Uber’s bumpy IPO raises questions on startup valuations

The Uber Technologies Inc. application is displayed in the App Store on an Apple Inc. iPhone in an arranged photograph taken in Arlington, Virginia, U.S. on Monday, April 29, 2019. Photographer: Andrew Harrer/Bloomberg

Entrepreneurs have to be good storytellers. From the first seed round of funding to each subsequent capital raise, there’s value in having a distinctive and compelling story. So, funding pitches are often laced with exaggeration, half-truth, and public relations spin.

A well-told story with strong emotional appeal, the right delivery, and repeatability can have a hypnotic effect on people. A classic example is the unbridled rise and calamitous fall of health technology startup Theranos, whose charismatic founder Elizabeth Holmes was known as a “consummate pitchwoman”. She racked up a $9 billion valuation but was later charged with “massive fraud” as her technology claims proved to be hollow. This fake-it-till-you-make-it mindset goes for a toss when you are gearing up to take your firm public. The story-telling remains important, but exaggeration and half-truth have to be replaced with data-backed conclusions and forecasts.

Stories are important as they build narratives that drive valuations. In his book Narrative And Numbers, valuations guru Aswath Damodaran talks about the 3P test for business stories—whether it’s possible, plausible and probable.

It’s small wonder then that Uber (which is no way a Theranos) explicitly stated that it does not know when it is expected to turn a profit. Uber pitched the initial public offering (IPO) as a once-in-a-generation opportunity: a chance to back a business with the potential to transform mobility. However, burning through $2 billion in cash a year in the second decade of its existence seems outlandish by any standard. So, it chose smart positioning, likening itself to Amazon rather than Google, because Amazon was unprofitable when it went public. Also the way Amazon transformed retail, Uber did with transportation.

Clearly, the underwhelming performance of the Uber IPO is an indicator that the markets were not convinced about the story. As shares slid, posting a 7.6% loss in its market debut, the biggest first-day dollar loss in US IPO history, it became increasingly clear that investors were looking for something more fundamental: the building of a sustainable and profitable business. Uber could only muster a valuation of about half its peak private valuation ($120 billion). Its IPO verdict is the ultimate report card of the dissonance between private markets and public markets.

Each era of tech has its defining IPO: Google (rebound of consumer internet after the dot-com crash), Facebook (rise of social media), and Alibaba (China’s internet powerhouse on the world stage). Uber was one of the most anticipated IPOs since Facebook, and the defining IPO for unicorns. The challenge with any category-defining IPO is that it can make or mar it. To be fair, a first-day pop is not necessarily a guide to the future, but the IPO tested some assumptions and will have implications as we go forward. I look at just two for now:

Staying private longer: The rise of unicorns is a hangover from the last recession—low interest rates, cheap lending, and a huge amount of money still washing through the financial system, with money begging to go somewhere. Such a “gold rush” has essentially meant that startups were able to stay private much longer, fuelling this new ecosystem of opacity. Both Amazon and Google were about three years old when they went public, while Uber is in its second decade. Amazon’s annual loss was reportedly around $3 million a year on less than $10 million in annual sales. Uber managed to stay private much longer with huge losses. “Companies may not be able to chase growth at all costs and will have to explore public markets earlier than later,” an investor tells me.

Platformania: The Uber IPO has also thrown wide open some questions on the defensibility of platform businesses. According to Richard Waters in the Financial Times, Uber’s bumpy IPO has been a “pointed reminder of both the power and the limits of digital platforms. While Uber has benefited from clear network effects—it also exhibits one of the most common mistakes made by would-be platform operators, failure to price effectively. In Uber’s case, the subsidies have come on both sides, and there is no end in sight to the oceans of red ink.” It’s often easier for a digital platform to achieve scale than to sustain it.

Investors are also discussing the effect of the Uber IPO on home-grown rival Ola. Will it become more difficult for Ola to raise capital as investors are now wary of ride-hailing? At the same time, let’s not forget that Uber raised $8 billion in primary money this IPO. That’s a lot of firepower. If it can convince investors that leadership in markets like India is important, then it will become difficult for Ola. On the other hand, if Uber pushes towards profitability, Ola can breathe a sigh of relief.

One can only hope that the storytelling and founders’ claims of billion-dollar valuations—often like the boy who cried ‘wolf’—will settle for some time.

This article was first published on livemint.com