As reported by Joe Light in the WSJ yesterday, Fidelity is dumping Facebook (FB) shares left and right. If this were a singular event that didn’t have bearing on anything outside of Facebook’s share price, which it is obviously disastrous for, it really wouldn’t be reason for broader alarm as the title says it is.
But unfortunately that’s not the case, and it is.
Last July I wrote a post here titled “The Coming Tech Crash” which readers of this blog are probably bored to death of me bringing it back up again and again. I do it for good reason, because the consequences of what is taking place between our private and public markets will have a profound effect on the returns that most equity investors see as long as this new paradigm is in place.
In short, the post made the case that because companies are waiting to IPO far longer into their revenue growth cycle than they used to, their valuations are 10 to 20 times larger than they used to be at IPO, which is preventing public market investors from capturing the lion's share of returns and will cause average equity returns to plummet over the course of time. The private market is capturing returns that the Fidelitys of the word used to capture form mutual fund investors.
To combat this from completely killing their growth funds, Fidelity and other growth mutual funds have started investing in late stage private market deals, typically the series C or D rounds of tech companies, which are creating a lot of revenue and will likely come public soon. They were forced into doing this, so the $200M private share stake they took in Facebook should not have been a surprise to anyone.
But here’s why their dumping of the Facebook stock is such a disastrous signal. Fidelity doesn’t flip stocks, their bread and butter has always been finding young companies in the range of 300M to 5B in market cap and owning them for 2-4 years. That’s the only way that funds as large as theirs can make great returns. And in the past they have, they are the best at managing a ton of capital in this manner. Their analysts are great, they spot these companies quickly, they don’t miss many. At Geller Capital and later on at Surfview Capital, our strategy often rode on the back of Fidelity, we would look for patterns in what they were buying given away by the volume spikes on the stock charts caused by them trying to force a lot of capital into a stock they really wanted to be in.
But now things have changed. Facebook came public at 100B, other high growth tech companies aren’t coming public at less than 5B, some north of 10B. Airbnb is an amazing example of a company which 15 years ago would be public by now, but they likely won’t come public at less than 10B either.
Fidelity has no shot, and investors in Fidelity mutual funds don’t have one either.
It’s not that valuations are bubblicious, they aren’t, it’s that a company like Airbnb has gone from 0 to 60 on the revenue meter in a far shorter time than it would have 15 years ago, but it’s still not a mature company, so it’s not going to come public. You can’t blame them for not coming public, it’s not in their best interest, they aren’t focused on bottom line numbers right now, they are focused on completely reinventing how people pay to stay in places that they don’t own, and make money off the excess capacity in the places they do own or rent. And because they can access a ton of capital in the private markets from investors who are willing to take a 10 year view of their company, they can focus on what they want to focus on.
But the public markets don’t treat companies that way.
Fidelity had to buy Facebook at a valuation north of 50B whether they liked it or not, and now they are realizing that all the growth was already sucked out, and that the private market valuation was much higher than the valuation the public market would give it a few months later.
The majority of the growth is already gone, and public market investors are taking on more risk than is warranted for the reward. For this reason, I believe public market equity returns will collapse, the majority of gains take place between 300M and 5B, but those are not accessible to the Fidelitys of the world anymore.
This is scary, will be disastrous for the market, and especially firms like Fidelity. There aren’t many solutions to the problem either. It’s up to the companies when they want to come public, not you or me, and I don’t blame them.
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