Initial public offerings are all the rage these days as several high-profile companies have gone public recently. Recent examples are Uber, Lyft, Zoom, Pinterest, Beyond Meat, and Chewy. These offerings have been greatly anticipated and have been met with much enthusiasm by investors and financial media. The pipeline for future offerings is also robust, with Slack set to list this week and Airbnb, Palantir, and WeWork all set to come public in the near future. Given the excitement and press coverage, it’s no surprise we’ve received questions from clients looking for ways to participate, how to do so, and, most importantly, whether to do so.
What’s an IPO?
An Initial Public Offering is when a company, and/or its investors, sells shares to the public for the first time. The company files an S1, more commonly called a prospectus, with the Securities and Exchange Commission. The S1 contains all kinds of details about the company: its history, its business, financials, risks,and more.
IPO’s have historically been how companies raised capital and provided liquidity to early investors. Usually the company hires an investment bank, and then their bankers take the company on a “road show”, pitching the company to institutional buyers. The banker’s job is to generate as much demand as possible for the offering, simultaneously trying get the highest price for the company that still results in a first day “pop” for its new investors. Too big of a pop and the sellers will feel like they left too much on the table, and no “pop” means no instant gratification for those who are allocated shares.
What’s different today? There is a lot more venture capital (“VC”) money funding companies for longer and at higher and higher valuations. There are a significant number of high profile, private companies with valuations over $1 billion. These are often referred to as “unicorns”, implying there’s something magical about them. The VCs drive valuations and have significant influence on these unicorns’ decision to go public. In a lot of instances, the motivations forgoing public have changed, from accessing capital to cashing out. This should give investors pause, since the highest profile companies are offering shares to the public at a later, more mature stage in their life cycle when the growth curve is slowing, and based on today’s market, much higher valuations.
We think there is some evidence of a mini-mania in IPO-land. There are all kinds of signals, from price action in the market to the way some of these companies are being presented to investors. Here are a few anecdotes:
- In the lead up to and through the Zoom IPO, a pink sheets company called Zoom Technologies rose more than 47,000% as unwitting investors mistook it for Zoom Video, the one going public.
- Private company WeWork, which is currently preparing to list, and is basically a shared office space company, has positioned itself as some sort of new age company. Its CEO has described it, not as a real estate company, but “a state of consciousness” with a bunch of “emotionally intelligent, interconnected entrepreneurs”.
- Uber recently came to market with a valuation of more than $80 billion, one of the largest listings ever, despite having never turned a profit and a risk factor section that took over 35,000 words. The financial media covered the event like it was the Super Bowl.
What should individual investors do in the IPO boom?
Individual investors often see companies register large gains in their first trading days and naturally look for ways to participate. Unfortunately, as an outside individual investor, there usually is not a good way to get in on the action pre-listing and the only option to participate is to simply join the frenzy after the fact.
A lot of the recent activity reminds us of another time, about 20 years ago, when investors enthusiastically bid up shares in recently offered companies 50, 60, 70 percent and more on the first day of trading. Surely those investors got to keep all of their gains and continue to enjoy them to this day, right?
Wrong, at least as it relates to most investors. As an example, even a successful company that IPO’d in the late 1990’s, like Amazon.com, has very view successful investors that bought it at the IPO and held it through the ups and downs of the following two decades to reap the massive long-term gains. While we have no doubt that some of these companies could prove to be long term winners, most individuals looking to participate aren’t thinking long term and even if they were, it is incredibly hard for individual investors to separate the wheat from chaff.
If you can’t tell, we think joining the frenzy can be hazardous to your wealth. For us at Accretive, the only role we want to have in the IPO boom is as a spectator. Something about buying a security actively marketed by sophisticated bankers to sophisticated institutional investors in order to get the best price for the company and a first day pop for institutional investors tends to put us off. We couldn’t find the origin of the phrase,but at some point, investors began to joke that IPO stands for “Its Probably Overpriced”. We think that has tended to be true over time and continues to be true today.