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- The Capital Window Has Closed: Which Companies Will Make It
The Capital Window Has Closed: Which Companies Will Make It
The window has closed.
The cycle has turned. The days of free money are over.
Any company looking — or needing — to raise money will do so at very expensive terms.
This puts many companies at risk of bankruptcy.
Why? Because many companies grew out of a free money world. These companies borrowed billions of dollars with near-zero interest rates.
It’s very easy to pay a loan back when there’s almost no interest accruing. It’s also easy to refinance a no-interest loan with another one.
But now rates are higher.
These companies will need to refinance their debt at higher rates. But how high? That depends on U.S. bonds — a.k.a the risk-free rate.
Any lender (i.e. banks or private equity) will look at the risk-free rate and ask themselves how much premium they need to be compensated to lend to a company, relative to what they can earn in U.S. bonds.
Here’s our explanation from April 19th in our missive Why Mortgage Rates Are Rising:
“The U.S. government is considered the safest institution in the world.
It has the strongest economy. The backing of the U.S. taxpayer. And the strongest military.
Lend your money to the U.S. government and you’ll get paid back. Uncle Sam has never missed an interest payment or failed to pay back your principal.
That’s why U.S. bond yields are considered the “risk-free” rate.
The Argentinian government, on the other hand, has defaulted 9 times since its independence in 1816. It’s also needed 21 International Monetary Fund (IMF) relief packages since 1956. And has a long history of political turmoil and corruption.
So if both the U.S. and Argentine governments were offering interest rates of 3% on a 5-year bond, you’d always choose to give your money to the U.S.
Why? Because the U.S. government has the better track record. It’s “safer.”
Therefore, in order for Argentina to “win” you over and get your money, it would need to offer a higher interest rate to compensate you for the risk of lending them the money – known as the risk premium…
Right now, U.S. 10-year bonds have a yield of 2.8%. Meaning you’ll get paid 2.8% per year in interest for 10 years on however much you lend the government – i.e. You are buying a bond. Then they’ll pay you back the principal after year 10.
Argentinian 10-year bonds have a yield of 49.7%. Meaning investors are demanding a 46.9% risk premium (49.7% - 2.8%) versus lending to the U.S. government. That’s how much risk is embedded in Argentina.
What does that have to do with mortgages?
Well, there’s a risk premium lending to individual people too.
Banks are looking for yield. Just like the rest of us.
They have the option of buying U.S. bonds. Or lending money to homebuyers. (Among other places: like companies, etc.).
Therefore, banks assess the risk premium needed to offset lending to you vs. lending to the U.S. government.
So the bank has to make a decision whether to lend money to the U.S. government or the homebuyer.”
The same applies to companies.
The lender needs a higher interest rate to be compensated for the risk, relative to lending to the U.S. government.
It’s one of the main reasons why you’ve seen the implosion of many companies’ stock prices… because investors can finally earn yield in the safest asset.
There were over 1,000 IPOs (Initial Public Offerings) last year according to Nasdaq. These companies raised over $286 billion.
Yet 80% of them were unprofitable.
Almost every single one of these companies’ shares have been destroyed. Investors know the window has closed. And their chance of making it continues to close with it.
Here’s a look at the performance of a few of the well-known unprofitable IPOs from last year.
Roblox is down 75% from its peak:
Allbirds is down 90%:
Robinhood is down 79%:
Here’s a graphic of more unprofitable companies whose shares have been crushed from Market Sentiment.
The valuations on these companies were absurd to begin with. But whether they can stay solvent is dependent on if they can get access to capital.
(They probably will… but not at the terms current shareholders will be happy with. Meaning even lower share prices.)
Take Blue Apron for example. They’re one of our Flawed Companies You Should Avoid At All Cost. Here’s what we said on August 9th:
“Blue Apron is held hostage by the variable costs of food and drink prices. Then it has to worry about the cost of shipping big boxes with ice packs to keep the food cold and fresh. It’s a nightmare in and of itself.
Gross profit margins have been around 35% for the last 5 years and haven’t budged.
Second, APRN has conditioned its customers to wait for coupons and discounts like Bed Bath & Beyond. Meaning it loses money on every order…
Third, they have a hard time bringing customers back.
Below is a chart from its most recent investor presentation. And tells you how many weeks it takes Blue Apron to win back customers after their previous order.
Look to the furthest left column.
It shows you it takes nearly 1 1/2 years to get that customer to order again after their first time. Ouch.
It gets better over time as the customer comes back a second, third, and fourth time. But not by much…
Blue Apron has never made a profit in its history. And it doesn’t look like it’s coming anywhere close to doing so now.
They’ll try and make it up on volume. But will continue to lose more money because of it.
Trying to get profitable by making it up with volume is another flawed type of company you should avoid at all cost.”
Blue Apron is down another 66% since our post just four months ago.
The markets don’t think Blue Apron will make it.
The companies who will make it through are ones with cash, a lower cost of capital, and pricing power.
But the takeaway is it’s not too late to do a revaluation of your portfolio. And know thyself and what you own.
Unprofitable companies will continue to struggle in a higher interest rate world because the capital markets are closed. The only way to raise money or refinance debt is at a much higher cost of capital. One that will kick the can down the road. But be a death-grip... meaning their shares are likely to head lower.
Expect these companies to try and prove to shareholders that they have viable business models in a positive interest rate world. Those that don’t will see their shares continue to drop… or worse.
Good investing,
Lance