What If the Mag 7 Concentration Problem Is About to Get Worse?

When I interviewed the Lingotto Innovation duo, James Anderson and Morgan Samet, at Italian Tech Week, Morgan pointed out that the stockmarket will likely look very different in a few years. I hadn’t previously thought about this and asked for their data on private companies.

The history is intriguing – we know that more companies are staying private for longer, but I hadn’t fully appreciated either the scale of these private markets, or the uplift in the last few years, particularly since the public launch of Chat-GPT.

Number of Large Private Companies Trend

Source: Lingotto Innovation Strategy

Morgan points out that in 2019, there were 500 unicorns; today there are over 3 times that number and she sees another 500 emerging unicorns just behind those. She puts this in the context of c.4,500 publicly traded companies in the world with a market cap of over $1bn. Lingotto estimates that private unicorns went from 11% of all unicorns to 37% in 6 years. I prefer to calculate this as 1670/(4500 + 1670) or 27% vs 10% pre-Covid. It’s still an amazing increase.

Growth in Large Private Company Numbers

Source: Lingotto Innovation Strategy

The number of mega companies with a valuation of over $10bn has increased even more rapidly. I think that some element of this is likely over-valuation – with so much capital being raised by venture funds and with almost 50% of it going into AI, it would be surprising if not.

Leaving the issue of valuation to one side, most of these private companies are growing much faster than their public counterparts; hence, bubbles aside, whatever the relative position is today, the relationship will skew more strongly to these private companies over time. 

For investors in quoted markets, the status of private companies is mainly peripheral. But I think it’s really important to consider how the indices will change if more of these large private companies come to the stockmarket. You might want to plan your analytical resources before the IPOs, rather than afterwards.

The concentration of the Mag 7 and top 10 in the S&P500 and even world indices is causing real problems for fund managers and there is a general hope/belief that this concentration will reduce in time. But what if this is a trend that is here to stay, and indeed to be enhanced by the flotation of a large number of these hitherto private companies?

I know neither the probability nor the timescale, but it seems likely that the majority of these $20bn+ companies will eventually end up in public markets. In theory, they could stay private forever, but I suspect at some point, more of their investors will want to realise their gains. And I wonder if the private markets will be deep enough, especially if these companies continue to grow and new ones are created at similar rates.

There are a few reasons why we should expect more of these companies to float:

• Sheer size- if enough of these mega companies need more capital, the private markets may not be deep enough.
• Number of employees requiring liquidity – as these firms grow and employ more people and more have stock options worth more money, the pressure for liquidity will increase. A private market buyer and seller matching system is clunky relative to a public listing and the frictional costs are much higher.
• Some founders will prefer private markets and will prefer not to deal with regulations, sellside analysts and buyside investors. But not all. Some companies may benefit from IPO publicity. A few founders might even perceive that public market discipline may be a positive.
• Some founders may like the idea of having a currency to do acquisitions. That will surely be easier in public markets.
• I imagine that VC funds must have a fiduciary responsibility to extract the best price when they exit. A listing at least protects them from accusations (and potential lawsuits) that they sold stock too cheaply.
• It might be easier to sell the value of the stock to potential employees if there is a daily market in the shares.

Combining the Universes

I thought it would be an interesting exercise to look at how the S&P might change if the top 50 US unicorns were all to list tomorrow, and then to see how that universe might change over the next 5-10 years. There were actually 51 decacorns and above.

I took the Crunchbase database of large private companies because it’s reasonably up to date, not perfect of course, but probably the best source of private company valuations. I left out the European companies because although they may float in the US, there aren’t that many of them and the picture would not be that different if I included them. I also left out the Chinese companies as I think it’s more likely they will float in Hong Kong.

Here is the list of the top US private companies. They are not all tech companies – for example Gousto in 51^st place, but they are primarily tech and I classified Anduril and Ripple as tech rather than defence and financial. I wanted to see how important tech was today if privates were included, so I excluded Gousto as food and the biotech names – the full details are in the spreadsheet for premium subscribers.  

