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The current wave of technology flotations comes with risk

Lyft shares are down by almost a fifth since their IPO two weeks ago. With other tech companies rushing to market, caution is warranted.

The current wave of technology flotations comes with risk
Garry white employee

Garry White

in Features


‘Unicorns’ listing in the US are welcome additions to public markets – but the current wave of new issues is vastly different than those that have gone before. These companies are coming to market at a much later stage of development than businesses such as Amazon, so their fastest phase of growth is likely to be behind them. This means the bulk of investment profits could have already been made. The pricing of these issues is therefore tricky and, with Lyft shares down significantly from their IPO price two weeks ago, bankers may need to rethink valuations in upcoming listings such as Uber and Airbnb. 

The proliferation of private money available through venture capitalists, sovereign wealth funds and private-equity firms means businesses have been able to stay private for much longer than they did in the past. This has many advantages for the companies involved. Their founders have more control over strategy, as they are not answerable to a wide range of investors, there are fewer costs involved in administration and participation in quarterly reporting cycles – and it is more difficult to be taken over by a larger rival. These factors have come together to create a range of so-called “unicorns”, many of them technology companies.

A unicorn is described as a private company that has been valued in excess of $1bn in a private round of funding. However, there is one major advantage to being a public company when compared with being private – and that is liquidity. Following flotation, it is much easier for early-stage investors to cash-in their investment and sell their shares. Many of these IPOs are not seeking massive rounds of funding for investment; they are providing a route out for people who have already made a lot of money.

Lyft was first out of the blocks in the latest listing IPO wave, and reports ahead of its listing suggested significant demand, even though it remains unprofitable and it is smaller than the largest “first mover” in the sector, Uber. Despite the hype and a positive first day of dealings, the shares have been trading below their listing price since then. Anyone who bought shares post-IPO will now be sitting on a loss, possibly a significant one.

The largest tech listing before Lyft was social-media group Snap in March 2017. Shares in this unprofitable unicorn are now trading around 30pc below their flotation price. Other unicorns expected to float this year include accommodation group Airbnb, office space group We Company (previously known as We Work), analytics software group Palantir and work collaboration company Slack. However, the latest company out of the blocks is scrapbook site Pinterest, which is expected to start trading in New York this week.

Pinterest shares look set to be priced at a discount to the last private fundraising in 2017. The company said it will price its shares at between $15 and $17 apiece – valuing Pinterest at as much as $11.3bn. Although this is an impressive figure, the last time investors were involved in a private fundraising the business was valued at $12.3bn. This means some venture capitalist investors will be sitting on losses at the proposed IPO price. Hopefully, this implies that valuations are getting more sensible, which is positive for investors in the secondary market. However, it will also worry venture capitalists that they have been valuing businesses far too highly in private funding rounds.  Their business model will collapse if other investors find their valuations utterly unrealistic.

One major problem is that most of these companies do not make a profit. The bulls argue that tech businesses in today’s market can be valued higher than previous tech IPOs because the global penetration of devices such as smartphones is much higher than ever before. This makes the addressable market for these companies much greater than when companies such as Amazon came to market. However, earnings still matter – and profitability for many of these companies still seems a long way off.

Over the longer term, these companies may prove their business models work and there could be substantial gains for investors that buy into the IPO. However, the big winners are likely to be those cashing out of early-stage investments, as well as the State of California. Receipt of capital gains taxes from Silicon Valley IPOs this year is likely to be huge. Taxes are usually due when employees vest stock awards, sell shares or exercise options, so a second-quarter IPO gold rush is expected to swell the state’s coffers. Reports from Sacramento suggests that the state was expected to generate around 10pc of its budget – around $13.8bn – from capital gains taxes this year, but the actual figure could be considerably higher. Note the California state government took in about $1.3bn from the flotation of Facebook alone, according to its Department of Finance.

As with any IPO, the price really matters. The performance of Lyft over the last week suggests the market could now be waking up to the dangers of investing in companies with stunning revenue growth, but no profits and unproven business models. Investors already know that buying into flotations by private-equity companies is a risky business, as a lot of the potential upside has already been captured. Bankers therefore need to price these upcoming unicorn IPOs much more sensibly to ensure they do not fail.

A version of this article appeared in Friday’s Daily Telegraph.  

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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