Investors push back on IPOs with high valuations, murky path to profitability

Key Points
  • The buying public is saying prices for IPOs are too high.
  • Many companies going public are not profitable.
  • The winners will be the investing public, who may see more sanity to IPO prices going forward.
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The disappointing debut of Peloton is part of a larger problem: sky high valuations and money losing companies.

The at-home fitness company priced at $29, the high end of the $26-$29 range, opened at $27, and closed at $25.76.

First SmileDirectClub, than WeWork, then Peloton, then Endeavor, which reportedly shelved its IPO plans less than 24 hours before launching. All disappointments.

What's going on? First, the buying public is saying prices for IPOs are too high, even if the companies are centered around sound concepts. Many point to bankers who likely have more loyalty to private investors than public buyers.

"The valuations are broken," Santosh Rao, Managing Partner at IPO research firm Manhattan Venture Research told me. "What are the bankers thinking? Private valuations are way out of sync with what the public is willing to pay."

The other major issue that is resurfacing: lack of profitability. Peloton, for example, lost $296 million on $915 million in revenues. It's not clear how many years it will take to become profitable, part of a long string of companies that are very good at burning cash but not great at generating profits any time in the near future.

"The markets are getting more skeptical of companies that can scale up but have no path to profitability," Aswath Damodaran, Professor of Finance at Stern School of Business, said on CNBC.

John Fitzgibbon, who has been tracking the IPO market for decades at IPOScoop.com, told me, "There's a newer caveat about unicorns making the rounds on the Street: 'Unicorns produce huge revenue on a money-losing operation and don't do well in the aftermarket.'"

These concerns did not start this week. The Renaissance Capital IPO ETF, a basket of the last 60 largest IPOs, peaked in late July (up 43% on the year) and has been trending down since then. Of 120 IPOs done so far this year, 22 have broken their IPO price on the first day of trading. About half (48%) are trading below their initial price.

Many IPOs, particularly software IPOs started strong but have begun to slip as investors question valuations. Many names that have only begun trading in the last couple months are already significantly off their highs:

Recent IPOs

(from highest price since going public)

Lyft — down 52%

PagerDuty — down 52%

Slack — down 45%

CrowdStrike — down 42%

Uber — down 32%

Zoom — down 26%

Pinterest — down 25%

Who's to blame for this state of affairs? Rao says, don't blame the company: "To the extent this is a liquidity event, it was a success for Peloton--they got $29."

Instead, he says, point the finger at the bankers: "The reputational risk is to the bankers. When you start getting the prices wrong over and over again, you start losing trust in the process. If this keeps up, investors are going to move to the sidelines, and say, 'Let's buy tomorrow and see how it trades."

Unfortunately, the alternatives are limited. Companies could simply stay private. But that has its limits, Rao notes: "All the early investors will get antsy, they want to cash out, so there is a limit to how long you can stay private."

What about a direct listing like Slack and Spotify, which allows companies to go public without selling additional shares and without paying high fees to underwriters? Rao points to AirBnB, who may be able to go public without the need for additional cash that selling extra shares would bring.

But most companies do need to raise money: "You can do a direct listing if you are well-known and are well-funded. But most companies need the cash that selling shares will bring in, and they need the public attention."

The winners, Rao notes, will be the investing public, who may see more sanity to IPO prices going forward.

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