TheChek News Flow

It’s no surprise that the United Kingdom is deeply divided over consequences of leaving the European Union. The Remainers, who want to stay in the EU, believe a no-deal Brexit will leave the country in ruins. Leavers, on the other hand, say Brexit will eventually fuel growth and produce a thriving U.K.

A no-deal Brexit means the U.K. leaves the European customs union and single market without an EU deal, opting instead to trade under World Trade Organization rules.

The Leavers make a case for the world they see unfolding. For instance, the pound to euro exchange rate, at 1.12 euro to the pound, is the lowest in 20 years, apart from the 2009 financial crisis. The pound is also at a 16-year low against the dollar, at $1.27, down from $1.62 in 2003.

The First Democratic Debates Left Out Inconvenient Details

They argue that the currency may have bottomed out. On Wednesday, Boris Johnson, the former foreign secretary and favorite to become prime minister in July, declared he would take the U.K. out of the EU by the end of October “come what may, do or die.” Johnson may be controversial, but he provides some hope of a more decisive approach to Brexit after months of debate, blown deadlines, failed votes, and uncertainty. Moreover, as a note from Australian investment bank WestPac noted, “Markets have priced in the potential of Boris Johnson as a more hard Brexit PM and even [the] risk of a no-deal exit.”

There are risks. Economists from the International Monetary Fund, the Bank of England, and the U.K. government have all sounded alarms about a “disorderly” Brexit. A February government report suggests the U.K. economy would be as much as 9.3% smaller over the next 15 years if the country leaves the EU without trade agreements.

But a London think tank, Economists for Free Trade, challenges that view. Cardiff University economist Patrick Minford, who is also chairman of the think tank, calculates a no-deal exit would deliver a 7% GDP gain to the U.K. economy over the next 15 years—worth about £140 billion. Minford ticks off the savings: £39 billion EU membership fee, benefits from free trade with non-EU countries, and the elimination of subsidies provided to unskilled immigrants. He estimates EU regulation and red tape reduce U.K. GDP by around 6%, about a third of which can be reversed, giving a projected gain of 2% of GDP over the next 15 years.

Sorting through claims and counterclaims isn’t easy. On Tuesday, the U.K.’s Society of Motor Manufacturers and Traders (SMMT) warned that friction at the borders in a hard Brexit could add up to £50,000 a minute for the sector, and repeated warnings about tariffs. But the SMMT has a vested interest in remaining. It’s funded by car giants, including Renault (ticker: RNO.France), which is partly owned by the French government, and Volkswagen (VOW.Germany), partly controlled by Germany’s state of Lower Saxony.

But other industries may be relatively untouched by a no-deal Brexit. In a report, the government noted that for “some sectors (such as life sciences or electronics) the effect of tariffs would be minor.” Diageo (DGE.UK), the world’s largest spirits company, has said it will benefit from zero tariffs post-Brexit. And despite fear of a dearth of trade deals, the government says it has signed 40 agreements with countries including Switzerland and Chile.

Neither side owns a crystal ball. But if investors or voters are ever going to bridge the divide, it behooves them to know what the other side is arguing.

Two decades after the dot-com crash, Pets.com remains the symbol of 1990s excess in initial public offerings. EBay is littered with listings for the pet supplier’s vintage sock puppets—the most tangible evidence of the company’s short existence. Today, the website, Pets.com, forwards to bricks-and-mortar retailer PetSmart.

When it filed to go public in 2000, Pets.com had lifetime revenue below $6 million and just a year of operations under its belt. Still, the company came public with a valuation of more than $300 million. Within a year, Pets.com had shut down. Investors lost everything and a legend was born.

Presiding over the Pets.com madness was CEO Julie Wainwright, an experienced software and e-commerce executive. While she wasn’t the company’s founder, Wainwright was there almost from inception, and the collapse was a cloud over her for years.

Now, Wainwright has brought a new company public—The RealReal (ticker: REAL)—an online luxury consignment shop that she founded in 2011. And Wainwright is back in the CEO chair—comeback complete. The company sold 15 million shares at $20 each, giving it a market value of $1.65 billion. On Friday, the first day of trading, the shares rose sharply.

It is hard to miss the parallels to the dot-com boom. Initial offerings could raise a record level of capital in 2019, potentially breaking the nearly $97 billion record set in 2000. But Wainwright, and IPO investors, have returned wiser and more disciplined.

