The Great Public Market Reckoning

Dan Primack wrote in his friday newsletter:

Public market investors have become less willing to leave their comfort zones, and it’s manifesting most obviously in the IPO market.
Novel disruption has fallen out of favor, with many preferring more time-tested models like enterprise SaaS and biotech.
Peloton yesterday raised over $1.1 billion in its IPO, pricing at the top of its $26-$29 range, but its shares then got crushed (although still valued well above the last private mark). Its CEO talked to Axios yesterday about the falling stock price.
Endeavor, the live events and artist representation firm led by Ari Emanuel, last night canceled an IPO that originally was to raise over $600 million, before it was later downsized.
WeWork… well, you know the story there.
Yes, all three companies have dual-class shares. Yes, all three were highly valued by venture capital or private equity investors. Yes, all three were unprofitable for the first half of 2019.
Those characteristics are also true of Datadog and Ping Identity, both of which had successful IPOs this month and continue to trade above offering.
The trio’s real similarity was that each had a very complicated story.
Peloton is a high-end hardware and SaaS business that produces original media content, sells apparel, and runs its own delivery logistics.
Endeavor began life representing movie stars and Donald Trump, but later expanded into a massive live events business that includes the UFC and Professional Bull Riders. Plus, it’s got a streaming platform.
WeWork… again, it’s different.
All of this comes against the backdrop of Uber, which also had a very complicated story and an IPO that emboldened short-sellers.
Up next: A lot of biotech startup IPOs, but no high-growth, complicated tech unicorns.
“We’re about to get a bit of a break from those sorts of deals, which I think is good for everyone,” a top Wall Street banker told me this morning.
Private markets follow public markets, so don’t be surprised to see some valuation and/or deal size pullback for these “hard to comp” companies.
Particularly if SoftBank fails to raise Vision Fund 2.
Goodbye to egregious governance terms. Dual-class will survive, but WeWork laid a third rail for others to avoid.
U.S. IPOs have still outperformed the S&P 500 in 2019, although the gap has shrunk significantly this month.
Or, put another way: The sky isn’t falling, but it’s gotten a lot darker. And, for some, downright stormy.

While all of this is true, I think it is a lot simpler than that.

The public markets are a lot different than the private markets.

Financial transactions in the private markets are controlled by the issuers, happen when the issuers want them to happen, and are generally auctions, particularly in the late stage markets.

Public market investors can buy and sell stocks every day based on what is attractive to them and what is not. If they feel like they missed out on something, they can get into it immediately.

For this reason, valuations in the private markets, particularly the late-stage private markets, can sometimes be irrational. Public market valuations, certainly after a stock has traded for a material amount of time and lockups have come off, are much more rational.

For the last five or six years, I have been writing here that I very much want to see the wave of highly valued and highly heralded companies that were started in the last decade come public. I have wanted to see how these companies trade because it will help us in the private markets better understand how to finance and value businesses.

And now we are seeing that.

And what we are seeing, for the most part, is that margins matter. Both gross margins and operating margins.

If you look at the class of companies that have come public in the last twelve months, many of the stocks that have performed the best are software companies with software margins. One notable exception to that is Beyond Meat.

  • Zoom – 81% gross margin
  • Cloudflare (a USV portfolio company) – 77% gross margin
  • Datadog – 75% gross margin

If you look at the same list, many of the stocks that have struggled are companies that have low gross margins.

  • Uber – 46% gross margin
  • Lyft – 39% gross margin
  • Peloton – 42% gross margin

Some other notable numbers:

  • WeWork gross margins – 20%
  • Spotify (down almost 30% in the last two months) gross margins – 26%

I believe that we have seen a narrative in the late stage private markets that as software is eating the world (real estate, music, exercise, transportation), every company should be valued as a software company at 10x revenues or more.

And that narrative is now falling apart.

If the product is software and thus can produce software gross margins (75% or greater), then it should be valued as a software company.

If the product is something else and cannot produce software gross margins then it needs to be valued like other similar businesses with similar margins, but maybe at some premium to recognize the leverage it can get through software.

But we have not been doing it that way in the late-stage private markets for the last five years.

I think we may start now that the public markets are showing us how.

#stocks#VC & Technology

Comments (Archived):

  1. Salt Shaker

    Asking this respectfully, do you (and your colleagues) take any responsibility for creating these unjustifiable valuations? These companies get so propped up financially w/ only one course of exit, without the sound requisite financials to do so. When some do go public it’s similar to selling junk bonds.

