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Private Valuations Aren't Grounded in Reality, Study Finds (bloomberg.com)

Posted by msmash on from the magic-trick dept.

Unicorns aren't real, and neither are the valuations ascribed to many of the startups that say they're worth $1 billion or more, study finds. From a report: About half of private companies with valuations exceeding $1 billion, known as unicorns, wouldn't have earned the mythical title without the use of complex stock mechanics, according to a study by business professors at the University of British Columbia and Stanford University. The tools used to negotiate a higher share price with investors often come at the expense of employees and early shareholders, sometimes drastically reducing the actual value of their stock. The chasm between public and private valuations is a topic of increasing prominence following several disappointing listings. Among them is Blue Apron Holdings, which is trading well below the price venture capitalists paid in the last fundraising round. An often-overlooked explanation for the divide is buried in investor contracts. Blue Apron, which delivers meal kits to customers, gave stock preferences to Fidelity Investments and other backers in 2015 in exchange for a $2 billion valuation. The shares included a provision to receive additional equity if an initial public offering is set below a target price. Investors took advantage of the mechanism after Blue Apron's mediocre IPO.

47 of 74 comments (clear)

  1. And the sky is blue... by jebrick · · Score: 2

    Who really believes the valuations given by these firms that just want someone else to buy them?

    1. Re:And the sky is blue... by Anonymous Coward · · Score: 2, Insightful

      Yeah, the only surprise to me is that it's only half of unicorns that are overvalued into the status.

    2. Re:And the sky is blue... by jellomizer · · Score: 1

      The value of everything is subjective.
      If people want it then it worth more products that people don't want.

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    3. Re:And the sky is blue... by Mashiki · · Score: 4, Insightful

      Who really believes the valuations given by these firms that just want someone else to buy them?

      Suckers. Nothing more. Look over the last 10 years of all the tech companies that pre-IPO were valued more then companies which had physically manufactured products. Twitter is probably one of the best examples, and at one point was valued more then General Motors. Uber was valued more then Intel. Yeah, nothing but suckers.

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    4. Re: And the sky is blue... by Mr+D+from+63 · · Score: 1

      The article really isn't telling us much. Of course private investors place a high valuation on their company prior to IPO. The IPO market typically doesn't pay much attentin to that number anyhow. And of course some companies IPO at a valuation lower than what VCs payed, its part of the gamble and in some cases an IPO is a way to limit their losses.

    5. Re: And the sky is blue... by ceoyoyo · · Score: 1

      The companies are getting those valuations from the VCs by agreeing to terms that protect the VCs and screw all the smaller investors.

    6. Re:And the sky is blue... by WhiplashII · · Score: 2

      Um, something is worth what someone will pay for it. If the last investors bought 10% of the stock for $100M, the value is $1B. It's not like people are making this stuff up.

      What the article is really saying is that private investors in large private companies are willing to pay more than public shareholders. This is really just a legacy of Sarbanes Oxley.

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    7. Re:And the sky is blue... by ShanghaiBill · · Score: 2

      If the last investors bought 10% of the stock for $100M, the value is $1B.

      But if there is an investor contract that promises them 20% if the stock price goes down, then it isn't really worth $1B. It is only worth $0.5B.

    8. Re:And the sky is blue... by ShanghaiBill · · Score: 1

      valued more then companies which had physically manufactured products.

      So? There is nothing magical about "physical manufacturing" that should make a company valuable. If anything, the opposite is true. It is better to own the IP and outsource the physical work.

      Twitter ... at one point was valued more then General Motors.

      GM makes commodity products, competes with cheap overseas labor, and has burdensome legacy costs. I would expect their valuation to be near zero.

    9. Re:And the sky is blue... by Dogtanian · · Score: 1

      Who really believes the valuations given by these firms that just want someone else to buy them?

      Suckers. Nothing more.

      Just as likely people who think they're taking advantage of the greater fool theory a la Tulipomania. (Bearing in mind I'm pretty sure hardly any of the people involved actually thought tulip bulbs were really worth anywhere near the sums involved).

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    10. Re:And the sky is blue... by Dorianny · · Score: 1

      Care to remind me exactly what Facebook is manufacturing?

    11. Re: And the sky is blue... by ceoyoyo · · Score: 2

      Not if the company management has an incentive to always make sure the pre-IPO valuation is unreasonably high.

    12. Re:And the sky is blue... by Mashiki · · Score: 1

      Care to remind me exactly what Facebook is manufacturing?

      Marketing data. That's somewhat useful, if you're trying to sell something.

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    13. Re:And the sky is blue... by Mashiki · · Score: 1

      So? There is nothing magical about "physical manufacturing" that should make a company valuable.

