Tech Unicorn Valuations Are a Lottery Bet, Not an Investment

I recently came across Saku Panditharatne's Bloomberg opinion piece, "Instead of Criticizing Tech Valuations, Embrace Them," and as a former equity analyst, I wholly disagree.

 

In short, no. Just no.

The stock market is not supposed to price in not yet developed novelty products—that’s the VC’s modus operandi, and that’s why they ultimately value incorrectly 99% of the time. See SoftBank and WeWork. The stock market is supposed to be a check on speculative VC valuations (which consists of basically a couple of lunch meetings and no due diligence). With fully public financials and appropriate risk disclosures, stock price is supposed to reflect current information, with some projections on the business as it stands today. When a company announces that major new product, investors price the value of that new product, and then the company’s stock price adjusts incrementally and accordingly. 

You don’t value Apple, assuming it will have an iPhone-like revolutionary product again in the future. The author speculates that “many people would put a high probability” on Apple doing exactly that—completely ignoring the fact that Tim Cook’s only successful product releases in the last 15 years have just been derivatives of the iPhone (including the watch and iPad). The author argues more money should be flowing to these innovative companies based on their creative potential to allow them to plow more into R&D (or M&A) for more new products. 

First, for a company like Apple, which has a proven history of developing/marketing/selling from products, there is an existing source of cash flow for this R&D—it’s called profits. This is the standard R&D/M&A model for nearly all industries. The author also completely ignores the $200 billion in cash/investments on Apple’s balance sheet, intended for this exact purpose. Panditharatne instead suggests Apple trading at 30x earnings is far too low. For perspective, that’s valuing Apple at their mature-ish earnings level today for thirty years out—it’s not impossible, but it’s a major leap of faith for a tech a company of its size and maturity. And as a reminder of how quickly tech tides can turn, Apple was trading at a buck per share in the early 2000s in the middle of the dot-com bubble. Lightning doesn’t often strike twice. 

Second, for a company not yet generating profits, (e.g. most of the unicorn IPOs in recent years), I don’t think they deserve more capital for new products until they prove they can get their original novelty product to work out. It’s absolutely bizarre to me that someone will look at the prospects/financials of Uber and be like, “yes, this company just needs more money and time to spread itself totally thin over a series of money-losing products, rather than just the one.” 

It’s funny. I am a staunch defender of the Powerball lottery, because I view it as an almost-free bet in exchange for a bit of boundless, irrational hope. These bets on tech unicorns are absolutely lottery bets, but it’s real money—not just $2 I would have blown on coffee anyway. 

This op-ed’s absurd rationale just reflects how insane tech valuations are today, and how people are trying to justify and encourage more of it. Yes, I mean Tesla. Who are the fools buying? It’s not just one or two retail dum-dums on Robin Hood—73% of the float is held by institutions. Institutional investors have pumped hundreds of billions into a company that hasn’t turned a real profit in its history. I take issue with Apple at 30x, but bear in mind, Tesla trades at +45x FY2024's expected earnings (forward earnings expected in 2024, notably, because again, Tesla has no historical/trailing earnings to reference). And worse, who are the fools who are buying now at $1,500/share, as opposed to earlier in the year when the stock traded around $200? I partly blame sell-side, who, rather than admit they don’t know how to value Tesla, simply adjust their price targets as the stock price climbs higher. I’d be curious to read Credit Suisse’s report which raised its price target for Tesla from $700 to $1400 on no news Friday.

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