Episode 37 – How SpaceX Bolsters Our IPO Views

Welcome to Market Perspectives, a Mercer Advisors podcast. On today’s episode, we’re going to be talking about navigating the historic IPOs that are hitting the stock market this summer. I’m Josh Zumbrun. I’m the Director of External Communications at Mercer Advisors. And I’m joined today by Don Calcagni, our Chief Investment Officer. Don, thanks so much for being with us here today.

Thank you, Josh. Looking forward to a fun conversation on IPOs.

Well, there’s some big ones this summer. Right? We had SpaceX in June, June twelfth initially almost two trillion dollars briefly in in market capitalization.

We have potentially Anthropic and OpenAI, the AI giants coming later this year.

Don, a lot of interest in this topic, right? I mean, lot of people are wondering, okay, what should I do here? And so that’s the first question for you. How should investors think about IPOs?

Well, Josh, I think the short answer is they shouldn’t. Right? For for most for most investors, IPOs are something that they should probably just push out of their mind knowing that if it’s a big enough and a successful enough company, they’re going to end up owning it anyway at some point.

And so as far as the IPO exercise is concerned, I would argue most investors shouldn’t even be thinking about IPOs.

And so walk through exactly what it is that actually happens on an IPO. I mean, what is what is the actual kind of IPO day process that gets so much media attention when it finally hits?

Well, mean, just just high level. I mean, an IPO first off, let’s just define it. It’s an initial public offering. And it’s the exercise whereby a previously private company works with an investment banking firm or a group of investment banking firms to put a price on some percentage of the firm’s equity, the stock, and then they offer it to the public for sale. And so that is a process that takes many, many months of underwriting and regulatory filings and so on and so forth.

But once a company is ready to go public, the way the mechanics work is the investment banking firms ahead of time are taking indications of interest from investors through select platforms, through relationships. So the big investment banking firms are working with their clients, getting a sense for how many shares of a specific IPO that they might be interested in at a given price. And the IPO price is not the price at which the stock starts trading. The IPO price is the price at which the private company has priced its shares and sell those to select investors, that are coming, into the IPO process by way of the investment banks that are doing the underwriting.

And so in the case of SpaceX, for example, that IPO price was one hundred and thirty five dollars a share. So if you signed up for one hundred shares of IPO through your particular stockbroker, and if their firm was participating in the IPO and you were awarded those hundred shares, you’re not always awarded what you request by the way.

In situations where a highly anticipated IPO is oversubscribed, chances are you might get cut back. You may say, look, I wanted a hundred shares, but I only got fifty. That’s very common, very normal. It happened in the case of SpaceX where it was oversubscribed.

Not all of the investors got their entire requested number of shares. But that one hundred and thirty five dollars that’s the price you pay if you are participating in the IPO. That is very different, Josh, from the price at which the shares begin trading on the floor of the exchange. That is a very different price.

That is a process whereby the market makers will match bids for buying and for selling of those shares. And in the case of SpaceX, the first shares, the very first shares started trading at one hundred and sixty dollars a share, not one hundred thirty five. And this is I think part of the allure for why so many investors look at these IPOs like they’re Powerball tickets. They’re thinking, wow, I’m gonna buy at some pre IPO price and then I’m gonna strike it rich when it starts trading.

Well, sometimes yes, most of the time no, as we’ll see when we look at the data.

Yeah. So let’s pull up the data now. And this is just a very simple chart on screen for those of you listening. It’s just a simple chart of SpaceX’s stock performance since since the IPO.

So like Don said, the there’s we should there’s a line throughout here that shows the one thirty five dollar price. That’s the price that you got pre I if you were if you were in the if you if you were if you were pre IPO, that was the price. Started trading at one sixty. It closed the first day of trading at around one ninety.

Briefly, a couple days later, reached all the way closed it just shy of two twenty. Actually, in the middle of the day there, it was it was briefly a little bit over two twenty.

Correct.

And then almost immediately, after just a couple of days trading on the open market, started to decline. And so what you see here is that now, as of Monday, July twenty seventh, it was just under one fifteen.