    1. fredwilson

      We don’t lead rounds in the late stage private markets at USV. So while we should all take some responsibility for what has happened, the driver of this is the very large growth funds

      1. Salt Shaker

        Thank you, but as a predominately early stage investor doesn’t that often translate into a seat on the BOD? These companies are taking on enormous debt in the pursuit of growth and scale, an admirable goal, but often without fiscal responsibility. Funny money is just that, until it isn’t.

        1. Matt A. Myers

          And how does one know if you’re indoctrinated like the WeBOD must have been to allow this to unfold as it has?…

      2. Richard

        I’m old enough to remember the Kin cryptocurrency IPO. How many Kin investors were under 18? And should the Board resign if it is a countable number?

  2. jason wright…“One day when we go public, it’s not going to be a technology IPO, it’s going to be a new type of company, which in the future we will have more and more, because entwining physical and digital has never been more important” – Adam Neumann.This may be correct.The rest of the article portrays him as a bully and a bit if a git (English slang). Rene Girard is so right about human nature.

    1. Matt A. Myers

      Was Adam saying it’s going to be an “abundance company” as the new type of company?He may have a vision that could potentially work, however his management and organization skills seem lacking.Brute force – as the behaviour described seems to portray – doesn’t work when you need to convince people you’re working with – that you depend on to understand your vision, it’s akin to tyranny. If you require brute force then you’re simply not ready to move forward, you’re not skilled enough to eloquently articulate your vision.The comparison in the article between WeWork and Alibaba strike me as apples to oranges.

      1. jason wright

        He was a running a ‘fear factory’ operation camouflaged by his ‘new age’ rhetoric. Neumann is 6’5″ tall. Quite an imposing figure at WW HQ i imagine, but scapegoating employees as a technique of control is akin to fascism.

  3. JamesHRH

    It is an embarrassment.How can anybody sell Peloton or WeWork as tech plays?

    1. jason wright

      …and be expected to buy them as such?

      1. JamesHRH

        YEs, should have written sell/buy.

    2. Matt A. Myers

      Choo-choo! All aboard the tech hype train!

  4. Girish Mehta

    This has been obvious since after 2015. It has been stated in comments section of this blog a few times.It is interesting that this “Great Public Market Reckoning” is being talked about only now after the problems have started to manifest in the IPO market. Horse. Bolted. Barn Door.Interesting, but not surprising. Because many people who knew how irrational the private valuations were in the past few years had an interest in keeping quiet, to getting the IPO out the door before the big chill set in, to get their exit before there was a scramble for the exit.Like I said here last week , it was not just the events that transpired with WeWork in the past few days, but the absurdity in the past few years that led to that point with WeWork. I had written here when the Uber IPO finally happened (below the previously rumoured $120 billion valuation), that it was still valued too high, and believe that even more so today.Why are pure software gross margins so high ? There are some things that go into the “pricing power” side of the gross margin equation – product differentiation, distribution/licensing deals leverage. But the bigger driver of the gross margin sits on the cost side – the near-zero marginal costs. Software businesses scale with volume – driving incremental revenue almost untouched to the gross margin line. Then, look at Uber’s marginal costs (not Uber’s software, but Uber the company).And regarding Uber’s gross margins – as Ben Thompson points out, for a different perspective calculate the gross margin on what the rider pays and it is in single digits. (source: Stratechery by Ben Thompson). https://uploads.disquscdn.c…The last 3 years of private markets tech investor behavior (esp later stage growth funds) has been a case study.True Skin in the Game has deadly consequences for foolish behavior. But “Incentive” is not “Skin in the Game”. Incentive (Carry) masquerading as Skin in the Game has few downside consequences (there is that mgt fee regardless), while providing the temptation for irrational behavior.There is a sequel to this coming. Instead of The Great Public Market Reckoning, it will be called The Great Crypto Reckoning.

    1. jason wright

      “the near-zero marginal costs”, and universal computation. They threaten the very fabric of the physical ‘real’ world. America’s infrastructure is crumbling, and we can see why.

    2. jschwiz84

      Re: Uber and Lyft, it’s amazing to me that people don’t get this already. They are low margin businesses masquerading as high margin software businesses given the fact that their revenue only includes the fee paid to them. What happens when you have to pay the driver more due to political pressure or unionization? Will the consumer fund all of this? Maybe, but I have a lot more faith in the software company being able to raise prices on captive businesses than Uber/Lyft on customers.

