No self-respecting brand manager would ever name a newspaper The Economist. You might as well name it “dry and boring eat-your-greens stuff which you probably won’t even understand.” And yet, improbably, The Economist is today worth an eye-popping $1.5 billion. That’s six times the value of the Washington Post, which comes out seven days a week and which has must-read status in the most important political capital in the world. It’s even more than the $1.3 billion that Nikkei Group paid for the Financial Times.
There’s no obvious reason why The Economist, which had a net profit of just $72 million last year, should be worth $1.5 billion. (Or, for that matter, why the FT Group, which has less than half The Economist’s profits, should be worth nearly as much.) Indeed, it would seem that in a contradiction of its venerable name, the valuation of The Economist violates a couple of pretty basic laws of economics.
For one thing, there’s the whole issue of a "control premium." People will pay more for control of a company than they will for a noncontrolling stake. Yet when Pearson sold its 50% stake in The Economist for $734 million earlier this month, the sale came with a raft of safeguards designed to ensure that none of the buyers – and no future buyer, either – would ever be able to control the company. Economic theory says that in such circumstances, any stake should be sold at a discount; instead, the final price was some 28% higher than the Economist’s own most recent (and quite generous) internal share price.
Then there’s the law of supply and demand, which is about as basic as economic laws get. If you have a finite supply of something – company stock, say – then the greater the demand for that stock, the higher the valuation of the company will be. This is one of the main reasons why companies go public. When a company IPOs, the price of its stock is determined in a massive auction: of all of the millions of potential investors around the world, only those willing to pay the highest amount for the stock will end up being able to buy it. It’s simple economics then, that public companies should see significantly higher valuations than private companies: by increasing the size of the investor base, you widen your net to include the people willing to pay the most money.
The corollary is that when you have just a handful of potential investors, that should decrease potential demand and lead to lower valuations. And if the number of investors participating in the auction is exactly one, then you should never see a high valuation.
In the price negotiations over The Economist, the company itself, along with deep-pocketed board member John Elkann, had every incentive to drive a hard bargain and to pay Pearson as little as they could for their stake. What’s more, they knew they weren’t competing against anybody else: there was no underbidder, and they knew that Pearson had zero strategic interest in holding on to its stake after having exited the rest of its publishing-industry holdings. And yet, somehow, the final price ended up being so high that The Economist had to sell its iconic St James’s headquarters in order to raise the necessary cash.
The general rule of corporate capitalism has always been that public valuations are higher than private ones, and when public companies are bought or taken private, those transactions are always justified by strategic considerations and always come with control.
Yet it turns out that The Economist’s high private valuation was no outlier. Look at valuations in Silicon Valley, and you’ll see something similar has been going on for some time. In March 2012, for instance, Facebook shares traded hands privately at $44.10 apiece. Two months later, when Facebook went public, the shares were priced at $38, and a week after that they were trading at less than $27. By August, they were less than $20. It wasn’t until more than a year later, in September 2013, that the share price finally traded higher than the $44.10 that it had been valued at in the private markets.
Or look at Box: after being valued in the private markets at $2.4 billion in July 2014, the data-storage company went public in January 2015 at a valuation of just $1.7 billion, and the shares are at pretty much the same price today.
Public stock-market valuations aren’t exactly cheap. But even after an impressive six-year bull run, some kind of sanity does still prevail. Take Time Inc, the publishing company spun out of Time Warner. It owns no fewer than 90 different brands, from Sports Illustrated to Fortune and Time itself, and has a market capitalization of $2.4 billion – that’s about 11 times its net income, or just 1.6 Economists.
What explains this topsy-turvy world in which noncontrolling corporate stakes are worth more when they’re private than when they’re public? Part of it is the fact that investors in private companies naturally have longer time horizons. If you buy a large chunk of The Economist at a valuation of more than 20 times its annual earnings, it’s not because you think you can make a profit by selling it in one year or one month or even one second. That’s public-market thinking. It’s because you think that the asset is going to be a valuable one over decades or more, for your grandchildren, and possibly for theirs, too. The Economist has been around for 172 years, and in a world where the 30-year German Bund yields just 1.3%, a decent dividend alone would do better than that.
There have been recent signs that long-term thinking is making its way out of the private markets and into more public spheres. Investors cheered Google when it reinvented itself as Alphabet, funder of “moonshots” which might not pay off for decades. They also snapped up a $650 million stock offering from loss-making Tesla, valuing the electric-car company at more than $30 billion. Even Hillary Clinton has taken aim, on the campaign trail, at what she calls quarterly capitalism: “Real value,” she says, “comes from long-term growth, not short-term profits."
Still, many of the oldest companies in the world are private. They’re solid, valuable businesses which retain their value, and their values, over centuries. In a world where the rich have never had more liquidity, and where they want to preserve their wealth for generations to come, perhaps it makes perfect sense that they are willing to pay top dollar for high-quality private assets. Even as we commoners are forced to make do with risky and volatile public stocks.