The year 2019 will be remembered for a lot of things in the world of markets: a robust performance for risky assets; a substantial rally in bonds; declining trade fears and an accommodative central bank. But perhaps the story receiving the most attention is that of the “failed unicorns” — the disastrous post-IPO results for a plethora of high-profile, brand-name companies that were thought to be the 2010s version of the “dotcoms.”
From Uber to Lyft to Slack to Peloton, the days of “hot IPOs” representing free money for their lucky buyers — let alone the pop-culture narrative — are seemingly dead and gone. Only a couple of IPOs saw any price appreciation at all in 2019 after their first public trade, and the highest-profile debuts were also the worst performing. And WeWork — the office-landlord brand popular for its shared-office-space model and broad appeal to short-term Millennial tenants — is the best example yet of capital markets behaving exactly how they ought to behave.
In short, the WeWork story showed the Hayekian notion of price discovery on full display. Capital markets did what they are supposed to do in a free-enterprise system: price risk and reward, and brilliantly. WeWork began raising funds in private markets a decade ago, initially with an implied market valuation below $100 million. Future rounds saw escalations in market value, and by the time the company had its Series G round in early 2019, private institutional investors at the Japanese firm SoftBank valued it at $47 billion. WeWork was bleeding cash at record levels, so its need to access public markets was not a mere case of rewarding early-stage investors. When troubling information emerged before the IPO — first about its problematic governance structure (according to which its charismatic founder, Adam Neumann, had 20 times the voting rights of other investors), next about rampant self-dealing, nepotistic hires, and gratuitous perks and travel and parties — it seemed the public was at risk of being sold an overpriced hot potato.
What kept that from happening was, well, the public. The smartest and best investment banks in the world were unable to generate public appetite for WeWork — not just at the $60 billion market cap the company supposedly wanted, or at the $47 billion market cap at which they had already privately traded, but at any market cap. There simply was not going to be a public offering of this company once light shone on its governance structure, financial realities, and long-term business model. Yes, the company had cachet, and yes, it had a sexy story and brand. But the pricing of risk and reward ultimately worked, leaving the highly sophisticated and risk-tolerant institutional investors who had already invested in it holding all the risk — and keeping it from being transferred to a gullible public.
Some have pointed to the outlandish deal Neumann walked away with to exit the company as a sign of capitalism run amok. He reportedly received something around $2 billion to exit his position. That is a reasonable response; all indications are that Neumann was grossly incompetent and irresponsible, eventually culminating in the company’s liquidity squeeze and capital-markets rejection. But the important thing to understand is that it wasn’t ordinary mom-and-pop investors footing the bill, but SoftBank, J. P. Morgan, and other leading institutional investors who did so. Rational market actors kept this hot potato from being in the hands of those who were less capable of withstanding such a loss.
What explains the difference between the 1990s dotcom hysteria and today’s more skeptical atmosphere? The public appetite for money-losing companies with no real path to profitability is apparently not what it used to be. Some of the carnage over the years may have done what it is supposed to do: teach lessons. And many companies are no longer desperate for the “sucker capital” of the American public, as private equity has provided both growth capital and liquidity for founders, allowing companies to deal with the accountability of public markets at a later stage in their development.
This change in timeline has altered everything, in both good and bad ways. Amazon had a $400 million market capitalization when it first decided to go public. Uber had an $82 billion market capitalization when it did. Active secondary markets in private companies have been remunerative for early-stage investors, and have given companies time to build before going public. The downside for retail investors is that by the time companies reach public markets, they are already established, have seen a sizable market-capitalization form, and offer less “juice” to the now late-stage public investors. Yet access to public capital has hardly become obsolete — and an eventual public-markets destination is still highly likely for most large and successful companies.
Because capital will continue to seek its best use, market losses will still exist in public markets until Kingdom Come. But they are not themselves evidence of the failure of the free-enterprise system. The loss of value for these companies was a time bomb that could have dumped tens of billions of dollars of losses onto the public, but it was averted with no government intervention and no screaming activists. Rational actors rejected a governance structure they didn’t like and refused to pay a certain price for a business model they felt did not command it.
It is entirely acceptable to hope that WeWork finds its way and that the private investors who are invested in its long-term success discover eventual rewards. But whatever happens, capitalism requires robust capital markets to freely and intelligently adjudicate risk and reward. In 2019, they did.