It’s the (Social/Mobile/Cloud) Economy, Stupid (Part 3)
And now for the dramatic conclusion…. In Parts 1 and 2, I outlined how the social/mobile/cloud economic expansion will stimulate job growth, market gains, and consumer spending that will incite a sustained period of broad economic growth. Now let’s look at how it trickles down to bankers, investors, and consumers. (Uh huh, trickles down.)
NASDAQ 5K
“When the ducks are quacking, feed ‘em.”
That’s what my equity capital markets guy used to tell my banking clients during the dotcom boom. (And hey, that’s him above. Hi, Mike.) They’re quacking again. And they’ll be well fed again. And, more importantly, the impact of each deal ignites a cycle that incites the bubble. Here’s how:[[MORE]]
(1) Institutions invest in the IPO and the bankers make their fee.
(2) The IPO pops and the institutions make an instant profit by blowing out their shares.
(3) The newly public company is flush with cash and uses it to hire people, buy equipment and services, and acquire companies (benefiting those who get all that cash).
(4) Institutions quack for the next deal and the next quick profit. And the companies, venture capitalists, and bankers are all too happy to feed them.
(5) Secondaries, mergers and acquisitions, and other transactions add fuel to the fire.
Let’s look at the LinkedIn deal for reference. Whether you agree or not that the deal was well executed (I believe it was), it’s difficult to dispute the positive impact the transaction will have on this cycle. LinkedIn raised over $350 million by selling 7.84 million shares to the public at $45 per share. Assuming a 7% IPO fee, the company still netted well over $300 million and the bankers made about $25 million. (Assuming they exercised the greenshoe over-allotment option, increase those figures by 15%.) On the day of its debut, the stock traded over 30 million shares between $80 and $123 per share; that is, the entire float (all of the publicly tradable shares) turned over almost four times. An institution can’t pass on a gain of 78% (assuming the low of the day) on capital risked for one day so they sold, netting them a profit of over $270 million in aggregate.
While LinkedIn figures out how to spend that money - and injects it back into the economy - the investors quacked for the next deal, which they got, in the form of Pandora, and the bankers and the company will be working on the strategy for the secondary equity offering that occurs six months after the IPO, when the lock-up expires. It will allow for an orderly exit of insiders that could not sell in the initial public offering as well as provide additional capital for the company, likely at a higher valuation than the IPO (for reference, at the time of this post, LNKD was trading at >$100 per share, compared to the $45 IPO price).
But Pandora broke its IPO price several days in, right? Yes, but even Pandora priced almost 15 million shares at $16 per share (up from the original range of $9-11), traded over 42 million shares (excluding the greenshoe) on its opening day between $17 and $26 per share (so the float traded almost three times that day). Assuming the institutions traded out of the stock at the low for the day, they still made around $20 million, the bankers made $16 million (7% of the IPO proceeds, excluding the “shoe”), and the company netted over $200 million to spend, hire, and acquire. Pandora’s aggressive IPO pricing, while maximizing the company’s net IPO proceeds, likely will cause the next companies to price more conservatively to allow a more folks in the chain to benefit from transactions. (For what it’s worth, at the time of this post P was trading at ~$18 per share, still above it’s IPO price.)
LinkedIn, Pandora, Yandex, Zillow, etc. A few isolated transactions. But when we look at IPOs and other transactions that have already happened as well as deals in the pipeline, a somewhat familiar (to some) picture begins to emerge. Here is a quick and dirty look at banking fees and (more importantly) my estimate of investment returns from a few deals this year. I estimate bankers generated around $200 million from a handful of completed IPOs and investors reaped a whopping $850 million in (almost single day) returns. Moreover, there is another $1+ billion in fees waiting to come in and over $3 billion in investment returns.
Yes I’ve made some overly simplifying assumptions in that spreadsheet, but the order of magnitude impact should still be evident. And this is just a handful of names off the top of my head. For every CafePress (and Zazzle) there’s a Spreadshirt… A One King’s Lane and its brethren for the Groupons and LivingSocials… The RockYou’s for the Zyngas… The GetGlue’s, the Mahalo’s, the Secondmarket’s, the Meetup’s, the Blip.tv’s, the Stumbleupon’s, etc. And what about the even less-than-household names? My mother knew about LinkedIn, but she sure as hell never heard of Fusion-io. How many more arms suppliers are there? There are tons more solid, quickly growing, positive cash flow companies in the mix (not to mention the weaker set of companies with less certain futures that could come at lower valuations to account for their greater risk).
This activity has a direct and profound impact on market indices, especially the NASDAQ Composite. About half of the NASDAQ Composite is composed of companies in information technology and because the index is market cap weighted, the top ten (e.g., Microsoft, Apple, Google) of the thousands of companies in the index represent roughly one third of its value. Considering we’ve got some gigantic market cap companies debuting soon (Facebook, Groupon, Zynga, etc.) combined with the onslaught of other new issues in social/mobile/cloud as well as the aforementioned positive impact the move to social/mobile/cloud will have on existing technology (and other) companies, a(nother) monster rally is in the cards. (We’ll explore exactly how the index can attain such lofty levels in another post - hint: its all about the vol.)
Who are these institutions raking in millions on these IPO pops? Mutual funds like Fidelity, American Funds, T. Rowe Price, etc. as well as hedge funds and other private investment partnerships. Collectively, these institutions manage trillions in assets in pension funds and retirement and other accounts of the investing public. Institutional portfolio managers and analysts compete with one another for performance to maximize their own payout. When the guy next door, down the hall, at the other fund, wherever… profits from an allocation in one of these deals, the portfolio manager risks lower returns, redemptions, or worse if he or she is unable to put up comparable numbers. So the chase begins and the cycle continues.
Everybody wins, for now.
The Consumer and The Cycle
We’ve almost come full circle. The confluence of paradigm shifts to social, mobile, and the cloud result in incremental consumer spending as well as incremental corporate hiring and spending. The financial markets provide capital to fuel the cycle and coincidentally grow the public’s capital. Employment has possibly the most significant impact on consumer spending. And it won’t hurt that the investment and retirement accounts of everyday Americans will mushroom, giving the public a greater appetite for risk and leverage (again).
With consumer spending comprising over half of US GDP, the effects on this cycle on the overall macroeconomic environment are clear. They’re real. And they’re spectacular.