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Absolute Return Podcast #33: IPOs: Idiot’s Purchase Only?

By September 30, 2019 No Comments

September 30, 2019—Peloton Falls as Much as -15% in its Underwhelming IPO. Why Did Investors Sour on the Stock?

UFC-Owner Endeavor Pulls IPO Amidst Lackluster Demand. Why Did its IPO Flop?

WeWork CEO Fires Himself After Investors Lose Confidence in the Co-Working Company’s Leader. What Led to His Downfall?

Altria and Philip Morris Call off Merger Talks as Vaping Crisis Hits Juul. Why Did the Deal Fall Apart?

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Transcript

Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at Accelerateshares.com.

Julian Klymochko: Welcome, investors. This is episode 33 of the Absolute Return Podcast. I am your host Julian Klymochko. 

Michael Kesslering: And I am Michael Kesslering.  

Julian Klymochko: Today is a cold Friday, September 27. It looks like winter is starting out there. Nonetheless, some pretty hot events in the market this week. We are going to be focusing in on IPOs, initial public offerings, also known as it is probably overpriced or one of my personal favourites, Idiot’s purchase only. 

    • Nonetheless, Peloton was a big IPO that happened this week and stock fell as much as 15 percent in its debut during its underwhelming IPO. We are going to chat about why investors soured on this stock. 
    • UFC owner Endeavor pulled its IPO amidst lack lustre demand from investors. Why did this IPO flop? 
    • Some more WeWork news. Finally, we are probably done with WeWork for a while, but we just wanted to wrap up this one. As the CEO, he fired himself after investors lost confidence in the co-working company’s leader. What led to his downfall? 
    • Lastly, we are going to chat about Altria and Philip Morris that proposed two hundred billion dollar tobacco merger. They actually called off talks, so they scrapped that potential merger amidst regulatory concerns and a big push back from investors. We are going to chat about those reasons more in depth on the podcast today.

Peloton 

Julian Klymochko: We had an underwhelming IPO hit the market this week with Peloton. It fell as much as 15 percent on its debut day of trading. The fitness equipment maker Peloton had a hard time selling, quote, “happiness” as its CEO indicated. That is what it does, but public investors were not having it as a stock really tanked in the couple of days of trading that it had this week. This stock IPO, investors bought it for 29 bucks. It actually opened up on a delayed basis a couple of days ago at 27. It actually opened nowhere near its IPO price and ultimately closed below 25 bucks per share. So investors not feeling Peloton on this one. Some details on the deal. This deal raised one point one 6 billion and initially valued the fitness company at a point one billion. But it did lose one billion in market cap on its first day of trading. However, this is significantly higher than the four point two billion price tag attached to the company after its last round of private fundraising last August. So just over a year and you are seeing the market cap up over 50 percent. Just a comment on the general IPO market. I mean, this Peloton IPO comes two weeks after the IPO of Smile Direct Club, which priced its IPO above its marketing range, which you would expect to accompany a bullish or rising share price on its first day.

But Smile Direct Club actually tanked pretty significantly. It fell 20 percent on its first day of trading. This is also coming after underwhelming IPO showings from both Uber and Lyft. Uber was a really, really high profile IPO and that’s down about 30 percent since it made its public market debut. Shares of its rival Lyft have fallen 40 percent since their IPO in March. Chewy the online pet food retailer. They went public in June; their stock is down over 25 percent. There is an ETF that invests exclusively in IPOs. It was doing great up until a couple months ago. It is now down about 15 percent from its peak. However, not all-prominent IPO have floundered. Many of the smaller ones have done quite well. One high profile deal specifically was Pinterest, that IPO in April and it is up about 44 percent. Investors really had to pick and choose here, but nonetheless, I mean, you’re seeing not much of an IPO pop these days. It is turning more into an IPO tankage. What are your thoughts on the recent action in the IPO market in general and Peloton specifically?

