Sometimes a cigar is just a cigar, as Sigmund Freud once pointed out. It is easy when analyzing financial markets of any kind to look a little too deep for hidden meanings to explain something, when, in reality, it is not that complicated.
Yesterday, for example, shares in the meal delivery company Blue Apron (APRN) debuted, and their low offering price and lackluster first day of trading is being explained away by many people as a timing issue. Amazon (AMZN)’s recent proposed purchase of Whole Foods (WFM) and the fact that yesterday was a bad day for tech are all being touted as excuses, when the real reason that APRN flopped is the simplest one: Even at the eventual offering price of $10, APRN was overpriced.
That may come as a surprise to investors who have been following the offering. Ten dollars was at the bottom of the quoted $10-11 range, a range that itself was dramatically lowered from an original target of $15-17, so based on that original valuation APRN could be considered cheap. A thirty percent discount from the original valuation would be just that if the initial target were anything like realistic, but in this case, it was not.
Given that Blue Apron is in a market that has become massively competitive over the last few years, showed decent but not spectacular growth in the first quarter of this year, and has huge customer acquisition costs, the problem is with that initial target, not the $10 eventual price tag. Overvaluing a young company that adopts a growth at any cost strategy is nothing new, nor is it something exclusive to Blue Apron. It is part of a worrying trend that gets at the most basic function of a company and the purpose of an IPO.
We live in a capitalist economy, and therefore the most basic function of a corporation is to make money. Along the way some can do a lot of good, or at least “do no harm” as was famously Google (GOOGL)’s stated aim, but providing employment, giving back to the community, or even promoting healthier eating habits to counter an obesity epidemic can only be done if the company survives.
To do that you need to make money.
So far Blue Apron has been unable to demonstrate that they can do that, but it could be argued that it is not their fault.
What is at fault is a pre-IPO financing system that massively rewards growth in customer base without regard to profitability now or in the foreseeable future. There is just so much private equity and venture capital cash chasing the next big thing that a company that demonstrates growth, even without any clear path to profitability, attracts funds competing to pour money in. That makes it only logical for the management of a young company to focus on customer acquisition regardless of cost, and believe that that alone makes their company valuable.
It seems that early investors have become obsessed with finding the next Amazon or Facebook (FB), but that obsession is causing them to overlook a few basic things. Obviously, spectacular growth such as the sort Amazon was showing in its early days hints at potential, but that is not the same thing as growth per se.
Yes, Blue Apron is growing, but the customer base increased sixty percent from Q1 2016 to Q1 2017 to just over 1 million. At a $2 billion valuation, that represents $2,000 per customer. It is not apples for apples, but compare that to Amazon’s nearly 3000% revenue growth in 1996, or Facebook’s $127 per active user valuation and you begin to understand where the problem is.
At the root of all this is the fact that funding has become too easy for startups to find. Rather than having to demonstrate a path to profitability to skeptical stock market, they now have only to show VC and PE firms that they can increase exposure, and funds come pouring in. As a result, in some cases, going public is about allowing those early investors to cash out rather than attracting funds, and obviously the optimum point to do that is when the valuation is stretched to the max.
Stock investors have been burned by this too many times, dating back to Twitter (TWTR)’s IPO at a higher per user valuation than Facebook’s earlier launch and continuing through Snapchat (SNAP)’s overpriced offering of a few months ago. The drastic reduction in pricing and the lackluster trading performance of APRN yesterday indicates that the market is sending a message that startup valuations in the tech sector have got out of hand.
That may present a problem to late round funders of companies like Uber and Airbnb, but for the rest of us, it is good news. It is an example of the market correcting inherent problems with limited disruption, just as it should.
As good a sign as it is from a broader perspective, however, that does nothing to make APRN more attractive. The $10 price probably reflects current reality, but there are so many risks going forward that the risk-reward calculus is out of whack. Early investors have stolen all of the value, and traders are obviously reluctant to compound the valuation problem by bidding the stock up now.