May 5, 2019

Axios Capital

By Felix Salmon
Felix Salmon

Happy Uber IPO week! Do keep the requests coming. I'm at felix@axios.com. And thanks for reading!

1 big thing: 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 Pets.com of the current decade, except it's even frothier. Chewy lost more money last year than Pets.com did over its entire lifetime, and it's worth 10 times more than Pets.com 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.

2. Experience equity

Illustration: Aïda Amer/Axios

Eventbrite was one of the hottest IPOs of 2018. After pricing at $23, it closed up 60% at $36.50, giving the ticketing company a valuation of $2.8 billion. Today, just over 6 months later, the stock is languishing below its IPO price, at $18.41, and well over a billion dollars' worth of market value has evaporated.

  • Eventbrite was sold as a way to bet on a booming "experience economy." The intuition: Companies that can deliver real-life experiences have real value in a world increasingly intermediated by smartphone screens. The problem: Companies are having difficulty turning that intuition into stable profits.
  • SoulCycle never even made it to IPO. Another hot experience-economy company, it filed to go public in 2015, but then never did, eventually giving up on the idea last year.
  • Next up: Peloton, which reportedly plans to go public later this year. Peloton is a large part of the reason why S0ulCycle never made it to IPO: It offers a similar product, but with more convenience, and it can credibly claim to be a media/tech company rather than a gussied-up gym class. Still, it has the same reliance on a core group of ultra-loyal repeat customers. Which raises the question: In the experience economy, how much do people want the same experience, over and over again?

The experience economy itself is not new. Travel and tourism are huge, and have been around for millennia. And Disney, in particular, has perfected the art of selling its theme-park and cruise-ship experiences. Even its theatrical movie releases ("Avengers: Endgame" has now grossed $2.2 billion at the global box office, after just 2 weekends) are built on shared real-world experiences. Disney, however, constantly reinvents itself. Replicating Disney's success is almost impossible, especially if you lack billions of dollars to buy franchises like Marvel, Pixar and Lucasfilm.

  • The NYT Magazine asks, this week: "Can an art collective become the Disney of the experience economy?" Rachel Monroe tells the story of Meow Wolf — a scrappy art collective from Santa Fe that seems to be on its way to becoming the next Cirque du Soleil. But ultimately it's Disney itself that is, and always will be, the Disney of the experience economy. Notable: Meow Wolf's CEO tells Monroe that Disneyland is his "single favorite place in the world."

Be smart: We know that software as a service works extremely well. But experience as a service? It's no coincidence that Meow Wolf's installations are mostly in tourist towns like Santa Fe and Las Vegas. The toughest nut to crack in the experience economy is finding a large group of people who want to pay to repeat their experience. SoulCycle and Peloton are counting on social dynamics to help them get there, but that, so far, is an unproven model in financial markets.

3. Public markets take center stage

Illustration: Lazaro Gamio/Axios

Uber. WeWork. SoftBank. Even Tesla. After a decade in which private markets have overwhelmingly funded the most innovative and dynamic companies in the world, public markets are having their day, and showing what they're capable of.

  • Uber will go public this week in the most feverishly anticipated IPO since Facebook. (Let's hope it goes better than that fiasco.) It's probably going to end up raising somewhere in the region of $9 billion. To put that in context: The company has raised about $20 billion to date and is currently sitting on about $6.4 billion in cash. So while the public markets are providing a lot of capital, they're still providing less than private investors have done over the years.
  • WeWork burned through more cash than Uber did last year; it too is going public, in an attempt to keep finding fuel for its cash fire. The news was music to bondholders' ears: The benchmark 2025 bond, which had a yield of more than 11% in January, now trades above par and yields just 8%. Debt investors believe, it seems, that a large cushion of public equity might be able to protect them should WeWork run into financial trouble.
  • Tesla is raising money in the stock market too — as much as $2.7 billion in total, between fresh equity and an equity-linked bond. The move is a retreat for CEO Elon Musk, who had previously been adamant that he would raise no fresh equity and who was cutting costs aggressively in an attempt to avoid such dilution. Shareholders don't share his aversion to fresh capital raises: Tesla's stock price rose on the news.
  • Even SoftBank is reportedly considering an IPO of its $100 billion Vision Fund. The move would be legally dubious, at least in the U.S., but I'm sure that if he's serious, CEO Masayoshi Son will be able to find a stock market happy to accept the listing — and that there would be no shortage of investors willing to buy shares in the fund, at the right price.

The big picture: Buybacks have already reached $272 billion this year and are on track to exceed $1 trillion for the second year running. That's a lot of cash going into investors' pockets, and most of it is going to get reinvested in the market somehow. It stands to reason that liquidity-constrained companies would want to access that source of funds, possibly on a repeated basis. If Tesla can do secondary offerings, there's no reason why Uber or WeWork shouldn't be able to do so as well.

4. The Goldilocks economy
Expand chart
Data: Federal Reserve Bank of St. Louis; Note: Chart shows Fed’s preferred measure of inflation, core PCE; Chart: Andrew Witherspoon/Axios

Axios' Courtenay Brown writes: Unemployment in the U.S. is now at 3.6%, the lowest level since December 1969.

