More, smaller IPOs do not signal a bubble

About a year ago, we published an article expressing our concern that the landscape for companies making it from start-up to IPO had become very unhealthy and had turned into an absolute desert (see "Crossing the chasm to IPO becomes even more difficult," May 17, 2013).  

In that article, we noted that since 1999, and especially since 2008-2009, IPO data has shown a clear trend towards fewer and larger IPOs, making a distinction between the number of IPOs and the amount of dollars raised in those IPOs: the data at that time showed that even when the amounts raised turned back upwards, the number of IPOs remained depressed, indicating that only a few "super-investments" were making it all the way across the difficult chasm from startup to IPO, and that the few who did make it were going public for much larger valuations than were typical in the past (companies like Facebook typified this recent trend).*

We argued that this situation was a negative sign for the economy, for a number of reasons.  First, it indicates that many companies which might have been good enough to go public in the past were languishing in the desert between initial venture backing and IPO, where many would likely perish for lack of funds that in the past could have helped them get their companies off the ground.  When that happens, new and innovative ideas that could make the world better are never realized.  Competition that could bring down prices for consumers or increase quality in that particular industry dies before it makes it out of the nest.  Big incumbents can swoop in and buy up potential competitors for lower prices, either incorporating their potential competitor's innovation, or shelving it indefinitely.  Companies that could contribute to the general standard of living and to the economy might never provide the products, services, or jobs that they might otherwise have provided.

A second negative aspect of the unhealthy IPO desert of the post-2008 era, in our view, is the fact that the trend towards fewer and larger IPOs means that what we might call "ordinary investors" miss out on the opportunity to invest in young, innovative companies before they become behemoths.  If the only companies who make it to the IPO stage are marquee-names like Facebook (which went public at a valuation of over a hundred billion US dollars), then those companies are already huge, mature corporations when they make it to IPO -- and the IPO is by definition the first time that the general public has a crack at investing in those names.

Since we published that article last year, however, the situation has begun to turn around.  An examination of the IPO statistics over at the excellent website of Renaissance Capital now shows clearly that the number of IPOs is growing much faster than the proceeds raised over the past year.  For data through the 26th of March, 2014, their website shows that the volume of proceeds raised in IPOs in the US has grown by 32.2% versus the prior year at this time ("blue chart," below), while the volume of pricings of individual IPOs themselves has grown by an astonishing 83.3% for the same period!  This means that the trend is reversing: more and smaller IPOs are coming to the market.

Right on cue, however, the financial media is now wailing about an "IPO bubble."  Here is a sampling of some recent headlines:

• "Is the IPO market in a bubble?  What to look for . . ."
• "Silicon Valley Hears Echoes of 1999"
• "Are we staring at a tech stock bubble?"

That last article features this quotation: "One of the great indicators of a bubble is when young companies are trying to access the capital markets in great quantities.  We've seen a proliferation of these at an accelerating rate over the past six months."

We would disagree with that broad assertion -- in fact, we would argue that one of the great indicators of a healthy economy is when there are large numbers of young companies making their way "across the chasm" from start-up to IPO.  That is exactly what is supposed to happen in a growing economy!  

It is certainly possible for that process to get out of hand, and most would argue (ourselves included) that the process did get out of hand in the late 1990s, but we believe that it is very difficult to argue that the current environment resembles the 1990s in any way.  In fact, as the above discussion illustrates, the numbers argue that we have been in a very unusual IPO "desert" in recent years, and so arguments that a pickup in IPOs from smaller, younger companies after such a dearth should hardly be taken as a sign of an unhealthy "bubble" situation in the IPO market.

Pictured above is the first page of the initial offering prospectus from another "young company" that was "trying to access the capital markets" -- back in December of 1980.  That company was Apple Computer, and as the prospectus shows, they offered four million six hundred thousand shares of their company in their IPO, at a price of $22 per share, for a total raise (price to the public) of $101.2 million.*   If you take a look at the original prospectus here, you will find a table on page three showing that the company had a little over 54.2 million total shares outstanding at the offering, giving the company a valuation (or market capitalization) of about $1.19 billion at $22 per share.  In other words, the company went public at a much lower valuation than some of the mega-IPOs of recent years.  This meant that even "oridinary investors" could get in on this young company and experience growth in the years to come.  The company was by no means a behemoth by the time it came public.

