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Inside the Market Response to Uber’s IPO reveals a trend at play in tech investing

An Uber banner adorns the facade of the New York Stock Exchange ahead of the ride sharing company's IPO, on May 10, 2019, in New York.

DON EMMERT/Getty Images

When shares of Uber Technologies Inc. began trading last week following a much-anticipated initial public offering, the ride-hailing company joined the list of unprofitable companies debuting on the stock market this year, drawing comparisons to the nutty peak of the dot-com era.

The fact that Uber shares fell as much as 17.6 per cent in their first two days of trading has only added to concerns of frothy market conditions and whether a reckoning is due for companies that are chasing growth at the expense of profits.

But wait: Is profitability really so important for relatively young companies with a lot of opportunity ahead of them? Given the success of companies such as Amazon.com Inc., Netflix Inc., Ottawa-based Shopify Inc. and others, perhaps not.

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IPOs, clearly, aren’t for everyone. Young companies can be volatile. Investment bankers can be keen to generate fees rather than offer new investors a great deal on an awesome company. And companies tend to time their IPOs to take advantage of an enthusiastic market and high valuations.

Academic research suggests that IPOs tend to underperform the broader stock market over time. The Renaissance IPO ETF, which tracks the performance of newly listed U.S. companies, has lagged the S&P 500 by nearly three percentage points, on an average annual basis, over the past five years (to the end of April).

So why do IPOs attract so much attention? Simple: Pick the right one and your returns can be staggering.

Since Amazon.com Inc. went public in 1997, the shares have increased more than 100-fold. Facebook Inc. went public in 2012 at US$38 a share. The shares now trade at US$186.32, for a gain of 390 per cent.

Netflix Inc. is up 23-fold since its IPO in 2002. Tesla Inc. is up 13-fold since its IPO in 2010. Google (now Alphabet Inc.) has risen 27-fold since its IPO in 2004. And among Canadian stocks, Shopify Inc. has risen more than 15-fold from its IPO price of US$17 in 2015.

Yes, these are cherry-picked success stories that stand out from more than 1,300 technology IPOs in the United States over the past 20 years.

But they have several things in common. The companies emerged with competitive advantages: Facebook, for example, enjoyed a near-monopoly. They’ve adapted to changes: Netflix began as a DVD rental service. And they all debuted with either scant profitability or substantial losses, enticing investors into a story about growth rather than maturity.

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Can Uber join this elite group?

There are certainly plenty of things to worry about. Uber’s revenue growth was just 2 per cent in the fourth quarter, which raises questions about the company’s ability to disrupt car transportation. It has lowered its fees in Latin America to fend off competition and its battle for market share with rival Lyft Inc. – which completed its IPO in March – has weighed on margins in the United States.

And yes, Uber is losing piles of money – US$1.8-billion in 2018 alone.

That fits into a troubling trend. According to Jay Ritter, a University of Florida finance professor who tracks IPOs, just 16 per cent of technology IPOs in 2018 were profitable companies. That marks the lowest percentage since the peak of the dot-com bubble in 1999 and 2000.

There is no doubt, then, that Uber is probably not suited to risk-averse investors.

But there is a bullish case here. For one thing, comparisons with the dot-com bubble only go so far. Twenty years ago, a flimsy concept was enough to attract enormous attention in the stock market, illustrated by the fact that there were 370 U.S. technology IPOs in 1999 alone, according to Mr. Ritter’s data. In 2018, there were just 38 technology IPOs.

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In terms of valuations, newly listed stocks debuted in 1999 at an average price-to-sales ratio of 43. In 2018, the average ratio was 11.3 (and Uber’s IPO priced the stock at about six times sales last week).

What’s more, Uber is at the centre of one of the most exciting developments in transportation. Although the company is best known for its disruptive influence on the taxi industry, it could revolutionize our approach to car ownership if autonomous electric vehicles take hold and more commuters start using Uber services.

Does that make Uber a slam dunk? No way. But if you wait until the company is profitable, then – like Facebook, Amazon.com and Google – the big gains will be in the past-performance charts rather than in your portfolio.

Meanwhile, Uber’s share price is coming back: It has rallied nearly 12 per cent over the past two days.

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