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ANALYSIS: IPOs Reveal Fears & Flops in SmileDirect & Peloton

Oct. 16, 2019, 11:29 AM

Another quarter, another unicorn unmasked: WeWork’s initial public offering, anticipated to rank as the second-largest in 2019, was heckled by investors and the media until its co-founder CEO was fired and the offering humiliatingly withdrawn. Among the largest third quarter offerings now trading, SmileDirectClub brought only frowns. It earned the dubious distinction as the worst mega-IPO priced above-range since at least 2008. SmileDirect’s closest IPO competitor, Peloton, failed to keep pace, as its IPO clocked in as the third worst trading debut in 10 years for companies raising at least $1 billion.

As a recent Bloomberg Businessweek story headline declared, “There’s Unicorn Blood in the Streets.”

The IPO performance doom and gloom in the third quarter was largely contained to those three unicorns—companies valued at $1 billion or more just before their public offering. Increasingly, the market is rejecting fast-growing technology and e-commerce company IPOs for being overvalued and far from profitability.

Even with this increased investor skepticism, the overall appetite for IPOs remains strong. For example, an unprofitable unicorn company with an undemocratic dual class share structure can still enjoy a healthy first day price pop if, like Cloudflare, it operates in the right space (e.g., cybersecurity). Cloudflare’s shares caught fire, shooting up 20% on its first day of trading. Bloomberg reports that while overall share prices of IPOs have risen 12.6% this year, based on a weighted average, the share prices of 18 software and computer security companies have increased nearly 40%. The market continues to embrace initial public offerings from many companies when they meet investors’ criteria.

IPOs Trudge Onward Against Increasing Skepticism

Overall, the IPO market did fine in the third quarter of 2019, despite optimistic predictions. Those forecasts failed to foresee that a trio of unwelcome guests would arrive to disrupt the planned IPO festivities. First, many assumed market momentum would continue after the sizzling second quarter—but the traditional summertime slowdown appeared as usual. Second, increased market volatility fueled by fears of a pending global recession landed a painful blow to investors’ psyches, causing many to switch to a defensive posture. Third, and perhaps most impactful, growing demands from increasingly skeptical investors have changed the IPO game. Investors are no longer willing to fork over cash for an innovative concept and fast growth—cash flow, debt, corporate governance, and a path to profitability are now also part of their investment decision equation.

Those three factors worked to cool the jets somewhat on the speed of this IPO market. When one considers the raft of negative or concerning news during the third quarter 2019, the U.S. IPO market held together rather well. Attacks on Saudi oil fields. Unrest in Hong Kong. Constitutional crises on two continents. An ever-worsening U.S.-China trade war along with mixed economic data in both countries. Europe staring at Brexit and a recession. There was lots of news for markets to absorb and yet the IPO bull run emerged largely intact.

The third quarter continued the established trend toward fewer but larger deals. Deal count dropped to 63, down from 73 compared to the same period last year and down from the 84 total deals in the second quarter of 2019. (Last quarter’s results were distorted by a first quarter federal government partial shutdown that delayed some offerings to the second quarter.)

Deal volume improved year-over-year from $15.87 billion to $17.08 billion but was down from the $30.1 billion haul in the previous quarter. The surge in offerings following the first quarter federal government shutdown and the large number of unicorns going public greatly increased the total value of IPOs priced in the second quarter of 2019. The three biggest offerings in the second quarter 2019 were mammoth: Uber ($8.1 billion), Avantor ($3.33 billion), and Lyft ($2.34 billion).

By contrast, SmileDirect ($1.34 billion) and Peloton ($1.16 billion) completed the largest third quarter IPOs. The market anticipated WeWork (now, The We Company) would produce the second largest IPO of 2019, boasting an offering size between $3 and $4 billion. However, WeWork pulled the offering—along with its CEO—at quarter’s end, after a cascade of criticism.

More IPOs Trading & Pending on U.S. Exchanges

After a backlog of initial public offerings created by a partial federal government shutdown in January, the number of trading IPOs increased substantially by the end of the third quarter. Pending IPOs also increased for the year, while postponed and withdrawn offerings saw modest increases despite some prominent names delaying (Postmates, Palantir Technologies) or withdrawing (e.g., WeWork) their IPOs.

Some companies, such as Postmates and Endeavor Group Holdings Inc., have delayed their public IPO filings in the face of an increasingly demanding and choppy market. It is possible they seek a warmer reception from private equity and VC investors. Other companies, like Airbnb, are known to be planning IPOs (or direct listings) for 2020. Palantir Technologies’ IPO could be postponed until 2022 or 2023 while the company seeks private money instead. Payments company Stripe Inc. is reported to have recently raised additional private funds sufficient to make it the third most valuable U.S. start-up.

Financial Sector Takes Crown for Quarter Count

Consumer, non-cyclical offerings lost the top spot amongst all industries for numbers of deals in the quarter, and its margin over the diversified sector narrowed considerably. Financial offerings led all sectors with 17 deals, followed by the consumer, non-cyclical sector with 16 deals, and diversified with 14 deals, in the quarter.

