This was supposed to be the year of the IPO. Uber, Pinterest, and Lyft have already gone public this year with other high profile startups, including Spotify, set to follow. The IPOs presented an opportunity for normal retail investors to get in on the startup action, for staff to get their just rewards, and for early investors and venture capitalists to take out their money to invest afresh.
But not even a full five months into the year, that optimism is gone. It’s not just president Donald Trump’s trade war with China that’s rattled investors, it’s a general worry about whether the cash-burning hyper-growth business models of the latest crop of Silicon Valley’s finest actually make any sense.
Scrapbook website Pinterest has had it the easiest so far; since its listing just over one month ago, its shares are back to about where they began. Bigger companies have fared much worse. Lyft – best known for its ride-hailing app – has seen its share price plummet from $88 (£69) to around $55 (£43) now. Its bigger rival Uber is also struggling, despite bringing its share to the market at a relatively low price. Despite this, the expected upward bounce has failed to materialise. Listed at $45 (£35), shares fell by as much as 20 per cent before recovering a bit, to just over $40 (£31).
It all makes for a worrying time for companies like Slack and others that are lined up to land their IPO in the coming months. So has the IPO bubble burst? More importantly, has the Silicon Valley business model – invest heavily even into loss-making companies, because you have a good chance to get your money back in the stock market – run out of steam?
One of the main reasons for the rough IPO environment is very high market volatility, says Barrett Daniels, a partner at Deloitte. The trouble started at the end of last year and got worse because of the economic fallout of the US government shutdown in January. “I think a lot of it has to do with some of the uncertainty,” he says.
Globally, there are 300 unicorns – firms with a valuation of more than one billion dollars; more than 180 are based in China. Given the number of companies in the IPO pipeline, “it’s reasonable to anticipate some disappointments in the mix,” says Drew Bernstein, co-managing partner at accounting firm Marcum Bernstein and Pinchuk.
“Whether an IPO is a hit or a flop depends on whether you are the investor or the company,” he adds. Some companies burn huge amounts of cash pre-IPO, and the focus of the market environment is on how management performs relative to investor expectations.
Companies that are private don’t have to disclose anything in the US. Once they are a public company, however, they have to be crystal clear on their profitability and plans “or the market and shorts [people betting on a decline of the share price] will take their toll,” says Bernstein. When Snap, the owner of Snapchat, went public in March 2017, the company used its public declarations as a chance to redefine itself as a camera company.
But how likely is it that unicorns will pierce the IPO bubble and bring a repeat of the dot-com bubble bursting in the 1990s? Bernstein says that the situation is now very different – and the companies aren't the same.
Unicorns are special for a reason – they tend to be unique and difficult to compare with other startups (rival pair Uber and Lyft excepted). Each has its own strengths and weaknesses – and the key is for investors to do their due diligence to understand the business models and financials. Daniels argues that the current run of IPO flops may well be down to company size, because smaller companies listing on the market “seem to be doing quite well.”
“You don't see $20bn and $80bn IPOs often, but you do see one, two and three billion dollars IPOs often,” says Daniels. “I would say there's certainly people that think that there is a bubble, but there's also people that think that tech stocks are still quite undervalued. I think it's too early to say.”
Big listings like Uber and Lyft certainly seem to be skewing the overall performance of US stockmarkets. James Clark, the head of Tech And Life Sciences at the London Stock Exchange, says that “2019 has certainly been an interesting year for tech IPOs so far.”
He says it’s “easy to focus too heavily” on the IPOs of big brand names. If you look at the average performance of US tech IPOs so far, they have managed to add 9.1 per cent to their stockmarket value, while UK tech IPOs grew 14.8 per cent.
One possible issue is the fact that many US startups have stayed private – and grown in value – far too long to deliver spectacular stockmarket gains. There are many reasons for this: easy access to venture capital; and the long-term fallout from the financial crisis that started more than a decade ago.
European startups, in contrast, have gone to market earlier and more often. During the past four years, says Clark, Europe “has seen approximately double the number of tech listings compared to the US, with the majority of the capital raised in London.” He points to the example of Blue Prism, which started out on London’s stockmarket three years ago, with a market value of around $70m. “Today it’s worth around $1.8bn,” says Clark.
So how can investors make a safe choice where to invest and which firms to avoid? There are some fundamental problems, says Bernstin: “Take a Chinese unicorn and a US unicorn – they are incomparable. Both are growth based, but they operate in totally different governmental and business environments and at much different scales.”
Bernstein says the key is for pre-IPO companies to communicate effectively with investors. This involves preparedness in terms of providing accurate financials, clarifying the business model, fielding experienced management teams and explaining how the company can or will make money. And, says Bernstein, “companies touting expansion for the future need to clarify how they will navigate international markets and varying government structures.”
One crucial thing is to be able to show potential investors evidence of a clear path to profitability – and if you don’t, you may get penalised. “Ultimately, for the company, it's just a matter of being able to tell a believable story,” says Daniels. “And they have to execute on that story. If they continue to struggle, and they end up down, where profitability is even farther down the road than they first were communicating, those are the kind of things that could cause problems down the road.”
This article was originally published by WIRED UK
