David Garrity on Bloomberg: Investors Must Be Cautious With New Breed Of Unicorns

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Up To $100bn In Capital To Be Raised Through 2019 IPO Wave

With markets on a calendar year basis appearing robust on the heels of the recovery from the Christmas Eve 2018 low, the IPO calendar has become quite active with offerings either filed or expected to be filed estimated to raise up to $100bn in new capital from institutional and retail investors. The IPO class of 2019 is comprised of tech companies such as Airbnb, Lyft, Pinterest, Uber, WeWork, among others, that represent the result of long gestation as private companies backed by substantial amounts of venture capital raised in progressive rounds at multi-billion dollar valuations, a process that has created companies now known as “unicorns.”

Are The Unicorns Real Thoroughbreds?

Investors traditionally consider companies with sustainably growing sales, margins, profits and cash flows to be thoroughbred investments. In the tech sector, companies such as AMZN and NFLX have proven exceptions to the rule as their valuations have grown on accelerating sales growth despite negative cash flows, in large part because investors became convinced that management’s execution of a market share capture strategy would eventually yield the desired positive cash flows. Funded by venture capital focused on achieving scale and dominant market share, the unicorns have “blitzscaled” their way to the brink of public ownership. “Blitzscaling” growth has not come cheap. The dozen “unicorns” have cumulative losses of $47bn and are expected in 2019 to post a further combined loss of $14bn.

While earlier tech companies have built significant networks (e.g. GOOGL, FB) in which they enjoy the dominant market share, investors should be cautious in considering whether something similar can be achieved in the “sharing” economy in which many of the “unicorns” participate. For example, are Lyft and Uber the only companies capable of marketing ride-sharing and other logistics services? Same for Airbnb in temporary accommodation. The question is whether public market investors will support growing marketing budgets that only produce losses. Is the “blitzscale” philosophy of buying customers at any price peaking? Separately, regulators and governments are interested that such companies obey the law, something that also includes paying all requisite taxes and fees. Last, will public market investors support governance models in which their voting rights are severely limited or capped? These are challenges to be faced before “unicorns” become thoroughbreds.

Markets Likely To Move Sideways As IPOs Digested

The successful execution of the IPO calendar generally requires stable capital markets. To this end, there needs to be a balance between how much capital the IPO calendar seeks to raise and the carrying capacity of the capital market. As we know, nothing succeeds like excess, so clearly there is the risk that the “unicorn” IPO stampede may swamp the market. Consequently, investors should be mindful that as the IPO calendar is priced, distributed and otherwise digested by the market, there is a possibility of markets trading sideways during that period.