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Lessons From the Lyft IPO

- By John Kinsellagh

On Wall Street, there always seems to be a reliable flock of complacent investors condemned to follow the crowd. After much hype, Lyft Inc. (LYFT) debuted at $72 per share -- above its original contemplated range of $62 to $68 per share.

After a brief flirtation in the high $80s, the stock crashed back down to $71. It is currently trading at $61; its valuation now rests at $21 billion, down from $24 billion. By any measure, a botched liftoff. In short, two days after Lyft's initial public offering, despite attempts at price support from its underwriters, the stock collapsed. The lesson? Many investors' fear of missing out on the "next Facebook (FB)" caused passion and paranoia to supplant reason and its investment handmaiden, prudence.


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Even though finding stocks that are undervalued may be more difficult in a modern environment of rapid dissemination of relevant market information, one of the reasons opportunities will always abound is that human nature hasn't changed much in the last 1,000 years. Greed has always been a prevalent characteristic on Wall Street; the Gordon Gecko ethos will never go out of style.

The recent Lyft offering lends itself to some lessons, discussed at length by the father of value investing, Benjamin Graham, that remain timeless and instructive. Indeed, one could argue Lyft is a sterling example of the difference between investment and speculation, which Graham took pains to distinguish. To paraphrase the legendary investor, in order to have a reasonable chance for better-than-average results, an investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street. In hindsight, the decision to buy Lyft shares on the new offering was not sound, though it was popular on Wall Street.

Why so many Wall Street players made the valuation leap from Lyft's last round of private financing to its new enhanced pre-IPO valuation is an endearing mystery. The corporate finance departments of the investment banks issuing the new shares all seemed to dismiss or discount the component of price in their bloated valuations because they valued the company based on prevailing conditions of the stock market rather than its financial condition. Many investors missed the gargantuan valuation increase from the date of these companies' last round of venture capital private financings to the underwriters' proposed new offering price, after taking interest from potential investors -- both institutional and retail alike.

Consider the following:

Uber most recently was valued at $76 billion in the private fundraising market; that didn't stop its underwriters from upping the ante a whopping $56 billion to $120 billion. Lyft's valuation prior to its IPO last month was similarly the product of fantasy. It revised its valuation range upward last month, assigning it a valuation of more than $24 billion in an offering that raised $2.34 billion. Lyft was assigned a private market valuation of $15.1 billion last year. It is mystifying how that valuation vaulted almost 50% while the company continued to pile up losses.

The pre-IPO valuations were especially rich in light of both companies' actual financial results: Uber reported a third-quarter loss of $1.07 billion, an increase over $891 million from the prior period last year. The Wall Street Journal reported Lyft logged $563 million in revenue and posted losses of $254 million. As Jack Hough of Barron's sarcastically noted, "Last year, Lyft lost $1.47 per ride. One way to think of the company is as Burger King to Uber's McDonald's. Another way is as a company that buys Whoppers and resells them for $1.47 less."

After Lyft crashed to earth, Uber is now seeking a lower valuation of between $90 billion and $100 billion. The voice of reason seems to also have impacted pending IPO unicorn Pinterest, as the company has now adjusted its pre-IPO valuation below the $12 billion tied to its last round of private financing.

Another lesson is when analysts adjust traditional and reasonable valuation methodologies to fit and adapt to a company that has nothing but losses, beware. For Lyft, certain accommodations were made for the pre-IPO roadshow. Newfangled and unorthodox valuation methodologies were trotted out, such as price-sales ratios, assigning multiples based on existing revenue, etc., instead of more meaningful and traditional measures that form the staple of security analysts' toolkits for assessing a company's future financial prospects and whether the current price reflects these projections.

New York University professor Aswath Damodaran made the astute observation relative to Lyft's overvaluation when he said, "The driver is a free agent. The customer is a free agent. There is absolutely no stickiness in the business, and they know it. That's the basic problem I have with the ride-sharing business, not just Lyft."

Finally, a plea to investors, analysts and writers for the Wall Street Journal and Barron's, please stop mischaracterizing these unicorns as "tech" stocks or the "next Facebook." They aren't. Facebook is nothing more than a giant advertising platform that flourished in a laissez-faire environment of zero regulation. Those halcyon days are over. The business models of Lyft and Facebook couldn't be more different.

The watchword going forward for new IPOs with outsized valuations? Caveat emptor.

Disclosure: I have no positions in any of the securities referenced in this article.

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This article first appeared on GuruFocus.