ETF Edge - The Sizzling IPO Market

Episode Date: September 8, 2021

CNBC's Bob Pisani spoke with Kathleen Smith, Principal and Co-founder of Renaissance Capital – and Brian Schaeffer, Managing Director at Invest-X Capital. They discussed the year that was and what��s to come for the fall season of IPOs, opportunities in the private market and how to get involved in promising pre-IPO investments in the future. In the ‘Markets 102’ portion of the podcast, Bob continues the conversation with Kathleen Smith from Renaissance Capital and discusses direct listings and SPAC's. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, Supporting the Innovators Changing the World, Invesco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you're in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Tassani. It's been a sizzling hot year for IPOs. Today on the show, we'll dive into the year that was, and what's to come for the fall season of IPOs. but beyond the public market, we'll also be discussing opportunities in the private market and how to get involved in promising pre-IPO investments in the future. Here's my conversation with Kathleen Smith, principal and co-founder of Renaissance Capital and Brian Schaver, managing director at Investex Capital.

Kathleen, first eight months, I have 279 IPOs raised $96 billion. How about the overall outlook for the final four months? And you think this could be a record year, right? Well, we think so because when the returns on the already trading IPOs are doing well, and that is the case with our index, the ETF tracks that index. Returns had been great in 2020, up over 100%. And that put out a slew of companies into the market, that receptive market. And then we're seeing in recent months again outperformance of the segment.

And so we're predicting that we're going to have a very big year, finishing up with more IPOs than we've seen since the internet bubble. And the amount of dollars raised, which could be about $125 billion, that'll be more than the IPO market has ever seen. And what's striking to me is normally we have to explain software companies and biotech companies and what they do. But so many of these names that I see coming are big consumer names, Warby Parker, Fresh Market, Authentic Brands, a lot of others,

Is there some kind of zeitgeist in the air with suddenly big consumer names are going to be going public? Well, I think it's good to see breadth of that sort in the IPO market. And if you look back year-to-date, you'll see some of the best returns have come from the consumer discretionary names.

So because of that, and the technology companies that are often the bread and butter of the market, they seem to be getting a bit pricey. high evaluation. So the ones that have performed well, the consumer discretionary, so it should be no surprise that we're seeing a lot of these names. And it makes it kind of fun because now we don't have to describe what Giovanni does. Yeah, and there's a number of other well-known consumer brand names that have not yet formally filed, but have a pretty good chance of going public

next year, this year as well, Kathleen. And I'm just very impressed with the list. The list is great. We're going to see Warby Parker try to do. a direct listing, and we think that could be a billion dollars of issuance at maybe a $3 billion or so valuation. We have some other really big names, authentic brands, which ought to be doing a billion-plus IPO, and that's a licenser of brand names like Brooks Brothers and Nautica, and a company called Fresh Works. They're a little bit like Zendesk, very fast-growing, and again in the billion-dollar category. Once we got back from Labor Day,

we just saw a tremendous quality of company get onto the IPO calendar. So next week, we're going to see over $3 billion of issuance, and they're from companies that all have valuations of over a billion, some up to $8 billion. Yeah, and we're putting up a list right now here, including ThoughtWorks and Definitive. Rivian's another one that's a potential IPO company

that's out there. I'm wondering if you think all of these are going to be coming. Obviously, the most important thing is the state of the market. So far, the market's been holding up very well. Are we going to see a sudden rush in the next, starting next week, where in the next three weeks you're just going to see a massive number? What does the calendar look like? The calendar is filling up now.

So I would say we're seeing a rush. Now, the one important thing about the IPO market is there's a pricing mechanism here. And these companies are all going to be compared to already traded public peers. So if the overall market goes down, the pricing will be adjusted on these IPOs. They should be. If not, the deals won't work. And that is important because if deals don't work, then investors stop participating. So I think the IPO mechanism has been working just fine.

I don't see why it wouldn't. And unless we get to some really big corrections, I think the pricing mechanism and will give us deals that have values that make sense to investors. Yeah, Brian, let me turn to you. It's striking that some of these companies have been private for many, many years. They used to be companies who would be private for five years and then go public. But now I'm seeing companies that are private 10 years, even 15 years, before they go public. And they're still private here.

