Public Float Pt. 1: The Anatomy of the IPO

Feature image of Baked Alaska at the Oceannaire, by vxla, chosen because, much like an IPO, it's a hard thing to get right.

2019 has seen the spectacular success and objective failure of several very high-profile IPOs. On average, they’ve basically tracked the index, and that’s to be expected.

The Renaissance IPO ETF has basically tracked the S&P 500 for the past 12 months.

But we’re stock pickers, and stocks we will pick. IPOs have been known to cause manias and associated melt-ups that cement the stock as a brand and earn the name a benefit of the doubt going forward. It’s the exception, not the rule, but it’s definitely how Wall St. and Bay St. would prefer the public imagine what might happen. Ahead of a look at some cannabis-sector IPOs soon to debut, we’re out to understand what makes the difference between the IPOs that take off like a rocket, and ones that burn up on re-entry.

The one and only Josh Brown, putting it better than I can.

No sex in the champagne room

No matter what they tell you about the reason the company is doing an IPO, the real reason is that the founders want to cash out.

It’s certainly possible that the business being listed, newly cashed up, is ready to execute its next stage of growth in a liquid market, that they’ll convert on the opportunity that comes with the attention by showing the street that they are worth the risk. It’s also possible that the stripper really DOES have a crush on you, but that doesn’t change the facts on the ground.

The UBER (NYSE:UBER) and LYFT (NYSE:LYFT) IPOs and every other public listing of any size are effectively the founders and early financiers of these businesses hiring agents of commerce to sell their stock to the unwashed masses. Early rounders may or may not be selling their stock right away. In fact, they’re often subject to a lockup period. But they’re certainly looking to make a market for it, and nobody does that because they want to keep it or buy some more.

The principles’ value being locked in doesn’t mean that there isn’t still value in a company being publicly listed. It just means that the principles would rather see how the sell-side brokerages make out selling the street on the idea that there is, and give themselves an opportunity to lighten up.

You have to sell them on it, and name recognition will not help you.

Sell side firms are happy to oblige. Helped along by a bit of manufactured scarcity (“I’d like to get you some of that IPO, Fred, I really would, but it’s over subscribed already, and…”) Wall Street dials together a pitch and does their best to convince the public that they’re missing out if they don’t tuck some of this away. When the stage lights come on, the agents are ready to let it rip with their 8-Mile-style, one-shot, don’t-miss-your-chance-to-blow narrative that the crowd is either going to love or hate. UBER’s went something like this:

The company who changed the way we do urban transport is still expanding. This ubiquitous software is something you’ve definitely heard of, and they’re booking more rides all the time. A bunch of boring nerds are going to point out that they don’t yet make money, but so what? Chasing profitability now would mean giving up on growth, and why would they want to quit scaling before they’ve got every cab ride in every developed economy in the world? You know who else lost money until they were sure they had the whole market for a new type of business? AMAZON! Ever heard of them?! A $70 billion market cap is a pretty great deal for a company that dominates for-hire auto transport and is about to do the same thing for delivery. How ‘bout it, Fred? How would you like to tell your grandchildren you bought Uber at $40?

-Some made-up broker

The crowd wasn’t having it. A sixty billion dollar valuation is a tough sell for a growth company, no matter how high the ceiling, and once the first few million in assets decided it was worth waiting a while to see how it goes, so did the rest of them. It’ll take a bit more convincing to suspend the street’s disbelief.

The short version of why this story came up short is down to size and a lack of familiarity. UBER and LYFT are the first public listings of their kind. The idea that a $68B company that doesn’t make money might still have great value as a developing enterprize isn’t too much of an ask all on its own, but the turn in the second act that’s supposed to put them in the black seemed far fetched. It isn’t something the audience can imagine happening. There just seems like more ways they won’t be able to pull it off than ways they will.

The dog is full grown, sir… it just isn’t mature yet.

For the long version, we start out with frequent Fundamental Hype punching bag and Minister of Information at Grizzle Media Scott Willis. Our longstanding objection to Willis’ work is that he doesn’t disclose when it’s being done in service of clients and, when he’s doing that sort of work, his lack of objectivity shines right through.

But Scott Willis is a good analyst when he puts his mind to it. The Grizzle report on the UBER IPO relative to the LYFT IPO was an epic piece of data journalism. He used the numbers to show unique angles relevant to the story, the trade, and the business. We sincerely hope we get more like this out of Scott and his team.

Grizzle really delivered on the UBER IPO breakdown, so we’re going to let the double axes slide.

