In Depth

For Unicorns, Valuations (Eventually) Trump Hope and Hype

If 2015 was the year of the unicorn, 2016 may be the year the wings come off the horse. Here’s why private firms may stay private amid froth, and why investors may ultimately lose out.

The unicorn – that fabled beast of real and implied market capitalization of $1 billion or more – dominated the headlines in payments and FinTech this past year. Certainly the riches that leave VCs and company founders breathless with anticipation, along with retail investors clamoring for a piece of IPOs, makes for good copy in the financial trade press.

But looking beyond the hype and the hope, what’s left? A growing pantheon of private companies that have lots of technology but little to show in the way of profits. The key is that profits ultimately win out and are the yardstick by which solid projections can be made, not just by investors, but the companies themselves, moving forward.  

Some reports peg the number of privately held startups at the $1 billion demarcation point at more than 140 companies. That’s quite a roster.  

But there’s a tell in the transition between private to public, a bridge that has been seeing less traffic. Overall, noted Renaissance Capital, which tracks IPOs, there have been roughly two dozen tech IPOs in 2015, which is far outpaced by 2014, where 55 companies within tech went public. And amid the high-profile busts: Square, at least initially, which priced below its IPO range. And there were also a few writedowns, where huge investors (with lots of clout) marked down their holdings in Dropbox and Snapchat last month.

Consider at least one pairing: Stripe and Vantiv. On the former, what does it say about investors’ mindsets when a company with not even a publicly disclosed top line gets a mid-single digit billion dollar valuation? It says that hope and hype trump knowledge. What does it say about the market when Vantiv, a company that has real numbers in place with billions of transactions worth billions of dollars gets a valuation only a few billion dollars above Stripe? It says that reality is, well, ho-hum.

Consider this a warning, as even First Data, among the biggest IPOs of the year, trades at, or around, its offer price, and this is despite the existence of a real business (trading at 1.7x sales, a favorite metric of the Street, whereas peers trade at 6-7x that), and while growing quite a bit more slowly, has the leverage to throw off both earnings and cash flow. These are important numbers in an environment that is going to see rising rates – right around, oh, now. Why? Rising rates mean that funding will be tougher to come by and that investors will demand a premium over what they can get in the open market for their dollars … so the onus will be on companies to be ever more judicious on just how they plan to return cash to holders, especially those who get in on the ground floor.

 The overarching theme here is mismatch: between what people imagine the sky may impose as a limit (which is, of course, none) and what the numbers foretell. The businesses that show black ink are not as sexy as the ones where spreadsheets can tell some fanciful tales. But clearly the anemic pace of IPOs and the prevalence of busted IPOs shows that the markets – both public and private – are ultimately weighing mechanisms, giving proper credence to reality – and unicorns may fall to earth.

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