The RealReal has lots of things that Pets.com never had. It is more than eight years old, and it has a track record: 2018 revenue of $207.4 million, up 55% from 2017. Since its launch, The RealReal has paid sellers about $1 billion. In 2018, it processed 1.6 million orders, up 42% from the total a year earlier, with an average size of $446. The company expects revenue growth above 20% for several years to come, with cash flow margins around 25%.

If the Wainwright connection doesn’t get investors thinking about 1999, Chewy (CHWY) surely will. The pet-food supplier went public in June to huge demand, but it, too, is no Pets.com. Chewy, like The RealReal, was founded in 2011; it had 2018 revenue of $3.5 billion, 68% above the previous year’s level. The stock traded recently for about $33, up 50% from its IPO price, giving it a $13 billion market cap. It is instantly one of the world’s most highly valued pet businesses.

Goodbye, sock puppet. Hello, Mr. Chewy.

“ Strong returns are the fuel that drives the issuance engine. ”

—Kathleen Smith, Co-Founder Renaissance Capital, an IPO research firm

Yes, this is not your father’s IPO market. The resurgence of IPOs is no flash in the pan, no signal of a bubble reinflated. Instead, it reflects a shift in the way that investors and entrepreneurs approach company creation, the rich supply of mature companies that have yet to come public, and investors’ insatiable hunger for growth stories.

In a sense, the IPO market has simply grown up. For one thing, the median age of tech companies going public in 1999 was four; last year, it was 12. And having been burned in the bubble years by IPOs for wildly speculative and ultimately failed businesses, such as theGlobe.com and eToys, investors have tightened their standards. They now want established businesses with substantial revenue and high growth.

Most members of the recent class aren’t profitable—and that could be the undoing of some. But demand is high, and so is the quality of new issuers. Result: This IPO market is thriving.

Heading into 2019, there were high expectations for IPOs, but Barron’s was skeptical about how it might all unfold (“Why Investors Should be Wary as the Unicorns Finally Seek IPOs,” Dec. 21, 2018.) We worried that there was too much riding on Uber Technologies (UBER) and Lyft (LYFT), which were lined up near the front of the IPO runway. If the already pricey stocks sputtered, they were liable to take the whole IPO market with them.

We were right to worry about Lyft and Uber—both are below or near their IPO prices, even after debuting with slightly disappointing valuations. But the market for new stocks nonetheless has proved to be resilient and more.

The roster of this year’s successful IPOs is long, and includes Beyond Meat (BYND), Pinterest (PINS), and Chewy, all delivering strong performances after their market debuts.

There has been a particularly ravenous appetite for enterprise technology businesses, with impressive starts by Zoom Video Communications (ZM), PagerDuty (PD), Fastly (FSLY), and CrowdStrike Holdings (CRWD), and huge demand for Slack Technologies (WORK), which did not sell any new shares in a rare direct public listing. All of those companies had big first-day gains and remain ahead of their IPO prices.

If the trend continues, 2019 could be the best IPO year ever, in terms of total capital raised, according to Kathleen Smith, co-founder of Renaissance Capital, an IPO research firm. She says this year’s take could top the $85 billion raised in 2014, the year Alibaba Group Holding (BABA) listed, or the more than $90 billion raised in both 1999 and 2000, the heart of the bubble years.

Why? “Strong returns,” Smith explains, “are the fuel that drives the issuance engine.”

Smith’s firm runs the Renaissance IPO exchange-traded fund (IPO), which tracks an index of recent initial public offerings. This year, it’s up 35%, as investors continue to scoop up new offerings. Jay Ritter, a University of Florida finance professor who focuses on initial offerings, says the average listing-day return for them this year is at the highest since 2000. He expects 2019 to have the most new listings since 2014.

Here’s a closer look at the ingredients in the IPO revival—and why the trend is likely to continue.

Unicorn Supply: Unlike in the days of Pets.com, today entrepreneurs and the venture capitalists who fund them have been taking their time with the public markets. Many new issuers have been in business for a decade or more. And there has been no slowdown in venture-capital investing. Over the past 10 years, more than $628 billion has been invested in venture deals, including a record $132.1 billion last year alone, according to the PitchBook-NVCA Venture Monitor.

That cash is creating seasoned, valuable businesses. CB Insights lists 362 companies from around the world with private-market valuations of more than $1 billion, with 18 worth $10 billion-plus. At some point, almost all of them will seek liquidity.

