IPOs Without the IPO

CONTRARY INDICATOR November 3, 2011 By Daniel Gross

Groupon is expected to price its initial public offering Thursday. The debut of the daily deals site has been one of the most anticipated events in the capital markets for 2011. But it may prove to be anti-climactic. For in some important regards, Groupon’s IPO has already happened.

IPOs serve a few important purposes for technology companies. They allow the firms to raise new cash that can spur growth. They let founders, early investors, and early employees cash in on all their hard work by creating a market for shares and options. And they create a currency companies can use to make transactions. The day of an official debut has frequently been a life-changing one for employees and early investors. Once the stock symbol hits the tape, they can start making plans about new houses and cars, philanthropy, and new ventures.

But that’s the 1990s way of thinking about it. These days, many of the hottest technology companies effectively go public months before their smiling bosses ring the symbolic bell at the NASDAQ or NYSE. Fevered interest by venture capitalists and institutional investors has allowed companies like Groupon or Zynga to sell big chunks of shares. And new platforms like SecondMarket, which create private markets for the stock of hot companies that aren’t yet publicly traded, provide a venue in which investors and shareholders can meet. SecondMarket runs programs for companies that let insiders with options or shares — be they low-level programmers or top executives — monetize their illiquid assets by selling them to accredited investors and institutions through regular auctions.

In the 1990s, the only way for a founder or early employee to make big money on the success of their company was to sell shares to the public, cede some control, and open themselves up to scrutiny, criticism, and oversight. That has changed. Mark Zuckerberg of Facebook has been able to maintain some of the (wait for it!) privacy that comes with avoiding a public offering while reaping some of the benefits of owning a huge chunk of stock that occasionally trades. Grand gestures, like Zuckerberg’s September 2010 commitment of $100 million to Newark’s public schools would have been impossible in an era when shares of private companies didn’t already sell in size.

So why do I say that Groupon’s public offering has already happened? As Jennifer Van Grove reportedon Mashable in June, Groupon had recently raised nearly $1.1 billion in two rounds in venture capital funding: $135 million in April 2010 and another $950 million in December 2010 and January 2011. But the overwhelming majority of that cash did not wind up in Groupon’s coffers. As Van Grove wrote, “altogether, $946.8 million, or roughly 86% of the funds raised across the three investments, was paid out to Groupon directors, officers and stockholders. Just $151.4 million was retained by the company to use as working capital and for general corporate purposes.”

IPOs frequently let founders sell in the offering, or simply create a market in which they can sell. These deals were a little different. The company sold shares in a private offering and then used the proceeds to buy shares from insiders who had a much lower cost basis. Andrew Mason, co-founder and CEO, received $28 million for parting with some of his shares. Entities controlled by co-founder Eric Lefkofsky “cashed in shares for a combined total of $381,904,359.” By this spring, fueled with the cash thus raised, Lefkofsky was already on to other ventures. In September, he joined other investors in purchasing Chicago’s iconic Wrigley Building.

Meanwhile, Groupon’s shares have continued to trade on platforms like SecondMarket, allowing other employees to cash out and effectively setting a “market price” on the company. Now, the strategy behind IPOs is that releasing a small amount of shares onto a huge public market on a single day will create a frenzy of demand that boosts the value of the company. But the successive rounds of venture capital and the periodic trading of shares on SecondMarket have allowed that buzz to build up — before the shares hit the market. SecondMarket and the venture funding market are different than public markets. There’s no shorting, and you can’t buy puts on the shares. Markets are places where people express opinions about stocks. But the only opinions expressed in these markets are positive ones.

In the months after a hot tech IPO, reality often sets in and the price comes down. But there are signs that this cycle has already happened with Groupon — before the official IPO. In the thinly traded secondary markets, the air can come out of stocks before they go public. In October, tech reporter Michael Arrington reported that a SecondMarket auction for Facebook shares failed for the first time. In the weeks and months approaching the IPO, analysts and critics began punching holes in Groupon’s expense and accounting structures, and questioning its long-term prospects. Some fret that the company’s most explosive growth may be behind it. And that caused some of the air to come out of its stock — before it even started to trade. As Alistair Barr reports in Reuters, the IPO is expected to value the company at somewhere between $10.1 billion and $11.3 billion. That’s less than the value private investors placed on it this summer. In fact, “it is unlikely to go anywhere near the value of close to $20 billion that the company fetched in the secondary market this summer.”

