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The easy money fuelling the market’s fever

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Irrational exuberance or the new reality? The US stock market rally that has shrugged off the pain in the real economy in the wake of Covid-19 shows little sign of running out of steam. Despite markets falling back since the August peak amid fears of a resurgence of the virus, investor appetite for equities remains undimmed. Wall Street just witnessed its biggest week for initial public offerings since May last year, when Uber came to market. Shares in Snowflake, a cloud-computing business, doubled on their first day of trading on Wednesday, valuing the lossmaking company at more than $70bn. 

The extraordinary rally has been driven as much by exceptional monetary policy as by growth-hungry investors fearful of missing out on the next Tesla. On the same day as Snowflake’s initial public offering, the Federal Reserve signalled it expected to keep interest rates near zero at least through 2023. This promise of cheap money for longer is helping to push cash into the market — there is a scramble to invest in nearly everything on offer. 

The obvious example of this is the boom in special purpose acquisition vehicles, or Spacs, which list their shares on the premise that the promoters have a great deal lined up in the future that will make their backers a decent return. Seasoned financiers, entrepreneurs and former politicians are all putting their names to Spacs, with tens of billions of dollars raised on little more than the hope that these plans for deals will come to fruition.

Stock market bears fear a repeat of the 1990s dotcom bubble that prompted Alan Greenspan’s warning of irrational exuberance. That era saw internet companies achieve inflated valuations based on little more than hot air, while stocks of other companies were shunned. Today’s bears point to the stretched valuations of many recent IPOs as well as the indiscriminate appetite for shares of any business that can claim the technology badge. The usual metrics of valuing a company’s prospects have been dropped in the rush to catch the next rally. 

There are crucial differences this time round. The fundamentals of the Big Tech companies that have driven the market rally are built on more solid ground, with strong balance sheets and cash-generating capability. A greater cause for concern, however, lies in the dominance of these stocks — which has only been amplified during the pandemic. Analysts at JPMorgan point out that the combined weighting of technology and communications stocks, as well as Amazon, in the S&P 500 index is 45 per cent. That contrasts with a concentration of just over 20 per cent for financials at the height of the credit bubble 10 years ago. 

This skewed nature of the market comes with the obvious risk that if any of these titans stumbles, it could trigger a wider sell-off, bringing down retail investors with it. Recent falls have taken some of the froth out of tech stocks, but many small investors are turning to more risky equity derivatives, hoping to maximise their gains if stock prices rise. 

The coming months will test the market’s resilience. Schools have reopened and people are returning to their offices even as coronavirus cases rise in parts of the US and much of Europe. Equities might not so easily shrug off the damaging effects of lockdowns a second time around. A contentious US election will add to the volatility. There are clear signs of a market bubble, yet for the foreseeable future low rates will keep supporting equities and buoy the hopes of many that the rally is the beginning of a new reality. The real test will come when the easy money tap is turned off by central banks. 

Letter in response to this article:

Central banks need to act to forestall asset bubble / From Dhruv Narayanan, London EC4, UK



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Pepco and Poundland chains target multibillion valuation in IPO

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South African conglomerate Steinhoff is set to raise up to 4.6bn zlotys ($1bn) when it lists its Pepco chain of discount retailers in Warsaw this month in the latest in a series of asset sales.

Pepco, which operates about 3,200 stores in countries including Poland, Romania and Hungary, as well as Poundland in the UK, said on Wednesday that shares in the offering would be priced between 38 zlotys and 46 zlotys.

In total, Steinhoff and members of Pepco’s management team will sell 102.7m shares or 17.9 per cent of Pepco to the public, valuing the company at between 21.9bn zlotys and 26.5bn zlotys. The final price will be set on May 14, and trading will begin on May 26.

A portion of shares will also be placed directly with some of Steinhoff’s lenders, following an earlier agreement between the conglomerate and its creditors.

Andy Bond, the former Asda chief executive who now runs Pepco, intends to sell more than 1m shares in the IPO, worth roughly €9.7m at the midpoint of the price range, though he will be subject to a lock-up period until the end of 2023 thereafter.

Bond said the company planned to open a further 8,000 stores “over the longer term”, but would also keep “a clear focus on costs and delivering additional efficiencies as we grow”.

Pepco’s listing is likely to be one of the biggest this year on the Warsaw exchange, which has seen a flurry of activity since Poland’s dominant ecommerce platform Allegro raised 9.2bn zlotys last year in the country’s largest initial public offering

Steinhoff will initially retain a stake of about 82 per cent, but the group is looking to sell assets to reduce debt after an accounting scandal in 2017. 

It has already sold Bensons for Beds, another UK retailer, to private equity group Alteri, and has an option to sell a further 15.4m shares in Pepco in the offering if investors show sufficient interest. Goldman Sachs and JPMorgan are advising on the IPO.

Pepco’s business heartland is in central Europe, but the group is planning to expand elsewhere on the continent, such as Spain, and is targeting earnings before interest, tax, depreciation and amortisation of more than €1bn within the next “five to seven years”.

In the year to the end of September, it reported sales of €3.5bn and underlying ebitda of €229m. Ebitda was almost a third lower than in the previous 12 months, as the pandemic forced stores to close across Europe.

