What price will the tech unicorns be selling at three years from the date of their initial public offerings?
That is the question investors ought to be asking before participating in the recent new offering madness. Lyft will go public on Friday and its main competitor, Uber, is slated to tap into the new offering market in a couple of weeks. The ride-hailing service is a prime example of a company looking to break into the new offerings market with a history of losses.
Here are several factors that many investors, in their quest not to miss out on the next Netflix (NFLX, Financial) or Facebook (FB, Financial), fail to consider. These issues could be considered “qualitative” factors, as that term was defined and discussed repeatedly by Benjamin Graham and that investors often discount at their peril.
Investors are wont to view Lyft and Uber as innovative disruptors, much in the same way as Netflix and Facebook have dramatically upended other industries and businesses. The differences between Netflix and Facebook and the new unicorns, however, are almost as important as their similarities.
Although investors are quick to compare Uber and Lyft as “tech” or “growth” companies in the same vein as Facebook, they overlook the fact the social media giant grew at an astronomical rate in a historically unprecedented environment that was regulation-free.
As any astute observer will note, for Facebook, the carefree, halcyon days of conducting business are over. Uber has already encountered regulations at the local, regional and state levels in the U.S. and Europe. Additionally, both ride-hailing companies have faced political pressure exerted by local taxi unions as well as local councils who want to regulate the ride-sharing service, for the safety of the public.
Far too many investors ignore these realities and instead believe the new transportation companies, because they are engaged in a process of innovation and creative destruction, will be untouchable by governments, similar to the manner in which Facebook was able to conduct its business with impunity while abusing and deceptively harvesting its users' private data.
A comparison between Netflix and Lyft shows that Netflix, a true innovator and disruptor, will never have to deal with heavy-handed regulators or legislators because their only product is entertainment. Can Lyft and Uber make the same claim?
Given these substantial hurdles, let’s look at Lyft’s latest, pre-IPO valuation. The company anticipates that its underwriters will price the shares between $62 and $68 on the offering, which means it would be valued at more than $23 billion.
Is the current valuation reasonable in light of the company’s financial performance to date?
Lyft had losses of $911 million last year. According to S&P Global Market Intelligence, this represents the largest loss of any other U.S. startup in the past 12 months preceding the company’s IPO.
Although Lyft's revenue dramatically increased to $2.2 billion in 2018 from $343 million in 2016, for the same period, its losses swelled to $911 million last year from $683 million in 2016, while its market share in the U.S. rose 39% in December 2018 from 22% in December 2016. Against this backdrop of continuous losses, analysts have been forced to use nontraditional indexes to measure the worth and risk of investing. Analysts use the price-sales ratio, based on enterprise value, instead of earnings history and free cash flow, price-earning ratios, etc.
The bottom line for enterprising investors? Without any profits, it’s difficult to value the company on a rational basis. At its currently planned valuation, Lyft is selling at eight times 2018 revenue. Investors ought to ask if this is a bit rich given the lackluster performance to date.
During its roadshow, Lyft executives claimed that longer term, using autonomous vehicles could be a boon to its bottom line. The question of exactly how autonomous vehicles — another idea that has been overhyped —will rescue its bottom line was left unanswered.
Warren Buffett (Trades, Portfolio) recently said that a $50 billion public company should earn $5 billion in pretax earnings in five years. That would mean Lyft would need to earn approximately $2 billion in pretax earnings. During a recent appearance on CNBC, Buffett said, “You wait five years to get 10% on your money. And people, they don’t sell them that way, you know?”
And finally, perhaps the most important question: How will the new publicly traded stock fare in the long run? As James Mackintosh of the Wall Street Journal noted, a study by Professor Jay Ritter of the University of Florida showed that, on average, stocks on a new offering shot up in price on the first day of trading in the secondary market. Afterward, the stocks underperformed the market for the following three years.
The tech-heavy Nasdaq Composite has increased approximately 16% this year. Clearly, it is advantageous for Lyft to offer its shares to the public. But will investors on the other side of the trade fare as well as executives and stock option holders who will be cashing out on the offering? Unless the greater fool theory prevails in the long run, many IPO investors are going to be disappointed.
There has been standing room only during the company’s due diligence road shows. Since the purpose of a company’s pre-IPO roadshow is to drum-up interest for the new offering, however, investors would be better off consulting the prospectus or offering circular for an unvarnished look at the genuine risks Lyft faces.
Disclosure: I have no positions in any of the securities referenced in this article.
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