This is progress of sorts. In bubbly periods, individual investors desperate to get in on hot initial public offerings frequently paid very high entry prices — only to see the value of the shares drop. In Groupon’s case, the successive fundraising rounds and regular trading on secondary platforms has already established a market for the shares. Groupon’s IPO may be the rare case in which individuals buying small lots of shares wind up getting a better price than well-connected institutions and millionaires.

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IPO Market in the Doldrums

The IPO market, an engine of job growth, stalls

ASSOCIATED PRESS Matthew Craft, Monday October 24, 2011

NEW YORK (AP) — Two companies with quirky names, Ubiquiti Networks and Zeltiq Aesthetics, made their public debuts earlier this month with listings on the Nasdaq Stock Market. Each company’s stock went up modestly on the first day of trading.

Ubiquiti pocketed $106 million for the day, and Zeltiq made $91 million. They were the most successful stock debuts of the past two months. Then again, they were the only stock debuts of the past two months.

The market for initial public offerings, or IPOs, is suffering through a drought of Texas proportions. Companies thinking of going public are deciding it’s just too risky.

The stock market lost nearly 20 percent of its value in a month this past summer. Swings of 200 points for the Dow Jones industrial average continue to be commonplace. Getting the timing wrong for a coming-out party can mean missing out on millions of dollars.

A dried-up IPO market matters because stock debuts aren’t just a chance for tech whizzes to become overnight billionaires and ring the bell at the New York Stock Exchange. Companies use the cash they raise to grow — and that means hiring people.

And at a time when 14 million Americans are looking for work and the unemployment rate has been stuck near 9 percent for two years, the last thing the economy needs is for one engine of hiring to stall.

There are 215 companies waiting to go public. They’ve filed the necessary paperwork and lined up bankers, and are just holding out for the right time to unleash their stock. The waiting list is the longest since 2001, according to Renaissance Capital, an investment advice firm.

LogMeIn, a Massachusetts software company, went public in July 2009, raised $107 million and harnessed the cash to hire people. Within two years, its work force grew by a third, to 432 people. Without the IPO, the company might have added only 10 percent to its work force, says Jim Kelliher, the chief financial officer.

“It’s cash to expand your business,” he says.

That’s how it usually works. For upstart companies, IPOs and hiring sprees go hand in hand:

— LinkedIn, the online social network for professionals, went public in May to fanfare, raising $353 million. In the three months through the end of June, it expanded its staff by 17 percent.

— Pandora, which streams music online, debuted in June. It bulked up the product development staff by 74 percent and sales and marketing by 125 percent. Pandora employed about 300 people at the end of January and now has more than 400.

— ReachLocal, an online marketing company, went public in May 2010. From the month before its coming-out party through the end of the year, its work force grew 30 percent, to 1,381.

In good times, an open door for stock market debuts can start a snowball of benefits, says Steven Kaplan, a professor of finance at the University of Chicago Booth School of Business.

Venture capital firms bankroll small upstarts, like Amazon and Google, years before they go public. A successful IPO enriches the venture capital backers. They then have an easier time raising money from new investors to plow into companies that might be the next Amazon or Google.

“There’s a feedback effect,” Kaplan says.

For profitable businesses, an IPO can also unlock the door to corporate debt markets, another source of cash that helps a company grow.

Entrepreneurs and investors describe going public as a crucial hurdle for fast-growing companies, one that divides the Amazons and Googles of the world from the graveyard of startups.

Those that clear the hurdle can transform themselves from obscure businesses to household names. A recent study by the National Venture Capital Association, a trade group, and IHS Global Insight, an economic forecasting firm, examined companies that went public from 1970 to 2010 and had been backed by venture capital before their IPO.

