Putting the IPO boom into perspective
In recent weeks, we have seen a frenzy of prominent tech IPOs with, at best, mixed results for investors. Ride sharing company Lyft launched on 28 March 2019 and saw its share price decline 17% within the first month of trading. Its bigger rival Uber fared even worse, debuting on 9 May 2019 and declining 17.6% in the first three days of trading. Since then, the stock has recovered somewhat, but it is still significantly below its IPO price. On the other hand, foodtech company Beyond Meat launched on 1 May 2019 and tripled its share price in the first three days of trading.
None of these companies are profitable at the moment and analysts don’t expect them to become profitable in the next couple of years. This, in turn, has created a lot of media attention and comparisons with the IPO boom of the late 1990s. So, I went to the website of IPO guru Jay Ritter and checked the recent market conditions. Our chart shows the number of tech and biotech IPOs since 1980 as well as the share of companies that were unprofitable at IPO. The good news is that while 2018 saw the second largest number of tech and biotech IPOs since 2000, the sheer number of IPOs remains very low by historical standards. There are other healthy signs as well. During the tech boom of the late 1990s, the average age of a company at IPO dropped to just four years in 1999, while today it is 12 years. Thus, companies cannot just run to the stock exchange anymore with a largely unproven business model to cash in on initial strong growth. Tech companies looking for an IPO today must have a much longer track record in order to attract investors. Furthermore, the average price-to-sales ratio of tech IPOs in 2018 was 7.6, above the long-term average since 1980 but still well below the excesses of the late 1990s.
Given these lower valuations, it is not surprising that the long-term performance of recent IPOs compares quite well with historic averages. Jay Ritter does not separate long-term performance of newly-listed companies by sector, so we have to use his statistics for all IPOs in the US, not just tech and biotech IPOs. The return of newly listed companies since 1980 in the first three years was on average 17.9% below the market return. However, the companies that had an IPO in 2016 managed to beat market returns by 15.2% in the three years since their IPO. In general, between 2000 and 2016, newly-listed companies managed to have the same return in the first three years after listing as the overall stock market, which is quite a good track record, in my view.
But in the tenth year of a stock market boom, one should expect IPO standards to erode somewhat and this is indeed what we have seen. The share of newly-listed companies in the tech and biotech sector that are profitable is now at the lowest level since the measurements began in 1980. Only 6% of the tech and biotech IPOs of 2018 were profitable at the time of listing. So far, this has not led to lower performance over the long run as the three-year returns shown above indicate, but it is unclear how far the shares of unprofitable companies will fall in a bear market, whenever it comes. More worryingly to me, however, is the rise in IPOs with dual share classes. Both in 2017 and 2018, 13 tech IPOs had dual share classes giving different voting rights to the different share classes. As a share of the total number of IPOs in the tech sector, this is the highest share ever recorded and indicates a worrying trend that tech entrepreneurs and VC companies are increasingly trying to raise capital without handing over control to outside shareholders. The result is a rising number of newly-listed tech companies that have little incentive to act in the best interest of public shareholders, and that is something that might lead to disastrous results for individual companies.
The current IPO boom in perspective
Source: Jay Ritter, Fidante Capital.