July 7, 2014

$18 billion does not necessarily buy you love.

Parts of London were recently gridlocked by black cabbies (the licensed, metered cabbies who have had to pass the fiendishly difficult “knowledge” test on the geography of the sprawling city). This imitated demonstrations in other European cities.

The target of their ire was Uber, the smartphone application that electronically “hails” a driver (not necessarily licensed as a taxi driver), provides on-screen updates as to the driver’s location and imminence, and thereafter logs time and distance in order to levy a charge via the mobile phone bill. The fee varies according to consumer demand and time of day (so-called “surge pricing”). Uber takes a slice of the fee and pays the driver the rest.

Uber was recently accorded a post-money enterprise value of $18 billion: impressive even for the high-multiple, awash-with-cash financial markets we inhabit today. Uber’s fundraising is instructive in the light it shines on both new entrants to the private company fundraising market as well as on how valuations are being approached by investors.

Uber is part of the so-called “ web-enabled, sharing economy”. Like Airbnb, it allows owners of under-utilised assets (a spare room, a car) to rent them via an enabling platform. Established interests, such as cabbies in London, see their livelihoods and business models being radically and suddenly undercut by such technology. This radical change, and accompanying growth, excites investors.

Uber & New Investors

Uber recently raised $1.2 billion in fresh capital on a $16.8 billion pre money ($18 billion post money) enterprise value. Yet beyond the headline number what was most striking was the cast of investors participating in this financing round.

Historically one would have expected venture capital and growth equity investors to be the lead participants: they are experts in the technologically-driven end of private investing, having decades of experience investing in pre-revenue and emerging-revenue firms.

Yet the largest investor in Uber was not a venture capital firm, nor even one of the large growth equity funds or increasingly diverse major private equity complexes. Instead mutual fund powerhouse Fidelity Management led the round, providing $425 million of the $1.2 billion. Mutual fund and institutional powerhouses BlackRock and Wellington also participated. Providing air cover was well-known Silicon Valley venture capital firm Keliner Perkins and acknowledged growth equity leader Summit Partners (both of which took smaller positions).

The phenomenon of big public (stock market) fund managers investing in private companies is a new and growing phenomenon. Fidelity, to continue the example, also invested in Facebook prior to the latter’s IPO whilst BlackRock has invested in Turn (an online advertising firm) and data software firm Hortonworks.

Even smaller public equity groups groups are moving into pre-IPO investing. For example Mr Neil Woodford, formerly a star manager at Invesco, left the fund giant to hang up his own shingle. He raised £1.4 billion in the new CF Woodford Equity Income Fund; we understand that up to 7% of this will be earmarked early-stage/pre-IPO investments.

Why are these public stock market investors doing this? Does it represent a sea change wherein the pool of private company/growth equity investors is permanently enlarged, and all successful entrepreneurs can therefore expect higher valuations for their companies?

Some caution is required.

Fidelity and Wellington and Blackrock, to repeat the names of three firms listed above, sell investment products to the mass market. Silicon Valley, and the vast fortunes it creates, have become an object of popular fascination that far transcends the business press. The late Steve Jobs was the subject of a feature film and HBO has launched an eponymous satire focused on Silicon Valley and the tribulations of a startup seeking funding.

By participating in highly publicised fundraisings for companies with products entering mass use and mass consciousness – such as Uber – these firms seek the allied benefits of making money, generating publicity and being seen to be actively involved in the Silicon Valley “gold rush”.

Yet these giant stock market funds are focused on the reddest, hottest portion of the Silicon Valley heatmap: web-enabled applications where rapidly scalable businesses can leverage “big data”, cloud computing and smartphones. This is why Dropbox (the cloud storage firm) and Airbnb were both able to command $10 billion valuations.

“If you want to be a public company, there is no reason to wait to start talking to the big public company investors [that traditionally buy IPOs]”, Mr Andrew Boyd, head of global equity capital markets at Fidelity told the Financial Times (5th July 2014). He further noted that firms such as Uber “used to be small-cap companies, now they’re big-cap… If you are not investing in private companies, you’re missing out to a degree.”

Hedge funds have also been expanding into private equity investing, with some funds participating in literally tens of smaller technology company deals, again mainly focused on social networking, big data, mobility and other select sectors.

The unfortunate converse of this may be that that companies with less web-enabled, less glamorous stories might find that valuation fervour in Silicon Valley does not translate into great benefit to them.

As for the public equity investors currently stampeding into private equity deals, they may also (re)learn another lesson, namely that shrinking the pre-IPO discount because it is a hot IPO market may well have consequences when markets turns down. The pre-IPO discount VC/private equity investors traditionally demanded was a reflection of both the fundamental illiquidity of private investments as well as the fact that IPO windows can close rather abruptly.

For example in Europe private equity has a strong run of issuance in the first half of the year, but with the average buyout-fund backed IPO sagging somewhat over 1% since issue, investors are showing greater reluctance despite equity markets reaching towards all time highs.

