Uber last 3.5B$ Raise - Debt disguised as Equity? (Technical Disc.)

How to prove that there's no tech bubble through Uber's latest financing round: Uber's Series G is frequently brought in as an example of the perceived tech bubble that should be afflicting Silicon Valley and most of the startup world.

I personally don't think there such a bubble as I see Uber's 2.1B$ fundraise (than oversubscribed at 3.5B$) by the Saudi Wealth Fund as a simple debt transaction disguised as equity.

What I mean by that:
What I think is that the Saudi Wealth Fund basically said: "Take whatever valuation you want, but we are going to set a senior 2x non-participative liquidation preference". This way the sovereign fund will have a position which is not linked to performance but guarantees a nice return, risk-free. Much better than corporate bonds with the boon that the company witnesses an increase in the perceived valuation and therefore might command a higher initial share price in the case of an IPO.

Proving such a thing would show how the real valuation is lower than hugely critiqued 70B$ valuation, and that in general behind high valuation there's not a blind belief in the potential of a company but a traditional lending process.

What do you think?

Comments (29)

 
Oct 14, 2016 - 12:37pm

Creating the application itself is easy (how many ride sharing apps are there?).

The real value lies in brand and driver and user base.

Array
 
Oct 13, 2016 - 11:09pm

It's known that the way most lay people think about valuations (shares x last price) does not work for companies multiple classes of equity securities. There was a good piece on this topic from Andreeson Horowitz recently on how they mark their portfolio companies: http://a16z.com/2016/09/01/marks-offmark/.

Still, these are far from risk free. Liquidation preference does not matter if liquidation value is zero.

 
Oct 14, 2016 - 9:06am

Debt can be over valued as well. You can pay too much for debt. So I don't understand what you mean when you say "personally don't think there such a bubble as I see it as simple debt transaction." Also, preferred equity resembles debt in some areas, and resembles equity in others. This is the nature of a mezzanine security. I don't see how this is a special case. 2x liquidation preference is not unheard of.

“Elections are a futures market for stolen property”
 
Oct 14, 2016 - 11:14am

@Jec, how can Uber get a valuation of 0? ...

@esuric, the whole point of the tech bubble discussion is not that companies are giving away / paying too much for equity (or debt). The discussion revolves around the perceived over-valuation of such companies.

But, bear with me, as the liquidation preference clause doesn't rely on the good performance of the company it shows how in reality players aren't over-valuating companies, but are simply playing a different, and pretty smart, game (something that borders on hedge-fund transactions).

As for the mezzanine and the liquidation preference they are completely different. First, the mezzanine participates in the performance of the business, and second, you pay interests. A senior ?X non-participative liquidation preference assumes that at that valuation no one will invest anymore so having seniority the investors are sure that they will be the first ones to cash in (and for Uber to receive less than 7B$ in an IPO is unthinkable).

The non-participative clause simply restates the fact that they cannot participate in the distribution of the remaining capital (in a 2x scenario they will cash in 7B$ and that's it).

@pio nono No one raised more capital than Uber, Didi which comes second has raised 7.5B$ (in a mix of Equity and Debt) while Uber has raised almost 15B$ (again debt and equity).

 
Oct 14, 2016 - 1:14pm

Obviously zero is an exaggeration. My point is, even the most senior claim on the company will not get back the full amount of their initial investment if the company never ends up making enough profits to cover the capital raised so far (mostly burned on expenses, not invested in assets in Uber's case mind you).

 
Oct 14, 2016 - 11:54am

"@pio nono No one raised more capital than Uber, Didi which comes second has raised 7.5B$ (in a mix of Equity and Debt) while Uber has raised almost 15B$ (again debt and equity)."

So a mobile phone app company (which someone can make in their bedroom or on the toilet) has more paid in capital than any other company in any industry including things like petroleum, power generation, the automobile industry, massive retailers with hundreds of thousands of employees? I'm sure this will end well.

Next thing your going to tell me is that a free online survey website raised more than half a billion in capital.

