Talk Your Book: Why Aren't There More IPOs?

0:00Ben Carlson:Today's Animal Spirits Talk Your Book is brought to you by VanEck. Go to VanEck.com to learn more about how they can help you access private markets. That's VanEck.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:40Ben Carlson:Welcome to Animal Spirits with Michael and Ben. Michael, I love a good straight shooter. On today's show, we have one. We talked to Krish Manafa. He's the head of private growth strategies at VanEck. And he enlightened us with some information today that was new to us. because there's not a lot of data with as far as private markets go. Not nearly as much as public markets, obviously. And I think it's fair to say now that the 2021-2022 period is maybe one of the crazier periods ever for late-stage growth companies. Yes. In terms of pricing, things got just absolutely insane, right? It's like the hangover scene the next day where everyone's walking through the hotel room and there's beer bottles everywhere and there's a tiger in the bathroom and everyone kind of wakes up and goes, what happened?

1:21Michael Batnick:Who was I talking to about this? Probably Josh, I can't remember. the context of the conversation, but oh, it was actually on TKF. A comment was made about valuations back then, and I said, listen, I get it, not to absolve everybody. Oh, maybe it was you and I of their duties as an investor, but we were all a little bit drunk.

1:39Ben Carlson:Yes. It was an exciting time, and yeah, you're right. There was tons of new and obviously no one saw AI coming, which was kind of the next thing, so you're right. It's not everyone that's absolve there, but there was, there's just so much money sloshing around. Right. And that was, yeah, it was, it was a different period and maybe one that we'll never see again, but Christian kind of set us straight and told us like why there's a, I mean, I guess if you have a private investment on your, on your books and you don't have good see-through that there hasn't been a round in a while with the pricing, you should probably give it a haircut.

2:15Yeah.

2:16Ben Carlson:Not a Ben Carlson haircut, a Michael Badnik haircut. There we go.

2:18Michael Batnick:All the way to the skin. But think about 2020, 2021, everybody was at home all day, every day. Hop on a Zoom, hop on a Zoom, hop on a Zoom.

2:26Ben Carlson:Well, and think about the growth in business startups then to people like the ideas. And it was an exciting time. Funded, funded, funded. Yes. You and I had a lot of conversations with people who was just like, I have an idea. I don't have a business model, but I have an idea. People are throwing money at me. You can't blame people for taking that money. And yeah, there's a lot of money sloshing around. So we kind of did a state of the private markets with Christian in terms of of IPOs and AI companies and what it means for private markets and why there haven't been more IPOs. So this was a really fascinating conversation.

2:55So as I'm concerned, the fact that he said there's 1 ,000, this is the stat of the show, 1 ,000 unicorns essentially.

3:02Ben Carlson:And just six of them have had a down round in the last, what did you say, 12 months or something? So these things are just not, these companies got so much money and they don't have to reprice. But you can make the assumption most of their valuations are way, way too high. Interesting stuff. But it's not going to be a car crash. It's going to be what? A flat tire that catches up with you five miles down the road. Sorry, I'm reaching out to my analogy there. Anyway, here's our talk with Christian from VinEk.

3:29Michael Batnick:Christian, welcome back. It's great to be with you guys. Last week, I was talking with Josh about Airbnb and the stock is doing quite well. It's at about the highest level it's been at since it came public. And we were talking about the the business and the underlying fundamentals and what's changed. And one of the big stories or the primary story, as far as I'm concerned, high level with Airbnb is the starting valuation. It came public in 2021 during a very different environment, trading at whatever, 70 times sales, I don't even know what it was. Company was unprofitable and the market cap just didn't make any sense.

4:07Michael Batnick:And Chesky and team have been operating and it just, you know, it took time, took five or six years to grow into that valuation. The market in 2026 looks a lot different than 2021, but we are still dealing with some of the bad decisions, some of the sloppy investor behavioral decisions that were made back then. Where do you see the growth equity environment today? Yeah, I mean, it's a spot on question. We talk about a lot here. I think, as you said, back in 21, you had just these absolutely incredible valuation runs without, without, in many cases, the underlying operating metrics to support them.

