Follow-up on the IPO conveyor belt disconnect

We certainly don't agree with Mark Cuban on everything, but we give him credit for continuing to hammer on a subject of great importance to the economy at large: the lack of IPOs.

We wrote a post last week entitled "Disconnect in the IPO conveyor belt" discussing some of the ramifications of this problem, ramifications which extend far beyond the somewhat rarified and (to many investors) unfamiliar world of start-ups and venture funding -- ramifications which impact employment, prices, innovation, and the quality of all kinds of goods and services used in business and in daily life.

This morning, Mark Cuban was on CNBC again talking about this subject, and made the point that the dysfunctional IPO landscape also has a negative impact on equity markets in general.

Specifically, he said (beginning at about 00:45 seconds in the above-linked clip):

If we have a problem, it's not that there's frothy valuations for tech companies in the public markets: it's that there's no tech companies that have high growth rates, that are in a position to get frothy valuations -- that's the problem. I mean, if you look at, you know . . . tell me who the high-growth-rate companies are today that have under a hundred billion dollar market caps -- Netflix? You know, how many of them are  there? And that's the real problem in this market. And what's happening is, you've got -- because companies are refusing to go public -- it's just, you know, if you want to talk about the Valley, the whole ethos is now: "Don't go public." It's crushing our stock market.

This is a huge issue, for all of the reasons we discussed in the earlier post (here's that link again) and in our post from 2013 on this same subject, as well as the reasons discussed in Mark Cuban's blog post from February on this topic, and the even more in-depth discussion in the excellent article from Julie Segal from 2010 which we linked in the previous post as well.

Despite what Mark Cuban appears to be saying at the very beginning of the clip above, we don't actually agree that the solution is to "write down to zero" any investment in a private company that is not yet profitable -- one reason start-up companies raise venture capital is because they are not yet profitable, despite having a new or innovative idea which could be profitable in the future.

For that matter, many innovative public companies may not yet be profitable, but this does not mean that investors should "write their stock down to zero." We actually do believe that there are innovative and worthwhile companies for investors to analyze whose market capitalizations are well below $100 billion (some of which may not yet be profitable), but we definitely agree with Mark Cuban that there are a lot fewer of them than there might be if the funding and IPO landscape were not as dysfunctional as it has been for the past fifteen years.

Of course, there are many other contributing factors to this present environment, including the increasingly convoluted regulatory landscape and the additional costs which have been added to the burden of being public in the past fifteen years (or more -- the process has been going on for quite some time).

We commend Mark Cuban for his efforts to bring this situation to the attention of a wider audience.



At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Netflix (NFLX). For the record, the market cap of Netflix at time of publication was approximately $38 billion.

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Disconnect in the IPO conveyor belt

image: Wikimedia commons (link).

Entrepreneur and investor Mark Cuban was on CNBC's "Squawk on the Street" this morning discussing what he sees as a "disconnect" in the progression from company formation ("start-ups") to growth and access to the capital markets through public listing. In a response to a question about the lackluster economic growth in recent years, he replied:

There's a disconnect right now because so few companies are going public. That gives an incentive for any S&P company, any major public corporation, to just wait and see rather than investing -- making capital investment in their own company, the things that make them competitively strong -- just waiting to make an acquisition. 

And so if you are not investing in yourself -- look, there's hundreds of billions of dollars being invested in start-ups of all kinds, whether it's retail start-ups, technology start-ups, biotech start-ups -- and so, rather than big companies having to invest in their own R&D, they just sit back and wait because now the culture of start-ups is you don't go public: you look for an exit. [based on the unofficial transcript posted by CNBC here].

In other words, he notes that very few start-ups are trying to make it all the way to public viability as a new competitor on the scene, and instead their founders and investors are just looking for "an exit" by selling to a large company. One effect of this situation, he points out, is that the big companies can outsource the research and development that they would normally undertake, and just watch for interesting or innovative start-up companies, and buy the ones that look promising -- absorbing their technology.

Mark Cuban casts this situation as a negative development -- and we agree with him.

