How can 10+ year old unprofitable tech companies be worth billions?
AirBnB, Uber, Zillow, Spotify, DoorDash etc. The list goes on and on.
I get the fact that early in the game, tech companies are not going to be profitable due to investment in people and things needed to grow.
That being said, I see dozens of these tech companies that have been in operation for over ten years, and they still are hemorrhaging money. How can these companies be valued so high? I mean Spotify is 16 years old. Zillow is 15. At what point does not being profitable bring down the value of a business?
Whether you're in IB, hedge funds, private equity--we all exist to make a profit for our investors. The more profit we make, the better we are compensated. These billionaire founders of unprofitable tech companies are honestly brilliant--they had a great idea, but no profitable business plan. And even if their business never becomes profitable, they have already sold hundreds of millions worth of stock. It's crazy.
Great question. Will give my 2cents to start while I take a work break but someone else can probably give a more fulsome answer. I’m talking broadly about unprofitable software companies. The gist is that while they are unprofitable today, they have great underlying economic models. Basically, you need to look at how profitable they’d be at a slower growth rate. Most are unprofitable bcs of S&M spend to acquire customers. The one-time CAC gets paid back over the life of the customer (x years) rather than in the same year so profitability will be suppressed in early years. Scaling business also impacts margin as generally cost to serve each customer goes down as you have more. Same thing with R&D spend (again broadly). If you slowed growth (less S&M and R&D spend) and ran off your existing customer base, you’d see a big uptick in margin. The eventually slow down in growth and uptick in margin is being valued by investors. Someone will eventually pay for those profits so that gives the companies value.
Hopefully in future they make super profits. Amzn is meaningfully profitable now I believe. There was a long time of it being unprofitable. Now humongous I think. Maybe 20b a year in fcf? I haven’t really kept up to date with its numbers
Because (most) of these businesses can profitably invest in growth (i.e. you can put in a $1 and get out more), and because of that choose to burn money to do so.
In a low-interest-rate environment with cash freely available, investors reward growth.
They also are increasing the enterprise value of their companies and thus returns for their shareholders by investing aggressively in growth, new product adjacencies, etc.
Those investors are paying for things that may or may not realize one day. Put in other words, they treat those companies AS IF they are already profitable and give them that kind of valuation. Those VC investors somehow believe a certain future outcome has a significantly large probability of coming true. Think about it in a [sigma (probability * outcome)] way.
I think it's because venture capital is dumb money. I know I might get a lot of MS for this.
Venture capital is a business where you only lose a set amount of money, say $1mn; that's your limited downside. Meanwhile, when you have your exit, you have a huge upside.
Theoretically, if you are the BlackRock for venture capital, you invest in almost every single company in the world. Some will be unicorns and you reap profits. Now you are a world-class investor. It doesn't require thinking.
In the real-world, apparently most people don't have unlimited cash. However, big venture funds do have a LOT of cash. If every big name is getting in, it's probably something and you'd better get in.
Therefore, if you have a BIG ENOUGH cash pile, you don't really need to think to be in venture capital. That's my view.
There is certainly luck involved with VC but it is not "dumb money", only dumb IB analysts and value investors who can't comprehend that things that can't fit into their narrow view of the world.
Dumbest thing I've read from an IB analyst this week. This is coming from someone who was an IB analyst. Not looking down on you but come on man, how do you expect yourself to get far in financial services, and potentially an investments role, with that mindset.
I said I might get MS. Care to explain why? I’m not a smart guy, help me understand your reasoning.
Look at CAC, customer acquisition costs. Look at customer churn. Fill in enough sales and marketing expense to maintain the existing customer base size and strip out all the rest. Also strip out R&D for future product developement and you have what is often referred to as a harvest or maintenance case. The Company's are usually extremely profitable on this basis.
The story behind it is, these companies choose to not be profitable due to the growth they can achieve by continuing to burn.
Now, this does not hold true for all companies, and in general there is a stupid culture of burning cash is cool in the Valley and tech in general. The good tech investor is the one who can discern between the two.
is there even such a thing as a good tech investor
silverlake
At the PE level? Thomas Bravo, SL, Veritas, Vista Equity.
"in general there is a stupid culture of burning cash is cool in the Valley and tech in general" - check out this cringey fucking 'video announcement', i swear the whole tech/startup culture is such a turnoff to so many more normal people out there:
https://twitter.com/nasdaily/status/1415933826531053572
Thanks for sharing, such a cringey video. I'm surprised this guy is saying it for real. It sounds like a complete joke: who gave us $11M? you don't need college, Youtubers can teach you cause they're successful :)
I could only make it halfway through, that was painful.
(a) Paying for growth, (b) fundamentals aside, there is also a stupid amount of dry powder available. Tons of capital raised in VC/PE/growth that need to be deployed
This. Function of interest rates and technology -> long term deflation.
You can turn profitability on or off very quickly at most of these companies.
The key is understanding LTV/CAC and cohort economics...
Can you say more (with specific detail) about exactly what you think of when you say cohort economics? Thanks very much always enjoy your posts.
Rate of innovation has been speeding up. I read a few articles somewhere that almost half of the S&P 500 companies will be replaced in the next 10 years, and this cycle time is set to become shorter as the pace of disruption speeds up (hence exponential growth). Investors' mindsets have changed - they all want to pay upfront for the next Amazon, Facebook etc before they get more expensive down the road
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