Dara Khosrowshahi, chief executive officer of Uber Technologies Inc., speaks on a webcast during the company’s initial public offering (IPO) on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Friday, May 10, 2019.
Michael Nagle | Bloomberg | Getty Images
Nobody in Silicon Valley should be surprised by Uber’s disappointing IPO. Or Lyft’s.
Experts have been predicting this type of performance for years.
Marc Andreessen called “the effective death of the IPO” in 2014 and said that with high-flying tech companies staying private longer, “gains from the growth accrue to the private investor, not the public investor.”
Fred Wilson of Union Square Ventures told CNBC the following year that these late-stage IPOs mean “all of the gains are captured among a very small cohort of people.”
In 2016, Alex Mittal of FundersClub wrote that today’s top tech companies are raising gobs of private cash, “leaving the bulk of returns out of public investors’ reach.”
These are the very people that benefit from companies who stay private longer while their valuations skyrocket, because they’re the early investors. They get to ride the valuation up from the millions to $10 billion, $20 billion or $50 billion and then sell their shares to the masses of public market investors who are thirsting for the next Amazon or Google.
They were the ones warning us about the emerging Uber-Lyft problem. And they were right.
Over the last two-plus years, public investors have gotten consumer brands with big names but few gains. Snap has lost about one-third of its value since its 2017 IPO, while Dropbox and Spotify are up just slightly from their debuts last year. Uber and Lyft have dropped. After falling 13% on Friday on a bad earnings report, Pinterest is back to where it was trading in its first few days in April.
“Maybe we made a mistake in having these unicorns sucking in huge amounts of private capital and delaying their IPOs,” said Duncan Davidson, a partner at venture firm Bullpen Capital, in an interview this week. “Maybe we’d be better off having these puppies go public earlier like we used to.”
A good chunk of the capital at the later stage has come from firms like T. Rowe Price and Fidelity, who normally buy public stocks but moved into the private markets in recent years so as not miss out on all the value creation. Since they’re already shareholders it’s hard to get them to buy more when it’s time to take the company public.
“A lot of the prime public investors you’d want in your stock after the IPO already own the stock,” said Iris Choi, a partner at early-stage venture firm Floodgate who previously worked in investment banking at Goldman Sachs. “What is their incentive to actually buy at the IPO?”
Of course, it’s still too soon to come to any conclusions about where Uber, Lyft and others will be trading months or years down the line. Investors can point to Facebook’s miserable kickoff in May 2012, and the fact that it lost half its value over the next three months before rebounding. Now shareholders who bought in at the IPO and held have seen their investments quintuple. There was plenty of skepticism surrounding Google’s lofty valuation in 2004, but buy-and-holders are up 2,800%.
However, if you’re banking on a similar result from this new class, consider two important factors:
- Facebook and Google are outliers.
- They were profitable at the time of their IPOs.
‘Unit economics really do matter’
With the latest crop of consumer offerings, public investors are being asked to pick up where the venture community left off and continue to subsidize cash-burning growth while the companies seek to prove they can morph into sustainable long-term businesses. Investors are balking.
“The big lesson everybody in Silicon Valley learned is unit economics really do matter,” Davidson said.
So what happens from here?
There’s still little pressure for start-ups to change their approach because private capital is so plentiful. SoftBank’s Vision Fund, which has poured billions into Uber, WeWork and other capital-heavy businesses, is only planning to get bigger. Venture fundraising hit a record $55.5 billion last year, according to the National Venture Capital Association, and those firms have to put their capital to work.
In the first quarter of 2019, five “mega-funds” (over $500 million) closed, the NVCA said, and more prominent firms are in the process of raising $1 billion or more. These funds are increasingly willing to put some of their cash into secondaries, buying shares from founders who can lock in a portion of their riches while steering clear of quarterly earnings and the scrutiny of public markets.
“Mega-funds are creating challenges with the oversupply of capital, and it’s reducing discipline in operating companies,” said Robert Mittendorf, who invests in health-tech companies at Norwest Venture Partners. “We forget out here that operating results are more important than the amount of capital raised. We should be applauding operating performance more.”
It’s certainly not all gloom and doom. Enterprise software companies continue to reward public investors.
Videoconferencing company Zoom, which is profitable, has more than doubled from its IPO price in April and has even generated substantial gains for investors who missed the initial pop. PagerDuty has also more than doubled, and Fastly, whose technology helps companies more quickly deliver online content, surged 50% in its debut on Friday.
Smaller enterprise companies have had even more success since going public. In January, venture capitalist Jeff Richards of GGV wrote on LinkedIn that 14 of the 20 best performing tech IPOs since 2014 were worth less than $1 billion at the time of their offering. Almost all of them sell to businesses.
But Dan Scholnick of Trinity Ventures says things are changing rapidly. The late-stage investors who previously concentrated their dollars in consumer companies have caught onto the enterprise, where cloud software, developer tools and collaboration technologies are seeing huge adoption and have increasingly predictable revenue models.
Scholnick, who invests primarily in business software and infrastructure start-ups, points to companies like Snowflake Computing, Hashicorp and Confluent, which have all raised money at valuations in the billions of dollars. His firm is an investor in data backup start-up Cohesity, backed by SoftBank and valued last year at over $1 billion.
“The private markets for consumer funding developed and got frothy long before enterprise was considered interesting,” Scholnick said. Now that the enterprise has caught up, for public market investors “it’s not going to get any better,” he said. “It’s probably going to get worse because the system is awash in capital.”
— CNBC’s Christina Farr contributed to this report
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