We look at why so many fast-growth companies are floating in the US
Thursday 09 May 2019 Author: Daniel Coatsworth

We’re seeing a large number of high profile companies join, or plan to join, the stock market in 2019. The catch is that they are choosing the main stock exchanges in the US rather than listing in the UK.

That isn’t generally a problem in terms of getting access as most UK stockbrokers and investment platforms let you buy shares in overseas-listed companies.

The real issue is whether you should want to invest in the likes of Uber, WeWork, Pinterest and Lyft, all of whom are big names offering retail investors the chance to buy their shares once they hit the market.

These are all fast-growing businesses either disrupting industries or creating new ones. On paper they are exciting with bold ambitions to keep driving up sales. While the majority earn large amounts of revenue, nearly all are loss-making.

Buying their shares would mean having faith in them achieving growth goals. Some of the companies will need significant amounts of new cash to help them on their path to positive earnings. Others need to overcome significant regulatory or legislative hurdles which threaten to derail their sales momentum.

WHAT TO LOOK FOR

Being a ‘hot’ name with fast growth is not enough to warrant making an investment. You need to think about financial strength, competition, other risks, and also question why existing backers want to use the stock market listings as a partial or full exit. After all, has the easy money already been made?

Most of these new stock market floats are companies previously backed by venture capital funds or private equity. The fact that numerous so-called ‘unicorns’ – start-ups valued at more than $1bn – are now coming to the market would suggest the current backers are seeing an opportunity to cash out while the going is good.

‘We have had a dearth of tech IPOs (initial public offerings) in recent years as the so-called unicorns have got fat on private equity money. Now those same investors want to realise their investment and that’s where I see the risks,’ says Richard Holway, analyst at TechMarketView.

‘We should remember that in the dot.com bubble of 1999/2000 the majority of companies that floated either failed or were bought out at fire-sale prices over the next three to five years. I suspect a similar fate awaits many of the current IPO crop.’

‘BUT we also had a few mega stars. Again I expect there will be a few of the current IPO crop that will shine brightly too,’ he adds.

THE NEXT BIG THING

Jake Robbins, fund manager of Premier Global Alpha Growth Fund (B6740K6), also believes the big tech unicorns are taking advantage of strong equity markets to go public. ‘It’s only natural that investors are seeking to identify the next big thing that could join the $1trn club,’ he says.

‘Investing in some of these companies requires quite a leap of faith that selling services or goods at a loss can one day create a network that can support real profits.

‘Clearly if it can’t then they won’t be able to support any kind of valuation let alone the sky high prices currently being bandied around. For those companies that do succeed then their investors will be phenomenally well rewarded, but for the many that fall by the wayside current valuations will, with the benefit of hindsight, look very much like an investment bubble,’ add Robbins.

UK investors flock to US stocks

US-listed stocks are popular among UK investors, according to investment platform provider AJ Bell Youinvest.

For example, more of its customers hold shares in Tesla than classic British companies Whitbread (WTB), which owns the Premier Inn hotel chain, and retailer Next (NXT). Other US-listed stocks widely held among AJ Bell Youinvest customers include Amazon, Facebook and Netflix.

OFF TO THE RACES

It helps that investor sentiment in the US is being supported by markets trading at record highs, thus making it relatively easy for companies to be confident about floating.

Many of the recent unicorn floats have soared on their first day of trading including video conferencing firm Zoom Video Communications which jumped by 80%. Online scrapbook Pinterest floated at $19 a share on 18 April and two weeks later it was trading at $31.23.

Lyft initially did well, rising by 25%, but has since pulled back and is now trading 18% below its listing price. Its disappointing performance on the stock market is a good illustration of why you shouldn’t get caught up in the hype around all the unicorn companies.

How do you buy an overseas-listed stock?

Buying a stock listed on an overseas exchange such as New York or Nasdaq is relatively easy, assuming the company is large and liquid enough.

