- The public markets haven’t been kind to many of the startups that have — or tried — to go public lately, such as Uber, Casper, and WeWork.
- The problem is not that public investors are souring on tech in general, but they’ve become much more discerning about what is actually a tech company — and valuing each accordingly, Bullpen Capital general partner Duncan Davidson told Business Insider.
- That differentiation is going to have big implications for the venture market — among other things, investors are going to have to re-evaluate investments, he said.
- What’s more, some of the giant startups likely won’t be able to go public and others, possibly including DoorDash, may face big hurdles to doing so, he said.
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To Duncan Davidson, there’s a simple explanation why Zoom’s stock took off after its initial public offering last year — and why WeWork couldn’t even complete its own IPO and ended up seeing its valuation slashed.
Zoom is a real technology company. WeWork isn’t.
Public investors have become much more discerning when evaluating companies that claim to be in the tech business, Davidson, a general partner with Bullpen Capital, told Business Insider in an interview this week. They’ve become less willing to pay a premium for and assign a high multiple — the ratio of a company’s valuation to its sales or earnings — to what he calls “fake tech” firms, he said.
“There were certain types of companies that were masquerading as tech and trying to demand ludicrous multiples,” said Davidson, whose firm backed such public tech companies as Zynga and Marketo. While companies such as WeWork or mattress retailer Casper may offer great products or services, he continued, they’re not tech companies and “they just don’t deserve a big multiple.”
The market’s differentiation between real and fake tech companies is going to have wide-ranging implications, he said. It’s going to force the venture industry to rethink its investments. Venture investors are going to have to take the lead of public investors and be more discerning about the kinds of companies they’re investing in, he said.
There are three kinds of venture-backed startups
Venture-backed startups can basically be placed in three different buckets, each of which is likely to have different prospects, Davidson said. There are real technology companies, such as Zoom, which offers a video conferencing service, and other software firms. Those companies are still generally highly valued by public investors, because their technology often gives them long-standing advantages that allows them to lock in years of revenue and profit growth.
In the next bucket are tech-enabled companies, such as those that offer digital marketplaces, like Airbnb or Uber. In certain cases, those companies can be great businesses, if their underlying economics are good, if they’re used frequently by their customers, and particularly if they can become the dominant player in a winner-take-all business, Davidson said. The reason Uber and Lyft haven’t done well, is because neither has been able to establish itself as the dominant player; they’re still competing head-to-head in many places, often sharing and fighting over the same drivers, he said.
And then there are the non-tech companies, of which there are lots of examples, not only including WeWork and Casper, but also, arguably, Peloton and lots of the direct-to-consumer product companies, he said. All of them were trying to tout themselves as tech companies, but they really weren’t, he said. WeWork is a real-estate company. Casper is a mattress vendor. Peloton’s products have some technology in them, but it’s really just a fitness equipment maker.
To be sure, some non-tech companies can be worthwhile investments, at least in the short term, Davidson said.
The direct-to-consumer product vendors can be much more responsive to consumer demand and desires than traditional product makers, he said. And companies like eyeglass vendor Warby Parker have built successful business by targeting markets where traditional players had huge markups on their products and underselling them.
But because they generally aren’t undergirded by any kind of unique and useful underlying technology or product innovation, those non-tech businesses tend to lose their advantages over time, because they get copied by other players, Davidson said.
The problem that the venture industry got into was that it was valuing all three kinds of companies — real tech, tech-enabled, and fake tech — as if they were all real tech firms.
“Fake tech may be good companies … but the multiples were driven to stupid levels,” he said.
The proof is in the pudding. WeWork’s valuation fell to less than $8 billion after its failed IPO from $47 billion a year ago. Casper’s went from $1.1 billion in its last private funding round a year ago to now less than $350 million as a public company. Lyft was valued at $15 billion in 2018 as a private company; public investors value it at $11 billion today, even though its revenue has grown significantly since then.
Many unicorns could be in trouble
In addition to forcing investors to think about the kinds of companies they’re investing in, the public market’s souring on fake tech companies is bad news for many of the so-called unicorns, the venture-backed startups with valuations of at least $1 billion. At least some of the unicorns — those that don’t have real tech bona fides — won’t be able to go public, he said. Others — the tech-enabled companies that don’t necessarily have good underlying economics — might be able to complete their IPOs, but they may, like Casper, have to do so only after accepting a big but in their valuations.
DoorDash’s prospective offering is one to keep an eye on, Davidson said. DoorDash is a tech-enabled company. Consumers use its app to place food delivery orders. Drivers are informed of such orders by their own app. Some restaurants use its service to take delivery orders.
But DoorDash’s economics — and those of its rivals such as Uber Eats and Grubhub — aren’t all that different from that of pizza delivery companies of the past, Davidson said. There’s not much of a technology-induced network effect or economies of scale, he said.
“I think the whole category is challenging,” he said.
Given that and how the public market is more closely scrutinizing startups and also given the market turmoil induced by fears about the impact of the novel coronavirus outbreak, the prospects for DoorDash’s IPO don’t look good, Davidson said.
“It could be a disastrous offering,” he said.
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