Had a great opportunity to listen first hand from Barry Silbert, CEO of Secondmarket, Peter Lehrman, CEO of AxialMarket and Daniel Confino, Founder of MergerID about market trends and different approaches among private company exchanges so thought of sharing. The discussion was organized by the Harvard Business School alumni of New York and held at KPMG’s New York offices (Innovation in Private Company Liquidity, April 4, 2011). Dan Burstein, Managing Partner of Millennium Technology Value Partners and David Weild, former Vice Chairman of NASDAQ also participated.
Private company exchanges (PCEs or online liquidity pools as we like to refer to them) may not have yet gained broad awareness or widespread adoption but they are making headlines by facilitating trading in hot, not listed stocks like Facebook, Twitter, Linkedin, Groupon or Zynga. It is by trading on SecondMarket, that Facebook’s implied valuation skyrocketed to $5obn. As these transactions have lately attracted SEC’s attention and Warren Buffet’s cautionary comments, let’s emphasize that valuations in these platforms are set by demand and supply among sophisticated investors; so it’s a “big boys” game in arm’s length transactions. It is believed that Facebook and some other hot private companies’ stocks have achieved such dispersion and active secondary trading that the line between what’s considered private or public is in essence blurred.
Apart from blocks of stocks, whole companies can as well change hands on these platforms. These “control transactions” aim to create liquidity for business owners and assist their advisors in consummating transactions. As exchange listings might be too cumbersome due to increased regulation and overhead or traditional offline M&As processes might be lengthy and costly, these exchanges create considerable efficiencies. This function is especially useful to middle market where is more difficult to attract buyer attention. More interestingly, they create opportunities for cross-border transactions, linking across global economies. For example, a US company that wants to enter the Polish market can easily research willing sellers there and make initial contacts. On the same time the Polish company can seek strategic buyers or investors around the world. That may erase inefficiencies that exist due to the fact that capital and investment opportunities usually reside in different locations these days. Capital has mainly accumulated in developed countries and opportunities arise in emerging with limited knowledge overlap between the two. This discrepancy in capital supply and demand create inefficiencies that may lead to misallocation of capital, value destruction and wasted resources; simply some capital is not put in use in the best way and companies on the other site may have to bear too high cost of capital and select projects with higher risk profiles to survive.
Benefits provided by this new technology doesn’t come without problems however Many investors or advisors, especially the “old school” often used to make deals face to face in golf clubs through long standing relationships, express disbelief. Some are worried that technology might take away businesses; some are turned away by dubious market participants. There’s some merit in that; quality of input is sometimes questionable. There are cases of buyers or sellers making false presentation of their abilities much like in a “push marketing” fashion; sometimes their intentions are not that innocent. Platforms are making efforts to remedy this by screening participants and providing research. In our opinion however, this poses a dilemma: should companies strengthen controls and by that increase operating costs, transaction fees and unintentionally drive away even legitimate liquidity or rate participants based on performance and simply caution buyers that some homework is required on their site? In the end, that’s part of the value brought on the table by knowledgeable advisors. We support the second option; see our views on operating models here.
As mentioned at the discussion, PCE adoption is increasing. Their establishment is pretty much a wish come true for many buyers, sellers and advisors spending immense amount of time and energy to communicate market opportunities. After all, we are living in a viral world; once an operating model proves itself it can grow quickly. According to the panel, it is estimated that PCEs is a promising market of $10bn. We would place the medium term target much higher. Another interesting point is that not all platforms are the same. Much like stock exchanges and darkpools, PCEs have different operating models and target different clientele. SecondMarket’s model focuses on pre-IPO stock while AxialMarket and MergerID are mainly geared towards control transactions and the middle market.
SecondMarket (formerly Restricted Stock Partners) was founded by Barry Silbert in 2004 to offer liquidity for restricted securities in public companies. Barry mentioned in an interview that had own experience in that from when working at Hoolihan Lockey and had to find buyers for parts of bankrupt Enron. SecondMarket gradually introduced trading for auction-rate securities, bankruptcy claims, limited partnership interests, structured products (MBS, CDOs, ABS), whole loans, private company stock, and government IOUs. Private stock was added two years ago. Trading is mainly geared towards pre-IPO companies and their employees on the supply side and venture capitals and high net worth individuals on the buy side. It has attracted much publicity and fame through trading stocks such as Facebook, Groupon and Linkedin.
