Category: Uncategorized

Robinhood may file for IPO next week

Though some expected it this week, we hear Robinhood’s much-anticipated IPO filing should be out next week to keep the popular but controversial stock and crypto trading app on schedule to debut later in June.

Among other things, it is going to be interesting to see how many users Robinhood now has. Despite getting all that bad press for restricting small investors from pushing up the prices of meme stocks such as AMC Entertainment and GameStop, the episode prompted many investors to find out more about Robinhood and how its app works (and sign up).

The other big question the filing will answer is how much of the IPO Robinhood will be allocated to its own users. Hot tech IPOs typically allocate only 5% to retail (excluding the directed share program), though Robinhood has such a large base of investors that will be interested that it may well set aside 10%-20%. If you love trading on Robinhood, why wouldn’t you bid for shares in its IPO?

Meanwhile, Robinhood this week conducted a small but fascinating experiment that saw it secure 1% of the $580m IPO of medical scrubs company Figs for its users.

No detail on how many requests or “conditional buy orders” Robinhood drummed up for Figs and how many users actually got stock but it was very easy to put in a request via the app. It was just much harder to get stock and I know first-hand that some that bid for even just one share got none .

Naturally there was not enough stock to go around but the IPO access feature on its app showcased a sleek and elegant way for investors to lodge requests for stock and get alerts on whether they were successful. Notably the app disclosed the final price of the IPO before the company got the press release out and before the media found out on Wednesday but it wasn’t until Thursday morning a few hours before the stock debuted that investors found out whether they got stock or not.

It may just be a teaser for how Robinhood is going to manage its own IPO, but there is no doubt the broader thrust of “democratising” IPOs (though not a new idea) in is keeping with wider societal changes that, like any change, not everyone is going to embrace.

There are definitely no technological barriers to getting small investors involved in deals where sometimes the terms can change materially late in the game.

Yet IPOs are still very tightly regulated and follow rules (communication rules especially) that often feel like they are from another era.

One possibility is that greater retail participation in IPOs brings with it greater volatility and is ultimately counter-productive by bringing more companies to market that shouldn’t be public (something the SPAC phenomenon has also resulted in). The full implications remain to be seen, though it is also true the technology allows Robinhood to closely monitor trading activity and, for instance, compel investors not to churn stock purchased in an IPO.

For banks, the debates rages as to whether fintechs like Robinhood are as much a threat to their businesses as is commonly believed. But one thing for certain is that the banks are still financing these upstarts and are likely to collect plenty of fees in the coming months as many of them are sure to go public.    

Inflation: Transitory or lasting, that is the question

The big debate in financial markets this week is whether Wednesday’s concerning April inflation data amount to a problem for the Federal Reserve’s easy money agenda or a blip that can be safely ignored.

A standard line in economics that one should get too worked up about one data point. But that’s exactly what happened this week when the S&P 500 fell 2.1% (before rebounding later in the week) and 10-year US Treasury bond yields spiked to around 1.70% (below).

Source: Refinitiv Workspace

Inflation fears had a more pronounced effect on the tech-heavy Nasdaq Composite Index, which as of Friday afternoon (a few hours before the close) was on track for its fourth straight week of losses.

Source: Refinitiv Workspace

Tech stocks have been cruising for a bruising for a while, the unknown being how much of a pullback is sufficient before the better names are worth buying.

We won’t go there today but one way of looking at the inflation question is to ask whether it is just the reversal of some deflationary trends with the onset of Covid-19 last year. If so, this would support the case that accelerating inflation is not likely to be permanent.

While inflation is running hot right now (driven by supply shortages in certain products), there was some deflation this time last year, exaggerating the extent of the move. Admittedly the headline data (+0.8% for all items) is measured versus March, not April 2020, but there is still a good argument to be made that the price rises reflect some pent-up demand for goods and services.

If strip out food and energy (see chart below), you can also see that the latest number also follows a weak print the same time last year.

