Investing in Disruptive Tech IPOs in 2021
We are fortunate enough to spend most of our waking hours researching some of the most exciting technologies you can imagine. It’s easy to make a case that today’s market is only the start of a multi-decade bull market, the likes of which mankind has never seen before. In 2021 alone, Gartner expects that AI will generate $2.9 trillion in economic value, all of which will be impacting bottom lines. Back up the truck, because this train is ready to depart. This time it’s different.
And that’s where the whole theory falls on its face. One of the greatest stock pickers of all time, John Templeton, once said that the four most dangerous words in investing are “this time it’s different.”
This Time It’s Not Different
As more Nanalyze Premium subscribers climb on board, we’re able to pay our bills and invest in developing more content, products, and services. One thing we’re working on is embedding some objectivity into our tech investing strategy, similar to what we’ve done with our dividend growth investing strategy. In the meantime, we’re often faced with tough decisions.
For example, we’re going long C3.ai because we believe that their traction and leadership will help them dominate the enterprise AI space. Yesterday, we pulled the trigger on 1/6 of our position, paying more than double what the IPO was priced at. (Our original plan was to buy one-sixth of our position on the first day of trading, but we realized it started trading a day late.)
Just yesterday, another IPO debuted showing triple-digit returns on the first day. It was a particularly remarkable event when you consider that the company, Airbnb, relies almost entirely on the travel industry for growth.
The Airbnb IPO
Rattling off P/E ratios and talking about EBITDA doesn’t allow us to see mania in its primal form. Instead, it’s best to use simple comparisons. This past spring, Airbnb laid off 25% of their workforce and raised a funding round at a valuation of $18 billion, down from the $31 billion they were valued at in their previous round. Eight months later, the company is suddenly valued at $86 billion after an IPO that Bloomberg described as a “euphoric moment.”
At the moment, Airbnb is worth as much as Hyatt, Marriott, and Hilton combined – or almost exactly that of Booking Holdings (previously known as Priceline.com). Here’s a look at how these companies stack up when looking at revenues and earnings.
We always emphasize the importance of revenues above all else when investing in disruptive technologies, but we have to wonder just how much disruption Airbnb can look forward to given that the pandemic has decimated the global travel industry. If we were to consider investing in the depressed travel industry, we’d invest in companies that were most likely to survive the massive downturn the industry is experiencing. No matter how many optimistic nightly news segments get published, there is no certain end to this problem in sight, nor is there any accurate measure of what fallout we can expect from it. It’s one of three reasons why we’re extremely suspicious about today’s booming stock market.
Three Red Flags
Newbie investors wreak havoc on valuations because they haven’t a clue that human emotion will drain your wallet faster than a 19-year-old “I only do this occasionally to pay for my college tuition” entertainer on Soi Cowboy. More than 13 million traders have flocked to Robinhood to trade stocks with the pandemic panic of March 2020 only serving to increase interest in the market. Many of these individuals are absolutely clueless, buying up shares of bankrupt companies, and then writing threatening letters of complaint because nobody explained to them how the bankruptcy process works.
When the market realized that these weekday warriors would trade just about anything, it started offering them special purpose acquisition companies (SPACs).
If you’re not familiar with what a SPAC is, just read our piece on How SPACs Reward Everyone Except Retail Investors. As the title implies, SPACs should largely be avoided. In the rare case that a quality company decides to IPO using a SPAC, you’ll still have to deal with irrational price swings based solely on hype. Such irrationality makes it very tempting for long-term investors to engage in market timing and trade in and out of their positions, something we try to avoid at all costs.
Most SPACs are easy to avoid because they’re pre-revenue businesses with nothing but a plan and lofty ambitions. Just look at battery maker QuantumScape (QS), a pre-revenue company with no commercial operations that’s up +700% since their SPAC merger was announced. Some of these companies you wouldn’t invest in during the best of times, even if they weren’t subject to hype. In the words of Warren Buffet, it’s better to buy a wonderful company at a fair price than buy a fair company at a wonderful price. In the case of most SPACs, you get neither, yet people are eating this stuff up with SPACs debuting left and right. To make matters worse, now seems like hardly the time to be taking on lots of risk.
The biggest concern we have right now is how little we know about the effects of a pandemic that has closed nearly every border on this planet. In the face of so many unknowns, the market seems to be largely unconcerned, with the Nasdaq index up +42% since The Rona reared its ugly head.
While the Americans have turned the pandemic into just another political pissing contest, the rest of the world is grappling with it in their own ways. If you’re a global traveler, the entire planet has turned to shite. The only places you can go – possibly – are the four countries seen below in grey.
With 98% of all countries on lockdown for most of this year, the global travel industry has been decimated, with international travel plummeting by 80% during the travel season’s biggest months. As of August, that translated into a loss of US $730 billion in export revenues from international tourism, more than 8X the loss experienced during the 2009 global economic crisis.
