Over the past few quarters, I have become increasingly critical of the Profitless Prosperity Sector, known amongst my friends as the Ponzi Sector. Why Ponzi Sector? Because these companies have no profits yet continue to raise new capital by showing explosive revenue growth. Oddly, the more revenue they show, the more money they lose, because incremental revenue is at a negative gross margin. Many of these companies are in consumer facing sectors where the product is not particularly unique. Rather, they are using a tech interface to offer an existing product and effectively subsidizing the consumer to use more of the product. Nothing shows this better than the ridesharing duopoly of Uber and Lyft (LYFT – USA). Therefore, last week’s LYFT IPO was enlightening.
To start with, $2.3 billion of stock was offered. While large for an IPO, it wasn’t particularly large in dollar value or in relationship to the overall purported equity value. Since the IPO, the shares have dropped like a rock without an uptick. As I write this, they’re still dropping and now 10% below the offering price. While the shares have only had 2 trading days to season thus far, the message seems to be that demand for the Ponzi Sector isn’t as high as previously anticipated.
This must be the panic moment amongst the VC community. Suddenly, their mark-to-fantasy valuations are in doubt. I can guarantee you that the VC community will rally together and find some way to prop LYFT up. Without idiot retail gladly taking these scams off their hands, VC portfolios will detonate. However, LYFT has already told you that outside of closed-door transactions amongst VCs marking up their books, the valuations are already suspect. Furthermore, since anyone who’s bought a share of LYFT on the stock exchange is underwater, I suspect that the desire to buy the next of these Unicorn IPOs will be substantially reduced.
This then weighs on the question of the future of the whole Ponzi Sector. LYFT and UBER need constant equity infusions to fund their never-ending stream of subsidized rides. Looking at the Ponzi Sector as a whole, who will be putting up a few billion a year (per Unicorn)? At some point, you’re talking about a whole lot of money. You can keep funding Unicorns if you believe the IPO will be at a premium to the Series D round. It doesn’t work if you have to actually analyze the business and determine a fair valuation for a company where losses will grow ad infinitum. Even worse, if the IPO window closes, you have to then start worrying about dilution as you raise new capital from private investors to offset accelerating losses. Remember, in a universe where billions are needed per year, the next offering can also be down from the last one done—sometimes by a shockingly large number. Money losing companies need to make payroll or they die—sometimes they cannot choose their cost of capital.
Is the LYFT IPO the inflection point in the Ponzi Sector? The next few weeks will tell. I’m on red alert as I have a list of similar companies that I’d love to buy puts on.