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This year was meant to be the year of the IPO, with some of the most anticipated tech unicorns poised to make their public debut. As we near the end of 2019, it’s clear that things haven’t gone according to plan. The poor stock trading performance of consumer-facing companies like Uber, Lyft and Peloton, with strong performer Pinterest serving as one of the rare counterexamples, has been significant. Add to that the storm of media criticism around WeWork, which did not even make it to the public markets. There is one consistent theme that public market investors are looking for and that’s a path to profitability. Investor appetite for companies that confidently post revenue growth numbers but avoid outlining a path to profitability has disappeared. In its place is renewed interest in cogent and sustainable business models instead of those whose road to profitability is too far in the distance to see.
A world where these high-profile technology companies didn’t experience post-IPO fall in share prices would have been better for everyone. However, there is a silver lining in the last several months of stock under-performance as it has been a big wake up call. We are very fortunate that this is all happening now, in a bull market, where investors and the market have the breathing room to push companies to articulate a clear path to profitability. It's much better for this market reaction to happen now, when there is time and room to course correct and the economy can absorb it when there are ample jobs and the economy is strong.
The last time we saw a major market correction with technology companies was in 1999. Today’s unicorns may seem different from what we saw in 1999, but there are some parallels. Take Pets.com, they were acquiring customers but hadn’t properly assessed the unit economics for acquiring those customers. They ended up burning through vast amounts of cash with no path to profitability in sight. This issue of unit economics can be seen in the ride hail businesses of Uber and Lyft along with some of the food delivery companies such as Grubhub. It is simply costing these companies too much to acquire and retain customers in an age when the consumer can easily move from one app to another.
The positive takeaway for boards, CEOs and investors should be that the immediate future is bright, because we have the time to course-correct. The public markets are holding strong and look to stay that way for now. Thoughtful management teams are aware of the shifting sentiment from growth to profit and will take steps to temper their appetite for the former, especially if they are only a few quarters away from an IPO.
Looking ahead to 2020, investors will reward companies whose business models are proven and show continued profitability alongside ongoing predictable growth. One hotly anticipated example for the coming year would be Airbnb. Airbnb is a true market-place technology business with real benefits of scale and compelling unit economics. There’s a lot we still don’t know in terms of numbers, but according to the Wall Street Journal, early indications show that they were EBITDA-positive in 2017 and 2018.
It’s plain to see that a company going public now without a compelling path to profitability story will be punished. Pre IPO companies which continue to invest in growth now need to focus on driving profits and managing costs and they will be well-rewarded by the public markets. The IPO woes of 2019 may well turn out to be 2020’s boon.
