"I think buying new offerings in a hot market is something the average investor should not think about at all." said Warren Buffett on CNBC Thursday, when asked about buying into the Lyft IPO, which is scheduled to begin trading on Friday.
I got a call from a trader friend Thursday afternoon, someone who's been trading IPOs for a long time. Like a lot of traders, he's a bit baffled by the Lyft phenomenon.
"The economics are completely upside down, and their biggest competitor is coming in the next few months," the trader said. "And guys are just guys falling all over themselves to get in on the deal. And they can't get in. They're telling me, 'If I get 5,000 shares I'll be happy."
My friend, who must be anonymous, is trying to separate the Lyft fundamentals from the action of the markets in general. He understands that the IPO market is hot because it's been closed for four months, the stock market is up 12 percent this quarter, there's a very limited float of about 13 percent and Lyft is a well-known name.
But people are wondering whether the fundamentals justify the valuation. The company's last round of private funding last June valued it at $15 billion. Now the company seems to be looking at a valuation of about $22 billion, 50 percent higher in less than one year.
Have the fundamentals improved that much in a few months? Santosh Rao, who evaluates IPOs at Manhattan Venture Partners, says the improvements have been only marginal. "Fundamentals did pick up in the fourth quarter. They are getting more efficient with the drivers and the incentives. But there is a little bit of hype too. You see the squeeze, demand is way above supply."
Like many on the Street, Rao is trying to justify the nose-bleed prices Lyft is likely to command.
The biggest problem are the huge losses. The company had $2.2 billion in revenue last year with losses of $911 million.
And this is where the Wall Street guys really get into "magical thinking." Rao explained the reasoning: "Revenues grew 100 percent in 2018, but losses only grew about 40 percent. In that sense, the margins are improving. The sequential progression is improving."
Rao doesn't know when Lyft will make money, but he insists they have bought themselves a lot of time. "The cash burn was $350 million in 2018, but they have $2 billion in the bank, and they are going to raise another $2.5 billion or so in the IPO. So they have a little room. $4.5 billion divided by $350 million implies they have 10 years."
When pressed on all this "magical thinking," Rao admits, "A lot of investors just want growth at any price."
Ah, there it is. Not growth at a reasonable price, but growth at any price.
And this is where things can go terribly wrong.
All signs are pointing to a big gain on Lyft's first day of trading Friday.
In addition to demand, Art Cashin at UBS made an interesting observation about the timing. He noted that, perhaps not by coincidence, the Lyft IPO is coming on the last day of the quarter.
This means that those who would normally sell on the first day of trading, especially if the stock is up big, might be very reluctant to sell because the 13-F disclosure form they have to file in the next 90 days would show they don't own it, and if they want an Uber allocation the underwriters might hold that against them, arguing that they are not long term holders. That might help support the price throughout the day.
Once the show is over, let's see what happens. Let's see what happens in two or three months when another 50 or 60 IPOs come down the lane that are not as famous, and it all gets a little blurry.