Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Welcome to the Actively Speaking podcast, where TD portfolio managers and their expert guests tackle current topics concerning capital markets and portfolio management. Join us for a fresh and insightful discussion from the perspective of an active manager. Welcome back to another episode of Actively Speaking. My guest today is Kevin Hebner, a frequent guest in the past. So welcome, Kevin, our global strategist here.
You know, one of the interesting features of equity markets over the last couple of decades has been what people call de equalization, meaning there was a pretty steady downward trend in the number of publicly traded companies. And some of that was just companies staying private for longer. Some of it was, also the D acquisition involved lots of buybacks by companies buying back their own stock.
So basically, you know, the amount of equity, public equity outstanding was sort of trending down for the last 20 years that it it was a not coincidentally, a time in which, quote, capital business models were kind of in the ascendancy. You know, you don't need so much capital. You don't need to go public, you don't need to be issuing more stock.
Whatever you have the cash flow, you can buy back the stock. But that all seems to be reversing now. And that's what we're going to talk about today. But we're we're going through, a pretty big wave of IPOs with kicked off. Well I mean there's always IPOs going on. But some mega IPO is going on this year starting with Space-x in in June.
And expectations are that both anthropic and OpenAI will will go public. So we're going to talk about that and what it means, why it's happening and and what it means for investors. So let's start with why is this happening, Kevin.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
So I guess with the Décrit ization, there are three drivers behind that over recent decades. One is a relative dearth of IPO.
So not many new companies coming to equity markets. The second being a lot of buybacks. So this year globally it could be $2 trillion in buybacks. So a lot about a trillion in the US. It's been averaging about 650 billion in the US over recent years. And the third reason would be, M&A activity in which a public companies take a private tour through a merger.
So, and this has been a nice tailwind for equity markets. So, less supply of equities, presumably lower cost of capital. And a nice tail tailwind. And we think this is turning into a headwind and maybe higher cost of capital. That's hard to say. How much. So, what is driving the increased number of IPOs?
And in fact, it's not increased number of IPOs. It's increased proceeds from IPOs because we have still a fairly small number of companies, going public, but with very big, issues. For example, Space-X, planned $75 billion. They ended up raising 86 billion, which is by far the largest ever. And then, as you're mentioning, anthropic and OpenAI expected Q4 of this year in early, Q1 of next year, they only to raise about 60 billion, and those will be the number two and three largest proceeds from IPO ever.
So a big increase in IPOs and what we think is driving that is this technology trend with AI. And if people are right that AI is going to be, highly disruptive, huge, to some extent, as big as the second duster revolution with electricity in the first with steam engine. It should be very big and it should run for quite a while.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
So why do companies go public? Because, as I was saying before, you know, in the last 20 years, companies seem to want to stay private as long as possible. Being a public company comes with all sorts of reporting obligations and so forth. Then, so why, you know, what are the advantages and disadvantages to a company going public?
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
So there's two big advantages to going public. One is you get off the hamster wheel of fundraising. So if you're in a fairly capital intensive business like space X or open air anthropic, so they're always going to the market, to raise capital. So, you get financing. Optionality is the term that, for example, the CFO of OpenAI has said recently.
The second big thing is if you're a startup, often you're dealing with, customers and they're wondering, you know, are you going to be around in a couple of years? And going public does sort of say that, you know, I'm a real company and increases your reputation value. I'm going to be here for quite a while. So those sorts of advantages, the and if you think about the financing, so OpenAI has stated that they're going to burn about $100 billion between now and the end of the decade.
So that's a lot of money they're going to private Mark investors for in space X is suggesting 3.5. That's all $350 billion between now and then. So that's a lot of money to raise in terms of did that the disadvantages one is all the disclosure the accounting regulatory requirements. And that's very different from being private in a lot of founders will come at that when they're running a private company.
