A month ago, it looked like tech IPOs were finally coming back after nearly a two-year hiatus. The enthusiasm for new listings was seen as a good thing for the next wave of start-ups from artificial intelligence and machine learning to fintechs, enterprise software as well as genomics and venture capital (VC) firms that back them.
With interest rates rising from near zero to 5.25% between March 2022 and August, the last 18 months were the worst period for IPOs in more than three decades. With cost of capital soaring, economies slowing and earnings sliding, investors have understandably shied away from new listings. This year so far, there have been 120 IPOs on US exchanges, down from 164 IPOs in the same period last year.
Last month, British mobile chip design house Arm Holdings, grocery delivery operator Instacart and marketing-automation firm Klaviyo listed within days of each other amidst hope that their back-to-back successful IPOs will open a floodgates of new listings from the much vaunted AI firms like Open AI and Anthropic.
The trio of September’s tech IPOs have turned out to be a disaster. Instacart, which raised US$660 million ($821.7 million), had priced its IPO at US$30 a share. Its stock soared to US$42.90 on Sept 19 opening day. By its tenth trading day, however, the grocery delivery firm’s stock had plummeted to US$26.11, down a whopping 40%. A new listing that plunges so precipitously and so fast tells you two things: Investment banks have massively overpriced the IPO, leaving retail investors to hold the bag of lemons; and investors are not enamoured with the overhyped grocery firm.
Arm Holdings, which listed a few days before Instacart, has fared slightly better. Though its shares fell 25% from their IPO day peak, they have rebounded since and are now trading just above their US$51 listing price. Marketing-automation company Klaviyo, which raised US$345 million, had a more modest opening day but its shares are now 9% above their issue price.
The rise and fall of Instacart
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Instacart works like this: Let’s say you order groceries online from the platform to be picked up from Walmart. Instacart sends a personal shopper to the nearest Walmart store to pick up your groceries from the aisles. I remember the first time I used Instacart — early during Covid lockdown in April 2020. Being lactose-intolerant, I take almond milk rather than dairy. The person shopping for me texted me from Walmart to say he could not find the 30 calories almond milk on my list. “Try soy milk or oat milk,” I texted back, “but 30 calories, please.” He responded promptly: “OK.”
Half an hour later, I found a big bag of groceries outside my apartment door. Everything was in order — except the milk, which was 90 calories oat milk. So, I complained to Instacart. They got the shopper to bring me almond milk from another store, free of charge. I could keep the oat milk or give it to the shopper who was free to take it home.
Instacart does not return perishables like milk back to the stores. It lets customers, or the personal shoppers, as the delivery guys are called, keep them. That’s a challenging business model. If you are in the business of delivering groceries, you are delivering perishables. And if you are delivering perishables, you are getting orders wrong some of the time. As a business with wafer-thin margins, Instacart has little room for error. That’s where high-margin ads come in.
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Instacart has been mocked as an ad company that also delivers groceries. 30% of its revenues come from advertising. Here’s how the ad business works: I am ordering groceries from Walmart and I type in “Coca Cola”. Instacart has partnerships with companies like PepsiCo so its algorithm says you can have a large bottle of Pepsi at 5% discount, which works out to an 8% discount over a same-sized Coke. Or, you can order Coke, but the shopper may text you from Walmart: “Store ran out of Coke, should I get Pepsi for you? Much cheaper.” I don’t drink sugary water but if I did, such a deal might be tempting. Indeed, Pepsi is one of Instacart’s biggest advertisers. And with a US$175 million investment in the grocery firm, PepsiCo was an anchor investor.
The problem is that Instacart’s core business is no longer growing. Moreover, it does not have the grocery business to itself. There is also DoorDash, the biggest food delivery firm outside China which has a growing grocery business. Instacart noted in its IPO prospectus that growth of its core delivery business slowed in the first half of 2023, with gross transaction volume — a measure capturing overall sales across its platform — rising just 4% to US$14.9 billion.
With almost no growth in its core business even as it loses market share to DoorDash and UberEats as well as supermarket operators like Walmart, Costco and Amazon, Instacart faces major structural headwinds. Since the end of Covid, fewer users are willing to pay US$3.99 for same-day orders over US$35, or more if your order is under US$35 or if you want the delivery within an hour. I live about a 10-minute walk from a supermarket, so paying US$10 for delivery that might take 50 minutes does not appeal to me. I bet that’s probably the way most people will see things until the next pandemic or crisis that forces us all indoors again.
