The Economist April 4th 2020 pp55-57 Briefing Anatomy of an investing bubble. “Exit unicorns, pursued by bears”. “The pandemic rams home what markets already felt: technology unicorns are headed for a fall. The consequences will not be all that bad”
Definitions
Unicorn-a privately owned company valued at $1bn or more. Private companies are valued based on what investors paid for a share times the number of shares issued during the last investment round. Investment rounds after the Seed/Angel Round are lettered A, B, C etc.
AI-Artificial Intelligence
Fintect-software/cloud computing technology for financial services
Fake Tech-companies claiming to be technology-based. True technology-based companie's core value is technology. Benefits like economies of scale and unique network capability accrue from leveraging internet-based networks. Having a unique network like AirBnb, for example, means that rivals can’t readily emulate or enter as competitors. Examples of Fake Tech are “capital intensive” companies masquerading at Tech companies. WeWork is often cited as being found out as Fake Tech. WeWork's business model like most companies today uses the internet for service but the company could only gain scale by renting more office space not by leveraging a unique hard-to-emulate technology. Fake Tech companies don't deserve lofty valuations be their variable cost structure or cost-per-unit is mostly based on capital investment. So WeWork, to expand has to keep buying/leasing and retrofiting office space.
Inside Rounds-financing rounds restricted to insiders or follow on rounds by the initial investment firm. Inside rounds are used to essentially hold or prop-up share valuation while infusing needed cash. Such actions protect insiders at least temporarily.
Down Rounds-secondary rounds of finance that result in lower company valuation.
Big Uglies-Apple, Microsoft, Alphabet, Amazon and Facebook are huge companies with great balance sheets. They have lots of cash to buy technology companies they deem important.
VC-Venture Capital
Companies Mentioned in the Article.
Toutiao (ByteDance) valued at $75bn, Chinese, AI
Didi Chuxing valued at $56bn, Chinese, Auto and Transportation
Stripe valued at $35bn, American, Fintech
Airbnb $35bn, American, Travel
SpaceX $33bn, American, Space Transportation
Kuaishou $18bn, Chinese, Mobile and Telecommunications
One97 Communications, $16bn, Indian, Fintech
Epic Games, $15bn, American, Software
DJI Innovations, $15bn, Chinese, Hardware
Grab, $14bn, Malaysian, Auto and Transportation
Lime, $2.4bn, American, Scooter Rental
DoorDash, $13bn, Food Delivery
Uber,$43bn, (Public), Internet Taxi
Lyft, Internet Taxi
Slack (Public), Corporate Messaging Software/App
WeWork, $8bn, American, Office Rental
Brandless, Online Retailer
Zume, Robot-Made Pizza and Delivery
Vision Fund of Softbank Venture Capital Group, Japanese
One Web, Bankrupt, British Satellite Start-Up
Tuandaiwang, Bankrupt, Chinese, Peer-to-Peer Lender
Casper, $575m (Public), American, Direct-To-Consumer Bedding
Box, (Public), American, Enterprise Cloud Company
Snowflake, Cloud-Based Services
PagerDuty, Digital Operation Consulting for Businesses
Zoom, Video Conferencing
Meituan-Dianping, Chinese, Food Delivery in China
Pinduoduo, Chinese, E Commerce Site
Bite Dance, $75bn, (Parent of TikTok-VideoSharing App)
SoFi
Provenance
Figure
Grab, $14bn, Malaysian, Internet-Taxi
Did Chuxing, Chinese, Internet-Taxi
EquityZen
Bird, Scooter Rental
Gojek, Indonesian, Internet-Taxi
Softbank
Intuit
Apple
Microsoft
Alphabet
Amazon
Summary
Since 2009, American VC have investments increased from $32bn to $121bn in 2018 for a total investment of $822bn since 2010. The number of American unicorns grew from about 25 ($50bn) in 2012 to more than 175 by 2019 ($600bn). In 2014, China and later Europe joined in the rush to fund start-ups.
Prior to COVID-19 unicorns were feeling headwinds created by UBER’s discounted IPO and after WeWorks valuation dropped from $47bn to $8bn. UBER's IPO valuation dropped 30% and WeWorks falling-out started with revelations leading up to their planned IPO. WeWork withdrew the IPO. Many “other [Unicorn] debacles followed” those events.
COVID-19 restrictions will uniquely impact some unicorns. For example, Scooter Rental companies will be hurt while food-delivery companies may benefit. Those types of exceptions aside, the overall economic contraction resulting from COVID-19 adds to the already increasing wariness of the unicorns and tightening of investment funds. Worldwide nearly 450 Unicorns are valued at more than $1trn.
Business models "born-and-raised" on perpetually losing money are not surprisingly falling out of favor. Investor sentiment has shifted from "...fear of missing...to fear of looking stupid”. New deals aren't being pursued as investment firms are salvaging what they can. Portfolio firms are being advised “to rein in costs, conserve cash and brace for capital scarcity”. “Pathway to profitability” has become the new mantra.
VC have always operated on a portfolio level. They invest in promising ideas and seek to capitalize on those realizing extraordinary success. The thinking has been, of nine investments; three would thrive, three would underperform and three would be sold at discount or die. The post COVID-19 economy may skew this distribution and lead to another dotcom-like bubble. Fortunately, most of these companies are privately-held but ripple effects are in the public markets are possible.
What can be learned from that current state of The Unicorns?
1) Some companies are Fake Tech. Fake Tech firms use the web or cloud but their businesses are fundamentally old school and capital intensive. As they grow, unlike true technology-based firms, they don’t realize economies of scale. Further, there offering is not really unique. They may build a brand but other firms easily enter the space and compete on price. At some point, low price is essentially subsidized by VC money “…selling $1 for 80 cents”. Uber (Public) and Lyft come to mind as examples.
2) Some Unicorns have good business models and enough cash flow to survive 'ups and downs' but many are plagued by “complex and opaque financial practices". One assessment by Ilya Strebulaev, Stanford Gradual School of Business, “found that firms were overstating their valuations by 48% on average”. This happens as early investors essentially protect valuations by maneuvering share classes and using inside rounds for additional funding. Mike Cagney, a Fintech co-founder, states “an unwritten VC rule advises against a firm which led one investment round in a startup leading the next”. Although this has been realized by the private investment firms, “down rounds” appear unchanged. Having noted that, secondary buyers are armed for taking discounts.
Next steps?
“If all else fails, ‘sell in to one of the big uglies’”. These big uglies namely Apple, Microsoft, Alphabet, Amazon and Facebook are “collectively sitting on more than $570bn in gross cash”. In order to strengthen the post COVID-19 economy anti-trust regulators may allow more consolidation favoring jobs over monopoly-forming concerns.