 
Oct 18, 2016 - 1:43am

Pio nono:

"@pio nono No one raised more capital than Uber, Didi which comes second has raised 7.5B$ (in a mix of Equity and Debt) while Uber has raised almost 15B$ (again debt and equity)."

So a mobile phone app company (which someone can make in their bedroom or on the toilet) has more paid in capital than any other company in any industry including things like petroleum, power generation, the automobile industry, massive retailers with hundreds of thousands of employees? I'm sure this will end well.

Next thing your going to tell me is that a free online survey website raised more than half a billion in capital.

Anyone can make an app - this I agree with you. But not everyone can get a millions of drivers and passengers onto the platform. Not everyone can play with the the supply of drivers/demand of passengers as required. And Uber's surge pricing does so beautifully.

The fundamental reason players like Uber and Airbnb are valued very high is that because these marketplace businesses can drive network effects. More drivers -> higher chances of passengers finding a car near them, i.e more rides -> better for drivers - > better for passengers.

Highly recommended read: http://platformed.info/uber-network-effects/

And yes, there is an online survey tool that has raised half a billion of capital - SurveyMonkey (unless of course you knew this and were being sarcastic :) ).

 
Oct 16, 2016 - 12:49am

Not sure if trolling but I'll bite...

  1. As people mentioned before, the nature of preferred shares have both debt and equity components attached. I would say non-participating preferred are more akin to vanilla preferred equity in a more mature company's capital structure. The key here is that you don't have covenants as a preferred equity holder to really bite into the company if business operations go south. There's no forced call feature I'm assuming (maybe I'm wrong) with the Saudi investment unlike actual debt. There's basically no way to force the company to give you your money back in the event of adverse business conditions, which is one of the hallmarks of debt financing (no 'teeth' so to speak).

  2. You can get primed down the capital structure. Uber has already begun to issue leveraged loans (basically because they don't have any EBITDA; think leveraged loans are typically categorized above 4x) and convertible debt. If valuation comes down even as Kalanick and co. continue to issue debt to prevent dilution, the non-participating preferred really gets screwed. Basically the non-participating preferred is a thin stack of capital stuck in the middle of the capital structure with a real chance of not getting paid in the event that valuation plummets, while sharing none of the upside of traditional equity. Not great at all.

  3. The recent trend of venture-backed businesses staying private is concerning. Especially since Uber is still running at negative cash flow, Uber quite obviously needs to continue to tap the equity (and now debt) capital markets. Said another way: Uber basically needs to refinance quite frequently to continue business operations/expand. What happens if the capital spigot gets turned off?

  4. In terms of business valuation, I'll take your point that we shouldn't think of valuation at $70bn. But even if we mark valuation down to $50bn which is more than generous in my opinion, I still think that valuation is ridiculous. At $50bn, that's around the EV of Delta Airlines for reference. And before you start arguing that Delta is a capital intensive business etc etc, I would say any business that burned through $10bn+ in five years is capital intensive - no matter how you book that accounting wise.

  5. I really don't think that the valuation takes into account the effects of competition in the industry. We've seen price wars most notably in China and other international markets; even with less brutal competition in the US, the US segment lost $100mm in the last quarter if I recall correctly. There's very little barrier to entry in this business with anyone with a bit of capital. There's no way to lock up drivers and diminish the supply of drivers in a market. Uber in China was an inferior product (which is why I personally think they lost there); Didi sold an entire ecosystem centered around Wechat while Uber was a standalone app.

  6. Just because valuation is lower than $70bn doesn't mean that the lower valuation is fair.

  7. Having a business that changes the world doesn't mean that the business is good. Airlines changed the way we travel and made the world much more interconnected than before, no doubt. But for 40+ years, competition eroded all profits such that even the biggest airline by EV is less than Uber's valuation now - with many airlines having some stints in bankruptcy no less.

All in, the Saudi investment was far from "risk free"; no investment is truly risk free, as history has proven time and time again.

 
Oct 16, 2016 - 4:06pm

Hey Crispy thanks for the bite,
a few comments.

