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John Kinsellagh
John Kinsellagh
Articles (88) 

New Tech Startups Eager to Go Public

Tech IPO market is currently white-hot, but valuations way out of kilter: caveat emptor

November 07, 2018

After years of reluctance for entering the initial public market, many Silicon Valley tech companies with lofty valuations are now eager to tap the new offering market and are poised to go public as early as next year.

Many tech startups shunned the public markets due to stringent regulatory requirements for listed companies as well as the specter of constant scrutiny on management to meet investors’ expectations of earnings growth on a quarterly basis. Another disincentive for going public was that there has been no shortage of cash available to meet these companies needs for capital, as venture and private equity firms had ample funds for early-stage or mezzanine funding as well as later-stage financing.

Given the bountiful private financing available, there were no compelling reasons or need for these tech companies to go the IPO markets to raise cash for their operations.

Even though they have been content to stay on the sidelines, however, the extraordinary performance of publicly traded tech stocks has captured the attention of private companies now interested in taking advantage of investors' insatiable and seemingly never-ending demand for tech companies.

Consider the following inducements for these private tech companies to go public:

According to Dealogic, the overall IPO market has been thriving with 201 businesses raising a total of $54 billion so far in 2018; 47 tech companies raised $17.8 billion in new offerings. This amount is more than that raised in IPOs for each of the prior three years and more than each of full-year 2015, 2016 and 2017.

More importantly, the initial offering price for tech IPOs has been priced at an average of 9% above their proposed ranges, according to Dealogic. Additionally, the shares of the average tech company rose 28% on the first day of trading.

Waiting in the wings of the IPO market are ride-sharing service companies Uber and Lyft. The current valuations placed on these companies is astounding — perhaps dangerously so — and is indicative of the red-hot tech IPO market that is starting to exhibit signs of overheating.

According to securities analysts, Uber could be valued as much as $120 billion. Should the company fetch only a comparable amount raised for companies its size in an IPO, the proceeds could be in excess of $25 billion.

The potential amount Uber could raise represents more than half of the $44.5 billion raised by all tech companies combined in 2000. Palantir, a data-mining specialist company, could enter the IPO market with a $41 billion valuation.

Palantir is an example of a private company that has been amply funded by private sources. Over the years, some of its long-term employees whose compensation was in the form of early stock options for shares in the privately held company, grew weary of waiting for the opportunity to cash out that, in some instances, only a public offering can provide.

Enterprising investors should approach the surging wave of tech IPOs with some healthy skepticism.

Consider the $120 billion valuation corporate finance specialists have placed on Uber Technologies, which is vying for a 2019 listing. If the current $120 billion target seems reasonable because Uber is considered a “tech” stock, consider that just six months ago, the company was valued at $76 billion in the latest round of private funding. That is a staggering amount less than the $120 billion investment bankers are telling Uber it can command in the IPO market.

Other tech companies, such as Lyft, are also being priced at levels that far exceed their last private rounds of funding. If Uber’s valuation seems a bit unreasonable, consider that Lyft received proposals from investment banks to take it public at a proposed valuation of $120 billion.

The risks for investors looking to ride the current frenetic tech wave is timing. Some new offerings that have astronomical valuations may ultimately prove inopportune for investors, as appetite for existing publicly traded tech companies has recently waned. Should the economy experience a downturn, a precipitous and significant drop in the initial offering price could follow in the secondary market.

Investors should also note that due to the overperformance of their publicly traded shares, many tech companies are returning to the well for additional funds. Additional rounds of IPO financing from new tech companies will exceed $21 billion this year. This factor may contribute to a flooding of the new tech IPO market, which ultimately would adversely impact either the valuation before the offering or a post-IPO stock price reduction in the secondary markets.

One can’t help but wonder if this rush to the IPO market, especially given the recent beating some of the FANG stocks have taken, isn’t a case of déjà vu all over again. As investors' ravenous appetite for all things tech continues unabated, there has been a seeming indifference to the fact that some tech startups poised to go public have zero profits, yet command lofty or excessive valuations.

Does this pattern sound familiar? Even though there are some differences between the current IPO tech mania and the 2000 dotcom bust, there are far too many similarities.

The ever-instructive warning of George Santayana seems particularly appropriate: “those who cannot remember the past are condemned to repeat it.”

Disclosure: I have no positions in any of the securities referenced in this article.

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About the author:

John Kinsellagh
John Kinsellagh is a freelance writer, former financial advisor and attorney specializing in civil litigation and securities law. He completed the Boston Security Analysts’ Society course on "Investment Analysis and Portfolio Management."
He has served as an arbitrator for FINRA for over twenty-five years resolving disputes within the financial services industry. He writes primarily on financial markets, legal and regulatory issues that impact the investment community and personal finance.
He is the author of "Election 2016" and "The Mainstream-Media Democratic Party-Complex" both available on Amazon. Follow him on Twitter @jkinsellagh

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