In this episode of Motley Fool Answers, Alison Southwick is joined by Motley Fool personal finance expert Robert Brokamp and Motley Fool analyst Abi Malin to take a deep dive into IPOs. Robert starts the show with an update on the current state of dividends, Americans' love affair with pickup trucks and its financial impact, and a recent article on physical and cognitive abilities of older people. Next, Abi takes us through the IPO process, sharing her expertise and answering IPO-related questions.
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This video was recorded on October 6, 2020.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, and I'm joined, as always, by Robert Brokamp, "Co-CEO of Southcamp Industries." Bro, how are you doing today?
Robert Brokamp: I'm doing fine. I'm looking forward to our IPO, because I want to be an instant millionaire.
Southwick: Yes, that's right. On this week's episode, we're going to learn all about IPOs. And we're so excited because Southcamp Industries is going public, thanks to the help of Abi Malin. All that and more on this week's episode of Motley Fool Answers.
So, Bro, what's up?
Brokamp: Well, Alison, I got a few things for you. No. 1, an update on the downturn in dividend. So, one of my favorite Twitter accounts for interesting market and economic stats is that of Charlie Bilello, who is the Founder and CEO of Compound Capital Advisors. And every week he tweets out his 5-Chart Friday, and one from this past week had some pretty good info on the current status of dividends, which I know are important to a lot of people, a lot of investors, especially people who want to live off their dividends.
So, according to Charlie and his charts, dividend info for the third quarter is in, and the cuts continue. Overall, the S&P 500 showed a dividend decline of 5.6% versus the third quarter of last year. And from their first all-time high in the first quarter of this year, S&P 500 dividends are down 9%. How does that compare to the last three recessions we saw? Well, here are the peak-to-trough declines in dividend. So, 1991 recession, dividends declined 13%. 2001 recession, 15%. The Great Recession of 2007-2009, down 30%. So, being down 9% is not so bad; of course, we're not through it yet. But still, it's pretty amazing that we can go through what we have and most companies are still able to pay their investors a good amount of cash.
[laughs] Another interesting chart from his 5-Chart Friday, he basically pointed out this chart that might be the most interesting chart of 2020, and it is the stock price of Crocs. So, Crocs from its January high fell 81% to its March low. Since March it has rallied 440%. So, this makes it the highest levels since ...
Southwick: Crocs are back.
Brokamp: [laughs] They're back. So, it's now at the highest level since 2007. But here's what I thought was interesting. So, it hits its high in January of $43.40; so, $43.40, keep that in mind. Drops 80%, rebounds 440%. Where do you think the stock price is now? $46. So, essentially if you drop 80%, you have to earn 400% just to get back to breakeven. That's the mathematics of significant losses.
All right. Moving on to item No. 2. Americans' love affair with pickup trucks might be derailing their retirement plans. That is the title of an article on MarketWatch by Ben Carlson of Ritholtz Wealth Management team. He started off the article citing a Wall Street Journal article that got a lot of attention, basically highlighting how some middle income and even higher income Americans are struggling, partially due to all the debt they have. So, the article highlighted a couple in Texas that pays $4,400/month on their mortgage for car loans and leases and student debt. One of the things they did to, sort of, get out from under that debt was the husband traded in his Ford F-150 for a lower cost car. He dropped his monthly payment from $820 to about $100.
I didn't know this, but according to Carlson's article, the Ford F-series trucks, most popular selling vehicle in the United States for 39 straight years, and in 2020, it looks like it's going to be 40. In fact, the top three vehicles in the U.S. over the past seven years are pickup trucks. Now, if you look at the cost of a pickup truck and depending on the bells and whistles that you get, it costs $50,000 to $70,000. Carlson calculated that if you take a 60-month loan at 4%, that's a monthly payment of $800 to $1,300. Carlson also looked at, OK, I'm going to compare the monthly payment on a $45,000 vehicle versus a $20,000 used vehicle, the difference in payments would fund your IRA for the year. If you compare a $70,000 truck and a $20,000 used car, the monthly payments would get you to 60% of funding your 401(k).
So, the bottom-line for Carlson, quote straight from the article, "Driving an inexpensive car is one of the biggest levers people can pull to free themselves up financially to save more."