      No? Let's look at the previous dotcom crash, and compare it against the current tech bubble. The question you should be asking is, who's going to be getting money to buy your product if you're not manufacturing anything.

      GM makes commodity products, competes with cheap overseas labor, and has burdensome legacy costs. I would expect their valuation to be near zero.

      Except the part where they have quarterly sales high enough to give GAAP 0.05-0.15/share in return right? They have physical assets, IP, manufacturing base. Do you get why they have market valuation that's considered reliable, compared to twitter which has only IP and produces...nothing. To a market that twitter can't even figure out.

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  2. It's the economy, stupid by grasshoppa · · Score: 4, Insightful

    What is "reality" anyway? Economies are built on nothing more than perception; on the small scale, how much widget X is worth to person Y. On the larger scale, it's run by "feelings" ( how much I feel this company will make long term ).

    Sure, we dress it up with pretty graphs and we all stand around in serious suits pretending we know what the hell we're talking about, but any economist will tell you it's all about perception and mood.

    The best we can hope for is rationalizing after the fact.

    The only reason economists' predictions don't have the same reputation as a meteorologist is because, generally speaking, we are all on the same bus and want to get to the same place ( more money. Hello greed! ).

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    1. Re:It's the economy, stupid by Actually,+I+do+RTFA · · Score: 3, Insightful

      The only reason economists' predictions don't have the same reputation as a meteorologist is because

      What a strange way to phrase it. Economists projections are regularly questioned, and the weather is well predicted on a 3-day, annual, and long term scale. Now, you get different granularities, but I find precipitation prediction works well on a 3 day scale, it does tend to be warmer in summer than the winter, and most years are the hottest years on record (lately).

      Weather benefits from the fact that clouds don't change behavior because we talk about them.

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    2. Re:It's the economy, stupid by nine-times · · Score: 1

      Economies are built on nothing more than perception... it's all about perception and mood.

      The best we can hope for is rationalizing after the fact.

      To an extent, but at the same time, we should acknowledge that there is such a thing as poor judgement and terrible predictions. You can say, "There's no objective measure of value," but if someone pays $10,000 for a normal slice of Wonder Bread, we can say that they overpaid. If they bought it because they predicted the cost of Wonder Bread would skyrocket in the next two days, we can say that was a bad prediction.

      I mean, yes, value is never completely objective, and there's always uncertainty to prediction. However, some things are more valuable than others, and some predictions are better than others.

    3. Re:It's the economy, stupid by sl3xd · · Score: 1

      Weather benefits from the fact that clouds don't change behavior because we talk about them.

      I dunno, we do have the butterfly effect.

      Both weather and markets are incalculably complex, and small changes do make big differences over the long term - whether the tiny gust of air from somebody talking about the weather in London, or some kid buying his first share of stock.

      I'm aware that the link explicitly states that the impact of the butterfly effect on weather is overstated... but the point is that even small changes in air current does change the weather as time progresses.

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    4. Re:It's the economy, stupid by grasshoppa · · Score: 1

      You can say, "There's no objective measure of value," but if someone pays $10,000 for a normal slice of Wonder Bread, we can say that they overpaid.

      "Value" is in the eye of the beholder. People spend ungodly amounts of money on stereo equipment, for instance. Sums and values which rival your slice of bread, btw. Yet they are entirely happy with their purchase, so who am I to say any different?

      There is no objective measurement of perceived value, which is what the economy runs on.

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    5. Re:It's the economy, stupid by monkeyxpress · · Score: 1, Insightful

      That's not how it is meant to work though. The idea behind the 'worth' of widget X is that it is at least marginally comparable to some widget X2 produced by a different competitor in the market. Each competitor tries to find a way to make their product worth slightly more than their competitors or for a cheaper cost, and the customer ultimately decides whether they agree with that effort. However, if each competitor cannot do that, then prices simply fall to the cost of manufacturer/supply plus a profit margin at which potential new competitors find other opportunities more attractive. That's supposedly the idea anyway.

      As for the value of a business, well the price is actually quite well defined - it should be an appropriate amount of return above the risk free rate of return (basically what you can get on a government bond) based on the the business' income producing ability/potential and the risk of it meeting that potential or going under. Of course there is a level of perception around the 'risk' there, but in normal times, it would be quite easy to define some reasonable upper and lower limits for a business' value, and you can then start working from there.