And so, I mean, Don, what’s kind of your takeaway from from looking at that chart and thinking about where we are now?

Well, mean, think the first thing is to keep in mind that this is a very normal, overwhelmingly normal trading pattern for companies that are newly public. And if you look at this particular chart like you were just describing, Josh, is we see this initial bounce. All of this retail investor money, this momentum, this pent up demand floods into the market within the first couple of days that a firm is now now trading its shares on the exchange. And so we see that initial pop.

You mentioned the intraday high. It actually peaked at around two little over two twenty five dollars per share. That’s when we saw the most buying interest. These were generally smaller investors coming into the stock that could not participate in the pre IPO process.

And then what invariably seems to happen, Josh, with all of these initial public offerings is eventually the market starts to reassess. They say, wait a minute, show me the profitability of this company. What do the revenues look like? What’s the earnings growth really look like?

What information do we really have to substantiate this valuation? And in the case of SpaceX, mean SpaceX was trading at really a nosebleed gravity defying valuation that most financial types like myself would just look at and say, I don’t see where this price is really justified. And so what we’ve seen since is really a pretty steady erosion in the price. Now, if you actually look at where it’s trading, virtually all investors who participated in the IPO process through the investment banks and all the investors who’ve purchased it in the month or so since then, month and a half at this point, all of them are in the red.

And again, that is a very normal trading pattern.

This isn’t meant to make any of those investors feel bad about their decision. It’s to normalize what they’re going through. This is very, very normal.

And so like we often counsel investors, Josh, if you are gonna participate in an IPO, you just wanna be prudent about it. And you wanna be honest upfront with yourself. What realistically should your time horizon be? How much should you realistically allocate to the stock of a newly public company?

If you’re really serious on buying it, okay, I can understand that, but let’s do it prudently. Let’s do it in a way that’s controlled, that’s diversified, and in a way that makes sense. And you just got to manage your expectations. So I think for a longer term investor who’s looking to hold something like SpaceX for five, ten, fifteen years, I mean, the first six weeks of trading activity arguably is totally immaterial.

And so if you’re gonna hold the company for a long period of time, you know, I would look past where we’re at today in terms of the stock price.

Yeah. And just to run that math real quick, if you got in at the IPO allocation price, you’re down fifteen percent now. If you got in on that opening day market price, you’re down over twenty eight percent. And if you accidentally bought on that all time high on June sixteenth, you’re down a little over forty nine percent. You’ve lost almost half your investment if you had, gone in at the very beginning like that. Now, Don, what’s kind of the process from here of understanding more about kind of SpaceX and and, you know, how what what kind of information are we gonna get about this company going forward?

Well, I I think that’s why we have markets. Right? That’s why we have buyers and sellers is the market is trying to find a price.

And the market is trying to digest all of the publicly available information that we have on the company. The challenge at the moment is we actually don’t really have a quarterly earnings report on SpaceX. And earnings is really what investors are looking for, information on revenue growth, profitability, and things like that. Well, SpaceX won’t have its first quarterly earnings report until August fourth. And so in situations where markets don’t have a lot of information, you should expect there to be volatility. And that’s because buyers and sellers just don’t have the information they need to really realistically arrive at a price.

And so it tends to be very sediment driven, very momentum driven based on the hype, the headlines, sort of the narrative, right? Almost this ideological belief that an investor has in a company. Like that’s, you know, you’re buying Elon Musk when you invest in SpaceX right now because arguably you don’t have a ton of information. We have some limited public financial information that was part of their initial regulatory filings, but there has been a lot of headlines related to SpaceX and a lot of its business activities since the regulatory filing that make it really hard for the market to figure out, you know, what is this company genuinely worth and what should investors pay on a per share basis?

The last thing that I would just highlight is only about fifteen percent of the company’s stock is publicly traded. This was a very limited public offering. It’s not like eighty percent of the company is now publicly available for public investors to purchase. And so it’s a very small piece of the company.

