Betting against unicorns

The new obsession of the VC world is Unicorns, those pre-IPO tech startups valued at $1 billion or more. CBInsights has composed a good list of startups that have achieved unicorn status which seems to be growing on a daily basis. There is no doubt there are many great companies in this list, but I believe several of these valuations have gone way ahead of themselves. I have discussed in the past why valuations don’t reflect real value  but when I see some of the companies in the unicorn list I can’t help but raise an eyebrow.

I don’t know what is more difficult – trying to spot a winner, or trying to predict which ‘hot’ startup is not that hot. I am going to list a few startups at the top of the unicorn club that I think are overvalued and take the chance that several years from now I will be publicly humiliated when it turns out I was dead wrong. I’d love to get feedback on why I am wrong, or what else am I missing.

Snapchat at $15B – I can see a case for how Snapchat is worth $15B. But my overall point is that there will most likely be multiple winning messaging platforms in mobile and not necessarily the kind of “winner takes it all” dynamic we have seen in the past with Facebook. Also, the amount of time that people can spend on social networks and messaging platforms is limited. So every minute that users are spending on Snapchat is a minute they don’t spend on Facebook / Whatsapp / Instagram. Therefore, in theory, if Snapchat is worth $15B then Facebook should be worth $15B less today.

Dropbox at $10B – I am a big fan of Dropbox and use it extensively. However, I believe the fierce price war that the cloud storage world is undergoing is just the beginning. Only a few days ago Google announced that the free photo app has unlimited cloud backup of photos and videos. The main issue with Dropbox is that it needs to charge for something that other large players such as Google, Apple and Microsoft will offer for free in the long run to get users hooked into their platforms.

Spotify at $8.4B – This is another product I love. However, I find it hard to see a hugely profitable music distribution company emerging in a space where “content is king”. Unless Spotify becomes a main source of revenue for record labels and artists, it will keep getting squeezed with high royalty rates (currently 70% of revenue). Now if I were a large music producer, I would work hard to support Spotify’s rivals so I am not dependent on a single distribution platform.

Square at $6B- I can’t understand how a low margin business can command such a valuation. Without seeing the numbers, I assume it is very difficult for Square to recover the high cost of acquiring SMB customers given the low margins. The real winners from Square are the credit card companies which are holding them hostage and collecting the majority of the revenue. Not less frightening is the intense competition from companies like Apple, Google and Paypal that have an inherent advantage of owning the underlying platform or payment solution.

WeWork at $5B- WeWork, the co-working space startup, has transformed the way people think about shared work space.  Moreover, they have a great business model breaking large spaces into small offices and leasing them at relatively high rates by not adhering to the common square feet listing. However, at the end of the day it is a game of Real Estate pricing arbitrage which will require a lot of effort to sustain, especially if interest rates go up or tech funding dries up (most likely both will happen simultaneously). Therefore, I find it hard to understand how the company can get away with a high flying tech multiple.

12 thoughts on “Betting against unicorns

  1. “The amount of time that people can spend on social networks and messaging platforms is limited”

    So true. This makes me think the advantage will go to platforms, or portals, that let you do everything in one place. Facebook is moving farther from being a place to struggle through friends’ baby photos and vacation albums with the addition of the Instant Articles partnerships, allowing follows vs. friends and better ad targeting.

    One of my colleagues here at CB Insights wrote this post using valuation multiples to see how publicly traded Box compares to Dropbox:
    https://www.cbinsights.com/blog/dropbox-valuation-bubble/

    1. Thanks Emily, and completely agree on Box vs. Dropbox.
      two similar examples I twitted about a while ago:
      Is M&A a better exit than an IPO? example #1- @AirWatch acquired by @VMware for $1.5B with similar revenue to $750M-EV public @mobileiron
      Example #2- @nest FTM was $300M and acquired for $3.2B while @GoPro LTM was $1B and valued at $3B

      1. Amit, you have a fair argument but ALL VCs want their companies to be unicorns. They just want to invest in these unicorns at early stages and they only complain about missed opportunities.

        Emily ever since Instagram was bought by FB, there has been a big push for minimal viable application, single feature app by VCs. You and Amit are correct in your observation but you will often hear VC still pushing this strategy. Slack is one big exception but they are the biggest unicorn of all.

    1. Thanks Ron!
      That’s the inherent problem of shorting companies… 🙂 But frankly, I still want to see the final jury of how the public market values WeWork in the long term… I know it’s not just for startups but many of these service providers depend on tech customers. So if/when the tech environment turns I expect them to suffer as well.
      The good news (for me) so far is that in the two months since I published this Apple announced Apple Music which is already a major competitor to Spotify (demonstrating the difficulty of music distribution business w/o owning an underlying platform) and I am sure Jack Dorsey’s dance between Twitter and Square is not helping the IPO process.

  2. You are 100% right, but this is only the top of the iceberg. What is with the +10.000 startups, that are valued with 1M+ and their only hope to sustain is to get more money from investors. The two questions for me are : When will it burst ( maybe the Uber IPO? ) and how can I bet against it, since they are all private companies, there are no instruments to short these companies, right ?

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