Year-to-date, the consumer non-cyclical sector maintains a commanding lead with 64 deals, followed by diversified’s 42 deals and financial’s 34 deals. Last year in the third quarter, the consumer, non-cyclical sector led with 26 deals while the financial sector posted 12 deals and diversified rounded out the top three industry sectors with 11 deals. Enterprise software IPOs, a sub-sector within the technology sector, have been among the best performing this year with leaders CrowdStrike and Zoom Video Communications each enjoying appreciation exceeding 100% above their IPO price. Enterprise software is software sold to companies rather than to consumers.

Consumer, Non-Cyclical Offerings Raise Nearly $5 Billion

The consumer, non-cyclical sector may have lost the lead in deal count but it wrested the volume crown away from the communications sector. The Internet-heavy communications sector often leads all comers in deal size, as it did in the first half of 2019 with huge offerings by Uber and Lyft.

The third quarter saw but one communications IPO, raising only $190 million. The consumer, non-cyclical sector crushed that deal volume raising $4.74 billion for the quarter. The financial sector took the silver medal raising $3.45 billion, followed closely by diversified’s $3.35 billion.

A year ago, the top three sectors for the quarter were consumer, non-cyclical ($4.04 billion), communications ($3.16 billion), and diversified ($2.6 billion). For the first nine months of 2019, communications is tops raising $15.31 billion, consumer, non-cyclicals is second with $13.84 billion, and diversified in third place has raised $10.22 billion thus far in 2019.

Fewer, Larger IPOs, but More Pricing Above Range

The established trend of fewer, larger IPOs continues to hold.

An emerging trend is developing in the final pricing of offerings. A small but growing percentage of offerings in recent quarters priced above range while the proportion pricing below range declined. This represents a positive indicator that fewer offerings overall are actually coming to market overpriced despite the tremendous recent attention paid to overvalued unicorns. Offerings that priced below range have typically posted substantially worse returns than offerings pricing within or above range.

Reminiscent of when fast food restaurants upsized their drinks so that a “large” soda became a “medium” and a “medium” a “small,” IPOs continue to upsize. Small ($1M-$100M) initial public offerings dropped to only 28.57% of third quarter IPOs while the middle ($100M-$500M) price bucket now represents the most popular IPO size (57.14%). Only last year, the $1 million-$100 million range garnered 43.22% of IPOs. Medium is the new small.

Larger IPOs increased their market share as well. Offering from $500 million-$1 billion took 11.11%, and those from $1 billion-$10 billion now represent 3.17%. Those two larger categories combined have increased from 10.99% of total offerings to 14.28% for the most recent quarter.

Two-thirds of third quarter 2019 IPOs priced within range, 17.46% priced above, and 6.35% priced below. For the first nine months of 2019, these figures are 70.37%, 15.34%, and 7.94% respectively. Pricing improved modestly year-over-year as only 13.7% of IPOs priced above in the third quarter 2018, 71.23% priced within range, and a higher percentage (9.59%) priced below range.

Spic & SPACs—Blank Checks Companies Continue Cleaning Up

Deal activity for the most recent quarter kept pace with the first half of 2019 and improved year-over-year. There were 14 SPAC deals in the third quarter totaling $3.35 billion compared to 11 deals totaling $2.6 billion for the third quarter of 2018.

During the first nine months of 2019, Special Purpose Acquisition Companies represented 22.22% of all IPOs over $1 million, raising $10.22 billion over 42 offerings. Compared to the prior quarter, deal volume dipped slightly while deal count increased from 13 to 14 deals.

The three largest SPAC offerings were: Conyers Park II Acquisition Co. ($450 million), Apex Technology Acquisition Co. ($350 million), and Thunder Bridge Acquisition II ($345 million).

ATMs Doling Out Ever More Cash

At-The-Market offerings increased in value and number over the same period in 2018. Long on the upswing, the use of ATMs has increased substantially in recent quarters. Already in the first nine months of 2019, there have been 202 ATM offerings totaling over $26 billion. These numbers are nearly on par with the $30.63 billion raised from 207 offerings in 2018. For comparison, the IPO market in 2019 has tallied 189 deals raising a combined $59.01 billion.

At-the-market offerings help issuers manage market volatility better because companies have more control over when and how many shares are sold. The attractiveness of shelf offerings is likely to rise given the increasing market volatility seen in recent quarters.

The three largest ATM offerings in the third quarter 2019 were Invitation Homes Inc. ($800 million), WP Carey Inc. ($750 million), and Gaming and Leisure Properties ($600 million).

Conclusion

Geopolitical events and troubling economic data weighed on IPO investors’ minds during the third quarter of 2019. This uncertainty and volatility also played a significant factor in some companies choosing to postpone, withdraw, and/or seek other types of financing. Nevertheless, the IPO pipeline remains robust during this market breather and the market still seems healthy. Some companies have already indicated they are trying to learn from the cautionary tales of unicorns like Uber and WeWork to focus on profit over torrid growth. This is a healthy development for the IPO market long-term. If more start-ups going public are profitable and well managed, the improved quality on offer could help drive more IPO success stories in future quarters as macroeconomic concerns recede.

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