SINGAPORE (Sept 30): This year was supposed to be the year for tech unicorns. Instead, many are getting unexpectedly strong pushback in the public market — best epitomised by the rapid unravelling of the hype and euphoria surrounding WeWork in the run-up to its planned IPO this month.
The company was forced to delay its listing to October at the earliest. This comes after widespread ridicule and scepticism over its prospectus, business model, governance and, critically, valuations.
Some reports suggest WeWork’s valuations may have fallen to as low as US$10 billion ($13.8 billion), down from US$20 billion to $25 billion just a couple of weeks prior and well below the US$47 billion valuation implied during its last private funding round. Not so long ago, Goldman Sachs (a lead underwriter for the listing) had pitched valuations as high as US$65 billion.
The spectacular climb down for WeWork is just the latest in a string of hot unicorn stocks that have underperformed post-IPO this year. They include Uber, Lyft, Slack (direct public listing) and, most recently, SmileDirectClub. Why is this so?
We believe the main reason has to do with valuations and the difficulty in valuing fast-growing tech stocks, especially when the company is in the red. Traditional valuation metrics such as the price-to-earnings ratio (PER) are not useful when companies are not making profits.
Table 1 shows key financial statistics for some of the biggest tech stocks right before their IPOs since 2013 and their stock price performances post-IPO. The numbers seem to suggest that companies are coming to the market with a higher margin of losses, yet are priced at lofty valuations. This trend has been more prevalent since Snap’s IPO in 2017.
Snap reported losses of US$515 million on US$404.5 million revenue when it filed for listing. By comparison, Twitter reported much smaller losses of US$79 million on revenue of US$317 million in 2012, prior to its IPO. Subsequent IPOs such as Meituan Dianping in 2018 and Uber and Lyft this year saw even larger losses.
We attribute this phenomenon to the flood of cheap money in private equity and venture capital. The margin of losses for earlier tech IPOs were generally smaller because most are operating under “real” business conditions and financial discipline.
By comparison, many of the high-flying unicorns were able to raise massive amounts of capital and were using money to buy sales and growth. On the other side, the private market is all too willing to fund these losses, using the resulting growth to push up valuations.
The playbook for SoftBank Group, one of the biggest late-cycle venture capital funds, is to invest huge amounts at higher and higher valuations at each funding round — on expectations that these jacked-up valuations will prevail upon listing. It could then cash out and recycle the money. Some of its most high-profile investments are Uber, Slack and WeWork.
Last year, SoftBank invested about US$2 billion in Uber, valuing the ride-sharing company at around U$70 billion, up from a US$48 billion price tag in 2017. By early 2019, Uber was floating a valuation of US$100 billion to US$120 billion before ultimately pricing its IPO at US$82.4 billion. It used the same playbook with WeWork — putting in US$5 billion in late 2018 and early 2019, and boosting valuations from US$21 billion to US$47 billion.
The public market is proving a much tougher sell, though. Uber’s market cap has fallen to around US$55 billion currently. The negativity surrounding WeWork suggests that the market is far less enamoured of charismatic founders with grandiose mission statements and plans, sold as tech-driven disruptors.
In fact, the resulting questions over valuations may have dampened sentiment for the broader tech sector, including cloud and enterprise software stocks.
This may be a good thing in the longer term, taking some froth out of this market segment. It says that markets are not irrationally exuberant, unlike the one in 1999/2000, before the dotcom bust.
Investors are discriminating between companies with bad and those with sound business models. It is the same for companies that are making losses, between those with and without a path to profitability in the foreseeable future.
Most start-ups cannot be expected to be immediately profitable. They need to spend on building up the business and acquiring customers. Eventually, the investments would pay off from scale and network effects. And they would grow into those lofty valuations rapidly.
Companies such as Uber and WeWork often draw parallels with the earlier crop of tech companies that have very successfully turned initial losses into huge profits over time. But making such comparisons without critically examining the differences in underlying business models is folly.
Case in point: Apple turned a profit just one year after it was founded in 1976, and well before it was listed in 1980. Facebook reported positive cash flow in 2009, five years after it started and three years before it made its debut on Nasdaq in 2012. It took less than three years for Google to be profitable and another three years before it went public.
Amazon.com was loss-making when it was listed in 1997. The company turned around — reporting its first annual profit in 2003 — nine years after Jeff Bezos founded the company in 1994.
By comparison, many of the current generation of tech unicorns have been in the red for far longer, enabled by the capital glut in the private market.
WeWork started in 2010, nine years ago. Uber and Lyft were established 10 and seven years ago respectively. Slack has been in operations for a decade and Pinterest, slightly longer at 11 years. Soon-to-be-listed Peloton Interactive, which sells internet-connected fitness bicycles and treadmills and live-streaming classes, has been in operation for seven years.
None of these companies are profitable. Indeed, for many, losses are widening and there is no visibility on when, if ever, they will turn around.
Instead of building a lasting moat through scale and network effects, their comparative advantage is, more often than not, the ability to outspend and outgrow the competition.
Would the disappointing performances of this year’s hottest IPOs spell the end of profligate private-equity funding for “cash-burning growth at all costs” start-ups?
And surely the heyday of private-equity funds must also be over. How realistic is it to sell the growth of an industry on the basis of making annual gains of more than 20% over many, many years? If anything, it is probably more like “locking in” paper profits pre-IPO.
The Global Portfolio fell 0.9% for the week ended Sept 26, compared with the 0.7% decline for the MSCI World Net Return Index. This pared total portfolio returns to 10.4% since inception. The portfolio continues to outperform the benchmark index, which is up 7.5% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports
This story first appeared in The Edge Singapore (Issue 901, week of Sept 30) which is on sale now
