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Submitted by Nick Colas of Convergex
Is Public Equity A Broken Concept
David Einhorn’s proposal to GM that it split its stock into dividend and capital appreciation shares got us thinking about the bedrock principles of public equity ownership. Other catalysts for this examination: recent IPO SNAP’s lack of shareholder voting rights, the reluctance of venture capitalists to list their “Unicorns”, and the dearth of IPOs generally. The critical question here is “Does the traditional one-size-fits-all model of publicly-held equity still work in a world that increasingly values customization?” Further, will other social and economic trends force a change in this structure, such as aging demographics in the US population and the investment-heavy nature of major technological developments like autonomous cars, workplace automation, and artificial intelligence? Bottom line: “public equity” needs to be a fluid concept that responds to the changing needs of both providers and users of capital.
If it is true that we learn the most from our mistakes, then I would posit that we can glean a lot of useful information from analyzing troubled industries rather than just focusing on commercial “Winners”. For example, I have studied the US auto industry for the last 25 years as both a sell side and buy side analyst, and more recently in the context of the macro work I do in these notes. It has been an education that has served me very well, even if the group has historically presented limited long term investment potential.
Here is a summary of everything I know about this auto industry:
I was therefore intrigued by investor David Einhorn’s proposal, made public today, to split GM’s stock into two pieces: a dividend paying equity and a capital appreciation “stub”. To be clear, I have no idea if it would improve the company’s equity market valuation. You can read a description here and see the slide deck from his firm, Greenlight Capital, as well: http://www.zerohedge.com/news/2017-03-28/david-einhorns-presentation-how-gm-can-unlock-between-13-and-38-billion-value
Einhorn’s proposal got me thinking about the nature of public equity capital. His thesis is that GM’s equity does not have a clean and distinct ownership base. Dividend-seeking investors are put off by the company’s share buyback program since it drains cash for purposes they don’t value, and capital appreciation-focused investors would prefer that GM just use all their cash generation to repurchase shares. Split the stock and the conflict goes away, or so the idea goes.
Regardless of the merits of the idea for GM, Greenlight’s proposal raises a provocative macro question: “Is a one-size-fits-all equity structure really the best approach to both maximizing corporate value and giving shareholders the types of investments they desire?” Once you pose the question that way, a raft of other capital market trends pop up:
Now, I am sure that Uber’s shareholders are happy just now that the company isn’t subject to the daily vagaries of the stock market, but on balance the absence of “UBER” as a symbol on the NYSE or the NASDAQ is troublesome.
At its core, the social compact between public equity markets and society is simple: over time, any investor should have access to the equity of important enterprises created by that society. If that isn’t happening by virtue of some misalignment of incentives, then those need to be fixed. The alternative – that the winners stay private but the losers are public – is untenable. Investors will choose to hoard cash and capital will slowly stop circulating to its best possible use.
Given the pace of innovation that seems to be on its way, this problem may only get worse. If the futurists are correct, there are several societal sea changes just over the horizon, from artificial intelligence to workplace automation to driverless cars, all in various stages of development. The home for that capital right now too often has a Sand Hill Road address rather than 11 Wall Street.
We’ve come a long way from what now seems like a pretty humble proposal regarding one car company, so let’s put on bow on all this. A few summary points:
Now, one caveat: all of this needs sufficient regulation to curtail abuse. The mortgage market of the early 2000s is the cautionary tale here, of course. Changes to the notion of public equity need careful scrutiny to make sure disclosures are complete and structures are sound.
But in the end, “Equity” will need to evolve in the same way everything else does in a capitalist society – in a way that serves both investors and users of capital.