Even a cursory look at both ride stocks reveals that venture capitalists got too greedy. Now “unicorn” valuations have become their headache as well as ours.
Uber was overpriced from the exact moment that every blue-ribbon venture capital fund and strategic investor needed a taste.
BlackRock and Fidelity are there. Goldman Sachs and Morgan Stanley made sure their best clients got pre-IPO shares.
Jeff Bezos took a $37 million bite back in 2011, when the company wasn’t even worth $9 billion on paper. If the biggest financial complexes were at the party, evidently the world’s richest man needed to be there too.
But here’s the thing. Uber’s addressable market hasn’t expanded 11-fold over the decade to match its theoretical market capitalization.
The number of people calling cars on their phones has climbed, but valuations kept rising even faster as a factor of the amount of cash sloshing around the market.
That’s a completely independent variable divorced from the actual number of rides. And when cars on the road hit a growth wall, people who bought the hype at its height are in trouble.
Watch these “unicorn” stocks carefully. The private equity funds that came in too late at too high a price will need to buy back in now to cover their numbers.
The question, of course, is when valuations reach a level that makes sense for the rest of us. Maybe Lyft investors made the right choice heading for the exit early.
Venture capital’s problems of scale
We’ve been waiting for Uber and Lyft to go public for years. Every time, management veered away from the public market and went back to bottomless private pockets for cash instead.
After all, VC collectively pumped $130 billion in fresh cash into their companies last year alone. Most business plans get a little. Some get a lot.
And the brightest stars of the start-up world get what amounts to a blank check to fund their most lavish dreams of disruptive mega-growth.
The headline numbers are enticing, don’t get me wrong. “In theory, ride sharing can open up a $12 trillion transportation opportunity.”
But getting from door to door, dream stage to $12 trillion, without needing to make sudden course adjustments is the hard part.
Uber captured $11 billion of that $12 trillion dream last year. They’ve got a 0.1% toe in the market, with another 99.9% worth of disruption left for future investors to enjoy.
It’s taken them a decade to get to this point. Maybe it takes another decade of accelerating traction to capture 10 times that share of the transportation universe.
At that point, Uber at $45 will be worth a year of revenue. Forget about profit. Maybe they’re profitable at that point, maybe they’re still pouring all the money back into that exponential growth curve.
As they’ve told shareholders, it doesn’t matter yet. The important thing now, they say, is building the network, getting to the next level.
The problem with that scenario of course is that no business ever scales eventually to infinity. You run into hard system limits.
People can only eat so many times a day. The number of restaurants the economy can support is fixed. Even if one restaurant chain captures 100% share of stomach, that’s “only” 1 billion meals a day.
If the chain’s business model doesn’t break even below 1.2 billion meals, you have a real problem. Scale is not your friend. It may even be trying to kill you.
Share of stomach, share of eyeballs, share of entertainment hours. Share of dog food. Share of rides.
Once Amazon took over traditional book retail, it had all the easy share of publishing it was ever going to capture. At that point, you either try to grow the market beyond its natural limit or you find new markets to conquer.
Growing the market is expensive because it involves retraining mass consumption habits. You aren’t just giving people a new way to buy something they already wanted. You’re actively selling them something they don’t know they want and maybe don’t even want.
And even then, you’re going to hit a limit. When everyone in the country is in a hired car all day long (either driving or riding), you’re not going to grow any farther. You’re mature.
You’d better be making money by that point. We don’t know if Uber will ever get to that stage. All we have is management’s word for it and some hypothetical projections that look sweet on paper.
In theory Uber can do $11 trillion a year and justify 1000X its IPO market cap, right? Reality is what happens to wreck your assumptions about the future.
Meanwhile, if you’re not making money, you’re burning it. In VC world, there’s always another funding round you can chase to pay the bills.
Maybe that’s actually your real job and the start-up is just the excuse that gets the dollars in the door. Gifted fund raisers are not necessarily great or even good inventors, entrepreneurs or managers.
The ticking clock
Where it gets ugly is when the IPO window closes and the funding rules change. Uber in particular delayed this moment for ages. Now, though, they’re being judged not as a magical, unique and especially disruptive unicorn but in the horse race we call the market.
Who will buy an unprofitable dream at 8X trailing revenue when you have thousands of companies to choose from that have already proved they’re sustainable entities?
The argument around Tesla being worth as much as General Motors or Ford is that its addressable market opportunity leaves conventional car makers in the dust. Uber opened within range of General Motors and Ford put together.
Will the company that facilitates the driving ever be worth more than the companies that make the actual cars? Maybe, if that’s the sweet spot in terms of efficiency and cash flow.
There’s no evidence of that from Uber yet. As a VC entity, it was magic. As a public stock, it competes for capital directly against Amazon, Apple, the entrenched giant company of your choice.
And unless any stock finds motivated buyers, it’s going to contend with motivated sellers. VC can sit on a portfolio company for years but sooner or later every position needs to be marked and scored so the fund can liquidate and money can get back to work.
This means VC’s patience is long but hits its own limit. If the average position scores within seven years or maybe nine years if you exit via IPO, patience with Uber is running out now.
Hype and hope have nothing to do with that math. It’s how VC works. When the fund’s time runs out, you need to go, whether the portfolio is full of gems or dirt.
We hit that limit. Uber got its IPO and now the funds have gotten their chance to exit.
It was far from a perfect exit but the time for patience and calling your IPO window ran out years ago. The company simply took too long feeding from the VC pump.
So when they go out, it’s into the worst market week in months. A lot of big bets are unwinding. Uber alone has already dropped 18% from its deal price, destroying $15 billion of paper capital.
Lyft, of course, has been cut in half. It’s gone from 10X revenue to a 5X valuation, which implies that Uber is going down to $30 just to keep up.
And it’s had an extra six weeks to start making friends with institutions, get the professional market coverage going.
By the time Uber is where Lyft is now, there’s no telling where either stock will be. My guess is that both have a tough road ahead. The window shut.
The clock is now ticking on when either or both runs out of cash. Growth rates flatten when you’re trying to curb the burn. You go into survival mode.
Their best bet is for their early-stage backers to float them a secret lifeline. They can’t just file for another multi-billion-dollar funding round without diluting the stock and alienating everyone.
However, their backers can buy more stock, doubling down but also averaging their overall cost.
PayPal, for example, spent $500 million to buy in at the IPO price. Another $50 million here gives them a total basis of around $44.50 – not great, but better than what they have now.
If they had conviction then and still have the cash to deploy, they ultimately get a better deal. Toyota, Google, just about any strategic partner can grab a bigger piece now.
The question is whether that’s what they want. What we know is that Lyft was always smaller. It went public earlier in its growth cycle and never raised as much cash to bloat its valuation.
The numbers make more sense for manipulators trying to keep that stock afloat. In theory they can always amass a large enough stake to force a marriage of desperation with Uber or take it private.
It only takes $12 billion now. Apple can write that check today from petty cash and become a star in the auto world after all.
Perversely, saving Uber – even if it looks like the stronger player in the industry in terms of numbers – is harder. You need five times as much cash to get that kind of leverage.
And you’ve got at least five times as much built-up hope waiting to curdle. VC’s exit horizon is mostly done. They’re all eager to go.
Motivated sellers. Who will buy? If it's only people who already own and are just trying to keep the ultimate exit open, you've got a problem.