May 5, 2019

The degraded stock market

Illustration: Sarah Grillo/Axios

The stock market is getting worse at an accelerating pace, as is demonstrated by this week's Chewy filing.

Background: Chewy is the of the current decade, except it's even frothier. Chewy lost more money last year than did over its entire lifetime, and it's worth 10 times more than ever was. Chewy is also being taken public by its current owner, PetSmart, which is struggling with the debt it took on to buy Chewy in 2017.

Be smart: The problem with the Chewy IPO filing is not that the valuation is high. Rather, it's that PetSmart's private-equity owners, primarily BC Partners, have decided that they're going to retain control of Chewy by giving their shares 10 times the voting rights of the shares being sold in the IPO.

  • Dual-class stock structures are popular to the point of ubiquity among the current crop of unicorns going public. Spotify, Lyft, Pinterest, Slack — all of them have given their founder-CEOs super-voting shares, just as Google and Facebook did before them. (The big exception, Uber, is going public with a single class of shares, entirely because its CEO is not its founder.)

It wasn't meant to be this way. In 2017, S&P Dow Jones Indices announced that no new companies would be admitted to the S&P 500 if they had a dual-class share structure. S&P 500 index funds are the best and most loyal long-term shareholders that any company can ever hope to have, and the hope was that the new rule would persuade companies to have just a single class of stock: one share, one vote.

  • The plan didn't work. Now, we're entering the worst of both worlds — one where a whole slew of multibillion-dollar companies are neither democratic nor included in the benchmark that almost every fund manager uses for the U.S. market.
  • The Chewy IPO is arguably the worst yet, because this decision is not about the founder retaining control. The founding CEO, Ryan Cohen, left the company after the sale to PetSmart, and he no longer owns any shares in Chewy. Rather than placing control in the hands of a product visionary, Chewy's structure places control in the hands of litigious financial engineers who are looking to exit with their own maximum profit.

Details: Chewy's own bankers are warning potential shareholders in its IPO prospectus that they might end up shortchanged.

  • In legalese: "The ability of PetSmart to privately sell its shares of our common stock, with no requirement for a concurrent offer to be made to acquire all of the shares of our Class A common stock that will be publicly traded hereafter, could prevent you from realizing any change-of-control premium on your shares."
  • Translated: PetSmart might be able to sell its controlling stake in Chewy at a premium, with public shareholders having no tag-along rights to sell at the same price.

The big picture: Since the passage of the Exchange Act of 1934, the public stock market has been supposed to be a level playing field. But as Judge Jed Rakoff recently ruled, "Anyone who thinks that the stock market is a level playing field obviously has no contact with reality." The balance of power lies with the private companies going public, who feel free to set whatever terms they like, no matter how much they tip the scales in favor of a select few. The fractured and greedy public stock exchanges seem powerless to stop them.

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