It really feels like it's their company. They're in control. They're making the decisions. You go public and you lose a lot of, governance and a real. They really do determine both tactical and strategic shifts in the company. And one way that, IPOs are trying to get around this recently is and maybe we can delve into this is by issuing dual class shares rather than single core shares.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Yeah. So let's talk about that because that, that is something that from a, from a ESG or a governance perspective, it does trouble some people that you can have these companies go public, but the, you know, the shareholders still don't really have the ability to exercise much control over the company. The founders have retained this, the, you know, share class that has more voting power. So what's, you know, is that becoming more common?
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
Yeah. So it's, you know, for decades has been the case that some small percentage of companies have issued, dual class shares. Historically it's been a number, about 8%. Even a decade ago it was about 8%. And then it seemed to change. 2012, we had Meta, which was, dual class. The other big tech example was, was Google, in 2004. But shortly after Meadows, I think a lot of people paid attention that, how it was received, the controller gave Mark Zuckerberg, and since then, the share of IPOs that have been had dual class shares has gone from 8% to 50%. That's on an equal weighted basis. If you did on a market cap basis, I think it'd be well north of, 50%. So, for example, with Space-x, Elon Musk has 46% ownership, 86% control. And this gives him a lot of confidence in his ability to determine the future direction of the company. And I think it's all but certain that OpenAI and Anthropic, when they go public, will also issue dual class shares. And we're not exactly sure what those will be. I think some of them will be quite different than either meta or SpaceX, but they won't be single class, one share, one vote. Issuances.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Now, I know you've done some work on looking at performance, post IPO. Yeah, of companies, by all sorts of cutting in all different ways. But one of the ways I know you've looked at it is to a class shares versus single class here. Yeah. And talk about, what the performance is with it might be somewhat surprising. You might think that, you know, gee, if, if dual class, maybe the, you know, you might it's sort of has a negative connotation, but I don't that's not necessarily what the performance data shows.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
Yeah. So, there's only well just over 300 issues in the tech sector a dual class. But in that case there is significant outperformance of the dual class shares relative to single class. And that's surprising for the universe. Outside of tech there isn't really a difference. But for tech the list seems so far. And it could be that way. You know, I wouldn't necessarily want to stress that there's a causal relationship, because I don't know how one can say that. But at least so far, with just over 300 issuances, dual class is significantly outperforming single class share. And that that surprises people. The other thing that stand out in terms of performance is larger companies tend to do better than smaller companies. VC backed companies do a lot better than none VC backed companies. And tech companies, probably not surprisingly, do a lot better than non-tech companies. So that's probably not surprising given that the tech part of the public markets done a lot better than the tech part, non-tech part of the public market. The final thing I note in terms of performance is that, and then again, this is not shocking to public market investors is really expensive IPOs underperform relative to less expensive. In particular if you're price to sales is over 40. And it's not like there's been thousands of these, but there's been enough to have, a significant data set. But those companies, which I think anyone would agree are expensive on some type evaluation metric, have pretty severe underperformance over time.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
I just want to talk a little bit more about the dual share class thing, because one thing that strikes me is that a lot of these companies, you know, these are it's still a fairly recent phenomenon. I mean, these companies that we're talking about, you know, Google that was only about 20 years ago, you know, and so in most of these companies, the founders are, you know, still around what, you know, if any provisions are there in in the way these things are set ups that the founders will eventually one day they will die. And, despite their best efforts to pursue immortality in some cases. But so what happens? Is it what happens from that over the years? What's the plan?