Like many other discount retailers, Pepco does not trade online, as the small size of the purchases typically made by its customers makes the economics of ecommerce difficult.

The group said last week that sales had risen 4.4 per cent in the six months to the end of March, thanks to the opening of more than 200 new stores. However, on a like-for-like basis, sales were down 2.1 per cent.



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Honest Company’s market debut marks a comeback

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When the Honest Company lists on the Nasdaq exchange on Wednesday, it will be the culmination of a long recovery for the baby and beauty products group co-founded and fronted by the actress Jessica Alba.

The company priced its initial public offering on Tuesday at a valuation of $1.4bn, having worked to shake off much of the reputational and financial damage from a series of product lawsuits and recalls.

Honest, founded in 2011, had been valued as high as $1.7bn in 2015 before controversy over some of its claims to be using only natural ingredients in its products. In 2017, the company also recalled baby wipes because it found mould in some packages, and baby powder over concerns it may cause skin or eye infections.

Sales slid and Honest lost its status as a “unicorn”, a private company worth more than $1bn.

“Our rapid growth,” Alba wrote in a confessional passage in the IPO prospectus, “was compromising key business functions.”

Honest has never been profitable, but its revenue rose from $236m in 2019 to $300m in 2020 as the pandemic fuelled a run on cleaning products and other household staples. That took sales back to the level the company last enjoyed in 2016.

Losses narrowed last year to $14m from $31m in 2019.

Honest has previously said it expected to price its offering between $14 and $17 a share. At $16 each, it raised $413m, a majority of which will go to existing investors who are selling some of their stake.

Alba had been inspired to launch the brand after the birth of her first child left her scrambling to find household products she deemed safe to use around her daughter. She pledged to hold the company to an “honest standard of safety and transparency”.

Honest markets its products as natural, boasting that “we ban over 2,500 questionable ingredients”. It is one of many consumer goods makers seeking to tap into buyers’ appetite for household products seen as non-synthetic and sustainable.

The company still flags “health and safety incidents or advertising inaccuracies” as a continued risk factor in its prospectus. In January the brand issued a voluntary recall for one of its bubble baths, out of concerns that it could cause infections.

Ahead of the IPO, the company said two weeks ago that Alba would be stepping down as chair of the board when the company lists, handing the role to James White, former chief executive of Jamba Juice. She will remain the company’s chief creative officer, on a salary of $600,000 a year and, according to the prospectus, key to the company’s future success.

“Jessica Alba is a globally recognised Latina business leader, entrepreneur, advocate, actress and New York Times bestselling author,” it said. “Our brand may . . . depend on the positive image and public popularity of Ms Alba to maintain and increase brand recognition.”

Alba’s 6.1 per cent stake after the IPO was worth about $90m at Tuesday’s offer price.

The 3.8 per cent stake held by chief executive Nick Vlahos was valued at $57m. Vlahos has been steering Honest’s recovery since 2017, when he replaced co-founder and serial entrepreneur Brian Lee.

Honest secured a $200m investment from the consumer-focused private equity group L Catterton in 2018. The group is selling about half of its current 37.1 per cent stake in the offering, enough to recoup that investment, leaving a 17.4 per cent holding worth another $252m.

Morgan Stanley, JPMorgan and Jefferies are leading the offering.



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Oxford Nanopore/IPO: sequencer has Woodford in its DNA

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The stampede of pandemic winners to the stock market inspires wariness. Oxford Nanopore, which plans to go public this year, is one such beneficiary. The spinout from Oxford university is responsible for a fifth of the international sequencing that tracked coronavirus mutations.

That has drawn attention to a company with a lot of potential in a wide range of applications. An initial public offering could value it at significantly more than the £2.5bn price tag from a private funding round on Tuesday.

Started in 2005, Oxford Nanopore has benefited from the support of long-term shareholders. However, the backing of Neil Woodford is a complicating factor. The funds business of the prominent UK asset manager folded in 2019 following dire performance.

A successful float would benefit Schroder UK Public Private, the “patient capital” investment trust Woodford formerly ran. But there will be anger from former investors in his defunct income fund. Its 6 per cent stake in Oxford Nanopore was bought by Nasdaq-listed Acacia Research, which put a valuation of just $111m on it in its latest accounts. Woodford, who announced a controversial plan to restart his career in February, is working with Acacia as an adviser.

Oxford Nanopore’s decision to join the London market rather than Nasdaq will also hamper the valuation. But assume, as Jefferies does, that sales more than doubled to £115m in 2020. Even if Oxford Nanopore was valued at half the multiple of peers like US Pacific Biosciences, it would be worth £3.6bn.

That is less than a tenth of the size of San Diego’s Illumina, the global leader. Oxford Nanopore argues its sequencing technology — which monitors changes to an electrical current as nucleic acids are passed through a tiny hole — beats traditional camera-based approaches. Sequencing can be done quickly and cheaply by miniaturised devices. Accuracy has been a weak point, but is improving.

Investors should focus on the science, setting aside market froth and the Woodford connection. At the right price, Oxford Nanopore’s plan to facilitate the analysis of “anything, by anyone, anywhere” would be worth investing in.

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