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“Please, please may I buy some ROBUX” was the daily battle cry from our children earlier in the year after a day’s home-schooling. I perhaps tolerated the children playing Roblox for hours rather too sympathetically. Although, the obvious pressure to purchase the in-game currency or "ROBUX" was concerning and the subsequent pressure to use ROBUX to make those all-important in-game purchases that drive the company’s profitability.
But at least they could interact with their friends albeit virtually and maintain some sort of social contact during lockdown. An antidote to the hours in the Teams online classroom. But most importantly at that especially challenging time for children, they were happy.
So when US video game developer Roblox Corporation came to the New York Stock Exchange (NYSE) on 10 March with a market capitalisation of around $40bn after a 54% spike on its first day of trading, I perhaps paid more attention than to many of the other successful US tech IPOs.
Not just because of my children’s insatiable desire to inadvertently finance the company, but also because the Roblox listing seems to sum up so many of the issues, features and paradoxes of the current surge in IPOs including:
- The timing of the IPO, so soon after the latest funding round, removing the need to raise additional capital at the IPO
- Using a Direct Listing one of the novel derivatives of the traditional Initial Public Offering
- The very high valuation especially after the day one share price spike
So is this recent surge in IPOs, particularly of so many loss-making companies, benign and a sign of a healthy liquid market? Or is this an echo from 2000 and the dot.com boom and a bubble waiting to burst?
In Q1 alone the UK saw its strongest IPO performance in 14 years, with more funds raised than in any other Q1 since 2007 and the most raised in any quarter since Q2 2014.
Just playing catch up?
If there is one aspect of this current wave of IPOs that is irrefutable, it is the sheer scale of money raised in new listings. According to Ernst & Young’s April Global IPO Trends Report, in Q1 alone the UK saw its strongest IPO performance in 14 years, with more funds raised than in any other Q1 since 2007 and the most raised in any quarter since Q2 2014. The Global IPO market in Q1 was even stronger with more money raised than any quarter in the last 20 years. So what was so special about Q1 2021 for IPOs?
As ever in financial markets, there are several explanations. Of course, the Covid pandemic inevitably had its part to play, but that’s probably not the whole story.
The IPO market did slam shut in the first half of 2020 as the economic and market uncertainty took hold, which would have delayed any intention to list a new company. In the UK, and to some extent Europe, Brexit was a key overhang discouraging corporate sellers over the previous few years. Perhaps the more difficult market conditions in 2016 and 2017 also postponed attempts to IPO.
Inevitably there would be an element of rebound from pent up demand from the second half of 2020 as market sentiment improved and especially so when the end of the pandemic was emerging from November, following Pfizer’s vaccine announcement. So perhaps the scale of the IPOs seen in Q1 is partly just catch up from lower issuance in H1 2020 and the preceding few years, as demonstrated by issuance in the US shown in figure 1 below.
Staying private for longer
However, there also seems to have been a change in behaviour from the management of privately-owned companies. Many company owners are intentionally "staying private for longer".
Towards the end of the 2000 dot.com boom, there was a frenzy of IPO activity. The number of loss-making IPOs now is very similar to the peak of the dot.com boom, as can be seen below in figure 2. So it's not surprising why some are comparing the end of that bubble to now.
However there is also a key difference, the companies being "IPO’d" now are generally far more established. The IPOs in 2000 were far more likely to be very early-stage companies or even “concepts”. Maybe we’re not seeing echoes of the dot.com bubble, but for once the market has learnt lessons from the past.
Most of the current wave of IPOs have substantial sales and a proven multi-year track record. Private financing is plentiful and readily available so there is no necessity to access public markets for additional capital to fund growth. Even to the extent that Institutions or Sovereign Wealth Funds, that would typically "cornerstone" an IPO, are now participating in late-stage private funding rounds before an IPO. Roblox, for instance, was founded in 2004 and had nine funding rounds before listing, and generated $524m of cash flow in 2020. Furthermore, because of the last private funding round that raised $520m in January 2021, Roblox did not need to raise additional capital in its IPO.
Contrary to popular perceptions that financial institutions are short term, investors in private companies are far more willing to fund a growth strategy even at the expense of short-term profitability. Not least because "staying private for longer" can be very value-enhancing as each additional fundraise is generally at higher valuations, especially in companies experiencing high levels of growth.
These multiple fundraisings therefore also help establish “price discovery”. Roblox had three fundraisings since September 2018, initially valuing the company at a mere $2.5bn, then in February 2020 the company was valued at $4bn and finally in January 2021, just before listing, that final fundraising valued Roblox at $29.5 bn.
"Staying private for longer" can be very value-enhancing as each additional fundraise is generally at higher valuations, especially in companies experiencing high levels of growth.
Historically unprecedented valuations
There is little doubt that the current valuations of IPOs are attractive for corporate sellers. Ernst & Young in their latest Global Quarterly IPO Trends Report even spells out how attractive valuations are at the moment and suggested: “IPO candidates should consider accessing the markets while the window of opportunity exists”.
The valuations of current IPOs, particularly in the tech sector, are unprecedented in the context of previous IPO cycles. The leading academic and world authority on IPOs, Professor Jay Ritter from the University Of Florida uses a ‘’price to sales’’ multiple that compares a company’s stock price to its revenues and is a metric commonly used for loss-making companies with no profitability. Professor Ritter has recently referred to the increases in valuation seen over the past decades: "typically 20 years ago the median tech company going public, had a price-to-sales ratio of about six. In 2018/19 that nearly doubled to 10 or 11. In 2020, the median tech company went public at a [price to sales] ratio of around 24x”.
