Unicorn IPO Investing: To buy or not to buy, is it worth the risk?

In today’s technological era, it’s a given that Unicorns are non-existent creatures. We know that with (almost) absolute certainty! So, when Cowboy Ventures founder Aileen Lee coined the phrase “Unicon Club”, the intent was to underline the non-existence (or extreme rarity) of successful start-ups valued at over $1 billion or more in private or public offerings.

Today, Unicorns include companies that Lee’s firm brands as “paper Unicorns” – referring to companies that have not yet had a “liquidity event”. Translation: These are loss-making private entities, some of whom have gone public at lofty valuations.

The big quest for investors is: Are these IPOs (and subsequent publicly-traded names) worth investing in?

The Unicorn stampede

Before we answer the BIG QUESTION, let us look at the Unicorn landscape as of earlier this year. While companies like Lyft, Inc. (LYFT) and Uber Technologies, Inc. (UBER) have sucked up a lot of air time recently, there have been over 350 Unicorns created since 2010.

In 2018, the number of start-ups joining the Unicorn ranks was 119. So far this year, there’s been a stampede of Unicorns with nearly 40% of the 2018 number reached in just under 5-months worldwide. A close look at the valuation of the top 15 or so names in the exclusive club (some of whom have now gone public) gives us an idea of the magnitude of the Unicorn stampede crisis.

But these numbers don’t really paint the true picture.

Investor caution warranted

When LYFT went public in late March 2019, its stock opened at slightly above $87. At the time of this writing, the shares were trading at $58.07 – that’s an over 33% decline! So, what happened to this Unicorn? Well, when the company published its quarterly results post going public, it reported a $1.1B loss for the quarter ending March 2019. On the backs of that dismal report, the shares tanked nearly 11% for the day.

Source: Yahoo Finance

As is indicated in the price movement chart above, LYFT hasn’t had a smooth ride since going public. However, despite analyst skepticism of the company’s near-term prospects in a toughly competitive marketplace, LYFT sold nearly 35.5 million shares – something that blew past expectations – at an average price of $72. Doing the math then, the company raised $2.3B from its IPO!

Now, take the much-anticipated IPO of ride-hailing darling UBER. Just a few weeks prior to its going public, it was believed that the company was reportedly looking at a valuation of over $100B! The company priced its IPO at the lower range of its target – $45 but debuted at $42, and by the close of its first trading day, the stock was already down by 7.6%. By the close of day-1, the company was valued at $69.7B – way lower than its $100B Unicorn price tag! At the time of writing, the shares are struggling to hold on to a $41 price tag!

The challenges

Unicorns face a number of challenges that other “normal” companies don’t:

  • They are typically disrupters, and therefore their business models are relatively novel and unproven
  • They are overly aggressive in their growth strategies – they have to be! – and therefore risk missteps
  • They face internal pressures from employees and contractors (like LYFT and UBER drivers), and therefore must walk a thin line between pleasing internal forces and external ones (investors, shareholders and business partners)
  • Because everyone wants a slice of “Unicorn bacon” – including government – they are frequently the target of legislation and regulatory body scrutiny

In such an environment, investing earlier on in start-up IPOs might not be a great idea. Let’s learn from lessons in patience from some other famous disruptors. When Facebook (FB) went public back in 2012, it shares plunged significantly during the initial months of its trading.

Source: Yahoo Finance

And even though early investors are looking back in hindsight with glee, one can’t help but wonder what would have happened if FB had gone public under today’s regulatory environment! Snap Inc. (SNAP) is yet another one of those Unicorns that went public back in 2017. However, unlike FB, this one has been a dismal failure – as investing in Unicorn IPOs go.

The stock closed its first trading day at $24.48, with 217,048,900 shares traded. By day-2, as the shares closed at $27.09, early investors were feeling very confident that they had struck gold. Sadly, for those early investors, the company’s stock has never recovered to its early-IPO price – EVER! On Dec 21, 2018, during the Big Meltdown, the stock sank down to $4.99. At the time of this writing, the SNAP is trading at the sub-11.50-dollar range.

And then, there’s Beyond Meat, Inc. (BYND) that went public on May 2, 2019, at $46 and closed the day at $65.75 – a more than 41% spike. Today, the shares are trading at an intra-day price of $88.67. Early investors would have made a killing had they stuck with this one!

Temptations and takeaways

There are many more tempting opportunities that lay ahead for Unicorn watchers. Workplace collaboration and communication platform Slack plans to go public in the next months or so in an expected $7B IPO. Also hotly anticipated is another Unicorn – Airbnb – that’s expected (or maybe not!) to go public sometime in 2019.

While you may be tempted to bet on some of these companies, you should temper your urge and hold back. Unless it’s “gambling money” that you have to spend, don’t make Unicorns a key part of your portfolio. And never jump in on day-1 of the IPO action. History shows us that the patient investor can wait for a few weeks (or even months!) to find out whether the company will really be worth adding to a portfolio.

One advice that veteran investors always give is: Look at the company’s financials before adding a name to your portfolio. Unfortunately, because Unicorns are largely privately held entities prior to going public, they are not bound to provide much data to the investing public. And that makes it even more important for you to put a damper on any urge to “get on the ground floor” of an impending IPO.

Unicorn alternatives

If IPOs are really your “thing”, then there’s a safer way to play that theme. One relatively easy way to add some IPO action to any portfolio is through an ETF.

Source: Yahoo Finance

First Trust US Equity Opportunities ETF (FPX) has been around since 2006 and has been a great performer – even outperforming its benchmark index (IPOX®-100 U.S. Index.) over a YTD, 3-year and 10-year period, as well as handily over the past 3-months.

The one thing that you should be aware of is the Expense Ratio. The ETF charges a fee of 0.59%, which is significantly higher than its category average of 0.39%.

The author does not have an investment in stock discussed in this article.

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Published by
Monty Rodrigues, Contributing Editor

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