The IPO of LinkedIn demonstrated a public premium: public markets offered a higher valuation than the private markets did. Valuations can be higher because discount rates are lower. Think about it: public investors get maybe 15% in a strong year. Private Equity investors are organized around discount rates of 20% or higher. If your discount rate is so high, future profits are simply not worth as much.
There is another important reason for a public premium: regulated standards of conduct and transparency. When owners (shareholders) are more informed and confident, risk is reduced and value goes up.
The reason to hope this is the case is for the public good. If IPOs and public listings are shown to be a rational — because the cost of compliance is less than the valuation premium — then more companies will be public and capitalism will be more broadly accessible. Also, this will lead to higher overall investment rates and stronger economic growth.
The information age has transformed the economy. The financial service industry has been a tremendous beneficiary with huge financial rewards for innovation and engineering. The financial services sector grew to at least 2nd largest in the US on at least 2 occasions, and that’s not counting banking and securities brokerage*.
Financial engineering created such large returns in the investment industry that it absorbed a large number of top talent from the global workforce for a generation. The industrial world, through automation and logistics applications has changed, too, but not like the financial markets.
Financial engineering has matured and the breakthroughs for systemic outperformance and securitization are harder to find. There is still obvious room to improve how to tailor services for individuals, but you know what I’m saying. Rather than choosing to innovate in the financial services, more engineers will see the best opportunities in industry.
And that gets me to the point: As the information age matures, I think we will see that financial engineering will give way to industrial logic as the most powerful force in the economy. Now that capital is being allocated so efficiently, productivity gains will increasingly come from industrial logic: information systems tied to production and services.
APIs** will be a catalyst for industrial communications. Companies can become part of a global network of improving efficiency, production, services, and innovation.
Reading my Clay Shirkey book from Christmas has me all optimistic.
Happy New Year. Get back to work,
* based on my recollection of Value Line data from over the years…
** It stands for Application Protocol Interface. Just like consumers have been blessed with this new smartphone app phenomenon, developers have been blessed with APIs. APIs let companies talk to companies over the internet. They can send data and receive responses with other data. It’s great.
Feeling down on angel investing? I am. But maybe we shouldn’t.
An interesting new study, “The Economic Future Just Happened,” found that more than half of the companies on the 2009 Fortune 500 list were launched during a recession or bear market, along with nearly half of the firms on the 2008 Inc. list of America’s fastest-growing companies.