Why you should be wary of unicorns

As unicorn companies are floated on the stock market, we'll see which are the real businesses – and which are the dead horses, says Matthew Lynn.


Deliveroo: on the move, or a dead horse?

Spotifyis preparing a float. The takeaway food service Deliveroo is also getting its initial public offering ready. Over the next year, there is talk that Airbnb, WeWork and BuzzFeed may well join them. This could be the year when the tech unicorns that is, unlisted start-ups with a value of $1bn or more finally go public.

That will give the stockmarket a big boost, as well as allow ordinary investors a chance to buy into some very exciting companies. But it will also mean that those firms have to prove they are real businesses. That might be a problem, because when you strip away some of the hype, that is not always clear.

Small firms, big challenges

Take music-streaming service Spotify. In many ways it's a fantastically successful business. It has reinvented the way people listen to and pay for music and created a powerful global brand. It now has 70 million paying subscribers, more than the population of the UK, and that has doubled in a little over a year. But there is a catch. It doesn't make any money.

Last year its losses doubled to more than €500m even as its revenues doubled. Its marketing costs are huge, and it has to pay out a big percentage of its revenues in royalties. At the same time, it faces ferocious competition from Amazon and Apple, two of the richest, most competitive companies in the world, which makes it virtually impossible to raise prices. Can it ever make money?

It's a similar story for Deliveroo. Again, it has carved out a place for itself and created a powerful brand. Takeaway food ordered over the web is a big and growing market, and Deliveroo has one of the strongest positions in the industry. It already operates in 12 countries.

But again, it is not making money. Its latest figures showed a loss of £129m, up from £30m a year earlier. It too faces huge challenges. The market is ferociously competitive; the margins slim. There are legal and political pressures to give higher pay and more rights to its delivery workers. Whether it will ever be profitable, we don't really know.

There are often common challenges facing these tech stars. For starters, margins are often wafer-thin. Many of these firms are basically connecting people musicians with listeners, restaurants with customers, drivers with passengers. You can't charge a huge amount for what is basically just a middle-man fee. A few percent of each transaction may be the best you can do, and even that might be a stretch.

A glut of capital for competitors

The markets they operate in are all fiercely competitive. The vast sums investors have poured into tech start-ups in the last year mean that every market is very crowded. As soon as an area gets hot, dozens of companies are launched, and they can all raise a few tens of millions in capital.

None of them will be very bothered about racking up big losses for the first few years, and their investors will carry on subsidising them. At the same time, Google, Facebook or Amazon are always ready to launch their own version of a successful product. Such intense competition is bad for profits.

It can be done of course. Nobody thought you could make any money from a load of angry rants about Brexit until Twitter came along. But this month, it has turned a profit for the first time. Just because there are question marks over a business model doesn't mean it can never make money. However, for the moment, many of the unicorns are lossmakers.

Pension funds, and general investors, won't like that: they're looking for stability, reliability and profitability. Some unicorns will deliver that eventually, but not all of them. And those that do will have to tighten up their businesses, and show they can make money as well as carve out market share. As the unicorns gradually float, we'll find out which are the real businesses of the future and which are a dead horse.

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