Trader Talk

Square IPO points the way for lower valuations of 'unicorns'

Traders work on the floor of the New York Stock Exchange in New York City.
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Payment provider Square priced 27 million shares at $9, below the price talk of $11 to $13.

Square is far and away the more important IPO today because it is being watched as a leading indicator for other "unicorns," tech companies with heavy rounds of private fundraising that are now seeking to go public.

The company raised $243 million, 25 percent less than what they had aimed for. It had been valued at $6 billion in private financing last year, but is now worth half that: $2.9 billion.

Square is particularly important as a leading indicator for "unicorns." And the indication is that valuations are too high.

Square is being looked on as the playbook for other large companies that are waiting in the wings to go public in 2016. I'm talking Snapchat, Dropbox, Pinterest, Airbnb.

There is a little bit of come-uppance for the private markets here. Everyone had an attitude that the "smart money" was in the private market. The public markets were less disciplined, or so the "smart money" wanted you to believe.

Ah-hem. Turns out prices can get stupid in the private markets as well. These unicorns — and all the smart money behind them — are now being subject to the discipline of the public markets.

And in some cases it's the public mutual funds that are the ones forcing them to bring the valuations lower. Mutual funds can have up to 15 percent of their assets in these "private" investments. There is a lot of money now being allocated to these "alternative" investment funds. But they have to mark these alternative investment at fair value because they sell their funds every day.

Fidelity, for example, has marked down the value of Snapchat by 25 percent, and Dropbox had its valuation lowered by BlackRock earlier this year.

This is part of a broader trend in IPO valuations. I have been noting for more than a month that IPO investors started saying No! to higher valuations on IPOs at the end of the summer, and with good reason: for the year up until August 31st, when most IPOs priced at or above the midpoint of the price talk, the average return for an IPO was down 8 percent from its IPO price.

In other words, IPO investors were losing money. Consistently.

Starting around Labor Day, investors pushed back. Since September 1st, there have been 32 IPOs that have priced as of the end of last week. On average, they have priced 18 percent below the midpoint of the price talk, according to Renaissance Capital, which runs the Renaissance Capital IPO ETF, a basket of roughly 60 recent IPOs.

The average return of those 32 IPOs has been 8.7 percent from the IPO price. That's good for buyers of IPOs!

The lesson: cut the price, and the IPOs perform better!

Match Group is a bit different because it's a spinoff from IAC, but they too priced at the low end of the range: 33.3 million at $12, the low end of the price talk of $12-$14. Match is also a bit different because it is very profitable.They use very little advertising; the vast majority of their revenue comes from users paying to use their sites. Investors love that.

Finally, a cybersecurity firm, Mimecast, priced 7.8 million shares at $10, also the low end of the price talk of $10-$12.

Finally, don't cry for the poor Square employee: the average insider at Square owns it at $2.48, though there were later rounds of fundraising above the IPO price.