Recent share prices for 2019’s IPO class reveal stark differences in the way public and private markets value enterprise software and consumer businesses.

2019 was supposed to be the Year of the Unicorn – when technology companies valued at more than $1 billion would finally, triumphantly, move en masse toward public listings. However, as WeWork’s recent botched IPO attempt and its aftermath demonstrate, the reality of the unicorn IPO has proven more complex.
 
For those U.S. unicorns that made the leap to the public markets in 2019, performance has varied widely, but a clear trend has emerged: Enterprise software unicorns have largely outperformed while those focused on the consumer sector have languished (Exhibit 1).

bar chart - of companies that had IPOs in 2019, the stock prices of enterprise software companies have generally outperformed consumer companies

As discussed in our paper, Age Really Does Matter When It Comes to Unicorns, there are meaningful differences in the business models of these two types of companies. Enterprise-focused software companies largely follow a software-as-a-service (SaaS) business model, which has high up-front costs, but marginal costs that approach 0% as a company scales. As such, the path to eventual profitability for SaaS businesses is relatively well understood and driven by the addressable market and the lifetime value of a customer (primarily customer acquisition cost, duration of the relationship, and revenue generated).

The business-to-consumer segment, meanwhile, has several differentiated business models. Two of the more common are the advertising-driven model employed by companies like Google, Facebook, and Pinterest, and one that leverages technology to provide a tangible product or service (e.g., Chewy, Uber, and Lyft). For the second group, we noted concerns that these companies were not pure technology companies and that their profitability could partially resemble that of the very industries they sought to disrupt.

Public market investors appear to agree, as we have seen reflected in the share prices of these companies post-IPO. Driven by a “growth-at-all-cost” approach in private markets, many consumer-focused, tech-enabled companies delivered “profitless prosperity” for their private market shareholders. In the public markets, they have struggled to justify their valuations. Public markets have recognized these differences and largely chosen to award higher valuations to those companies with higher margins and a clearer path to profitability.

bar chart - on the whole, 2019's enterprise IPOs have stronger fundamentals than consumer IPOs

This discrepancy in how the private and public markets have approached valuing software-enabled businesses versus businesses in which software is the product has also not gone unnoticed by private market investors. This notion was most eruditely captured by Fred Wilson of Union Square Ventures in a recent blog post:

I believe that we have seen a narrative in the late stage private markets that as software is eating the world (real estate, music, exercise, transportation), every company should be valued as a software company at 10x revenues or more.

And that narrative is now falling apart.

If the product is software and thus can produce software gross margins (75% or greater), then it should be valued as a software company.

If the product is something else and cannot produce software gross margins then it needs to be valued like other similar businesses with similar margins, but maybe at some premium to recognize the leverage it can get through software.

But we have not been doing it that way in the late-stage private markets for the last five years.

I think we may start now that the public markets are showing us how.

It certainly seems that, in this corner of the market, at this moment in time, the brute efficiency of the public markets has led the way.

Was this article helpful?
YesNo

IMPORTANT INFORMATION

This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security offered by Institutional Capital Network, Inc. or its affiliates (together “iCapital Network”). Past performance is not indicative of future results. Alternative investments are complex, speculative investment vehicles and are not suitable for all investors. An investment in an alternative investment entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. The information contained herein is subject to change and is also incomplete. This industry information and its importance is an opinion only and should not be relied upon as the only important information available. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed, and iCapital Network assumes no liability for the information provided.

Products offered by iCapital Network are typically private placements that are sold only to qualified clients of iCapital Network through transactions that are exempt from registration under the Securities Act of 1933 pursuant to Rule 506(b) of Regulation D promulgated thereunder (“Private Placements”). An investment in any product issued pursuant to a Private Placement, such as the funds described, entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. Further, such investments are not subject to the same levels of regulatory scrutiny as publicly listed investments, and as a result, investors may have access to significantly less information than they can access with respect to publicly listed investments. Prospective investors should also note that investments in the products described involve long lock-ups and do not provide investors with liquidity.

Securities may be offered through iCapital Securities, LLC, a registered broker dealer, member of FINRA and SIPC and subsidiary of Institutional Capital Network, Inc. (d/b/a iCapital Network). These registrations and memberships in no way imply that the SEC, FINRA or SIPC have endorsed the entities, products or services discussed herein. iCapital and iCapital Network are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.

© 2019 Institutional Capital Network, Inc. All Rights Reserved.

Nick Veronis

Nick Veronis

Nick is Co-Founder and one of the Managing Partners of iCapital Network, where he oversees Research and Due Diligence. Nick spent 11 years at Veronis Suhler Stevenson (VSS), a middle market private equity firm where he was a Managing Director responsible for originating and structuring investment opportunities. He holds a BA in economics from Trinity College and FINRA Series 7, 79, and 63 licenses. See Full Bio.

Aref Jessani

Aref Jessani

Aref Jessani is a Senior Vice President of Research and Due Diligence at iCapital Network where he is responsible for performing single manager analysis on alternative investment funds, and developing multi-hedge fund solutions for clients. Prior to joining iCapital in 2016, Aref was a Director and member of the Investment Committee at Lanx Management for seven years. He holds a B.Sc. in Economics, from the London School of Economics and Political Science, and an MBA from Columbia Business School.