Tuesday, October 15, 2019
The decision to withdraw the planned IPO of WeWork poses an interesting question of whether technology companies are becoming over-hyped once more. GAM Investments’ Mark Hawtin looks at the recent spate of disappointing IPOs in the technology space and considers whether the wave of irrational capitalism may be coming to an end.
The failure of WeWork to launch onto the public market is a major victory for common sense over hype. We have been saying for some time that the attempt to pin a USD 50 billion+ price tag on an office sharing business with few definable technology benefits was impossible to justify. As with so many hype cycles, the support of very credible investors – in the form of Softbank and JP Morgan’s Jamie Dimon, together with a star studded line up of investment banks – created an allure around the business that allowed its IPO attempt to get as far as it did. Failure to reach the public markets has proven fortuitous for the investment world given the valuation has fallen from a vaunted range of USD 60-90 billion to less than USD 15 billion in a matter of weeks. We contend that the company is far more likely to file for bankruptcy than regenerate itself into anything of significant value to investors. The company has USD 35 billion of very long non-negotiable leases on the liability side of the balance sheet countered by an asset side filled with short-term tenants offering little by way of guaranteed long-term revenue streams. Indeed any signs of economic slowdown or recession could spell disaster for many of their fledgling start up tenants – a natural arctic winter-like culling of the weak. In our view, the outlook is truly bleak and this extends not only to the investors who overpaid in earlier funding rounds but also to many of the 15,000 employees who were anticipating their new found unicorn wealth – not only is it unlikely they will ever see that, but many could also lose their jobs in the downsizing and cost cutting that now seems inevitable.
The example of WeWork underpins the much bigger issue of what will happen to the broader initial public offering (IPO) market for large-cap names in technology. We think WeWork will be a pivotal moment in the bridge between the private and public markets. Public markets do not typically tolerate large loss-making businesses – there is too much risk, too much hype. The recent IPOs of Uber and Lyft illustrate this point; their stock prices are already showing signs of distress from falling into the camp of (admittedly) disruptive business models that have not found the right formula for profitable success. Based on recent results, Uber is losing about USD 1 billion per quarter (which rounds up to a loss of USD 4 billion annually) and the (irrational?) capital required to support this is huge – hence the need to ultimately access the public markets. Using the Gartner hype cycle as a barometer of all disruptive investment themes, we think that ride sharing is pretty much on the downslope from the peak of inflated expectations to the trough of disillusionment. The business model is likely flawed at this point, requiring significant amounts of (irrational) capital to fund the building of the network; this capital will then need to be passed on to incentivise drivers and passengers alike to join and utilise the platform. There is one scenario suggesting the model only really squares the circle when driver costs are reduced – possibly by the use of autonomous vehicles – but if that is the case then we believe the near-term outlook for the ride sharers appears grim.
The knock on effect extends to valuations more generally and so it is no surprise to us that many unicorn IPOs are seeing poor after market price action. For example, is exercise equipment and subscription company Peloton really worth USD 8 billion? Similarly, Pinterest has attractive niche business potential but is USD 15 billion fair?
The endgame here is that, tied to a slowdown in world economic growth, the wave of cheap and irrational capital may be coming to an end. This could then back up through the system starting with what public markets are prepared to pay and pressing down earlier round values in the private markets. Exuberance will likely wane…
We are all human and it is easy, however much experience we have gained, to get carried away by the hype. There is a saying in markets that there is no price too low for a Bear or too high for a Bull – even the most seasoned investors get caught by this time after time. As Sir John Templeton said, the four most dangerous words in investing are ‘this time it’s different’. It would seem that psychology has driven even the most expert of investors to support these disruptive businesses. But in our view, this is madness and it never ends well.
WeWork is almost certainly the catalyst that will deflate the bubble in this part of the market, in our opinion. These types of exuberance are common place in technology-led segments of the market and it is why a focus on intrinsic valuation, via discounted cash flow modelling, helps keep feet firmly grounded. It also allows for a framework to identify winners and losers in the technology space that make for interesting opportunities from both a long and short investing perspective. With the 10-year bull market in its sunset phase and the exposure of irrationality in certain parts of the market, we think the ability to exploit the polarisation between the rational and the irrational, between the winners and losers in the technology space, could deliver attractive investment returns.
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