Unicorns aren't so beloved anymore
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.