Even more valuable than the profits investors make in the stock market are the hard lessons they learn along the way… Thing is, the lessons are only valuable if they’re actually learned.
I’ve been meaning to write about this topic for a while since the year 2019 presented an interesting case study with (often misplaced) vaulting optimism in tech companies from venture capitalists. It was the year where investors seemed to have ditched the age-old wisdom of putting your money on a company that had a secure business plan, was either profitable or had a clear path to profitability, kept debt loads low and had a positive press following. It was the year when venture capitalists flocked from shiny new company to shiny new company, picking up shares in the companies with the sleekest packaging and best marketing team. For most of these companies, the ‘packaging’ laid a temporary veneer over huge financial losses, a chaotic board, endless controversy, and no clear plan in place to turn financials around.
One after another, these tech unicorns filed for IPOs, leapt into the public eye… then swiftly crashed and burned, culminating with the particularly fatuous WeWork saga — the much-anticipated would-be IPO that never was.
It seemed that after such a disastrous year, the first quarter of 2020 would come as the epiphanic ‘back to basics’ moment when investors would put their money in profitable, stable companies with a strong foundation and a talented boardroom of business leaders. Before I sat down to write this out, I read a few headlines about the online mattress retailer, Casper, with that tricky three-letter word in it: “IPO” (between the time this is written and the publication date, the company was demoted from its unicorn status, but the sentiment remains). The company has yet to turn a profit, has burned through funding for marketing, and has a lofty valuation that draws more skepticism than awe from investors. Surely, we’ve all learned a few valuable lessons… right?
The term “unicorn” refers to a privately held company valued at over $1 billion, being coined in 2013 to highlight the statistical rarity of these ventures. By that definition alone, they sound like they’re automatically poised for success (it also seems that if they’re so supposedly ‘rare’, it’s odd that so many came to market over the past year, but I digress). This isn’t necessarily the case: many of these companies haven’t been profitable prior to filing for an IPO and have taken on a crushing amount of debt.
Many headlines reporting on tech unicorns included coverage of companies that aren’t traditionally (or even technically) defined as ‘tech companies’, though most of these companies operate and proliferated on a technological platform, thus lending to their quick success. To clarify my definition of ‘tech unicorn’, I’ll be referring to companies with billion-dollar valuations that exchange goods and services, generate subscriptions or operate substantially on tech platforms.
Anyone who was paying attention to the unicorns that went off to the races last year could name off the notable failures: Jumia (which dropped 54 per cent from launch to the year’s end), Lyft (-45 per cent), Slack (-40 per cent), Pinterest (-24 per cent), and Uber (-16 per cent). With the exception of Jumia and Pinterest which both saw a pop after going public before fizzling out), most of these examples have face-planted as soon as they came to market.
There are various nuances with each company that explain exactly why each failed as they came to market that this feature won’t have the room to get into each and every one. There are a few over-arching red flags each of these companies waved that overly optimistic investors seemed to ignore, seeing seductive marketing and the vague promise of ‘potential’ and ‘innovation’ instead. Reminds me of a quote from Bojack Horseman: “When you look at someone through rose-colored glasses, all the red flags just look like flags.” In hindsight, those flags were screaming red:
The Profit Problem
The most widely quoted, glaring issue with most of these companies is their struggle on the path to profitability. The priority of growth over profit seemed to be the mantra for these companies and the strategy inevitably backfired by the year’s end. Forbes described the consistent revenue estimate misses from the African online marketplace company, Jumia. Ride-sharing services Lyft and Uber have never posted profits of their own. Worse still, they actually reported mounting losses before turning to the public to raise additional capital. Mike Isaac’s Super Pumped: The Battle for Uber outlined the dramatic trajectory of the company. Isaac reported last August that the company reported its largest loss of $5.2 billion. The argument that this funding was funnelled into maintaining a loftier company image was bolstered by WIRED’s review that described how Uber was losing $2 billion annually on “promos for drivers and riders in order to support said juggernaut.”
Again and again, these company announcements of IPOs quickly yielded an analysis piece in mainstream financial publications about how these companies couldn’t turn a profit. Slack and Pinterest also have the profitability test in 2019, posting larger losses. It was probably more rare to come across a unicorn that had a secure profit model in place. Swiftly burning through investment capital to grow faster than the other disruptors appeared to be the Silicon Valley mantra, one that was broadly adopted by many tech CEOs in 2019.
