Unicorn Valuations Plummet Resulting in VC Confidence Drop

By the Curmudgeon

Unicorns are private start-up companies with assessed valuations of at least $1 Billion. The Curmudgeon first started writing about them in 2015 with posts you can read here and here. We also did a post on Fidelity corralling 24 Unicorns in its mutual funds.

Unicorns were all the rage from 2014 through 2018 but have collectively lost about $100 billion in value this year. That steep drop in valuations is prompting a lot of nervousness and declining confidence amongst Venture Capital (VC) investors.

Let’s look at a few highflyer unicorns that have fallen from grace:

· WeWork’s waterfall decline started when the shared-office company’s parent We Co. filed to go public, revealing in detail its steep losses, lax corporate governance and multiple conflicts of interest—was particularly stunning. By the time it was rescued by majority investor SoftBank Group Corp. last month, WeWork was valued at about $8 billion, compared with $47 billion in its latest private funding round.

· Uber’s market capitalization is approximately $32 billion below its valuation at its May 2019 IPO.

· Lyft has lost about $10 billion in market cap since it went public in March of this year.

· E-cigarette company Juul Labs, which once ranked second behind WeWork in private-market valuation, said earlier this month it is cutting about 16% of its workforce. Its largest investor slashed Juul’s valuation by $14 billion after the company shelved its best-selling vaping products amid a regulatory crackdown.

Keith Wright, an instructor at Villanova University's business school in Pennsylvania, warned in a 2018 CNBC article that these unicorn startups would likely meet the same fate as the dot-com companies. "In case you missed it, the peak in the tech unicorn bubble already has been reached. And it's going to be all downhill from here," he wrote.

It appears Wright was dead right (no pun intended)!

Image courtesy of iStock

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The latest Silicon Valley Venture Capitalist Confidence Index (from University of San Francisco professor Mark Cannice) had a reading of 3.58 on a five-point scale. That's down from 3.76 in the previous quarter and below the 15-year average of 3.70. The index is based on a survey and interviews this past October with 29 of the greater Silicon Valley region VCs, showed a reading of 3.58 on a five-point scale.

The recent low for the index came with readings of 3.52 in a Q3 2018 report and 3.2 in Q4 2018, amid a government shutdown and growing trade tensions.

"Coupled with the issue of high valuations have been the disappointing performances of some newly public venture-backed firms and fewer exits in Q3," Prof. Cannice wrote in his report. "Of course, high initial valuations and fewer exits will make positive returns more difficult to attain."

“We’ve been in the middle of a rollicking party that’s gone on for five years and someone has snapped on the light switch,’’ said Chris Douvos, whose firm, Ahoy Capital, invests in venture-capital firms and startups. “We are all adjusting our eyes and no one has any idea how the rest of the night is going to go. That’s how Silicon Valley feels right now.”

Through the largesse of VCs and angel investors, the startup industry remains awash in cash. With interest rates staying historically low (and negative real returns on fixed income) any further steep decline in the private equity markets is unlikely.

Yet the magnitude of the steep decline in private company valuations has cast a level of uncertainty over the venture-capital industry not seen in years. It has also prompted calls by investors for stricter corporate governance and for their portfolio companies to show how they can become profitable.

At meetings with VC firms over the past two months, some limited partners (LPs) voiced concerns about getting their money back, according to the Wall Street Journal. The number of U.S. IPOs—one of two start-up company exit strategies (the other is buyouts/acquisitions)—fell by more than a third from the second to the third quarter this year, according to fund manager and IPO research firm Renaissance Capital.

The number of funding rounds raised by “Unicorn startups” and the average dollar value of those rounds, fell in the third quarter this year to their lowest level since the second quarter of 2018, according to data firm PitchBook.

"The venture capital markets are due for a major correction and it's going to happen soon," Venky Ganesan of Menlo Ventures said in the report. "Right now, capital is cheap and time is expensive. This cannot go on forever."

Bob Ackerman of Allegis Capital agreed, saying, "WeWork is a classic demonstration of the consequences of overcapitalization of undifferentiated innovation and a 'Sky's the Limit' hype cycle."

Vitaliy Katsenelson, chief executive of Investment Management Associates Inc., likens the current moment to the crash in internet stocks two decades ago (AKA the dot-com bubble and bust).

“We are in the dot-com bubble 2.0, except it’s not happening in the public markets but in the private markets,” he said. Mr. Katsenelson’s Colorado investment firm sold its stake in SoftBank in October over concerns about the Japanese investor’s plans for a second tech mega-fund.

"The venture world is walking on the edge of a precipice," warned Bill Reichert of Garage Technology Ventures, citing a global backlash against FAANGs, the trade war with China and the "valuation overreach of WeWork and many of the other unicorns."

"Amazingly, we keep getting pulled back from the edge, thanks to all the money sloshing around the world looking for better returns," Reichert said. "But we can't assume this will go on without interruption."

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End Quotes:

“All the beasts obeyed Noah when he admitted them into the ark. All but the Unicorn. Confident of his own abilities, he boasted “I shall swim.”” – Ukrainian Folktale

“Unicorns don't care if you believe in them any more than you care if they believe in you.” – Anonymous

“It’s not a unicorn. It’s a horse with a sword on its head that protects my hopes and dreams.” – Anonymous

“Dreams are the playground of unicorns.” – Anonymous

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Good luck and till next time……

The Curmudgeon
ajwdct@gmail.com

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Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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