Think Twice: Uber is the Victim
The massive initial public offering (IPO) by Uber earlier this month was a pivotal landmark for the so-called “unicorn era”. The open question was whether a company with slowing growth and continuous operating losses could defend its private market valuation. Now, with Uber’s stock at $40 at the time of writing this post the firm is worth significantly less than the $45 per share at which it went public. So the answer so far is: nope sir, can’t do.
Uber was quick to blame market conditions for the disappointing results, given that we are experiencing a period of turmoil associated with the rocky trade negotiations between USA and China, increasing political tensions in Europe due to the messy Brexit process and the rise of populism, plus global GDP growth slowdown. That is always an easy excuse; it should be pointed out that this April, in similar market conditions, Zoom Video Communications’ shares closed their first day of trading at $62, up 72% and valuing the company at nearly $16 billion, and Pinterest’s stock soared in its trading debut after the company raised $1.4 billion in the second-biggest USA initial public offering of the year prior to Uber’s.
Now, the biggest IPO of the year prior to Uber’s is more indicative of what is really going on here: it was that of Lyft, Uber’s fiercest rival in the ride-hailing market. Its public offering mirrored the same disappointing bearish patterns. The matter should be settled just noting that as of yesterdays’s close, revolutionary vegan protein company Beyond Meat has gained 244% since its May 1st IPO, while Uber and Lyft, the two most-anticipated debuts of they year, have left investors in the red with losses of 9% and 21%, respectively.
So what the Uber fiasco has really shown is that companies which get public on brand more than fundamentals face grim prospects gaining the trust of stock market investors. Uber was certainly aware of it: CNBC reports that Uber’s underwriters decided to use naked short-selling, which is is generally against the rules and definitely frown upon in the context of an IPO, in a futile attempt to prop up shares once they hit the public markets.
With a bit of bruised ego Uber published a memo that states: “Remember that the Google and Facebook post-IPO trading was incredibly difficult for those companies. And look at how they have delivered since”. Ok, point taken, but the yearly operating profit for Google and Facebook at the time of their IPOs was $423.8 and $1.75 billion, respectively, while Uber’s stood at minus $3.03 billion at launch. So don’t hold your breath on this one either.
Don’t get me wrong, I don’t want to be too harsh on Uber because that is not the root issue here. This does not mean that Uber is a bad investment, nor that they can’t be successful in the long term with their current strategy. It just is not the type of investment that stock markets are ready to embrace.
This points to a wider, structural problem at the core of our financial system; namely the fact that the number of publicly listed companies in the U.S. has fallen steadily since 1997. More companies have delisted than gone public in every year of the past 20 years except one, 2013. The swan song happened in 2000, with 8000 listed companies and the number has been halved nowadays to about 4000 listings. Put in a more shocking perspective the pool is getting smaller even while the population and economy are expanding: in 1976 there were about 23 listed companies per 1 million U.S. citizens. Today, it’s closer to 11 per million.
At the most basic level, fewer stocks means fewer options. It becomes more difficult to build a diversified portfolio when you don’t have a diversity of stocks to choose from. Why is that? There’s plenty of M&A activity of course, and there is nothing wrong with that. The problem arises when there aren’t enough IPOs to replenish the pool and give investors early access to new firms. And why would a company like Uber or Pinterest choose not to seek public funding? Because of stricter regulations on publicly traded firms and the related boom in private equity.
Companies prefer not to have added costs associated with compliance (like the Sarbanes-Oxley Act), they don’t want to answer to a stockholders board and don’t want to share financial details publicly. These are among the complains that Elon Musk was venting about during his famous grudge with the SEC around speculation to take Tesla back to private.
Concurrently private markets grew in depth, breadth and sophistication in order to accommodate the financial needs of these stay-private companies and cover billion-size rounds. For sure it has been an amazing opportunity for venture capital and private equity funds alike, but it is turning into a malaise. Before Sarbanes-Oxley the average age of a company at the time of its IPO was 3.1 years. Today, it’s more like 13.3 years, according to S&P Global Market Intelligence.
Such long delays in the the most important liquidity channel for funds (besides M&A) eventually hurts investors on both sides. Having the public and private realms sliding further apart in orientation, metrics and appetite leads to two pernicious consequences that we are experiencing today: either the companies reach the IPO point at the tail of their innovation spree, when private investors have reaped most of the returns and public investors are in for, at best, meagre appreciations, or the companies launch IPOs with an unrealized growth potential that the market does not buy in and hence misprizes the opportunity relative to private investors, like in Uber’s case.
That is why I find so exciting that at the beginning of this month the SEC approved the creation of the Long-Term Stock Exchange (LTSE), a Silicon Valley-based national securities exchange that will give high-growth technology companies more options to list their shares outside of the traditional New York exchanges.
The LTSE is a bid to build a stock exchange in the country’s tech capital that appeals to hot startups, particularly those that are money-losing and want the luxury of focusing on long-term innovation even while trading in the glare of the public markets.
The stock exchange is the brainchild of Eric Ries, a key figure in the lean startup movement, who has been working on the idea for years. Eric’s vision in clear in that the public market’s focus on short-term results leads to a decline in innovation. Besides all we already mentioned, a 2017 study by public policy think tank Third Way showed that going public was accompanied by a 40% decline in patents within five years after listing, the result of pressure to satisfy analysts’ short-term expectations.
The new exchange will have extra rules designed to encourage companies to focus on long-term innovation rather than the grind of quarterly earnings reports by asking companies to limit executive bonuses that award short-term accomplishments. It will also require more disclosure to investors about meeting key milestones and plans, and reward long-term shareholders by giving them more voting power the longer they hold the stock.
At the end of the day Eric’s plan is to have companies go public sooner and keep the ability to continue experimenting. This way more value can be created in the public markets, closing that enormous gap between the private and public realms and giving retail investors a chance to cash in on high-growth startups. This is innovation and value creation at its finest!
