A bad year to go public: Why Wall Street skeptics are suddenly poking at the startup bubble
This was supposed to be the year when America’s biggest startups would finally make their triumphant debut on the stock market.
Billionaire Silicon Valley investors, sneaker-clad founders and button-down bankers all expected enormous stock sales to turn companies like Uber, Lyft and WeWork into a new generation of corporate giants.
It hasn’t quite turned out that way. Last week, WeWork postponed its planned initial public offering. Uber and Lyft sold shares earlier this year only to see their prices collapse. Investors took a look and backed away, seeing overpriced companies with no prospect of making money any time soon, in some cases led by untested executives.
It’s becoming a tough time to go public, there’s no question
John Foley, chief executive of Peloton
The rejection threatens Silicon Valley’s favored approach to building companies. The formula relies on gobs of money from venture capitalists to paper over losses with the expectation that Wall Street investors will eventually buy shares and make everybody rich. If mutual funds and pension funds are no longer willing to buy once the companies go public, fledgling companies are unlikely to find funding in the first place.
“When the IPO market is hurting, it has a domino effect on valuations and venture capital deals,” said Steven Kaplan, a professor of finance and entrepreneurship at the University of Chicago. If it persists, that could make it harder for startups to raise money, he said.
Much of the recent concern has been directed at WeWork, a shared office space company based New York. As it began to approach stock market investors, the company revealed losses of US$1.37 billion in the first half of 2019. Investors also questioned financial dealings of WeWork’s chief executive, Adam Neumann, and the company’s accounting.
On Tuesday, Neumann stepped down under pressure from directors and investors. It is now uncertain when the company will return to the market.
Uber, by comparison, cut its expected price in May. Even so, its shares have fallen about 30 per cent as the company’s financial losses have deepened. In the three months through June, the company said it lost more than US$5 billion and reported its slowest revenue growth in its history.
Shares of its rival Lyft have fallen 40 per cent since the company’s debut in March.
The fitness startup Peloton has also reported deep losses on its business of selling high-end exercise bikes and livestreaming classes into users’ homes. On the stock’s first day of trading Thursday, it ended 11 per cent lower than its IPO price. Such a sharp drop in a first day is a rare occurrence for a new listing.
“It’s becoming a tough time to go public, there’s no question,” said John Foley, chief executive of Peloton. “I’m happy we got out, but I think it’s going to get pretty tight.”
Other companies have delayed their plans. Airbnb, the vacation-rental business, said last week that it did not plan to go public until 2020, later than expected. Palantir Technologies, the data mining firm that billionaire investor Peter Thiel helped found, now does not expect to go public for years, because it can continue to raise money from private investors, two people familiar with its plans said.
Not every prominent offering has floundered. Many smaller listings have soared. Among the larger ones is the online pinboard company Pinterest. Its shares are up 44 per cent since it went public in April.
But Pinterest priced its IPO conservatively, told investors that it was close to profitability, and has narrowed its losses in the months since it became publicly traded. And the company is increasing revenue — which comes from advertising — fast.
“Investors are buying the future, so help them pencil out the future,” said Rett Wallace, whose firm, Triton Research, analyzes tech companies that are going public. “You can do that with Pinterest. You can’t do that with WeWork. You can’t do that with Uber or Lyft either.”
Charles Kantor, a senior portfolio manager at Neuberger Berman responsible for managing more than US$5 billion, said he asks a few simple questions when considering an IPO investments, including: can a company’s profit margins hold up, what kind of competition does it face, and can executives be counted on to deliver results?
“The ones that we pass on, we don’t feel comfortable with the answers that we get,” Kantor said. “It’s got to be really obvious, really quickly that they can grow.”
Everyone feared this would be another bubble like in 1999 and 2000
Kathleen Smith of Renaissance Capital
He did not invest in Uber or Lyft, or Pinterest, for that matter. But he did buy shares of the online pet store Chewy, which went public in June. He said its profit margins, a large potential market, and solid executive team were all reasons he was persuaded to buy.
In many ways, the current standoff between Wall Street and these giant startups comes down to a simple issue: price.
Because of expectations set by venture capitalists, and given the risks they face, the companies simply asked for too much.
Uber, which private investors valued at roughly US$72 billion before its IPO, is now worth about US$54 billion in the public market. Lyft, once said to be worth more than US$15 billion as a private company, now has a market capitalization of roughly US$12 billion.
WeWork was last valued at US$47 billion in the “late stage” market of mature private companies. In the run-up to its failed attempt to list shares, executives and bankers had discussed slashing the valuation to US$15 billion — but were still unable to gin up enough interest.
The tepid response to these companies stands in stark contrast to the dot-com bubble of 20 years ago, when shares of startups with little revenue or prospects for profit — like Webvan and Theglobe.com — were greedily bid up in their market debuts.
“Everyone feared this would be another bubble like in 1999 and 2000,” said Kathleen Smith, principal at Renaissance Capital, which provides research on IPOs and manages exchange-traded funds that track their performance. “But there is a lot more sanity in the reaction of investors to these deals.”
Now, the verdict from the stock market is that it’s the private investment binge that has gone too far. With a flood of cash, private investors backing the hottest startups have inflated their valuations to a point that public investors cannot tolerate.
“Things have gone a bit nutty,” said Fred Wilson, a partner at Union Square Ventures, a New York based tech investor. This moment could be a turning point in what public market investors will accept from highly valued, money-losing startups, he said.
“I think that’s very important for private markets,” Wilson said.
The recent troubles may stem from the long incubation period the largest startups have had. Flush with funding from venture capital and other private investors, the companies have not been forced to go to the public markets to secure financing like they might have in the past.
It was not always this way.
Traditionally, the IPO market has allowed investors to put their money into relatively small, higher-risk firms with enough potential for fast growth that stock buyers are willing to overlook their often numerous warts.
Amazon.com sold shares to the public just three years after its founding in 1994, raising just US$62 million in a deal that valued the company at more than US$400 million. The company has a value of more than US$800 billion now.
Google was a much bigger, and older, company when it went public in 2004, valued at roughly US$23 billion, a deal that was enormous by the standards of the time. But it was also incredibly profitable — with an annual profit of more than US$400 million the year it went public — and still fast growing.
That last part is particularly important, says Jeff James, who manages more than US$1.7 billion for clients at Driehaus Capital Management, a Chicago-based investment adviser, who bought shares of Pinterest in its IPO.
“Growing above expectations, that really cures valuation and other faults,” he said.