tl;dr Private markets distort valuations because there are only bulls setting prices
Uber is down nearly 20% from its IPO with Lyft down over 30%. Someone must surely be to blame! Did the bankers give bad advice? Were the managements too greedy holding out for the best price? Did the media fail to generate sufficient retail froth?
What Really Happened
Maybe those explanations have some credence but the bigger issue is there was pent up demand to short the stock. Per Bloomberg, after three days of trading, Uber already has 11% short interest. This will likely keep rising as Lyft is 62% shorted!!! The cost to borrow Lyft is 14%! There is a lot of short squeeze risk there yet the bears are not deterred.
Lyft and Uber are far from the first controversial names to IPO and attract a lot of shorts. Some names retain large short interests for a long time. Tesla is still around 30%.
The Perils of Private Ownership
However, there is one big difference between Uber and Tesla. Tesla has been public for nine years while Uber stayed private.
While there are many good things about private ownership, it is not meant to be a permanent condition. Markets enforce discipline that is often lacking when ownership is confined to true believers.
The Math Problem
It also creates valuation distortions. If you have a business with a binary outcome, a bull might think it’s worth $100B and a bear worth $0. If they trade with each other, the market should clear around $50B.
On the other hand, if the bears have no mechanism to express a view, then only the bulls will buy and it will be valued at the $100B best case (or $76B in the case of Uber’s last round).
Venture capital, especially when it comes to these big “unicorns” (and when the Softbank polyannas are involved), is inherently optimistic. There is clearly a winner’s curse element where, for the next round to be done at a higher price than the last, they need to find an even more optimistic investor. If it takes 99 no’s for every yes, that one yes sets the new “clearing” price.
Compare that to Tesla which has been fighting shorts since 2010. Tesla has a $40B market cap. If they had been able to stay private until now, does anyone doubt they would have come public today at $80B too?
But There Have Always Been Overhyped IPOs…
Yes, that is true. The difference is in the past companies were going public far earlier in their lifecycle. Thus, the drift between “fair market value” and “private value” didn’t have as long to compound and reach such extremes.
Tesla came public in 2010 before the model S launched. It’s market cap was $1.7B. As mentioned, it is now $40B. If Uber came public at the same point in its cycle, it probably would have been around the time UberX launched over five years ago. Instead, they waited and waited continuing to exploit a one-sided market where it only took one yes to get another record valuation.
Hey, This Reminds Me of Bitcoin!
Very good observation! A big part of the reason for bitcoin’s hyperbolic ride in 2017 was there was lots of automatic buying and no way to short it. Bitcoin peaked 12/17/17. What else happened that day? It was the debut of bitcoin futures. In other words, you could finally short bitcoin! This is no coincidence!
So Should I Buy the WeWork IPO?
Umm, no. Definitely not.
The Broader Lesson
Don’t trust prices that aren’t set freely. I won’t get into a whole spiel about why short sellers are necessary but there needs to be the ability to both buy and sell. Markets with restrictions on trading terms send false signals.
This is about more than financial instrument prices. It applies to any good that is subsidized (hello, college education). It explains why single payer healthcare isn’t optimal (no ability to find a market clearing price). It explains why our current private payer healthcare isn’t optimal either (can’t choose level of service based on price vs. quality tradeoff).
Frankly, suboptimal markets also explain most financial mischief that occurs. Generally, people are exploiting loopholes that get created when the true value of something is artificially suppressed (or inflated).
BONUS CONTENT: NBA Predictions
Back at the NBA trade deadline, I made quite the long shot prediction. I said the Pelicans would win the draft lottery and get Zion Williamson to entice Anthony Davis to stay.
Unfortunately, this blog started after I made that prediction, so I don’t have any evidence, but there were some people I texted at the time so the proof does exist elsewhere!
My logic was the NBA, whether through divine will, David Stern’s will, or just peculiar luck, tends to reward teams who lose their stars. It happened multiple times in Cleveland. It happened with New Orleans after they lost Chris Paul (that’s how they got Davis!). It was going to happen again because of Davis.
I also have some pretty left field free agency predictions for the summer so I figure I might as well get them immortalized in the ether for future reference.
Players staying: Klay, Butler, Russell, Harris, Middleton
Kyrie Irving
He’s rejoining LeBron in LA. It’s too poetic. It has to happen. They will probably also trade for Kevin Love. 🙂 They are not getting Anthony Davis.
Kawhi Leonard
He’s obviously going to the Clippers. Nothing bold about that prediction. The bold part is, if Davis does get traded, he’s going to the Clips (Gilgeous-Alexander, Gallinari, Harrell and picks).
Before last night, I assumed this would happen. Now, it seems less likely. However, this would repeat the Chris Paul history where everyone thinks he is going to LA…but they didn’t realize it would be the “other” LA team.
Kevin Durant
He’s not going to New York. Typical East Coast media bias. I’m starting to think he stays because I can’t find a home for him. If Kawhi stays in Toronto, I think KD is a Clipper…and Kyrie might join him.
Otherwise, the only home I can find that makes sense for him is little talked about…Dallas. He gets to be the alpha with two young stars in Doncic and Porzingis. He played college in Texas and no state taxes. Seems like a pretty good setup.
Kemba Walker
Notice how all these players begin with K? If you want your kid to make the NBA, give him a K name! OK, I don’t feel super strong about this but it feels like Kemba will take the Knicks money and come home. Since they have room for two players, I’m also giving them…
Boogie Cousins
It seems like such a Knick thing to do. Overpay a big name after striking out on the bigger name targets, hope he’s healthy, and find out he’s not. Actually, this is exactly what the Knicks do (sorry Amare)!
But if he can stay healthy, Kemba + Boogie + their young guys is enough to make the East playoffs and sell tickets at the Garden. However, Kemba + Boogie < Kyrie + KD and it costs the same $ unfortunately.