WeWork debacle resets expectations on Wall Street

After the dotcom bust, Dan Chung, chief investment officer for Alger, a tech-focused fund manager based in New York, was desperate for hot stocks to fire up his portfolios.

In 2003, he spotted a small-cap stock that had dropped 65 per cent in the five months after going public. The company — a specialist in mail-order DVD rentals — was increasing its revenues, but investors had soured on it, worrying that it was precisely the type of risky business that had contributed to the big crash.

Mr Chung snapped up stock in the company, Netflix, for $1.20 and within a year the price had climbed fivefold.

The gain was a lifeline for Alger, which had suffered outflows after being hit hard by the 9/11 attacks. The holding boosted the asset manager’s small and mid-cap funds, helping stem a wave of withdrawals. Netflix stock would climb further, breaching $200 in 2017, the year Alger sold its stake, to more than $300 today.

“After 2001 we lost a lot of clients,” Mr Chung said. “We were trying to prove we could stay in business.”

Mr Chung’s big bet on a beaten-up newcomer is worth considering, as a chill descends on some of this year’s newly-listed companies.

The five largest US deals of the year, which all fall into the “unicorn” category of private companies worth more than $1bn, have lost an average of 24 per cent of their value since going public. Three of the five remain lower than their IPO price, including Uber, the year’s biggest newcomer, which has lost 37 per cent since its debut in May.

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SmileDirectClub, the teeth straightening start-up, is down 60 per cent since listing in September, wiping out about $5bn of equity value.

“The large unicorns were mispriced and performed very poorly,” said Kathleen Smith, principal of Renaissance Capital.

WeWork, which scrapped its own listing in September after investors balked at a combination of a high price and dubious governance, has dominated cocktail party chatter. But the downfall of its former chief executive Adam Neumann goes beyond schadenfreude — it has triggered a rethink on valuations.

So far in the fourth quarter, three of four listings have priced below the midpoint of their expected ranges set by underwriters, compared to less than one in three over the first three quarters of the year. The numbers suggest that the likes of Goldman Sachs, JPMorgan and Morgan Stanley have responded to investors’ demands for a better deal.

The shift in sentiment was probably long overdue, said Mr Chung, given that companies losing billions of dollars a year were being handed very high pricetags. “In hindsight it felt like it was getting out of hand and it has been brewing for years,” he said.

The unease coursing through the market for new listings has not completely sapped demand for untested growth companies. Stock in Peloton, the exercise bike start-up, for example, dropped 12 per cent on day one in September, after its bankers priced the deal at the upper limit of its price range, but this week it edged above its listing price for the first time.

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The company’s market capitalisation is now about eight times its sales over the past 12 months, a significantly higher ratio than the average 3.6 times in the year Mr Chung bought Netflix. (Netflix is now at about seven times).

However, the recent weakness in new listings has injected a dose of reality — and has presented growth-focused investors like Alger with a set of new opportunities. Many of them recall what happened to Facebook, which was the largest tech IPO in history when it rang the opening bell in May 2012.

The social media group’s shares rose on their first day of trading to close at $45, from $38 at the open, but fell to $21 in the following months. Today, the stock trades at $197.

“I think the recent correction is super healthy,” Mr Chung said. “The risk is being taken out of [new listings] as we speak.” Ms Smith of Renaissance calls it “a buyers’ strike” on the part of fund managers who normally pile in to IPOs.

Ms Smith added that a lull in new listings could easily be followed by a snap back. “I anticipate we will see an awful lot of private companies that are getting their act together, and they will probably be more cautious in how they price their IPO,” she said.

But, for now, the whiff of WeWork’s failure still hangs over the market.

“When something like that happens it’s usually an inflection point,” said Stephen Blitz, chief US economist for TS Lombard. “It tells you smart money is no longer doing stupid things.”

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