21 December 2020
Valuations in parts of the disruptive technology universe are increasingly stretched, particularly in the initial public offering (IPO) arena. GAM Investments’ Mark Hawtin believes an intrinsic valuation-based approach to investment is now paramount to avoid pitfalls.
Early December has seen no let-up in the rush to get companies to the market. Doordash and Airbnb are the latest high profile names to defy gravity as their IPO prices were set at higher than anticipated levels and then those levels were eclipsed with >100% first day trading surges. Such moves have drawn plenty of commentary about the dot-com bubble of 2000. We believe that there are clear signs of irrational exuberance in the IPO market at present but unlike 2000, when all disruptive companies (whether real or perceived) surged to eye-watering levels, the IPO and work from home (WFH) names are a subset within a far more rational valuation framework.
The current landscape could well prove to be a significant one for alpha generation over the next 12 months. In more than 25 years investing for clients in this part of the market, we have never seen such dispersion in valuations and expectations. A mania fuelled by the digitisation of everything, including online trading, has made owning shares even more effortless. The result is over USD 18.4 trillion of client assets held at the leading online brokerage companies, according to The Ascent (part of The Motley Fool). Many of these assets are chasing the ‘hot’ growth names higher and higher, with little or no regard for valuations. IPOs are a big part of that group and in our view Doordash and Airbnb reflect the excessive levels now reached.
The Renaissance IPO ETF clearly shows how the hype cycle is playing out in the IPO world. Traditionally the performance of IPOs over time closely matches the S&P 500 Index, but more recently this relationship has broken down. The impact is even more marked when considering first day price moves for the included names. The ETF can only buy the names once they are trading and during the first five days after IPO. This means that the huge first day opening gains are not included in Chart 1 below. What it therefore shows is the potentially irrational activity of non-professional investors, unable to get an IPO allocation, but more than happy to drive these prices higher and higher post IPO.
Chart 1: IPO bubble (five-year change: Renaissance IPO ETF versus S&P 500).
According to Bloomberg, the amount raised in IPOs so far in 2020 exceeds USD 160 billion and sets a new record. On the day of the Doordash IPO alone, there were another six IPO debuts including C3.ai, an enterprise artificial intelligence (AI) company (160% higher from the issue price), an internet ad platform PubMatic (60% higher) and four new special purpose acquisition companies (SPACs) or blank cheque companies as they are commonly known due to their all cash, no investment yet, nature. We believe the SPAC market itself is also developing into a concerning bubble of its own, as we will explore in an upcoming article.
There are numerous patches of concerning price action in the current landscape but because this is set against the context of numerous companies trading on reasonable, if not cheap, valuations, the alpha generating opportunity appears significant. This is completely different from the context in which the internet bubble burst. In our view, an intrinsic valuation-based approach to investment is now paramount to avoid pitfalls. Where the thundering herd is defining share prices, a sensible approach to value is likely to pay off. Popularity is not synonymous with fiduciary responsibility.
Tesla’s market capitalisation (circa USD 600 billion as of 11 December 2020) is in line with the market value of the entire legacy auto industry. This likely implies that Tesla will either replace the total existing auto industry or that its electric vehicles / battery technology will create a completely new, disruptive and huge transportation and energy segment. In our view, either scenario is hard to justify. Likewise, many of today’s marquee IPOs are trading at eye-watering valuations. Doordash closed its first day of trading with a market capitalisation of circa US 60 billion - 21x 2020 revenues. Grubhub, the number one player in the US food delivery market, was acquired earlier this year for 4x revenues and the acquiring company, Just Eat Takeaway, trades on 5.7x 2020 revenues. Uber, as a large player in the market with its Eats product, trades on 9x revenues and these revenues are arguably depressed by the Covid-19 driven ride-sharing dip. In software, one could be forgiven for thinking that Snowflake was set to take over the world given its extraordinary valuation post IPO of 175x 2020 revenues.
To conclude, we believe parts of the disruptive universe are becoming very stretched, particularly in the IPO arena where retail investors would appear to be happy to pay any price to acquire shares. Elsewhere, we believe there is plenty of value in next wave disruptive themes like the automation of knowledge work, healthcare, industrials, transportation and fintech and this, in our view, is where we can generate alpha for our clients.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice.