SINGAPORE (Oct 7): Corporate sagas often unfold excruciatingly slowly. Over the past two years, several high-profile, fast-growing, overhyped venture capital (VC)-funded companies have imploded. There was Theranos, a blood-testing start-up founded by charismatic young college dropout Elizabeth Holmes at the age of 19, which took more than a year to unravel under the glare of negative headlines that accused it of being a scam. The battle for the control of ride-hailing giant Uber Technologies also unfolded over a year after founder Travis Kalanick found himself entangled in a series of scandals, including accusations that he condoned sexual harassment, drivers were exploited and employees blatantly stole autonomous vehicle technology from Google to help fast-track Uber’s own robotaxi efforts.
In contrast, the climactic ending for WeWork late last month was more rapid than anyone could have imagined. Less than 24 hours after word spread that some of WeWork’s directors were ready to fire charismatic founder CEO Adam Neumann, it was all over.
With the firm just days away from a planned IPO process, the board pushed out Neumann, who remains chairman, named two co-CEOs as replacement, postponed its listing indefinitely, started selling assets, scaled expansion plans in China, purged Neumann’s family members and friends and is preparing to fire a third of its workforce to wring out more cost savings in the hope that it might help the company get over the hump.
The jury is still out on whether the rebooting of WeWork will work without addressing its flawed business model. The controversial co-working firm is sitting on US$47.2 billion ($65.25 billion) of future undiscounted lease costs. Chris Lane, an analyst for Bernstein & Co in Hong Kong who covers SoftBank Group’s stock, estimates that WeWork will most likely run out of cash before June. “In the absence of an IPO and associated senior secured debt raising [of US$6 billion], WeWork does not have sufficient funding to meet its growth plan,” rating agency Fitch said in a statement on Oct 2.
If WeWork is to survive, its new management must pivot to expanding margins instead of trying to boost top-line growth. That is the only thing that is likely to help stabilise the ship and pave the way for an eventual IPO.
Show me the money
Clearly, the sentiment regarding tech IPOs and tech stocks generally has shifted in recent weeks as public market investors have turned against overhyped VC-funded companies with lofty valuations. For years, ambitious tech companies coming to market were rewarded for growth at all costs. Now, investors are demanding to see positive cash flow and a visible path to profits. Recently listed companies such as ride-hailing giants Uber and Lyft as well as connected fitness pioneer Peloton Interactive have seen their stocks pummelled in the aftermath of their IPOs. Uber’s stock is down 41% from its May IPO, Lyft’s shares are down 58% since its March listing and Peloton’s is down 22% from its debut last month.
In the private markets, Uber last raised money at a whopping US$72 billion valuation. It now has a market capitalisation of under US$49 billion as a listed firm. Private markets had valued Lyft at over US$50 billion. Its current market capitalisation is about US$11.3 billion. Investors scarred by the US-China trade war are seeking comfort in safer business models such as subscription-based software as shares of software-as-a-service companies like Zoom Video Communications earlier this year, CrowdStrike Holdings two months ago and Datadog last month have had spectacular IPOs and are indeed thriving in the current environment.
Worried about the escalating trade war, the US$17 trillion in sovereign debts in Europe and Japan that have negative yields, the slowing global economy and falling profit margins, public market investors around the world are increasingly more selective about what they are buying, particularly within the tech sector. To tech investors, growth for the sake of growth no longer matters. They are now laser-focused on the bottom line because too many businesses such as ride sharing and meal delivery have a long history of growth, but are still as far from profitability as they ever were. Not surprisingly, there is more money on the sidelines today than at any time in history, and despite a burgeoning bond bubble, a record amount of money continues to flow into the safe haven of low-yielding government bonds rather than risky assets such as tech stocks.
How did we get here? As one of the longest bull markets in history got extended, investors looked the other way at frothy tech valuations. They ignored warning signs about some of the high-profile emerging tech players that had no pathway to profitability and embraced anything that showed high growth. Companies such as Uber, Lyft and WeWork got ridiculous valuations because of the willingness of Silicon Valley to tolerate huge losses while their top line was growing at warp speed. Now, VCs are trying to stay away from companies that have nothing to show for themselves aside from growth, which they have acquired by pouring in massive amounts of capital. There is a realisation that the growth-at-all-costs mentality is no longer viable for start-ups hoping to become profitable. Moreover, blitzscaling may work for a handful of players that have a clear “network effect”, but not for most tech companies.
