This post was written with contributions from Charlotte Irwin. Charlotte is a Research Strategist in the ETF and Mutual Fund Research Team.
It’s ironic. Private companies with valuations of $1bn or greater are christened “unicorns.” By definition, unicorns are mythical creatures, but the word also describes something that is highly desirable but difficult to find. Yet, in the realm of private companies there are more than 340 unicorns worldwide. That doesn’t seem so mythical, highly desirable or particularly hard to find.
Thanks to a recent deluge of initial public offerings (IPOs), unicorns will be even easier for investors to track down. Twenty unicorns went public in 2018, a 54% increase over the 13 IPOs in 2017.1 And 2019 could see more than five times last year’s numbers, with more than 100 unicorns2 set to tap public markets. In May, Uber’s hotly anticipated IPO—the biggest unicorn since Facebook went public in 2012—will grab the spotlight, making it this month’s Big What If.
The running of the unicorns
There are plenty of reasons for the explosion of highly valued private companies. The Sarbanes-Oxley Act of 2002 made the financial auditing and reporting requirements for public firms much more onerous. At the same time, pensions, endowments and sovereign wealth funds have been pinched for returns and hungry for opportunities as yields compressed globally and growth remained sluggish. Their longer investment horizons and deep pockets were a match made in heaven for the vest-clad Silicon Valley crowd intent on scale and secrecy at all costs.
Now, a decade on from the financial crisis, many of these investors are exiting their standard 10-year lockup periods. And with markets at all-time highs, they can’t believe their luck. Having survived 2018’s Q4 pullback, private investors are itching to cash out while markets are at historic highs. Tech is trendy, and the contributions that the listings of Facebook (2012), Alibaba (2014) and Google (2014) have made to returns over the past few years are fresh in investors’ minds.
All seemed to script when Lyft went public in March. After an 8.7% opening day pop to compensate exiting investors, the stock now sits roughly 17% below its IPO price and about 40% of the float is currently sold short. This could be due to the imminent listing of arch-rival Uber, but I think it’s more about what investors found on their first look under the ride-sharing hood. While Lyft’s valuation soared as high as $22.4bn on its IPO, the company posted a $911mn loss on $2.1bn in revenue last year. That’s the biggest loss ever in the year leading up to a US startup IPO.3
Those numbers aren’t unique. Eighty-four percent of companies looking to IPO today have no profits, up from 33% just a decade ago.4 While their performance on the date of the IPO is similar to profitable peers, in the next three years, unprofitable companies underperformed the market by 9.7% while companies that turned a profit prior to their listing outperformed the market by 7.9%.5
*Privately held. Source: Company reports, The Economist, Bloomberg. April 20, 2019. The Wave of Unicorn IPOs Reveals “Silicon Valley’s Groupthink: A Stampede of Mythical Proportions.” The Economist, April 30, 2019.
Around the horn: Unprofitability can rock sentiment
By some calculations, today’s average unicorn is 60% overvalued.6 And while the cardinal sin of investing is over-paying, that’s not what concerns me most. As companies have stayed private longer, the median age of a tech company at its IPO is now more than 12 years, yet just 16% have turned a profit. Sure, they have established brands and sizeable user bases, but their customer churn rate is also high. And their slowing growth rates underscore the challenges of scaling a business with low barriers to entry. In fact, given the pace of disruption, it could be that some of 2019’s unicorns’ best gains have already been had by the private investors hoping to cash out. And notably, with a target valuation of $80.5bn to $91bn, Uber is coming to market well below its peak valuation of $120bn.7
This poses a risk to market sentiment going forward. Public and private investors are very different—and the speculation and scrutiny that go into earnings announcements and forward guidance will be a learning curve for both executives and investors.
Circling back to Uber, much of its IPO value is based on moonshot projects like autonomous vehicles and a freight business. However, these growth engines will be expensive—and Uber posted an adjusted loss of $768mn in Q4 2018.8 Because public investors take a shorter term, reactionary approach to investing, expensive, unprofitable companies haven’t traditionally fared well. If underperformance of these blockbuster listings becomes the straw that breaks the unicorns’ backs, the bull market could feel the pain.
1The Unicorn IPO Report, Harvard Law School Forum on Corporate Governance and Financial Regulation, March 20, 2019
2UBS Investment Strategy Insights, 2019: The Year of the “Unicorn” IPO?, April 2, 2019.
3Eliot Brown, “Lyft Leading Wave of Startups That Will Make Debuts With Giant Losses,” The Wall Street Journal, March 25, 2019.
4Initial Public Offerings: Updated Statistics. Jay R. Ritter, University of Florida. Accessed April 30, 2019.
5Kate Rooney, "More Money Losing Companies Than Ever are Going Public, Even Compared to the Dot-com Bubble," CNBC, October 1, 2018.
6“The Wave of Unicorn IPOs Reveals Silicon Valley’s Groupthink: A Stampede of Mythical Proportions,” The Economist, April 30, 2019
7Corrie Driebusch, Katie Roof and Maureen Farrell, “Uber Outlines First-Quarter Results After Cutting Valuation Target,” The Wall Street Journal, April 26, 2019.
8Megan Rose Dickey, “Uber Reports $3B in Q4 Revenue, Rising Operating Losses,” TechCrunch, February 15, 2019.
The number of shares available for trading of a particular stock. Floating stock is calculated by subtracting closely-held shares and restricted stock from a firm's total outstanding shares.
A term most commonly used to describe a company, for example, a startup, that started out small but has since increased its market capitalization substantially.