- REUTERS/Lucas Jackson
- Many of the startups that have tested the initial public offering market in 2019 have floundered amid a disconnect between private valuation and public trading levels.
- Several unicorns – or startups valued at more than $1 billion – have even called off their IPOs or pushed them back as the market sends mixed signals.
- Here’s what’s keeping public investors wary of the IPO market, and what it means for the future of startups looking to go public.
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This year hasn’t been kind to unicorns.
From fitness-bike sellers to ride-hailing giants, 2019’s newly public companies are floundering despite their quick rises to cultural prominence. Nearly half of all companies to go public in 2019 are trading below their offer prices, with major IPOs wiping out hundreds of millions of dollars in investor wealth in a single day.
Perhaps the most high-profile example is the ride-hailing duopoly of Uber and Lyft, which stumbled out of the gate and have struggled to regain their footing. There’s also Peloton, which opened 6.9% below its offer price, marking the third-worst trading debut for a mega-IPO since the financial crisis.
Some unicorns haven’t even made it to market at all. They’ve either cancelled their IPOs entirely, or delayed them significantly. WeWork announced Monday it’s indefinitely postponing its public offering as its new co-CEOs “focus on our core business.” The announcement sent WeWork bonds to record lows.
Elsewhere, Hollywood conglomerate Endeavor canceled its IPO at the last minute September 26, saying it would evaluate market conditions to better time the offering.
For context, a startup achieves “unicorn” status after receiving a $1 billion valuation. Those types of companies are quick to garner investor interest from their novel status among traders and analysts, yet the latest batch is faring far worse than past startup classes.
Unpacked below are three reasons why investors are fleeing the once-popular unicorn investments and bringing new scrutiny to those companies. There’s also a look ahead at the potential implications.
Reason #1: Weak margins
- Michael Kovac/Getty Images for WeWork
This year’s IPO class is the least profitable since the tech bubble, with less than a quarter of the newly tradable companies set to reach positive net income by 2020. Many of this year’s unicorns – and their disruptive “platform” models – are struggling to reach levels of profitability sought by public investors, and its sending their stock prices to the floor.
The growing focus on software-based businesses has led many firms to classify themselves as software companies, but “that narrative is now falling apart” as investors demand software-company margins, venture capitalist Fred Wilson wrote in a Sunday blog post.
Some software unicorns have maintained their IPO prices through the year, with Cloudflare and Zoom Video both trading above their offer level. Wilson notes that the two companies have gross margins of 81% and 77%, respectively, above the 75% standard for software companies.
On the other hand, some of the year’s biggest IPO flops tout themselves as software companies but lack the margins to match. Here’s where those public-market duds last reported gross margins:
- Uber: 46%
- Lyft: 39%
- Peloton: 42%
- WeWork: roughly 20% (S-1 filing used a slightly different metric)
“If the product is something else and cannot produce software gross margins then it needs to be valued like other similar businesses with similar margins, but maybe at some premium to recognize the leverage it can get through software,” Wilson wrote.
Reason #2: The macro landscape
- Yuri Gripas/Reuters
Though recession fears have calmed from their late-August highs, plenty of factors continue to drive market volatility and keep investors on their toes. A recent Preqin survey covering the second half of 2019 found 74% of investors viewing the market at the peak of its cycle, implying a downtrend is just around the corner.
Meanwhile, major stock indexes have remained near record highs despite significant outflows from equity markets, with investors moving capital to less volatile investments.
The latest warning signs hint at an upcoming economic slowdown, and it may be scaring investors away from volatile IPOs. Stocks are among the riskiest assets to hold in a downturn, and newly public companies typically see more price swings than average as investors pile in to make their first bets.
While margins and marketing are crucial for investors looking to back a unicorn, macroeconomic conditions could keep investment away from equities as a whole.
Reason #3: Branding
The move from private to public ownership has become increasingly rocky, as investors are expecting more from unicorns and aren’t as easily swayed by lofty marketing techniques.
WeWork’s IPO filing noted its goal was to “to elevate the world’s consciousness.”
Peloton “sells happiness” according to its S-1 filing, before adding, “but of course, we do so much more.”
Lyft “is at the forefront of a massive societal change.”
IPO documents tend to lean toward the dramatic and appeal to investors with ambitious language. However, many of the unicorns pitching themselves as disruptive to the status quo don’t possess the business models to reliably grow profits.
“When it comes to ‘platform’ companies, venture capital has done a generally terrible job building these businesses into viable companies,” DataTrek researcher Nicholas Colas wrote in a September 27 note.
Public investors “need vibrant, growing platform companies to create long-term value,” he added, and “the focus on price momentum over fundamentals” that worked in private funding doesn’t attract public capital as easily.
The longer-term implications
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Recent unicorn performance is sure to have investors, analysts, and executives questioning the future of startup IPOs. Hype built in private funding rounds is mattering less in public markets, and investors are less willing to overlook poor margins.
Direct listings are an increasingly popular option for startups hitting the market, with Airbnb reportedly opting for such a strategy over an IPO. A direct listing keeps companies from paying millions of dollars in IPO bank fees, and doesn’t require the issuance of additional shares.
No matter the path to markets, firms are seeing greater public scrutiny toward their financial figures. The “honeymoon phase” of post-IPO pops “is going to go away,” Manhattan Venture Partners head of research Santosh Rao said.
Companies will need “a clear path to profitability” if they want to transition from private funding to public markets, he added, stating that private funding rounds will hinge more on bottom-line performance and projected public performance.
“Toward the later rounds, private investors will have to be more rational in what they’re willing to pay,” Rao said in an interview. “The company has to be able to withstand public market scrutiny, which will only get more intense after this round of IPOs.”