MorningWord 9/13/16: The Silicon Stock Exchange

by Dan September 13, 2016 10:21 am • FREE ACCESS

Last week Kara Swisher of Recode sat down for her weekly Recode Decode podcast with venture capitalist Bill Gurley of Benchmark (early Uber investor and board member). Listen here, I have 2x:

There is a lot of great stuff in there. Especially for those contemplating career moves within finance and tech as there’s some reminiscing about the history of the good (and bad) ol’ days from two peeps who had a front row seat to the internet bubble. And of course some opinions on the current private tech investment environment.

One of the most important takeaways from the discussion as it relates to public markets is his comment about the sense of entitlement disruptive companies have at the moment (specifically as it relates to forecasts and reporting results). And what that means for potential backlash when the music stops:

“When we act like we have the right to disrupt everything or eat every industry, but we’re not willing to play by the rules of profitability or GAAP accounting or being public, we look like entitled brats. And the really bad end state of that type of behavior is [that] we invite regulation from Washington that I’d prefer we not have.”

For the first time in a very long time (or at-least in the modern investment era) private market investments may pose the greater risk of wreaking havoc on public markets, than the other way around.  While the demise of Theranos (once valued at close to $9 billion, now basically zero) has been contained, can you imagine if Uber (who’s most recent valuation neared $70 billion, with $9 billion in cash in the bank and $2 billion in debt, raised close to $15 billion to date) experienced massively decelerating growth before profitability? Would the push-out of profitability due to what Gurley calls the “intense subsidy battles” among many sharing economy companies cause massive reverberations in the public markets, where most tech companies who have IPO’d in the last 5 years have materially less profitability on a GAAP basis (or in many cases like Twitter, adjusted profits swing to a huge loss)?

A meaningful markdown of tens of billions of private tech investments would cause liquidations in the public markets. It would cause investors to rethink Facebook’s (FB) $370 billion market cap, trading 13.6x 2016 sales, 33x expected 2016 adjusted earnings of $3.95 (43x expected GAAP eps of $2.98).  While FB revenue has clearly benefited from all the buzzwords; first mover advantage, product market fit, network effects, stickiness, monetization of mobile etc etc, trees don’t grow to the sky. The history of similar growth trajectories in tech show us this, and it seems that despite the secular shift towards mobile and ad budgets from offline to online, meaningful growth deceleration could cause investors to hit the pause button in a very crowded trade. That said, while earnings and margins will fluctuate for a growth company like FB, who is committed to reinvest at a brisk pace, sales growth is another story, as it reflects the fruit of those investments that investors are willing to discount in place of sales growth (see for the last ten years). In 2014 FB grew sales 58% yoy, saw sales growth dip in 2015 to 44% and is expected to re-accelerate to 51% in 2016. All seems just fine on the western front, and attempting to call a top in an increasingly narrow and concentrated grouping of public and private equities is a bit of a fools errand.

But I do think you have to keep an eye on headlines in the private market, not just public markets for any indications of a market turn. Obviously, that’s a lot harder to do as the market is much more opaque. But that opaqueness is the issue.  Guys like Gurley, who obviously have a strong vested interest in the whole thing not coming apart as it did in the early part of the century is not shy of calling it like he sees it, via NYT’s DealBook in June:

“It’s not the second inning or even the sixth, it’s the 14th inning in a five-hour baseball game,” Bill Gurley, the famed venture capitalist who has as a stake in Uber and sits on its board, warned on his blog about the state of Silicon Valley. He alerted investors about unicorns that come to them seeking funds: “You are not being invited to a special dance, you are being approached because you are the lender of last resort.”

It’s no accident that we have companies like Uber with $70 billion market caps still in the private market. A relatively small group of people are making big money (for now on paper) in a market that only they have access to. And now your money, in the form of mutual and pension funds is piling into that opaque market at a really late stage in the game. You don’t even have to be that good at history to know how that will end.