Exits Down 75%, IPOs Non-Existent, Secondaries Rising The markets they are a-changing

According to Pitchbook:

 “PE exits in the US dropped from $876.7 billion in 2021 to $295.8 billion in 2022, according to PitchBook's 2022 Annual US PE Breakdown, as investors held onto assets longer to ride out rising inflation, geopolitical turmoil and public market volatility. At the same time, the IPO market almost completely dried up, with public listings accounting for only 2.5% of exit value last year.

 The secondary market—specifically continuation vehicles and GP-led secondaries—offers alternative exit opportunities for GPs hoping to satiate investor demand for liquidity. A GP can retain an asset through a continuation vehicle by moving a trophy asset from one fund to another. In this type of transaction, LPs have the option to liquidate on the secondary market and GPs can retain the asset until the market becomes more favorable for a sale.  Lazard pegged 2022 as the second highest year on record for secondaries issuance and 2023 is setting up to be even bigger.”

 The capital markets are finding ways to continue to fund deals through the double-barrel gutshot of increasing interest rates and higher inflation.

 What does this mean for Main Street (Middle Market) Businesses?

 While deal volume is certainly down from the record levels of 2021, PE firms report a decrease in reserves of only about 10%, meaning there is still about $800B of liquidity in the system.  The question is how much is earmarked for new deals and how much is available for new platform acquisitions and add-ons?

As the graphic above shows, the 2021 vintage year has the greatest remaining bucket of cash followed by 2022.  Funds in these vintage years are still in their deployment phase so most of that capital is available to new acquisitions whole older vintage years will see fewer add-ons with the majority of cash reserved for operations.

While it makes sense to time an exit during a period of low interest rates, low inflation and relative economic stability, there is still plenty of capital available for quality businesses with consistent performance. 

The professionals at Vertical Capital Advisors have experienced many market cycles and can help you realize the maximum value for your business if now is the time consider an exit.

https://files.pitchbook.com/website/files/pdf/2022_Annual_US_PE_Breakdown.pdf

The Problem with Bitcoin (and all cryptocurrencies) – The Greater Fool Theory

A Lesson From Jimmy Buffet

The subtitle is just eye-candy to catch readers who, upon seeing Warren Buffett’s name, would click on to the next item of interest.  Warren Buffett’s 2011 shareholder letter is a classic.  You have no doubt heard of it and probably even quoted or misquoted from it.  Page 17 begins Buffett’s musings on gold.  Buffett writes:

“The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future… The major asset in this category is gold”

In banking we called this the Greater Fool Theory.  If a loan became a problem asset, we began the process of managing the borrower out of the bank, hoping that another “hungry” bank/banker would take the problem off our hands.  But the problem with cryptos goes farther than that because, unlike gold, they have no commercial or decorative uses AND, this is huge, you can lose them - forever!

Back to Buffett:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.”

We have all read stories about crypto owners losing their keys or their cold wallets or hackers stealing their quarry – sometimes into the hundreds of millions of dollars.  It would be hard to lose a 68 square foot of gold.  The problem is that you would have to store, protect and insure the gold, meaning you lose value unless the price per ounce continually rises. 

“True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Prophetic, Warren!  In January this year, 11 years after Buffett’s letter, you could buy an ounce of gold for less than the $1,750 per ounce that Mr. B wrote about in 2011. 

So, as a store of value, cryptocurrencies are exactly like gold without the key benefit that Buffett mentions: “You can fondle the cube, but it will not respond.”

But all of those shortcomings of Bitcoin are not the primary problem.

The problem is the price.

The problem with every cryptocurrency is that it is a currency that trades like a stock.  Its value for everyone is set by the single most recent reported transaction.  It is subject to supply and demand, fear and greed – the same motivators of every stock purchase and sale.  Harvey Salkin, my portfolio management prof at Case Western Reserve University, equated stock investors to a psychotic neighbor who, as soon as you step out the front door, starts screaming that he wants to buy your house alternating with shouts of wanting to sell you his house.

Buffett illuminated the shortcomings of gold and, in corollary, I am drawing the same inference for cryptocurrencies:

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobil (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

One share of XOM would have cost you about $90 on the day that Buffett’s shareholder letter was published in 2012.  In the 10 interceding years you would have received about $30 in dividends and still have your original investment.  Gold and cryptos can only sit idle until exchanged for something else.

Cryptocurrencies trade like stocks – their price is set by the last reported transaction – the price for everyone is set by the single most recent reported transaction.  And unlike gold, there is no intrinsic value at all.  Cryptos produce nothing.  Cryptos have no earning capacity.  The only value cryptos have is value that the next person who wants it is willing to pay.  And cryptos have unique risks.

Until and unless cryptocurrencies have an independent intrinsic value separate and apart from the most recent reported transaction, cryptos will fluctuate wildly in value, until the last person with the last Bitcoin loses their key and Bitcoin passes from existence.