Every era of tech has its defining IPOs. From the dawn of the PC (Microsoft,1986) and the Web revolution (Netscape,1995) to the rise of the Faangs (Google, 2004) and China’s new tech champions (Alibaba, 2014) these stock market debuts have been emblematic of their times.
Tech’s unicorn era is finally having its Wall Street moment and in our opinion it isn’t pretty. WeWorks biggest backer, Softbank, wants to call a half to a planned listing, while Uber’s shares stumbled to a new low recently, around a third below their IPO price.
These have been the two biggest candidates for a stock market listing in 2019, for what was meant to be tech’s year of the IPO. It comes after a long drought during which the most promising tech start-ups chose to stay private, enjoying a valuation premium in the private markets often pushed by Softbank and its Vision Fund. But it turns out that the easy cash has bred bad habits. If Uber and WeWork come to be seen as the emblematic deals of a period of excess capital, the investors who have pumped them up will have only themselves to blame in our opinion. Not that all the new companies Silicon Valley has been foisting on Wall Street are as overvalued or us steeped in governance and ethical controversy. In fact, the market for the IPOs appeared to be functioning pretty much as intended. Internet services company Cloudflare for example boosted the price range for its initial public offering in the face of strong demand, while online orthodontics supplier SmileDirectClub raised the price of its shares ahead of the first day of trading, valuing it at nearly 9 billion US-Dollar. With gross profit margins of nearly 80%, both companies are founded on solid economics – even if the costs of growth mean each is still spilling red ink. These solid economics we miss at Lyft, Uber and WeWork for example.
Still, the heightened flow of stock market listings like these during 2019 pales in compovisor to WeWork and Uber. The ride-hailing company was once eyeing a valuation of 100 billion US-Dollar or more. Last week it touched 52 billion US-Dollar, as California moved ahead with a law that could force it to treat drivers as employees. That would obviously put further stress on a business model that critics claim has been little more than an arbitrage all along, taking advantage of a pool of low-cost contract labor to undercut established services.
WeWork, meanwhile, was hoping for an IPO that would bring a premium on top of the already absolutely crazy and in our opinion unjustified 47 billion US-Dollar it was last valued at the private market. Then finally reality set in. WeWork’s business is also based on an arbitrage, signing long-term leases on office buildings and bringing in tenants on commitments that average 15 months. Wall Street is apparently unwilling to consider a share sale valued at even 20 billion US-Dollar – in our opinion it should not even exceed 10 billion US-Dollar.
Big valuation swings around a listing aren’t unheard of. Facebook’s stock fell by 50% soon after its listing on worries that it had missed the shift to mobile, before surging ten-fold in the next 6 years. But as the products of a period of ready capital, Uber and WeWork have remedial work to do to prove their businesses will be sustainable if the cash tap is turned off – which in our opinion is close to impossible.
It isn’t just that the ready supply of cash may have led both companies to overspend (though that could also be a problem – Uber just laid off more than 400 workers, its second round of job cuts in less than a year as a public company).
Rather, their very businesses were founded on the premise that cheap capital would always be available, and in large amounts. The aim was purely to establish an impregnable scale and brand, along with whatever network effects they could muster to dig moats around a new market. During this unprofitable dash for growth, investors were urged to keep their eyes on the pot of gold at the end of the rainbow: a potential market that WeWork put at 1.6 trillion US-Dollar, while Uber conjured up a total addressable market of more than 12 trillion US-Dollar.
It turns out Wall Street isn’t to willing to go along with such airy promises. That leaves both companies facing a similar, unappealing set of questions in our opinion. If they pull back from unprofitable growth and try to pivot to financial sustainability, what will it do for their growth rates? And can they make a decent margin from the new territory they have already carved out?
A public market corrective in our opinion was long overdue – with remedial work, both could emerge as sound businesses – even if that means some tough decisions and consolidation ahead. But for the tech’s IPO class of 2019, the damning verdict is already in.
