Startup Bubble Too Big For Exit, Investors in La-La Land

Carl Icahn, whose passion it is to squeeze cash out of corporations one way or the other, is worried. Not that there isn’t enough cash left to squeeze out, but that something untoward might happen. That’s what he told FOX Business Network:

I’m not telling you this market is going to crash, going to go down next week, next month, even next year, but you have to be extremely concerned with what’s going on. I mean, consumers really aren’t spending. By keeping interest rates this low you’re creating bubbles that you don’t even know about. And I do think that sooner or later the Fed can’t just keep this market up by itself.

It’s not, will it happen? It’s when it will happen….

It would be a mega-problem for his buddies at hedge funds, PE firms, and pension funds that are plowing money into startups late in the game when valuations are already sky-high. They used to buy the IPO shares. Now they get in earlier, hoping for a pot of money at the end of the rainbow.

That exit would be an IPO or an acquisition by a math-challenged giant corporation that can use its own overvalued shares or cheap debt to buy the overvalued shares of these startups. But corporate buyers for mega-startups have become scarce. Hence IPOs.

But there’s a little problem. There are currently 65 VC-funded startups in the US with a “valuation” – in quotes because it is a rubbery concept – of at least $1 billion, according to the Billion Dollar Club. Together, their combined valuation amounts to $232 billion.

A year ago, there were 42 members in that elite club with a combined valuation of $109 billion. Within a year, their count jumped 54% and their valuation 113%.

The total valuation of all VC-backed startups reached $750 billion at the end of 2014, according to Sand Hill Econometrics, cited by the Wall Street Journal. That would be over 2.5% of total US stock market capitalization. The only other time it got anywhere near that high was in the second quarter of 2000, when it was just under 2.5%. At the time, the bubble-implosion process had already begun.

Uber now has a valuation of $41.2 billion. It’s trying to raise up to $2 billion at a valuation of $50 billion, 12 times its valuation of $3.8 billion a year ago, and about 120 times its 2014 revenue, after accounting for the part that goes to its drivers.

But at least it has real revenues.

Snapchat, the ephemeral photo sharing app used by folks who think that these messages will actually disappear from Snapchat’s servers after they disappear from their smartphones, is now in second place with a valuation of $16 billion. It is finally trying to get some revenues, after all these years of just burning cash – by advertising to teenagers.

CEO Evan Spiegel sees what this is: a bubble. He said so. Already in an email in November 2013 that became public as part of the Sony hack in December 2014, he pooh-poohed tech valuations and figured that there would be a major correction. Wrongly so far. But like Icahn, he didn’t put a date on it.

Then a few days ago, he went at it again in an interview at the Code Conference.

“I think that people are making riskier investments and … there will be a correction,” he said. “Easy money policy” and low interest rates are fueling this investment bubble, but it might not last much longer, based on recent economic indicators. When? “If I knew for sure, I’d make a lot of money,” he said.

But here’s the thing. “We need to IPO,” Spiegel said. “We have a plan to do that.”

Because: Who else is going to buy a company with such an enormous valuations and barely discernible revenues? So it’s the public. Well, mostly institutional investors that hold the public’s nest eggs. The “public” would never have to know about it.

These crazy valuations are determined by a few players behind closed doors. They make sure valuations only go up because no one in that room benefits when they’re heading down. When that starts, it’s over. Earlier investors would have to write down their investments. It would destroy the appetite for more investments. It would freeze up the money spigot. Hence the relentless push by all involved to drive up valuations no matter what.

For these investors, an IPO would be the pot at the end of the rainbow. Alas, the combined valuation of VC-backed companies now amounts to 2.5% of total stock market capitalization; the last time they tried to dump such a load of IPOs on the market – in 2000 – the market couldn’t absorb them. IPOs crashed and burned.

That’s a bloody exit. And now this happened, according to Renaissance Capital:

After a record year in 2014, the IPO market slowed dramatically in the first quarter of 2015. The 34 IPOs raised $5.4 billion, making it the least active quarter by IPO count since the 1Q 2013 and the smallest by proceeds raised since the 3Q 2011.

Half of them were in the healthcare sector, particularly biotechs. But…

Technology IPO issuance was likely dampened by the widespread availability of private funding at very high valuations, which produced little urgency for companies to seek IPO capital.

So here is the quandary: Easy money and low interest rates channel funds from all over the world into the US startup sector and drive up valuations. But now valuations are so high, and there are so many startups with such valuations, that the stock market might not be able to digest them.

It doesn’t take much to take down this magnificent top-heavy construct. And IPO shrapnel has a nasty tendency to ricochet wildly around the stock market.

Is it a sense of desperation among CEOs? Read…  Last Two Times This Happened, Stocks Crashed

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  14 comments for “Startup Bubble Too Big For Exit, Investors in La-La Land

  1. Vespa P200E says:

    I recall the IPO craze back in the late 90’s. My office was filled with the newbie lemmings following the Motley Fools and oh yeah the feeling of winning a lottery when one got their hands on some limited IPOs. Yeah motto back then for the halcyon induced valuations was that profit is for pussies or somethings.

