Unicorns Are Racing to Wall Street. Is It Time You Invested In an IPO?

Unicorn Startups IPOs.jpg

We’ve seen the hype around “unicorn” companies (worth at least an estimated $1 billion) making their debuts as public companies recently. These privately held startups are racing to Wall Street to capitalize on the bull market and to beat a recession some think will be in here in the next year or two.

How fast are they running? In 2017, 13 unicorn companies went public in the U.S. Last year, the number increased to 20. This year, the gallop has turned into a stampede. It’s estimated that nearly 120 unicorns may go public this year.

So far, Pinterest, Zoom, Lyft, and Uber have gone public. Airbnb, CrowdStrike, and Slack, among others, plan to offer an IPO in 2019.

Investors often seek out these highly valued startups, believing that getting in early on the IPO will lead to significant growth in their investment down the road. But the road to profit often is bumpy and one that is not guaranteed.

Recent IPOs Have Hits and Misses

Pinterest, Zoom, Beyond Meat, Lyft, and Uber all went public in the last two months and had quite different experiences in the market.

Lyft, the first of these four companies to go public, had an IPO share price of $72. The company faced a disappointing debut after concerns of profitability and forecasted slowing growth. Its shares are now trading at around $53 as of May 20.

Just before Uber went public May 10, Lyft announced it lost $1.14 billion in the first quarter of 2019, all but $211 million related to a charge for its stock-based compensation. The company expects the losses to continue this year.

The news from Lyft loomed over Uber’s IPO. It went public at $45 a share, lower than previously expected, and has declined since the IPO. At close of the second day of trading, shares were down nearly 19%. Uber also went public on the day President Trump imposed higher tariffs in an escalating trade war between the U.S. and China, which caused the markets to tumble.

The share prices for Pinterest, Zoom, and Beyond Meat have grown since going public. Beyond Meat went public with shares at $25 and closed its first day of trading at $65.75. By mid-May, it was trading at around $88.

Historical IPO Performance

Many of these unicorns go public at times when they are not profitable. A recent report from PitchBook looked at the 20 U.S. unicorns that went public in 2018 and found public investors valued unprofitable companies higher than profitable ones at the time of IPO.

The median annualized stock price change for the unicorns since the IPO was 120%, showing investors are more likely to value future growth over current profitability.

This positive performance is keeping investors engaged and has encouraged more to enter the market. In 2018, Ernst & Young noted that U.S. IPOs averaged first-day returns at around 15%. The average current share price for these companies post-IPO went up approximately 11%.

Data from UBS going back to 1980 shows that the average first trading day return for IPOs is 18%, with relatively few negative returns. After five years, however, nearly 60% of all IPOs had negative total returns! Only a small percentage had exceptional returns, according to UBS.

The mixed results of unicorn IPOs in 2019 may cause some investors to pause plans to purchase shares in a newly public company. However, just because a company is in the red at the time of going public does not mean it isn’t capable of growth. Facebook went public in 2012 with much fanfare and shares at $38. While the company struggled to gain much traction initially, as of mid-May 2019, its stock is trading at around $185 a share.

3 Things to Consider when Investing in an IPO

Are you thinking about buying shares of a newly public company? We encourage investors to try to cut through the hype around the unicorn IPOs and determine how the investment fits in with their short- and long-term financial goals.

  • Research the company. Investors need to choose wisely and carefully which companies they want to sink money into early on during the IPO process. Discuss which company you are interested in with your financial advisor. Read as much as you can about the company in public filings – annual reports, registration statement (Form S-1) with the SEC, and the company’s website. Also keep in mind the current market conditions and any other factors that may impact the company’s performance (and therefore, its stock price). Does it have new revenue streams in the works? Is it profitable or will it be profitable soon?

  • Take your time. Unless you feel you must jump right in and purchase a newly public company’s stock on opening day, take a wait-and-see approach with your investments. The stock price is often quite volatile on opening day, and often even for weeks after the IPO. Sometimes, the stock steadily increases; other times, it may drop – drastically. Some IPOs recover (see Facebook), others do not (see Pets.com). Do your research and work with your advisor to determine when is the best time to buy.

  • Always diversify. While it may be tempting to invest a lot into a new company you think is going to kill it in the market, protect your money by starting small. We always encourage our clients to have a well-balanced portfolio to protect against fluctuations in the market. The companies that go public now are doing so at a time when volatility has returned to the market, thanks to a slowing economy, the looming Brexit, and uncertainty in the U.S.-China trade negotiations. In addition, investors have enjoyed markets with low volatility in recent years and may need to re-evaluate their risk tolerance with their advisor.

With many unicorn startups going public, investors have multiple opportunities to score big gains on an early investment. However, the IPOs in 2019 so far have produced mixed results for investors. Talk to your advisor about how an IPO may fit in your portfolio in light of your investment goals.  

Would you like to learn more about investing in IPOs? Contact one of our advisors at Fi3 today.