Revisiting Tech IPO of 2019

How Tech IPO performed in 2019

In 2019, many high profile tech unicorns decided to go public through tech IPO.Many of these tech unicorns were already valued very highly by their VC investors and hoped to get a IPO valuation at the same or above their recent rounds of valuation.
The tech IPO’s caused higher enthusiasm in the stock markets not just for the companies going public, but also for the public market investors because they would now own equities of these unicorns which made their founders rich.Many of these unicorns got listed this year with exception of WeWork and were able to raise large amounts of capital in the primary markets.Almost all the listings have caused disappointment to the investors and this is evident from the fact that most of them are trading below the listing price.
The WeWork fiasco created a huge amount of collateral damage to its founders and investors.At the same time, this has triggered active discussions about how VC companies price their investments and whether public investors should base their pricing on the VC model.In addition, we should also look at the existing IPO processes and analyse if it requires a change.The big question for the public market investors is that whether they should even enter the IPO space where there is a lot of uncertainty and the investors are bound to burn their cash.

2019 Tech IPO Pricing retrospective

• As the stock markets were booming globally and especially in US, 2019 saw an increase in the number of companies looking to go public to take advantage of the booming stock markets.Let us take a look at the major tech IPOs and review their performance after listing in 2019.We will look at companies like Uber, Lyft, Pinterest, Slack and Peloton and track the performance of these stocks since they got listed.
• Like almost all IPOs that have created huge anticipation among the public market investors, all the above companies had their opening price rise by more than 20% when compared to their offer price.Post the opening day, the stock prices of all the companies with exception of Pinterest have plummeted.
• This shows that some of these hyped IPOs had difficulty gaining traction.Since these IPOs gained a lot of public attention and media coverage, this has created a perception among the investors that investing in IPOs is a losing proposition atleast in 2019.

Key learnings for Public market investors from Tech IPO

• The public market investors need to know how VC price companies and the pressures they put on these companies to scale up quickly without paying heed to check for the viability of these business models.
• The investors should hence realize that valuing companies have become a pricing game.The price of an asset and its value are determined by different forces and estimated using different tools.The price and value of a company can be aligned only in an efficient market.In markets that are speculative, they can diverge creating both opportunities and dangers for investors.

Investors playing the Tech IPO game

• The public investors who are playing the IPO game also realize that these valuations are based on pricing.Inspite of that, they enter the IPO market because they feel that IPO process is based on demand and supply and then setting a price based on that assessment.It is not about estimating the value of the business.The bankers who price these companies base the offer price on revenue multiples, user value and other pricing metrics by comparing relevant companies.
• The players who get drawn to the IPO game tend to be those with the shorter time horizons who wants to exploit the high momentum and then sell off before the rest of market detects.These players are traders and not investors.
• Companies who file for IPOs generally tend to be younger and are often less matured than their more seasoned public counterparts. Investors hence price these companies based on their future potential.Hence there is more uncertainty in assessing numbers of these companies which might lead the investors to abandon these stocks.
• The pricing game followed generally leads to high volatility in the stock prices based on the momentum and news stories.The fact that pricing of these companies has no relation with their underlying value can be a huge risk for investors akin to riding a tiger on the back.

Pricing of Tech IPO stocks are shaky

• The pricing game estimates how much to pay for a company by looking at how similar companies are being priced by the market by using common metrics like earnings, book value or revenues as well as it’s own pricing history. In the case of IPO companies, this process gets difficult because of the lack of enough information.
• The peer group for a company is generally arrived at by analyzing the operating history of the company and then doing a market study.Hence for companies like Adobe or Microsoft, investors generally agree on what constitute the peer group of these companies.IPOs on companies which are built around new business models will have difficulty in identifying the peer group for comparison.The IPO companies take advantage of this by grouping themselves in sectors which will deliver a higher pricing.This explains why companies like Uber and Peloton use the word tech in its description even when they are not core tech companies.
• The IPO companies do not have a pricing history.The only pricing we have is from their prior VC rounds.The pricing of these companies are extrapolated from a small VC investment.For instance in the case of Lyft, VC company made an investment of $600 million for 4.1% equity stake.When we extrapolate this to price the entire company, the estimated pricing is $14.5 billion.This is actually not the right pricing because VC investors negotiate for post investment protections when they invest.For instance, ratchets allow VCs to adjust their ownership stake in a company, if subsequent funding round is based on the lower pricing of the company.In the case of WeWork, much of the surge in its pricing came from Softbank’s continued investments in the company.
• In case of the traditional IPO model, the investment bankers form a syndicate to sell the shares at a pre-set offer price.The bankers have access to the public investors and they can use this relationship to finetune the pricing.In case of Uber and Peloton, the stock prices crashed on the offer day and with Wework, the pricing estimates imploded which derailed the public offering itself.This has led VC firms and founders to question the competency of the bankers and whether it is worth spending thousands of dollars to hire a banker in the first place.

Tech IPO companies have different confusing share counts

• Most of the IPO companies issue different classes of shares with different voting rights.This is very different from how public companies float their shares.
• In addition, these companies issue employee stock options which can be exercised at a price lesser than the offer price.When arriving at the market capitalization, companies ignore the stocks issued under employee options.This can lead to pricing issues.
• Investors need to take into account the options pricing before arriving at the stock price of the company.For instance if the offer price is $20 and the employee options are provided which can be exercised at a future date for $10, then there is every chance that these options will be exercised because the stock price will not fall below $10.Hence the enterprise pricing of these firms will change.

Question of Profitability

• All IPO companies follow a pricing game rather a value game.In order to boost the pricing, these companies focus on subscribers and users growth thus inflating their revenues without giving a thought on the viability of their business models.
• Sooner than later the pricing has to converge with the intrinsic value.The investors are going to ask about the company’s path to profitability.If their business models don’t have any scope to achieve margins consistently, then these companies will crash overnight.Companies like Apple, Google and Facebook had a viable business model, hence they were able to go profitable after their initial loss making period.The same thing cannot be said about these tech IPO companies.

Final Takeaway

• All the recent tech IPOs in 2019 have followed a pricing game which is the reason why most of these companies were overvalued in the opening day.Eventually the prices of these stocks crashed because stock prices eventually converged to its value.
• The reason why investors go for IPO companies rather than investing in matured companies is because the payoff to imprecisely valuing a stock like Uber is higher than payoff to precisely valuing a matured company like Coca cola.