Investing for Retirement: Beware the Unicorn IPO Stampede

In medieval and Renaissance allegories, unicorns are uncommon and wild creatures that signify honesty, constancy, purity, and therapeutic.

On this planet of finance, unicorns are venture-capital- (VC-)backed and privately funded firms with valuations in extra of $1 billion which might be now not so uncommon — and should not at all times be so pure. And that’s one thing funding advisers must be particularly aware of. Why? As a result of unicorns are about to enter the preliminary public providing (IPO) market and turn into a part of index funds which have a big presence in retirement portfolios.

Earlier this month, the ride-sharing service Lyft kicked off what is predicted to be a file yr for unicorn IPOs by submitting its pre-IPO Kind S-1 with the US Securities and Alternate Fee (SEC). Lyft, which can be listed on the NASDAQ as LYFT, represents a complete new breed of unicorns which might be galloping round world capital markets. Many of today’s unicorns are poised for IPOs despite losing quite a lot of money. Certainly, Lyft incurred a web working lack of $911.3 million in 2018.

Whereas such unicorns have sturdy development prospects, they typically have unsure paths to profitability. They might be on the forefront of innovation, however a lot of them are additionally early-stage enterprises with a excessive probability of failure. And that’s why analysts and traders must beware: As unicorns go public, they’re added to main large-cap indexes and, by means of the mechanics of index funds and passive investing, discover their manner into portfolios all alongside the earnings and wealth spectrum, together with portfolios with retirement financial savings. This exposes these portfolios to the dangers — and potential rewards — at the moment related to VC investing.

In keeping with latest information from CB Insights, there are actually greater than 150 unicorns in the US alone and sizeable cohorts in China, the EU, India, Singapore, Israel, Canada, Japan, and elsewhere. The US record consists of high-profile enterprises which have remodeled our client expertise — from Lyft and WeWork to Airbnb and Epic Video games.

US Unicorns, Cumulative and New, 2006–2018*

Number of Unicorns, Cumulative and New, 2006–2018

* As of year-end 2018

Supply: CB Insights 2018 (cumulative); Preqin (all different information)

Which brings us again to Lyft. The corporate began operations in 2012 in California and reached unicorn standing in 2015. For 2018, the corporate reported revenues of $2.2 billion, twice its 2017 revenues. The $911.3 million web working loss was up from $688.3 million in 2017 and was largely pushed by its fleet of drivers and bills associated to intangible property. With bills of $3.1 billion, Lyft had a income/expense ratio of 68.8% for 2018, which is similar to that of the median tech IPO in 1998 and 2001, which fell within the 60%–80% vary.

The median revenues/expense ratio of tech IPOs bottomed out under 60% in 2000 and has been above 80% all through the 2002–17 interval. A significant factor of Lyft’s bills pertains to its intangible property and is likely to be extra correctly capitalized as an asset on the steadiness sheet as an alternative of an expense on the earnings assertion. Nonetheless, Lyft’s income/expense ratio is traditionally within the low vary of tech firm IPOs.

Within the S-1, Lyft’s administration emphasizes the significance of key efficiency indicators (KPIs), resembling income per lively driver, rides by annual cohort, variety of bookings, and income per reserving in evaluating the corporate’s working outcomes. Lyft’s US ride-sharing market share was 39% in December 2018, up from 22% in December 2016. For the quarter ended 31 December 2018, Lyft had 18.6 million lively riders and over 1.1 million drivers. These KPIs help Lyft’s anticipated IPO valuation regardless of adverse free money flows and no earnings generated so far.

Aswath Damoradan recently estimated the value of Lyft’s equity at approximately $16 billion, together with $2 billion from the IPO, at about $59 per share. He additionally estimated the potential for Lyft failing inside the subsequent 10 years at 10%. Had been that 30%, all different elements being equal, the IPO’s estimated valuation could be adjusted to $13.3 billion, or $47.7 per share. As a result of the IPO is oversubscribed, the precise IPO valuation will seemingly fall within the $20–$25 billion vary.

After its IPO and a associated “suspension” interval, Lyft will turn into eligible for inclusion in varied US large-cap indexes. The S&P 500 Index calls for 4 straight quarters of optimistic as-reported earnings as a part of its standards. Different indexes, nevertheless, have far much less stringent necessities. As an example, the NASDAQ 100 forbids an issuer in chapter proceedings from issuing securities however doesn’t have optimistic money movement or earnings necessities. Lyft will even be eligible for inclusion in sure CRSP capitalization indexes designed to characterize the market of investable US fairness securities based mostly totally on measurement. Common exchange-traded funds (ETFs), such because the Invesco QQQ Belief, which tracks the NASDAQ 100, and the Vanguard Giant-Cap ETF (VV), which tracks the CRSP US Giant-Cap Index, will find yourself holding many Lyft shares after the IPO.

The monetary business has been working onerous to rebuild public belief for the reason that Nice Recession. Unicorn IPOs can provide important return alternatives for traders and higher distribute the wealth generated by VC markets. However in IPOs the place preliminary unicorn shareholders will acquire speedy advantages, just a few questions must be answered: Are these companies well worth the money that the IPO itemizing will present them? What’s the chance that cash-burning unicorns will find yourself turning a revenue, and when? Which unicorns can be able to long-term worth creation for his or her traders?

Finally, the monetary business is chargeable for offering the transparency traders deserve and ethics dictate. If unicorns are built-in into ETFs and mutual fund portfolios, traders should be adequately knowledgeable and obtain appropriate recommendation about how such firms match into their index fund holdings. They will then make knowledgeable choices on whether or not an publicity to VC-style securities, both instantly or by means of index funds, is appropriate for his or her funding objectives.

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All posts are the opinion of the creator. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially mirror the views of CFA Institute or the creator’s employer.

Picture credit score: Domenichino, Public Domain

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Antonella Puca, CFA, CIPM, CPA

Antonella Puca, CFA, CIPM, CPA/ABV, CEIV, is a Senior Director within the Valuation Companies group of Alvarez & Marsal in New York and the creator of Early Stage Valuation (Wiley, 2020). Previous to A&M she was a part of the choice funding group at KPMG/Rothstein Kass, the place she helped launch RK’s Bay Space observe, the worldwide hedge fund observe of EY in San Francisco and New York, the monetary companies staff at RSM US LLP, and BlueVal Group in New York. Puca served as a director within the ethics {and professional} requirements group at CFA Institute and as a volunteer centered on certifications and curriculum packages. She has served as an government committee member of the board of the CFA Society of New York and as a member of AIMA’s analysis committee. She is a member of the Enterprise Valuation Committee of the AICPA. Puca is licensed as a CPA in California and New York. She is accredited in enterprise valuation (AICPA), holds the valuation analyst and the entity and intangibles valuation certifications. Puca is a member of the Italian Skilled Affiliation of Journalists. She holds a level in economics with honors from the College “Federico II” of Naples, Italy, and a grasp of legislation research in taxation from NYU Legislation Faculty. She has been an adjunct school member at New York College, a analysis fellow on the Hebrew College of Jerusalem, and a member of the 420 Italian Nationwide Crusing Crew.

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