Another example of companies taking financial advantage of the Federal Reserve largess this year is young tech startups moving from private to public firms.
The SPAC vehicle, or blank check companies, have stepped up and are now acquiring many young, VC-owned companies and taking them public years earlier than otherwise.
This is just another example of how Federal Reserve actions are distorting financial market performance, something that investors need to be aware of as they build their portfolios.
"For over 20 years in Silicon Valley, founders have been taught that staying private longer and going public later is a good idea,” said Arjun Sethi (in the Wall Street Journal), co-founder and partner at venture firm Tribe Capital.
Going public earlier “is always healthier because it presents more transparency and accountability,” Mr. Sethi said.
The times have changed.
Yuliya Chernova writes in the Wall Street Journal that:
in the second half of this year,” the situation has changed “due to successful tech initial public offerings, high prices in tech stocks generally, and the popularity of special-purpose acquisition companies, of SPACs, that lower some of the hurdles of traditional IPOs.”
In other words, we are seeing massive changes in the financial markets.
Thank You, Federal Reserve
I have written before about SPACs, or blank check companies, and how they are serving as a conduit for the financial flows generated by the Federal Reserve. These blank check companies are rising up everywhere and drawing many famous people, as well as sophisticated finance people, to act as backers of the efforts.
This move into the area of private companies going public is just one of the latest “distortions” created in the Federal Reserve drive to keep the economy liquid. Faced with a shutdown of the economy and an impending recession, the Federal Reserve set about to pump billions... even trillions... of dollars into the U. S. economy and the world economy in order to make sure the financial markets had sufficient liquidity to make it through the early stages of the economic disruptions.
At this particular time, it appears as if Federal Reserve has been successful and has helped the banking system and the financial markets avoid a short-time crisis. But in pumping so much money into the markets, the Fed has created distortions that we may have to live with for some time.
Venture-Backed Tech Companies
As of October 23, almost two-dozen venture-backed companies have agreed to be acquired by these SPACs, or blank check companies. The median age of these companies is around seven years old, and a few of them have little or no revenue. And more of these deals seem to be in the works.
Ms. Chernova writes:
About 165 of the SPACs that went public in 2019 and 2020 and have raised about $53,6 billion are in that camp...”
So, the move is on.
What is changing with this development?
Well, over the past 20 years, venture-backed companies held onto the companies for a longer-period of time and saw them move into a period where they all were generating positive revenues. They were older and had raised other monies and were profitable.
Being further along and generating more profits allowed the venture funds to get a higher price for the companies, but as later results showed, this meant that the ultimate buyers tended to get less “bump” from the companies once they went public.
One of the selling points of the new environment is that they are younger, smaller, and are not generating a lot of revenues. Thus, more of the growth and performance will go to the SPAC.
In the older environment, the companies going public from the VCs
did all the growth with VCs and then they heaved themselves on the public market that didn’t appreciate them….”
So far, the results are good. As Ms. Chernova reports:
As of mid-October, their IPOs had a median first-day stock-price pop of 81 percent, up from 35 percent for such IPOs in 2019.
So, there is a very active market for these young companies in the new environment.
But these companies are young and don’t have a record. More of the companies could fail. And this is where the market distortion comes in. The Fed, by providing more money to the financial markets, can generate a flow of funds that accelerates these companies going public.
However, these companies, in a very uncertain environment, may have a failure rate higher than the investment community might be expecting.
Another Example
We see how other areas of the financial market can also result in distortions from the Fed’s efforts. I have written about this in an earlier post.
Many U. S. companies were not doing that well at the start of the current recession. One thing the Fed actions did for them was to allow them to issue a substantial amount of new debt that helped them to stay afloat for a little longer.
That is, these companies that were already in trouble before the recession began were able - because of the Federal Reserve’s largesse - to issue a bunch of new debt at quite low interest rates and remain alive.
Current estimates point to about 20 percent of U.S. companies being seen as zombies - firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing.
Bottom Line
The two examples given in this post are not the only cases where loose Federal Reserve policy has created market distortions. The takeaway from these examples is something investors need to be aware of and include in their assessment of where and how to invest in today's markets.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
