I don’t know about you, but I have always been fascinated by the stock market. I lived through, and survived, the 2000 tech bubble. Now I feel like I’m watching a sequel to that movie, albeit a smaller one.
That’s when a crazy thought hit me:
“Should money-losing companies be allowed to IPO?”
Okay, I’ll vote yes on that question, but…
…like the bubble itself, there’s a sequel to that question, and it’s the more pertinent question to ask:
“Should we invest in money-losing companies when they IPO?”
I believe the answer is buyer-beware.
My thought, when I started writing this blog post, was to set out a compelling argument that money-losing companies should not be allowed to IPO. I quickly realized that was silly. It’s never going to happen, and there are examples of companies, such as Amazon.com, that were money losers when they IPO’d, yet became remarkable success stories.
Why should the Amazon’s of the world be punished?
The short answer is they shouldn’t be. However, we, the investing public, need to be very wary of companies that are losing money when they IPO.
Let’s look at the data. Tableau Software, in 2009, researched the fates of the largest market cap software IPO’s since 1980, and the data is startling:
For the first two years it doesn’t matter whether a company is profitable when it IPO’s. In fact, the non-profitable companies performed better than their profitable counterparts. After that, all I can say is that profitability sure does matter. By the end of year 3:
- The companies that were profitable upon IPO were up an average of 160%
- The companies that were unprofitable upon IPO were up only 39%: a drop of 90% in one year.
- The standard deviation on the unprofitable companies was much higher than profitable companies, so more of the unprofitable companies likely failed
Why do the non-profitable companies drop like stones in year 3?
It’s not complicated: Profitability matters! You can sell whatever story you want (in today’s market, it’s top line revenue growth without regard to profitability), but, eventually, every company needs to be profitable to survive.
I think this data points out that many companies surely will benefit from waiting to IPO until they are profitable. Certainly, the investing public would benefit.
What does it mean for the likes of unprofitable Twitter, Fireye, Box, et al?
It will not be pretty if the past is any predictor of the future.
It doesn’t have to be that way though, both for the companies and the people that invest in them. Imagine if these companies focused on achieving profitability as private companies. The risk to public investors would be reduced, and the companies would likely thrive in the long-term.
That’s all for now,