Will Public Markets Embrace the Upcoming Slew of Tech IPOs? Here’s What Casper Taught Us.
Over the past week, we saw numerous technology companies file S-1s with the SEC, including SumoLogic, Unity, Snowflake, Asana, JFrog, Airbnb and the much-anticipated Palantir. We also witnessed Ant Group file a dual-IPO in Hong Kong and Shanghai, setting the stage for what could be one of the largest IPOs in history.
However, given the public market’s cold reception towards recent tech IPOs (i.e. Uber, Lyft, WeWork and Casper, among others), compounded by the detrimental economic impact of COVID-19, are we set for yet another round of disappointment as these tech darlings make their long-awaited public debut?
To answer this question, let's break down the recent Casper IPO to help shed light on why there is so much disparity between public and private market investors.
Casper’s IPO Flop
Following Casper’s IPO roadshow, management was able to establish an approximate value at which investors wanted to purchase the company’s stock; coming in at $17–$19 per share, valuing the company at ~$760MM.
However, the day before its NYSE debut, Casper lowered its share price to $12–$13, resulting in a valuation of only ~$476MM. This represented a significant markdown (i.e. ~57%) from the company’s prior private market valuation of $1.1B.
Management cited the price cut as a result of less-than-expected demand due to the company’s lack of profitability, coupled with high customer acquisition costs. Moreover, Casper management cited a weary public market following the WeWork fiasco, as well as the poor performance of recent high-profile IPOs, including Uber and Lyft––each trading well below their IPO price (even pre-COVID).
To put this into perspective, Casper’s private market valuation of $1.1B was based on revenues of $416MM. However, the company had yet to turn a profit, reporting a net loss of $67.3MM. In comparison, traditional mattress retailer Tempur Sealy had a public market valuation of $5B based on revenues of $2.9B, and the company had long been profitable, with $156MM in net income over the same time period.
Now, there certainly is value in the capital efficiency of Casper’s direct-to-consumer (D2C) business model (i.e. shipping mattresses directly to people’s homes, without the added overhead of showrooms and sales staff). However, in recent years, Casper’s company roadmap has included the opening of brick-and-mortar retail locations — something which goes against its initial D2C model, thus increasing overhead and cutting into margins. As such, Casper had already opened 60 retail locations, with plans to open an additional 200 across the US following its IPO.
If we look at Casper’s pre-COVID stock performance since it’s February 6, 2020 debut, public markets unquestionably agreed with the lowering of Casper’s IPO price, trading below $10 per share pre-COVID:
As a result of Casper’s stock performance since it’s IPO, the price of $12/share was unquestionably a stretch; and the initial price range of $17–$19/share was surely unjustified.
Diving a bit deeper, we can see significant differences between many of Casper’s key ratios, compared to well-established competitor Tempur Sealy:
At the time of IPO, while Casper’s gross margin was in-line with industry comparables (i.e. ~43), they had a long way to go at improving operating margin (i.e. -25.69 vs. 11.81, respectively), and net margin (i.e. -25.73 vs. 6.15, respectively).
As we saw with recent high-profile IPOs, including Uber, Lyft and WeWork, public markets place a much larger emphasis on profitability (or a least a path to profitability), whereas private markets appear to emphasize growth-at-all-costs as a mean of marking-up the next round of funding.
Given this private vs. public market disparity, are private market participants ultimately doing founders and investors a disservice?
Misaligned Incentives: The Concerning Disconnect Between Private & Public Markets
Over recent years, there seems to have grown a significant disconnect between private and public market valuations, largely reminiscent of the dom-com bubble.
For instance, let’s assume VC Fund 1 leads Casper’s Series A round of financing. It seems many VCs these days guide founders to grow, grow, grow; disregarding profitability and positive unit economics — to be figured out at a later time once the company has acquired a critical mass of customers.
Casper, therefore, grows over the ensuing 14–18 months, thus setting the stage for their next round: Series B. Due to the company’s increased growth, VC Fund 1 marks-up the deal, generating a nice paper gain for its LPs (limited partners), while VC Fund 2 joins the party and participates in the Series B.
Once again, VCs instruct management to grow, grow, grow over the ensuing 14–18 months, setting the stage for yet another round: Series C.
As a result, VC Fund 1 marks-up the deal once again, realizing an even larger paper gain for its LPs, while VC Fund 2 now also benefits from a markup on its Series B entry, making a paper gain for its LPs and pushing towards a Series D.
The cycle continues as an increasing number of investors enter the game at subsequent rounds of financing, therefore inflating valuations until the company is eventually acquired or goes public.
As a result, VC Fund 1 looks like a rockstar in the eyes of its LPs, thus allowing the firm to raise another fund based on past performance. Moreover, VC Fund 2 (as well as any VCs which entered at subsequent rounds), also register markups for LPs, thus encouraging the launch of subsequent funds.
Based on the typical annual management fee of 2%, no wonder we are seeing massive funds such as SoftBank’s $100B Vision Fund takeover private markets — i.e. 2% on $100B is a pretty tasty management fee!
Therefore, the question becomes:
Are VCs in the business of helping founders build sustainable companies in persuit of eventually profitability, thus being accepted with open arms by public markets?
Or…
Are VCs more interested in financial engineering for the purpose of raising subsequent funds and generating a continuous flow of management fees?
Founder of Social Capital, Chamath Palihapitiya, highlighted this systemic issue in his 2018 annual letter –– an issue which appears to be largely unresolved today.
Founders: Choose Your Investors Wisely
Personally, I view this as a conflict of interest.
For example, if VCs force the founder to focus on growth instead of profitability and strong unit economics, they are essentially setting the company up for failure if/when the company reaches public markets (as we’ve seen with Lyft, Uber, WeWork, and now Casper).
VCs which invested at an early enough stage will still register an attractive markup for LPs but not nearly to the extent if they had helped the company build a stronger, profitable business.
Moreover, as we saw with the failed We Work IPO, public markets weren’t fooled, and instead, understood that the business was nothing more than a real estate company, therefore marking-down the organization’s valuation to a few billion dollars (from as much as $47-billion).
The VCs had been wrongfully valuing WeWork as a software/technology company, therefore superficially inflating the organization’s value well beyond it’s worth.
Therefore, for anyone wishing to raise a venture fund (or for founders seeking venture investment), bring the focus back to building sound businesses with a focus on profitability and positive unit economics; not superficially marking-up deals for the purpose of raising the next fund and collecting additional management fees.
Otherwise, LPs get short-changed, founders get taken for a ride, public markets refuse to buy the hype, while VCs continue to collect steady management fees.
Invest wisely.
About the Author
Matthew is the founder of Allied Venture Partners, a new AngelList syndicate dedicated to the growth and diversity of Western Canada’s technology ecosystem. To learn more please visit Allied.VC
If you liked this story, please give it a “Clap” so others might find it.