Southwick: If you sell your truck, are you even still a Texan?
Brokamp: [laughs] That's a good question. Here's the thing, my dad had a truck for years, but he bought it used and it was, like, a super-basic truck that he kept for $200,000. [$20,000] (sic) I think you can get rid of your new fancy truck, buy a used older truck and still pocket a lot of money and still be a Texan. That's my guess.
Southwick: Yeah. Well, I mean, also trucks have to guzzle more gas than smaller cars too. Like, that's even another -- I'm sure they're a lot more fuel efficient than they were 10 years ago, but that's going to be even more added cost.
Brokamp: Right. And that depends, again, on the truck. It depends, if you have 4-wheel drive or 2-wheel drive. A great tool, by the way, is Edmunds' True Cost to Own calculator. You put in the car, it estimates payments; how much it costs to insure the cars, because some cars are much more costly to insure; how much it costs to repair a car, it uses repair records for different cars; and fuel mileage. And it gives, like, sort of, overall total cost of owning one car versus another. Excellent tool.
Rick Engdahl: I once went to a wedding in South Dakota and I had to rent a car when I got there. And I, of course, rented the economy car, because it was just me. And I was upgraded to the Ford F-150 or whatever, because that's pretty much all they had on the lot there. That's all they had was that pickup truck, and a lot of them. So, those of us coastal elites may not realize how popular those cars are out there.
Brokamp: Yes. And while Ritholtz Wealth Management is stationed in New York, Ben lives in Michigan, so he commented how he sees them everywhere. And another note about Ben, by the way, is that he's the co-host of the Animal Spirits Podcast, which I recommend.
And our third item for today is something that Ben and his co-host Michael Batnick mentioned on their most recent episode, which is, so No. 3, Older People Have Become Younger, and that's the title of an article on NeuroscienceNews.com, which discussed a recent study out of Finland. And the basic finding is, the physical and cognitive health of people aged 75 to 80 is significantly better than those of that age range 30 years ago. So, the study was conducted at the Faculty of Sport and Health Sciences and Gerontology Research at the University of Jyvaskyla. But anyways, the bottom-line is, among men and women between the ages of 75 and 80, muscle strength, walking speed, reaction speed, verbal fluency, reasoning, and working memory are nowadays significantly better than they were in people at the same age 30 years ago.
What's the reason? So, basically better nutrition and hygiene, improvements in healthcare and the school system, better accessibility to education, and improved working life. So, you might wonder, well, does something that they found in Finland apply to people in the U.S.? I would say it's probably mixed, because a lot of those things that I just mentioned, do not apply to all populations in the U.S., but I imagine it does apply to most people listening to this show.
So, basically, I think this is good news, as I said before, I do think most people should consider working longer, partially because a lot of people haven't saved enough, but partially because the research on whether retirement is good for you is very mixed. So, I think it's great news that physically and mentally we can work much longer than our forefathers and foremothers in previous generations could.
That said, we just had an episode a few weeks ago where we talked to Richard Johnson at the Urban Institute, where he talked about how something like 52% of people in the early 50s at some point will experience some sort of income disruption before they reach age 65. So, you do have to take the steps to shore up your human capital to increase the chances that you'll have a job for as long as you want.
So, those are the three things. Finally, I just want to point out a reminder. A few episodes ago, we talked about the refinance fee, so the 0.5% adverse market fee for anyone who wants to refinance their mortgage, that starts on December 1st. So, interest rates are still low, the 30-year mortgage rate is now 2.88%. If you're thinking of refinancing, start that process now.
And that, Alison, is what's up.
[...]
Southwick: Snowflake (SNOW -2.95%) sold 28 million shares for $120 each; a sharp increase from its initial price range of about $75 to $85. They raised a total of $3.4 billion, and made Berkshire Hathaway about $800 million richer; but who's counting? So, here we are amid renewed interest in the IPO market, and joining us to help understand it is, Abi Malin. Hey, Abi, you're an analyst at The Motley Fool.
Abi Malin: Hey, Alison, thanks for having me today.
Southwick: Hey! Have you been on the show before, it's probably been a while if you have?
Malin: I've done it before, but I think it has been a while.