Michael Kesslering: Yeah, and when you mention the IPO market in some of the pops, it is really some of the companies that, yes, are having losses, but they are true SAS companies. Software as a service companies. Whereas when you get companies like Peloton, WeWork, Uber, Lyft that are really kind of old world business models like in the case WeWork, it’s real estate Peloton, it’s, you know, a fitness bike with a physical component, with a software overlay where they’re really just adding that software over top. Those are the ones that you’re actually seeing the really poor IPO performance in. Just in terms of numbers going into the year, investment bankers were really excited about 2019 as this was seen as the year that a lot of these really large private companies were going to go public and there would be a bonanza of fees. So far this year, we have seen 53 billion dollars raised in the IPO market, which is the most since 2014, when seventy seven billion dollars was raised. Keep in mind that most of that was raised, I believe 25 billion dollars was raised just by Alibaba that year so that’s kind of an outlier. Where this year, you’ve had a number of really large IPO. And in terms of for the fees for the investment bankers specific to Peloton, despite the poor trading performance post IPO so far, the underwriters are splitting about 60 million dollars in fees after helping them raise, as you had mentioned, just over a billion dollars, and those underwriters, I believe co underwriting was Goldman Sachs and J.P. Morgan. They have been very, very popular with these tech companies, hybrid tech companies that have been going public this year.

Julian Klymochko: Right, and with respect to point on money losing IPO’s. I think the main reason why investors have been so sceptical and the share price performance has been quite poor. On the IPO of these money-losing companies is that, these ones specifically don’t present a clear picture to investors on a path to profitability, which is ultimately needed to have a successful investment. As we have previously discussed, WeWork’s IPO prospectus, they really gave no path to profitability and we saw something similar with respect to Uber. And that’s why you’re seeing these IPO has really come out of fashion, but you indicated SAS and other software type businesses where investors believe they can scale and ultimately become profitable within the next few years. They still have faith in those types of IPO’s, and those stocks continue to do well. So we’re seeing an interesting divergence between IPO performance, depending on the business model. 

UFC

Julian Klymochko: UFC owner Endeavor, they pulled their IPO amidst lack lustre demand. So it’s really in the midst of weak investor demand, as we previously discussed ad nauseam. Just a lot of IPO’s these days are for money losing entities of which Endeavor is one, I believe, in terms of total IPO’s. We are seeing as high as 80 percent of them being unprofitable companies. Really, the investors here, they had two problems with the Endeavor IPO and why it couldn’t get off the ground. Number one, just recent poor performance of other IPOs. Specifically, they cited Peloton tanking in its debut a couple of days ago. Endeavor was actually supposed to start trading today, but obviously, that did not happen. Then the other thing is just valuation. I mean, I believe Endeavor was trying to come out at eight billion, which was an aggressive valuation in investors’ minds. So there’s really tepid demand with respect to that. Now, what Endeavor does the real powerhouse in Hollywood, they manage entertainers. They are run by a super-agent Ari Emanuel, and they’re known for owning the UFC, Ultimate Fighting Championship and the Miss Universe pageant.

Now, this IPO, it was led by Goldman Sachs, who has been leading a lot of these high profile IPO. They targeted to raise more than six hundred million by selling shares in a price range of 30 to 32 bucks a share. That was the initial range, this was actually lowered to 26 to 27 bucks a share and they still could not get it done as they reprice that lower. That would evaluate them at about seven point two billion. Now, this was above the six point three billion valuation that the company commanded in 2017 when they scored a one billion dollar investment from CPP, the Canada Pension Plan, and Singapore, a sovereign wealth fund. So what’s interesting about that is that given the CPP owns a material stake in Endeavor, it appears that every single Canadian owns a portion of the ultimate fighting championship, which is a pretty cool thing. Nonetheless, this is actually the second time Endeavor hit the brakes on its IPO this year. Which begs the question, are they ever going to go public?

Michael Kesslering: Yeah, and the other interesting aspect is you have mentioned CPPIB and some other investors as well. Silver Lake owns a significant minority position there, a large PE firm in the U.S. and Softbank, which they had their own challenges with Wework. Not a very good week for Softbank as they own five percent of Endeavor, but in terms of, what was the rationale for doing their IPO? Now it was a fairly leveraged company. I don’t have the numbers right in front of me right now, but part of debut use of proceeds was to pay down a portion of that debt.

Julian Klymochko: Right and I remember specifically when UFC buyout for four billion. It was an LBO; I believe they leveraged that deal at least six times EBITDA, which is a highly leveraged buyout.

Michael Kesslering: Absolutely. Then the other use of proceeds and part of their strategic shift. Now, you did mention that. They are, led by Ari Emanuel. Which fans of the HBO show Entourage will recognize him as being the inspiration for the Ari Gold character, which is quite interesting. It was really a shift from the pure agency model that Ari Emanuel had started and really transformed them. It is over 100-year-old company, technically. But really, he kind of transformed it in 1995 when he split from his previous agency and really moving into more of a media conglomerate, buying the Miss Universe pageant, UFC and they’re looking at a number of other assets. So it’s really part of this strategic shift that they’re looking at that right now the market just really doesn’t have much of a desire for.

