Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 313

Insane prices as private equity quits market

Recently, sitting at lunch among reputable, intelligent and enormously-successful fund managers, there was one thing we all agreed on. Prices for many listed and unlisted companies have reached insane levels.

I listed the worst offenders:

  • Wisetech, on the same market cap as Qantas of $8.5 billion but earning 2% of Qantas’s revenue.
  • At 60 times earnings, Appen must have the smartest AI shareholders in the world because Appen’s US-based and private equity-owned competitor, Lionbridge, wants to list here too.
  • The printed circuit board (PCB) software designer, Altium, is on a PE of 57 times, putting it on the same market cap as JB Hi-Fi, Metcash or Air New Zealand. But while the latter three each earn revenue of between $4 billion and $14 billion, Altium earns $177 million.
  • After 12 years of operations, Xero has finally achieved cashflow break-even. In 2021 it is expected to earn a little over $20 million in profit too. It just has to be worth over $8.5 billion or 370 times forecast profits!

This will end badly, but when?

At that table, a lot of fundie experience with stock market corrections agreed that this ends badly. What we could not agree on, however, was how it ends, nor when.

But perhaps that latter question has an answer and in this article I’ll highlight a possible stumbling block for a continuation of heady valuations of profitless tech companies.

The calendar year 2019 is shaping up to be the busiest for new tech stock listings since 2000. I was working at Merrill Lynch in 1999 when analysts were concocting new ratios to justify billion dollar market valuations for companies (nay ‘projects’) with no revenue. Analysts told investors that the ability of these companies to transform e-commerce, for example, meant that almost ‘any price’ should be paid to acquire a piece of the action.

So far this year, 25 tech companies have IPO’d in the US raising US$19 billion. At the time of writing, the average gain on listing has been 34% according to Dealogic. The picture was a little different in 1999, when the first day gain for IPOs on the Nasdaq was closer to 90%. Perhaps conditions aren’t as crazy now.

But does that really matter? That would be like suggesting one patient in the asylum is slightly less insane than another. Neither of them should fly a passenger jet nor should they be put near an equity portfolio.

Most new listings are questionable quality

Of the 25 companies that have IPO’d this year, less than half can be classed as ‘major tech companies’. They are: Beyond Meat, which is up over 500% since listing, Zoom Video (+170%), PagerDuty (+120%), CrowdStrike (+110%), Pinterest (+45%), Chewy (+47%), Fiverr (+30%), Slack (+27%), Fastly (+10%) and Uber and Lyft (both negative).

Share price performance, however, doesn’t really matter. It cannot tell you what will happen next.

Aneet Chachra, is a Portfolio Manager at Janus Henderson Group. Chachra studied the history of 220 US technology IPOs from January 1, 2010 to March 31, 2018, focussing only on those with a 12-month trading history. Chachra observed:

“Statistically, if you can get into a tech IPO at the deal price, you are going to do well.”

Presumably he was referring to the final funding round deal price before IPO. Pitchbook’s 2018 study reaches a similar conclusion. Pre-IPO investors do better from the IPO ‘step-up’ than investors who buy on the first day of public trading.

This makes sense. PE investors will want to price their IPO so that all existing shareholders make money at the time of listing, and they will time the IPO to give their investors the best chance of achieving that outcome. In a 10-year bull market fueled by historically low rates that caused investors to spurn cash and migrate to anything and everything that might go up, including private equity, the study’s findings should not be surprising.

Two glaring issues for investors

The first is that if 10 years of declining interest rates has encouraged or forced high-net-worth and ultra-high-net worth investors to buy private equity and invest pre-IPO, who will be left to buy these stocks after they list?

Chachra’s and Pitchbook’s findings may reflect the fact that the exponential growth in the number of private equity firms globally since 2009 has attracted most of the money of high-net-worth investors leaving only ‘Mom & Pop’ investors to pick up the scraps.

Second, of the largest tech stocks that have listed this year, only 10% to 15% of their scrip has been available to trade. A 180-day lock up (escrow) period for founders and backers means 85-90% of scrip is still waiting to be sold.

