It seems that hardly a week has gone by in the past 18 months without some trendy start-up raising money at valuations that are nothing short of astronomical, leaving traditional, fundamentals-driven investment managers scratching their heads. Like all good fantasies, though, it has to come to an end.
What started as a gentle sell-off in tech stocks in the public markets two weeks ago has become a landslide. Fears about a severe slowdown in the Chinese market, the global growth engine for the past 20 years, plus hawkish signals from the US Federal Reserve have resulted in markets tanking – with highly valued tech stocks bearing the brunt.
Alibaba, the Chinese e-commerce group that came to the US market in the world’s largest initial public offering last October, is now below its offer price, while struggling US techs such Twitter and Etsy are also trading at a significant discounts to their IPO valuations.
The biggest of them all, Apple, is itself now well into a price correction, having lost 20 per cent of its market capitalisation since its February highs, despite being one of the few that actually makes enough money to justify its valuation. Its chief executive, Tim Cook, made a rare contact with US television stations yesterday, emailing CNBC to say that Apple’s business in China was “strong”, briefly pushing its shares into positive territory.
However, it is in the private market where the pinch might be felt hardest. Many of these companies, dubbed “unicorns” thanks to the $1bn-plus valuations they have gained on the back of investors willing to pay huge sums to for tiny stakes, have such fantastic internal growth projections that many private investors have thrown all risk analysis out of the window. Anyone with a mere smattering of investment experience should have baulked. And yet the wagon has rolled on.
Start-ups such AirBnB and SnapChat, which just a year ago turned down an offer worth $3bn from Facebook and is now valued at something like $16bn, have been raising (and spending) money like there’s no tomorrow. Only now, with China’s economy and market apparently in freefall and US interest rates set to take a hawkish turn, are those investments are beginning to take on a decidedly sickly hue.
Perhaps the clearest signal that it was all about to end came last week, when Microsoft confirmed that it would invest $100m into Uber, the taxi app, based on a staggering valuation of $50bn. Such is Microsoft’s abysmal recent record of throwing good money after bad that its decision to get on the unicorn bandwagon was, for some cynics at least, the clearest signal yet that the private market has reached the end of the Yellow Brick Road.
It isn’t just panic in the public markets that is causing investors to worry. Numbers leaked to the media website Gawker confirm that SnapChat, famously started by chief executive Evan Spreigel in his dorm room at Stanford University in California (itself now a tired start-up cliché) is hardly coining it in.
The company made revenues of just $3m in 2014, although with the very clear caveat that it only started carrying advertising in the last three months of the year and did not include its new advertising platform. Even so, that’s a long way short of the mark for a company that is apparently worth more than the B&Q retailer Kingfisher, a company with approximately $16bn in annual revenue and 80,000 employees.
One investment manager, who declined to be named, told The Independent: “Some of these unicorns might survive, but most investors will end up writing off whatever they’ve put in. Clever people have thrown all fundamental investment principles out of the window and have been seduced by what is in fact too good to be true. They are scared now, and they should be.” As it happens, Uber, the poster-child for excessive start-up valuations, probably has as good a chance as any of actually surviving, although the form its business ends up in may be very different from its current configuration. With billions of dollars in funding burning a hole in its pocket, Uber (again revealed by Gawker) is getting through cash at an incredible rate but is at least making real revenue, even if it is still a long way from the global domination its valuation implies.
Uber is far from alone in being forced to spend huge sums fighting legal battles – something that should have given every investor pause for thought before writing it a cheque. Its claim that drivers are independent contractors rather than employees is still far from settled, while AirBnB, the room renting start-up, is spending millions as it tries to convince regulators that its renters are not running hotels and should not be regulated accordingly. As is often the case, the real winners may end up being the lawyers.
And yet, do these valuations really mean anything when a company is privately owned? Without an open market to buy and sell, probably not. A company could be valued at trillions, but if there is no liquidity that valuation is arguably moot, at best.
According to Harvard Business Review, these unicorns are in fact far rarer than the headlines would have us believe. Two weeks ago, Stephanie Guo wrote: “If there were really a bubble in tech, then funds would theoretically be readily available. Yet venture capital firms fund only two out of every 1,000 start-ups they meet with annually, and only one out of 10,000 funded start-ups becomes a “unicorn”– a start-up worth over $1bn. Currently, the chance of a random start-up reaching a value of over a billion dollars is a flimsy one in five million.”
That unicorns are far more rare than we believe may well be true – but just as public investors are losing sleep in the mist of the current meltdown, so private investors are losing sleep too. Hiding places are few and far between, and if Apple can tank despite its comparably sound fundamentals, then there is potentially much more blood to be spilled.Reuse content