Another illustrative example is Microsoft, which went public in March of 1986.*  As the first page of their prospectus (shown below) explains, Microsoft offered a total of 2,795,000 shares priced at $21 per share on the day of their IPO, for a total raise of $58.7 million.  If you take a look at their original prospectus here, you will find a table on page four showing that the company had a little over 24.7 million total shares outstanding at the offering, giving the company a valuation (or market capitalization) of about $519 million at the $21 per share.  

Again, we can see that the company went public early enough in its history that "ordinary investors" could purchase shares and participate in years of growth.  When the situation is skewed towards only behemoths like Facebook hitting the IPO market, the only people who can buy shares when the company is valued at $500 million (like Microsoft at their IPO) or even $1 billion (like Apple at their IPO) are the venture capitalists, angel investors, and corporate insiders at the company itself.

Some pundits are apparently happier to see the IPO market restricted to only the enormous mega-successful names, along the lines of Facebook, rather than Apple in its 1980 incarnation or Microsoft in 1986.  We believe that is a mistake, and that the current trend is a healthier sign.  We hope that it continues.

* At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Facebook (FB) or Microsoft (MSFT).  At the time of publication, the principals of Taylor Frigon Capital Management did own securities issued by Apple (AAPL).

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A walk down memory lane

Yesterday marked the five-year anniversary of the lowest point for the bear market of 2008-2009.  On March 09, 2009, the Dow Jones Industrial Average reached a low of 6,516.90 (today, March 10, 2014, the Dow opened the day at 16,453.10).  The S&P 500 index actually reached its low of 666.79 on March 06, 2009 (today, the S&P opened the day at 1,877.86).

On March 02, 2009, we published a post in this blog entitled "Don't get off the train," in which we wrote: 

As unbelievable as it seems now, there will be a turn in what seems to be a never-ending bear market cycle.  When the markets will turn back up is anybody's guess.  However, when it moves, it can move very rapidly.  [. . .]  This is why we have always emphasized focusing on the business and not the market prices, as we discussed in this previous post, as difficult as it might be in this environment.

One month later, we reflected on that discussion in a post entitled "Don't get off the train, revisited," in which we noted that there were plenty of people who had missed the sudden turnaround in the equity markets which took place in March of 2009 -- and that there were still plenty of people saying the move was just a "sucker's rally" (and we linked to an interview of one well-known investment personality saying that the recent rally was not to be trusted, that the March 9 bottom was not the bottom, and that "we're going to see more bottoms in the next few years").

Since that (incorrect) prediction by that colorful commentator, there has been no shortage of pundits warning that the recovery in the economy and the equity markets was doomed to collapse at any moment, and that investors were in for (as another confident financial personality put it) either a "nasty correction or years of treading water."  You can see on the S&P chart above where the markets were when we commented on that dire prediction -- and you can see where the equity markets have gone since that prediction and the returns that those who listened to those market predictions would have missed, had they taken that (incorrect) prediction to heart and stepped "off the train" based on what the pundits were saying.

During just about every dip in the chart above, there were serious-looking commentators standing by to deliver confident-sounding predictions of another "double-dip" recession, meltdown, or return to the 2009 lows.  Some of the posts we wrote in order to try to inform our readers of what they should really be paying attention to are listed along with an arrow pointing to the point in time at which we published them.  Those include "Double-dip ahead?" "More data says 'no recession.' So why is everyone so uneasy?" "Who is right, Bill Gross or Jeremy Siegel?  Answer: George Gilder"  and "Rip Van Winkle, revisited."

The point of this walk down memory lane is emphatically not to try to establish our ability to predict the market direction better than the talking heads you see on the financial media outlets.  We have always disavowed any ability to "call the market" correctly, year-in and year-out for decades -- and we don't believe anyone else can do that, either.

Instead, we believe that the lesson investors should take from the above record is that they should give up on the "persistent delusion" of trying to time markets, which (as the above chart shows) can be just as dangerous as trying to time trains!  We even wrote a post making that exact point, along with a graphic video that should drive it home quite strongly, entitled "Market-timing and train-timing," in which we said: "trying to time markets is a lot like trying to time trains: if you make a mistake, you can get flattened."

Today, on the fifth anniversary of the turn in the bear market, it should come as no surprise to find plenty of articles noting the occasion and ringing alarm bells that the "party could soon be over." We hope that readers of this blog will quickly recognize that the authors of those articles are reinforcing that "persistent delusion" -- and will waste little time with such "stock market guessing."  

We believe that time invested in finding well-run businesses positioned in front of fertile fields for future growth is a much better use of investors' time than listening to the prognosticators who can always find a host of reasons to back up their often-incorrect predictions (you can see the performance of the TFCM Core Growth Strategy here for an example of how our portfolio of well-run businesses has performed since inception).

