Startup Bubble Too Big For Exit, Investors in La-La Land

Wolf Richter

Carl Icahn, whose passion it is to squeeze cash out of corporations one way or the other, is worried. Not that there isn’t enough cash left to squeeze out, but that something untoward might happen. That’s what he told FOX Business Network:

I’m not telling you this market is going to crash, going to go down next week, next month, even next year, but you have to be extremely concerned with what’s going on. I mean, consumers really aren’t spending. By keeping interest rates this low you’re creating bubbles that you don’t even know about. And I do think that sooner or later the Fed can’t just keep this market up by itself.

It’s not, will it happen? It’s when it will happen….

It would be a mega-problem for his buddies at hedge funds, PE firms, and pension funds that are plowing money into startups late in the game when valuations are already sky-high. They used to buy the IPO shares. Now they get in earlier, hoping for a pot of money at the end of the rainbow.

That exit would be an IPO or an acquisition by a math-challenged giant corporation that can use its own overvalued shares or cheap debt to buy the overvalued shares of these startups. But corporate buyers for mega-startups have become scarce. Hence IPOs.

But there’s a little problem. There are currently 65 VC-funded startups in the US with a “valuation” – in quotes because it is a rubbery concept – of at least $1 billion, according to the Billion Dollar Club. Together, their combined valuation amounts to $232 billion.

A year ago, there were 42 members in that elite club with a combined valuation of $109 billion. Within a year, their count jumped 54% and their valuation 113%.

The total valuation of all VC-backed startups reached $750 billion at the end of 2014, according to Sand Hill Econometrics, cited by the Wall Street Journal. That would be over 2.5% of total US stock market capitalization. The only other time it got anywhere near that high was in the second quarter of 2000, when it was just under 2.5%. At the time, the bubble-implosion process had already begun.

Uber now has a valuation of $41.2 billion. It’s trying to raise up to $2 billion at a valuation of $50 billion, 12 times its valuation of $3.8 billion a year ago, and about120 times its 2014 revenue, after accounting for the part that goes to its drivers.

But at least it has real revenues.

Snapchat, the ephemeral photo sharing app used by folks who think that these messages will actually disappear from Snapchat’s servers after they disappear from their smartphones, is now in second place with a valuation of $16 billion. It is finally trying to get some revenues, after all these years of just burning cash – by advertising to teenagers.

CEO Evan Spiegel sees what this is: a bubble. He said so. Already in an email in November 2013 that became public as part of the Sony hack in December 2014, he pooh-poohed tech valuations and figured that there would be a major correction. Wrongly so far. But like Icahn, he didn’t put a date on it.

Then a few days ago, he went at it again in an interview at the Code Conference.

“I think that people are making riskier investments and … there will be a correction,” he said. “Easy money policy” and low interest rates are fueling this investment bubble, but it might not last much longer, based on recent economic indicators. When? “If I knew for sure, I’d make a lot of money,” he said.

But here’s the thing. “We need to IPO,” Spiegel said. “We have a plan to do that.”

Because: Who else is going to buy a company with such an enormous valuations and barely discernible revenues? So it’s the public. Well, mostly institutional investors that hold the public’s nest eggs. The “public” would never have to know about it.

These crazy valuations are determined by a few players behind closed doors. They make sure valuations only go up because no one in that room benefits when they’re heading down. When that starts, it’s over. Earlier investors would have to write down their investments. It would destroy the appetite for more investments. It would freeze up the money spigot. Hence the relentless push by all involved to drive up valuations no matter what.

For these investors, an IPO would be the pot at the end of the rainbow. Alas, the combined valuation of VC-backed companies now amounts to 2.5% of total stock market capitalization; the last time they tried to dump such a load of IPOs on the market – in 2000 – the market couldn’t absorb them. IPOs crashed and burned.

That’s a bloody exit. And now this happened, according to Renaissance Capital:

After a record year in 2014, the IPO market slowed dramatically in the first quarter of 2015. The 34 IPOs raised $5.4 billion, making it the least active quarter by IPO count since the 1Q 2013 and the smallest by proceeds raised since the 3Q 2011.

Half of them were in the healthcare sector, particularly biotechs. But…

Technology IPO issuance was likely dampened by the widespread availability of private funding at very high valuations, which produced little urgency for companies to seek IPO capital.

So here is the quandary: Easy money and low interest rates channel funds from all over the world into the US startup sector and drive up valuations. But now valuations are so high, and there are so many startups with such valuations, that the stock market might not be able to digest them.

It doesn’t take much to take down this magnificent top-heavy construct. And IPO shrapnel has a nasty tendency to ricochet wildly around the stock market.

Is it a sense of desperation among CEOs? Read…  Last Two Times This Happened, Stocks Crashed

Source:http://wolfstreet.com/2015/06/02/what-will-crush-our-magnificent-startup-boom/

Reprinted with permission