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In this week's newsletter: No one wants to go public except Saudi Aramco; stock-trading commissions go to zero; developed countries default on debt; and more. The whole thing is 1,674 words, which will take you about 6 minutes to read.
1 big thing: Going public still sucks
Once upon a time, going public was a fun and joyous thing to do. In the late 1990s, young companies would raise money in an IPO, there would be an enormous first-day pop, everybody would start talking about you, and the combination of new money and free PR would turbocharge your business.
- Today, it's hard to find anybody who's happy with way that companies transition from being private to being public. Even the institutional clients of the large investment banks, who can get significant allocations of coveted IPOs, are feeling the pain. Companies like Uber and Peloton have never traded above their IPO price.
Driving the news: Venture capitalists are so unhappy with IPOs that they spent Tuesday at a high-level conference devoted to direct listings (a slightly different way of going public, that doesn't involve raising money).
- But direct listings solve none of the problems of being a public company — not just Sarbanes-Oxley compliance and other bureaucratic overheads, but, more deeply, the feeling that you're constantly trying to do your work with second-guessers peering over your shoulder who could seize the company at any time.
- The highest-profile direct listing to date, Slack, has traded miserably as a public company. Early trades were above $40 per share, but now it's trading at about $23.
- Once you're public, everybody starts to judge you by your share price, over which you have very little control. Private companies can refuse to sell stock at a level lower than they think it's worth, but public companies have no such power to dictate valuations.
Being public is so miserable that people like the Chang family, who founded retailer Forever 21, refused to raise equity capital.
- When they expanded using only debt instead, they found themselves overlevered and were forced this week to file for bankruptcy protection. It's not clear that bankruptcy is worse for them than the specter of quarterly earnings reports and activist shareholders.
The bottom line: In 2012, I wrote a feature for Wired about "why going public sucks," and suggested that maybe the answer might lie in companies staying private instead, orchestrating deals on their own terms to provide liquidity to investors and employees who need it.
- That never really happened. The market leader in terms of matching buyers and sellers of private-company stock was SecondMarket. They ended up being bought by Nasdaq, which obviously has an interest in maximizing the number of IPOs.
- If you have employees and investors who own stock, then they need to be able to sell that stock at some point. So far, no one's come up with a good long-term way of allowing them to (a) sell their equity, while (b) managing to avoid the public markets altogether.
2. What they're saying
Now that WeWork has pulled its IPO, the equity primary markets seem sure to end this year with a whimper.
- It's far from clear when the IPO market can really recover, especially for anybody outside the biotechnology sector. (And even biotechs are pulling their IPOs right now.)
What they're saying:
"I like to recite Prufrock internally while we check we're GAAP compliant, but feel free to use whatever method you prefer to numb the pain."— Frank Vernon, "Succession" character, in S2E6
"Uber started the decline and WeWork has massively increased the momentum. It’s like we’ve had this cocaine-fueled party at Studio 54. Uber was the lights starting to go on, and now they’ve gone on so bright it’s like you’re in an operating room. Endeavor couldn’t get out. Basically, these guys have totally shit in the IPO pond."— NYU's Scott Galloway to NY Magazine
Bonus: A miserable quarter for IPOs
The S&P 500 was flat in the third quarter. The stocks in the Renaissance IPO index, on the other hand, were not.
3. Beware investing in autocracies
One company that's still desperate to go public is Aramco, Saudi Arabia's state-owned oil company. (Hence the long list of financiers willing to return to the country's "Davos in the Desert" conference later this month.)
- The big problem with Aramco is not so much that it's being hit by drone strikes, or that oil prices are unhelpfully low. Rather, it's that it's owned by the Saudi state, which is to say, the Saudi royal family.
Driving the news: Aramco promised this week that it would set a dividend of at least $75 billion through 2024 — or, at the very least, that non-government shareholders would receive at least $750 million in dividends for every 1% of the company that they own, from 2020 through 2024.
Why it matters: Because the Saudi royal family controls Aramco, it doesn't need the company to pay any dividends at all.
- If they need to extract money from Aramco, they can always raise the company's tax rate, or simply expropriate what they need.
- Foreign shareholders could be stuck with worthless shares paying zero dividends.
Between the lines: In many ways the Aramco situation is similar to that of Fannie Mae and Freddie Mac. The U.S. government controls the agencies and their profits. Private shareholders, who own 20% of the equity in the companies, have received nothing from them for over a decade.
