In a recent post we expressed some skepticism about the suitability of private equity investment for most investors. One reason we said these investments were risky was that it’s very difficult to come up with an accurate price for a smaller private company without a lot of profit or a long track record. Recently I came across an interesting example in Uber, the trendy and fast-growing taxi cab service. Uber puts passengers in touch with cabs via an easy-to-use smartphone app. Since its founding in San Francisco in 2009 the company has spread across the U.S. and the world, disrupting the taxi cab industry. I sometimes use Uber myself in Philadelphia and have always found it reliable and pleasant.
Still a privately owned company, Uber has attracted a lot of attention from venture capital and private equity investors. Based on investments that have been made so far, the implied value of the company is a whopping $17 billion dollars. This is a big number for such a young company that is not yet profitable. To put it in perspective, this is larger than the market capitalization of profitable and well-established companies like Whole Foods (WFM) and Clorox (CLX), and about the same size as Marriott (MAR).
Recently finance professor Aswath Damodaran took on the Uber valuation on his blog. He did a very thorough valuation of his own, walking through each step and using fairly optimistic assumptions along the way. For instance, he notes that while Uber currently gets a cut of 20% from its cab fares, this slice is likely to be eroded by new competition that is already emerging. Damodaran remains optimistic, though, and sticks with that 20% cut for his projections. His valuation, however, produces a value of only $6 billion for the company, implying that Uber is almost 300% overvalued. Uber is a very impressive company, but as Damodaran demostrates, its valuation seems to be a strerch. How does this happen? Here’s how Damodaran puts it:
How would I explain their pricing? I will not try, since I did not pay the price, but it is worth remembering that even smart investors can collectively make big mistakes, especially if they lose perspective. The tech world is a cloistered one, where the leading players (venture capitalists, managers, serial entrepreneurs) immerse themselves in minutiae and know and talk to each other (and often only to each other). Not surprisingly, they develop tunnel vision where technology (or at least their version of it) is the answer to every problem, the status quo is both inefficient and easily disrupted and 50 times revenues is cheap! If history is any guide, tech geeks are just as capable of greed and irrational exuberance as bankers are.