JPMorgan’s OpenAI coverage is just the start

Shuli Ren, Bloomberg

The trickle will soon be a flood.

Wall Street banks are starting to cover firms that are not publicly traded. JPMorgan Chase & Co. kicked off the trend with a report on OpenAI Inc. Citigroup Inc. followed suit a week later with a list of roughly 100 large private companies it will focus on, predominantly in the tech sector.

It’s only a matter of time that their peers join the ranks. With the US stock market at a record high, investment banks are keen to arrange secondary share sales for the hottest unicorns. Brokerage fees aside, they will have direct access to startup employees who want to divest their stakes. Banks’ wealth managers, in turn, can offer services to these newly minted billionaires when they cash out. It’s a lucrative business for all.

But when brokers dangle shares of, say, OpenAI or SpaceX to investors, they run into a big problem. Even the most savvy money managers may not have a clue what a fair price should be, especially when news reports of company valuations jump around so much. OpenAI, for instance, is in talks about a secondary sale at a valuation of $500 billion. Only four months earlier, it was seeking $40 billion in new funding, valuing the company at $300 billion.

JPMorgan’s research came in handy. It doesn’t offer price targets, but it does lay out a thought process. It’s instrumental to brokers who have largely relied on media reports to educate their clients.

OpenAI has reportedly told investors that it could hit $174 billion in revenue by 2030, up from an estimated $13 billion this year. Since Big Tech are on average valued at 10 times sales, OpenAI could be worth $1.7 trillion in five years’ time, thereby giving substantial upside to those who buy into secondary sales.

JPMorgan’s analysts are throwing cold water on this logic, calling the 2030 sales projection “ambitious.” To hit this target, OpenAI would need to capture about a quarter of the total market share, which would require “flawless execution” since it’s still at the early stage of commercialization. Rather, the focus should be on how fast the startup can achieve scale.

Market concentration means that asset managers just have to understand a few dozen stocks, thereby reducing their need to outsource due diligence to investment banks.

It’s no secret that many bank executives see their research divisions as nothing more than a cost center, whose financial burden has to be shared among brokers, dealmakers and wealth managers.

This new trend therefore provides a chance for analysts to showcase their worth. It will be more work, however. Instead of writing about quarterly earnings, which more or less read the same over time, they will have to talk to customers, business partners and everyone else within the ecosystem to understand billion-dollar tech companies that may never go public.

As a former analyst myself, I always see parallels between equity research and journalism. Both embrace the Mosaic Theory, piecing together an overlooked pattern by collecting small pieces of information from various sources. In recent years, however, I find that sell-side research from the biggest banks has been losing some of that artisanship. It’s not timely or edgy. The more relevant insights can be found elsewhere.

It’s time to go back to the basics.

[Abridged]

Courtesy Bloomberg/Shuli Ren