What SpaceX, OpenAI and Anthropic's IPOs mean for investors | The Economist

Key Concepts

• Giga IPOs: Extremely large initial public offerings (IPOs) from high-valuation companies (SpaceX, OpenAI, Anthropic).
• Index Tracking: Investment strategy where funds (like ETFs) mirror the composition of indices such as the S&P 500.
• Fast-tracking: The practice of index providers adding new IPOs to major indices shortly after listing (e.g., within 5 days).
• Market Weighting: The proportion of an index a company occupies based on its total market capitalization.
• Price-to-Sales (P/S) Ratio: A valuation metric comparing a company's stock price to its annual revenue.
• Bull/Bear Market: A market characterized by rising prices (bull) versus one characterized by falling prices (bear).

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1. The "Giga IPO" Phenomenon

SpaceX, OpenAI, and Anthropic are preparing for massive stock market listings, collectively projected to add up to $4 trillion in value to the U.S. stock market.

• Motivations for IPOs:
  • Capital Raising: Need for massive investment to fuel growth.
  • Liquidity: Providing an exit strategy for employees and early-stage investors.
  • Market Timing: Capitalizing on the current intense investor enthusiasm for Artificial Intelligence (AI), which has driven share prices to record highs.

2. Risks to Pension Schemes and Index Funds

A significant concern involves the "fast-tracking" of these companies into major indices like the S&P 500.

• Volatility Exposure: Index funds are forced to buy shares shortly after listing, often when prices are highly volatile, potentially leading to losses for retirement savers.
• Liquidity Exhaustion: There is a fear that once index funds—which act as a "natural pool of buyers"—have finished their mandatory purchasing, there will be insufficient demand to support the stock price, leading to a subsequent decline.
• Scale Context: While the IPOs are massive, they are small relative to the $70 trillion U.S. market. For example, SpaceX is expected to represent only about 0.1% of the S&P 500, suggesting that the systemic risk to the entire index may be overstated.

3. Investment Performance and Historical Trends

Academic research, specifically from Jay Ritter (University of Florida), provides a cautionary perspective on IPOs:

• Underperformance: Data dating back to 1975 indicates that, on average, companies underperform the broader market by approximately 20 percentage points in the three years following an IPO.
• Valuation Sensitivity: Companies with high valuations relative to their revenue (like SpaceX) tend to experience even greater underperformance.
• The "Seller’s Market": Bankers and companies time IPOs to maximize their own returns, which often coincides with the peak of a bull market. Consequently, individual investors often buy at the top, just before a market downturn.

4. Valuation and Growth Expectations

SpaceX is targeting a valuation of $1.75 trillion, which presents a challenge for future growth:

• Missed Growth Phase: By the time a company goes public at such a high valuation, the "explosive" early growth phase has already occurred.
• Aggressive Multiples: The $1.75 trillion valuation is based on a price-to-sales ratio of 90x. To justify this, the company must achieve extraordinary, long-term growth, such as dominating space-based data centers or colonizing Mars.

5. Structural Shifts in Market Dynamics

The current trend represents a potential shift in how tech firms interact with capital markets:

• From Cash-Generators to Capital-Sinks: Historically, big tech firms operated with little capital and returned cash to shareholders via buybacks.
• Reversal of Capital Flows: These firms are now issuing more bonds and follow-on shares, effectively "sucking up" cash from the market rather than returning it. This reduces the liquidity available to push stock prices higher, potentially signaling a downward pressure on the broader market.

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Synthesis and Conclusion

The surge of "Giga IPOs" in the AI sector is driven by a desire to capitalize on current market hype. While these companies are significant, their inclusion in indices poses risks to passive investors due to volatility and the tendency for IPOs to underperform over the long term. Furthermore, the shift from tech giants returning capital to absorbing it suggests a fundamental change in market dynamics that could lead to a cooling of the broader stock market. Investors are cautioned that the "best time to sell" for a company is rarely the "best time to buy" for an individual.