More art than science in pricing share offers - Milford Asset

More art than science in pricing share offers

Brian Gaynor

Non-Executive Director

Brian is a non-executive Director of Milford Asset Management, Member of the Board Investment Committee, and he Chairs the Private Equity Investment Committee.

Brian’s career includes roles as a Partner and Head of Research at stockbrokers Jarden & Co, and a member of the New Zealand Stock Exchange. He has also been a board member of a number of listed and public owned entities, including the Guardians of the New Zealand Superannuation Fund. He is also one of the original founders of Milford Asset Management and was Portfolio Manager of the Milford Active Growth Funds (Unit Trust and KiwiSaver) from their establishment in 2007 until April 2017.

This article originally appeared in the NZ Herald.

There are two clear lessons to be learnt from recent US Initial Public Offerings (IPOs). The first is that investment bankers don’t excel at IPO price setting, the other is that “unicorn” companies continue to attract huge media and investor interest.

Unicorns are privately held start-up companies worth more than US$1 billion.

Traders work during Uber IPO on the floor of the New York Stock Exchange. Photo / Bloomberg

The Uber Technologies IPO, which was the biggest by a wide margin, has been all about CEO incentives and mismanaged expectations.

Morgan Stanley, bankers to the issue, indicated late last year that the ride-hiring company could be worth around US$120b.

This figure is consistent with Uber CEO Dara Khosrowshahi’s contractual agreement whereby he will receive US$80m to $100m if the company’s sharemarket value is worth $120b or more for at least three months in the first five years after listing.

A $120b valuation would have exceeded Facebook’s $104b valuation when that first listed.

The projected $120b valuation would be quite extraordinary as Uber had pro-forma revenue of only US$11.3b for the December 2018 year and a pro-forma net loss of US$2.0b for the same period.

Uber also has a dented image, particularly around the 2017 resignation of former CEO Travis Kalanick, who co-founded the company in 2009.

Uber has also been criticised for its labour practices, with Farhad Manjoo writing in the New York Times in early May: “Uber — and to a lesser extent, its competitor Lyft — has indeed turned out to be a poster child for Silicon Valley’s messianic vision, but not in a way that should make anyone in this industry proud”.

“Uber’s is likely to be the biggest tech IPO since Facebook’s. It will turn a handful of people into millionaires and billionaires. But the gains for everyone else — for drivers, for the environment, for the world — remain in doubt.”

A recent study by Ridester, a US publication that focuses on the ride-hailing industry, confirms this. It concluded that the median pay for Uber drivers is US$14.73 per hour, including tips, but excluding estimated costs of US$5 per hour for petrol, insurance and depreciation.

This net US$9.73 per hour is lower than the minimum wage in several states, with California, Washington, Massachusetts and Washington DC all having an hourly minimum wage of US$12 or more.
But the major issue facing Uber is the low barriers of entry to the ride-hailing sector and increased competition, with Lyft being the more high-profile example of this.

Lyft focused on its “contribution” profit rather than “Generally Accepted Accounting Principles” profit (GAAP) during its pre-IPO road shows. This allowed the company to claim it made a profit of US$921m in 2018 rather than a net GAAP loss of US$911m on revenue of $2.2b.

The company’s “contribution” profit only included costs associated with each ride, and excluded company operating costs, research and development, sales and marketing, and general and administration costs.

By focusing on the “contribution” profit Lyft was able to show that this represented 43 per cent of revenue in 2018, compared with 38 per cent the previous year and only 24 per cent of revenue in 2016.

These figures didn’t fool investors as its share price is down sharply from the US$72 a share IPO price (see accompanying table).

Late last week investors filed a class-action lawsuit alleging that Lyft had overstated its US market position with its prospectus statement that its US market share “was 39 per cent in December 2018, up from 22 per cent in December 2016”.

But Uber faces competition from more than Lyft, as demonstrated in New Zealand. There are several ride-hailing competitors in this country, including Zoomy and Ola.

Zoomy, controlled by the family of the late John Spencer, claims more than 3500 drivers in Auckland, Wellington and Christchurch. It charges them 15 per cent commission compared with Uber’s 25 to 28 per cent levy.

Zoomy CEO James Fisk has been quoted as saying, “Zoomy is more cost-effective for passengers while the biggest point of difference is the commission rate they charge drivers”.

Ola Cabs, the Indian based company, is another new entrant to the New Zealand market.

The company operates in 110-plus cities in India, Australia and New Zealand and has more than one million drivers, including taxi operators.

It claims to have signed up more than 4000 New Zealand drivers since launching in November last year.

The Indian company attracted new drivers by charging commission of only 9 per cent for the first 30 days and 18 per cent after that. This compares with Zoomy’s 15 per cent and Uber’s 25 to 28 per cent.

Ola seems to have the resources to take on Uber as its Indian parent company shareholders include SoftBank and a new fundraising announced this month is supported by Hyundai and Kia Motors.

The Indian company, which has a reported value of US$6.2b based on its latest capital raising, has also been criticised for its low payments and poor treatment of drivers.
Nevertheless, several Auckland taxi drivers have expressed the view that Ola offers a bigger long-term threat to them than Uber or Zoomy.

The poor share price performances of Lyft and Uber indicates that investors believe competition in ride-hailing will remain intense and these two companies won’t be able to establish dominant global positions, like Facebook, Google and other US tech companies.

Other recent interesting IPOs include:

  • Beyond Meat has been one of Wall Street’s best performing recent IPOs. The company produces a range of traditional meat products, including burgers and sausages, from plants rather than animals. It says, “By shifting from animal, to plant-based meat, we are creating one savoury solution that solves four growing issues attributed to livestock production: human health, climate change, constraints on natural resources and animal welfare”.
  • Levi Strauss, the 166-year-old San Francisco jeans maker, returned to the NYSE on March 21 after a 34-year absence. It first joined the stock exchange in 1971 but the descendants of Levi Strauss made a successful takeover offer for the company in 1985 and took it private.
  • Luckin Coffee, founded in Beijing in 2017, claims to be the only serious competitor to Starbucks in China. Investors believe anti-American sentiment in China, in response to the current trade dispute, could benefit the company but there is considerable scepticism about its ability to compete with Starbucks over the longer term.
  • Pinterest, the social media company, started off with a hiss and a roar on Wall Street and reached a closing high of US$34.26 on April 29, compared with its IPO price of US$19.00. Its shares plunged on May 16 after it announced a March quarter result in line with expectations, but its sales guidance was disappointing.
  • Zoom Video is a California based company that provides remote conferencing services using cloud computing. It offers communications software that combines video conferencing, online meetings, chat, and mobile collaboration.
  • Finally, this column wrote about Blue Apron’s IPO in June 2017 because it had a similar meal-kit business model to NZ’s My Food Bag.
    Blue Apron’s stock price has fallen from its US$10.00 IPO price in mid-2017 to just US$0.73 this week. Ironically, Uber Eats has become one of its major problems as this competitor delivers restaurant meals for US$3.99 plus a service fee.

As NYSE companies can be delisted once their shares drop below US$1.00, Blue Apron will hold a meeting on June 13 to approve a share consolidation, aiming to lift its shares above $1.00.
Recent US IPOs, including Blue Apron in 2017, clearly show that these offerings can deliver massive gains, as well as big losses. This is partly because IPO price setting is an art, rather than a science, and is often heavily influenced by the interests of existing shareholders.

Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser. Past performance is not a guarantee of future performance.