As much as I like Amazon and admire Jeff Bezos, I believe Amazon’s
success (combined with the zero interest rate policy of the Fed) kicked off a
type of thinking that, in my view, has now led to a bubble in Venture Capital
and some areas of publicly traded tech companies (though not all; notably
Google, FB are highly valued but within fair zone, Apple even has a bargain ‘multiple
and growth combination’). Amazon was the initial (and possibly the only
surviving) pioneer of this idea which took root in the late 90s and generally
goes, "We are investing for the next
50 years, hence, earnings don't matter, we are building scale, gaining first
mover advantage, profits will come later, we are plowing all our earnings into
growth investments, etc.” It might be true for Amazon. But, as always,
first the pioneers, then the imitators.
What has happened is that today this logic gets thrown
around by every newly formed highly valued company as an excuse for losses
(witness Softbank's grand 300-year plan and its investees equally grand losses).
It's almost as if profits are anathema for a company with a big plan and grand
dreams. Exhibit A: Uber, Lyft, WeWork, Slack, Spotify, Square, Shopify, etc.
What started off with the companies has now been seized upon by investors to
justify buying something (anything?) that they want to buy. The scooter
companies (Lime, Bird) are the latest, but by no means the only, examples.
Bird's latest valuation is $2 billion as of June 2018 funding....compared to a
March 2018 valuation of... $300 million. So a 6.6x in three months. Uber
invested in the rival to Bird, called Lime, and bought another scooter company called
Jump. So unicorns investing in unicorns, all without profit. It started with a
good idea but, in my view, we are now squarely sitting in the crazy territory
where anything goes. The rationales given for losing money can even be made to
sound legitimate to those only paying casual attention, to those blinded by the
possibilities of high returns (drawing, of course, from the bottomless well
that is past returns), to those who have not studied history, and to others who
desperately want to believe. As an
example, see this explanation of their investment strategy given by Softbank's
investment professionals (http://fortune.com/2018/07/17/softbank-vision-fund-capital-investment-strategy/).
Softbank not only justifies large valuations on companies with gargantuan
losses, but also believes that putting more money into a loss making company
actually serves as a competitive advantage (which strikes me as bull market
thinking). Since only companies with large losses need large external capital
raises, theirs seems to be a roundabout way of saying the more money you lose
the better!
I think it's a great case study of social proof, commitment
tendency, and authority principals at play. At the extremes, investors even
WANT to be fooled, i.e. they might agree it's not okay to just focus on DAU,
MAU, subs, etc. but as long as everyone else is focused on it, they might feel
that's what the company should do so that the stock/valuation can go up
quickly.
There is no basis in history that would allow engaging in
this type of behavior without penalty. Examples include the Nifty Fifty of the
late 60s and early 70s, the 1999 tech bubble, and others. If history remains a
faithful guide and laws of mathematics (particularly time value of money)
remain in place, there is every reason to expect that new investors will learn
old lessons again.
In the next post, I take a specific investment to further
illustrate this point.
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