IPO Market Commentary

What’s a Unicorn Worth?

September 12, 2017

What’s a Unicorn Worth?

Silicon Valley’s still-private tech giants must think that Christmas has come early! When blank check company Social Capital
Hedosophia announced its intention to raise up to $575 million to purchase a technology unicorn, they promised to provide an
attractive alternative to the traditional IPO market, which they contend discourages going public through suboptimal price
discovery. According to Social Capital, “limited price discovery and short-term focused investors” have resulted in systemic
underpricing of technology IPOs relative to non-technology IPOs.

To correct the inadequacies of the traditional IPO process, Social Capital plans to purchase at least one of the estimated 150
unicorns with a valuation as of the last round of financing of at least $1 billion. They will use their experience in “value creation”
in technology companies like Slack, Intercom, Netskope and Wealthfront to offer tech executives and VCs who want to
monetize their asset a superior alternative to an IPO. Paraphrasing Samuel Goldwyn: “We’re overpaying, but it’s worth it.”

Provoked by Social Capital’s assertion that in 2016 technology IPOs were significantly underpriced compared to non-technology
IPOs by 31% to 13% based on the first day of trading, we decided to investigate.

For the ten year period 2006-2016, the average first-day pop for the 1,681 US IPOs in our database was 12.7%, comprised of
27.4% for VC-backed technology companies and 10.4% for non VC-technology companies. During the same period, US
technology unicorns, as defined as VC-backed deals with a $1 billion valuation at IPO, were up 49.1%.

On the surface, those one-day returns seem to support Social Capital’s contention, but they fail to take into consideration a
number of important factors, including the elevated volatility of technology stocks, their lower floats relative to non-technology
IPOs and the unique supply-demand mechanics of first day trading. These factors all contribute to manufactured first day
performance that may be unsupported by subsequent fundamentals. By citing 2016, Social Capital also cherry picks a period of
time in which the IPO market was staging a recovery, when IPOs in general and tech deals in particular tend to be of higher
quality with above-average pricing discounts.

In 2015, 2016 and year-to-date 2017, the average IPO continued to provide positive returns for investors, with the strongest
aftermarket returns coming from 2016’s vintage.

All IPOs Number of IPOs Avg 1st Day Pop Avg. Total Return Avg. Float at IPO
2017 YTD 92 9.7% 22.4% 23.0%
2016 105 11.4% 37.9% 22.6%
2015 170 14.3% 19.5% 23.8%
Source: Renaissance Capital. Return Data as of September 12, 2017.

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 IPO Market Commentary
What’s a Unicorn Worth?

Comparable data for US technology IPOs shows higher first day pops, which should be expected of high volatility equities,
which carry greater risk. In addition, technology IPOs often purposefully have lower IPO floats. This plays a significant role in
supply-demand, resulting in inflated immediate post IPO valuations. This has been the case in 2017, 2015 and 2016. So far, the
years’ cohorts have produced significant aftermarket returns, in part helped by a rising stock market.

US Technology IPOs Number of IPOs Avg. 1st Day Pop Avg. Total Return Avg. Float at IPO
2017 YTD 15 18.0% 34.3% 14.9%
2016 16 37.5% 82.8% 18.2%
2015 20 18.9% 49.4% 17.5%
Source: Renaissance Capital. Return Data as of September 12, 2017.

Finally, we looked at the comparable metrics for US technology unicorns, the $1 billion valuation cohort targeted by Social
Capital. What stands out are the extremely low floats and lack of positive aftermarket returns. In 2017 and 2016 investors who
didn’t get IPO allocations lost money. Aftermarket returns for the 2015 vintage were a paltry 7%.

In fact, the probability of losing money on these unicorns was significant. In 2017, four of the six large IPOs – Blue Apron,
Yext, Mulesoft and Snap – had negative aftermarket returns. In 2016, it was two of three and in 2015 four of five.

$1 B+ US Tech IPOs Number of IPOs Avg 1st Day Pop Avg. Total Return Avg. Float at IPO
2017 YTD 6 28.4% 15.3% 11.2%
2016 3 102.7% 70.9% 10.7%
2015 5 40.8% 47.6% 12.1%
Source: Renaissance Capital. Return Data as of September 12, 2017.

It is helpful to put the results in context. In 2015, there was a sharp decline of VC-backed technology, the lowest since the
financial crisis. Companies were staying private longer. We also found that while sales were increasing rapidly, valuation multiples
were increasing even more rapidly, as were losses.

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 IPO Market Commentary
What’s a Unicorn Worth?

The contention that unicorn IPOs are undervalued is further undermined by data comparing Price/Sales ratios for unicorns and
all US technology IPOs. Sales multiples have reached a ten-year high in 2017. This is due to Snap, which was priced at 60 times
market value to trailing 12-month sales, over four times the next richest unicorns, Mulesoft and Okta. Most of these unicorns
are unprofitable and burning through copious amounts of capital.

Average Price/Sales: US Tech vs. US Tech Unicorns

Sales Multiples Are at 10-Year Highs
25.0

20.5
20.0

15.7
14.5 14.5 13.9
15.0
12.3 12.0

10.0 9.0 8.4

7.8 7.9 8.1 8.2 7.7
6.3 5.7
4.5 4.8
5.0 4.2 3.9
2.3

0.0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

US Tech US Tech Unicorns

Source: Renaissance Capital Data excludes IPOs with <$15M in LTM sales and market caps <$250M

The evidence does not support the hypothesis that public investors have historically “misevaluated” technology unicorns. Rather,
the correct diagnosis is the lack of returns in the venture capital asset class, which Cambridge Associates recorded as 1% in 2016,
due to valuation pushback. This is now being evidenced in the increasing number of private down rounds, markdowns of private
companies by mutual funds and continued IPO discounts on these highly volatile companies. It is happening because the public
markets are highly rational and demand what Benjamin Graham quaintly called a “margin of safety”.

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