  5. pKR

    I tend to see private market valuations tend to be fairly rational while public market valuations tend to be irrational. I find this to be the case because private markets have fewer players which tend to lower the band that valuation can change. Public markets, sometimes millions of marginal owners or buyers have a willingness to sell or buy that’s way higher or lower than the actual intrinsic value of the company, leading to sometimes, massive dislocations.One thing is for certain. The higher the gross margins, the more value customers perceive is given by that provider of service. I am not surprised those companies do well. Thanks for your post today.

  6. JLM

    .All of this falls under the heading of willful blindness, arrogance, and stupidity at the founder, lead investor, and board level.Look at the bloodbath that We Work is undergoing right now on the heels of Adam Neumann being jerked back to earth — he’s gone, his wife is gone, the $60MM customized jet is gone, the $6MM We extortion is unwound, there is still a spa next to his office, 20+ of his henchpersons are gone, the company staff is likely to downsize by 50%, the company mojo is wrecked, they are going to get rid of their last 5 unrelated acquisitions.They invested in a wave generating company and a health food company. Nuts.Oh, yeah, the company is probably worth less than $4B — so a lot of value is gone.All the underwriters have been burned and JPMorgan is scorched.There was a founder cult that was funded and encouraged by the lead investor and the board did NOTHING.None of this stuff should ever have happened. Any decent CEO or board member would have stopped it before it got out of the cradle.Those idiots on the board didn’t even bother to tie the guy up with an Employment Agreement when they said in the S-1 his leadership was critical to the company. This one fact alone is an indictable offense.This guy — Adam Neumann — tried to sell the market, the investors, the board that a business that has been around since man was living in caves was somehow a SaaS business commanding/demanding multiples like a software company. He actually used to say he was going to deliver Real Estate as a Service.Meanwhile, real estate — in which 25% of the world’s wealth resides — has been and always will be a rental arbitrage business.You own real estate that lasts for 100-150 years and you enter into 15-25 year NNN leases with 15% bumps every 5 years.You leverage it 3:1, while your 95% occupied building is throwing off a 10% ROI. That results in a 1.5-1.75 LTV and a 1.5+ DCR which makes it an A-AA security.Your mortgage is 25 years at 4-5% and there are no pre-payment penalties such that you can refinance it every 11 years (two rent bumps + 1 year) and enjoy tax free “whip out.” The refi proceeds are tax free.Meanwhile you are writing off income with the depreciation and interest deductions.See all the numbers in those preceding paragraphs. Real estate is a numbers game.BTW, the preceding paragraphs are why Donald J Trump can be rich as Hell and it doesn’t show up on his tax returns. He’s whipping out massive cash every 11 years and it isn’t taxable income so it doesn’t go on his tax return.You lease it fairly long term (15-25 years) so you can ride out the real estate business cycles (never longer than 12-15 years) and you own it looooooonger term.We Work rented it short term and rented “desks” even shorter term. And, still they could not turn a current cash flow profit on every building.Pros in the RE business saw this shell game a hundred miles away. The numbers are the numbers.The idiot who gave this guy money was totally under his spell — don’t get me wrong, he’s an idiot.Real estate is not tech. It is not software, but it is a damn good business if you follow the rules. This guy, this company, this VC did not invent real estate or sex.There is a good Swiss company, IWG, that figured this real estate play out. I predict that We Work will ultimately merge with IWG.JLMwww.themusingsofthebigredca…

    1. Michael Spacey

      Maybe the investors purposedly let the founder loose so he will mess up and then investor can take over. Else I don’t see how the shenanigans at wework could have went unnoticed

      1. Matt A. Myers

        Gambling perhaps, and perhaps believing the CEO/founder takes the fall and reputation hit – same thing happened with Uber/Travis.

      2. Mani Gandham

        Doesn’t seem like they were unnoticed but rather encouraged with the optimism of a frothy market eating it up.

