The role of IPOs: Why we chose not to ride with Lyft

April 23, 2019 Edward Golding

           

Technology has brought Wall Street to main street—it has made buying and selling just about any investment product easier and more efficient for the average investor. Nearly all investor transactions occur on what is called the "secondary market"—stock exchanges like the Toronto Stock Exchange (TSX), the New York Stock Exchange (NYSE) and the NASDAQ. 

However, individual investors will still find it difficult to participate in the initial public offering (IPO) of shares.

Primary markets and IPOs: The process of going public

A private company looking to issue shares will typically hire investment bankers to source large purchase commitments from institutional investors—this is the IPO and this happens on what's called the "primary market." 

Individual investors usually have a difficult time accessing IPOs because they don't have a direct channel to the primary market. Additionally, the window of opportunity is small as the investment bankers are selling the shares over a short period of time. Making things even more challenging is the difficulty for smaller investors to assess whether a private company (which is about to go public) is a good investment because there is little public data available for them to review.

These days, IPOs are more important than ever to investors. Despite a myriad of uncertainties (Brexit, U.S.-China trade), the IPO market was quite strong in 2018. Global proceeds generated from IPOs rose 6% to US$204.8 billion despite volume declining by 21%. The most prolific sectors being information technology, industrials, healthcare, telecom and financials. The Asia-Pacific region accounted for nearly 50% of all deals and proceeds last year. 

IPO spotlight: Lyft off to a bumpy start

Technology company IPOs  have always generated a lot of buzz and anticipation. The IPOs of Facebook and Alibaba rank among the largest in history. So last month, when ride sharing company, Lyft, announced its own IPO, investors took note—Lyft had a large loss totaling US$911 million but with impressive revenues of US$2.2 billion in 2018. To put their revenue in perspective, only Google and Facebook had larger information technology revenues when they went public. Lyft is now the first ride sharing company to be listed on a stock exchange. 

Initially priced at between US$62 and $68 a share, high demand  bumped the IPO share price up to US$72. Lyft shares started trading on March 29th and shot up to US$87, returned to US$72 after two days of trading and is currently trading below US$60 as of writing (April 12th, 10:00AM).

We didn't ride with Lyft

Our U.S. equity sub-advisor  partner Janus Henderson Investors is positive on the long-term growth prospects of the ride sharing industry overall, but they did not participate in the Lyft IPO on behalf of MD clients for several reasons:

  1. We prefer Uber over Lyft. Lyft is currently a smaller player in the ride sharing market compared to Uber and smaller networks are costlier to run. In this regard, Uber has a cost and scale advantage over Lyft that could lead to higher long-term profit margins for Uber and competitive pressure on Lyft. Both could be successful, but we believe Uber is in a stronger competitive position today.
  2. Lyft and Uber are the leading ride share companies today. We have concerns, however, about how long this Uber/Lyft duopoly position will last. This is because ride sharing is only part of the broader category of autonomous vehicles—and their development and potential entry into the ride sharing marketplace could be transformative.  For example, new entrants, particularly autonomous vehicle companies Cruise and Waymo, threaten to disrupt the current ride sharing pricing model. Driver costs represent 75% of total operating expenses for Uber and Lyft, hence we believe autonomous vehicles (which could theoretically operate at a much lower cost) pose a material threat prospectively.
  3. Lyft’s initial valuation at an IPO price of US$72 implies substantial long-term promise against, what we see as, both near and longer term questions. In addition, the upcoming Uber IPO may put additional downward pressure on Lyft’s current valuation as investors have a comparable ride sharing substitute in which to invest.

IPOs are an important part of available investment opportunities 

Lyft proved a bumpy ride for investors so far and shines the spotlight squarely on how IPOs are priced and what criteria we must use to determine whether or not to participate. This kind of analysis is critical as IPOs have become an important part of  the global pool of investment opportunities. 

The IPO market is now more important to MD investors than ever before, with the MD Platinum Global Private Equity Pool. The pool invests solely in companies that are currently private or are taken private from the public markets. Investments in these companies are typically held for longer periods with the expectation that profitability will grow and a healthy return can be achieved for our clients when we sell.

Private companies can be sold to another private equity manager or to a strategic buyer (usually a large public company that is looking to acquire a business). Another option is to take the company public through the primary market and an IPO. 

All three methods are viable but timing can be an important aspect as to which path is taken, however what is certain is that MD will be relying on a healthy IPO market to sell some its private investments that are held within the MD Platinum Global Private Equity Pool.

For more information, please contact your MD Advisor. 

About the Author

Edward Golding

Edward Golding, CFA, MBA, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

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