      The problem with all these quite reasonable value finding mechanism is that they assume that money is some sort of scarce commodity that investors/customers are wary of wasting. That ceased to be the case sometime in the 1990s when the financial industry was deregulated. After many years of creating rubbish credit (which creates money) all that credit got shown to be the garbage it was by successive financial crises, and governments responded by bailing everyone out and driving interest rates down to make that debt 'sustainable'. Now interest rates are broadly negative, and we wonder why there is no rationality to asset valuations any longer. The bankers know that as long as they stay away from anything that will affect the inflation goods basket, they can run bubble casinos on whatever other assets they want. And frankly, many regular folk are quite happy to join in the game while they are winning.

      My guess is that at the next crash they will just ban cash and implement aggressively negative interest rates. We can probably get another 10 years out of running 1-3% negative nominal rates (with the continual promise that it is an emergency measure). After that, I think people will just bail on fiat currency again like they normally do. Crypto-currencies have shown that we can come up with working alternatives that meet our modern transaction needs if it really comes to it. It will take a big shock though, but I'm sure the bankers will get us there in the end.

    6. Re:It's the economy, stupid by nine-times · · Score: 1

      I don't want to get too deeply philosophical here, but what do you think you're talking about when you use the phrase, "objective measurement of perceived value"? That seems like a dumb, nonsensical phrase to me.

      Some things are more valuable than others. That much is true. It's possible to judge value incorrectly. I can think that something is worth $10k and be wrong about that. But I've never claimed that there's an "objective measurement of perceived value." I don't think you know what you're talking about.

    7. Re:It's the economy, stupid by grasshoppa · · Score: 1

      I don't think you know what you're talking about.

      I don't think you fully understand what I'm saying, personally. If you did, you'd understand why your 10k slice of bread is a meaningless analogy.

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    8. Re:It's the economy, stupid by swillden · · Score: 1, Interesting

      There is no objective measurement of perceived value, which is what the economy runs on.

      Nonsense.

      You absolutely can objectively measure value, in both individual and aggregate cases. The measurement will not be a single number, it will be a probability distribution, and the distribution will vary over time, but that makes it no less a real, objective measurement. What you're measuring is human demand and desire, and that is a real, objective thing, even if it's variable across the population and across time, and even if it is hard to measure accurately.

      If you measured the value of a slice of Wonder bread, you'd find the distribution has a mean on the order of a few pennies, and the vast majority of potential buyers would be willing to buy it for that. There is a non-zero probability you can find someone to pay $10K for it, but it's extremely small unless there's something unusual about your particular piece of Wonder bread. If it's fungible with all of the other pieces of Wonder bread, then the probability approaches zero.

      Basically, you're confusing "objective" with "fixed and universal". Objective measurements need not have single values, nor do they have to remain fixed over time or space.

      In the case of business valuations, unlike goods there's very little variation (after risk adjustment) across the population, because people rarely have individualistic reasons for wanting to own shares of one company over another. People buy stocks because they hope to make money. On the other hand, business valuations are inherently rooted in predictions of future business prospects. That doesn't make them so much "subjective" as it does "uncertain". Different analysts will assign different probabilities to different outcomes, because forecasting is an unpredictable business. Also, new facts will change the probabilities.

      However, aggregate, broad-scale predictions, made by large groups of people tend to produce fairly good results... and that's what stock prices are. Aggregated predictions.

      What this study found is that the aggregated predictions of small groups of private investors do not match the aggregated predictions of the public markets, and that the private investors systematically overvalue the companies, as compared to the public markets. Does this mean the private investors' predictions are wrong and the public markets' are right? In one way, yes, by definition, because the private investors ultimately cash out through the public markets, so the private investors are really trying to predict the valuations that will be assigned by the public markets. In another way, no one knows, because the actual value of the company depends on what happens in the future. On average, though, it's likely that the public markets make better predictions.

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    9. Re:It's the economy, stupid by Tablizer · · Score: 1

      What is "reality" anyway? Economies are built on nothing more than perception...suits pretending we know what the hell we're talking about, but any economist will tell you it's all about perception and mood.

      That is largely true, but there are also patterns to perception and results of perception. These patterns can be studied to make statistical predictions. Human behavior can be modeled to some degree in aggregate. I agree the models are not perfect and that's partly why economists are often wrong.

      However, part of the reason they are wrong is because investors are using the same or similar models and try to take advantage of their predictions. Investors have access to the research papers also. Thus, it's a moving recursive target because the new models are intentionally used to muck up the new models by getting a jump on trends.

      In this case one can see if investments in Category X pay for themselves in a given time-frame as valued in stocks or the recent revenue of the company, among other metrics. That much is an objective measurement. (I suppose there may be disagreement over how to determine if a company is in Category X, but that doesn't seem the point of contention.)