So there’s not nearly as much supply as some investors might think out there in the broader marketplace. They did float about eighty five billion dollars worth of their shares. And I think to most lay people, we’re like, wow, that’s a lot. And it certainly is, but this is a company with a market capitalization at least at the IPO time of about one point seven trillion dollars.

And so it’s actually a very small percentage of the company’s equity that was offered for sale to the public.

And now, you know, we’re kinda talking about this in the context of of SpaceX, but a lot of these insights are gonna be relevant when it’s anthropic or OpenAI if those happen. And they’re and they’re applicable in general. Like, the nature of IPOs is they happen kind of at a peak of a hype cycle before you have the underlying information you need and so you see this is a common pattern. And so we’re gonna put up some numbers that we crunched a few months ago on ten of the largest IPOs of the past. I think these were the ten largest IPOs since the turn of the century actually. And you see in this chart that we have up a pattern where almost all of these companies, six months after their public debut, were in negative territory from their IPO price.

Correct. Correct. And one thing I would just highlight again, I want to normalize this for investors. It’s one of the reasons why at Mercer we often counsel patients, Josh.

It’s not that we’re saying that these are horrible companies and you shouldn’t own them. What we’re saying is all in due time. Let’s take the time, add them to the portfolio once they become part of the major indices, things like that. If there’s one investing lesson I could pass on to our listeners and to all of our clients, it’s to never ever rush an investment decision.

Right? FOMO, fear of missing out, is one of the worst, most disastrous, most harmful behaviors that we as investors can cave into.

SpaceX isn’t going anywhere, Josh. It’s a publicly traded company now. The shares are out Whether you buy them today or six months from now, it doesn’t matter. You’re gonna be able to buy the company. You’re gonna be able to add it to your portfolio.

But what I often see with these IPOs, I see it with our own clients, is folks just they have this fear of missing out.

They rush into an investment. And I rarely ever see that end well, Josh. And I think this pattern that you’re that you’re that you’re describing to our listeners, I think that is evidence for why you should be very patient when you are making these types of investment decisions.

Yeah. I mean, look at this table in one of the companies on here is Facebook. Eighty one billion dollar valuation at its IPO in twenty twelve and it’s not to say like Facebook has gone on to be a successful company. It’s ended up being a good investment but the IPO as this chart shows was not a good time to get into it.

It actually lost fifty percent from its IPO price over three months. Even six months later, it was down thirty one percent. You would have been a lot better obviously waiting until after the IPO and and getting in a little more gradually. You still would have been on the ride of the last, you know, ten or twelve years.

It was just the IPO ended up being a particularly poor moment to to invest in that company. It’s not to criticize the company. Facebook’s been very successful.

Right. And you know, I’ve been in this business since nineteen ninety eight.

So I remember each and every one of the IPOs

that you have

on the screen.

And I distinctly remember the Facebook IPO. Clients were just, they were like barbarians at the gates. They wanted a piece of this company at any price.

And that’s usually a sign that it’s way overvalued.

We saw the company’s stock price collapse fifty percent within the first three months. So Josh, this just gets back to I think a very perennial evergreen lesson when it comes to investing. Never rush, take your time, be very careful when a company is newly public. There is all of this pent up investor demand. Most of it’s smaller investors, a lot of retail money that wants to rush into the stock. Remember, the insiders have way more information than you will ever, ever, ever have.

And remember that for every buyer there must be a seller. And so you must ask yourself, well, gee, if the company is so great, why are they selling?

Why are they selling their shares? Well, I think part of it’s liquidity. There’s some very human realistic reasons why sellers are selling.

But remember, they’re selling at an opportune time because they know the valuation is pretty high, that they’re gonna get a good price for the shares. So again, for longer term investors, short term sell offs arguably are immaterial, but you just need to know going in, this is the pattern that we observe when it comes to most IPOs.

