The Diminishing Returns of Tech IPOs

Too much money chasing too few good deals is lowering returns for tech startups. The best young companies are being acquired by corporate strategic buyers, meaning that those going public simply have no better option. JL

Carol Ryan reports in the Wall Street Journal:

Recent tech IPOs tend to be less profitable, slower-growing and more aggressively priced than their predecessors. In 2018, just 28% of all U.S. companies that came to the public market were profitable. That is close to the lows of the 2000 dot-com bubble. In 2010 and 2011, the market value of tech companies after their first day of trading represented 5.5 times their pre-IPO annual sales. It has jumped to 15 times for the tech names that have listed in 2019. Deals remain the more lucrative exit for venture capital. An IPO delivers lower returns. That makes it likely that what does make it to the public market has been  passed up by a corporate buyer.
Investors who buy into today’s high-profile initial public offerings are getting a raw deal. Recent tech IPOs tend to be less profitable, slower-growing and more aggressively priced than their predecessors.
In 2018, just 28% of all U.S. companies that came to the public market were profitable, data from WilmerHale shows. That is close to the lows of the 2000 dot-com bubble, when 26% of newly listed companies were in the black.

Investors are willing to overlook losses when they come with strong growth, but this isn’t always the case now. Unlike during the dot-com era, when very young companies went public, many of today’s IPOs have been making losses for years. With age comes slowing growth. Uber, which went public in May, this month reported its weakest quarterly revenue growth on record.
It will be some time before there is data to show how the likes of Uber, Lyft and Slack grew sales during their first year as public companies. But a full year of revenue figures are available for companies that listed in 2016 and 2017, including Snap and Blue Apron. The venture-capital-backed tech names that went public in the U.S. over this period grew their sales by an average of 18% in their first year as publicly traded stocks, according to an analysis compiled for Heard on the Street by Cordell Professor Jay Ritter of the University of Florida.Compare that with the VC-backed tech names such as LinkedIn and Pandora Media that went public in 2010 and 2011. This cohort of companies grew sales by 31% on average in the first year after their IPOs. Moreover, 48% were already profitable when they made their debuts, compared with 20% in 2016 and 2017, according to Prof. Ritter’s research.
Today’s high prices compound the problem for public-market investors. In 2010 and 2011, the market value of tech companies after their first day of trading represented 5.5 times their pre-IPO annual sales on average. By 2017 and 2018, that ratio had nudged up slightly to six times. But it has jumped to 15 times for the tech names that have listed so far in 2019.
Startups are coming to the market later than they used to, not least because entrepreneurs have access to ample funding in the private market. The $130 billion invested in U.S. venture capital last year was the highest annual total in history. Private investors arguably now get to own these companies during their most attractive growth phase, before they cash out by way of a deal or an IPO.
Deals remain the more lucrative exit for venture capital. An IPO delivers lower returns on average, with the additional downside of a lockup period that restricts how many shares early investors can unload. Last year, companies in the U.S. spent a record sum buying businesses from venture-capital backers, according to a WilmerHale analysis.
That makes it more likely that what does make it to the public market today has been raked over and passed up by a corporate buyer. There are notable exceptions, though: Household names like Uber have grown so large in private hands that there aren’t obvious corporate buyers, and a few entrepreneurs might prefer the greater independence possible through an IPO.
Overall, the data shows a need for greater caution. On average, today’s tech IPOs offer investors poorer growth prospects and a muddier path to profitability—all for top dollar.