Tesla move shows lack of appeal in market

Elon Musk’s desire to withdraw from the harsh glare of the public equity markets is understandable. Companies pay a significant price for the access to capital that a public listing brings. As the Tesla boss detailed in an email to the electric carmaker’s employees, the costs include volatility, the requirement to make short-term decisions, and the unwelcome attention of short-selling unbelievers.

It is understandable, but also regrettable from the perspective of ordinary investors without access to the private equity funds which increasingly are capturing the market’s most exciting investment gains. As Musk added in his note to staff, Tesla will probably come back to the stock market “once [the company] enters a phase of slower, more predictable growth”. If that sounds a bit dull, it’s because it is.

Whether Tesla actually delivers on Musk’s promise is unclear. The appeal of the company to traditional private equity buyers is not obvious given the absence of positive cash flows to finance the massive debts that will be required to relieve existing shareholders of their stock. Tesla has been burning through cash at the rate of $1bn (£783m) a quarter.

The reason Tesla’s proposal is regrettable is that it is just the latest example of a very long-running trend. Mckinsey described this in a recent report as “the rise and rise of private markets”. It might also be described by its flip-side: the long, slow decline in importance of public equity markets.

The number of publicly listed companies has roughly halved in the US over the past 20 years and a similar picture has emerged in many other markets. The companies that remain in the public gaze are older, larger and slower growing, says another report by private equity investor Pantheon. This does not reflect an absence of money flowing into public markets. In the years from 1996 to 2016, the total market capitalisation of global stock markets doubled. But the money is now invested in firms that are on average 18 years old – compared with 12 years in 1996 – four times larger than they were, and growing about half as fast.

The stock market is like a bathtub with the plug pulled out. In order to keep the bath full of water (listed companies), the new listings coming out of the taps have to match the number of companies pouring out of the plug hole via takeovers or voluntary de-listings. This balance hasn’t been achieved for many years.

In fact, the number of US flotations fell from an annual 300 or so between 1980 and 1996 to just 140 in the years that followed. A slowing rate of IPOS would not matter if the pace of companies leaving the market had also moderated. But it hasn’t. Since 1996, de-listings have exceeded new listings by more than 80pc.

The reason is simple. A business will go public if the perceived benefits exceed the costs and aggravation of doing so. There are several advantages of seeking a public listing: access to capital, the ability to use shares as a currency in future takeover deals, to incentivise staff, to cash in value already created by a firm’s founders and to get the credibility that a stock market quote can provide.

A key difference in recent years has been the increasing availability of private funding. Being able to attract finance without all the headaches associated with a public quote has seen the average age of a company at flotation rise from eight years to 11 since the Nineties. The time from first venture capital investment to IPO has risen in just a decade from five years to eight. Does this matter? I think it does because the longer companies remain in private hands and the bigger and more mature they are when they finally decide to tap the public markets, the lower the potential growth rate the rest of us can enjoy.

Two of the “FAANGS” illustrate this well. Amazon came to the market in 1997, three years after it was founded. Its market capitalisation at flotation was about $650m, sales $31m and the growth in its revenues in the first year of public life a mouth-watering 600pc.

Facebook, by contrast, took eight years to come to market, by which time it was worth more than $100bn, had revenues of $4bn and so unsurprisingly was able to grow its sales in its first year on the market by a much more pedestrian 36pc. Guess which has been the better investment?

The stock market still delivers some fantastic growth stories, the 10 and 20-baggers like posh tonic maker Fever-tree, that keep us on the trail of that life-changing investment. Increasingly, however, they are the exceptions that prove the rule.

‘The number of publicly listed firms has roughly halved in the US over 20 years’

Tom Stevenson is an investment director at Fidelity International. The views are his own. He tweets @tomstevenson63