Stock market shakeout: Big investors now shun the growth-at-all-costs model

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It didn’t take long for Adam Neumann to lose his aura of invincibility. It disappeared in a matter of a few weeks.

As a co-founder of We Co., the parent company of WeWork, Mr. Neumann had been hailed as a real estate visionary. The company secures office space under long-term leases, renovates it and then divides it up to sublease it with shorter terms and premium prices.

Backed by private capital, the company earlier this year had a private-market valuation of US$47-billion. Then came its filing for a public listing, which exposed the size of its losses (US$1.9-billion in 2018 and another US$905-million in the first six months of this year) and the discovery of some questionable transactions. For example, investors learned that We paid millions of dollars to a company controlled by Mr. Neumann for the “We” trademark, a deal the company later said it would unwind.

As the company’s public face, Mr. Neumann bore the brunt of the backlash. After its initial public offering was ultimately postponed a few weeks later, he was booted as chief executive.

In the aftermath, it has been easy to paint Mr. Neumann as a problematic founder who spooked investors. But there’s been a sudden shift in market sentiment that’s bigger than him, or even WeWork. Quite simply, many investors have new expectations.

For years, ambitious companies coming to market were rewarded for growth at all costs. But now, institutional money managers have started to demand positive cash flow and a visible path to profits – and these businesses struggle to show it.

​“We have been through one of the glory periods for companies to remain private and get funding and do things without making money for a long period of time," Tim Armour, CEO of American asset-management giant Capital Group,​ said at an investor conference two weeks ago. “I question whether that will continue.”

The issue is that many companies are talked about as startups, even though they have been in business for many years.

“If you’ve got a company with no revenue, investors can dream whatever revenue number they want,” John Ewing, chief investment officer at Ewing Morris & Co., said in an interview. That let venture-capital backers speculate about valuations. Eventually, though, "the dreamers move on.”

As the original backers exit in search of funding the next big thing, public-market investors start to value the companies using different metrics. “You hit an air pocket when you transition," Mr. Ewing said.

Public investors weren’t so skeptical only a few months ago. Ride-hailing giant Uber Technologies Inc. piled up operating losses totalling US$10.1-billion from 2016 to 2018, but was still able to go public in May at an US$82-billion valuation. Rival ride-hailing company Lyft Inc. also went public despite losses, as did workplace messaging company Slack Technologies Inc.

At the time, the expectation was that once these companies and others like them had sizable market shares, they would start to raise prices. No one seems to know whether that will work any more.

“Uber may never prove their business model,” said Kim Shannon, president of Sionna Investment Managers and a value investor who has long been skeptical of the growth-at-all-costs model.

Since going public in May, Uber’s shares have dropped 33 per cent. Lyft’s have tumbled 43 per cent since its March IPO.

It isn’t solely a Silicon Valley phenomenon. In Canada, cannabis producers are enduring similar struggles.

At its peak, Canopy Growth Corp., the largest of the Canadian players, was worth $23-billion. It even attracted a $5-billion investment from alcohol giant Constellation Brands Inc. last summer.

But just like the Silicon Valley startups, Canopy has hit the air pocket.

In July, Canopy founder Bruce Linton was ousted as CEO. A month later, the company disclosed that it will not be profitable for three to five years. On a conference call, executives said Canopy had been so focused on being the early market leader that it cut corners, and now has to go back and retrofit greenhouses and fix problems across its supply chain. The company’s shares have plummeted 53 per cent from their 2019 high.

This type of shift in investor sentiment has happened many times before. The dot-com bubble is often cited as the prime example, but since the start of the century investors have also gotten into frenzies over sectors such as telecommunications and clean technology, only to abandon them.

This time around, the frenzy is defined by the extent to which investors idolized company founders − something Ms. Shannon called the market’s “collective mania." For cannabis, it was Mr. Linton. For ride-hailing, it was Uber’s Travis Kalanick. For WeWork, it was Mr. Neumann. All three are now gone.

To their credit, these men leave behind legitimate businesses with respectable revenues – unlike many companies from the dot-com boom. The question, however, is whether investors will stick around for the transition to profitability.

Because unlike private capital, Mr. Ewing said, "public investors have a lot of alternatives for where to invest.”