    Roll forward 15 yrs and there appears to be less excitement over the actual IPO (and allow the openly traded shares under scrutiny of public company accounting oversight to price the company value) but ridiculous valuation based on VCs, hedge and even pension funds literally stepping on each other for private placement “privileges”. In other words people playing with other people’s money.

    We learn history so as to discount that it does indeed repeat at our own peril thinking it’s different this time.

  2. Debtserf says:

    As long there’s ZIRP this one could run and run, seeing as its all based on free monopoly money anyway.

    As with all manias, however, eventually someone will go just that little bit too far. At that point, he who gets out first gets out best.

    This time really is different though – everything is in a bubble everywhere. This bubble is so vast and interconnected that any glitch, no matter how small, could set off a chain reaction of contagion that even the central banks wont be able to backstop this time.

    • Vespa P200E says:

      “As with all manias, however, eventually someone will go just that little bit too far. At that point, he who gets out first gets out best.”

      Trouble with the private placements are that they are rather illiquid. Good luck to those who hold boat loads of private placements to unload during the times of market turmoil without losing a lot of money as there is no stock exchange per say for these instruments.

  3. ERG says:

    You want to know what/who the Black Swan is? Look no further than the Eccles Building. The Fed is going to pop the bubble when they jack interest rates. In an act of True Genius (sarc!), they waited so long to increase rates, that they have nearly no choice but to raise them right at the moment we are going back in to an official recession; not that what we’ve had the last 7 years was anything else anyway.

    • Petunia says:

      Most people think the fed doesn’t raise interest rates because they don’t want to deflate/hurt the bond market. I think they don’t raise interest rates because they suspect that no one will care. This seems to be reflected in the low volumes in most markets. Investors have no confidence in the posted rates and don’t invest at those price levels. If the fed changes the price levels(rates), investors will have to decide if they believe those levels to be correct. They might decide they are not and I think that is what is holding the fed back.

      What if they threw a party and nobody came?

  4. Michael says:


    That remains to be seen.

  5. NY Geezer says:

    The finance industry is in charge of our government, or at least the part of the government that purports to support and regulate the economy. IPOs and VCs are the creation of the finance industry and could never succeed even moderately without governmental help.

    Our financial companies are all Government Sponsored enterprises. They are all recipients of, and grasping ungrateful beneficiaries of corporate welfare and almost tax free status at the expense of the rest of us.

    The oligarchs who run these companies are much too firmly entrenched. They have been in power for much too long. They have impunity for criminal prosecution for any crimes they commit. They have become much too rich. They are able to thwart any effort for meaningful reform just as Japan’s oligarchs have been able to thwart reform since the 1990s.

    In 2008 I believed there was a chance for essential reform to restore the US economy when we elected a President who promised us “change we can believe in.” Notwithstanding the gains in the stock market our economy has not recovered much since 2008 because the financial oligarchy is blocking essential reform to feed its greed. The US economy is much weaker today than it was in 2008.

    Time may have run out to prevent a true, deep, worldwide depression.

  6. Cocoabean says:

    This is being driven by a desperate search for yield, heedless of risk and at any price. Any entity, even a no-cash-flow IPO, might provide a smidgen of yield…

    That’s the way today’s financialized world works. Entities crave that yield, need it to pay their fundholders, unitholders, pensioners, bondholders, fixed costs, payroll, whatever. The LAST thing they want to do is actually do the work and take the risk of capex.

    A debt-deflationary world is slowing, turning. ZIRP is killing the current definition of investment as “…a purchase of debt paying out an income stream” and the only way to obtain a return will once again be by the producing of real goods sold to solvent purchasers…

  7. Petunia says:

    Most of these over valued tech startups are relying on advertising revenue to grow while the consumer is tapped out. At some point companies are going to realize that they don’t need these huge advertising budgets, what they need to do is cut prices. When that happens all these startups will fade away unless they can raise revenue directly. These startups can send all the ads they want to the millennials using their sites, but it won’t translate to sales because these kids don’t have jobs, and their parents are broke too.

    • Mark says:

      I thought it’s been established for years now there is no ROI advertising to mobile devices.

    • illumined says:

      As I recall that was how a lot of dot coms tried to raise revenue in the 90’s. It rarely worked because all of that cheap investor money meant the budgets were always way bigger than the revenue could ever hope to be. Excite 2.0 anyone?

  8. WhoMe says:

    Interesting observations Petunia

  9. illumined says:

    Most tech people I’ve talked to are totally in the dark about this. When they are informed that there is a bubble they always give reasons why this time is different, my personal favorite so far was “our culture is more stable now”. Basically they don’t want to hear any of it, it’s a fascinating exercise in willful ignorance.

  10. Michael Gorback says:

    Icahn isn’t going to appear on BubbleVision and telegraph his investing ideas before he’s already implemented them. If he’s throwing this out there he has already acted on it.

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