There were high expectations for 2019’s IPO market. After all, 2018 was one of the strongest since 2014. Going into 2019, there was a lot of optimism for an even better year, especially when a bunch of companies with huge valuations and brand awareness had been teasing the idea of going public. Then, at the beginning of the year, the U.S. had a month-long government shutdown that really put a damper on the market. After the shutdown ended, it was hard to recapture that optimism. It was a slow start with a lot of hesitant companies that didn’t want to go public when the market wouldn't be receptive. But things really picked back up in April. That’s when the real changes started happening in the IPO market, changes that could be for the better and actually benefit investors.
Now, the market has no tolerance for companies with over-inflated valuations because of all of the funding that venture capitals threw at these popular businesses. Investors want to see the profitability of companies. They don’t care how flashy they are or what they’re promising for the future. If they aren’t making any money now, how can you really be confident that they’ll make money later on?
People are realizing that what worked before doesn’t necessarily work now.
Did the 2019 IPO Market Take a Hit?
A few weeks ago, WeWork, a well-known privately held company, filed its S-1 in the hopes of going public within the month. But that’s not all... the company soon withdrew its IPO and fired its founder and CEO Adam Neumann.
The company’s business model consists of signing long-term leases for properties, dividing them into smaller units, renovating those units, and renting them out on a flexible short-term basis. It's helped the company become the largest private tenant in New York City and London. According to CoStar, it had 7.7 million square feet of office space in New York City and 4.1 million square feet in London.
This kind of aggressive business model meant the company took on $47 billion in lease liabilities. Before announcing its IPO and filing its S-1, WeWork was popular, with a lot of clout, making it easy to lease those spaces out.
It also made it easier for the company to negotiate with landlords and create deals so it wouldn’t have to spend so much cash upfront and go into more debt. WeWork received about $455 million in upfront payments in the first half of this year.
What a lot of analysts realized when WeWork released its S-1 is that the company may not be able to pay its rent. If it stays on its current path, it will run out of money next year. That’s the last thing you want when investing in a company.
In January, the company had a private valuation of $47 billion, but its public valuation was below $20 billion. This is a recurring theme for popular unicorn companies.
Will the 2020 IPO Market Embrace Change?
It’s been a tough year for companies like WeWork. Investors and analysts have been fooled by them before, and they’re realizing that transparency is the best policy.
You could say investors have become a lot more aware this year, and they’re no longer buying into the hype. No one wants to invest in a company just because it’s the next “hot” stock as there will always be another one just around the corner. Investors want a company that lives up to its valuation.
Usually, when people think about IPOs, they like to think about those exciting first-day surges and gains. That’s not entirely realistic, and, more importantly, it’s not what an investor truly wants.
You want stability and some idea that the company has the finances to push it forward for years to come.
Take a look at Facebook; its IPO was very lukewarm and shares even fell. But now that the site has become an influential part of our daily lives, the stock now trades for around $180 per share. These days, there are more unique companies going public — so many that it’s hard to tell which one will be around in the next few years.
Kathleen Smith, principal at Renaissance Capital (a provider of institutional research and IPO exchange-traded funds), had this to say:
The IPO window is closing on growth-at-all-costs, highly valued private companies that are trying to come to market with excessively valued pricing... It’s called price discovery, and it’s a cleansing process that will make for better days ahead.
There very well may be more direct listings ahead, which might work a little better for highly valued, well-known companies.
The 2020 IPO Outlook Looks Promising
2019's IPO market shift will continue into 2020.
Megan Bent, a managing partner at the venture capital firm, Harbinger Ventures, had this to say about the IPO market:
We are seeing a beginning of a correction, a back-to-sanity moment. Vision alone is not enough to overcome weakness on the bottom line -- and revenue growth alone can’t overcome weak corporate governance.
2020 will bring higher expectations of private companies that have a huge venture capital backing and hope to go public.
Dev Kantesaria, founder and portfolio manager of Valley Forge Capital Management said, “I’m generally not a fan of money-losing IPOs. It’s a dangerous place to invest.”
And that’s exactly what the mindset should be for investors looking at IPOs. Going into 2020, value is going to be worth more than hype. Those unicorn companies will need to recognize that and price shares realistically.
Retail investors and institutional investors (hedge funds) are losing interest in companies that have a lot of risk. Taking a risk on a hot tech company is no longer exciting. If it isn't making money and probably won’t make money for a while, it's a bad investment.
What to Expect from 2020’s IPO Market
In 2019, we saw successes with companies that have proven profitability or headed towards it. Those successful IPOs also indicated that they were in a market with a significant growth projection.
Some of 2019’s hottest sectors were cloud security, software, and healthcare IPOs.
Renaissance Capital reported that healthcare and technology companies dominated IPO issuance, making up 62% of all IPOs.
Turning Point Therapeutics (NASDAQ: TPTX) and ShockWave Medical (NASDAQ: SWAV) made their public debuts in the first quarter of 2019 and are seeing above 90% in returns compared to their offer prices. Both are part of the healthcare sector.
InMode Ltd. (NASDAQ: INMD) and Zoom Video Communications (NASDAQ: ZM) are technology companies that have returned above 70% since going public.
Yes, there have been disappointing public debuts, especially coming from those hyped-up companies, but that doesn’t mean this year was a bust.
In 2020, we could expect Airbnb, the home-sharing company, to go public. There are rumors that it will take the direct listing route. And though this company has some hype attached, it does have the financials to back it up. It has been EBITDA profitable for the past two years and reported $3.5 billion in cash during the first quarter of 2019.
Airbnb could be one of 2020’s big public debuts and create a path for other profitable companies to make their market debuts as well.
Those big IPO “fails” from Uber (NYSE: UBER), Lyft (NASDAQ: LYFT), and the revelation that WeWork was a huge risk before it even went public doesn’t mean the IPO market is dead.
It’s actually the opposite; 2020 is poised for greatness!