We would argue that the reason so many entrepreneurs have a culture of (in Mark Cuban's words) "You don't go public: you look for an exit" is not that they wouldn't want to go public and compete as an independent entity, but because the path to doing so has become much more constricted over the past twenty years, for a variety of reasons, leading to an unhealthy situation which has ramifications far beyond the world of venture investing and which ties in to the health of the economy at large. 

The "conveyor belt" connecting innovative ideas with access to capital that entrepreneurs require in order to grow and compete on their own in the economy is broken, to the point that many companies which could become viable players never even get funded, and those who do end up getting bought by big, existing companies. It is a problem that signals unhealthy developments involving the capital market landscape, although it may manifest itself more noticeably in the world of start-ups.

It is a topic that many experienced investors in the venture capital landscape have been writing about for the past few years. Mark Cuban published a more detailed discussion of some of the issues he expressed in today's interview in a blog post he wrote this past February, entitled "The Pre-cognitive Anti-trust Violation: How the decimation of the IPO market has hurt the economy and worse." 

The title may at first seem a little whimsical, but it actually conveys an extremely important idea, albeit in a somewhat obscure metaphor that takes a little thinking in order to unpack. 

It appears to be a reference to the "pre-cogs" in the famous movie Minority Report, which depicts a dystopian future in which three psychic beings known as "pre-cogs" are able to see crimes before they happen, and then law enforcement officers can go take down the criminals before they even carry out the future crime (a situation which is obviously ripe for horrific abuse, as the movie dramatizes quite effectively, and as the brilliant author Philip K. Dick was trying to warn society when he wrote the story upon which the movie was later based).

Mark Cuban implies that unhealthy constriction in the pathway to public viability is enabling established competitors to do a kind of "pre-crime" take-down of their future competitors, before the competitor even has an opportunity to get out into the world and become a competitor. Thus, it is a situation in which competition is killed off in much the same way that the anti-trust advocates of a hundred years ago were worried about, but in an even more sinister way -- before the competition even happens (hence the reference to the "pre-cogs" of Minority Report fame).

The negative effects of such a situation are obvious: less opportunity and incentive for companies to innovate;  less opportunity for investors to invest in small public companies before their real growth kicks in; less capital available for entrepreneurs to create a viable business; less ability for employees to benefit financially from the added work and risk they take by working at a startup; and ultimately fewer jobs, fewer opportunities, and less innovation for the economy at large.

And those are just the more obvious negative effects of the problem that Mark Cuban is describing!

We ourselves also wrote about this phenomenon back in May of 2013, in a post entitled "Crossing the chasm to IPO becomes even more difficult."

Perhaps the deepest and most thorough analysis of the historical causes of this phenomenon could be an article written by veteran investment journalist Julie Segal, published in 2010 in Institutional Investor entitled "Death of the IPO." Even more wide-ranging consequences that she traces back to this problem include a reduction in the volume, availability, and ultimately quality of equity research. 

The most telling of the ramifications she points to is the widening divide between "Main Street" and "Wall Street," as the connecting link between the two is narrowed, constricted, or obstructed completely.

This is a very serious subject, and one we commend Mark Cuban and others for discussing candidly. The solutions to the problem are not easy or obvious -- as Julie Segal points out in her article, some of the contributing factors go back to decisions made decades earlier. But it is one that we believe investors should think about and understand.

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Pfizer CEO Speaks Out Against the Insanity

image: Charles Pfizer (1824 - 1906), entrepreneur, chemist, co-founder of Pfizer.

We have been long-term owners of the shares of Pfizer, Inc., the major drug company, in our TFCM Income Strategy.  Its more than 3.5% dividend yield, which has grown over 8% per year in the last five years, and its slow but steady growing business has made it a fine investment for that strategy and for our clients who own it.

Given that we make a point to own companies run by people who are very capable and smart, we are particularly proud of the opinion piece written by Ian Read, Chairman & CEO of Pfizer, that was published in the Wall Street Journal.

In it, Ian highlights the folly of the recent ruling by the U.S. Treasury Department, run by Jack Lew (and ultimately Barack Obama), which undermines the very core of the rule of law and further puts American companies and the American economy at risk of further weakness.