It found that 92 percent of the people hired by those companies over the four decades came on after the IPO.

A separate report by Nasdaq OMX, which owns the Nasdaq Stock Market, examined companies that went public from 2001 to 2009 and found that they increased their collective work force by 70 percent. The number of employed people in the United States in that time rose 1.3 percent.

Of course, the economy has bigger problems than a barren IPO market. Even if all the promising upstarts in line for an IPO went public, it might not put a dent in the 9.1 percent unemployment rate.

And it’s difficult to know exactly what companies will do with the money. Most are vague in regulatory paperwork about their next steps. And would-be public companies are barred from talking about their plans until a month after their debut.

Before this past summer, fast-growing companies like LinkedIn and Pandora had been jumping into the stock market at a brisk pace. The companies got a good initial price, and their stock generally did well after that. LinkedIn went public May 19, and its stock more than doubled on its first day.

For a while, it appeared that 2011 would be the best year for IPOs since the Internet bubble popped in 2000. Investors were ready for Internet companies like Zynga and Facebook to go public.

They’re still waiting. The Dow lost more than 2,000 points from late July through mid-August. And while the market has rallied since early October, the past two months have been a series of up and down lurches.

As dry as it’s been, the drought for IPOs is still not as bad as during the financial crisis. Just one company, Grand Canyon Education, managed to go public in six months, August 2008 to February 2009.

Faced with a long wait and a volatile stock market, some companies have decided to give up. At least 15 private companies have withdrawn their IPO paperwork from the Securities and Exchange Commission in the past two months.

Others are getting snapped up by larger corporations. Of the five companies that pulled their IPOs in September, three were acquired. Hitachi, Nestle and private equity firms all picked up companies that gave up their dream of going public.

What will it take to end the drought? Calmer markets. In recent weeks, moves by European officials to end the region’s debt crisis have lifted stocks, but the market remains volatile.

In the meantime, companies are warily eyeing the calendar. Groupon, the daily-deal email service, plans to go public in early November. It was valued as high as $25 billion in June, but it now expects less than half that.

 

Housing Bubble Crushes American Middle Class

How the Bubble Destroyed the Middle Class

by Rex Nutting
Friday, July 8, 2011

Commentary: Sluggish growth is no mystery: No one has any money

A lot of people say they are deeply puzzled by the slow recovery in the U.S. economy. They look at the 9+% unemployment rate and the mediocre growth in national output, and they scratch their heads and wonder: Where is the boom that inevitably follows a deep bust, such as we experienced in 2008 and 2009?

But there is no mystery. What other result would you expect from the financial ruin of the once-great American middle class?

And make no mistake, the middle class has been ruined: Its wealth has been decimated, its income isn’t even keeping pace with inflation, and its faith in the American economy has been shattered. Once, the middle class grew richer each year, grew more comfortable, enjoyed a higher living standard. It was real progress in material terms.

But that progress has been halted and even reversed. In some respects, the middle class has made no progress in a generation, or two.

This isn’t just a sad story about a few losers. The prosperity of the middle class has been the chief engine of growth in the economy for a century or more. But now our mass market is no longer growing. How could it? The middle class doesn’t have any money.

There are a hundred different ways of looking at the economy, and a million different statistics. But if you wanted to focus on just one number that explains why the economy can’t really recover, this is the one: $7.38 trillion.

That’s the amount of wealth that’s been lost from the bursting of housing bubble, according to the Federal Reserve’s comprehensive Flow of Funds report. It’s how much homeowners lost when housing prices plunged 30% nationwide. The loss for these homeowners was much greater than 30%, however, because they were heavily leveraged.

Leverage is an amazing thing: When prices go up, the borrower gets all the gains. And when prices go down, the borrower takes all the losses. Some families lost everything when the bubble collapsed, others lost very little. But, on average, American homeowners lost 55% of the wealth in their home.

Most middle-class families didn’t have much wealth to begin with — about $100,000. For the 22 million families right in the middle of the income distribution (those making between $39,000 and $62,000 before taxes), about 90% of their assets was in the house. Now half of their wealth is gone and it will never come back as long as they live.