Southwick: Yeah. Well, we appreciate you taking the time to join us. We have talked about IPOs before, but let's do it all over again, huh! I recently read that book publishers had held off releasing books earlier in the year because there was so much uncertainty around the pandemic, but then at some point publishers were like, let's just get on with it. And a flood of new books are now being published. Is this the same thing that's happening for companies that wanted to IPO?
Malin: Yeah, I think you're right there, or at least partially. If there's one thing we know about financial markets it's that they hate uncertainty. So, I think we saw the IPO market kind of unpause, as it was determined what would happen in financial markets more broadly. And so, what we've seen in financial markets is that they've actually had a fantastic performance, specifically off the lows of late-March. And so, I think now that it's kind of clear that we've weathered through some of what could have been argued as maybe the worst of the financial market impact, specifically from COVID-19, with business shutdowns and things like that, at least in the short-term, we are seeing companies now seize the valuations that we're seeing today in the market, which are pretty high relative to historical averages. And so, we're seeing them IPO again.
But, you know, the one caveat I always like to give when we talk about this is that, I think it's really important to note here that financial markets are not the economy. So, while the economy is struggling by a lot of metrics, right, certainly unemployment figures coming to mind is the biggest one, financial markets are impacted by that, but they're independent of it. So, again, we've seen financial markets actually have a very strong year relative to the backdrop.
Southwick: So, we've kind of covered this before, the IPO process, in the past. But then again, Bro has also explained safe withdrawal rates probably a thousand times ...
Brokamp: And people love it every time, they can't get enough of it ...
Southwick: People love it more and more every time. Yeah. So, we're going to cover old ground. For our older listeners this is going to sound familiar, but for our newer listeners this is new. Hey, thanks to newer listeners. And old listeners, you know what, just listen to it again, you know you love it.
All right. So, the IPO process. I'm going to pretend that I am the company and you, Abi, are going to help walk me through this process. Okay, hello, Abi, I lead a very successful company called "Southcamp Industries." Our dedicated listeners know us as the finest purveyors of loofas and bourbon. I'd like to go public; why is that exactly?
Malin: Yeah, it's a great question. So, traditionally companies have elected to go public for access to capital. And so, the general idea was that private companies who needed more capital to, sort of, fund growth objectives would enter the public markets, raising funds through that initial public offering. And then ideally, you the company, Southcamp Industries, would then reinvest those funds that you've raised to grow your business. So, you'd create this time period of accelerated growth for shareholders who invested in that IPO; again, ideally leading to wealth creation for individual investors in the public markets, right?
That dynamic has shifted a little bit though. So, there's a lot more capital available to the private sector; more so now than ever before. And so, this is really due to growth in private equity, growth in venture capital, as well as, the proliferance of affordable rates on debt, so thinking just regular bank loans. So, the impetus nowadays is much more likely that the private company has reached a substantial size and is experiencing pressure from shareholders, which could be either those private equity firms or those venture capital firms or even employees who want a liquid, meaning cash, exit strategy for their investment.
So, there's really two options. The first is that, either the company wants to raise funds to invest for growth, or the second is that shareholders, including PEs, VCs, and employees, in a liquid exit strategy to convert those holdings of a private company just to cash.
Southwick: Okay, let's do it. And I'm a really traditional kind of person, so I don't want to do anything weird. But what do I do now if I want to do a more traditional sort of IPO?
Malin: Yep. So, you, as part of the management team for Southcamp Industries, are going to look to hire an underwriter. And so, usually it'll actually be a team of underwriters from very large financial institutions. And these underwriters are going to help guide you through the process of being listed as a public company. And most importantly what they do is that they set the price at which your shares will trade and thereby decide the dollar value of the funds that you're going to be able to raise in the public markets. So, the real advantage to hiring these underwriters is that they create price stability and predictability, which again, if you, as Southcamp Industries, need to reinvest for your growth opportunities, it's really important, right? So, in exchange for this benefit, they're going to charge a pretty hefty fee.
Southwick: Oh, Abi, the SEC is bugging me, they want me to, like, tell them a bunch of stuff, something like an S-1. Oh, this looks like homework.
