Are Markets Pricing Tech IPOs Efficiently?
Successful private companies face tough choices every day, but perhaps no individual decision carries higher stakes than whether or not to go public. Every day, we read news articles speculating when Uber, Airbnb, Pinterest and other unicorns will go public, as well as debates about how recent IPOs such Blue Apron, SendGrid and StitchFix are faring.
Evaluating whether an IPO is the right choice for a company involves a series of complex calculations. Going public provides rapid and easy access to global capital markets, which can help a company grow its business. On the other hand, the compliance costs and disclosure requirements for public companies are considerable. Adding to the complexity of the decision is the importance of getting the timing and pricing right. Changes in market sentiment or liquidity can result in adjustments of millions or even billions of dollars in market valuation.
We examined 35 technology companies in the Craft database that went public in 2016 and 2017. Our objective is to see whether pre-IPO funding and IPO pricing provide clues about market performance:
We analyzed whether these companies’ fundraising activities in the private market impacted the valuation they received in the public markets. First, we looked at the 16 companies for which we had reliable last private market valuation (“LPMV”) data and compared this to their IPO valuations.
Eight of the companies had higher IPO valuations than their LPMV while eight others had lower valuations. Interestingly, there were wide divergences in the percentage changes. Four companies had IPO valuations more than 40% higher than their LPMV, and six had double-digit percentage increases from their LPMV.
On the other side of the coin, five companies had IPOs priced at a greater than 25% discount from their LPMV while three were priced at a discount of more than 50%.
Are there clues in these companies’ private fundraising activities that could explain the wide disparity in valuations they receive from the public markets?
We set out to answer this question by examining the last funding amount raised by each company compared to the total amount raised pre-IPO (“LF/TF”). Our hypothesis is that companies who did larger raises prior to going public might not fare as well in their IPOs. Of course, there are many other factors that influence the IPO price, but we wanted to see if there were any patterns in this relationship :
The two companies with the highest LF/TF ratios, Appian Corp. and Veritone, Inc., both had IPOs priced at significant discounts to their private market raises.
If we plot the LF/TF ratios against the percentage change from LPMV to IPO, we see that there appears to be a negative correlation between these two values. In other words, raising a significant amount of money closer to an IPO generally correlated with a lower IPO valuation compared to LPMV:
We also examined total funding before IPO as a percentage of last private market valuation (TF/LPMV) to see if this ratio had any relationship with the percentage change from LPMV to IPO valuation. This would provide another metric for examining whether the amount of money raised prior to an IPO affected the IPO valuation:
We then charted TF/LPMV against the percentage change from LPMV to IPO. With this, we see that these values are also negatively correlated although the inverse relationship is not as strong as it is for LF/TF. Once again, however, this suggests that companies that raise larger amounts of funding in the private market have IPOs priced relatively lower compared to companies that raise less funds.
While it’s impossible to draw any firm conclusions from this data without analyzing a host of other variables, our analysis suggests that the timing and size of pre-IPO raises may play a role in IPO pricing.
Finally we examined the 27 stocks for which we had reliable data to measure the returns each stock generated from its IPO price to its share price on November 27, 2017.
Of these companies, nineteen of them are higher than when they priced their IPOs, and eight of them are higher by more than 100%. Of the eight companies that are trading lower than their IPO price, seven are down more than 15% and three are down more than 50%.
The extreme volatility suggests that tech IPOs are not being priced efficiently. Most of the gains for the top performing IPOs occurred on the day of their trading debut. Coupa Software, for example, soared 87% on the day of its IPO pricing, while Twilio rose by 92%. In comparison, according to a University of Florida study, the average IPO between 2001 and 2015 returned 13.9% on its first trading day.
As for the worst performers, some of them didn’t perform nearly as well on their first day of trading. Blue Apron shares closed flat on their first trading day and Monster Digital shares declined 18.1%. NantHealth shares rose 32%.
• There are wide disparities between pre-IPO and IPO valuations, and the timing and amount of private fundraising may be a contributing factor in these disparities.
• IPO pricing appears to be negatively correlated with the relative size of funding raised in the private market.
• IPO pricing also appears to be negatively correlated with the relative size of funds companies raised in their last funding rounds compared to overall private funding.
• Public markets still have many apparent inefficiencies in pricing IPOs.
One interesting hypothesis we may examine in a future report is whether first day IPO performance is a harbinger for future stock performance. Perhaps stocks that generate first-day returns well above or below a typical IPO underperform their peer group of IPOs over the intermediate term.
Craft is a machine-learning powered data and analytics platform building the ‘Source of Truth’ on companies, and mapping the global economy. We organize data from thousands of sources to provide comprehensive, up-to-date sector and company profiles, ranging from early-stage to the largest companies in the world.
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