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
Well, I'm not necessarily an expert on that part, but I do know that, there's many different variants on dual class and in some cases, you'll have, say, a particular type of class gets, ten votes for each share. But over time that will reduce, say, maybe eventually becoming two votes per share, one vote per share. So there's an awful lot of variance on this. And so the case of, Sergey Brin and Larry Page, particularly as Larry Page becomes less involved day to day with Google, does he still want to have, preferential voting rights in his. Sure. Does that make sense? So but I'm not really an expert on that topic.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Let's go back to the hope, the reason why all these companies are going public, which is that the need for capital, and so then you have to ask yourself, how long is that need for capital to get to continue? I mean, we're all very familiar with the huge increase in capital spending by the so-called hyperscalers over the last few years. And, you know, how much longer are they going to need to do this? I've seen some forecasts for free cash flow for these, for this group of companies where there seems to be a consensus expectation that, that their free cash flow will improve pretty dramatically in a couple years. It's gone down a lot in the last couple of years. They had so much, you know, most of these businesses, whether it's Google or Amazon or Meta, you know, they have these very large sources of revenue from what had been their sort of core businesses. And so that has been funding, initially a lot of the AI CapEx. Now, you know, the reason that some of these companies need more cash or more capital now is because, you know, now they're they've sort of drawn down the cash flow and they need to supplement it with either debt or more equity. So if the, you know, if you see these forecasts that that free cash flow is going to recover in a couple of years, that implies one of two things. Number one is the CapEx will go down in a few years, which would be hard to square with, the recent stock price performance of the companies that receive that CapEx as their revenue, the chip manufacturers and so on. Or the other explanation is that the CapEx will stay high, but the revenue will suddenly will materialize from all this, AI spending. What do you what do you make of that?
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
Yeah. So we've, you know, had a long period of couple light companies documenting so digital companies that didn't have to invest a lot. So producing lots of free cash flow. And this changed three years ago with, OpenAI's, ChatGPT release. And then we've moved into this capital heavy phase, investing a lot in data centers and other things. And so for the hyperscalers, their cash flow from operations that growth remains really strong. So 20% plus, but their CapEx spending, that growth rate has been even higher than that. So as a consequence, even cash flow from operations that chart looks really nice. CapEx looks even steeper. So overall free cash flow, has gone from a very, very high number, to probably next year moving into negative territory. And that's a real shock. And then some people think that, well, maybe 3 to 4 years ago were get a pivot on that number and it'll revert back into positive territory 3 or 4 years from now. Yeah. You start from, from now, which would suggest either that their revenues or cash flow from operations skyrockets. I'm not sure how that would happen or their CapEx spending plummets. And in which case the AI CapEx beneficiaries shouldn't be behaving as strongly as they are right now. My perspective on this is when you have a big tech wave, if AI is in fact this big tech wave, it should last a long time. 100 and years ago, electricity that lasted over three decades, the first industrial revolution with railways on steam engine that lasted well over 50 years. This is happening faster and more intense. And also be less than 30 years. But it's certainly reasonable to think it's going to last 10 to 15 years and not in a straight line. There will be many booms and busts. That makes sense. So I think there is, a lot of discrepancies and inconsistencies in the pricing and markets.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Yeah. I mean, and, and it's important to note that a stock can, you know, there were plenty of examples of this 25 years ago after the, the.com boom sort of fell apart of companies that had done phenomenally well, during that period. And then the stocks came way down. But the businesses are still around today and doing fine. But you know, the stock price got so far ahead of itself. In essence, you know, for a while 25 years ago that it didn't, you know, not people. You love to talk about the Pets.com and, you know, the sock puppet and all that. You know, there were ridiculous companies that when it went that disappeared. But many of the companies stuck around. It's just that the stock prices had discounted too much too soon, you know, and it took years to, to get back to where they had been at. So, I mean that that could be where we go with it. It's not that these, you know, companies that some of these companies that have done really, really well, the stocks over the last year or two, it's not like, oh, they're, they're it's some sort of, you know, fake thing. They're going to go out of business, not going to go out of business. But it could just be that the stock price was being too optimistic.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
