This has been one heck of a phenomenon to observe as it climbs relentlessly from one level to the next, and each level seems to be so out of whack and so crazy that no crazier level would ever seem possible. And just then, it jumps to an even crazier level.
In January, it was online storage provider Dropbox. In a deal decided behind closed doors, a group of Wall Street firms and VC funds decided to chip in up to $250 million, and with that stoke of the pen, they multiplied its “valuation” 2.5 times, from $4 billion to $10 billion, “according to unnamed sources” that routinely leak this stuff to the Wall Street Journal. It’s all part of the hype.
I wrote at the time: “With that same stroke of the pen, they also jacked up the future valuations of all other startups, and many more billions will be made – just like Twitter’s IPO helped jack up Dropbox’s valuation [How to Manipulate the Entire IPO Market With Just $250 Million].
Then things got even crazier. In March, it was leaked to the Wall Street Journal that apartment-rental site Airbnb was raising $500 million in its seventh round of funding. During the negotiations, it was decided to give Airbnb a valuation of $10 billion, up from $2 billion in 2012. This new valuation exceeds the market capitalization of mega hotel chains Wyndham Worldwide ($9.4 billion) and Hyatt Hotels ($9.4 billion).
We’re “not in a normal valuation environment,” explained VC Fred Wilson at the time. And there was a reason: central banks. “They have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis….”
This tsunami of cheap money made those with access to it close their eyes and take huge risks and do the craziest things because yield has been reduced to microscopic trace elements. He concluded, “It’s been a good time to be in the VC and startup business, and I think it will continue to be as long as the global economy is weak and rates are low.”
So in late August, “people with knowledge of that matter” whispered to the Wall Street Journal that Kleiner Perkins Caufield & Byers had decided to sprinkle up to $20 million into message-app maker Snapchat, a tiny amount for this huge VC firm, for a minuscule portion of ownership. In this manner, Snapchat’s valuation has been multiplied by 5 since last November: from $2 billion to $10 billion, and it created $8 billion in new paper wealth by a few strokes of the pen [read…. Pump and Dump: How to Rig the Entire IPO Market with just $20 Million].
And now it gets even crazier. These “people familiar with the matter” that keep popping up told the Wall Street Journal in another masterful stroke of hype that Airbnb “has met with investors to discuss an employee stock sale that would value the apartment-rental site at about $13 billion.”
In this deal, Airbnb is playing the middleman between employees and investors. That kind of “secondary share sale,” decided behind closed doors, would not raise any money for the company. It would just be a way for employees to dump some of their shares. And thus, with another stroke of the pen, but this time without raising any money – not $250 million and not $20 million, but zilch – the company inflated its own valuation by $3 billion, or 30%. Why go public if it’s this easy to create $3 billion in paper wealth in a totally controlled manner?
No matter that the company’s business model has gotten tangled up in a legal thicket. For example, in New York, attorney general Eric Schneiderman’s report found that 72% Airbnb rentals “appear to violate New York Law” and that operators likely owed “millions in unpaid hotel taxes from private short-term rentals.” Most of the units are in expensive Manhattan neighborhoods. And it’s turning into big business: over 1,400 commercial operators – the largest one with 272 units – generated 36% of the reservations. Some of the units were essentially illegal hostels.
Even with those legal challenges to Airbnb’s core business model still unresolved, the “secondary share sale” would raise its valuation to $13 billion. In this game, the actual amounts changing hands are small in relationship to the valuation. These “people familiar with the matter” cautioned that exact details haven’t been nailed down. While the secondary share sale could amount to only about $50 million, it would raise the valuation by $3 billion.
The idea is to ratchet up the valuation in large increments with small amounts of actual money and in the process create hype and hoopla long before any financial information about the company is known to the public. Mystique builds. More money piles in. As long as the new money is assured that the next round will be even crazier and generate fat paper gains for the old money, the game continues.
And each time a valuation is jacked up, it provides fuel for the valuations of other startups. There is no upper limit as long as this minutely orchestrated game can be nurtured with new money. This requires the prospect of an even crazier exit at the other end, such as an IPO at an outright silly valuation or a corporation that can print enough of its own shares to buy whatever it wants regardless of how crazy the price – equations that work only in an environment of cheap money and endless hype.
But when all this liquidity evaporates, as it tends to do very suddenly, the whole scheme comes tumbling down. Those companies that operate in a profitable manner with sound business models will survive and thrive, if at more realistic valuations. Most of the others will fall by the wayside. VC firms will do fine in this process. They usually do. But their fund investors, and those with these post-IPO shares in their conservative-sounding mutual funds, well, they might have to kiss some of their money goodbye.
Amazon, a star of the prior tech bubble and one of the survivors, has become a master at its game. So what’s wrong with it? Here is the most self-explanatory and ridiculously clear chart that simply says it all. And it’s one ugly dude. Read… This is the Most Self-Explanatory, Ridiculously Clear Chart About Amazon I’ve Ever Seen