One risk to both the stock market and the economy that we were closely tracking in 2019 was the ebullience in the market for highly valued start-ups (commonly referred to as unicorns for their $1 billion or higher valuations). This is a trend we’ve kept our eyes on for years, but we knew 2019 would mark an important turning point as many of the best-known unicorns were finally going to IPO and become accessible to public market investors.
With some eyebrow-raising valuations in private markets, the question was whether the public markets would be equally willing to embrace the companies’ promised growth or cast a more discerning eye. The risk? A round of IPOs puffed up by hype could inflate a stock market bubble whose eventual bursting would not only hurt investors but also risk sparking a recession.
Uber and WeWork were arguably the poster children for the unicorns. Having been fueled by private investors for years at ever-increasing valuations, they have grown revenues by using their investors’ cash to aggressively woo customers. But concerns remained as to the companies’ underlying business models, and their high valuations left little room for doubt about their greatness.
Uber did manage to IPO, but investors in its IPO faced losses of over 30% of their investment by the end of the year. After attempting to IPO at a fraction of its last private market valuation, WeWork was forced to postpone its public listing. Numerous other 2019 IPOs, including Slack and Peloton, have also struggled in the public markets (Display 1).
In the end, the public market did what it was supposed to do. It wasn’t swept up in a wave of hype but instead took a critical look at the quality and prospects of the businesses on offer. While its evaluation of WeWork’s business was too low to allow the company to IPO as desired (Display 2) and instead forced its largest shareholder to step in, bail out the investment, wipe out returns to many early investors and employees, and restructure the company’s operations, it served its purpose in the overall economy.
And in the process, public market investors have arguably kept a potential Tech Bubble 2.0 at bay, taking one major recession risk off the table. Looking forward, the public market’s skeptical stance on unicorn valuations suggests that we could be witnessing the end of what NYU Stern professor Scott Galloway has called “capital as a strategy,” at least for the time being. Innovation, especially for the game-changing technologies that excite us and other investors, requires a lot of capital. So does rapidly scaling a company in a winner-take-all market. But arguably too much capital has been driven into these areas too quickly and at overly optimistic valuations.
According to PitchBook, 2018 set a record for venture capital investment, with over $130 billion invested. When the numbers are tallied for 2019, it will undoubtedly have set an all-time record for exits, reaching over $200 billion by the end of the third quarter, with time left for that number to rise further. But with exits more challenging, the unicorns’ failure to fly may push investor dollars into public stocks or more neglected areas, supporting valuations elsewhere. And ultimately, if the oversupply of capital to early-stage companies reverses, it should improve the future returns on investments there, which future investors will be keen to take advantage of as opportunities present themselves.
Chris Brigham is a Private Client Senior Research Associate at Bernstein.
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