Can Silicon Valley ‘Unicorns’ Be Shorted?
Another stock bubble is emerging within the capital markets, largely fueled by the Silicon Valley “unicorns” that have scored sky-high valuations in recent years. The company that started by offering air mattresses in San Francisco, Airbnb, has been valued as high as $30 billion. Even more shocking is the suggestion that the ridesharing service Uber could be valued as $66 billion. Contrast Uber’s valuation with that of BMW ($60.4 billion) and and GM ($49.6 billion), companies that own assets across the globe, own copious amounts of technology and at a fundamental level, actually manufacture real things. The continued growth of these companies has led several analysts to suggest that the markets could be subjected to a massive “short,” akin to what happened with the credit default swaps that helped destabilized global financial markets in 2008. As dramatized in last year’s hit movie, The Big Short, the collateralized debt obligations that repackaged portfolios of sub-prime mortgages led to the demise of a wide range of financial institutions, from Lehman Brothers to Washington Mutual. Those few who bet against these portfolios made out big. But to put things in perspective, the tech market is financed and structured in a way vastly different from the tech boom of the 1990s. Back then, countless internet companies went public in the belief that online advertising would pay for everything and that the way goods and services were bought and sold would be revolutionized. The latter certainly proved true. The problem was that internet advertising was more of a dribble of revenue than a wave, and companies such as Amazon really did not come part and parcel of consumer culture until well after the tech crash of the early 2000s. Spooked by that history, along with financial reforms such as the Sarbanes-Oxley Act, many companies within this new generation of companies have stayed private, unless they have developed a robust business model like Facebook's. When a company remains private, employee stock options are usually illiquid. "Option" being the option to purchase stock at a set price if the company ever goes public. But some see a possibility with the changes in which stock options are rewarded and rewritten. Stock options have been a lure in signing and retaining employees for years, but they are useless unless a company is acquired or sells it shares publicly. When a big company stays private indefinitely, employees start to have a problem with these golden carrots. The New York Times has reported that stock option plans at privately held companies, including Airbnb, are being redrawn in order to let employees sell limited amounts of shares to in certain markets. One firm that has benefited from this trend is NASDAQ Private Market, which manages transactions involving privately-held shares so that these companies can manage their liquidity while allowing employees to cash out some stocks with the aim to keep them motivated and inspired enough to stay with the same company. As the Financial Times has noted, there are at least 100 privately held companies in the U.S. that have attained a valuation of at least $1 billion. Despite new ways in which the stock options of private companies are written, this is still a tough market to enter: only the well-connected and those who own or manage large numbers of assets can usually play in this market. Nevertheless, investors are still salivating over the opportunity to manipulate the securities of the likes of Airbnb and Uber. After all, those who underwrite the shares of publicly held companies are required to follow far more rules, are held to far more scrutiny and have values far more sensitive to both trends and externalities in the marketplace. That, in turn, creates an illusion that these privately owned unicorn shares are even more valuable, adding to the ongoing bubble we see. So is it still possible for investors to wreak havoc by shorting these companies? Possibly, but via indirect tactics. Erin Griffiths of Forbes, for example, has suggested going after the firms selling goods and services to these companies, especially within the financial sector. Another option, Griffith explains, is going long against the companies supposedly being disrupted, whether they are the conventional hotel chains competing with Airbnb, or the automakers and taxi medallion lenders that are vying for supremacy with Uber and Lyft. But as Quartz writer Steve LeVine points out, such tactics are also complicated. Despite all the naysaying and hopes for Schadenfreude, the unicorns like Uber are still taking in the lion’s share of venture capital, delaying their need to go public, thereby making such a scenario close to impossible. And in any event, while the transportation sector will probably not revolve around ridesharing firms anytime soon (as in how automakers redefined transportation after World War II), they are becoming more integrated. The world’s automobile companies know ridesharing in any form is here to stay, which is why GM has invested in Lyft and Volkswagen has plunked $300 million in Gett. And everyone is buying into the future of autonomous cars, from stodgy Ford to futuristic Tesla. If you are going to short the Ubers, you may need to short the auto manufacturers, too. Finally, despite fears to the contrary, Uber most likely will not rule the world: its defeat to Chinese rival Didi Chuxing in that country, and the rise of domestic competitors in other markets such as Russia and India, means that we are seeing a market that is not consolidating, but will still be remarkably fragmented. If Uber and its ilk become desperate and decide that they will go public and become vassals of the Securities and Exchange Commission, the chances are high that investors captivated by the opportunity to short those shares will be few and far between. Image credit: Aaron Parecki/Wiki Commons Published earlier today on Triple Pundit.