There’s also a lot of mixed signals and several classic signs of a inflation breakout are missing, including any big move up in wages.

This is one of the reasons the Fed is not panicking just yet and this data may support the case that at least part of the April bounce in CPI was transitory.

Source: BLS

How’s that GM call going?

Sorry I haven’t posted for a while. I promise to do better.

I’ll start with this. Almost exactly a year ago, I told investors to consider GM stock since it looked cheap.

Now I admit there have been better investments out there (including Tesla) and a lot has happened in a year, not least Covid-19 and a flood of liquidity into financial markets driving much speculative excess. But even old GM is starting to shine:

General Motors share price chart

General Motors’ one-year chart. Source: Refinitiv.

GM wallows while Tesla soars

Reading this weekend’s edition of Barron’s, I was reminded about a stock I have long thought worth buying but never felt any urgency to do so.

I am talking about General Motors (GM). Yes, I know what you are thinking: Forget about it.

Shortly after I arrived in the US just before the financial crisis, I happened to listen to one of the automaker’s quarterly earnings calls.

I remember thinking I had never seen (or heard of) a company with as many problems as GM had at that time. They included too much debt, huge pension and healthcare liabilities, product recalls, poor corporate governance, and, more subjectively, an inferior product to most of its competition.

Yet the overhaul of the company alongside its 2009 pre-packaged bankruptcy and November 2010 re-IPO was supposed to plant the seeds for a new GM that would return to the top of the American corporate heap.

Well, the company shed a lot of debt and liabilities and got new management, but turns out it was still not much of an investment.

Consider the IPO priced at $33.00. Roll forward to today and the stock is trading at just $33.63. Talk about a lost decade.

Here’s the chart:

GM’s lost decade
Source: Refinitiv/Eikon

When I looked at the stock about a year ago, it was trading above $40 a share and I felt I’d probably missed an opportunity to get this one really cheaply. Having been burned on a few turnarounds that never happened (not mentioning any names), I wasn’t about to chase it.

But with all the attention on Tesla and investors thinking this is late in the cycle for auto sales (ICE cars at least), GM shares now wallow at a mid-single digit forward PE, just 5.7x 2020 estimates based on the numbers below.

The lack of enthusiasm for the stock partly reflects the company’s flat 2020 adjusted EPS forecast of $5.75-$6.25 a a share unveiled just this past week, somewhat undermining its investor day pitch that its stock is undervalued.

GM reported adjusted EPS of $4.82 last year, but this was depressed by work stoppages in the second half. The forecast is actually below GM’s 2018 adjusted EPS of $6.54.

CEO Mary Barra was asked by clearly frustrated analysts (none have a sell recommendation) what she is doing to get the stock price moving up and whether GM should bite the bullet and merge with a rival.

Here’s what she said.

“We are always exploring opportunities that are going to create long-term shareholder value. We’re not interested in doing something that (creates) just a short-term pop, but – and we consider all alliances…We’re in an era right now where a lot of people are talking to a lot of people. People don’t understand how significant the work that we’re doing with Honda is when you think about fuel cells, when you think about AV and when you think about effectively EV cells. For those of you who have had a chance to see or look online for the Cruise Origin, the three teams work together rather seamlessly. And in order for groups to work together, it’s got to be at the engineering level, and we’re demonstrating that and we have been. But again, we’ll consider all those opportunities.

“I think to get to your core question, we do feel General Motors is a compelling investment opportunity. We feel, across many of our strong franchises, you mentioned trucks, we’ve talked about OnStar, we talked about mid-crossovers, (and) we do believe China is going to be very important in the future. It still is a market that has tremendous growth potential. The scale that we get allows us to compete in a way, from an electrification perspective, across a full range of products from value brands to luxury brands.

“So I will tell you, there’s nothing that’s off the table that we don’t think is going to create long-term value. And we’re going to aggressively go at what we’re working on – improving the business…especially the small and the compact crossover segments. The global family of vehicles has been very important around the globe for doing that.