    2. Matt A. Myers

      “Under his spell” is the indoctrination game – I’ve noticed too many of the “entrepreneurs” who rent desks at WeWork are also caught up in the hype, extremely inefficient way to spend money – giving it to a rent-seeking industrial complex. Here I am, spending 80% of my money on stem cell treatments, while sitting at a cafe currently – writing this comment, doing design work, and organizing my future empire, that will lead to someday JLM realizing how brilliant and right I am about future POTUS Andrew Yang. Love ya J… ;)Oh, and my daily “rent” at cafes is ~$3 to ~$7 CAD for a tea or two with tip for 4+ hours of time – with no monthly (or daily) lock-in, no notice required, etc.. So having my “office” costs ~$210 CAD ($158 USD) per month assuming I show up 30 days a month. Today will end up being another 8 hour day at the cafe. The staff are friendly, love chatting – getting to know them, welcoming the new staff as they cycle – and have met and stayed in touch with a few random patrons who I either engaged with due to seeing the work they were doing on their laptop, or perhaps engaged with me due to the large I Live Yoga sticker on my laptop – or are a fan of Elon Musk – seeing The Boring Company hat I wear daily.This was the biggest fuckup in the “Toronto Tech Startup” community – where they bought a big building – MaRs Discovery District – instead of funding 1,000s of teams with $200,000 investments – an easy, lazy “career safe” move vs. investing in people that you’re able to create a team of people who know how to vet people, passion, talent; I won’t go into the cascading detail of how investing in teams instead of property would have created multiple $ billion companies by now.Curious about We buying a wave generating and health company. It’s possible there was a path that could lead to those becoming profitable investments – except the founder, leadership, has now failed to show their direction was good or adequate enough; proved they don’t really know what they’re doing.Social’s the future. A relatively new friend came by last night, along with his friend – an even newer friend of mine – to help me setup audio and video for a stream I want to start, eventually expand into doing long-form Joe Rogan style video podcasts – as where the medium clearly is going, for news, learning, and so on. The newer friend just came back from doing a party where he was hired to do caricatures of the guests. He pulled out his Wacom drawing tablet out, setup his mini portable colour printer, and over a relatively short-time turned me into a badass – and printed me off a copy. It wasn’t the soft look I normally associate myself with, feel I have, so he ended up after he left doing a second one taking some of my guidance that makes looks much softer, emailed me the digital copies this morning; I may pay him to tweak it some more, a bit of my perfectionist side coming through, yet I like the style enough that I’ll ask him.https://uploads.disquscdn.chttps://uploads.disquscdn.c…P.S. Yes, I’m sporting longer hair and a beard now – a strong contrast to my profile photo; I call it my hippie disguise.

      1. JLM

        .Andy Yang has a sense of humor, something in deadly short supply with the rest of the Dem candidates.Unfortunately, many of his policies are also laughable.He’s clearly a smart guy.JLMwww.themusingsofthebigredca…

        1. Matt A. Myers

          I agree with the humor and smart guy statements. 🙂

    3. CJ

      I feel like I should pay you tuition for that one. Appreciate the education.

      1. JLM

        .On Saturday I had lunch at Matt’s El Rancho in Austin By God Texas — a holy shrine to Tex Mex that has been around since 1952 though the guy who started it was selling tamales since 1923 — and had lunch with a young man and his beloved.He had hauled his ass up from Houston to learn something about the real estate business. I gave him a three hour lesson for the cost of fajitas. They are very good fajitas.His name is Jeffrey. My name is Jeffrey.His father was my classmate and best friend from college. Fifty years ago, his Dad arranged a blind date with a young very Southern woman who I fell in love with at first sight. It took ten years of my roaming the world, her going to law school and working in DC to finally get her to agree to marry me. That was 40 years ago.We had two kids and I have one grandchild. Both of the kids turned out cracker jack. The girl is the co-founder of Weezie Towels. Look it up. She is way smarter than her father. It’s her second startup. I never thought she was listening, but she, apparently, was.Life is a cycle and when we get a chance to give back, we should. Not in huge things, in small things.Pay your tuition by calling an old pal you haven’t spoken to in years and go have a cup of coffee.Is this a great time to be alive or what?JLMwww.themusingsofthebigredca…

        1. CJ

          Pay your tuition by calling an old pal you haven’t spoken to in years and go have a cup of coffee.Is this a great time to be alive or what?Absolutely. People poo-poo the internet all the time, I’ve learned so much because of this medium – I’d never give it up.In terms of paying if forward, I’m doing my best to mentor youth who are growing up where I come from. If I can give them just a 1% better chance, it’s more than worth my time. I take a lot of the lessons I’ve learned here with me. It works.

