Remember the dotcom boom? Gregory Perdon of private bank Arbuthnot Latham does. As its co-chief investment officer, he worries that 2019 feels a bit like 1999: “In the late 1990s, taxi drivers in New York would tell me which call options they were buying on which tech stocks — it was euphoric back then. I don’t think we are at those levels just yet but, equally, I don’t think we are a million miles away.”
In fact, some argue that the only real difference is that the taxi drivers are now the investment, rather than the investors. Last month’s initial public offering of shares in Uber, the ride-hailing app, saw a tech company that is set to lose $5.4bn this year seek a stock market valuation of around $80bn.
Nor is it the only heavily loss-making company to launch an IPO on a multibillion-dollar valuation. Lyft, Uber’s main rival in the innovative business of booking cabs by phone, posted a net loss of nearly $1bn last year but in April pursued an IPO valuing its business at $24bn. Pinterest, the website that appears to do little more than let users collect pictures of soft furnishings, managed to lose $63m last year and launched an IPO seeking a $12bn valuation this spring. WeWork, provider of serviced offices full of little but hard furnishings — recently posted a $264m loss, as it considers an IPO with a $47bn valuation.
Research by Jay Ritter, a specialist in corporate finance at the University of Florida, has found that the last time there were this many loss-makers trying to flog shares to investors was 2000 — the year the dotcom boom turned to bust. Back then, 81 per cent of US companies coming to the market had lost money in the year leading up to their IPO. In the first nine months of 2018 — even before those tech unicorns had tried to tap investors — the proportion was 83 per cent.
As in 1999, there are plenty of people claiming "this time, it's different". Some point out that the high level of loss-maker IPOs reflects the number of biotech companies raising equity these days — which they must do to fund drug trials. Others note that in recent years, several loss-makers have turned into stock-market darlings. Uber boss Dara Khosrowshahi cites the journeys of Facebook and Amazon. Facebook floated in 2012 at $38 a share when it made a $59m loss, and saw its price fall to $20; last year its shares peaked at $210. However, for every Facebook, there is a Snapchat. Shares in the messaging app initially rose from their $17 IPO price despite the company never having made a profit. They traded as low as $5 earlier this year, and, at $14 currently, the company still hasn't gone into the black. They now trade as low as $14, and the company still hasn't gone into the black. And Amazon's rise from loss-making online bookstore to ecommerce giant did not require investors to buy into sky-high valuations: when it floated in 1997, its market capitalisation was only $300m.
Why, then, are so many loss-makers asking for so much of your money all at the same time? Two reasons suggest themselves, both to do with market conditions.
First, cash flooded into the private equity market between 2011 and 2014, as asset managers sought higher returns in a low interest rate environment. Their investment created a spate of billion-dollar tech “unicorns” that stayed private longer than usual. This created pent-up demand from equity investors, which now gives those early backers the chance of a lucrative exit.
Second, those investors and their advisers are now looking at the longest equity bull market in history, and worrying that their chance to cash in might be running out. Some 29 banks had something to gain from Uber’s IPO.
So is now the wrong time for any investor or wealth manager to be giving it to them?
In many cases, yes — though not necessarily. At London & Capital, private investment office partner Iain Tait sees the recent loss-maker IPOs as feeding a market appetite for “disruptive growth investments” — and reflecting their scarcity value. But he says it is imperative to employ critical analysis of each investment case to avoid excessive valuations.
“An investor with a long-term time horizon with the appropriate risk tolerance may well be suited to a high growth investment opportunity that is currently loss-making. But it would be critical to assess the roadmap to profitability,” he says.
Profit projections are also key for Cesar Perez Ruiz, chief investment officer at Pictet Wealth Management. "We analyse the long-term profitability of these companies, and the valuations must compensate adequately," he explains. "Loss-making alone is not a reason to avoid investment — Amazon was loss-making and we bought aggressively. On the other hand, Uber's average revenue per user is going down."
With many private equity and venture capital-backed unicorns, the ability to stop burning cash and start making it is unproven, reckons Wesley Lebeau, senior portfolio manager at CPR Asset Management. “On the one hand, there are those, such as Uber and Lyft, that have benefited from years of venture capital in a very cheap money environment with big question marks about long-term profitability, as they burn through billions in cash,” he says. “On the other hand, there are those who have been able to accelerate growth, leveraging access to equity markets nearly at break-even margins, like Pinterest and Zoom Video.”
Even then, they may not suit wealthy investors’ risk profiles. “In Europe, most wealthy clients focus on capital preservation. For most of those clients, investments in loss-making companies are not suited,” observes Patrik Lang, head of equities at Julius Baer.
For those still unsure about loss-making companies’ IPOs, William de Gale — who spent 20 years at BlackRock covering the tech sector before running money for BlueBox Asset Management, has a simple rule: “Don’t go near them.” He says the IPOs are happening for a simple reason: “These companies now need to go public to satisfy their private equity backers, but none of them have ever needed the discipline to create a return or even have a real plan for how to achieve one.”
De Gale suggests investing in “more established tech companies that make the unicorns’ businesses possible in the first place”. Perhaps the ones that make the taxi drivers’ mobile phones. – Copyright The Financial Times Limited 2019.