“But there’s the work we’re doing on the core we feel very good about, and we feel we’re getting to the final chapters in that. But then also our conviction around EV, our conviction around AV, we think it sets up General Motors to be uniquely positioned to participate strongly in the future of mobility.”

This very accident-prone stock could sure use a near-term catalyst, but, I don’t know, it doesn’t sound like Barra has something up her sleeve.

The positive is that it probably can’t get much worse for GM.

The company is expecting a significant increase in what it calls adjusted automotive free cash flow this year ($6bn-$7.5bn versus just $1.1bn last year) and once that begins to become more apparent in the numbers investors might give the company a bit more credit.

GM is now committed to what it calls an “all-electric future” and with Tesla shares running hard, there will be a point at which GM’s EVs will get a closer look from consumers and, hopefully, investors.

Particularly if there is a swing away from momentum stocks at some point this year (in that event, there’s certainly going to be less downside).

On valuation grounds alone, GM, and Ford for that matter (it similarly trades at single-digit multiples), look worthy of further investigation.

Nobody knows anything: the Netflix story

I just finished reading Netflix founding CEO Marc Randolph’s That Will Never Work: The Birth of Netflix and the Amazing Life of an Idea. While it trails off a little towards the end, I highly recommend it, both for investors and aspiring entrepreneurs.

At a time of peak cynicism about the companies/IPOs coming out of Silicon Valley, Randolph’s “memoir” of the DVD rental-cum-streaming service’s early years offers a timely case study of an idea that not only worked but overcame many of the challenges/issues that have plagued today’s up-and-coming tech stars.

Netflix today

The book covers the period roughly from the company’s foundations in 1997 to its IPO in 2002, since Randolph bowed out not long after the company went public.

Here are some insights that I took away from reading the book:

  1. Success is not linear, even for really good ideas. It’s tempting to think the setbacks that startups face reveal some fatal flaw in their business model that will eventually bring them undone. Not really. Netflix had its share of existential moments, not least the tech bust in 2000 which dried up sources of capital and forced the company to put its finances on a sustainable footing and refocus by slashing its staff. But it came back stronger after that setback, as it has done a few times. Luck cannot be underestimated as an element of success either. Netflix got into DVD rentals before/just as DVD players and DVDs began replacing video cassettes, and was lucky that the big electronics manufacturers were prepared to support it (by putting its promotional material in their boxes). Even then it wasn’t clear that online DVD rental would be a success. Later on, Netflix didn’t let success go to its head, recognizing the need to constantly reinvent itself. The company knew that DVDs would not be the preferred format forever and made an early effort to investigate streaming, even when download speeds were too slow to support it.
  2. Leadership is everything. Already a seasoned and successful tech entrepreneur, Reed Hastings put up much of the early money. But he wasn’t so hands-on until he realized Netflix could be something really big. Hastings comes across in the book as an enigmatic figure (I suspect the full extent of Randolph and Hastings’ relationship is a little sanitized), but an extremely decisive person and someone not afraid to make very tough business decisions or criticize the way the business is run. Randolph often doesn’t agree with Hastings but later accepts that he was right almost every time. Hastings’ track record prompted the VCs to overlook some deficiencies in the company’s pitch, enabling Netflix to get enough early financing.
  3. Focus on where there is less competition. A key early decision was to ditch DVD sales and focus solely on rentals, even at a time when sales of DVDs were overwhelmingly the company’s largest source of revenue. Hastings and Randolph knew that Amazon (which also offered to buy Netflix early but not for much) would eventually sell DVDs as well as books and margins would collapse. It was much harder for anyone else (even Blockbuster as it turns out) to get into the online DVD rental business, which didn’t really take off until the company introduced a monthly subscription service.
  4. Balancing scale and profitability is not easy. It is easy to criticize recent IPOs for coming to market before they are showing profits. But businesses that are growing fast and are subscription-based will chew up cash. Netflix was giving away free rentals to new subscribers while collecting only a small amount on a monthly basis from its existing subscribers. Though the book did not mention it, I went back and checked the original IPO filing. Netflix went public when it had 600,000 subscribers and was still to pass through $100m of revenue. It had just reported a $30m quarter so it would have passed through that threshold that year. The company also reported a $4.5m loss in that quarter, but was Ebitda positive and operating cash flow positive. WeWork has a lot more revenue but reports negative operating cash flow. Incidentally, Netflix went public at $15.00 (versus the $13-$15 range) with a $310m market cap, whereas the shares now trade at more than $260.00 each with a $115bn-plus mark cap (the shares traded as high as $386.00 last year). To the extent that WeWork was/is looking to get a $10bn-$47bn valuation, it is a lot harder to see WeWork producing Netflix-like returns (if WeWork ever goes public).
  5. Nobody knows anything. Randolph cited screenwriter William Goldman for this line, which is saying no one really knows what the future holds. When we see the hype around WeWork and Uber, it is sometimes easy to think their success was pre-destined. Similarly, when analysts and others write them off they are stating an opinion – they may be right but a lot comes down to whether management makes the right decisions about the next steps for these businesses.
  6. Rules for success. Randolph provided a list of rules for success handed down from his father. These are particularly good for modern kids whose parents are starting to worry they are getting a little too entitled. Here they are: “Do at least 10% more than you are asked. Never, ever, to anybody present as fact opinions on things you don’t know – takes great care and discipline. Be courteous and considerate always—up and down. Don’t knock, don’t complain—stick to constructive, serious criticism. Don’t be afraid to make decisions when you have the facts on which to make them. Quantify where possible. Be open-minded but skeptical. Be prompt.”