So tell us a little bit of what kind of opportunities are available for people who want to buy or sell private securities, and what are you doing to help that? So, I mean, that's a great observation, Bob, and I'll tell you that there has been a massive paradigm shift, obviously, within the industry. And I would say that's now the norm, right? So you're seeing companies stay private 10 to 15 years because you've had a handful of the largest buy-side investors getting involved, injecting cash and liquidity into these companies at very early stages. We're talking B and C rounds. And at that point, they no longer need to go to the public markets for liquidity. And so, again, that new trend that we're seeing, and as we say down on the floor of the exchange, the trend is your trend.

friend is companies are staying private longer. And so having access to that and thinking about how to democratize the process of investing is something that's very important and is on our mind quite a bit. As we know that the regulators are looking at it very, very hard. And as the regulatory dust settles, we want to find ways to... Explain how this works. So right now, under your company, if I had shares I wanted to sell, I would go on the platform and seek a brokerage company. You'd go through the brokerage company, right? And then the company had... You still need a approval of the company itself. That's exactly right.

And again, it's a great point. There's a lot of snafus in investing in private companies. It hasn't been electronified the way investing in public companies. As you can't hit the button and buy shares in a millisecond the way my algorithms that we built in the past have done. Today, this process could be very long and arduous. It could be days to months. By the time, and again, by the time you get in front of the companies to find out if they are going to roe for those shares. And the rofer is the most important part of the process, because it seems to be the most...

Rofer meaning the right of first refusal. And so to your point of the question, which is, those companies have the right. If I were to go to them as an early employee and say, I'm about to sell my shares for 20 bucks to someone, they can say, we have the right of first refusal to say, no, we'll pay you the 20 and take those shares back, whether into Treasury or for whatever reason. This is still a pretty antiquated process. It's really like an over-the-counter transaction, essentially. So if I'm at XYZ company and it's been private for 10 years, not going public, and I own 10,000 shares, pick a number, and I want to sell 1,000 shares, it's actually fairly difficult to do that right now.

You're trying to find some way to not automate the process, but do more electronic kind of trading. Yeah. But you still have to get the approval of the company, and you still have to have selling shares, you know, you still have to get the company approval, and you still have the fact that this has to be a qualified individual, right? That's exactly right. And so there's a number of different checks you need to go through. And today it is extremely antiquated and high touch. And that is the reason that Investex exists today is because our very ambitious goal, while ambitious, we don't think it's impossible. This isn't rocket science.

At the end of the day, is figuring out a back office rails so that when you want to make an investment, or if there's a roefer process, that it can be automated slash electronified. And that's very important. So is there an ETF angle here? So, for example, could you ever envision a process whereby you can actually get private companies in an ETF as a group and trade it as a group? Funny, I had just a meeting this morning with one of the largest ETF issuers out there who is very aggressively seeking to do exactly that, which is build an ETF around private companies. And if you think about really the larger U.S. consumer, the larger swath of the consumers who are not accredited, today have no access to private companies. And the SEC has inadvertently made the rules, such as what their definition of an accredited investor is, have inadvertently made it very difficult for the masses, if you will, to invest.

And so we believe that's kind of where the puck is going, not where it's at. And there are specific E2F issuers who are seeking SEC approval to come up with ways and building baskets around private companies. Kathleen, what's your take on this whole thing? Number one, what do you think about the ability, should people have an ability to buy or sell shares in a, a private company as Brian is essentially trying to set up. And why are companies staying private so long? It used to be five years, and even with the venture capital, they want it out. Now I see 10 years and more with venture capital firms.

Well, we would comment that in the private market, I think the most important thing for all markets to work well. It's kind of like the Amazon. The more information you have about what you're buying and selling, the more transparency, you have a better marketplace. And that's why I think the IPO market has worked so well. There's a requirement for disclosure, audit financials, and stuff like that. So the more that Brian's efforts enable investors to access with good information, then I think the growth ought to be there, and I think it's a noble effort. I myself think that the FCC should get rid of the accredited investor rule.

