More updates…

We start the week with the latest news that have been shaking up some of the topics we have already covered in this blog.

News brought to you courtesy of Warren. Credits: Daily Mail.
News brought to you courtesy of Warren. Credits: Daily Mail.
  • Apple struggles to maintain its market share in China according to the company’s latest filings released last month. Although Apple’s revenues in the country are up 50% compared with 2014, local rivals such as Huawei, Vivo and Oppo have been offering cheaper although similarly powerful devices. The firm is supposedly eyeing towards India as its next revenue growth driver. In the meantime it launched its latest ‘product’, a retrospective book entitled ‘Designed by Apple in California’, and priced the Apple way: $199 to $299 depending on the edition.
  • Twitter has announced it would cut 9% of its workforce in order to keep costs down. This comes at a bad time for the firm which have been increasingly criticised for allowing cyberbullying, racism and misogyny to flourish on its platform and now has to find a new COO after the departure of Adam Bain. Twitter responded by suspending several accounts belonging to right-wing extremist groups, although it has for the moment ruled out ‘instant message moderation’. The idea that “good speech naturally wins out” is a fallacy, argues heather Brooks in the Financial Times.
  • The election of Donald Trump in the US caused a mini-stock market shock to tech values. Mr. Trump is indeed believed to ease the tax policy surrounding corporate earnings made overseas – currently those earnings are taxed at 35% and the rate could go down to as low as 10%. This explains why Microsoft, Apple and Google have been keeping billions of dollars offshore. This news could have been welcomed but are investors actually fearing what executives are going to do with this ‘idle’ money?
  • Notwithstanding this rumour Facebook announced earlier this week a $6bn share buyback aimed at curbing the negative share price impact of an expected growth slowdown expressed during its latest quarterly result presentation. This decision represents an archetype of buyback for ‘wrong’ reasons, as flagged in my post a few months ago. Facebook is not buying shares because it believes they are cheap but because it needs to satisfy its existing shareholders – a typical value-destroying move.
  • Microsoft’s acquisition of LinkedIn could trigger a wave of antitrust challenges, according to Marc Benioff, Salesforce’s CEO. LinkedIn’s data could indeed provide Microsoft with a unique competitive advantage especially in the field of CRM – hence Mr. Benioff’s ire. As a response Microsoft proposed to give rivals access to its software and offer hardware makers the option of installing other services.
  • SoftBank is entering the ‘tech unicorn’ investor market the big way, through the launch of a $100bn fund anchored by Saudi Arabia. The implied equity cheque size (up to $5bn according to its CEO) could provide a private exit door for a handful of existing unicorns reluctant to go through the ‘IPO gateway’.
  • Sigfox, the French ‘Internet of Things’ specialist, could soon join the unicorn club, being valued at €600m according to its latest fundraising round. The operation was relatively unique in the sense that it gathered public entities, private companies and VC funds around the same (investor) table.
  • Fitbit could conversely become the next ‘unicorpse’. The company’s share price has declined by 80% over the last 18 months as tech behemoths have been progressively entering the field of connected objects. On its side, Fitbit tried to put the blame on one of its suppliers to explain its recent supply chain disruptions – whereas analysts attribute this phenomenon to incorrect demand forecast.
  • Karhoo has already reached this status, filing for bankruptcy after just 6 months of activity. The start-up, which raised $250m and was employing 120 people despite only generating $1m of revenues in London. A very aggressive promotional policy, consisting of ‘thousands of pounds of vouchers’, alongside a “ludicrous lack of corporate governance”, led the company to ruin in a highly contested market.
  • Nutmeg managed to raise £30m from international investors despite posting pre-tax losses of £9m this year.
  • Snapshat could be the big IPO of 2017, hoping to raise additional equity at an implied valuation of $20bn to $25bn – although the exact amount still needs to be determined. The two founders will keep the control in any case through the use of preferred shares.
  • Uber faces legal challenges in the UK, where a court ruled that Uber drivers were not independent but actually salaried workers. In France the fact that some Uber drivers could under some circumstances be promised a minimum wage is also a cause for dispute.
  • The Airbnb business model is being challenged in an increasing number of cities. After New York and San Francisco, Berlin and London have joined the fight to prevent the firm from putting pressure on dwelling supply and subsequently pushing rents up in the most touristic areas. After relentlessly fighting all forms of regulatory resistance, the firm has changed its approach and is now intending to strike as many tax deals as possible with the cities it operates in – bringing the figure up from 200 to 700 and covering 90%+ of its revenues.

That is it for this week in terms of updates! Next post (hopefully later this week) will introduce the cybersecurity topic.

