Over the last couple of weeks, your columnist’s inbox has been filling up each morning with emails about the imminent listing of SpaceX. About two-thirds of those emails have been newsletters from various financial media outlets – Bloomberg, the FT, the WSJ, etc – worrying about changes to the listing and index inclusion rules and how this could potentially create a clear-cut case of overvaluation. The remaining third, meanwhile, have come from various brokerages explaining how to take part in the initial public offering.
Back in April, the Clark Center’s Finance Experts Panel looked at the proposed changes to Nasdaq’s indexing rules ahead of the expected mega-IPOs of SpaceX, Anthropic and OpenAI. As this column explained at the time:
Nasdaq proposes three major changes, together with a host of smaller tweaks. Firstly, when considering market capitalization for the purposes of eligibility to be included in indices, Nasdaq proposes now including unlisted equity in the numbers. As they note, “As corporate and share class structures evolve, it is increasingly likely that large companies will have significant portions of their market capitalization represented by unlisted shares”.
Secondly, they propose a major change in the timing of index entry: “Currently, new constituents may only be added to the index at the time of the Annual Reconstitution, as a replacement for a deleted index member, or as the result of a spinoff event. As a result, large companies that are newly listed on an eligible exchange (either by way of an initial public offering (IPO) or by transferring from an ineligible exchange) often aren’t added to the index in a timely manner”. Under the new system, a constituent could be added to the index within weeks of listing at an IPO.
Thirdly, they have mooted a formula for calculating index weights as opposed to the current setup, which imposes a 10% free float minimum on equities included in their benchmark indices.
Taken together, these measures would mean that following an IPO in which a company chose to list only, say, 5-15% of its available equity at an IPO, those new shares could be added to several large indices within days of being initially sold to the public. And with, perhaps, quite large weightings.
That theoretical scenario now looks set to become a reality. As many market commentators have been keen to point out, the new index composition rules mean that – within days of the initial listing – SpaceX shares will be added to the NASDAQ Composite and, hence, bought en masse by passive investors in tech stocks. The potential at least is present then for a sharp overvaluation of the initial sale, as savvy investors attempt to preempt the passive buying. Although, of course, it is also possible that investors – anticipating this exact chain of events – will price this in straight away.
Interestingly, as the FT has reported, the allocation of the IPO to retail investors is set to be around 25% – whereas large IPOs more typically offer just 5-10% to non-institutional buyers.
This week, the Clark Center’s Finance Experts Panel looked at the issue of potential overvaluation.
Asked whether “the large demand of passive investors for shares in SpaceX in the days after the IPO will cause substantial overvaluation of the stock”?
Weighted by confidence, 8% of respondents strongly agreed, and 38% agreed. 25% of respondents expressed uncertainty, 24% disagreed, and 5% strongly disagreed.
Given that the panel is often reluctant to speculate about valuations in the near-term – and that uncertainty tends to be very high in the face of such questions – this is a reasonably strong result.
Although, as John Campbell of Harvard argued, such an overvaluation might not prove especially lasting, “I think this is likely – but only as an amplification of overvaluation resulting from the demand of other active investors, and only as a temporary phenomenon”. A point echoed by the Clark Center’s own co-director, Anil Kashyap, who thought any such overvaluation might only last “for a few days”.
There, of course, is more at play than just the index rules and passive investor flows. As Haoxiang Zhu of MIT Sloan – who disagreed – put it, “Index funds are not everything. Investments not in index funds will provide price discovery”.
Indeed, quite a few panel members took the opportunity of the question to express wider concerns. Viral Acharya of NYU Stern fears that “Retail investors are chasing the skies at this moment of overvaluation in the market as a whole, and even the rational ones have FOMO, which is affecting the valuations they are willing to pay”, while Jonathan Parker of MIT Sloan is “ more concerned about meme-stock overvaluation than “hold the market” investors”.
It’s clear that many panel members are concerned that there is a touch of irrational exuberance in the wider tech markets and especially around SpaceX. As David Thesmar, also of MIT Sloan, noted about the SpaceX listing, “The IPO valuation seems extremely high (about 100x sales)”. According to Reuters this week, Goldman Sachs expects that SpaceX’s sales will surge 100x in the coming years. But then again, if you believe that, then your columnist has a rocket launching/satellite running/AI lab/social media platform to sell you.
