Facebook (NASDAQ:FB) spends $2 billion to take out Oculus VR the same day King Digital Entertainment (UNKNOWN:KING.DL) goes public. The message? Sorry, tech investors, only billionaires get nice things.
The billionaire who said it best
This is the era we live in now. IPOs are mostly reserved for the incrementalists, the tech enterprises whose disruptions didn't threaten the establishment enough to warrant a rich buyout while still private. Companies like King, which derives 95% of its gross bookings from Candy Crush Saga, Farm Heroes Saga, and Pet Rescue Saga, all of which are variations on the same theme.
An IPO built on the sort of incrementalism Google (NASDAQ:GOOGL) co-founder and chief Larry Page railed about during an interview with Charlie Rose at a recent TED conference: "Companies are doing the same incremental thing that they did 50 years ago, 20 years ago. That's not really what what we need," Page said. He's right, and you know it. We all do.
Imagine you could own shares of either King, or one of the potential disruptors taken out recently: WhatsApp, Nest Labs, Maker Studios, or Oculus. You can't sell for 20 years. Which business would you back? If King really is your choice, then I need you to explain why in the comments section below.
The big winners: VCs
To be sure, backing start-ups isn't easy business. But for VCs, it has to be nice knowing you have a built-in pipeline for selling your best bets at an outrageous premium, leaving the dicier, more regulated IPO market as the exit pathway of last resort.
Look at Facebook. The social network's board of directors includes VCs Peter Thiel and Marc Andreessen, whose Andreessen Horowitz led a $75 million financing round for Oculus VR in December. According to Bloomberg, the firm owns a 17% stake worth about $340 million as of this morning. Talk about a home run of a return.
Yet this happens more often than you might think. According to research from CB Insights, 57 of the 472 IPO candidates it named heading into 2013 have since exited the private market -- 21 via a public offering and 36 via a merger or acquisition, creating $44.4 billion in value for early backers.
Let's be clear: I'm not accusing Facebook, Google, or anyone else of impropriety. Rather, I'm saying venture capital firms and other private equity specialists haven't been leaving much for common stock investors to choose from.
In a way, I can't blame them. Crowdfunding alternatives and secondary markets like the Nasdaq Private Market, created in concert with private company stock seller SharesPost, have made it easier for entrepreneurs to bypass VCs in the quest for financing. Mix in a slew of cash-rich companies looking to buyouts as an R&D alternative, and you have the makings of a front-loaded tech investing environment, where astounding gains go to those who refuse to wait.
How to mitigate the mess
Judging from the outrage we're seeing on Twitter and elsewhere -- outrage aimed at Oculus by those who first backed the company in 2012 via Kickstarter -- I'm expecting more investors to respond to the shift by rushing into complex and expensive funds that promise access to early-stage deals.
Take the new mutual fund SharesPost is offering. Dubbed the "SharesPost 100 Fund," the vehicle requires a minimum $2,500 investment and a graduating fee scale that could include up to a 5.75% sales charge for early investors and a 2.50% annual expense ratio. (Download a complete prospectus here.)
While both fees could moderate over time -- or even prove inconsequential if the fund produces stellar returns -- the "SharesPost 100" doesn't offer anything that common investors can't already get with a dose of patience. After all, venture capital is as much about strikeouts as it is home runs, and the best returns are earned only after years or even decades of holding fast.
Where VCs and common investors converge
Just look at the numbers. The National Venture Capital Association's Q3 2013 report shows the 1-year venture capital index return at 15.1% through the end of September, noticeably below the Nasdaq's 21% return over the same period. By contrast, the average VC return reaches 26.1% annualized over the past 15 years and 30% over the past 20 years -- figures that absolutely destroy the market's average for the same periods.
You know what? Common stock investors who buy to hold for the long term can also expect excellent results. We've seen it over and over and over again, and not just from Warren Buffett, but also our own David Gardner, whose early bet on Amazon.com has returned more than 100 times his buy-in price, no gimmick required.
So, forget settling for low-quality businesses such as King. Ignore the buyouts and get-rich-quick schemes for cashing in pre-IPO. Instead, be choosy with what you invest in, and then go in with the intent of staying in. If you've bought well, you've nothing to fear.