The dismal debuts of Lyft Inc. and Uber Technologies Inc. sparked hand-wringing and a search for scapegoats. One theory gaining ground centers on the high number of special purpose vehicles that invested in the twin ride-hailing giants when they were private companies.
SPVs are often set up to invest in fast-growing startups, especially those like Uber that stay private for many years. Many employees with equity want an exit and won’t wait for an initial public offering, so those vehicles are formed to buy their stock.
Uber’s IPO flop suggests investors are growing wary of the business prospects in ride-hailing, but the proliferation of such structures may have precipitated a market selloff. There are at least 100 Uber SPVs, according to Atish Davda, chief executive officer of EquityZen Inc., a firm that handles private market transactions. He doesn’t know how many there are for Lyft. But a regulatory filing by the U.S. company in June listed seven SPVs among about 75 total backers.
Read about how Morgan Stanley got wealthy clients into Uber before the IPO.
This creates a new set of investors who may be keen to sell — or hedge their positions by short selling — when the IPO finally happens. Short-selling of Lyft shares was particularly heavy after its debut. By May 9, short interest in the No. 2 U.S. ride-hailing company was 27 million shares, or 82% of the total available stock, according to financial analytics firm S3 Partners. For Uber, it was 12% on Wednesday. Less than 1% is considered normal.
“This exact price pressure on the public stock happened to Facebook, so it would be no surprise to see it happen again,” said Neil Campling, head of TMT research at Mirabaud Securities Ltd.
Facebook Inc. stayed private for about eight years before going public in 2012. About a year before the float, Goldman Sachs Group Inc. created an SPV to let some of the bank’s wealthy clients invest as much as $1.5 billion in the social media giant. A document for investors disclosed that Goldman might sell or hedge its stake without warning clients.
Campling said he helped arrange SPV investments in Facebook and other tech startups. “Early investors and, particularly, early employees need a means to find a path to liquidity or get a way to lock in some gains,” he said. “So as the path to an IPO sometimes was three times longer than Silicon Valley startups were used to, these SPVs were born.”
When Facebook went public, its stock fell more than 50% in the first three-and-a-half months. Lyft lost as much as a third of its market value after its debut in late March. And Uber was down as much as 18% in the first few days of market trading.
To be sure, SPVs often have rules that subject their backers to the same lock-ups as other shareholders. In the case of Lyft and Uber, stockholders can’t sell or short for 180 days. However, selling pressure can come in less direct ways.
Investors in such vehicles are allowed to short, or bet against, other stocks. So some investors in Uber SPVs may have shorted Lyft to hedge their positions, and vice versa. There are more Uber SPVs than Lyft SPVs, so this could explain why Lyft stock was shorted so much more than Uber’s shares. That’s not a perfect hedge, but the companies have similar businesses and are affected by the same external factors, such as the supply and legal status of drivers.
Campling has another explanation: Depending on the terms of the SPV, there are trading strategies that could enable their investors to protect themselves while complying with the typical 180-day lockup that prohibits sales of shares and hedging, he said, citing options as a possible tool. The typical lockup rules focus on the shares, not other financial instruments tied to the economic value of the stock.
Still, it’s unclear how much responsibility SPV investors bear for the early declines in Lyft and Uber shares. EquityZen’s Davda thinks SPVs are not to blame. And there are other reasons for the poor IPO performances.
Lyft and Uber lose lots of money, which has unnerved public market investors. Then there’s the sheer number of other shareholders who already own stakes in the companies. That leaves fewer buyers for an IPO. The New York Times reported this week that the IPO banks struggled to persuade some existing investors to put more money into the companies.
There’s also a potential silver lining to the SPV theory. Once SPV-related transactions and shareholder lockups are “flushed through, then you can look at the stocks on a pure fundamental basis rather than being at risk from synthetic structures,” Campling said.