My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

IPOs and the story of DoorDash and AirBnB

DISCLAIMER: Below are my opinions on two stocks, DASH and ABNB. I am not a research analyst or a registered investment advisor, and the information in this article is not a recommendation to buy or sell shares. It is just my two cents. I do not own shares of either company.


Introduction


This article discusses the highly successful IPOs of DoorDash (“DASH”) and AirBnB (“ABNB”) last week. I thought that I would also use this occasion to provide a brief overview of the IPO market, and I mean very brief because my background is in debt (bonds) not equity. In fact, I probably know just enough about the intricacies of the public equity markets to be dangerous, so any input from readers would be terrific should I mis-speak in this article. I want to focus mainly on the price action of the stocks of these two spectacular IPOs from last week, and to show the reader how valuations of these high-flyers compare to other similar companies that are publicly listed. Before getting started, let me provide one more disclaimer. As much as I would have enjoyed reading the S-1 registration statements for both companies (sarcasm alert), I thought I had better things to do than plough through hundreds of pages of intricate details, much written in “legalise”, on these two companies. I have provided the link to both companies’ registration statements later in this article in case you wish to learn more about these companies.

The reason I am writing this article is that both DASH and ABNB raised over $3 bln in IPOs last week, and the shares promptly gapped up once they started trading by 86% and 113%, respectively. The market capitalisation of these two companies, neither of which is profitable, is wildly optimistic in my opinion. Is it possible that DoorDash (market cap of $55.6 billion) is worth more than Dominos and Chipotle combined? Or that AirBnB (market cap of $83.2 billion) is worth more than Marriott, Hilton and Expedia combined? Both companies are valued at over 20x trailing (4Q) revenues, whilst valuations of comparable companies – save one – are not even near 10x revenues (which is in itself outrageous). These sorts of valuations simply don’t work for me, although admittedly, this is coming from an investor that thought Tesla was ridiculously priced at slightly less than $100/share (adjusted post-split) last year at this time (now $638.71/share).


Fundamentals are the traditional way to value companies, meaning looking at future cash flows (or perhaps more appropriately discretionary free cash flows), and discounting these back. This sort of valuation technique is simply being ignored more often and more broadly, or so it feels to me. Many high flying stocks have become the focus of a growing cadre of investors that simply don’t care about intrinsic value, but instead focus only on situations where they think a demand-supply imbalance (in essence technical factors) will cause a stock to be worth more tomorrow than it is today. And why not? Like it or not, it has been an effective strategy as momentum investors have largely overwhelmed value investors, generating spectacular returns in recent months. I also cannot argue with the macro trends embedded in this strategy. Cyclicals, energy companies and travel/hotel/entertainment companies were punished during most of the pandemic as their outlook dimmed, whilst WFH (“work from home”) stocks and companies benefitting from an acceleration of trends in place pre-pandemic (e.g. the move to on-line shopping) prospered. There is nothing irrational about this, it makes sense.


There is another important factor to consider not related per se to individual stocks but to asset classes, which is the ongoing super-accommodative stance of the Federal Reserve. The central bank is pumping massive amounts of liquidity into the markets, much of which is finding its way into assets of all types, pushing their prices higher as they become increasingly unlinked from fundamentals.


This is the context in which we currently find ourselves, like it or not, and it is the context in which we now have to make investment decisions. With that slight digression, let’s get back to IPOs, and to DASH and ABNB, starting by stepping back and looking at the IPO market. What is an IPO?

IPO means “Initial Public Offering”, which is the creation and sale of new shares (referred to also as equity) to public investors. This is also known as “listing shares”. Before a company becomes a candidate for selling shares to public investors, it generally raises money through multiple rounds of private equity financing, often starting with money from the founders themselves and / or “friends & family”, then – as the company grows and its capital needs become greater – from other (unaffiliated) high net worth individuals, family offices and eventually venture capital and / or private equity firms. (One such later stage institutional investor about which I have written, for example, is the SoftBank Vision Fund – see article here from July 16th.) An IPO – the process of which is described in the rest of this section – is by far the most popular way for companies to go public, although it is not the only way as I discuss later in this paper.


