Fear Overtakes Greed in IPO Market After WeWork Debacle

It would appear that my question from some months ago, "Is this the beginning of the end?", may be true. For all those who have forgotten the dot com slide, it took over a year to bottom out. Hang on for the ride!   .....Aivars Lode

The IPO market has gone from hot to not.

Shares of newly public companies, earlier this year one of the hottest investments on Wall Street, are now in a slump after investors soured on unprofitable startups from Uber Technologies Inc. to WeWork.

Shares of technology startups and other companies that went public in the U.S. this year are trading roughly 5% above, on average, their prices at their initial public offerings, well short of the 18% gain in the S&P 500 index, according to Dealogic data. That is a reversal from earlier in the year, when IPO shares were big outperformers.

IPO-stock performance is the worst it has been since at least 1995, according to a recent research note from Goldman Sachs, whose analysts measured it relative to a broad stock-market index.

That and recent market gyrations have helped bring IPO activity to a virtual standstill heading into what is traditionally one of the busiest times of year for new issues, as companies planning debuts wait for conditions to improve.

The stall upends expectations that 2019 would be a record year for IPOs by money raised. It also highlights the risks for private investors who have endured long periods of losses funding a crop of companies that are older and bigger than IPO candidates in previous cycles. That could put a chill on a private-funding market that has been red hot and hamper the ability of the next generation of startups to raise seed capital. 

The slowdown could also hit fees at the banks that underwrite IPOs and push some companies to rethink plans for traditional IPOs in favor of alternatives such as cheaper direct listings. 

“I don’t see a lot of deals that are likely to go out the rest of this year,” said Rick Kline, the co-chair of law firm Goodwin Procter LLP’s capital-markets practice. “The market sentiment has changed.“

Bankers and lawyers now say it is unlikely that 2019 will be the record year that many had envisioned. So far this year, 158 companies have raised $53.1 billion on U.S. exchanges, according to Dealogic, the fourth-busiest year on record behind 1999, 2000 and 2014. Should activity taper off as expected, 2019 could fall behind other years too.

After a hiccup caused by the government shutdown, 2019 got off to a fast start with the well-received debuts of Pinterest Inc. and Zoom Video Communications Inc. Even after ride-hailing apps Uber and Lyft Inc. stumbled in their debuts, the new-issue market stayed strong. But a failed flirtation with public ownership on the part of WeWork, together with other soured listing plans, appears to have changed that.

We Co., as the WeWork parent is officially known, abruptly postponed its highly anticipated IPO last month after prospective investors revolted against the office-sharing company’s governance and big losses. The New York company and its underwriters had already lopped off some $30 billion from its expected valuation in anticipation of weak demand. Two other companies with sizable losses—entertainment firm Endeavor Group Holdings Inc. and biotechnology concern ADC Therapeutics SA—also postponed listings within the past two weeks.

Companies that had raised record amounts of money in private began lining up to go public, eager to tap what seemed like insatiable demand from stock-market investors. But the weak performance of many of these companies in the public market is making it clear that private investors often were too optimistic.

This year’s crop of IPOs is expected to be the least profitable since the technology boom, according to another Goldman research note, and investors have taken notice.

In March, Lyft was valued in its IPO at $24 billion, far above its previous valuation in the private markets of $15 billion. Since then, its stock has fallen 46% as investors grew increasingly worried about the company’s steep losses.

Uber followed a similar trajectory. It had been valued at roughly $68 billion in the private markets and went public in May at a price that gave the company a fully diluted valuation of some $80 billion. Since then, its stock has dropped 34%, putting the company’s market capitalization far below where it was last valued privately. Uber incurred a $5.2 billion loss in its latest quarter, hurt by billions in costs related to its IPO.

Slack Technologies Inc., which is also unprofitable, made its debut in June through an unusual method called a direct listing. As such, the company didn’t raise capital and simply used $26 as a reference price for when its shares started trading on the New York Stock Exchange. Despite surging initially, Slack shares now trade 4% below that reference price.

“Some companies became convinced that the public market would welcome them with high cash burn and long runways to profitability,” said Paul Hudson, founder and chief investment officer of Glade Brook Capital Partners LLC, a pre-IPO investor in Uber, Lyft and We. “The reality is the public market rewards profitable companies that generate cash flows in addition to growth.”

Indeed, Pinterest, the fast-growing and nearly profitable platform for online image searches, is up 44% from its April IPO price. Datadog Inc., a cloud-based software-management platform with limited losses that made its debut in September, is up nearly 30% since then.

Once the present market volatility passes and would-be public companies have a chance to adjust to the current environment and recalibrate their pitches to investors, the IPO market could stage a comeback. There are still a number of successful startups planning IPOs as soon as next year, including Airbnb Inc. and possibly a retooled We.

“I see a lot of exciting companies gearing up for the first half of 2020,” said Goodwin Procter’s Mr. Kline.

When the IPO market does come back to life, more companies are expected to stage direct listings, in which no money is raised and banker fees are smaller than in traditional IPOs.

Airbnb, set to go public as soon as the first half of 2020, might do so via direct listing, according to people familiar with the matter. The home-rental app doesn’t have an urgent need for capital, but it likely has enough name recognition to successfully bypass the traditional new-issue marketing process.

None of that is good news for banks, which reap big fees from underwriting IPOs, but it reflects a belief among some in Silicon Valley that Wall Street has mishandled this year’s troubled IPOs.

By Maureen Farrell - Wall Street Journal