Malin: It is a little bit of homework. As a company that's new to the public markets, you file what's called an S-1. And so, an S-1 is a summary of your business really. So, typically it looks about three years back, and you'll give exciting trends, metrics that you're looking at, what you're going to do with the funds once you raise them, who's running the company, how they're being compensated, just a lot of really good and helpful information, things that you might typically find in a 10-K -- which is a public company's annual report -- but even a little bit more inclusive than a 10-K.
Southwick: All right. So, I think there's something called a roadshow that we have to do. Now, what does that mean when you're a pretty little unicorn like me? Oh, wait, what is a unicorn? And actually, tell me about the dog and pony show that's in my future. Bro, I hope you're onboard with this; we're going public, I didn't ask your opinion.
Brokamp: I just do whatever you tell me to do, Alison. That's the way this whole thing works anyhow.
Southwick: And it's worked so well so far. So, I mean, come on. All right. So, yes, the roadshow, is that what happens next?
Malin: Exactly. So, I guess we can start with what is a unicorn. A unicorn is a privately held company that's valued at more than $1 billion. And it was initially termed a unicorn because it was so rare, but again, we're seeing companies, sort of, opt to stay private for longer, as there's more access in those private markets. So, being termed a unicorn is less rare today than it was even a decade or more ago.
But after your underwriters look into your business and learn all about it and they place a value on what they think you are worth, you will travel on what's called a roadshow. And the goal of a roadshow is to get lots of public market investors excited at the opportunity to buy your shares in the public market. So, it's sort of a means of judging demand for the shares, which as we all know has power to substantially impact the price.
Southwick: Okay. So, wait, do I physically have to go see these people or do I just do like pretty PowerPoint presentations?
Malin: So, before COVID, I think it was a lot of physical meetings. But I think we're shifting more and more into this sort of Zoom-capable economy. And so, again, I think that was sort of why the market stalled for a little bit. But we've seen the markets adapt, right, so I think more and more it's happened digitally.
Southwick: Okay. So, I only need to buy the top-half of a new suit, I don't need to worry about the bottom half ...
Malin: Exactly.
Southwick: All right. So, the big day is here, Southcamp Industries is going public, what happens?
Malin: So, on the day of the IPO, the underwriters of the bank facilitate the shares to be trading on the open market. And so, the key here is that it's only the initial trade which is from the company to the public market that Southcamp Industries will actually raise the funds. And it happens at that predetermined price set by the underwriters. After those shares trade hands for the first time, they enter what we call a secondary market. Meaning that the first buyers, including the underwriter sometimes and even large investment clients, can then sell to anyone who has a trade account open at the price that's set by supply and-demand.
Southwick: Oh, OK. You know what, I should have probably called Rick as like the -- I should've brought you into this, you could have been the first person to buy our shares. Congratulations, Rick! So, you bought our shares and then you probably immediately sold them on the secondary market. Geesh! No faith in Southcamp Industries.
Engdahl: Woohoo! I'm rich.
Southwick: Yeah. All right. Whoa! That's crazy. We said, each share was worth $100, but now it's trading for $150 on the -- I don't know, did we list on the Nasdaq, the NYSE, where did we go? We traded on the NYSE. Good for us. All right. So, our stock popped, it's now trading for $150.
Malin: Yeah. So, the idea of a share pop is caused by the public having a lot more demand for the stock than the initial underwriters foresaw. And so, because the supply of shares is limited in the IPO process and it's limited by that predetermined amount set by the underwriters, the impact of a lot of demand is that the price can increase dramatically. So, put another way, in the example of Southcamp Industries, investors are willing to pay $150/share for the business that the underwriting team felt was only worth about $100/share. So, ideally, a successful IPO day, as we call it, is one where the ending share price is higher than the initial value set at open.
Underwriters design that price specifically so that this happens. So, they typically institute what we see is a 3% to 5% haircut to what they think the actual fair value per share is. And shares typically do increase on the first day of trading about 80% of the time. But the downside of this practice is that Southcamp Industries doesn't have access to that huge increase in share price value. So, Southcamp Industries only received $100/share, but the market was actually willing to pay $150/share. So, it's actually not as great for the company, because they could have theoretically raised more funds for reinvesting in growth.
