This year has been dubbed the year of the Unicorn IPO, with many Silicon Valley-based start-up firms listing in the US, to fervent retail investor interest.
Those that have come to market before the end of April have had good to excellent first-day returns, with $24 billion ride-hailing app Lyft (LYFT) surging 25% initially before closing up 8%. Elsewhere, $12 billion photo-sharing app Pinterest (PINS) was up 28% at close of its first day. Video conferencing firm Zoom (ZM) finished its first trading day up 72% and is now worth $17 billion.
Post-first-day trading, fortunes have differed. Zoom remains 83% above its $36 offer price, while Pinterest, which went public on the same day – April 18 – is up 58%. Lyft, on the other hand, is 21% below its $72 offer price. Early in April, data firm S3 partners revealed hedge funds had bet almost $1 billion that Lyft would fail by shorting 41% of its free-float.
Investors, then, will be interested to see how rival Uber gets on when it joins the stock market in May, with an estimated valuation of $90 billion.
These start-up companies are well-known and popular brands, so, inevitably, demand for stock is going to be high. Not only will their initial offerings be over-subscribed with the US public, but UK retail investors are still committed to investing in US tech names.
Four of the five most-popular international stocks by clients of investment platform interactive investor during the 2018/19 ISA season were FAANGs. Tech-heavy funds like Baillie Gifford American, Scottish Mortgage (SMT) and Allianz Technology Trust (ATT) are sought after.
Therefore, shares in Uber, Airbnb, WeWork et al will be just as popular in the UK as they are in the US once they come to the market later this year. That, of course, begs the question of whether investors should buy these companies at all.
Indeed, the valuations of both Uber and Lyft have been criticised as being excessive, particularly in the case of the former, which has already said it may never make a profit having made a $1.8 billion loss last year.
There’s also a plethora of regulatory risks it must negotiate, that could see earnings growth impacted. And competition abounds from both Lyft in the ride-hailing space and Just East and Deliveroo in online food delivery. This means prices, and therefore margins, will come under pressure.
With such exuberance and excitement in the market surrounding these IPOs, many fund managers suggest waiting until the hype dies down before looking to invest. “When looking at IPOs, imvestors should try to analyse the opportunity as objectively as possible as it’s all too easy to be driven by the FOMO mindset,” says Alex Neilson, investment manager at Investec Click & Invest.
Neilson, though, says he does not tend to invest in IPOs for clients, instead favouring a wait-and-see approach to review how these companies trade after a few quarters compared to his expectations.
Mark Hargraves, head of global equities at AXA Framlington, agrees. “We base our decisions on our fundamental, bottom-up stock selection, looking at the details like returns on invested capital and free cashflow generation once a company has been trading publicly for some time,” he says.
“For example, we waited for four full quarters of earning before investing in Facebook (FB) following its IPO to ensure we saw commercial proof of its advertising platform.”
US IPOs Underperform in the Longer-Term
While, clearly, past performance is no indicator of what will happen in the future, data from investment bank UBS shed some interesting light on how newly floated companies tend to perform.
Generally, US IPOs see positive returns during their first day of trading, with the average first-day return over the past 40 years being 18%. Many bring gains well in excess of this, while few lose money as investment banks stabilise the share price in the secondary market to keep it from falling below the offer price on the first day.
For those with revenues above $1 billion in the pre-IPO year, the first-day gain since 1980 is 8.6%, while those with revenues below $1 billion return 18.6%. Interestingly, those with negative earnings per share in their pre-IPO year have returned 25.6% compared to 12.8% for those with positive EPS.
“First-day returns are clearly attractive, but they really are exclusive to investors who received an IPO allocation,” say Jason Draho and Michael Gourd, the report’s authors. “That’s because the typical opening price already accounts for [90% on average] of the first-day return. Thus, investors who buy at the opening should expect a minimal first-day return.”
Looking further down the road, IPOs have tended not to perform particularly well. “In an efficient stock market, a portfolio of IPO stocks shouldn’t consistently outperform the market. But they also shouldn’t underperform on average, which is what they’ve done over a multi-year period.”
Data show that from 1980 to 2016, companies with pre-IPO year revenue of over $1 billion returned 8.4% excess return versus a risk-adjusted benchmark over three years from first-day close, while firms with revenue of less than $1 billion lost 8.9%.
Meanwhile, those backed by growth capital returned 15.5% excess over the same period, compared to a loss of 3.3% from venture capital-backed companies. “This superior performance, coupled with smaller first-day returns, suggests that larger, established companies are safer IPO investments.”
The conclusion from UBS is that IPOs can be attractive investments if you can get an allocation, but much less so if you’re buying in the secondary market. The latter is generally how UK-based investors would gain access.
A comparison of the post-IPO performance of Google (GOOGL), Facebook (FB) and Twitter (TWTR), pulled together by UBS, is interesting. Twitter, at 73%, returned more than both Google and Facebook on their respective first trading days.
However, since their first-day close, both Google and Facebook have well outpaced the S&P 500's returns, while Twitter has not. In fact, Twitter has lost 25% in that time compared to the S&P 500's 83% gain.
Is Another Tech Bubble Forming?
Some fund managers have suggested the excitement surrounding the current tech IPOs has some of the hallmarks of the dotcom boom and subsequent bust. But Draho and Gourd do not believe this is the case. They point out a few key differences between today’s cohort and those before.
One of these is the average age of the firms, which today stands at 10 years, versus four in 1999 and five in 2000. Further, today’s larger unicorns have sizeable revenues and have accessed growth capital in order to stay private longer.
“All of these attributes are consistent with moderate first-day returns and above-average long-term returns, the exact opposite of the dotcom bubble experience.”
Of course, there will be other, more fundamental and company-specific, considerations to take into account when assessing each IPO. One of those is the long-term theme that each plays into.
With Uber and Lyft, most analysts question the car-sharing model. The economics are not immediately or obviously attractive for sustainable, long-term investment, says Hargraves.
Walter Price, manager of the Allianz Technology Trust, says his team is split. “Some of us believe that Uber and Lyft are taking a mediocre business of taxis and making it worse, while others think they will drive taxis out of business and then raise rates dramatically and make it a good business,” he explains.
One thing the team does agree on is that it is now a good business today. They are also more constructive on Pinterest and Airbnb.
These companies have hitherto been phenomenally well backed with capital, allowing them to invest and grow with little regard to the losses they have racked up, notes Jake Robbins, manager of the Premier Global Alpha Growth fund.
At some point, he continues, they will have to show an ability to not only grow revenues but also generate profits. “This creates significant risks, as many of these companies will turn out to have been the investment equivalent of black holes and will never generate a return.”
Of course, some will come to be dominant forces, while many more will be quickly forgotten. Robbins suggests that gaining exposure through a well-diversified selection would be preferable to betting the ranch on one or another.
