What’s SnapChat Worth?

Yesterday, Fidelity Investments wrote down their investment in Snapchat.  There was much consternation and rejoicing on Twitter ($TWTR) depending on who you follow.  Fidelity did the responsible thing.  If the big banks would have written down all their loans in 2006-7 instead of continuing to pump them up, the financial crisis might not have been as bad.

Marking to market is a good practice.  Better to mark up extremely conservatively and slowly.  Mark down prudently.  In my own personal portfolio, I only value companies based on actual negotiated term sheets, not on where I think they can raise money.

The “there is a bubble” crowd pointed to the devaluation as evidence there’s a bubble.  Of course, if you talk to Professor Eugene Fama, he will tell you that no human can predict bubbles.  I think his efficient market hypothesis is coming into play when it comes to tech companies going public.

We are seeing a pattern in public markets.  Tech sensation goes public.  Tech sensation gets killed.  Groupon $GRPN, Etsy $ETSY, Twitter $TWTR, Box, $BOX, LinkedIn $LNKD and even Facebook $FB post IPO got crushed. Only Facebook survived.  Here is some recent data on tech stock performance.
BOX Chart

BOX data by YCharts

Square was valued in the private market at almost 2x the price it will IPO at.  Contrast this to the early 2000’s when stocks were undervalued in the private market and would have rocket ship IPOs.

Public markets have the chance to price in all available information about a company immediately. They are “efficient”. Private markets do not.  Private markets are “inefficient”.  Venture capital makes it’s money because it has more information than the market and can arbitrage it over time.

Free markets allocate resources and capital better than hierarchy.  Venture capital is hierarchy.  Ironically, our federal bureaucracy gets in the way of free markets and so entrenched corporations can use hierarchy as a competitive advantage.

Most tech companies raise money every 12-18 months.  At each round, their past performance is analyzed.  But more importantly, their future performance is speculated on.  VCs are under pressure to put money to work in winners-and so when the window opens they value based on expectations for the next round.  This even happens at seed stages to a certain extent.

For example, say you have a software as a service company.  You want to raise a seed round.  VC’s that invest in the SaaS space have metrics that you almost have to hit if you want to raise a Series A.  $1.2M in annual recurring revenue (ARR) is one of them.  Can you get there?

Investors in the current round are speculating that you can hit the mark.  If you can’t, there might be a bridge round and the company will take a slight hit on valuation.  The public markets are undressing the speculation that happened in the private market.  As Warren Buffett has opined, that usually is never pretty.