4:45I think now you have this environment where you have companies that used to take maybe eight to 10 years to hit 100 million in revenue. They're hitting it in 12 to 18 months, right? In some cases, you have companies hitting a billion revenue inside of a couple years, which is just incredible. So I think to your point, there's definitely a dynamic when you have all these valuations running in private markets where some companies are going to take longer to grow into them, once they go public. And I think in our market, you have a situation where there's more concentration of value, more concentration of capital, concentrating in fewer and fewer numbers.

5:21So back in 21, I think you had this ubiquitous run-up just across all these innovation themes. I think now you're seeing some of that in our world in private markets, but more and more of it is being driven by fewer and fewer companies. So I think that's what we're seeing now. And in some cases, I think, frankly, the valuations have gotten ahead of themselves. And in other cases, it's actually warranted.

5:44Ben Carlson:Is it harder to stay disciplined in this environment? Because there's just so much more money in private markets now, where it's like, hey, you talk about these concentrated deals, it's like, take it or leave it. You know, everyone else wants to throw their money in here too. So how hard is it to be disciplined in a market like this? Because it seems like that was kind of what was going on in 21 and 22, is that there was so much money sloshing around, people were given these really high valuations just because people were throwing money at them. Yeah. I think in this time around, there's more money but going to fewer companies.

6:15And so if we focus on the fewer companies that are getting the money, you're right. Some of these valuations are like really hard to swallow. Like one of the biggest things we're facing right now, you know, we've stepped back and look at the major themes, right? Major themes that we think about them. On one side, you have AI touching everything, like software, hardware, physical. On the other side, you have the whole re-industrialization of the economy, whether it be space, defense, advanced manufacturing, energy. One of the biggest things that we're seeing is companies being awarded valuations without actually having demonstrated the ability that they can produce products at scale.

6:53So you have companies in the defense space, for instance, in certain areas that are generating all sorts of capabilities, autonomous systems, and are getting valuations that essentially give them credit for executing on a rollout of multiple product lines. I think for us, that's the biggest thing that we're getting concerned about and where we're pausing. Other investors are not. And I think to some extent, the TAM is so large that you're giving them credit because maybe they're good seasoned operators and you say, hey, they did this before, they're going to do it again. And so you can kind of get behind why people are doing it.

7:27Frankly, we're trying to avoid that. And then there's different tactics you can use, like buy secondaries, maybe at like better pricing to offset some of that valuation froth. But you're absolutely right. It is hard to be disciplined.

7:40Michael Batnick:2000, I guess, post-GFC through pre-COVID was a really nice glide path for private markets. There was a lot of money subsidizing a lot of really interesting companies that ultimately transformed the world and returned a great amount of money to the investors at every stage. And that environment is now over. We're in this weird place where you mentioned companies are getting to a billion dollars faster than ever. And it's obviously very exciting to have growth rates like this, which poses another problem. investing during disruptive times and disruptive technologies, who the hell knows where this is going, and companies that can get to a billion dollars overnight or seemingly overnight, are they at risk of disruption?

8:26Michael Batnick:Because holy cow, look what they did. And now there's a million other copycats. Yeah, Michael. So we have a saying, if it goes up like a rocket, it could fall like a bomb, right? So a lot of these companies, it's questionable what the durability and shelf life is of these businesses, right? There's no moat in many situations. In some instances, in hardware in particular, like capital almost becomes the moat. So your ability to out-raise the cohort that you're competing against in some instances becomes a bit of a moat. But if I could just step back a little bit, because you're right, like 0 % interest rates, right, for 10 years, in some instances, seems like it was great.

9:09The reality is, as you point out, on one hand, that led to everything getting funded, good and bad ideas. Frankly, we've been seeing that in the past several years as well. It's starting to tighten up a little bit. But if you actually look at the data, there's still a tremendous amount of unrealized value locked up from those ZERP-oriented capital deployment vintages that investors have not received, right? There's one of the lowest kind of distribution cycles over the past kind of five, six, seven years that we've seen in a very long time. And just because SpaceX goes public and maybe an Anthropic or an OpenAI goes public, it's not going to change that overnight, right?

