. As a result, many talented executives are opting to work at private firms rather than public companies, and many big private companies are putting off initial public offerings to delay taking their stocks public. Hence the recent “unicorns” buzzword, which was coined to denote private companies valued at more than $1 billion.
Investors need to understand that short-term thinking will always kill the potential for long-term gain when it comes to technology disruption.
Deal flow in the technology sector declined by almost half last year, from 69 IPOs in 2014 to 35 IPOs in 2015. That marks the lowest annual number since 2009, according to the 2016 IPO Report by WilmerHale.
The tech sector’s share of the U.S. IPO market has fallen every year for the past five years, from 46 percent in 2011 to 23 percent in 2015. The majority of these listings were lost off of the NASDAQ, the tech-heavy exchange that is home to more than 90 percent of technology listings. And, so far, the tech IPO class of 2016 has been even more dismal.
Interestingly, the volume of technology-related private equity (PE) deals in Q1 2016 was up 61 percent YOY and 31 percent sequentially, ranking as the second-highest PE volume ever recorded, according to the recent Global technology M&A report from Ernst & Young.
Still other private startups are turning to private stock offerings without jumping through regulatory hoops to issue public shares. This option has led to the rise of new companies such as SharesPost and Digital Offering, which offer online platforms to reach individuals and small investor groups.
All of these trends point to a need for real structural changes to streamline our public equity markets for investors and management teams alike. When it comes to technology innovation, a whole new set of rules apply — none of which are baked into the public market setup.
Investors need to understand that short-term thinking will always kill the potential for long-term gain when it comes to technology disruption. This is why so many incumbent technology providers are losing out to newer startups, and the hottest tech companies in cloud, mobile, social and big data analytics, etc., are constantly being faced with the prospect of being disrupted themselves.
Perhaps the best solution is to follow the innovation model set out by Google. That would mean doing away with quarterly guidance for institutional investors, which would go a long way toward restoring technology companies’ ability to innovate and invest over a long-term horizon. Paradoxically, this would begin to restore the trust that investors have lost in the public markets. We will also need to see a recalibration of private company valuations, particularly amongst unicorns.
As long as we continue to see sky-high multiples and inflated valuations that exceed what these companies could earn under the glare of public markets, the tech IPO pipeline will likely stay dry.
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