The NZX has struggled to attract quality listings. Photo / NZME
There’s a battle going on between the public sharemarkets and private equity, and private equity is winning.
JPMorgan Chase & Co chief executive Jamie Dimon has for some time commented on the diminishing role of public companies in the American financial system.
From their peak in 1996 at 7300, United States public companies now total 4300 – the total should have grown dramatically, not shrunk, Dimon said in a letter to shareholders.
Meanwhile, the number of private US companies backed by private equity firms, which does not include the rising number of firms owned by sovereign wealth funds and family offices, has grown from 1900 to 11,200 over the past two decades.
“This trend is serious and may very well increase with more regulation and litigation coming,” Dimon said.
“Along with a frank assessment of the regulation landscape, we really need to consider: Is this the outcome we want?”
Dimon feared regulation could be driving companies from the public markets.
“The reasons are complex and may include factors such as intensified reporting requirements (including investors’ growing needs for environmental, social and governance information), higher litigation expenses, costly regulations, cookie-cutter board governance, shareholder activism, less compensation flexibility, less capital flexibility, heightened public scrutiny and the relentless pressure of quarterly earnings.”
Dimon’s comments could apply anywhere.
In New Zealand, it’s been a long time since the NZX has seen an initial public offer and sharemarket float of any size.
There was the disappointing debut of My Food Bag in March 2021.
Then came chemicals specialist DGL, which listed in May that year only to decamp to the ASX in July 2022 after a public fracas surrounding comments made by founder and chief executive Simon Henry.
The highlight of 2021 was Vulcan Steel’s debut in November of that year.
The dual-listed steel distributor, which started life in a garage in East Tamaki, two trucks and a Portacom, is now worth about $1 billion.
Since 2021 it’s been slim pickings.
Devon Funds head of retail, Greg Smith, said it’s been a disappointing trend.
“We know first-hand in New Zealand that the public markets have been pretty constrained.
“We have seen so few new listings and a lot of companies either abandon their listing or get taken over,” Smith said.
He said there is a lot to be said for healthy public markets.
Public access to capital can help businesses grow and can play a big part when things go pear-shaped, but being listed comes with baggage.
“When you are in the public markets, you are in the public eye,” Smith said.
“There is more transparency and more regulation.
“That can come at a cost.”
Conversely, private equity-funded businesses can conduct themselves outside of the public eye.
Firms sold to private equity tend to go at a higher premium, said Smith.
“That’s also what the public capital markets are competing with.
“If you list on the public market, much of its success depends on the environment.”
As a case in point, Smith highlighted Virgin Australia pulling its initial public offer plans last year due to a nervy market.
“Exit, via private equity, is a lot more about negotiation and there is more certainty there.
“When you list on a public market, you don’t know what kind of valuation you’re going to command.
“With private equity, you can be a lot more precise, so that’s probably the battle,” he said.
Smith said there is widespread appreciation of the need for healthy capital markets.
He said Dimon’s concerns arise from the intense public scrutiny of US-listed companies, partly due to the requirement for quarterly reporting.
“That doesn’t happen in private equity. We need to look at this in terms of how we attract more companies to look at the public market as a viable option.”
Smith said companies around the globe should consider the public markets.
“New Zealand Inc, I think, benefits if we see more public companies list.”
The public versus private debate may well play out with Fonterra, which has its consumer business up for review.
Smith said that while an initial public offer for the business is possible, either a trade or private equity sale looks likely.
“The share market has been fairly tepid this year, so when you have buoyant market conditions, there is more attraction for a company to list.
“But good businesses will be rewarded on the capital markets over time.”
He said there can be an element of “short-termism” with private equity.
“With private sales, you can negotiate the price and you know what you are going to get – whether it be a partial or full exit.”
On the public markets, the good companies that perform over time see their shareholders rewarded.
“If you take a long-term view, that’s the big attraction.”
Going public has its advantages from a capital management perspective.
A case in point is the Auckland International Airport’s quickfire $1.2b capital raise in April 2020, when it was becoming clear that Covid-19 was going to hit aviation hard.
“It’s a tremendous source of capital, as and when required,” Smith said.