9:53More and more of the exit value that you're reading about is in fewer and fewer names. The story that's not being told is there is a tremendous amount of unlocked value that's continuing to sit out there. And frankly, and this isn't meant to be Mr. Doom, but there's going to be a lot of capital destruction from that era, from companies that have been rendered obsolete and that, frankly, have not pivoted enough and don't have an ability to raise more capital to sustain themselves. So you're absolutely right. The low interest rate cycle definitely led to some good outcomes. The ending of the story is not yet written.

10:33I have a fairly good sense, I think, of where it's going for a lot of the market, and it's concerning.

10:37Michael Batnick:Christian, it's funny you mentioned this. I was looking at a report from PitchBook this morning, private equity zombie problem. And they say of the 13 ,509 PE-backed companies currently in US-sponsored portfolios, 33.8 % of the total universe have been held for more than five years. And 2 ,536 of, again, that 13 ,509 have exceeded the traditional exit window. So GPs are sitting on more than$860 billion in buyout NAV across funds that are more than seven years old. And the problem, as we discussed earlier, not surprisingly, the problem is most acute among the 2018, 2022 vintages. So what does this zombie problem, how does this ripple across the rest of the pond, the investable landscape?

11:29The other aspect of that on the buyout side, Michael, is those companies are all levered, right? So you've got a leverage problem on top of the duration issue for the equity investors, you have a leverage problem. And an interest rate problem. And an interest rate problem, right? When you look into the buyout assets, I mean, the world we focus on kind of the later stage venture growth, these companies typically don't have leverage, they don't deserve it. They're not often like printing cash or dividends, right? They're just investing into growth. And I'll give you one other stat that's kind of similar to that, which also comes from PitchBook recently.

12:00We're having a debate internally here. Maybe this is all assets as like a trivia question for you guys. So there's roughly like 1 ,000 reported of these unicorns in like the venture growth landscape, 1 ,000 of them. Some other publications say there's more than that. Let's just say it's 1 ,000, okay? How many of those do you think have reported down rounds in the past 12 months? Because we hear a lot about up rounds. How many of them have actually reported down rounds, would you guys say, of the 1 ,000?

12:32Ben Carlson:That'll be a small number. I would guess a small number. No, I was going to guess 30%, 300. Six companies. Yeah, because they don't want to yet, right? Yeah, that's what I was thinking, that people, that those down rounds are, that's kind of where you're going here, right? Is that, I told this to Mike about a month ago, I said, like, it just seems like the reason these companies aren't going public is because they don't want to admit that they're overvalued, right? I mean, that's kind of what you're getting at, right? It's a huge issue, right? So these companies are going to make the runway last as long as they possibly can until they have to reprice themselves.

13:04Now, you can, on one hand, say some of them may be profitable. Okay, great. If you're profitable, you don't need to raise money. God bless you. The reality is most of these companies, shocker, are not yet profitable. So they're using the runway and extending it as long as they can until they have to reprice, until they get bought on the cheap, or until they go away. And this is a follow on trivia question. So how many of these companies, the 1000 companies, right? What percentage of those would you say, have not priced a new round in the last two to three years?

13:44Michael Batnick:I'm afraid to answer. 80 %? Yeah, 80. Sounds good. About half. Wow. So about half of those companies, you're talking about probably low trillions in market cap of arguably stale market cap value. And Christian, these are the companies that we're raising every six months. They were.

14:02Ben Carlson:They're not now, right? But to your point, they raised enough money where they have this runway. And to Michael's earlier question, a lot of these companies have probably been disrupted in many ways. A thousand percent.

14:14Michael Batnick:How many of them are software? Let me ask you that, Christian. What percent of the number of software? A lot. I can come back to you with the stat. The answer is a lot. This is not me being like Dr. Doom. This is just saying that you're looking at these numbers, right? I've lived in this world the past 25 years. The reality is it's not all sunshine and rainbows, right? Everything's not SpaceX or Anthropic. So like we have to step back and say there's going to be some incredible wins, right? There's going to be some incredible success stories. You have companies raising three, four rounds in a 12 to 18 month period, each one successively larger than the next one.

