A daily market update from FS Insight — what you need to know ahead of opening bell

“There are far, far better things ahead than any we leave behind.” — C.S. Lewis

Overnight

Israel set a March 10 deadline for the return of all hostages held by Hamas, warning it would otherwise push into Rafah. link

Houthis strike U.K.-owned, Belize-flagged Rubymar cargo ship in Bab al Mandeb strait with anti-ship ballistic missile. Crew abandons disabled vessel. link

European Commission President Ursula von der Leyen seeks new term amid Ukraine, U.S. challenges. link

Chinese Coast Guard boards Taiwan tour boat as dispute escalates. link

Capital One buying Discover Financial in $35 billion deal for vastly increased payments ecosystem power. link

Apple faces €500 ($539) million fine from the EU over allegedly breaking antitrust law in the streaming-music space. link

U.K. court hears WikiLeaks founder Julian Assange’s latest, possibly last legal attempt to avoid extradition to the U.S. on espionage charges. link

Chinese banks cut mortgage reference rate by 0.25-percentage-points, the most on record, as new data showed FDI at 30-year low. link

Auto parts giant Forvia to cut up to 10,000 jobs amid global shift to EVs. link

Biden administration gives $1.5 billion in grants to chipmaker Global Foundries to build, expand facilities in New York, Vermont. link

U.A.E. poised to exit financial watchdog’s dirty money list. link

Recent report says global water crisis already here, not on horizon. link

Hundreds of thousands march in Mexico against government proposals seen as anti-democratic. link

Little-known fact: President Lincoln pardoned President Biden’s great-great-grandfather, Moses Robinette, who had been convicted of attempted murder. link

First news

• Reddit signs content-licensing deal with AI company in effort to boost valuation ahead of IPO
• If you are a U.S. citizen aged 30-55, you too can aid science by spending a year in a Mars simulator in Texas
• OpenAI completes $80 billion tender offer.

Chart of the Day

MARKET LEVELS

MORNING INSIGHT

Good morning!

Fifty-four companies are reporting this week. Of the 397 companies that have reported so far (79% of the S&P 500):
Overall, 80% are beating estimates, and those that “beat” are beating by a median of 7%.
Of the 20% missing, those are missing by a median of –5%.
On the top line, overall results are beating estimates by a median of 4%, missing by a median of –3%, and 64% of those reporting are beating estimates.

Click HERE for more.

TECHNICAL

Due to a medical emergency affecting Mark Newton, our Head of Technical Strategy, there is no technical update this morning. Thank you for your understanding.

CRYPTO

• Bitcoin’s performance relative to other risk assets following a hot CPI print was a great example of how passive ETF flows can affect the way that BTC trades in a post-ETF world.
• Altcoins have seen gains from recent capital inflows, resulting in expanded market breadth. However, when market breadth is measured in BTC, it continues to decline, signaling a market led by Bitcoin. This is typically characteristic of the earlier phases of a market cycle and bodes well for continuation higher in alts.
• Older wallets, who presumably purchased at a lower cost basis, have begun selling their BTC. While this might appear bearish on the surface, it signifies strength and is a characteristic feature of every previous bull market cycle.
• With an impending cliff unlock for ARB, nearly equivalent to the current circulating supply, we anticipate strength leading up to the Dencun upgrade. However, our assessment of the risk/reward equation suggests it will be prudent to derisk on any significant rally prior to the unlock.
• Thus far this week we have seen nearly $2 billion in net inflows across all BTC ETF products, and continued creations within the stablecoin market.
• Core Strategy – Our Q1 outlook anticipated some headwinds, and it seems the initial turbulence has subsided for now. Flows into crypto remain strong and breadth against BTC remains subdued. We maintain that ETH, L2s, and STX offer compelling idiosyncratic upside due to their near-term catalysts. Further, we have no reason to fade the recent strength out of SOL.

Click HERE for more.

FIRST NEWS

Getting Ready for Their Closeup. Reddit has reportedly signed a content-licensing deal allowing an artificial intelligence company to train models using Reddit’s data – an archive going back almost 20 years and covering posts on the site dubbed “the front page of the internet”. The deal with the unnamed AI firm, worth $60 million on an annualized basis, was signed earlier this year, could be a model for future contracts, and is an example of a new revenue stream for social media sites and news publishers. OpenAI signed similar agreements with AP and German publisher Axel Springer last year. As we’ve written recently, Reddit is expected to go public next month at a valuation of at least $5 billion, and its licensing deal could help drive up that figure. Bloomberg

Not Yet Ready for Their Closeup. NASA is recruiting volunteers for a simulated year-long mission to Mars. The Crew Health and Performance Exploration Analog (CHAPEA 2) will host a quartet of brave souls in a 1,700-square-foot sealed habitat meant to mimic life on Mars. Just in case you skimmed over the first two sentences, this will all be taking place in Houston, Texas – not on Mars (although to some NYC dwellers, a 1,700-square-foot spread is as science-fiction as Mars is to others). The first crew is roughly halfway through its 378-day assignment. This will be the second of three simulations, preparing for a NASA mission to Mars ‘as early as the 2030s’. The CHAPEA simulations will help scientists understand how humans will fare during the long journey to the Red Planet. Applicants must be English-speaking U.S. citizens aged 30 to 55 with a STEM master’s degree and two years of work experience – which, accounting for requisite industry-appropriate adjustments, sounds very much like the requirements for landing a junior analyst role at a Wall Street bank. Semafor, Engadget, NASA

Tender Is the Price. OpenAI, the company behind ChatGPT, has completed its latest round of fundraising, valuing the company at some $80 billion, which will give it the wherewithal to build on ChatGPT, as well as Sora, the text-to-video tool previewed last week. Despite the corporate-governance drama in November 2023, OpenAI’s unusual corporate structure remains, with the (capped) for-profit company still controlled by a non-profit board of directors.