Each country has regulatory and disclosure requirements for companies that are traded in the public markets, and these can be very rigorous in order to protect public investors from a company’s failure to disclose all relevant information or even to defraud investors. In the US, all IPOs are reviewed by the Securities & Exchange Commission, or the SEC, which is a demanding, time consuming and expensive process. Both the company and its lead underwriting banks have top-drawer legal firms involved to handle the drafting of the very comprehensive and extensive disclosure document (“registration statement” or “prospectus”). The company’s auditors are also heavily involved and have to provide comfort on all financial disclosure.


A company is guided through an IPO by investment banks that will ultimately underwrite the issue after determining a “fair” price for the shares. This is determined by the lead banks, which conduct an extensive price discovery process involving meetings and discussions with potential investors prior to the offering. Once the banks decide on a price and other parameters of the offering (size of the offering, number of shares, etc), the underwriting banks then simultaneously buy and on-sell the shares to public investors, including individuals and institutions, at the IPO price. This process is referred to as “underwriting.” Once a company’s shares are listed, investors can buy and sell them in the secondary market. Once a company has gone through the process of listing its shares, it can raise more equity capital more easily in the future through additional share sales, referred to as “secondary offerings”. As an aside, the major prerequisite for a company to do a successful IPO is that there must be a compelling story for growth in the future. Also, a company must have a strong and experienced management team, and appropriate governance as far as financial reporting, board of directors, etc. Most companies that go public are “unicorns”, meaning that they are valued at $1 billion or more.


Is there an alternative to a company listing shares via an IPO?


As I suggested in the preceding section, there is indeed an alternative for a company going public without following the traditional IPO process. Rather than creating and selling new shares via an underwritten IPO, existing investors in a company can instead simply list their shares for public sale via a “direct listing”. No new shares are created and no underwriting banks are involved, although the process as far as disclosure, SEC registration, etc. is just as rigorous as with an IPO. Since no underwriting banks are involved in direct listings, the transparency and entry costs (no IPO commissions) tend to be much lower. The downside is that there is less protection and support for the shares at the early stage of the post-offering process because underwriting banks are not involved to stabilise the price. Investopediahas a succinct article on this: “IPO vs Direct Listing: What’s the Difference.” Several rather prominent companies have used a direct listing in lieu of an IPO with mixed success, not different really than the outcomes for an IPO although perhaps less euphoric. Companies using direct listings to go public have included Spotify, Uber and Slack, to name three.

I suppose I would be remiss were I not also to mention SPACs, or “Special Purpose Acquisition Companies”, which are getting an enormous amount of attention at the moment. SPACs, which are publicly-listed, offer another way for a private company to become a publicly-listed one. A SPAC is a “blind pool”, listed (public) company, meaning it has no assets initially aside from cash raised in an IPO. The strategy for a SPAC is to use this “blind” investment pool to acquire a company, generally a private one. This transaction allows the private investors in the target company to realise value via the sale of their company to a listed company. Most SPACs have sector or geographic themes, and generally have 18-24 months to find a suitable target in which to invest. If an acquisition does not take place within the specified time frame, the SPAC is unwound and cash is returned to the investors. In essence, being acquired by a SPAC is the means for a private company to “back into” becoming a public company. Should you want to learn more about SPACs, I thought this article from PWC regarding SPACs was very good: “How special purpose acquisition companies (SPACs) work”.

Can I buy shares in an IPO?

The simple answer is “yes”, but the reality is different because getting shares in a “hot” IPO depends very much on who you are. Firstly, to get shares in a popular IPO at the listing price requires that you have a brokerage account at one of the underwriting banks. However, that is only the first box to tick. Secondly, if the IPO is “hot”, meaning it is expected to perform strongly in the secondary market, institutional investors are likely to receive the largest allocation of shares because of the scope of business that these investors do across the board with the lead underwriting banks. Once a price is fixed, the lead banks allocate shares to investors that have placed orders to buy shares. If the issue is over-subscribed, meaning that the order book is larger than the number of shares available, investors are “scaled back” in a way that is more of an art than a science, in an effort to sell shares to as many investors as possible, but to also acknowledge the size of each investor’s order and their business history with the bank. Lastly, underwriting banks generally focus on allocating the large majority of shares to “buy & hold” institutional investors rather than to “fast money” accounts that might sell – or “flip” – the shares as soon as the shares are free to trade, which happens sometimes if the share price pop is substantial. How have IPOs performed? As I was writing this article, my attention was firmly on the high flying IPOs like DASH, ABNB, Snowflake (SNOW) and Lemonade (LMND). But for each of these, there might be many more underperformers that don’t come to mind as quickly. There are a fair number of these newly-listed companies, whether by IPO or direct listing, that were not able to maintain their IPO price after issuance. These include, for example, Slack (WORK) and Uber (UBER). You might even remember Facebook (FB), which listed shares at $45/share on May 18, 2012, and fell to as low as $17.33/share in the ensuing months before finally closing above its IPO price 16 months later (Sept 11, 2013). Even worse, there are some potential IPOs that simply never got out of the starting blocks. Remember WeWork?