The UBER and LYFT who IPOed in 2019 are still experiencing a rapid rate of user growth and that user growth is likely to continue.
But that wasn’t enough on IPO day to justify their valuations. Not entirely because they lose money on each user, but more because of the possibility that they could easily lose a lot more money before gaining a market saturation, and because it’s still unclear what they’re going to do to make money or when they’re going to be able to do it. The dollars spent on a ride are split between the driver and the company at about 80/20. At that split, Willis’ model says that UBER needs to book 15 billion rides a year to break even at their present cost structure. In 2018, the company booked 5.2 billion rides.

The rideshare companies keep their drivers as independent contractors to avoid being liable for healthcare or social security contributions or anything else expensive, and end up in a situation that cost them $0.71/ ride in 2018. Meanwhile, the drivers are getting louder and louder about the $7.62 of every $9.50 average ride that they’re getting. Apparently, it doesn’t amount to a whole lot after they take off gas maintenance and insurance, and the cities are starting to think that the taxi companies who are losing interest in paying their medallion fees have a point. It’s unclear how consumers would respond to a fare hike. A reduction in ridership might give back any gain made by a fare hike, and would probably chase drivers besides. Turnover is already high.

Disrupting the economics, not the mechanics

UBER and LYFT are the first rideshare IPOs because they’re the first rideshare companies of any kind. Before 2014, we were all hailing cabs on the phone like luddites. A central dispatch would then engage in a radio or text transaction with its drivers to find the closest one available, and send it to the pickup location. Then, among an explosion of smartphones and the ongoing attempt to automate the world, someone figured out how to replace the dispatch process with an app, and handle the billing all in one go. Cab companies were old news overnight. Consumers in urban areas began to expect to be able to summon a car right from their smartphone, and licensed drivers with registered vehicles suddenly had a new way to earn that car payment. The terms “side hustle,” and “gig economy,” entered the public lexicon as opportunities to trade rides for cash popped up all over a digitized map in their phone like side missions in a video game.

Rideshare, a Taxi reboot. Ben Schwartz as Jim, Rainn Wilson as Latka the mechanic, Chris Pratt as Tony. There’s no dispatcher, and they’re all looking at their phones the whole show, but maybe we can still work Danny DeVito in as a QA auditor from head office or something. Netflix: DM me for a script.

The rapid explosion of UBER and LYFT had less to do with the convenience and fluidity of a machine-based dispatch relative to a phone-based dispatch than it did with an abundance of buyers and service providers being connected by an end-run around the rules. For most of the era of the American automobile, the right to operate a taxi was one granted by the city. Private citizens giving rides for money in their personal vehicles were frowned up on and ticketed. When UBER and LYFT deputized a fleet of gypsy cabs in Austin, TX, the city and county – possibly with no small amount of pressure from the holders of taxi medallions – asked the companies just what the hell they thought they were doing circumventing city ordinances that required taxi drivers to get licenses from the city?

The companies quickly teamed up to form the Ridesharing Works for Austin political action group and solicited enough signatures for a special election in May of 2016. Proposition 1, the only question on the ballot, asked the people of Austin to declare that rideshare drivers not be subject to the same background checking, fingerprinting and licensing as taxi drivers, as the city had mandated, and instead be able to operate at the company’s discretion. Ridesharing Works for Austin mounted an $8.2 million campaign – the largest for any initiative or candidate in city history by a wide margin. Glossy mailers and social media ads brought Austinites the message that UBER and LYFT’s background checks were superior to the ones done by the city. That the great digital sharing economy was working just fine, and imploring them to use their vote as an opportunity to break free from outdated paradigms.

It seemed like a lot of effort to get out from under their drivers having to pay the city forty dollars for a background check. Michael King, a well respected columnist for the local weekly, The Austin Chronicle, framed the situation differently than RWA. It wasn’t about whose background checks were better, or even whether or not rideshares and taxis were the same or different. A couple of Silly Valley monster startups had just walked into Austin and decided that they were going to re-write the rules. Texans tend to react sharply to that sort of thing.

UBER and LYFT spent a lot of money losing an Austin referendum that made their operation subject to city licensing.

The May special election drew a 17% voter turnout, abnormally high for a one question special ballot in May, as the city of Austin voted 56% to 44% AGAINST allowing rideshare drivers to operate without background checks from City Hall.

Following through on a threat they made before the vote, Uber and Lyft took their ball and went home. The apps were shut down the next day and the people of Austin wrung their hands for about two days until several new rideshare apps who had no problem with having their drivers follow the rules spun up and started matching smartphone-equipped drivers with smartphone-equipped passengers who had money and needed a ride. Austin just carried on without UBER and LYFT. Subsequent attempts by the rideshare giants to return to the music and tech mecca were unsuccessful. The Austin election was national news. It telegraphed a new vulnerability for the rideshare giants in the form of a sensitivity to regulation.