          1. JLM

            .You never know when you impact a kid’s life. I used to coach my kids in sports. Even today I run into a kid and he calls me “coach” and we both laugh. They’re usually in their early 30’s.I coached Gov Anne Richard’s granddaughter and we used to have a lot of fun. She used to call my office and ask if Lilly was playing on Saturday. She would tell my assistant to tell me: “I don’t care if he’s in a meeting. Tell him it’s the Governor.”I made my daughter play basketball with the boys and she earned 11 varsity letters in HS. I am convinced that that experience made her tough. Today, she’s the co-founder of Weezie Towels.I ran into a guy in Sam’s Club who had been in my platoon in the Army in the early 1970s. He told his wife all kinds of nice things about me. Of course, I had no idea who this old fart was, but I could recognize his voice.It is a great big world out there, but it takes a very small kindness to change something. Good on you for the mentoring. Kids need to see an example that looks like them to give them hope that they can make it.JLMwww.themusingsofthebigredca…

    4. henrus

      This was like getting an advanced degree in RE in one post. Incredibly well summarized. Kudos.

    5. Njonjo Ndehi

      Thanks for the education, man.

  7. Steven Kane

    Fred, do you sense any agitation in the VC LP community because of all this? How many new VC funds got raised based on what now seem like bogus valuations of portfolio companies in existing funds? Or do you think the number of paper unicorns is small enough that LPs feel that little if any arguably deceptive marketing took place?

  8. Barry Rubenstein

    High valuation doesn’t have to be just for technology. It could be for a sustainable, high margin, growth business. We Works is not that either so I agree that it borders on being a scam pretending to be what it’s not. PTON on the other hand should be valued as 2 businesses. One a growing nice hardware seller and the other a subscription business that will evolve into a high margin one. Right now their problem is market share as they have to quick grow in order to lock out competition. If they can keep churn down and learn to upsell to their base they could become a very valuable business.

    1. JLM

      .It is a very expensive piece of hardware and the software (the content, the classes) is a small follow on to such an expensive piece of hardware.I think they have skimmed the cream and will have a hard time growing this business because of the real life alternative — riding a bike.JLMwww.themusingsofthebigredca…

      1. henrus

        Not trying to defend PTON as I’ve not read their S1 nor am I interested in evaluating the stock. This is more a reaction to the comment that the alternative to spinning is riding a bike. Actually, it’s not. Most people who spin don’t even own a bike, nor would they ever be tempted to ride outside (it’s dangerous, more time consuming, takes more effort, less convenient, and there’s no instructor+soundtrack). PTON probably needs to be evaluated as an entertainment company that is selling subscriptions (plus expensive hardware) to entertainment/lifestyle experiences. For anyone who regularly goes to spin classes where there is a popular instructor, they treat it as therapy/emotional/quasi-spiritual experience. PTON offers some of that in a more convenient package because you don’t have to actually commute anywhere or be on someone else’s schedule. I suspect the question regarding their business model is whether their subscription model can generate positive net margins compared to the compensation and production costs of developing their online “content.”

        1. JLM

          .Agree completely. Thanks.You — right. Me — wrong.JLMwww.themusingsofthebigredca…

  9. Mike

    First, it’s great to see efficient capital markets at work.The observation on gross margins makes sense. The higher the GM, the more internal cash is available to invest in Marketing & Sales and other activities to drive growth. I suspect investors are questioning some of these companies’ ability to generate sufficient internal cash flows to sustain their high growth rates. This relates to the earlier discussion on Unlimited Capital where external capital can compensate to help sustain growth. But this is only a temporary state. Eventually the company needs to generate its own cash flows and internal growth. Growth (of positive cash flows) is obviously the key driver of a company’s valuation.Many companies and industries operate very successfully, and profitably, on lower gross margins. The problem, as pointed out in the post, is the growth valutions.Just by the numbers, to me, the concern with a We Work is not the losses, but the fact that the losses do not appear to be improving relative to sales levels. There needs to be a path to profitablity and it is not evident in the numbers.

