Uni­corns aren't so beloved any­more

The Pak Banker - - OPINION - Matt Levine

THE way a bub­ble works is, peo­ple get en­thu­si­as­tic about a thing, so they buy a lot of it, and its price goes up. Then peo­ple re­al­ize the price is too high, so they sell a lot of it, and the price goes down. All of your fa­vorite mar­ket things -sup­ply and de­mand, buy­ers and sellers, the price mech­a­nism -- get a work­out. It is a good time, un­less you bought the thing near the top.

To­day's Wall Street Jour­nal has a ter­rific story about how mu­tual funds that bought stakes in large closely held tech­nol­ogy com­pa­nies are now writ­ing down some of those stakes: Black­Rock Inc., Fi­delity In­vest­ments, T. Rowe Price Group Inc. and Welling­ton Man­age­ment run or ad­vise mu­tual funds that own shares in at least 40 closely held star­tups val­ued at $1 bil­lion or more apiece, ac­cord­ing to se­cu­ri­ties fil­ings an­a­lyzed by The Wall Street Jour­nal.

For 13 of the star­tups, at least one mu­tual-fund firm val­ues its in­vest­ment at less than what it paid, the Jour­nal's anal­y­sis shows. Those firms are valu­ing the 13 com­pa­nies at an av­er­age of 28% below their orig­i­nal pur­chase price. One way to read this story is that there was a uni­corn bub­ble and it popped. But it has played out, as it were, with­out mar­kets -- or at least, with­out mar­ket trad­ing of those uni­corns' shares. (At least, on the way down.) In­stead, the mu­tual funds' port­fo­lio man­agers got en­thu­si­as­tic about uni­corn shares, so they bought a lot of them, and their prices went up. And then the mu­tual funds' val­u­a­tion com­mit­tees re­al­ized that the prices were too high, so the prices went down. Sell­ing wasn't re­quired: The com­mit­tees just de­cided on the price, and that was the price.

I mean, it wasn't ex­actly the price. A mu­tual fund val­u­a­tion com­mit­tee's de­ci­sion that, say, Zen­e­fits is worth 30 per­cent less than it was a few months ago doesn't nec­es­sar­ily mean that any­one bought or sold shares at the new lower price. But in other ways, those num­bers re­ally are per­form­ing the func­tions of a price mech­a­nism. For in­stance, lower "prices" are telling in­vestors to al­lo­cate less cap­i­tal to uni­corns: No U.S.-based, ven­ture-backed tech­nol­ogy com­pa­nies have gone pub­lic so far this year. Last year, 16 such com­pa­nies had IPOs, down from 30 in 2014. Their shares had fallen more than 30% on av­er­age as of mid-Fe­bru­ary. The suf­fer­ing stock mar­ket is likely to keep the IPO pipe­line shut to com­pa­nies that pre­vi­ously raised cap­i­tal at lofty val­u­a­tions and don't want to go pub­lic at a lower price.

And the big mu­tual fund com­pa­nies in the story -- Fi­delity, T. Rowe Price, Black­Rock, Welling­ton -- are them­selves mak­ing fewer startup in­vest­ments than they did in pre­vi­ous quar­ters. The reg­u­lar work­ings of the price mech­a­nism are un­nec­es­sary: You don't need buy­ing and sell­ing; pure ab­stract con­tem­pla­tion by com­mit­tees at in­vest­ment firms is enough to cre­ate a mar­ket price. Econ­o­mists have long de­bated how prices could be set and re­sources al­lo­cated by a cen­tral plan­ner with­out the use of mar­ket mech­a­nisms to sig­nal de­mand. This is called the so­cial­ist cal­cu­la­tion prob­lem, and it is pleas­ing that lat­estage uni­corn cap­i­tal­ism has solved it.

I mean, I kid, a lit­tle. Th­ese prices are based on mar­ket trans­ac­tions. Just not trans­ac­tions in the uni­corns' stock:

Fi­delity has cut its val­u­a­tion of Mon­goDB in eight of the nine quar­ters since Fi­delity made its in­vest­ment in De­cem­ber 2013, valu­ing the shares 58% below what it paid. The soft­ware firm's rev­enue roughly dou­bled to about $100 mil­lion last year, ac­cord­ing to a per­son fa­mil­iar with the mat­ter.

But the com­pany's last val­u­a­tion of $1.6 bil­lion is a larger mul­ti­ple of rev­enue than at pub­licly traded com­pa­nies such as Hor­ton­works Inc., where rev­enue has been grow­ing at a sim­i­lar rate. Hor­ton­works's price has fallen even as its rev­enue has grown, and Mon­goDB is, in the ab­sence of a pub­lic trad­ing mar­ket, just a math­e­mat­i­cal trans­for­ma­tion of Hor­ton­works. This shouldn't seem too weird: Pub­lic stocks, too, of­ten be­have like math­e­mat­i­cal trans­for­ma­tions of each other, as trad­ing al­go­rithms based on his­tor­i­cal cor­re­la­tions per­pet­u­ate those same cor­re­la­tions. The pub­lic stock mar­ket is a very high-pow­ered cal­cu­la­tion mech­a­nism for work­ing out those math­e­mat­i­cal re­la­tion­ships, but if you can't use the mar­ket, a spread­sheet will prob­a­bly work.

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