You buy the shares in the same way as you would for a UK-listed stock. The only extra bits to consider are foreign exchange charges which can be up to 1% for dealing and potentially 0.5% fee to convert any dividends into sterling.

For US-listed shares, you will need to complete a W-8BEN form which will be available from your investment platform provider.

DISRUPTOR FATIGUE?

We sense that many investors are getting tired of companies claiming to be market disruptors. There is an increasing shift among long-term investors back to companies which make positive earnings as they believe ‘profit is better than promise’, to borrow a phrase from a recent article in the Evening Standard.

This is a good reason why we believe Airbnb stands a better chance of generating good returns for investors than Uber – the former already makes a profit and the latter has no idea when its earnings will turn positive. However, you also need to factor in valuation for any company and not simply pick the profitable ones.

Many fund managers like to wait until a company has been trading on the stock market for some time before considering an investment. They want to see how the market has reacted to the stock, as well as how the management have performed in the public spotlight.

You may argue that waiting means missing out on potential gains, yet a good company should still be able to generate positive returns for shareholders over time.

Furthermore, it also means you avoid the initial period where many people like to trade in and out on stock market floats. You often see a pattern in the share price where an IPO rises, falls back as traders bank profits, and then rises again as longer-term investors take positions.

IPOS TO BUY OR AVOID

Of the recent batch of new stock market entrants, we like the look of Beyond Meat for significant earnings growth potential albeit recognise that it is very highly valued. We are cautious towards Uber as costs are ballooning and its bigger-picture plans to be a mobility champion are likely to require very large amounts of investment.

Among future potential stock market listings, Airbnb looks the most interesting as an investment, assuming its valuation isn’t excessive. Palantir is also a fascinating business but we’re lacking detailed financial information at present. Avoid WeWork’s parent We Company which is listing later this year.

If you don’t want to risk your money on individual stocks, it is worth considering there are plenty of investment trusts and funds with access to these types of fast-growth businesses thanks to being able to invest in unquoted companies. For example, Scottish Mortgage (SMT) already has stakes in Airbnb and Palantir, alongside more mature companies.

2018 IPO SUCCESS STORIES

Last year saw some spectacularly successful US technology stock market floats. The best performer was cyber-security firm Zscaler, which went public in March 2018 at $16 per share with a valuation of $1.9bn.

By the end of the year the shares had gained 160%, valuing the business at almost $5bn. This year the shares have gained another 80%, giving the company a value of almost $9bn. 

Having racked up quarterly losses of $5m to $10m, Zscaler is slowly moving towards making a profit although it isn’t there yet.

The next-best performing public offering was Elastic which powers the searches which connect ride-share customers with drivers at Lyft and Uber and which connect lonely-hearts on dating app Tinder.

Elastic floated at $36 per share in early October and on the first day of trading the shares soared 94% to $70, giving the company a valuation of $5bn. By the end of the year the shares were up 115%, and since the start of 2019 they have added a further 25%. That makes the total shareholder return so far 135% and values the business at $6.2bn even though it still hasn’t turned a profit.


COMING SOON – CONFIRMED AND RUMOURED

UBER

WHAT IS THE GAME PLAN?

Uber wants to grow in areas such as electric bikes and scooters, freight and self-driving vehicles, as well as its core ride-hailing and food delivery interests.

In less than 10 years Uber has extended its service to over 700 cities on six continents, making 14m trips every day.

Yet it still accounts for less than 1% of all miles driven globally every year, and only a small proportion of people in countries where the service is available have ever used it.

Uber believes that the total addressable market is 11.9trn journeys a year which equals a market  worth $5.7trn.

In theory it can keep on expanding into this market while its in-house technology and network of connected consumers, drivers, restaurants, carriers and shippers gives it the ability to grow in new markets like food delivery and logistics.

So far investment needs and payments to drivers – which by the end of last year totalled $78bn – mean that it continues to run big losses.

WHO IS THE COMPETITION?