Weighed Down by Debt
Of course, burning through money and not having a profit is a recipe for burgeoning debt loads. A sensible amount of debt can be a natural part of any company finding its footing, but it doesn’t take a certified accountant to figure out that a growing pile of debt without the means to pay it down is bad for the balance sheet. Worse still, it’s unattractive to investors. While multiple funding rounds may have given companies like Uber more funding to burn through, the amount borrowed to fund their aggressive expansion gave it a long-term debt burden of $5.7 billion, according to Wolf Street. The analysis surrounding Jumia’s relationship with debt was a bit more optimistic — provided they maintain higher levels of cash and their long-term profitability plan pans out. It should be noted that Pinterest and Slack have managed to get by with little debt.
At the End of the Year, It All Comes Down to Risk
Economic uncertainty forces businesses to work on a shakier foundation and investors to make unconventional decisions with their money. 2019 has been a case in point with these rookie companies that appeared to have potential as renegade market disruptors, but ended up being colossal cash pits with elevated risk.
The Bad and the Ugly
Of course, there were more company-specific problems that set some of these unicorns apart from the rest. The poster child companies of unicorn IPO failures involved having very dramatic negative public press stories that lead to very public failures. The Uber and WeWork sagas presented the most headline-hogging company meltdowns. Uber’s controversies surrounding ride-sharing sexual assaults and the CEO, Travis Kalanick, caught on camera berating one of his drivers, lending to the impression that the company severely undervalued the people who worked for their platform.
Despite the losses and the inflammatory headlines, there is value in painful lessons — they certainly stick for longer.
2020 rolled in as a new year with new problems: the escalation of U.S.-Iranian tensions had skittish investors pulling out and throwing around mentions of World War III and concerns surrounding coronavirus. With added uncertainty and given last year’s performance with these companies, it seems like unicorns are starting to lose their magic in investors’ eyes. Analysts hold a more skeptical view of these companies, particularly after their financial documents made public prior to the IPO showed companies quickly losing money. 2020 will likely be the year that investors go back to basics and invest in companies with clearer paths to profitability.
Companies themselves are making a few moves of their own: their younger, less experienced CEOs are being replaced with industry veterans that have a lengthier resume. Uber was one of the first unicorns to trade off their embattled CEO with Dara Khosrowshahi in a bid to redirect its ‘moral compass’. WeWork pushed fresh-faced Adam Neumann off of the board and recently brought in Sandeep Mathrani, who is expected to assume the role on February 18th. Mathrani holds a documented background in real estate and, in stark contrast to Neumann, he plans on approaching WeWork’s restructuring plan with a level-headed, five-year plan to turn the company around, achieve profitability, and reach a positive free cash flow by 2022, according to CNN Business. The cultish CEO-deifying attitudes of Silicon Valley are being left behind in the pursuit of a more sensible business plan.
I spoke with Darren Sissons (@KiwiPMI), an experienced tech investor and the Vice President and portfolio manager of Campbell Lee & Ross’ investment management team. Investors like him see tech unicorns as a less reliable, long-term investment opportunity compared to the veteran sectors in the tech space: “We look for mature tech companies with experienced management that have gone through a few market cycles.” The example he used was the semiconductor industry, which has a 60-year track record with experienced management that have been watching the sector for decades.
Sissons sees investors making a quick trade on these tech unicorn companies to gain a swift profit, prompting a brief surge after these companies go public before the enthusiasm fizzles out — and the stock price with it.
He further added that with these new unicorn companies, investors don’t know how they will respond to significant market downturns. If it’s a new company in the tech space, then a more viable opportunity would be a company with a new technology that is set to be acquired. “When we look at a company to invest in, we look at its story. If there’s no big profitability story, … we don’t recommend it as an investment.”
‘New’, ‘Innovating’, and ‘Game-Changing’ are all seductive words in the business world. Everyone loves an underdog story and everyone wants to be the first one in on a company that’s about to make it big. If 2019 taught investors anything, it’s that the shiny new company may be an underdog for a reason — it hasn’t quite found its footing as far as profitability goes. Their lack of scars also show that they don’t have the experience to weather a downturn, failing to put investors’ minds at ease in uncertain times. Despite the money lost to these companies, I think the 2019 ‘unicorn stampede’ presents an interesting case in behavioural economics where investors were more eager to short companies and watch them fail rather than to incubate its growth.
Follow me on Twitter @StephHughes95 and visit my website at stephaniehughesjournalism.com.
Stephanie Hughes 