So I guess Cisco would be a good example of that. So it was a great company, great management critical for network equipment is still critical for network equipment. It's still a great company. And is still, say a top 30 global tech company. But for a while it was the most valuable company in the world trading at, extremely elevated multiple and as you say, getting ahead of itself. But it was a good company. Yes. Just for quite a long time. Not a great stock.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Right, right. And then today, I mean, what's, you know, in particular, in recent months, we've seen these incredible moves in, you know, the memory related names. And, because there is a shortage of it right now. And, but people are, you know, there is a potential that markets are making the mistake of projecting the current conditions out into the indefinite future in terms of both the shortage, because, you know, supply will react to meet the demand and pricing, that, you know, pricing will not stay at that current levels for, for the underlying chips that I don't mean the pricing, the stocks. But you know, that when you have shortages like this, it sort of inevitably does lead to, you know, increased supply and falling prices, you know, and so you can't necessarily project today's prices out into the future.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
I remember, because you and I were working together in 1999, 2000, and at that time you were being critical of people's assumptions that we'll always need more memory and that the price of memory should always go up. And I think you had a good insight at that time. This is before the bubble burst. There was, in fact, no reason to believe that there would be this infinite demand for memory. And we seem to be, to some extent, in a similar period now, or people are thinking the demand for memory is no longer cyclical. Is this going to keep going up and up and up? But my guess is it's going to feel a lot more like it did 25, 30 years ago. Highly cyclical. There's a short term, blockage here. And so the prices is going vertical, but the cyclical cycle hasn't been eradicated.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Yeah. Well, it's very nice of you to bring that up because I don't really remember being that fresh yet. But, if you say I was, I believe that but the other thing, which, well, it just leads me to make one other comments about and that the analogy that 25 years ago that, you know, 25 years ago, there was that phrase that became free come the new economy. People got the new economy. And that if you tried to point out that, well, gee, a lot of these, quote, new economy companies aren't really making any money that, you know, you'd get this kind of response, oh, you don't get it. You don't really understand. This is a new economy. And, my, my feeling at the time was that I did say this back. That was like, well, it may be a new economy, but it's still capitalism. And in capitalism, people put capital at risk. They want to earn a return on their capital. That doesn't change. You know, in 25 years ago, you know, the idea that you could go to the shareholders and say, well, we're not making any money, but we got, you know, look at all these people coming to our website. Yeah. Well, if they're not spending any money, I, as the person put up the capital, don't really care. You know, I want to make money that doesn't change. And at the same sort of thing happening today and one of the somewhat worrying, worrisome things, that I would point to over the last, year or so is that, you know, in the, in the risk model, we used to look at portfolio risk from this company called axiom. There are these, there's a dozen quote style risk factors. Things like size, profitability, growth value and profitability is one of the factors that has had the most consistent positive return over time. Which makes sense, makes intuitive economic sense. It's you know, profitability is a measure of basically your margins, your return on assets, your return on equity. It's a composite measure. It would make sense that if you are more profitable than other companies, you should get rewarded for that. And you have over time. But with two exceptions, if you look back, there's almost 30 years of data from axiom on these factor style factor returns. And there have only been two calendar years where profitability as a factor had a negative return. One of them was 2025 last year. The other one was 1999. Not necessarily the best, you know. Omen that, you know, given what happened after 1999. But when you find yourself in an environment where people are, where investors seem to be saying, I don't care about profitability, that's not what I'm going to reward. I'm going to reward these other things, that that in the end tends to come back to bite to that, because again, it's still capitalism. People still need to make return on the capital. They're, they're putting into a business. That's what it's all about. So, that does give me some pause that, that we.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
Yeah, again, I think it was 99. You brought, soda can into one of our cell location meetings, and you noted that the manufacturer had added.com to their name, and you couldn't understand how this is going to add value to the consumers. But regardless, they had a nice, surprise pop, as a consequence. And there's a bit of that going on now with ideas, AI is going to magically solve all these problems. And, beyond coding, it's not really clear that these applications are going to be solved. Really quickly. Customer service representatives are sort of the number two areas. I don't know if you've tried any of these services lately. They're still pretty terrible. And one of our themes is that AI will change the world. But as with every new technology, it takes a lot longer than people think, and especially true when you start moving into physical AI, Avs, robotics and stuff. This thing will take decades.