A few years ago, Deloitte wrote a glowing report on global travel which dropped some interesting facts:
According to Phocuswright, global travel industry gross bookings reached $1.6 trillion in 2017, making it one of the largest and fastest growing sectors in the world. Factoring in indirect economic contributions, travel and tourism now accounts for a staggering 10.2 percent of global GDP.
That $1.6 trillion dollar industry has been all but devastated, yet times couldn’t be better according to the market. Look no further than the Airbnb IPO. It’s difficult to justify this without resorting to “this time it’s different.” It is different indeed. This time, a pandemic is wreaking havoc across the entire planet. Still, this doesn’t mean you should liquidate all your positions and board the next flight to quality.
The Deep Value Play
ARK Invest is the leading institutional investor when it comes to disruptive technologies. Their fearless leader, Catherine Wood, argues that investors fail to realize the potential for disruptive technologies such that they’ve undervalued these stocks. Consequently, they see disruptive tech stocks as a “deep value play.” If that’s the case, then you ought to be invested in stocks, and use any sort of market corrections as an opportunity to add to your positions. That’s why we’re staying long and strong with current positions, and slowly accumulating shares in positions we want to increase. It’s why we bought shares in C3.ai.
The Problem with Investing in IPOs
The impetus for writing this piece was the number of inquiries we’ve been receiving on how to buy pre-IPO shares, and two recent situations we encountered in our own investing activities.
The C3 IPO
C3 is a company we really want to be invested in for reasons we’ve discussed. The IPO was priced at between $42 a share. That’s what sophisticated institutional investors were willing to pay for shares several days ago, and that’s the price we wanted to pay. A fair price.
On the second day of trading, shares closed at $130 a share. The efficient market hypothesis tells us that nothing happened within two days that merits a +210% price appreciation for these shares, yet here we are. For serious long-term investors wanting a piece of this company, this presents a dilemma. All you can do is wait for the dust to settle.
The Desktop Metal SPAC
The second issue we came across was the sudden rise of Desktop Metal. It’s what happens when you invest in a SPAC. In advance of the ticker being changed to DM signifying that the deal is all done and dusted, shares traded up over +120% in just a few days’ time. In all likelihood, that’s hype. With the deal complete, investors in the SPAC can now begin selling shares and driving the price down. And that’s exactly what’s happening.
One of our readers presented these facts and asked what we planned to do. Well, as we do in all cases, we stay long and strong. We don’t trade in and out of stocks, but as you can see, it’s very tempting not to. These temptations are what happens when you get involved in these messy SPACs that serve more as a gambling mechanism for Robinhood speculators than an investment vehicle for serious long-term investors.
The entire SPAC mess should be avoided like the plague, save for a few exceptions that may merit a look after the dust has settled. We’ve now adopted a new rule for any SPAC we might consider investing in (we can count the number on two fingers). We won’t even consider investing in any SPAC until the entire process has completed and the ticker changed.
Loving or Avoiding
The biggest problem we’re facing right now is that quality companies may choose to go public since the IPO window is open. And they’d be fools not to, given that valuations no longer seem relevant.
Let’s say Gingko Bioworks decided to have an IPO. Based on past research, Ginkgo is an absolute must-have investment for our disruptive tech portfolio. (Fortunately, there are only a handful of startups we would put in that bucket.) So, what approach should we take?
Ideally, the market undergoes a massive correction, and this becomes a non-issue. But let’s assume that we’ll see more IPOs in 2021 we want to invest in which will behave like the ones we’ve discussed earlier. In the face of such volatility, we need to set some sort of purchasing schedule in advance to remove emotion from the equation. As we’ve done with C3, we’ll look to spread out the buying of any IPO over five or six months. We’ll pick an arbitrary day of the month and purchase one-sixth of our position on that day – for six months in a row. If the market corrects while we’re doing that, we’ll have the dry powder to take advantage of it.
Waiting to accumulate our positions could mean that we purchase shares at an even higher price down the road, but that worry is based on greed. We’re more interested in reducing market timing risk which is what you incur when trying to call the bottom or top for any stock. Not to mention we sleep much better at night knowing that our emotions have been left at the door.
We’re not going to compare what happened in the dot-com bubble to what’s happening today. Apples and oranges. The only thing that we can be certain of is that both exhibit the sort of blatantly obvious mania that’s reminiscent of the recent cannabis stock craze. Loads of first-time investors with visions of profits dancing in their heads are propelling IPOs to triple-digit gains while institutional investors are laughing all the way to the bank.
As we enter 2021, investors are best served to stay out of the fracas and keep their eyes on the horizon. When the market finally corrects, you’ll be glad to have some dry powder. Of course, there’s always a chance that this time it’s different.
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