Disruption isn’t necessary something that creates new value. More often, it re-organizes the value that’s already there by achieving its part of the whole more efficiently than whatever it’s replacing, gives up part of the value that it replaced as a discount to gain market share, and keeps the difference. The stock market of 2019 doesn’t think much of UBER and LYFT’s prospects of gaining enough rides or a large enough split to be a worthwhile disruption. Between that and a consumer market landscape that could easily be balkanized by a few city council votes, UBER and LYFT just couldn’t sell their future to the street at their IPO price, so they came out of the gate in a dive looking for support.

Shout out to my sister the vegetarian, who doesn’t understand what use a meat substitute is if it has the taste and texture of meat.

So what DOES work?

For growth-stage co’s, the first step might be not waiting until they’re oversized behemoths to pay Wall Street to float them some liquidity. The IPO of fake meat company Beyond Meat (NASDAQ:BYND), which raised $240 million to open at a market cap of $1.5B finished opening day at $65, two and a half times its IPO price, was up another 20% in the week that followed the launch, has since gaped up to peak at $186.43 and closed today at $141.45.

At that size, there’s still growth to dream on. Just like UBER and LFYT, BYND had to nail the pitch and make the street believe! They sold their vision beautifully and, in the process, established themselves as something very new, that occupies a growing part of the cultural zeitgeist. The idea that it’s on its way up is easy to buy.

Have a read of this letter from the founder in the offering prospectus:

Beyond Meat’s story begins on farmland. Through my father’s love of farming and the natural world, my urban childhood was interwoven with time spent on our family’s farm in Western Maryland where we were partners in a Holstein dairy operation. As a child, I was fascinated by the animals surrounding us: the companions at our sides, the livestock in the barns and fields, and the wildlife in the woods, streams, and ponds. As a young adult, I enjoyed a career in clean energy but continued to wrestle with a question born of these early days: do we need animals to produce meat? Over the years, the question knocked more loudly and I set out to understand meat.

[…]

We do not, however, face a binary decision to eat or abandon meat. There is a path forward that I believe will unlock a new era of productivity for farmers, one capable of exceeding the gains made in the 20th century. It requires a change in perception, coupled with the use of science and technology.
If we insist meat be defined by origin—namely poultry, pigs and cows—we face limited choices. But if we define meat by composition and structure—amino acids, lipids, trace minerals, vitamins, and water woven together in the familiar assembly of muscle, or meat—we can innovate toward a solution.

[…]

For the consumer, this means that we can provide great tasting meat from plants -meat that delivers health benefits and environmental upside (90% fewer greenhouse gas emissions, 99% less water, 93% less land, and 46% less energy) and side steps the animal welfare issue. This is not a call to consume less meat. My own children enjoy more, rather than less, of their favorite meat occasions (sausage breakfasts, burger dinners) as I am comfortably aware that Beyond Meat products are free of cholesterol

– Exerpts from a letter to shareholders by Ethan Brown, Founder of Beyond Meat, in the company’s 2019 offering prospectus.

WHAT a pitch! It reads like a TED talk. Some of us piled that science on top of some lived knowledge of a high-profile rollout of Beyond Meat products at A&W locations last fall selling out right away.

Beyond Meat loses proportionately more money than UBER and LFYT by any reasonable metric, but the market doesn’t care. The perception that the company will be able to harness a portion of the food budgets of the consumers whose ecological consciousness play in their buying decisions is an easy one to create. A five dollar “burger” being a lot more accessible than a $40k-$80k electric vehicle or a rooftop solar array is a pretty easy sell. There’s no arguing with this revenue growth that they’re experiencing in the early stages of consumers gaining access.

If the street won’t believe, the company has to at least make them understand.

Pintrest (NYSE:PINS) IPO’d 4/18/19 at $24.40, peaked at $34 4/29/19, and appears to be consolidating between $26-$28, so it’s fair to call it an IPO that was priced right, but perhaps more accurate to call it a known quantity. PINS loses money too, but the market is acclimatized to the idea that it can work. The potential and growth profiles of social networks are something it is familiar with, the IPOs of Twitter and Facebook being relatively recent memories, and both companies becoming market darlings. Even the most fickle of markets knows what to do with something that it knows what to do with. “Oh. Yeah. One of those. OK. I can expect it to run on user growth and revenue growth, and they say the kids like it. Sure. This is fine.”

The IPO horizon

As the cannabis market continues to bog, we’re seeing private companies rushing their way into IPOs and RTOs. It’s tempting to see this as a form of panic selling, but we’re nonetheless inclined to evaluate these new issues on their merits. Even in a sagging market, the potential for a sentiment-based melt-up remains for companies who can really stick the landing on that opening pitch. We’ll take a look forward tomorrow.

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About Braden Maccke 60 Articles
Founder and Editor in Chief at Fundamental Hype, a blog about venture stage finance and the media that supports it.

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