1&2) Agree, but:
1.1 Uber raised "only" 3B$ in debt (with a revolving credit line of 2B$);
1.2 The company will hardly raise additional equity;
1.3 It's almost impossible for Uber to raise less than 10B in the event of an IPO (everything's possible but that highly unlikely);
1.4 As they burnt 3-4B$ to date they still have a lot of cash to fund future operations, so I don't see the need to prevent dilution through new debt issuing atm.

So although preferred equity comes after debt obligations the current debt structure makes a senior liquidation preference quite safe, with the additional boon of raising the company's valuation and again, potential IPO price.

4) Just to clarify, I'm not a fan of how Uber has been valued so far, I encourage caution, I don't think that big funds and big investors are completely mental and there are many ways to protect capital, even equity from adverse scenarios, and the various liquidation preferences are one of those.

5) Again I'm not going to comment on their business model, they still have to find a solid way to monetise consistently and some studies say they will achieve profitability by 2019. There are many ways in which they could pull that off, everything depends on the timing.

6) Anyone remembers the 296x P/E ratio of Amazon? And they are not even private. There are many valuations that to my eyes are overstated but that's not the point of the post. As a matter of fact, until an abysmal valuation of some 10B$, the reasoning would work.

I totally agree on the impossibility of having a truly risk-free investment, but let's just say that differently from a liquidation that's pari passu among all levels of preferred shareholders, a senior liq. pref. with a nice multiple is much safer and much more appealing therefore justifying an otherwise unjustifiable valuation.

 
Oct 16, 2016 - 4:49pm

1.1 By my calculations Uber has raised a little less than $5bn in debt. $1.6bn convertible, $1.15bn leveraged loan, $2bn credit facility.
1.2 ...says who?
1.3 What if capital markets close in the next two years?
1.4 They just issued a leveraged loan in the last three months...

  1. Yes they are protected to an extent but I don't think that protection is anywhere near as solid as it seems.

  2. I don't know why you wouldn't comment on their business model. Their business model drives valuation. Without the business, the numbers are exactly that - just numbers.

  3. P/E isn't the right way to look at Amazon. Cash flow is better. From a cash flow multiple, they're at ~40x

- slightly less insane. The businesses are fundamentally different as well. Amazon has a lock on online retail with tremendous barriers to entry. Amazon Web Services is a top notch service. There's a lot of option value in their other ventures like eSports (Twitch is basically the ESPN of eSports, acquired at $1bn). Not the same as Uber at all. And by the way, the largest loss Amazon ever posted was in 2000, of $1.4bn; operationally, they were around cash neutral. Uber exceeded those losses in a half year.

At current run-rate losses, they'll have to come to market again in 2019 at the latest. Will they be profitable by then? Well, any business is profitable in excel. They claimed they would be profitable in developed markets this year. In the US in the 2nd quarter they lost $100mm. They also lost a huge growth engine in China. Again, I don't think this investment is safe as it seems.

 
Best Response
Oct 16, 2016 - 6:49pm

Densetsu:

Come on guys this is a PE forum not a forum on treasury notes, it's obvious that there's always some risk involved...

If you are at all representative of the mindset in Silicon Valley, then this thread is all I need to know there is in fact a giant VC bubble.

"Risk-free"..."guaranteed"..."impossible to raise less than $10B in an IPO"...

I hope you don't kiss your firm's Partners with that mouth.

Nevermind your fundamental misunderstanding of the capital structure and valuation. You point to Uber having raised mostly equity by now yet they are burning $3B-$4B of cash a year. If anything, they are going to start waving this $70B valuation at lenders and those prefs are going to get the shit primed out of them.

Here's another way of telling the story: They've raised a ton of equity capital and burn a lot of cash. Where is the next round of funding coming from? At what price? And what if they can't get it?

 
Oct 18, 2016 - 11:55am

Based on the number of ride share apps in NYC alone, it feels more like gambling and less like investing to put money into Uber. I'm certain there will be consolidation at some point, but I'm far from certain how long that will take or if Uber will be the last man standing.

Life's is a tale told by an idiot, full of sound and fury, signifying nothing.
 
Oct 18, 2016 - 3:22pm

Doesn't seem like anyone has mentioned this, but Uber is Travis and Garrett's 3rd company(ies). Both come from successful and non-successful exits. They are/were masterful with terms sheet dynamics and are well known for their investor relations tactics.