Floating or sinking? 5 questions to understand the IPO challenge

Mark Zuckerberg at the NYSE in 2012
Mark Zuckerberg at the NYSE in 2012

In this post I would like to take an interest in ‘Initial Public Offerings’ or ‘IPOs’. We all remember the big tech offerings of the last two decades (Yahoo in 1996, Google in 2004, Facebook in 2012) which made their founders join the billionaire club. Today a company founder is usually considered as ‘unanimously successful’ if he has managed to ‘float’ a significant share of his company – and if the share price has not collapsed since then, meaning that he has won a ‘seal of approval’ from the stock market. Behind this phenomenon, I have highlighted 6 questions worth thinking about in my view.

 

What are the pros and cons of public as opposed to private ownership?

‘Public ownership’ means by definition that shares are made available to the public. Shares in a public company are therefore much easier to buy and sell through marketplaces (stock exchanges) or ‘over the counter’ (where the buyer and the seller negotiate directly). Private company shares can only be exchanged through the latter way. This largely prevents small shareholders (such as employees) to monetise their shares.

Credits: www.cartoonstock.com
Credits: www.cartoonstock.com

Public ownership requires that all potential investors benefit from the same level of information. This explains why public companies’ annual reports are usually hundreds of pages long. Producing this information and, more importantly, making it compliant with regulatory requirements, comes at a (significant) cost, notwithstanding the fact that a public company may have to reveal competitively sensitive information – one of the reasons why they tend to have recourse to cryptic jargon. Conversely, private companies do not need to release any data to the public -they just need to maintain an even level of knowledge within their current investor base.

The fact that information is limited and that share trading mechanisms are more difficult to implement makes the potential shareholder base narrower in the case of a private company. As a consequence, the investor base in a private company is usually much more concentrated, meaning that it is easier for shareholders to push management in the same direction – this one of the core governance principles underlying private equity – and this may seduce ‘activist’ investors.

On the contrary, public companies can attract a higher number of small investors and could thus raise a higher amount of money – a few years ago raising money to fund growth was one big reason for companies to go public, at least in Europe. Nowadays, with quantitative easing in place and interest rates in negative territory, private companies can fund their growth without having to go public – see Uber’s recent $3.5bn fundraising round.

Source: Financial Times
Source: Financial Times

So, to summarise, going public provides liquidity to existing shareholders and enables the company to tap into a wider investor base, but this comes with a price associated with the publication of regulated information.

 

Why is there a push for private tech companies to go public? Is this push unanimous?

Tech company shareholders (e.g. venture capital funds) perceive the current environment (excess of liquidity, stock markets reaching all-time highs etc.) as extremely favourable for introducing new stocks at a relatively high price compared with historical standards. These funds typically have 10-year lifespans and are in a pressure to return liquidity to their investors. Pressure has been formalised in Spotify’s last debt fundraising round terms: the more the company waits to file for an IPO, the more expensive the debt will become. Separately, employees in these companies accepted to trade a share of their cash compensation for shares (‘stock-base compensation’ represents 31% of revenues at Twitter) and would like to see their hard-working, poorly remunerated efforts ultimately pay – as mentioned earlier, it is nearly impossible for an individual shareholder to sell the shares he owns in a private company.

On the other side, you have management teams which, as mentioned above, do not perceive the need to go public any more to fund growth, although they can clearly see the regulatory burden associated with public ownership.

Source: Financial Times
Source: Financial Times

To hep the two sides meet, ‘secondary markets’ have recently developed as a middle ground between unstructured private ownership and fully-fledged public stock markets. These secondary markets enable early-stage investors to cash out while maintaining the ‘private’ nature of the company.

 

Why is the IPO window said to be narrowing?

The number of IPOs has over the last few months collapsed – only 14 since the beginning of 2016 compared with an annual average of 49 since 1980. Not that the flow of candidates has dried up: Misys, a UK financial software provider, cancelled its IPO last month while O2 has indicated that the company’s planned IPO would not happen this year.

After having been attracted by the new shiny unicorns, ‘public investors’ are now proving much more cautious in their approach – possibly still having in mind the misfortune of past so-called ‘success stories’ such as Zynga. See for example this list of ‘top 10 IPOs to watch in 2016’ and compare it with the actual number of completed IPOs to get a feel of the chilly market weather.

Yes, 2015... Credits: www.turner.com
You could recycle the list for 2017. Credits: www.turner.com

Now a shiny brand name and a glossy equity story are usually not enough and the days of valuation based on revenues (i.e. putting aside any profitability consideration) or eyeballs (the mantra of the late 1990s) are over. Investors are looking for an established business model, a diversified product portfolio (suspected to be the cause of Dropbox’s IPO delay), a clear strategic edge, proven profitability (at least in some geographies) or a clear path to achieving so in the short-term, and a robust and fully committed management team with significant ‘skin in the game’.

This list of selective criteria does not prevent some IPOs to successfully complete. Coupa (despite having not made any profit) or BlackLine are two recent examples of recently floated companies which experienced significant share price growth on their first day of trading.

