The new generation of tech companies galloping toward the stock market have one big thing going for them: Their technology works. Book an Uber on the app and – voila! – along comes an Uber. Last year, more than five billion rides were booked on the ride-hailing service.
And they have one big thing working against them: They lose money – not just a little, but shocking amounts. Some of the big-name tech “unicorns” that have already landed on the stock market (Tesla, Lyft and, as of Friday, Uber) and those about to be listed (WeWork, among others) are losing fortunes, and the bigger they get, the more they sink into the red.
Uber loses more than 50 US cents on each ride. According to the business-information site Crunchbase, the company has burned through almost US$25-billion of investor money in the past decade. In 2018, Uber’s operating losses totalled US$3-billion on revenue of US$11.3-billion. Lyft, which went public on March 29 – the first ride-hailing company to do so – lost US$1.1-billion in the first quarter, more than all of last year’s losses.
What investor would buy into the initial public offerings of companies whose tech gizmos work like a dream but have no prospect of making a profit any time soon?
At Uber, Lyft and Tesla, there is no clear path to sustained profitability. Their industries (electric cars, in Tesla’s case) get more competitive by the day, making it difficult, perhaps impossible, for them to raise prices. That is, unless they establish monopolies or near-monopolies, and that’s not going to happen. For years, Tesla had the pure-electric market pretty much to itself. Now, every automaker is getting into the game, especially the German ones.
Two factors seem to be driving the money-losing tech companies’ appeal among public investors, or at least enough of them to make the IPOs hot commodities. The first is the perennial, and increasingly fraught, hunt for growth; the second is the naive belief that the private funds are getting out not because they think their investments have topped out but because they simply can’t wait forever to book a profit for their client investors. In other words, they’re leaving some upside on the table for you. And if you believe that, we’ve got some SNC-Lavalin stock you might find attractive.
Let’s start with growth. To use the argot of economists and market strategists, the economy seems to have gone “ex-growth.” That means the wider economy, at least in the West, has lacklustre increases in gross domestic product, partly because the size of the work force is no longer expanding. So all growth has to come from productivity gains, which are proving elusive.
For investors, the better meaning is that equities are no longer growth stories, generally speaking. Companies no longer join the stock market as often as they used to. Others are delisting or shrinking their presence on the market by devoting obscene amounts of money to share buybacks.
Today the name of the game, promoted by activist funds, is returning capital to shareholders through buybacks and dividend increases, though more of the former. Last year, the S&P 500 companies repurchased more than US$800-billion of their own shares, up 55 per cent from 2017. Goldman Sachs expects this year’s buyback figure to hit US$940-billion. That’s more than the GDP of Switzerland or Saudi Arabia. If the companies doing the lavish buybacks were truly keen to pursue growth, they would be devoting that buyback loot to R&D, innovation and mergers and acquisitions, not artificially boosting earnings per share by shrinking the number of shares.
But there is still a die-hard subset of investors who adore growth companies and will load up on them whenever they can, even if those companies are losing billions. Tesla is a fringe automaker, lost US$1-billion last year and another US$702-million in the first quarter. Yet its market value, at US$43-billion, is greater than Ford’s. Uber on Friday made its debut on the New York Stock Exchange by selling 180 million shares at US$45, raising US$8.1-billion and valuing the company at US$82-billion.
Given Uber’s horrendous losses, that valuation seems like a fantasy. Yet the growth story – real and potential – is so compelling that investors couldn’t resist loading up on the shares. To them, growth beats profits – for now anyway.
They must also believe that the private investors who are using the stock market to monetize their holdings haven’t kept all the upside for themselves. If so, they are deluded.
Many of the big private investors and their funds got burned badly on the public markets in the 2008 financial crisis. So they naturally switched to non-listed investments, which would help lead to the rise of the unicorns – the private companies that achieved a valuation of US$1-billion or more before seeking IPOs. As luck would have it, interest rates plummeted, allowing them to turbocharge their strategies. Private equity and venture capital got bigger and bigger, and tech was their target.
At the same time, many of these funds bought and sold investments from each other, at ever-rising premiums. The investments were not marked to market, meaning their worth was merely a guess. Since no one knew their true value, it was safe to keep bidding up those assets, until you had profitless tech companies worth tens of billions of dollars.
Lyft apparently got overbid by the private markets – the shares are a quarter below their US$72 IPO price. It looks like the private investors took their Lyft money and headed for the hills at just the right time. Ditto Uber, whose shares on Friday traded below their IPO price. The IPO crowd in both companies got burned. Lyft especially is an early sign that some tech companies are not worth as much as the private markets suggest they are and that chasing growth for the sake of growth can backfire. At some point, the growth story has to turn into a profit story to justify the sky-high valuations.
Eric Reguly