When big money is lost on Wall Street virtually overnight—yes, the $40 billion haircut that institutional investors took on WeWork still counts as “big money”—there is bound to be some serious fallout. That’s what Wall Street underwriters are now grappling with in the aftermath of the WeDisaster, which in the span of a few weeks saw the office-rental company’s IPO get pulled, its puerile CEO get canned, its business model get thoroughly trashed, and its valuation drop from $47 billion to $7 billion. “It was a house of cards,” one senior Wall Street banker told me of the WeDisaster. “Everything you really shouldn’t want to put into the pubic markets, he”—Adam Neumann, the former CEO—“tried to do.”
That might not be the end of the bloodletting at WeWork (officially “the We Company”). No less an authority on the art of losing money than hedge fund billionaire Bill Ackman, the founder of Pershing Square Capital Management, predicted at the Robin Hood Foundation investor conference last week that the equity value of WeWork is going to zero—and that the value of the company’s debt could go to zero too. Even with SoftBank’s nearly $10 billion bailout, then, Neumann’s baby could be headed to bankruptcy court. That would be a face-plant of epic proportions, right up there with all-time value-destruction champs Enron, WorldCom, and Lehman Brothers, and far beyond the more than $4 billion Ackman lost in his ill-fated investment in Valeant Pharmaceuticals. (Ackman’s hedge fund was up 54.5% in the first eight months of 2019, which may explain why he has started coming out of his shell.)
The WeDisaster may already be catalyzing a major Wall Street rethink, just as we saw in 1989, with the botched United Airlines management buyout, or in 1998, with the collapse of Long-Term Capital Management. This might be the healthy end of a capital-markets mini cycle marked by nosebleed valuations in the equity markets and massive investor permissiveness in the debt markets. “While some clients have chosen to delay their IPO,” said David Ludwig, the head of equity capital markets in the Americas at Goldman Sachs, “many have stayed on track. Growth IPOs can still get executed in the current environment, but it is natural that issuers may need to approach the market differently given recent changes in valuation and increased volatility."
If this turns out to be a much-needed reset, it’s been a long time coming. Over the past several months, one after another fancy Silicon Valley unicorn has come a cropper: Uber, Lyft, Slack, Peloton, SmileDirectClub, and Dropbox, among many others, are all trading below their IPO prices. Retail investors, especially, have gotten singed. Consider the vaunted supernova Beyond Meat, the plant-based protein company that soared more than 800% since its May IPO, and has since seen its value cut by nearly two-thirds.
What makes the WeDisaster so interesting, though, is that it never made it to the public markets—its IPO was pulled—and so it was the institutional investors, the ones that Wall Street is geared up to protect, that suffered dearly. Of course, the number one casualty of the WeDisaster has been Masayoshi Son, the chairman of SoftBank, whose behemoth investment firm gave Neumann carte blanche. In 2017, Son famously spent just 12 minutes with Neumann before deciding to invest $4.4 billion. The investors in SoftBank’s funds have since lost billions, at least on paper. “The guy is completely discredited,” the senior Wall Street banker told me. Son’s business model, it seems, had been to invest in unicorns at high valuations and hope that private rounds would set the price for public-market investors. But Wall Street investors are finally wising up: “The idea that last-round smart money is setting the floor for the public markets? Just not happening,” the senior banker said. “Off the table. You know, ‘I’m going to do my own work—I don’t care what Masayoshi Son paid for this.’”
There’s a contagion effect, to be sure, although it’s a necessary corrective to years of irrational thinking. It used to be that IPO investors were “the last dumb money,” the senior banker said. But counting on public markets to provide “the greater fool” is no longer as viable an exit strategy for institutional investors. Part of the reason is that the days when an IPO was a relatively scarce event, and therefore a unique opportunity to buy the stock of a desirable company, are over. Nowadays, unicorns and decacorns are staying private longer. And institutional investors, which once upon a time could be counted on to invest in IPOs to help drive demand, are wetting their beaks during earlier rounds of financing, when terms are better and valuations are lower. Or they are not investing at all. “Big IPO buyers are not even coming into these deals because they already own the stock at much lower valuations,” the senior banker says. A big IPO—WeWork was hoping to raise up to $4 billion—requires “everyone to participate,” he says. But if you’ve already invested in an earlier round, you’re much more likely to sit out the IPO, crushing demand and causing the process—at least recently—to implode. “The order books are really hard to develop for big deals like this,” he continues.
The other consequence of the Uber and WeWork implosions is that investors now want companies to be profitable. Shocking, I know. The days appear to be over (for now, anyway) of promising profitability at some future date while losses in the billions of dollars mount in the name of impressive revenue growth. Public-market investors are saying to Wall Street bankers, essentially, “What gives?” These companies have been private for years. They’ve raised a bunch of money. They are at scale. And they are still losing money. How big do you have to be to make money?
Tech unicorns have been taking a dimmer view of the traditional IPO process too, though for a separate set of reasons. As I wrote about in July, more and more unicorns are using so-called direct listings to sell stock to the public, costing Wall Street underwriters tens of millions of dollars in potential fees. Many of these companies, such as Spotify and Slack, don’t need to bring cash in—on the contrary, they’re mostly looking to give early investors a way to cash out. That appears to be the case with Airbnb, the decacorn online lodging marketplace that is widely expected to pursue a direct listing, rather than an underwritten deal. And why not? It’s profitable; it’s a market leader in its sector; it will be covered by the Wall Street research analysts; and it has patient private investors who will continue to provide it with capital as needed. “We expect a broader set of companies go public via the direct listing approach over time,” Ludwig predicts. “All market participants, including institutional investors, are preparing for more diversity in how companies will get public.”
We’ve seen the IPO horror story repeatedly in recent years. And we’ve also seen how badly it can end. Take, for instance, the story of Fitbit, the pioneer of wearable fitness-tracking devices. Fitbit went public in June 2015. It was a fine company, a technology pioneer of sorts. But like so many others before and after it, the Fitbit IPO was hugely hyped by Wall Street and retail investors took to it in droves, driving up its price roughly 50% on the first day of trading to around $30 a share. A month or so later, Fitbit was trading near $50 a share. Then the euphoria subsided and reality kicked in. Customer-acquisition numbers were missed. The company punted on the data-monetization strategies that were supposed to provide profit upside. Investors began to question the company’s path to profitability. (Fitbit lost nearly $150 million in the first six months of 2019.) The stock deflated.
In August, Fitbit’s shares traded as low as $2.81 each. Then, on Friday, Google agreed to buy Fitbit for $7.35 per share, or $2.1 billion in cash. Fitbit CEO James Park proclaimed the deal’s fabulousness and said Google was the “ideal partner” to “advance our mission.” He said he could not be “more excited for what lies ahead.” But Park, no surprise, had nothing to say to those investors who bought Fitbit’s shares in the IPO or in the months afterward. Their billions of dollars of losses have now been locked in. Once again, investors like you and me got burned while early, “smart money” investors made out like bandits.
This post has been updated.