Julian Klymochko: So Endeavour had a failed IPO and we are going to talk about another company that recently had a failed IPO, WeWork. 

WeWork

Julian Klymochko: They actually had a number of huge changes at the company. That CEO Adam Neumann, the controversial co-founder of Start-up WeWork, which is basically the king in the co-working leasing space, actually ousted himself as the CEO after this failed IPO. He really faced pretty much a boardroom coup after the company’s largest investor, Softbank, put pressure on Neumann after the IPO flopped. He was saying that investors lost faith in Neumann ‘s leadership and they wanted a fresh face at the top of the company. Now, the failed IPO happened as estimates of WeWork value fell by tens of billions of dollars amid investors’ concern about its corporate governance. Which we have touched on a lot in the past, inability on its future ability to generate profit. As we know, WeWork is losing billions of dollars per year, just burning through a ton of cash, which is why I was so reliant on this IPO getting done. Now they are really scrambling, they are selling businesses, they are cutting a ton of jobs, really trying to save money, stem the cash burn. They really need to come up with billions of dollars in financing that they really were relying on here.

It is an interesting situation, as things seem to be spiralling out of control a little bit at WeWork. Nonetheless, Softbank’s Masayoshi Son, who basically financed WeWork to the tune of over 10 billion dollars. He is basically the biggest victim of what happened here. He pumped a ton of money into it the last time at a 47 billion dollar valuation and by the time the IPO was pulled, estimates of WeWork’s valuation have dropped all the way down to as low as 10 billion dollars. Now, interesting point on this story is that when investment banks were initially pushing to win the IPO business, they were saying that they could take WeWork out at valuations as high as 90 to 100 billion. So it really gives listeners a sense of what investment banks are willing to do to land a deal and the sort of nonsense they’re willing to feed to founders and CEOs of start-up or private companies when they are looking to win that IPO mandate. Nonetheless, there is a message from the board to Neumann. Basic message was, listen; this IPO has gotten distracted by you. There is this so many corporate governance issues here. We talked about how he sold the trademark to the word We to the company for six to seven million bucks.

He had a 65 million dollar G 650 private jet, which he travelled around the world in, and he got busted with drugs in the Middle East on it. He actually hired a driver; it was a WeWork employee to drive him around in his luxury Maybach automobile. And, you know, just tons of stories of insider dealing, whether it be buying properties, renting them back to WeWork. He cashed out nearly a billion dollars in pre-IPO stock prior to it going public so we could go on and on with the massive red flags raised on this file. It was really tremendous. Like I have never seen anything like it. Nonetheless, no surprise as to what happened here. Investors balked at not just the valuation, but the corporate governance issues. Ultimately Neumann ‘s head rolling on this one. I mean, he cannot stay CEO. The company is desperate for money. They are planning on raising 9 billion and now they have nothing. I saw an estimate at current burn rate; they could run out of money by next summer. So what are your thoughts on what is going to happen with rework here?

Michael Kesslering: Yeah, and just for context, our listeners may wonder, you know, why does the corporate governance of, you know, one tech company, you know, hybrid tech company matter. You know, them having horrible corporate governance. Why does it matter? Why have we focused on this on the podcast? And I really saw this as kind of a crossing of the Rubicon of sorts. If this IPO went through with those terms of what public investors would be willing to let a founder and a management team get away with at a high growth tech company. And you know, what this really showed is that. There is a limit to the bad corporate governance. Now, just for an example, I just wanted to highlight some of the voting rights and how this kind of played through on in super voting structure. Was originally you will remember that he had 20 to one voting rights. Then last week as they were getting a lot of pushback on the IPO, that was reduced to 10 to one in an attempt to appease investors. Then now that he has stepped down, it is 3 to 1. Now, the company has not officially disclosed how much Neumann owns of the company, but its insiders say it is about 25 percent. 