We might even add that reading back issues of the Taylor Frigon Advisor might be a better use of their time as well!

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Post-Newtonian economics

In spite of the fact that recent US economic data has shown new home sales increasing strongly (latest report showed a 9.6% increase in January new single-family homes), strong numbers on business investment in equipment (growing at a 10.5% annualized rate according to today's US GDP revision data), and strong corporate profits (recently making a new all-time high), investors and the general public at large continue to demonstrate angst over the economic outlook and to express concern that somehow any recovery since the 2008-2009 crisis has been entirely engineered by the Fed and could collapse again at any moment.

As an example, after Fed Chair Janet Yellen addressed a Senate panel yesterday (article here) and said that it is difficult to determine whether recent "softness" in economic data was related to exceptionally cold weather over the past few months or whether it could indicate that growth was slipping for another reason, many observers took it as evidence that the Fed might soon consider putting a temporary hold on the "tapering" of quantitative easing -- and financial markets rallied at the prospect!

We have said many times in the past that we do not believe that good investing is based upon an ability to predict the next move in the economy, and we have also said that we have never held ourselves out as being able to predict the next move in the economy, either (see for example here).  We also do not have much confidence in anyone else's ability to do so. 

However, we can say for certain that we do not believe that the economic recovery that has taken place since the 2008-2009 recession -- as weak as that recovery has been, for a variety of reasons -- has been due to the easy-money policies of the Fed or its quantitative easing.  Neither do we think the economy will suddenly collapse again if the Fed keeps on tapering, or even if the Fed raises interest rates.  In fact, we would argue that the Fed's extreme policies have actually been part of the reason that the recovery has been less robust than it should have been.

This is because we believe that economies are actually driven by something very different than what most people mistakenly believe drives economic growth.  We do not believe that economies tend to fall apart without government care or central bank micro-management.  We do not believe that various forms of "stimulus" are necessary to prod and poke people into spending money or starting businesses or trying to improve their own situation -- or even trying to improve the situation for other people around them.  In fact, we believe that these things tend to happen by themselves, as men and women use their talents and creativity to come up with new ideas and to experiment with solutions to problems.  It is government tinkering that tends to be the problem, not the solution, although a big economy composed of enough men and women trying to solve problems can resist an awful lot of government tinkering without breaking down (as evidenced by the economic growth over the past five years).

In light of this view, we would like to introduce into the discussion some extremely important statements made by George Gilder in a recent talk (video here), in which he expounded upon the revolutionary economic views he published in his new book, Knowledge and Power. In that talk, he explains that the economics of Adam Smith -- as positive as Adam Smith's contribution has been to economic thought -- were really a reflection of Newtonian physics, and the view of the human being as a kind of atom in a world of other atoms, responding to the incentives and pressures and scarcities and resources that he or she encountered (see the portion of the video between 3:00 and 4:00).

This view, Gilder explains, in many ways reduces men and women (in the eyes of economic theorists) to the equivalent of a chicken in a "Skinner box," reacting to this or that stimulus.  Such a view invites governments to try to create the perfect set of conditions, adding or withdrawing stimulus here or there, trying to prod the poor homo economicus this way or that, in order to steer the economy into growth.  George admits that even supply-side economics (of which he has been a champion in the past) falls into this fallacious view of mankind (see the portion of the video between 4:00 and 5:00).

Instead, George offers a radical new view of economic theory -- one that may perhaps be called "post-Newtonian economics"!  He argues that an economic system is "a knowledge system, not an incentive system."  In a knowledge system, knowledge is gained by performing a series of falsifiable experiments, in order to gain information and ultimately form conclusions.  This, George argues, is what entrepreneurs do at all levels (from the largest businesses to the smallest): they try different solutions to see what works.  It is the entrepreneur or innovator who comes up with a new solution, who introduces the key element of surprise into the world, who actually creates economic growth. 

This is a very different model than the "incentives-driven" view of economic growth.  We have touched on this important insight of George's previously here as well.  If he is correct, and we believe that he is, then that means that investors should spend a lot less time worrying about the level of Fed stimulus, and a lot more time analyzing which companies are creating "successful experiments," so to speak.  Which companies are offering some new solution, a solution which may have been a surprise when they first brought it out, and which solutions are gaining traction as people or businesses like that solution and find value in that solution. 