We gets down to work

Update 9/16/19: Latest reports say WeWork is considering delaying its IPO until next month at the earliest, and maybe until next year.

It’s hard to think of a recent IPO that has garnered as much bad press as The We Company, better known as flexible office space provider WeWork. And it hasn’t even launched yet.

For contrarians like me, poor headlines are not necessarily a reason to keep away from an IPO (or a stock). All that negativity can sometimes translate into a bargain buying opportunity.

Yet the reality here is the majority of investors are going to remain extremely cautious about backing the WeWork story, whatever the price.

The deal has zero momentum heading into its possible launch tomorrow, though there is a faint hope the cut-price valuation lures in some meaningful interest.

As you might have read once or twice, there are big reservations about WeWork’s business model, including that its growth depends on entering into more long-term leases (with the associated long-term liabilities) or buying real estate, both requiring WeWork to come up with billions more in cash with no guarantee it will turn a profit.

I have heard some sources suggest the business, which charges entrepreneurs a membership fee rather than rent to use its space, could become profitable in just a few years if it slowed down its growth rate.

But it’s a Catch-22 situation because without growth investors are unlikely to be much interested in paying up for the stock. And WeWork starts to look more like a boring REIT than a sexy technology company (which it is not, but anyway).

There is also the awkward timing of the deal and how WeWork would fare in a recession. WeWork’s members are highly sensitive to any change in economic (and financing conditions), plus start-ups can find cheaper alternatives if they are feeling the pinch (after all, WeWork is all about flexible use of space).

Then there’s the potential for commercial landlords to essentially copy the WeWork model to deal with their vacant space.

Still, investors should reserve judgment until they see the valuation, which is only revealed at the launch of the offering.

That is supposed to happen tomorrow (Monday) morning, which means the official roadshow will begin (with the release of a slick online version for retail investors) and the IPO probably price on September 25 or thereabouts ahead of the stock’s Nasdaq debut the next day.

Of course, a late change of plans is always possible, especially as investors might be facing a volatile week after the troubling events in Saudi Arabia over the weekend (production disruptions from a drone strike on the country’s oil facilities). So really nothing is going right for WeWork and its 40-year-old founder Adam Neumann.