On the travel side its principal competitor is Lyft as well as traditional taxis and public transportation. Just Eat (JE.), Delivery Hero, Deliveroo and GrubHub are among the names competing against Uber to  deliver food to your home.

DOES IT MAKE A PROFIT?

No. Uber lost $3bn last year and net losses for the first quarter this year are estimated to be $1.1bn.

WHAT ARE THE KEY RISKS?

First and foremost, valuation. Second, regulation. Uber treats its workers as independent contractors but costs could go up a lot if they had to classify them as employees.

Investors may look at Amazon, which ran losses for decades as it invested in its business yet still made its early shareholders rich beyond belief, and assume that Uber will do the same.

However Uber is betting on one thing to be profitable: driverless vehicles. A fully autonomous fleet would be available 24/7, would offer safer, more efficient rides for customers but most crucially would save it tens of billions of dollars.

As seductive as the idea is, large-scale deployment of autonomous vehicles is a long way off meaning Uber is set to continue racking up losses for many years to come.

SHARES SAYS: This IPO is strictly for high risk-takers only. It is expected to float on 10 May.


WEWORK

WHAT IS THE GAME PLAN?

The We Company uses the WeWork brand to provide shared workspaces for smaller, often start-up companies that cannot afford a large initial office, as well as property services for firms of all sizes, from freelancers upwards. The firm has also opened other divisions, such as WeLive (apartments) and WeGrow (schools).

WHO IS THE COMPETITION?

Regus – owned by IWG (IWG) – is the major player in the business of offering co-working, shared office space. ImpactHub, founded six years before The We Company in 2011, is also building a strong global community while there are also lots of local options, including Convene in the US. Freelancers also have the option of working at home and bigger firms can use premises offered by more traditional landlords or buy their own property.

DOES IT MAKE A PROFIT?

No. For a nine-year old firm, its 2018 results were almost embarrassing as net losses of $1.9bn outstripped sales of $1.8bn. Sales may have doubled, but so did the losses.

WHAT ARE THE KEY RISKS?

A $6bn cash pile gives The We Company time to work on its strategy but its bonds are already rated junk by the ratings agencies who clearly see the firm as a risky proposition thanks to its losses.

The firm is diversifying into new areas before its core area is profitable. Any economic downturn could lead to tenants cutting back on space or going bust and there is no shortage of competition.

SHARES SAYS: Avoid. The financials tell a worrying story.


SLACK

WHAT IS THE GAME PLAN?

Slack aims to take online messaging to the next level by providing a software platform that workers can use to share information in one place, making collaboration easier, so customers get a better service. It has more than 10m daily active users worldwide.

WHO IS THE COMPETITION?

The main competition is email, which most firms and workers still use as their prime form of communication. Microsoft Team, Facebook Workplace, Alphabet’s own chat system and Cisco are all directly comparable rival services.

DOES IT MAKE A PROFIT?

No. It generated $400m revenue in the year to 31 January 2019 and made a $138m pre-tax loss.

WHAT ARE THE KEY RISKS?

Slack is six years old and has a relatively limited revenue base. Its core service is offered for free and customers then pay for additional features, so there is a risk that companies do not upgrade and stick with what they know (which is email) – people and firms can be resistant to change. Slack also faces lots of competition from bigger, well-funded rivals.

SHARES SAYS: Users of Slack talk very highly of its services which is promising. Its challenge is to get more people to pay to use its messaging platform. Definitely worth a look.


AIRBNB

WHAT IS THE GAME PLAN?

Having cracked the short-term rented accommodation market, Airbnb’s ultimate plan is to have an end-to-end travel platform that will handle every part of a trip. More than half a billion people have so far stayed in homes, yurts, treehouses and more via its platform, and hosts offering accommodation have earned more than $65bn.

WHO IS THE COMPETITION?

These include traditional accommodation providers such as hotels, travel agents and bed and breakfast operators, as well as websites like Booking.com and TripAdvisor.