SecondMarket surpassed a half-billion dollars in private company transactions since this market was launched in April 2009. In fourth quarter of 2010 transaction fees more than doubled compared to the previous quarter, to all times high (probably helped by the Facebook stock that accounted for around 40% of volume). At the same time market participants rose to 35,000 compared to little more than 5,000 a year ago. Companies with stock trading at SecondMarket, can control trading terms. It comes at no cost to them but sellers have to pay a 3-5% fee on transactions. According to Barry Silbert the differentiating factor between stocks traded at SecondMarket and traditional stock exchanges will at some point simply be the platform used. The companies would then choose the venue that better suits their needs. That’s interesting; after darkpools, stock exchanges may also see business taken away by PCEs in the future.
SecondMarket has already gained market recognition. It was named 2011 Technology Pioneer by the World Economic Forum and one of the “Top Fifty Tech Startups You Should Know” by BusinessWeek. Fast Company recognized it as one of eight startups “brimming with hope” for the financial industry. AlwaysOn Media named it as the overall winner of the “Global 250” list of the top private companies in the world.
AxialMarket (formerly Cathedral Partners) is focused on middle market control transactions basically catering to business owners. It was founded by Peter Lehrman with background in the Gerson Lehrman Group, the online community for on-demand consulting services. Peter is passionate for high tech B2B marketplaces, even where many thought they couldn’t exist. Probably that drove him to establish AxialMarket in 2007; outstanding foresight admittedly.
Since AxialMarket’s inception, over 3,000 privately held companies were sold through it. In the first quarter of 2011 over 500 opportunities, a 12% increase, with over $7billion in revenue and $800M in EBITDA were delivered via AxialMarket. Its platform includes over 1,200 qualified M&A advisors and private business owners. Apart from enabling transactions it also offers proactive research over targets and industries. AxialMarket follows a mixed subscription and transaction model. Most of transactions are concentrated in North America. It has strong presence in the US private equity industry.
MergerID is part of the Pearson/Financial Times group. It was founded by Dan Confino, a seasoned international M&A lawyer now based in London. MergerID leverages a strong global footprint and market insights to provide value added M&A information to its members. After all, Mergermarket a leading information platform for the M&A market, is also part of the FT group. MergerID focuses more on the CFO community and the middle market. It has adopted a membership model charging no commission on deals executed. In the first year of its operation (was launched in September 2009), over 25,000 matches between buyers and sellers have been recorded. Its platform includes more than 1,300 companies in 65 countries that is present.
According to Jonathan Goor, Managing Director of MergerID: “Through MergerID, users can effortlessly access a global audience. The interest in all the BRIC and aspirant BRIC countries as well as in the Middle East and Africa has been fantastic so far…” According to Mergermarket data, the total value of cross-border transactions rose by 60% in first half of 2010 reaching 31% of global deal value. Alongside the interest from western world to the BRICs, Mergermarket data shows that emerging market companies are also increasingly acquiring abroad. Outbound deal activity from the emerging markets has risen 318% by value and 111% by deal count in the first half of 2010.
The above platforms are not the only ones, however they are the early market participants and among the most popular. Many more new competitors have started to appear and raise capital (see our post on that here). Hopefully competition will increase product awareness and liquidity for private transactions. After all maybe PCEs are the best platform for investors and companies especially in middle market: in a stock market plagued by short-termism, analyst pressure, where average stock holding period has fallen to 6-7 months and high frequency trading accounts for as much as 70% of trading, PCEs can be a more suitable venue for some companies and long term investors (even though the motives for investing in facebook stock might be speculative..).
Will be interesting to see at some point research on the cost of capital for companies trading in PCEs versus that for listed companies (especially those not actively trading and not followed by many analysts). And one more topic to research: valuations and volatility of private equity investments based on data from PCE trading; we bet that portfolio managers, wealth advisors and accountants would love to see that.
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