Of course, rich folk lost lots of wealth during the panic as well. Their wealth is mostly in paper not bricks — stocks, bonds, mutual funds, life insurance. The market value of those assets fell further than home prices did during the crash, but they’ve mostly recovered their value now. The S&P 500 (^GSPC – News) lost 56% of its value when it crashed, but it’s doubled since then. Stocks are down about 13% from peak.

The rich recovered; the rest of us didn’t.

If losing half your meager life savings weren’t bad enough, the middle class has also been falling behind in terms of income for decades. Families in the middle make most of their money the old-fashioned way: Working their fingers to the bone for 40 years for wages and a modest pension.

Their wages have been flat after adjusting for inflation. In the late 1960s, the 20% of families right in the middle were earning almost their full share of the pie: they had 17.5% of total income. Their share has been falling steadily ever since. Now, that 20% is earning just 14.6% of all income. Meanwhile, the top 5% captured a growing share, going from 17% in the late 1960s to 22% today.

The housing bubble was the last chance most middle-class families saw for grasping the brass ring. Working hard didn’t pay off. Investing in the stock market was a sucker’s bet. But the housing bubble allowed middle-class families to dream again and more importantly to keep spending as if they were getting a big fat raise every year.

I don’t think we’ve quite grasped how much the bubble distorted the economy in the Oughts, and how much it continues to distort it today. We’re still paying the bills from that binge.

During the last expansion from 2003 to 2007, according to an analysis by Fed economists, American homeowners took $2.3 trillion in equity out of their homes through cash-out refinancing and home-equity loans, and they spent about $1.3 trillion of it on cars, boats, vacations, flat-screen televisions and shoes for the kids.

All that spending circulated through the economy, creating millions of jobs here and in China, where they make those TVs and shoes.

During that period, the economy grew at an annual average rate of 2.7%, which is about typical for our economy. But growth would have been closer to 2% if we hadn’t had a housing bubble; if we hadn’t had the extra consumption financed by the bubble and if we hadn’t built millions of surplus homes. That’s a huge difference. At 2.7%, the economy can create a significant number of jobs. But 2% is stagnation, not even keeping pace with population growth and productivity improvements.

Now that the bubble has burst, homeowners are putting money INTO their homes, not taking it out. The impulse to pay down the mortgage and the credit card is reducing the amount of money we’re spending on other things. Since 2007, instead of taking $2 trillion out of their house, homeowners have put $1.3 trillion into them.

You think that might be having an impact on consumer spending?

Even with trillions in debt being paid off or written off, very little progress has been made in deleveraging. The debt-to-disposable income ratio has slipped from 130% at the height of the bubble to 115%, but that’s still far more than the 90% recorded in 2000 or the 80% of 1989 or the 60% of 1976. No one knows how far it needs to fall before American families are comfortable with how much they owe.

The slow growth in the economy is no mystery: Most families don’t have any extra money to spend. It will take a long time for the middle class to rebuild its wealth, especially if we don’t find some work.

The crazy thing is that our leaders aren’t even talking about this crisis. With the upper classes prospering and global markets booming, they don’t need the U.S. middle class any more. The market is up, profits are soaring, and the corporate jet is fueled and ready for takeoff.

And if the middle class can’t buy bread? Let them eat cake.

 

Hedge Funds Get Closer Scrutiny

NEW YORK TIMES   JESSE EISINGER, Wednesday February 16, 2011

Now for a bit of good news: Rationality may be breaking out in the hedge fund world.

Investors are punishing funds that have engaged in questionable behavior and balking at ever-escalating fees. Regulators are showing uncharacteristic backbone, insisting that they will not merely fight the last war when it comes to new rules.

That’s a big change from the old way of doing business in hedge fund land, which was to reward failure and ignore problems.

Think back to Long-Term Capital Management. The multibillion-dollar hedge fund imploded spectacularly in 1998, presaging much of the larger financial crisis a decade later. The fund’s implosion was caused by excessive leverage and gigantic derivatives positions.

