BM Research

The recent flotation of Uber was probably the largest VC backed IPO of all time. After initial suggestions of a $120bn valuation pre-IPO, the actual figure was $82bn, including a fundraise of $8.1bn. Both were clearly lower than management had hoped for. The stock plummeted in the immediate aftermath, but has since recovered to close to the $45 per share issue price.

The subject of Uber’s valuation has been a topic of much debate. With operating losses of over $3bn in 2018, the company is not ready for a P/E multiple. Many believe it never will be. The company has singularly failed to deliver any economies of scale as it has grown. Bulls believe it has grown revenue with an innovative business model. Bears will tell you that all it does is use it’s VC funding to subsidise fares and its regulatory arbitrage will peter out. Both views probably have elements of truth.

For what it is worth, I don’t think it can be financially successful using its current business model in its main market. For a solid takedown of this check out Hubert Horan’s analysis. Self-driving cars will transform the economics, though whether that brings profits is less clear. While the cost of paying drivers will disappear, the capital intensity may change. If it can tap into people who have their car spare between their own usage it may prove to be right [1]. If it has to invest itself then it is probably screwed. Adjacent markets is the other promise, but I suspect success in these may depend on the same issue. But that’s not what I want to discuss here.

Are valuations too high?

I was listening to Mitch Kapoor on the Angel podcast discuss the large amount of capital floating around the VC world. This has been a topic of much discussion over the last few years. While this fact may mystify companies seeking (S)EIS investment, these larger amounts may be making it harder at the small end. Big funds need big investments. Seed rounds are the size of what used to be Series A. And most of this capital is going to the bigger VC companies. Kapoor’s worry was that the urgency to invest, and deploy, this means that companies are scaling prematurely. But another concern is that is has pushed up valuations.

Softbank is both the epitome of this issue and the gorilla in the VC room. Its Vision Fund, established in conjunction with the Saudi Arabian government, has almost $100bn to deploy. And although its described as a private equity fund, many of its high profile investments are better described as venture capital. Which brings us back to Uber.

In late 2017, Uber needed to raise money. The brand was struggling at the time, with a culture that appeared to prize rule breaking above ethical sense and had a misogynistic bent that was wrong in the #metoo era. Several people wanted liquidity for their shares. Most notable amongst these were the former CEO, Travis Kalanick, who had been kicked out earlier that year and Benchmark, a prominent VC firm and early funder of Uber. And Softbank was in prime position to fill that gap.

How to get a fudge

The problem was the valuation. Softbank wanted an entry price significantly lower than the last funding round, which gave a $68bn valuation. However, many of the existing investors did not want to have a down-round which would bring down their valuation, and performance. So a compromise was reached. IN conjunction with existing investors, Softbank would buy a mix of existing shares and new shares giving it a 15% stake. However, this would take place in two transactions.

• the majority, mostly secondary sales, would take place at a $48bn valuation;
• $1.25bn of new money would subsequently be raised at the previous valuation of $68bn.

The point, of course, was that by having the last transaction at the same valuation as the previous deal no-one had to write down their investment. Now in one sense, this doesn’t matter that much. Those who received cash would have to use the lower valuation anyway. Performance fees for VC funds are only payable on exit and the whole deal is transparent.

But on the other hand it stinks! Basically the whole deal was really at an average of $48bn and $68bn, weighted way more towards the former. The structure was a sham to avoid embarrassment.

So what?

As an analyst, the question in my mind is who else is doing this? I haven’t heard of anyone doing it, but that doesn’t mean it doesn’t happen. Its another thing to be aware of when looking at companies.

The other issue is who is setting the price? Valuing an investment based on a subsequent transaction that you made is more than just frowned upon. At the moment I’m reviewing a new product where the manager hasn’t done interim valuations, partially because they are involved with most subsequent fundraisings.

Now, at the moment the Uber valuation is up even on the $68bn, though not by much once you account for the additional cash raised. For progress over 16 months that’s not great, but at least now we can see what the valuation is. IPOs can be a good thing 🙂

[1]: My one Uber experience was in Cape Town. A local taxi driver did me over after I arrived at the airport and everyone told me to use Uber. So I did. It seems that many (most?) Uber drivers there are Zimbabwean. Cars need to be less than three years old, which most cannot afford. So they lease/rent them. Typically professionals such as dentists or doctors buy them and get ~£500 per month. So maybe Uber can get away without investing capital when self-driving cars arrive.