A Peek Into the World of Initial Public Offering (IPOs)
Given recent talk of the worlds largest IPO, Saudi owned Aramco, we dive deep into the world of IPOs and look at the winners and losers when IPOs go wrong.
An Initial Public Offering or IPO for short is the process by which the shares of private companies initially begin to trade publicly on a regulated stock exchange, such as the LSE or the NASDAQ. This process is also commonly referred to as the company going public.
IPO's have historically been the yardstick for which to measure the success of a company. Publicly traded companies were deemed to be more prestigious. As such, when large companies decide to list publicly for the first time, it is often associated with extensive media attention, such as the media attention surrounding the forthcoming Saudi Aramco IPO.
Admittedly, IPOs have generally become less significant capital market affairs over the past decade or so, following the growth of the venture capital/private equity. Companies are no longer in a rush to go public.
21st-century private corporations, often backed by an army of PEs or VCs generally prefer to continue growing without seeking a listing because of their greater access to capital. They are in no rush to raise capital from the public to expedite their growth or offer an exit for the investors.
The growth of PEs and VCs has given companies most of the benefits of going public, without the unwelcome drawbacks (such as the increased public scrutiny, regulatory requirements or focus on short term profitability). As such, companies are quite happy remaining private, allowing them to grow without the pressure of being a publicly listed company.
Uber, WeWork and Airbnb are some of the large companies that initially spring to mind, that didn't pursue a listing and quite happy to grow on private capital, despite being worth tens of billions of dollars and larger than most publicly listed companies.
Perhaps the vast size of startups looking to list for the first time is a reason for IPOs no longer providing sufficient value to the companies or their investors? Growth through private capital has become increasingly common. Consequently, the larger these companies become in private hands, the more difficult it is to accurately value increasingly large and complicated businesses, particularly in the case of fast-growing (and often loss-making) tech companies.
The difficulty in valuing these companies may explain why the valuation of many IPOs have gone spectacularly wrong over the last few years; Uber, Slack, Lyft, Funding Circle and Aston Martin to name a few.
With respect to Saudi Aramco's impending IPO, Saudi officials and insiders close to the deal have disclosed that the crown prince, Mohammed bin Salman, is seeking a $2tn valuation. Depending on which analyst involved with the IPO, the value of the company is between $1.2tn and $2.5tn. A $1.3tn margin is enormous and shows there is a broad scope to misprice this IPO, getting it completely wrong.
The traditional methods of valuing companies, based on earnings, is becoming increasingly less relevant in the current dynamic, PE-backed environment. The private equity industry has changed the games.
Uber's Failed IPO
The most hotly anticipated IPO (Uber Technologies Inc) of recent history has been labelled as a disaster by much of the media.
Uber IPO'd in May 2019 for $45 per share, valuing the company at about $82bn. This valuation is significantly below the valuation being touted pre-IPO. The company valuation pre-IPO was in excess of $100bn.
Who are the winners and losers with this loss of value?
At first glance, it would appear to be either the company itself or its pre-IPO investors. At the time of writing, the company is currently trading at $30 per share, with a market cap of $51bn, but IPO'd at $45.
The company managed to convince investors on IPO that it was worth $45 per share when it was actually worth $30 per share. Uber is worth $51bn - almost half the company had been expecting to list for pre-IPO. Two-thirds of Uber's value since IPO has been wiped out. To give some context, Uber had a $74bn valuation in its last private investment round.
Uber had been able to convince investors that the company was worth a lot more than the market perceives it to be worth, evidencing the difficulty in valuing private companies, especially huge, fast-growing companies like Uber, yet to turn a profit.
It's like a used cars salesman trying to flog an old banger at an inflated price. Uber was quite simply not worth the price being touted by its directors or the banks as it could not support this valuation but was able to sell at an inflated price above its actual valuation to the public.
There are winners and losers to this apparent overvaluation of companies on IPO. Although being labelled as a disaster, investors holding shares pre the IPO will be describing this as a success. They have sold shares to the public for $45 each, which are now worth $30.
Therefore Uber (or more accurately the pre-IPO investors in Uber) should be considered the winners of this transaction. The banks, lawyers, accountants and other advisors to the transaction who have helped themselves to a nice chunk of the fees would have also done pretty well. The losers are the public — the poor investors who bought shares in Uber on IPO at an inflated price.
IPO's can be extremely risky and volatile, especially if mispriced.
Recent Failed IPOs
Unfortunately, Uber's failed IPO is far from unique. At the time of writing, the following companies are trading at a fraction of their IPO price, suggesting that the valuation the companies were able to convince the IPO investors were inflated and overvalued.
- Slack is trading at 56% of its IPO price
- Uber now back up to 71% of its IPO price
- Lyft is at 5% of its IPO price
- Aston Martin is at 25% of its IPO price
- Funding Circle is at 22% of its IPO price
You may question why all this is relevant for you.
If you have any savings accounts, pensions or use any government services, then the efficiency of the public markets is very relevant to you. It would determine the quality of life you have in retirement. The level of taxes you paid. Government services you can use. The returns you earn on your savings.
How will Saudi Aramco's impending IPO turn out? No one knows. One inevitable outcome is that there will be winners and losers. Let's hope the advisers don't screw up the world's largest IPO to date.
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