When I was learning this, right, I was like, okay, I don’t want to buy in on IPO day. But I think a lot of people are probably looking at this and saying, okay, well how do I get into the company even sooner, right? Like how do I become one of these investors who owned a stake at some sort of in one of these pre IPO fundraising rounds? Like how do I get to be one of these people? And so I’m kind of curious, you know, what are the options that people have to you know, is there a way to get in early and, you know, be one of the people who’s selling on IPO day instead one of the people buying on IPO day?

I mean, answer to that is yes and no. There’s ways to do it. But the truth is, I think for most investors, you are a qualified purchaser, right, which is an SEC definition, Securities and Exchange Commission definition, the reality is most of these types of vehicles that invest in private companies, most of them are gonna be closed to you. And so a qualified purchaser is someone that that has five million dollars or more in investable assets and meets several other criteria.

So I think that’s the first thing you need to keep in mind. If you don’t have five million dollars in investable assets, the truth is most of the private equity vehicles or what we call continuation vehicles that are out there, special purpose access vehicles, things like that. A lot of those things are closed to most investors. Now, if you are a qualified purchaser, you still need to have access to a vehicle, to a private equity fund or a venture fund that actually has an allocation to this specific company.

If you’re connected to the founders of the company or perhaps within your social circle, you could perhaps be an angel investor. You could actually invest directly in the company’s shares. That’s kind of rare, right? It it naturally it does happen.

I mean, early early early rounds of fundraising for a lot of these companies, they’re bringing in friends and family, friends from business school, friends from college, people like that. So that’s usually where a lot of these folks would get really super early access to these types of companies. As time goes on and you saw this with SpaceX, you had certain private equity funds that would return capital to investors but they would still hold on to SpaceX and maybe they’d spin it off in some sort of you know, what we call a continuation vehicle and they could bring new investors into this particular vehicle.

And we saw a lot of this with SpaceX over the last couple of years. The challenge with that, Josh, is a lot of those vehicles were vehicles inside of vehicles inside of vehicles inside of vehicles, which is a fancy way of saying that there were so many different layers that SpaceX was embedded in, that you were paying fees to arguably anywhere from two to as many as five different entities before you actually had direct exposure to the actual SpaceX company. So a lot of folks would say, why own SpaceX? No, you don’t.

You own a vehicle that has an interest indirectly in SpaceX. So a lot of this was just cocktail party talk. A lot of these folks wanted to be able to get access to some sort of vehicle that claimed to have ownership in SpaceX so that they could, you know, the country club or the cocktail party could tell their buddies about it. And I get that, that’s very human.

You know, we we we enjoy having those types of conversations.

But it’s real very difficult, Josh. I think my colleague David Krakauer said it best is people actually don’t want access to pre IPO companies like SpaceX. What they really want is a time machine where they can go back in time and theoretically buy the stock at private stock price during one of its earlier rounds of fundraising. And the reality is that’s just not possible.

And the other point think bears mentioning is that these kind of secondary platforms often have real restrictions on when you can actually unload it. Like, even if you had been able to get into one of these vehicles and managed all those fees, you wouldn’t necessarily been able to sell on IPO day or on on June sixteenth when the price hit two twenty. You might have been restricted and you you might be stuck holding this thing as it’s been writing its way down for the past month.

Yeah. Absolutely. An excellent point. Right? We we’ve seen a proliferation of new sort of secondary market type platforms where employees in these companies can try to sell their interests in their employer.

A lot of these vehicles, actually all of these vehicles, Josh, they’re illiquid, Right? They’re illiquid. Like, sure, you might be able to get in, but you can’t very easily get out. Remember what I said a few moments ago.

SpaceX only offered fifteen percent of its shares to the public. Right? So even many of these early stage investors, they didn’t get full liquidity. They got some, but they certainly did not get get full liquidity by by any stretch of the imagination.

And you rightly point out there are significant restrictions with respect to when insiders can sell their can sell their shares to the public.

So what should investors do instead? Right? I mean, this is good. We this this appears to be a significant company even despite the the decline of the past since June twelve. So how should investors think about, you know, this is a trillion something dollar company now. How should how should they be approaching it?