  10. JLM

    .Gross Margin — (Gross Revenue – COGS)/Gross Revenue — is not the ultimate determination of the financial health of a business engine.It is the earnings — Net Profit/Gross Revenue — which may be described in percentage form as Net Margin.Net Profit/earnings is what is left after ALL the bills are paid.You can have a company with a large Gross Margin that is losing money and has no earnings.Conversely, you can have a company with a smaller Gross Margin that is otherwise profitable because it has real earnings meaning a good Net Margin.I would take a company with a 40% Gross Margin with a 20% Net Margin all day long.It is the COMBINATION of Gross Margin and Net Margin that indicates the health of the business corpus. Think of it like heart rate and blood pressure. You can have a slow/high heart rate and great blood pressure and you’re as healthy as a horse.This inability to really put a finger on the financial health of an enterprise is a function of three things:1. Basic lack of understanding of simple accounting definitions.2. The inability to use careful measures when dealing with a money losing business that is going to lose money for a long time. This requires the ardent analyst to measure rates of growth and the relative growth of top line revenue (Gross Revenue), expenses, and bottom line revenue (Earnings).The problem with companies like Uber is that there is no credible story or trend that indicates that the company will EVER be profitable.3. The VC/PE/investment industries get sidetracked using measures like EBITDA as a measure of cash flow. This is fine if you are looking at the trend line — “Make the trend your friend” — but it is folly when trying to predict actual earnings. The public markets are going to eventually make a company suit up in its P/E ratio. This is inevitable.These companies — We Work, Uber, APRN, Lyft, Peloton, SNAP — are some of the worst losers as it relates to near term and long term cash flow and earnings. There is simply no guaranty that they will ever cross over and make a profit.The IPO underwriters may be able to ship out a prospectus without gagging, but the second these companies are on their second earnings conference call, it is going to get very real. Tesla, as an example, has been able to continue the sleight of hand after an IPO, but even they are getting ready to take a barbed wire enema.You can only fool the markets for so long. That string is about up.There are companies — a few — like Beyond Meat who do have a credible story. Look at their stock. They are being rewarded handsomely for their credible future earnings.The reliance on the public markets to herd up a bigger bunch of fools to buy these IPOs is just about over. The shorts are also circling up to pounce on some of these companies.JLMwww.themusingsofthebigredca…

    1. Girish Mehta

      Take two businesses that have the exact same Topline $$ and same Bottom line $$. One operates at a gross margin of 50% and the other at a gross margin of 25%. The one with the lower gross margin % has an opex structure that will be more resilient in a downturn.I initially wrote a long comment about a personal experience from more than 20 years back regarding this….which I deleted down to the TD;LR point above.Now, speaking to the Gross Margin line only – COGS has two subcomponents – BOM and Transformation costs. The proportion of BOM and transformation costs within a specific industry segment will typically be similar across competitors. One industry can have a 80-20 BOM-to-Transformation cost ratio, another may have a 20-80 BOM to Transformation cost ratio. But within a industry segment, the proportion will be similar across competitors.An opportunity arises if a company can figure out a sustainable competitive advantage in the subcomponent that is the higher proportion of COGS. It doesn’t do much if you have a 10% transformation cost advantage in a COGS structure that is 80-20 BOM-to-Transformation. But a 10% BOM cost advantage in a COGS structure that is 80-20 BOM-to-transformation cost helps you win.

      1. steve

        I think you’re touching on a point that’s lost on the hyper focus on gross margins: SaaS companies need a healthy R&D spend to remain competitive. If a software company stops innovating, their competitors can easily switch vendors due to the lower implementation costs of a SaaS model. In that sense the R&D spend is much more central to the ongoing success of an enterprise and not a cost that can simply be “turned off” when profits are more important.

    2. nemrut

      How do you explain Amazon which historically has had very poor margins/earnings prior to AWS?

      1. Mani Gandham

        Amazon has had great profits for a very long time, they just reinvested everything into the company to grow and expand until they became a behemoth taking over ecommerce and even fending off competition from the likes of Walmart. AWS is a direct result of that reinvestment and shows the possibilities, with advertising being another industry that they’re gaining rapidly in.Considering their public stock performance, many concur that it’s been a rewarding strategy.

        1. nemrut

          True that is clear in hindsight but from a pure stock mkt performance point of view, it wasnt evident at the time and looked like very bad investment.

