WeWork’s stumble shines a light on companies that sound cool but lose money like crazy as they try to grow at all costs. They include such flashy newcomers as ride-hailing giants Uber and Lyft, teeth beautifier SmileDirectClub and, as of Thursday morning, the exercise bike maker Peloton. But since going public, Uber, Lyft and SmileDirect have seen their share prices fall 30 percent or more.
“Investors have learned from disappointing stock performance of Uber and Lyft, so when WeWork came along, they said, ‘No mas,’ ” said Kathleen Smith, a principal at Renaissance Capital, which manages IPO-focused exchange-traded funds.
I have always stayed away from buying stock on the first day of sales. As I said in a column six months ago, I am a confirmed Boglehead — a long-term, index investor who follows the lead of the late, legendary John C. Bogle, the founder of mutual fund giant Vanguard.
But I know several investors who have the money and the facility to buy into the WeWorks, Pinterests and Ubers on the private, pre-IPO markets. Then they hold on to ride the inevitable roller coaster. I remember one mogul who said he bought shares in Alphabet, when it was known as Google, for a relatively tiny amount per share when the company was still private. As of Sept. 25, Google was selling for more than $1,200.
Then there’s WeWork.
Once valued on private markets at $47 billion, most analysts say WeWork would be worth closer to $15 billion on the public markets given its massive loss.
As of Wednesday, Uber was trading down around 30 percent from its initial share price from May 10, 2019. Lyft is down even more at 42 percent since its debut in late March. SmileDirect was down 32 percent Wednesday from its IPO earlier this month.
All are cash burners with one thing in common: lack of a clear path to profitability and a growth-at-all-costs model.
“WeWork’s IPO got pushed back because investors had trouble figuring out when they would be profitable and by how much,” Smith said. “Uber and Lyft have the same issue.”
Goldman Sachs provides some clues on how to spot the next Google in a chart-packed, 42-page report titled “What Matters for IPOs.” The report goes back 25 years, examining 4,500 IPOs, and looks at what makes the winners vs. the losers.
Bottom line: Look for tsunami sales growth and look for profit by year three.
“Companies with those two criteria typically outperform the market over three years,” said David Kostin, lead author of the Goldman study.
Since 2010, according to the report, firms growing sales by more than 20 percent annually have been more likely to outperform the Russell 3000 index, a benchmark of the entire U.S. stock market, than slower-growing IPOs.
Net income in year three was another common denominator for success in the 4,500 IPOs going all the way back to the beginnings of the tech boom in 1995.
There are exceptions, including Amazon for one. The online retail giant took six years to turn its first annual profit after going public in 1997. The company, founded by Washington Post owner Jeff Bezos, has had a total return of 483 percent over the past five years alone — turning Bezos into the richest man on the planet.
Winners like Amazon make up for the zillions of underperformers.
“A portfolio that invested $100 in the Amazon IPO in 1997 would have outperformed the Russell 3000 through August 2019 even if it also made $100 investments in the 160 IPOs that subsequently went bankrupt,” according to Kostin’s report.
It’s not unusual for an IPO to trail the Russell 3000. According to Kostin’s report, the typical IPO has underperformed the market since 1995. But if you invested in all of the 4,500 IPOs, you would surpass the index because of the few superstars.
Let’s take one of the outperformers so far in 2019.
Remote conferencing company Zoom Video had a great profile for an IPO, including a clear path to profitability. Zoom debuted April 17 at $36 per share. It is now trading at $79, an increase of nearly 120 percent.
Nicole Tanenbaum of Chequers Financial Management said part of Zoom’s success with investors is its subscription-based business model. Subscriptions create reliable, recurrent means of revenue — the altar at which companies and investors worship. Businesses like that are often referred to as toll booth or toll-taker businesses.
“The market is placing premium valuations on these businesses given these more predictable metrics and stronger fundamentals,” Tanenbaum said. “The question is, how high is too high and what happens when markets come under pressure or sentiment cools off?”
Investors may get a glimpse of Zoom’s long-term resilience in October when a lockup period prohibiting initial investors from selling their shares expires.
Giants like Uber and Lyft illustrate the perils of investing in businesses people may love but that lack a business model that generates profits.
“For someone who takes an Uber every day to their WeWork office space, it may seem like a no-brainer to invest in these companies,” Tanenbaum said. “But familiarity may not ultimately translate to outsized portfolio returns.”
Uber, which wants to be the Amazon of transportation, is a case in point: The ride-sharing company has lost billions, and there is no end in sight. The company expects to lose more than $3 billion this year. Lyft also has lost a fortune.
Tanenbaum said owning the stock is a matter of balancing patience that future cash flows will materialize against common sense that tells you to sell and put your money elsewhere.
“At some point, the music stops and the lights come on,” Tanenbaum said.