Much has been said in this column about the inevitability of gravity when physics takes hold of markets best described as #RotationToReality, especially when valuations blast into outer space from time to time. No, I am not referring specifically to Space X or Elon Musk but the significant pullbacks in last year’s excesses such as GameStop meme stocks.
These fluffy tech stocks are best represented by Goldman Sachs’ Unprofitable Tech Index, which is down more than 70% from the peak last April, or the handful of Covid-fuelled consumer stocks like Peloton and Netflix. London-listed Deliveroo or US-listed Didi Global are also beating a hasty retreat too. Investors fled upon the realisation that much like the eyeballs of the dotcom era, the wobbly paths to profitability touted by bankers in the Wild West require a long hard look when the cost of capital starts going up.
Private equity exits slowing
Amid the wider woes, I find something else somewhat concerning. The pace of IPOs and exits by private equity (PE) and venture capital behemoths have slowed. US spac listings contributing to the bubble of 2020 and 2021 have started fizzling out as they head towards the redemption deadlines of 2H2022 onwards. It is getting harder and harder for bankers and sponsors to find Pipe (private investment in public equity) investors for deals where company owners are clinging on to price expectations based on last year’s peak. There is a distinct mismatch between public market reality and private market valuation.
For the last decade and especially in the last three years, there has been a similar sharp acceleration of private market valuations, particularly in the future economy sectors of platform consumer tech, digital fintech and ABC: artificial intelligence, big data and cyber security.
The growth of PE had been supported by cheap funding from negative interest rates by central banks, enabling them to aggressively embark on leveraged buyouts of poorly-valued companies in the public market. (Incidentally, this is a phenomenon in part correlated with the decline in sell-side research and the growth of index trackers, driving many investors to an increasingly narrow group of crowded trades, leaving value to be discovered only for those who do their homework and have patience.)
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Given high-octane returns and opportunity cost of holding cash next to nothing, private banks and institutional investors all eyed the same world of opportunity. It was an easy sell. With smoothed returns on paper, periodic mark-to-market valuations showing ever higher watermarks and next to nothing on volatility on the downside, Fomo was the order of the day as banks scrambled to offer while accredited investors wanted in.
To be fair, there are many good managers and some have a good record in transforming privatised public companies and growing them. In addition, some industries such as biotech or future tech require smart money in PE with the patience to make longer-term bets, suffering from lower liquidity in return for potentially higher returns.
In the years leading to mid-2021, exits into the public markets by PE were hugely rewarding. Given US markets were on a tear, newer PE firms with huge cash hordes fell over each other to get in on the sexiest start-ups, pushing up valuations of all manner of innovative ideas and products.
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These conditions reached a crescendo somewhere in 2Q2021. While there is capital rolling over from previous successes into new PE vehicles and the aggregation of more private wealth, the reverse in some of the overheated sectors has been stealthily working its way through. Public market exits have been less than welcoming, often correcting, right at or shortly after, public market listing. And it is not just the SoftBank-backed deals (often associated with perceived visionary valuations) that have struggled.
It is possible that with credit becoming more expensive and path-to-profitability stories more difficult to sell to retail investors, we are now in a downtrend for what has been a steady wealth accumulator (at least on paper) for many high-net-worth and institutional investors.
It is not the end of the world but it could lead to a period of digestion that serves as a reality check and suspends complacency that had taken hold in this private part of the market. Yes, companies have stayed private for longer as investors had been willing to fund with less liquidity and transparency for the proverbial windfall. If the odds are shifting and private valuations are higher than public markets even after correcting, then they may have to chase them down for a while.
May the Fourth
The 50bps raise by the Fed on May 4 or Star Wars Day, saw the US and global markets rally for a day (after a horrendous performance year to date). This was a relief rally (especially in tech) many were hoping for after the pounding in the first four months of the year for most global markets. Indeed, it played out for a day and then reverted to its true nature, a dead cat bounce right after as the corrections that followed took it to an even lower low level than before the rally. This was similarly observed by the almost 10% pop in Chinese tech stocks as at the end of April and had retreated back below where it came from by May 9.
There have been many reasons ascribed for this — from politics to policy in China or earnings disappointments for US bellwethers. But the fact of the matter is that relative valuations between future profit and real profit have now been reset and continue to be so. Likewise, the private market cannot exist independently of the public market. And as the cost of capital rises, the carry for future equity growth could turn negative for some strategies and assets classes.
Conversely, companies with cash to carry and deploy will find opportunities in this correction at entry points one could only dream of 12 months ago. Our three local banks may hold up the Straits Times Index, which is still one of the handful of markets in positive territory thus far this year. Other markets in similarly positive territory thus far this year include Saudi Arabia’s Tadawul, which is up mainly because of Aramco, and a couple of other Asean bourses because of favourable demographics and commodities price trends.
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The post-Covid recovery themes and corporate restructurings have enabled new growth from companies with healthy balance sheets. M&As (and rumours of M&A) continue, especially with real estate and finance-related business trading at discounts to book value.
If interest rates continue to rise, some local stocks with a double negative (negative carry and negative to NAV) may not just preserve capital but could become a positive jackpot for the patient and the prepared. May the force be with you through the summer.
Chew Sutat retired from Singapore Exchange after 14 years as a member of its executive management team. During his watch, the exchange transformed from an Asian gateway into a global multi-asset exchange. Chew was awarded FOW’s lifetime achievement award in 2021