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    10. Re:It's the economy, stupid by geekmux · · Score: 1

      Sure, we dress it up with pretty graphs and we all stand around in serious suits pretending we know what the hell we're talking about, but any economist will tell you it's all about perception and mood.

      All of these revelations won't change a damn thing. We'll still pay glorified tarot-card readers millions of dollars to manage portfilios, that reality distortion field around Wall Street will continue to be maintained by Greed N. Corruption, and all the computing power in the world won't be able to predict or avoid the next collapse.

      Find something that actually devalues "complex stock mechanics", preventing it from shitting out billion-dollar valuations. Then we'll be making progress.

    11. Re:It's the economy, stupid by grasshoppa · · Score: 1

      Basically, you're confusing "objective" with "fixed and universal".

      Fair enough and you're quite correct. In fact, while reading your post I realized there's a very quick and obvious way to determine an objective measurement of perceived value; how much someone is willing to pay for it. :)

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    12. Re:It's the economy, stupid by zifn4b · · Score: 1

      What is "reality" anyway?

      It's subjective perception. My perception is that you don't exist nor does this post. In fact, what you don't realize is that you typed this post in an altered state of consciousness. You're just talking to yourself.

      What's more plausible, that or materialism? You decide.

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    13. Re:It's the economy, stupid by nine-times · · Score: 1

      I'm pretty sure I understand. You think that things need to have an "objective measurement of perceived value" in order to have the possibility of assigning value outside of "what someone is willing to pay". That is, you'd probably claim that in my example of someone paying $10k for a slice of bread, the slice is inherently worth $10k because someone was willing to pay that much, and there's no other meaningful way to talk about value.

      That's my guess, anyway, from the nonsense talk about "objective measurement of perceived value".

    14. Re:It's the economy, stupid by grasshoppa · · Score: 1

      As I mentioned in a different comment, that term was incorrect. However, you did seem to get the gist of my comment so it's a moot point.

      Regardless, by virtue of someone willing to pay 10k for widget X, that assigns value to it. I don't see how debating the value after the fact changes the assigned value.

      Explain that to me, I'm legitimately curious. If two parties agree to payment terms and close the transaction successfully, how does anyone else's rationalization change the value inherent in that transaction?

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    15. Re:It's the economy, stupid by nine-times · · Score: 1

      how does anyone else's rationalization change the value inherent in that transaction?

      What value is "inherent" in the transaction?

    16. Re:It's the economy, stupid by grasshoppa · · Score: 1

      The agreed upon price between the parties. If Person A agrees to buy Widget X from Person B for 10k, the inherent value of Widget X is 10k.

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    17. Re:It's the economy, stupid by nine-times · · Score: 1

      ... the inherent value of Widget X is 10k.

      Ok, so what does that word "inherent" mean in that context? Earlier, you brought up the phrase "objective measurement of perceived value". Is the "inherent" value some kind of objective value, or objective measurement of value?

      Because I think I might have an idea of the mistake that you're making. You're saying that there's no "objective measurement of perceived value", but what you really want to say is that nothing has "objective value", and that all value is a matter of perception. But then, you also seem to want to put a lot of stock in this idea of an "inherent value", which seems to just be a stand-in for the idea of an "objective value". So you're saying:

      * There's no such thing as objective value of an item
      * There is only perceived value, i.e. the amount that people perceive an item to be worth
      * If a person is willing to pay a certain amount for an item, that's proof that the item is perceived to be worth at least that much
      * Therefore, the amount that someone is willing to pay is the objective value

  3. Didn't Gregory House teach you well enough? by Rick+Schumann · · Score: 1

    Everybody lies.

    -- Dr. Gregory House, M.D.

    1. Re: Didn't Gregory House teach you well enough? by Rick+Schumann · · Score: 1

      Was he wrong? No.

  4. Yes and no by davidwr · · Score: 1

    By definition, if a willing buyer pays $1B to a willing seller for 50% equity, the company is valued at $2B at that instant in time.

    The fair-market valuation a moment later is unknown - it is whatever a willing buyer would pay a willing seller for equity in the company.

    The big problem with private-company valuations is they are like art, real estate, rare coins, and other things that aren't traded on a daily basis: it's always just a guess - an educated guess - what the true value is.

    --
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    1. Re:Yes and no by Cassini2 · · Score: 1

      The stock market does exactly the same thing. A companies valuation is based on the price of the last stock market transaction times the number of outstanding shares. The variance is also huge. This is the reason why one rogue trader can tank a companies stock. It is also the reason why a short selling hedge fund can also tank a companies stock.