By the numbers:

  • The economy has added jobs for 103 consecutive months. There has never been an economic cycle with a longer stretch of job growth.
  • Wages have grown at nearly the fastest pace since 2009 for 9 straight months.

The big picture: Both unemployment and inflation are at multiyear lows. In theory, companies should be offsetting higher wages by raising prices for consumers, ultimately causing inflation. But this hasn’t happened.

The bottom line: The Federal Reserve has two jobs: maximize employment and keep inflation at or near 2%. It’s doing a great job on the employment front, but inflation remains stubbornly below the Fed's target rate.

5. No Moore, Cain

Illustration: Lazaro Gamio/Axios

Stephen Moore has now followed Herman Cain in announcing that he doesn't want to be nominated to the Fed board after all. (Moore’s decision came, awkwardly, just minutes after the WSJ sent out a news alert quoting him saying that he was “all in.”)

  • Both Moore and Cain were unqualified for the job: Their monetary views are incoherent and their political partisanship would not fit in well at an institution that takes pride in its independence. But it's not obvious that their lack of qualifications was the reason that they were forced to withdraw from the process.
  • Moore is complaining that "gutter campaign tactics and personal assaults" are responsible for his failure to get onto the Fed board. The same can be said of Cain, who faced multiple claims of sexual assault and harassment.

Why it matters: If Moore is correct, then an equally political nominee with less personal baggage might get through the Senate and be confirmed to the Fed board. Sexist attitudes have no place at the Fed, but neither do partisan attempts to cut rates whenever a Republican is president and raise them whenever a Democrat is in the White House.

6. Milken's diversity problem

Six white men discuss "Common Sense from Uncommon Investors" at this year's Milken Global Conference. Photo: Michael Kovac / Getty

One of the more dubious values in the experience economy is a $15,000 ticket to the Milken Global Conference in Beverly Hills.

Milken went to great lengths this year to tout diversity at its 22nd annual conference, writes Courtenay, but it's still very male and white.

By the numbers: A Milken spokesperson tells Axios that 250 out of its 800 speakers were women, which the conference believes is an improvement over last year, but can't say for sure. They can't say how many speakers were people of color, as they don’t track ethnicity.

  • Only 20% of speakers on the main stage were women, not counting the moderators. Mike Milken himself moderated 10 panels, which between them featured 32 men and 7 women.
  • The lack of women was felt walking around the conference, as many others pointed out.
  • I went to 10 panels over the course of 3 days. Just 3 panelists were black, and more often than not, I was the only person of color in the room.
  • None of the main stage panels, and very few panels generally, were majority women.

One panel, "The Hedge-Fund Shakeout," had four men and one woman debating how to stand out in an environment that's shrinking and underperforming. Missing from the conversation was the lack of diversity at hedge funds, even though the few female-run hedge funds out there have outperformed the rest of the industry.

Why it matters: This is not a problem unique to Milken. This week's Sohn conference, for instance, has 4 women and 17 men speaking. The majority of speakers are white.

7. Fund management fees plunge
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Data: Morningstar Direct, Morningstar Research; Chart: Axios Visuals

U.S. investors hit a major milestone in 2018: In aggregate, they now pay less than $5 in annual fees for every $1,000 they have invested in ETFs and mutual funds. The 6% decline in fees last year was the second-largest since 2000, and there's every indication that the downward trend will continue.

Why it matters: Investors have learned the value of low fees: $605 billion flowed into the cheapest 20% of funds last year, per Morningstar, while $478 billion flowed out of the most expensive 80%. Expect the growth of passive funds to continue, and expect continued price competition within passive funds as well.

By the numbers: Vanguard is still by far the market leader on fees, with an asset-weighted expense ratio of just 0.09%. State Street is second, on 0.17%, and BlackRock is third, on 0.30%.

8. The week ahead: An era-defining IPO

Illustration: Rebecca Zisser/Axios

Uber is expected to price its shares on Thursday and begin trading on the New York Stock Exchange on Friday, writes Courtenay. Founder Travis Kalanick may or may not be there to celebrate.

  • Rival Lyft, whose shares are 40% below where they opened on IPO day, will report quarterly results for the first time as a public company on Tuesday.

Google will hold its annual developer conference on Tuesday, where it’s expected to announce new Pixel phones.

Chinese Vice Premier Liu He — along with a 100+ person delegation — will be in Washington on Wednesday, per the Washington Post, for another round of trade talks. Sources told CNBC that a trade deal could possibly come as soon as Friday, a day after the latest numbers on the U.S. trade deficit are released.

9. Building of the week: The Museumotel Raon-l'Etape

Photo: JEAN-CHRISTOPHE VERHAEGEN/AFP/Getty Images

Swiss architect Pascal Hausermann built the Hotel Thierry just outside Raon-l'Etape, France, in 1966, using a brand-new technique of pouring concrete to create "bubbles."

  • The 11 buildings fell into disrepair after the property was sold in 1980, but they were lovingly refurbished in the mid-2000s. Sadly, the new project, dubbed the "Museumotel," collapsed under the weight of its own debt.
  • The property was auctioned off on Friday for a mere €120,000 ($135,000). That's quite a significant discount to the reported $450 million asking price for Pierre Cardin's pink bubble house, 400 miles south in Cannes.
Felix Salmon

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