At some point we believe Americans will have to take a stand against this type of behavior.  Unfortunately, what most may come to realize is that more and more American companies will simply choose to leave altogether, likely led by the smaller businesses who will choose to start somewhere else (maybe Ireland?) rather than put up with the type of anti-business rhetoric and actions that seem to have become commonplace in America these days.

Enough said, since Ian does a better job of describing the predicament than we can!

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Extraordinary Happenings In Brazil

image: Brazil protests (link).

It has not been highly publicized in our media but the events in Brazil in the last few weeks are nothing short of extraordinary and underscore how socialist, crony policies and actions are always doomed to fail.  What is most notable is that Mises is being preferred to Marx by the young people in the streets; 4 million of them!  This is worth noting as we have watched the "Latin Miracle" go up in flames in recent years.  In the 1990s, led largely by movements in Chile and Argentina, it looked like the decades of "Banana Republics" were finally over and free enterprise was taking hold.

Many businesses were being privatized, most notable Telebras, the Brazilian telecom monopoly that was broken up in favor of regional "baby bras's".  Over the course of the next several years however, many of the nations that were leading the charge seemed to give up on the experiment and allowed characters like Lula in Brazil, Kirchner in Argentina, Morales in Bolivia and of course, Hugo Chavez in Venezuela, in one form or another to set back or completely reverse the reforms that had made it look in the 1990s as though Latin America was going to join the ranks of the "free enterprise" nations.

Maybe they will someday get it right?

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Mobile World Congress 2016

We just returned from the Mobile World Congress 2016 (MWC 2016) in beautiful Barcelona, Spain.  With over 2,000 companies presenting their products and services, and 100,000-plus people in attendance, MWC 2016 lived up to expectations as the premiere trade show/conference for "everything mobile" again this year.

We attended MWC 2016 in order to get firsthand experience viewing the latest and most innovative offerings from many of the companies in our portfolios, as well as to gain exposure to new ideas and companies from around the world, upon some of which we will certainly be doing due diligence with respect to new investment opportunities.

As the MWC 2016 tag line was "everything mobile" and "mobile is everything," we couldn't agree more as there is no doubt that some of the most exciting ideas in the investment world relate but their  to mobile/wireless technology.  Full disclosure: we are invested in private Israeli company ASOCS, Ltd through  Taylor Frigon Capital Partners LP (TFCP LP), but their launch of the generation 3 virtual base station (vBS) was simply mind-boggling!  

ASOCSs software defined radio (SDR) is going to make it possible for carriers such as Deutsche Telekom, Telefonica, Verizon and AT&T to reduce the cost of deploying base station for cell towers by roughly 90% by some estimates.  This is huge for purposes of increasing cell coverage and the bandwidth capability for mobile networks around the world.  The most significant take away from our discussions with CEO, Gilad Garon, was his statement: "5G is just a software upgrade with our system."

Additionally, the Internet of Things (IoT) was a major focus at MWC 2016.  Here, TFCM Core Growth Strategy holding Qualcomm (QCOM) was clearly making major noise with its Snapdragon processors.  Snapdragon can be found in devices that enable everything to be "connected" -- from your car to your clothes!

TFCM Income Strategy holding, Intel (INTC), is also a big player in the IoT.  Its "Smart Home Gateways" are set to connect just about everything in your home.  It's great to see a company that pays significant cash dividends is still investing in the future so as to ensure they will be able to grow those dividend over the coming years!

Another big hit at the show was the Samsung "Gear VR" (powered by Oculus, a Facebook company) virtual reality device which enables you to connect your Samsung Galaxy phone to the Gear VR headset and become immersed in "virtual worlds."  Another TFCP LP company, OTOY, Inc., is very closely working with Oculus on the delivery of VR/AR content through the cloud.

The description of innovative and fascinating technologies can go on and on but the most important revelation we take away from the 2016 MWC is that many of the trends and paradigm shifts that we have been following for the last fifteen to twenty years seem very much intact and perhaps even accelerating.

At the time of publication, the principals of Taylor Frigon owned securities issued by Qualcomm (QCOM), Verizon (VZ), Telefonica (TEF),  and Intel (INTC). At the time of publication, the principals of Taylor Frigon did not own securities issued by Facebook (FB), AT&T (T), Samsung Electronics (SSUN), or Deutsche Telekom (DTE).

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