During the writing of my last article (do check it out if you haven’t already – Rethinking how we eat), I took a moment’s pause to reflect on the burst of market activity so far in 2019. Beyond Meat is one of quite a few unicorns (private companies with a value of >$1bln) that have IPO’ed this year.
Unicorns have a bit of fascination attached to them – and not just in the mythical sense! The tech community is driven by them and wanting to be like them. I’ve written a few articles in the past that you may find interesting (Case study: Snap IPO and transparency and Case study: Raising $1bln and why cash is king are two examples for you).
Eye watering valuations are only part of it, quite a few of these beasts end up being integrated into our lives – just look at Spotify, Uber and Airbnb. For the consumer they can be great things but I am more interested in the businesses themselves. Firstly, I am going to refer you to an article in The Economist – ‘the wave of unicorn IPOs’. It is worth having a read and it has influenced some of my thoughts. They also do a much better job than I ever could with their number crunching. It should help you decide if the lack of profitability, suspect growth numbers and questionable sales justifies the huge valuations, spoiler alert – it’s all rather questionable…
The big question
What immediately springs to mind is ‘why now?’. What is it about 2019 that has driven these companies to go public. The Economist suggests the average age of a company that may IPO is now 10, up from 7 in 2013, meaning that companies stay private for longer. Staying private means you can avoid prying outside eyes as there are no obligations on disclosure. It also leaves you with a degree of flexibility in building your vision – in many cases this means aggressive growth at the expense of profit. Furthermore the investment scene is currently flush with money, so it is easier to get funding privately. The overall incentive to go public has very much gone down.
So what is the purpose of an IPO if the incentive isn’t just to raise money? It is to allow private investors and VCs to exit and to finally get a return on their investment. These funds usually have a lifespan of 8-10 years, so the downside of staying private for longer is that the big investments are not realised for possibly the entirety of the fund life.
If I am a VC all I care about after 10 years is getting my return. My plan would be to urge my unicorn to IPO, paint a rosey picture in the filing, pump up the price a bit when it hits the market and then sell. So you could see IPOs as a means to dupe the common investor. Who gives a damn what other mug gets short changed, right? Ride hailing startup Lyft have been accused of just that.
Telling the whole truth and nothing but the truth
As a recap, Lyft are the ride-sharing competitor to Uber. Their share price jumped 9% on debut (29 March) valuing the company at $22.4bn before crashing on May 7 (Q1 results day) to $17bn. Those results were not great – losses of $1.14bn in Q1 alone were reported(!). As of writing this article their market cap hovers at just over $16bn. Some investors are not impressed. So much so a class action lawsuit has been filed accusing Lyft of misleading investors in its filing to go public. Issues such as labour and safety with regards to “more than 1,000 of the bicycles in Lyft’s rideshare program suffered from safety issues that would lead to their recall,’
Lyft’s are not alone with poor results. Pinterest and Uber have also underwhelmed in the past weeks. Zoom, a cloud conferencing startup and another ‘unicorn’ also IPO’ed in the past months, having actually made a profit in 2018 before going public. A novel idea.
But we’ve seen this before you may cry. These companies will continue to grow and eventually profits will come – just look at Alibaba, Google, Facebook. The Economist reckons that –
“…based on a discounted cashflow model, in aggregate the dozen firms will need to increase their sales by a compound annual rate of 49% for ten years to justify that valuation”.
Beyond sales they also need to improve their margins –
“…In aggregate these would have to increase by 34 percentage points. That would be truly unprecedented. The average for Amazon, Facebook and Google was only 19 percentage points”.
It will make even the most optimistic investor question if there ever is a path to profitability for any of these newly publicly traded companies.
So ‘why now?’
Trying to answer ‘why now’ has given us more questions than answers. It almost seems as if there has been a coordinated effort to get these Unicorn IPOs done as soon as possible this year – and we still have Airbnb to look forward to. One argument to be made is that a private investors are getting jittery with their investments and wanted an out sooner rather than later. Maybe they have started to wisen up and panic that the numbers simply don’t add up? I find that only a partially acceptable answer. A lot of what builds a unicorn is hype, branding and to be seen as a fast growing startup. To an extent these are controllable parameters and there is enough industry experience to manage a ‘unicorn’
I believe there is a growing sense that the current economic climate and outlook have played a greater part in the nervous energy being generated. Look around you; a lot of things are happening – take your pick from slow global growth, Brexit, trade wars and inequality (just off the top of my head). Maybe some have taken the view a recession or a market collapse is imminent. This puts the common investor at risk – the ones most likely to take a large financial hit if the market tanks. That would not be good news.
However, even if the market stays buoyant, I can see a scenario in the next 2-5 years where one of these unicorns runs out of money after going public and then collapses. It should lead to a debate (maybe even a prosecution or two) about the responsibilities that CEOs, co founders and investors in Silicon Valley have. There has to be a better balance between aggressively growing a startup and trying to maximise returns on investments. It may mean that we don’t see as many tech unicorns in the future as valuations are tempered. And that is ok, I call it progress in how startups are built. Creating more realistic expectations can never be a bad thing!