Robotics will be the biggest industry ever, but not until 2045. So yeah, I think the, the focus on profitability, and when that becomes what comes clear is really important. And there's so much focus now on hype on narratives and tech, stock price momentum.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Well, as a gift to all the economics nerds out there in the audience, let's talk about one last topic, which is, I'm not quite sure how to introduce this, but, because we talked about this, offline here, the, the sort of, Adam Smith versus Joseph Schumpeter and what is that? What am I talking about here? Tell the type of people what, what I'm referring to.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
Yeah. So for economists, you have Adam Smith, to some extent founded the profession. And so he had a view that there were cycles, but overall economic growth was stationary. You'd have marginal Arizona version. But really what created growth was gains from trade specialization, mercantilism, this sort of thing.
Schumpeter had a very different view, that you'd have major tech technological, revolutions. You'd have disruptive, disruptive innovation, creative destruction. So some firms disappearing, new firms coming. And so we think AI very much as schumpeterian in the growth coming from AI Schumpeterian growth, not Smithson growth. And so it's highly disruptive. There will be a lot of losers.
So we've noted that of the top 20 global tech companies now, the titans, probably half of those will no longer be in the top 20 pillars, say in 2035. And then there's over 2,000 unicorns globally. These are private companies valued over a billion. And many of these will go public. So for example, the top 20 unicorns in 2025 of those have since gone public, including Space-X, Palantir, Airbnb and so forth.
So and that that matters a lot for how you're thinking about the environment is we think that, you know, you still have to pay attention to some smithing indicators or indicators of the cycle, for example, unemployment claims and this sort of thing. But we may need to be paying a lot more attention to schumpeterian factors, the dislocations, the new companies coming forward who are going to be the winners, who are likely to be displaced and be the losers.
So I think the framework that investors need to adopt, is quite different for this sort of area than a more stable era. And this is what Smith had in mind, both Smith and Ricardo, they were actually very suspicious of innovation because they thought it would destroy a lot of jobs and not create many jobs. And there really hadn't been, much innovation, disruptive innovation, for thousands of years leading up to Smith and to Ricardo, the two industrial revolutions are poster writing.
So it is quite a different way of thinking about, financial markets and the economic environment underpinning them. That's that's pretty, economically wonky, I think.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Yes. Well, I know I'm sure our audience is very is on the edge of their seats for that stuff. I said that was the last question, but I like to, I guess we should wrap up with, like, advice to investors in this, in this wave of these sort of, IPOs that are coming, I guess some of the work you've done on looking at the performance of IPOs seems to imply that it's you kind of if you want to try to participate in these, it's best to try to get them all as opposed to picking your spots. You talked about that.
Kevin Hebner, PhD, Managing Director, Global Investment Strategist, TD Epoch
So for example, if you look at say what we do is look at the 14 most high profile tech IPOs over the last couple of decades. The average performance exceeds that of the S&P. But the distribution is really broad and it's skewed.
So a majority of companies underperform the S&P a couple outperform a lot. These are like the Googles and Amazons that outperform a lot. And so and but it's super hard for an investor an analyst to differentiate between those who will underperform on those outperform. So we think if you're going to participate in IPO's, what you want to do is to participate in all of them if you can.
So diversifying and diversification. So the one free lunch in economics, and to the extent you differentiate go for larger companies, tech companies VC backed companies, dual class companies we mentioned underperform and be suspicious of companies that trade on very high multiples, like a price of sales greater than 40.
Steven D. Bleiberg, Managing Director, Portfolio Manager, TD Epoch
Okay. I think we'll leave it there. Thanks Kevin for joining me. And, thanks to everybody for listening.
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