Views From the Floor

Why we believe a unicorn cull is no bad thing; and a look at just how sharp the rotation toward Value was in September.

The Unicorn Cull? No Bad Thing

From valuation drops (and ultimately no initial public offering) to heavy discounts following a trading debut, 2019 has been a difficult year for unicorn IPOs. But it’s not just the public markets that are suffering. Private markets are also definitely feeling the pinch.

Two main drivers are behind these bloated IPO valuations, in our view.

The first is the build-up of capital in private markets. Data provider Preqin estimated that almost USD5 trillion had been raised by private funds between 2012 and 20181; USD 778 billion of new capital flowed into private markets in 2018 alone, according to McKinsey; and venture capital firms injected about USD131 billion into deals in 2018, the highest level since 2000, according to data published by PitchBook and the National Venture Capital Association in January.2

The second is that there are fewer companies on the stock market: not only are there less private companies coming to market now, but the number of public companies have also decreased due to M&A.3

The consequences of these developments is that an increase in capital has come at a time when there are fewer companies to invest in! As such, there has been an uptick in mutual funds investing in private companies.4

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Source: Statista; as of 2018.

Figure 2. 2019 US IPOs With Deal Size Over USD1 Billion
Industry Performance Since Offer
Internet Based Services -32.29%
Life Science Equipment 5.00%
Internet Based Services -43.28%
Internet Media 39.21%
Technology 3.55%
Medical Equipment -39.65%
Institutional Brokerage 36.96%
Sporting Goods -13.45%
E-Commerce Discretionary 11.73%

As of 1 October 2019.

However, investing in these unicorns does come with a considerable amount of risk: these are illiquid investments, so it can be difficult to cash out if something goes awry; these companies can be hard to value; and investing at private stage (pre-IPO) cannibalises their demand when the IPO lists i.e. these mutual funds are now sellers where historically they were likely subscribing at the IPO. On top of that, there is the risk that the unicorn fails to IPO; or that even if it does make its trading debut, that private investors are left with a hefty ‘down round’ valuation haircut.

Indeed, with the mixed IPO performance this year (as Figure 2 shows, of the nine US IPOs with an initial deal size of more than USD 1 billion, four are trading lower than the offering price, with three trading at discounts of more than 30%), private investors may be turning elsewhere to get better returns.

Sometimes a cull is the best thing for the herd.

Value – Return of the King?

Unless you live under a rock, September’s rotation toward Value will not be new news. It is interesting, however, to reflect for a moment on just how big it was empirically, and in particular for the US.

Figure 3 shows the performance of the top quintile of each metric minus the performance of the bottom quintile. So, for example, we can see that the top quintile US stocks measured by free cash flow yield outperformed the bottom quintile of the same metric by 3.7 percentage points. Averaging together the five Value metrics, we see aggregate value performance for the US of +7.9%. In the 12 months prior to September, this same field had returned -9.7%. So, almost three-quarters of the previous year’s decline in performance was made up in a single month!

It is well known that Growth has had the upper hand over the last decade (Figure 4). At some point, one of these reversions will prove to be the start of a reversion to type.

Figure 3. September’s Rotation Toward Value
  US  
  September 2019 YTD 1Y
Value 7.9% -2.8% -2.2%
Book Value to Price 7.6% -4.1% -4.8%
Sales/Price (BF1Y) 9.7% -4.6% -8.7%
Earnings/Price (BF1Y) 8.9% 2.9% 6.2%
EBITDA/EV (BF1Y) 9.8% -9.4% -9.8%
FCF Yield (FCF/P LTM) 3.7% 1.4% 6.2%
Growth -2.4% 2.6% -1.2%
5Y Actual Sales Growth -0.4% 4.9% 3.6%
5Y Net Income CAGR -0.7% 4.4% 1.7%
5Y Assets CAGR -1.9% 1.6% -0.9%
1Y Fwd Sales Growth (BF) % -6.2% -0.1% -7.8%
1Y Fwd EPS Growth (BF) % -2.8% 2.3% -2.3%
Momentum -4.5% 1.2% -0.3%
1Y Total Return -9.0% -3.0% -4.4%
3M Stories Growth % -0.1% -0.4% 0.5%
Qtly Sales Acceleration -1.0% 4.2% 2.0%
6M Target Price Change % -7.9% 4.6% 3.1%
3M Sales Revision % (FY1) -4.2% 0.8% -2.9%
Size 1.8% 9.3% 15.3%
Total Assets 4.1% 10.3% 15.2%
Sales LTM 3.8% 10.6% 16.3%
Market Capitalisation -2.0% 12.1% 19.8%
EBITDA LTM 3.1% 7.3% 16.6%
# EPS Estimates (FY1) 0.0% 6.1% 8.7%
Risk 0.2% -3.2% -10.0%
1Y Volatility -0.7% -9.8% -21.4%
2Y Beta 2.2% 2.7% -6.9%
5Y CFFO Variability 2.2% 0.4% -2.8%
Rev Est Dispersion (FY1) -1.1% -2.1% -5.4%
EPS Est Dispersion (FY1) -1.7% -7.1% -13.7%
Quality -0.5% 1.6% 7.8%
3Y Average ROE 2.1% 6.8% 15.0%
Assets Turnover LTM 1.1% 1.0% 1.8%
3Y Avg EBITDA Margin % 2.4% 8.0% 18.4%
Net Debt/EV -5.3% -7.6% 5.9%
Capex to Sales -2.7% -0.4% -2.1%

Source: Man Solutions; as of 30 September 2019.

 

 

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Normalised to 100 as of 31 December 2009. As of 4 October 2019.

The US Jobs Market: A Goldilocks Outcome?

Data on 3 October showed that US unemployment fell to 3.5% in September, its lowest since December 1969, and below economists’ expectations of 3.7%. However, average hourly earnings rose by 2.9% from a year earlier, below the 3.2% consensus, while US non-farm payrolls data came in 136,000 new jobs in September, below the 145,000 average expectation.

A combination of the softening average hourly earnings, ok non-farm payrolls and record low unemployment represents a Goldilocks outcome for markets, in our view: the numbers support calls for the Federal Reserve to keep on cutting interest rates, providing a relief for markets against a backdrop of soft data.

With contribution from: Juan Platt (Man GLG, Head of Global ECM), Henry Neville (Man Solutions, Analyst) and Ed Cole (Man GLG, Managing Director).

1. As of February 2019.

2. https://fortune.com/2019/09/30/2019-ipo-lessons-venture-capital/

3. https://www.wsj.com/articles/where-have-all-the-public-companies-gone-1510869125

4. https://www.cnbc.com/2017/05/17/mutual-funds-are-juicing-their-returns-by-investing-in-private-companies.html