There are a number of companies with pre-initial public offering valuations of at least $10 billion, which are commonly referred to as “unicorns,” slated to issue shares to the public this year. Both of the competing ride-sharing services, Uber and Lyft, are planning to tap the public markets with a combined valuation, assigned by underwriters’ corporate finance teams, of $130 billion. Private funding for startups has been bountiful.
In the fourth quarter of last year, venture capital firms invested $55 billion in privately held startups, an increase of 10% over sums committed in 2017. In 2018, $230 billion in funding was provided, approximately 35% above amounts invested in 2017.
Those investors longing for shares of what many mistakenly denote as “tech” stocks should be mindful of the fact calling some of these companies such a name merely because their original funding came from venture capital firms is a gross mischaracterization. For investors “hungry,” as so many finance articles have perennially described them, for new tech offerings, a question arises: exactly what is high tech about Uber and Lyft? Upon reflection, many would stumble providing an intelligent response.
This misperception is significant because a company that is displacing or upending a century-old mode of transportation may come up against resistance from local authorities. Distilled to the basic service offered consumers, both Uber and Lyft are nothing more than a 21st century replacement for taxis.
Uber has already fallen prey to a number of local ordinances, either existing or subsequently enacted, that curtail its ability to follow its principal ride-sharing business model. Lyft will inevitably be subject to the same regulatory exposure. While these local hurdles may prove to have a limited impact on the company’s overall revenue, they pose difficulty most tech companies would never have to endure.
Another factor that should warrant caution is that the private valuation assigned may have been established for the benefit of the original ground-floor investors, controlling shareholders or venture capitalists, who are looking to cash out. A new public offering may be the best vehicle for founders and private shareholders to receive a long-awaited return on their original investment; those investors buying on the new offering may not fare so well. The interests of the selling shareholders of the private firm and those buying on the new offering don’t necessarily align.
Some IPO investors may express a blithe indifference to this potential conflict of interest because they feel they hold shares of the next Facebook (FB, Financial), Netflix (NFLX, Financial) or Google (GOOGL, Financial).
Consider the $120 billion valuation corporate finance specialists have placed on Uber Technologies, which is looking to be listed as a public corporation sometime this year. If the current target seems reasonable because Uber is considered a “tech” stock, consider that just six months ago, it was valued at $76 billion in its 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. Lyft was assigned a private-market valuation of $15.1 billion last year.
The pre-IPO valuations are especially rich in light of both companies’ actual financial results: Uber reported third-quarter losses of $1.07 billion, an increase over $891 million from the same period last year. The Wall Street Journal reported that Lyft logged $563 million in revenue and $254 million in losses.
Investors, who believe the secondary market, because of all the pre-offering hype, is going to react with the same post-IPO euphoria harkening back to the early days of Facebook and Google, are going to be in for a rude awakening. Currently, the market is entering a period where price-earnings multiples are under stress as the rate of corporate profits cannot possibly match the double-digit growth seen over the last three quarters.
Those hoping to get in on the next Netflix may find the price of that company had dropped precipitously, perhaps never to meet the original private and lofty valuations set by venture capitalists or investment banks underwriting the offering.
For IPO investors, here is a sobering statistic: According to IPOScoop.com, out of the previous 100 IPOs, 65 dropped from their initial offering price. For those companies going public in 2018, returns from the IPO price are yielding approximately -2.3%. Here is an even more ominous sign for investors hungry for new deals. According to Renaissance Capital, secondary market trading after the first day’s post-IPO close were a dismal -16.9%.
Another reason for skepticism relates to the maturity of the unicorn at the time it sells shares to the public. According to Goldman Sachs' quarterly review of the venture capital industry, the more seasoned the startup company, the more value it creates is captured by the venture capital firm. The report notes venture capital-backed IPOs since 2015 have underperformed IPOs backed by venture capital in prior years.
Here is another sobering statistic: Over the past two years, IPOs backed by venture capital firms have dropped an average of 8%. The unsavory conclusion? Those “deal-hungry” investors, pining for the next Facebook, actually lost money buying on the offering.
Perhaps Pamela Rosenau, chief investment officer of the Rosenau Group, who predicted the sudden market volatility in 2018, said it best, “A number of unicorns are supposedly going public this year. I think they should stay in the mythical world, and not part of investors’ portfolios.”
Disclosure: I have no position in any of the securities referenced in this article.
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