In recent weeks, WeWork’s purported valuation (market capitalization or enterprise value we are not sure) has reportedly come down on several occasions to just $10bn from more than $20bn and versus the last private financing round at $47bn (not a real number to be fair but we won’t go into that).

The company has made a series of corporate governance concessions as well, including reducing the number of votes attached to Neumann’s supervoting shares. Not to diminish the importance of corporate governance, but generally it is not a huge consideration for investors in tech IPOs because they tend to be more focused on the growth prospects of the company concerned.

WeWork’s biggest supporter, Japan’s SoftBank, is expected to take $750m of the shares in the offering. Its name is bound to be emblazoned on the cover of the IPO filing to highlight its show of support.

As embarrassing as it is for SoftBank to be averaging down from its previous pre-IPO investment at a $47bn valuation, this anchor order will leave less stock for others.

Without SoftBank, WeWork would be selling 30% of the company at the IPO – it has to raise $3bn in order to also secure $6bn in debt from the banks – yet this is far larger than the 10%-15% free float on hot tech IPOs (tight supply and excess demand is one of the reasons they often surge massively on debut).

SoftBank’s enthusiastic backing is a small positive, but a positive nonetheless (worth watching if the stake is locked up for six months or a year).

At $10bn, WeWork will be coming to public markets at a significant discount on an EV/sales basis to Uber (roughly 3x-4x 2019 sales of around $3bn at the current growth rate versus 4.5x for Uber). WeWork’s underwriters clearly figure some will find WeWork irresistible at these levels, but the risk is they will be hedge funds rather than long-only/long-term investors, increasing the chances of a calamity on debut.

A WeWork office in Harlem, New York City.

The “R” word: Possible, yes, but how bad will it be?

Recent surveys suggest as many as three in four economists believe the US will go into a recession by 2021. Maybe they are right. I don’t know about 2021 (and they don’t really either) but as night follows day, there will be a downturn eventually.

To me, the bigger question is this: How deep the next downturn will be?

Now I am not really going to answer that question but I think this is what people should consider before they buy into doom-and-gloom prognostications.

There hasn’t been a US recession since 2007-2008, which means forecasting one in the next year or two is almost like insurance for a professional forecaster. Forecasts are mostly wrong too but that doesn’t stop people from making them.

In fact, countries can go for very long periods without a recession (Australia, for instance, hasn’t had one since the early 1990s).

Next year’s US Presidential election also means there is a huge political dimension to the economic commentary that appears in the press, and one should be especially wary of any politician trying to pass themselves off as an economist.

A recession is arguably the only event that assures Donald Trump will lose. His opponents know that when they discuss the economy.

I think it is possible that the next recession could well be more of the “statistical” variety and quite shallow.

For one thing, economic activity in the past year or so has been juiced by the 2018 corporate tax cuts (people seem to forget about them).

Greater corporate earnings flow through to the economy in a variety in different ways and quite quickly too (one reason why governments prefer tax cuts to spending on big projects when trying to quickly stimulate the economy).

If the growth numbers were in any way exaggerated in the past year, which seems entirely possible, then it is simply a mathematical reality it is going to be harder to grow at the same rate and better those conditions a year or two hence.

Real GDP grew 2% year-on-year in the second quarter of 2019, but you can see on a long-term chart (below) GDP growth has flattened over time as the economy has got bigger and bigger save for large blips like 2007-2008.

Growth is harder to come by when you are already the biggest economy in the world (a $20trn economy), so let’s not pretend it is easy to do so.

US GDP through time. Source: US Bureau of Economic Analysis

A recession also means different things to different people.

Here’s an article from the New York Times published in December last year:

“Some say (a recession) happens when the value of goods and services produced in a country, known as the gross domestic product, declines for two consecutive quarters, or half a year.

“In the United States, though, the National Bureau of Economic Research, a century-old nonprofit widely considered the arbiter of recessions and expansions, takes a broader view.