DOES IT MAKE A PROFIT?

The company says it has made a profit for the past two years on an EBITDA (earnings before interest, tax, depreciation and amortisation) basis, although it does not disclose any figures.

WHAT ARE THE KEY RISKS?

Regulators are cracking down on Airbnb in various parts of the world including restrictions in places likes Paris and Amsterdam on the number of nights a home can be offered via its platform.

SHARES SAYS: The business is well-established and already has considerable scale. This is one of the more interesting names to watch for a forthcoming IPO. Get ready to buy, assuming the valuation isn’t excessive.


PALANTIR

WHAT IS THE GAME PLAN?

Palantir is a data analytics group that makes people better at doing important work, such as battlefield intelligence systems for soldiers. It is involved in a lot of activity for government agencies as well as corporates such as United Airlines. The plan is to grow its position across the public, private and not-for-profit sectors.

WHO IS THE COMPETITION?

Mu Sigma, Splunk and Tableau are considered to be key competitors to Palantir. However, the broader big data and analytics space is also very crowded.

DOES IT MAKE A PROFIT?

We don’t know as Palantir has been very secretive about its finances.

WHAT ARE THE KEY RISKS?

Palantir is considered to be heavily reliant on government contracts which exposes it to the risk of public sector budget constraints. A stock market float may not give investors detailed company information as much of its work is likely to be highly classified.

SHARES SAYS: We await IPO details with interest. Its business is fascinating but the financials and projects are surrounded by mystery.


RECENTLY LISTED

BEYOND MEAT

WHAT IS THE GAME PLAN?

Beyond Meat’s timing is perfect. It has floated on the stock market precisely at the time when demand for plant-based meat substitutes is really taking off. That might explain why so many investors rushed to own the stock on the first day of dealings (2 May) where the shares jumped by an incredible 163% to $65.75.

Consumers are turning their back on meat for cost, health and environmental reasons. That’s led to growing demand for plant-based food – importantly this demand is quite widespread rather than simply coming from people who don’t eat meat.

Many people have opted to reduce the amount of meat in their diet and switch to vegetarian or vegan food several days a week or on an ad-hoc basis. This presents an opportunity for Beyond Meat to sell to a mainstream rather than a niche audience.

The company’s ‘Beyond Burger’ product is designed to look, cook and taste like traditional ground beef. It has done a fantastic job of getting its products in stores across the US and now overseas, and brand awareness is strong enough for its name to prominently feature on menus in restaurants, hotels and other food outlets.

Growth plans include setting up production capabilities in Europe next year and expanding across Asia.

WHO IS THE COMPETITION?

Impossible Foods (which is now supplying Burger King in the US), Hungry Planet and Next Level Burger are among the main competitors, yet you also have big companies such as Unilever (ULVR) getting in on the act. Unilever last year bought meat-free food company The Vegetarian Butcher and Nestle is using its Garden Gourmet brand to also capitalise on the same market.

DOES IT MAKE A PROFIT?

It made an estimated $8.5m gross profit in the first three months of 2019 but incurred a $2m loss from operations. In 2018 it made $87.9m revenue and a $29.9m pre-tax loss.

Beyond Meat warns that operating expenses and capital expenditures will increase substantially in the foreseeable future as it invests to increase its customer base, supplier network and co-manufacturing partners. It also flags plans to spend money on marketing, distribution and manufacturing facilities, hiring more staff and boosting its technology and production capabilities.

WHAT ARE THE KEY RISKS?

It relies on a limited number of raw material suppliers and adverse weather conditions hurting crop yields could have a major negative effect on its earnings. It has already experienced interruptions with the supply of pea protein.

Beyond Meat has done a good job getting its products into stores but that also means competitors will be thinking hard about how to do the same thing. Copycat products are a major risk, particularly as Beyond Meat is probably too young a business to command brand loyalty.