14:48But the frequency of that across the book is smaller. So there's more concentration of value and more capital flowing to fewer managers and to fewer assets. So the question is, what happens to the rest of them?

15:02Michael Batnick:Well, let me ask you this. You know what's great about this model? I think investors mentally understand that the 20, 21 vintages are terrible. and maybe they see AI as their get out of jail free card. And they think that the 24, 25, 26 vintages will be better. And by the time these numbers really show up as actual cash returned or lack of cash returned to investors, all right. I mean, it's nine years ago, right? So these numbers will show themselves actually mark, they will mark the market in 2029. Who cares? It's so old. What do you think about that? So one, you're right. However, if you factor in that the exit activity for the past 10 years has been pretty low, you have a situation where you have investors that are already quite overweight in liquid assets.

15:54And unless you can see a path to liquefying that through increased frequency of M &A or IPOs, a lot of these institutional investors are tapped out. Now, why is everyone spending time focusing on the RIA and wealth channel? Because there's a new channel of capital to access that doesn't have a lot of that legacy overhang of these in some situations, right? Like zombie capital. And so I think that's one, a good thing because the ecosystem can continue to access capital. We have to be careful for all the reasons that we're talking about. But unlike the past, I would say it's not as easy as to say we're going to kind of keep raising and by the time this catches up, we're on two, three funds from now.

16:38I think there's a problem. There's an unrealized problem that increasingly needs to be solved, especially for your more institutional grade investor.

16:48Ben Carlson:So they're going to have a much harder time fundraising because you're right. Hey, we did fund three a couple of years ago. It's time for fund four. Either pony up or you're not going to be included anymore. But a lot of allocators are probably saying, no, we're going to wait. We're still, you still haven't called much capital. So what, does that just mean that fewer deals going forward? Or what's the outcome here? So one word, secondaries. So I've been in secondary since the early 2000s. And back then there was probably like five, six billion of annual deal volume. And everything was just playing musical chairs with LP stakes, right?

17:23Like an endowment needs to sell their LP stake for this, whatever. It was just this very kind of uniform market focused on LP interests. And the last 20 years, you've seen this evolution where now annual deal volume this year will probably be a quarter trillion at least. And at least half of that is going to involve everything but LP stakes. So basically, these GP leads you hear about, we were working on them 20 years ago before we had names for them. So like fund recapitalizations, winding down funds, strip transactions to manufacture liquidity for the GP ahead of exits so they can get capital back to the LPs to recycle.

18:01Ben Carlson:What kind of discounts are you thinking here? It depends on, one, the asset class, and two, the underlying fund and manager, frankly. Like, the better managers are always going to warrant a higher return. And then in venture, historically, you'll see, like, bigger discounts. Usually, like, in a normal environment, you'll see, like, I don't know, 10 % to 30 % discounts in venture, maybe like single digits to 15 % in buyout and probably similar with real assets. In periods of disruption, right? So think of like 22 to 24, 25, when you've got 11 consecutive interest rates just knocking a big kind of hit to the private markets, those discount ranges at least double.

18:45But the higher quality managers and the higher quality assets, even in those market cycles can actually defend better pricing. And this is what I keep saying. There's more capital flowing to the perceived winners, whether you're a fund manager or whether you're an underlaw operating company. But secondaries in general, whether it's fund-level solutions or asset-level solutions, tender offers, helping employees achieve liquidity, getting early investors liquidity, secondaries is going to be a major release valve for all of this unlocked, unrealized NEV that's creating problems?

19:19Michael Batnick:I think private equity, primary fundraising will have a problem with the wealth channel. I think secondaries and private credit make a lot of sense. Secondaries is a very easy story to understand. Private credit is, all right, income floating rate, no duration, right? People like that. But private equity, all right, I'm going to lock my money up for 8 to 10 years. Maybe I'll beat the S &P by 2 % to 3%, maybe, if they're really good a little bit more. I don't know. That doesn't sound that attractive to me, especially when advisors and clients are looking in the rearview mirror. Not saying that that's right, but the reality is we've gotten 14 % for the last decade.