The ride-hailing company Lyft went public with an IPO share price of $72 valuing the company at over $24 billion. Last year Lyft took a loss of close to $1 billion, it was a 32% increase in loss compared to the previous year. So why would a company increasingly showing a loss be valued at tens of billions of dollars? Lyft’s high IPO is not a unique event, in fact, over 80% of IPO’s in 2018 were unprofitable leading up to their filling.
To understand this change in investors strategy we first need to explain how IPO’s work. There are two markets in the capital market system: primary and secondary. Primary markets are where companies raise capital by selling equity in their organizations in the form of shares. The initial public offering is where the shares will first be sold. The price of the IPO shares reflects the demand for the company’s stock by investors. Once the IPO is over the existing shares are traded between investors on a secondary market such as a stock exchange like the NYSE. The primary market is where the company is raising capital, the company does not profit from the resale of a company’s stock from one investor to another in the secondary market.
Companies use their IPO’s to raise large amounts of capital to help them expand their operations in the hopes that it brings added profits. In the past investors wanted profitable companies with steadily increasing revenues to offset the risk of investment. The shift in recent years has been to get early access to companies with high potential for growth. This allows investors to gain the most from a company that successfully reaches its high growth potential.
This change is mindset is in part due to Amazon which continuously reinvested its revenues into more and more projects. Amazon has high revenue and low profit due to this strategy, and it has paid off with the company’s market value over $800 billion. Amazon can simply stop spending its revenue on further investments and instantly show huge profits, and this philosophy is what is driving the new unprofitable IPO craze. Lyft could have been profitable in 2018 if the company did not spend on R&D and marketing (including its discounted ride coupon codes). However, these expenses are what make Lyft a relevant ride-hailing service, so the logic still has some flaws.
A lot of people would be surprised to hear that companies like Lyft, Uber, and WeWorks currently are not profitable and actually report high loses year after year. Investors are looking at the long game and are placing growth potential over consistent profits in their investment strategies. Lyft is working on rolling out a huge fleet of self-driving cars that will remove the need for people to even own a car. This is an ambitious goal and investors are taking note, if the company can pull it off there will be a huge return on investment. This is the logic that investors are using to value a company like Lyft at $24 billion.
There is a danger in investing with this mindset as it brings a high level of risk into the market. With 80% of IPO’s unprofitable there is a high risk that many of these companies fail before even reaching profitability. The last time IPO valuations got out of hand there was a huge dot com crash. Investors should keep this in mind when investing in risky IPO’s and diversify their portfolio accordingly. What do you think about the Lyft IPO valuation?