 

If the environment happens to be so favourable, why are Airbnb or Uber delaying their IPO?

Airbnb and Uber are often announced as the ‘hottest IPOs of 2017‘ – alongside with Snap. Those two brands however have been enjoying success for years now and one could wonder why these firms have been waiting before testing the public markets.

Credits: www.licdn.com
Credits: www.licdn.com

The reasons can be found in the previous questions. Airbnb currently does not need public markets to raise new money. Uber is burning cash at a gigantic speed – more than $1bn in H1 16 according to estimates – which makes the aforementioned ‘path to profitability’ tedious at best. Another less honourable reason is that the firms’ current valuations ($68bn for Uber, $30bn for Airbnb) would probably not withstand public markets scrutiny. Indeed, these valuation figures are purely based on extrapolations of the last fundraising round (see my previous post for further explanation) and tend to be substantially higher than the value allocated to a larger share of the equity.

As another example we could have mentioned Palantir which, despite being privately valued at $20bn, has yet to report a profit. According to Alex Karp, the company’s CEO, the IPO was postponed on the belief that large public companies struggle to recruit the most talented engineers – this statement must have been welcomed by Alphabet‘s teams.

 

Many of the tech start-ups, from small to very large, will have to face the ‘IPO hurdle’ in the coming months or years. In a world where investor liquidity does not represent a discriminating factor any more, public markets may become the next justice of the peace.

Updates, updates…

Some more follow-ups this week:

  • coupa-softwareEarlier this month Coupa Software proved to be one of the very few completed AND successful tech IPOs this year, despite reporting a loss of $24m for total sales of $60m. The shareholders were wise enough to limit the sale to $153m worth of shares, a fraction of the $1bn+ total enterprise value, in order to price the IPO at the top of the range. On the first day of trading the share price had jumped by 121.7% to $39.71, although it has since cooled down to c.$27. In any case this event shows a clear investor appetite for this kind of assets – good news for the likes of Uber and Airbnb.
Coupa Software share price evolution in USD since IPO. Source: Yahoo Finance
Coupa Software share price evolution in USD since IPO. Source: Yahoo Finance
  • On the contrary Theranos, once valued at $9bn, is close to bankruptcy after the FDA pointed out failures in its patient data collection procedures, highlighting the risks for investors who put their money in unicorns operating in ‘regulated’ areas such as healthcare or financial services – remember Lending Club.
  • Credits: rt.com
    Credits: rt.com

    Airbnb is facing ‘life-threatening’ disputes in New York and San Francisco whose governors have expressed the intention to rein the ‘short-term rental’ offering in. It is indeed argued that this type of systems contributes to the increase of rents in tight dwelling supply areas since landlords prefer to rent unoccupied flats on a short-term basis rather than putting it back on the market. So far the New York governor has approved a law which allows the city to fine landlords who list apartments for rentals of less than 30 days – a ‘half-baked measure’ difficult to enforce given that the authorities do not have access to the landlords’ identities.

  • After China, Uber is facing tough competition in Russia where Yandex Taxi, funded by the eponymous deep-pocketed search engine, has decided to cut its minimum base fares in half, leading to a taxi driver protest.
  • More generally the funding environment for start-ups has deteriorated slightly as investors prove increasingly selective in their investment decisions. Venture capital investment in European companies dropped 32% yoy in Q3, in line ith the 35% YTD drop noticed in California. The IPO window has also proven more and more difficult to reach, with investors perceiving some proposed valuations “ludicrously overpriced compared to existing peers”.
  • Credits: www.juancole.com
    Credits: www.juancole.com

    Twitter is back in the doldrums after the last takeover candidate, namely Salesforce, dropped the case after careful deliberations. The share price had already taken a hit after Microsoft denied interest, lowering the competitive tension. Although some experts believe that the company would represent a great ‘trophy asset’ for an activist shareholder, management has now shifted its attention back to streamlining its cost structure, initially designed to serve more than 500m users, way higher than the actual user base (300-350m). This exercise will result in 300 employees losing their job this year, according to Bloomberg.

Twitter share price evolution over the last 60 days in USD. Source: Yahoo Finance
Twitter share price evolution over the last 60 days in USD. Source: Yahoo Finance
  • Carrefour and Auchan have launched initiatives to tap into the wisdom of start-ups to boost their digital capabilities. Les Echos reports that Carrefour has built relationships with more than 150 start-ups and has invested in the VC fund Partech Ventures while Auchan organised earlier this month its first ‘Salon des start-ups’. Due to its close proximity with historical retailers, Lille appears as the spearhead of ‘French retail tech’, having hosted the #conext show as well.
  • UBS became the latest major bank to join the ‘robo-advisor trend’ after it announced that it would roll-out such a service in the UK no later than next month. This decision will make the service available to users with as little as £15k in personal savings, although the 1% annual fee levied for customers investing solely in ‘passive’ funds is still high compared with industry best practices. In the same vein Charles Schwab announced its robo-advisor service was now managing more than $10bn in assets, a c150% yoy growth. The first independent ‘French tech’ player, Yomoni, has much more modest ambitions, targeting $1bn of AuM by 2020.
  • Apple reported its first annual decline (9%) in iPhone sales volumes (in line with analysts’ expectations) despite the misfortune of the Samsung Galaxy S7.
Updated chart showing yoy ASP and sale volume evolution for the iPhone. Sources: SEC filings, author analysis
Updated chart showing yoy ASP and sale volume evolution for the iPhone. Sources: SEC filings, author analysis

That’s it for now!

