IPO Fever a Sign of Market Sickness, Not Health

In 1999, a number of companies could slap a “dotcom” after their name and get funding. That’s because the hope of the 1990’s and the start of the internet era had started with no-holds barred. It was a free and seemingly endless digital frontier with endless possibilities. So, like settling any frontier, the belief was that getting there first was paramount. Business concerns, like making a profit, were second. Plenty of companies went public with no plan in place to make money for years down the line. Investors, seeing the early returns of internet stocks, overlooked economic reality. Some ideas were good and survived big drops in shares—Amazon and eBay have become game-changers for investors, even if they bought near the 2000 top and simply held on until today. Most companies, even those with good ideas, couldn’t last without more capital. It’s taken 20 years, but once again we’re seeing an IPO fever as a large number of companies have decided to go public around this time. Some of them are tech related. Lyft (LYFT), one of the major ride-share companies, just went public last month. Uber, their main competitor, is working on finalizing their IPO process now. Other names have included Pinterest, and Levi’s jeans. That sounds like a nice mix of businesses—and without the “dotcom” suffix that would make investors wary today. But we know that investment fads can and do happen. Uber has been honest in its IPO paperwork, stating that it does not make a profit, has never made a profit yet, and may never make a profit. Uber, like Lyft, has crushed the traditional taxi industry with their ride-sharing apps. While you can make rides cheaper for consumers and give anyone with a car a chance to make some gas money, it doesn’t create the kind of full-time job that a taxi owner had. It’s no wonder that Lyft shares are tanking. It’s a low-margin business—assuming it ever makes money at all. Pinterest, essentially a crafting-related site, isn’t going to scale to the size of internet commerce giants eBay or Amazon. And one of the hottest potential IPOs, Saudi Aramco, looks dubious, and not for reasons to do with oil prices or the questionable amount of reserves the kingdom truly has in the ground. Who in their right mind would invest with the same government that organizes the murder of journalists and still treat women as chattel? And, as part of OPEC, the Saudis could cut off or increase production, causing shares to swing wildly. Who’s to say they wouldn’t try to make it so that they unduly profit while the rest of the market suffers? There’s too little ethics and too much conflict of interest there. No wonder their planned IPO keeps getting pushed back. These aren’t terrible companies per se, but they’re not necessarily ones that are worthy of becoming a publicly-traded company. Worse, once these companies go public, their valuations will be large enough to put them into indices, meaning passive investors will end up with shares whether they want them or not. The bottom line is that a company going public is a great milestone. They’ve built a great business that needs capital markets to go to the next level. A truly great company can go public whenever it wants, and at a valuation that reflects the underlying business value. It will go on to great heights irrespective of what the market does. But a large cluster of companies going public, and at staggering valuations against flimsy business prospects, is a sign of market sickness, not health. It means there’s a lot of greed in the system, which means prices are at a premium. Indeed, many of today’s IPOs look more like an opportunity for owners to cash out. During the tech bubble, the late Sir John Templeton looked at many of the companies that went public in the late 1990’s. He found that, whether or up or down from their IPO, their shares tended to see consistent selling about six months after shares first went public. That’s because the insider lockup period ended, and corporate insiders were finally free to cash out. Today’s investors should pay more attention to how a company is faring 6-9 months after going public, not the day of. Speculate if you want to, but the IPO space is running hot, and unprepared investors are apt to get burned. There are plenty of public companies that are offering a value right now instead.

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