      The key difference between public and private sales is liquidity. The public market is much more liquid. An ecosystem of financial traders exist. These traders do clever financial transactions that try to find the optimal price to purchase / sell shares. This reduces the variance. Some people question the wisdom of these sophisticated trading algorithms (rightly). However, they do have the effect of ensuring that anyone selling a stock at the wrong price runs the risk of being gamed. A perceptive trader can simply purchase the trade at the lower price, and sell it later in the day at a higher price. These transactions correct the price of the shares to the true market value. On most days, this significantly reduces price volatility.

      This doesn't mean that you can't game public shares, it only means that the variance will be less and that whoever is gaming the share prices must by much more clever about it. Whereas for private shares, it is possible to do whatever the seller / buyer want.

  5. As a long-time investor, I agree by WillAffleckUW · · Score: 1

    Having participated in hundreds of IPOs over the decades, I'd tend to agree with this analysis. Probably about 50 percent of the public or private offerings I looked at were not viable long term, usually predicated on a lack of both competition and regulation, both of which would exist.

    That said, if you actually read the offerings, you'll find they disclose such things. Sometimes a good idea can in fact be a wise investment.

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  6. That's the whole purpose of the stock market by gurps_npc · · Score: 1

    We know private valuations are crap. It is too hard to decide how much things like "brand", "Expertise", "Experience", and "Business Secrets" are worth. Enter the stock market.

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  7. The concept of an accurate market by bravecanadian · · Score: 1

    Backed by rational thought and informed actors has to die.

    People do stupid things all the time.

    1. Re:The concept of an accurate market by Shotgun · · Score: 1

      And they should suffer from it. Stupid should hurt. Pain is the only thing stopping stupid.

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  8. File this under... by neo-mkrey · · Score: 1

    DUH!

  9. Old News by sciengin · · Score: 1

    Bloomberg had a nice article on this a while back:

    (Apparently they paywalled it so Im posting the google cache version)

    https://webcache.googleusercon...

  10. Fidelity mentioned 44 times in SEC IPO doc by laughingskeptic · · Score: 1

    Fidelity is mentioned 44 times here: https://www.sec.gov/Archives/e... . But I suspect the information one needs to fully understand the agreement between Fidelity and Blue Apron is in the referenced and non-public "Investor's Rights Agreement". The article certainly doesn't make it clear what documents it referenced to draw its conclusions or how to detect such hidden agreements in future offerings.

  11. Willing buyer at arms length by FeelGood314 · · Score: 1

    If a willing buyer who has no other ties to a company pays 1B for 50% of a company at that instant the company is worth 2B. However if a group of investors own 100% of the outstanding stock of a company, and then issue 1% more shares which they then buy for 20M the company market capitalization would be 2B. However no ownership changed hands in that transaction. All that happened was 20M was put into the company. The investors where not true buyers. There are a lot of other funny things that go into pre IPO valuations. So unless the company is publicly traded or you see a true new investor who isn't getting something else along with their stock purchase, many of these valuations are invalid.

  12. It's the economists, stupid by caseih · · Score: 1

    I am reminded of a fascinating interview I heard last year with two economists, and the interview was entitled, "It's the economists, stupid," a play on the classic phrase you quoted as your subject. Their point in the interview was that "the markets" have taken on an almost anthropomorphic character in our thought and economy. And economists have become the new oracles to tell us what the markets "say" and where the value lies, replacing the ancient ones that would tell people the moods of the gods so they could get better crops. Economics is certainly a branch of psychology not mathematics, though, as you say, they try to wrap it up in some mathematical rationalization and modeling. Can you mathematically model psychology? Yes to a degree. We can even make a formula that lets us value and trade debts themselves! It works because the math says it works!

  13. So... fraud? by EndlessNameless · · Score: 1

    If Fidelity and others are adjusting their valuations based on compensation from the entity that they're evaluating, how is that not fraud?

    There is an assumption that a private valuation is based on the fair, rigorous analysis of the company and its place in the market. If they are taking money (profit) to adjust their valuation (deceit), that's stretching into fraud territory. It's almost textbook that deceit + intent + profit = fraud.

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    1. Re:So... fraud? by laughingskeptic · · Score: 1

      They are not taking money, at least not immediately. I believe these agreements work like an insurance policy that none of the other investors get. They will be given more shares in the future to bring their stake up to what they invested while everyone else gets diluted IF at the specified time the value of the company is below the IPO valuation or the company is sold below the valuation at an earlier time. My objection is that the general public is not informed in a clear and public way of these special arrangements that could directly affect the future value of the shares purchased. If the stock really tanks, the protected investors will wind up holding the full value of the company while the other "share holders" shares could be diluted to nothingness. Kind of mocks the definition of the term "share".