Businesses which we believe are doing that can be found all over the economy, even in the economic conditions we are facing today.  They may be creating new solutions in surgery, by using robots; they may be creating new solutions in transportation, by matching up carriers with shippers in more efficient ways; they may be creating new solutions in data networking, by using software to do tasks that previously required dedicated hardware; they may be creating new solutions in ways that we haven't even noticed yet, but which you have noticed in your own business activities or daily life!

We believe George Gilder's new, post-Newtonian way of looking at economic and entrepreneurial activity is truly world-changing.  And we believe that adopting that mindset can be very beneficial for investors and economy-watchers alike.

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The Truth About the Minimum Wage

One would have thought by now that in a country as advanced as the United States, a debate about the merits of minimum wage laws would be unnecessary.  Anyone who has a rudimentary knowledge of economics knows that if you increase the cost (price) of something, you tend to get less of it.  Therefore, if the goal is to lessen the availability of lower paying, low skilled jobs then mandating that the provider of such jobs increase the wage (cost) that it must pay to employees in those positions could be considered a sure-fire way of lessening their availability.  

It is a shame that the recent politicizing of this issue has caused it to become considered a viable option for improving economic growth.  However, given that there are those who apparently believe that increasing unemployment benefits are also acceptable methods of fostering economic growth, perhaps we should not be surprised that views on the minimum wage are surfacing in the manner that they are!

Fortunately, there are still voices of reason and truth out there who are able to put the nonsense in its proper place.  Economist Scott Grannis in his Calafia Beach Pundit blog, offers some excellent data on the reality of the minimum wage in this country.  The "money" statement from Scott regarding the minimum wage is "....Raising the minimum wage would therefore benefit only 1-2% of the population, but it would probably make life miserable for young and inexperienced workers, who could find that the jobs available to them have vanished because the minimum wage has been set at a level which exceeds their productivity."  We completely agree.  Kudos to Mr. Grannis!

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Have you heard of this company? QUIK

Over the years, this blog has highlighted companies as examples of the type of growth investment we look for when allocating investment capital and which embody the business characteristics we write about on this forum.  We have previously explained in some detail that we look for companies which we believe exhibit two fundamental characteristics: "capable, dynamic management operating in fertile fields for future growth" (see for example this and this previous post). 

Previous companies we have discussed which we believe exemplify these two broad characteristics have included TSCO, RMD, and EZCH.*

Another company we believe to have "capable, dynamic management operating in fertile fields for future growth" is programmable semiconductor designer QuickLogic (QUIK).* 

QuickLogic is currently a small company, with a market capitalization of only a little over $200 million.  The company designs semiconductors which can be used in consumer electronic devices to perform a variety of tasks in conjunction with the main processor (or apps processor) to enhance the device's overall performance while at the same time reducing power consumption and extending battery life.  These two characteristics (enhanced performance and reduced power consumption) are extremely important to designers of mobile devices, for obvious reasons. 

Having another processor, such as those sold by QuickLogic, handle certain tasks rather than making the apps processor handle them typically saves power, because running the apps processor consumes a lot of power. 

Also, apps processors by their nature are typically "general purpose" -- they are designed to be able to run all manner of applications, from helping you find your way with turn-by-turn navigation to allowing you to play Angry Birds, and everything in between.  Therefore, the apps processor does not really enable makers of consumer devices to easily differentiate their product in the highly competitive markets in which they compete.  Many of their competitors will be using the same (or similar) apps processors, and the consumer will only notice a difference when one processor is noticeably faster or more powerful than a competitor. 

QuickLogic's products, however, are designed to provide very distinctive features that enable device manufacturers to differentiate their devices.  For example, one product category offered by QuickLogic enables better visibility of a display screen in conditions of bright sunlight, while at the same time providing savings on power consumption (because QuickLogic's solution runs algorithms to optimize aspects of the image and contrast, but does it outside of the apps processor using Quick's inherently low-power logic).  This capability is an example of the kind of differentiation which makers of consumer electronic devices desperately need in the highly competitive race to produce the next popular smartphone or tablet.

Another important category of products, newly announced by Quick and discussed in the video above, is a processor designed to monitor sensors. The number of sensors on mobile devices is growing rapidly; sensors can be anything that is designed to measure and monitor the environment or the device's position in three-dimensional space, and include cameras, microphones, thermometers, accelerometers, gyroscopes, compasses, and other tools. 