  11. gmalov

    Yes, I agree, the valuations of many of these companies need to be recast but I’m not ready to throw in the towel. I’ll use Twitter for argument sake – went public in 2013 (market cap $25B), but had its first profitable year in 2018, which continues to impress with 20% Y/Y revenue growth and triple digit Y/Y earnings growth through Q2-2019; This required some patience, but the Twitter team eventually figured it out (current market cap $32B).Again, there are other success stories as well (Quora stats):Once public, number of years to becoming profitable-Apple: 2 YearsGoogle: 3 YearsFacebook: 5 YearsAmazon: 8 YearsThe successful denominator here, the underlying technology was eventually paired with a sustainable business model. This can often take several years to form, which means the numbers may look untraditional because sound financial principles don’t always show up on day one. Here’s a few indicators below that I use for sanity check purposes:Quality of Revenue – not all revenue is good revenue (ex. Uber in China or costly markets)Gross Margin – does the rate improve with scale (ex. Spotify-revenue up, margins down)Capacity Utilization – recalibrate valuations based on revenue capacity (100%,80%,60%-like TAM/SAM/SOM), this is revenue utilization, then reevaluate the business model REV-COR thesis (ex. WeWork value, based on 100% occupancy rate revenue)

    1. Mike

      Both Facebook and Google reported positive Net Income in their S-1 filings?…Through 1996 Amazon doubled its revenues every quarter. Losses were flat from Q3 to Q4 showing operational efficiencies starting to kick in:…They did hit profitability several years later but their growth rate was significantly less. Possibly pressure from public markets during the Tech reset to slow down and turn a profit. The company is not afraid to make big bets and run at a loss (in the near term).https://www.computerworld.c

      1. Merc

        And Amazon Prime and AWS did not hurt

      2. gmalov

        good adds, thanks Mike.

        1. Mike

          No worries. I was curious myself and thought I would share what I found.

    2. Salt Shaker

      Compare AMZN’s stock price over those initial 8 years vs. gains in the Dow or an S&P Index Fund, for example. As an investor a serious opportunity cost was in play in those early years, plus WS was exceedingly kind to AMZN’s unprofitability cause of the company’s rev growth. Not sure many foresaw the financials that subsequently ensued after 2012, especially when their biz model seemed quite flawed in its early stages. Obv a lot of patience (and luck) came into play w/ a post-IPO early stage investment in AMZN. I personally wasn’t on the lucky side.

      1. Merc

        And don’t forget Amazon Prime did not exist before 2005 and AWS did not exist until 2006 and has been growing exponentially since then. Hindsight is 2020, but plenty of people sold Amazon in the dotcom crash. – In Mar 2001 you could have picked it up for $10.00 per share.I have a friend who bought a bunch then because hi liked the service, and forgot to sell when it doubled, tripled, etc. because he was too busy running a business. Let’s just say he – and he is a great guy and friend – is not worried where his next meal is coming from, and like good Seattle wealthy people lives a very modest, unpretentious lifestyle – no gold bathroom fixtures in his cabin.

        1. Salt Shaker

          True story. I’m from nyc, but now live in Seattle. Pretty much retired. As a fluke, I sent an email to Bezos on a rainy Sunday afternoon with some marketing ideas for AMZN’s Prime Video programming. (I took a guess at his email address and hit send, never frankly giving it another thought.) Next thing I know, I’m getting an email from an internal recruiter at AMZN, which subsequently lead to five interviews, including with the #3 guy in the company. Crazy! Nothing came of it, and I really didn’t care too much cause I didn’t want to go back to work f/t, but I def had to play it out. AWS was a pleasant surprise, and Prime’s roll up is quite good if one sees value and takes adv of its tentacles.

      2. gmalov

        I remember studying AMZN, GOOG, and AAPL Case studies in Business School, AMZN numbers were really hard for everyone to grasp and understand the model. You’re right about luck too, thanks for feedback.

  12. William Mougayar

    I think another factor in the past few years is the increasing global nature of investors/speculators, especially from Asia who continues to increase their part of the overall economic pie. The Asian investment psychology is different.

    1. jason wright

      How is it different?

      1. William Mougayar

        It’s hard to pin it down. The thinking & expectations are different.

    2. Matt Zagaja

      This feels like the beginning of an interesting blog post. Please share more!

  13. awaldstein

    Concerning that platforms like Uber/Lyft and Peleton that have so impacted my life for the better, are such bad businesses.And counterpointed that Zoom which was changed how I work in many ways is such a good one.