Southwick: Oh, wait, never mind, now we're back to $80/share. Woomp-woomp!
Malin: [laughs] So, this is also a common occurrence, with the majority of recently IPO'd companies typically tending to lag the market for the first two years of being public. And I think there's a lot of reasons for this, but really, they can all be summed up to, again, uncertainties. So, the market needs a little bit of time to learn what to expect with Southcamp Industries, and the management style of setting expectations for revenues and earnings. And so, oftentimes what we see with IPOs is that the market is a little bit too aggressive in setting expectations. So, you know, anytime the stock doesn't meet market expectations, we'll see a pullback or a fall.
Southwick: So, I guess, like you said, it's just a one-and-done capital raising event. What's next for Southcamp Industries? Maybe I need to ask Bro this question too.
Malin: [laughs] Yeah. So, this IPO is sort of a one-and-done capital raise for Southcamp. And the good news is that Southcamp Industries now has capital on the balance sheet that they didn't have before, so they can use that for increasing their sales and marketing efforts to get your products in more stores, you could grow your production capabilities to fulfill those increased sales orders, you could hire more people to develop more products, however you see fit as growth, right?
And if they ever decide that you need more funding at Southcamp Industries, an already public company can do what we call a secondary offering, where they issue new shares to the public markets. So, they dilute existing shareholders a little bit, but again, they have access to more capital.
Southwick: As some companies are opting for the direct listing route, I think Palantir and Asana are two of the recent ones, what does that mean?
Malin: Yeah. So, in a direct listing, the company going public foregoes utilizing that underwriter. So, through this process, the existing investors, promoters, and even employees holding shares of the company can directly sell their shares to the public. And so, the benefit is that Southcamp Industries or the company pursuing this strategy, wouldn't have to pay that hefty underwriting fee and it doesn't dilute your shareholders by issuing new shares, and it allows everyone who's invested in the company to be free from lock-up agreements. And so, lock-up agreements just means that insiders can't sell their shares in a significant amount of time. And usually, it's predetermined between six and 12 months.
So, again, you're free from lock-ups, you don't have those hefty underwriting fees, and you don't dilute your existing shareholders. But the downside of this direct listing option is that there is no support or guarantee for the share sale price. So, there's an aspect of unpredictability. So, it's still a newer option. I think we've seen it pursued also by Slack and by Spotify, but generally speaking, I think it's more of an option for companies that feel that they have sufficient interest in their business and are less concerned about that share price volatility specifically in the short-term.
Southwick: All right. Well, let's shift and talk about some of the headlines that are happening in the world of IPOs. I mentioned Snowflake, Palantir, Asana, I also heard about something called Lemonade that's apparently popular with the kids. I was a little bummed when I found out it had nothing to do with Beyonce. So, what are some of the big headlines in IPOs right now?
Malin: Right. So, you mention Palantir, which is sort of one of the best examples of this so far. I think, generally speaking, there are so many new players in the IPO markets recently. And part of the reason we're all hearing so much about them is because we're seeing companies that have opted to stay private for so long, finally pursue the public market. So, again, Palantir is probably the best example of this.
Palantir is a data analytics company that uses highly confidential data and data algorithms to develop insights and predict future events. And so, it was founded after 9/11 and has focused primarily on serving government clients through the Palantir Gotham division. And more recently, it expanded to serving commercial customers through Palantir Foundry. And I think, sort of, the highly sensitive and secretive nature of the work is something that made it so intriguing when they entered the public market.
You also mentioned Asana, which is a workplace collaboration tool. And so, while that may sound vague, I would encourage people to think of it this way: according to a survey conducted by McKinsey Global, knowledge workers spent 28% of their time in a day answering email, 19% of their time gathering information, and 14% of their time on internal communication. So, Asana is sort of a multifaceted tool that creates a system of record for work that then collects and structures institutional knowledge about how past work was completed and then provides a real-time plan and roadmap for future incentives using machine learning.
So, I think the real entry with Asana is the management team here, because the company has two co-founders who met while working at Facebook, and the Co-Founder and current CEO, Dustin Moskovitz, was actually also a Co-Founder of Facebook. And so, they've created this really unique culture and it's been branded a lot of things, not the least of which is, sort of, anti-Silicon Valley, with Moskovitz actually taking no salary for his work and agreeing to give away the majority of his wealth. So, from a cultural perspective, it's really intriguing.
