Analysis: No profits? No problem for red hot tech IPOs

Remember “irrational exuberance,” the phrase coined by former Federal Reserve chairman Alan Greenspan to describe soaring stocks in the mid-1990s? Welcome to irrational exuberance 2.0.

Exhibit A: the one day pops in unicorns DoorDash and Airbnb that are just flat out ridiculous.

DoorDash surged more than 85% when it debuted on Wall Street Wednesday while Airbnb opened about 115% higher in its initial public offering price Thursday and quickly reached a 135% gain. DoorDash is now valued at nearly $70 billion while Airbnb is worth more than $100 billion.

To put that in perspective, both companies have higher market valuations than Dow Jones Industrial Average components Travelers, Walgreens and Dow Inc. Airbnb is also valued higher than Dow stalwarts Goldman Sachs, Caterpillar, American Express and 3M.

It’s true that both DoorDash and Airbnb are leaders in their respective industries of food delivery and short term real estate rentals. But neither company is profitable. (Let that sink in.) And both face daunting challenges.

DoorDash is going to have to deal with intense competition from Uber, which is bulking up its Uber Eats division with the acquisition of Postmates, as well as from Europe’s Just Eat Takeaway.com, which now owns Grubhub.

IP Uh Oh?

There are also concerns that demand for food delivery, which is surging in the midst of the ongoing pandemic, could wane if vaccines are successful and consumers once again look to dine out more.

As for Airbnb, it is going public at a time when its revenue is plunging as a result of the Covid-19 pandemic. It may have fewer pure rivals than DoorDash, but Airbnb’s success is dependent on whether and when the overall economy — and travel demand in particular — bounces back. That’s far from certain.

Plus, it’s not as if Airbnb faces zero competitive threats. The company has to contend with the likes of Expedia’s VRBO unit as well as major hotel chains such as Hilton, Marriott and Wyndham.

Investors don’t seem to be worried about any of that. It’s full-blown unicorn mania. Other money-losing companies, such as software firms C3.ai and Snowflake, have soared as well following their IPOs.

Several other unprofitable unicorns have successfully gone public by other means.

Controversial big data firm Palantir has surged after a direct listing of its shares. And sports gambling powerhouse DraftKings went public earlier this year following a blank check merger with a so-called special purpose acquisition company, or SPAC.

Investors partying like it’s 1999

All this seems eerily reminiscent of the late 1990s, when many companies went public without profits and traded at sky-high valuations. In fact, IPO activity has reached levels not seen since 2000, according to research from Renaissance Capital.

That tech bubble eventually burst. And although some companies such as Amazon, which had its IPO in 1997, survived and thrived, many more startups from the late 1990s and early 2000s went out of business or got bought by other companies at huge discounts from their IPO price. In memoriam: Pets.com, Webvan, eToys and theglobe.com.

“I’d be concerned about IPO valuations,” said Phil Orlando, chief equity market strategist at Federated Hermes.

Orlando conceded that DoorDash and Airibnb are not the 2020 equivalent of Pets.com. And he added that these companies are probably wise to strike while the proverbial iron is hot and take advantage of surging investor interest in order to raise money by selling stock.

But that doesn’t mean investors should be buying at these levels.

Newly public stocks are inherently risky

IPOs often fall in the weeks and months following splashy debuts, in part because insiders may unload shares after lockup periods that prevented them from selling at the IPO price expire.

And newly public companies often find that it’s not easy to live up to the hype once they begin reporting quarterly earnings. Uber faced a rough go after its May 2019 market debut until the stock finally found its footing.

But the lack of profitability is probably the most troubling aspect for investors in today’s unicorns. It wasn’t all that long ago that startups waited until they could generate actual earnings before going public.

Google (now Alphabet), Facebook and Alibaba were all profitable before their IPOs — and those three stocks have thrived.

Exuberance aside, waiting until a company is a more mature startup may not be the worst investing decision in the world.