Experts predict a flurry of IPOs over the next few months as the US market hits new highs. The latest to announce plans to list on the stock market is communications darling Snapchat which has a growing fan base and a rumoured $20 billion valuation. Like so many high-value/loss-making technology companies of years gone by it has polarised views. So, why are technology IPOs better off loss-making when they launch on the stock market?
Hope value springs eternal
If you think about it, if a company has a massive fan base, such as Snapchat, which has yet to be monetised what kind of value would you put on the company? Would you value it at $1 million, $10 million, $100 million or $20 billion?
While the valuation prior to moving into profit is based purely and simply on the current membership and the expected growth in the short, medium and longer term, can this be predicted with any real accuracy? The company is rumoured to have 161 million active daily users which is a phenomenal figure especially when you bear in mind the companies which tend to have high user numbers but relatively low activity figures.
Viral reach
There is no doubt that the main growth tool for companies such as Snapchat has been smart phones and the ability to download an app in a moment and begin talking with your friends via Snapchat. These programs work on the herd mentality whereby one or two people from a group of friends have Snapchat and the rest automatically seem to follow. Very quickly membership mushrooms and before you know it the app becomes an integral part of everyday life for social media addicts.
If I recall correctly, when Hotmail was introduced by Microsoft there was a simple link at the bottom of each email encouraging recipients to sign-up for their own Hotmail account. As we know, Hotmail quickly became one of the most popular email services of all times and this was in the very early days. Indeed, many people still cherish their Hotmail account today even if new services and new systems have emerged to cast a shadow over the “old father”.
Reaching profitability
For many high-tech loss-making companies the most challenging period is the crossover from losses to profitability. Once you make a profit then a lot of the hope value disappears and the company becomes susceptible to traditional valuation methods. If the company is not able to deliver on growth forecasts introduced when it was loss-making then investors can lose confidence and the share price can fairly quickly go into reverse.
On the flipside, if the company moves into profitability and is able to show a path to greater profitability in the short, medium and longer term then this should offer at least some support to what could have been an inflated share price. If we look at Tesla, the award winning electric car manufacturer, this company is still loss-making but Elon Musk is building an empire as opposed to a business. As a consequence, investors at the moment believe his forecasts for the future hence he has little difficulty raising additional funds to cover the company’s exceptional cash burn.