And then the last one you mentioned is Lemonade, which is an insurance business. And this has been innovative, because not only is Lemonade beloved by its customers; which is something unique for insurance, but they're actually a registered public benefit corporation, also known as B. Corp. And this means that they pledge to donate excess premiums collected through their business to the charity of the consumer's choice. And so, I think this one is interesting, because IPOs are known for bringing the newest and most innovative to the market, and so, Lemonade is notable in that regard in terms of how a business can generate both meaningful wealth and do social good.
Southwick: So, those are some recent IPOs, let's talk about maybe what's coming down the pike. I hear Airbnb being tossed around.
Malin: [laughs] Yep. So, Airbnb would be another one that qualifies as one that's been private for so long and just has so much investor interest. And I think part of that is because a lot of consumers use Airbnb, and I think it's one of the most consumer habit changing companies that we've seen over the past decade. It was sort of unthinkable before Airbnb that you would rent a room in a stranger's house [laughs] for vacation, but that's sort of where we are. So, I think Airbnb is going to be a really interesting one to follow.
Southwick: What are some other IPOs that are maybe going to happen in the coming year?
Malin: Yep. So, we've heard about Robinhood, which is an online brokerage account. And so, the thing that's intriguing about Robinhood is that they are the first mainstream player to institute commission free trading. And so, they started the whole movement toward commission free trades, which I think we, here at The Motley Fool, really commend and appreciate in terms of financial equity. So, that's one that's pretty cool.
We've also heard about Bumble, which is a dating app founded by a female CEO who was previously an executive at Tinder. And she felt that there was a lot of gender dynamics at play that she wasn't necessarily supportive of or comfortable with, so she founded Bumble to be, sort of, a female-centric dating app. So, again, it feels really prevalent or prominent to the times that we're in right now.
We've also heard about Instacart and DoorDash, things that [laughs] I think have been used probably more than ever in this pandemic that we're in, as people can't actually go and eat in restaurants. So, two other really interesting ones that I think have been long-watched for a while now, and people will be excited -- again, even if you're not buying it, I think just getting to read the S-1 and see, sort of, the business economics and the dynamics there, the revenue, how many customers they're serving. All of these things can be just really interesting.
Southwick: Of these IPOs that we've talked about, are there any that you're particularly interested in, that you think you're going to potentially invest in or want our listeners to take a look at?
Malin: Yeah. So, I work on our Discovery IPO service. And so, we sort of monitor and read about, watch [laughs] almost everything that's coming to the IPO market. And so, one that we've talked about recently as a team is Unity, which is the gaming platform. And they are sort of the system behind more than 50% of the top games in the app store. And so, it's a really interesting platform. I think gaming, as a macrotrend, is gaining significant tailwinds right now. And so, that's one that I'm excited to continue to watch and follow along. And I think many of your listeners might actually be possibly familiar with it.
Southwick: Yeah. All right, what is your parting advice to our listeners if they are thinking they want to invest in an IPO, whether that's maybe by some magic happenstance they actually do get to invest in an IPO or whether they want to invest in a company that has recently IPO'd?
Malin: Right. My parting advice is that, know that IPOs tend to be volatile. So, I would encourage anyone -- you know, if a company interests you, maybe take a small position, that can be as small as even just one share, now that commissions are essentially negligible. And just follow along, because I think there's so much to learn in this space and with all of these companies that getting a little bit of skin in the game can be really helpful and really fun.
Southwick: Great. Abi, thank you so much for joining us and talking about this super-interesting topic. I enjoyed it, let's do it again in a year.
Malin: [laughs] Sweet. Thanks for having me, guys.
Southwick: As always, The Motley Fool may have recommendations for or against -- can you have a recommendation against? Whatever -- stock we talked about on the show, [laughs] don't buy and sell stocks based solely on what you heard here.
Well, that's the show, it's edited publicly by Rick Engdahl. Our email is [email protected]. For Robert Brokamp, I'm Alison Southwick, stay Foolish everybody.
