It’s hard to ignore the hype that surrounds IPOs, especially with words like “unicorn” being tossed around — who doesn’t love unicorns?
Last September, the hype was centered on Chinese e-commerce king, Alibaba (NYSE: BABA). BABA was one of those unicorns — a company with at least a $1 billion valuation based on fundraising.
BABA’s record-breaking IPO was the largest to date, but the company is now involved in class-action lawsuits on behalf of investors who believe they were misled in regards to BABA’s growth rates.
BABA’s CEO Jack Ma has openly admitted that shareholders rank at the bottom of his priority list.
Since BABA’s IPO, shares have tumbled 30%. The company’s market value is down $140 billion since its peak, and investors who bought shares on the first day are still down 8%.
This type of story is not isolated to Alibaba.
There have been a handful of failed tech IPOs in the past few years — Facebook (NASDAQ: FB), Groupon (NASDAQ: GRPN), Zynga (NASDAQ: ZNGA), and others.
This trend should have investors practicing a little more scrutiny before assuming that “IPO” is synonymous with “profitable.”
The most recent IPO blunder occurred just yesterday, when Square (NYSE: SQ) was forced to price shares at about 25% less than the company had originally hoped.
With more than 320 million shares outstanding after the IPO, Square is now valued at $2.9 billion — less than half of its most recent 2014 valuation of $6 billion.
Square was founded in 2009, providing a way for small-business owners to accept credit card payments using mobile devices.
The technology behind Square is great — I love being able to use my credit card at my local farmer’s market.
Square was forecast to disrupt the entire payment system.
Unfortunately, that technology failed to meet expectations and left investors disappointed.
However, Square’s IPO wasn’t just disappointing — it reeked of desperation.
Desperation is the only reason the company accepted such a low offering.
Square has been burning through cash so quickly that most analysts believe the company would have been bankrupt within two years without the IPO.
Square recently posted $131.5 million in losses, up from $117 million the prior year.
James Gellert is the CEO of Rapid Ratings, a firm that rates the financial health of companies. After his company evaluated Square, Gellert stated:
“What you see here is a deterioration. They are losing more money, and cash from operations continues to be negative.”
Companies like Square, which go public as a last-ditch effort to stay afloat, should not be approached by individual investors.
The Truth Hurts…
In the wake of this string of disappointing tech IPOs, now seems like a good time to just come out and say what needs to be said.
First of all, every investor needs to realize one very important fact: The IPO market does not exist to make individual investors rich.
Not every IPO is bad, but individual investors usually end up on the losing end.
IPOs are all about the heavyweights: venture capitalists, investment bankers, and private inside investors.
Although it might seem like “getting in on the ground floor,” you’re actually far behind other private parties who have already invested at much lower prices.
Second of all, financial hype ≠ financial health. Companies go public for a variety of reasons. Unfortunately, strong financials are not always one of those reasons.
The hype that surrounds upcoming IPOs is a ploy created to get your attention about inflated claims — it’s how those private investors get a return on their risk.
I’m not saying it’s a Ponzi scheme but “if it looks like a duck, if it swims like a duck…”
You know the rest.
Hype can be exciting (it’s supposed to be), but investors cannot ignore the fundamental principles behind a financially healthy company.
Before you get caught up on the whirlwind of generated propaganda, be sure to do your research.
Has sales growth outperformed other companies in that industry? Is the company gaining market share?
Is the company advertising gross profit margins or adjusted profit margins? Upcoming IPOs have been known to exaggerate profitability. Being selective about the information they share is part of the hype strategy.
Also, consider the broader market and a company’s long-term potential.
As larger competitors like Apple (NASDAQ: AAPL), Google (NASDAQ: GOOGL), American Express (NYSE: AXP), and PayPal (NASDAQ: PYPL) are expanding into the mobile payment sector, there is an increasing chance that Square will simply be overshadowed by those rivals.
As if Square didn’t possess enough fundamental flaws, CEO Jack Dorsey is currently splitting his time between Square and Twitter (NYSE: TWTR).
Dorsey has yet to communicate with investors about how he plans to manage his time, which has them very concerned about his ability to boost financial conditions at Square, especially considering Twitter’s own IPO failure.
Although lower IPO prices like Square’s might seem like a bargain, resist the urge to open your wallet.
Instead, sit tight for upcoming financial reports.
There’s a Bright Side Beneath the Radar…
Although this article has been stacked with bad news from the beginning, investors should not lose faith.
Like I already mentioned, not all IPOs are bad. The key, as you might already expect, is to look beyond the hype.
The best-performing IPO of the past year is a growing biotech company called Radius Health (NASDAQ: RDUS). Although Radius initially fell short on funding, shares of the stock are up 357% from their first-day closing price last June.
The difficulty is in finding companies like Radius Health, whose IPOs aren’t plastered across every major headline.
However, it is often “under-the-radar” deals like this where individual investors see the most profits.
IPOs are a complicated game, and what we’ve discussed here only touches on the surface.
Although the potential for high reward might be tough to resist, I urge individual investors to take a step back.
Don’t fall for the hype.
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