Part Deux – In Which I Continue My Rant On Valuations
The other day, I penned my thoughts about private equity. Amplifying on that theme, there are a lot of unprofitable companies out there funded by private equity or venture money, with multi-billion dollar valuations. Oh yeah? Sez who?
Apparently only the people who hope to make a spectacular profit through an IPO or being acquired by another company or equity group.
I used to sell companies for a living. When I started, the “formula” was a very simple 2.5 X gross revenue for the most attractive profits. Over time, this switched to 5 X EBITDA, then 10X EBITA, then 5X projected EBITA five years out.
A lot of today’s multi-billion dollar valuations are based on those same kinds of hyportheticals; if company “A”, does XX in revenue, they can expect to bring XX to the bottom line, thereby justifying a XX valuation.
Expect projections rarely happen the way analysts and financiers predict, there are two many variables they don’t have control over – new technology, new competition, regulatory problems (as in the case of Uber and AirBnB for example).
If part of the equity or venture investment is in the form of debt, that pokes another hole in projections.
An investor’s only hope (and I admit it seems to work) is getting the high valuation, and cashing out a portion of one’s holdings immediately afterwords, obtaining an immediate (silly-sized) return while waiting out the long run.
One of the thing that makes me giggle the hardest is a number of these “hot companies” not only don’t MAKE anything, but they don’t really provide a real service, either. In the midst of a growing “sharing economy” (again, sez who?) these companies make their money off of the sweat of others, and just take a percentage. Middle men. Hardly ever a justification for middle men to exist. I know, I’ve spent a lot of my career as a middle man.
Valuations that extend past a reasonable multiple (determined by the ability to repay the entire “purchase price” on a reasonable basis, as if the investment was debt, are just damn silly.
While I’m alone in the forest crying out about this…….can you say “bubble?” “BIG BUBBLE?” Be prepared.
Has it really been so long that people don’t remember Webvan or Pets.com? Apparently.