- Wall Street anticipated several massively successful initial public offerings in 2019. Instead, investors received canceled offerings, multibillion-dollar devaluations, and a shift in the funding landscape.
- Investors are trying to diagnose what went wrong as once-exciting opportunities to buy shares of Lyft, Uber, WeWork, and Peloton soured.
- A lawyer, venture capital managing director, and the CEO of car-sharing startup Turo all chimed in on the state of the IPO, how it may change, and how private companies can succeed in public-market debuts.
- Visit the Business Insider homepage for more stories.
Wall Street expected a slew of successful initial public offerings in 2019.
It received pullbacks, multibillion-dollar devaluations, and a diminished appetite for risk.
The IPO market now faces numerous challenges to its status quo, and investors are still trying to diagnose what exactly went wrong. Some point to larger-than-life S-1 filings with pitches to “sell happiness” or “elevate the world’s consciousness.” Others think companies’ business models weren’t proven enough to earn investors’ trust.
Several massive companies around the world are still looking to go public in the near future, from state-owned oil behemoth Saudi Aramco to home-sharing startup Airbnb. Here’s what a lawyer, a managing director, and a startup CEO had to say about the IPO landscape, how investor sentiments have shifted, and what may be next for the path to public ownership.
This year’s IPO class is the least profitable since the tech bubble, and the marketing used by buzzy tech startups isn’t drawing capital like it used to. Investors are more interested in profitable businesses than those boasting rapid growth, and some companies were late to realize the shift, Turo CEO Andre Haddad said.
“I think the markets have been very unforgiving with the companies that are burning a lot of cash, and are not showing material changes in their profit margins,” the car-sharing startup’s chief executive said in an interview. “If you’re a startup and you’re in that camp, then you’ve got to change.”
The adjustment may be a product of some companies’ flashy marketing and troubling bottom-line performance.
Peloton branded itself as a media company and a technology platform, but posted a net loss every year since its 2012 founding. When the exercise-bike company went public, its stock tanked 11% and wiped out more than $900 million in investor wealth.
WeWork was once the most valuable US startup, but the company pulled its public offering after analysts balked at its lofty promises, annual losses, and leadership choices from former CEO Adam Neumann. The company went from being valued at $48 billion to bankruptcy talks in just six weeks.
Several other companies gambled on glitzy messaging in their bids to go public, but a new focus on fundamentals seems to have taken companies by surprise. The shift reflects a change in risk appetite, and investors are less inclined than ever to give money to cash-burning firms, Lonne Jaffe, managing director of venture capital firm Insight Partners, said.
“If you believed the market was going to give you incredibly cheap capital even through your story was messy, that was the window that closed,” Jaffe said. “It’s not to say it’s not a good company or it shouldn’t exist. What you’re seeing is a more accurate or better pricing of risk.”
Goldman Sachs CEO David Solomon recently spoke up on the renewed interest in profitability over growth. The investment bank took an $80 million hit from its investment in WeWork during the third quarter, and the chief executive said the heightened expectations will yield a better investing environment down the road.
“It’s important for people to grow, but there’s got to be a clear and articulated path to profitability. I think there’s a little bit more market discipline coming into play and I think that’s healthy for markets,” Solomon said on Bloomberg TV.
In the wake of new IPO volatility, some firms are eyeing other methods for going public.
Among the increasingly popular is the direct listing, an approach to public markets that does away with the issuance of new shares. Firms save money by avoiding banks’ expensive underwriting fees, and their share price isn’t diluted by the offering of additional stock.
Spotify and Slack completed direct listings in 2018 and 2019, respectively, and Airbnb is reportedly eyeing a direct listing for a 2020 public trading debut. These well-known companies will only help bring direct listings further into the spotlight, Goodwin Procter partner Rick Kline said.
“I think every VC who’s on a late-stage, highly valued company is asking their boards to consider direct listing as an alternative,” the lawyer said in an interview. “I don’t think it’s right for everybody but absolutely, sentiment has shifted.”
Other firms may change their minds completely, opting to remain private and avoid the demands that come with public trading. Venture capitalists will “almost assuredly” invest more than $100 billion for the second year straight, according to Pitchbook, signaling continued strength in the private funding environment.
Private financing also allows companies to hold their shares at a certain level, whereas investors can actively bet against a public firm’s prospects or current share price. Private companies can take risks and pursue faster growth without the need to appease short-term shareholders, Jaffe said.
“In private market financing, you have a dynamic where the company is the only seller. If you don’t like the highest bid, then you just don’t sell,” he said. “Once you expose it to a broader group of investors, you see the risk appetite is a lot lower, so people demand a higher return for that risk.”
Despite recent turmoil in the IPO market, certain companies have weathered the storm and stood out among disappointing performances.
Newly public software companies have offered portfolios relief through the tumultuous year. CrowdStrike and Cloudflare both trade above their IPO prices as investors sink capital into their cybersecurity products. Zoom Video Communications also stands above its offer price, combining the lucrative cloud-computing industry with video-conferencing tools to reap investor dollars.
Software isn’t just becoming a major industry in itself, but it’s also becoming “a huge portion of all other industries,” Jaffe said. Software products are also “incredibly scalable,” leveraging the internet’s cheap distribution costs to tout higher margins than most other sectors.
Beyond Meat stood out as another winning IPO. The plant-based-meat company trades more than 200% higher than its offering price, and its latest earnings report pointed to continued expansion in key partnerships with grocers and restaurants. When asked in a third-quarter analyst call if the company has faced any growth deceleration as competitors merge, CEO Ethan Brown noted the firm “has seen nothing at all.”
Whether a company is a first mover in a surging food sector, a cybersecurity provider, or a new name in the cloud computing landscape, this year’s investors found solid returns in a small crop of IPOs.
Growth at all costs is out, profitability is in. The recent IPO horror stories are sending investors back to the drawing board, looking for companies to prove their staying power instead of boasting rapid expansion. Private investors should value profitability just as much as public shareholders do and lead companies to shift their strategies accordingly, Turo’s CEO said.
“The goal is to really build a highly successful, profitable business, whether it’s public or private doesn’t make a huge difference, frankly,” Haddad said. “If we’re doing a good job, there shouldn’t be a difference between the two.”
Should direct listings rise in popularity, banks may be forced to take in less fee revenues. Bank earnings would likely be pressured by such a move, but competition to advise IPOs won’t fade, Kline said.
“I think the investment banks understand this is an alternative companies want to pursue. It’s a bit of a prisoner’s dilemma problem, where nobody wants to step back because they’ll lose business,” Kline said.
Outside the US, one IPO is making waves for its sheer size. State-owned Saudi Aramco is poised to begin listing shares in Saudi Arabia’s domestic exchange in December. With the state-owned firm targeting a record-high $1.5 trillion to $2 trillion valuation, the offering pushes the envelope of what can be regarded as a “traditional” IPO.
Companies will continue to seek public offerings, but the latest developments raise new questions around the IPO process, Kline said.
“That process works well, but I don’t think it’s perfect,” Kline said. “There’s no reason those things can’t be tweaked.”
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