Devices in general and mobile devices in particular are becoming more and more aware of their environment, and will soon be able to tell whether they are riding in a car, or being pushed in a baby stroller, or accompanying their owner in a pocket.  They will be able to tell if their owner is looking at their screen at the moment, or not, or if he or she has gone to sleep.  Some devices are already capable of some level of awareness, and some applications developers have already created apps to be able to take advantage of this awareness.  Examples include games that can be controlled by tilting or shaking your smartphone or applications that count how many steps you take during the day and which give feedback on calories burned.  Indications are that the number of sensors on mobile devices (and virtually every connected device in the "internet of things") is about to grow exponentially, as will the number of applications written to take advantage of all the new awareness these sensors will provide.

One of the challenges that all these new sensors will pose, of course, will be the potential for a massive increase in power consumption.  If your phone's apps processor is required to constantly monitor the level of ambient light, the surrounding temperature, and whether the phone is at rest or in motion, that will create a major drain on the battery.  QuickLogic's solution is to offer a separate processor (sometimes called a "co-processor") which is far more energy-efficient than the "speedy" but power-hungry apps processor, and to use this processor to monitor all the sensors in the device.  This co-processor in charge of all the sensors is sometimes referred to as a "sensor hub."  The sensor hub can wake the apps processor up if it is needed, based on input received from a sensor, but otherwise it can let the apps processor rest in a low-power state while the sensor hub monitors the surrounding environment.

This type of capability can enable tremendous differentiation for makers of mobile devices.  For example, perhaps some consumers would like to have a phone that can tell if their user has put the phone inside of a purse, so that the phone can know to ring louder when it receives a call or a text while it is in the purse.  Or, as described in the video above, perhaps a phone with an app that is supposed to count steps taken during the day could tell if it is being pushed along in a jogging stroller, so that it could continue to give credit for those steps too, instead of thinking that it is sitting still and therefore not giving its user an accurate count. 

The possibilities for sensors and the apps that developers can come up with are endless, but if the device's big, power-hungry, speed-optimized apps processor had to monitor all the sensors all the time, most of those possibilities would never see the light of day, because they would be too taxing on the battery.  QuickLogic's solutions are extremely power-efficient, and (as described in the video above) are the first sensor hubs which use less than 2% of the battery power.  In fact, Quick estimates that their processors use about one-thirtieth of the power of other processors that have been put forward as possible sensor hubs by competitors so far.

Another important aspect of QuickLogic's products is the fact that they are programmable.  This aspect is also extremely important to device designers attempting to differentiate their products in a competitive and rapidly-changing marketplace.  Programmability enables equipment designers to customize a chip, and to do it much more rapidly than the non-programmable alternative which can be time-consuming and expensive.

In fact, QuickLogic has a long history competing in the programmable-logic market, which is dominated primarily by two much larger companies, Altera (ALTR) and Xilinx (XLNX).**  QuickLogic's approach was far more power-efficient than that of either Altera or Xilinx, but in the era before the recent mobile-device revolution, that approach was not a significant differentiator in most large markets, and Quick eked out its living servicing a few very niche markets. 

However, as CEO Andy Pease explains in the first part of the video above, when he was hired to lead the company, he assessed the company's key strengths and focused their efforts on addressing the areas where Quick's unique capabilities could provide the most value to their customers.  It just so happens that the ongoing mobile-device revolution, and (we believe) the upcoming sensor-driven revolution, play right to Quick's strengths, a fact which tends to validate Andy Pease's vision for Quick's future and the decisions he has made since joining the company in 2006.

This point brings us back to the first important characteristic in the classic growth formula: not only must the company be positioned in front of fertile fields for future growth, but it must also be characterized by capable, dynamic management.  Our interactions with the company so far, and the company's history since Andy Pease took the helm, indicate that QuickLogic is extremely well-led.  His recent decisions to develop re-programmable technology in addition to Quick's traditional one-time programmable technology, very important for navigating the rapidly-changing environment as the sensor revolution unfolds, and to establish an "office of the CTO" in order to make his Chief Technology Officer more of a strategic executive steering the company's future technology course, are both briefly discussed in the above video and both support the conclusion that Andy Pease is an insightful leader capable of making tough decisions necessary to position the company for the future.

We believe that investors can learn a lot by studying QuickLogic as an example of a classic "Taylor Frigon growth company" that typifies capable dynamic management positioning their business to address fertile fields for future growth.

* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by Tractor Supply Company (TSCO), ResMed Inc. (RMD), EZchip Semiconductor (EZCH), and QuickLogic (QUIK).

** At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Altera (ALTR) or Xilinx (XLNX).

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