The company would sell existing shares in a so-called tender offer led by venture firm Thrive Capital, with OpenAI employees selling their shares to existing and new investors.

OpenAI had agreed to a similar deal early last year, when VC firms Thrive Capital, Sequoia Capital, Andreessen Horowitz, and K2 Global agreed to buy OpenAI shares in a tender offer that valued the company at ~$29 billion. OpenAI had also previously attracted a strategic investment of $10bn from Microsoft in January 2023, as well as prior rounds in 2019 and 2021. The large investments have attracted the attention of regulators, with European Commission officials announcing intentions in early January to look into whether Microsoft’s backing raises antitrust concerns.* Stateside, the FTC said it was investigating whether investments from Microsoft, Google, and Amazon into AI companies, including OpenAI, are harming competition.

The Unbreakable Sammy Altman

The current valuation of $80 billion vaults OpenAI into the ranks of the world’s most valuable startups. It’s a headspinning rise for the company that touched off the tech industry’s obsession with all things AI with its release of ChatGPT a year ago, becoming Silicon Valley’s most talked-about AI startup. 

It had previously been in talks to sell shares as part of a deal that would have valued it at $86 billion. A range of investors was expected to participate prior to the November saga, including Ashton Kutcher’s Sound Ventures, an existing shareholder whose participation in the tender had not previously been reported. Prior to Altman’s exit and re-entrance, Sound Ventures had committed ~$100 million to the tender offer; it is no clear whether it’s participating in the current deal. Indeed, some investors have opted not to invest this time around following Altman’s brief but shocking ouster as CEO; still, after Altman was reinstated, there was enough demand from investors to cover the dropouts’ portion of the deal.

Thrive Capital-led OpenAI tender picked up smoothly after Altman returned. As part of the then-pending deal, a group of investors led by Thrive committed to buy up to $1 billion of stock, and conceivably more, held by employees or other investors. Closely held companies use tender offers like this one to give employees a chance to unlock the value of their holdings in the period before an initial public offering. It also gives investors the chance to snap up more equity.**

The problem is the pricing

As companies, particularly those planning a direct listing, head toward the public markets, tender offers provide valuable guidance on what their stock is worth. Tender offers also serve the vital purpose of providing a scalable route to liquidity for employees at fast-growing companies. The problem with tender offers is that they underprice a company’s stock, sometimes drastically.

In late 2019, Asana employees sold stock as part of a tender offer priced at $15.82 only to see the company go public less than a year later at $28 a share. In February 2020, Snowflake employees sold shares into a tender at $38.77 per share. In September, the company went public and hit $253 on its first day of trading. The promise of tender offers to employees of private high-growth companies is de-risking and diversification, but chronic underpricing means that selling into a tender frequently means leaving large sums of money on the table.

For investors, tender offers can help win deals and get a larger percentage of ownership than they could otherwise; in the vast majority of cases, they can do so at or below the price of the last round of funding. Tender offers are priced at the price of the last round or lower in 83% of all transactions, with 15% priced at a 20% premium or better and less than 0.5% at a 2x premium or better. Pricing tender offers based on the last round’s valuation is convenient, but it tends to misprice high-growth companies. By relying on the last round’s valuation, all new growth and changes to the company’s fundamentals are not priced in, and employees and other shareholders end up selling at a discount.

Why participation in tender offers is under 40%

Underpricing hurts employees by reducing their overall returns from selling into tender offers while dampening participation rates – calculated as the portion of shares sold into a tender by a stakeholder divided by the portion of shares eligible for sale – keeping employees from getting liquidity.

Unsurprisingly, tender offers that were less than 30% underpriced saw participation rates of between 30% and 50%, while tenders more severely underpriced saw their participation fall to between 10% and 30%. The upshot of underpricing in tender offers was not just low employee participation, but low prices for employees selling stock compared to founders and investors selling stock in private secondary transactions apart from tender offers. A look at all secondary sales, including one-off and founder sales, revealed that employees sold at significantly lower prices than founders and investors.***

How to fix the tender offer

The state of liquidity has come a long way since the days when VCs would never agree to shareholders taking money off the table. Founders and angels in particular have much better access to one-off secondary sales to de-risk themselves and their portfolios. But as companies stay private longer and longer and look to provide liquidity to their early employees, the tender offers they use to do so at scale still tend to leave much to be desired.

At the core of the problem is a lack of liquidity in the very market for secondary shares. In almost all cases, tender offers are closed-door transactions with a buyer who is an existing investor and major stakeholder with control rights and a board seat. For tender pricing to become responsive to the real value of companies, information about companies would need to be released and external investors would need to be invited into the process.

In the case of OpenAI, this may not be an issue, but is something to watch out for with other tender offers. Yahoo Finance, Bloomberg, Reuters, CNN, The Information, Chartr, The Guardian

^{* Microsoft holds a 49% stake in the for-profit operating company. Another 49% is divided among other investors and employees, while the nonprofit parent company of OpenAI retains a 2% ownership.}

^{** In October, Joshua Kushner’s $5.3 billion Thrive Capital – a VC fund that has won over top Silicon Valley CEOs, from OpenAI to Instagram, in record time – reportedly led a funding round to buy OpenAI shares at a price that valued the company at $86 billion, per Crunchbase and other reports. That funding would also have valued shares that OpenAI employees may receive as compensation.}

^{*** All secondary sales tend to be at or under the last round’s price, but founders and investors were more likely to sell at a 1:1 ratio to the price of the last round, while employees were more likely to sell at a discount. These subpar outcomes may help explain why only 24% of employees ever exercise their options.}