IPOs: 'Forecasting the dream'

In 2017, WeWork's CEO said, somewhat emblematically: “Our valuation and size today are much more based on our energy and spirituality than on a multiple of revenue". Then in 2019, public markets chopped their spirituality-based valuation to ribbons before the IPO spectacularly imploded. More locally, Latitude Financial’s massive second tilt at listing didn’t pass muster either. 

Between shoots of Buy Hold Sell last week, we took the chance to ask Jelena Stevanovic from Platypus and James Miller from Firetrail Investments for their view of these events and to ask what it takes to 'forecast the dream' correctly with IPOs. 

And when we asked for one ASX listing they could back, notably, both managers picked the same stock, a SaaS business servicing the lion's share of a huge and established sector. Watch or read for their exclusive insights.  

Transcript

Jeremy Hook: Welcome to Buy, Hold, Sell. My name's Jeremy Hook from TMS Capital. Joining me on the panel today is James Miller from Firetrail, Jelena Stevanovic from Platypus. We're looking at IPOs today, Initial Public Offerings. Typically, they excite the market but not all are as simple as they seem.

Recently, WeWork in the US and Latitude Financial here, as well as PropertyGuru, just recently all been canned. So, what's it saying about IPOs generally, and does it mean, James, going to you first that we're getting a bit late in the cycle and floats are getting a bit ratty?

James Miller: Well, I think it's both the cycle and the markets right now. So, if you look at equity markets around the world, valuation multiples are right up there compared to history, which is a natural function of our lower risk-free rates around the world.

But, if you look at these companies that are coming to market, they're saying it's a great opportunity. I want to get that multiple, but you've got to show us that you've got a sustainable path to earnings, or path to cash flow, so we can actually value you. So, that quality really hasn't been there recently.

The second thing I'll point out is that there's a big difference between IPO sell down and IPO raising for growth capital, as well, and growth capital, we much prefer that one.

Jeremy Hook: Okay, excellent. Jelena, do you agree, or is there something specific about these ones, or do we read more into the whole thing?

Jelena Stevanovic: Look, as a general sign, we think that this is a signal that the markets are still functioning rationally and that's a positive thing. I mean, generally speaking, aggressively-priced IPOs are often cited as a sign that the looming bear market is ahead of us. The fact that we're not seeing excessive equity issuances either through aggressive capital raise to fund silly M&A, or very highly-valued IPOs getaway is a positive sign for equity market outlook, in my opinion.

In particular, I mean Latitude, as one that you called out, that was a difficult IPO. The company attempted to list a couple of times, at least, and through that process we, as investors, got to see historical financial targets that would have been prospectus targets in earlier attempts and we also got to see that those targets were missed, had it not been for some material one-off adjustments. All of that made it difficult for that IPO to get away.

Jeremy Hook: Just staying with you there on the issue of valuation, so WeWork started with a valuation of 47 billion. I think, when it was last canned, it got about 10 Billion. Does this now say something about valuations in equity markets overall?

Jelena Stevanovic: Look, I think the fact that valuations still matter is a positive sign. We're not seeing that exuberance in the equities market. That's typically a good sign. It's a sign that we might be late cycle, but not hitting into bear market just yet.

Jeremy Hook: Yeah. Great. James, just coming back to your point, and then, looking at valuations, is there something you're looking at differently in an IPO to the stocks that are listed currently.

James Miller: Ah, no, not at all. Valuations have always mattered and earnings have always mattered, as well. Where, I think, a bit more focus has come on recently is, we want to see those earnings in a company whether they're loss-making now and will make money in the future. We want to be able to forecast them.

So, a company like WeWork, in private hands it might have convinced its investors that it was changing the way we work and making these great co-working spaces. But, when it came to equity markets, we were going to look at a company that was losing $1 billion a year. More than that. $50 billion of lease liabilities. And, to be honest, it could be relatively easily replicated by competitors.

So, that scrutiny, when you come to public markets-

Jeremy Hook: Different level of scrutiny, isn't it?

James Miller: It's still there.

Jeremy Hook: Yeah, good. Scrutiny of the Australian attempted float of Latitude Financial. Do you think we can read anything into the state of the Australian consumer from that failure to get away?

James Miller: Talking about the consumer is a broad term because there's bright spots, and then, there's weaker spots, as well. And, one thing I like to like to look at is new car sales. It's been 16 consecutive months, year-on-year declines in new car sales, so that, by itself, says things aren't that great, but you break up their data, luxury car sales are actually going all right, close to flat in recent months, so you can't make a broad brushed assumption about anything there.

There are two things that I think will probably happen though that are pretty clear. Firstly, Sydney and Melbourne property prices. We've seen this before. Property prices go up, more houses are listed, more houses are transacted, and then, people buy more things to go inside of those houses. So, furniture, electrical goods, JB Hi-Fi, Harvey Norman, they will be beneficiaries there.

Jeremy Hook: And car sales are backward-looking and the property sales are giving us more confidence.

James Miller: Yeah. That's one way to think about it there.

Jeremy Hook: Can you read in something broader in the macro sense here, Jelena?

Jelena Stevanovic: Look, I'll come back to my original comment on Latitude. I think that that particular business had difficulty with the equity market, in particular, having tried to list multiple times. I wouldn't necessarily extrapolate across the consumer sector.

I agree on the fact that domestic housing looks like it has bottomed, and a number of stocks exposed to that theme should benefit, with a lag, but should benefit over time.

On Latitude, again, I just think given that it's essentially a consumer finance business, the proposed valuation metrics were simply too high for that nature of that business.

Jeremy Hook: And, did they try to spin the market to have the buy now, pay later, add on icing on the top of the cake, when the cake was maybe a big problem?

Jelena Stevanovic: That was the unproven part of the business. That's a new venture, and to your point, as a listed investor, you want to see a little bit of track record, something to hang onto to be able to forecast the dream.

Jeremy Hook: Okay. Now, talking about dreams. IPO, the average investor likes them. Have you found one in the last 12 months that you liked and invested?

Jelena Stevanovic: Yeah. So, in last 12 months we have participated in Fineos Corporation Holdings. It's a software as a service provider to the insurance sector, in particular, health, accident, and life insurance. The company was started in 1993. Initially, in its first phase of its life, it focused on claims management software as a service.

In more recent times they have broadened that product portfolio to include things like billing, absence management, policy, et cetera. So, going forward, forecasting the dream, we think the company can grow earnings through either selling more modules to existing customers, through adding new customers, through going into new geographies.

Jeremy Hook: Okay. That's great. James, have you got a special for the viewers from the last twelve months?

James Miller: I do. And, there's some rationality in equity markets because we like Fineos as well.

Jeremy Hook: Wow. There you go.

James Miller: This is a company that's an exciting company, but it's in a really boring industry.

Jelena Stevanovic: Correct.

James Miller: It provides core system insurance software to companies that are really running on largely legacy systems, some that are over 20 years old. So, Fineos can come in there, provide its cloud-based software. It's got a great management team. The founder has been around for years and years. It's worth about $800 million as a market cap, and we think it's got great growth potential.

Jeremy Hook: Okay. So, when you are looking at IPOs, founder-led businesses coming to market for the right reasons, maybe buy from governments or receivers, but be wary of private equity.