January 2020 - Market Research & Commentary
The financial markets changed dramatically in the previous decade. The 2010’s saw a consequential trend of “going private”. The number of publicly listed companies in the U.S. has declined precipitously, private equity’s continued popularity and changing markets dynamics have contributed to this decrease. The 2020’s will be the decade where general investors have greater access to the private markets bringing the public and private markets closer together. Digitalization and increased connectivity will change how market participants interact with the private market bringing it more in the public realm, fundamentally changing the way the financial markets operate, again.
The number of public companies today, 3,600, is half the number of public firms in 1997. Part of this trend can be explained by the dot-com bubble and the last financial crisis, which lead to many bankruptcies. After 10 years of economic growth, one would expect some rebound in this trend. Not so, firms are going public at a slower pace and the public market has become dominated by fewer but larger firms.
Chart I
As we know, the U.S. financial markets have not gotten smaller despite fewer publicly listed firms. The largest firms now make up a greater percentage of the total market capitalization than in recent past. For the first time in history there’s a trillion-dollar company, Apple, and Amazon and Google are not far behind. Pending any regulatory changes, we’re likely to see this trend continue.
Chart II
These trends are further supported by a consistent volume of M&A transactions. Under the conditions of fewer, larger and more dominate public firms, consistent M&A activity depresses the number of firms that go public. M&A deal volume has remained steady for the past two decades and our increasingly digital and connected economy has fueled this activity through the ease in which investment opportunities and business ideas can be shared and vetted. Given how steady M&A has been and the decreased number of public firms, private firms are now more than ever an important contributor to attractive investment opportunities.
Chart III
Today’s economy has been molded by a powerful internet, advances in technology and further digitalizing our world. Pausing for a moment, today’s economy would look foreign to a someone from 2000. Increased digitalization has allowed the biggest firms to get bigger through lower operating costs but it also has provided greater access to all types of markets, not just financial, and for all firm sizes, creating the environment for smaller, leaner companies. The massive amounts of data resulting from digitalization is becoming one of the most powerful currencies and it has the power to further change the financial markets. This change necessitates more inclusion into the private markets as everyday investors and institutional investors seek more information about the private market and clearer benchmarks for private investment performance.
Most recently, the SEC proposed new rules that would give more investors access to private security offerings further changing the financial markets and the economy. To date, SEC has restricted the general public from accessing private security offerings based on wealth or income, the accredited investor requirement. As the referenced WSJ article argues, the reason for this limitation was to prevent the general public from being caught up in fraudulent and complicated investments that characterized the 1920’s stock market.
Today conditions are quite different, the role of data, the decreased cost to share information, and the dearth of information mediums has fundamentally changed the financial markets. Its unlikely the U.S. stock market again sees upwards of 7,000 publicly listed firms as firms can more easily grow and access capital while staying private. Thus, private firms can more easily command a dominate market share, provide strong returns to investors and attract substantial interest from potential acquirers.
Take for example, Google and GE, a 21st century powerhouse vs. an industrial stalwart. At GE’s peak in the early 2000’s it employed over 300,000 people on average in a given year. Google by comparison, in 2018 still employed less than 100,000. Yet, Google more rapidly came to be a dominate force in the economy and now boasts a market cap much larger than GE ever reached even at its peak. Public investors were able to participant in Google’s historic rise as it IPO’d when doing so was the natural culmination of a private investment. Today, if fewer firms are going public and if the largest firms are acquiring the next “Google” fewer investors will have access to attractive investments.
If the proposed changes go into effect, private markets will become more competitive and more “public” in nature. Private equity has come under scrutiny in recent years as more participants enter the space and more funds are raised; purchase prices have risen dramatically, and benchmarking returns is inconsistent and uncertain. Permitting a larger pool of investors to participate in private markets will naturally lead to more clarity surrounding investment performance and risk the private markets will become more efficient.
The role of data has never been more hyped or important to our economy. Readily available data dramatically changed the public financial markets and it will do the same to the private markets. Market participants can now more easily than ever share and analyze information. The decreased costs to disseminated company information to shareholders means smaller companies can more easily cater to a larger investor base. As more investors are allowed to participant in the private markets this will lead to an increasingly “public” market for private securities. Ultimately market and capital efficiency will improve helping the U.S. economy grow.