Cult of the founder
One silver lining in the aftermath of the WeWork saga is closer scrutiny of the cult of the founder in Silicon Valley. Tech firm founders have been for years revered and worshipped as gods. Apple’s late founder Steve Jobs was the poster child. Apple faltered after Jobs was fired and only regained its mojo after he returned to the company. These days, billionaire founders such as Facebook’s Mark Zuckerberg, Alphabet-owned Google’s Larry Page and Sergei Brin and Tesla’s Elon Musk are among the more esteemed icons. Uber’s Kalanick was seen as a cult-like figure until he was fired from the ride-hailing giant two years ago.
To keep control of their companies and avoid the fate of Apple’s Jobs, founders created a special class of shares with outsized voting power. WeWork’s Neumann initially gave himself 20-to-1 voting power so that despite a small stake, he could retain absolute control of the firm he founded. That was reduced to 10-to-1 after corporate governance in WeWork was put in the spotlight and finally cut to 3-to-1.
The corporate structures of start-ups make it impossible for founders to even be reprimanded by boards for bad behaviour. Indeed, until the very end, Neumann had the power to fire WeWork’s entire board. Dual-class share structure, or threeclass share structure in the case of Alphabet, needs to go because it is seen as a serious governance issue. In the aftermath of the WeWork debacle, founders will have to make concessions on control if they want to take their company public.
There has been a sea change in investors’ attitude over the past two months as the IPO market has begun to sour and high-profile IPOs such as that of WeWork have been yanked. Over the next several months, valuations in the private markets will continue to be ratcheted down. Sure, good start-ups will always get funded, but even they will have to accept lower, more realistic valuations than many of their peers did over the last three years. Of the 400 or so unicorns, or private companies with billion-dollar valuations around the world, 60% to 70% will, more likely than not, see a down round, or a drastic cut in their valuations, at their next round of funding. The IPO window for unicorns has not completely closed if the recent successful listing of software firms such as Datadog is any guide, but it will get a lot tougher for companies that are merely trying to weave a good story, such as Uber or WeWork.
Writing on the wall
Already some companies are seeing the writing on the wall and abandoning their plans for an eventual IPO, selling themselves instead to larger companies at valuations much lower than what they had received in the private markets just weeks or months ago. One such firm is Rubrik, which makes software for managing and recovering data. It last raised US$261 million at a US$3.3 billion valuation in January. Rubrik has incredible networking in the Valley. Microsoft chairman John Thompson is a Rubrik director, and former Cisco CEO John Chambers is an investor. If the likes of Rubrik have to put themselves up for sale instead of doing another fundraising round or an IPO, there is little hope for less-well-connected players or those with less-viable business models.
In Asia, the focus over the next 12 months will be on Chinese ride-hailing giant Didi Chuxing and Singapore-based Grab, both of which have SoftBank as an investor as well as Uber because Didi and Grab bought out the local operations of the US ride-hailing giant. SoftBank and Abu Dhabi’s sovereign wealth fund, Mubadala, last invested US$4 billion in Didi at a US$56 billion valuation. Toyota Motor Corp last year invested in Didi at a US$57 billion valuation.
US media has reported that some Didi shareholders are looking to sell down their stakes. A Chinese investor reportedly sold Didi shares at a US$40 billion valuation recently, and a US fund that has been trying to sell its stake at a US$43 billion valuation has reportedly found no buyers. Didi expects to raise an additional US$2 billion by the middle of next year. Analysts say in the changed environment, its next round is likely to be a down round, or a substantially lower valuation. Grab raised US$4.8 billion earlier this year at a US$14 billion valuation. Indeed, the US’ second-largest ride-hailing firm Lyft now has a market capitalisation of just US$11 billion, more than 20% lower than Grab’s last valuation.
As start-ups and late-stage tech unicorns around the world look at the post-WeWork landscape, they will find that it is a whole new world out there. The dwindling tech IPO pipeline will be replenished again, but one thing is for sure: The next lot of VC-funded companies that list on Nasdaq, the New York Stock Exchange and in Hong Kong, even Singapore, will be a lot different from the recently spurned ones.
Assif Shameen is a technology writer based in North America