The Federal Reserve Bank of New York engineered a Wall Street bailout and, in the immediate aftermath, regulators and investors professed a desire for change. Yet John W. Meriwether, the impresario who had blown up L.T.C.M., soon gathered billions in new assets – only to blow up again. Regulators watched passively as hedge funds grew meteorically without close monitoring.

Now after the financial collapse of 2007-8, changes are dribbling in. It’s all the more surprising since hedge funds were not a cause of the crisis. Banks, especially Wall Street firms, get the credit for that. Plenty of hedge funds went out of business, but almost none of them were systemically important enough to stoke fears of a wider panic.

Nevertheless, the changes are welcome.

One hopeful sign is that institutions like pension funds and foundations are pulling money from hedge funds that acted cavalierly during and after the crisis. They are nervous about the insider trading scandal sweeping the industry.

Funds that had spectacular returns only to crash during the crisis, like Atticus Capital, have wound up their operations. At Harbinger Capital, the founder lent himself money from the fund, and investors have punished him for it. Shumway Capital tried to change its management structures without giving investors what they considered adequate notice, and now it is closing. Funds that have been ensnared in the insider trading investigation, fairly or not, are shutting their doors.

When liquidity dried up at the height of the crisis, certain funds prevented investors from taking money out of their firms. Now, some are suffering large-scale redemptions.

D. E. Shaw, the gigantic hedge fund complex, lost investors throughout last year even though it invoked triggers on terms agreed in advance. Other funds engaged in the more controversial practice of suspending redemptions without a previous contractual agreement. Investors have reacted bitterly to both kinds of suspensions.

Another sign of the new rationality is that hedge fund fees are finally creeping downward, a trend long predicted that had not ever managed to arrive.

In the past, hedge funds have been something of a “Giffen good” – that unusual market phenomena of demand rising as the price climbs. The more the hedge funds charged and the more exclusive they were, the more they were desired. Incentive fees, however, have finally begun to ebb, down to 19 percent, from 19.3 percent three years ago according to Hedge Fund Research.

D. E. Shaw is lowering the management fee on its Composite Fund to 2.5 percent from 3 percent and dropping its performance fee to 25 percent from 30 percent. D. E. Shaw declined to comment on the changes and, with about $19 billion under management, something tells me the firm will manage to scrape by, even with lower rates.

Still, fees ought to come down – the performance hasn’t been there.

Sure, there are examples of funds with spectacular returns, like Daniel S. Loeb‘s Third Point, which had a 34 percent gain last year. Over all, however, performance lagged the stock market. Both the Hedge Fund Research composite index and its index of equity-based hedge funds trailed the Standard & Poor’s 500-stock index’s total return two years running.

Hedge fund managers justifiably argue that investors shouldn’t expect funds to beat the market every year. A well-managed hedge fund is devised to make money in good markets and bad, with less volatile returns.

But since many hedge funds lost spectacular sums in 2008, their credibility has been shaken. It turned out they weren’t hedging enough and were more correlated to the markets than they should have been. Investors weren’t getting what they are paying for.

We’ll see how long these positive developments last. Investors put almost $150 billion into hedge funds in the fourth quarter, a record, according to Hedge Fund Research. Assets now stand at $1.9 trillion, just below the peak reached before the financial crisis.

Still, funds that aim for slow-and-steady returns appear to be thriving amid the new risk-averse mood.

And as money rushes back to the industry, regulators seem poised to impose the first genuine controls on it. Hedge funds will have to register and disclose more about their activities to financial overseers.

Last week, the Federal Reserve issued its definitions of what a “significant nonbank financial institution” will be, drawing the lines broadly enough to include big hedge funds. The Fed, properly, has judged institutions’ significance based, in part, on how interconnected they are: how many trades they do, how many counterparties they have, how much they have borrowed. It’s a good, and necessary, step toward policing systemic risk in the system.

Just because hedge funds didn’t cause the last crisis doesn’t mean they can’t cause the next one