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John Kinsellagh
John Kinsellagh
Articles (158) 

IPO Market Spawning Far Too Many 'Tech' Stocks

A successful launch doesn’t magically transform companies with banal, easily replicated business models into industry disruptors

What’s in a name?

How many times have we read the by-now hackneyed phrase, endlessly repeatedly by financial journalists, that investors are “hungry for tech stocks?” Do any of these purported “tech” companies manufacture new layers for graphics chips or designed a tenfold increase for the number of transistors that can be embedded on a silicon chip? Or solved the heat-dissipation issue for processors with increased clock speeds? The answer, of course, is no, no and no.

Then why are they called tech stocks?

In terms of tech stocks' performance post-initial public offering, in the short run, how the plethora of companies in the IPO pipeline are characterized, may be immaterial and unimportant. But what about the long term, which will test how disruptive, unique or technologically ascendant these companies’ products or services truly are.

In the past, a tech company usually had something to do with…tech. Many of the recent crop of initial public offerings have been called tech stocks in the sense that they are industry or sector “disruptors.” Although most of the recent “tech stocks" that have gone public have been afforded lofty valuations, many don’t have the explosive growth potential of many tech stocks of yore, such as early-stage companies like Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) as well as semiconductor companies that all became entrenched for years and profitable within their respective markets.

Does the fact Uber (NYSE:UBER) is a replacement for the taxi cab make it a tech company, whose service is so revolutionary that it can be assured of market dominance for a long period of time? Do all of the recent so-called tech companies have the benefit of a product or service that enjoys copyright, trademark, trade secret or patent protection that can provide market dominance? The answer for many of the recent crop of companies gleefully ringing the opening bell is no.

The reason many companies looking to go public are called tech stocks is because they use or leverage existing technology, most prominently the internet, rather than create it. Judging by their eagerness to pour money into new offerings, even for those companies who have failed to turn a profit, investors may have failed to appreciate the difference in terms of the long-term growth potential for the stock.

Although the performance of some of the recent public offerings have been stellar, far exceeding expectations, other tech companies are now selling well below their new offering price as competitors eat into their profits and once predictable revenue streams.

Perhaps the most telling example that demonstrates the difference between tech stocks that introduce truly disruptive technology or business models and those whose initial novelty invites competition are the recent new stock offerings of Lyft (NASDAQ:LYFT) and Uber.

Both companies are considered industry disruptors in the sense they are looking to replace the taxi cab as a mode of transportation, but neither company has been profitable. There is not one iota of difference between the service offered by each company and, hence, neither enjoys any competitive advantage. Indeed, both companies seem to be on a path of mutually assured destruction, chasing after the same customers. How many of us have received the perennial ride discount emails from Lyft?

According to FactSet, Uber has gone through almost $10 billion in cash since 2016; Lyft has burned through $1.4 billion. Yet, despite this race to outspend each other, Lyft reported in a recent Securities and Exchange Commission filing that ride-sharing accounts for little more than 1% of the total vehicle miles traveled in the U.S. in 2016.

To add insult to injury, what happens if autonomous vehicles become a reality? Investors may continue to call these two companies’ disruptors or tech stocks, but neither enterprise seems poised to be profitable in the near future.

It is instructive to note that Lyft’s last round of private financing valued the company at $15.1 billion; it went public at $24 billion. Uber’s investment bankers, at one point, were looking to price the company at a $120 billion valuation. When Uber went public, it fetched a $76 billion valuation.

The disruptive or tech nature of some of the other companies in the IPO pipeline is questionable as well. How truly disruptive is WeWork, the company that has been hemorrhaging cash, but still banking on making a profit in an office-sharing market that has existed for years?

Tech hungry investors have short memories. Does anyone remember Blue Apron (NYSE:APRN)? The company was the first to create the home-cooked meal idea on a large scale. No other company had entered the market with a similar strategy. Venture capital firms flush with cash, looking to get into the next hottest thing, quickly funded the competition. The result? Though still in business, Blue Apron’s stock, on a split-adjusted basis, has dropped almost 95% from its offering price two years ago, valuing the company at $90.4 million. According to Fact Set, Blue Apron has burned through more than $500 million in cash since 2014. Does this scenario look familiar?

The food delivery business, which Uber recently entered with its Uber Eats, seems to be going down a similar path. Uber Eats now competes with Grubhub (NYSE:GRUB), DoorDash, Postmates and many more. Seamless Web, the original disruptor in the modern online food delivery business, merged with Grubhub in 2013. Shortly thereafter, imitators rushed into the fray. Investors underestimated the costs for retaining drivers to make the deliveries as well as consumers increasing demand for low prices and quick turnaround service.

Because of fierce competition, Grubhub’s stock is down almost 45% over the past nine months.

Based on the most recent new tech offerings, Uber and Lyft may prove to be anomalies. According to Dealogic, 2019 tech IPOs have traded, on average, 30% above their listing price this year. Some of the companies have exceeded their founders’ wildest expectations, such as Zoom (NASDAQ:ZM), which has more than doubled from its IPO price, and Beyond Meat Inc. (NASDAQ:BYND), which is now trading at more than six times its new offering price.

Even though Uber and Lyft may be the exceptions and not the rule, it should be noted for many later entrants in the IPO market, such as Pinterest (NYSE:PINS), the initial offering price was set significantly lower than the price its shares fetched in its last private offering.

The danger for some of the new “tech” kids on the block is that new offering prices, eagerly paid by investors, have been bid far above their latest round of private financings and at some point, public investors may sour on the increasingly bloated valuations that have become unhitched to reality.

Despite all the hyperbole about market disruptors and demonstrated revenue streams, intelligent investors should always be mindful of the greater fool theory.

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 adviser 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 25 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 "The Mainstream Media Democratic Party Complex" and "Election 2016," both available on Amazon. Follow him on Twitter @jkinsellagh.

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