Yeah. I mean, first off, I mean, I personally think, you know, a lot of these companies, SpaceX, Anthropic, OpenAI, these are amazingly innovative companies. Right? That doesn’t mean you should rush to own them.

Right? So that’s, that, those are two different things. But, but the right way to approach owning these types of companies is to always take a disciplined and a diversified, and I’m gonna emphasize it again, a very patient approach to adding them to your portfolio. And so that’s the right way to think about it.

SpaceX will eventually at some point likely become part of the S and P five hundred index. Most investors have exposure to the S and P five hundred index either through a direct indexing type strategy that owns individual stocks or through an ETF, perhaps the Vanguard Group’s ETF or I’m sorry, VOO.

So there’s lots of ways that you’re gonna end up owning SpaceX anyway. Now S and P Standard and Poor’s, the company that constructs and manages that index, they’re not in a rush. They have certain requirements that need to be met. Right? But the point is is that you’re gonna own this anyway. And I think many of our listeners, Josh, would be surprised to know, well, what percentage of my portfolio would be allocated to SpaceX if I took a very simple, what we call market weighted approach, right? So you may hear investment types like myself talk about being overweight or underweight or having a market weight relative to a given company.

Let’s just focus on the market weight for a moment. The market weight is the weight that the entire market, all of the investors the world over have determined is the right percentage of your portfolio to hold in a given company. And so let’s just assume for a moment, Josh, that your portfolio was one hundred percent invested in the S and P five hundred index. So what that means is no bonds, no international stocks, no real estate. Let’s just assume a very simplistic, pretty undiversified portfolio that was only diversified within the largest U. S. Companies.

And that would be the S and P five hundred index. If you really wanted to own SpaceX as part of that portfolio, your portfolio should have eleven basis points in SpaceX. And that’s when S and P decides to add it. It’s very likely that S and P will not add it until the middle of next year, which I’ll get to in a moment.

But I to focus on that eleven basis points. That’s less than one percent of your portfolio should be in SpaceX stock if your portfolio was a hundred percent just U. S. Large company stocks.

So if you just do the arithmetic on that, let’s say you had a one hundred thousand dollars portfolio, that’s one hundred and ten dollars that you would put in SpaceX stock, which means you couldn’t even afford one share right now because it’s trading at one hundred fifteen.

So just keep that in mind, that oftentimes investors are like, it’s gotta be meaningful or else it’s not gonna move the needle.

I should put five percent of my

Yeah, right.

Well, if it’s meaningful, it means it can also blow up your portfolio. So this is why you diversify is because you don’t want any single company to really blow up your portfolio. Now I wanna go back to that eleven bps one more time.

Now let’s assume you had a diversified portfolio. Let’s say something simple like a sixtyforty, sixty percent global stock, forty percent bonds type portfolio. What we see in those portfolios is typically about forty percent of the portfolio is invested in U. S. Companies.

So multiply that eleven basis points that we have here on the screen by zero point four.

Truth is you should probably have, if you had a one hundred thousand dollars portfolio, forty dollars worth of SpaceX stock would be the right weight. Now I know we have many listeners saying, my gosh, no way, no way, no way. It’s gotta be something a lot, lot bigger, right? But what that means is you are saying, I’m gonna take an overweight position in this particular company. Well, you better have a religious like ideological faith in the company if you’re gonna take a really heavy overweight to a company like that. So again, that’s why we always counsel prudence and diversification.

In terms of the indexes here, Josh, S and P has not added SpaceX to the index yet. They have certain requirements. Russell one thousand, another index.

Russell is another index provider. NASDAQ one hundred, I know many of our clients are familiar with NASDAQ, which is a more technology heavy index. NASDAQ and Russell, they’ve both already made a decision to add SpaceX to their indices. And so what that means is if you owned an index ETF that tracks one of those particular indices, you already have exposure to the company. The Russell one thousand has a ten basis point exposure to SpaceX.

