By all accounts, 2014 was the year of the “on-demand” economy. Ride-sharing service Uber recently closed out a $1.2 billion funding round, placing the start-up’s total valuation at $41 billion. That represents an almost tripling of the company’s value – a half a year ago Uber was valued at $18 billion.
Uber is very successful, both at disrupting taxi markets and at generating headlines that keep journalists interested. It is unsurprising that mobile businesses from dry cleaning to office storage market themselves as the “Uber of…,” because with a $41 million dollar valuation after only five years in operation, it’s obviously good to be Uber.
But then, according to a recent report in The New York Times, it’s good to be a a lot of entrepreneurs in the new mobile economy.
Same-day grocery delivery service Instacart kicked off a $100 million fund-raising round that places its value around $2 billion. Instacart is currently only available in 15 markets in the U.S. Stripe completed a $70 million round that placed its value at $3.5 billion. WeWork Companies, which provides shared office space using an Uber-like app-based model, closed a $355 million funding round that places its values at $5 billion.
None of these companies existed more than five years ago and the relationship between their revenues and valuation are not entirely clear. Uber for example is valued at $41 billion, despite the fact all that the revenue from the entire taxi industry in the United States is only about $11 billion a year. Granted Uber is international, but Uber also has some globally sized problems in the swath of nations, including the U.K. Germany, Spain and France among others seeking to block it as an illegal taxi service.
So what gives with the sky-high valuation? According The Times, it essentially comes down to an outbreak of magical thinking among Silicon Valley investors that’s overly reliant on perfect execution among innovative start-ups. This enthusiasm comes before there is adequate data about whether the actual execution resembles perfection remotely.
Magical, or associative, thinking is a notion emerged in the 18th century to explain the attribution of causal relationships between actions and events which cannot be justified by reason and observation.
Start-ups, according to The NYT, are being priced for something “almost never happens” – perfect execution.
Uber presents a good example. The investor view of Uber – what justifies the massive investment in a service that essentially can be copied by any comer (and has been, many times the world over by well-known competitors such as Lyft, as well as traditional taxi services that are firing back) – “is as a bet that Uber will be able to induce more people to take taxis, expand to ride-sharing and even replace cars.” In fact Bill Gurley, a partner at Benchmark Capital, which is an Uber investor, used this argument when critics were balking at Uber’s $18 billion valuation six months ago.
“Some interesting demographic trends are also underway that favor Uber’s opportunity in this market. First, there is the continuing trend of urbanization in America. But more importantly, America’s youth have fallen out of love with the notion of owning a car. Kids are no longer rushing to obtain their license on the day they turn 16.”
Now it is possible that Uber will be “the category killer” that justifies the big valuation, but because that view is based on unknown and presently unknowable knowledge makes valuation a challenge.
Aswath Damodaran, a finance professor at New York University’s Stern School of Business labeled by The Times “the guru of tech valuation,”, was only able to narrow the range of Uber’s valuation to somewhere between $799 million to $90.5 billion, depending on how much of the market the company could capture. He even encouraged the readers of his blog to try to come up with a more certain value.
No one will argue that Uber isn’t changing the way people use taxis. It seems certain that if they don’t manage to put themselves out of business with amateur hour antics, they will likely make hundreds of millions of dollars, if not billions.
But even Uber is not a sure thing, as antics, legal challenges, competitors and a variety of other factors will affect its actual revenue outcomes, meaning that “pricing it to perfection,” is a form of magical thinking.
And big bets on what its market share will be are eerily similar to the old “eyeball-count” valuations that were once used to justify Yahoo’s multibillion-dollar purchases of GeoCities and Broadcast.com.
Part of the problem identified by the Times piece is the “big app hunters” at firms like Facebook and Google that are driving up prices, pushing the feeding frenzy and encouraging extremely optimistic projections about value.
Even with ideas that don’t have a great track record of success. Instacart is pushing a $2 billion dollar valuation, despite the fact that Kozmo.com and Webvan were same-day delivery services that failed when the dot-com bubble burst, losing hundreds of millions of dollars. Okay, so they were different business models and a different non-mobile, non-app time in our history, but you get the point.
The article also notes that Vox Media, an Internet media start-up, closed a funding round that valued it at $380 million. Meanwhile Change.org, the online petition service, raised $25 million at an undisclosed valuation from a number of investors, including theBill Gates, Jerry Yang, and Twitter co-founder Evan Williams.
Jeff Bezos paid $250 million for The Washington Post. John Henry, one of the owners of the Boston Red Sox, paid $30 million for The Boston Globe. The Times notes “When media start-ups can raise millions just because they are new companies, rather than the old struggling ones, you know the froth has spread.”
But is the froth paying out?
Not so much, it seems.
According to Cambridge Associates, venture capital’s returns trailed the Standard & Poor’s 500-stock index by 5.4 percentage points, earning 12.5 percent a year against the S.&P. 500’s 17.9 percent.
Venture capitalists also founding themselves trailing private equity firms by an even wider margin, failing to justify the 10-year lockups and other fees that investors in venture capital funds must agree to. According to the report, only the top 10 percent or so of venture capital firms – and exclusive tier inhabited by players Andreessen Horowitz and Accel – consistently perform well.
But despite the mixed track record, VC firms continue to throw money at software for apps. According to the National Venture Capital Association more than 40 percent of venture capital’s investment so far this year was in software — mainly apps. Mostly they won’t pay, but they might, and firms afraid of missing out on the next Facebook are pricing to perfection and hoping for the best.
Some of them will no doubt get it – and make billions for their trouble. But it is unlikely if not fully impossible that so many companies priced to perfection will actually perform perfectly, meaning the widespread application of Ubernomics to the mobile economy could well leave more firms broken than enriched in its wake.