It doesn't seem to make any sense to me. Investors can know what they're doing. So I think that it's a good approach. I would say that an answer to why there's so many companies that have stayed private, back during the Jobs Act, the SEC put in a regulation or relieved a regulation that said, if you had so many shareholders, like it was I think 500, you were that, you then had to go public because basically once you have that many shareholders, you're effectively need to tell them what do the financials look like and stuff like that.

well, they extended that number to like over 2000. And so that enabled companies to stay very big and not to go public. And, okay, that's fine. We're in a point in time right now where there's a lot of capital available. And it makes it easy. But remember, there are times when we know the IPO window can be closed and capital is not available. And it's important for companies to get the, the fact that they have,

traded shares, liquidity, can really give them a benefit of being able to use that stock to raise additional capital to make acquisitions that they would not have if they stay private. But isn't the, I mean, other than the change in the SEC rule of what 2,000 shareholders, isn't the simple answer that capital is really cheap and it's easy for these companies to stay private. Why bother going public when your venture capital firm, you'll do a series ABC, D, E, F, G. We've gone through the alphabet with some of these rounds of funding that are going on. Why go public when you could get cheap money for the rest of your life, essentially?

Isn't that the real answer? Right. And the equation sort of flip-flop because generally speaking, these valuations should not be as high as they are. I mean, we've seen a lot of IPOs that are done at valuations that are lower than their last rounds. So the fact that capital is running to these companies, it's not the best formula, but look, we've been in all kinds of markets. markets adapt. That's what they are. Brian, what about access to information that Kathleen was talking about? Today, if you want to invest in a private company, it is really hard to get information.

She's right. It's nearly impossible. You use the word asymmetrical. Yes, and that's exactly what it is. So what are you going to do? How do you make it possible? Right. So when I say asymmetrical, only from the sense that the larger investors that we spoke to earlier,

involved in those earlier rounds do have access to the company's financials or otherwise. And so, again, Kathleen brings up a great point. And as we're sitting here in this great institution that once had a point of sale, which, you know, not to the extent that it used to be, but again, price discovery is a big part of the challenge for investors in private companies. And so that's another one of the things that we try to provide on our platform, which is access to financials, albeit some of it publicly sourced, but others that we gain access to directly from the companies. And after ascertaining that, put that on our platform for our broker community and our broker partners to share with their customers and so that they can make more informed decisions in their investments. You know, Kathleen, one of the disappointments with IPOs this year has been the poor aftermarket performance. IPOs, on average, lost money, as you have noted, after the first day of trading. Now, why was that happening?

And is there any improvement recently? Well, there's definitely been an improvement recently. The aftermarket returns are positive now for the last three months. I think it's about 12 percent, which is very good. But if you drag along the full year, they are still, they're just about break-even now. When after-market returns go negative, investors start to step back, and you don't get the follow-through that you want with a priced IPO. So that signals a slowdown in interest and therefore slow down the IPO market. We saw that in terms of issuance.

We saw that slowdown this past summer. We also had a slowdown related to the Chinese IPOs that were done. Those performed very poorly. So that dragged down the aftermarket returns too. And so we go through a cycle. Now we're at a better phase of the cycle. Valuations seem to be pricey, especially for the tech companies. So then you see the new ones come in, their price better,

the aftermarket returns improve, and the cycle kind of starts over again. So it strikes me as two things. When I saw the IPO ETF drop notably, it was February March. That's when interest rates also moved up. And obviously, higher rates affect some of these younger startup growth companies, which are valued less on a discounted cash flow model. I think that's probably a major issue.

But also, prices were too high. Are you saying that we, and we've seen the IPO ETF do better in the last month or so, is this because in July and August, the IPOs, the price of the were lower price and they're performing better in the after market after they start trading? I think that it's a little bit of that because the ETF is including companies that are already public and just on the quarterly basis will pick up new ones. So I think it had to do with the performance of growth companies, as you mentioned, when interest rates appeared to be rising. It's not happening

now. But if rates go up, it does affect the value of growth companies. Now we seem to be, have turned around, and we're in a market where it's investors just want growth. They're ignoring anything that's not growing. So investors are willing to pay a lot of money for growth when interest rates are, the real return is negative on any kind of fixed income products. In terms of yield, you really value that. The company, that can produce growth and cash flow. Interestingly enough, unlike 2000, the cash flow is very good on most of these companies.