9 investor considerations about unicorns (2/2)

[continued from Monday]

logo6. Private information leaves investors in the dark: No other example could better embody this issue than Rocket Internet. Valued at €6.7bn after a successful IPO in 2014 the company is now worth less than 50% of this amount. The lowered valuation reflects two major investor concerns. First, none of the companies in Rocket Internet has proved profitable yet, despite earlier management commitments to IPO one of its companies by end 2016 – a pledge that has now become a promise to turn at least 3 companies profitable by end 2017. Second, and more importantly, in the absence of benchmark, Rocket Internet can use a lot of discretion when valuing its private investments and the Global Fashion Group case shows that Rocket errs on the very aggressive side of the spectrum. This explains why Rocket Internet currently trades at 1/3 of the value of its companies as reported in April – the market believes there are other exaggerations lying in the dark. Research teams focused on private companies (Pitchbook is one of the most famous) have been proliferating in an attempt to guide prospective investors – but the task proves harder in the absence of official financials.

Share price evolution of Rocket Internet since IPO (in EUR). Source: Yahoo Finance.
Share price evolution of Rocket Internet since IPO (in EUR). Source: Yahoo Finance.

7. Soaring valuations are a rational but meaningless answer to a biased set of incentives: Showcasing the highest possible entreprise valuations, especially greater than the ‘magical’ $1bn, represents an efficient way for stakeholders to get (almost free) publicity in a hypercrowded VC market, but such assumptions make little economic sense. In the extreme, if I invest $1 in any given company to get 0.0001% of its capital, the company will have been implicitly valued at $1bn and could theoretically claim to be a unicorn. In real life, Airbnb used a $30bn valuation to raise $550m, i.e. less than 2% of the pre-money capital. Venture capitalists could thus be incentivised to dilute themselves in order to benefit from a better valuation. For instance, if a VC wants to invest $100m in a company, in the case it gets 12% of the shares the company will reached an implicit equity value of $833m ($100m/12%); but if the VC decides to agree on not 12% but 9% of the shares (which make a limited difference a exit unless the firm becomes the next Facebook), the company is now valued $1,111m  ($100m/9%) and has now entered the unicorn club. Great publicity for the firm, but also for the VC, which will be able to leverage this investment case to attract new investment opportunities and/or investors – in that respect Quanergy or Takeaway.com will certainly offer a good window for its backers. For the company’s existing shareholders, this capital inflow priced at a discount is a godsend – Deliveroo raised a $275m Series E last month with no real growth agenda.

8. In fundraising, quality is at least as important as quantity: A global investor footprint is also crucial, especially when the company is considering international expansion. Raising debt, which implies periodical interest payment and thus some form of cash flow predictability, is also a good indicator of the robustness of a business model – Airbnb raising $1bn of debt is a positive sign in that respect.

9. Glimpses of hope announce a rude awakening: As investors are digesting the first wave of start-up investments, they are showing decreasing tolerance for ‘hockey sticks’ in business plans, and TechCrunch recently noted that required metrics and milestones for Series A fundraising are now closer to the ‘classic’ Series B. The number of new European unicorns reached 10 in 2015, down from 13 in 2014. Fundraising amounts in Europe were down $1bn yoy in H1 2016 to $5.9bn.  Showing a clear path to profitability is a key consideration to raise additional fund and investors are less prone to buy the ‘scalability’ argument. Has the European market slowed down quickly enough? This was at least the viewpoint that the Financial Times was defending before the summer – referring to the fact that there is one new unicorn in Europe every 2.5 months compared with one every 1.7 months last year. On top of a structural regression to the mean, Brexit could harm the financing of UK-based start-ups, although the first post-referendum figures tend to contradict this belief. The adjustment could be tough to make internally: entrepreneurs need to switch from ‘hypergrowth’ to ‘sustainable growth’, a mode that requires different skills, a revised strategic approach and a distinct management style.

andrew-evans“Unicorn valuations, in many cases, are a triumph of hope over reality.”

(Andrew Evans, Equity Value fund manager at Schroders, in the Financial Times)

Any other thoughts? Please feel free to contact me or comment under this article.