Monday, December 8, 2014

The Price is Right or Is It?

The latest financing round values Uber at more than $40B. Uber’s transaction volume is around $2B of which their take is 20% or $500MM. Yes its revenues are doubling each year over its short existence. Still this seems richly priced. How long and fast can they grow, and when do they start earning a return? Keep in mind Uber’s value exceeds that of Aetna, CBS and KKR among others. Uber’s price is being justified on a winner- take- all, first mover, basis. I wonder, however, about the economic validity of this agreement. The industry entry barriers seem porous, switching costs for both users and drivers are low and international competition exists. Furthermore, as the Wall Street Journal notes, some smaller tech firm valuations have recently fallen prior to their planned IPOs. So, is Uber immune to such a reversal?

Some VC observers like Play Bigger Advisors have tried to explain away a possible bubble by inventing a new metric- Time to Market Cap (TTMC). They believe special firms like Uber represent mythical Unicorns endowed with unique market characteristic justifying what at first glance appear to be nose-bleed valuations. Past Unicorns included Apple, Microsoft and Google who capture a disproportionate share of their market categories. They cite the TTMC of $1B for Unicorns has fallen from 8.5 years in 2000/2003 to now just under 3 years. VC are focusing on a few winner Unicorns with big investments and driving up their values. Conversely, they are pulling back from losers referred to in the Wall Street Journal article just as quickly. Therefore, they conclude there is no bubble.

This sounds like another version of the “This Time Is Different” justification. How do you operationalize the invest in winners (Unicorn) strategy? Is it like buy low and sell high? Can TTMC slow down and mean revert? The problem with these types of relative value approaches is they lack an intrinsic value anchor. They can quickly degenerate into a herding or momentum investment strategy. Over optimistic investors ignoring the base case who have excess liquidity and are eager to invest will keep pushing prices higher until there is no one left who believes and the process corrects. The price is right, but which one-the price going up or the price coming down? Finding mythical Unicorns may be more difficult than thought. Even if you do, at what price does investing in Unicorns cease making sense?


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