When pre-IPO discounts compress, and a market correction ensues, history suggests that the private company discounts sought coming out of the correction over-compensate in the other direction. Which therefore brings us to a discussion of Uber’s valuation…

Uber & Valuations

A year ago Uber raised $258 million on an enterprise value of $3.5 billion in a round led by TPG and Google’s venture capital arm. Some months ago, buoyed by growth and publicity, Uber began talking to investors about a $10 billion valuation (seemingly to match that of Airbnb and Dropbox).

With the entrance of enthusiastic new investors (as described above) expectations inflated and the round was done at $16.8 billion – or $18 billion post-money. In another curious near-symmetry this compares to the take-out valuation of $19 billion paid by Facebook to take control of messging app maker WhatsApp. In effect Uber’s valuation soared by five times in a year.

In the wake of this transaction there was a rash of articles asserting that “everyone views Uber as overvalued. We take the contrary view, and here’s why.” The only problem with this line of reasoning was that the actual bearish views were thin on the ground and justifications for  $18 billion rather plentiful.

Uber is not alone in the market: Lyft, Sidecar and Hailo all aim to do much the same thing. Uber, however, is present in almost 130 cities and has ambitious plans to expand into parcel deliveries and other transportation-based services; it seems to be racing to become the dominant platform of this type. Being the “second” steel company is potentially a wonderful business. Being the “second” smartphone-enabled transportation platform could be the death of a company. Facebook and Myspace anyone?

How therefore was Uber valued? At a pre-money $16.8 billion it seems to command an estimated 84x – 129x revenue multiple. (Some reports have Uber generating $130 million in turnover whilst other peg it at a $200 million in sales – this amount being the percentage of total Uber fares kept by the firm.

Let’s put 84x sales in context.  A consumer-oriented company that recently went public is GoPro (GPRO-NASDAQ): the maker of helmet-top cameras beloved by a devoted clientele of skiers, surfers, climbers etc. GoPro generated just shy of $1 billion in sales in 2013 and has posted revenue growth rates over the last three years of 263% (2011), 125% (2012) and 87% last year. It trades at 47x EBITDA and 88x earnings per share (not revenues). It does so on gross margins of ~37%: much the same as those of Apple Inc.

Can one link this sort of valuation to Uber? Mr William (Bill Gurley), the well-known venture capitalist, early investor in and board member of Uber recently explained that the “rather unusually high valuation” was attributable to what certain “intelligent” investors perceived in Uber’s financials.

“From our perspective, we’re very lucky with its growth trajectory. Of all the companies we’ve been involved with, only eBay has anything like the same type of trajectory,” he said. “It is pretty remarkable and rare.”

Therefore what of eBay (EBAY-NASDAQ), the first mover in online auctions? eBay has a market capitalisation of $64 billion and an enterprise value (thanks to $7.8 billion of cash and $4.1 billion of debt) of $60.8 billion. This equates to 3.7x revenue and 12.4x EBITDA.

eBay generated $18 billion of revenue this year: double the 2010 number and up 14% from 2013. The company is projected (consensus analysts numbers) to continue to grow at 14%, reaching $23.6 billion of turnover in the December 2016 fiscal year.

eBay went public in 1998 on $30 million of revenues. It debuted near $5 billion and quickly reached a $18 billion market capitalisation. In effect the buyers of the IPO were right: eBay went on to increase revenues by 600x (a compound annual growth rate of ~49%). More problematically, buyers at the IPO managed to make 13x their money and those entering just a short while later only 3.6x – over 16 years – impressive, but the broad NASDAQ composite index has roughly doubled over the same period.

Being right about a company’s prospects for revenue growth may therefore not necessarily translate into a lockstep investment return

How could Uber’s valuation math work?

Using average taxi fares and current exchange rates it is arguable that Uber could generate an average $2 fee per ride.

If the average “Uber City” generates 5 million taxi rides per annum, and Uber expands to 150 cities, then the company could reach $1.5 billion in revenues on 750 million Uber rides.  This would require Uber to command something like 1/4 of the taxi market in the US and Western Europe. (By way of context, the New York Times reports that average citizen of London or New York spends ~$240 per annum on taxis; under the Uber pricing model this would yield an estimated $24 per person to Uber.)

eBay has a 30% EBITDA margin. Applying this to Uber’s prospective revenue base would yield EBITDA of $500 million.  A $16.6 billion pre-money valuation equates to a 33.2x notional EBITDA multiple: below GoPro’s current valuation, but not enormously so given that Uber is private, its shares illiquid, and the regulatory environment uncertain (Uber does not own the cars, is not responsible for their maintenance and has yet to fully clarify the consumer safety and protection aspects of the business model).

On the other hand, an early investor in the company, Mr Shervin Pishevar, calls Uber “digital mesh – a power grid which goes within metropolitain areas… after you have that power grid running, in everyone’s pockets, there’s lots of possibility of what you could build…”

Whether or not Uber’s valuation does play out as the bulls would hope is perhaps secondary to the observation that this does not provide a valuation umbrella for all successful, fast-growing private companies, let alone all technology companies. The valuation attached to Uber is specific and tightly related to the global scalability and network effects of consumer-facing, smartphone-enabled businesses. Not every company can command this type of valuation.



This document does not constitute an offering of securities.  The authors believe that the information contained in this presentation was accurate and gathered from sources believed to be reliable at the time of writing. No representation or warranty is given as to the  accuracy of  information contained herein.