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St. Louis money manager: Beware of unprofitable ‘unicorns’

18 November 2019

(St, Louis Business Journal)

November 13, 2019 (Greg Edwards)

Argent Capital Management is telling its clients to beware of what are called unicorn IPOs, especially those that show no signs of turning a profit anytime soon.

As Argent senior portfolio manager Ken Crawford puts it: “What do you pay for a company that is not making money?”

A unicorn is a term used in the venture capital industry to describe a privately held startup company with a valuation of more than $1 billion, and an increasing number of IPOs involve unicorns that aren’t making money.

In a report to clients, Argent makes four key points:

Less than a quarter of companies going public this year will report positive net income in 2019, the lowest level of profitable IPOs in their first year as public companies since the tech bubble. The reason: “With very low interest rates, investors are looking for yield,” Crawford said. “The early IPOs made a lot of sense and a lot of money, but declined from there.”

While the thought of making a quick fortune through a disruptive company is enticing, public markets appear to be signaling increasing skepticism of unprofitable unicorns, such as Uber, Lyft, Slack and the failed WeWork IPO. “You’re talking about overvalued companies that keep going up, like Bitcoin,” Crawford said. “Investors and journalists became infatuated with WeWork, but it didn’t make sense.”

Earnings seem a thing of the past in the current IPO market. Investors are now paying even greater sky-high multiples for growth in companies, especially the enterprise technology names, that are trading at 25 to 30 times projected current year revenue, not earnings. “Amazon has changed retail. Netflix has changed the way we watch what we watch,” Crawford said. But now Amazon is being challenged by Walmart and Target, which are offering delivery. “Do I want to pay 65 times forward earnings for Amazon versus 17 times for Target?”

Many IPOs are bleeding cash, but trying to convince investors of their value with “creative new accounting measures” that mimic profitability. Uber uses a metric called “core contribution platform,” and WeWork focuses on “community profit.” These types of creative accounting methods were used during the dot-com bubble when companies used “revenue per eyeball” as a measure of performance.

Crawford advises carefully considering what disruptive changes are sustainable, and what you would pay for those changes. “A million-dollar house is a really nice house, but if you are being asked to pay $2 million, it’s not a nice deal,” he said.