This overhang could easily become selling pressure if PE investors who have been locked in for a decade, such as with Uber, decide they want out. It’s the marginal seller that determines the price for everyone. If the Uber investors who bought in 2010 at much lower prices decide they want to sell, their trading will impact the market capitalisation for everyone.

And this transmission mechanism is perhaps another explanation for the poor post-IPO performance of the average tech float.

Beyond Meat will see an additional 86% of its scrip released for possible sale in November 2019. CrowdStrike will see 92% of its scrip released in December, Fiverr (85% in December), Lyft (90% September), PagerDuty (88% October), Pinterest (86% October), Uber (90% November) and Zoom (93% November). And a record number of IPOs this year will ensure the pressure doesn’t let up until next year.

Tech IPO investors in Australia won’t be immune from the impact of the 2019 US private equity exit.

 

Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is for general information only and does not consider the circumstances of any individual.

 

6 Comments
Wayne
July 08, 2019

Roger, what are you saying won't appen? (pun intended)

Are you suggesting that these insane valuations have more legs in them yet?.... I guess this is your whole point though - that people with cash are chasing returns, and assuming this continues (contrary to Chris's comment), at some point someone will be left holding the can.

Roger Montgomery
July 08, 2019

Thanks Carlos, yes, the implication is that investors have caused the 'offence'. And Chris, I know that if there are too many sitting on the sidelines waiting, it probably won't happen.

Dudley
July 08, 2019

"investors have caused the ‘offence’":

Not a runaway positive feedback where reducing interest rates pushes money away from cash to speculative capital gains; amplified by central banks pushing cash into markets in a partially successful attempt to increase labour participation but also resulting in increased labour replacing / displacing capital investment?

Carlos
July 04, 2019

calling those stocks "worst offenders" is unfair wording as the companies themselves have done nothing wrong. It's the market's fault their prices are so high. The companies themselves are being very well run.

Chris
July 04, 2019

Bring it on, I say. Nothing quite like a good market crash to clear the detritus out. I'm waiting with cash and lines of credit to go and press the buy order button, but not right now. Things are too expensive in the USA and the time isn't right.

SMSF Trustee
July 09, 2019

Chris, I don't think Roger is talking about a 'market crash', but simply an issue with a sub-set of the market.

He can't be talking about 'insane prices' for the whole market. The All Ordinaries PE is just under 17 with the index at 6,730. 17 is a little on the high side, but can't be thought of as 'insane'.

The long run growth of earnings in Australia has been 4.7%. If you grow the current level of earnings by that into the future, then the implied discount rate to get us to 6,730 is about 11%. That seems to be a pretty hefty risk premium over the ten year bond rate of 1.25% that's factored in.

Interested in Roger's thoughts, but the word 'insane' is stock specific, not applicable to the whole market. (Haven't done the same maths for the US market though.)

 

Leave a Comment:

RELATED ARTICLES

Collateral damage follows the end of profitless prosperity

Why August company reporting season was poor

How we have invested during COVID-19

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Investment strategies

Finding income in an income-starved world

With term deposit rates falling, bonds holding up but with risks attached, and stocks yielding comparatively paltry sums, finding decent income is becoming harder. Here’s a guide to the best places to hunt for yield.

Economy

Fearful politicians put finances at risk

A tearful Treasury chief, a backbench rebellion, and crashing bonds. What just happened in the UK and why could Australia’s NDIS be headed for the same brutal fiscal reality?

Shares

Investing at market peaks: The surprising truth

Many investors are hesitant to buy into a market that feels like it’s already climbed too far, too fast. But what does nearly a century of market history suggest about investing at peaks?

Shares

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Investment strategies

Will stablecoins change the way we pay for things?

Stablecoins have been hyped as a gamechanger for the payments industry. But while they could find success in certain niches, a broader upheaval of Visa and Mastercard's payments dominance looks unlikely.

Infrastructure

An investing theme you can bet on for the next 30 years

Investors view infrastructure as a defensive asset class rather than one with compelling growth prospects. These five tailwinds for demand over the coming decades suggest that such a stance could be mistaken.

Investment strategies

A letter to my younger self: investing through today's chaos

We are trading through one of history's most confounding market environments. One day, financial headlines warn of doomsday scenarios. The next, they celebrate a new golden age. How can investors keep a clear head?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.