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Dizzying pre-IPO tech values spurred by rush of hedge-fund money
[NEW YORK] A flood of money from unconventional sources has sent valuations of late-stage technology startups, including Uber Technologies and Snapchat, to levels that haven't been seen since before the dot-com crash.
Hedge funds and mutual funds that once shunned venture- style deals are flocking to the market's hottest corner, paying 15 to 18 times projected sales for the year ahead in recent private-funding rounds, according to three people with knowledge of the matter. That compares with 10 to 12 times five years ago for the priciest companies, one said.
While some of the startups may become profitable, others are consuming cash and could fail. The torrid action is spurring talk that 15 years after the collapse of the Internet bubble, the market may be setting itself up for another bruising fall.
"Some of the valuations are mind-boggling," said Sven Weber, investment manager of the Menlo Park, California-based SharesPost 100 Fund, which backs late-stage tech startups.
Companies now valued at 16 times future revenue could easily lose a third of their value in a market pullback that Mr Weber and others say may occur in the next three years. The other people asked not to be named because they didn't want to be seen criticizing competitors' deals.
Such worries have done little to cool the market. Investors' appetites have been stoked by jackpots won in initial public offerings. Among the biggest: an almost fourfold US$3.2 billion paper profit earned by Silver Lake Management LLC in Chinese e-commerce giant Alibaba Group Holding's record- breaking, US$21.8 billion September IPO. It was a quick kill for Silver Lake, coming three years after the private-equity firm's investment in the company.
Private values also are soaring. Online scrapbooking startup Pinterest Inc. raised US$367 million this month, valuing the company at US$11 billion. Snapchat, the mobile application for sending disappearing photos, is valued at S$15 billion, based on a planned investment by Alibaba, according to people with knowledge of the deal. Uber's valuation climbed more than 10- fold since the middle of 2013, reaching US$40 billion in December.
Mutual funds and hedge funds have elbowed into late rounds, both to boost returns and to ensure they can buy blocks of shares in IPOs as competition for tech offerings intensifies. Mutual-fund giants Fidelity Investments, T Rowe Price Group and Wellington Management and hedge funds Coatue Management and Tiger Global Management took part in at least 37 pre-IPO funding rounds totaling US$5.55 billion from 2012 to 2014, according to Pacific Crest Securities, a Portland, Oregon-based technology investment bank and IPO underwriter.
"Mutual- and hedge-fund dollars coming is one of the main things driving these higher valuations and larger deal sizes," said Terry Schallich, Pacific Crest's co-chief operating officer and co-head of investment banking. "You didn't used to see that before. The trend is accelerating." Investors of all stripes poured US$59 billion into US startups last year, according to Seattle-based research firm PitchBook Data, the most since the dot-com era. Late-stage companies received two-thirds of it, with a record 62 firms raising money at valuations of US$1 billion or more, almost three times as many as in 2013. About half the investors weren't venture-capital firms, PitchBook data show.
Pension money also is pouring in. Government and corporate pension funds, a key source of financing for leveraged buyouts, have reaped gains selling private-equity holdings since 2012. They are redeploying some of those profits in late-stage and growth funds, including vehicles created by early-stage venture- capital firms to meet the demand.
The growth funds of venture-capital firms, which typically avoided pre-IPO rounds of financing, joined the fray. In June, Kleiner Perkins Caufield & Byers and Menlo Ventures were among those that invested US$1.2 billion in Uber in a round of funding led by Fidelity Investments valuing the company at US$17 billion.
The venture and growth arms of private-equity firms TPG Capital and Bain Capital LLC also took aim at the segment.
"You had what were purely venture firms raising growth funds, and private-equity firms looking for growth deals," said Michael Krupka, a managing director at Bain Capital Ventures, whose group last year gathered US$850 million for its largest pool. "Public-market investors got into it. Prices got bid up way above historic norms." Waiting Longer Today's frenzy has a logic lacking in the days when waves of newborn outfits with big dreams died soon after their IPOs. Most of today's hottest names produce real revenue, are growing fast and rank among the top three in their businesses. The market's tone is more sober, the investors say.
That change in psychology dovetails with another trend: Startups are waiting longer to take themselves public.
"Investors now realize that the biggest growth and highest values for these companies typically come in years eight to 11," said SharesPost's Mr Weber, several years later than historic norms. "To maximize their returns, they are waiting to exit." Skyrocketing values in the past two years are making that game tougher to play, investors said.
By today's standards, Silver Lake paid cheaply for Alibaba in 2011 in a deal that valued the company at US$32 billion, less than 10 times sales for the previous 12 months. In 2013, TPG paid a higher multiple for Uber - a US$2.7 billion valuation equal to 27 times net sales for the previous 12 months, according to a person with knowledge of the matter. Lisa Baker, a TPG spokeswoman at Owen Blicksilver Public Relations, declined to comment on the investment.
Private valuations since then have gotten frothier, at times surpassing IPO values. In the past four months, cloud-storage service Box and Hortonworks, a data-services provider backed by Yahoo!, went public at valuations lower than their last private-funding rounds.
Some late-stage investors have struck deals guaranteeing them a return in an IPO, typically in the form of additional shares they'd get if the offering is priced below what they paid. Known as ratchets, these arrangements water down the gains of other investors who haven't yet cashed out.
When Box's IPO priced in January at US$14 a share, or 30 per cent less than Coatue and TPG had paid in July for 7.5 million shares, the firms salvaged a 10 per cent unrealized gain owing to a ratchet, according to offering documents.
Some firms that backed late-stage deals are scaling back or avoiding them. Krupka said that Bain Capital Ventures, which made several times its money cashing out of LinkedIn in 2011, is prowling for younger startups at lower values, as is SharesPost's Mr Weber. They and others said that as the number of billion-dollar startups multiplies, so have the odds that many will saddle investors with losses.
"There are typically 10 to 15 exits a year at US$1 billion or more in value," a total that has changed little in five years, Mr Weber said. "You can count on half a finger the exits at US$30 billion or more." While some said the tech market probably will fall in the next three years, there's debate over how severely. None of the people interviewed for this story expect a replay of the market's implosion in 2000 and 2001, when the Nasdaq Composite Index fell 59 percent in a year.
"We don't think the market will contract meaningfully," said Pacific Crest's Schallich.
Others aren't as sanguine, saying many money-guzzling startups are ripe for a fall.
"When the market turns, and it will turn, we will find out who has been swimming without trunks on," Marc Andreessen, a venture capitalist and co-founder of Netscape Communications Corp., said in a Twitter post in September. "Many high burn rate co's will vaporise."