To the shock of practically no one, Casper Sleep Inc's (NYSE:CSPR) stock has continued to be a disappointment since going public. The stock debuted at a value of $12 per share after slashing initial expectations of $17 or $18. But after rising initially, Casper has seen its shares fall to $10.64 at the close of trading on February 14. The company has a valuation of $407 million, a drastic collapse compared to how it was valued at $1.1 billion in a March 2019 funding round.
Casper may be a value investment at this lower price, or it may not. But the more important thing is to figure out why this IPO failed so badly, why Casper was overvalued so much to begin with, and what this means for stock markets and other unicorns going forward. While Casper may be disappointed in its failure, this failure shows that investors are becoming more prudent and are not falling for flashy hype.
The Profitability-Growth Discussion
Most IPOs do not make a net profit. For example, Casper reported losses of $67 million in the first three quarters of 2019, up from $64 million in 2018 according to its prospectus.Being unprofitable is not necessarily a bad thing. In fact, investors may not want an IPO to be profitable as that signifies the company is not reinvesting said profits into its own operations. However, investors will want to see that a company has a viable path toward profitability. In Casper’s case, its rapidly diminishing revenue growth rate and heavy sales and marketing expenses called into question its ability to do that.Unicorns in the past have been able to discount their lack of profitability by pointing to high revenue growth. They point to the example of Amazon (NASDAQ:AMZN) and argue that they can grow their way towards profitability. But Casper is showing that this argument is far less palatable to investors. Unicorns do not have to have a net profit on going public. But they do have to show how they are going to get there and not just admit that they are not profitable and may never be.
Real vs. Fake Tech companies
It sometimes seems that if little Johnny called his lemonade stand “Johnny’s Tech Lemonade Stand,” an investor would show up in a few hours and dump a wheelbarrow of money into Johnny’s lap. Casper was not just a company which sold mattress, you see. No, Casper claimed that their offerings encompassed “sleep technology, such as tracking devices, medical machines, bedside clocks, and connected devices.” Pay no attention to the tiny little fact that Casper does not have any such products for sale yet.
Perhaps the most infamous example of a company trying to pretend to be a tech company was WeWork, which tried to claim that technology played an integral role in how it rented out office space. Investors became wise to what WeWork was trying to do, and the same thing happened to Casper. Companies which attempt to position itself as a tech company need to show how technology plays a meaningful role in their business.
A Smaller Unicorn Market
The above factors create a dilemma for unicorns that are either public or intend to be. Unicorns, private companies with a valuation of over $1 billion, received that name because they were supposed to be incredibly rare. But in 2019, Reuters reported that 66 unicorns were created in the United States that year, up from 58 in 2018.
How did something so rare become so commonplace? The primary reason is that we have seen an explosion in private funding as private equity firms and mutual funds chase yields. Companies can stay private for longer as they can count on a near endless pool of private firms from which to raise money from. Furthermore, those same private firms have an incentive to help the companies they invest in reach that tantalizing $1 billion figure, as that makes it easier to attract other investors and the public.
But if the public grows more skeptical about these unprofitable unicorns like we have seen with Casper and WeWork, then the equation changes. The above private investors will become cautious having no one to foist their shares onto, which means that less viable unicorns will be faced with a harder investing environment. They cannot easily hope that they will just be bought out by some holding investments company or count on continual private investment.
As a result, unicorns will have to readjust their businesses to show how they can make a profit even if it might impact their ability to grow or find themselves facing a dire financial situation. Casper will likely continue to remain a viable business for the time being and may even attract investors at its lower price. But its lack of success should serve as a warning towards other supposed unicorns that have no true path to profitability.