Uber is selling an Amazon play to investors; growth at all costs to corner the marketplace and continue developing a global network affect. This is what investors are buying into. Growth verse profits.

The argument against this is that:
A) Big players such as Apple, Google (Waze), Detroit and European Auto are showing up in the marketplace. Competition = expensive cash burn.
B) Ridesharing is becoming regulated and taxes are being imposed. Amazon doesn't have an "online marketplace selling license tax per" per online seller, per state. This is a superior business model feature compared to Uber.
C) Ridesharing/transportation could be the next Airline industry. Heavily commoditized with little product differentiation. Great products, experience, but no profits.

What you're seeing in the overall marketplace is a liquidity bubble. VCs/PE's/Large Funds trying to invest in companies to collect management fees, this means the ability to place large amounts of capital, and the fact that equity investors don't care a lot about debt.

1) VCs/PE/Large Funds are trying to place capital to generate fees. Only about 10% of funds make high quality returns from carry, the rest is all management fee's to GPs. The faster and more you invest = more fees.
2) Being able to invest $1B+ in a single investment verse piecing together 10 $100m investments is much more attractive. Particularly attractive if you have a $1-10B+ fund.
3) Equity investors don't care much, if at all about debt. Raise a $2B credit facility and the share priced just 3x'd last year? Sounds great to any equity investor. The reason equity investors care about debt is it affects equity ratios and multipliers which are fairly irrelevant in private markets.

Aswath Damodaran did a piece on Uber and it's financials. Worth a look:
http://aswathdamodaran.blogspot.com/2015/10/on-uber-rollercoaster-narra…

In Bill Gurley's words: "The greatest challenge as a VC in the current time is to turn paper gains into cash"

 
Oct 26, 2016 - 8:23pm

Interesting perspective. However, I'll offer the following points of caution in underestimating the risk when banking on a liq pref above 1x:

  1. While Uber will not go to 0 in all likelihood, the liq pref payout is dependent on the value to equity. The 2x is far from guaranteed, especially if you have debt above you.
  2. From past transactions I've been involved in, this structure can become a negotiation against yourself. If Uber needs to raise additional money, the next investor will come on top at the same terms, so your hurdle for the 2x increases substantially. Or, if Uber needs to raise money and has trouble doing so, existing structured investors will have to modify their rights in the interest of keeping the company going.
  3. Maybe an additional investor will take a pari passu structure. Once again, that increases your hurdle for the 2x.

Again, the thesis holds if Uber doesn't need anymore capital, and perhaps the underlying data reveals an increased chance of success, but structured liquidation preference in a late stage business is far from riskless

 
Oct 26, 2016 - 9:06pm

I'd say your assessment is wrong on many levels - like not being rude but its just a general lack of understanding of finance/valuation/capital structure/employee incentives.
1) most funding rounds have a liquidation preference - this is not unique and means nothing in regards to the bubble or valuation
2) valuation is still important because its still the hurdle that needs to be cleared beyond the liquidation preference - obviously the lower the valuation the easier it is to clear the hurdle,
3) its by no means risk free - the other funding round liquidation preferences can be pari as well as any debt that gets issued,
4) valuation effects current holders dilution, employees, etc. - hard to bring in new talent with options at the most recent valuation if your arguing the equity is worthless,
5) valuation effects future financing rounds, which ties in to all of the above points,
6) the company needs a cash flow stream to justify its valuation when real money investors get involved - if that path isn't there (price pressure, low margins, increased competition, regulation, etc.) its definielty within the realm of possibility for the company to have a very low valuation come IPO
7) regardless of uber - this one off transaction doesn't speak to the greater aspect of the tech bubble - still lots of very high valuations out there, excluding Uber, that likely aren't justified
8) low interest rate environment forces people to chase yield - as a result VCs now how more money to deploy, once rates rise and VC allocations are reduced from LPs valuations will likely come down, employees will be underwater in options leave jobs, companies go under due to lack of cash, etc. - snowball effect

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