He still does control a voting majority with the three to one voting rights. But it does, you know, they will be raising money in the future. So there is still a chance that like at some point he won’t have the majority interest there, in terms of the vote. But as well, I really just wanted to highlight that this as you mentioned, that now the growth narrative on this company is over officially. I mean, they have now halted all new leases. As you had mentioned. They are working to make job cuts of up to perhaps 50 percent or some of the reports and, you know, selling off some of their recent acquisitions that were bought at inflated prices. But, you know, really to me, like the issue, like what they’re really trying to show is that their current properties are profitable and show that to investors. But to me, this really wasn’t the issue. I mean, there is corporate governance issues as well. But the losses because of growth were not an issue. If they showed in their S-1. If they showed unit economics on current properties with real numbers, and showed that, those properties were profitable. But that why they had losses were because of the growth initiatives and that there was just a J curve where you have initial losses and then in the future you will be able to harvest those and harvest a lot of profits from those locations. Investors would be very fine with that. But what happened was they had no disclosure on the actual unit economics of the business. Now looking at it currently where they are really just hunkering down, making a defensive move, cutting costs like this is no longer a growth stock. It no longer should have it be supportive of this massive multiple to their revenue.

Julian Klymochko: Right, and really what the issue here is they have a very close competitor in the market. I mean, Regus does the exact same thing and they proven that it is a valid business model, can be profitable and can get a good valuation in the market. But what WeWork was trying to do, spend money like crazy, grow like crazy amidst losses that were spiralling out of control to get an egregious valuation. And that game really stopped working, ultimately just things fell apart. Investors balked at the deal and certainly corporate governance played a huge role in that. It got investors to wake up and be like, look, the pricing on this is crazy. The business model as it currently set does not make sense. However, that does not mean that it won’t make sense in a restructured form. In conclusion, one of the biggest victims here, I guess, aside from WeWork shareholders, WeWork employees and its former CEO. One of the biggest victims is Softbank because it is outraising its second vision fund, which it aims to be above 100 billion, and they are doing this as the wheels are really falling off the IPO market. WeWork IPO failed miserably, Endeavor’s did, Peloton not doing good. Tons of other high profile IPO shows are down double digits.  What the vision fund’s strategy is to invest in pre IPO private companies and then flip it to public markets and an inflated valuation, and what is happening here is that public markets are saying, hey, your private market valuations are crazy, We’re not going to bail you out at inflated valuations. That is exactly why you are seeing so many failed IPOs. And if they don’t fail, you’re seeing a lot of high profile IPOs trade very poorly with significant losses.

Altria

Julian Klymochko: Some M&A news with major IPO implications. What happened in the market this week is that tobacco companies Altria and Philip Morris. They actually called off merger talks. One of the main reasons was there’s vaping crisis at 35 percent owned by Altria Company called Juul, which offers vaping products. So the Altria and Philip Morris deal was going to be one of the largest mergers of all time. It was a 200 billion dollar proposed combination. This was shelved in addition to this massive increase in regulatory scrutiny on vaping products and Juul has really broad investors scepticism on the deal. What these companies do, I’ll just give you a little bit of background is they sell the Marlboro brand, as main one, Altria sells it in the U.S. and Philip Morris sells it internationally. They were going to merge and an all share merger deal. We talked about this last month on the podcast. This deal was pitched as a way for the companies to spread their bets on the future of nicotine consumption. As we know, tobacco use declining pretty significantly. Obviously, a massive health risk. People tried to be healthier and they are aware that obviously smoking cigarettes is very unhealthy and the market is really viewing vaping or smokeless tobacco products as a much healthier choice to get your nicotine fix. And that’s why Altria ultimately paid almost 13 billion dollars to take a 35 percent stake in Juul labs. Now, this was really their play to combat the declining cigarette market. And Juul has actually seized about 70 percent of us e cigarette sales, so they’re a massive player in E cigarettes.

But what happened was that there was massive regulatory crackdown recently in the U.S. and it’s spreading internationally as U.S. regulators and politicians, they are really cracking down on vaping products. They are looking to outright ban flavoured e-cigarettes, which they point to a massive increase in high rates of use in youth E-cigarettes, users. There is also concern on disease caused by vaping, but nonetheless, flavoured e-cigarettes represent 80 percent of Juul sales. And if the U.S. bans that, the valuation on Juul is obviously going to drop significantly from the roughly 35 billion in which Altria invested in it. That was one major concern, specifically from PMI, Philip Morris shareholders. 