Another key risk is working capital requirements. The company says existing cash will last it for another 12 months or so – beyond that it may need to raise new cash.

SHARES SAYS: Competition is tough but we’re encouraged by Beyond Meat’s progress and believe its earnings growth trajectory could be very good over the coming few years. We accept that the valuation is very high at $3.8bn but believe it has the right ingredients to do well. Treat this as a stock to own as a bit of fun alongside an existing diversified portfolio, rather than risking all of your money on it. The downside of having such a high valuation is that the stock is priced for perfection – any mistakes and the share price could collapse. Long-term investors who focus on fundamentals may not be able to justify paying top dollar when revenue is relatively small.


PINTEREST

WHAT IS THE GAME PLAN?

Pinterest is an online scrapbook which people view to find inspiration for their lives. It makes money from a range of different advertising formats. Growth is ‘pinned’ on making it easier for users to buy things they like, developing new features for specific industries such as automotive and travel, and having deeper relationships with brands, retailers and content creators.

WHO IS THE COMPETITION?

Pinterest argues that it is unique, however you could argue that Instagram, Facebook and Snap are competitors.

DOES IT MAKE A PROFIT?

No. It made a $63m net loss in 2018.

WHAT ARE THE KEY RISKS?

It is still in the very early stages of trying to monetise its platform and is heavily dependent on advertising. The company was founded in 2009 and hasn’t really been through a difficult period for the global economy, so it is hard to say if its business model is resilient enough to survive a sharp economic downturn. It needs to attract more advertisers, increase scale with existing advertisers and offer more advertising products, otherwise it may find it hard to sustain revenue growth.

SHARES SAYS: Pinterest doesn’t come across as having the right qualities for a business with everlasting appeal.


LYFT

WHAT IS THE GAME PLAN?

Lyft wants to keep growing, and establish itself as a leading player, in areas such as ride-sharing services, electric bikes and self-driving vehicles and continue to develop its platform so that it offers services that cover a wide range of transport.

WHO IS THE COMPETITION?

On the car ride-sharing side Uber is the principal competitor in the US while Uber and Jump are rivals in the bike-sharing and scooter markets. Travellers also have the traditional options of using their own cars, taxis and other forms of public transportation. There is a long list of rivals in autonomous driving, including Alphabet’s Waymo project, GM Cruise, Tesla and a range of Chinese, Japanese, European and Korean development programmes.

DOES IT MAKE A PROFIT?

No. In 2018, Lyft provided 619.4m rides and generated $2.2bn in sales but it lost $911m, or $1.47 for every ride it offered.

WHAT ARE THE KEY RISKS?

Competition is intense. Riders could press for higher pay, so any legal changes relating to the gig economy may be crucial. Its research effort in autonomous vehicles may not pay off. And the company continues to make substantial losses, with a profit looking very unlikely for several years to come.

SHARES SAYS: Avoid. The risks look very high versus the potential rewards from an investment. Its aspirations are admirable but this is not a stock for the faint-hearted.


ZOOM

WHAT IS THE GAME PLAN?

Zoom wants to offer a seamless, cloud-based video-oriented platform that makes communicating easier, so less time is wasted travelling to and from meetings and companies can work more efficiently.

WHO IS THE COMPETITION?

Zoom has a long list of rivals that includes Google, Cisco, Microsoft, TeamViewer and Polycom. Business people may also still prefer to travel to a face-to-face meeting.

DOES IT MAKE A PROFIT?

No. In 2018 the company broke even, as sales more than doubled to $331m.

WHAT ARE THE KEY RISKS?

Zoom faces lots of competition and quality of service is paramount – any technical failures with its cloud-based infrastructure or the internet more generally could compromise the quality of its service and reputation. Companies could delay trying, buying or upgrading its services if times get tough and money becomes tight.

SHARES SAYS: The stock has doubled in value since joining the market on 18 April. While investors have been happy to pay top dollar to get a slice of the business, we don’t share their enthusiasm.

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