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Why Warren Buffett Is Skeptical About IPOs

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- By Stepan Lavrouk

Shares of Lyft Inc. (LYFT), the San Francisco-based ridesharing company, debuted in the public markets last Friday. Priced at $72 per share, the stock was bid up to as high as $88.60 that day, and has since traded down to $70 a share. Are initial public offerings a good time to invest? Warren Buffett (Trades, Portfolio) doesn't think so. In a CNBC interview last week, the Oracle of Omaha cautioned retail investors against getting involved in IPOs in general, and had some thoughts on the Lyft IPO in particular.

Lyft's cash burn

Simply put, Buffett thinks that at a market capitalization of $25 billion and no clear path to profitability, Lyft is simply too expensive to invest in:

"The aggregate valuation that we're talking about here is close to $25 billion, and I certainly wouldn't buy the business for $25 billion. I always think in terms of buying the whole business. When we buy 100 shares of General Motors (GM), we think we're buying the whole business and we multiply [the number of shares that they have by the selling price] - that would be 40-odd billion in the case of GM. So I look at what I'm getting as a part owner of a business, and I don't know why, with all the things you can buy for $25 billion in this world you would pick a business that really has to be earning $2.5 - $3 billion pre-tax in five years, to even be on the same radar screen as things you can buy right now."

Buffett is a believer that the intrinsic value of a company is directly related to its ability to generate free cash flow. Lyft had a total cash burn of close to $350 million in 2018, which probably means Buffett won't be getting involved with it anytime soon.

Buffett generally stays away from IPOs

"We haven't bought an initial public offering - I haven't, Charlie [Munger] hasn't - I think since 1955, I bought 100 shares of Ford (NYSE:F) when they came out...I think buying new offerings during hot periods in the market I don't think is anything that the average person should think about at all."

Admittedly, this conservative attitude means Buffett has missed out on what are now some of the biggest companies: Amazon (AMZN), Alphabet's Google (GOOG) and others. When asked about this, he defended his decision by pointing out that investing based on the promise of growth is risky. Sure Amazon and Google are giants now, but who could realistically have modelled their growth in 1997 and 2004?

"There always can be [scenarios in which a company goes on to grow in price post-IPO]. I mean, there were a pair of dice at the Desert Inn one time many years ago - they had them in a little case - that came up 32 times in a row - 4 billion to 1, maybe a little bit over. So you can go around making dumb bets and win. It's not something you want to take as a lifetime policy, though. I worry much more about the things that I do than the things that I don't do. I missed all kinds of opportunities in my life. You just want to make sure that you're on the side of the house when you bet rather than bet against the house."

It is highly unlikely that a company will debut on the public markets for less than what the owners consider the intrinsic value of that business to be. The investment banks who underwrite the IPO are also unlikely to set a price that is below value. Crucially, both of these parties are privy to a lot more information about the company in question, and have a vested interest in overpricing the issue. This is what Buffett means when he says to not bet against the house - it usually wins.

Disclosure: The author owns no stocks mentioned.

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This article first appeared on GuruFocus.