Top 51 US Private Companies

Source: CrunchBase

I combined these with a list of around 1800 public companies listed in the US. They had a total capitalisation of $79.1tn and the smallest had a market cap of $1.8bn. I reclassified anything that looked like tech as tech – Meta, Amazon, Netflix, all the media companies. My base was that tech today in its widest possible form is 37% of the US index (using my 1800 companies as a proxy for the index).

When I add in the 51 private decacorns, that increases to 41%. If I were to include the next 470 companies, it would reach 42-43%, not that much of a difference.

I then tried to project how this would develop over time. I assumed that AI related tech would grow at 20% pa; normal tech would grow at 10% pa; good sectors in old economy would grow valuations at 5% – this included energy and hard assets like commodities; and I assumed that the rest – retail etc – would grow market cap at 0%.

Every reader will disagree with at least one of these assumptions, and premium subscribers can easily play with the assumptions in the spreadsheet. I also assumed that every private company would grow at 20%, again not realistic, but remember that I am projecting based on today’s universe – the universe of very large private companies is itself growing at a fast clip, so if anything I am likely under-estimating.

I haven’t tried to estimate how many SaaS companies for example will be displaced but as they will likely be replaced by new private players, my estimates of the overall proportion of tech vs non-tech should be reasonable.

The results based on these assumptions suggest that tech will grow from 41% today to 51% in 5 years’ time to 61% in 10 years’ time. The concentration also increases – from 30% of the top 1800 today to 35% in 5 years’ time to 41% in 10 years’ time.

The Top 20 Five Years Out

The spreadsheet was rather unwieldy, so I recreated the exercise using a $6bn cut-off which gave me c.1000 public companies and around 100 private, both US only. Using the same assumptions, tech was 40% of the public 100 and 42% of the combined universe, growing to 52% in 5 years and 60% in 10 years.

The Top 20 Ten Years Out

In 5 years’ time, Exxon would be #20 (I assumed growth in energy of 5% pa). Ten years out it falls to #30 and the only non-tech companies (counting Amazon and eta and Space X etc as “tech”) would be Berkshire Hathaway, Eli Lilly and Walmart.

Conclusions

Their sheer size and growing number suggest that more of the largest private companies will come to public markets. Staying private for longer may continue as a trend, but ultimately the depth of public markets will drive more flotations.

The volume, combined market caps and ongoing growth in revenue could change the composition of public markets significantly. I have written here before that this concentration is far from unprecedented, but echoes the railway boom – interestingly, there is also a parallel in respect of the AI boom’s capital intensity.

It seems perfectly possible that the concentration today – which is causing many active managers so much grief – may increase, not dissipate. And the emphasis on tech will similarly increase. We may all be tech analysts going forward.

This is a reasonable argument, but I should mention that I have a slightly different perspective.

The bubble, if there is one, is likely most pronounced in the providers of LLMs. For example, OpenAI is valued at $500bn. This for a company which has been reported to have $14bn in revenue with a projected run rate of $20bn. Its post-tax losses amounted to over $11bn last year, per Microsoft’s Q1 filing (assuming that its 27% economic interest remained constant) and pretax could have been as high as $15bn, depending on its tax treatment. My guess is that its costs have been running at c.2x its revenues – that would make it around the 140^th largest corporate cost base globally, with equivalent public companies having over 50k employees.

And as I was editing this piece on Friday, the front page of the FT flagged that Space X has been talking to investment banks about an IPO. That will of course get people thinking about others to come as discussed above. The FT mentions talks about a private share sale in December at a valuation of $800bn, twice its previous value of under $400bn. The database I used already had a valuation of $800bn.

It’s unlikely – but not impossible – that these mega companies will continue to grow at 20% for 10 years. These calculations therefore may offer an overly optimistic view of the importance of tech going forward. But professional readers should make their own assumptions and decide how to allocate resources.

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