The liquidity of public markets is another big plus. Listed company investors can come and go at a price determined by the second during any trading day.
That contrasts with virtually no liquidity in the private equity sphere.
“You are effectively locked in for the duration.”
Private equity valuations can also be subjective, he said.
Nigel Bingham, managing partner of Kiwi private equity firm Pencarrow, said Dimon’s comments are nothing new.
Pencarrow’s recent successes include Seequent, Icebreaker, BrewGroup (formerly the Bell Tea & Coffee Company), Avanti Finance, RedShield and The Skin Institute.
Seequent, a geoscience software company – sold to Nasdaq-listed Bentley Systems in 2021 for $1.45b – was the standout.
Bingham pointed to a widely-acknowledged paper published in the Harvard Business Review written by Michael Jensen in 1989.
The thrust of Jensen’s argument was the publicly held corporation had outlived its usefulness in many sectors of the US economy, with takeovers, leveraged buyouts, and other going-private transactions being manifestations of this change.
“The public corporation is not suitable in industries where long-term growth is slow, where internally generated funds outstrip the opportunities to invest them profitably, or where downsizing is the most productive long-term strategy,” Jensen wrote.
Bingham agrees with Dimon in as much as the shift to private equity is more a reflection of regulatory requirements in the public markets than anything else.
“The points he raised are not strangers to us,” Bingham said.
“It’s one of the main reasons I got into private equity in the first place, 20 years ago.”
He said Jensen’s comments, while still relevant today, were made at a time of the leveraged buyout, when poor-performing companies were picked off, often funded by mountains of debt.
Bingham said private equity has evolved over the years.
In the public markets, there is support for growth-style companies that may be looking to expand and which often do bolt-on acquisitions.
“Nevertheless, the underlying message is still the same – private equity is still a great form of ownership, so in that sense Dimon is right.
“You don’t have to worry about quarter-to-quarter returns and you can take a much longer-term view.
“If one or two strategic initiatives are going to depress earnings in the short term in order to create longer-term value, then private equity is not concerned, whereas you get much more public scrutiny to know the high degree of detail in the public markets.
“As a company, you don’t necessarily want to share that with the wider public because it’s part of your competitive advantage as a business to try to keep those strategic initiatives private and confidential.”
Bingham said private equity companies are still subject to the rule of law just as public ones are.
“The accounts are audited. You have got pension money largely backing it, so very long-term, careful money.”
Bingham said the future is positive for private equity.
“Now we have large companies in private hands, and able to remain in private hands.”
He said there will always be a place for public markets but they will continue to decline in size.
“It’s sad that we are losing so many public companies, but on the other hand there is always a place for the really great companies like F&P Healthcare, EBOS, Mainfreight and Infratil.
“But it’s a harder environment for mid-market companies to operate in and they are often better suited to private ownership until they get to a certain size, and then public ownership does make sense.
“It behooves us as a society to have a healthy public market and it’s sad to see so few companies list over the last few years.”
Pencarrow typically has investments in 10 to 14 companies at any one time.
It has 10 at the moment and has undrawn capital of $200 million to spend.
“We have a lot of undrawn capital that we have not invested.
“We are looking for opportunities and the merger and acquisition market has really started to open up.
“It’s been a tough period during Covid and post-Covid, as people work out what normalised sales and earnings look like.
“In New Zealand, it’s certainly not a high growth environment from a GDP point of view but earnings have largely stabilised.
“Companies now feel they have more confidence to go out and raise some capital or maybe sell part of their business.”
Bingham said Fonterra may opt for a private equity solution for its consumer business.
“Generally, if you look at Australia and New Zealand, private equity firms have invested over the last couple of decades in a number of food and beverage companies.”
The thing to be drawn from Dimon’s letter is that the NZX is not alone.
“This is a global problem for the public markets,” said Bingham.
“They are not seeing the level of IPOs that we have seen over the last 20 or 30 years.”
But Bingham said the investment cycle has tended to go in waves, with four or five years in between.
“When something triggers it, the whole market gets enthused about IPOs all of a sudden.
“It helps when you have a good economic environment, with low interest rates and reasonable economic growth, which we just don’t have at the moment.”
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
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