- If the U.S. government allowed Fannie and Freddie to start paying a dividend, shares would rise. But so long as the government holds the reins, shareholders know that their cashflows can always revert to zero at any time.
- The bull case for Aramco shares is that the Saudi government wants to see a multitrillion-dollar valuation for the company. If that fact ever changes, then it's hard to see foreign shareholders being able to extract much value.
Why you’ll hear about this again: Investing in autocracies is part of modern capitalism. In China, for instance, PayPal is buying Gopay, a local payments provider.
- It's easy to see why PayPal wants exposure to the massive Chinese market — but at the same time the company knows there's always a risk of the government turning against it and nullifying the deal.
- If that happens, PayPal has no real recourse. (It's not going to sue the Chinese government in Chinese courts.)
The bottom line: In countries with robust civil societies, shareholders have significant legally enforceable rights, and those rights underpin the value of their shares. In countries like China and Saudi Arabia, by contrast, foreign shareholders only win insofar as it behooves the local government to keep them happy.
File under "what took you so long": All the major discount brokerage houses are now charging $0 for stock commissions, following the lead set by the Robinhood app in 2014.
Zero dollars is the most obvious and logical price for stock commissions, as Matt Levine explained in April in a Bloomberg Opinion piece.
- Brokers have various different ways they can make money, including things like repo operations, payment for order flow, and execution quality. (Biggest of all is the net interest income they earn on the cash in brokerage accounts.)
- Most of these profit centers are largely invisible to consumers, while stock commissions are highly salient. So it makes sense to bring commissions down to zero for competitive reasons, and to make money elsewhere.
The upside: All of the brokerages saw their share prices fall on Tuesday, in an indication that Wall Street believes they will be making less money as a result of this move. If the brokers are making less, that's good news for their customers.
The downside: If commissions are set at zero, that makes the companies' business models more opaque. It also encourages customers to make more trades, since there's no obvious cost to doing so. Of course, the more you trade, the less well you will likely perform.
The bottom line: Brokerages' interests have never been aligned with those of their customers. Zero commissions are surely good for consumers, but the hefty commissions of yesteryear did help to discourage day trading and similarly dangerous activities.
5. Developed countries default
Countries defaulting on their debts have caused enormous problems for the international financial system since the Latin American debt crisis of the mid-1980s. But until this decade, the world's developed countries always found themselves as the creditors, not the debtors.
- Greece changed that in 2012, when it became the biggest deadbeat sovereign of all time.
What's new: The world's most comprehensive database of sovereign defaults, run by the Bank of England and the Bank of Canada, has been updated for 2018, and once again advanced economies are driving the numbers.
- Not only was Puerto Rico in default to the tune of $50 billion, but Greece also defaulted on $111 billion owed to the EU. (The European Stability Mechanism allowed Greece to push back its debt service payments and reduce the interest rate it was paying, which counts as a debt default for the purposes of the database.)
- The other big debtors in 2018: Venezuela with $64 billion of debt in default and Iraq with $41 billion.
The big picture: As countries struggle with growing debt burdens, sovereign debt problems will become increasingly common.
- Argentina looks certain to default again; Venezuela has lost control of Citgo, its most valuable asset; even Portugal was added to the database in 2013 thanks to another EU restructuring.
- Conceivably, even the U.S. could find itself in default if congressional gridlock prevented the debt ceiling from being raised.
- Puerto Rico might emerge from default in the coming months, albeit with a huge remaining debt burden. As we've seen with Greece and Argentina, once you've defaulted once, that often makes it more likely that you're going to default again.
6. Coming up: The September jobs report
Tomorrow’s jobs report is expected to show a gain of 145,000 jobs in September. Unemployment is expected to hold at 3.7% — a near 50-year low, writes Axios' Courtenay Brown.
Why it matters: A terrible manufacturing report this week renewed recession fears. Those fears will be exacerbated on Friday if the jobs report misses expectations and comes in below about 100,000. On the other hand, a big miss would almost certainly lock in a 3rd interest rate cut later this month.
7. Building of the week: The Sudak Fortress
Byzantine Emperor Justinian I built the first fortress in Sudak, Crimea, in the 6th century. Various other fortifications were added over the following 1,000 years, as Sudak became a major international trade center.
- The bulk of the construction took place between 1365 and 1475, when the city was under the control of the Italian city republic of Genoa.
- Russian troops invaded in 1771; Crimea remained part of the Russian empire until the collapse of the Soviet Union in 1991. Russia again invaded the peninsula in 2014; it is currently claimed by both Russia and Ukraine.