The Scarcity of Growth: One striking element of the recent IPO market is the sky-high multiples that investors are paying for growth. That is especially true when it comes to enterprise technology, with many companies trading at 25 to 30 times projected current-year revenue. Not earnings—revenue. In fact, few are profitable. That’s a striking new way to think about valuing growth.

“Investors are more focused on incremental reward than risk,” says Lise Buyer, founder of Class V Group, an IPO consultancy. With such high valuations, “any company not looking to tap the IPO market now needs their head examined,” Renaissance Capital’s Smith says.

Compare recent valuations, for instance, with the June 2004 debut of Salesforce.com (CRM), which priced at $11 a share and closed the first day of trading at $17.20. At that price, the company had a market value of about $1.7 billion. Salesforce had $176 million in revenue in its January 2005 fiscal year—84% more than it had the year before, and the company was profitable. The first-day close valued Salesforce at a little under 10 times revenue, pricey territory at the time.

Were a company with those numbers to come public today, the valuation would probably be at least twice that, and maybe as much as four times higher. And the thing is, the stock would still have been a huge winner. Last week, Salesforce was trading above $600 if adjusted for a 4-for-1 split in 2013.

There simply aren’t many mature businesses annually growing in the 40% to 50% range or higher. Keep in mind that some of the highest-profile technology companies have reached maturity, with low or even zero growth. At Apple (AAPL), the top line has been shrinking lately. Facebook (FB) and Alphabet (GOOGL) are still growing in the high teens or low 20s, but both face rising regulatory scrutiny.

In contrast, Zoom Video Communications’ yearly revenue is growing by more than 100%—and doing so profitably. While Facebook commands a little under eight times expected forward revenue, Zoom fetches 45 times. And Slack’s market cap is a smidgen smaller than that of Hewlett Packard Enterprise (HPE), which will report revenue this year 50 times as large as Slack’s. It’s all about growth.

Scarcity of Shares: There’s a less-discussed, but equally important element to the scarcity factor. Many of these newly public companies have thin floats. As one banker points out, Zoom’s IPO represented just 8% of the fully diluted share count — half of the stock offered came from existing holders. That left few shares for institutional investors. To build a significant position, investors had to pay up in a thin public market. Zoom has climbed 150% since its April IPO.

Uber and Lyft: Both Uber and Lyft had slightly disappointing debuts, with valuations well shy of bullish expectations in the face of growing global competition, unproven long-term growth bets (like autonomous cars), and nagging regulatory issues.

For both stocks, heated expectations simply got out of control. Lyft’s offering came first, amid investor doubts about the company’s ability to reach profitability in the near term—or maybe ever. That made it tougher for Uber, which reportedly hoped to go public with a stock market value of $120 billion.

But Uber and Lyft were not exactly disasters. Uber has a market cap of $76 billion—about $20 billion more than General Motors (GM). And the IPO market has shaken off its brief malaise; investors apparently have decided that what ails the two companies has no implications at all for other emerging businesses.

All About the Cloud: The high valuations for cloud-based software concerns are no fluke. These are big businesses with lower capital requirements than previous generations of tech start-ups. They aren’t creating a lot of infrastructure; they aren’t building big data centers; they don’t have factories; and they don’t have large quota-carrying sales teams. They can reach clients around the world with self-service offerings in the cloud, outsourcing infrastructure needs to Amazon Web Services. They can grow quickly, expand at low cost, and address large markets with relatively small teams. The new approach offers better economics—and higher valuations.

Slack, PagerDuty , CrowdStrike, Zoom Video, Zscaler (ZS), Atlassian (TEAM), Okta (OKTA), Elastic (ESTC), and MongoDB (MDB) are all growing revenue by at least 30% annually (and considerably faster than that, in most cases). And they’re all being rewarded with fat multiples.

This guarantees that the parade will continue. Among the candidates: Rubrik (cloud storage), Flexport (cloud-based freight forwarding), Snowflake Computing (cloud-based data warehousing), and Squarespace (web hosting). All have private-market valuations well north of $1 billion.

Why Slack Matters: Slack decided to go public by effectively declaring itself a public company, without raising additional capital. Slack did just the second direct listing in recent memory, following Spotify Technology ’s (SPOT) in 2018.

As one banker points out, Slack is a Silicon Valley creation, unlike European-born Spotify, and was funded by iconic Valley investors—Accel, Andreessen Horowitz, Social Capital, and Kleiner Perkins, plus the Vision Fund of SoftBank Group (9984.Japan), which has come to play an important role in many leading tech start-ups. Slack, even more than Spotify, could be a model for further direct offerings. One company to watch is Airbnb, which is reportedly considering a direct listing and has said it could go public this year.

