This week Chamath Palihapitiya announced that he has 3 more SPACs set up and ready to go. These SPACs are vehicles to enable a company to go public, and get cash, without an IPO. Instead of gifting cash to the friends of Morgan Stanley this method gifts cash to Chamath and his friends.
A Week of IPOs with $ billions raised.
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That Was The Week, #37
It is a popular sport, especially outside of Silicon Valley, to poke fun at the valuations investors attribute to both private and public companies. This week gave the critics a wonderful opportunity to double down on the humor.
But before we get into that I want to strongly suggest you read the piece by Tomasz Tunguz of Redpoint Capital about how the market determines the multiple of revenue to attribute to a company’s stock price. He very cleverly – after no doubt countless hours with data – reduces the variables down to a formula.
Forward Multiple = 6.3 + 38 x Revenue_Growth + 2 x Sales Efficiency
You will have to read his contribution to understand why. If you do, you will understand why Snowflake is valued by the market at 112 x forward looking 12 month revenue. Approximately $550m of revenue leads to a market cap of $62 billion. Or why Sumo Logic – valued at $2.33 billion, on revenues of $200m or so – is valued at only 10 times revenues.
The easy answer is that not all revenue is equal. Rate of Growth of revenue and efficiency of growing it translate into different sized opportunities over differing time periods.
With that said, the sight of many IPOs listing amidst the burning fires on the west coast and the global fire that is Covid seems incongruous. But it isn’t. These valuations are genuine efforts by the market to quantify the opportunity to own each company’s stock.
The Snowflake IPO is important for another reason. It gave the enemies of the IPO process an opportunity to fire a broadside at the Banks, like Morgan Stanley, who run the IPO sales process for many companies. The IPO priced, prior to trading, at $120 but opened at $245 and went as high as $319 before dropping back to around $225. At $120 a share the company raised $3.36 billion. Had it priced at $245 the amount raised would have been $6.86 billion. Critics like Bill Gurley will say that the underpricing denied the company over $3 billion in proceeds that instead went to IPO buyers who sold on the open. This, plain and simple, is pricing for friends and stealing from the company say the critics.
This narrative leads directly to the rise of SPACs. This week Chamath Palihapitiya announced that he has 3 more SPACs set up and ready to go. These SPACs are vehicles to enable a company to go public, and get cash, without an IPO. Instead of gifting cash to the friends of Morgan Stanley this method gifts cash to Chamath and his friends. Typically 20% of the SPAC is owned by the founders with the rest split between the investors and the company going public via merging with the SPAC. Direct Listings, also popular with Gurley and others, gifts stock to the pre-listing investors who get in early and see upside after the listing goes live. In all cases there is no free lunch. As the Snowflake CEO said after his company IPO’d:
Snowflake CEO Frank Slootman insisted the process had gone as planned. No. 1 on this year’s Cloud 100 list, Snowflake had prepared for a year, meeting with institutional investors and putting its ducks in a row for public scrutiny for months, including during its previous private funding round earlier in 2020, when the company underwent an intense pricing study as some early investors cashed out. Slootman’s third IPO after taking Data Domain and ServiceNow public, with many of the same key executives as in those processes, the roadshow had gone smoothly over Zoom, Slootman said.
“This is a very heavily vetted company,” Slootman told Forbes an interview on Wednesday afternoon. “The only problem today was that nobody wanted to be a seller because the conviction was so high.”
So all’s well that ends well? Not quite. Bill Gurley continues to attack the IPO process. Andreessen continues to support it and others are busy building SPACS.
The truth is, in every variation of going public somebody buys shares prior to a stock trading. And in all cases they buy low. Sometimes, in the case of SPACs, for nothing. Here is a graphic that shows who benefits depending on the approach.
The only debate is which group gets to make money quickly. Investors ,who the Bankers sell to, SPAC organizers and their investors, or VCs. Clearly once this is understood it is easy to see why each group prefers a specific approach. From the Company point of view all three are quite similar. But VCs like direct listings, Banks like IPOs and Chamath likes SPACs. I predict more and more SPACs and more VCs forming them.
Silicon Valley continues to build impressive growth companies that deliver fabulous investor returns. Covid has not changed that and seemingly nothing can. Where that wealth goes is one of the subjects of this years US election. Please go and vote.
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