The other was that PMI shareholders expressing a lot of concern about the exposure of Altria declining and litigation wracked the U.S. cigarette market. Altria shareholders not too keen on doing a deal in which they don’t get any sort of control premium. It was pitched as more of a merger of equals, but investors understood it as PMI acquiring Altria. Nonetheless, as we discussed previously, the share prices of these companies tanked upon deal announcement. It was really an investor revolt, so we are really not surprised. We said a very low probability of this deal actually happening, but obviously today on the deal, announcement of the deal talks over Philip Morris shareholders, quite happy with it. The shares rallying north 5 percent and Altria kind of stuck in the mud, their shares were flat. This deal also has major potential implications on the IPO market, because I am sure at one point we can expect a Juul labs to IPO. Right?

Michael Kesslering: Absolutely, and so just in terms of to put into context the market that Juul is in, it’s expected to be a five point six billion dollar market in the in the U.S. But the other really interesting stat that quite actually surprised me was that twenty seven point five percent of high school students reported that they had tried an E cigarette in the last month, which is a very high number. And so that’s really what was driving this ban on mint and fruity flavours that are very popular among high school students. As you had mentioned, this ban would really provide a lot of damage to the Juul business model. But this U.S. ban is actually a little bit reactionary to what’s happening globally, as you mentioned briefly. India has actually banned the sale of all e-cigarettes and China has stopped the sale of Juul products in the country. So that’s kind of interesting. 

But in terms of share price action. Between Altria and Philip Morris, since the Trump announcement of the ban on certain flavours, is Altria has been down 8 percent, which is not surprising given their exposure to Juul. Although there was a little bit of positive sentiment in the stock when you looked at some of the analyst reports, as some analysts believe that the restrictions on e-cigarettes could shift demand from the shift that was going from cigarettes to vaping, that it may reverse some of that. But, you know, it’s a little bit too early to be seen on that. And I can’t really see that being, at least couldn’t see the ship being positive for Altria in the long term, but they were down 8 percent. Philip Morris, their short shares were actually up just over 1 percent since the announcement. So a little bit less, immune to this E cigarette ban, although Philip Morris is coming out with their own brand of e-cigarettes. They would have different branding on it, as it is just another heating mechanism for tobacco.

Julian Klymochko: Yeah, I believe that is IQOS. And it actually works differently, It’s not vaporizing. It is just heating, but not burning the tobacco. And that one specifically, it faces less risk, I believe, because it does come with FDA approval. And so that’s kind of a big, big competitive advantage for that product. A couple of things that you mentioned I wanted to discuss. Number one, the price action on Altria. You said down 8 percent off the top of my head. I believe that probably represents around 8 billion dollars in lost valuation. Ultimately, you can point to what happened with Juul here. They put twelve point eight billion into Juul and I believe that eight billion dollar losses, nearly 1 percent attributed to that investment. So if you triangulate the numbers that is more than a 50 percent wipe out on the Juul valuation. And if it was publicly traded in its own right, losing 80 percent of its sales to a regulatory band, you can clearly argue that the stock would be down significantly, at least down more than 50 percent. The other thing is one of the reasons or the main reason that the regulators and politicians cracked down on this, as you indicated, was the massive increase in youth use of these e-cigarettes. And what they are doing is, they’re actually marketing heavily on Instagram, Facebook, obviously platforms that a lot of youth use, not to mention the flavoured e-cigarettes that makes it really attractive to kids, basically, so that was a big no, no. And similar to WeWork, we saw the CEO get fired. So heads are rolling for the strategy there. They are looking to bring in more professional management and turn around the ship at Juul. Nonetheless, the market would not be surprised to see merger talks between PMI and Altria continue in the future further down the road once some of these regulatory issues are resolved. But at this point, this deal is dead for now.

Ending

Julian Klymochko: We did not put out a blog post this week. We are too busy working on my book. That is right I put out a book. It is titled Reminiscences of a Hedge Fund Operator. That is a little hat tip to one of the best books on finance and trading and markets in general. Reminiscences of a Stock Operator by Edwin Lefevre, which tells the story of trader Jesse Livermore and his life. I really encourage investors to read that. I also encourage listeners to check out my book. If you go to our website, accelerateshares.com, you can check it out. Give it a download. It is a free e-book for now. It should be on Amazon in physical and Kindle form by October. So in a few weeks, but for now you can enjoy the free e-book.

That wraps things up for episode 33 of the Absolute Return Podcast. As always, if you liked it, you can check out more episodes on absolutereturnpodcast.com. That is it for us, If you enjoyed it, leave us a review. Give us a shout out on Twitter. Tell your friends about it. But until next week, we will chat with you soon. Cheers.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed. 

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