Looking at NASDAQ, which is a technology heavy index of a hundred companies, this NASDAQ one hundred here has a seventy basis point. So still less than one percent, seventy basis point allocation to SpaceX. So these are fairly small, fairly minor allocations that are well diversified within their respective asset classes. Now one last point that I’ll leave with our investors, to our listeners, is that the S and P requires positive GAAP net income. Let me put that in English. They require that the company be profitable in terms of earnings before they add it to their index. They also require that it has twelve months under its belt of public trading.

Russell and NASDAQ do not have those requirements. So my message to our listeners is just keep in mind that different indices, different index providers, they have different requirements that they have before they add a company to their respective indices.

And as investors, we should, we would be wise to make sure we understand those, that we really understand what kinds of companies are we adding to our portfolio based on the different index inclusion requirements.

Really interesting. Well, Don, kind of share, just summarize it for people. What do you see as kind of the key takeaways from all of this?

You’ve convinced me that I don’t wanna rush into the anthropic and open AI trades. But what are kind of the big picture things that our listeners should take away from this conversation?

I mean, there there there are several, Josh. And I know many of our clients, our listeners, they hear me say this all the time. Number one, stay diversified. Never fall in love with your investments. They sure as heck will not love you back. SpaceX doesn’t even know that you exist.

So you want to be very careful. Right? So staying well diversified, right? I heard an advisor the other day say something that look, our job is to help clients stay rich, stay wealthy, right?

You’ve built up a nest egg, let’s protect it, let’s not do anything foolish that requires us to start over. This isn’t golf, there’s no mulligans. We don’t get to just take the shot over again in life. Unfortunately, time is linear and none of us is getting any younger.

So again, diversified. Take an evidence based approach to building a broadly diversified, globally diversified portfolio. That’s how you’re really gonna get the best outcomes for you and your family. So number one, stay diversified.

Number two, avoid market timing and stock picking. Like I said, these companies, the insiders, they have way more information than you are ever gonna have on the particular company. So I personally, I think there’s value. Don’t rush.

Right? Resist FOMO, that fear of missing out. There is no good in the investment world that comes from chasing shiny objects. Right?

That’s not an investment strategy.

So avoid market timing, avoid trying to divine which companies you think are gonna beat the market over time. There are professionals with decades of experience, lots of world class training that fail to do that every single day. So I think a more prudent, very diversified approach, avoiding the market timing, avoiding trying to pick the market’s big winners. And then I think last is to gain these exposures organically.

Eventually, SpaceX will get added to the s to the S and P index. Eventually, SpaceX will provide the market some earnings reports, audited financial statements. And as investors, the world over, we are going to establish what the what the right price and what market weight is for these types of companies. And these types of companies ultimately will be added to your portfolio.

You know, Josh, one of the things I often say to folks is, look. If in nineteen ninety all you owned was the Vanguard S and P five hundred index fund, and if you fell asleep in nineteen ninety, and if you woke up ten minutes ago, guess what? Your portfolio already has exposure to AI companies. Well, AI companies weren’t even a thing when you fell asleep in nineteen Right?

And just by virtue of having a diversified portfolio that organically adds newly public companies, you’re gonna get exposure to these companies anyway. So I would just counsel that there’s no need to rush. Add exposure organically. Let’s do it in a risk controlled, measured way. And if we do those things, you’re going to have exposure to these companies and you’re going to do it in a way that is not going to jeopardize your economic freedom.

Don, thank you so much for providing this perspective today.

Thank you. It was fun.

If you’re already a Mercer Advisors client, don’t hesitate to talk to your advisor about any of this. And if you’re not a Mercer Advisors client, you’re interested in more information, go to our website, www.merceradvisors.com, set up a phone call. Thank you so much for joining us today.

This has been Market Perspectives.

This presentation by Mercer Global Advisors Incorporated also known as Mercer Advisors was intended for general information purposes only. No portion of the presentation serves as the receipt of or as a substitute for personalized investment advice from Mercer Advisors. All expressions of opinion reflect the judgment of the speaker as of the date of recording and are subject to change.