“According to the bureau, a recession is ‘a significant decline in economic activity’ that is widespread and lasts several months. Typically, that means not only shrinking GDP, but declining incomes, employment, industrial production and retail sales, too.”

All true, but you might also say that a recession means different things to different people, in that during this period one person can lose their job and come under financial duress, and another can be completely unaffected (if they have a steady job in a good industry). What I am trying to say is that the numbers in themselves don’t matter as much as how a recession actually affects people’s lives.

A deep recession would mean a spike in unemployment, which is really the key statistic.

Yet the data continue to show US job growth.

The chart below shows US unemployment (3.7%) is at its lowest level since the 1960s. Is a big spike in unemployment around the corner? Are these numbers even relevant any more?

The gig economy seems to be changing the definition of work and driving down the unemployment rate with lowly paid jobs. This may also mean unemployment doesn’t rise sharply in a downturn like it might have done in the past (as everyone picks up gig jobs if they have to).

US unemployment rate through time. Source: Bureau of Labor Statistics

Though some are talking about another credit crunch, there is no doubt the economy and companies are cushioned by low interest rates, in turn facilitated by low inflation.

By the way, that is another thing many economists have got wrong in the past decade. They expected inflation to break out because of the Fed’s rampant money printing, but funnily enough, it never happened and the Fed has had no choice but to keep rates low to try to ward off outright deflation.

The Fed is likely to cut rates later this month for the second consecutive meeting, somewhat reluctantly and unusually all while the economy and jobs are still growing.

The politics can’t be discounted here either, by which I mean the Trump Administration has much riding on there being no recession in the next year at least. This is why Trump is riding Fed chair Jerome Powell to cut rates and holding out the prospect of more tax cuts.

There is always a risk of a large downturn and the US economy has problems that stem from too much consumer and government debt and high healthcare costs, but my point is that pays to keep things in perspective.

WeWhat?

WeWork, or The We Company as it is now officially known, could launch its circa-$3bn US IPO as early as next week.

That’s despite some brutal commentary since the provider of flexible office space – or “space-as-a-service” if you subscribe to the spin – publicly filed with the SEC for its New York IPO on August 14.

It might even be said the press coverage WeWork and its co-founder Adam Neumann have received as the company prepares to go public is worse than Uber’s ahead of its debut in May. That’s saying something.

Here’s one cutting but hardly unique example of the critiques: WeWTF by Scott Galloway.

Galloway writes with impressive flourish and identifies plenty of red flags for investors contemplating this investment.

To rework the famous porcine analogy, WeWork is a pig caked in lipstick.

WeWork is “disrupting” real estate but instead of tenants, it has members. Instead of rents, it has membership fees.

Unfortunately, instead of profits (or funds from operations) you might associate with a REIT, WeWork has the big losses and poor corporate governance we have now come to expect from Silicon Valley unicorns.

After the disappointments of fellow “unicorns” Uber and Lyft earlier this year, investors are right to be very skeptical of this offering.

That said, the missing piece of information is what valuation WeWork is coming at. That won’t be known until the deal launches (next week or the week after).

The last private round led by Japan’s Softbank valued WeWork at $47bn but as Galloway points out, this investment came with a liquidation preference that means Softbank would get its money back first in the event of a sale or bankruptcy. In other words, it might not be a fair measure of WeWork’s value or any real indication of where underwriters will pitch the IPO.

WeWork has doubled revenues in the past two fiscal years and is on track to do it again this year. Though not necessarily a safe assumption, another doubling of revenues next year would see WeWork generating around $6bn of revenue (in calendar 2020). Put that on Uber Technologies’s current multiple of 4x-5x forward sales and you can get to a little more reasonable $24bn-$30bn valuation.

Reading the S-1 filing, there are clearly many other problems, including the company’s overly complicated corporate structure and related party transactions. These definitely should be discounted in the valuation.

Though it doesn’t really sound like Neumann’s style, a more reasonable valuation starting point would be one way to blunt the choral criticism.