Public Startups Venture

No One Knows What Anything Is Worth, Part II

Morning Markets: We tend to compare startup valuations to SaaS multiples. What happens if our benchmark is inflated? This post is a spiritual successor to this June entry.

The troubled IPOs from Uber and Lyft (fresh record lows set yesterday), Peloton (off over 10 percent yesterday) and SmileDirectClub (off over 40 percent from its IPO price) have the broader media world perking up and asking questions. What’s going on?

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As we’ve read and written lately, it seems that some recent technology-focused and venture-backed public debuts have been mispriced for one or two of a few reasons. These include slowing growth not being fully-factored into pricing (Uber), persistent or rising unprofitability (Uber, Lyft, SmileDirectClub, Peloton), and valuations set too high either while private (Uber), or going public at companies with gross margins far lower than what software companies earn.

The final point is something we covered yesterday. Namely that statups who earn revenue which generates lower gross margins than software companies are seeing public investors value them lower than some private investors anticipated. This, as Fred Wilson noted, should not be a surprise.

Software companies generate revenue which has attractive gross margins and often recurs. It’s coveted by private and public investors alike, each class of moneypeople being willing to allow software companies to lose money while they accrete more top line.

High margin, recurring software revenue is a revenue gold-standard of sorts. It regularly garners high valuation multiples. That makes it a good measuring stick. For example, if a company that generates non-recurring revenue with gross margins of, say, 50 percent, is valued like a software company, we can say that it’s likely overvalued.

But what if our measuring stick is broken? Yesterday we mapped the compressing revenue multiple of Peloton in the following way:

Shares in Peloton, a recent IPO, fell over 10 percent today to $22.51 per share. Peloton’s IPO price was $29 per share, valuing the firm at $8.1 billion. Today it’s worth $6.25 billion. At its IPO price, Peloton was trading for 8.8x trailing revenues (its fiscal year ended June 30, 2019). Today that same revenue multiple compressed to 6.8x.

We noted that Peloton is still worth more on a revenue-multiple basis than what old-school venture capitalists thought SaaS companies should be worth, also on a revenue-multiple basis.

That means that the revenue multiple gains enjoyed by SaaS companies could be expanding the window for companies with lesser-quality, allowing them to inflate their valuations; if something is worth a bit less than SaaS, say, but SaaS valuations double, what happens to the inherently less valuable company?

Provided that it can claim to be tech-ish, or tech-adjacent, or heading-towards-tech, perhaps it can get a higher multiple from private investors than it really deserves. Public investors make that decision far down the road, leading at times to unwelcome surprises.

Watching Slack reprice on the public markets, watching private market dreams run into public market realities, and watching gross margin ambiguous companies continue to raise huge sums, I reckon that no one knows what things are worth right now. The market is too uncertain, the expansion too long, the private capital too free, and interest rates still too low. Not in a moral sense, mind, but in terms of where we are today compared to historical norms.

And so we’re seeing valuations try to sort themselves out on a relative basis but from no zero point. SaaS is a good high watermark, but if it’s inflated itself, how can we tell what anything else is worth?

Illustration: Dom Guzman

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