Now it's time to round out the conversation with some analysis and perspective to help you better understand ETF. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Kathleen Smith from Menaceau's Capital. Kathleen, thanks for sticking around. The one thing I didn't get a chance to chat with you about

is your thoughts on direct listings and SPAC, which have come out as rather significant competitors to IPOs. Let me just start with the SPAC market. We had a torrid start to the year, and it's cooled off quite a bit, but still robust. The SEC several months ago announced they were a little concerned about some of the comments being made by people about SPACs, particularly forward-looking comments. Do you think that had anything to do with slowing the SPAC market down? And what's your thoughts on that versus the IPO process? For us, it's all about returns.

And SPACs have not produced the returns for investors that IPOs have. And for that reason, we think that the whole idea, and there's some validity to the idea, has really cooled off because companies, investors are not just not doing well. I have some data here, for example, year-to-date, regular operations. IPOs are up 19% and over half of them are trading above their IPO price. SPACs are flat for the year and only 37% are trading above their IPO price. So it's very tricky to go in to the SPAC market thinking that it may be a winner's game. You have to be so careful about each one.

So you can't just throw darts at anyone and think that you'll do well. And this data, we've looked at data going back five years. Just the historical data shows that the SPAC does not perform as well as IPOs over the same period of time. And why is that? What do you think? Is the problem with the SPAC structure or that it's just easier to go public using a SPAC with, I mean, the SPAC advocates say the disclosures are the same? Why is there such an underperformance? Well, we believe that it's harder to go public through a regular IPO.

The scrutiny, the disclosure is much greater, and we're talking about a company that exists. You're studying that. With the SPAC, you're starting out with a blind pool and then making an acquisition where the sponsor adds dilution to it. And so our view is that it's like one of those, I guess, a curse of the structure

where if you're a company that can go public and go through that scrutiny, you'll do it. It's the ones that can't go public that end up in the SPAC market. And because you can produce forecast, they tend to be ones that you need forecasts. They don't have revenue. There's a lot of far-out projections

in order to look at it. And so is it your opinion of the several hundred SPACs that went public this year? If we have a down market, if we have a 10% correction in the market, is a lot of these going to roll over more so than would in an IPO market? I mean, we've had a historic up market.

And as you said, they're already underperforming. Right. I think that SPACs have something going for them when they're a blind fool and that the downside's minimal. So if we had a big correction, you'll have some limited downside if it's still the blind pool. But after that, they become companies like anyone else. And we believe the risk level is high for SPACs.

So they should be challenged just like any other company that's in the marketplace and maybe more if the risk profile is higher. Yeah, the risk profiles higher. Why? Because there was less disclosure. What is more risky about the SPAC versus an IPO? Because we believe that a company that could go public would, but you have to withstand the scrutiny. The IPO markets requiring companies that have revenues, growth, many cash flow, with some exception. With SPACs, you don't need that. And so SPACs tend to be a different kind of company, a story stock, a space company where, you know, you don't have revenue yet.

And those can work. And for those companies, they need capital, so it's an outlet for them. But I think the risk levels are very high. Finally, just direct listings. There's only a half a dozen of them, really. But Warby Parker is likely going to be a direct listing. Is there anybody else that's a potential direct listing candidate? I mean, how do you feel about their performance?

Essentially, they're not selling any new stock, for the most part, to the public. And, you know, I guess there's less of a lockup. I mean, your thoughts on direct listings? Yes. Fundamentally, there's not a big difference. In fact, we include direct listings in our IPOETF. We own roadblocks. We own Coinbase.

And it's really hard to tell about the structure. I think the main thing is because it's a liquidity event for insiders and financial sponsors. It tends to be a little messy at the beginning. And so if the company can lock up shares and control some of the distribution during trading, I think it's helpful. Some of them have. So that's where we feel the company should be looking

at controlling the amount of stock that's out in the marketplace. But basically for investors, there's no reason to run after a direct listing. Plenty of time to buy it. Very good disclosure. And since it's a liquidity event, for instance, insiders wait a little bit and the market will find its way to value these and they may very well be good investments. We like roadblocks. That's performed really well. It has, yes. Okay,

Kathleen, thanks very much. That's it for today. Everybody, I'm Bob Pisani. Thank you for listening. Make sure you tune in next week. And in the meantime, you can tweet us your questions or topic ideas at ETF Edge. CNBC. Here's the greater possibilities together. Learn more at Invesco.com slash QQQ, Invesco Distributors, Inc.