Investors Will Buy Anything Now

Opinion

June 29th, 4:14am

Matt Levine

Matt Levine -

A model of corporate finance that I like and find helpful goes like this: 1. A company is founded to do a thing. 2. It raises money from investors to do the thing. 3. It spends the money to do the thing. 4. It does the thing profitably, which generates money. 5. It gives some of the money that it earned from doing the thing back to investors, pays some of the money to its founders and managers as compensation for their entrepreneurial vision, and invests some of the money in doing even more of the thing. 6. Eventually the thing stops being profitable and the company goes away. I have phrased it as simply and stupidly as possible to make it sound inevitable and obvious, but of course it isn’t; this is by no means the only model of corporate finance. The main alternative is the same through step 4, then branches off in step 5: 1. Found company. 2. Raise money. 3. Do thing. 4. Make money. 5. The company pays some of the money to its founders and managers as compensation for their entrepreneurial vision, invests some of the money in doing even more of the thing, and invests the rest of the money in finding new things to do. 6. Eventually the original thing stops being profitable but the company is doing new profitable things instead, which generate more money. 7. Go to step 5. My simple model terminates in step 6; this one has an infinite loop: The company uses the profits from the thing it does now to fund the next thing, and the profits from that fund the next thing, etc. Obviously most real companies look like some combination of these models. Real companies that make money use it to invest in research and development and new products and new markets and so forth. But also real companies in secularly declining industries often … decline. If you run a sprocket factory it is hard to transition to making social-media apps. A company will have some expertise, some set of things it is good at, and if those things are no longer valuable, the best thing for it to do might be to give its profits back to its investors and quietly go away. And then the investors could invest the money in some new startup that was purpose-built to do a new thing, that has its own expertise in doing things that are now valuable. Or not. A company will also have some set of social relationships and office space and letterhead and chairs and stuff, and it might be wasteful for the company to just go away while some other new company — with some new, currently more valuable expertise — has to build up those things all over again. Maybe the old company should pivot into doing the new thing, or maybe it should acquire the new company to give it the new-thing expertise, etc. These are obviously fact-dependent questions. Some companies can do new things or integrate acquisitions well; others can gracefully decline. For most of the time that I have been writing about finance, a basic theme of public-market corporate finance was what you might call “discipline.” Public companies did things, and made money, and gave a fair amount of the money back to shareholders. Conglomeration and “empire-building” were viewed as bad; stock buybacks were good. “People are worried about stock buybacks,” I wrote as a recurring bit: Investors and corporate executives broadly embraced the doctrine that if a company made money, it should return the money to investors to put into the next thing, rather than trying to find the next thing itself. This was a view that many politicians and journalists found infuriating (shouldn’t companies be trying to find the next thing themselves? shouldn’t America be innovating?), but it struck me as sort of conventional corporate finance. It was mostly the first model of corporate finance, though, a model in which companies stick to the thing they’re good at rather than noodling around trying to find something new. Of course a few wildly successful companies did devote lots of money to moonshots, but these companies seemed exceptional and their freedom was much remarked on. Alphabet Inc., Amazon.com Inc., perhaps Facebook Inc., perhaps Tesla Inc. were the famous examples; all of them had made enough money for investors through innovation that they were given a free hand to try for more. Also Alphabet and Facebook have multi-class stock that insulates their founders from outside shareholder pressure, and that innovation was much copied by other tech companies, because other founder-CEOs also wanted that sort of freedom from market pressure and capital discipline. The assumption was that public markets were “short-termist,” meaning something like “unwilling to finance speculative projects that don’t have a clear fit with the company’s current business or a clear path to profitability,” and companies that went public had to carefully guard their freedom. Meanwhile venture capitalists funded all sorts of wild money-losing stuff hoping that some of it would work. But that was in private markets, which were weird and insulated from disciplinary measures like activist hedge funds and short sellers. Public markets were about short-termism and capital discipline. Bloomberg

from Asharq AL-awsat https://english.aawsat.com/home/article/3052891/matt-levine/investors-will-buy-anything-now