However, these “unprecedented” multiples as Professor Ritter also acknowledged are a function of ultra-low global interest rates and more specifically the current “unprecedented” yields offered by US Government Bonds. I have discussed in my previous article the strong relationship currently between equity valuations and US Treasuries. At the start of 2000 US Treasuries were yielding almost 7% compared to 1.6% now. This fall, effectively in the risk-free rate, should justify much higher multiples if yields stay at these levels.
During waves of IPOs in the past, the pressure to IPO "while the opportunity exists" is commonplace. Naturally, more companies go public when they expect to receive a higher price for their shares. This can then be self-fulfilling, as more IPOs will inevitably follow successful IPOs. There are two indices, one in the US and another in Europe, which track the price performance of IPOs post-float. Both IPO indices have significantly beaten their benchmark domestic indices since the start of 2018, as can be seen in figure 3 below. Investing in IPOs to date has been very profitable. In the IPO market, there is no doubt “success breeds success”.
So not surprisingly, very attractive valuations and successful post-IPO performance have encouraged private business owners and late-stage investors to sell to the public market in recent months.
Increased flexibility to access public market
Another significant factor in the recent growth in IPOs is perhaps the flexibility on offer to corporates to access public markets. Roblox used a recent innovation on the NYSE, a Direct Listing or a Direct Public Offering (DPO). A Direct Listing effectively dispenses with the traditional bookbuild of pricing and the need for underwriters. In this case, the NYSE finds the clearing auction price based on the orders received. Although Direct Listings as yet do not raise additional capital, as discussed above, raising new capital isn’t so much of a necessity as it was in the past.
The NYSE claims the first Direct Listing was music streamer Spotify in 2018. Although I'm not so sure Direct Listings are that new. In the 19th Century, most early US Corporations sold shares in themselves directly to the general public. The only difference is the issue price was set by the corporation, not by auction.
The other supposed innovation that has driven the Listing boom over the past few months is the return of the Special Purpose Acquisition Companies or more usually known by the acronym “SPACs”. SPACs have been a hugely successful vehicle in the US. SPACs have so far raised more money in 2021 than in the whole of 2020 (as can also be seen in figure 1 above). But the UK isn’t seeing any of it, hence the recent review initiated by Chancellor Rishi Sunak to potentially change UK Listing rules to encourage more SPAC listings in London.
The listing mechanism of a SPAC is essentially very straightforward. The idea is that a sponsor will raise money on behalf of a single individual or collection of managers. Usually, these individuals or managers will have a particular industry skill or expertise. When the SPAC is "IPO’d", neither the sponsor nor the manager will disclose to potential investors how the money raised will be invested, other than in the most general terms consistent with their area of expertise. In many cases, the managers will not have even identified where they intend to deploy the IPO proceeds. So the investors in a SPAC will be handing over their money “blind” or giving the manager a “blank cheque”. The publicly quoted SPAC then typically at some point “buys” an unquoted company perhaps with additional fundraising at this point, so providing an immediate listing for the unquoted company. This flexibility for the managers is perhaps the main attraction of a SPAC and it makes the whole listing process a lot easier and cheaper.
However, the flexibility of the SPAC in many ways is also its weakness. This "blind cheque" investment company circumvents much of the Investor Protection regulations offered by an IPO or a DPO.
There is also certainly nothing new about blank cheque investment companies. They go back as far as the South Sea Bubble, where a promotor famously raised money through a stock offering for "a company carrying on an undertaking of great advantage, but nobody is to know what it is’’. What I also find so ironic about the recent rise of the SPAC is they circumvent the investor protections which were originally put in place in the aftermath of the Wall Street Crash to protect investors in the future from the ‘’blind’’ Investment Companies promoted heavily in the late 1920s.
Nevertheless, the simplicity and success of SPACs as a fundraising vehicle are undeniable. But following a 25% fall in the IPOX SPAC Index in recent weeks, the success for some of their investors is perhaps more mixed.
Investors for the time being in most IPOs still seem unconcerned about valuations and dismissive of any echoes from the dot.com bubble.
Echoes of March 2000?
So the last few months have been exceptional for IPOs, DPOs and SPACs. Valuations are very high, but does this mean this surge of IPO issuance is a sign of trouble ahead. Have we already seen the Lastminute.com of the 2021 Tech bubble, which famously listed in March 2000, two weeks before the dot.com bubble burst and never saw its issue price again?
That is, of course, a very difficult question to answer. Yes, valuations are exceptionally high, at least on a historic basis, and the number of non-profitable IPOs coming to the market is as high as in 2000. Yet, the companies coming to the market now are more established and more financially secure, having been through multiple funding rounds before IPO. In many cases, the recent IPOs are described as ‘’disruptive companies’’ - those that can already be seen to be displacing existing technology and legacy businesses and not just conceptual ideas.
The valuations of some IPOs are very high, but to an extent, the valuations of IPOs merely reflect the valuations seen elsewhere in the market and a result of a historically low risk-free rate reflected through historically low US Treasury yields. So to answer if IPOs are overvalued, we need to consider if parts of the broader market are also overvalued.
Investors for the time being in most IPOs still seem unconcerned about valuations and dismissive of any echoes from the dot.com bubble. The recent listing of Roblox was extremely successful. The stock spiked 54% on the first day of trading to $69.50 a share to reach a high of $82.
However, my children haven’t contributed to Roblox's success. I never did buy any of that highly profitable in-game ROBUX and they also won’t be contributing to Roblox's latest quarterly results even in the number of "active users’’. Since they are back at school they seem to have lost interest in Roblox. Although, I will be looking with great interest at those quarterly numbers as I wonder how many other children globally have penny-pinching fathers, and thankfully and more importantly, our children now have non-virtual friends to play with.
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