    1. Matt Zagaja

      I use a lot of Uber, Instacart, and UberEats. After moving to a more transit isolated part of the city my spend on Uber grew a lot. Pricing for Uber is clearly artificially low. Once the subsidies end it’s going to have to normalize at a higher price point. Already I can feel the quality of Uber slipping. I used to use their shared ride service which wasn’t awful but now requires waiting 2 minutes to find an optimal ride, waiting up to 10 minutes for the car to arrive from its current route, and then I might be prompted to pay an extra couple bucks to avoid walking a few blocks to my destination. Yet in the end the price differential between this product and the regular UberX is not much.

      1. awaldstein

        Thanks.To me for ride share, its geographical.In NY honestly, don’t use it a great deal, and Lyft is often 50% less expensive so go that way.In LA where i’m often, Uber is kinda essential for getting around and haven’t rented a car in years. For short hops, I do use scooters.My point is ride share is ingrained in life. Crazy that it may be a house of cards is all.

  14. Matt Zagaja

    Other than WeWork, another pattern I would note is the companies that you list that aren’t doing well are consumer businesses while the ones that are doing well are focused on B2B. Wondering if the software industry is struggling to convince consumers to pay for software.

  15. Tom Labus

    We are also in the later stages of huge market run from March 09. Somehow this seems to release crazy deals as people try to catch the last train out. There are lots of long forgotten companies wiped out by the Nasdaq crash in 1999/2000. It’s money! People and companies do crazy things for it and probably always will do so.

        1. Girish Mehta

          Beautiful. The Great Gatsby.

  16. pointsnfigures

    Profit margin and cash flow…..all that matters

    1. throaway_oct302019

      Not for late-stage Silicon Valley. The goal now is to cash out and move on. These IPOs are working…just like flipping homes in 2007 was indeed “working” for at least one party in the transaction.

      1. pointsnfigures

        Ha. Or unintelligent investors trying to flip companies like a trade on a stock…..

  17. throaway_oct302019

    Why do people think these IPOs failed? The VCs and founders cashed out. Was the goal ever to create value for shareholders or regular employees?As Index Funds and passive investing have become so pervasive, it is understood that money will flow in once the company lists. How do I keep my 401k from investing in Uber? I can’t

  18. iggyfanlo

    Maybe this is too simplistic but (ceretus paribus; i.e. company with same growth profile) should all trade at ~12-15X gross margins… I remember that’s what happened post bubble in the mid 2000s

  19. Stauning

    Let’s not forget about the “tech” IPOs prior to 2019. Carvana (IPO in 2017) is still valued as a tech company and not a used car retailer.

  20. Peter Moore

    Very right. Our new SaaS can help you quantify how much changes in outlook–for long-term size and margins etc–may drive changes in multiple. Here’s how: https://lisa-dolan-ebpl.squ

  21. Merc

    “as software is eating the world (real estate, music, exercise, transportation), every company should be valued as a software company at 10x revenues or more.”Correct fallacy, and as these companies have portrayed themselves as tech platforms to secure tech VC valuations, once they go public the markets view them as a bit more prosaic and comparable to more common place companies, which will tend to cause their valuations to revert to the mean.

  22. rychastings

    wework was always a pipedream. no prudent man would invest in it

  23. Merc

    SOOOO, when are the lenders going to get the hundreds of millions MeWork borrowed ahead of their IPO using their confederate currency stock as collateral?

  24. Gold_Star600 YT

    What about companies cheating on their gross margin by masking discounts and promotions as marketing cost, see Blue Apron, Uber, Lyft, Wework etc?How do we know a business is growing for real or just because they’re giving away something for cheap?

  25. sketharaman

    Maybe it’s a good time for me to pat myself on the back for calling out WeWork as not a tech play well before all this happened:)…

  26. robert krangle

    I do

  27. GlennKelman

    Yes, and for growth companies that aren’t ready to trade on a multiple of profits, then value them on a multiple of their gross profits, not a multiple of their revenues. Companies with lower gross margins than a pure software company also can’t spend as much on R&D and G&A without very high, durable growth rates like Amazon, and we can’t spend much to acquire a customer, regardless of growth rates. The mistake that Uber, WeWork and some other hybrid companies have made is to spend like pure tech companies when their gross margins are like other transportation or commercial real estate companies. You can still deliver enormous shareholder value, but you have to embrace who you really are, and the spending discipline that goes with that.

  28. Keyvan Firouzi

    Inspired by this, we did a detailed and statistical analysis to see how growth, gross profit margins, and EBITDA attribute to valuations (as measured by revenue multiples). For those that are interested: