In last quarter’s issue of Portfolio Valuation we raised the issue as to whether public market investors are more critical (or discerning) in establishing value than private equity investors. The evidence this year largely is, yes—at least for companies where there is skepticism as to whether meaningful profitability can be achieved.
Lyft, SmileDirectClub and Uber are examples of unicorns that saw share prices marked sharply lower after the IPO (Lyft, SDC) or during the roadshow (Uber); and The We Company’s planned IPO never occurred due to pushback by investors. At the other extreme is Beyond Meat, which as of early October had risen about six-fold from its May IPO.
The We Company’s (formerly “WeWork” and will be refered to in this article as WeWork) valuation journey is interesting (maybe even fascinating).
WeWork, which was founded in 2010, is a real estate company that signs long-term leases for pricey real estate that it refurbishes then releases the space short-term. The company describes itself somewhat differently as a “community company committed to maximum global impact.”
The S-1 disclosed not only massive losses, but also significant corporate governance issues. Year-to-date revenues through June 30, 2019 doubled to $1.5 billion from the comparable period in 2018, but the operating loss also doubled to $1.4 billion. EBITDA for the six months was negative $511 million, while capex totaled $1.3 billion.
That is a big hole to fill every six months before factoring in rapid growth to be financed. Cash as of June 30 totaled $2.5 billion, while the capital structure entails a lot of debt and negative equity.
From a valuation perspective, WeWork is problematic because operating cash flows are deep in the red with little prospect of turning positive anytime soon. Nonetheless, the increase in value private equity investors placed on the company was astounding.
The company pierced the unicorn threshold in early 2014 when affiliates of JPMorgan invested $150 million in the fourth funding at a post-raise $1.5 billion valuation. T. Rowe Price and Goldman Sachs invested $434 million in late 2014, which resulted in a post raise valuation of $10 billion.
The 7th and 8th funding rounds are where the valuation really gets interesting. In August 2017 SoftBank Vision Fund invested $3.1 billion, which implied a valuation of $21 billion. SoftBank Group Corp., which sponsors the Vision Fund, invested $4.0 billion in January 2019 at an implied valuation of $47 billion.
When the underwriters were forced to pull the plug on the IPO the targeted post-raise valuation reportedly was $10 billion to $15 billion—a value the company apparently was willing to accept because it needs the cash.
We do not know exactly how private equity investors valued the company. Presumably discounted cash flow (DCF), guideline public company and guideline transaction methods were used, perhaps overlaid with a Monte Carlo simulation.
The valuation history raises an important question: how was a stupendous valuation achieved in the private markets by a cash incinerator such as WeWork? A similar question could be asked about many high-profile PE-backed investments.
The short answer is that Softbank thinks the valuation increased significantly even though the company’s fundamentals argue otherwise.
Prospective investors such as the public ones who were offered WeWork shares in an IPO could prepare their own DCF forecast to value the company. They also could examine past transactions in the company for relevant valuation information.
Likewise, they could examine capital transactions in similar companies. Both sets of data fall under the guideline transaction method.
A transaction in a privately held company infers a meaningful data point about value to investors, but there are a couple of caveats. One is an assumption that both parties are fully-informed and neither is forced to transact. Great values were realized by those willing to buy during the 2008 meltdown because there were so many forced sellers that ran the gamut from levered credit investors forced to dump bonds to the likes of Wachovia Corporation and National City Corporation. The price data was legitimate, but many sellers faced margin calls and had to dump assets into an illiquid market. Is the valuation data relevant if “normal” market conditions prevail?
The second issue relates to private equity valuation generally, but especially those where start-up losses and ongoing capital requirements can be huge. The valuation issue relates to using transaction data from investments in other money losing enterprises. Is it always valid to apply multiples paid by investors in a funding round of a money-losing business to value another money-losing business? The valuation data may be factual, but it may be nonsense when weighed against the business’ operating and financial performance.
One can question Softbank’s motives. Did Softbank need a higher valuation to offset losses in other parts of the portfolio in order to maintain investor and lender confidence? Was a higher valuation necessary to support upcoming capital raises? We do not know, but prospective public investors were dismissive of Softbank’s valuations and they appear to be dismissive of the prior two raises given how low the price talk had fallen by the time the IPO was pulled.
We at Mercer Capital respect markets and the pricing information that is conveyed. The prices at which assets transact in private and public markets are critical observations; however, so too are a subject company’s underlying fundamentals, especially the ability to produce positive operating cash flow and a return on capital that at least approximates the cost of capital provided.
Mercer Capital can assist with the valuation of your portfolio companies. We value hundreds of debt and equity securities of privately held companies every year and have been doing so for nearly four decades. Please call if we can assist in the valuation of your portfolio companies.
Originally published in Portfolio Valuation Newsletter, October 2019.
Jeff K. Davis is the Managing Director of Mercer Capital’s Financial Institutions Group. The Financial Institutions Group works with banks, thrifts, asset managers, insurance companies and agencies, BDCs, REITs, broker-dealers and financial technology companies. Prior to ...
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