The Road Ahead: A steady stream of solid IPOs is coming. The head of technology, media, and telecom banking at one large Wall Street firm notes that there are “more big private companies that need to go public than ever before.” In most years, he adds, there are typically two to three companies that raise more than $1 billion through their IPOs; last year, there were 13. And this year, the number should match or top that.

READ THE SIDEBAR

How the Tide of IPOs Can Lift All Stocks

That will probably include a few iconic names.

WeWork, which provides workspaces for companies and individuals, is already valued at $47 billion. It has filed confidentially with the Securities and Exchange Commission for an initial offering; the timing is not clear, but this year is likely.

The food-delivery service Postmates and stationary-bike company Peloton Interactive likewise have filed confidential S-1s.

On the enterprise software front, the next to go is probably Medallia, a “customer experience management” company that filed in late June. For some other private companies—SpaceX, Stripe, Juul Labs, and Palantir Technologies—the wait is likely to be longer.

There also could be a longer wait for the single-largest remaining unicorn—Bytedance Technology, the China-based company behind the viral short-video site TikTok, with an estimated current value of $75 billion. Trade tensions between the U.S. and China could affect the ability of Chinese unicorns to tap the U.S. market.

Sen. Marco Rubio, the Florida Republican, recently introduced a bill that would subject Chinese companies listed in the U.S. to new accounting scrutiny—and eventually delist those that won’t comply. The result could be a shift in some listings to other markets, such as Hong Kong or London.

Where the Risks Lie: The thin floats for recently public stocks introduce risks down the road. As lockup agreements for insiders expire, their shares will hit the public market, increasing the supply of stock. If investor demand doesn’t keep up, the stocks will face selling pressure.

But the biggest dangers in IPOs are the same ones that apply to the broader market. Economic worries, trade wars, and geopolitical threats could cause investors to flee higher-risk, higher-growth stocks.

It is also possible that a big IPO could disappoint and slow the market. For the highflying software stocks, one risk would be a series of weak earnings reports from growth-driven companies that darkens the economic outlook. Several bankers point to 2016, when ServiceNow, Tableau Software , and LinkedIn all had earnings misses, suffered huge stock declines, and dragged the broader software sector down with them.

The IPO market isn’t for the faint of heart. But this isn’t 1999. The current generation of listing candidates spent years building their businesses in private. Now, growth-starved public investors are getting the chance to snap up the young companies’ shares. As long as that happens, initial public offerings will keep humming.

Barron’s weekend summary: positive feature on CCL; cautious on ABBV

* Cover story: Today’s IPO market in no way resembles the dot-com boom of the 1990s, which saw companies such as Pets.com crash; “The resurgence of IPOs is no flash in the pan, no signal of a bubble reinflated—instead, it reflects a shift in the way that investors and entrepreneurs approach company creation, the rich supply of mature companies that have yet to come public, and investors’ insatiable hunger for growth stories,” even if some recent IPOs aren’t profitable yet.

* Features: 1) Cautious on ABBV: With AbbVie’s acquisition of AGN at a 45% premium over the latter’s share price, it gets a company whose problems resemble its own, and if shareholders had been given a chance to vote on the deal they should have rejected it; 2) Positive on CCL: Shares plummeted following reduced 2019 financial guidance, but they now appear to be a bargain—they carry a 4.4% dividend and the cruise-line operator has the best balance sheet among the industry’s three big players; 3) IPOs can encourage risk-taking, which tends to drive up valuation multiples across the board—even for older stocks, thus benefiting investors who aren’t interested in taking risks with new issues such as BYND, ZM, or WORK, whose high valuations make the rest of the software sector look like a bargain; 4) Price targets may not always be useful for forecasts—many professional money managers say targets aren’t anything more than a marketing tool for the brokerage industry to generate interest in a stock, and for investors the assumptions behind them may not be obvious; 5) Proposed legislation would make it easier for employers to offer annuities in 401(k) retirement plans that provide retirees fixed payments for as long as they live, but such a move won’t necessarily solve the retirement crisis.

* Tech Trader: JPM and Bernstein recently asked hundreds of corporate executives for their 2019 purchasing plans, hinting at likely winners and losers in technology; Among the winners in both surveys are MSFT and AMZN, with the former topping the list of companies deemed indispensable, while the growing cloud business is likely to take mind share away from IBM and ORCL.