DASH and ABNB IPO parameters

With that background, let’s return to our focus on DASH and ABNB. Both companies raised around $3.5 billion, and the shares of both skyrocketed in the first day of trading although both have settled somewhat. From my perspective, the bad news is that the valuations at the current levels are absurd. However, the good news is that both of these companies now have a significant wad of cash to buy themselves time to implement their strategy and to ultimately (and hopefully) move from money-losing to profitable. Here are the metrics of each company.


The table below is summary of each company’s IPO.


You can find the very extensive S-1 Registration statements for each at these links: DASH, and ABNB. How do values of DASH and ABNB compare to other similar companies? As an investor in equities, you should of course always compare companies and their share prices to other similar companies to formulate a relative value picture, which should then clarify the best stock in which you should invest. A numerical comparison is far from the entire story of course, because this does not address things like market growth/potential, competitive landscape, “moats” (technology, patents, early mover advantage, etc), quality of management, and so on. In this respect, both DASH and ABNB are disrupters that have earned “proof of concept” with rapidly increasing customer bases (albeit COVID-19 affected). They are much more progressive and innovative than their peers, and therefore, justify higher valuation multiples on the basis of qualitative factors alone. However, neither company is profitable, and both are relatively small compared to near-peers, many of which are profitable and substantially larger. Also, the competitors have long histories and access to multiple channels of capital to finance their growth. When you mix all this together, it is simple for me – I can under no circumstances at this point come close to saying that either DASH or ABNB are attractive stocks to own at these levels. Look at the table below and decide yourself.



Were these two recently-listed companies inserted into the S&P 500 index (hypothetically), ANBN would be the 85th largest company by market cap, ranked just below food company Mondelez and just above Goldman Sachs. DASH would be the 126th largest company in the index, ranked just below Global Payments and just above Humana. Do I need to remind you that neither DASH nor ABNB have ever made a profit?


How are DASH and ABNB performing in the early stages of their existence compared to other recently-listed companies?


It’s really way too soon to tell, although both companies have come off their post-IPO highs. The table below shows several recently-listed companies, so you can get a sense of the variety of performance. In every case but Uber, had you bought shares in the IPO and sold them at the opening level, you would have made a very good one-day return. In most cases, there was money to be made if you bought shares even after the IPO (more or less at the IPO + day 1 pricing). The jury remains out as far as DASH and ABNB. Slack was a perineal underperformer but has been bailed out via the acquisition by Salesforce.com. Uber just recently found its momentum, perhaps some favourable contagion from the lofty multiple of DASH (because of Uber Eats).



One final point worth noting is that as I am finishing this article, I see that two brokerage firms have come out with “overvalued” recommendations on DASH and ABNB. Of course, these recommendations would not come from the underwriting investment banks, but rather from brokerage firms “away from the deal” that are more likely to call it as they see it, with no vested interest in seeing the shares go up and up and up. Brokerage firm D.A. Davidson cut DASH rating from buy to neutral, “broker-speak” for sell, whilst brokerage firm Gordon Haskett cut ABNB from buy to underperform. Both sited the reason as valuation.


Conclusion I struggled to get comfortable with PTON (IPO Sept 2019) and SHOP (IPO 2015) well after their post-IPO run-up, both of which I wrote about on November 10th in emorningcoffee.com (here). Are DASH and ABNB really that different? I think they are to differing degrees, because they simply don’t have the cocktail of quantitative and qualitative factors to justify their price level post-IPO. Although I would need to do more work, I would probably consider buying ABNB at a price more in line with its peers adjusted for its disruptive market position, but it’s simply way too high for my taste now. DASH is not my cup of tea, although it seems investors love it.


Hopefully the information in this article will help you better understand both companies, as well as more generally the process that a company goes through to become a public company. *** Follow emorningcoffee on Twitter, and please like and comment on my posts right here on my blog. You need to be a subscriber, so please sign up. Thanks for your support. ****



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