Instacart had US$2.5 billion in revenue last year. In the first half of this year, the grocery delivery firm raked in US$406 million in sales from ads and software — or up annualised 24% — that helped it to US$242 million in profits. But extrapolating those numbers would be wrong. Think of Instacart as a media firm or a newspaper. When circulation is flat or falling, and the newspaper is losing market share to rivals, advertisers would tend to spend less. More so if the overall economy is in a recession or slowing down since customers tend to spend less on products, or spend on lower-end products which tend to have lower margins.
One reason Instacart shares may have rebounded following their plunge is because it is now seen as a ripe acquisition target by predators like DoorDash, which is four times bigger. DoorDash apparently approached Instacart about an acquisition nearly three years ago when the grocery delivery firm had a valuation of US$39 billion. Its current market capitalisation is just US$7.5 billion compared to DoorDash’s US$31 billion.
When tech IPOs sour
So, what went wrong with the three recent tech IPOs? Prominent venture investor Chamath Palihapitiya, in a recent podcast, noted that the trio were a disaster because there was a very small float; less than 10% of their shares were sold to investors in the IPO. Moreover, IPO allocations were scattered all over rather than being placed to a handful of strategic long-term investors. IPO investors also had no lock-up period, so they could sell the shares the moment the firm was listed.
In the US, retail investors normally do not have access to IPOs. They buy shares in a new listing only after it begins trading, from existing shareholders or from institutions who were allocated IPO shares. On the first day of trading, retail investors bid up to buy IPO shares. With popular names like Instacart or Arm, the frenzy can lead to a huge opening pop, but as the stock moves up, existing investors head for the exit which leads to the IPO performing poorly. By the second or third week when investment banks start to release their first research reports on IPO firms with price targets based on fundamentals, the game is over.
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In recent years, less than 30% of all IPOs were above the issue price after six months. With tech, where there are a ton of unprofitable and overhyped companies going public and a large base of employees with stock options whose lock-up ends within three or six months and are eager to cash out, IPOs can sour fairly quickly.
What’s next? A higher-for-longer interest rate regime will continue to pressure long-gestation tech stocks. But VCs and institutional investors need liquidity so they can recycle the capital into new emerging firms. The world’s biggest unicorns — or VC-backed private firms worth over US$1billion — like Elon Musk’s rocket firm SpaceX (valuation US$ 150 billion), Bytedance (US$ 200 billion) Chinese online fashion firm Shein (US$ 66 billion) — are in no hurry to list. Large fintech unicorns like Dublin-based payments firm Stripe (US$50 billion) and London-based neobank Revolut (US$33billion) are eager for a listing but are staying on the sidelines because an IPO now will value them far below their last funding rounds.
Indeed, the sentiment is so bad for fintechs that shares of PayPal, the top listed firms in the sector, are down over 82% from their 2021 peak. The No 2 firm Block (formerly Square) is down 87% over the same period. I am told Stripe, which was valued at US$95 billion in 2021, would be lucky to price its IPO close to US$30 billion valuation if it sought a listing right now. And I won’t even talk about Chime, which makes money by collecting part of the interchange fees that merchants pay to process transactions. Chime had a spectacular US$25 billion valuation during the meme stock mania two years ago. A valuation of closer to US$10 billion is more likely if it seeks to list this year. Start-ups and unprofitable or barely profitable tech firms went through a similar dismal period in the aftermath of the dotcom bubble burst in 2000.
The next big tech IPO might be the one of the companies whose stock was among the most beaten down during the tech bubble: Yahoo! The search engine and Internet portal was overtaken by Google 20 years ago. By a stroke of luck, however, Yahoo invested US$1 billion in Chinese Internet giant Alibaba Holdings in 2005. By the time Alibaba went public, Yahoo owned US$32.5 billion in Alibaba shares and US$8.6 billion in Yahoo Japan. That allowed it to pay down its debts, pay dividends, buy back its shares, and invest in ad tech firms and other ventures. Eventually it was taken over by US telco Verizon, which took it private and then sold it to Apollo Global Management, the giant private equity firm.
Now, Apollo is getting ready to float it off again. Yahoo had US$8 billion in revenues in 2021, and is among the top two websites covering finance, news and sports. It also has the world’s fourth largest email service. And unlike many unicorns, Yahoo is profitable. Analysts believe a Yahoo IPO could command a US$20 billion valuation. But until central bankers get their foot off the pedal, don’t bet on the tide turning for tech IPOs.
Assif Shameen is a technology and business writer based in North America
