Private Valuations Bubble Is About To Burst

  • After years of constantly rising valuations, investment firms challenge unicorns investment value.
  • Together with the Theranos report, a trend is starting to re-evaluate existing private valuations.
  • The current model, wherein unicorns keep raising funds in an always increasing valuations environment, could not last forever.

At the beginning of September, ride-hailing service provider Uber raised an amazing amount of $1.2B from Baidu (NASDAQ:BIDU) to expand its penetration into the Chinese market, with the help of the local internet giant. This enormous funding round was nothing new for Uber; the company had raised a similar amount in single funding rounds last year, driving the company’s valuation, in the private market, to a whopping $51B. With the recent funds raised and the valuation boom, Uber became the second private tech company to reach a $50B valuation after Facebook (NASDAQ:FB). However, while Facebook survived the global financial crisis and succeeded in reaching $50B valuation in 7 years, Uber’s growth occurred during a six-year bull run in the public equity market, that also pumped-up the private equity markets and enabled Uber to reach a $50B valuation in only 5 years.

Earlier this year, a leaked document unveiled Uber revenues as the company expects to reach $2B in revenues in 2015, which reflects a P/S ratio of 25. Comparing these figures to other companies of similar size to Uber highlights the bubble claims:

Company Ticker Market Cap TTM Revenues P/S Ratio
Salesforce CRM $52B $5.9B 8.77
Uber N/A $51B $2B 25.5
EMC EMC $49B $24.7B 2
Netflix NFLX $48B $6.4B 7.48
Paypal Holdings PYPL $44B $8.9B 5

Source: Thomson Reuters

The table above includes only four companies, but it could easily contain dozens of companies that have a lower valuation than Uber and generate more revenue. The table only includes tech firms. However, General Motors (NYSE:GM), Mizuho Financial (NYSE:MFG), Bank Of New York Mellon (NYSE:BK), Teva Pharmaceutical (NYSE:TEVA), Ford Motor (NYSE:F), MetLife (NYSE:MET) and many are valuated very close to Uber and generate significantly more revenue than Uber. Uber might have a very good growth potential. However, a $50B company could not be measured based on the same metrics as a small $1B company. A company so big should have a clear and steady revenue stream, and it should look to generate sustainable growth while trying to reach profitability. Uber is far from that.

Uber is not the main issue but just an example for the ill private market valuations that investors are starting to challenge these days. Last week, I covered the unbelievable scandal around Theranos after The Wall Street Journal reported that the company uses Siemens machines to perform most of the blood tests instead of Theranos proprietary machines. This could undermine the company’s entire business model and also its $9B valuations. Moreover, the report claims that since Theranos published that 240 blood tests can be performed from just a few blood drops, the company could not request large amounts of blood samples from customers and had to dilute the samples. This dilution impacts the end results severely. The WSJ report, followed by an FDA investigation, might have a horrendous impact on the company that claimed to have disrupted the diagnostic blood tests market.

However, Theranos is just one case of a huge valuation challenged. Earlier this month, a public filing unveiled that Fidelity and BlackRock (NYSE:BLK) had cut the valuation of their Dropbox investments by 31%, mainly as a result of Dropbox’s rival Box (NYSE:BOX) going public. Dropbox was valuated at $10B last year; however, as mentioned in an earlier article, the company’s steep valuation will complicate the IPO. This was supported by bankers advising the storage company to delay its IPO for now.

Fidelity also reevaluated its investment in Snapchat its investment in Snapchat, and, according to the Financial Times, the investment firm cut the value of its investment by 25%, from the original $30.72 to $22.91. While it’s still unclear what drove Fidelity to cut the Snapchat valuation, there is a clear trend forming to challenge the massive valuations that the unicorns club has reached in the recent years. It has also impacted Square’s upcoming IPO, where the company price range reflects a $4B valuation compared to a $6B valuation in its latest funding round.

As this trend currently has no effect on the publicly traded companies, there are no immediate actions investors should take; however, investors should be very careful while investing in unicorn IPOs like the Square IPO next week. Going back to the Uber example from the beginning, I believe it is not a sustainable model to raise billions of dollars every year under increasing valuations as investors are still looking for an attractive upside. This could not last forever. As investment firms challenge current valuations, the magnitude of this trend will grow, and the result is unavoidable as investors will stop pouring money into the private market and huge start-ups will eventually decrease in size. I believe we are at the beginning of this process.

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